‘We are all tech lawyers now’ – the future of cryptocurrency

In October this year, the Australian Treasury released a proposal paper, “Regulating Digital Asset Platforms”, with submissions open until 1 December. The paper responds to increased concern about money laundering, terrorism financing and mishandling of customer funds within the cryptocurrency and digital assets markets. It discusses a proposed regulatory framework that would apply to digital asset service providers that present similar risks to entities operating in the traditional financial system.

“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,” Assistant Treasurer and Minister for Financial Services Stephen Jones said in an address to the Australian Financial Review Crypto Summit on 16 October in Sydney.

Jones went on to outline the Treasury’s proposal focusing on digital asset platforms; these will be required to hold an Australian Financial Services Licence, entailing obligations to act fairly and honestly, offer dispute resolution processes, meet solvency and cash reserve requirements, and maintain financial records. Additionally, crypto exchanges and other digital asset platforms will be obligated to oversee and intervene in market misconduct.

Jones added that the proposed new regulation would include platform contracts, standards for custody software, and standards for the transaction of tokens that would apply to all platforms with a holdings minimum of $1,500 per individual account or $5 million in aggregate holdings.

A consumer protection focus

Michael Bacina, a Partner at Piper Alderman, is based in Sydney. The practice is an industry-focused group that advises, among other things, on financial services and product advice, corporate matters, contracts and mergers and acquisitions. Piper Alderman’s clients include global and Australian crypto-asset exchanges, as well as traditional businesses seeking to adopt blockchain technology.

He says, “From the government perspective, the collapses of 2022 and court proceedings in the United States, as well as a focus on scammers using crypto assets as a means of moving their ill-gotten gains, have loomed large … This consumer protection focus by the current government underpins and is referred to in the current proposed regulatory framework, which seeks to implement custody requirements as well as licensing requirements on digital asset platforms in the coming years.”

Bacina says there are two sides to the current concerns facing the crypto industry in Australia.

“The first is industry led. The industry proactively sought out the inclusion of exchanges in the 2018 anti-money laundering and counter terrorism financing amendments which, at the time, placed Australia at the forefront of crypto-asset exchange regulation. The industry has continued to advocate for two key areas of guidance and clarity: a sensible definition of crypto-assets and a clear delineation between when crypto-assets will become considered a financial product or not, together with rules and guidance by which crypto-asset financial products could fit within the existing financial services framework.

“The second is for sensible and commercial custody rules for exchanges so that customers can be confident their crypto assets are safe in the event of an insolvency event.”

Bacina adds, “An overarching concern is of course cost and complexity of compliance, to support a competitive and thriving local crypto exchange scene.”

Currently, there are no specific laws in Australia governing cryptocurrencies. Rather, their ownership and trading exist within regulatory frameworks for financial services.

Under the Corporations Act 2001 (Cth) (Corporations Act) and the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act), cryptocurrency could fall within the definition of an investment or a financial product depending on how an offering is made. Cryptocurrency lending activities which fall within the scope of the National Credit Consumer Protection Act 2009 (Cth) require an Australian credit licence.  Digital Currency exchange (DCE) services who convert money to crypto and vice versa must register if they provide fiat currency to crypto currency exchange services, but if they are offering crypto-to-crypto services only, they don’t have to register.

Penalties for not registering are a maximum of two years imprisonment, a fine of up to $111,000, or both. DCE providers must renew their registration every three years and keep transaction records and customer identification records for up to seven years.

Elvira Sojli is Associate Professor of Finance and Scientia Fellow Alumni in the School of Banking and Finance at UNSW. She says there are both costs and benefits to regulation: enhanced confidence from investors and customers in embracing cryptocurrencies but increased burden on crypto businesses that may look to less regulated marketplaces.

Sojli says, “The proposed Australian regulation brings crypto exchanges and assets in line with other equity and stock investments. Crypto exchanges will have to be licensed through ASIC (which also licenses ASX) and adhere to the rules and regulations of ASIC. The proposed regulation will make market participants more certain about the safety of their assets; however, it will increase the burden on the exchanges.”

