Crypto Currency And Its Legal Implications

Bitcoins have captured the imagination of some, struck fear among others, and confused the heck out of many of us.

Tom Carper, U.S Senator

What is crypto currency?

Digital Currency/ Virtual Currency (“VC”)/ mathematical currency is ‘issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community[1], and relies on cryptography for its creation and management. It is called, the “Internet of Money” by crypto expert Andreas Antonopoulos, virtual currencies are an inherent enabler of public blockchain technology.

• An open-source software (can be reviewed by anyone)
• Peer-to- peer, decentralized (no central authority/bank acting as an intermediary), private digital payment system
• Total supply of such a currency is predictable and limited
• Electronic form of currency not backed by any real estate, coins or precious metals
• Their supply is based on an algorithm
• Their price relative to other currencies is determined by supply and demand
• Lost or stolen VCs are gone forever. Users can hold them in the form of wallets or convert them into cash. The wallet is the value of the VC which means if you lose the wallet, you will lose the money. Since there is no central database, you cannot retrieve the data. There are more than six million wallets in the world. Each currency has its own wallet with unique features
• Each wallet has its own numbering and password, whose confidentiality is the responsibility of its owner, just like any login and password. All system participants can check how many Bitcoins or fractions of Bitcoin are present in each system wallet in the whole system, but there is no way to know for sure who owns each wallet, since only their wallet number is accessible
• Relies on the principle of cryptography (process of converting a plain text into an unintelligible text and vice versa, storing and transmitting data in a particular form so only those for whom it is intended can read and process it and concerns with confidentiality, authentication, non-repudiation, integrity of the information)
• Each VC and each user is encrypted with a unique identity (A public and Private Key)
• Each transaction is coded in a decentralized public ledger (blockchain) that is visible to all computers on the network but does not reveal any personal information about the parties involved
• Blockchain records every transaction ever processed and allows users to verify validity of the transaction
• The transactions are irreversible
• There are over 20 other crypto currencies which exist today. Most of them came after bitcoin, even though bitcoin was precisely not the first. The list includes Litecoin, Peercoin, Primecoin, Ripple, Quark, and more. However, bitcoin is the only one which has created any kind of buzz, including in developing countries like India, first introduced officially in the form of ‘Bitcoin’ by pseudonymous developer Satoshi Nakamoto in 2009
• In the year 2009 when it was first introduced into the market, the value was trading at $ 0.0003, by the end of 2017, the value touched $17900. At present, the value is trading somewhere at $6000 or a bit higher
• The user is, at the same time, the owner, custodian and creator of the Financial instrument, a situation that has not yet been observed in large scale cross-border transactions

How to buy/obtain VC?

1.  Mining

• Reward for processing transactions/ securing networks
• The supply of the crypto currency is decentralized – it can only be increased by a process known as “mining”. For each bitcoin transaction, a computer owned by a bitcoin “miner” must solve a difficult mathematical problem. The miner then receives a fraction of a bitcoin as a reward
• A record of each transaction, using anonymized strings of numbers to identify it, is stored on a huge public ledger known as a blockchain. This acts to ensure the integrity of the currency
• If a person tries to perform a transaction with information that has not been incorporated in the Blockchain and that does not match the registries performed in the Blockchain (such as stating that one wallet has more bitcoins than it actually has), the miners will not be able to incorporate such a transaction in their blocks, guaranteeing the integrity of the system

2. In exchange of sale of goods and services.

3. Purchase at the exchange.

 Pros & Cons

 Advantages (Pros)

• Effective and efficient medium of exchange
• Lower transaction costs
• Increased privacy in dealings (also a growing concern in terms of untraceability of transactions.)
• It avoids the double spending dilemma. This dilemma is explained by Fernando Ulrich (2010, page 200) in the following terms: before the creation and dissemination of virtual currencies, online transactions required the direct intervention of a third party who acted as an intermediary in transactions given that virtual goods could be reproduced infinitely. In such a situation, the same virtual money could be presented to two different persons and perform two valid payments
• With the possibility of failures in this or even the need for changes, any member of the system can suggest requisite changes. Each of the other members may vote on such changes that will be implemented if more than half of the votes of the entire system agree to such a decision. Thus it gives extreme flexibility to the Bitcoin system and opens space for its improvement and evolution in a democratic way
• A system that feeds itself based on the active work of its members and a monetary unit that is not created and issued according to the need and subjective view of each country, but rather with a mathematical logic.

