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INTERPLAY OF INSOLVENCY AND THE CRYPTOCURRENCY INDUSTRY IN INDIA

[Udhav Mittal is student at National Law Institute University, Bhopal]


Introduction


Cryptocurrencies have brought about significant disruption in the global financial landscape, but their decentralized nature poses unique challenges, as demonstrated by the insolvency of FTX Token in the US. This event highlights the complex interplay between insolvency and cryptocurrency, which is increasingly relevant in countries like India. The insolvency of FTX Token resulted from mismanagement, market volatility, and regulatory issues, revealing the need for a nuanced understanding of cryptocurrency insolvency. In India, where cryptocurrency regulation is still evolving, addressing the implications of insolvency in the cryptocurrency realm is a crucial task. Striking a balance between innovation and investor protection, India must develop tailored insolvency procedures to effectively manage the risks associated with cryptocurrency insolvency, thereby promoting market stability and responsible growth within the cryptocurrency ecosystem.


However, the IBC does not explicitly address or recognize cryptocurrency as a form of asset or property that can be subject to insolvency proceedings. This creates a lot of uncertainty and ambiguity for both cryptocurrency users and insolvency practitioners, especially in cases where a cryptocurrency-related business becomes insolvent or a creditor or debtor holds cryptocurrency as part of their assets or liabilities. In this blog post, we will explore some of the challenges and implications of insolvency proceedings involving cryptocurrency-related businesses or assets in India. We will also examine the regulatory landscape, the treatment of digital assets during insolvency.


Regulatory Landscape


One of the main challenges for dealing with insolvency proceedings involving cryptocurrency-related businesses or assets in India is the lack of clarity and consistency in the regulatory framework governing cryptocurrency. Currently, there is no specific law or regulation that defines or regulates cryptocurrency in India. The RBI, which is the central bank and monetary authority of India, has issued several circulars and notifications warning about the risks and dangers of dealing with cryptocurrency and prohibiting banks and financial institutions from providing services to any individual or entity dealing with cryptocurrency. However, these circulars and notifications have been challenged and quashed by the Supreme Court in March 2020 in the case of Internet & Mobile Association of India v. Reserve Bank of India. The court held that the RBI circular was disproportionate, arbitrary, unconstitutional, and violative of Article 19(1)(g) of the Constitution that guarantees freedom of trade and commerce.


The court also observed that cryptocurrency is not illegal in India and that there is no legislative policy that prohibits its use or trade. However, it also noted that RBI has wide powers to regulate monetary policy and financial stability in India and that it can take appropriate measures to deal with any issues arising from cryptocurrency transactions. The court suggested that RBI should consider issuing appropriate regulations or guidelines for cryptocurrency instead of imposing a blanket ban.


The RBI's circular was also contradicted by another notification issued by the Ministry of Corporate Affairs (MCA) in March 2021, which made it mandatory for companies to disclose their crypto-assets and transactions involving cryptocurrency in their financial statements. The notification amended Schedule III of the Companies Act, 2013 and added a new clause that requires companies to report the profit or loss on transactions involving cryptocurrency, the amount of cryptocurrency held, and the deposits or advances received from any person for the purpose of trading or investing in cryptocurrency. The MCA's notification indicates that the government recognizes cryptocurrency as a legitimate form of asset or property that can be owned and traded by companies. However, it creates a potential conflict with the RBI's stance on cryptocurrency, which considers it as a threat to financial stability and monetary policy.


The government is also in the process of drafting a bill on cryptocurrency, which is expected to be introduced in the parliament soon. The bill, titled "The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021", aims to create a framework for the creation and regulation of an official digital currency by the RBI and to prohibit all private cryptocurrencies in India. However, the bill also allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses.


The bill has not been made public yet and its details are still unknown. However, based on the reports and statements of some government officials, it seems that the bill is likely to ban or restrict the use and trade of cryptocurrency in India, except for certain purposes such as research, experimentation, or innovation. The bill may also impose penalties or punishments for violating its provisions or holding or dealing with cryptocurrency.


