The commencement of two Parliamentary Inquiries into the cryptocurrency movement in New Zealand and Australia will bring home to policy-makers how complex this corner of the FinTech sector really is. As suggested in my earlier Part One article, the evolving technologies powering cryptocurrencies are advancing at a pace that our existing laws cannot handle.
That often happens with old-world regulations that were not designed to move with the times. Consequently, decentralised applications are popping up in fields where the rules are unclear. Both governments probably feel the emerging issues of all things crypto need attention.
There are many issues on the table to explore, and what follows is admittedly selective. It arises from conversations I’ve been having with clients engaged on these Inquiries, and writings from industry peers about the various considerations other nations have been clutching at.
With twin themes in mind of financial crime risks of abuse, and nascent regulatory frameworks, let’s look at what might surface in Australasia too. At the risk of being a tiny bit provocative, here are five crypto-conversation starters.
1. Investor risk and consumer protection
Accumulating intangible money in one place inherently has as much risk of bank robbery (of the hacking kind) as traditional bricks-and-mortar wild-west style heists.
We might ponder how long a shadow has the Cryptopia liquidation debacle cast over the fledgling currency exchange industry?
The online trading platform based in NZ’s South Island went spectacularly bust in 2019. A major website hack saw 15% of its stock of tokens/coins stolen, and traders then deserted in droves. Liquidators are still grappling with the complexities of how to divvy up the remaining holdings (potentially worth NZ$170m) among 960,000 account holders – in different coins, classes, with varying balances and investments at various stages.
This included a ground-breaking but expensive venture by liquidators into the NZ High Court to have cryptocurrencies declared “property.” That helped ascertain the competing rights of creditors/account holders/beneficiaries in a series of trusts hence created, but the troubles kept coming.
Cryptopia isn’t the first and won’t be the last exchange to fall victim to a virtual bank heist. Just recenty a De-Fi platform and another Japanese exchange was hit. There’s even the cruel irony of old-school robbery and new-tech crime merging, in this remarkable story of a safe in suburban Auckland being hauled away with critical wallet keys inside.
When the worst happens, can insolvency regimes do all that much? At the time of June 2021 it seemed almost NZ$12m had been spent on the Cryptopia liquidation mess, without much to show for it. Too little, too late, is the reality.
Parliaments in both countries may be wondering if consumer protection/prudential deposit-style regulation is necessary. Whilst warning private investors of buyer beware, and not to succumb to “FOMO”, regulators continue to tiptoe around bigger institutional issues in the growing sector.
For instance, ASIC in July 2021 (Consultation Paper 343) kicked around ideas to bring some order and “good practice” to regulated players who invest by exchange-traded products and other schemes into underlying crypto-assets. It raised some sound points about pricing transparency and manipulation of trading, custody and asset safe-keeping, as well as AML and CFT risk management baselines, and disclosure obligations to retail customers.
But anything more concrete seems a way off. For now, a piecemeal approach to classification and regulation persists.
2. Are regulators worldwide now circling on the sector?
Heads turned when trans-Atlantic regulators recently piled into Binance, the first or second-largest global exchange depending on what measure you use. A series of investigations and warnings stacked up this year, about operating without jurisdiction or permits, alleged failure to comply with local AML regulations, even potentially market manipulation (although firmly denied).
Coindesk had a good crack at compiling all the various regulatory actions in one place. A domino effect indeed. Binance isn’t alone. Another article in ACAMS recently highlighted a range of US probes and charges emanating from the OFAC to the CFTC, SEC and the New York Attorney-General. And new Non-Fungible Token (NFT) markets are experiencing their own similar challenges.
Legitimate players in the crypto-sector are generally keen to see action taken against rivals who may be operating in an unregulated fashion. But once a regulatory wave is up and rolling, it can always have potential to surge through the sector as a whole without much discrimination.
