What are Virtual Currencies?

A virtual Currency is a digital representation of value that is only available in electronic form. It is stored and transacted through designated software, mobile, or computer applications. Transactions involving virtual Currencies occur through secure, dedicated networks or over the Internet using blockchain or digital ledger technology.

These Currencies are a subset of digital Currencies and include other types of digital Currencies, such as cryptoCurrencies and tokens issued by private organizations or may be provided by a government organization. The advantages of virtual Currencies include faster transaction speeds and ease of use.

These Currencies are a form of digital Currency. They are issued by private parties, such as a group of developers or organizations, and are intended only for online use they do not have a physical incarnation like paper money. Thus, they are different from digital representations of central bank-issued Currency, also known as CENTRAL BANK DIGITAL Currency (CBDC).

Types of Virtual Currencies:

Depending on their operating network, virtual Currencies are classified as follows:

Closed virtual Currency
A closed virtual Currency operates in a controlled and private ecosystem. It cannot be converted into another virtual Currency or a real-world fiat Currency. Examples of closed virtual Currencies are Currencies in gaming systems. Though such Currencies can be used in their respective environments like games and other simulated environments, they cannot be converted into real-world cash.

Another example of closed virtual Currencies is airline miles. They are issued by private parties, can only purchase additional miles, and cannot be converted into their associated monetary value.

Open virtual Currency

Open virtual Currencies are also known as convertible virtual Currencies because they can be converted to other forms of money. They operate in open ecosystems and can be converted into another Currency either within or outside the platform. Examples of open virtual Currencies are stable coins (governments' digital Currency) and cryptoCurrencies. Bitcoin and Ethereum, one of the most used cryptoCurrencies having the biggest market capitalization, can be converted into other cryptoCurrencies or certain fiat Currencies. The IRS considers this conversion process a trade transaction and is taxed.

Though most open virtual Currencies have a decentralized setup, certain cryptoCurrencies like Ripple's XRP are centralized in design, meaning a central agency is responsible for their production and distribution[1].

Historical development of virtual Currencies

The first similar kind of system was witnessed back in the 1980s in the Netherlands. Smart cards were introduced in petrol pumps and the purpose of these cards was to avoid robbery during the night. David Chauhan who was an American cryptographer known as "the father of online anonymity" came up with the concept of the "Blind signature" which made the transactions secure[2].

In 1996, Douglas Jackson brought e-gold. It did not exist for long as criminals used it to do illicit activities which exploited the system and later the company was sacked by the FBI. PayPal came into existence in 1999 which made internet users trust money transfers.

The cryptoCurrency introduction can be linked to the USA Economic Crisis in 2008. One of the factors for the same was the deregulation of the financial market. The trust of the People in governments and banks declined. A huge amount of money was spent on fighting the debt crisis, meaning the government printed large amounts of money to stabilize the economy. The large amount of money printed was not supported by any economic production which is why it raises a debt tsunami in several countries which led to a rise in the price of gold. This crisis affected the world's economy at large. Bitcoins are the first cryptoCurrency that was introduced. In the very beginning, the price of Bitcoins when it was introduced was low but later in the year 2011 it raised at par with USA Dollar on a leading exchange.

Its history and regulatory development (Indian context)

Historically, Currencies were devised as means to replace the barter system. Currencies that we use in our regular life are also known as "fiat Currencies" since they are backed by a convertible or a commodity. In simple terms, the Currency that we use is issued by the Government and is a promissory note issued by the Government promising to pay the bearer the amount specified on the Currency.

With the exponential development and unprecedented advancements in the field of technology in India, the fintech sector has been correspondingly growing. CryptoCurrency emerged in India for the first time around 2009 in the form of Bitcoin. The first commercial transaction occurred in 2010, followed by the first cryptoCurrency exchange in 2013. It has garnered a significant following and interest in India over the past few years. Industry estimates that there are 15 to 20 million crypto investors in India, with total crypto holdings of around 41 thousand crore rupees ($5.37 billion).

