REGULATION OF VIRTUAL CURRENCY IN INDIA- PRESENT SCENARIO AND CHALLENGES BY - B.BEULA JAYARANI

REGULATION OF VIRTUAL CURRENCY IN INDIA- PRESENT SCENARIO AND CHALLENGES

AUTHORED BY - B.BEULA JAYARANI

Abstract-

A digital representation of value that is only accessible in electronic form is called a virtual currency. Through a certain computer, mobile, or software app, it is stored and transacted. Virtual currency exchanges take place through secure, specialized networks or the Internet Virtual currencies are a subset of digital currencies and include other types of digital currencies, such as cryptocurrencies and tokens issued by private organizations. The majority of the time, they are uncontrolled and granted by private individuals or groups of developers. Virtual currencies provide advantages such as quicker transaction rates and simplicity of use. The downsides of virtual currencies include that they can be hacked and do not offer investors any legal redress because they are unregulated. The government passed two rules requiring hefty taxes on transactions and unrealized profits connected to cryptocurrencies, which caused the Indian crypto market to lose some pace this year. India's crypto legislation — a 1% tax deduction at source (TDS) on each transaction — supersedes the previous crypto law, which mandates that its residents pay a 30% tax on unrealized crypto earnings. The IAMAI case held that the RBI had jurisdiction over issues relating to virtual currencies, as virtual currencies act as money under certain circumstances. Regulation of virtual currencies is necessary to leverage the underlying technology and protect investors. Any situation that might affect national security is a major regulatory concern. In this regard, officials are concerned about the abuse of cryptocurrencies and how their anonymity might undermine attempts to combat money laundering. Being a member of the Financial Action Task Force (FATF), India is required to adhere to its norms, which promote international cooperation among its sovereign members. The goal of regulating virtual currencies is to safeguard investors and maintain financial stability while promoting innovation and the appeal of the crypto asset industry.

Keywords: Virtual Currency, Crypto legislation, IAMAI case, Money laundering, Financial Action Task Force (FATF),

Introduction-

It is a sort of uncontrolled digital currency. A central bank neither issues it nor manages its management. Virtual money examples include XRP, Litecoin, and Bitcoin. Digital currency is a form of money that is stored in software, applications, and networks and used for transactions. Private issuers generally create virtual currencies that are used by particular online groups. A major concern is the safety of the networks and software that support virtual currency.

Traditional regulated currencies are backed by fiat currencies (government debt) or tangible assets like precious metals. Virtual currencies, in contrast, lack an intrinsic worth and are not backed. A virtual currency's value is mostly influenced by market sentiment. A virtual currency's unregulated status means that its value may fluctuate significantly.

Although virtual currencies have been available for more than ten years, efforts to regulate them have only recently risen to the top of the legislative agenda. This is partially due to the fact that cryptocurrency assets have just recently transitioned from being specialist items looking for a use to becoming more widely used as speculative investments, hedges against weak currencies, and prospective payment instruments.[1]

A surge in measures to control virtual currency assets has resulted from their remarkable, if erratic, growth in market capitalization and their encroachment into the regulated financial system. The expansion of cryptocurrency's wide range of products and services as well as the advancing innovations that have facilitated issuance and transactions[2] have both done the same. The desire for regulation has been fueled by the collapse of cryptocurrency issuers, exchanges, and hedge funds as well as a recent decline in the value of cryptocurrencies.

It can be difficult to adapt current regulatory frameworks to virtual currency assets or to create new ones. First off, the virtual currency industry is developing quickly. Given their limited resources and competing goals, regulators are finding it difficult to develop the personnel and skills necessary to keep up with the pace. Regulators find it challenging to keep track of thousands of actors who might not be subject to common disclosure or reporting obligations due to the patchy nature of the data and the difficulty in monitoring the crypto markets.

