A couple of weeks past the landmark cryptocurrency judgment setting aside the Reserve Bank of India’s 2018 ring-fencing notification, services from banks and service providers are yet to resume in full swing. The lack of an express direction from the court on this matter has left these entities awaiting clarity from the regulator, in order to avoid the 2018 pitfall a second time. Interim clarity from the RBI is an urgent necessity, and in fact, media reports have arisen last Saturday of a law firm approaching the RBI on this very matter. 

On the ground post the verdict

The Supreme Court’s setting aside of the notification restored the pre-2018 situation, where no express prohibition was in place, but multiple cautions were. However, a key aspect of the pre-2018 situation was that banks had already commenced withdrawing services to the crypto industry (the petitions, for eg., list a bank-issued communication to this effect dated December 2017 to a payment gateway; it is unknown whether these steps were driven by any internal indications of the soon-to-come regulatory stance). 

Post the verdict, as anticipated, the same reluctance has resurfaced. Most of the large, private banks are awaiting a regulatory go-ahead. Payment service providers (PSPs), which also play an essential role, have resorted to a wait and watch approach in the absence of clear directions. Crypto exchange operations that have commenced operations are working with smaller, public sector banks, which are showing greater willingness to take the risk and engage with the industry. 

Why banks and payment service providers play a key role

Trade in cryptocurrencies requires timely action, such as to instantly take advantage of the right price or of arbitrage between different exchanges. Practically, for users, this means the ability to make fast deposits and withdrawals. For the crypto exchanges, this means the ability to handle thousands of transactions per day, and to engage with the bank accounts of the almost 1.7 million verified cryptocurrency users in the country.

This is where the services of the larger banks and new age PSPs come in. These bring crucial advantages which drive up trading volumes, such as better quality APIs enabling automatic withdrawals and transfers, automated deposits using virtual bank accounts for thousands of customers, quick and efficient settlement, etc. 24x7 banking and the ability to trade and withdraw funds at any time is another advantage, given that unlike traditional stock markets, crypto markets allow trading 24x7.  

In the absence of these advantages, the option for businesses is to handle thousands of bank transactions manually, which can greatly bring down volumes and hamper liquidity. Smaller banks, similarly, can primarily provide services like basic online banking and statement, manual batch transfers, etc., but not APIs and other smart features.

How banks and PSPs are to act in the interim

The verdict set aside the RBI’s notification on a very narrow thread — on the grounds that the restriction on fundamental rights was not proportional. The Court, further, refused to interfere with RBI authority beyond a point, leaving the decision on the legality of cryptocurrencies entirely with the regulator. As a result, the verdict itself doesn’t offer clarity on the next steps of banks and PSPs until the RBI takes a final call.

From a policy perspective, the case demonstrates an interesting point here — an ambiguous regulatory stand could drive others in the ecosystem, here the banks, through their discretion with managing risk, to take a step in relation to new technology which in effect violated fundamental rights. Discussions around proportionality normally deal with a law that imposes the restriction, but here, the first (pre-2018) steps were taken before any law or RBI direction was in place. Even now, despite a verdict being in place, the situation isn’t very different. 

The verdict did recognise the petitioners’ fundamental right to do business, together with the role of banks and other regulated entities as a means to enable this right. Given that the cryptocurrency industry has regained some access to banking services (via the public sector banks), it technically cannot be argued that their rights are completely unrestored. However, for the industry to be able to resume operations at a meaningful scale, these rights need to be restored across the ecosystem. 

With no timeline being specified in the judgment for the taking of this call by the RBI, the possibility of this situation continuing indefinitely needs to be remedied. Here, some clarity from the regulator as to the provision of services in the interim would be very welcome. 

Dealing with businesses of ambiguous legality

Dealing with businesses of ambiguous legality is not new for the financial industry. With gaming (permitted) and gambling (not permitted) for instance, ambiguous cases are dealt with via an assessment by banks and PSPs based on current licensing regimes and court judgments. Similar assessments with cryptocurrency businesses would also be possible, such as by assessing their self-regulatory norms and self-imposed KYC requirements.

The ambiguity with cryptocurrencies, however, is perhaps on a different footing because of the severity of the perception of its threat and impact on financial systems and monetary policy. Some direction from the verdict can be inferred in this regard. The Court, while supporting the concerns of the RBI in relation to cryptocurrency as a substitute for legal tender (etc.), also simultaneously pushes it to move past these concerns and explore regulation as opposed to a prohibition. 

Apart from gathering the required empirical data as specified in the judgement (on the degree of harm actually suffered by regulated entities on account of cryptocurrency businesses), the regulator thus must also take into account the points offered by the Court in support of moving past these concerns. Among these is that a good argument the regulator can make against an outright ban is that cash is also fully anonymous and lawful, and that the only way to find out who is using it is to mandate user registration. A second is the European parliament’s report recommending that a ban would go too far, when a more comprehensive set of rules including KYC/AML/CFT rules would safeguard legitimate users. 

On self-regulation and the regulatory sandbox

Two other points to be mentioned are firstly, self-regulation, which, in the absence of a supportive law, can still run into issues. An example is that unless exempted, self-imposed KYC norms can lead to consent issues under the upcoming data protection law. A complete legal framework, permitting cryptocurrency business with suitable restrictions, would thus be essential. Secondly, along with its resistance to crypto currency related business, the RBI also resisted related innovation, as demonstrated by its express exclusion from the regulatory sandbox. While not a direct subject of the judgment, indirectly it calls for a revisit of this stand as well. A positive stance on cryptocurrencies may thus bode well for innovation as well. 

Awaiting the next steps of the RBI

How the RBI handles the present situation, be it the interim or final steps, will be crucial for not just cryptocurrencies, but also to gauge the regulator’s approach to controversial new technology and innovation in general. This is particularly in view of the upcoming department of fintech of the RBI, and the fintech regulation that will likely follow.

The author heads Fintech Policy at Cashfree; authored with inputs from the Cashfree team.