The Indian government is contemplating introducing legislation to ban crypto-currency trading, mining and investments in the country. At the same time the proposed legislation will pave the way for the Reserve Bank of India (RBI) to create a Central Bank-backed Digital Currency (CBDC). While the government’s decision to ban crypto-currency trading in India is still at an incipient stage, the final contours of the bill would depend on industry consultations and stakeholder feedback.
Here is a complete guide to crypto-currency regulation in India.
Evolution of domestic crypto-industry
Prior to the RBI’s April 2018 circular, which barred the banking system from providing services to crypto-firms in India, the crypto-industry was fairly un-regulated and represented a ‘free market’ in many respects. Once the RBI circular came into play, several companies facilitating crypto-trading had to shut down or move abroad. Those that continued to operate moved to a Peer-2-Peer settlement system to facilitate trading, since formal banking and payments companies would not do any business with them.
The industry, under the aegis of the Internet and Mobile Association of India, went to court challenging the RBI’s circular and in March last year, the Supreme Court struck down the circular stating that its regulatory action was ‘disproportionate’. Thereafter, banks and payment companies began opening up their services to crypto-exchanges and other firms in India as the RBI did not issue a fresh circular or direction surrounding the efficacy of crypto-currency trading.
The fact that there is no regulatory status afforded to the domestic crypto-currency industry, and no ban erected against such activities, all domestic crypto-exchanges saw a significant jump in their user-base. Between March and December 2020, trading volumes across the top 4 Indian crypto-exchanges grew by 500%.
According to research by global crypto currency exchange, Paxful, India is the second biggest Bitcoin nation in Asia, after China, and the sixth biggest in the world, after the United States, Nigeria, China, Canada and the United Kingdom. Between January 1 and November 14, 2020, close to $74.92 million Bitcoins were traded on Paxful by Indian investors, which is 347% higher than the previous year, it said.
CBDCs versus crypto-currencies
Unlike crypto-currencies which are issued without a central bank backing and are issued and traded on exchanges, a CBDC is a digital currency which holds the same value as fiat currencies issued by a country’s central bank. The value of the CBDC is pegged to the value of the fiat currency. The ‘private’ crypto-currencies include Bitcoin, Ethereum and Ripple, among many others.
While crypto-currencies can be used as a currency or as a means of exchange/payment, regulators across the world have adopted different approaches. Most regulators around the world treat the majority of crypto-currencies as investment vehicles, like in the case of the Securities and Exchange Commission of the United States. But since Bitcoins can be used as payment instruments in Singapore and Japan, the central bank in each country is in charge of issuing regulations for the use of cyrpto-currencies like Bitcoin as a means of exchange.
It is important to note that each crypto-currency can have several use-cases. While Bitcoin can be used as a means of payment, it behaves like a stock and is traded every day for the potential returns on their investment. Other cryptos like Ethereum and Ripple, which are also traded for investment returns, are building blockchain-based infrastructure and tools.
A CBDC can take many forms. It can be issued on blockchain ledger like regular crypto-currencies, or through a demat account or a specific payments instrument. There can be retail CBDCs, which would be accessible to all types of consumers, or wholesale CBDCs that are meant only for institutions. There are three models of issuing CBDCs:
- Direct: issued by a central bank to banks and then to consumers; the claim on CBDC payments is on the central bank
- Indirect, wherein digital currencies are issued by banks to customer; the claim on CBDC payments is on the bank or market players
- Hybrid: market players on-board customers and issue CBDCs; the claim on payments is on the central bank
Among the leading central banks of the world, the People’s Bank of China was the first major central bank to announce it would experimenting with a CBDC. This, along with Facebook’s Libra project, has prompted other leading central banks to explore doing the same.
According to a January 2020 survey covering 66 central banks by the Bank of International Settlements, 80% of central banks across the world were engaged in research and experimentation of a CBDC. Around 40% of the central banks surveyed had progressed from conceptual research in 2018 to experiments or proofs of concept (PoC) stage, while another 10% have developed pilot projects in 2019, the survey said.
The Bank of Canada, the Federal Reserve, the Bank of England and the Bank of Japan, have respectively announced that they are are evaluating the contours of issuing a CBDC, while the European Central Bank is working on launching Digital Euro project sometime in 2021. Further, according to recent reports in Cointelegraph, Lithuania launched its CBDC in July this year for limited purposes, Sweden has been undertaking a year-long pilot test for its CBDC since February this year, Cambodia‘s CBDC is in the final stages of development, South Korea will launch its pilot CBDC scheme next year and Brazil could develop its CBDC by 2022. The Bahamas became the first country in the world to start issuing CBDCs.