In India, the apex financial authority i.e., the Reserve Bank of India, has understood cryptoCurrency as a form of digital/ virtual Currency generated through a series of written computer codes that rely on cryptography which is encryption and is thus independent of any central issuing authority per se. It is facilitated through blockchain technology and has emerged as a person-to-person issuance and transaction system that uses private and public keys that enable authentication and encryption for secure transactions.

With the gaining popularity and awareness amongst the people of India concerning cryptoCurrencies such as Bitcoin, Ripple, Dogecoin, etc., many have started investing most of their time and money in these virtual Currencies, to ride amongst many others the present global wave in anticipation of profits. Witnessing the massive popularity of the crypto market, its usage within a year, and potential revenue loss the Government of India, the regulators, and authorities began to take notice and as a consequence, in 2013 the Reserve Bank of India (RBI) issued a press release, cautioning the public against dealing in virtual Currencies including Bitcoin.

In November 2017 the Government of India constituted a high-level Inter-Ministerial Committee to report on various issues about the use of virtual Currency and even though the report from the Inter-Ministerial Committee was pending, at the beginning of April 2018, the RBI issued a circular preventing all commercial and co-operative banks, small finance banks, payment banks, and NBFC from not only from dealing in virtual Currencies themselves but also directing them to stop providing services to all entities which deal with virtual Currencies.

This essentially broke down the crypto industry as exchanges needed the banking services for sending and receiving the money necessary for converting it into cryptoCurrency and for paying salaries, vendors, office space, etc. Subsequently, in July 2019, this Committee submitted its report recommending a blanket ban on private cryptoCurrencies in India. However, the circumstances prevailing around cryptoCurrencies and their usage completely changed on 4th March 2020, when the Apex court of India i.e., the Hon'ble Supreme Court of India, in a well-conceived judgment passed a decision quashing the earlier ban imposed by the RBI.

The Hon'ble Supreme Court of India predominantly examined the matter from the perspective of Article 19(1)(g) of the Indian Constitution, which specifies the freedom to practice any profession or to carry on any occupation, trade, or business, and the doctrine of proportionality.

About the proposed "CryptoCurrency and Regulation of Official Digital Currency Bill, 2021

The CryptoCurrency and Regulation of Official Digital Currency Bill, 2021 is a bill being introduced to the Lok Sabha. According to the Lok Sabha bulletin dated November 23, 2021, the Bill seeks to create "a facilitative framework for the creation of the official digital Currency to be issued by the Reserve Bank of India. The Bill also seeks to prohibit all private cryptoCurrencies in India; however, it allows for certain exceptions to promote the underlying technology of cryptoCurrency and its uses."

The proposed Bill may ideally introduce a level of uniformity of understanding and bring the various government agencies involved onto the same page. It will also be providing security and help regulate the otherwise unregulated markets and prevent their misuse.

However, on the surface, the Bill seems to be very restrictive in nature as it seeks to ban all private cryptoCurrencies including mining and trading therein. The Bill further seeks to promote the 'official digital Currency that is to be issued by the Central Government and the RBI. Further, the penalties prescribed under the Bill seem to be disproportionately harsher when compared with similar economic offenses. The text of the Bill is yet to be released to the public however and as such, it may differ greatly from the provisions of the previous draft Banning of CryptoCurrency & Regulation of Official Digital Currency Bill, 2019.

About the proposed "Banning of CryptoCurrency & Regulation of Official Digital Currency Bill, 2019"

These points are the part of the draft bill proposed by the government:

The then draft Bill seeks to prohibit mining, holding, selling, trade, issuance, disposal, or use of cryptoCurrency in the country and it is punishable with a fine or 10 years of imprisonment.

CryptoCurrency is defined as any information, code, or token which has a digital representation of value and has utility in business activity or acts as a store of value or a unit of account.

A person must declare and dispose of the cryptoCurrency in his possession, within 90 days of the commencement of the act.

