Virtual currencies can be regulated by RBI to protect financial system

The court held that despite virtual currencies (VCs) not being legal tender, they have the potential to function as a medium of exchange, unit of account, and store of value, giving RBI the power to regulate or prohibit activities involving VCs to protect the financial system. The court found RBI's decision to monitor VCs since 2013 and issue warnings was not hasty, properly exercised, and not vitiated by malice. However, the court set aside the circular due to lack of consideration of less intrusive measures and actual harm to regulated entities, emphasizing the need for proportionality in regulatory actions.

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Issues Involved:
1. RBI's power to regulate or prohibit virtual currencies (VCs) and VC exchanges.
2. The manner and extent of the exercise of RBI's power.
3. The impact of RBI's circular on the fundamental right to trade under Article 19(1)(g) of the Constitution.
4. The proportionality of RBI's measures.
5. The consideration of alternative measures by RBI.
6. The response of other stakeholders and countries to VCs.
7. The specific case of the freezing of Discidium Internet Labs Pvt. Ltd.'s account.

Detailed Analysis:

I. RBI's Power to Regulate or Prohibit VCs and VC Exchanges:
RBI issued a circular prohibiting its regulated entities from dealing with or providing services to individuals or businesses dealing in VCs. The petitioners argued that VCs are not legal tender but tradable commodities, falling outside the purview of the RBI Act, 1934, the Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007. The court held that VCs, despite not being legal tender, have the potential to function as a medium of exchange, a unit of account, and a store of value. Therefore, RBI has the power to regulate or prohibit activities involving VCs to protect the financial system.

II. Manner and Extent of Exercise of RBI's Power:
The court examined whether RBI exercised its power properly. The court found that RBI had been monitoring the developments in VCs since 2013 and had issued warnings about the risks associated with VCs. The court held that RBI's decision was not taken in haste and that there was sufficient application of mind. The court also rejected the argument that the circular was a colorable exercise of power or vitiated by malice in law.

III. Impact on Fundamental Right to Trade under Article 19(1)(g):
The court acknowledged that the impugned circular had a significant impact on the business of VC exchanges, effectively paralyzing their operations. The court held that while RBI has the power to take pre-emptive action, the measure must pass the test of proportionality. The court noted that RBI had not shown any empirical data of harm suffered by its regulated entities due to their dealings with VC exchanges.

IV. Proportionality of RBI's Measures:
The court applied the four-pronged test of proportionality: (i) proper purpose, (ii) rational connection to the purpose, (iii) no less intrusive measures, and (iv) balance between the measure's effects and the objective's importance. The court found that RBI had not considered less intrusive measures and that the circular had almost wiped out the VC exchanges without showing any actual harm to the regulated entities.

V. Consideration of Alternative Measures:
The court noted that the Inter-Ministerial Committee initially recommended regulating VCs rather than imposing a total ban. The court found that RBI had not considered alternative measures before issuing the circular. The court also noted that the European Union Parliament had suggested regulatory measures rather than an outright ban.

VI. Response of Other Stakeholders and Countries:
The court observed that other stakeholders, such as the Enforcement Directorate, SEBI, and CBDT, had not seen any grave threat from VCs. The court also noted that most countries had not imposed a total ban on VCs but had adopted a regulatory approach.

VII. Freezing of Discidium Internet Labs Pvt. Ltd.'s Account:
The court directed RBI to issue instructions to the Central Bank of India to defreeze the account of Discidium Internet Labs Pvt. Ltd. and release the funds, as RBI had not directed the bank to freeze the account.

Conclusion:
The court set aside the impugned circular on the ground of proportionality, allowing the writ petitions. The court highlighted the need for RBI to consider less intrusive measures and to show actual harm to the regulated entities before taking such drastic action.

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