Blockchain 2021

Last Updated June 17, 2021

Australia

Law and Practice

Authors



Piper Alderman works with clients across Australia and internationally to achieve optimum legal and commercial solutions. As a leading adviser to Australian commercial interests for more than 170 years, the firm continues to advance in knowledge, skills and commitment, and guides clients through increasingly complex regulatory and business landscapes. The firm utilises a united, national partnership with collaborative teams to harness its skills and network effectively for clients, and understands the importance of building enduring client relationships. Piper Alderman has a proud history of being at the forefront of many emerging areas of law, from landmark rulings to new legislation, to accepting digital bank guarantees and digital currency payments. The lawyers understand and contribute to Australia’s legal framework in ways that give the firm's clients a special edge.

Over the last 12 months, blockchain technology has continued to grow rapidly in its reputation and use, causing disruption to both Australian and global markets. Focusing just on Australia, an analysis of 138 blockchain activities conducted by CSIRO’s Data61 identified a clear upwards trajectory, with most of the activity appertaining to small-to-medium-sized businesses in New South Wales and Victoria.

The Senate Committee

In September 2020, the Australian Senate Select Committee inquiry into FinTech and RegTech (now the inquiry in Australia as a Technology and Financial Centre) released an interim report, six pages of which were dedicated solely to "Blockchain and distributed ledger technologies”, noting that the industry potential is estimated to be USD175 billion annually within five years and USD3 trillion by 2030. The report also noted the following:

  • the economic value that the technology brings to the financial sector;
  • the legacy issue of the tax treatment of funds raised by initial coin offerings (ICOs) as well as the Blockchain Australia and RMIT report proposing tax changes to help support digital currency use in Australia, and the question of regulation of digital currency; and
  • the potential for government property data to be stored on a distributed ledger technology (DLT) system (noted by the ASX).

The second interim report, released in May 2021, took a more action-based approach, making 23 recommendations to "lift skills and investment in the fintech sector". The following five of those recommendations communicate the government's ambitions to make Australia a more welcoming and hospitable place for blockchain innovators:

  • the consideration of international data standards for blockchain and smart contracts (Recommendation 14);
  • regular reports of information about the National Blockchain Roadmap's implementation and evaluation practices (Recommendation 15);
  • “flexible and responsible" updates to the National Blockchain Roadmap (Recommendation 16);
  • a blockchain land registry pilot (Recommendation 17); and
  • improved clarity on the standing of smart contracts "as a matter of priority" (Recommendation 18).

The National Blockchain Roadmap

The National Blockchain Roadmap, an Australian inquiry overseen by the National Blockchain Roadmap Steering Committee, continues to gather and analyse information designed to address the challenges and leverage the opportunities that are presented by blockchain technology.

ASX

The ASX has announced that it is replacing CHESS, “its well-functioning but ageing clearing and settlement system, with enhanced [blockchain] technology that will create new opportunities for the Australian market.” This update was originally planned for around June 2021 but his date pushed back to April 2023 in March, considering the impact COVID-19 continues to have on industry. However, the wheels are still in motion.

2021 Federal Budget

The recently released Federal Budget confirmed that AUD6.9 million has been allocated over two years from 2020-21 to support industry-led pilots to demonstrate the application of blockchain technology to reduce regulatory compliance costs and encourage broader take-up of blockchain by Australian businesses.

Reserve Bank of Australia

Following on from its early sceptical position in 2017, the Reserve Bank of Australia (RBA) published a detailed paper setting out its continued cautious position on retail central bank digital currencies (CBDCs). The updated paper "Retail Central Bank Digital Currency: Design Considerations, Rationales and Implications" explores some issues around the possible design, rationales for issuance, and implications of issuance of a retail CBDC. Despite this, the RBA has more recently announced its new partnership with the Commonwealth Bank of Australia, National Australia Bank, Perpetual and ConsenSys, in a fully fledged wholesale CBDC research project to move beyond a proof of concept project. The project report is expected to be released in the first half of 2021.

Blockchain technology has a wide variety of applications. While it was originally considered relevant for the banking sector, it has become a driving force of innovation in a number of industries, seeing various use cases arise, such as supply chain, healthcare, government, insurance, banking and finance and real estate.

An exciting accomplishment in the banking sector was the recent execution of the world's first blockchain-based legal agreement, between blockchain business Lygon and Sydney-based law firm Piper Alderman. Described as a “watershed moment for the legal services industry” by the CEO of Lygon, Justin Amos, this first-of-its-kind blockchain-based digital guarantee could offer the legal profession – a craft heavily reliant on paper-based guarantees – some major opportunities going into the future.

Immutable X has also launched a layer-2 scaling solution for Ethereum with aims to provide “gas-free transactions” that allow for the larger-scale processing of transactions for non-fungible tokens (NFTs) and blockchain-based video games. This project forms part of a relatively new and rapidly growing movement that explores the many potential benefits of NFTs.

A number of businesses are exploring and/or offering decentralised finance (DeFi) solutions in Australia.

The following laws may apply to DeFi in Australia:

  • the Corporations Act 2001 (Cth);
  • the National Consumer Credit Protection Act 2009 (Cth);
  • the Australian Securities and Investments Commission Act 2001 (Cth); and
  • the Consumer Laws (if none of the above apply).

Under the Corporations Act, if a business is considered to be dealing in or issuing a financial product it is required to be licensed. The same applies to a person "arranging" for another to deal in or issue a financial product. A difficulty arises in relation to DeFi where a protocol may have no entity and so not fit neatly – or at all – within the existing regulatory framework.

The legal status of DeFi protocols is uncertain. It is unclear how regulators may attempt to impose liability or accountability on Decentralised Autonomous Organisations (DAO) or their participants.

