ASIC guidance on crypto-assets
The global appetite for digital assets is strong and their popularity seems to be ever increasing. According to a recent survey, Australia currently ranks third highest in the world for the rate of cryptocurrency ownership at 17.8%. However the regulatory environment for digital assets is often uncertain as technology outpaces the law.
To assist businesses involved with crypto-assets, ASIC published INFO 225 on crypto-assets on 29 October 2021. INFO 225 provides guidance on:
Considerations when offering crypto-assets.
Misleading or deceptive conduct in relation to a crypto-asset or an initial coin offering (“ICO”).
When a crypto-asset or an ICO could be (or could involve) a financial product.
When a crypto-asset trading platform could become a financial market.
Considerations when offering retail investors exposure to crypto-assets via a regulated investment vehicle.
How overseas categorisations of crypto-assets translate to the Australian context.
Sources for further information.
ASIC has defined a crypto-asset as a digital representation of value or rights (including rights to property), the ownership of which is evidenced cryptographically and that is held and transferred electronically by a type of distributed ledger technology or another distributed cryptographically verifiable data structure.
Considerations when offering crypto-assets
ASIC says that all of the rights and features of a proposed crypto-asset need to be considered to determine if it is (or involves) a financial product and that the rights and features of an asset are more important than how it is named and marketed when deciding if the asset is a financial product. Where entities do not consider a crypto-asset to be a financial product, they should be prepared to justify their conclusion.
Misleading or deceptive conduct
ASIC warns entities to ensure that promotional communications about a crypto-asset or an ICO do not mislead or deceive potential consumers and do not contain false information. This extends to the content of documents such as “white papers” issued in connection with a crypto-asset or ICO. Whether or not a crypto-asset is a financial product, Australian laws apply to prohibit misleading or deceptive conduct in trade or commerce.
ASIC provides some examples of conduct that may be misleading or deceptive:
stating or conveying the impression that a crypto-asset (such as coins or tokens) or ICO offered are not a financial product if that is not the case;
stating or conveying the impression that a crypto-asset trading platform does not quote or trade financial products if that is not the case;
using social media to generate the appearance of a greater level of public interest in a crypto-asset or ICO;
undertaking or arranging for a group to engage in trading strategies to generate the appearance of a greater level of buying and selling activity for an ICO or crypto-asset;
failing to disclose adequate information about an ICO or crypto-asset; and
suggesting that the ICO or crypto-asset is a regulated product or the regulator has approved the ICO or crypto-asset if that is not the case.
Additionally, ASIC says entities should ensure that the public is not misled about the application of the crowd-sourced funding laws to an ICO, as crowdfunding using an ICO is not the same as crowd-sourced funding regulated by the Corporations Act.
When a crypto-asset or an ICO could be (or could involve) a financial product
INFO 225 considers several categories of financial products that crypto-assets or ICOs may fall into:
Managed investment schemes.
Securities.
Derivatives.
Non-cash payment facilities.
Managed investment schemes
ASIC says that where the value of crypto-assets acquired is affected by the pooling of funds from contributors, or the use of those funds under the arrangement, then the crypto-asset is likely to involve a managed investment scheme.
In the case where the crypto-asset or ICO issuer frames the entitlements received by contributors as a receipt for a purchased service, if the value of the crypto-assets acquired is affected by the pooling of funds from contributors, or the use of those funds under the arrangement, ASIC considers that the crypto-asset is also likely to involve a managed investment scheme.
Securities
When an ICO is created to fund a company, ASIC notes that the rights attached to the crypto-asset issued by the ICO may fall under the definition of a security if the bundle of rights attached to the crypto-asset are similar to those commonly attached to a share. This could include ownership of the body, voting rights in decisions of the body, or some right to participate in profits of the body. A right to acquire shares in a company in the future (such as when it lists on a stock exchange) would be an option, which is another form of security. Issuers of a security will generally be required to prepare a prospectus for an offer of the security.
Derivatives
A crypto-asset may involve a derivative if its price is based on the price of another financial product, a market index or another asset price. Where an issuer of a crypto-asset or ICO is making an offer of a derivative, a product disclosure statement (“PDS”) should be prepared, and regulatory requirements should be complied with. An Australian financial services (“AFS”) licence is required for financial services relating to crypto-assets that are derivatives.
