The institution of property – Form and Function

This is the second post in a two-part series about about the legal nature of cryptocurrencies in India. The first part is available here.

On December 28, 2017 the South Korean government banned domestic cryptocurrency exchanges from allowing users to transact through anonymous accounts.

Anguk Law Offices is a small boutique firm in Seoul holding itself out as a firm for foreign investors and immigrants. But, they are in the spotlight in the cryptocurrency and public law space as a result of this ban. Anguk, is putting forward a unique argument on behalf of cryptocurrency investors in retaliation to the South Korean government’s administrative guidance.

In a constitutional appeal, Anguk argues that this move of regulating the cryptocurrency trade through administrative guidance without any legal grounds is an infringement of property rights. The law firm argues that cryptocurrencies are assets or commodities and therefore should not be regulated differently. It argues that the government’s regulations led to devaluation of these assets making trading difficult and thus infringing on the right to property as guaranteed by the Korean constitution. This lawsuit assumes cryptocurrencies to be property.

This lawsuit is particularly relevant to the Indian landscape with the RBI recently denying formal banking avenues to individuals and businesses transacting in crypto assets. While the RBI has been sounding warnings about cryptocurrency since 2013, this is the first time formal action has been taken.

Like Anguk’s lawsuit in South Korea, Kali Digital Ecosystems, a company aspiring to start a cryptocurrency exchange. CoinRecoil, has also taken this matter to the court, citing the RBI circular as “arbitrary and unconstitutional”. Kali Digital Ecosystems specifically states that RBI’s move violates the firm’s constitutional right to practice any profession, trade or business.  It also argues that RBI’s decision constitutes discrimination under the Constitution, because it gives crypto services “differential treatment” without justification. This lack of justification, the company contends, stems from the failure of RBI to adequately define the scope of the term “cryptocurrency.”

While the two lawsuits target different sets of rights under their respective constitutions, what unites them is that they challenge the government’s understanding of the term “property.” But, to be treated as property, cryptocurrency must behave as such in both form and function.  In the previous post, we argued that cryptocurrencies by their form – through their inherent technological design, behave as transferable assets, thus constituting property. In this post, we take that analysis forward by looking at the function of virtual currencies from a jurisprudential perspective. We try to show that understanding this form and function should be the basis of any ensuing regulation.

The theory of Property

Two descriptive approaches to the theory of property help clarify the function of cryptocurrency as property – the bundle theory and the essentialist theory.

The traditional bundle theory understands property as a collection of rights derived from their relationship to a particular thing. This idea involves two concepts: a collection of tangible or intangible things and a collection of various relations that the owner has regarding such things as claim rights, liberties, duties, and liabilities and other basic legal concepts. This philosophical approach is equivalent to the legal concept of norms in personam.

On the other hand, the essentialist theory focuses on the most essential characteristic of property: the right to exclude. This approach can therefore be translated to the legal concept of norms in rem which bind “all the world.” The exclusion theory captures the essential idea of property as the right to exclude non-owners from the use of resources.

Academicians interpreting cryptocurrency in the context of the modern theories of property in philosophy rely more heavily on the essentialist or exclusion theory. To qualify as property under this theory, the interest behind property ownership must be exclusion of all others. We saw in the earlier post that the most primitive aspect of blockchain (and cryptocurrencies) is the digital signature. Created to prevent double spending, the primary function of the key was therefore to exclude everybody except the owner of a private key from modifying the content of a message. The owner of bitcoins has the exclusive right to dispose of them, transfer them using the blockchain, sell them for other currency, or give them away.

Secondly, to classify as property under this theory, the property in question must also be “separable.” This means that ownership should not presuppose any special relationship with the property (unlike talent), making the property rights transferable. Such a transfer does not alter the nature of the property and the duty of all other non-owners to remain excluded from it. Virtual currencies fully satisfy this separability criteria – they offer multiple modes of ownership change, not only in the form of transactions on the blockchain, but also in the form of the physical transfer of the key pair.

Reading the exclusion theory further, we see that although it seeks to exclude others, this does not equate this right to a full, liberal, ownership. The right to exclude is not absolute and can be overridden by legitimate state power.

One of the reasons, this discussion is highly relevant right now is due to newer developments in this field. For example, virtual currency platforms such as Ethereum are now developing smart contracts. Smart contracts are a series of “IF, THEN” statements, where the “ifs” are preconditions that must be met in order to trigger the “thens.” Proponents arguing that cryptocurrencies are beyond the realm of regulation often argue that as the smart contracts execute themselves without legal intervention, the “Code is Law.”.

