About cryptocurrency

A cryptocurrency or crypto, is a virtual currency which is aptly secured by cryptography. It is designed to work as a medium of exchange, where individual ownership records are stored in a computerized database. The word “cryptocurrency” is procured from the encryption techniques which are used to secure the network. Cryptocurrencies work based on blockchain. Blockchain connotes decentralized technology spread across many computers that manages and records transactions.

In India, at present, cryptocurrency is at the blooming juncture, but it is neither declared illegal nor legal and it is not specifically regulated by any Indian law. In India, the apex financial authority i.e., the Reserve Bank of India, has understood cryptocurrency as a form of digital/ virtual currency generated through a series of written computer codes that rely on cryptography which is encryption and is thus independent of any central issuing authority per se[1].

Flip-flop and uncertainty around cryptocurrency in India

In 2018, the Finance Ministry released a statement saying:

“The Government does not consider Cryptocurrencies as Legal Tender or Coin and will take all measures to eliminate the use of these Crypto Assets in Financing Illegitimate Activities or a Part of the Payment System. The Government will explore the use of Blockchain technology proactively for assuring in Digital Economy.” [2]

Thereafter, on 6^th April 2018, the Reserve Bank of India vide its Circular No. RBI/2017-18/154 DBR.No.BP.BC.104 /08.13.102/2017-18[3] prohibited all entities governed by it to stop offering any kind of service to the entities associated with virtual currencies. In 2018, Crypto Token and Crypto Asset (Banning, Control and Regulation) Bill, 2018 was introduced to control cryptocurrency market. The main highlights of the bill included prohibition of dealers of crypto tokens to be sold as securities or investment schemes as there is gap in regulatory framework and a register was required to be maintained of all the transactions on the recognized exchanges.

In July 2019, a high-level Inter-Ministerial Committee, constituted by the Government of India in 2017 to report on various issues pertaining to use of virtual currency, submitted its report recommending a blanket ban on private cryptocurrencies in India. Thereafter, in 2019, Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 was introduced. The bill envisaged banning of crypto currencies to be used as a medium of exchange, as a payment system, for providing cryptocurrency related services, for trading with Indian or foreign currency, for raising funds, for investments.

However, the circumstances prevailing around cryptocurrencies and their usage completely changed on 4^th March 2020, when the Hon’ble Supreme Court of India in the case of Internet and Mobile Association of India v Reserve Bank of India[4], struck down the Reserve Bank of India’s Circular that had effectively imposed a ban on virtual currency trading in India.

In 2021, it was divulged by the Government of India that it will introduce a new bill on cryptocurrencies, i.e. The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021. The Bill aims to create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India. The Bill also seeks to prohibit all private cryptocurrencies in India; however, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses. Further, there are speculations that Government of India is likely to set up a panel of experts to study the possibility of regulating crypto.

Of lately, Reserve Bank of India vide its Circular No. RBI/2021-22/45 DOR. AML.REC 18 /14.01.001/2021-22 dated 31^st May, 2021[5] has clarified that circular issued by Reserve Bank of India in 2018 is no longer valid from the date of the Supreme Court judgement, and therefore cannot be relied upon. Further, it was stated by Reserve Bank of India that banks/other entities dealing in virtual currencies may continue to carry out customer due diligence processes in consonance with regulations governing standards for Know Your Customer (KYC), Anti-Money Laundering (AML), Combating of Financing of Terrorism (CFT) and obligations of regulated entities under Prevention of Money Laundering Act, (PMLA), 2002 in addition to ensuring compliance with relevant provisions under Foreign Exchange Management Act (FEMA) for overseas remittances.

Pros and cons of cryptocurrency

Just like any other technology, cryptocurrency has its pros and cons. Pros of using cryptocurrencies includes relaxations pertaining to the fund transfer, no dependency on a third party while making payments, cryptocurrency systems come with a user “wallet” or account address which is accessible only by a public key and private key. The private key is only known to the owner of the wallet. Cons includes almost hidden nature of cryptocurrency transactions makes them easy to be the focus of illegal activities such as money laundering, tax-evasion and possibly even terror-financing[6].

Functioning of cryptocurrency

The following entities are involved in trading of cryptocurrency:

1.) Crypto Miner who creates cryptocurrency, such as Bitcon, Ethereum, Ripple, Litecoin, Dogicoin, etc.

2.) Crypto Exchange is a market intermediary and broker which provides trading platform for sale-purchase of cryptocurrency, such as WazirX, Coinx, etc. Crypto exchange is similar to trading platform of NSE, BSE, MCX, etc. providing trading platform for shares, mutual funds, currency and commodity.

3.) Digital Wallet which provides digital storage for cryptocurrency similar to depositories in India such as NSDL and CDSL.

4.) Smart Token Fund (STF) Traders similar to stock brokers.

5.) Payment Processor for settlement of payments. While payments of trades executed within same country and same currency are settled through normal banking channel, on the contrary, payments of trades executed in multiple jurisdictions and/or in multiple currency are settled through Peer-to-Peer (P2P) exchange of cryptocurrency without involving any bank or financial institution.

