The emergence and increasing widespread of cryptocurrencies in the economy has attracted the attention of both retail investors and financial institutions. As with any emerging market, financial regulators, all over the world are trying to catch up with the technology and have been tasked with protecting investors while ensuring stability in the market.
Globally, regulators have taken varied stands, while some countries like Singapore, Japan and Switzerland have already enacted legislation promoting the use of cryptocurrencies, China has called for an outright ban on them. On the other hand, the Indian Government is yet to clear its stand and introduce any legislation for the regulation of cryptocurrencies. However, the Indian Government is in the process of publishing a draft Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which seeks to create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India (RBI) and is supposed to prohibit all private cryptocurrencies in India, but promote the underlying blockchain technology.1
As the term suggests, “cryptocurrency” has some characteristics of a currency i.e., it can be used to pay for goods and services as well as characteristics of a commodity or an asset like gold owing to its use as a store of value and much like gold, cryptocurrency derives its value from the market forces of supply and demand.
Ever since the introduction of cryptocurrency in Indian market, RBI has raised concerns of anonymity of transactions, consumer protection, market integrity and inter alia money laundering. As a result, in April 2018, RBI issued a circular banning all regulated entities from providing any service related to any transaction in cryptocurrency which was challenged on various grounds including its jurisdiction to regulate cryptocurrency. Supreme Court in Internet and Mobile Assn. of India v. RBI2 even though set aside the circular, it upheld RBI’s power to regulate virtual currencies.
There is no doubt in the fact that the RBI concerns are well founded. The need for regulation arises from the risk of potential market failures and in the case of cryptocurrencies there are multiple risks. Most cryptocurrencies are not backed by any tangible assets or other securities which weakens price discovery and increases the risk of market manipulation. Further, technological complexities associated with the crypto assets, warrants regulations for consumer protection and adequate disclosures and transparency for investor protection. As the investor awareness on cryptocurrency is very low, there is risk of mis-selling, which further increases the need for adequate disclosure of their underlying asset, their performance and future potential and risks.3
However, at this juncture, the pertinent question is what are cryptocurrencies and how they are defined i.e., whether as a currency or a commodity or a security or all together a new form of asset because how they are defined will shape how they are regulated.
Cryptocurrency and blockchain
The definition of cryptocurrency is far from globally uniform, so broadly, cryptocurrency is defined as a digital store of funds that utilises a cryptography security technique to (i) control the creation of new units; and (ii) validate the transfer of assets.4 Unlike regular fiat money, cryptocurrency is a digital currency that operates on blockchain technology, and have no underlying asset, with the value solely dependent on market sentiments.5 It is easier to confuse cryptocurrency with blockchain technology but it is necessary to draw distinction, especially because blockchain based distributed ledger technology (DLT)6 has a variety of potential applications independent of cryptocurrencies. Blockchain is defined as, “a particular type of data structure used in some distributed ledgers which stores and transmits data in packages called ‘blocks’ that are connected to each other in a digital ‘chain’. Blockchains employ cryptographic and algorithmic methods to record and synchronise data across a network in an immutable manner.”7
Is cryptocurrency a “currency” or a “payment system”?
As more and more businesses have started accepting payments in the form of bitcoin in India and around the world, it is pertinent to question the legitimacy of this move i.e., whether or not, cryptocurrency can qualify as a legal tender or a valid payment system under the current legislations in India, which are: Reserve Bank of India Act, 19348; Foreign Exchange Management Act, 1999 (FEMA)9; Coinage Act, 201110; and Payment and Settlement Systems Act, 2007 (PSSA)11.12
Section 2(h)13 of FEMA provides for the definition of currency to include “all currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers 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” and foreign currency is defined under Section 2(m)14 as any currency other than Indian currency. Further, legal tender is defined under Section 2615 of RBI Act, which states that, “every bank note shall be legal tender at any place in India in payment or on account for the amount expressed therein, and shall be guaranteed by the Central Government”. The major difference between a virtual currency and fiat currency is that while latter is guaranteed by the Central Government, former has no backing.16 Further, as per Sections 2417 and 2518 of the RBI Act, Central Government on the recommendation of RBI specifies and approves the denomination value, form and material of bank notes. Similarly, Section 619 of the Coinage Act provides the status of legal tender to coins which are made up of metal or a material approved by the Central Government and minted by an organisation authorised to do so. Therefore, there is no sanction for cryptocurrencies as legal tender under the current legislations. Lastly, in order for a currency to be viable, it needs to have low volatility as, if the currency moves a lot, then it becomes difficult to value goods and services.
