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The Senate Economics Legislation Committee is
currently reviewing the
draft Digital Assets (Market Regulation) Bill 2023
. The bill
was introduced as a private member’s bill by Senator Bragg and
seeks to establish a licensing framework for cryptocurrency
exchanges, custodians and stablecoin issuers. The Piper Alderman
Blockchain team filed a submission to the review proposing a more
ambitious and comprehensive regime in order to fully grasp the
opportunities and efficiencies unlocked by blockchain technology.
The Committee is due to report back by 2 August 2023.
The submission is set out below in its entirety. The comments
within are the authors’ own and do not necessarily represent
the views of the Piper Alderman partnership.

Executive Summary

Advancements in blockchain, digital assets and distributed
ledger technology continue to gather pace, opening pathways for
innovation in a wide range of fields including finance, real
estate, supply chain, entertainment and ticketing, social media,
music and the arts. The development of a bespoke legislative
framework is necessary to enhance consumer protection and support
innovation to enable Australians to fully grasp the opportunities
and efficiencies unlocked by blockchain technology.

Many jurisdictions around the world including the European Union
(EU), United States (US), the
United Kingdom, Singapore, and Hong Kong are actively exploring and
implementing new regulatory frameworks for the issuance and trading
of digital assets. By moving in step with other jurisdictions in
establishing a broadly based legislative regime, Australia can
retain and attract young and highly skilled workers to support
domestic innovation and industry in Web3 technology.

We welcome the Australian Government’s Token Mapping
Consultation Paper and the Government’s efforts to progress a
legislative framework for licensing and custody of digital assets.
We also appreciate the Committee’s and Senator Bragg’s
continued leadership and effort in pushing forward an Australian
digital asset regulatory framework. The Digital Assets Bill is a
welcome step in seeking to formulate draft legislation.

The current focus of the Digital Assets Bill is to establish a
licensing and regulatory framework for digital asset exchanges,
custody providers and stablecoin issuers. While these are important
aspects of a digital asset licensing regime, we encourage
policymakers to consider a more ambitious and comprehensive regime
which would cover a broader range of digital asset services and
intermediaries, such as market makers, brokers, underwriters and
digital asset advisors. A comprehensive framework should also offer
a regulated pathway for start-ups and token issuers who will
otherwise leave Australia to establish operations in other
jurisdictions such as the EU or Singapore.

The EU’s Markets in Crypto-Asset Regulation
(MiCA) offers a workable model for a comprehensive
framework for regulating digital assets which sits alongside and
complements existing financial services laws. MiCA covers a wide
range of crypto-asset service providers and crypto-asset and
stablecoin issuers and includes market integrity
provisions.1 The full text of MiCA was formally ratified
and adopted by the European Parliament on 20 April 2023, and has
since been approved by the European Commission. It will enter into
force after 18 months from the date of official publication. MiCA
is the most comprehensive international precedent and standard
currently available for digital assets regulation.

Given the likely impacts of MiCA, we recommend that
consideration be given to implementing a more ambitious regime that
embraces certain concepts in MiCA in formulating Australia’s
own digital asset services licensing and regulatory regime.

To provide practical suggestions for the next draft of the Bill,
this submission outlines a few key areas that we believe could be
addressed by reference to regulatory developments in other
jurisdictions.

As further discussed below, we recommend that the Digital Assets
Bill explicitly exclude non-fungible tokens
(NFTs), tokenised financial instruments and
decentralised platforms. This would follow the EU’s approach
under MiCA, which excludes NFTs from its scope for separate review
in due course.

We also recommend that the Digital Assets Bill:

  1. Narrow the definition of “regulated digital asset” to
    exclude unique NFTs to exclude assets such as digital art,
    collectibles, in-game items and tickets and ensure technology
    neutral regulatory treatment;
  2. Narrow the definition of stablecoins to address core risks
    relating to redemption and reserve requirements and encourage
    adoption and usage;
  3. Create a regulated pathway for token issuance that is not
    limited to stablecoins;
  4. Expand the scope of the licensing regime to cover a range of
    digital asset service providers consistent with the MiCA regime and
    address regulatory arbitrage;
  5. Implement basic prohibitions on market misconduct, including
    insider dealing and market manipulation in relation to digital
    assets to promote fair, orderly and transparent markets;
  6. Narrow the scope of the proposed recognition of foreign
    licences to foster the domestic digital asset industry, ensure
    consistent regulatory standards and enhance consumer protection;
    and
  7. Extend the transition period to allow the regulator sufficient
    time to process licensing applications having regard to recent
    experience in the United Kingdom and Singapore.