Then there is pure political risk. Since publishing my earlier article on this rapidly evolving issue, the People’s Bank of China and other Chinese state agencies announced that all transactions of cryptocurrencies are illegal, and it banned digital tokens and trading. The Bank/Party intends to work closely to maintain a “high pressure” crackdown on speculative trading, and prosecute those involved in “illegal financial activities” including any foreign websites providing such services to China.
To some this came as a shock considering the scale of China’s influence as arguably the real world and virtual world’s largest markets. Cue more fluctuations and volatile falls in the price of Bitcoin and other cryptocurrencies, at least temporarily.
But China has been here before – it started cracking down on Bitcoin a few years ago, along with other digital-led companies like Twitter and Facebook. Trading crypto-currency on exchanges in China has been officially banned since 2019 but since continued through foreign exchanges and mechanisms. And energy-sapping mining operations have also been targeted in the past. So, it should have been less of a surprise.
Speculation about the implications of all this is now rife. Investment Week amongst others showcased the wide range of opinions amongst experts about whether Chinese abhorrence of crypto will make much difference, long-term.
3. De-banking
One thing an exchange, or at least its customers, still needs is a bank account. Or the means to exchange the fruits of speculation back into flat currency at some stage. Unless the Parliamentary Committees recommend bravely following El Salvador to recognise bitcoin as legal tender, or start to experimentally allow crypto credit card shopping transactions, for those wanting to buy real, physical assets the mainstream banking sector still holds a form of veto.
De-risking has been a real concern in this sector for years. How to reconcile the banking sector and FinTech’s acrimonious past has become a topic of interest in both Parliamentary Inquiries.
Recently, we saw banks retreating fast from Binance, but it has been happening to others regardless of any regulator enforcement action. In parallel money transfer or new payment technology fields, de-banking across Australia and New Zealand has been brutal. Recent oral submissions to the Senate evoked sentiments from the ACCC’s foreign exchange remittance non-competitiveness hearings in 2018. Everyone from FinTech Australia’s head to the self-styled Bitcoin Babe of NSW had a story to tell of rough treatment.
Genuine crypto players locally are keen to be regulated, as reported in the AFR, to achieve some level of respectability and retain banking relationships. That was partly why NZ’s Department of Internal Affairs (DIA) was happy to expand its reach and announce it was capturing the Virtual Asset Service Provider (VASP) sector for AML compliance purposes in 2019. Both AUSTRAC and the DIA have a good understanding of the perceived VASP high risks and red flags, involved in and following international FATF guidance and updates each year as a comprehensive start to addressing money laundering risks.
It remains to be seen how polarising this de-banking issue will be, and how to attempt reconciliation. The Australian Senate explicitly recognised it as a problem within its terms of reference, and it seems inevitable that it will creep into the NZ Parliament Inquiry too. We can contrast the submitting views of the Australian Banking Association and crypto mining company Cosmos Capital. The ABA told the Senate (Second Interim Report pg 89) it believes virtual assets have many potential benefits, but without proper sector regulation digital currency exchange providers:
“risk becoming a virtual safe haven for the financial transactions of criminals and terrorists…”
– and:
“there is a key risk for banks to be that the identity of users of virtual assets are often unknown to banks and sometimes not adequately known to the operators of the exchanges were virtual assets are traded.”
Mr James Manning, Founder and Managing Director of Cosmos Capital (pg 95) perceived this to be:
“… part of a larger fear, including from banks, about exposure to cryptocurrencies and possible Anti-Money Launder and Counter Terrorism Financing Act issues. There a ‘a raft of legal issues as to chain of title, who has owned the bitcoin prior to you, whether you knowingly or unknowingly are participating in some form of activity’, resulting in Australian banking groups finding it easier to say no than to try to understand the space.”
As a result, lack of access to mainstream fiat banking and insurance services may still be the single greatest impediment to FinTech firms on either side of the Tasman operating in a growth-enabling environment.
