On 31 October 2008, Satoshi Nakamoto, a presumed pseudonymous person(s), presented a paper titled "Bitcoin: A Peer-to-Peer Electronic Cash System". The intention was to create a decentralized digital currency that would operate without a central bank through an open-sourced network using cryptography to verify and validate transactions. There would, under this model, be no need for any intermediaries, and each transaction would be recorded on a public ledger called a blockchain. At least since 1983, when an American cryptographer David Chaum introduced an anonymous cryptographic digital money called "ecash", efforts had been made by many persons to create an alternative to fiat money, that is currencies which derive their value through government regulation. But the invention of Bitcoin was the first time a real breakthrough was made.
Since then, various other cryptocurrencies have cropped up, each using blockchain technology to record the transactions. The social media giant Facebook announced in June 2019 that it intended to launch its open form of cryptocurrency, Libra. In India, after the launch of Bitcoin a number of cryptocurrency exchanges began to operate. But they were working in what was really a regulatory vacuum. There was not only no clear definition of what a cryptocurrency was but there was also no law that prohibited or regulated their use. This situation prevailed until April 2018, when the Reserve Bank of India issued a circular, not banning the use of crypto currencies themselves, but the provision of banking services to any person who dealt with such currencies. This effectively meant, though, that any exchange which facilitated the use of cryptocurrencies stood thwarted. But now, in what might come as a temporary relief, if nothing else, to those who deal in these currencies, the Supreme Court has, in Internet and Mobile Association of India v. RBI, quashed the RBI's circular.
In a 180-page long judgment, authored by Justice V. Ramasubramanian, the court found that while the RBI has the power to regulate Virtual Currencies [VCs], the prohibition imposed through the April 2018 circular is disproportionate, and, therefore, ultra vires the Constitution. In the court's belief, in the absence of any legislative proscription, the business of dealing in these currencies ought to be treated as a legitimate trade that is protected by the fundamental right to carry on any occupation, trade or business under Article 19(1)(g) of the Constitution. According to the court, the RBI's circular, in imposing a wholesale moratorium on the provision of banking services to these dealers, unreasonably impinged on what is otherwise a valid vocation, by going beyond the limitations permitted under Article 19(6).
As the Court recognized in its judgment, the circular, issued on 6 April 2018, was a culmination of a series of measures undertaken by the RBI concerning the regulation of VCs. In 2013, the RBI first began to take stock of the proliferation of these currencies, and in June that year it released a Financial Stability Report in which it defined VCs as "a type of unregulated digital money, issued and controlled by its developers and used and accepted by the members of a specific virtual community" In December of the same year, the RBI issued a caution to the users, holders and traders of VCs, which, it said, would include Bitcoins, about the potential financial, legal, and security related risks that they were exposing themselves to, and also pointed out that the RBI was in the process of examining the very legality of the use of these currencies. More press releases followed, before an Inter-Disciplinary Committee, set up by the Government, released a report in July 2017. In this, the committee, once again, advised against dealership in VCs. What is more, the committee also made a recommendation to the government seeking legislative changes that would make the "possession, trade and use of crypto-currencies expressly illegal and punishable."
But, as is clear, there was, in fact, no law that banned the use of VCs, and that made trading in them illegal. Even as on the date of the judgment, while draft bills had been shared and circulated, with a view to bringing about legislation banning the use of cryptocurrencies, there was no statutory command expressly debarring their use. But the RBI through its circular had, for all practical purposes, put an end to the use of VCs in India by severing the ties between the cryptocurrency market and formal Indian economy.
Two different petitioners went to court against this move. One, the Internet and Mobile Association of India, a non-profit group that aims to represent the interests of the online and digital services industry, and two, a group of corporations that were in the business of running of crypto exchange platforms. Broadly, both the petitioners attacked the circular on the following grounds: first, that VCs are not legal tender but tradeable commodities and therefore that they fell outside the RBI's regulatory ambit; and second, even assuming VCs were amenable to regulation by the RBI, the circular nonetheless disproportionately impinged on the petitioners' rights. While the former ground proved unsuccessful, the court accepted the latter. These findings, as we will see, are likely to have serious long-term ramifications.
