A three-judge bench of the Supreme Court on Wednesday set aside a controversial circular issued by the Reserve Bank of India (RBI) that prohibited any entity from providing banking services to anyone dealing with virtual or cryptocurrencies. The apex court did so on the grounds that this prohibition, which applied to all RBI-regulated institutions, was not proportionate.
The judgment itself is structured like a film screenplay – complete with a flashback, background score, plot and climax – and makes for a curious read. Interestingly, for the first 172 pages of the 180-page-verdict, the apex court actually looks like it is headed towards upholding the central bank’s circular. It is only in the ‘climax’ of the judgment that the court makes a sudden U-turn and finds that the RBI has not presented any empirical evidence that virtual or cryptocurrencies have negatively impacted the banking sector or other entities regulated by the RBI. It is on the basis of this singular fact that the Supreme Court holds that this circular fails the test of proportionality.
Even though the celebration amongst the technology community on social media continues, the judgment itself appears to be a case of the RBI losing the battle but winning the war. In order to holistically assess the impact of this case, it is important to examine the broader questions that the Court answers, and what these answers mean for the future of virtual currencies in India. The RBI may not have yet presented empirical evidence of the destabilisation of the banking sector, but if the regulatory instincts of the central bank are consistent, then the enactment of similar regulation, supported with adequate documentation, might not be too far away.
Before examining the specifics of the Supreme Court’s judgment, it is important to identify the fault-lines which map the terrain of virtual currencies. Virtual currencies, or cryptocurrencies, as they are usually called, are virtual tokens which can be used to conduct transactions within specialised encrypted networks. Bitcoin, which is perhaps the most infamous of these cryptocurrencies, for example, operates on a blockchain. A blockchain is a decentralised ledger which relies on every transaction being simultaneously validated by every node of the network based on the integrity of the chain of preceding transactions, while encryption prevents others from viewing the substance of individual transactions – thereby ensuring a reliable, accessible record which is not in the control of a single point of failure while also ensuring the privacy of users. As such, cryptocurrencies are often hailed as the model that may successfully mount a challenge to centrally controlled economic systems, which has been a persistent objective of the libertarian impulses of the technology community.
On the other side of this revolutionary economic utopia, there are serious issues with cryptocurrencies which have drawn the ire of regulators worldwide: the privacy and anonymity offered by cryptocurrencies empowers money laundering and the financing of terrorism; the systems on which such cryptocurrencies operate are not reliable enough to uphold a system of exchange at scale; and the tremendous volatility of the value of cryptocurrencies worldwide make it unsuitable for integration within the larger economy. Regulators, consequently, approach cryptocurrencies from a position of emboldened scepticism and begrudging acceptance.
Along these fault-lines, the key question remains one of whether the system of cryptocurrencies will be allowed to operate outside of central control without being severed from the banking sector and rendered illusory, an arrangement that might move towards the alternate system of economic exchange that enthusiasts have dreamed of – or whether the financial system of the nation-state will exercise its regulatory powers over virtual currencies in a manner that undermines its primary function of decentralising exchange.
In this context, the court’s position on the bigger questions involved with virtual currencies assumes more importance than its act of setting aside this particular circular. Broadly, there were three significant questions before the court, notwithstanding its brief segues to the fields of Vedic metaphysics and Jain theology.
First, whether virtual currencies amounted to money. Secondly, whether the RBI had the power to regulate matters related to virtual currencies. And thirdly, whether this particular circular was a proper exercise of this power. It might dim some of the celebrations in civil society, but an examination of the judgment reveals that the first two questions are answered in the affirmative, and if not for the RBI failing to provide empirical evidence of harm, the third would have been as well.
On the first question, the court was faced with the argument that virtual currencies did not amount to money, but instead, were just goods. As a result, it was argued, the RBI had no business regulating the transfer of goods between private persons. After conducting an exhaustive survey of the functions of ‘money’, the definitions of ‘money’ in several legislative instruments and foreign jurisdictions, the court settled on a simple functional approach – stating that “if an intangible property can act under certain circumstances as money (even without faking a currency) then RBI can definitely take note of it and deal with it.” While the functional approach may be appropriate to take resort to, the reasoning of the court leaves the lines blurred – consequently, any assessment of the legal nature of cryptocurrencies is left open to ambiguity and speculation.