Sojli adds, “The US has flirted several times with regulation of the crypto market, but it has always stopped short of regulating, as it is concerned it will lose its leading marketplace. While Australia is not a leader in the global digital asset innovation, more regulation will push the exchange to set up in other jurisdictions with less regulatory burden, like Singapore. ASIC will then lose oversight of Australians’ participating – trading – in this market.”

LSJ asks, how possible is it to fully regulate and legislate crypto and digital assets when so many exchange platforms and businesses operate offshore, and often outside of Commonwealth jurisdiction?

Sojli responds, “I think this is a major challenge, and it’s not unique to the crypto space. The same problems have been faced in the foreign exchange (FX) market. The FX market still requires money transfers through banking entities for the most part and therefore, there can be some oversight of money laundering activities. Rules can be implemented at the bank level when electronic transfers are involved. This is not possible with crypto and digital assets. Any regulation will be superficial and will be hard to enforce.”

Bacina says, “The nations viewed by industry as leading [crypto regulation] are clearly the UAE, which has established a specialist crypto regulator staffed with experts who have a deep understanding of crypto-assets and the resourcing to stay up to date in this fast-moving space, and island nations, which have been welcoming or taken a ‘hands off’ approach to the industry. The incredible growth of Dubai as a crypto-city has been a direct response to this. Additionally, Singapore has introduced a licensing framework which is likely to be closer to the kind of regulation Australia will see in place in the future. Hong Kong has also recently jumped into regional contention, with very generous government support to encourage a return of tech businesses to their shores.”

Bacina adds, “We see some jurisdictions, such as the US, where there is strong criticism by regulators of whether decentralisation really exists, and no real path to compliance. Australia is at a turning point with our upcoming consultation. We will either introduce something closer to a Singapore model and retain our competitive advantage, or, if the framework is too complicated or costly, we will see a continuing departure of talent from our shores to jurisdictions which are welcoming to innovation.”

Legal and popular

Cryptocurrencies are legal and popular in Australia. The most popular are Bitcoin (65 per cent of cryptocurrency investors hold this form), Ethereum (42 per cent), Cardano (26 per cent), Dogecoin (23 per cent), and Binance Coin (14.6 per cent).

In 2017, cryptocurrency and the associated exchange platforms were given full legal status. With high-profile cases of fraud, scams and crashes – including the November conviction of FTX founder and CEO Sam Bankman-Fried on seven counts of fraud – it is timely that the Australian government is committed to introducing heightened regulation around the cryptocurrency industry, addressing existing loopholes and enhancing customer protections. According to Jones, around 50,000 Australians were affected by the crash of FTX.

On 22 November, Binance CEO Changpeng Zhao pleaded guilty to one count of failure to maintain an effective anti-money-laundering program in a Seattle federal court. The Cayman Islands-based Binance LLC has agreed to pay more than $US4 billion after a US government investigation into the biggest cryptocurrency exchange. Following the FTX crash in 2022, a closer focus on Binance resulted in accusations by the US government that it was operating as an unregistered securities exchange and violating multiple US securities laws, mirroring the practices of the world’s once second-largest cryptocurrency exchange FTX.

In an address to the Summit, Jones said, “Cryptocurrency has emerged from the sidelines of the finance world, where it was a favoured speculative asset of the tech-savvy. The Australian Tax Office now estimates around 600,000 taxpayers have invested in a cryptocurrency, though Swyftx tells us that 1 in 4 Australians have crypto.”

In 2023, according to Swyftx, 4.6 million Australians own cryptocurrency compared to 4.2 million in 2022. Following Nigeria and Malaysia, Australia has the third-highest adoption of crypto globally, just ahead of Indonesia and Hong Kong. By January 2022, the five most popular forms of crypto coins in Australia had increased in value annually from a minimum of 35 per cent (Bitcoin) to a 1,602 per cent increase in value (Dogecoin).

Over 60 per cent of Australian crypto customers store their crypto in hot wallets (purely accessible online through a cryptocurrency exchange platform), a cold wallet (stored wholly offline), a hardware wallet (a form of cold wallet, such as Ledger or Trezor), or a paper wallet (another form of cold wallet).

More vulnerable than banks?