 Disadvantages (Cons)

• There is high volatility in the prices of bitcoins, oft quotes as a bubble ready to burst, similarities drawn with the Dutch Tulip Mania
• Uncertain security from theft, frauds, money laundering, tax evasion, drug trafficking, terrorist financing. For instance, The Silk Road, online black market was shut down by the U.S. FBI and 1,44,000 bitcoins were seized worth US$28.5 million
• Long term deflationary bias, encouraging hording of bitcoins
•  It is not a legal tender at the end of the day, doesn’t have intrinsic value.
• Glitches of traffic load

Is it Legal in India?

India ranks amongst the top 30 Bitcoin using countries. Indian Bitcoin software downloads in the recent times has been double the average rate of growth in Bitcoin downloads registered by the other thirty countries. Currently crypto/virtual currencies and ICO’s (Initial Coin Offerings) remain unregulated in India. The Government is yet to finalize a regulatory mechanism so as to govern and regulate crypto/virtual currencies. It began with the RBI coming out with a circular, restraining banks, NBFCs and payment system providers from dealing with virtual currencies and providing services to virtual currency exchanges. This resulted in crypto exchange platforms filing a writ petition in the Supreme Court; the ban was ultimately struck down in the case of Internet and Mobile Association of India v. Reserve Bank of India, where the Supreme Court declared the RBI circular unconstitutional. 

The Supreme Court of India had issued notice[2] to the Ministry of Finance, Law and Justice, Information Technology, market regulators Securities and Exchange Board of India and the Reserve Bank of India after hearing a Public Interest Litigation (Writ Petition (Civil) no.1076 of 2017) under Article 32 of the Constitution against the Union of India filed by Adv. Dwaipayan Bhowmick (hereinafter referred to as “Petitioner”) seeking a regulatory framework to be laid down on Crypto Currency and wanted that the virtual currency be made accountable to the exchequer.

• RBI vide its Press Release Dated February 1, 2017, clearly stated that it has not given any license/authorization to any entity/company to operate such schemes or deal with any VCs. RBI also added, that the user, holder, investor, trader, etc. dealing with VCs will be doing so at their own risk.
• RBI vide its notification issued on April 6, 2018, prohibited financial institutions from dealing in virtual currencies such as bitcoin or providing services to facilitate any person or entity in dealing with or settling virtual currencies. The RBI’s move now means that incorporated technology platforms dealing with virtual currency will be cut off from the financial system and will not be able to operate bank accounts or deal with any financial institutions regulated by the RBI. Regulated entities which already provide such services shall exit the relationship within three months of the said notification.  This may have same effect of indirectly banning an organized crypto currency sector in India.
• The Delhi High Court has issued a notice to the Reserve Bank of India after an appeal was filed to scrap a notification that barred banks from supporting bitcoin related transactions. This case is pending. Similar petitions lie in Supreme Court.
• India is not a new candidate in the list of countries banning Bitcoin or other cryptocurrencies. It is, in fact, the 8th country to do so. However, the investment in bitcoins has not gone unnoticed as the Government continues to take measures to not let such investments go tax-free.
• The latest amendment to Schedule III of the Companies Act, 2013 issued on March 24th 2021 states that from the new financial year, all companies will be required to disclose their investments in cryptocurrencies and also state any profit or loss involved in the transaction. The holder of any virtual currencies will also have to declare the number of holdings, details of deposit and advances from any person for the purpose of trading or investing in cryptocurrency. 
• The Indian finance minister in the Union Budget 2022 announced that “any income from transfer of any virtual digital asset shall be taxed at the rate of 30 per cent.” Further, tax deduction at source at the rate of 1% has been proposed for transactions involving cryptocurrency. The minister also stated that taxation of a virtual digital asset does not imply the legal recognition of cryptocurrencies.  
• The Indian Computer Emergency Response Team (CERT-In) on April 28th 2022 issued Directions under subsection (6) of section 70B of the Information Technology Act, 2000 relating to information security practices, procedures, prevention, response and reporting of cyber incidents for Safe & Trusted Internet (Cyber Security Directions of 28.04.2022). 
• As per Cyber Security Directions of 28.04.2022, the virtual asset service providers, virtual asset exchange providers and custodian wallet providers shall mandatorily maintain all information obtained as part of Know Your Customer (KYC). It shall also maintain records of financial transactions for a period of five (5) years to ensure cyber security in the area of payments and financial markets for citizens while protecting their data, fundamental rights and economic freedom in view of the growth of virtual assets. If companies in the cryptocurrency sector have to maintain data for 5 years, it means such companies will need to exist for a further minimum period of five years. This in turn reveals the government’s position of permitting cryptocurrencies and service providers of such currencies to exist. 
• Entries 36 and 46 of List I of the Seventh Schedule of the Constitution state that the Central Government is allowed to legislate in respect of currency, coinage, legal tender, foreign exchange and bills of exchange, cheques, promissory notes and other like instruments respectively.
• The Supreme Court has recognized that in matters relating to economic policy, courts must not interfere unless arbitrariness is writ large in the decision-making process. Even in cases where intervention of the court is justified, the court would only examine the decision-making process and not the decision itself.