The second question introduces a little more complication to the court’s exercise. This question is made interesting by the contents of the RBI’s circular – the circular does not directly prohibit transactions in virtual currencies, but merely directs entities regulated by the RBI to not provide banking services to those engaged in trading or facilitating the trade of virtual currencies. The implication of this, however, is that cryptocurrency cannot be converted to fiat currency; that the interface between the alternative economy of cryptocurrency and the nation-state’s economy is severed, rendering virtual tokens illusory in value, and consequently, in effect, it amounts to a prohibitive measure on the trading of virtual currencies. The argument made to the court, consequently, was that this amounts to indirectly regulating a space that the RBI is not competent to regulate.
In answering this question, however, the court makes two important observations: first, that through its circular, the RBI is merely directing the entities that it is statutorily empowered to regulate and is not prohibiting all trade in virtual currencies, which continues to be permitted, even if rendered near-illusory. And secondly, and more importantly, that the scope of the RBI’s powers extends to regulating “anything that may pose a threat to or have an impact on the financial system of the country…despite the said activity not forming part of the credit system or the payment system.” In fact, the court goes on to state that this power extends to not just regulating virtual currencies but includes the power to completely prohibit them.
It is important to note that thus far, the court has been entirely unyielding to claims that cryptocurrencies can operate outside of central control. The power to regulate cryptocurrencies is discovered by the court in the mandate of the RBI; the ability of the RBI to both directly and indirectly, prohibit transactions in cryptocurrencies has been provided the rubber stamp of the Supreme Court; and every aspect of the alternative utopia of cryptocurrencies has been rendered within the centralised control of the RBI.
It is only in answering the final question of whether this particular exercise of power was proper that the Court echoes some of the sentiments of cryptocurrency enthusiasts. After rejecting a series of other technical legal objections, the court finally yields to a singular fact: that the RBI has not shown “semblance of any damage suffered by its regulated entities” – a failure which the court deems fatal to the RBI circular’s survival in an analysis of whether the prohibition was proportionate to the harm attempted to be addressed.
The finding of the court rests on this one singular pillar: the lack of demonstrated harm to the banking sector or other entities regulated by the RBI. Notably, the court continues to yield to the idea of pre-emptive regulation, it just holds that the material on record does not justify pre-emption in this particular instance.
At this stage, the judgment should leave anyone concerned about the future of cryptocurrencies with a few questions. Even though this circular was struck down, has the RBI’s conviction been altered? Is it beyond the RBI to procure or produce documentation demonstrating the material risks posed to the banking system by virtual currencies? If these risks are real, and the scholarly consensus appears to be that they are, what prevents the RBI from coming back with another prohibition, this time supported with adequate material? And perhaps most importantly, did the Supreme Court actually legalise cryptocurrencies, or did it just provide explicit legal backing to an even more stringent prohibition?
In spending most of its judgment establishing the need for regulation of virtual currencies, and then setting aside the regulation in place, the Supreme Court has fortuitously created an opportunity for arriving at constructive solutions to the questions at play. The cryptocurrency community must make the case for a carefully calibrated regulatory framework that allows for its growth – and if the RBI does not persist with its stance of ring-fencing or pursuing more stringent prohibitions, then it must identify nuanced multilateral solutions capable of dealing with law enforcement concerns, the stability of the financial system and the development of a responsible virtual currency ecosystem.
One of the most interesting paragraphs in the judgment mentions the Vedic concept of ‘neti neti’ – the negation of worldly signifiers of identity to get to the inexpressible essence of the self – in relation to the difficult task of defining virtual currencies.
Perhaps the concept of negation needs to be applied to the judgment itself. A negation of the worldly decisions made on singular contextual facts might reveal the essence of a growing leviathan which seeks to regulate that which it can – in this particular case – looking beyond the small act of setting aside this circular seems to reveal the larger implication of bringing all virtual currencies within the plenary control of a centralised regulator. The celebrations too, it seems, might need to be negated.
Aniruddh Nigam is a research fellow in the Public Law vertical at the Vidhi Centre for Legal Policy, New Delhi