Recommendation 1: Definition of digital
assets

In the draft Bill, the term “digital assets” could
potentially capture a wide range of assets, including
cryptocurrencies, digital securities, and digital representations
of tickets, art or music. The scope of the licensing and custody
regime in the draft Bill is appropriately confined to a more
limited subset of digital assets falling within the definition of
“regulated digital asset”.

However, the definition of “regulated digital asset”
includes “exchange token”. “Exchange token”
means a kind of digital asset (other than asset-referenced tokens
or electronic money tokens) the main purpose of which is to be used
as a means of exchange. This is potentially very broad and is
liable to catch a wide variety of tokens, including NFTs. That
definition flows through to the core sections of the Digital Assets
Bill including the operation of a digital asset exchange and
provision of digital asset custody services.

NFTs to be carved-out

To further aid regulatory clarity, we propose to specifically
exclude unique and non-fungible tokens which do not otherwise
qualify as financial products (e.g. digital art, collectibles,
in-game items, tickets, proof of attendance, music) from the
definition of digital assets, consistent with the EU’s approach
under MiCA. Many of these use cases bear little resemblance to the
features of other more financial-like crypto assets. NFTs are more
closely akin to digital goods, and issuers are already subject to a
comprehensive consumer protection regime under the Australian
Consumer Law.

The underlying analogue versions of these assets (e.g. a
physical piece of art, a physical Pokémon/basketball trading
card or a concert ticket) are not treated as regulated assets
similar to financial products. Equally, marketplaces that sell
these underlying assets (e.g. eBay, Amazon, etc) are not licensed
platforms. We submit that the law should adopt a technologically
neutral approach in relation to digital versions of these
underlying assets.

Absent this clarity, a marketplace for art-based NFTs,
collectible NFTs, or gaming NFTs (to name a few NFT use cases)
could be required to comply with the same standards expected of
persons carrying on a regulated financial services business. This
would include minimum capital requirements, custody, record-keeping
and reporting obligations.

Exclusion of financial products

The definition of “regulated digital asset” also
excludes digital assets which fall within the definition of a
financial product under the Corporations Act (i.e. tokenised
securities would be regulated under existing laws). This is
appropriate. The fact that a security is issued on a blockchain
rather than on paper or in dematerialised form should not impact
its regulatory treatment.

Such an approach would recognise the principle of “same
risk, same regulation” while acknowledging the differences
between cryptocurrencies and traditional financial products.
Certain laws that apply to financial products are not readily
applicable to cryptocurrencies. For example, continuous disclosure
obligations do not make sense in the context of a cryptocurrency
where its features are encoded upon issuance.

The Digital Assets Bill does not address the complexity of
assessing whether a crypto-asset is a financial product. This is
something that is difficult to effectively address in legislation.
Further regulatory guidance will be necessary to define the
boundaries of the financial product and digital assets regimes
respectively.

Recommendation 2: Definition of stablecoins

The current definition of stablecoins is broad and would cover a
wide variety of digital assets, including wrapped tokens as well as
algorithmic stablecoins. The current stablecoin definition includes
an “asset-referenced token” which purports to maintain a
stable value by reference to one or more fiat currencies,
commodities, digital assets or some combination of the same and an
“electronic money token” which purports to reference the
value of a single fiat currency. Both definitions are potentially
very broad.

At this time, it is appropriate to limit the definition to
stablecoins which purport to be pegged to a single fiat currency to
address the specific risks relating to these assets (e.g.
redemption and reserve requirements) and to encourage the adoption
and usage of stablecoins as a means of payment. This approach would
effectively ban algorithmic “stablecoins” (e.g. TerraUSD,
the stablecoin behind the Luna collapse) which purport to be pegged
to a single currency but which do not meet reserve requirements
under legislation. Consideration may also be given to identifying
systemically important stablecoins which are subject to enhanced
regulatory oversight.