Australia has “retrofitted" existing regulatory regimes to apply to participants using blockchain technology and cryptocurrencies. The starting point for businesses is to determine whether a crypto-asset is a financial product under the Corporations Act 2001 (Cth) and whether issuing crypto-assets will require the business to hold an Australian Financial Services Licence (AFSL). "Financial products" are defined under the Corporations Act as a facility through which or through the acquisition of which a person:

  • makes a financial investment;
  • manages financial risk; or
  • makes non-cash payments.

The Corporations Act also deems specific things to be financial products, including securities, derivatives and interests in a managed investment scheme.

Businesses offering to deal in crypto-assets, such as by operating a market or providing custodial services, must obtain an AFSL if they deal with, give advice on or provide intermediary services for crypto-assets that constitute financial products.

If businesses offer payment services, assuming that the crypto-asset is not a financial product, the business will still likely be providing a non-cash payment facility under Section 763D of the Corporations Act and must hold an AFSL with a non-cash payment facility authorisation unless an exemption applies. Digital wallets in Australia will most likely constitute non-cash payment facilities. The non-cash payment facility concept in Australia is broadly analogous to the e-money licence system in Europe.

The Australian Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) laws apply if a designated service is provided with a geographical link to Australia. The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 was updated to include a new designated service for digital currency exchanges (exchanging digital currency for money and vice versa), and existing designated services are technologically neutral and apply where applicable – for example, if a virtual asset has the characteristics of a security (including an interest in a managed investment scheme) or a derivative, if a business issues or sells the virtual asset or acquires or disposes of the virtual asset as an agent. When the amendments were made for digital currencies, the definition of property was amended to exclude digital currencies under the AML/CTF Act. This implies that the transfer of a digital currency is excluded from remittance services.

From a tax perspective, Australia also uses existing regulatory regimes but it has made Determinations that set out how the Australian Taxation Office (ATO) will apply the law to market participants using blockchain technology or digital assets.

Australia has adopted the guidance from the Financial Action Task Force (FATF) to regulate and supervise virtual assets and monitor for AML/CTF, virtual assets and virtual asset service providers to some extent.

The Australian Transaction Reports and Analysis Centre (AUSTRAC) regulates businesses exchanging cryptocurrency for fiat and vice versa, if they have a geographical link to Australia and are required to be registered. This applies in the following circumstances:

  • if the service is provided to the customer at or through a permanent establishment of the entity in Australia;
  • if the entity is a resident of Australia and the service is provided at or through a permanent establishment of the entity in a foreign country; or
  • if the entity is a subsidiary of a company that is a resident of Australia and the service is provided at or through a permanent establishment of the entity in a foreign country.

Therefore, the Australian regime does not capture the full breadth of businesses contemplated by FATF’s recommendations. The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) and the Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument (2007) (No. 1) (Cth) are principles-based legislation and require regulated entities to take a risk-based approach to complying with their obligations. Australia has implemented the recommendations for regulated digital currency entities, except recommendation 16: it is waiting to see how other jurisdictions handle the messaging and technological solutions that are being created.

While the website of the Bank for International Settlements (BIS) reveals that there have been many discussions on blockchain technologies with potential to benefit the Australian economy, Australia has yet to adopt any specific blockchain-related standards proposed by the BIS.

The regulatory bodies that are most relevant are the Australian Securities and Investments Commission (ASIC), AUSTRAC and the ATO.

ASIC’s role is to maintain, facilitate and improve the performance of the financial system and the entities in it, and to promote confident and informed participation by consumers in the financial system. Accordingly, ASIC regulates activities involving digital assets to the extent that the digital asset meets the definition of a financial product or that the business is providing a financial service under the Corporations Act. This includes taking action against misleading and deceptive conduct in the marketing and selling of financial products and services. ASIC has also said that it has been delegated powers from the Australian Competition and Consumer Commission to take action for misleading and deceptive conduct in the marketing or selling of digital assets that are not financial products, but this delegation is not public and has not been tested.

AUSTRAC regulates businesses providing certain services (designated services) in the financial sector with a geographical link to Australia. AUSTRAC receives reports from regulated entities, which assist it and its partner agencies in Australia and internationally to combat and disrupt financial crime. To the extent that a blockchain business or cryptocurrency business is providing a designated service with a geographical link to Australia, it will be regulated by AUSTRAC.

The ATO’s role is to methodically manage and adapt the tax and superannuation systems to support and finance Australian services. As a part of this role, the ATO will (not exclusively) collect revenue, administer GST on behalf of states and territories, and administer programmes that provide a means for transfer and community benefits. The Australian government made four taxation determinations in 2014 that provide guidance on the taxation treatment of digital assets, including the circumstances in which digital assets are considered to be a capital gains tax event, a property fringe benefit and a trading stock.

Blockchain Australia is a self-regulatory organisation for the blockchain and cryptocurrency industry that aims to represent blockchain businesses and market participants. Its Australian Digital Currency Industry Code of Conduct is an audited, self-regulatory scheme that allows Australian digital currency exchanges, if certified, to prove to consumers that they meet certain best practice standards in the operation of their business, including:

  • legal compliance;
  • the reputation and background of the owners and operators;
  • AML/CTF protections and reporting; and
  • consumer protection, including transparent pricing, dispute resolution and data security.

The Code also applies to businesses that provide or facilitate the storage of digital currency; however, at the time of writing, no digital currency custody services have yet been certified as required.

There are cases considering digital currency, but there have been no judicial decisions from Superior Courts that have played a role in interpreting (or establishing) the legal regime applicable to the use of blockchain in Australia. Decisions to date in lower courts have allowed digital currency as security for costs.

There has only been regulatory guidance from ASIC as to its interpretation of the applicability of the financial services laws to blockchain and digital assets in Australia. For example, ASIC has stated that Bitcoin and Ether are not recognised as financial products, and has provided guidance in relation to how digital assets and ICOs could be financial products based on their inherent characteristics and structure in Info Sheet 225. ASIC has also provided guidance in relation to the use of distributed ledger technology in Info Sheet 219 but, unlike the UK or Singapore, ASIC does not state when a project is not a financial product.