The bill has been met with a lot of criticism and opposition from the cryptocurrency industry and community in India, who argue that it is based on a misunderstanding and fear of cryptocurrency and that it will stifle innovation and growth in the sector. They also contend that banning or restricting cryptocurrency is impractical and ineffective, as it will only drive it underground or offshore and create more problems for regulation and enforcement. They suggest that instead of banning or restricting cryptocurrency, the government should adopt a more balanced and progressive approach that recognizes and regulates cryptocurrency as a form of asset or property that can benefit the economy and society.


Challenges caused by Cryptocurrency during Insolvency


The Insolvency and Bankruptcy Code of 2016 (IBC) is the main legislation that governs the insolvency and liquidation of corporate and individual debtors in India. The IBC defines an asset as any property, whether tangible or intangible, movable or immovable, current or non-current, owned or controlled by the debtor. The IBC also defines a claim as a right to payment or right to remedy for breach of contract, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured. Based on these definitions, it can be argued that cryptocurrency can be considered as an asset and a claim under the IBC, subject to certain conditions and limitations. However, there are various issues still prevalent, such as:


1. One of the main issues that arises in insolvency proceedings involving cryptocurrency is the identification and valuation of crypto-assets. Cryptocurrency is stored in digital wallets that are accessed by private keys or passwords. The ownership and transfer of cryptocurrency depends on the verification and consensus of the network participants, who maintain a distributed ledger or blockchain. Therefore, it may be difficult to ascertain the existence, ownership, control and value of crypto-assets in insolvency proceedings.


2. Another issue that arises in insolvency proceedings involving cryptocurrency is the enforcement and recovery of crypto-assets. Unlike traditional assets, cryptocurrency cannot be easily seized, frozen or attached by the insolvency resolution professional (IRP) or the liquidator appointed under the IBC.. Moreover, cryptocurrency transactions are irreversible and anonymous, which may make it difficult to trace and recover crypto-assets from third parties or fraudulent transfers.


3. A third issue that arises in insolvency proceedings involving cryptocurrency is the regulation and supervision of crypto-assets. As mentioned earlier, cryptocurrency is not regulated or supervised by any central authority or institution in India. There is no specific law or guideline that governs the treatment of crypto-assets in insolvency proceedings. The existing laws and regulations may not be adequate or suitable to address the unique features and challenges of crypto-assets.


Suggestions


The above mentioned issue of identification and valuation of assets can be tackled by engaging cryptocurrency valuation experts and blockchain analytics firms to determine the existence, ownership, control, and value of crypto-assets. Further, implementation of disclosure requirements and independent verification mechanisms will enhance transparency and accuracy in the valuation process.


For enforcement and recovery of crypto-assets, the government may seek assistance from specialized crypto-asset recovery firms and collaborate with law enforcement agencies experienced in cybercrime and cryptocurrency-related investigations. Also, advocating for regulations enabling the seizure, freezing, or attachment of crypto-assets and developing mechanisms to handle reversible transactions or fraudulent transfers may solve the problem above mentioned problem.


The government can establish specific legislation to address the issue of regulation and supervision of crypto-assets. Also, encouraging the development of industry-wide standards and best practices for handling crypto-assets as well as continuously monitoring and adapting the regulatory framework to keep pace with technological advancements and market dynamics.


Conclusion


The interplay between insolvency and cryptocurrency in India is a nascent and evolving area that requires further research and analysis. There is a need for a clear legal framework and regulation that recognizes and defines cryptocurrency as a distinct type of asset and claim under the IBC. There is also a need for developing appropriate mechanisms and tools for identifying, valuing, enforcing and recovering crypto-assets in insolvency proceedings. Moreover, there is a need for enhancing the capacity and awareness of insolvency professionals, adjudicating authorities, regulators and other stakeholders on the technicalities and implications of crypto-assets in insolvency proceedings.

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