In the petitioners' contention, VCs were neither money nor any other form of legal tender. They were, on the contrary, goods/commodities that fell entirely outside the purview of the legislation under which the impugned circular had been issued, that is the RBI Act, 1934, the Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007. Therefore, according to them, the RBI lacked the authority to regulate these currencies.
The court, in responding to this contention, analysed the role and the power of the RBI under these statutes, and sought to determine whether VCs did, in fact, fall within the scope of that power or not. In engaging in this analysis, it noted a rather thorny difficulty: that VCs eluded precise definition. While there were some who described the currencies as an exchange of value, and while some others called it a stock, there were many that pronounced it as a good/commodity. There was a belief that this lack of precise definition could easily see VCs slip out of all regulatory control. Therefore, one ought to examine, the court believed, what the basic, foundational objective of these currencies was.
From a reading of Nathaniel Popper's book, "Digital Gold: The Untold Story of Bitcoin" the court noted that even Satoshi Nakamoto saw cryptocurrencies as a "digital analog to old-fashioned gold, a new kind of universal money that could be owned by everyone and spent anywhere." Hence, the currency's very design was aimed at creating a "cleverly constructed decentralized network without central authority." Moreover, Nakamoto itself, the court observed, had defined bitcoin as a "new electronic cash system that's fully peer-to-peer, with no trusted third party." The judgment found that this basic objective had promoted states across jurisdictions to treat VCs—even though they had not acquired the status of a "legal tender"—as "digital representations of value." But even still, did this mean VCs are money? And ought that to matter, in deciding whether the RBI could regulate it?
Traditionally—in a theory which harks back to the time of Aristotle—money has been seen as anything that can serve as (a) a store of value, which means people can use it as an asset that can be saved, retrieved and exchanged at a later time; (b) as a unit of account, that is a measure to provide a common base for prices; and (c) as a medium of exchange, not as a commodity, but as something that persons can use to intermediate the swapping of goods and services. In the case of the Indian rupee, for example, it fulfils all three of these conditions. But the rupee represents that form of currency, which is typically referred to as "fiat" money, that is money whose value has been determined by the state. The fixing of this value, as the writer John Lanchester puts is, is "act of faith". Under this conception, a Rs. 10 note is worth what it is because of what the state claims its value to be.
If one were to use this definition, VCs too would likely fall within the meaning of money. They may not yet work well enough as a store of value or as a means of exchange, and given that they operate through a blockchain—which has no central server and uses digital, cryptographic technologies to authenticate a transaction—it is possible that they might never come to act as a real substitute for money. But that they have elements of each of the fundamental features of money means, as the court has held here, that they ought to be treated as such. The petitioners, however, contended that a fourth element has been added to the existing definition of money, and that for something to constitute money today it ought to also serve as a means towards the final discharge of a debt or as standard for deferred payment. In their belief, VCs did not fulfil this fourth function, either in the sense of being regarded as money by society or as being understood as money under the law.
The Court rejected this argument. It held that as long as there are certain institutions who accept VCs as valid payment for the purchase of goods and services, it was sufficient to bring the currencies within the regulatory power of the RBI. "Anything that may pose a threat to or have an impact on the financial system of the country," the judgment held, "can be regulated or prohibited by RBI, despite the said activity not forming part of the credit system or payment system." This power to regulate, the Court added, also included the power to prohibit. And, in any event, what was prohibited here wasn't the very act of trading in VCs, but merely the provision of banking services to those who trade in VCs.