A natural corollary to this would mean that while cryptocurrencies depict as “liberal” a form of ownership as possible, the holder of cryptocurrency can nevertheless be divested of this ownership by the “authority of law,” an understanding which is reflected in Article 300A of the Constitution.

Right to property under Article 300A

 Article 300A of the Constitution is a remnant of Article 31 which until 1978 guaranteed Indians the fundamental right to property. However, with the 44th Amendment, Article 31 was partly deleted. Article 31(1) was transferred to Article 300A and provides that “no person shall be deprived of his property, save by the authority of the law.”

The Supreme Court in recent years has accepted that Article 300A covers more than just ‘immovable property’ given the numerous judgements that have read intellectual property into this definition.

While cryptocurrencies may qualify as property both through theory as well as under a general understanding of 300A, rights in them may still be restricted by “authority of the law.” 300A places certain caveats on what this entails.

Firstly, it is restricted to only a legislation or a statutory rule or order and excludes executive fiats. This has been interpreted to mean that if one were to trace the source of the ‘law,’ one would find a route through a statute, to the legislature. Additionally, such a law must be just, fair, and reasonable. (See, Basantibai v. State of Maharashtra). Were the CoinRecoil lawsuit to argue an infringement to the right to property, the latest regulation by the RBI would most likely not stand this test, given that the action does not emanate from a statute that can be traced to the legislature. But, an act by the parliament such as the one discussed below may very well satisfy this standard.

Banning of Unregulated Deposit Schemes Bill, 2018

The Korean regulation or administrative guidance was put in place just a little while before the Indian government’s statements equating cryptocurrencies to Ponzi schemes. To tackle this, the Union cabinet recently approved the Banning of Unregulated Deposit Schemes Bill, 2018 which seeks to penalize “unregistered deposit takers.” To be able to regulate cryptocurrency, cryptocurrency transactions would need to be interpreted as “deposits” and cryptocurrency service providers as “deposit takers.”

As it stands, the draft bill defines deposits to mean “the receipt of money, by way of advance or loan or in any other form, to be returned, whether after a specified period or otherwise, either in cash or in kind or in the form of a specified service, by any Deposit Taker, with or without any benefit in the form of interest, bonus, profit or in any other form.” A deposit taker could be an individual or group of individuals, partnership firms, LLPs, companies, association of persons, trusts, co-ops, or any other arrangement. It excludes companies incorporated under acts of the parliament and banking companies. Furthermore, for companies, the definition of deposits is as per the Companies Act. We now look at these definitions from the perspective of different stakeholders in the cryptocurrency ecosystem.

1. Cryptocurrency exchanges: While the sale of virtual currencies can occur freely in the marketplace, buyers or sellers will not be able to convert these cryptocurrencies to fiat without a cryptocurrency exchange. In this transaction, cryptocurrency exchanges would receive money (as fiat) or as virtual currency, however as they don’t receive it with the intention of return, they would not qualify as “deposits.”
2. Service providers: This analysis is particularly important for providers offering engaged in one of the burgeoning areas of cryptocurrency investment: sale of tokens and the ICOs – Initial Coin Offerings. While the specific workings of these transactions are beyond the scope of this paper, both types of transaction exchange fiat currency for “tokens” or “coins” which represent a shareholding in the venture. These tokens can be programmed to behave as securities or bonds or derivatives. (See discussion on smart contracts above) It is possible that the service providers may envision “returning” the original investment thus classifying these transactions as deposits.

However, the definition of deposits specifically excludes amounts received by way of contributions towards capital by partners of any firm. By this logic, cryptocurrency service providers raising capital through tokens or ICOs could claim that the money received is capital towards the firm and that token or coin-holders are in fact partners of the firm thus being exempt from the ambit of this bill.

Thus, the application of this new bill is transaction and user specific. Moreover, the legal analysis above underscores the argument that cryptocurrencies behave just like other classes of property.

While this post only discusses two attempts at regulation of cryptocurrencies, as they behave similar to other assets, virtual currencies are capable of being regulated under other existing laws and regulations. In this matrix, we try to sum up other applicable laws that may be relevant, although each heading could be the subject matter of an entire blog post by itself.

Prachi Srikant Tadsare is a legal consultant at the World Bank and Namratha Murugeshan is 3rd year student of NALSAR University of Law.

Disclaimer: The views expressed by the authors are in their personal capacity and do not necessarily reflect the views of the institution the authors are affiliated to.