Australian Law Reform Commission comments on regulation of crypto assets and decentralised autonomous organisations
The Australian Law Reform Commission is inquiring into the potential simplification of laws that regulate financial services in Australia. A background paper on the regulation of new business models, technologies and practices (with a specific focus on crypto assets and decentralised autonomous organisations) was released on 12 October 2022 as part of the inquiry.
As part of the Government’s response to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry released in February 2019, the Australian Law Reform Commission (ALRC) was tasked with a Review of the Legislative Framework for Corporations and Financial Services Regulation (Inquiry). The terms of reference for the Inquiry indicate that its purpose is to ensure meaningful compliance with the substance and intent of the law.
The ALRC has released a series of interim reports and background papers relevant to the Inquiry. The ALRC published its seventh background paper, ‘New Business Models, Technologies, and Practices’ on 12 October 2022. This background paper discusses technological innovations in the financial services sector and specifically considers reforms for the regulation of crypto assets and decentralised autonomous organisations (DAOs).
We summarise our key takeaways from the background paper.
Principle of ‘technology neutral’ regulation
The ALRC acknowledges the importance of regulation being ‘technology neutral’. To this effect, the ALRC suggests that regulation should be driven by the function performed by the crypto asset or DAO and the necessary obligations attaching to activities associated with the crypto asset or DAO, rather than being driven by the technology itself.
Technology neutrality is central to developing an adaptive and robust legislative design that minimises the complexity of the legislative framework and reduces the risk of regulatory arbitrage.
Regulation of crypto assets
To date, Australia has not enacted bespoke laws for the regulation of crypto assets and instead relies on the existing regulatory framework. Specifically, a crypto asset would be regulated as a ‘financial product’ if it meets the functional definition of a ‘financial product’ in section 763A of the Corporations Act, which involves:
- the making of a financial investment;
- the management of a financial risk; or
- the making of non-cash payments.
A deficiency of the functional approach of recognising financial products (as compared to specific legislation addressing crypto assets) is that it can create uncertainty with respect of the proper classification of the asset. Regulators such as ASIC, AUSTRAC and APRA have issued guidance in an attempt to provide regulatory clarity.
The ALRC suggests that it may be appropriate to include a new term in legislation to reflect the definition of a crypto asset, however the label and definition used to describe the concept should be considered carefully. The specific inclusion of crypto assets in legislation could provide clarity on which exclusions, exemptions and specific rules would apply.
South Africa is an example of a jurisdiction that has recently inserted the definition of a crypto product into its financial services laws. On 19 October 2022, the Financial Sector Conduct Authority of South Africa declared crypto assets a ‘financial product’ under its Financial Advisory and Intermediary Services Act. Under this declaration, the definition assigned to a ‘crypto asset’ is:
‘a digital representation of value that:
- is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility;
- applies cryptographic techniques; and
- uses distributed ledger technology.’
We highlight that this type of definition appears to be at odds with the ‘technology neutral’ principle outlined by ALRC in its background paper.
We are hopeful that the Government’s token mapping exercise, as flagged in our recent update, will guide the development of an appropriate regulatory framework that is ‘technology neutral’ and driven by the nature and function of a particular crypto asset.
Regulation of DAOs
We provided an explanation of DAOs and their structure in an update earlier this year.
Based on existing Australian laws, there is an argument that a DAO could satisfy the definition of a ‘partnership’, which is defined as the relation which subsists between persons carrying on a business in common with a view of profit and includes an incorporated limited partnership within the meaning of Part 5 of the Partnership Act 1958 (Vic). Where a DAO is treated as a partnership or association, we note that section 115 of the Corporations Act 2001 (Cth) will apply, which places restrictions on the number of members an unincorporated partnership or association may have.
To date, only a few jurisdictions have adapted their regulatory framework to accommodate the regulation of DAOs, generally in some form of a limited liability company. The nature of a DAO does not allow it to fit cleanly within existing company structures under Australian law, meaning that bespoke laws (similar to the rules for corporate collective investment vehicles) would need to be introduced if a DAO was to be structured as a company.
We reported in October last year that the Senate Select Committee on Australia as a Technology and Financial Centre recommended that the Government establish a new DAO company structure. The proposed structure would give DAOs separate legal identity, with DAO token holders given limited liability.
The ALRC notes in its background paper that while there are advantages of allowing a DAO to adopt a corporate form, such an approach detracts from a DAO’s decentralised and autonomous nature as it requires a human agent or representative to be appointed on behalf of the DAO.
Even if some form of registration or incorporation is adopted for DAOs, legal uncertainties such as liability, accountability and off-chain dealings with third parties will continue to exist.
Possible regulatory design choices for DAOs posed by the ALRC include:
- a DAO that operated in a purely decentralised, unwrapped form, which is treated as an unincorporated association or otherwise; or
- a ‘wrapped’ or hybrid arrangement under which a DAO operates through a company or corporate form, tailored to the operation and activities of DAOs.
What does this mean?
The background papers released by the ALRC are intended to provide a high-level overview of topics that are relevant to the Inquiry. We expect that the ALRC will make recommendations to address the topics discussed in the background paper.
The ALRC’s work on the Inquiry complements work undertaken by the Department of Treasury to simplify relevant legislation. The Government released exposure draft legislation on 24 August 2022 to implement recommendations from the ALRC’s Interim Report A, which was tabled in Parliament on 30 November 2021.
It is likely that the Department of Treasury will introduce further exposure draft legislation to address the ALRC’s recommendations contained in later reports. Interim Report B was tabled in Parliament on 30 September 2022. Interim Report C is due by 25 August 2023, with the Final Report due by 25 November 2023.
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