4. Do the means exist to regulate it all?
Cryptocurrencies represent an existential challenge for any single nation/regulator aspiring to control them. How to move unilaterally, ahead of other countries? And which of many potential regulatory buckets should you place these sectors into?
On social media channels, the regulatory topic sometimes descends into polarisation of debate, where investors and crypto-aficionados argue that a decentralised, virtual, stateless form of money needs no regulation. On the other hand, exchange businesses and brokers who still need to accommodate a sceptical financial mainstream may “beg for regulation”.
In New Zealand, at least, enthusiasm may have to be tempered by reality. There is not yet even a form of Electronic Money Institution licence, like the UK has, for mainstream online payments providers, let alone a strong record in getting to grips with crypto or NFT technology developments.
Which inevitably leads to another issue: who should be the regulator? Agencies domestically in both countries have differing remits and powers, sometimes overlapping. Any of these Kiwi and Aussie agencies could lay claim to a slice of the regulatory action:
- New Zealand’s DIA, or AUSTRAC
- Financial Markets Authority/ASIC
- RBNZ or Reserve Bank of Australia
- NZ Commerce Commission/ACCC
There are multiple aspects of digital money to get to grips with, which slide over jurisdictional boundaries. That is even before looking to Australian Federal Police or NZ Police financial crimes units when something digital has already turned dodgy.
Governments around the globe are battling with regulatory issues and their natural desire to bring some order to the Wild West by extending jurisdiction. Perhaps the Director of Cosmos Capital again summed it up well (Second Interim Report pg 88):
“As a direct result of the inability to launch suitably regulated and governed retail financial products in the crypto asset space, there exists a current framework in which investors are exposed to little or inappropriate disclosure. There is an increased likelihood of being scammed. There are increasingly high transaction costs, very poor understandings of the underlying asset class, exposures to unscrupulous offshore operators and unclear treatment of insolvency. We believe the government could address this by having a clear disclosure regime and encouraging clear dispute resolution programs for an alternative asset class.”
5. Could government nationalisation of cryptocurrency be a bigger threat?
Just like big banks sometimes run scared of new payment methods until they can vertically-integrate and control it, central banks around the world have been pondering whether to launch or nationalise their own cryptocurrency.
Stablecoins are an attractive development to dampen the wild market volatility of most forms of cryptocurrency. They tether the virtual asset to a regular, respectable fiat-based asset, often with 1-to-1 real currency back-up. They may be also provide an attractive starting platform for a central bank keen to put things back into perceived traditional boxes.
The Reserve Bank of NZ recently announced it would do some thinking out loud about a central bank digital currency (CBDC). It mused that a CBDC could support the role of central bank money as an anchor of value, in the face of declining and risky use of cash in society. Further, CBDCs may provide a “fair and equal way to pay and save”, including by disintermediating those less efficient banks. But RBNZ sounds numerous alarm bells about different types of risks, including from privately owned stablecoins becoming large and scary enough to undermine monetary sovereignty (pg 14):
“Notably, large technology companies have proposed issuing global stablecoins. These instruments promise more efficient and innovative means of paying and might obtain rapid global adoption due to the market power of their issuers. …
If a global stablecoin were issued successfully in New Zealand, the Reserve Bank could face a scenario where a potentially large number of transactions and savings would be conducted outside NZD and offshore. This could limit our ability to use monetary policy to influence interest rates and therefore inflation and employment targets, which would mean a loss of monetary sovereignty for New Zealand.”
Another key obvious risk discussed in the consultation is cyber-security. Privately owned and uncontrollable offshore stablecoins might not be to a central bank’s liking, but can we realistically believe the RBNZ’s own degree of privacy law compliance and its past level of cyber protection will be much better than Cryptopia’s?