Australia is actively looking to overseas jurisdictions for policy and guidance on whether digital currency is money.

ASIC has acted to stop proposed and completed ICOs as well as token generation events that raise capital without the appropriate investor protections. According to ASIC, in taking these actions it has identified consistent problems that occur in these areas, including things like the use of misleading and deceptive comments in sales and marketing materials, and the operation of unregistered management investment schemes and businesses not holding an AFSL.

AUSTRAC is able to refuse, suspend or cancel the registration of a registered digital currency exchange that it believes poses “an unacceptable risk of money laundering, terrorism financing or other serious crime”, and keeps a public list of registration cancellations and refusals to renew registrations on its website. However, AUSTRAC does not publicly specify case-by-case reasons for its actions.

There is no specific regulatory sandbox geared towards blockchain-based projects, but Australia does have a regulatory sandbox that “aims to facilitate financial innovation in Australia.”

The ASIC sandbox sets out a range of services a business can provide without first needing to obtain an AFSL or Australian credit licence (ACL), or vary their licence to include additional authorisations, for a period of up to two years. However, prior to participating, the business must meet a public benefit test and an innovation test. While businesses must still report to ASIC on their activities, this licensing leeway is designed to grant businesses the opportunity to find their feet. Should they wish to continue their business after these two years, they will need to apply for the appropriate licence well before the end of the sandbox.

The ASIC Innovation Hub assesses the application to use the sandbox and also provides practical support to fintech start-ups and other innovators as they navigate Australia’s financial regulatory system.

Blockchain-based start-ups are unlikely to fit within the criteria to utilise the sandbox.

The ATO updated its tax regime to include its current views on the taxation treatment of cryptocurrencies in four 2014 taxation determinations.

In Taxation Determination 2014/25, the Commissioner expressed the view that Bitcoin is not foreign currency for the purposes of Division 775 of the Income Tax Assessment Act 1997.

In Taxation Determination 2014/26, the Commissioner expressed the view that Bitcoin is a capital gains tax asset for the purposes of Section 108-5(1) of the Income Tax Assessment Act 1997. This determination also sets out the following.

  • A disposal of Bitcoin may give rise to capital gains tax if the capital proceeds exceed the cost base of the tokens. Capital proceeds can include the market value of other property given for the disposal. There appears to be a somewhat widespread misapprehension in the marketplace that disposals between various cryptocurrencies do not give rise to gains and that only conversion to fiat currency crystallises a gain – which is incorrect.
  • If the first element of the cost base of a token is AUD10,000 or less and the token qualifies as a personal use asset, the gain may be disregarded under the personal use exemption.
  • In some cases, a gain on the disposal of cryptocurrency may be on income account (in which case, the capital gain is disregarded). Taxpayers should refer to Taxation Ruling TR 92/3 for guidance on these points.

In Taxation Determination 2014/27, the Commissioner expressed the view that Bitcoin held for the purposes of sale or exchange in the ordinary course of a business is trading stock for the purposes of Division 70. This determination also sets out that:

  • Bitcoin held by a taxpayer carrying on a business of mining and selling Bitcoin or a taxpayer carrying on a Bitcoin exchange business will be considered trading stock; and
  • Bitcoin received as a method of payment by any business that sells goods will also be considered to be trading stock of that business where the Bitcoin is held for the purpose of sale or exchange in the ordinary course of business.

In Taxation Determination 2014/28, the Commissioner expressed the view that the provision of Bitcoin by an employer to an employee in respect of their employment is a property fringe benefit for the purposes of the Fringe Benefits Tax Assessment Act 1986. The determination also sets out that:

  • Bitcoin is "any kind of property other than tangible property" for Fringe Benefits Tax Assessment Act purposes; the provision of it to an employee is therefore a property fringe benefit; and
  • Bitcoin will not be a property fringe benefit if it is salary or wages.

Fringe benefits are taxed differently to salary or wages.        

In February 2020, the federal government announced its National Blockchain Roadmap, which is a five-year plan that sets out a strategy for the government to look into the benefits of blockchain and address the challenges thereof. To investigate the potential for blockchain technology, particularly in the Roadmap’s showcased areas of supply chains, credentialing and KYC, the government has formed working groups to explore several use cases in each sector.

The much-anticipated Roadmap also sets out the establishment of a National Blockchain Roadmap Steering Committee, with a Terms of Reference that will oversee the 12-step strategy for the Australian government to best address the challenges and leverage the opportunities that are presented by blockchain technology.

In order to remain relevant in the international regulatory conversation, the Australian government formed the Senate Select Committee on Financial Technology and Regulatory Technology to investigate the policy settings for fintech and regtech in Australia. As part of its goal to develop an internationally competitive edge in fintech, the committee inquires and reports on many areas, including the challenges and expansive opportunities presented by blockchain innovation.

How the ownership of a digital asset whose transfer is determined based on an instruction given to a blockchain network using a private cryptographic key is determined is not clear in Australia at present; it depends on the blockchain network being referred to and how many blocks need to be created before a transaction is considered to be irreversible on account of being too deep within the ledger's history to be altered.

On a public blockchain with no central party that determines when a transaction is final, ownership is probabilistic and statistical. On a private blockchain, the operator of the blockchain would be expected to determine when a transaction is final.

No token classification system has been adopted under Australian law. To determine whether a digital asset is characterised as a financial product under the Corporations Act 2001 (Cth), the specific things that are financial products and the specific things that are not financial products need to be considered, which includes general definitions of financial products.

Specific things deemed to be financial products, include securities, derivatives and interests in a managed investment scheme (amongst other things).

The general definition of a financial product is a facility through which, or through the acquisition of which, a person:

  • makes a financial investment;
  • manages financial risk; or
  • makes non-cash payments.

