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The Future of Finance: The Australian Treasury’s Proposal for Regulating Digital Asset Platforms
Substantive Law| What area(s) of law does this episode consider? | The Treasury’s proposal paper on regulating digital asset platforms. |
| Why is this topic relevant? | In recent years, the rise of digital assets has presented both opportunities and challenges for regulators worldwide. Australia is no exception, with the Treasury recently proposing a possible approach to addressing the unique regulatory considerations posed by digital assets. By introducing a regulatory framework tailored to the digital asset space, the proposal aims to protect consumers from potential risks while fostering an environment conducive to innovation and growth in the sector. This move underscores Australia’s commitment to maintaining a competitive edge in the global fintech landscape. |
| What legislation is considered in this episode? | Corporations Act 2001 (Cth) Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) |
| What are the main points? |
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| What are the practical takeaways? |
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| Show notes | Australian Government Treasury, Regulating Digital Asset Platforms: Proposal paper, October 2023. Piper Alderman, Australian Treasury Digital Asset Platforms Consultation. |
DT = David Turner; SP = Steven Pettigrove
| 00:00:00 | DT: | Hello and welcome to Hearsay the Legal Podcast, a CPD podcast that allows Australian lawyers to earn their CPD points on-the-go and at a time that suits them. I’m your host David Turner, Hearsay the Legal Podcast is proudly supported by Lext Australia. Lext’s mission is to improve user experiences in the law and legal services, and here’s how the legal podcast is how we’re improving the experience of CPD. Over the past decade, digital assets like cryptocurrency have presented challenges for regulators worldwide, to put it mildly, and Australia is no exception, with the Australian Treasury recently proposing a possible approach to addressing some of these unique regulatory considerations. They’re considering introducing a regulatory framework tailored to the digital asset space and the proposal aims to protect consumers from potential risks while also fostering an environment conducive to innovation and growth in the digital asset sector. This move underscores Australia’s commitment to maintaining a competitive edge in the global fintech landscape, or so they say. Our guest today is Steven Pettigrove, a partner in the Blockchain Group at Piper Alderman, and he brings a wealth of knowledge in advising on financial services and fintech with a specific focus on digital assets, crypto regulation, and disputes. We’ve met Steven before on the podcast back in 2022. We spoke then about distributed ledgers, blockchain, and smart contracts. With over 14 years of experience as a startup founder and as a regulatory specialist, Steven is uniquely positioned to provide invaluable insights on the implications of treasury’s proposal. Steven, thank you so much for joining us today on the Hearsay podcast! |
| 00:01:45 | SP: | David, thanks very much for having me again. |
| 00:01:47 | DT: | Now, before we get into Treasury’s proposal for the regulation of digital assets and digital asset platforms in particular, tell us a bit about your experience. I mentioned you were a startup founder. |
| 00:01:57 | SP: | Yeah, that’s right. I’ve gone full circle in my career. So I started out as a traditional financial services litigation lawyer, and then did that for a few years. I always had a bit of an interest in business and startups in particular, and that flourished at some point into doing or being involved in my own startup, which was a fantastic journey for me. I think having that experience of being at the coalface gives you a huge amount of empathy for the journey of being an entrepreneur or a commercial operation and what’s involved in pulling everything together, which is literally everything. So, I loved that experience. In the end, the startup that I was involved in, didn’t flourish or go on to big and great things, but certainly, I feel like it’s stood me in good stead when I came back to the law and have increasingly focus my practice around working with startups and early stage companies, particularly in that growth phase and helping them navigate some of the challenges that they face in growing a business in what is quite a complex regulatory environment. |
| 00:02:55 | DT: | Yeah, you know, we were just talking before we started the episode about how important it is as a lawyer to differentiate yourself. You need to understand the client’s business and what keeps them up at night and the challenges that they’re facing every day, much more so than you understand any particular regulatory instrument or cause of action or bit of arcane case law. So that experience as a startup founder, I imagine places you in good stead and in rare company amongst advisors to startups as well. TIP: So before we can talk about digital asset platforms, we need to talk about what digital assets are, and Treasury’s paper gives us some guidance on this. They say that a digital asset refers to a token and its associated entitlements or what it calls a digital bearer asset. Well, what’s a digital bearer asset? The clearest example is the asset class that has sparked this whole proposal; cryptocurrencies like Bitcoin or Ethereum, as well as cryptocurrency tokens, which exist on the blockchain that might represent some other utility value or right or entitlement. This could even extend as we’ll speak about a little bit later in the episode to items in Web3 based video games that might entitle a character in that video game to use a special item or power that can be traded with other players. Treasury also gives us a good example of what’s not a digital asset according to this proposal, which is a token-like system as distinct from a token. They give the example of a token-like system being things like event tickets or gift cards that are delivered by email. Treasury says these are different because a token-like system is just information, information that’s unlikely to have a competitive ecosystem of third party marketplaces spring up around it. They give the example of a gift card or event tickets. If I sell you an event ticket, maybe I send you the ticket by email. I can actually sell that again, even though I’ve already sold it to you. I could sell it many times and then I could use the ticket myself if I got to the front of the line at the event before you, I suppose. But true tokens, true digital assets that exist on the blockchain and have a digital form of title or cryptographic authenticity don’t have these issues. Now we’re talking about the Treasury’s proposal for regulation of digital asset platforms. Before we dive into what the proposal proposes, tell me what a digital asset platform is. |