The Payments System in India is regulated by RBI under the Payment and Settlement Systems Act, 2007. However, the Act does not define digital or virtual currency but a working group on electronic money set up by RBI prior to the enactment of PSSA has defined “electronic money” in its Report in 2002 as “an electronic store of monetary value on a technical device used for making payments to undertakings other than the issuer without necessarily involving bank accounts in the transaction but acting as a prepaid bearer instrument”.20 While the definition of electronic money is wide enough to include cryptocurrency, it must be read harmoniously with the definition of “payment system” under Section 2(i)21 of the Act which provides, “ ‘payment system’ means a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange”. Further, RBI also issued the Master Direction on Issuance and Operation of Prepaid Payment Instruments in 2017 in order to regulate prepaid wallets. In order to fall under the purview of “prepaid instrument”, the cryptocurrency must hold some inherent value, however, as held by Supreme Court in IMAI judgment22, since cryptocurrencies do not hold any inherent monetary value due to their decentralised nature it cannot be termed as a prepaid instrument under PSSA r/w Master Direction on Issuance and Operation of Prepaid Payment Instruments.23 However, Court did recognise RBI’s power to regulate cryptocurrencies under the PSSA since cryptocurrency transactions include “payment obligation” and/or “payment instruction”.
Do cryptocurrencies fall under the purview of “security”?
With the growing cryptocurrency market and new crypto exchanges in India and around the world, cryptocurrencies have taken a form of investment. However, before classifying cryptocurrencies as an investment, it is important to determine that whether they can be brought under the ambit of Securities and Exchange Board of India (SEBI). The evolution of the crypto market has brought forth a new form of fundraising, initial coin offerings (ICOs) which may fall under the purview of SEBI.
Initial coin offerings (ICOs) are a way for companies to raise money by issuing digital tokens in exchange for fiat currency or cryptocurrency.24 It is a form of fundraising that is akin to initial public offering (IPO) in structure, but instead of shares, it allocates virtual tokens25 to investors. These tokens usually are not a representation of ownership in the company, but can be transferred across the network and can be traded on cryptocurrency exchanges. They can serve various functions, from providing investors access to a service to entitling them to a share of the start-up company’s dividend. The regulation of these tokens depends on their characteristics and the purpose they serve. The token in contention here is security tokens. Security tokens represent an investment in a company and just like shareholders, investors holding tokens receive dividends in the form of additional coins every time the company earns profit in the market.
