ASIC case against Block Earner provides guidance for crypto business

By John Bassilios and Livia Tsipos

Background

On 9 February 2024, the Federal Court of Australia handed down its judgment in ASIC v Web3 Ventures Pty Ltd [2024] FCA 64. The judgment was highly anticipated because it's one of the first to tackle how financial services law applies to crypto-related products and services. This case will help us understand how the courts will handle regulating crypto-related products in future.

The case concerned two separate product offerings:

  • “Earner” (operative from March 2022 to November 2022); and
  • “Access” (operative from March 2022 to present).

ASIC alleged Web3 Ventures Pty Ltd (trading as Block Earner) contravened sections 911A(1) and 911A(5B) of the Corporations Act 2001 (Cth) (Corporations Act) by carrying on a financial services business without holding an Australian financial services license (AFSL) covering the provision of financial services.

Additionally, ASIC alleged Block Earner contravened sections 601ED(5) and 601ED(8) of the Corporations Act by operating an unregistered managed investment scheme that required registration .

ASIC sought declarations, injunctions, and pecuniary penalties from the court.

Block Earner also operates a digital currency exchange (Exchange Service), which permits users to buy and sell over 100 crypto currencies using the Block Earner platform. Block Earner referred to itself as a “digital currency exchange” and claimed it only had to meet the light-touch AUSTRAC registration process and did not require regulatory oversight with ASIC. To this end, Block Earner was registered with AUSTRAC but did not hold an AFSL or have the benefit of an AFSL.

Relevant product summaries

Earner

This product allowed users to lend cryptocurrency to Block Earner in return for daily interest payments. This was a fixed rate return over the term of the loan. Block Earner then loaned the crypto assets to third parties for higher interest rates than the users were being paid to generate income. This product was discontinued in November 2022.

Access

The Access product operates differently from Earner. While Earner takes customer funds and invests them in other protocols to generate a fixed yield, Access simply connects the customer directly with protocols that offer a variable yield.

Decentralised Finance (DeFi) refers to peer-to-peer finance enabled by smart contracts rather than a centralised intermediary, like a bank. This Access service provides users with access to two DeFi generating protocols, ‘Aave’ and ‘Compound’, which operate without traditional intermediaries such as banks or financial institutions.

Proceedings

Earner

Managed investment scheme

ASIC alleged the Earner product was a managed investment scheme. Under section 9 of the Corporations Act, a managed investment scheme requires:

  • contribution of money or money’s worth as consideration to acquire rights to benefits produced by the scheme;
  • that the contributions are pooled or used in a common enterprise to produce financial benefits for the members; and
  • the members do not have day to day control over scheme operations.

Contribution and consideration

ASIC referred to Earner’s ‘Terms of Use’, which stated the consumer, by investing in the Earner product, deposited money with or Block Earner, and Block Earner undertook to repay that money as interest. The fact Block Earner invested its own funds alongside the money from its customers did not prevent the money from the customers from being a ‘contribution.’ The court concluded that users contributed money as consideration to acquire the right to the promised fixed interest yield under the Earner product.

Pooling

ASIC asserted the Block Earner website referred to the pooling of customer funds to generate returns with a favourable yield rate.

Further, ASIC noted it wrote to Block Earner on 21 October 2022 outlining its concerns that Earner was a managed investment scheme, an investment facility and derivative noting various statements on Block Earner’s website. Justice Jackman suggested this prompted Block Earner to remove from the website the statement connecting user-provided funds with the favourable fixed interest rates. The question “how is fixed yield generated?” on the website was also amended at the time.

In response, Block Earner indicated the website statement was drafted by a junior employee and was not reviewed carefully. It was not Block Earner’s intention to suggest the ‘return’ repayable to users from the Earner service was generated by pooling customer funds and lending those funds to third parties. The ‘pooling’ referred to the holding of loaned cryptocurrency assets in one wallet for the purpose of Block Earner making loans to third parties for its own benefit.

While the court recognised the Terms of Use did not mention pooling for any common benefit, it was sufficient that Block Earner represented that contributions would be pooled in order to generate a financial benefit for users.

Justice Jackman also referred to the judgement of Justice White in ASIC v Great Northern Developments Pty Ltd [2010] NSWSC 1087(2010), in which he held that loans with fixed interest returns can fall within the definition of “managed investment scheme” and that the right to interest and repayment of principal can be a right to “benefits produced by the scheme”.