| 00:05:18 | SP: | That’s a great question, David. So you’ll probably be aware, I mean, listeners will be aware that cryptocurrency exchanges have for quite a long time, sort of sat outside the Australian financial services system, or at least that’s been a point of contention, and most of them do not currently hold an Australian financial services license to carry on digital asset trading. The genesis of this proposal was really to address that particular risk, and in light of some high profile failures over several years, including perhaps most notably the FTX failure in 2020, the idea is to put in place a framework that licenses these cryptocurrency exchanges, but also could go a lot broader than that. So, this conception of a digital asset platform, the core of it is around digital asset custody, which is, if you are holding digital assets for another person as a business over certain thresholds, you’ll be obliged to have a license under the Australian financial services law regime in order to operate or deal in a digital asset facility but if you’re also providing certain additional functions, for example, training functionality, like a traditional cryptocurrency exchange, there will be additional obligations around that. What’s interesting about this proposal is that it is very ambitious in scope. I think most seasoned practitioners in the space were expecting a regime that targeted specifically cryptocurrency exchanges, but Treasury’s proposal is actually much broader than that, and goes to fundraising using digital assets or digital tokens, tokenisation of assets – we’ll talk a little bit about that – but also staking as well, which has been another area or product in the cryptocurrency digital asset space where it’s struggled to find a home within existing financial services laws and therefore sat outside them for some time. |
| 00:07:01 | DT: | Yeah, I recall advising on these sorts of issues years ago now where cryptocurrency sat in uneasy equilibrium without a traditional approach to regulating financial services and financial products, and there was really a question around “well, is the coin or is the digital asset in substance of security?” If it’s in substance of security, then it’s a financial product, and there’s licensing obligations that go along with that. But, that question can be difficult to answer where you’re dealing with things like utility coins or utility digital assets, but I am interested in the breadth of this, and I think we’ll come on to talk about this a little bit later. You mentioned in Piper Alderman’s consideration of the proposal, the non-financial instruments this could extend to, including things like video game entitlements, thinking about trading platforms for video game collectibles and cosmetics. Counter Strike: GO skins, I think, go for a few thousand dollars a pop, so they’d pretty immediately hit that $1,500 threshold. But maybe we can come back to intended or unintended breadth of scope. I guess the highest level of detail you could give about the digital asset platform proposal is that it will require operators of digital asset platforms to hold Australian financial services licenses, and as you said, the obligations imposed on them will depend on whether that platform includes trading functionality. Tell us a bit about the other aspects of the proposal going a little bit deeper than that licensing consideration. |
| 00:08:30 | SP: | Sure. So, one of the points that you just touched on there, David, really goes to the heart of the issue, which is how to deal with tokens and what are tokens, and obviously this all started with Bitcoin back in 2008, which is almost 16 years ago now, which is quite extraordinary to think about. But Bitcoin was conceived as effectively a form of currency outside of sovereign issuance and control. And so, we had Bitcoin, but then obviously there’s been a lot of other coins that followed, and the exact form of what these things are… “are they a currency? Are they an investment?” Has been something that’s been in the eye of the beholder in some respects, and that’s why it’s had this sort of uneasy tension with the existing financial services system. What’s interesting about the treasury proposal, and it sits in this respect relatively neatly with proposals we’re seeing in other jurisdictions, is that for the most part, it’s accepting that these cryptocurrencies or tokens are not themselves financial instruments, but that will be a live issue under the new regime. So, at the moment, all cryptocurrency exchanges look at every single token that they issue on the platform, and generally, they have a system or process for looking at them and determining whether or not they’re a financial product of some sort, whether that’s an equity or managed investment scheme, etc. Under this new regime, those sorts of questions will still arise. But inadvertently, by regulating the custody piece of holding or offering trading in tokens ASIC and the treasury will be regulating digital tokens or cryptocurrencies, even if they’re not calling them directly financial products, they’ll be regulating basically anybody who provides an intermediary service in relation to those tokens. So, the gamekeepers will be regulated, but there’ll still be the sort of peer-to-peer sphere and DeFi, which we’ll probably talk a little bit about further in this conversation, which will sit in something still have a little bit of a grey zone as to whether that is a true intermediary offering or something that happens on a peer-to-peer or autonomous basis. |
| 00:10:26 | DT: | I suppose it’s unquestionable that the proposal if implemented would increase the regulatory burden and I’m not saying it’s a bad thing, but increase the regulatory burden for digital asset platforms. But, will it simplify the process of determining what is and isn’t regulated and in what manner it’s regulated, in the sense that a token which might have in the past been caught as a financial product, an interest in a managed investment scheme for example, is now regulated as a digital asset and as a digital asset alone? Or does it compound the regulatory burden in the sense that it says, well, this digital asset may also be an interest in a managed investment scheme as well as a digital asset to which this new regime applies? |
