A student-run group at NALSAR University of Law
The Ministry of Economic Affairs in its recent press release dated July 22, 2019, prepared a report on the Committee on Virtual Currencies, which proposed a ban on the so-called “private cryptocurrencies”.
The Government of India had constituted an Inter-Ministerial Committee (IMC) on November 2, 2017 under the Chairmanship of Shubash Chandra Garg (Secretary, Department of Economic Affairs) in order to study the issues related to virtual currencies and propose specific action to be taken in this matter. The committee recommended that all private cryptocurrency like Bitcoins should be banned due to the volatile nature of their price. Additionally, a fine of INR 25 Crore may be levied and imprisonment of up to 10 years may be awarded for carrying on activities associated with cryptocurrencies in India.
The report garnered a lot of negative attention, with the crypto community taking the view that it was extremely backward looking and had a regressive approach to such a futuristic concept. In order to recognize the impact of the announcement, it is necessary to first understand what virtual currency is.
A virtual currency is a digital representation of value that can be digitally traded and functions as (a) a medium of exchange, and/or (b) a unit of account, and/or (c) a store of value, but does not have legal tender status. A virtual currency is a private medium of exchange that does not in any way reflect a sovereign guarantee of the value or legal tender status. Virtual currency is therefore distinguished from the FIAT currency of a country that is designated as its legal tender. Cryptocurrencies are a subset of virtual currencies that is decentralized and protected by cryptography. Bitcoin is an example of a cryptographic virtual currency, and was the first of its kind.
Currently, the term “legal tender” finds expression under Section 26 of the RBI Act, which states that, “every bank note shall be legal tender at any place in India in payment or on account for the amount expressed therein, and shall be guaranteed by the Central Government”. The main point of difference between fiat currency and virtual currency is that while the former is expressly guaranteed by the Central Government, the latter does not provide for the same. In order for any virtual currency to be declared as legal tender, it would need to be expressly guaranteed by the Central Government. Only in that scenario would the parties be legally bound to accept it as a mode of payment.
In the third chapter of the report committed projected the idea of Central Bank Digital Currency (CBDC) that shall be the “Digital Rupee” to be the sole cryptocurrency in India having the following key attributes-
Having discussed the above, the Committee appreciated the regulatory concerns associated with virtual currencies. The topics relating to Distributed Ledger Technology (‘DLT’) and Blockchain were delved into deeply and their complexity duly recognized. DLT refers to technologies that involve the use of independent computers to record, share and synchronize transactions in their respective electronic ledgers. Keeping such distributed ledgers obviates the need for keeping the data centralized as is done in a traditional ledger, which is why DLT is extensively utilized by virtual currencies.
Primarily, a transaction under DLT refers to the transfer of ‘value’ from one to another, which could be a record of ownership of assets— money, security, land titles, etc. — or the record of specific information such as information about one’s identity or health. Blockchain, on the other hand, refers to a specific kind of DLT which uses codes to encrypt transactions and stack them up in blocks, creating Blockchains.
As mentioned above, the IMC recognizes the potential of DLT and Blockchain and acknowledges that the application of DLT is being explored in the areas of trade finance, mortgage loan applications, digital identity management or KYC requirements, cross-border fund transfers and clearing and settlement systems. To that effect, the Committee advised the Department of Economic Affairs to take necessary measures to facilitate the use of DLT in the entire financial field after identifying its uses, and further suggested that regulators such as RBI, SEBI, IRDA, PFRDA, and IBBI explore the idea of evolving appropriate regulations for development of DLT in their respective areas.
Consequently, the IMC is of the view that it “would be advisable to have an open mind regarding the introduction of an official digital currency in India”. It is pertinent to note that that the RBI Act has the enabling provisions to permit the central government to approve a “Central Bank Digital Currency” (CBDC) as legal tender in India.
While the use of technology in virtual currencies has multiple upsides, it is not without grave risk. The IMC was of the view that private cryptocurrencies lack the necessary attributes of a currency, such as a fixed nominal value that characterizes legal currency.
Another concern plaguing the committee is that non-official virtual currencies can be used to defraud consumers, particularly unsophisticated consumers or investors. The IMC gives the example of the Rs. 2,000 crore scam involving GainBitcoin in India where investors were duped by a Ponzi scheme. In addition to the above, it has been observed that certain volatility exists when dealing with such currencies. In a country where lakhs of traders get involved in such currencies, this could have huge implications. Secondly, the IMC is worried that if private cryptocurrencies are allowed to function as legal tender, the RBI would lose control over monetary policy and financial stability, as it would not be able to keep a tab on the money supply in the economy.
Also, the anonymity of private digital currencies poses a risk to law enforcement, due to the potential for its use in illegal activities such as money laundering and terrorist financing activities. The lack of grievance redressal mechanisms is another major issue, due to the irreversible nature of such transactions.
The IMC report promulgates that the government should consider an official digital currency in lieu of private virtual currencies or crypto coins and tokens. On the other hand, the committee notes the risks involved and volatility in the prices of private cryptocurrencies, which inevitably led to them recommending a ban on cryptocurrencies in India and imposing fines and penalties for carrying on of any activities connected with cryptocurrencies.
This has been subjected to backlash from private traders who have sharply criticized Section 2.7 of the Recommendations which states that “the Committee notes with serious concern mushrooming of cryptocurrencies almost invariably issued abroad and numerous people in India investing in these cryptocurrencies. All these cryptocurrencies have been created by non-sovereigns and are in this sense entirely private enterprises.”