Having answered the first question thus, the court proceeded to examine whether the practical prohibition of VCs that resulted from the circular unreasonably impinged on the fundamental rights of those who used and traded in VCs, and of those who facilitated such use and trade. On this, there were four primary arguments that were made. First, it was argued that the Section 35A of the Banking Regulation Act required RBI to "satisfy" itself, among other things, that "public interest" or "the interest of banking policy" required it to issue directions. In this case, the petitioners said, no such "satisfaction" had been arrived at. In other words, the RBI, according to them, had failed to apply its mind. The court rejected this argument outright. At least from June 2013 onwards, the RBI, it held, had been studying the use of VCs and pondering over what action ought to be taken.
Second, the petitioners argued that the exercise of power in this case was colourable. In making this argument, they relied, on a reply to an RTI query, in which the RBI had claimed that it had no power to freeze the accounts of defaulting companies or of shell companies. But as the court held here, what the circular did was not to freeze bank accounts, but to simply order entities regulated by the RBI from exiting any relationship that they might have with a person or entity that deals with VCs.
Third, the petitioners argued that the RBI had sought to illegitimately improve its case by supplying reasons for the circular through counter affidavits and submissions. Here, the court held that while the test employed in MS Gill v The Chief Election Commissioner (1978) prohibits an authority from improving its case—in that the impugned order should speak for itself—the court is always free to examine subsequent materials in larger public interest. In this case, the court had expressly directed RBI to issue a detailed reply to representations made by the writ petitioners, and, therefore, the argument based on MS Gill could not be sustained.
Fourth, the petitioners argued that the circular did not meet the test of proportionality. By virtually choking into submission any VC exchange, the circular, according to them, infringed the right to practice any profession, or to carry on any occupation, trade or business, contained in Article 19(1)(g). While this right can be restricted through reasonable measures imposed in the "interest of the general public" under Article 19(6), such measures must conform to the doctrine of proportionality.
This test, as it exists in India, was first expounded by a constitution bench in Modern Dental College and Research Centre v. State of Madhya Pradesh (2016). There, the court held, that this doctrine is inherent in Article 19 and partakes four separate lines of analyses: (1) that the measure has to be designated for a proper purpose; (2) that the measure undertaken is rationally connected to the fulfilment of that purpose; (3) that there are no alterative and less intrusive measures available that may similarly achieve that same purpose with a lesser degree of limitation; and (4) that there needs to be a proper relation between the importance of achieving the aim and the social importance of preventing the limitation on the constitutional right.
Having noted that the proportionality test represents the relevant standard—and the judgment needs to be commended for this, given how rare it is that our apex constitutional court respects its own precedents—the court then plunged not into an analysis of the four prongs and whether they were met by the circular but rather into a consideration of the UK Supreme Court's verdict in Bank Mellat v. HM Treasury (No. 2) (2013). Bank Mellat concerned the Financial Restrictions (Iran) Order 2009 issued by the Treasury under the Counter Terrorism Act of 2008. Through the order, persons operating in the UK's financial sector were directed to discontinue any transaction or business relationship with the Bank, with immediate effect. As Justice Ramasubramanian held, this order, which was under challenge in the UK Supreme Court, was somewhat identical to the RBI's circular. There, as he noted, the majority on the bench struck the Treasury's order down on the grounds that the issues which the order sought to address, that is the financing of nuclear proliferation activities, were inherent to banking in general and were not special to Bank Mellat, and that in picking and choosing a single Iranian bank the order was arbitrary, disproportionate and irrational. What is more, the majority also found, through Lord Sumption's opinion, that the order did not arise out of a matter of necessity when less drastic measures were considered to provide protection in relation to other Iranian banks.
In Internet and Mobile Association, the Supreme Court held that it could not go as far as the UK Supreme Court had in Bank Mellat, because the UK has a statute where standards for judicial review are clearly set out. This finding though is perplexing because the Supreme Court has previously held in Modern Dental that the doctrine of proportionality, and the four-prong test it entails, is inherent in Article 19 itself. In any event, having said so, the Court, in Internet and Mobil Association, nonetheless proceeded to examine the circular on the doctrine. It did this not by testing the circular on each prong as laid down in Modern Dental, but only on the question of whether the RBI considered alternative and less intrusive measures than that which the circular adopted. To this, however, the court added an additional test, seemingly derived from a 1969 judgment in Md. Faruk v. State of MP. There, a constitution bench of the Court had held that when a right under Article 19(1)(g) is encroached upon by a complete prohibition of any activity, the State must show the court that the nature of such an activity is either inherently pernicious or has a capacity or tendency to be harmful to the general public.