Laws concerning Crypto

1. The Constitution of India, 1950;
2. The Foreign Exchange Management Act, 1999 (“FEMA”);
3. The Reserve Bank of India Act, 1934 (“RBI Act”);
4. The Coinage Act, 1906 (“Coinage Act”;
5. The Securities Contracts (Regulation) Act, 1956 (“SCRA”);
6.  The Sale of Goods Act, 1930 (“Sale of Goods Act”); and
7. The Payment and Settlement Systems Act, 2007 (“Payment Act”).
8. Indian Contract Act, 1872 (“Contract Act”)
9. Information Technology Act,2000
10. The income Tax Act, 1961 (VC may be treated as capital assets under section 2 (14)6 of the Income Tax Act, 1961, which talks about properties and securities held by an assessee. Further, any profit or gain arising from the transfer and sale of an asset, i.e., Bitcoin, may be treated as income or capital gain under the Income Tax Act, thereby making it taxable.)

• ‘Currency’ has been defined under FEMA to include, ‘all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank’. FEMA defines ‘foreign currency’ as any currency other than Indian currency. Definition of ‘Indian Currency’ under FEMA states that Indian currency is the currency which is expressed or drawn in Indian Rupees. The definition excludes special bank notes and special one rupee issued under section 28A of the RBI Act
• The term currency notes are specifically defined in Section 2(i) of FEMA to mean and include cash in the form of coins and bank notes. This definition therefore does not cover Bitcoin which are not issued either under the Coinage Act or RBI Act. S. 22 of the RBI Act provides that RBI has the sole right to issue bank notes and S. 26 provides that bank notes shall be legal tender in India. From the above it appears that while Bitcoin have several features of a currency or legal tender it is not bank notes and is consequently not legal tender in India
• Similar petitions lie in Supreme Court in respect of the.maxim ‘expresses um facit cessare tacitum’. The maxim represents the principle ‘when there is express mention of certain things, then anything not mentioned is excluded’. The maxim has been recognized by Indian courts and was also relied upon by the Supreme Court in Shankara Rao Badam & Ors. v. State of Mysore & Anr. and Union of India & Anr. v. Tulsiram Patel. In light of the provisions of the law, it can be reasonably concluded that ‘virtual currency’ should be considered excluded from the definition of currency. While it may be argued that it may fall under ‘such other similar instruments’ under Section 2(h), but such ‘other instruments’ need to be specifically notified by the RBI which is not the case. There is no such declaration in respect of cryptocurrencies in general or Bitcoin in particular. RBI has merely advised the public to be cautious regarding the trading of virtual currencies. Therefore, under the provisions of existing law, Bitcoins are not currency.

 Could Virtual Currency be classified as “goods”?

Article 366(12) of the Constitution of India defines – “goods include all materials, commodities, and articles”.

