In a landmark judgement on March 4, 2020, (Internet Mobile Association of India v. Reserve Bank of India), the Supreme Court set aside a circular issued by the Reserve Bank of India (“RBI”), which had earlier directed all banks not to deal with persons in transactions involving cryptocurrency (referred to as virtual currencies).

Genesis

On April 5, 2018, RBI issued the Statement on Developmental and Regulatory Policies (“Statement”) which directed entities regulated by RBI

  1. not to deal with or provide services to any individual or business entities dealing with or settling virtual currencies (“VC”), and
  2. to exit the relationship, if they already have one, with such individuals/ business entities, dealing with or settling VCs.

Further, on April 6, 2018, RBI issued a circular (“Circular”) reiterating the directions given in the Statement in exercise of the powers conferred by the Banking Regulation Act, 1949 (“BR Act”), the Reserve Bank of India Act, 1934 (“RBI Act”) and the Payment and Settlement Systems Act, 2007 (“PSS Act”).

Prelude

Writ petitions challenging the Statement and Circular were filed in the Supreme Court. The petitioners were seeking a direction not to restrict/restrain banks and financial institutions regulated by RBI, from providing access to the banking services, to those engaged in transactions in crypto-assets and VCs.

  1. The first writ petition was filed on April 17, 2018, by companies (along with their founders) operating online crypto assets exchange platforms and a few individual VC traders.
  2. The second writ petition was filed on May 22, 2018, IAMAI (Internet and Mobile Association of India), a body representing the interests of online and digital services industry.

Analysis

The Supreme Court examined the following grounds raised by the petitioners specifically while challenging the validity of the Statement and the Circular:

  1. Whether the RBI acted beyond the scope of its power?

The RBI Act, the BR Act and the PSS Act cumulatively recognize and confer extensive powers upon the RBI. Thus, the Supreme Court held that the functions and powers entrusted to the RBI allows it to fix the identity of the nature of VCs (whether they are legal tender or commodities). Further, anything that may pose a threat to, or have an impact on the financial system of the country, can be regulated or prohibited by the RBI, despite the said activity not forming part of the credit system or payment system.

  1. Whether there was an application of mind on the part of the RBI for issuance of Statement and Circular?

The Court observed that based on the host of material, which was taken note of by the RBI while coming up with their reports and the caution/ warnings repeatedly issued by the RBI from June 2013 up to April 2018, it was clear that there was an application of mind on the part of the RBI.

The Court also observed that the RBI had taken into account only those considerations which multinational bodies and regulators of various countries such as FATF, BIS, etc., have taken into account.

  1. Whether the RBI should have followed a wait and watch approach like that of other stakeholders?

The Court held that the RBI could not be faulted for not adopting the very same approach as that of other stakeholders such as:

  • The Enforcement Directorate (which is concerned with money laundering),
  • the Department of Economic Affairs (“DEA”) (which is involved with the economic policies of the State),
  • Securities and Exchange Board of India (“SEBI”) (which is concerned with regulating the securities market) and
  • Central Board of Direct Taxes (“CBDT”) (which is concerned with the tax regime relating to goods and services)

The Court also said that since each of these bodies has a different function to perform, they and are entitled to take a different approach to any issue.

  1. Whether the RBI should have adopted a light-touch approach like the other countries?

The Court observed that while it has studied how VCs have been regulated in other jurisdictions there cannot be a comparison with the approach adopted by countries which have developed economies like UK, US, Japan, Singapore, Australia, New Zealand, Canada etc., which are capable of absorbing greater shocks emanating from prospective tidal fluctuations in the VC value .

  1. Whether the precautionary steps taken by petitioners were enough to address the red flags raised by RBI?

On this issue the Supreme Court  concluded that since they are not the experts in the domain, they cannot determine whether the safety valves put in place by the petitioners (such as avoidance of cash transactions, enhanced KYC norms and confining their services only to persons within India) could have addressed all the issues raised by the RBI.

  1. Whether different types of VCs warrant different treatment?

It was contended that some VCs such as Bitcoin are pseudo-anonymous and banning transactions only in case of fully anonymous VCs  (such as Dash and Monero) could have been a better and less intrusive measure. The Supreme Court concluded that this, again, is for experts to decide and that it would not opine on the same.