| 00:11:13 | SP: | Yeah, that’s an interesting question. So, the way in which the proposal approaches this subject is basically to say “if the thing you are offering is a financial product and falls within one of the existing definitions, you are still within the existing AFSL regime. So, if what you are in substance offering is a security, then in order to deal in that, you’ll have to have an authorisation to deal in securities under AFSL. If what you’re offering is not in and of itself a financial product because it doesn’t fit within the definitions, but you’re providing custody of it or dealing services in relation to it, then you’ll have to have an authorisation under your license to deal in digital asset facilities.” TIP: As Steven and I have just discussed, digital tokens or cryptocurrencies aren’t automatically considered financial products under Australian law. Their legal status, and the extent to which they’re regulated at the moment, depend on the specific rights and entitlements that the token represents and grants to its holder, and whether those resemble a traditional financial product, like shares, securities, derivatives, or an interest in a managed investment scheme. If the rights associated with a token or another cryptocurrency asset resembles a financial product under this scheme, then an entity will need to hold an Australian financial services license to provide financial services around that asset like trading or custodian services. At the heart of this proposal is the suggestion that whether or not a digital asset and the rights attached to it look like an existing form of financial product, a range of digital asset related services will require an Australian financial services license. Well, tokens that generate income or confer upon the holder rights in certain tradable assets, tokens that might behave like bonds that pay interest in principle, or that behave like shares entitling the holder to a kind of dividend, those might be considered to be financial products. But at the moment, utility tokens that are used solely to access a product or service, or that represent a non-financial asset, like an NFT, a non-fungible token, which we talk about a little bit later in the episode, don’t meet the definition of a financial product at the moment. As you can imagine, the uncertainty of whether a token meets the definition of a financial product on a case by case basis right now confers a pretty big regulatory burden on both cryptocurrency exchanges and the services that are built up around them, as well as creating a lot of ambiguity for the holders of those tokens about what their rights are exactly. What’s interesting about the proposal, they’ve tried to frame it as a relatively light touch regime in some respects to say “well, we’re not going to call everything a financial product and therefore bring the full force of financial services laws upon it. But what we’re going to do is try and frame it as, you know, if you squint, it kind of looks a little bit like a non-cash payment facility, your holdings, not money, but crypto for somebody else, and you’re doing something with it and you’re offering some services in relation to it and there’s a intermediary risk there that there’s theft, fraud, misuse of those assets, and that’s the harm that we’re going to try and address.” Now, the other aspect of this is kind of, look at the tokenisation of financial markets generally, and that’s a whole big other subject matter. If you’re tokenising something like a security or a derivative, then that’s going to be under existing financial services laws, and if you’re offering derivatives in relation to cryptocurrency as the underlying asset, then that will be within the existing regime, you’ll need an AFSL with a derivatives authorisation in order to deal in those assets. |
| 00:14:38 | DT: | I suppose one benefit of this proposal is that it resolves this uneasy tension that existed. Well, it certainly existed in the United States until relatively recently where derivatives of cryptocurrency interests could be freely traded on public markets. There was a lively market for those interests, but the underlying asset itself, which although volatile is probably less volatile than a futures product for that asset could not be traded publicly, whereas now there are ETFs that track interest in blockchain in the US market. So, is that a benefit that there is a normalisation of the regulatory approach to both the derivatives, which are financial products that might otherwise be bought and sold on, if you like, traditional markets for financial products and securities or over the counter, and digital assets which haven’t necessarily been regulated or traded in the same way? |
| 00:15:35 | SP: | So, I think the whole point is addressing this harm that’s been evident in cryptocurrency markets over the last several years, which is this risk around an intermediary or someone who holds himself out as a so called good actor, a trusted third party to help people on board into the cryptocurrency ecosystem, and then misuses that trust. It’s often quite hard to distinguish between who are the good actors and who are the bad actors in the space. What is a regulated platform and unregulated platform? Because they kind of all look the same. We live in an age of kind of deep fakes and many other things that appear to be genuine but are not, but this is certainly an issue that’s plagued the cryptocurrency ecosystem because there are many platforms originating from all parts of the world that look the same as the ones that are issued from Australia and issued by companies that have been around for 10 or 12 years and have serviced their clients very happily. So, giving it a badge of approval for want of a better word in terms of recognising those cryptocurrency exchanges or custodians who are complying with basic standards have taken the time to apply for authorisations and are required to meet pretty strict ongoing compliance requirements, I think is a good thing for consumers, and that’s the real, I think, core harm that needs to be addressed. |
| 00:16:51 | DT: | Is there a real risk that some of the platforms currently in the market won’t be able to comply with this regime? I’m thinking you mentioned the FTX collapse. The CEO of FTX following its bankruptcy, John J. Ray III, said of its books, you know, this is a crime scene. It was a complete mess, the worst he’d ever seen, and he had worked on Enron. TIP: FTX was one of the world’s largest cryptocurrency exchanges, and it collapsed spectacularly in November 2022. Sam Bankman-Fried founded FTX in 2019, and it quickly became a leading cryptocurrency exchange, at one point it was valued at $32 billion but it all began to unravel when reports emerged that FTX had loaned billions of dollars of customer money to Alameda Research, Bankman-Fried’s investment fund, violating rules around it keeping its customers assets separate. This revelation led to a liquidity crisis as FTX customers rushed to withdraw their funds and FTX and over a hundred affiliated companies filed for bankruptcy on November 11th, 2022. Investigations revealed that FTX had engaged in misuse of customer funds, lack of corporate controls and other fraudulent practices, and the collapse triggered wider concerns across the globe about crypto regulation and consumer protection. Finally, after a high profile trial, Sam Bankman-Fried was convicted of fraud in November 2023 and sentenced to 25 years in prison in March 2024. He’s appealing that sentence. I wonder whether the internal management of a platform with the scale of FTX would have been prepared for the compliance requirements of an Australian financial services licensee and whether there might be other platforms in the market that are in a similar state in terms of their readiness to comply. |