• Sale of Goods Act, 1930: “Goods” means every kind of movable property other than actionable claims and money; and includes stocks and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale [Section 2 clause (7)]
• Bitcoins are listed and traded on stock exchanges in various jurisdictions around the world. Some examples are (i) Mt. Gox in Japan (previously one of the most widely exchanges); (ii) BTC China; (iii) BitBox in the United States;(iv) Bitcurex in Poland and (v) Bitsamp in Slovenia. Although there is no formal Bitcoin exchange in India at present there are numerous websites through which Bitcoin can be bought and sold. At present, as many as 23,000 Indians possess e-wallets where their digital currency is stored.112 Bitcoin wallets keep a secret piece of data called a “private key” for each Bitcoin address.
• If we were to assume that Bitcoins are goods that does not cease it to be money and hence the exclusion from definition of goods. (Reliance on Imperial Tobacco Co. v. IRC 25 TC 292 (CA))
• In Tata Consultancy Services v. State of Andhra Pradesh, the Supreme Court stated that, “computer software is intellectual property, whether it is conveyed in diskettes, floppy, magnetic tapes or CD ROMs, whether canned (Shrink-wrapped) or uncanned (customized), whether it comes as part of computer or independently ,whether it is branded or unbranded, tangible or intangible; is a commodity capable of being transmitted, transferred, delivered, stored , processed , etc. and therefore as a ‘good’ liable To sale tax.” Similarly, Bitcoin being of an incorporeal nature may fall under the ambit of the term “goods”.
• As long as Bitcoins are not currency / legal tender, they can only be considered as ‘value for money’ or goods. Therefore, Bitcoin would qualify as a consideration under the Contract Act but not as consideration under the Sale of Goods Act.

Would RBI Act apply?

It does not apply.

• It does not come within the ambit of “Currency” Section 2(m) of the FEMA defines “foreign currency” Section 2 (q) of FEMA defines “Indian Currency”. Section 2(h) of FEMA defines “currency”. Since “virtual currency is not included in the definition, the Act does not apply.
• It does not come under the ambit of “legal Tender” According to Section 26 of the RBI Act, 1934 bank notes can be considered as “Legal Tender”. Further, according to Section 24 of the same only RBI has a power to issue it and no one else. Since this does not include “Virtual Currency” expressly not any court of the country has interpreted this in including the same. Thus, Bitcoin does not come under the ambit of “legal Tender”.
• It does not come under the ambit of “foreign exchange” Section 2(n) of FEMA 1999 defines “Foreign Exchange. Since, it does not fall under currency, thus cannot fall under credits and balances payable in any foreign currency

 Would FEMA apply?

• It depends on the nature of what a Bitcoin is, how it is used and the transaction itself.
• Non-applicability: i. Bitcoin does not fall under the ambit “currency” under Section 2(h) of FEMA or “currency notes” under Section 2(i) of the same. Applicability: Referring to Section 3 of FEMA it can be stated here that, purchasing of Bitcoin by a resident Indian from a person resident outside India (through legitimate banking channels) will not be in violation of FEMA. Further, Bitcoin transaction between two residents should also not trigger FEMA and should not therefore be in violation of the same. However, the sale of Bitcoin to a non-resident person (i.e. to a person outside India) by a resident Indian will be in violation of the provisions of the FEMA. Further, it can also be regulated by RBI in this condition.

What are the steps to be taken for setting up Bitcoin trading business? Do you need to register as stock exchange?

Registering as Stock Exchange depends on the condition that whether Bitcoin fall under the Securities or Derivative. As such, a Bitcoin is neither a security nor a derivative under the Securities Contracts (Regulation) Act, 1955. Apart from the term derivative, the only other way in which Bitcoin can be brought under the definition of ‘securities’ is if the Central Government notifies Bitcoin as such.

Digital Rupee versus Crypto Currency

There is no direct comparison between the digital rupee and cryptocurrency, as both serve different purposes.

• Cryptocurrency is a decentralized form of money with no intermediaries in the transaction process. On the flip side, a digital rupee is a centralized form of money issued and regulated by the RBI
• The digital rupee uses a private blockchain, while cryptos operate on a public blockchain in a decentralized infrastructure
• Users making payments via cryptos remain anonymous. However, it is not the same case with the digital rupee
• Regarding use cases, the digital rupee is just used for payments and other monetary transactions. But cryptocurrencies are categorically both assets and currencies
• The digital rupee responds to inflationary pressure. However, crypto is a currency that acts as a hedge against inflation
• When it comes to scalability, the digital rupee is efficient as they operate on permissioned networks similar to databases

Way forward

Definition of currency has scope for expansion, Sec. 2 (h) of FEMA, 1999 defines currency to include: all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank

