‍Key takeaways from Australia’s proposal for regulating digital asset platforms

‍Key takeaways from Australia’s proposal for regulating digital asset platforms

Earlier this week, the Commonwealth Treasury released its long awaited consultation paper proposing a comprehensive regulatory framework for digital assets in Australia. In this post, we take a look at the key elements of the proposal and what this means for Australian digital asset businesses.

‍Recap: Token mapping

The development of this framework began with a token mapping exercise earlier this year. Token mapping went back to fundamentals, mapping crypto tokens to the definition of financial products in the Australian Corporations Act, which, in turn, feeds into the Australian Financial Services Licence (AFSL) regime regulated by the Australian Securities & Investments Commission (ASIC). 

The thinking was, if digital assets bear the same characteristics as other financial products, they should be regulated in a similar manner. As Assistant Treasurer and Minister for Financial Services Stephen Jones memorably said at the time: "If it looks like a duck, walks like a duck and sounds like a duck then it should be treated like one."

‍AFSL for crypto: Customer asset holding and consumer protection‍

This latest consultation crystallizes exactly what an AFSL might look like for digital assets. In doing so, it goes right to the heart of a main concern for policymakers: consumer protection. 

In a speech announcing the consultation, Minister Jones said that “collapses are front and center on [the Government’s] minds,” with around 50,000 Australians “tangled up in the collapse of FTX.” Australians remain “heavily invested” despite “market volatilities” - according to Australian exchange Swyftx, 1 in 4 Australians currently hold crypto assets. The Minister also cited concerns around market misconduct (e.g. rug pulls) as well as crypto-related scams.

With this in mind, Treasury has proposed to anchor digital asset regulatory obligations around the activity of customer asset holding, “where the highest risk lies” for Australian consumers. 

Asset holding is an existing concept in the AFSL universe. Entities that hold customer assets (aka asset holders), such as fund managers and custodians, are subject to minimum standards to ensure that client assets are not exposed to unnecessary risks, and that holding and dealing arrangements are operationally efficient.

A new financial product, the digital asset facility, will be introduced into the AFSL taxonomy to operationalize this:

• A digital asset facility will be an asset holding arrangement (i.e. custody of customer assets). 
• Any entity in Australia that provides financial services (e.g. dealing, market making, custody, advisory) in relation to a digital asset facility, above a specified threshold, will require an AFSL. The proposed threshold is AUD5m in aggregate or AUD1,500 for any individual customer. 
• In identifying licensable businesses, the principle of control will be applied - for example, “businesses with the ability to exercise, coordinate or direct ‘factual control’ over the assets in a real and immediate sense.” Similar concepts have been applied by the UK Law Commission and the Financial Action Task Force (FATF). 

‍What will be the obligations of licensed digital asset platforms?

Licensed digital asset platforms will have to meet general AFSL obligations in areas such as disclosure, reporting, solvency and governance. 

Additionally, unique obligations for digital asset platforms will be introduced. Digital asset platforms must have standard user contracts that meet certain predefined minimum standards for asset holding, platform entitlements (i.e. customer rights), and transactional functions (e.g. disposal, transfer and exchange of assets and related rights). For example:

• Customer assets that are financial products will need to be held on trust.
• Tokens will need to be safeguarded at the “highest level” balancing timeliness and ease of withdrawals with security. Custody software, service providers or third-party custodians must meet certain minimum standards as well.
• A listing criteria must be in place for making tokens available on the platform.
• Licensed platform providers are expected to be the “primary enforcement mechanism” for market misconduct, and must make “reasonable efforts” to “identify, prevent, and disrupt” such activities. 

These obligations broadly align with recent policy recommendations from the Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO), reflecting Treasury’s mind towards achieving “consistency with the international community.” 

“Financialized” functions

The consultation also proposes additional obligations around what it calls “financialized” functions of digital assets. Non-financial products (e.g. wine, collectibles) are not typically covered by Australian financial services law. However, noting that non-financial products can be easily “financialized” in the digital asset universe through tokenization, Treasury considers that a “commensurate regulatory response” is required. The proposal thus includes minimum standards around four “financialized” functions for non-financial products:

1. Token trading
2. Token staking
3. Asset tokenization
4. Funding tokenization (aka fundraising)

Requirements for such functions include market efficiency and fairness, pricing transparency, and clear disclosures, among others. 

So, where do we go from here?

Looking ahead, we can expect a high regulatory bar. On the back of the consultation, ASIC also laid out its expectations and regulatory approach for the crypto sector. ASIC Chair Joseph Longo emphasized that “[c]rypto must be held accountable to the same high standards we expect of everyone else” and that “effective regulation requires strong enforcement.” This is unsurprising given the spate of enforcement actions ASIC has taken against crypto service providers. Exhorting the industry to create a “culture of compliance,” Mr Longo stressed that “compliance is not simply a box-ticking exercise” but “putting the consumer first [...in] every aspect.” 

At the same time, supporting digital asset innovation remains very much on the agenda, and the government knows that regulatory clarity and proportionality is a critical piece of the puzzle. Minister Jones acknowledged: “If we’re going to have a world‑class digital assets market, we’ll need fit for purpose regulation that can keep pace with a rapidly evolving ecosystem.”

The consultation is open for comments until December 1, with draft legislation expected to be released in 2024. Once it has been passed into law, industry participants will have a 12-month transitionary period to “ensure compliance and obtain a licence where required.”

For more Aussie crypto policy, check out our TRM Talk on Australia here.