The current aggregate market value of the digital asset ecosystem globally is estimated at approximately AU$2.8 trillion. There are approximately 221 million users worldwide having traded a cryptocurrency or used a blockchain-based application as of June 2021, up from 66 million at the end of May 2020. Despite this, the committee noted that the digital assets sector is still poorly understood by regulators and governments in Australia. It’s no surprise then that its primary focus for the report was the regulation of digital and crypto-assets in Australia. It says that taken together, its recommendations “will address significant issues of concern and increase Australia’s competitiveness as a technology and financial hub in our region”.
We summarise below the findings and the rationale and aims of the committee’s major recommendations on the regulation of crypto-assets set out in the 150+ page report. A key theme of many of the recommendations is addressing the current absence of formal regulation of crypto-assets without stifling innovation and growth in this area (noting digital assets’ ever evolving nature). It’s evident that the committee does not want to discourage industry in the process of implementing a regulatory regime in view of the potential economic benefits for Australia in becoming a welcoming environment for new and emerging digital assets.
The committee appears to have adopted many recommendations from submissions from the industry. A notable exception is the proposed “safe harbour” provisions to allow for a period of adjustment to any new regulatory regime. The committee did not explain why it made no safe harbour recommendations. Query the impact of the absence of such provisions on fostering the industry to develop.
The Bragg report is just the beginning of any potential legislative process for a comprehensive regulatory regime for crypto-assets. The recommendations represent a significant departure from the current regime which many suggest is not fit for purpose when it comes to digital assets. Whether the Federal government ultimately adopts the recommendations remains to be seen. Irrespective of the outcome, the report represents a significant coming together of industry, regulators and government grappling with a problem yet unsolved in Australia: how to regulate crypto.
Recommendation 1: The Government establish a market licensing regime for Digital Currency Exchanges (DCEs), including capital adequacy, auditing and responsible person tests under the Treasury portfolio.
DCEs enable customers to exchange or trade digital currency for other assets such as conventional currency or other digital currencies. They are subject to limited regulatory oversight, despite some managing billions of dollars’ worth of trades annually and holding hundreds of millions worth of client assets in custody. The committee believes a licensing regime will bring comprehensive consumer protections, noting many in the industry are calling for increased regulation to ensure consumer confidence. It notes that “[t]he existing Market Licence regime under the Corporations Act 2001, which is currently applied to a limited number of stock exchanges and other financial markets, is not well suited to become directly applicable to DCEs”. A new regime is to give consumer protection and operational integrity, without being so onerous as to drive away industry participants.
Recommendation 2: The Government establish a custody or depository regime for digital assets with minimum standards under the Treasury portfolio.
Some crypto-asset businesses provide a custodial or depository service for customers (ie. hold an asset on behalf of a customer) despite there being limited consumer protections, unlike for traditional financial assets. The committee recognised the unique and novel risks that custody arrangements for digital assets present and that having a clear framework in place will encourage development of custodial industry for digital assets in Australia. It suggests that the detailed submissions it has received on how a custodial framework for digital assets should work will assist the government in developing its own regime.
Recommendation 3: The Government, through Treasury and with input from other relevant regulators and experts, conduct a token mapping exercise to determine the best way to characterise the various types of digital asset tokens in Australia.
In some cases, crypto-asset related products meet the Corporations Act 2001 (Corporations Act) definition of financial product and are therefore subject to the requirement to hold an Australian Financial Services Licence and the associated obligations. In some cases they do not and the committee notes that this uncertainty needs to be addressed to give investors and market participants clarity to allow them to operate efficiently. It received submissions about proposed Corporations Act changes to bring digital assets within the existing financial services regulatory regime. Any regulatory framework needs to know precisely what it is regulating so the committee has recommended the government first classify the various types of crypto-asset tokens and other digital assets being developed in the market. It suggests that the typology ultimately developed will need to be sufficiently flexible to account for the dynamic and constantly evolving crypto technology.
Recommendation 4: The Government establish a new Decentralised Autonomous Organisation company structure.
