The Curious Case Of Cryptocurrencies

On April 5, 2018, the RBI issued a statement directing all entities regulated by it not to provide services to individuals or businesses dealing with cryptocurrencies, such as Bitcoin, Ethereum and Litecoin. Regulated entities that had pre-existing relationships with those individuals or businesses were asked to bring those relationships to an end. The RBI issued a circular on similar terms the following day, directing entities regulated by it to exit these pre-existing relationships within three months. While the circular was ambiguously phrased, it was not understood as prohibiting all transactions in cryptocurrencies. Rather, it was directed towards severing the link between fiat currencies and cryptocurrencies. Peer-to-peer transactions in cryptocurrencies, undertaken without the intervention of banking channels, would continue unabated.

An industry body called the Internet and Mobile Association of India, various crypto-asset trading platforms, and several individuals with interests in the industry filed petitions challenging the RBI’s decision. The decision was challenged on broadly two grounds.

• First, the RBI lacked the authority to make the decision. Fundamental to this argument was that cryptocurrency was neither a currency nor part of the credit system of the country. Rather, it was a commodity and therefore beyond the scope of the RBI’s authority.
• Second, assuming that the RBI did have the authority to make this decision, that authority was improperly exercised and its decision violated the fundamental right to freedom of trade.

The Supreme Court arrived at carefully-reasoned conclusions on the first issue. It acknowledged that although the applications of cryptocurrency had evolved over time – and that it was often traded as a commodity – it was difficult to ignore the fact that its founders and early adopters held it out as an alternative to fiat currency, minus the central bank. The court held that the RBI had wide powers to address any threats to the financial system of the country. These powers included not just the power to regulate, but also the power to prohibit. The RBI could exercise its powers in anticipation of an imminent threat, or to recompense for damage that had already been done.

The court’s decision was written in the style of a screenplay, with its analysis of the second issue (whether the RBI’s exercise of authority was unconstitutional) approaching the ‘climax’.

It deployed a proportionality review to determine whether the RBI’s decision violated the right to freedom of trade of cryptocurrency traders and exchanges. This entailed considering if the decision was justified by a proper purpose, if the means deployed were rationally connected to achieving that purpose, if less restrictive (but equally effective) means were available, and if the social benefits outweigh the social harms of the decision. The court concluded that while the RBI’s decision was justified by a proper purpose – protecting the integrity of the financial system – the RBI failed to establish that the means deployed (decoupling cryptocurrencies from the banking system) were rationally connected to achieving that objective.

In particular, the RBI failed to demonstrate, based on evidence and empirical data, that cryptocurrencies actually had a detrimental impact on the financial system. Up to this point, the court’s decision was robust and well-considered This was a classic example of evidence-based proportionality review, with the court making clear that conjecture would simply fail to pass muster. This sets down an important marker for testing the constitutionality of all state action, not just action taken in relation to the financial system.

What followed, however, was more surprising.

The Supreme Court also held that the RBI’s decision was disproportionate because neither the RBI nor the government had chosen to impose an absolute prohibition on cryptocurrency transactions. Consider the spectrum of possible decisions that the RBI could have taken in respect of cryptocurrency. This spectrum would begin with no action and no regulation, progress to regulation, and progress finally to absolute prohibition.

Since the Court held that the RBI’s power includes the power to regulate and prohibit, all options along this spectrum were open to the RBI in principle. It elected not to pick the nuclear option (absolute prohibition), but a measure short of that option. How could the court then consider the RBI’s decision disproportionate on the basis that it did not exercise the nuclear option? It is common for courts to strike down state action as disproportionate when a less restrictive measure would have been equally effective. In this instance, the court did so on the basis that the RBI elected not to pursue the more restrictive measure. This analysis turns a proportionality review on its head.

Proportionality review is meant to encourage an institutional interaction between the administration and the courts. This is directed towards finding a middle ground that enables the administration to achieve its objective whilst imposing the least restrictive limitations on fundamental rights. The court’s call for empirical evidence achieves that objective – its invitation for a prohibition does not.

Chintan Chandrachud is a lawyer and the author of ‘The Cases that India Forgot’ and ‘Balanced Constitutionalism: Courts and Legislatures in India and the United Kingdom’.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.