Accordingly, the categorisation of a digital asset as a financial product is broader than similar categorisations in other jurisdictions.

Depending on its specific features, a specific stablecoin may meet the definition of a financial product (eg, a derivative, an interest in a managed investment scheme or a non-cash payment facility). If a stablecoin meets the definition of a "financial product", the issuer and any secondary exchange listing the stablecoin must obtain an AFSL.

While there is no regulation that specifically addresses the distinctions between asset-backed and algorithmic stablecoins, these characteristics are considered when making a determination as to whether the digital is a financial product. There is no clear guidance or safe harbour for stablecoins at present.

The government has recognised digital assets as a lawful form of payment only in the sense that it has acknowledged that digital assets can be used in the same way as other non-cash consideration in barter transactions. However, no digital asset is recognised as legal tender in Australia and the government has yet to accept any digital asset as a means of payment.

Some businesses in Australia are accepting cryptocurrencies from customers and making payments on their behalf to merchants in fiat currencies.

If a business is facilitating payments in digital currencies between parties, it may be providing a non-cash payment facility, in which case it would need an AFSL; it should also consider whether it may be providing a payment system, which is regulated by the RBA.

Australia does not have specific arrangements for the regulation of NFTs. Generally, the law treats NFTs like other non-tangible assets, and will permit them to be bought, sold and owned, intervening to uphold property rights (including intellectual property rights) and contractual obligations, including those created by smart contracts.

However, in the absence of specific remedies, Australia falls back on “default remedies”, using the "reasonable person" test by making a determination based on what a hypothetical person who exercises "average care, skill and judgement" would do. This raises issues in relation to discerning the reasonable person test in these circumstances due to the nature of NFTs.

The three types of markets for digital assets are for digital currencies, blockchain-based regulated products (exchange-traded funds, derivatives, funds) and NFTs. Each of these assets may be purchased via digital asset exchanges.

Custodial exchanges are traditionally the larger exchanges, as they hold crypto-assets on customers' behalf. As non-custodial exchanges do not hold onto customers' digital assets, they are traditionally the smaller exchanges. The difference comes down to who has control or "custody" of a customer's private keys to access the funds – the customer or the exchange.

There are more than 400 AUSTRAC-registered digital currency exchanges. All entities in the business of exchanging digital currency for fiat and fiat for digital currency must be enrolled and registered with AUSTRAC, and must comply with the AML/CTF laws. Digital currency is excluded from the definition of property under these laws and, accordingly, the transfer of digital currency is excluded from being classified as remittance (money transmission).

At this stage, purely crypto-to-crypto exchanges remain unregulated by AUSTRAC. However, it is best practice to adhere as much as possible to the AML/CTF laws in order to minimise the risks associated with providing such services. The FATF recommends that such exchanges be regulated, and Australia is expected to adopt this recommendation at some stage.

Businesses offering to deal in digital assets, such as by operating a market or providing custodial services, must obtain an AFSL if they deal with, give advice on or provide intermediary services for digital assets that constitute financial products.

The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) and Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (Cth) (No. 1) set out the know-your customer and AML/CTF rules applicable to transactions in digital assets.

These include that entities which operate a business of a crypto-to-fiat digital currency exchange must have risk-based procedures, systems and controls in place to manage their risk and comply with the AML/CTF laws. These include:

  • being registered as a digital currency exchange and enrolling with AUSTRAC;
  • conducting KYC identification and verification on all customers and beneficial owners;
  • conducting ongoing customer due diligence;
  • complying with reporting obligations such as threshold transaction reporting, suspicious matter reporting and submitting annual AUSTRAC Compliance Reports;
  • having appropriate management oversight and record-keeping procedures in place;
  • training, monitoring and supervising representatives;
  • having an employee due diligence programme in place;
  • undertaking ongoing and independent reviews; and
  • having a compliant AML/CTF programme in place.

Under Section 1041A of the Corporations Act 2001, it is illegal to implement transactions that have or are likely to have the effect of creating an artificial price for trading in financial products on a financial market. A person can be found guilty of this kind of market manipulation if they are directly or indirectly involved by means of taking part in the transaction or having it carried out on their behalf. The allegations cover direct involvement by the accused as well as transactions managed for him or her by certain relatives. Accordingly, these laws only apply to digital assets if the digital asset is a financial product.

There are no specific regulatory limits on the ability of a digital asset exchange to re-hypothecate (on-transfer) its digital assets to third parties. However, if the digital asset exchange is providing a financial service or product under Chapter 7 of the Corporations Act 2001, or a managed investment scheme under Chapter 5 of the Corporations Act, it will be required to comply with the relevant requirements of ASIC and the Corporation Act.

If a business stores tokens that fall within the definition of a "financial product", it will need to hold an AFSL and the relevant custodial and depository authorisation.

If the tokens are not financial products, then there are no specific regulations applicable to either hot or cold storage.

The specific regulations that are applicable to fundraising through a token issuance depend on the characteristics of the token.

If the token is a financial product and the issuance is undertaken in Australia or to Australians, the exchange will be required to comply with Chapter 7 of the Corporations Act and will accordingly require an AFSL, unless an exemption applies.

The AFSL authorisations and the disclosure documents required for the issuance will be determined by the type of financial product and whether the issuance is to wholesale clients only or also to retail clients.

In its guidance in INFO Sheet 225, ASIC considers there is a high risk that most token issuances or token generation events will be considered a managed investment scheme, and the token-issuing entity will therefore be required to hold an AFSL in order to conduct the sale.

If the token being issued has the characteristics of an interest in a managed investment scheme, share or derivative, and the issuer has a geographical link to Australia, the issuer will also be providing a designated service for the purposes of the AML/CTF laws and will be required to comply with such, including enrolling with AUSTRAC. The issuer may also be required to register as a digital currency exchange.

