The Supreme Court of India (‘Supreme Court’) recently set aside a circular issued by the Reserve Bank of India (‘RBI’) on virtual currencies (‘VCs’) in its judgement dated March 4, 2020 (‘SC Judgement’) in Internet & Mobile Association of India v. Reserve Bank of India[1]. Amongst the various grounds of challenge raised in the petitions, the Supreme Court set aside the Circular only on the ground of proportionality, holding that RBI failed to establish how entities regulated by it have suffered any loss or have been adversely affected, directly or indirectly, on account of the interface that VC exchanges had with them. This was driven by the fact that trade in VCs itself was not illegal.

Brief Background

RBI issued a circular dated April 6, 2018 (‘Circular’) under which RBI directed its regulated entities not to deal in VCs or to provide banking related services for facilitating any person or entity in dealing with or settling VCs.

The Circular was challenged before the Supreme Court by way of writ petitions by affected parties, including an industry body representing the interests of online and digital services industry, i.e., the Internet and Mobile Association of India, and a few companies which run online VC exchange platforms along with the shareholders/founders of the companies and a few individual VC traders.

The SC Judgement is a significant step forward in regulating the financial technology (FinTech) space in India. It upholds and recognizes RBI’s vast powers in regulating, and even restricting, the interplay between its regulated entities and technological developments. Contemporaneously, the Supreme Court re-emphasizes the legal position that actions by the State resulting in an infringement of fundamental rights may be upheld for larger public interest, subject to such actions being supported by empirical evidence establishing the actual damage caused to meet the test of proportionality.

Key Takeaways from the SC Judgement

a.     Powers of RBI

RBI has very wide powers under the Banking Regulation Act, 1949, the Reserve Bank of India Act, 1934, and the Payment and Settlement Systems Act, 2007. RBI is not akin to any other statutory regulator. Its decisions in the economic domain, including its circulars, are supplemental to the statutes themselves.

While the Circular may have been struck down, the Supreme Court nonetheless recognized the wide and extensive powers of RBI in regulating the financial system, including the power to regulate any act that may pose a threat to or have an impact on the financial system of the country. RBI may do so by, among other things, taking preventive steps.

A hands-off approach entailing greater deference to RBI’s economic decisions ought to be applied by the judiciary. RBI’s circulars and decisions are sacrosanct in the economic sphere and should not be susceptible to stray challenges. However, empirical evidence and material in support of the concerns highlighted by RBI would be beneficial.

b.     Regulation of VCs by RBI

While VCs have not acquired the status of legal tender, they nevertheless constitute digital representations of value as they are capable of functioning as: (i) a medium of exchange; (ii) a unit of account; and/or (iii) a store of value. VCs are capable of performing some or most of the functions of real currency.

RBI has the power to regulate or restrict VCs as VCs, being methods of payment for goods and services, have the potential to interfere with matters within RBI’s regulatory domain.

RBI also has the power to direct ‘Know Your Customer’ (‘KYC’) compliance and can decide how best to carry it out. Accordingly, the Supreme Court rejected the self regulation KYC approach adopted by the VC exchanges, as it did not unravel the anonymity associated with VCs.

c.     Proportionality and Safeguarding Fundamental Rights under Article 19(1)(g)

The Supreme Court observed that banking channels provide the lifeline of any business, trade or profession, particularly in light of restrictions on cash transactions contained in Sections 269SS and 269T of the Income-tax Act, 1961. The denial of banking channels would result in the closure of trade or business. Accordingly, only larger public interest warranted such a serious restriction in the first place.

In this background, the Supreme Court applied the ‘least intrusive measure test’ to judge the proportionality of the Circular.

The Supreme Court observed that RBI had not, in the past five years or more, found the activities of VC exchanges to have an actual adverse impact on the way the entities regulated by RBI function. Only persons dealing with VC exchanges were irreparably affected, whereas, persons trading in VCs continue to have various options to procure, store, utilize and transfer VCs. It was also observed that VCs are still not banned, but trading in VCs and the functioning of VC exchanges were prevented by the Circular by disconnecting their lifeline, namely, the interface with the regular banking sector.

Accordingly, the Supreme Court held that there was no empirical evidence to suggest how entities regulated by RBI have suffered any loss or have been adversely affected, directly or indirectly, on account of the interface that VC exchanges had with them. Thus, the Supreme Court set aside the Circular as disproportionate on the lack of any damage suffered by RBI’s regulated entities.

Conclusion and the Way Forward

In view of the SC Judgement, RBI’s regulated entities are no longer restricted from providing banking related services, including maintaining accounts, trading, granting loans against virtual tokens, accepting virtual tokens as collateral, opening accounts of exchanges, dealing with them and the transfer / receipt of money in accounts relating to purchase/ sale of VCs.

While trading between VCs (without use of rupee payments for settlement) had continued despite the Circular, services focused on converting VCs like Bitcoins and Ethereum to fiat currency can now be provided in India. Hence, the SC Judgement allows access to the banking system for persons dealing with VCs. Banks may also allow customers to link bank accounts to VC exchanges / platforms.

Given the fact that an Inter-Ministerial Committee has already proposed a Bill prohibiting and criminalizing private VCs in India, i.e., the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019, the approach of the Government of India towards VCs is still uncertain. It remains to be seen how VCs will be adopted by the banking and finance sector.

[1] W.P. (C) No. 528/2018. Tagged with Rajdeep Singh & Ors. v. Reserve Bank of India, W.P. (C) No. 373/2018.