| 00:18:35 | SP: | Well, one of the curious aspects actually, of the FTX case was that FTX did hold an FSL for its derivatives business. The fact that someone holds a license in and of itself doesn’t necessarily mean they’re a good actor. But in this context, some of the live issues in relation to digital asset platforms are the extent to which these cryptocurrency exchanges have set outside that platform can meet the ongoing compliance requirements that they will lead to once they actually have an authorisation to run this type of facility. So, there will be requirements to have responsible managers, for example, to meet net tangible asset requirements, to meet minimum custody standards, to have admissions and listing criteria. Now, the more sophisticated ones in the market have been gearing up for this for years, and they’re pretty sophisticated operators generally, and so I have no doubt they’ll be ready, but there will be a winnowing of the market, I suspect, where you see certain smaller players who aren’t able to make that leap to full licensing or their business model may move into more of a corporate authorised representative type arrangement where they’re feeding one of the bigger exchanges. Or, potentially we’ll see some merger activity where there’s some consolidation in the sector and you start to see, because of the need for greater capital to run a higher compliance business, that it’ll consolidate into some bigger players. |
| 00:19:50 | DT: | The last time you were on the show two years ago in 2022, we spoke about this interesting tension, I guess, in practicing in the cryptocurrency space that crypto has had a history of not being just unregulated, but potentially anti-regulated or having a culture around it that was staunchly opposed to regulation, staunchly opposed to a central authority having a role in the way the market operates, and the tension between the community that operates these platforms potentially having some of that culture embedded within it and trying to bring regulation to the space. I guess my first question is, do you believe that that culture still exists in digital asset platforms and cryptocurrency markets? Do you think it’s still at play in the corporate cultures and in the minds of the managers and directors who are running these platforms? And if it is, what impact do you think that’s going to have on adoption and compliance with the new regime? Assuming, of course, that it’s implemented. |
| 00:20:56 | SP: | That’s an interesting question, David. I mean, certainly that ethos and spirit of self sovereignty was the genesis of Bitcoin and you continue to see aspects of that today, particularly in relation to decentralised finance, and there’s a lot to be honest, to like in that in the sense of, if we’re just going to reintroduce intermediaries and do exactly what we’re doing in the existing financial system, is there any real value add there for consumers? So the premise of it being that you can have more autonomy and financial control is a good thing, but what we’ve seen in the blockchain cryptocurrency spaces, those same sorts of very human failings where you give your trust to somebody else, and this sort of eternal questions of why this trust is misused has affected cryptocurrency like every other industry before it. And so, hopefully I think where we get to, is we can strike a bit of a balance where you give that autonomy to the individual to be able to make choice and make decisions, but it’s guided by proper disclosure, and where you do have trusted intermediaries who are operating in the ecosystem, that they’re subject to the proper compliance requirements that will try and mitigate some of the risk around misuse or fraud in relation to assets. |
| 00:22:09 | DT: | Yeah, I suppose as you said, the history of this sector really goes back 16 years to Bitcoin and its birth post the global financial crisis at a time when there was a deep distrust of the capacity of regulators to manage and prevent crises in the traditional financial system and yearning for a better alternative, and the operators who subscribe to that philosophy might say, “well, to what extent is the imposition of a traditional regulatory approach to the financial system providing the better alternative?” But as you said, we’ve seen a great deal of volatility in the market in the past 16 years, a great deal of money lost by everyday investors and speculators, and hopefully there is a middle ground between that fiat and decentralised approach. One of those collapses that wiped out, by some estimates, half a trillion dollars from cryptocurrency markets was the collapse of the Terra stable coin, or so called stable coin, it was not so stable in the end. The proposal, like other digital assets, aims to regulate stable coins. What is a stable coin and what does the Platform proposed in relation to it? |
| 00:23:24 | SP: | So, a stable coin is a type of digital asset that purports to maintain a stable value by reference to some other reference asset. Typically, that’s a fiat currency. So 2 of the best examples of this is something called the USDC or USDT. coin. These are US Dollar denominated stable coins. One of them issued by a group associated with Coinbase and Circle out of the United States and another one that’s issued by a provider in the Caribbean called Tether. Those coins have, if you look at the charts over the last four or five years, gone from effectively minimal volume to hundreds of billions in volume or tens of billions of volume every day. So, they really have found a niche use case within the cryptocurrency ecosystem as a reference asset because of that stable value, but they have also found some real world use cases as well, particularly around remittance and payments, and that increasing, I think, adoption has been something that’s been really interesting to track. Obviously, there’s some issues around that as well, because if you’re creating something that purports to be stable, well, it better be stable, because if it depegs, which has