The specific regulations that are applicable to fundraising through an initial exchange offering depend on the characteristics of the token, as set out under 5.1 Initial Coin Offerings.

Australia does not have any special regulations concerning investment funds or collective investment schemes that invest in digital assets as an alternative to traditional assets. Investment funds are regulated as managed investment schemes. Australia has draft legislation for establishing, registering and operating corporate collective investment vehicles.

Broker-dealers or other financial intermediaries that deal in digital assets that are financial products must hold an AFSL, which is likely to cover providing financial product advice and dealing and/or arranging in the applicable financial product. These dealings may be to all customers, or may be limited to wholesale customers only.

Where the broker-dealer is exchanging digital assets for fiat currency (whether Australian or not) or vice versa in the course of carrying on a digital currency exchange business, the broker-dealer must also apply for registration as a digital currency exchange with AUSTRAC and prepare a compliant AML/CTF programme.

Alternatively, if the broker-dealer is not providing a digital currency exchange designated service but holds an AFSL and is arranging for the client to be issued a token that has the characteristics of an interest in a management investment scheme, security or derivative, it will be providing an item 54 designated service and will be required to comply with the AML/CTF laws, including enrolling with AUSTRAC and implementing a Special AML/CTF Programme.

Whether smart contracts are legally enforceable depends on the form of the particular smart contract. The term "smart contracts" is used for various contractual relationships, including:

  • an unwritten agreement, where inputs and outputs are extremely limited and trust is not required between the parties (eg, a vending machine);
  • a standard written agreement (eg, an agreement for the sale of land);
  • a written agreement incorporating the parties’ reliance on a software-driven outcome, where control over the execution of the software process is in the hands of a trusted third party (eg, an escrow service);
  • a written agreement, usually in a human language, incorporating the parties’ reliance on a software-driven outcome where the software resides on a blockchain and executes without human intervention; and
  • an agreement written only in machine-readable computer code, executed entirely without human intervention once entered into, known as "the code is the contract" or even presumptuously as ‘"smart contract law".

A legally enforceable smart contract must meet all of the traditional elements of a binding contract, including intent to create legal relations, consideration, offer and acceptance, among others. Any duress, undue influence or unconscionable dealings could render a smart contract void at law, despite being potentially unstoppable digitally. The most pure "the code is the contract" smart contracts are of particular concern as they lack any notification of their terms, which exist only as machine-readable code. The identity of the other party to the contract, or whether that party has capacity to enter into the contract, is usually unknown. Australian superior courts have yet to address a smart contract dispute of this kind or make rulings in regards to smart contracts.

It has been argued that if traditional contract law applies to the underlying transactions between parties using smart contracts in some circumstances, then, on the same basis, software developers could be found to be liable for poorly written software code that results in a loss for someone that uses their software. However, this theory has not been considered by the Australian courts at this stage so there is no authority on this issue to date. Under existing law, it is difficult to see how a software developer would be found to be a fiduciary absent a compelling factual matrix.

DeFi activity is allowable as long as the decentralised platforms have the right AFSL and credit licence authorisations.

To the extent a DeFi platform meets the definition of a "financial service", it will need to hold an AFSL.

Similarly, to the extent a DeFi platform's lending activities fall within the definition of "credit activities and services" under the National Credit Consumer Protection Act 2009 (Cth), it will be required to acquire a lending licence.

However, digital currency is not “money” and most regulation is specific to payments of “money”, so the application of the legislation is unclear.

The only way to show control and perfect interest in a digital asset is by owning the private key. For instance, when a customer uses a third party exchange and uses a "hot wallet", that exchange holds the private key, meaning the exchange owns the asset. The reverse is true for an owner of a "cold wallet".

A lender would need to have some control over the digital asset to have a practical security interest, potentially through a sharded key or total possession.

There are currently no specific obligations that apply to a professional investor transferring its digital assets to a custodian.

Digital asset custodians are regulated only if the digital assets stored by the custodian entity are financial products under Chapter 7 of the Corporations Act, in which case the custodian must obtain an AFSL with appropriate custodial and depository authorisation.

The Australian data privacy laws are set out in the Privacy Act 1988 (Cth) and regulated by the Office of the Australian Information Commissioner (OAIC).

The Privacy Act applies to a range of different businesses, including those regulated by AML/CTF laws. Accordingly, all registered digital currency exchanges are required to comply with these laws. If an entity providing blockchain-based products or services is not regulated by AUSTRAC, the Privacy Act will apply to entities with an annual turnover of more than AUD3 million.

If the Privacy Act applies, businesses will be required to collect, hold, use and disclose personal information in certain ways, and will be required to have a compliant privacy policy. They will also have data breach reporting obligations.

However, there is currently a mismatch between the expectations of the Privacy Act and the inevitability of a public blockchain.

While granting individuals the right to have their personal information erased may appear to uphold privacy and security in a traditional commercial context, when considering decentralised technology – which aims to deliver security through the absence of an intermediary, with no easy way to erase data from a public blockchain data ledger – the solution appears to be that personal information should never be entered in a public blockchain.

If transactions on a blockchain were to be made fraudulently, it would be difficult to relocate the stolen assets as reversing data is not possible.

The specific regulations that are applicable to data protection are the same as those set out under 8.1 Data Privacy.

The government allows cryptocurrency mining, as evidenced on ASIC’s moneysmart website. However, it does take a cautionary approach to the process by recognising the risks it involves, such as fewer safeguards, the fluctuation of value, and the ability for a digital wallet to be stolen.

Cryptocurrency mining is not a regulated activity, unless it facilitates a clearing and settlement process for digital assets that are financial products in accordance with the Corporations Act. While ASIC refers to this potential in INFO 225, no real-world examples of this have been provided.

