Editorial Notes

[Editorial Notes] Supreme Court lifts ban on Cryptocurrency

Supreme Court has set aside a ban by the Reserve Bank of India (RBI) on banks and financial institutions from dealing with virtual currency holders and exchanges.
By IASToppers
March 09, 2020

Contents

  • Introduction
  • Fiat currency
  • Virtual currency
  • Differences between Fiat and Virtual currency
  • Risks posed by cryptocurrency
  • RBI’s stand
  • Supreme Court’s verdict
  • Fixing the loopholes
  • Way Forward
  • Conclusion

Supreme Court lifts ban on Cryptocurrency

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Introduction:

On April 6, 2018, the RBI issued a prohibition on all dealings in virtual currencies by regulated entities. The move seemed extreme; set against the backdrop of caution exercised worldwide, it marked a stark departure from the relatively non-interventionist stance the regulator had previously adopted. However, the Supreme Court has recently lifted the ban by the Reserve Bank of India (RBI) on banks and financial institutions from dealing with virtual currency holders and exchanges.

Fiat currency:

  • The money we use (fiat currency) is a product of lending by institutions or commercial banks.
  • What makes it credible or trustworthy is that it is backed by the state through its central bank.
  • What makes its usage ubiquitous is the law, which establishes that our taxes can only be paid in state-issued fiat currency.

Virtual currency:

  • The term ‘virtual currency’ (or ‘cryptocurrency’) is a misnomer, as it seems to indicate that these tokens operate like ersatz (fake) money.
  • There is no globally accepted definition of what exactly is virtual currency.
  • Some agencies have called it a method of exchange of value; others have labelled it a goods item, product or commodity.
  • Satoshi Nakamoto, widely regarded as the founder of the modern virtual currency bitcoin and the underlying technology called block chain, defined bitcoins as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party”.

Differences between Fiat and Virtual currency:

  • Although cryptocurrencies are intended to function as a means of payment, unlike fiat currencies, they lack a sovereign guarantee and their source of value is not quite clear.
  • These tokens suffer from technical and economic faults in their core design, rendering them far from pervasive in the financial system as a means of payment.
  • Moreover, they are a poor unit of account, as demonstrated by their frequent and high fluctuation in value.

Risks posed by cryptocurrency:

  • Crypto-assets indeed pose several risks, including anti-money laundering and terrorism financing concerns (AML/CFT) for the state and liquidity, credit, and operational risks for users.
  • Particularly for consumers, the pernicious effects of cryptocurrencies are heightened by the striking paucity of information on their design, use and operation and indications of market manipulation.
  • However, in treating these tokens as currency, the existing regulatory regime misunderstands both the instrument and the attendant risk; and by extension, fails to effectively contain them.
  • Organisations across the globe have called for caution while dealing with virtual currencies, while also warning that a blanket ban of any sort could push the entire system underground, which in turn would mean no regulation.

RBI’s stand:

  • In June 2013, the RBI had for the first time warned users, holders and traders of virtual currencies about the potential financial, operational, legal and customer protection and security-related risks that they were exposing themselves to.
  • Owing to the lack of any underlying fiat, excessive volatility in their value, and their anonymous nature which goes against global money-laundering rules, the RBI initially flagged its concerns on trade and use of the currency.
  • Risks and concerns about data security and consumer protection on the one hand, and far-reaching potential impact on the effectiveness of monetary policy itself on the other hand, also had the RBI worried about virtual currencies.
  • In a circular in 2018, the RBI had banned banks from dealing with virtual currency exchanges.
  • In its arguments in the Supreme Court, the RBI said it did not want these virtual currencies spreading like contagion, and therefore, in the larger public interest, asked banks not to deal with people or exchanges dealing in these non-fiat currencies.

Supreme Court’s verdict:

  • The court held that the ban did not pass the “proportionality” test.
  • The test of proportionality of any action by the government, must pass the test of Article 19(1)(g), which states that all citizens of the country will have the right to practice any profession, or carry on any occupation or trade and business.
  • SC held that the RBI directive came up short on the five-prong test to check proportionality — direct and immediate impact upon fundamental rights; the larger public interest sought to be ensured; necessity to restrict citizens’ freedom; inherent pernicious nature of the act prohibited or its capacity or tendency to be harmful to the general public; the possibility of achieving the same object by imposing a less drastic restraint.

Fixing the loopholes:

  • The SC’s judgment could lead to the RBI rethinking its policies surrounding virtual currencies.
  • It is expected that the RBI will reconsider its approach to cryptocurrency and come up with a new, calibrated framework or regulation that deals with the reality of these technological advancements.
  • The decision will help those investors who had used legitimate money through banking channels.

Way Forward:

1. Strengthening regulatory frameworks:

  • First, in the face of growing technological innovation in the financial sector, it is critical to strengthen the supporting regulatory frameworks that operate regardless of the nature of an instrument.
  • Emerging technologies are characterized by steep information asymmetries among the innovators, regulators and users, which limits the potential for pre-emptive action.
  • Re-examining and strengthening the complementary framework allows for, to a certain degree, the creation of a safety net which operates irrespective of the regulatory arbitrage sought to be exploited by new players.

2. Set clear parameters:

  • Second, the RBI must set clear parameters on functional grounds to evaluate the appropriate course of action.
  • A regulatory framework that is aligned with the economic functions of a product or service, or a “same risk, same rules” principle, can avoid the pitfalls of policy that narrowly strikes at business models and technologies already observed and consequently risks missing the forest for the trees.
  • Realigning regulation along functional lines allows regulators to draw more meaningful perimeters and expand oversight to cover the system’s current blind spots.
  • New business models and technologies are guided by regulation to the extent that they seek to circumvent it.
  • Striking at function, rather than just form, will aid the umpire in distinguishing the desirable from the undesirable as more new players populate the field.

Conclusion:

In the changing world dynamics, the money has also to be evolved with time. The worldwide proposal for central-bank digital currencies, which could allow for money to be transferred between users without the involvement of a third-party (commercial bank) should be carefully calibrated and thereafter new legal framework to control and monitor it should be worked upon. 

[Ref: The Hindu Businessline, Indian Express]
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