What the top court’s order means for virtual currencies

The Supreme Court of India ruled that the Reserve Bank of India (RBI) has the authority to regulate virtual currencies but found its decision to ban regulated entities from providing services to virtual currency exchanges disproportionate. The ruling clears the way for RBI to issue specific regulations on cryptocurrencies, likely more stringent than those in other countries, recognizing the potential stronger adverse effects on India’s developing economy.

This article was first published in The Mint. You can read the original at this link.

Nearly two years ago, the Reserve Bank of India (RBI) prohibited banks and all the other entities that it regulated from providing services to anyone who deals with or settles virtual currencies. At the time, I wrote in this column that this step was not only deeply misguided, it was wholly unwarranted.

I argued that while virtual currencies do permit the anonymous transfer of funds—a feature that terrorist and other illegal outfits may use to their advantage rather than simply banning access to these currencies entirely—law enforcement agencies would do far better to focus on improving their forensic abilities so that they could cut through the shield of anonymity and identify the criminals who use the technology for nefarious purposes. I pointed out that prohibiting a service rarely halts its use, as the only people who abide by the terms of a ban are those who use the service for legitimate purposes. Those who do not just take their illegal activities deeper underground.

Two weeks ago, the Supreme Court, after having heard arguments against the RBI ban on virtual currencies, delivered its judgement in the case of Internet And Mobile Association of India v. Reserve Bank of India. To begin with, the Supreme Court clarified that RBI had the authority to regulate virtual currencies. After analysing regulations and judicial decisions from around the world, the court pointed out that even though virtual currencies are generally not recognized as legal tender, they are capable of performing almost all the functions of money. Since RBI has the power to regulate instruments that operate as “valid discharge” (or the creation) of a debt between persons, it certainly has the statutory authority to regulate virtual currencies. By the same token, RBI is acting well within its mandate in framing policies and issuing directions to regulated entities with respect to payment transactions that involve virtual currencies.

Interestingly, when it was pointed out to the Supreme Court that countries such as the UK, US, Japan, Singapore, Australia, New Zealand, Canada, etc., have adopted a light touch approach while regulating virtual currencies, the court made it clear that it was not going to test the correctness of the measures taken by RBI on the basis of regulations in developed countries, as their economies were capable of absorbing greater shocks than India.

However, when it came to whether RBI’s decision to ban regulated entities from providing services to virtual currency exchanges was proportionate or not, the court said it did not believe that the actions of RBI met the standards of proportionality expected of a statutory authority.

The decision of RBI did nothing to halt trading in virtual currencies in the first place. As long as virtual currencies were not converted into Indian currency, there was no real or implicit restriction on their continued existence. For instance, persons who provide services in exchange for virtual currencies were not prohibited from continuing to do so. It is only those who were engaged in the business of exchanging virtual currencies for Indian rupees that were affected by the RBI restriction.

With regard to these entities that found themselves without any means to conduct their business, the Supreme Court pointed out that access to banking channels was the lifeblood of any venture. Accordingly, RBI should have demonstrated that the larger public interest warranted the imposition of such an extreme measure before imposing the ban. It needed to show that the prohibition was rationally connected to the fulfilment of a specific purpose, that there were no alternative, less invasive measures, and that there was a proper relation between the importance of achieving the aim and the importance of limiting the right. It could not claim that virtual currencies should be banned simply because they made space for money-laundering to take place and black money to exist. Instead, it needed to show that had the ban not been imposed, the ability of RBI-regulated entities to function would have been seriously compromised.

In fact, RBI was unable to show that the existence of virtual currency exchanges had adversely impacted the ability of RBI- regulated entities to function at any time in the previous five years. The court made it clear that while it does have the wide power to take preventive measures, RBI should, in exercising this power, demonstrate the existence of at least some semblance of damage suffered by the entities it regulates. In the absence of any such evidence, RBI’s decision was not proportionate and liable to be struck down.

What does the Supreme Court ruling mean for cryptocurrencies in India?

It is clear from the judgement—if it wasn’t before—that RBI has every right to regulate cryptocurrencies. Thus, even if the ban it had imposed has gone away, the apex court’s decision has cleared the way for RBI to issue specific regulations on bitcoin and other cryptocurrencies, and we should expect specific regulations to be issued that govern both virtual currency exchanges as well as the provision of services in exchange for virtual currency.

More importantly, these regulations are likely to be more stringent than those adopted by other countries, as the court has recognized that for a developing economy, more stringent restrictions are probably appropriate, given that the adverse effects could be stronger.