•  If legalized Bitcoins will have to comply with the FEMA regulations
• In India it is not easy to convert rupee to other currencies. ▫ Capital account transactions are not freely convertible
• Bitcoins are not replacement of a currency it has a complimentarian function to the currency
• Cyber security will be a huge challenge
• The Government panel is also contemplating introducing compulsory Know Your Customer (KYC) norms in order to regulate the kinds of individuals/entities who can invest in these activities, and be able to track and identify them
•  At present, the Bitcoin prices in India are $1000 to $900 lower than the international market so one can easily make use of this arbitrage opportunity eventually despite whatever the government says
• The intention of the RBI appears to clampdown on alleged money laundering activities, tax evasion and to protect the consumer from the incessant speculation that is being conducted through virtual currency transactions at these exchanges. However, the net effect of sucking the oxygen out of this nascent industry will be just the opposite
• Without a functioning bank account, the exchanges will either be forced to deal in cash or shut shop altogether. Currently most of the organized crypto currency exchanges in India do extensive KYC of customers and do not take cash to ensure traceability of transactions. However, this step will only hamper operations of exchanges that want to do things in a legitimate way with high transparency. Rogue players will still continue to operate through cash or in some other covert manner.
• Cryptocurrency trade may get taxed @ 18% under GST.

Probable impact of future legislations

In a recent decision, the Supreme Court of India (SC)[3] has elaborated on general principles of retrospectivity as under :

• One of the established rules of interpretation was that unless explicitly stated, a piece of legislation is presumed not to be intended to have a retrospective operation4 The idea behind such a rule was that a current law should govern current activities. The principle of lex prospicit non respicit, which means that ‘The Law looks forward and not backward’, was upheld.
• Retrospective legislation was contrary to the general principle that ‘legislation introduced for the first time need not change the character of past transactions carried out upon the faith of the then existing law.5 The obvious basis of the principle against retrospectivity was the principle of ‘fairness’, which must be the basis of every legal rule.
• Legislations which modified accrued rights or imposed disabilities were to be treated as prospective in nature unless they were accounting for an obvious omission, or explaining a former legislation.
• L.J.M. Cooray in “The Rule of Law” has written that “Retrospective 1/8retroactive 3/8 legislation destroys the certainty of law, is arbitrary and is vindictive, (being invariably directed against identifiable persons or groups). Such laws undermine many characteristics of the rule of law.”
• Crypto currency exchange in India while still unregulated, has the potential to be deemed illegal vide future legislations in this regard. These legislations would most likely include:

1. The Foreign Exchange Management Act, 1999.
2. The Prevention of Money Laundering Act, 2002.

These legislations are unlikely to have retrospective effect. The Karnataka High Court recently issued its judgment in Obulapuram Mining Company Pvt Ltd v Joint Director Directorate of Enforcement Government of India, which dealt with the issue of retrospective application of the Prevention of Money Laundering Act 2002. The court held that a person cannot be tried for an offence under the act for the period when the said offence was not inserted in the schedule of offences under the act. The court held that this would deny the writ petitioner the protection offered by Article 20(1) of the Constitution, which is a fundamental right guaranteeing that “no person shall be convicted of any offence except for violation of the law in force at the time of the commission of the offence”.

Conclusion

Virtual currencies have had mixed reactions from Nations all over the world with countries like China and India (RBI) banning them, on the other hand Canada being the first country to have a national legislation on them, while Japan, South Korea and Australia, US, UK continue to regulate their functioning and exchange, recognizing their potential if harnessed rightly. Logically, in India, RBI shouldn’t be able to give their instructions/orders without amending the Information Technology Act, 2000 as VCs are not legal tenders/money/currency at all. India awaits a decent legislation on the same, predicted to be enacted this year. Even if RBI has banned their use, crypto-to-crypto exchanges are on the rise and users have found alternatives to circumvent the impugned RBI notification dated 6th April 2018, appeal against which currently lies pending before the Hon’ble Supreme Court. The term crypto currency is a misnomer and misleads the public to perceive it as some form of “currency” while in actuality; legally they are more likely to come under the definition of “goods” unless the term “currency” is amended to include VC. A uniform international regulation on the same is also sought as in the era of Internet, boundaries are practically nonexistent. UNCITRAL could issue model legislation for its members to enact locally.

[1] As defined by European Central Bank in its Report on Virtual Currency Schemes, October 2012.

[2] http://supremecourtofindia.nic.in/supremecourt/2017/35252/35252_2017_Order_13-Nov-2017.pdf

[3] Commr.Of Income Tax-I,New Delhi vs Vatika Township P.Ltd on 15 September, 2014