happened previously, it’s happened with USDC, for example, following the Silicon Valley Bank collapse last year, what people think is a stable asset is no longer a stable asset, and you see often a flight or a run very similar to a bank run on a stable coin in a situation like that. So there’s clearly again, a kind of intermediary risk, is really what we’re talking about, of someone having to place trust in an intermediary who is holding the bag basically for that token, and the treasury proposal in relation to digital asset platforms doesn’t directly deal with stable coins, but they do have a whole nother work stream around payments that is underway and late last year, there was a proposal published or consultation issued in relation to payments and a specific aspect of that was stored value facilities. The proposal is that stable coins would be regulated as a type of stored value facility with specific rules around the need to maintain reserves, for example, and the nature of those reserves, the quality of those reserves in order to meet this risk around depeg type events or fraud type events. The LUNA collapse, which you mentioned has just come full circle, was in relation to a so-called algorithmic stable coin, which is this idea that you can issue a stable coin that has a stable value by algorithmically trading an asset in that coin or other related assets in order to maintain a stable value. The history of algorithmic stable coins is a very patchy one as the LUNA terror collapse demonstrated and what we’re seeing actually globally, is if not outright ban on algorithmic stable coins, certainly only endorsement for fiat backed stable coins at this stage. I know the EU is contemplating going a bit further, looking at things like gold referenced stable coins or asset referenced tokens. But for the most part, algorithmic stable coins look to be treated in a sort of similar bucket to other volatile cryptocurrencies rather than stable coins per se. |
| 00:26:37 | DT: | That makes sense. TIP: This is a reference to the failure of the Terra blockchain ecosystem and its associated cryptocurrencies, Terra USD, which was said to be a stable coin and LUNA in May, 2022. Terra was a blockchain protocol that used what’s called an algorithmic stable coin called terra USD, which was meant to maintain a one-to-one ratio or peg with the US dollar through an intricate system involving LUNA, the protocols other native token. Now on the 7th of May, 2022, Terra USD began to lose its dollar peg. The difference between Terra USD and a single US dollar began to grow after a large sell-off of over $2 billion worth of Terra USD occurred. As the stable coins value fell below one US dollar, traders could burn or remove Terra USD from circulation by swapping it for discounted LUNA tokens, then causing LUNA’s supply to rapidly increase and therefore its price to plummet from $80 to almost $0 in a few days. This created a death spiral where Terra USD’s peg couldn’t be restored despite Bitcoin reserves being deployed to defend it. Within a week, the Terra ecosystem had collapsed entirely, wiping out around $45 billion in market cap. Subsequent investigations pointed to flaws in Terra’s design, a lack of transparency, and the fragility of its algorithmic stablecoin model as a key reason for the catastrophic failure. The enduring legacy of the Terra (LUNA) collapse has been to discredit the so-called algorithmic stablecoin, as Steven has said. So when you’re describing an obligation to hold reserves, it’s a little bit like a bank’s liquidity requirements. |
| 00:28:16 | SP: | Yes, although in many ways a lot more severe. So many banks operate on a marginal reserve type basis. So if everyone who has money on deposit at a bank goes in today and asks for it, the bank invariably will not be able to repay it because they don’t hold full reserves. Interestingly, one of the features of the cryptocurrency ecosystem is there does seem to be a tacit expectation among users of cryptocurrency platforms. So digital asset platforms, which we’ve been discussing today, that they will actually have your crypto at any time to take out. Now, some have terms of service, which say they can do certain things with those coins, like staking it, for example. But that’s sort of a market convention that’s grown up and stable coins is a similar story. So, the idea is that for every US dollar stable coin or USDC, there will be one US dollar sitting in a bank account or in very liquid US treasuries that’s able to be accessed. So if everybody runs for the exits at the same time, the issuer can make those liabilities, and that will be one of the four requirements is, what assets can you hold your reserves in? If you’re holding them in illiquid Chinese property, just to take a real world example, some speculation at one point in relation to USDT. That’s probably not going to be treated as a valid type of reserves or a compliant type of reserve to hold your stable coin reserves in. There’ll be some minimum requirements there around audits and checking that the reserves exist and then around the types of assets that you can hold. |
| 00:29:40 | DT: | That’s interesting. I suppose that sounds like a more stringent liquidity requirement than we expect of our traditional banking system, and I suppose that leads me to a question I wanted to ask around the effect on innovation and participation in the cryptocurrency sector in Australia, both by Australian entrepreneurs and by overseas entrepreneurs looking to choose a home for their startup or enterprise. As I said at the top of the episode, Treasury says that one of the goals of this proposal is to foster innovation and growth in the cryptocurrency sector in Australia while balancing community and investor safety. We’ve spoken already about how there’s a kind of anti-regulatory bent in at least part of the cryptocurrency sector or some of the operators within the sector. What sort of an impact do you think the regulatory proposal will have on innovation in the economy? Is it more likely to bring more players in as they see some of the volatility come out of the sector with further regulation? Or do you think this is going to have a cooling effect? |
