On 9 February 2024, the Federal Court of Australia handed down judgment in [ASIC v BE], which had been characterised as a “test case” concerning important issues with respect to the application of financial services laws to crypto-related products and services.
Gilbert + Tobin acted for Web3 Ventures Pty Ltd, trading as Block Earner.
The Court found that Block Earner had contravened the Corporations Act by offering a (since closed) fixed yield product without an Australian Financial Services Licence (AFSL), but dismissed the Australian Securities and Investments Commission’s (ASIC) claims in relation to a separate decentralised finance access product.
Introduction: ASIC v Block Earner
In November 2022 ASIC commenced proceedings in the Federal Court of Australia (the Proceedings) against Block Earner, alleging that Block Earner required an AFSL for certain products offering customers access to yield related to cryptocurrency, on the allegation that they were either managed investment schemes, investment facilities or derivatives for the purposes of the Corporations Act 2001 (Cth) (Corporations Act). ASIC had previously characterised the Proceedings as a ‘test case’, to test the applicability of financial services law and financial product regulation to cryptocurrency-related products. In 2023 ASIC labelled crypto as one of its enforcement priorities, and the Proceedings provide important insight into how the regulator and Courts will seek to apply existing laws to this space.
This is a significant judgment providing greater insight to the market and legal practitioners as to types of crypto-related products that may fall within the remit of existing financial services laws, albeit questions remain more broadly as to the general applicability of existing concepts in the regulatory regime. It also serves as a reminder that the operation of financial services laws are complex and their application highly fact-specific, such that one crypto product or service may be subject to regulation while another product may not.
Overview of the issues
The claims brought against Block Earner related to two distinct services offered by Block Earner:
- the “Earner” service (closed in November 2022), which allowed users to lend cryptocurrency to Block Earner in return for a fixed interest rate. Block Earner had separate institutional arrangements with platforms for fixed yield; and
- the “Access” service, which facilitated access to the Aave and Compound DeFi lending protocols operating on the Ethereum blockchain.
Block Earner also allowed users to exchange Australian dollars for cryptocurrency for use in these services.
ASIC alleged that each of the Earner and Access service were one or more of a managed investment scheme, an investment facility and/or a derivative for the purposes of the Corporations Act, and accordingly could only be offered under an AFSL.
In summary, ASIC alleged that each service involved:
- having regard to the statutory criteria for managed investment schemes and investment facilities, Block Earner ‘pooling’ customer funds or otherwise using customer funds to generate financial returns for customers; or
- for the purposes of the statutory definition of “derivatives”, the customer obtaining rights, the value of which varied by reference to the exchange rate between the relevant cryptocurrency and AUD.
With respect to the Earner product, ASIC also relied on an “FAQ” on Block Earner’s website that referred to the company pooling customer funds to lend to its partners to generate returns.
In brief, Block Earner’s defence focused on submissions to the effect that:
- for the Earner product, customers were entitled to a fixed yield from Block Earner regardless of the performance of Block Earner’s activities with its institutional partners;
- for the Access product, the nature of Block Earner’s service was to provide assist users with accessing DeFi lending protocols, where the customer retained ownership of their digital assets and all yield was passed from such protocols to customers by Block Earner; and
- customers could transfer their own cryptocurrency for use in the services rather than exchange Australian dollars via the Block Earner platform, albeit this required a manual process facilitated by the company’s customer support.
Outcome of Proceedings
In relation to the Access service, Jackman J accepted Block Earner’s arguments in relation to the Access service and dismissed the proceedings insofar as they related to the Access service.
In relation to the Earner service, Jackman J accepted ASIC’s arguments that Earner was an unregistered managed investment scheme and an investment facility and that the company was required to hold an AFSL for this product. His Honour relied in part on the FAQ noted above which had referred to ‘pooling’. Given his Honour found that the Earner service was a managed investment scheme it necessarily followed, as a matter of law, that it was not a derivative. There will be a further hearing to determine any pecuniary penalty.
While the Government has proposed reform relating to the regulation of cryptocurrency-adjacent products and services, this case is an important reminder that the Australian financial services regime may apply to certain products and services involving cryptocurrency even where cryptocurrencies themselves have not necessarily been treated as financial products and noting the application is unlikely to be straightforward in many cases. We expect that ASIC will continue testing the regulatory perimeter with respect to crypto-related businesses. Firms operating in this space should carefully consider whether their activities are captured by existing regimes.
It is also a timely reminder that while contractual terms and conditions are important, businesses should also carefully consider other materials provided to customers (eg, the language that appears on their promotional material), which in some cases may be found to affect the legal character of the relationship between the business and the customer.