"RBI regulated institutions are required to stop having business relations with the entities dealing in virtual currencies forthwith and unwind the existing relation in three months," RBI Deputy Governor B P Kanungo said.
A cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions. Cryptocurrencies usually function on block chain technology, with the most popular example being bitcoins.
While some welcomed the RBI's move, others stressed on the need for more regulation rather than a ban.
"You have countries in Europe that have regulated cryptocurrency and these regulations ensure there is no money laundering and Ponzi schemes. What you need to do is regulate and not ban," senior lawyer in the Bombay High Court, Sujay Kantawala told NDTV.
Mukul Shrivastava, Partner, Fraud Investigation & Dispute Services at Ernst & Young said, "The last couple of months has seen Investments in cryptocurrency more as a 'herd mentality' - it was almost a bubble waiting to burst."
However, the RBI has kept a window open for digital currencies in the country.
"While many central banks are still engaged in the debate, an inter-departmental group has been constituted by the RBI to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency. The report will be submitted by end June," it added.
Some people who have invested in cryptocurrencies are disappointed with the bank's step to ban cryptocurrencies altogether.
"I feel it's a sad idea because many countries are going ahead with cryptocurrencies where it's doing really well. So many people have invested in them and were earning at high levels," says Zoheb a bitcoin investor.
In another important move, the RBI has also made it mandatory for payment system operators to store data within the country.