| 00:30:51 | SP: | It’s an interesting question. I mean, Australia, from a digital assets perspective, has been one of the more active jurisdictions on the investor or speculator type side, as we know Australia’s tend to love a bet or punt, and they’re probably punting a little bit on crypto as well, alongside horses and football and many other things as well. No doubt that will probably continue under this regime from the innovator and entrepreneurial side. I mean, I think speaking as a former entrepreneur myself, there’s a lot of things to work on when you’re building a business and what you don’t want to be doing is looking over your shoulder at regulation every five minutes and trying to work out where you sit alongside the latest court decision, as we’ve seen, I think, over history, certainty helps people make choices and helps people to make investments, and hopefully what we’ll see, I mean, out of a digital asset platform regime, and particularly one that if it can be as ambitious as proposed, what we’ll see is actually a real flourishing beyond just tokens, which have a payments type application but to a much wider variety of digital assets. And I think it’s important to sort of bear in mind that one of the real breakthroughs of cryptocurrency and blockchain is this idea that you can have digital ownership of an asset, something that is uniquely owned by you and verified by the blockchain. Now that could be a currency, but it could be a financial asset. It could be a game asset. For example, in a video game, Web3 gaming is an area that’s seen some real traction over the last little while. It could be a governance token or something that you use for voting on a club or proposal, that sort of thing. So these tokens can have all sorts of applications. TIP: What’s Web3? Maybe you’ve heard that term before. Well, it’s used by its proponents to describe the next stage in the life of the internet, as distinct from Web2, which is characterised by the dominance of large, centralised players like Google, Facebook, and other social media giants. Web3 is said to be all about decentralisation and reducing the control of both governments and these large tech companies that have dominated Web2 over online data and services, envisioning a more open form of internet infrastructure. Cryptocurrencies, NFTs, and smart contracts, these are all Web3 concepts, and while still an evolving concept without an exact definition, Web3 is a vision of a reshaping of the internet’s infrastructure to reduce centralised control and increase user sovereignty over data and digital assets. What we’ve in some ways perversely seen is that the absence of regulation has meant that the sorts of tokens that often have got currency are those that have effectively no features, no rights attaching to them and have basically only a purely speculative type function, and so mean coin crazes, for example, something that’s come back into the news again over the last six months of tokens with pretty pictures of dogs or whatever the case may be becoming a sort of vehicle for speculation and in some cases fraud. Ideally, what we’ll see in this new world is some more certainty for entrepreneurs to be able to invest, but then also to look at new potential applications for blockchain technology, and that’s where the proposal veers into talking about things like asset tokenisation and for example, creating tokenised versions of assets for video games or tokenised wine collections for people to invest in or tokenised sneakers, if that’s your thing. So lots of potential applications, tokenised property. There’s kind of been one of the holy grails for many entrepreneurs in this space as well, to look at more ways to allow people to invest smaller amounts into real estate to get a foothold in the market. Obviously there’s a fair bit of work to do there, and it’s got its own risks as well, but part of the ambition of the space is to try and create greater access and more equitably, and ideally, if we create the right regulatory settings for that, we can both balance consumer protection, but also allow great innovation, great access. |
| 00:34:48 | DT: | You mentioned the regulation of digital asset platforms. One of these more exotic forms of digital assets that you mentioned was Web3 gaming assets that are items, cosmetics, some other widget that is designed to be awarded, traded, held as a token, as a cryptocurrency asset associated with a game or a gaming platform, but something that’s interesting to me about this proposal is that the definition of a digital asset could extend to some similar sort of assets that haven’t historically been regarded as crypto assets. I mentioned before skins for a popular online game called Counter Strike: GO, which are not cryptocurrency assets. They are not verified on the blockchain but they are traded for thousands of dollars online. There are similar cosmetics in other games. We don’t have that decentralised ledger that gives that level of certainty about their ownership, but there is a rich and thriving market for these items, which can extend to values above the $1,500 threshold on an individual basis that the platform talks about. Are these sorts of assets going to be caught by the digital asset platform regulation where users could be trading hats in Team Fortress or skins in Counter Strike or magic swords in World of Warcraft? |
| 00:36:10 | SP: | There’s many types of assets that we don’t treat as financial products and that aren’t within the current scope of the FSL regime, but nevertheless treated by many people as a form of investment. So, that so called serious type assets like property cars, wine, art, for example, but also frivolous things like basketball cards, for example, or sneakers, etc, which have a secondary market value, they’re tradable, they’re desirable, people want them, but we don’t treat them as financial products, although they can be financialised in much the same way. This regime, I think, tries to skate the balance there of not saying necessarily that these things that we don’t treat as financial products as such are now suddenly all going to be treated as financial products but it does look at the financialisation aspect and the ease with which these things can be traded in a digital form and try and address some of the potential harm and that’s why I think suggestions like having minimum thresholds to meet in order to acquire licensing are sensible, but there will be interesting cases where, for example, tickets to a Taylor Swift concert that might be valued at or trade at more than $1,500 in a secondary market might suddenly be within the scope of this regime, and there’s a kind of risk balancing that’s going on there to try and work out how we protect consumers, because they are potentially subject to harm. If you’ve got someone holding your tokenised Taylor Swift tickets and they nick it, well, you will be pretty upset. |
| 00:37:37 | DT: | Yeah, absolutely. Because I suppose one of the features of the enhanced level of regulatory scrutiny that a platform might be subject to is where that platform allows trading in regulatory assets. There have been some, well, I suppose they’re amusing from the outside, but they could be heartbreaking or pretty damaging to the people really involved in them… in some of these video game platforms, there have been examples of assets, in-game items that could have a real world value of up to $22,000, for example, thinking about one example in the game, EVE Online, that can be stolen or traded fraudulently in the game. These are not crypto assets, they don’t come with a complete ledger of the transactions in relation to them, and I wonder whether the games or gaming platforms in which these transactions or changes in ownership occur extend to trading as a function of a digital asset platform. |
