Last week, the Australian Treasury released its long awaited token mapping consultation paper, setting out the direction of travel for crypto regulation in Australia. TRM’s policy team unpacked the key themes discussed in the paper and what this means for the industry.
What is token mapping?
Token mapping, a novel concept first mooted by Prime Minister Anthony Albanese’s government shortly after he took office in mid-2022, refers to "the process of identifying the key activities and functions of products in the crypto ecosystem and mapping them against existing regulatory frameworks." The approach emphasizes understanding the crypto ecosystem before identifying the risks and how they can be addressed through regulatory levers.
What you need to know
The proposal begins by laying out some key definitions as part of its “token, token system, function” mapping framework:
- Tokens are defined as “a physical or digital unit of information.”
- Token systems are defined as “anything designed to ensure or facilitate a function.”
- Crypto assets: Token systems that are “intrinsically linked to a specific crypto token” are defined as “crypto assets.”
- Functions are defined as “any benefit ensured or facilitated by a token system.”
“If it looks like a duck, walks like a duck and sounds like a duck…”
The consultation, most importantly, sets out to map the crypto token ecosystem against the existing financial regulation framework. Central to mapping is the concept of “financial product,” where the provision of services may attract licensing and regulatory obligations, such as an Australian Financial Services (AFS) license from the Australian Securities and Investments Commission (ASIC).
In a precursor to the consultation, Assistant Treasurer and Minister for Financial Services Stephen Jones memorably invoked the “duck test” for crypto assets, stating that "if it looks like a duck, walks like a duck and sounds like a duck then it should be treated like one" as opposed to "setting up a completely separate regulatory regime."
The consultation crystallizes the “duck” test by proposing two questions to help determine whether or not a crypto token system is a financial product:
- Is the token system a facility?
- Is the facility one through which a person does any of the general financial functions (i.e. making a financial investment, managing financial risk or making non-cash payments)?
Treasury notes that the assessment outcome will depend on whether the token system is:
- An intermediate token system, which involves “intermediaries or agents performing functions pursuant to promises or other arrangements;” or
- A public token system, which involves “functions being performed by crypto networks in the absence of promises, intermediaries, and agents.”
The Treasury then goes on to propose a “high-level taxonomy” of four product types:
For intermediate token systems:
- Crypto asset services, defined as “token system[s] that accept crypto tokens as part of performing a function under a legal agreement or arrangement.” Examples given include crypto trading, lending and borrowing, custody and fiat on/off ramping.
- Intermediated crypto assets, defined as “crypto asset[s] where the link between the crypto token and the token system is created by legal agreement or other arrangement.” Examples given include stablecoin arrangements and initial coin offerings.
For public token systems:
- Network tokens, defined as “crypto tokens that are created as part of the ‘consensus mechanism’ on public crypto networks, but that are used by holders for various other functions.” These appear to describe native tokens of blockchains such as BTC and ETH.
- Public smart contracts, defined as “smart contracts (and their associated crypto tokens) that are created for the purpose of enabling unknown parties to enter transactional relationships”. These include decentralized finance (DeFi) protocols.
Of the four product types, the Treasury appears most immediately concerned with crypto asset services, as they are “by far the most common way for consumers to get exposure to crypto assets.” The Treasury also notes that most of the major failures of the crypto winter were related to entities in this category, with “clear centralized control over user assets” and there was thus a “strong need for consumer protection” in this product class.
According to the consultation, the question of whether or not a crypto asset service is considered a financial product hinges on the “terms and functions” of the arrangement. The Treasury expressed concern about regulatory arbitrage through “complex or obscure arrangements” that “complicate the assessment.”
Thus, the paper seeks feedback on whether and what further guidance should be provided in assessing crypto asset services against the financial product definition.
On public token systems and their related product types, the paper highlights that these cause “several issues for legal and regulatory frameworks” , because existing frameworks are set up to be applied in the context of “products that involve promises, intermediaries, and agents,” which “do not map to public token systems.”
This conundrum is not unique to Australia.
Ultimately, the question of how to regulate decentralized arrangements is a challenging one for regulators everywhere, because existing regulatory frameworks are set up to impose obligations and oversight on centralized legal entities, where specific persons can be held accountable.
Where do we go from here?
Following this consultation, the Australian government will propose “a framework for custody and licensing,” which they expect to consult on in mid-2023.
Based on this consultation paper and the Treasury’s accompanying media release, we can expect the regulatory framework to focus on addressing consumer protection and financial stability risks. This is in line with regulatory efforts in other leading global jurisdictions, and is expected following the high profile failures of 2022.
The Australian government has also laid out strengthening enforcement action as another priority. ASIC had earlier identified crypto assets as one of its eight strategic priorities, and has already taken a number of enforcement actions against crypto companies. The Treasury highlighted that ASIC is increasing resources to support these efforts, and has promised that the regulator will take legal action “where it identifies crypto offerings being marketed without the appropriate [...] license.”
Nonetheless, the government is cognizant of the need to balance innovation and oversight, and reiterated its commitment to “working methodically with regulators, industry, and consumer and business advocacy groups to get the policy settings right to protect consumers and support innovation in this emerging sector.”
Its decision to consult on the results and proposals from its token mapping exercise are a step in this direction, and represent an opportunity for the Australian crypto community to engage in the policymaking process.
The consultation is open for industry feedback until 3 March 2023.
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