As the use cases, volatility, disasters and triumphs of blockchain technology and crypto assets continue to grow at pace, legislators and regulators are trying to keep up.
You might be forgiven for thinking that these emerging clusters of technology, and their uses in finance and investment products, exist in the Wild West, but that is starting to change and 2023 could be shaping up as the year of significant regulatory progress in Australia.
While cryptocurrencies and other digital assets are currently regulated within ASIC’s existing regulatory framework to the extent that they fall within a category of financial product or service, outside these categories, the crypto sector remains largely unregulated.
In the past 12 months, there has been an increased push for greater regulation of the crypto sector to promote industry confidence and growth while safeguarding consumers against unnecessary financial harm.
Background – the Bragg Report
Much of the recent discussion around the regulation of cryptocurrency and other digital assets in Australia has been driven by the October 2021 report published by the Senate Select Committee on Australia as a Technology and Financial Centre chaired by Senator Andrew Bragg (the Bragg Report).
The Bragg Report sets out 12 recommendations for regulatory reform in Australia’s crypto sector that all broadly point towards a departure from the current approach of regulating cryptocurrency within existing regulatory parameters. The recommendations, if adopted, would see the introduction of a new licensing regime for digital currency exchanges, and the recognition of a decentralised autonomous organisation entity type, among other things.
While it remains to be seen which of the recommendations (if any) will be adopted by the Australian government, there has been some progress towards legislation in the form of a draft private member’s bill titled Digital Assets (Market Regulation) Bill 2022 (Bill) introduced by Senator Bragg.
The draft Bill – the framework for a new regulatory framework in Australia?
The draft Bill proposes to:
- implement two key recommendations in the Bragg Report, namely the licensing of digital asset exchanges and digital asset custody services;
- introduce parameters around the issue of stablecoins against the backdrop of the collapse of popular US stablecoin UST (Terra); and
- facilitate the entrance of digital currencies into the Australian market, starting with the digital Yuan.
If the Bill is passed, it will be a stepping stone towards a new and more comprehensive regulatory regime for the crypto sector. The consultation process for the Bill completed on 31 October 2022.
The approach in other jurisdictions
In some respects, the draft Bill follows moves in other jurisdictions, such as Singapore and the United States, which have developed crypto-specific legislation, but in other respects, it aims to position Australia as “a global leader in cryptocurrency.”
The proposed licensing regime for crypto exchanges appears to have been inspired by Singapore’s regime. Towards the end of 2021, one of Australia’s most well recognised marketplaces, Independent Reserve, obtained a regulatory licence in Singapore, a development which according to the Bragg Report, shows “what Australia is missing out on by not developing an appropriate framework here”.
Similarly, the proposed licensing regime for the issue of stablecoins reflects one of the earlier versions of a draft US stablecoin bill, which was drafted in the months ensuing Terra’s collapse. To provide some context around why stablecoin regulation is currently a hot topic both internationally and in Australia, we set out below a snapshot of the Terra crypto crash.
Stablecoin regulation – the Terra crypto crash
Stablecoins are cryptocurrencies that attempt to peg their value to an external reference point, such as a commodity or currency. The Terra stablecoin was designed to be pegged to the US dollar. Instead of that peg being backed by reserve capital or some other asset, which matched the value of Terra in circulation, Terra operated as an “algorithmic stablecoin.” In Terra’s case, this meant that its value was linked to the value of its sister coin Luna: one Terra was to equal USD1 of Luna.
In theory, the stablecoin algorithm was supposed to peg the value of Terra at or very close to its target of USD1. So:
- if the price of one Terra was greater than USD1, then traders would have an incentive to trade USD1 worth of Luna for one Terra to make a profit, therefore increasing the Terra coins in circulation and bringing the price of Terra down to its peg; and
- if the price of one Terra was less than USD1, then traders would have an incentive to trade one Terra for USD1 worth of Luna to make a profit, therefore reducing the Terra coins in circulation and bringing the price of Terra back up.1
However, in May 2022, approximately USD60 billion was erased in a “new kind of bank run”2 when a major sell-off caused Terra to fall below its peg of USD1. Investors started to lose confidence in the Terra model, and as more Terra coins were traded in for Luna coins, the value of Luna continued to drop, resulting in a “death spiral.” Although Terra attempted to stabilise its peg through selling its Bitcoin reserves for Terra, the value of its Bitcoin reserves was insufficient to save Terra / Luna from crashing.
The collapse of Terra had a ripple effect on the crypto sector, wiping out an estimated USD300 billion from the value of all cryptocurrencies in the week ended 13 May 2022.3 Bitcoin in particular suffered a significant drop in value.
Unsurprisingly, the fallout from Terra sparked calls for greater regulation of the crypto sector, particularly in the stablecoin space. While the initial reaction of US legislators was to require the holding of more substantial capital reserves for stablecoins to manage the risks, the latest draft US stablecoin bill is considering the ban of algorithmic stablecoins altogether for the next two years.