| 00:38:35 | SP: | So yeah, that will be one of the live issues. I think we’re seeing different jurisdictions look at this in different ways. The EU has parked the whole question. So the EU has probably been the fastest to pull together what is a comprehensive crypto asset regime. Their’s will begin to enter into force from one July this year, they’ve actually excluded what’s called non-fungible tokens from the scope of that regime, parked that whole question and said, “we’re still looking at this, we’ll come back to it in the next two years and decide how we’re going to deal with those issues. We’re just going to focus on fungible tokens for now.” So that’s your traditional cryptocurrencies or potentially financial assets. In terms of non-fungible tokens, though the same sorts of issues can arise. One of the questions that’s being debated through this consultation process is whether, if the time is right to regulate those non-fungible tokens in the same way as we regulate fungible tokens, recognising that the kind of investor expectations around them might be somewhat different. So we’ll need to see how the consultation shakes out on that point and whether or not things like digitised sneakers or digitised tickets will fall within scope. Looking at this, zooming out, there is a potential creep here going on where everything becomes financialised at some point and becomes within the financial services regime and that’s something that regulators will need to balance and consider the big picture policy questions around that. |
| 00:39:56 | DT: | Yeah. As someone watching this space pretty closely, is it a little bit too little too late with NFTs? I thought the tulip mania has already happened. A lot of these assets have already gone to zero. Is there a future for that market? Is it starting to come back in the way some other crypto assets are coming back or not really? |
| 00:40:12 | SP: | No, I don’t think NFTs have come back in terms of price speculation in quite the same way. I think some of the so called blue chip type NFTs like a Bored Ape Yacht Club, for example, those PFPs or profile pictures with the little monkeys on them, you may have seen still have significant value and there are other collections like it that still have significant value. There’s a lot of NFT trading platforms out there. What we’re actually seeing, rather than the speculative art market type bubble, is a lot more activity around Web3 gaming in particular, and looking at giving gamers the opportunity to own their own in-game assets and potentially take them, sell them, convert their in-game currency, cash out, go and play another game. There’s definitely a use case there for users to be able to say this is better than the existing system but there is some legal risk that’s introduced as well, where you say to people, “well, you can go and trade these things in an open forum as well” and some trust that’s introduced as well, where you have marketplaces and custodians for those assets. |
| 00:41:09 | DT: | Yeah, absolutely. I guess just to clarify some of the things we were talking about earlier around non-crypto video game assets and whether they comprise digital assets is what you’re describing, the kind of Web3 gaming approach is the trading for these for real world value is specifically contemplated and provided for in the platform, there is an intended market for these items, it is intended that you can buy and sell them for real value, whereas what I was describing in, if you like, legacy platforms like World of Warcraft or EVE Online, is that there’s a grey market for these items. They’re associated with particular user accounts, but it’s not really intended that they be sold for value, although there is a thriving grey market for those items where payment is achieved in other ways and transfers of those are achieved in other ways. One aspiration the proposal has is to use the licensing regime as a means of cracking down on scams and fraud. The guise of a cryptocurrency exchange has been used in scam tactics like pig butchering, where victims are encouraged to buy cryptocurrency on a fraudulent exchange. There are exchanges that have operated that have had far greater entitlements to deal with the user’s tokens or assets than they should. What impact do you think regulation and licensing will have on the prevalence of these scams? |
| 00:42:35 | SP: | So scams are a multifaceted problem. There’s a number of different interlocking issues that kind of need to be addressed. We all probably are suffering through this deluge of SMSs trying to remind us to click this link or that link or certain points being expiring. So that’s one aspect to it but cryptocurrency has certainly been used as a vehicle for moving people’s hard earned money into illicit money and trying to siphon it off. And what we’ve seen over the last 12 months is both the financial institutions but also the cryptocurrency platforms themselves really stepping up in terms of trying to put in some compliance checks to at least slow the movement of these cryptocurrencies or traditional funds to mitigate some of the risk around that. I think what the promise of this regime is that you will start to have this badge of AFSL holder with a number attached to it, an authorisation for certain platforms and consumers should be looking for that and if it is authorised, they’ve got a little bit more confidence that the platform that they’re dealing with or the operator that they’re dealing with has a license. Now, we still see financial scams in traditional markets as well and it’s really important from a consumer perspective, I think that we continue to educate and continue to encourage people to look at everything online these days with a real sense of circumspection because just because someone writes that they are an AFSL holder, doesn’t necessarily mean that they are, you’ve got to go and actually do an ASIC search and double check, or if someone sends you a link, don’t click the link, go and look it up yourself and see in Google whether or not that is in fact a legitimate institution. So as I say, it’s a multifaceted problem and will require a multifaceted approach. |