For example, transaction in INR by an Indian resident with another Indian resident is settled by way of exchange of real money/ fiat currency between buyer and seller (non-P2P transaction). However, transaction involving more than one currency where buyer and seller are in different countries involves settlement through P2P transaction. In WazirX, non-P2P transaction is carried out by WazirX (Zanmai Labs Pvt. Ltd.) but P2P transaction is carried out by its holding company, Binance Holdings Ltd. (a company headquartered in Malta and based out of China).

Cryptocurrency outside India

Legality of cryptocurrencies varies from country to country. For instance, cryptocurrency exchanges are legal in the United States and fall under the regulatory scope of the Bank Secrecy Act (BSA). In UK, cryptocurrencies are considered as a property instead of a legal tender since UK has no specific cryptocurrency laws. Further, from 10^th January 2021, all UK crypto asset firms (including recognized cryptocurrency exchanges, advisers, investment managers, and professionals) that have a presence or market product in UK, or that provide services to UK resident clients, are mandated to register with the Financial Conduct Authority (FCA). Apart from this, entities engaging in activities involving crypto assets must also comply with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs).

Cryptocurrency in India – Legal Issues

The following legal issues need attention of the regulators, entities and investors involved in trading of cryptocurrencies in India:

1.) Foreign Exchange Management Act

Cryptocurrency is not a legal tender in India and is therefore not an Indian currency. However, in many countries (e.g. USA, Canada, Australia, European Union, etc.), many companies (e.g. Dish Network, Microsoft stores, Subway, etc.) have started accepting payment in the form of cryptocurrency for sale of their products in exchange. Due to its acceptability in many countries for payment of goods and services, cryptocurrency may be termed as virtual foreign currency for an Indian resident. On the contrary, in some countries, cryptocurrency is considered as asset or commodity. In our view, trading in cryptocurrency is akin to binary trade which is not permissible in India. Even otherwise, any transaction of cryptocurrency between the person resident in India and the person resident outside India will have implications under the Foreign Exchange Management Act 1999 and rules thereunder.

In general, cryptocurrency is not backed by any business or valuable asset and its prices are determined purely on the basis of demand-supply principle and that is why, we see huge fluctuation in the prices of cryptocurrency. Therefore, transactions in cryptocurrency can be considered as speculative in nature which is prohibited as per Schedule I of the FEMA (Current Account Transactions) Rules 2000.

In case cryptocurrency is considered as virtual foreign currency in view of its acceptability in many countries for payment of goods & services, transactions in cryptocurrency will be regulated by FEMA (Permissible Capital Account Transactions) Regulations 2002. There is a limit of USD 2000 for retention of foreign currency notes by an Indian resident as per the Foreign Exchange Management (Possession and Retention of Foreign Currency) Regulations, 2015.

In case cryptocurrency is considered as asset or commodity, transactions in cryptocurrency will be regulated by FEMA (Export of Goods & Services) Regulations 2015. It means, the buyers and sellers of cryptocurrency are doing export-import of cryptocurrency in digital form but may be without complying with export-import rules including requirement to have importer-exporter code (IEC) and without payment of any custom duty.

Assuming that transaction in cryptocurrency by an Indian resident is covered under the Liberalised Remittance Scheme (upto USD 2,50,000), such persons may not be complying with the provisions of this Scheme which includes filing of Form A-2 with RBI through Authorised Dealer.

2.) Income Tax Act and Black Money Act – In case of remittance under the Liberalised Remittance Scheme, as per Section 206C of the Income Tax Act 1961, TCS @ 5% needs to be collected by Authorised Dealer at the time of collection of payment. Further, cryptocurrency (whether virtual foreign currency, asset or commodity) should be disclosed in the Income Tax Return, otherwise it may have implications under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

3.) Money Laundering – Cryptocurrency can be used for conversion of black money into legal money similar to trading in penny stocks. Cryptocurrency can be transferred from one digital wallet to another digital wallet which are in different jurisdictions and these transactions will not be reported to any regulators. As per media reports, many criminals and hackers have started blackmailing and extortion by demanding payments in the form of cryptocurrency.

Conclusion

Considering the legal issues and threat of tax evasion, money laundering, cyber-attack and terrorism, cryptocurrency may be completely banned in India. Considering number of Indian investors dealing in cryptocurrency and amount invested by them, the Government of India should take immediate action to clarify its position on cryptocurrency, and till then, a regulatory framework for registration, reporting and record keeping by the persons/ entities involved in dealing of cryptocurrency should be implemented to balance the fundamental right guaranteed under Article 19 of the Constitution of India vis-à-vis safety, security and sovereignty of India.

[1] https://www.legal500.com/developments/thought-leadership/the-legality-of-cryptocurrency-in-india/#:~:text=The%20Indian%20government%20is%20now,certain%20exceptions%20to%20promote%20the

[2] https://economictimes.indiatimes.com/markets/forex/forex-news/are-your-crypto-investments-legal-heres-everything-you-need-to-know/articleshow/82259869.cms

[3] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF

[4] 2020 SCC Online SC 275

[5] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45VIRTUALCURRENCIES37FE644EF97F4A36AAB951C73A411E96.PDF

[6] https://byjus.com/current-affairs/cryptocurrency/