Legal aspects and regulation in India-

The RBI has not recognized cryptocurrencies as legal tender, and as of this writing, no particular regulations or laws relating to cryptocurrencies have been created in India. Cryptocurrencies are now governed by a number of requirements of applicable legislation due to the lack of a clear legal definition for them. The Indian Copyright Act of 1957 includes "computer programme" as a definition that could apply to cryptocurrencies. This is a set of instructions that can be expressed in other ways, such as computer-readable media like words, codes, schemas, or computers, and which carry out specific tasks[3] or produce certain outcomes. Additionally, according to the Sale of Goods Act of 1930, cryptocurrencies can very definitely be categorized as intangible "goods." Taxes on foreign exchange, revenue, and the applicability of service taxes (if bitcoin mining is regarded as a service). However, there is still some ambiguity around bitcoin taxation, and the regulatory climate is also unpredictable. The purchase of cryptocurrencies by Indian citizens can be viewed from the perspective of currency control law as the importation of software or computer programmes into India. This necessitates adherence to all relevant exchange control legislation, including RBI's importation regulations. Regarding goods produced in India that are intangible. Additionally, the RBI oversees "payment systems" and "prepaid equipment," both of which need to be approved by the RBI and adhere to all applicable rules and guidelines.

 Cryptocurrency use and trade, however, protects information and sensitive personal data. Each cryptocurrency mandates adherence to the guidelines set forth in the information protection act when being used. Concerns about privacy may arise, such as how to handle it. The Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data and Information) Regulations of 2011 are described in the Regulations for Compliance with Indian Law, particularly the IT Act (2000). Therefore, one must examine the following guidelines before evaluating the status of the currency

1. The Federal Reserve Bank of India Act of 1934 and The Exchange Management Act of 1999 ("FEMA") ("RBI Act")

2. The 1906 Coinage Act ("Coinage Act")

3. The 1872 Indian Contract Act

4. The Securities Contracts (Regulation) Act of 1956;

5. The Securities Contracts (Regulation) Act of 1956;

A sector-specific regulatory framework for virtual currencies, cryptoassets, virtual digital assets, or cryptocurrencies does not yet exist under Indian law. The Reserve Bank of India's (RBI) VC Circular, which limited the use of regulated banking and payment channels for the sale and purchase of virtual currencies, was overturned by the Supreme Court of India on March 4, 2020 for constitutional reasons (the IAMAI case). This reaffirmed the Constitution of India's provision of the basic right to trade and conduct business on virtual currency exchanges. New income tax laws for virtual digital assets went into force in April 2022, while new cybersecurity regulations for virtual asset corporations went into effect in June 2022.[4]

The RBI and the Ministry of Finance have already issued alerts on the risks connected to virtual currencies, such as those related to volatility, consumer protection, market integrity,[5] and money laundering. However, a number of government committee investigations have also praised virtual currencies for their effectiveness and cost-cutting capabilities.In July 2019, a study on a suggested regulatory strategy for distributed ledger technology and virtual currencies was published by an Inter-Ministerial Committee set up by the Ministry of Finance (the IMC Report). The Committee suggested a complete ban on trading with virtual currencies, as well as criminal sanctions. Additionally, it suggested looking into a national digital currency and promoting distributed ledger technologies without the usage of virtual currencies. The government looks to be taking the Committee's non-binding proposal into account. The government will likely introduce a consultation paper on regulating the industry, according to a statement made by a senior Ministry of Finance official in June 2022, after "seeking viewpoints of both domestic institutional stakeholders and international organizations, including the World Bank and the International Monetary Fund (IMF)." To further understand the point of these regulation systems we need to read  about the landmark IAMAI Case.

IAMAI vs RBI-

A circular from the Reserve Bank of India (RBI) was published on April 6, 2018. The circular forbids dealing in virtual currency by the bank and other organizations as well. Furthermore, the circular forbade banks from offering any form of services to anyone who deals in or sets up virtual currencies. The Reserve Bank of India's prohibition had a severe impact on the Indian economy since it made it impossible to continue operating the bank accounts that served as the trading platforms for virtual currencies, which effectively put an end to that sector of the industry.Regarding this, no legislation prohibiting the trade of virtual currencies had yet been passed at the time the Reserve Bank of India issued the circular. In other words, the economy's assets and virtual currency were kept distinct. The Reserve Bank of India's worry over the hacking of virtual currencies was the driving force behind the circular's release that this could cause a variety of economic issues, including: loss to the economy; money laundering; and the promotion of terrorist actions.

