Insights / November 21st, 2023

Crypto Exchanges: A New Regulatory Framework

Last month, Treasury commenced consultation on a new regulatory framework for digital assets. In the wake of a series of scams, hacks and other failures (including the cataclysmic demise of FTX in November last year), Treasury is seeking to establish a more stable and secure ‘digital asset ecosystem’ by integrating it into the financial services regime.

Over the past decade, the concept of digital records of ownership (or ‘tokens’) has entered the mainstream. With one in four Australians now holding some form of cryptocurrency and tokens like Bitcoin, Ether and Dogecoin now household names, it is unsurprising that bringing some certainty, security and oversight to the currently unregulated digital asset ecosystem is high on the Government’s priority list.

What is a digital asset?

Digital assets consist of tokens and their associated entitlements. These entitlements can take a number of different forms and, in some cases, can even amount to a financial product or a right to assert ownership over another asset (“assets backing digital assets”).

The proposed regulatory framework

Under the proposed regulatory framework, it is not digital assets that will be regulated. Rather, it is the arrangements by which digital assets (and assets backing digital assets) are held that will be regulated. These arrangements will be known as “digital asset facilities” and will be treated as financial products under the financial services law.

The majority of digital asset facilities consist of “digital asset platforms” that offer custody, administrative and transactional functions. Digital asset platforms are often referred to as ‘crypto exchanges’ and include Binance, Gemini, Kraken and Coinbase.

Why are platforms the focus?

Due to the way in which digital asset platforms are structured, it is the platform, not the investor, that holds the value (that is, the digital assets and the assets backing digital assets). Whilst this feature makes on-platform transactions safer than off-platform transactions (due to there being no risk of a party defaulting on the transaction), it means that digital asset platforms shoulder an enormous amount of risk and responsibility (which can be, and has been, exploited). Given the significant proportion of Australian investors who own digital assets, the potential ramifications of such exploitation are likely to be material. It is for this reason that Treasury has chosen to focus the regulatory regime on digital asset platforms rather than digital assets themselves.

What obligations will apply?

The obligations that will apply to individuals and businesses who deal with, advise on or provide any other financial services in relation to digital asset facilities will be made up of a mixture of existing financial services obligations and new obligations that have been tailored to the product. These new obligations include the requirement to provide a ‘facility guide’ to, and enter into a ‘facility contract’ with, clients, and the requirement to adhere to certain minimum standards when holding assets, intermediating platform entitlements or providing transactional functions.

Consultation closes on 1 December.

For further information please contact Zac Mizgalski or Richard Hopkin in our Financial Services team.

This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice. You should not act upon the information contained in this publication without obtaining specific professional legal advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.

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