So, the question is that whether these tokens fall under the term “security” under Indian laws? And given the similarity in their structures, can ICOs be regulated in the similar manner as IPOs? In India, the term “securities” defined under Section 2(h)28 of the Securities Contracts (Regulation) Act, 1956 includes “shares, scrips, stocks, bonds, debentures, debenture stock, or other marketable securities of a like nature in an incorporated company or body corporate”. Even though cryptocurrencies are not included in the definition, they may be considered as a security under the phrase “other marketable securities” which gives an expansive meaning to the word securities. Further, Supreme Court in the landmark case of Sahara India Real Estate Corpn. Ltd. v. SEBI29, has held that “marketable securities of a like nature” means securities capable of being freely transferable. Therefore, if tokens are issued by a body corporate and are capable of being freely transferable they may fall under the jurisdiction of SEBI.30
Moving forward, an argument can also be made that ICOs can be considered as an “investment contract” or “collective investment scheme”. Section 11(c)31 of SEBI Act, 1992 gives powers to SEBI of registration and regulation of collective investment schemes and Section 11-AA32 define them. In Paramount Bio-Tech Industries Ltd. v. Union of India33, a Division Bench of Allahabad High Court has held that in order to gauge that whether an instrument is a “collective investment scheme” or not, the Court shall use the Howey test. The Howey test, laid down by US Supreme Court in Securities and Exchange Commission v. W.J. Howey Co.34 lists three main features of an investment contract: (i) involves an investment of money; (ii) investor has an expectation of profit; and (iii) the profit is generated by the issuer. It is pertinent to mention here that Section 11-AA(2)35 of SEBI Act, 1992 draw its inspiration from the features laid down in Howey test. As far as the provision is concerned, some may argue if the funds raised by an ICO are pooled and utilised for the purpose of scheme or arrangement, but there can be no doubt that contribution by investors is made with a view to receive profits, and investors do not have the day to day control over the management.36 Nevertheless, Central Government may consider amending the definition of crypto intelligence system (CIS) in order to bring ICOs in its ambit and clear the ambiguity.
Is cryptocurrency a commodity?
The term “commodity” has neither been defined anywhere in Indian laws nor there is any established jurisprudence. The commodity is generally considered to be any kind of good that can be interchanged with other goods of the same type.37 In Tata Consultancy Services v. State of A.P.38, Supreme Court observed that a commodity is generally understood to mean goods of any kind, something of use, or an article of commerce. The term “goods” has been defined under Section 2(7)39 of the Sale of Goods Act, 1930 which reads as:
(7) “goods” mean every kind of movable property other than actionable claims and money; and includes stock 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.
Now, in order to classify cryptocurrency as a “good” according to the definition, it must be a “movable property” that has been defined under General Clauses Act, 189740 as property of every description, except immovable property.41 The definition of the term “movable property” being wide enough, cryptocurrency being an intangible property should fall under its ambit.42 Further in Tata Consultancy Services v. State of A.P.43, Supreme Court has held,
“Indian law does not make any distinction between tangible property and intangible property. A ‘goods’ may be a tangible property or an intangible one. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) capable of being bought and sold; and (c) capable of transmitted, transferred, delivered, stored and possessed. If a software whether customised or non-customised satisfies these attributes, the same would be goods.”
Therefore, given the current legal position in India, I am inclined to believe that cryptocurrencies can be classified as intangible movable property and can be identified as a “commodity”.
The cryptocurrency market has seen exponential growth both in India and on a global scale with a substantial monetary investment. However, these investments stay at a great amount of risk as they depend on the fate of cryptocurrencies and their regulation. Therefore, it has become necessary to address all the legal issues surrounding cryptocurrencies as they did not seem to have slowed down investors from finding alternatives to capitalise their investments in the Indian cryptocurrency market.
As the Central Government paves way for Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 and official digital currency to be launched by RBI, it will be interesting to see how cryptocurrencies will finally be regulated i.e., as a currency, security or commodity. Interestingly, recently leaders of some cryptocurrency exchanges have filed petition before the Central Government asking Securities and Exchange Board of India (SEBI) to regulate the cryptocurrencies as they are traded more as a commodity. In the author’s opinion, the Central Government should engage industry participants and make an attempt to understand multiple characteristics of cryptocurrencies before coming out with legislation on cryptocurrencies because however Indian Government decides to regulate them, the same would have a market-wide implication.
† Alumnus, National University of Study and Research in Law, Ranchi [BA LLB (Corporate Law Hons.)] and Government Law College, Mumbai (Post Graduation Diploma in Securities Law).
3 The Need to Regulate Cryptocurrencies is Loud and Clear Mint, <https://www.livemint.com/opinion/online-views/the-need-to-regulate-cryptocurrencies-is-loud-and-clear-11610555985823.html> (last visited on 27-5-2021).
