Cryptocurrency circular: Unintended consequences?

By Arun Prabhu, Cyril Amarchand Mangaldas
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Cryptocurrencies use cryptographic functions rather than central banks or ledgers to validate transactions and are an increasingly important part of the global financial landscape. The absence of central regulation or records enables transactions in cryptocurrencies to enjoy varying degrees of anonymity. This, along with rising prices of popular cryptocurrencies such as bitcoin, has made mining, using and trading in them increasingly attractive in India.

Arun PrabhuPartnerCyril Amarchand Mangaldas
Arun Prabhu
Partner
Cyril Amarchand Mangaldas

Cryptocurrencies are regulated to varying degrees. While some jurisdictions ban transactions in cryptocurrencies outright, citing money laundering concerns, others have been content to tax them, or treat them as “means of payment” but not legal tender.

The legal position of cryptocurrencies under Indian law has evolved a lot.

In 2013 and 2017, the Reserve Bank of India (RBI) released three press releases on the subject. While the press releases did not prohibit or restrict transactions in cryptocurrencies, or indeed clarify their legal status, they warned about substantial volatility, money laundering and risks to customer protection.

In January 2018, income tax authorities conducted raids on cryptocurrency exchanges in India. In February, Citibank India and HDFC Bank prohibited use of their credit and debit cards to buy cryptocurrencies.

The finance minister in his budget speech on 1 February 2018 said “the government will take all steps to stop the usage of cryptocurrencies in financing illegitimate activities … and eliminate them from the payment system”. However, also in February, the RBI released a report on fintech which took a positive tone, recommending a “regulatory sandbox” model for cryptocurrencies. Regulatory sandboxes are safe spaces where innovators can test out their fintech products after regulators relax regulatory norms in order to foster innovation. The RBI also seemed to be considering a “native”, centralized cryptocurrency of its own.

Then on 6 April, the RBI released a circular prohibiting all entities regulated by it from dealing in virtual currencies. Thus, all banks, non-banking financial companies, payment system providers, intermediaries and other financial institutions regulated by the RBI are prohibited from providing services to to any individuals or business entities dealing with, or settling, virtual currencies (including crypto currencies and crypto assets).

Such services have been defined to include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to purchase/sale of virtual currencies. Any regulated entity which is providing any services to any entity that deals with or settles virtual currencies has to discontinue such services within three months from 6 April 2018.

Several ambiguities arise out of the circular. An analysis of its impact on some businesses which deal with cryptocurrencies follows.

Validating a cryptocurrency’s “blockchain” ledger – known as “mining” – usually results in the award of fractional cryptocurrencies. An evolving computing ecosystem and large volumes of legacy hardware have led some businesses to set up mining operations in India. Mining does not require the purchase of cryptocurrencies or their sale to persons in India. Indeed, it is difficult to differentiate miners from other companies (e.g. cloud companies) which provide computing capacity for financial remuneration.

The circular would prohibit regulated entities from dealing with mining businesses and may also prohibit them from dealing with manufacturers of bitcoin mining hardware or persons who provide software development, support services, or even hosting services, to cryptocurrency miners. A plain reading of the circular would also extend the prohibition to transacting with entities engaged purely in cryptocurrency-to-cryptocurrency transactions. These prohibitions are difficult to justify, as the activities of such entities would not involve any transactions in fiat currencies or involve any payment systems in India.

Cryptocurrencies and their underlying blockchains, can be (and are being) used to enable charitable donations and humanitarian aid, as well as for currency speculation and funding illegal activities. A blanket prohibition that makes no distinction between these uses seems, at least prima facie, to be arbitrary.

A Supreme Court hearing of several clubbed petitions challenging the 6 April circular is scheduled for 20 July. It will be interesting to follow developments and see whether the RBI issues clarifications to mitigate some of the above concerns.

Cyril Amarchand Mangaldas is India’s largest full-service law firm. Arun Prabhu is a partner at Cyril Amarchand Mangaldas. He was assisted by Deepthi Bavirisetty and Siddharth Manohar.

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