Cryptocurrency and its future prospects in India

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Context: Supreme Court has set aside an RBI ban on banks dealing with virtual currency holders. How do these currencies work, how did the court rule on the RBI concerns, and what happens after the ban is lifted?

Relevance:
Prelims: Current events of national and international importance
Mains: GS III- 

  • Science and technology- developments and their applications and effects in everyday life.
  • Achievements of Indians in science & technology; indigenization of technology and developing new technology.
  • Awareness in the fields of IT, Space, Computers, robotics, nanotechnology, biotechnology and issues relating to intellectual property rights.

Background

In a circular in 2018, the RBI had banned banks from dealing with virtual currency exchanges and individual holders on the grounds that these currencies had no underlying fiat and that it was necessary for the larger public interest to stop banks from providing any services related to these.

What are virtual currencies? Are they different from cryptocurrencies?

  • There is no globally accepted definition of what exactly is a virtual currency.
  • Some agencies have called it a method of exchange of value; others have labeled it a goods item, product or commodity.
  • Virtual currency is a type of unregulated digital currency that is only available in electronic form.
    • It is stored and transacted only through designated software, mobile or computer applications, or through dedicated digital wallets, and the transactions occur over the internet through secure, dedicated networks.
    • Virtual currency is considered to be a subset of the digital currency group, which also includes cryptocurrencies, which exist within the blockchain network.
  • Satoshi Nakamoto, widely regarded as the founder of the modern virtual currency bitcoin and the underlying technology called blockchain, defined bitcoins as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party”.
    • This essentially meant there would be no central regulator for virtual currencies as they would be placed in a globally visible ledger, accessible to all the users of the technology.
    • All users of such virtual currencies would be able to see and keep track of the transactions taking place.
  • Virtual currency is the larger umbrella term for all forms of non-fiat currency being traded online.
  • Virtual currencies are mostly created, distributed and accepted in local virtual networks. Cryptocurrencies, on the other hand, have an extra layer of security, in the form of encryption algorithms.
  • Cryptographic methods are used to make the currency as well as the network on which they are being traded, secure.
  • Most cryptocurrencies now operate on the blockchain or distributed ledger technology, which allows everyone on the network to keep track of the transactions occurring globally.
  • Virtual currency is different than digital currency since the digital currency is simply currency issued by a bank in digital form.
  • Virtual currency is unregulated and therefore experiences dramatic price movements since the only real force behind trading is consumer sentiment.

Are cryptocurrencies dangerous?

  • Organizations across the globe have called for caution while dealing with virtual currencies.
  • They have also warned that a blanket ban of any sort could push the entire system underground, which in turn would mean no regulation.
  • 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.
  • The following year, the Financial Action Task Force came out with a report that highlighted both legitimate uses and potential risks associated with virtual currencies.
  • In a different report, it again said the use of such virtual currencies was growing among terror financing groups.

Why did the RBI ban virtual currencies?

  • Owing to the lack of any underlying fiat, episodes of 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 its arguments in the Supreme Court, the RBI said it did not want these virtual currencies spreading like a contagion, and had, therefore, in the larger public interest, asked banks not to deal with people or exchanges dealing in these non-fiat currencies.
  • The RBI argued that owing to a “significant spurt in the valuation of many virtual currencies and rapid growth in initial coin offerings”, virtual currencies were not safe for use.
  • However, petitioners told the Supreme Court that the RBI action was outside its purview as the non-fiat currency was not a currency as such.
    • They also argued that the action was too harsh and there had been no studies conducted either by the RBI or by the central government.

What did the Supreme Court rule?

  • In its 180-page judgment, the Supreme Court held that the RBI directive came up short on the five-prong test to check proportionality-:
    1. the direct and immediate impact upon fundamental rights;
    2. the larger public interest sought to be ensured;
    3. the necessity to restrict citizens’ freedom;
    4. inherent pernicious nature of the act prohibited or its capacity or tendency to be harmful to the general public;
    5. the possibility of achieving the same object by imposing a less drastic restraint.
  • The apex court said the right to create something that doesn’t violate any existing rule is an unsaid fundamental law.
  • Hence, citizens have the right to create a new industry of cryptocurrencies and exchanges along with the fundamental right to trade, it said. 
  • The bench also said that the central bank hadn’t demonstrated that trading in such currencies was damaging to the entities it regulated.
  • Apart from domestic agencies, the RBI could not be faulted for not adopting a “light-touch” approach as adopted by other countries, the court said, adding that there could be no comparison with other countries such as the US, the UK, Japan, or Singapore as they were developed economies.
    • Therefore, it will not test the correctness of the measure taken by RBI on the basis of the approach adopted by other countries.
  • The Supreme Court observed, “Every court which attempted to fix the identity of virtual currencies, merely acted like the 4 blind men in the Anekantavada philosophy of Jainism, who attempt to describe an elephant, but end up describing only one physical feature of the elephant.”


What happens now?

  • The Reserve Bank of India (RBI) is planning to file a review petition in the Supreme Court against the quashing of the central bank circular aimed at curbing cryptocurrencies.
  • The central bank is concerned that the apex court’s decision on Wednesday could pave the way for trading in virtual currencies and put the banking system at risk.
  • Several cryptocurrency platforms that had shifted base to Singapore and elsewhere after the RBI circular that was issued on April 6, 2018, are now looking to move back to India.
  • This may also mean that banks will allow customers to link bank accounts to cryptocurrency platforms, facilitating trading.
  • The Supreme Court’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.
  • In a way, the verdict upholds the legality of cryptocurrencies and decriminalizes the investors who have already invested in various crypto assets like bitcoin, ether, and various others.
  • The verdict removes the arbitrariness of regulatory actions without disregarding the power of RBI to regulate.
  • Cryptocurrency exchanges in India can now legally operate for fiat-to-crypto trading pairs as well, in addition to crypto-to-crypto pairs. It remains to be seen how soon the banks will start supporting the exchanges.



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