This approach would be consistent with global regulatory trends.
MiCA seeks to regulate fiat-backed and collateralised stablecoins
and imposes additional requirements on significant e-money and
asset referenced tokens. The proposed Responsible Financial
Innovation Act
(RFI) in the US focuses on
payment stablecoins which are redeemable for US dollars.
Singapore’s proposed amendments to its Payment Services
Act
would regulate so-called single currency pegged
stablecoins (SCS), which have a stronger use case
for payment and settlement.2 Late last year, the
Monetary Authority of Singapore undertook a consultation seeking
comment on whether systemic stablecoin arrangements should be
subject to higher regulatory and supervisory
standards.3

Recommendation 3: Token issuance

We propose a more ambitious draft of the Digital Assets Bill
which provides a pathway for regulated token offerings in addition
to stablecoin offerings.

In our view, the token issuance provisions under MiCA represent
a potential game changer by establishing a regulated pathway for
token issuance and basic consumer protections for consumers. The
relevant protections include professional obligations for issuers,
minimum disclosure and notification requirements for Whitepapers,
and restrictions on misleading marketing and promotions. Token
issuers will also need to provide an explanation of why the
relevant crypto-asset is not a financial instrument or other
regulated product.

In the absence of a regulated pathway for token issuance,
entrepreneurs and software developers will leave Australia to build
blockchain startups and applications where there is greater
regulatory clarity in relation to token issuance. The regulation of
intermediaries represents a partial solution only. Creating a
minimum set of standards for token issuance in Australia will serve
to provide regulatory clarity and is likely to encourage a new wave
of product innovation in a range of fields.

In the absence of a regulated pathway, token issuance will take
place overseas under local laws. Paradoxically, tokens issued
overseas may nevertheless trade as regulated tokens on secondary
markets in Australia.

Recommendation 4: Digital asset and custody
services

The Digital Assets Bill should be extended to cover other types
of crypto asset intermediaries consistent with the MiCA regime
(e.g. market makers, brokers, underwriters and those providing
advice in relation to digital assets).

A broadly based regime is likely to promote the growth of the
domestic digital asset industry in Australia which otherwise risks
being substantially based offshore. A limited regime which focuses
only on exchanges may encourage regulatory arbitrage and
inadvertently encourage the establishment of unregulated digital
asset brokers and other intermediaries.

Minimum requirements should be specified relating to the
admission of digital assets to trading on an exchange. For example,
issuance should be in accordance with a regulated token offering
regime, subject to appropriate grandfathering provisions.

It would be beneficial to clarify what constitutes
“operating” for the purposes of the Digital Assets Bill
insofar as it pertains to the operation of a digital asset exchange
and licensing requirements. Decentralised digital asset exchanges
generally operate by virtue of user interaction with smart
contracts and typically do not involve a centralised intermediary
having custody of assets. For this reason, decentralised exchanges
do not present the same risks to consumers as centralised
platforms. Further, a number of the Digital Asset Exchange
Requirements in Section 11 do not readily apply to decentralised
platforms, such as minimum capital requirements or segregation of
assets.

Development and deployment of smart contract code does not
necessarily constitute operation of a digital asset exchange. Where
a person or group of people are able to augment or upgrade the
underlying smart contract software, this action should, in our
opinion, be considered separately to the management and control of
a centralised exchange. Development and deployment of code,
including through upgrades, tweaks and patches, should not trigger
a raft of regulatory requirements akin to that imposed upon
centralised exchanges.

It may be appropriate to consider alternate licensing
requirements which are specifically tailored to decentralised
platforms, including code/security audits, in future in line with
the development of this technology. For the time being, crypto
asset services that operate in a fully decentralised manner should
fall outside the framework, consistent with MiCA.

We would encourage the adoption of a licensing regime which
applies to all digital asset intermediaries to ensure consistent
regulatory standards. The fact that an intermediary already holds
an Australian Financial Services Licence does not necessarily mean
that it will have the necessary expertise and experience to provide
digital asset services. A single licensing standard for digital
assets is also likely to be more readily understood by Australian
consumers.