The IMC has opined that these crypto-assets are not backed by any intrinsic value, which have not been recognized as a legal tender in any jurisdiction, but that’s not entirely true. Many cryptocurrencies, these days, are backed by petroleum, gold, as well as the US dollar in the case of Facebook’s Libra. The IMC does not make any differentiation among cryptocurrencies that are not backed by any central banks. The report presents energy consumption as an issue in the context of Bitcoin mining, however, the report does not delve into the numerous solutions suggested world over to curb this consumption. Cryptocurrencies have never been used as a legal tender or currency in India, nor was it the expectation of any crypto startup. It has always been traded as an asset, which is now being banned.
In reference to the same, the panel has asked the government to consider the launch of an official government-backed digital currency in India, to function like banknotes, through the Reserve Bank of India. Authorities in various countries are considering how to regulate cryptocurrencies, particularly after Facebook announced plans to launch one called Libra, because of risks to the financial system and consumer data. According to recent reports, Libra will not be launched in India due to the current Indian regulation of not endorsing private cryptocurrencies. While Libra is likely to have a massive impact on global e-commerce, it is in the money transfer space where it could be a potential game-changer.
Aside from an extremely brief inspection of the application of DLT in India, the report also includes the proposed bill banning crypto assets that will be presented to the Supreme Court as well. It remains to be seen whether the Supreme Court accepts or rejects the same in toto or comes up with their own guidelines on the issue.
Bitcoins have disrupted e-commerce not because of the idea of virtual currency but the peer- to-peer system it has developed. The USP of bitcoins was the decentralised structure of data entry. Any participant in the entire network can make an entry into the ledger if they follow certain rules. This reduced the dependence on trusted third-parties (Pay Pal, Master Card, etc.) or a centralised authority (governments). This has been made possible using an open database called Blockchain. This article will give a brief explanation of blockchain and the possible applications it can have across sectors.
Blockchain is a ‘distributed public ledger’ system which has records of every single transaction ever conducted using a bitcoin. The idea behind blockchain is very simple. All information during a given time-period is stored in a block with its hash – a cryptographically shortened version of the data set given. Each block acts like a page of the ledger. The hash of each block has to be related to the previous block turning it into a chain of blocks, hence the name. Any data once entered into a blockchain cannot be erased or modified. This makes the blockchain transparent and authentic, yet anonymous. The blockchain system has been created in such a way that any user or attacker with enough power to be able to tamper with the network will find it more favourable to become a part of the system and benefit from it rather than harm it.
One sector where blockchain can have a large influence is the financial sector. One of the major issues affecting large financial institutions is the lack of synchronisation of the ledgers within their own company and when they deal with other companies. The lack of centrally available data to all participants in the business leads to an increase of the need for trusted third-party intermediaries who offer unbiased dispute-resolution mechanisms. This problem increases as the number of units engaged in the same project increases. The data in a blockchain is chronologically listed and collectively maintained by all parties involved. The amount of computational power required to change any data in the ‘ledger’ is extremely high and will far outweigh the benefits derived from tampering the data. Use of this technology will also lead to a reduction in the need for an intermediary to decide the validity of the information. Embracing this technology will also reduce the friction between companies as they will operate from a single source of ‘truth’.
Digital asset management is another possible application for the blockchain technology. Bitcoins are not software/data actually getting transferred from one individuals account to another; they are simply a record that at some point your account received that bitcoin. This means that we can embed any asset to the blockchain network like securities, stocks, even fiat currency, discount coupons, tickets, etc. This will enable us to use a purely digital asset management system, with the advantages it provides for the end-user as it will make the transaction more secure and transparent. The other benefits of using the blockchain technology are the impossibility of creating counterfeits and auditability. The blockchain algorithm can also be embedded with the rules framed according to the regulatory bodies, which makes it all the more important for them to encourage the use of them.
Protecting intellectual property and preventing the creation of copies of a piece of art or music is also a possible use of blockchains. Startups like Ascribe provide notary services to artists and writers; they can upload their work and receive a digital key for it. The idea behind this is pretty straight forward, the author’s composition is added to the blockchain; this becomes a permanent proof that the author owns the work. Every time someone copies or uploads that work the creator gets to know about it. This would mean that at least at a theoretical level that there can be no duplicates without the creator’s permission, making licensing and transferring easier for the artists.
Last year around May, the government of Honduras has tied-up with a startup called Factom to keep up its land records using blockchains. The benefits for government authorities are as great as they are for corporations, creating a decentralised system for data entry for land records, vehicle registrations, patents and almost everything that requires a certain amount of permanence. Use of blockchains will also make transfer of information within governmental departments to manage their records within and between departments. A more radical idea proposed by some is making voting a purely online activity, by giving each individual a voting token and making the system more transparent and accessible. Use of blockchains in state machinery will lessen the inefficiencies generally associated with bureaucratic operations.
The system is self-regulating in terms of it not requiring any outside entities having to interfere or dictate the way the system has to work so as to ensure that every single participant remains honest and tries not take advantage of the system. It will also significantly lower the cost of spending on expensive intermediaries and will further facilitate the growth of a more connected and transparent mode of governance. This will also pave way for increasing accountability standards for state bodies and corporation towards citizens and shareholders respectively. The possible advantages of using blockchain make it very attractive system for governments and corporations to invest in and they should try the system to test it.