Contributed By Piper Alderman
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 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 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.
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:
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:
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:
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:
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.
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:
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:
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:
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:
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:
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.
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.