In his presentation to the Summit, Jones admitted that the majority of financial scams in Australia are the result of bank transfers. However, he said, “We are also concerned that crypto exchanges are being used to facilitate scams. This year, financial losses via crypto have increased by 33 per cent to $146 million. It’s one of the main ways scammers facilitate payments.”

The levels of confidence in crypto ownership and trading are increasing despite the crash of Bankman-Fried and his FTX crypto empire 2022. This form of currency, and similar digital assets, draw people despite the volatility of the market and despite the lack of thorough understanding many crypto investors have in the product.

An April 2023 study by Pew Research Center in the US found that 39 per cent of adults who have heard of cryptocurrency have little to no confidence in what it is. A global study in 2022 found that 60 per cent of the 10,500 survey respondents did not understand crypto. That survey took place at the time when FTX had recently crashed, and, despite the very public downfall of a highly publicised crypto business, 81 per cent of survey respondents said they intended on maintaining or increasing their crypto assets within the next six months.

“I am somewhat astonished by the resilience of this market,” admits Sojli. “As you can see from the prices of the most popular assets, they’ve been on the up in the last couple of weeks. And for some, the FTX collapse is not different from the Silicon Valley Bank (SVB) collapse, the only difference being that SVB clients get some of their lost deposits back through the Federal Deposit Insurance Company (FDIC). Crypto investments are not covered by deposit insurance – understandably, given they are investments, not deposits.”

Sojli says there are two types of investors in the crypto market.

“There’s the enthusiasts and the speculators. Fundamentally, these assets were conceptualised to work around the current banking system. The desire is to remove the mediator, or ‘disintermediate’. The enthusiasts are the core investors that will never leave the market. The technology is inspiring to some people because of its ideals of democratising currency, and those ideals have taken root.

“It will take more than this current volatility to quash that fundamental need and want to sidestep the use of the banking system. The speculators will enter and exit this market when they believe there are returns to be made. Many of those have already left the market and are waiting to see where some of these firms are going and how legislation is shaping.”

‘Crypto winter’ is ongoing

“’Crypto winter’ began around May 2022,” Sojli says, “instigated by a series of dramatic and unexpected market events: it started with the failure of multiple stablecoins, such as TerraUSD and Luna in May, and was followed by the collapse of FTX in November. The crypto winter is still on-going, fuelled by the on-going regulatory risk and the broader macroeconomic risks like inflation and unemployment.

She continues, “Crypto winter describes the prolonged bear market, a period of significant price decline and pessimism in the cryptocurrency market. During this period, the value of many cryptocurrencies experienced a sharp decline, often leading to a sustained period of reduced market activity, decreased enthusiasm, and a general downturn in sentiment within the cryptocurrency community.

“Personally, I think the market is reverting to where it should be, given the small – even non-existent – tangible benefits or cash flows that the crypto assets provide. I think they are still clearly overvalued. This market needs to consolidate and to provide clear business propositions. The technology behind this market is valuable, but it is not what is being sold through the crypto assets. The crypto companies do not have unique claims to the technology, which can be used by other more mainstream companies without the need to pay licence fees.”

‘We are all tech lawyers now’

Section 1013D of the Corporations Act 2001 (Cth) requires that a product disclosure statement must outline information a financial product buyer would reasonably require in order to make a decision about whether to buy or not, which ASIC identifies as the characteristics of crypto assets and the risks involved in purchasing those assets.

ASIC identifies the basic information buyers should be provided with should encompass the technologies that underpin crypto-assets, such as blockchains, distributed ledger technology, cryptography and others; how crypto-assets are created, transferred and destroyed; how crypto-assets are valued and traded; and how crypto-assets are held in custody.

While many investors in the crypto market still don’t fully comprehend cryptocurrency, it is increasingly a market that Australian lawyers will need to comprehend, says Bacina.

“I heard someone comment the other day that whether we like it or not, we are all tech lawyers now. That resonated with me. For any practice which is industry focused, understanding the nuances and details of that industry is key. When it comes to technology, having a comfort and understanding of programming, networks and code is a significant advantage in being able to give advice to clients which speak the client’s language.”