In response to the aforementioned worry, the RBI issued a press statement before issuing the circular, advising banks and other institutions to exercise caution when trading in virtual currencies. In addition, the bank (RBI) did not draw attention to any additional risks at the time the circular was issued.

Brief facts-

The Reserve Bank of India expressed concern over consumer protection from virtual currency trade in a press statement on April 5, 2018. They believed that trade in virtual currency, often known as crypto currencies, was vulnerable to hacking and may thus result in money laundering, terrorism, and other bad things. According to this perspective, the RBI requested that banks refrain from handling any transactions involving the trade of virtual currency.

Maintaining accounts, registering, trading, settling, clearing, making loans secured by virtual currencies, accepting virtual currency as collateral, opening accounts with exchanges that deal with them, and transferring or selling or buying virtual currencies were among the services that the RBI ordered the bank not to provide.[6]

Issues-

The RBI Circular was contested before the SC by the Petitioners on a number of grounds, including:

1.The Payment Settlement and Systems Act, 2007 ("PSS Act") does not grant the RBI the authority to prohibit the activity of trading in virtual currencies (VCs), for a number of reasons, including the fact that (a) VCs are not legal tender and are not subject to its regulation, and (b) the services provided by VC exchanges do not qualify as "payment systems," and as a result, these entities are not subject to the RBI's regulation.[7]

2.The RBI did not follow the stated guidelines when it used its authority to impose the ban. The petitioners argued the following in this regard:

• The RBI did not apply thought while passing the RBI Circular.
• The RBI Circular was tarnished by legal malice since it was issued in ill faith with no intention of safeguarding the regulated firms or the public at large.
• The RBI Circular violated Article 19(1)(g) of the Indian Constitution's fundamental right to practice any profession and to engage in any occupation, trade, or business because it failed to meet the standards of reasonableness and proportionality when compared to the broad prohibition placed on the regulated entities.

Judgment-

Following consideration of the parties' arguments and the factual matrix, the SC reached the following conclusions:

•  It is obvious that users and traders of VCs engage in activity that directly falls under the purview of the RBI given that some institutions accept VCs as lawful payment for the acquisition of goods and services. The SC determined that VC has the potential to establish a competing monetary system that could endanger the existence of a centrally controlled, regulated monetary system. The RBI therefore has the necessary authority to control or forbid any such activity.[8]
• The RBI Circular principally addresses banks that fall within the category of "system participants" subject to RBI regulation under the PSS Act. It is impossible to claim that the RBI lacks the authority to set policies and give instructions to banks that are active players in the system about transactions that would be considered payment obligations, payment instructions, or payments systems.
• The SC agreed with the RBI's arguments on the use of mind because the RBI had taken a number of acts over the course of nearly five years that explicitly explained the rationale behind the decisions made.
• In regards to the claimed violation of the Petitioners' fundamental rights, the SC ruled that any limitations on the freedom protected by Article 19 (1) (g) of the Indian Constitution must meet the standard of reasonableness. The petitioners argued that since having access to banking is comparable to having access to air in a contemporary economy, denying those who engage in unrestricted trade that access to banking is not a legitimate restriction and is disproportionately harsh.
•  As a result, the SC found that the RBI circular is neither reasonable nor proportionate, even if it agreed with the Petitioners' arguments:
• Over the previous five years or more, the RBI has not discovered any negative effects of VC exchange activity on the operations of regulated entities (such banks).The RBI claims that it has not outlawed venture capital (VC) in the nation.  As a result, the SC determined that the RBI Circular could be invalidated for lack of proportionality in view of the foregoing.