Token holders who participate in “staking” their tokens as part of a process to validate transactions on their host blockchain network ordinarily receive rewards in the form of additional tokens, which are subject to tax implications. Rewards received from staking by a token holder are considered as ordinary income and need to be included in assessable income in a tax return.

On a broader level, if a token is found to be a “financial product” by its nature, then standard disclosure and licensing requirements will apply to the creators of the token, and staking may also be an aspect of the underlying financial product. Failure to obtain the proper licensing and establish investor protections will amount to grounds for ASIC enforcement action.

There is no guidance on which staking is not a financial product but logically a reward for services, such as processing transactions should be treated differently to a passive reward for simply depositing or “locking” up tokens.

Piper Alderman

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Piper Alderman works with clients across Australia and internationally to achieve optimum legal and commercial solutions. As a leading adviser to Australian commercial interests for more than 170 years, the firm continues to advance in knowledge, skills and commitment, and guides clients through increasingly complex regulatory and business landscapes. The firm utilises a united, national partnership with collaborative teams to harness its skills and network effectively for clients, and understands the importance of building enduring client relationships. Piper Alderman has a proud history of being at the forefront of many emerging areas of law, from landmark rulings to new legislation, to accepting digital bank guarantees and digital currency payments. The lawyers understand and contribute to Australia’s legal framework in ways that give the firm's clients a special edge.

The past year has seen a marked increase in the consideration of practical blockchain solutions and some action to identify the regulatory barriers impeding innovation and adoption.

Currently, regulatory oversight over uses of blockchain technology in Australia is fragmented and focuses on the activities conducted, with a stated aim of technology neutrality. A project delivering a financial service integration will likely be regulated by the Australian Securities and Investments Commission (ASIC), whereas businesses distributing and auctioning non-fungible tokens (NFTs) as collectibles may only be governed by the Australian Competition and Consumer Commission (ACCC). A broad definition of digital currency conversion can mean that many blockchain businesses may need to enrol or register with the Australian Transaction Reports and Analysis Centre (AUSTRAC – Australia’s financial crime regulator) as a digital currency exchange. This means that individuals and businesses must be aware of the different approaches of each entity that may regulate their activities.

The myths surrounding blockchain and digital currency (that it is environmentally destructive or a tool for criminals) have led to reluctance from other services providers to support digital currency, including critically in the banking sector, a matter that is now the subject of a Senate Committee Inquiry into “debanking” more generally. This article sets out a high-level overview of the Australian regulatory framework, the practical challenges individuals and businesses are facing in Australia, and Australia’s National Blockchain Roadmap.

While blockchain trends may be considered locally, they occur globally by the very nature of the borderless technology. These global blockchain trends cannot be ignored as they influence Australia’s regulatory and technological advancement priorities. Therefore, this article also outlines the global trends that Australian regulators are feeling pressure to consider and prioritise.

Australia’s Legal Framework

In Australia, blockchain innovations tend to fall into one of the following areas:

  • digital currency/cryptocurrency-related uses, which are still fairly niche and experimental but a vessel for innovation – eg, decentralised finance (DeFi) and other highly decentralised uses;
  • digital currency exchanges, which are rapidly growing in size and complexity, with over 400 exchanges registered with AUSTRAC; and
  • blockchain/distributed ledger technology (DLT) only related uses, which harness blockchain technology in real-world deployments, usually without any public or permissionless aspects (eg, land title replacement, digital bank guarantees and supply chain and similar use cases).

ASIC – financial services

ASIC’s position on digital currencies is not clear, and recent comments from a Commissioner are to look to the federal government for a Digital Asset Framework. The primary published guidance in Australia falls behind clearer guidance in the UK and Singapore, with ASIC’s Information Sheet 225 "Initial coin offerings and crypto-assets" (INFO225) first being published in September 2017 and subsequently updated in several iterations, aiming to provide “high-level regulatory signposts for crypto-asset participants as a starting point”.

ASIC’s previously published versions of INFO225 have stated that ASIC “does not consider Bitcoin to be a financial product”. ASIC has not provided commentary on why this clear guidance was removed, but it seems widely accepted in Australia that Bitcoin is indeed not a financial product.

The published guidance from ASIC emphasises all the ways that blockchain and crypto-asset use-cases could be financial products requiring the token-issuing entity to hold an Australian Financial Services Licence (AFSL) to operate, with a clear emphasis towards token sales. The extraordinarily broad definition of a Managed Investment Scheme (MIS) is “likely” to apply to token sales in particular. There have not yet been any court decisions on the application of the definition of an MIS to a token sale in Australia or made to Australians, and none of ASIC’s regulatory guides address how a digital currency-based project that is a financial product could meet regulatory requirements.

ASIC asserts a reversal of onus in stating that it expects entities that do not have an AFSL to be able to justify a conclusion that their token or initial coin offering (ICO) is not an interest in an MIS or any other type of financial product.

The above positions have regretfully seen many Australian blockchain projects leave Australia in search of greater regulatory clarity, a matter which appears likely to be addressed in the near future with a digital asset framework being developed.

ASIC – digital asset custody

The nature of blockchain technology means that, if the private keys to digital assets are compromised, those assets can be permanently lost with no prospect of recovery. To paraphrase, the saying in the digital asset world is “not your (private) keys, not your Bitcoin”. In the last 12 months as consumers and individuals have become increasingly aware of the risks associated with the storage of private keys, there has been an explosion in demand for custodial services in digital assets. However, none of those custodial services would appear to meet the definition of a custodial service under Australian law, leaving a gap.

In Australia, ASIC has approved one app-based round-up product to permit users to hold up to 5% Bitcoin exposure in their portfolio, which in turn sees that Bitcoin held by an offshore custodian. This approval may be seen as a small step towards Australia accepting a pure Bitcoin exchange-traded fund (ETF) product on a Tier 1 exchange (discussed below). However, as far as is known, there is no fund providing exposure to digital assets that uses a local digital asset custody solution. Currently, AFSL holders are uncertain as to how this innovative set of digital assets can be held in a compliant way.

