Back in scope: High Court confirms fixed-yield cryptocurrency product is a financial product

Block Earner operated an online platform through which, from 17 March 2022 to 16 November 2022, it offered the Earner product. Under the product, a user deposited AUD into an account held in Block Earner’s name, nominated an amount to be invested, and received a fixed rate of return of seven per cent annualised percentage yield (APY) paid in the relevant cryptocurrency.

Block Earner’s business model was to on-lend that cryptocurrency to third parties at higher interest rates, retaining the margin as profit.

Despite the Act requiring any business carrying on financial services in Australia to hold an Australian financial services licence (AFSL), Block Earner did not hold an AFSL for the Earner product. ASIC brought proceedings alleging a contravention of s 911A of the Act.

To establish that the Earner product was a financial product, ASIC needed to show that it was a ‘facility through which a person makes a financial investment’ within the meaning of s 763A(1)(a) of the Act. Section 763B provides that a person makes a financial investment where the investor gives money or money’s worth to another person, that other person uses the contribution to generate a financial return or other benefit for the investor, and the investor has no day-to-day control over that use. 

ASIC submitted that the contribution was the AUD nominated by each user to be invested, and that Block Earner used that AUD to generate a return for users in the form of the APY. Block Earner disagreed on both points, contending that the relevant contribution was cryptocurrency rather than AUD, and that Block Earner used the cryptocurrency only to generate profit for itself. Block Earner further argued that section 763B required a ‘demonstrated nexus’ between the contribution and its use, such that the investor must hold some right or interest in the downstream activities of the issuer’s business, described in the judgment as the investor having ‘skin in the game’.

The High Court accepted ASIC’s case, finding that users gave AUD, not cryptocurrency. Although the Terms of Use used words such as ‘lend’ and ‘loan’, users never held any rights to the cryptocurrency into which their funds were converted. Upon conversion, the Terms of Use required users to grant Block Earner ‘all rights and title’ to the cryptocurrency. It was therefore incorrect to describe the users of the Earner product as lending cryptocurrency to Block Earner.

The court held that Block Earner did use the AUD contribution to generate a return for users and drew an analogy with an interest-bearing deposit account, noting that a bank pools customer deposits, on-lends them to third parties, and pays customers a return from the proceeds in the same way as Block Earner did. 

The court also rejected Block Earner’s ‘nexus’ argument, finding that nothing in section 763B requires the investor to hold any right or interest in the activities of the issuer’s business. That construction placed a gloss on the definition of a financial product and was contrary to the text, structure and purpose of Chapter 7 of the Act.

Under s 761D of the Act, a ‘derivative’ includes an arrangement where a party must provide consideration at a future time and the amount of that consideration varies by reference to the value or amount of something else, including for example an asset, an interest or exchange rate, index or a commodity. 

ASIC contended that the Earner product satisfied this definition because under the Terms of Use, the amount of AUD a user received back at the end of the term depended on the prevailing exchange rate between AUD and the relevant cryptocurrency.

Block Earner argued that the currency conversion from cryptocurrency back to AUD was performed under a separate ‘Exchange service’, distinct from the Earner product itself, such that the consideration under the Earner product was fixed in cryptocurrency rather than variable in AUD. Furthermore, Block Earner relied on the exclusion in section 761D(3)(b) for a ‘contract for the future provision of services’, arguing that the conversion function was a service Block Earner provided and was not part of the financial product.

The High Court rejected both arguments. 

On the first, the court held that the Terms of Use constituted a single arrangement under which a user gave AUD to Block Earner and received AUD back. A user could not use the Earner product without currency conversion at both entry and exit, and the Exchange service was part of the product, not a separate arrangement. 

The court dismissed Block Earner’s reliance on six users who had transferred their own cryptocurrency directly, characterising these as ad hoc variations that could not alter the terms of the legal relationship. 

On the second, the court found that the substance of the arrangement was to provide a return in AUD of which the exchange service formed part, and the exclusion in s 761D(3)(b) did not apply accordingly.

Block Earner also argued that the Earner product was a ‘credit facility’, which would have excluded it from the definition of financial product under s 765A(1)(h)(i) of the Act. 

However, the court disposed of this argument briefly, noting that under the applicable regulations, a credit facility cannot be a financial product within the meaning of s 763A(1)(a). Having found that the Earner product was precisely that, the credit facility exclusion could not apply.

This decision is likely to significantly clarify the regulatory characterisation of fixed-yield cryptocurrency products in Australia and lends considerable weight to ASIC’s position that such products fall within the financial services regulatory regime. 

In this regard, we see the following practical implications:

• Any platform that accepts customer funds, converts them into cryptocurrency and pays a fixed or variable return is likely to be offering a financial product. The fact that a return is fixed does not remove the product from regulatory scope.

• The court’s finding that labels such as ‘lend’, ‘loan’ and ‘exchange’ do not determine legal characterisation suggests that regulators and courts will look through to the economic substance of an arrangement.

• The court held that there is no requirement for a nexus between the investor’s contribution and downstream use, and no need for the investor to share in business risk. The ‘financial investment’ definition may have a wider reach than the Full Federal Court had suggested.