Non-cash payment facilities
Using a crypto-asset to facilitate a transaction does not automatically qualify it as a non-cash payment (“NCP”) facility, but if the asset provides the holder with a right to use the asset to make payment, ASIC’s view is that it is likely to be an NCP facility. Crypto-assets such as tokens offered under an ICO are unlikely to be NCP facilities, although they may be if they include an arrangement that allows payments to be made to a number of payees, or payments to be made through a token that is converted to fiat currency to complete the payment.
Financial markets
Where a crypto-asset is a financial product, ASIC says that any platform that enables the purchase or sale of these crypto-assets may involve the operation of a financial market. To operate in Australia, the platform operator must hold an Australian market licence unless covered by an exemption. Depending on how transactions are cleared and settled, a clearing and settlement facility licence may also be required.
Exposure to crypto-assets via regulated investment vehicles
INFO 225 includes good practice guidance for issuers of investment products that provide retail investors with exposure to crypto-assets through products such as exchange traded products (“ETPs”), listed investment companies and investment funds, and unlisted investment funds.
Custody
When dealing with crypto-assets, ASIC advises that it is good practice for the responsible entity (“RE”) to:
have specialist expertise relating to crypto-asset custody;
keep crypto-assets segregated on the blockchain;
ensure the private keys used to access the scheme’s crypto-assets are stored securely;
adopt a signing approach that minimises single point of failure risk (e.g. using multi-signature based approaches);
use custodians which have robust systems, cyber and physical security practices for their operations;
independently verify the cybersecurity practices and controls environment of the custodian to the appropriate standard;
have access to an appropriate compensation system where crypto-assets are lost; and
have the appropriate competencies to assess the custodian’s compliance where external or sub-custodian are used.
Private keys are critical for crypto-assets and ASIC emphasises the importance of ensuring that they are protected from unauthorised access.
Risk management
In addition to the general requirements of financial services licensees in respect of risk management, ASIC recommends that the RE should be satisfied, based on reasonable due diligence, that any crypto-asset trading platform it relies on is a digital currency exchange provider registered with AUSTRAC (or is regulated by one or more laws of a foreign country giving effect to the Financial Action Task Force recommendations on customer due diligence and record-keeping) and implements risk-based AML/CTF systems and controls which are supervised or monitored by body empowered by law to do so. In addition, the RE should ensure that authorised participants, market makers and other service providers that trade crypto-assets in connection with the product do so on crypto-asset trading platforms that meets these same standards.
Disclosure
ASIC says that for investment products that invest in, or provide exposure to, crypto-assets, there must be sufficient information about the characteristics and risks of those products in the PDS, as well as sufficient information about how the product is intended to operate. In relation to the characteristics of crypto-assets, the information to be disclosed may include:
the technologies that underpin crypto-assets, such as blockchains, distributed ledger technology, cryptography, and others;
how crypto-assets are created, transferred, and destroyed;
how crypto-assets are valued and traded; and
how crypto-assets are held in custody.
In relation to the risks of the crypto-assets, ASIC says that the types of matters to be disclosed may include market risk, pricing risk, immutability, political, regulatory, and legal risk, custody risk, cyber risk, and environmental impact.
Licensing of scheme operators and registration of schemes
Operators of schemes that hold crypto-assets will generally need to hold an AFS licence or be exempt from the requirement to hold a licence. ASIC expects applicants to operate two named crypto-asset registered schemes for at least two years before it will consider granting them a broader “kind scheme” authorisation for crypto-assets which would allow the licensee to operate multiple crypto-asset schemes without needing to vary the licence with each new scheme.
Listed investment companies
ASIC expects listed investment companies (“LICs”) that provide investors with a material exposure to crypto-assets to follow the same good practices for custody, risk management and disclosure as registered managed investment schemes, and also expects market operators to develop rules for LICs that invest a material portion of investors’ funds in crypto-assets so that there is a level playing field between them and crypto-asset ETPs.
Structured products
ASIC says that structured products (“SPs”) that offer investors exposure to crypto-assets should follow the same good practices for custody, risk management and disclosure as registered managed investment schemes. SPs are a subset of ETPs, and ASIC notes that these products will be subject to market operator rule frameworks as they apply to ETPs.
Overseas categorisations of crypto-assets in an Australian context
There has been guidance issued by several international regulators relating to the application of their securities and financial services laws to ICOs and which define the function of a range of crypto-assets. ASIC comments that these categorisations do not automatically translate to equivalent products in Australia and that it is always important to consider features of an individual ICO or crypto-asset in relation to Australian law.
Patrick Dwyer and Kathleen Harris
Legal Directors
Thanks to Danielle Hodgson for assistance in preparing this article.