Before proceeding with an analysis on these lines, though, the Court made two critical interventions. First, it held that given that a person who is denied access to banking services faces onerous consequences, including the effective shutting down of his or her trade, the burden in this case is on the RBI to show that its circular does not unreasonably infract on the petitioners' rights. Second, it rejected the RBI's argument that there is, in fact, no fundamental right to trade, sell and invest in VCs and therefore that the petitioners could not invoke Article 19(1)(g). This is because there was no legislation, as on date, that prohibited the use of VCs. Given that, to thwart any exchange that facilitates such functioning by altogether denying them access to banking services would certainly constitute an encroachment on fundamental right. The only question was whether such a restriction is a reasonable one or not.
On that, the court proceeded to examine whether there were less intrusive measures available and whether RBI had considered the adoption of such measures. Potential solution that could have been considered, the judgment held, includes those suggested by the EU's Parliament: a report by the Union, that examined whether cryptocurrencies ought to be banned outright, for example, recommended that no such ban was necessary so long as good safeguards were in place "protecting the formal financial sector and more in general society as a whole, such as rules combating money laundering, terrorist financing, tax evasion and maybe a more comprehensive set of rules aiming at protecting legitimate users (such as ordinary consumers and investors."
The RBI, the court held, clearly did not consider such alternatives before issuing the circular, but it had, after the writ petitions were filed, done so by providing specific rebuttals to the petitioners' contentions. In the court's belief, once the RBI has applied its mind to the issue and considered alternatives measures it could not sit on judgment over whether such measures are merely illusory. It noted: "While exercising the power of judicial review we may not scan the response of RBI in greater detail to find out if the response to the additional safeguards suggested by the petitioners was just imaginary." This is disappointing. The test, as laid down in Modern Dental, as we saw earlier, is to examine whether "there are alterative and less intrusive measures available that may similarly achieve that same purpose with a lesser degree of limitation." The test isn't, as the court held here, whether the state authority considered alternative measures, but whether such measures as a matter of fact do exist.
Yet, the court still held, based on an application of the judgment in Md. Faruk, that none of the entities under the direct regulatory control of the RBI—the nationalised banks, the scheduled commercial banks, cooperative banks or NBFCs—had suffered any actual harm or loss either directly or indirectly on account of their dealings with the exchanges that have facilitated trading in VCs. Moreover, the RBI, the judgment found, submitted no empirical data on the degree of harm occasioned by dealing with these traders. And in the absence of such data, as the Court had held previously, in State of Maharashtra v. Indian Hotel and Restaurants Association (2013), the State could not be held to have discharged its burden. Therefore, the court held, that the circular offended the doctrine of proportionately and was in violation of Article 19(1)(g).
There are a number of positives to take from the judgment. Not least the reaffirmation of the doctrine of proportionality as the bright-line rule to determine claims made under Article 19, and the actual application of principle to facts. Remember, in Anuradha Bhasin v. Union of India, the court invoked the doctrine but still didn't apply it to the facts before it. Here the court doesn't shy away from doing so, and for that it must be lauded. What is more, given that the circular under challenge here was in the nature of a statutory direction any eventual legislation that seeks to regulate cryptocurrencies—or perhaps even ban their use and trade—will have to still conform to the doctrine of proportionality. But when the court tests such a law, it must go further than this. It must also ask the State to show it that it not merely considered all potential measures to regulate the currency but that the eventual measure adopted was, in fact, the least invasive one.
Author is a Madras Based Lawyer and Writer
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This article was first published here