  1. Whether acceptance of Distributed Ledger Technology (DLT) and rejection of VCs is a paradox?

It was argued that while DLT has been accepted by various authorities like DEA, SEBI and CBDT, the rejection of VCs by the RBI is actually a contradiction in terms because VCs also emanate from the same technology. The Supreme Court noted that there is nothing irrational about the acceptance of a technological advancement/innovation (DLT), but the rejection of a by-product of such innovation (VCs).

  1. Whether RBI’s decisions qualifies as judicial deference?

The Court delved into the differences between other statutory bodies and the RBI. Post doing that it concluded that while the actions that may be undertaken by statutory bodies (like the RBI) could be on lines similar to those by the executive, it is in fact an independent body. The Court said that the powers conferred upon other authorities under any other statute may be tinkered with, amended or even withdrawn, however the power conferred upon the RBI under Section 3(1) of the RBI Act to maintain the inherent structure of the financial system, cannot be taken away or withdrawn. Therefore, the Court refused to accept the argument that a policy decision taken by the RBI does not warrant any deference.

  1. Whether the issuance of Statement and Circular by RBI is proportionate in light of Article 19(1)(g) of the Indian Constitution?

Article 19(1)(g) of the Indian Constitution provide the right to practice any profession or to carry on any occupation, trade or business to all citizens. The RBI had contended that there is no fundamental right to purchase, sell, transact and/or invest in VCs and that therefore, the petitioners cannot invoke Article 19(1)(g). However, this contention was rejected by the Court as some of the petitioners were claiming a right to provide a platform for facilitating an activity (of trading in VCs between individuals/entities willing buy and sell VCs, which is not yet prohibited by law). Further, the Court observed that the Circular did not prohibit the purchase or sale of VCs per se.

The actual target of the Circular, as seen from various communications and committee reports that preceded it, was the trade in VCs.  However, since this was beyond the domain of the RBI, the Circular purportedly sought to protect only the entities regulated by the RBI, by ring-fencing them.

The Court further observed that in this process, persons who have adversely suffered from the Circular are only those running VC exchanges and not those who trade in VCs.

While coming to the above conclusion, the Court also noted the following observations:

  • During the past 5 years, the RBI has not found any adverse impact emanating from the activities of VC exchanges on the entities regulated by the RBI,
  • The RBI has consistently taken the stand that it has not prohibited VCs in the country, and
  • The Inter-Ministerial Committee constituted on November 02, 2017, which initially recommended the introduction of a new law (Crypto-token Regulation Bill, 2018), was of the opinion that a ban might be an extreme tool and that the same objectives can be achieved through regulatory measures.

The Court opined that while the RBI has very wide powers which can be exercised both in the form of preventive as well as curative measures, while applying the test of proportionality, the impugned measure (in the form of the Circular and the Statement) taken by the RBI was not proportionate.

An interesting aspect of the decision was the Supreme Court’s attempt to address the business harm done to one of the petitioners, Discidium Internet Labs Pvt. Ltd., which ran India’s largest crypto exchange Koinex, by ordering the release of its bank account, to the Company with interest accrued. At the advent of the Circular, many banks had unilaterally frozen accounts of crypto currency exchanges, traders and market participants. It is expected that any other market participants affected in like manner by the Circular can now seek to get their accounts released by the banks.

Epilogue

While VCs were not technically banned before this judgement, however, in effect, the Circular prevented the trade in VCs and the functioning of VC exchanges by disconnecting them from regular banking sector. With this judgement, such a bar has been removed, paving the way for trade and business in VCs.

In the past 48 hours, the RBI has made public statements that it is considering a review before the Supreme Court of the current 3-judge bench order. Further, the Governor of the RBI, Mr. Shaktikanta Das, has stated to BloombergQuint in an interview that “The RBI has decided to set up an exclusive department of fintech to focus on digital transactions and adoption of technology across all aspects of banking and non-banking services”. Having said that, it remains to be seen whether the entities regulated by the RBI would start engaging with VC exchanges right away or await a clear set of guidelines from the RBI, thus pushing the immediate applicability of this judgement into the unforeseen future and whether the RBI and the government of the day would take a favourable view to dealing with VCs going forward.

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