Despite the numerous calls to action, Australia has adopted a ‘watch and learn’ approach to regulating digital assets. While some jurisdictions have taken significant steps (eg, Wyoming), Australian regulators have opted to observe the offshore response in the hope that it will better inform how we do things here. It has been quite the wait. Which has many commentators in a frenzy, asking the question of “how hard could it really be?”
Well, the challenge in Australia is understanding what you are regulating as well as who you are regulating.
Before you can effectively regulate something, you need to understand what you are regulating and the risks at play. However, the narrative around digital assets in Australia has tended to cause many people to consider that all digital assets are “cryptocurrencies”. We believe the flow on effect of this has caused many to believe that all digital assets are purporting to be a “currency” of some description, which begs the question (of course) how can we possibly need so many?
A simple way to break it down would be:
- Digital assets are all non-tangible assets that are created, traded and stored in a digital format. That is, an umbrella concept that can include cryptocurrencies and crypto tokens.
- Cryptocurrencies can be considered a subclass of digital assets that are the native asset or transactable unit associated with a blockchain and/or protocol (eg, BTC, ETH).
- Crypto tokens can be considered a subclass of digital assets that (unlike a cryptocurrency) are generally created as part of a platform built on an existing blockchain (eg, ERC-20 tokens on Ethereum) and can represent almost any asset or bundle of rights.
Commentators abroad have demanded regulation of cryptocurrencies without appreciating the distinction from other digital assets. Although some digital assets are fungible and derive value in similar ways, it doesn’t necessarily follow that the asset is a currency. Effective regulation needs to recognise this distinction, otherwise, it is like saying all objects that have wheels must be regulated in the same way, irrespective of whether it is a car, a skateboard or an office chair.
Many regulatory regimes look at the provider as well as the product. For example, in the context of an investment platform, the platform operator will be subject to regulatory oversight as will those that issue or distribute products via the platform.
This approach is demonstrative of regulatory regimes that address centralised operators, issuers and distributors. However, digital assets can interact with networks that do not have and can operate without, a central provider. That is, they are “decentralised”. Governance and operation is distributed across the network by those participating in the network, as is the accountability for risk. The extent to which decentralisation occurs may also be affected by the imposition of a “decentralised autonomous organisation” or “continuous organisation”; however, these sub-networks of participants may still be very extensive. When you consider these networks may be platforms that provide users with access to financial services (ie, decentralised finance or DeFi) via smart contracts that enable such users to achieve financial outcomes without a counterparty, the regulatory challenge is clearly greater.
“But they already ARE regulated!”
Many digital assets are already regulated under existing frameworks. Australia’s regulatory regimes are technologically neutral such that if the relevant attributes are present, the product will be captured.
- Some areas focus on function: Australia’s financial services framework looks to the rights attached to the asset and what it functionally represents. For example, if you purchase a token the value of which is determined by reference to the efforts of others, it may be captured as an interest in a managed investment scheme.
- Other areas focus on risk: Australia’s anti-money laundering and counter-terrorism financing framework looks to the practical risk associated with digital currencies and regulates the point at which they intersect with the traditional financial system.
So, what now?
The path to effective digital asset regulation is riddled with challenges. ASIC’s approach in its recent digital asset consultation paper suggests regulators are open to seeking industry feedback through a measured process that prioritises assets with a level of market maturity. While it may be slow, digital asset projects and operators should embrace this approach as an opportunity to assist regulators and define this emerging space to ensure that the outcomes adequately protect consumers without impeding technological innovation. Our Fintech practice is part of the conversation and we invite you to be too.