RBI’s circular banning cryptocurrency set aside on the grounds of proportionality under Article 19(1)(g) of the Constitution of India April 28, 2020
Published in: Between The Lines
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The Supreme Court of India in the case of Internet and Mobile Association of India v. Reserve Bank of India (decided as per order dated March 04, 2020) has held that the Reserve Bank of India (“RBI”) circular dated April 06, 2018, virtually banning cryptocurrencies and their trade in India, is violative of Article 19(1)(g) of the Constitution of India, 1950 (“Constitution of India”)
Cryptocurrencies and Blockchain technologies are one of the most profound and intelligible innovations of the 21st century, which in the long term have a potential to allow economies to detach themselves from governments, and herald an era of “trust-less” money. Cryptocurrencies although often seen from the myopic standpoint of Bitcoin as a currency or an alternative to money, is in reality a dyson sphere of possibilities. Take for example, Ethereum, another cryptocurrency with the highest market capital after Bitcoin, is a decentralized software platform that enables Smart Contracts and Decentralized Applications (DApps) to be built and run without any downtime, fraud, control, or interference from a third party. The applications on Ethereum are run on its platformspecific cryptographic token, ether. Essentially, the cryptocurrency Ethereum may one day allow a trader sitting in China to automatically purchase a certain amount of goods at price X, when the given price hits the limit price. What separates cryptocurrency from any other market allowing for such trade is that there is no central governing authority whatsoever, thereby eliminating the middleman.
Technology and innovation are major changes that often face opposition and ostracization from the incumbents, which in this case came in the form of RBI circulars dated April 05, 2018 and April 06, 2018 in exercise of the powers conferred by Section 35A read with Section 36(1)(a) and Section 56 of the Banking Regulation Act, 1949 and Section 45JA and 45L of the Reserve Bank of India Act, 1934 (“RBI Act”) and Section 10(2) read with Section 18 of the Payment and Settlement Systems Act, 2007, directing the entities regulated by RBI (i) not to deal in virtual currencies nor to provide services for facilitating any person or entity in dealing with or settling virtual currencies; and (ii) to exit the relationship with such persons or entities, if they were already providing such services to them.
The RBI took its first anti-cryptocurrency stance in the year 2013, when they issued a press release cautioning the public about the potential threats of cryptocurrency because of it lacking any authorisation from a central bank or monetary authority. Over the years, RBI and its research divisions had held via various reports that although in its nascent stage, cryptocurrency poses a major threat in terms of risk, volatility, and difficulty in tracking transactions thereby, paving the way for money laundering and illegal activities.
On February 01, 2017, RBI again issued a press release cautioning users, holders and traders of virtual currencies. This was followed by a carte blanche ban via the impugned circulars.
Arguments of the Petitioner
The arguments of the Petitioner can be summarized as follows:
Arguments of the Respondent
Observations of the Court
The Supreme Court’s inquiry into the validity of the circular revolved around two major questions:
The role of RBI
The Supreme Court observed that as the Preamble of the RBI Act suggests, the object of constitution of RBI was threefold namely (i) regulating the issue of bank notes; (ii) keeping of reserves with a view to securing monetary stability in the country; and (iii) operating the currency and credit system of the country to its advantage.
The object of establishment of RBI is also spelt out in Section 3(1) of the RBI Act. It says that “a bank to be called the Reserve Bank of India shall be constituted for the purpose of taking over the management of the currency from the Central Government and of carrying on the business of banking in accordance with the provisions of this Act”.
While examining the ambit of Section 45JA(1) of the RBI Act, the Supreme Court observed that the concerns sought to be addressed by Section 45JA(1) are: (i) public interest; (ii) financial system of the country; (iii) interests of the depositors; and (iv) interests of NBFCs.
A careful scan of the RBI Act in its entirety would show that the operation/regulation of the credit/financial system of the country to its advantage, is a thread that connects all the provisions which confer powers upon the RBI, both to determine policy and to issue directions.
Section 35A of Banking Regulation Act, 1949 empowers RBI to issue directions to banking companies. Such directions are binding on the banking companies. The directions under Section 35A may be issued (i) in public interest; (ii) in the interest of banking policy; (iii) to prevent the affairs of the banking company from being conducted in a manner prejudicial to the interests of the depositors or of the banking company itself; and (iv) to secure the proper management of the banking company.
On the issues of payment systems under the Payments and Settlement Systems Act, 2007 the Supreme Court observed that Section 17 empowers RBI to issue directions to a payment system or a system participant, which, in RBI’s opinion is engaging in any act that is likely to result in systemic risk being inadequately controlled or is likely to affect the payment system, the monetary policy or the credit policy of the country.
Finding the identity of Cryptocurrencies/ VCs
It was observed that the difficulty in regulating and defining VCs was that they neither completely fit in the definition of a commodity, nor widely accepted enough to be considered a currency. The Supreme Court dwelled in depth on the origins of cryptocurrency and its purpose. According to an International Monetary Fund Report, it was observed that there are four factors which lie behind the rise of crypto currencies, they are:
The petitioner and RBI both agreed on one point, which is, VCs do not hold the status of legal tender, but RBI justified its decision of banning them on the grounds that VCs are capable of being used as a medium of exchange.
After examining the definitions given by various committees and countries all over the globe, the Supreme Court observed that there is unanimity of opinion among all the regulators and the governments of various countries that though virtual currencies have not acquired the status of a legal tender, they nevertheless constitute digital representations of value and that they are capable of functioning as: (i) a medium of exchange and/ or; (ii) a unit of account and/or; (iii) a store of value.
