An extract from The Virtual Currency Regulation Review - 2nd edition

Introduction to the legal and regulatory framework

The Indian population has shown significant interest in virtual currencies. Prior to a major regulatory restriction that was introduced in April 2018, there were estimated to be around 5 million traders in India in 24 exchanges, with trading volumes in the range of 1,500 bitcoins a day.

As the law currently stands, there is no clear definition of virtual currencies, crypto assets or cryptocurrencies in India. The single regulation directly on the subject of virtual currencies is a circular (the VC Circular) issued by India's central bank, the Reserve Bank of India (RBI), which restricts the use of regulated banking and payment channels for the sale and purchase of virtual currencies. The VC Circular is currently under challenge before the Supreme Court of India on constitutional grounds.

Prior to the VC Circular, the RBI and the Ministry of Finance had issued warning statements about the risks associated with virtual currencies, including money laundering, consumer protection, market integrity, cybersecurity and volatility.

This shows that so far, the key government bodies, namely the government and the RBI, have significant reservations with respect to the usage of and trade in virtual currencies in India.

In July 2019, an Inter-Ministerial Committee established by the Ministry of Finance released a report on a proposed regulatory approach towards distributed ledger technology and virtual currencies. The committee has recommended an outright prohibition, along with criminal penalties, on dealing with virtual currencies. It has also recommended the promotion of distributed ledger technology without the use of virtual currencies, and the exploration of a sovereign digital currency. The committee's recommendation is non-binding and is currently under consideration by the government.

Currently, there is no express law that classifies a virtual currency as a good, service, security, commodity, derivative or currency. The categorisation of virtual currencies into one or more of these stated classes is important, as the existing law would apply differently based on the categorisation.

At the time of writing, there are over 2,000 virtual currencies in existence, all with differing properties, and their categorisation depends on their nature. For instance, some are intended to be electronic cash (e.g., Bitcoin) and some are intended to be 'gas' for computer processing operations (e.g., Ether).

In our view, for the reasons described in Section X, it is likely that virtual currencies in the nature of Bitcoin and Ether will be in the nature of goods or digital products, akin to software.

As there is no specific legislation regulating virtual currency, the laws referred to in this chapter are all of general application and we have interpreted them in the context of virtual currency.

Looking ahead

The law in India on virtual currencies is in flux. There is a pending Supreme Court case against the VC Circular, as well as a multi-stakeholder government committee that has now submitted its report to the government, as discussed in Section I. In our view, the report's recommendation of an outright ban, along with criminal penalties, is excessive, as the risks involved with virtual currencies can be addressed with less invasive measures. International bodies such as the G20 and the Financial Action Task Force, and leading jurisdictions such as the European Union, Singapore, the United Kingdom and the United States, have all proposed regulatory approaches to address the risks, so that the benefits are not lost out on.

Prior to the committee report, the government made several pro-blockchain statements in various reports and press statements, but continually cautioned against the risks associated with virtual currencies.

In our view, blockchain as a system would be rendered either impotent or severely restricted (depending on the blockchain implementation) without any virtual currency or crypto-token. This has been recognised by several global experts, including Ethereum co-founder Vitalik Buterin and author Andreas Antonopoulos. These tokens act as an incentive to blockchain participants to verify transactions, and hence preserve decentralisation, which is the very breakthrough of blockchain technology. As a result, it may not be a wise policy to try to promote blockchain on the one hand, and then severely restrict tokens on the other.

The current stance espoused by the VC Circular appears to be borne from a negative impression that media reports may have created after incidents of fraud, such as the WannaCry ransomware, activities on the dark web and certain Ponzi schemes. However, virtual currencies also bring with them several benefits, most notably disintermediation and cost savings. Outright restrictions on this technology are impractical and might be relatively straightforward to circumvent. Rather, as with all disruptive technologies, balanced regulation should be adopted to mitigate the risks and promote the benefits. It is our hope that any impending government decision recognises this fact, and adopts a nuanced framework towards this.

Some uncertainty may continue to prevail in India until industry and regulatory understanding matures both domestically and globally; however, our long-term view is positive. The implementation of successful regulatory models in other jurisdictions should also hasten progress towards a balanced regime.