Decentralised Finance (DeFi) involves a block-chain based business model or structure which aims to provide financial services without relying on central intermediaries or institutions. It does so through distributed ledger technology, digital assets and smart contracts. A recent Australian example is the development of cryptocurrency derivatives trading platforms which enable cryptocurrency holders to lend their cryptocurrencies and earn a return.
Many of these projects are now being set up with a decentralised ownership structure, through a model known as a Decentralised Autonomous Organisation (DAO). The committee notes that DAOs operate “on decentralised blockchain infrastructure, whose operations are pre-determined in open source code and enforced through smart contracts”. This means they don’t fit neatly within Australia’s existing company structures. The committee suggests that the resultant regulatory uncertainty “is preventing the establishment of projects of significant scale in Australia”. It takes the view that implementing a DAO company structure will “drive economic activity in this space and be a magnet for Australian innovation for DAOs, driving local jobs and tax revenue”.
Recommendation 5: The Anti-Money Laundering and Counter-Terrorism Financing regulations be clarified to ensure they are fit for purpose, do not undermine innovation and give consideration to the driver of the Financial Action Task Force (FATF) “travel rule”.
AUSTRAC implements guidelines released by the international FATF on virtual asset providers (VASPs) (ie. cryptocurrency or digital asset service providers). FATF’s travel rule requires VASPs to obtain, hold and exchange information about the originators (payers) and beneficiaries (payees) of virtual asset transfers. The committee noted that jurisdictions which have strictly implemented the rule to date have faced issues. Its view is therefore that Australia’s AML/CTF regulations must be fit for purpose for crypto-asset businesses, should not undermine innovation and take into account the driver of the travel rule.
The committee also made the following crypto-asset related recommendations:
- 6: The Capital Gains Tax regime be amended so that digital asset transactions only create a CGT event when they genuinely result in a clearly definable capital gain or loss. This to enable clarity as to the tax implications of digital asset transactions where it is currently lacking.
- 7: The Government amend relevant legislation so that businesses undertaking digital asset ‘mining’ and related activities in Australia receive a company tax discount of 10 per cent if they source their own renewable energy for these activities. This is to counteract energy intense activities such as cryptocurrency mining and any undermining effect they may have on Australia’s net zero emissions obligations.
- 8: The Treasury lead a policy review of the viability of a retail Central Bank Digital Currency (CBDC) in Australia. The Reserve Bank of Australia submitted that a CBDC “represents a potential new form of digital money that would be a liability of, or a claim on, a central bank”. The committee noted they are likely to be implemented in a growing number of jurisdictions in the coming years so Australia must actively investigate its options in case it becomes a pressing concern in future.
The remainder of the committee’s recommendations (recommendations 9–12) address de-banking (when a bank chooses to no longer offer banking services to a customer, an experience shared by many FinTech businesses, including those in the digital asset sector) and replacement of the Offshore Banking Unit (OBU) following concerns raised by the OECD Forum on Harmful Tax Practices. On debanking, the committee is concerned “that the lack of banking options for digital assets companies in particular is not only hampering innovation and investment in Australia but is potentially creating a single point of failure for the industry… and also leading to ineffective competition and a concentration of risk”.
- 9: The Government, through the Council of Financial Regulators, enact the recommendation from the 2019 ACCC inquiry into the supply of foreign currency conversion services in Australia that a scheme to address the due diligence requirements of banks be put in place, and that this occur by June 2022. This would allow the ACCC to examine whether debanking raises concerns under the Competition and Consumer Act 2010 (Cth).
- 10: In order to increase certainty and transparency around de-banking, the Australian Government develop a clear process for businesses that have been de-banked. This should be anchored around the Australian Financial Complaints Authority which services licensed entities. This is to provide increased certainty and transparency around decisions taken by banks to debank businesses.
- 11: In accordance with the findings of Mr Scott Farrell’s recent Payments system review, common access requirements for the New Payments Platform should be developed by the Reserve Bank of Australia, in order to reduce the reliance of payments businesses on the major banks for the provision of banking services.
- 12: The Government establish a Global Markets Incentive (GMI) to replace the OBU regime by the end of 2022. The committee suggests the introduction of the GMI regime will maintain and enhance Australia’s global position.