| 00:44:17 | DT: | Yeah, that’s sort of what I was thinking, that there are still plenty of mum and dad investors, punters who are the victims of scams perpetrated by someone who claims to be a traditional asset manager or fund manager who has no Australian Financial Services License for the traditional service they claim to offer. It’s not easy for the average punter to perform a search for an Australian Financial Services License on the ASIC website, sometimes I find it difficult. So I wonder whether licensing will be an effective guard against the real bad actors out there without that being made a little bit easier or a little bit more transparent for the public. There’s another set of proposed reforms that the digital asset platform proposal feeds into which is the Attorney-General’s proposal for sweeping changes to the AML and CTF Act, the Anti-Money Laundering and Counter Terrorism Funding Act. The second set of consultation papers was released earlier this year by the Attorney-General’s Department. It proposes some pretty dramatic changes to the act, increased obligations on a variety of actors in Australia, including law firms. What do you think the interplay between anti-money laundering and digital asset platforms is going to be, recognising as we’ve just acknowledged that cryptocurrency and digital assets are often used as a means of laundering illicitly obtained funds? |
| 00:45:37 | SP: | Yeah. So I think one of the misconceptions around cryptocurrency is that it’s untraceable and certainly what we’ve seen is that as probably over the last seven or eight years, technology has improved. A number of businesses have sprung up that do blockchain analytics and trace what is happening on the blockchain and many of the actions, enforcement actions you often see coming out of the United States are driven by data analytics, people tracking what is going on on the blockchain and tying it back to IP addresses and individuals involved. And so while blockchain is pseudonymous, it’s not entirely anonymous and there are tools which can help to identify and disrupt this type of illicit conduct or money laundering. All that being said, there’s definitely more work that can be done. And the attorney general is looking at that with their current consultation across a range of sectors, including digital currency. Australia is under a little bit of pressure to bring its AML regime generally up to FATF standards and part of that is to look at a broader range of digital asset related activities, including custody, for example or transfers of digital assets and to bring them within the regime as designated services. So what you’ll see is a broader range of crypto businesses that have AML obligations and will be required to run an AML/CTF program, do KYC, have transaction monitoring. So we’ll close down some of the gaps for this sorts of activity, but there’s also a technology piece as well, which will help to solve some of these and will continue to help to solve some of these problems. There’s still a balancing act there of letting people transact and interact while trying to mitigate some of the bad actors, sanctioned actors from misusing technology. |
| 00:47:31 | DT: | Absolutely. Well, Steven, we’re nearly out of time for our interview today, before you go, though, you’ve carved out a niche and expertise for yourself in FinTech, digital asset regulation, blockchain and the law. For some of our younger listeners, maybe law students or newly admitted lawyers listening to this episode wanting to follow in your footsteps and pursue a similar path, what advice would you give them to upskill in this area and build out a practice for themselves in it? |
| 00:47:59 | SP: | Sure. We live in a fast-paced world of technological change, and there’s a lot of really interesting areas, I think, for people to sink their teeth into. I think what I’d encourage people to do or students to do particularly is follow your passion, investigate what you’re interested in and really try and just be curious and learn. And certainly that’s how I have progressed into this space. It started with a curiosity and then suddenly I’m involved and I realised how much depth there was to this technology, but also some of the legal issues that arise and thinking about things like AI, for example, the same sorts of the technological breakthroughs, but also issues and legal policy issues that will affect our future are thrown up by this technology. So, the great thing is that there are lots of great resources now in terms of podcasts, blogs, bespoke niche websites that people can follow to learn about this stuff. Reach out to experienced practitioners or knowledgeable academics in this space, learn more, and ideally, try and get a paralegal or clerk position and get on the ladder in terms of learning about some of this stuff at the coalface, because you really are the beneficiary of that curiosity and passion if you apply yourself. |
| 00:49:08 | DT: | Absolutely. And I couldn’t agree more with your suggestion to follow a genuine passion for one of these areas. I think if you are trying to keep up with some of this fast-paced technological change because it’s an opportunistic move to keep abreast of something that seems new and exciting and generating a bit of buzz, then you just might not have the stamina to keep up long term. You do need that genuine passion, genuine curiosity to last long enough to carve out a niche for yourself. Well, Steven, thank you so much for joining me today on Hearsay the Legal Podcast. |
| 00:49:41 | SP: | Pleasure. Thanks very much for having me, David. |
| 00:49:53 | DT: | As always, you’ve been listening to Hearsay the Legal Podcast. I’d like to thank my guest today, Steven Pettigrove, partner at Piper Alderman, for coming on the show. Now, Steven has been on the show before to talk about Web3 for an episode about smart contracts. So you might want to go and listen to that one next or, if the cutting edge tech that you want to hear about is AI instead, you could listen to one of our interviews with Ray Sun on the regulation of AI around the globe. If you’re an Australian legal practitioner, you can claim one continuing professional development point for listening to this episode. Now, whether an activity entitles you to claim a CPD unit is self assessed, but we suggest this episode entitles you to claim a substantive law point. More information on claiming and tracking your points on hearsay can be found on our website. Hearsay the Legal Podcast is brought to you by Lext Australia, a legal innovation company that makes the law easier to access and easier to practice, including your CPD. Before you go, I’d like to ask you a favour, listeners. If you like Hearsay the Legal Podcast, please leave us a Google review. It helps other listeners to find us and that keeps us in business. Thanks for listening and I’ll see you on the next episode of Hearsay. |
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