The central government, in consultation with the RBI, may issue a digital rupee as legal tender. The RBI may also notify a digital Currency recognized as legal tender in a foreign jurisdiction, as a foreign Currency.[3]

Existing Laws

Regulatory laws mentioned under Companies Act 2013
To bring transparency in reporting of financial statements, the Ministry of Corporate Affairs (MCA) vide notification dated 24.03.2021 has amended Schedule III to the Companies Act, 2013 effective from 01st April 2021 to mandate various disclosures by companies in their financial statements.

Details of Crypto Currency or Virtual Currency
Where the Company has traded or invested in CryptoCurrency or Virtual Currency during the financial year, the following shall be disclosed:

• profit or loss on transactions involving CryptoCurrency or Virtual Currency
• amount of Currency held as of the reporting date,
• deposits or advances from any person for trading or investing in Crypto Currency/virtual Currency.

Review:
We can infer from that act that virtual Currency or cryptoCurrency does not hold much relevance as the lawmakers want to disclose the profit or loss that the party imparted to themselves. The lawmakers did not define the term cryptoCurrency or virtual Currency. They wanted disclosure of deposits or advances taken for trading or investing in crypto/virtual Currency.

Lawmakers being versed in the scene tried to put normal regulations to get to know about the transaction amount, profit, loss, and other company details, etc.

Regulatory Mechanism Adopted By Rbi

Regulatory Mechanism

RBI apprehension and reluctance manifested circular issued by the RBI on April 6, 2018 ("2018 Circular") prohibiting all entities regulated by the RBI from rendering services in connection with VIRTUAL Currencies including maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to purchase/sale of VIRTUAL Currencies. This circular was later set aside by the Supreme Court in March 20204 in the case of the Internet and Mobile Association of India V. Reserve Bank of India.[4]

The circular published by the RBI states:
All Commercial and Co-operative Banks /Payments Banks/Small Finance Banks /
NBFCs / Payment System Providers

Madam / Dear Sir,
Prohibition on dealing in Virtual Currencies (VCs)

1. Reserve Bank has repeatedly through its public notices on December 24, 2013, February 01, 2017 and December 05, 2017, cautioned users, holders and traders of virtual Currencies, including Bitcoins, regarding various risks associated in dealing with such virtual Currencies.
    
2. In view of the associated risks, it has been decided that, with immediate effect, entities regulated by the Reserve Bank shall not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase/ sale of VCs.
    
3. Regulated entities which already provide such services shall exit the relationship within three months from the date of this circular.
    
4. These instructions are issued in exercise of powers conferred by section 35A read with section 36(1)(a) of Banking Regulation Act, 1949, section 35A read with section 36(1)(a) and section 56 of the Banking Regulation. [5]

Review: Through this circular RBI intends to prohibit services, and transactions in virtual Currencies. These services include accounts, registering, trading, settling, etc as mentioned above in the notice. The circular had been issued before dated December 24, 2013, February 01, 2017, and December 05, 2017. The circular also mentioned the various section under which they are authorized to do so. The sections exercised are 35A and 36(1)(a) of the Banking regulation act,1949.

Later that circular was challenged in Internet and Mobile Association of India V. Reserve Bank of India [6] and was set aside by the honourable supreme court and another circular was published. The circular states that:

All Commercial and Co-operative Banks / Payments Banks/ Small Finance Banks / NBFCs / Payment System Providers

Madam / Dear Sir,
Customer Due Diligence for transactions in Virtual Currencies (VC)

1. It has come to our attention through media reports that certain banks/ regulated entities have cautioned their customers against dealing in virtual Currencies by making a reference to the RBI circular DBR.No.BP.BC.104/08.13.102/2017-18 dated April 06, 2018. Such references to the above circular by banks/ regulated entities are not in order as this circular was set aside by the Hon'ble Supreme Court on March 04, 2020 in the matter of Writ Petition (Civil) No.528 of 2018 (Internet and Mobile Association of India v. Reserve Bank of India). As such, in view of the order of the Hon'ble Supreme Court, the circular is no longer valid from the date of the Supreme Court judgement, and therefore cannot be cited or quoted from.
    