AUSTRAC

Since 3 April 2018, Digital Currency Exchanges (DCEs) operating in Australia must comply with the anti-money laundering/counter-terrorism financing (AML/CTF) laws and register for the DCE Register managed by AUSTRAC. These DCEs are captured when exchanging fiat currency for digital currency in the course of carrying on a DCE business. Once registered with AUSTRAC in accordance with the AML/CTF laws, there are no further licensing requirements for a DCE unless the exchange lists or deals in a token that is a financial product.

AUSTRAC displays a list of deregistered DCEs, but it does not have a publicly available list of registered DCEs, which creates an opportunity for scams to proliferate. Transparency around regulated DCEs in the future will assist both the companies running those exchanges and the consumers using them.

Australian Tax Office (ATO)

The ATO’s current views on the taxation treatment of cryptocurrencies are contained broadly in four 2014 taxation determinations.

  • In Taxation Determination (TD) 2014/25, the Commissioner expressed the view that Bitcoin is not foreign currency for the purposes of Division 775 of the Income Tax Assessment Act 1997 (ITA).
  • In TD 2014/26, the Commissioner expressed the view that Bitcoin is a capital gains tax asset for section 108-5(1) of the ITA. This means that a disposal of Bitcoin may give rise to a capital gains tax event if the capital proceeds exceed the cost base of the tokens.
  • In TD 2014/27, the Commissioner expressed the view that Bitcoin held for sale or exchange in the ordinary course of a business is trading stock for the purposes of Division 70 of the ITA. This includes, for example, Bitcoin held by a taxpayer carrying on a business of mining and selling Bitcoin or Bitcoin held by a taxpayer carrying on a Bitcoin exchange business being considered as trading stock.
  • In TD 2014/28, the Commissioner expressed the view that the provision of Bitcoin by an employer to an employee in respect of their employment is a property fringe benefit for the Fringe Benefits Tax Assessment Act 1986, which is taxed differently to salary or wages.

Decisions are expected in the next 12 months on further taxation matters, and tax is expected to be considered in the upcoming digital asset regulatory framework.

ACCC

Australia has some of the strongest consumer protection legislation in the world, which plays an active role in protecting consumers from conduct that either misleads or deceives or is likely to mislead or deceive. In particular, the Australian Consumer Law provides the following core protections for consumers under the Competition and Consumer Act 2010 (Cth):

  • a prohibition on misleading or deceptive conduct;
  • a prohibition on unconscionable conduct;
  • consumer guarantees deemed into contracts; and
  • provisions rendering unfair terms in contracts void.

The ACCC plays a role here by regulating misleading and deceptive conduct by any entity. However, with the external trends of prolific scams and enforcement, there may be broader scope for consumer commissions in Australia and globally to play a broader educatory role around what to look for and how to safely hold digital assets.

In one small improvement, the ACCC has updated its annual “scam” report from stating "The government or legitimate businesses will never ask for payment via... cryptocurrencies" in 2018, to the slightly improved "The government or legitimate businesses will never insist on payment via... cryptocurrencies."

Given that many digital asset businesses will only deal in digital currencies, it is unfortunate that the ACCC – the agency charged with policing misleading and deceptive conduct – is not clearer in communicating the growing acceptance of digital currencies and still reinforces the myth that digital currencies are used for crime. Bank transfers are used in three times more scam payments.

Barriers to Banking

Digital asset companies regularly have difficulties in obtaining reliable banking services. Banks have broad discretion to suspend and limit access to accounts on “risk appetite” or “commercial grounds”, with no obligation to provide reasons or review of a decision for a business to be “de-banked”.

Australia has no "right" to banking, meaning that in an increasingly digital world, banks are holding an increasingly powerful position to permit or prevent digital currency and blockchain businesses from accessing the traditional payment system. The dramatic drop in the use of cash and the rise of online commerce further highlights this trend and concentration of power in the last 12 months.

It may well be that a clearer regulatory position around digital asset products will help banks become more comfortable with digital asset businesses' risk profiles, but it is suspected that, absent a "right" to banking with some framework for review (which seems unlikely), many involved in an industry that is itself likely to be disruptive to banking will find incumbents/competitors reluctant to provide services.

Government Priorities

Before turning to the global trends impacting the regulatory framework, the current government’s approach to blockchain can be seen as a key indicator of local regulatory priorities in Australia.

A key driver of the blockchain agenda in Australia is the National Blockchain Roadmap, which sets out a five-year plan for progressing blockchain development and adoption in Australia. The National Blockchain Roadmap sets out the establishment of a National Blockchain Roadmap Steering Committee with a Terms of Reference that will oversee the 12-step strategy for the Australian government to address the challenges and leverage the opportunities that are presented by blockchain technology.

The Federal Budget released in September 2020 confirmed that USD6.9 million was allocated over two years from 2020–2021 to support industry-led pilots to demonstrate the application of blockchain technology to reduce regulatory compliance costs and encourage broader take-up of blockchain by Australian businesses.

The Australian Senate Select Committee inquiry into Australia as a Technology and Financial Centre has released two interim reports, with the first noting that the blockchain industry may grow to be worth AUD175 billion annually within five years and USD3 trillion by 2030. In the second interim report, the Committee made five specific recommendations to support blockchain:

  • the Council of Financial Regulators Cyber Working Group should take into account international data standards for blockchain and smart contracts via Standards Australia (Recommendation 14);
  • the Department of Industry should regularly publish information about the National Blockchain Roadmap's implementation and evaluation of that implementation (Recommendation 15);
  • the Department of Industry should "act flexibly and responsibly" to update the National Blockchain Roadmap (Recommendation 16);
  • the National Cabinet should consider supporting a blockchain land registry pilot (Recommendation 17); and
  • the Australian government should improve clarity on the standing of smart contracts "as a matter of priority" (Recommendation 18).

