VIRTUAL CURRENCIES- UNDERSTANDING THE BAN #2 (Analysis of the RTI application and actions of the RBI

ANALYSIS OF THE BAN

Background

For the first part of the post which covered the background and the developments in India, can be accessed at https://winvestment.wordpress.com/2018/10/05/virtual-currencies-understanding-the-ban-1-introduction-development-and-powers/

Following is an analysis of RTI application filed by a lawyer with the RBI trying to understand the ban and also an attempt to understand the reasons behind every notification released by the RBI in this regard.

Application  under Right to Information Act

Though RBI does have powers to enforce a ban on banking relationships with VC entities, it has not taken appropriate steps to understand the technological and economic implications of VCs. An application under Right to Information Act, 2005 bearing no. RBIND/R/2018/51897 dated April 9, 2018 (“RTI Application”) was filed by Mr. Varun Sethi with the RBI seeking explanation for its actions and efforts to arrive at the decision stated in its Notification and other circulars cautioning users. On perusal of RBI’s response to the RTI Application bearing no. DPSS.CO.RIA.No. 3134/01.06.006/2017-18 dated May 9, 2018 (“RBI Response”), it can be concluded that:

1. RBI had not done any research before reaching the conclusion as stated in the Notification;

2. No committee was set up for understanding the usage of VCs for legal or illegal activities;

3. No committee was constituted within RBI that studied and arrived at the risks said to have been associated with the VCs;

4. No committee has been established or responsibility has been entrusted with its officers to understand the nature, working and usage of VCs worldwide; and

5. RBI has, neither received inquiries from central banks from other countries about `the VCs nor has it sent out communication to its counterparts.

Further, RBI has circumvented most questions in the RTI Application by stating that it does not fall under “information” under Section 2(f) of RTI Act. The only justification offered by RBI is membership of an Inter disciplinary committee constituted by the Ministry of Finance and a committee chaired by Secretary, Department of Economic Affairs that was constituted in November, 2017.

Analysis observing Global Events and Actions by Other Central Banks

Since the Notification, by RBI’s own admission, is not backed by any analysis or study, it is reasonable to speculate that the conclusions therein have been influenced by global events and the actions of other central banks. This speculation can be justified by observing the timing of certain events and the RBI notifications as presented below:

a)      RBI’s first notification (December 24, 2013)

The Silk Road fraud is uncovered in the US in October, 2013 and subsequently China prohibits financial institutions from trading in Bitcoins on December 5, 2013.[1] Within that period, the price of a Bitcoin crashes to $600, rebounds to $1,000, crashes again to the $500 range and stabilizes to the $650–$800 range, exhibiting huge volatility.[2] This could be the reasons that RBI stated concerns like money laundering and huge volatility for banning bitcoins.

b)      RBI’s second notification (February 1, 2017)

Officials from People’s Bank of China meet with representatives of major Bitcoin exchanges in January, 2017 following which their press releases translate to: “bitcoin cannot and should not be used as currency in the market. Participating institutions and individuals should be cautious in activities such as Bitcoin investment and bear corresponding responsibilities and risks.“[3] Also in the same month, the price of Bitcoin breaks $1000 for the first time in 3 years since the infamous Mt. Gox hack assault.[4] When transaction data from Mt. Gox became public following the hack, it was discovered that the prices of bitcoins were artificially inflated.[5]

c)      RBI’s third notification (December 5, 2017)

China issued a notice dated September 8, 2017 deeming initial coin offerings illegal and ordered all mainland-based cryptocurrency exchanges to shut down.[6] Further, Bitcoin seems to have entered a price bubble, reaching around $10,000 for the first time on the November 28, 2017.[7] This shows that RBI, fearing that bitcoins might be a bubble and following the looking at the notice issued by China might have reiterated the concern.

d)      RBI Circular (April 6, 2018)

On January 15, 2018, a Bloomberg news report citing unnamed officials revealed that the Chinese government is planning to block domestic access to homegrown and offshore platforms that enable centralized trading, and to target individuals and companies that provide market-making, settlement and clearing services for centralized trading. Further, on January 16, 2018, BitConnect, a crypto-token that was used by rich investors in Gujarat to allegedly launder their black money during the demonetization drive, ceased operations. Investigations revealed it was a Ponzi scheme leading to a loss of Rs 22,000 crore of investors’ money. Thereafter, on March 31, 2018, the price of Bitcoin was at $6,927,[8] almost a 50% drop in value within a single quarter. This led to widespread public perception that the Bitcoin bubble has finally burst. Perhaps, following the footsteps of China and looking at the worldwide events, RBI banned the banking relationship.

Conclusion

The follow up post shall be an analysis and solution proposed to every concern raised by RBI in its notifications.

[1] People’s Bank of China, Five ministries and commissions such as the People’s Bank of China issued the “Notice on the Prevention of Bitcoin Risk, December 5, 2013, access at

http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2804576/index.html

[2] https://bitcoincharts.com/charts/bitstampUSD#rg60zczsg2013-12-01zeg2013-12-31ztgSzm1g10zm2g25zv

[3] People’s Bank of China, The People’s Bank of China Business Management Department, Beijing Financial Work Bureau and relevant regulatory authorities understand the operation of some bitcoin trading platforms, January 6, 2017, access at

http://beijing.pbc.gov.cn/beijing/132005/3230072/index.html

[4] https://bitcoincharts.com/charts/bitstampUSD#rg60zczsg2017-01-01zeg2017-02-01ztgSzm1g10zm2g25zv

[5] Neil Gandal, JT Hamrick, Tyler Moore, Tali Oberman, Price manipulation in the Bitcoin ecosystem, Journal of Monetary Economics, Pages 86-96 (Vol 95, May 2018), access at

https://www.sciencedirect.com/science/article/pii/S0304393217301666

[6] People’s Bank of China, Public Notice of the PBC, CAC, MIIT, SAIC, CBRC, CSRC and CIRC on Preventing Risks of Fundraising through Coin Offering, access at http://www.pbc.gov.cn/english/130721/3377816/index.html

[7] https://bitcoincharts.com/charts/bitstampUSD#rg60zczsg2017-11-28zeg2017-11-28ztgSzm1g10zm2g25zv

[8] https://bitcoincharts.com/charts/bitstampUSD#rg60zczsg2018-03-31zeg2018-03-31ztgSzm1g10zm2g25zv