Day to day control

It was accepted by the court that members had the ability to control when they entered and withdrew from the scheme, but this did not amount to day to day control over the scheme.

The court found Earner was a managed investment scheme as:

  • investors paid money or money's worth to obtain a benefit (being payment of interest);
  • the benefits were generated from pooling or a common enterprise; and
  • there was no day to day control of the scheme by investors.
Financial investment

ASIC also claimed the Earner product was a ‘financial ‘investment’ under section 763B of the Corporations Act.

The court found the Earner product met the definition under the Act which requires that:

  • an investor provide money or money's worth and expect the other person to use it to generate returns (or the other person expects that or in fact does generate a return); and
  • the investor has no da to- day control over the use of the contribution.
Derivative

ASIC also alleged the Earner product was a derivative. The court held that the Earner product did not meet the definition of a derivative under section 761D of the Corporations Act. Pursuant to sections 761D(3)(c), 764A(1)(ba) and 601ED(1), an interest in a managed investment scheme that is not a registered scheme and has more than 20 members is excluded from the definition of ‘derivative.’ Justice Jackman concluded that as he found the Earner product to be a managed investment scheme that was not registered with over 20 members, the Earner product could not be a derivative by exclusion.

Access

As with the Earner product, ASIC claimed that Access was a managed investment scheme, a financial investment and a derivative, however the court dismissed these claims.

Managed investment scheme

Contribution and consideration

ASIC submitted that for a consumer to acquire, invest in or use the Access product, they must have an account with Block Earner into which they deposit AUD, which is then converted into a crypto asset through a centralised exchange service provider.

Pooling

ASIC claimed the Terms of Use provide that under the Access product, Block Earner “aggregates” the DeFi tokens on its Block Earner omnibus account on each DeFi protocol. The court rejected this argument that “pooling” in the omnibus account satisfied the pooling requirements of the managed investments scheme definition as there were no evidence that the pooling itself generated benefits (eg individual account fees being saved).

Day to day control

The court agreed with ASIC’s assertion that while the investors could decide when they would enter and withdraw from the scheme, they otherwise had no control over its operations.

Given the ‘pooling’ element of the definition was unable to be satisfied, the court found the Access product was not a managed investment scheme.

Financial investment

ASIC also claimed the Access product was a ‘financial ‘investment’ under section 763B of the Corporations Act but failed on this point. The court held the Access product did not meet the definition and compared Block Earner to a 'broker' connecting users to smart contracts. Justice Jackman also pointed out the definition of financial investment doesn't consider giving money to a broker to buy shares as a financial investment on its own.

Derivative

ASIC claimed the Access product was a derivative within the meaning of section 761D of the Corporations Act. It submitted the Access product is a derivative because, in the usual case of the user being repaid in AUD, the amount of AUD to be paid will vary according to the value of the tokens and the value of the cryptocurrency into which those tokens are converted.

However, the court held the arrangement in question was a “contract for the future provision of services” under section 761D(3)(b) of the Corporations Act and therefore exempt from the definition of derivative within the Act. Had this not been the case, the court accepted  the Access product would have fallen under definition of derivate.

Outcome and orders

ASIC succeeded in establishing contraventions of sections 601ED and 911A of the Corporations Act in relation to the Earner product. It failed to do so with respect to the Access product.

The court ordered that:

  • the proceedings be dismissed with respect to the “Access” product;
  • the cost of the proceedings to date be reserved; and
  • the proceedings be listed for a case management hearing at 9.30 am on 1 March 2024 in relation to the preparation of, and fixing of a date for, the hearing as to any pecuniary penalty.

Significance

This case provides insight into how the courts may approach regulation of cryptocurrencies in future and foreshadows that businesses using cryptocurrencies maybe subject to the same regulations as other financial services.

Jackman J noted there is legal controversy as to whether cryptocurrency is property under common law. While he referred the English Court of Appeal’s decision to recognise it as property, he declined to form a view on this matter to resolve the proceeding and expressed no opinion on it. Currently, there is no formal Australian authority confirming the position on this matter and will be open to courts for interpretation in future.

Contact

John Bassilios

John Bassilios

Partner & Fintech and Blockchain Lead

John has broad experience in financial services, funds management, blockchain, crypto, web3 and corporate law.

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