[Job Michael Mathew is a 4th year BA.LL.B (Hons) student at NALSAR University of Law]
In October 2009, for every dollar one could purchase 1309 bitcoins. At the beginning of 2017, the price of one bitcoin was close to $1000. It attained $5000 in October and nearly doubled in November. In December it rose to $20000 in some exchanges. This post does not attempt to document the reasons for this phenomenal spike in the price of bitcoins. Rather it aims to shed light on some of the consequences of this rally from an Indian regulatory perspective. The bitcoin price spike has captured the imagination of investors and, as a result, there are attempts in some parts of the world to design investment vehicles that provide investors exposure to bitcoins or other cryptocurrencies. The objective of this post is to look at the possibility of such investment vehicles in India and the challenges such structures could face.
A cryptocurrency in simplistic terms is digital money which is completely decentralized and not issued by any central authority. The decentralized nature of cryptocurrencies gives it a huge advantage over fiat currency, the transfer of which incurs steep processing charges from banks and other financial institutions. The underlying technology of cryptocurrencies helps maintain an online ledger of all transactions conducted with it, such that there is no possibility of double spending. Thus, the fact that there is no central authority verifying if someone has the money to make a payment does not affect cryptocurrencies. The Indian rupee has value because the Government through fiat has assigned value to it. There is no central authority in a cryptocurrency therefore the value of the same will depend upon wide adoption of it as a means of exchange.
Cryptocurrency in India: The Story so far
The Indian Government’s stance on cryptocurrencies has become evident through a circular issued by the Reserve Bank of India (RBI), statements of the Finance Minister and finally a press release issued by the Ministry of Finance. The RBI in 2013 cautioned users of cryptocurrencies against the risks they are exposed to. The circular stated that use or trading of cryptocurrencies have not been authorized by the RBI or any monetary organization. The gist of the RBI’s concerns related to the lack of central authority and any framework for dispute resolution, consumer problems, lack of underlying asset backing cryptocurrency and use of cryptocurrencies for illegal activities. These concerns were reiterated through circulars in February and December 2017.
In April 2017, the Government constituted an Inter-Disciplinary Committee comprising nine members including representatives of RBI, the Securities and Exchange Board of India (SEBI), NITI Aayog and Department of Financial Services. This panel was tasked to examine the existing framework on digital/crypto currencies both in India and globally and come out with measures for dealing with such virtual currencies on issues relating to consumer protection, money laundering among others. The panel submitted its report in August, but the contents are yet to be published. Perhaps giving an indication of the findings of the committee, the Finance Minister in late November categorically stated that India does not recognize cryptocurrency as legal tender as of now. This was followed up by a press release from the Ministry of Finance which likened cryptocurrencies to a Ponzi scheme. The press note stated that the prices of cryptocurrencies are a matter of speculation since it has no intrinsic value and is not backed by Government fiat. The argument that cryptocurrencies are a Ponzi scheme is not well received in much of the world, with even the World Bank in a 2014 report stating that it is not a deliberate Ponzi. Historical Ponzi schemes require a central authority to hide facts and promise a certain annual percent return. Cryptocurrencies have neither. Further, commentators have identified easy methods which can be employed to check to spot a Ponzi scheme designed as a cryptocurrency. Despite coming out strongly against cryptocurrencies, the Government has not taken any active step to close down bitcoin exchanges or bring them under regulatory overview. A number of bitcoin exchanges presently operate in India, without any regulatory oversight, giving access to bitcoins to anyone who wants them.
Cryptocurrency Investment Vehicles
In this part, I look at the possibility of cryptocurrency investment vehicles in India with reference to present regulatory environment. By cryptocurrency investment vehicles, I mean those structures which will provide investors exposure to cryptocurrency without owning the underlying asset, such as a mutual fund (MF), alternative investment fund (AIF) or exchange traded fund (ETF) among others. As stated in the introductory part, presently the Government has taken a rather strict view on cryptocurrencies going on to say that they are Ponzi schemes and investors should be careful while using the same. Therefore, in such a context, approving investment vehicles that provide investors exposure to such currencies does not seem possible at least as of now. However, the objective of this post is to look at the possible regulatory challenges such vehicles would face if the Government changes its views on cryptocurrencies. Countries such as the United State (US) and Japan have approved cryptocurrency as legal tender and have approved investment vehicles which provide investors exposure to cryptocurrencies.
Nature of Cryptocurrency
The most important question in discussing the possibility of cryptocurrency investment vehicles is the nature of cryptocurrency itself. This is because the nature will determine whether cryptocurrency is a permitted investment under MF or AIF Regulations. So, is cryptocurrency a currency? Or it is a security? Or is it a commodity? The Commodities Futures Trading Commission, the commodities regulator of the US, found bitcoin to be a ‘commodity’ in a 2015 order. The Securities Exchange Commission (SEC), the securities regulator of US, however found the same to be a ‘security’ in a 2017 order. Whereas, in India the RBI and Finance Ministry circulars have addressed cryptocurrency as currency with no asset backing.
Even though regulators have arrived at different conclusions with respect to the same object, in reality there is no conflict in the conclusions. The answer to the question of what exactly is a cryptocurrency is: it depends. It depends on what use the cryptocurrency is put to. If it is used to make purchases from Microsoft or Expedia, then it is currency. However, if a start-up company issuing tokens in lieu of cryptocurrency in an initial coin offering, then the token issued is security and the whole enterprise will come under the radar of the securities regulators. This is because, the token is more or less similar to a share of a company on which one will receive profits and can also trade the same in the secondary market. Arguably, it is the token which is the ‘security’ and not the cryptocurrency, but the important aspect is that such use of cryptocurrency will bring in the securities regulator. Thirdly, if one is holding cryptocurrency itself as an investment, then it takes the form of a commodity. The expectation of a person holding cryptocurrency is to profit from a future favourable movement in the price of the same, much like a person who trades in gold or silver. One can argue that there are certain classes of investors who hold shares in the hope of favourable movement in the price and then sell it; and the question is whether that makes shares commodities. The reason why shares in the hands of such investors should not be considered as commodity is because shares derive their intrinsic value from the efforts of the entrepreneur who has set up the company, whereas the value of the commodity such as gold is completely at the mercy of the market.
[to be continued]
– Job Michael Mathew
 Press Release dated 29 December 2017, Ministry of Finance.