With the US midterm elections scheduled for 8 November 2022, it is likely that any consideration of the stablecoin bill will now be delayed until next year, but it is clear that the regulation of stablecoins is high on the agenda.
A market for digital currency in Australia?
The Bill released by Senator Bragg also proposes to introduce the digital currency developed by the People’s Bank of China, the digital Yuan, into the Australian market.
The Bill imposes reporting requirements on facilitators of the digital Yuan and requires APRA and the Reserve Bank of Australia to submit annual reports on the information received from facilitators to specified parliamentary committees.
The primary rationale for the reporting requirements is to obtain information about the digital Yuan, while ensuring that there is a degree of oversight by statutory authorities in the interests of consumer protection, security, and transparency.
If the Bill is passed, Australia would become one of the first countries (other than China) to facilitate payments using the digital Yuan. The Bill represents an ambitious move towards the goals outlined in the Bragg Report, namely Australia “becoming a leader in the digital assets space.”
Crypto regulation within ASIC’s sights
In the meantime, pending regulatory reform in Australia’s crypto sector, ASIC continues to regulate crypto assets within the scope of its existing regulatory framework.
In a recent media release dated 17 October 2022 (22-278MR), ASIC reported that it had made interim stop orders against three crypto investment funds (each invested in an individual crypto asset – bitcoin, ether and filecoin) for having non-compliant target market determinations (TMDs) in contravention of their design and distribution obligations. According to ASIC, the wide target market defined in the TMDs, which included investors with a potentially medium, high or very high risk and return profile, and investors intending to use the fund as a satellite component (up to 25%) of their investment portfolio or as a solution/standalone component (75-100%) of their investment portfolio, was not appropriate in light of the funds’ asset risk factors (which it seems ASIC considers make a narrower TMD, at the higher risk / lower exposure end of the spectrum, more appropriate).
ASIC’s comments in 22-278MR highlight that there is a recognition on its part that crypto-assets are a major area of concern from a consumer protection perspective, given the “highly volatile and complex” nature of such assets, particularly where crypto-assets comprise all or a substantial portion of an investment portfolio. The enforcement action reported by ASIC in 22-278MR makes it clear that ASIC is willing to use all its available tools to prevent consumer harm associated with crypto assets, including by using its discretion to set a high threshold for compliance where crypto assets are involved.
On 25 October 2022, ASIC also announced that it had commenced proceedings against BPS Financial for alleged false, misleading or deceptive representations and unlicensed conduct in relation to crypto-asset Qoin, saying “where it falls within our remit, ASIC will take targeted action against unlicensed conduct and misleading promotion of crypto-asset financial products that could harm consumers – this is a key priority for ASIC.” It also reiterated its earlier comments in 22-278MR on the volatile, risky and complex nature of crypto assets, and the need for honest and accurate disclosure in the context of crypto-assets in particular.
But wait, there’s more…
In October 2022, Roofstock onChain (the web3 subsidiary of US real estate investment platform, Roofstock) announced its first real estate sale that was settled instantly on an NFT (non-fungible token) marketplace. In a “one-click” transaction utilising blockchain-enabled smart contracts, the purchaser acquired title to a home in South Carolina, as well as financing for the purchase.4
Clearly, the use of these emerging and developing technologies is going to continue to disrupt existing investment and transaction structures.
What is on the agenda for 2023?
We expect that there will be significant developments in the crypto asset regulatory space, regardless of whether or not the Bill is passed by the Australian parliament. As well as following any developments in relation to the Bill, we will have the following on our radar for 2023:
- The Albanese government’s token mapping exercise – this exercise will be the first of its kind and will reportedly “make Australia leaders in this work.” The aim of the exercise is to identify how crypto assets and other digital assets should be regulated. A public consultation paper on ‘token mapping’ is expected to be released later this year or early next year.
- The US stablecoin bill – the key questions are whether the stablecoin bill will undergo any further changes before a final version is released and whether the bill will ultimately be passed. It is likely that any stablecoin regulation in the United States will become a source of inspiration for stablecoin regulation here in Australia.
Developments in the blockchain space generally continue at great pace, and it seems likely that governments and regulators will always be playing catch-up to some degree, making a considered and principles-based approach critical.
1 How $60 billion in Terra Coins Went Up in Algorithmic Smoke (available at: https://www.bloomberg.com/graphics/2022-crypto-luna-terra-stablecoin-explainer/?leadSource=uverify%20wall)
2 An $85 b crypto collapse reveals a new kind of bank run (available at: https://www.afr.com/technology/an-85b-crypto-collapse-reveals-a-new-kind-of-bank-run-20220524-p5anzq#:~:text=TerraUSD%20was%20a%20so%2Dcalled,that%20had%20topped%20%24US60%20billion).
4 https://finance.yahoo.com/news/ “Roofstock Sells First Real Estate Property On Ethereum, Powered by Origin Protocol NFTs And Teller DeFi”, 19 October 2022.