On March 4, 2020, a three-judge bench of the Supreme Court of India (“Supreme Court“) set aside the Reserve Bank of India’s (“RBI“) circular dated April 6, 2018 (“Circular“), which prohibited entities regulated by the RBI from dealing in virtual currencies or providing services for facilitating any person or entity in dealing with or settling virtual currencies. The Supreme Court set aside the Circular on the ground of proportionality. We will in this article enumerate on what is the test of proportionality that the Supreme Court has relied on and the certain other aspects such as the identity of virtual currencies, the RBI’s powers to regulate it etc. that the Supreme Court has shed light on.
The judgment extensively highlights the historical background of the RBI and the powers and functions conferred upon it. Subsequently, the Supreme Court investigates the identity of virtual currencies around the globe. The Supreme Court broadly analyses three (3) significant questions before it:
- Whether virtual currencies amounted to “money”?
- Whether the RBI had the power to regulate matters related to virtual currencies?
- Whether the Circular constituted a proper exercise of power of the RBI?
In the first part of the judgment, the Supreme Court is concerned with the historical background and scope of the RBI. It is concluded by the Supreme Court that the RBI Act, 1934, (“RBI Act“), the Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007 cumulatively recognize and also confer very wide powers upon the RBI to inter alia:
- Operate the currency and credit system of the country to its advantage.
- Take over the management of the currency from the central government.
- Have the sole right to make and issue bank notes that would constitute legal tender at any place in India.
- Regulate the financial system of the country to its advantage.
- Have complete control over banking companies.
- Regulate and supervise the payment systems.
- Prescribe standards and guidelines for the proper and efficient management of the payment systems.
- Issue directions to a payment system or a system participant which in RBI’s opinion is engaging in any act that is likely to affect the payment system, the monetary policy or the credit policy of the country; and
- Issue directions to system providers or the system participants or any other person generally, to regulate the payment systems or in the interest of management or operation of any of the payment systems or in public interest.
In the second part of the judgment, the Supreme Court is concerned with the identity of virtual currencies. It is understood that while some call virtual currencies an exchange of value, others may call it a stock or a good or commodity. According to a report submitted to the International Monetary Fund (“IMF“), there are four (4) factors which lie behind the rise of cryptocurrencies. They are:
- The development of block chain technology.
- Concerns about conventional money and banking.
- Privacy concerns.
- Political views about the role of the Government.
The petitioners contended that today virtual currency is not money or other legal tender, but instead is a good/tradable commodity and thus the RBI has no role in regulating and/or banning the same. The RBI submitted that although virtual currencies are not recognized as legal tender, they are capable of being used as a medium of exchange. In view thereof, the Supreme Court examines the definition of virtual currencies by regulators in different jurisdictions in addition to the definition given to it by governments and other statutory authorities of various countries through statutory instruments, non-statutory directives and interpretation given by the courts of such jurisdictions. In comparing the diverging views and definitions across several jurisdictions, the Supreme Court concludes that there is unanimity of opinion among the regulators and the governments of various countries that although virtual currencies have not acquired the status of a legal tender, they nevertheless constitute digital representations of value and are capable of function as:
- A medium of exchange and/or
- A unit of account and/or
- A store of value.
Based on the above, the Supreme Court concludes that “what an article of merchandise is capable of functioning as, is different from how it is recognized in law to be. It is as much true that virtual currencies are not recognized as legal tender, as it is true that they are capable of performing some or most of the functions of real currency.”Thus, although virtual currencies do not have the status of a legal tender, as they are not backed by a central authority, however, they are capable of being used as real money. Thus, if an intangible property can act under certain circumstances as money, then RBI can definitely take note of it and deal with it.
To answer the second question, the Supreme Court observes that as per Section 3 of the RBI Act, RBI is the sole repository of power for the management of currency and under Section 22(1) of the RBI Act, it is vested with the sole right to issue currency notes supplied to it by the Government of India. The RBI has an important role to play in evolving the monetary policy of the country and hence anything that may pose a threat to or have an impact on the financial system of the country, can be regulated or prohibited by RBI, despite the said activity not forming part of the credit system or payment system.The expression “management of the currency” appearing in Section 3(1) of the RBI Act need not necessarily be confined to the management of what is recognized in law to be currency but would also include what is capable of faking or playing the role of a currency. Secondly, the Supreme Court observes that through its Circular, the RBI is not prohibiting all trade in virtual currencies but is only directing the entities that it statutorily regulates to not provide services to those persons or entities dealing in or settling virtual currencies. Citizens who have taken up the trade of buying and selling virtual currencies are not prohibited by the Circular either from trading in crypto-to-crypto pairs or in using the currencies stored in their wallets, to make payments for purchase of goods and services to those who are prepared to accept them, within India or abroad.
Test of Proportionality
It is while answering the third and final question that the judgment takes an interesting turn. The Supreme Court states that, the measure of banning cryptocurrency taken by RBI should pass the test of proportionality, since the Circular has almost wiped the virtual currency exchanges out of the industrial map of the country,thereby infringing Article 19(1)(g).It is well established that any restriction to the freedom guaranteed under Article 19(1)(g) should pass the test of reasonableness.
The Supreme Court has held that while the RBI has the to take a pre-emptive action, to assess the reasonableness or the proportionality of this measure the RBI needs to show at least some semblance of any damage suffered by its regulated entities. The Supreme Court holds that the RBI has so far not found i.e. in the past five (5) years or more, the activities of virtual currency exchanges to have actually negatively impacted, the way the entities regulated by RBI function. It is stated that the “RBI has not come out with a stand that any of the entities regulated by it, namely the nationalized banks/scheduled commercial banks/co-operative banks/non-banking financial company’s has suffered any loss or adverse effect directly or indirectly, on account of the interface that the virtual currency exchanges had with any of them.”
Further the judgement states that “When the consistent stand of RBI is that they have not banned virtual currencies and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate.” Thus the impugned measure taken by the RBI failed the test of proportionality.
The judgment however leaves us with the remaining question as to the legality of cryptocurrencies. It appears that the Supreme Court has said very little on the legality of cryptocurrencies but instead has laid the ground for what the RBI needs to show if it wishes to prohibit virtual currencies in the future.
The RBI has in response to the judgement stated that it might file a review petition in the Supreme Court against the quashing of a central bank circular aimed at curbing cryptocurrencies. The RBI is apparently concerned that the Supreme Court’s decision could pave the way for trading in virtual currencies and put the banking system at risk.