Applicability of Securities and Investment Laws on Cryptocurrency Exchanges in India

Based on the Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies [1], the cryptocurrencies like Bitcoin or Ether are unlikely to be brought under the ambit of regulations relating to securities. The Securities Contracts (Regulation) Act, 1956 (SCRA) provides a non-exhaustive definition of securities.[2]There has been no notification from the relevant regulatory authorities such as SEBI regarding the same. The cryptocurrencies do not fall under the ambit of any of the enumerated items enlisted in the non-exhaustive definition of the ‘Securities.’ The items enlisted have a major characteristic, i.e., they derive their value from some underlying asset. But, the value of cryptocurrency depends on the demand-supply economics. Because the cryptocurrencies are a by-product of distributed ledger technology, there is no identifiable issuer of the same while other items on the list have a clear identifiable issuer. 

Securities are defined in Black’s Law Dictionary[3] to include instruments evidencing a holder’s ownership rights in a firm or a holder’s creditor relationship with a firm (or government). It also states that securities indicate an interest based on investment in a common enterprise. But the cryptocurrencies in general do not give the holder of cryptocurrencies any ownership rights in a firm, creditor relationship with a firm, or investment in a common enterprise. Therefore, the cryptocurrencies are unlikely to fall under the ambit of the definition provided in Black’s Law Dictionary.[4]

But there might be exceptions to this rule. According to the Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies [5], the regulation of digital coins or tokens depend on the characteristics and the purpose for which they are being issued. Depending on the objective of issue, tokens can be grouped into two broad categories:

1. Utility tokens: Utility tokens offer investors access to a company‟s products or services. They are not to be treated as investment in a company.

2. Security tokens: Security tokens represent investment in a company. Just like share-holders in a company, token holders are given dividends in the form of additional coins every time the company issuing the tokens earns a profit in the market.

What makes a token a security? The Howey test by the U.S. Securities and Ex- change Commission (SEC) provides an objective framework to distinguish between utility tokens and security tokens. In order for a financial instrument to be considered a security and fall under the ambit of the SEC, the instrument must meet these four criteria:

1. It must be an investment of money;
2. With an expectation of profit;
3. In a common enterprise; and
4. With the profit to be ge

If the issuer of the tokens is identifiable and the tokens have some identifiable underlying asset(s), or the token in question passes the Howey test, the tokens can be brought under the ambit of The Securities Contracts (Regulation) Act, 1956 (SCRA). These tokens would fall under the ambit of the Companies Act, 2013, SEBI(Security and Exchange Board of India Act, 1992) and the SCRA. The securities which fall under the ambit of the SCRA can only be traded on the licensed exchanges and an exchange trading such securities might be held retrospectively liable under the SCRA.

 

The Exchange might be subjected to other regulations against the Tokens which are not ‘securities.’ To analyse the same, we have to look at the specific provisions of the Companies Act and Companies (Acceptance of Deposits) Rules, 2014. In the latter Act, ‘deposit’ is defined as- “any receipt of money by way of deposit or loan or in any other form, by a company, but does not include..”[6] We also need to determine whether these transactions would fall within the ambit of ‘deposits’ and consequently, if specific provisions of the Companies Act, RBI compliances and other regulations under other regulatory and/ or statutory bodies would be applicable on the same. This would be judged on case to case basis. But in the generic scheme of Cryptocurrency exchange, any amount received in the course of, or for the purposes of, the business of the company, as an advance for the supply of goods or provision of services accounted for in any manner whatsoever provided that such advance is appropriated against supply of goods or provision of services within a period of three hundred and sixty five days(365 days) from the date of acceptance of such advance would not come under the ambit of ‘deposits.’

Under The Banning Of Unregulated Deposit Schemes Act, 2019, “deposit” means ‘an amount of money received by way of an advance or loan or in any other form, by any deposit taker with a promise to return whether after a specified period or otherwise, either in cash or in kind or in the form of a specified service, with or without any benefit in the form of interest, bonus, profit or in any other form, but does not include…’ To escape the ambit of this Act, the cryptocurrency token issuers and the cryptocurrency exchanges would need to ensure that any money received should not be liable to be returned.

 

BY

Vijay Pal Dalmia, Advocate

Supreme Court of India & Delhi High Court

Email id: vpdalmia@gmail.com

Mobile No.: +91 9810081079

Linkedin: https://www.linkedin.com/in/vpdalmia/

Facebook: https://www.facebook.com/vpdalmia

Twitter: @vpdalmia

AND

Siddharth Dalmia

dalmiasiddharth1994@gmail.com

Mobile: +91 9971799250

[1] https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf

[2] Securities include:

(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;

(i)(a) derivative;

(i)(b) units or any other instrument issued by any collective investment scheme to the investors in

such schemes;

(i)(c) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of

Financial Assets and Enforcement of Security Interest Act, 2002;

(id) units or any other such instrument issued to the investors under any mutual fund scheme.

Explanation – For the removal of doubts, it is hereby declared that ‘securities’ shall not include any unit

linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides

a combined benefit risk on the life of the persons and investment by such persons and issued by an insurer

referred to in Clause (9) of Section 2 of the Insurance Act, 1938 (4 of 1938);

(i)(e) any certificate or instrument (by whatever name called), issued to an investor by any issuer being

a special purpose distinct entity which possesses any debt or receivable, including mortgage debt,

assigned to such entity, and acknowledging beneficial interest of such investor in such debt or

receivable, including mortgage debt, as the case may be;

(ii) Government securities;

(ii)(a) such other instruments as may be declared by the central government to be securities; and

(iii) rights or interest in securities.

[3] Black’s Law Dictionary (10th edition 2014).

[6] Section 2 (c) of the Companies Act and Companies (Acceptance of Deposits) Rules, 2014.