Digital Banking

Regulation of Virtual Currencies in India

Virtual Currencies

Virtual Currencies (VCs) have been popular among Indians. Before regulatory restrictions were imposed, a number of traders in India were dealing with Virtual Currencies (VC). The single regulation on virtual currency is a circular issued by the Reserve Bank of India. It restricts the use of regulated banking and payment channels for selling and purchasing VC.

What is Virtual Currency?

A Virtual Currency is a form of digital currency that represents a value and is issued by private developers and is denominated in their own unit of account. The concept of virtual currency covers a number of “Currencies” ranging from simple IOUs of issuers to virtual currencies backed by assets like gold and cryptocurrencies like Bitcoin etc.

Certain VCs can be converted into fiat currency while others can’t, and as such, the latter’s use for payment is limited. VC does not have the status of legal tender. A legal tender is guaranteed by the Central Government, and everyone is bound to accept it as a mode of payment.

Regulatory Framework for Virtual Currencies

As stated earlier, a single regulation on VC is circular. The VC circular has been challenged in the court of law (Supreme Court) on constitutional grounds. Before issuing the VC circular, the RBI had warned about the risks associated with VCs, including money laundering, consumer protection, cybersecurity, and volatility. It shows that government authorities like RBI have significant reservations about the usage of VCs in India.

Last year in the month of July, an Inter-Ministerial Committee formed by the Ministry of Finance released a report on the proposed regulatory approach on distributed ledger technology and VCs. The committee recommended a complete prohibition on dealing with VCs along with criminal penalties. It also urged the promotion of distributed ledger technology without VCs’ use and the exploration of sovereign digital currency. The recommendation of the committee is non-binding, and it is under consideration of the government.

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At present, there is no express law that defines VCs as a service, security, commodity, or currency.  The categorization of it into at least one of these classes is essential as the existing law applies differently based on the categorization.

Challenges related to Virtual Currencies

The Inter-Ministerial Committee observed that cryptocurrencies cannot replace conventional or traditional currencies as there are a number of issues with them.

Some of them are as follows:

Virtual Currencies in India
  • VCs are subject to market fluctuations

The VCs are prone to hit all-time highs and also likely to hit all-time lows. In such an incident, the value of Bitcoin reduced from 20,000 US Dollars in December 2017 to 3800 US Dollars in November 2018.

  • VCs are challenging to regulate

Virtual Currencies like cryptocurrencies are decentralized; therefore, they are difficult to be regulated. This poses a considerable challenge to government regulatory authorities. 

  • Prone to Cyberattacks

The design of VCs has certain vulnerabilities that pose a risk to consumers. The consumers can be subjected to cyberattacks and Ponzi schemes. These cyberattacks can cause a massive loss to consumers. Moreover, the transactions are irreversible, which means there is no way to redress wrong transactions. 

  • Requirement of ample storage and processing power

It requires a large amount of storage and processing power. It can have unfavorable consequences on the energy resources of the country.

  • Anonymous character

It provides significant anonymity that makes it vulnerable to high risk of money laundering as well as terrorist financing activities.

Regulatory Framework of Virtual Currencies around the world

Different regulatory frameworks are followed for VCs in different parts of the world. Countries like Japan, Switzerland, Thailand, etc. allow the use of VCs as a mode of payment, whereas in contrast, China has completely banned the use of VCs. As such, no country has fully allowed the use of any virtual currency as a legal tender.

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VCs also pose a challenge to regulators around the world. Although the crypto assets can improve the efficiency and the inclusiveness of the financial system, they pose a challenge to both customers as well as to the regulators all around the world. Some of the regulators in the world have devised policies to address the risk posed by VCs, while many of them have imposed a blanket ban on it.

Some countries treat VCs as commodities, while others consider them to fiat money. Various nations have taken different approaches to taxation of VCs.

RBIs power to prohibit and regulate VCs

The RBI has the following power with respect to regulation of VCs:

  • To operate the currency and the credit system of the country to its advantage;
  • To take over the management of currencies from the Central Government;

To regulate  the financial system of the country to its own advantage; and

  • To regulate and supervise the payment system of the country.

As per the ruling of the Apex Court (SC), the powers of the RBI would compel it to naturally address all issues that pose a potential risk to the financial system of the country, including the VCs.

Virtual Currencies: Road Ahead

There is a possibility that a new law may be formulated on VCs in the future. There is also a possibility that the Reserve Bank of India may find another way out to tackle the trading of VCs. These are all assumptions based on the current situation, but no one knows what the future holds; therefore, it is critical that the regulator has a flexible approach given the rapidly evolving nature of VCs.

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With disruptive technologies, balanced regulation is essential to mitigate the risk and promote the benefits. One can hope that the government recognizes this fact and adopts a refined framework for this.

Conclusion

As there is some uncertainty on the use of Virtual Currencies, it is essential that regulatory understanding matures nationally as well as internationally. The risks, as well as the benefits associated with VCs, must be adequately researched in order to come to a conclusion regarding its prospect.

Also, read: Supreme Court Lifts RBI Ban on Cryptocurrency Trading: Bitcoin Legal in India

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