Some of the recommendations are already in action, with two grants recently released for AUD3 million each to help develop measures that demonstrate the potential for blockchain to reduce the regulatory compliance burden for business. These grants will be used to fund two pilot projects that will focus particularly on the minerals and food and beverage sectors.

These recommendations demonstrate tangible ways for government and regulatory bodies to provide clarity for start-ups and consumers, and also support innovative initiatives. A digital asset policy is high on the committee's agenda as "an area that will be of continued focus for the remainder of the committee's inquiry" in 2021. After receiving 217 submissions and holding 13 days of public hearings, it is clear that the Senate Committee's focus has harnessed the key issues raised in the hearings, and that Australia needs to work to improve its position "as a global financial and technology hub".

Global Trends

Turning to global trends, the following key trends are present:

  • institutional adoption of blockchain and digital currency;
  • the emergence of Central Bank Digital Currencies (CBDCs) and NFTs; and
  • custody of digital assets.

Institutionalisation

Mastercard, PayPal, Visa and Venmo have all recently entered the digital asset space. The network abundance of these players will reduce barriers for consumers to digital currencies for payments within a “walled garden” approach. These large payment providers operating in a highly regulated space provide a significant signal to the market and regulators that digital currencies are demanded by consumers and are not fringe products.

CBDCs

There has been dramatic and significant strides made across the globe in the understanding and deployment of CBDCs this year. Research shows that 80% of central banks worldwide are engaging in CBDC-related research, exploring existing open source platforms on which they may run a CBDC.

Several central banks are following a "two-tiered approach" where the central bank will mint the CBDC while the private sector institutional players would distribute them.

A notable example is Mastercard and Island Pay’s launch of "the world's first central bank digital currency linked card". Users will be able to instantly convert their non-CBDC digital currency to a stable "Sand Dollar" (a Bahamian Dollar) to pay for goods and services across any of the 700 islands that make up the Bahamas and, critically, also in the global Mastercard network.

NFTs

Excitement about NFTs has been evident in 2021, with the high-profile sale of Beeple’s "The First 5000 days" for USD69.4 million. NFTs use a blockchain to provide a cryptographically secure record of digital scarcity, which may be tied to a physical or digital artwork or object.

In almost all popular cases to date, NFTs are broadly analogous to a digital print of an artist's work, with no transfer of copyright ownership, but also no restriction on subsequent transfer. Intriguing possibilities are being experimented with around ongoing royalty payments to artists from secondary sales, but we are seeing the rise of offerings to sell future royalty streams from NFTs, which are likely to be treated as financial products in Australia.

The NFT industry is so small and new that regulation will likely be some way off, but it seems sensible to consider regulation in a way similar to collectable items, despite at least one ATO private ruling finding that an NFT was not a collectible for the purposes of the tax law.

It will be interesting to see whether competition and consumer regulators enter this regulatory arena to ensure that consumers are aware of and able to discern which rights are actually being purchased.

NFTs have great promise in safeguarding against copies claiming to be the original, ensuring the authenticity of digital art and allowing for artists to obtain royalties downstream; however, it is crucial that consumers know what they are buying when entering the market for digital art.

Custody and Regulated Products

A further key trend is the increase of digital assets being used in regulated financial products. The Toronto Stock Exchange recently listed 19 ETFs backed by digital currencies: principally Bitcoin and Ethereum. Custodians of these funds manage their digital assets using a combination of a custodian and a sub-custodian to hold the private keys to the underlying digital assets, which are the assets of the fund.

These custody solutions have been approved, presumably as being compliant with Canadian laws and the requirements of the Ontario Securities Commission, with the Wyoming Division of Banking having approved custodial services for digital assets and major provider BitGo (which has a US trust company in that state).

The drive of international financial innovation is being followed in Australia with a number of ETF applications being made for Bitcoin ETFs, but none have yet been approved. Similarly, there are no licensed custody providers currently offering digital asset custody, but that may change in the future.

Conclusion

The pace of development in the blockchain world and the fact that the law is far slower in keeping pace with technologies means there will always be a gap, but with pervasive myths slowly fading and large companies embracing digital assets and an ongoing inquiry into a digital asset framework, Australia is well positioned to catch up with some of the more advanced competitor nations like Singapore and the UK in embracing blockchain innovation.

Piper Alderman

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Governor Macquarie Tower
1 Farrer Place
Sydney NSW 2000
Australia

+9 253 9999

piperalderman@piperalderman.com.au www.piperalderman.com.au
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Law and Practice

Authors



Piper Alderman works with clients across Australia and internationally to achieve optimum legal and commercial solutions. As a leading adviser to Australian commercial interests for more than 170 years, the firm continues to advance in knowledge, skills and commitment, and guides clients through increasingly complex regulatory and business landscapes. The firm utilises a united, national partnership with collaborative teams to harness its skills and network effectively for clients, and understands the importance of building enduring client relationships. Piper Alderman has a proud history of being at the forefront of many emerging areas of law, from landmark rulings to new legislation, to accepting digital bank guarantees and digital currency payments. The lawyers understand and contribute to Australia’s legal framework in ways that give the firm's clients a special edge.

Trends and Development

Authors



Piper Alderman works with clients across Australia and internationally to achieve optimum legal and commercial solutions. As a leading adviser to Australian commercial interests for more than 170 years, the firm continues to advance in knowledge, skills and commitment, and guides clients through increasingly complex regulatory and business landscapes. The firm utilises a united, national partnership with collaborative teams to harness its skills and network effectively for clients, and understands the importance of building enduring client relationships. Piper Alderman has a proud history of being at the forefront of many emerging areas of law, from landmark rulings to new legislation, to accepting digital bank guarantees and digital currency payments. The lawyers understand and contribute to Australia’s legal framework in ways that give the firm's clients a special edge.

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