International obligation-

The Financial Action Task Force (FATF) is an intergovernmental policy-making body whose goals are to create and promote national and international policies to fight money laundering and the funding of terrorism as well as to set worldwide standards. It was established in 1989 to lay out the steps that needed to be taken to combat money laundering. The FATF has since released 40 recommendations to combat money laundering and 9 unique suggestions to combat terrorism financing. The FATF has established international standards to combat money laundering, funding of terrorism, and more recently, financing of proliferation. These standards are known as the FATF Recommendations. They address the full range of precautions that nations should implement within their criminal justice and regulatory systems, the protective measures that financial institutions and other businesses and professions must take, the precautions to ensure that ownership of legal persons and arrangements is transparent, the establishment of competent authorities with the necessary functions, powers, and mechanisms for cooperation, and the arrangements to cooperate with other countries.[9] There are currently 39 members of the FATF.

The FATF has released universal, legally binding criteria to stop the use of virtual assets for money laundering and terrorism financing, with the assistance of the G20[10]. Any digital representation of value that can be exchanged, transferred, or utilized as payment is referred to as a "virtual asset." The electronic depiction of fiat money is excluded. By implementing the same safeguards as the financial industry, the FATF guidelines guarantee that virtual assets are handled properly. Both when virtual assets are traded for fiat money and when they are moved from one virtual asset to another, FATF regulations are in effect.

India and FATF-

As a member of the FATF any regulation related to the virtual currency shall be in compliance with norms and recommendations of the FATF. The Financial Action Task Force (FATF) modified its policies and procedures in October 2021 for the supervision and control of "virtual assets" (cryptocurrencies) and "virtual asset service providers" (exchanges). These updated guidelines make it clear that VAs and VASPs are subject to FATF standards, thus the FATF will evaluate nations based on how they perform on the new measuring tools. By eliminating the bank or other financial institution as an intermediary, cryptocurrencies. Cryptocurrencies would place such financial movements outside the purview of international law enforcement agencies in the absence of international coordination. According to the guidelines, VASPs are subject to the same comprehensive set of duties as financial institutions and specifically recognised non-financial enterprises and professions. The directive additionally recommends that nations implement all pertinent FATF recommendations related to VAs and VA.

All governments have also received copies of these new instructions. The advice describes how "countries and competent authorities; as well as to VASPs and other compelled entities that engage in VA operations, including financial institutions such as banks and securities broker-dealers, among others," should implement the FATF recommendations.

By early 2023, the Indian government hopes to submit its final position on whether cryptocurrencies are lawful to the Financial Action Task Force (FATF) for a mutual examination.

Challenges in regulation of virtual currency in India-

India's laws regarding cryptocurrency are unclear. Use of cryptocurrencies is neither prohibited nor controlled at this time. As long as they abide by all relevant laws, both private individuals and commercial entities are permitted to acquire, invest in, and use cryptocurrencies. Once the text of the draft bill "The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021" is made available to the public, it would be obvious where India stands on cryptocurrencies.

There are three legal and regulatory issues that need to be resolved before the measure is made public. These are what they are:

• Anti-Money Laundering Goals - Due to the anonymity of virtual currency transactions, regulators frequently struggle to keep track of them. Despite being maintained on the blockchain, wallet IDs cannot be associated with specific people. Regulators are concerned about the idea of sending anything valuable via the internet without using the traditional framework for financial surveillance because they cannot monitor the flow of money that could be used for money laundering[11]. Regulations governing Know Your Customer ("KYC") and Anti-Money Laundering ("AML") are currently outlined in a number of different pieces of legislation and RBI guidelines. But enterprises that use virtual currency are not particularly covered by these limitations.
• Tax Scenarios- Cryptocurrencies have not yet been categorized as either assets or products. On the other hand, profits and revenues from the sale of cryptocurrencies are subject to income tax since, according to Indian law, software is regarded as a "good" and can be taxed as such[12]. Similar to other capital assets, selling cryptocurrency will trigger capital gains tax. The holding period, trading frequency, holding size, and accounting treatment are taken into consideration to make this determination because there are so many virtual currencies and each transaction is different, choices about how to apply the GST must be made individually. GST must be added to invoices for those who sell goods as part of their line of work and are required to register for GST. In addition, services provided in connection with the sale and acquisition of virtual money are subject to GST. There shouldn't be any negative effects from GST when someone sells virtual currency for recreational purposes. GST shouldn't be due when previously owned virtual currency is sold for investing purposes.
• SEBI regulations - Investment advisors and fund managers in India are governed by the SEBI Investment Advisers Regulation 2013 and the SEBI Portfolio Managers Regulation 2019. Despite the fact that managing and giving advice on cryptocurrency assets is not prohibited by the aforementioned legislation, SEBI has developed a list of the commodities that managers and advisers are permitted to trade. As a result, any investment advisers[13] or fund managers offering virtual currency services in India do so in their individual capacity rather than as managers or advisers who have received SEBI authorization.

