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.

 

SN

Law

Applicable Sections

Conclusion

“Currency”

1

Coinage Act, 2011

Section 2 (a): “coin” means any coin which is made of any metal or any other material stamped by the Government or any other authority empowered by the Government in this behalf and which is a legal tender including commemorative coin and the Government of India one rupee note.

Virtual currencies lack the sanction of the appropriate authority in India, and would not be governed by this Act.

 

Foreign Exchange Management Act, 1999

“Currency” has been defined under Section 2(h) of Foreign Exchange Management Act to include all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank.

Section 2(m) of FEMA, ‘foreign currency’ has been defined as any currency other than Indian currency. Under Section 2 (q) of FEMA, “Indian currency” means currency which is expressed or drawn in Indian rupees but does not include special bank notes and special one rupee notes issued under section 28A of the Reserve Bank of India Act, 1934 (2 of 1934).

Virtual currency does not fall under any of these definitions as it lacks RBI sanction.

“Security”

 

Securities Contracts (Regulation) Act, 1956

Under Section 2(h), securities is defined as: (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.

 

Section 2(ia) added by the 1999 amendment of Securities Laws and includes ‘derivative’ as a security. Derivative is defined in Section 2(ac)[A] as a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security and in 2(ac)[B] as a contract which derives its value from the prices, or index of prices, of underlying securities.

 

 

It is highly possible that smart contracts which behave and exhibit the properties of a security could be classified as such. This is particularly true of derivatives which by their nature are a series of “If..Then” transactions.

“Payment System”

 

Payments and Settlements Act, 2007

Section 2(i) –  ―payment system means a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange.

 

Explanation.—For the purposes of this clause, ―payment system‖ includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations.

It is unclear whether such platforms are payment systems although they enable payment as they are not exactly clearing houses given the decentralized nature. RBI has clarified that it does not intend to use these services for payments and settlements.

“Goods”

 

Sale of Goods Act, 1930

‘Goods’ have been defined under S. 2(7) of the Sale of Goods Act, 1930, to include every kind of movable property, including stocks, shares, crops, grass, severable objects, etc. It is supplemented by the definitions of movable and immovable property under S. 3(36) and S. 3(26) of the General Clauses Act, 1897.

There is a possibility that bitcoins may be considered as ‘goods’ as per section 2(7) of the Sale of Goods Act, 1930. But in situations where bitcoins are used as consideration, this Act will not apply since consideration can only be in the form of price as per Section 2 (10) of the Act, which is regulated by an existing law and not otherwise, i.e., consideration cannot be in kind under the Sale of Goods Act. The applicability of the Indian Contract Act, 1872, could also be considered if the transactions between parties are formed by lawful consideration.

“Capital Assets”

 

Income Tax Act, 1961

Section 2(14) of the act defines capital assets. It includes property of any kind not related to business or profession, but excludes, stock in trade, raw materials, consumables, personal effects of movable nature, rural agricultural land, and gold bonds issued by the central government as well as under the gold deposit schemes.

Cryptocurrencies may be treated as capital assets under section 2(14) of the Income Tax Act, 1961. Further, any profit or gain arising from the transfer and sale of an asset, i.e., bitcoin, may be treated as income or capital gain under the Income Tax Act, thereby making it taxable.

Miscellaneous

 

KYC Norms

Know your customer’ is a process by which banks obtain information about the identity and the address of its customers. The KYC procedure is meant to be undertaken by the banks while opening its customers’ accounts. In India, KYC norms are set by the RBI as banks are required to continuously monitor their customers’ transactions, keep an up-to-date record of their identity, and take appropriate steps in case any of the transactions of a customer break from his or her usual pattern of behavior.

One of the most prominent bitcoin wallet/app in India, Zebpay, while following the KYC and Anti-Money Laundering (AML) norms, adheres to a self-regulation structure at present. This provides the need to attract the applicability of the provisions of the Prevention of Money Laundering Act, 2002 (PMLA), in order to ensure and secure that individuals or organization do not use these platforms for illegal purposes.

 

Other RBI directives

The RBI vide its press release, has restated the concern over the usage and flow of virtual/digital currency including bitcoins by drawing the public’s attention to its own earlier press release 2016-17/2054 dated Feb 1, 2017, wherein it was clarified that it has not given any license/authorization to any entity/company to operate such virtual currency. Further, it was also clearly stated that any user, holder, trader, investor etc., will be doing business solely at their own risk.

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.

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