An important observation made by the Supreme Court on this comparative analysis was that “It is clear from the above that the governments and money market regulators throughout the world have come to terms with the reality that virtual currencies are capable of being used as real money, but all of them have gone into the denial mode (like the proverbial cat closing its eyes and thinking that there is complete darkness) by claiming that VCs do not have the status of a legal tender, as they are not backed by a central authority. But what an article of merchandise is capable of functioning as, is different from how it is recognized in law to be. It is as much true that VCs are not recognized as legal tender, as it is true that they are capable of performing some or most of the functions of real currency.”
The Supreme Court opined that it is incorrect to state that RBI’s role and power can come into play only if something has actually acquired the status of a legal tender, and that for RBI to invoke its power, something should have all the four characteristics or functions of money.
In a landmark decision of the United States District Court of New York in the case of United States v. Ulbricht [31F. Supp. 3d 540 (2014)], it was held that “Bitcoins carry value-that is their purpose and function-and act as a medium of exchange. Bitcoins may be exchanged for legal tender, be it US dollars, euros or some other currency”.
In another decision of the same court in the case of United States v. Faiella [39F. Supp. 3d 544 (2014)], it was held that “bitcoin clearly qualifies as money or funds under the plain meaning definitions. Bitcoin can be easily purchased in exchange for ordinary currency, acts as a denominator of value and is used to conduct financial transactions.”
Interestingly, several matters before the Commodity Futures Trading Commission held VCs to be “commodities”, in relation to public administrative hearings to determine whether the defendant was engaged in violation of the provisions of Commodity Exchange Act.
In a completely different context, the Singapore International Commercial Court ruled in B2C2 Limited v. Quoine Pte Limited [(2019) SGHC (I) 3] that virtual currency can be considered as property which is capable of being held on trust.
Test of proportionality
With regards to the test of Article 19(1)(g) of the Constitution of India, the Supreme Court observed that in Modern Dental College and Research Centre v. State of Madhya Pradesh [(2016) 7 SCC 353)], four tests were laid down in respect of the test of proportionality: (i) that the measure is designated for a proper purpose; (ii) that the measures are rationally connected to the fulfillment of the purpose; (iii) that there are no alternative less invasive measures; and (iv) that there is a proper relation between the importance of achieving the aim and the importance of limiting the right.
The affected parties in this case are the VC exchanges that are unable to trade due to ban on banking services. The court heavily relied upon the European Union Parliament’s view that it is not necessary to impose a total ban on cryptocurrencies/ VCs related business and the formal finance sector, and regulatory methods can be relied on.
Finally, the Supreme Court observed the following points on the grounds of proportionality:
Decision of the Supreme Court
On the basis of analyzing the nature of powers conferred upon the RBI and the treatment of cryptocurrencies in various jurisdictions around the world, the Supreme Court held that if an intangible property can act under certain circumstances as money (even without faking a currency) then RBI can definitely regulate it. Hence, it is not possible to accept the contention of the petitioners that they are carrying on an activity over which RBI has no power statutorily.
The Supreme Court further went on to hold that the RBI has been correct in exercising its powers under the Payments and Settlement Systems Act, 2007 and did not find the RBI guilty of non-application of mind, as it had arrived at a “satisfaction” under Section 35A(1) of the Banking Regulation Act after years of consideration.
The expression “banking policy” is defined in Section 5(ca) to mean any policy specified by RBI: (i) in the interest of the banking system; (ii) in the interest of monetary stability; and (iii) sound economic growth. Public interest permeates all these three areas. Thus, the contention that the exercise of powers by RBI in respect of VCs is a colourable exercise of power and it is vitiated by malice in law was rejected by the Supreme Court.
The Supreme Court also rejected the contention that different VCs require different levels of regulation, as they fall under separate categories and have different levels of anonymity.
On the test of proportionality, the Supreme Court observed that although VCs are not banned till date, the functioning of VC exchanges has been crippled by the impugned circulars, especially when RBI did not find anything wrong with their functioning. Till date, no entity regulated by the RBI has faced any loss or adverse effect directly or indirectly on account of VC exchanges. The impugned circular dated April 06, 2018being the statutory direction was accordingly set aside on the grounds of proportionality.
Vaish Associates Advocates View
This judgement ushers a new era in the economic and financial domain of India. Cryptocurrencies are not a result of a science experiment gone wrong, or like the internet, was not setup for military purposes. The need for cryptocurrencies arose due to various central banking institutions and middlemen violating the trust of the masses since time immemorial.
The 2008 mortgage crisis is a stellar example of the misuse of trust reposed in the banking systems, the burden of which was borne by individuals all over the world. This crisis was also the tipping point, and fortunately the technology of our times allowed for the innovation of something so radical, without the limitations, its predecessors had in the past. Any sufficiently advanced technology is indistinguishable from magic. That is truly the case with cryptocurrencies, as the technology and its potential was not completely understood by the RBI, and like most cases in our country, banning was the easier option.
The Supreme Court although rejected most of the contentions of the petitioners, they were able to see through the conundrum of the RBI in banning exchanges but not the trade, without proof of any damage caused to institutions under the domain of the RBI.
The Supreme Court considered an exhaustive list of opinions made by committees of other jurisdictions, and held that there are various regulatory alternatives to banning, which could have been considered by the RBI.
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