2. Banks, as well as other entities, addressed above, may, however, continue to carry out customer due diligence processes in line with regulations governing standards for Know Your Customer (KYC), Anti-Money Laundering (AML), Combating of Financing of Terrorism (CFT) and obligations of regulated entities under Prevention of Money Laundering Act, (PMLA), 2002 in addition to ensuring compliance with relevant provisions under Foreign Exchange Management Act (FEMA) for overseas remittances.[7]

Circular Review: In this respective circular even though the regulatory circular was set aside but it also mentioned that banks can continue with due diligence and can pass respective regulations related to money laundering and terror financing etc. the circular.

Regulatory Mechanisms Adopted By Different Nations

1. Regulatory Mechanism Adopted By USA

   CryptoCurrency exchanges are legal in the USA and are regulated by the BANK SECRECY ACT (BSA). But the Financial Crimes Enforcement Network (FinCEN) does not consider cryptoCurrencies to be legal tender. CryptoCurrency exchange service providers must register with FinCEN, implement an ANTI MONEY LAUNDERING /COUNTER FINANCING OF TERRORISM (AML/CFT) program, maintain appropriate records, and submit reports to the authorities. While it is difficult to find a consistent legal approach at the state level, the US continues to progress in developing federal cryptoCurrency legislation.
    

2. Regulatory Mechanism Adopted By Australia

   CryptoCurrencies and exchanges are legal in Australia, and the country has been progressive in its implementation of cryptoCurrency regulations. In 2017, Australia's government declared that cryptoCurrencies were legal and specifically stated that Bitcoin (and cryptoCurrencies that shared its characteristics) should be treated as property and subject to CAPITAL GAIN TAX (CGT). Since 2018, the AUSTRALIAN TRANSACTION REPORT AND ANALYSIS CENTRE (AUSTRAC) has required exchanges operating in Australia to register, identify and verify users, maintain records, and comply with government ANTI MONEY LAUNDERING /COUNTER FINANCING OF TERRORISM (AML/CFT) reporting obligations. Unregistered exchanges are subject to criminal charges and financial penalties. In May 2019, the AUSTRALIAN SECURITIES AND INVESTING COMMISSION (ASIC) issued updated regulatory requirements for both initial coin offerings (ICOs) and cryptoCurrency trading. Similarly, in August 2020, Australian regulators forced many exchanges to delist privacy coins, a specific type of anonymous cryptoCurrency
   
    

3. Regulatory Mechanism Adopted By Japan

   Japan is one of the most progressive countries in regulating cryptoCurrency and recognizes Bitcoin and other digital Currencies as legal property under the Payment Services Act (PSA). Recent regulations include amendments to the PSA and to the Financial Instruments and Exchange Act (FIEA), which took effect in May 2020. In 2020, Japan established the Japanese Virtual Currency Exchange Association (JVCEA) and the Japan STO organization. Both regulators work to provide advice to as-yet unlicensed exchanges and promote compliance.[8]

End-Notes:

1. Virtual Currency Jake Frankenfield, "Virtual Currency Definition" (Investopedia, March 24, 2022) accessed September 30, 2022.
3. Draft Banning of CryptoCurrency & Regulation of Official Digital Currency Bill, 2019 (Draft Banning of CryptoCurrency & Regulation of Official Digital Currency Bill, 2019) accessed September 30, 2022.
4. Neil Hildreth, "CryptoCurrency Bill 2021: The Road Ahead - Fin Tech - India" (CryptoCurrency Bill 2021: The Road Ahead - Fin Tech - India, December 28, 2021) accessed September 30, 2022.
5. Reserve Bank of India - Notifications (Reserve Bank of India - Notifications) accessed September 30, 2022.
6. Internet and Mobile Association of India V. Reserve Bank of India, Supreme court, 2018, SC 3554
7. Reserve Bank of India - Notifications (Reserve Bank of India - Notifications) accessed September 30, 2022.
8. https://www.thomsonreuters.com/en-us/posts/wp-content/uploads/sites/20/2022/04/Cryptos-Report-Compendium-2022.pdf