Regulation and Change in the Crypto Sector
While the regulation of cryptocurrency has been under discussion for some time in Australia, the topic has taken a new focus with the demise of FTX, which has resulted in significant losses for over 25,000 Australian customers, and many USD billions of missing client funds globally, and consequent effects on the wider crypto sphere.
What is the current state of crypto regulation in Australia?
The crypto market globally and in Australia is largely unregulated.
The existing Australian framework consists of a patchwork of requirements from other parts of Australian law, including the Corporations Act 2001, the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML), and the Competition and Consumer Act 2010.
The main operational requirement on Aussie Crypto operators is being registered with AUSTRAC and undertaking AML.
Actual and perceived gaps in regulation
The lack of specific regulations applicable to crypto assets and service providers has resulted in actual and perceived regulatory gaps.
Providers of crypto services offer access to crypto assets in a number of ways, including brokerage services, exchanges, and by dealing directly with consumers. A number of these providers (including FTX) exchange fiat currency for crypto assets and although commonly thought of as exchanges, these operators are really custodians and market makers with little or no financial, capital or reporting requirements.
This is in stark contrast to regulation of traditional financial product and service providers including custodians and market makers, who are required to hold an Australian Financial Services Licence (AFSL) under which there are significant financial, capital, operational, reporting and audit obligations, and for the big end of town, including banks, who have very significant obligations and prudential requirements over all aspects of their operations.
It has been difficult for crypto service providers to apply for and be granted an AFSL due to the current lack of clarity around what a crypto asset is - there are no definitive rules as to whether cryptos are financial products, and regulators have been declining to make decisions, or commit and allow crypto operators to be licensed, which leads to further operational issues.
When the prices of crypto assets were increasing, many retail consumers sought crypto investments through crypto service providers. Some consumers may have believed that crypto service providers are subject to regulatory oversight like traditional financial services licensees.
Under the current environment and regulations, consumers have limited recourse in the case of financial, operational or cybersecurity failure of crypto-related service providers including FTX.
What steps are being taken to regulate the crypto sector?
In August 2022, the Australian Treasurer said government would prioritise ‘token mapping’, a process to identify the characteristics of all digital asset tokens, including charting the types of crypto assets, their coding and any other technological features.
After the collapse of FTX in November 2022, the Australian government signalled that it would introduce legislation covering crypto exchanges and the custody of crypto assets with the goal of preventing losses, such as those that affected FTX customers.
In the past few years, the Australian government commenced industry consultation. In September 2022, a private member’s bill was introduced for consultation. The bill introduces licences for digital asset exchanges, digital asset custody services and stablecoin issuers, which would include auditing, capital adequacy and responsible person tests. It also would establish disclosure requirements for the e-Yuan (the first central bank digital currency released by the central bank of a major economy in Australia).
Whilst licensing exchanges and custody service providers will help to reform the crypto environment, some crypto exchanges behave more like banks that use customer deposits to trade and lend, and a simple market licensing regime might not be sufficient, and a more prudential approach may be appropriate in certain circumstances.
Next steps for crypto regulation in Australia
The losses and flow on effects resulting from the collapse of FTX have increased the urgency of regulating cryptocurrency assets and services. It is expected that legislation will be introduced in 2023. The form of this will depend on the current token mapping being undertaken by Treasury.
Around the globe, a few other countries have implemented regulation of exchanges and custody arrangements. The European Union has defined digital assets according to their function, Singapore has introduced crypto exchange licensing, and Hong Kong has developed regulations for businesses managing crypto assets.
Introducing pro-active regulation and supervision as soon as practicable will give Australia a significant competitive advantage in attracting a rapidly developing industry, and will give Australian consumers a much more certain and safer environment in which to participate.