“In our early experiences with bitcoin, we found how few people were building bitcoin exchanges the right way. They really weren’t taking the regulation seriously; they were taking it too much like how you would approach something when you’re 18, full of the excitement of youth and throwing caution to the wind.”
— Tyler Winklevoss
The shape of things to come?
We all know that while regulation inevitably follows market innovation, it often lags so far behind that it only provides consolation, assurance and limitations on future innovation.
Thankfully, as the digital frontier expands, Australia is finally gearing up to establish a robust regulatory framework for digital asset platforms and create a conducive environment for the operation and management of digital assets by Australians and local enterprises. It’s designed to address consumer-related challenges while fostering innovation in digital assets and associated technologies.
In this article, we’ll delve into the blueprint of this proposed regulatory framework and its likely implications for financial advisers and licensees.
Context is king
Recently, Treasury outlined its vision for the future in a consultation paper titled “Regulating Digital Asset Platforms,” which aims to formulate a regulatory framework for entities facilitating access to, and holding of digital assets for Australians and local businesses.
Driven by the competing (and sometimes conflicting) objectives of mitigating consumer-associated risks and promoting innovation in digital assets and emerging technologies, the paper outlines the design of a secure digital asset ecosystem encompassing critical functions, licensing obligations, and facility contracts.
Treasury’s proposal addresses the operational model of ‘multi-function platforms that hold assets for customers’ (digital asset platforms), which are identified as common conduits for consumer-related issues. These include the dominant players in the digital asset market in terms of transaction volume and customer numbers, as well as brokers and intermediaries engaged in ‘asset-backed token’ arrangements.
Consumer Protection and Oversight
Recent events have highlighted digital asset intermediaries flaws and vulnerabilities, particularly that have given rise to consumer harms such as fraud, asset loss, among other risks. To alleviate these issues, Treasury have proposed a regulatory framework that imposes a set of standardised regulations on digital asset intermediaries. By adopting the Australian Financial Services Licence (AFSL) model, the framework aims to ensure consistent oversight, consumer protection, and a structured approach towards licensing obligations, financialised functions, and facility contracts.
The AFSL model, a tried-and-tested regulatory framework, will now extend to digital asset service providers presenting similar risks as traditional financial entities. Under this arrangement, such service providers will be mandated to adhere to comparable licensing obligations and minimum standards as traditional financial service providers.
If you need more information about Licensee Obligations, please read Reasonable Steps: Licensee obligations and regulatory risk management, Allen’s “s912A does not require perfection” or visit the ASIC’s website.
For your convenience, we’ll delve into potential drawbacks and criticisms of the proposed framework another time. Keen observers might, like us, question the efficacy of extending traditional financial regulations to the digital asset space, which has unique challenges and for which providers may be ill-equipped to address.
A notable aspect of the proposed framework is the disclosure obligations imposed on digital asset service providers to ensure clarity and transparency for consumers. One such obligation is the provision of a ‘facility guide’ to retail clients prior to service delivery. This guide is expected to encompass essential information about the platform, service terms, and links to comprehensive disclosures, mirroring the requirements of a financial services guide (FSG).
Identifying Digital Assets and Intermediaries
The term, digital assets, as used by the Treasury encompasses tokens and their associated entitlements, which replicate records or entitlements analogous to physical token-based systems and account-based systems. Digital assets, transferable and often cryptographically authenticated, include cryptocurrencies, security tokens, and other digital tokens.
On the other hand, digital asset intermediaries refer to entities facilitating access to and holding digital assets for Australians and local enterprises. This encompasses digital currency exchanges, wallet providers, and other digital asset service providers. The regulatory framework aims to ensure that these intermediaries operate within a structured and secure environment, thereby protecting consumers and promoting a healthy digital asset ecosystem.
- Mitigating Risks and Regulatory Arbitrage: The framework could potentially impact existing brokers in the market by either posing additional risks or opening doors for regulatory arbitrage. However, it encompasses general obligations like ensuring the provision of financial services efficiently, honestly, and fairly, which can help curb risks and opportunities for regulatory arbitrage.
- Tailored Licensing Obligations: The mix of standard and tailored licensing obligations for digital asset service providers is crafted to ensure that they meet standards akin to traditional financial service providers while addressing the unique risks associated with digital assets.
- Separate Consultation for AML/CTF Requirements: While the proposed framework focuses on consumer protection and innovation, it does not cover anti-money laundering and counter-terrorism financing (AML/CTF) requirements. A separate consultation led by the Attorney-General’s Department is underway to consider expanding the range of digital asset-related services subjected to AML/CTF regulation in line with global Financial Action Task Force Standards. For additional information, please explore AUSTRAC’s website.
Proposed Minimum Standards
The draft framework outlines minimum standards for facility contracts to ensure appropriate arrangements for safeguarding customer assets and ensuring platform entitlements even in the event of insolvency of the platform provider. These standards encompass holding customer assets on trust, maintaining adequate records, and having suitable insurance arrangements in place.
The consultation paper is an invitation for stakeholders to provide feedback and contribute to the shaping of this regulatory framework. Submissions can be lodged electronically or via post, with a preference for electronic lodgement at email@example.com.
The reality is that even this slowly evolving regulatory framework for digital asset platforms in Australia is a significant stride towards establishing a better structured and more secure digital asset ecosystem. It not only aims to protect consumers but also to foster innovation in digital assets and emerging technologies, thereby potentially catalysing the growth of the digital asset industry in Australia.
If you are a financial adviser or licensee whose clients may want to play in this space, you need to stay abreast of these developments and the opportunities and obligations that they bring along.
We’re here to help.