Other countries regulations-

Japan

The Payment Services Act in Japan, which recognises cryptocurrencies as legal property, has a progressive approach to crypto regulation (PSA). In the meanwhile, local cryptocurrency exchanges are required to register with the Financial Services Agency (FSA) and adhere to AML/CFT regulations. All cryptocurrency exchanges are members of Japan's Japanese Virtual Currency Exchange Association (JVCEA), which was founded in 2020. Japan classifies bitcoin trading earnings as "miscellaneous income" and taxes investors accordingly.

Australia

Australia considers cryptocurrencies to be legal property, making them liable for capital gains tax. Exchanges are permitted to operate in the nation without restriction, provided they register with AUSTRAC and adhere to certain AML/CTF requirements.

Initial coin offerings (ICOs) are regulated by the Australian Securities and Investments Commission (ASIC), which also outlawed exchanges that offered "privacy coins," which are digital currencies that protect user anonymity by concealing the movement of money across their networks.

Australia made plans to develop a licensing system for cryptocurrencies and may introduce a central bank digital currency public in 2021. (CBDC).

United States

In 2022, the United States unveiled a new framework that allowed for additional regulation. The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission, two existing market regulators, have been given authority under the new mandate (CFTC).

Conclusion-

Although there are risks associated with virtual currencies, there are also many advantages, most notably disintermediation and cost savings. Absolute limitations on this technology are unworkable and may be quite easy to get around. In order to reduce the risks and enhance the advantages, like with all disruptive technologies, balanced regulation should be implemented. We hope that any upcoming government decision acknowledges this reality and adopts a sophisticated approach to it. Although there may still be some uncertainty in India until domestic and international industry and regulatory understanding deepens, our long-term outlook is optimistic. Progress towards a balanced regime should be sped up by other countries adopting successful regulatory models.

[1] IMF.ORG, https://www.imf.org/en/Publications/fandd/issues/2022/09/Regulating-crypto-Narain-Moretti (last visited, Nov. 15, 2022)

[2] ibid.

[3] Deshant Singh Thakur , Prof. Raj A. Varma , Prof. Damodar Mayappa Hake,Journal of Positive School Psychology , Vol. 6, No. 5, 8922

[4] THE LAW REVIEWS, https://thelawreviews.co.uk/title/the-virtual-currency-regulation-review/india, (last visited Nov. 15, 2022)

[5] ibid.

[6] Internet and mobile association of India vs Reserve bank of India , SCC online SC 275

[7] LAW INSIDER,https://www.lawinsider.in/trending/payment-and-settlement-systems-act-2007 (last visited Nov. 15, 2022)

[8] AZB & PARTNERS ,https://www.azbpartners.com/bank/supreme-courts-judgment-on-virtual-currencies/, (last visited Nov, 15 2022)

[9] FINCEN.GOV,https://www.fincen.gov/resources/international/financial-action-task-force (last visited Nov. 14,2022)

[10] FATF,https://www.fatf-gafi.org/publications/virtualassets/documents/virtual-assets.(last visited Nov.15,2022)

[11] Supra note 4.

[12] KSANDDK ,https://ksandk.com/finance/cryptocurrency-laws-in-india /(last visited Nov. 13, 2022)

[13] ibid.