Finally, we submit that the definition of “digital asset
custody service” should be clarified such that the licensing
requirements only cover intermediaries who have the ability to
initiate a transaction in respect of client assets without
reference to a client. This would exclude from the definition
non-custodial software wallet applications which generally do not
permit the software developer to control customer assets or
initiate transactions on their behalf.

Recommendation 5: Market Integrity

Consideration should be given to implementing basic market
integrity rules which would enable regulators to target misconduct
in digital asset markets such as insider dealing and market
manipulation. While these activities may be restricted under
state-based fraud laws, there is currently substantial uncertainty
as to whether they are covered by market conduct provisions under
the Corporations Act. Crypto intermediaries should also be required
to implement appropriate conflicts rules to curb proprietary
trading which may adversely impact consumers.

MiCA contains specific prohibitions on insider dealing and
market abuse. Singapore and Hong Kong have proposed or are in the
process of implementing similar prohibitions on these types of
behaviours which undermine fair, orderly and transparent
markets.

Recommendation 6: Foreign licences &
passporting

Foreign digital asset exchanges and custodians which offer
services to Australian retail investors should be obliged to seek a
domestic licence in order to promote full compliance with
Australian regulatory standards and facilitate domestic recourse
for consumers.

The MiCA regime requires Crypto-Asset Service Providers to
establish an EU presence, have at least one local director and
imposes strict reverse solicitation requirements. A similar regime
would serve to foster the domestic digital assets industry and
ensure minimum compliance standards across the sector.

Section 21 of the Digital Assets Bill contemplates that foreign
stablecoin issuers may be taken to be issuing the stablecoin in
this jurisdiction where the person issuing the stablecoin engages
in conduct that is intended to induce people in Australia to use
the stablecoin or is likely to have that effect. In that context,
consideration should be given to whether it is appropriate to
permit foreign stablecoin issuers to issue and offer stablecoins
(in particular, Australia dollar-backed stablecoins) under a
recognised foreign licence in accordance with Section 31.

It is likely to be more difficult for Australian consumers to
assess the risks of purchasing stablecoins regulated under overseas
regulatory regimes and seek recourse against foreign issuers.

In the context of globally available stablecoins, Singapore is
considering a passporting regime whereby the regulator would need
to be satisfied that a fiat-pegged stablecoin offered in multiple
jurisdictions is appropriately regulated in each jurisdiction in
order to become licensed for issuance in Singapore.4

Recommendation 7: Transition period

It is our view that a three-month transition period is likely
too short based on past experience in other jurisdictions, such as
the UK and Singapore, where there have been lengthy delays in
processing applications to register with financial conduct
regulators. It is likely that additional time will be required
after legislation is enacted for the preparation of appropriate
regulations and guidance in advance of the regime coming into
force. ASIC will also need to be allocated sufficient resources to
deal with licensing applications.

The EU is proposing a 12 to 18 month transition period under
MiCA. Article 123 of MiCA provides for grandfathering arrangements
in respect of existing crypto-assets and transitional arrangements
for existing crypto-asset service providers. Hong Kong is proposing
a 12 month transition under its licensing regime.

Regulated businesses will also need to develop new
infrastructure and processes to comply with the new law once the
details of the new regime become clear. Implementation takes time.
Compliance frameworks will need to be built, technology will need
to be sourced, implemented and integrated, staffing and resourcing
requirements will need to be addressed and training will need to
occur.

We recommend a 12 to 18 month transition period to allow new and
existing entities the chance to comply with legislation consistent
with the MiCA regime. Providing for a sufficient transition period
will be key to ensuring that the new protections are properly
implemented and that the necessary regulatory resource and
supervisory arrangements are in place.

Footnotes

1
https://data.consilium.europa.eu/doc/document/PE-54-2022-INIT/en/pdf
.

2
https://www.mas.gov.sg/-/media/MAS-Media-Library/publications/consultations/PD/2022/Consultation-on-stablecoin-regulatory-approach_PUBLISHED.pdf
.

3 Ibid.

4
https://www.mas.gov.sg/-/media/MAS-Media-Library/publications/consultations/PD/2022/Consultation-on-stablecoin-regulatory-approach_PUBLISHED.pdf
.

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