4 Matthew Blumenfeld, Michael Horn, Keaghan Ames, Nikhil Raina, Cesar Munoz and Margaret Paulsen, Carving Up Crypto: Regulators Begin to Find their Footing, Regulatory Brief (accessed on 1-7-2021) <https://www.pwc.com/us/en/financial-services/regulatory-services/publications/assets/cryptocurrency.pdf>.
5 Matthew Blumenfeld, Michael Horn, Keaghan Ames, Nikhil Raina, Cesar Munoz and Margaret Paulsen, Carving Up Crypto: Regulators Begin to Find their Footing, Regulatory Brief (accessed on 1-7-2021) <https://www.pwc.com/us/en/financial-services/regulatory-services/publications/assets/cryptocurrency.pdf>.
6 DLT refers to novel and fast-evolving approach to recording and sharing data across multiple data stores (or ledgers). This technology allows for transactions and data to be recorded, shared, and synchronised across a distributed network of different network participants.
7 World Bank Group (H. Natarajan, S. Krause and H. Gradstein), Distributed Ledger Technology (DLT) and Blockchain, 2017, FinTech Note, No. 1. Washington, DC, <http://documents.worldbank.org/curated/en/177911513714062215/pdf/122140-WP-PUBLIC-Distributed-Ledger-Technology-and-Blockchain-Fintech-Notes.pdf>.
12 Karan and Rishi, Cryptocurrency: A Legal Perspective on a Misunderstood Technology, Tatva Legal Blog, (last visited on 6-7-2021), <https://tlegal.com/blog-details/cryptocurrency-a-legal-perspective-on-a-misunderstood-technology#_ftnref5>.
16<https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf> (Department of Economic Affairs, Ministry of Finance, New Delhi, India, Report of the Committee to Propose Specific Actions to be Taken in Relation to Virtual Currencies, 2019.
23 Anu Tiwari and Anindita Bhowmik, Cryptocurrencies Unchained? India Business Law Journal, (last visited on 6-7-2021) <https://law.asia/cryptocurrencies-unchained-cryptos-india/>.
24 Anu Tiwari and Anindita Bhowmik, Cryptocurrencies Unchained? India Business Law Journal, (last visited on 6-7-2021) <https://law.asia/cryptocurrencies-unchained-cryptos-india/>
25 A token is a utility, an asset or a unit of value issued by a company.
30 Anu Tiwari, Ritu Sajnani and Bharath Sridhar, Cryptocurrency in India, India Corporate Law, (last accessed on 1-7-2021) <https://corporate.cyrilamarchandblogs.com/2021/05/fig-paper-no-7-cryptocurrency-in-india/>.
35 (2) Any scheme or arrangement made or offered by any [person] under which—
(i) the contributions, or payments made by the investors, by whatever name called, are pooled and utilised for the purposes of the scheme or arrangement;
(ii) the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement;
(iii) the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors; and
(iv) the investors do not have day-to-day control over the management and operation of the scheme or arrangement.
36 (2) Any scheme or arrangement made or offered by any [person] under which—(i) the contributions, or payments made by the investors, by whatever name called, are pooled and utilised for the purposes of the scheme or arrangement; (ii) the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement; (iii) the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors; and
(iv) the investors do not have day-to-day control over the management and operation of the scheme or arrangement.
37 SEBI FAQs on Commodity Derivatives at <https://www.sebi.gov.in/sebi_data/faqfiles/aug-2020/1596600172449.pdf>.
42 Jay Parikh, India: The Legality of Crypto-Currency and its Repercussions on the Crypto-Currency Exchanges in India, Mondaq, (last visited on 6-7-2021), <https://www.mondaq.com/india/fin-tech/697982/the-legality-of-crypto-currency-and-its-repercussions-on-the-crypto-currency-exchanges-in-india>.