Regulatory and legal developments
- December 24, 2013: RBI cautions users about risks of Virtual Currency, as their value is a matter of speculation and not underpinned by an asset or good. [RBI December 24, 2013 Press Release]
- August 26, 2015: R Gandhi, deputy governor of the RBI at the time, expresses concern over crypto-currencies, stating that they have the potential to support criminal activities in money laundering, terrorist funding and tax evasion.
- February 1, 2017: RBI issues second advisory cautioning users, holders and traders of virtual currencies again. [RBI February 1, 2017 Press Release]
- February 27, 2017: Crypto-firms establish Digital Assets and Blockchain Foundation of India
- April 12, 2017: Government sets up an Inter Disciplinary Committee to study crypto-currencies and the growth of virtual currencies
- August 7, 2017: Inter-Disciplinary Committee submits report. The report was not made public
- November, 20 2017: PIL filed before the Supreme Court seeking regulation of crypto-currencies
- December 5, 2017: RBI issues third advisory cautioning people about the risk of virtual currencies. [RBI December 1, 2017 Press Release]
- December 29, 2017: Ministry of Finance compares crypto-currencies to Ponzi Schemes, cautions users that virtual currencies are not legal tender in India and to not invest in them.
- February 1, 2018: Former Finance Minister Arun Jaitley says that crypto-currencies are not legal tender, and cannot be used as part of the payment systems. The government will come down heavily if someone does, and crypto-currencies will not be allowed as they can be used for illegitimate activity. [Union Budget Speech 2018-19]
- April 5, 2018: RBI says it is planning to prohibit its banking and related entities from dealing with crypto-currencies. [RBI Statement on Developmental and Regulatory Policies April 5, 2018
- April 6, 2018: RBI issues circular barring banks from dealing with crypto-firms and virtual currencies. “Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase/ sale of VCs,” it said. [RBI Circular April 6, 2018: Prohibition on dealing in Virtual Currencies (VCs)]
- April 23, 2018: Delhi High Court admits a petition challenging the RBI’s circular and issues notice to the central bank, the Ministry of Finance and GST Council on the matter. [Read]
- June 13, 2018: Right-To-Information filing reveals that RBI’s April 6, 2018 circular, that prevented banks and other regulated entities from dealing with virtual currencies, was not backed by public consultation or independent research. [Read]
- July 5, 2018: Supreme Court refuses to grant interim relief on an RBI circular which barred all regulated entities from dealing in virtual currencies. [Read]
- August 28, 2019: RBI sets up inter-departmental group to study the desirability and feasibility to introduce a CBDC. [RBI Annual Report 2017-18]
- February 28, 2019: Finance Ministry committee on virtual-currencies recommends banning crypto-currencies in India and suggests creating a digital Rupee. [Report of the Inter-Ministerial Committee on Virtual Currencies]
- The committee prepares a draft bill banning all crypto activity in the country, punishable with fine of up to ₹25 crore or with an imprisonment term of one to ten years, or both. This was never approved by Parliament. [Draft Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019]
- December 4, 2019: RBI Governor Shaktikanta Das says it is very early to speak on CBDCs. [RBI Media Presentation for the Fifth Bi-Monthly Monetary Policy Press Conference 2019-20]
- March 4, 2020: Supreme Court of India overturns RBI’s April 2018 circular on the grounds of proportionality. “While we have recognized elsewhere in this order, the power of RBI to take a pre-emptive action, we are testing in this part of the order the proportionality of such measure, for the determination of which RBI needs to show at least some semblance of any damage suffered by its regulated entities. But there is none,” the apex court said. [IAMAI vs Reserve Bank of India, March 4 2020, Supreme Court of India]
- January 25, 2021: RBI says it is exploring the possibility as to whether there is a need for a digital version of fiat currency and in case there is, then how to operationalise it. [RBI Booklet on Payment Systems in India 2021]
- January 30, 2021: The government plans to introduce the The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 during the Budget session of Parliament in 2021. [Lok Sabha Bulletin Part II]
Since announcing the proposed crypto-ban bill in early 2021, there have been numerous regulatory developments:
- February 9: Government says new law to ban crypto-currencies being finalised [Read]
- February 12: Industry experts say a CBDC or stablecoin model will give regulators adequate powers of oversight and monitoring [Read]
- February 16: IAMAI questions governments’ pre-emptive ban on ‘private’ cryptos [Read]
- February 19: Government says that it will levy Income Tax and Goods and Services Tax (GST) on commissions and trading gains made from trading crypto-currencies [Read]
- February 22: Securities and Exchange Board of India tells promoters to square their crypto-currency investments before they launch an initial public offer or other capital raising instruments [Read]
- February 24: IAMAI finalises Code of Conduct for crypto-currency firms in India [Read]
- March 8: Finance Minister says the government will adopt a ‘calibrated approach’ to crypto-currency regulations [Read]
- March 11: IAMAI publishers white-paper highlighting the negative effects of a crypto ban [Read]
- March 15: Finance Minister says that the proposed crypto-bill will allow experiments’ in crypto-currencies [Read]
- March 22: Government says it is considering block IP addresses of prominent crypto-currency exchanges after a three to six month moratorium window for investors [Read]
- March 23: Nandan Nilekani says that government should treat crypto-currencies as an asset class [Read]
- March 23: Government tells Parliament that the Income Tax authority will tax capital gains on crypto-investments, while the and GST authority will tax fees earned by exchanges [Read]
- March 25: Government amends company financial disclosure rules mandating companies to disclose crypto-holdings, investments and funds received from end investors [Read]
- April 12: Bengaluru-based technology think-tank iSpirt says that by leveraging India Stack, Indian small-medium businesses can tap large amounts of crypto-capital [Read]
- May 4: Leading private sector banks begin shutting accounts and payments channels for crypto-exchanges [Read]
- May 7: IT industry body IndiaTech.org recommends that the government enact traceability provisions as part of crypto-currency regulations [Read]
- May 16-18: Crypto-exchanges face bank and payment issues, leading to them stopping fresh investor deposits [Read]
Policy recommendations
- September 2017: Bank for International Settlements (BIS) releases paper on the efficacy of CBDCs. The paper says that “central banks will have to consider not only consumer preferences for privacy and possible efficiency gains – in terms of payments, clearing and settlement – but also the risks it may entail for the financial system and the wider economy, as well as any implications for monetary policy.”
- March 2018: BIS releases a comprehensive report on CBDCs.
- June 2018: In its annual report, the BIS says the rise of crypto-currencies raises new challenges and potentially call for new tools and approaches for regulators. This dilemma on how to regulate crypto-currencies arises as authorities want to protect the integrity of markets, payment systems, consumers and investors, they also want provide incentives for innovation.
- 2019: Cambridge University Centre for Alternative Finance publishes study on Global Cryptoasset Regulatory Landscape.
- June 2019: Financial Action Task Force publishes Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers. The report highlights various approaches across countries towards regulating and supervising virtual asset activities and virtual asset service providers to prevent their misuse for money laundering and terrorist financing.
- 2020: Cambridge University Centre for Alternative Finance publishes study on Legal and Regulatory Considerations for Digital Assets.
- March 2020: BIS releases paper on technology standards for retail CBDCs. “The consumer’s need for cash-like payment safety means that a CBDC must be secure not only from the insolvency or technical glitches of intermediaries, but also from outages at the central bank. The choice is whether to base this infrastructure on a conventional centrally controlled database or instead on DLT – technologies that differ in their efficiency and degree of protection from single points of failure,” it said.
- May 2020: Former finance secretary Subhash Chandra Garg reiterates his stance on private crypto-currencies and says that creating a Digital Rupee through digital wallets, instead of blockchain based technology, would be more cost effective.
- June 2020: Ripple Inc. publishes policy paper on Digital Assets regulation in India. “Policy options like foreclosing banking system access to digital assets service providers, or other forms of outright (direct) prohibition of businesses dealing with digital assets will have the effect of pushing this ecosystem outside the regulatory perimeter, and perversely, further reduce the visibility regulatory authorities have on transactions in digital assets. Such a ‘shadow crypto economy’ is a far greater source of risks to financial stability and law and order of a country,” it said. [Ripple Inc. June 2020: The Path Forward For Digital Assets Adoption In India]
- July 2020: G30 Working Group releases report on Digital Currencies and Stablecoins. It says that Central Banks and Finance Ministries should play an active leadership role in setting standards and providing public infrastructure for payments, and must ensure there is a balance between protecting individual data versus the government’s imperative to enforce laws, regulations, and taxes.
- October 2020: BIS issues a paper on standards and principles to be followed by central banks when designing CBDCs. “Authorities would first need to be confident that issuance would not compromise monetary or financial stability and that a CBDC could coexist with and complement existing forms of money, promoting innovation and efficiency,” it said.
- October 2020: Global Legal Insights publishes 3rd edition of Blockchain and Crypto-currency regulation for 2021, studying the regulatory approach and industry developments in 21 jurisdictions.
- January 2021: CREBACO and Khaitan and Co. publish recommendations for regulating crypto assets in India. The report suggests that the government could either amend existing regulations to make them applicable to crypto assets or create a separate and dedicated legislation to govern crypto assets, which would include a self-contained code and an independent regulatory to govern the crypto industry.
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