The Reserve Bank of Australia (RBA) may be further advanced in its thinking. But some large and complex implications of stablecoins still have to be grappled with. As reflected in the Second Interim Report (pg 101):
“… the RBA has focussed its recent work on stablecoins. RBA staff members are ‘participating in several global regulatory groups focused on stablecoins, including a group that developed recommendations on the appropriate regulatory and oversight approach for global stablecoin arrangements’. The RBA noted the possibility of both positive and negative implications of the widespread adoption of stablecoins. Potential benefits include reducing the costs of cross-border payments and overcoming some aspects of financial exclusion. Potential negative implications include their use for money laundering or illicit activities, consumer protection and privacy concerns and potentially undermining monetary and financial stability.”
So, plenty to talk about around the Parliamentary dinner-table. Regardless of where these conversation starters lead, all New Zealand and Australian lawyers working with technology, blockchain or virtual asset businesses may find the months ahead worth watching, to see where all this governmental engagement leads next.
By Gary Hughes (Barrister), with assistance from Holly Whitney (Law Clerk)
POST SCRIPT
Since the recent preparation of this article the Australian Senate Committee presented its final report on 21 October 2021, which can be found here: Final report – Parliament of Australia (aph.gov.au).
The Final Report has set out a number of important recommendations to the Australian Government, including as to de-banking and a clear need for constructive financial regulation. This gives a boost to the ‘Conversation Starters’ outlined above, and also for the New Zealand Parliamentary committee which is still working through its early stage hearings at present.
For Australia, the Final Report provides a strong roadmap where the Select Committee members invite government to now put in place the infrastructure that will foster controlled growth of the crypto and fin-tech sectors.
The Senate final report deserves a full reading, but its main recommendations can be briefly summarised below.
Cryptocurrency and digital assets:
Since Australia has not yet introduced a “fit-for-purpose” regulatory system that would give market participants certainty and provide consumer protections, the Committee has put forward a series of recommendations:
- A form of market licensing regulation for Digital Currency Exchanges (at present limited only to registration with AUSTRAC). Since these are now businesses that may deal with billions of dollars in assets, a full Market License for this sector will assist it to mature and improve market confidence.
- Devise an appropriate regime for custodial and depository services for digital assets. Assets that are basically intangible code/software assets present risks very different to fiat or traditional assets. The Committee sees scope for Australia to benefit from becoming a leader in minimum standards and treasury rules in the digital assets space.
- A “token mapping exercise” is required to classify the various types of crypto-asset tokens and other digital assets developed in a fast-changing market. Knowing how to properly characterise and assign classifications to these different assets will help improve the regulatory framework.
- A new form of legal structure, known as a Decentralised Autonomous Organisation, is desirable to ensure emerging blockchain-based organisations can become established with clarity and sound basis for how they can operate in Australia.
- Reviewing the Anti-Money Laundering and Counter-Terrorism Financing Regulations to ensure that these rules do not undermine innovation and can manage the FATF’s “travel rule” concept.
- NOTE also that, just days after the Senate Report was released, the FATF has since released its own updated guidance in the AML sphere for Virtual Assets.
- Taxation rules for digital assets require further clarification, particularly around when capital gains tax applies to cryptocurrency and digital assets and their new types of structures.
- Potentially a corporate tax concession of 10% for digital asset miners operating in Australia who can demonstrate they source their own renewable energy.
- Treasury to lead a policy review on the potential for a retail Central Bank Digital Currency in Australia, to continue exploring that field further.
De-banking:
Recalling that the Committee heard sometimes harrowing evidence from individuals and businesses that have experienced de-banking in Australia, particularly remittance, payments, and digital assets sectors, there are several specific recommendations on this complex problem:
- Press ahead with a recommendation from the ACCC foreign currency conversion services studies in 2019 to create through the Council of Financial Regulators a due diligence scheme that will meet or regulate banking requirement (and move rapidly, to be finalised by June 2022).
- More work to ensure there are clear guidelines around de-banking and a process exists (through the Australian Financial Complaints Authority) to build avenues for recourse for those who have been treated unfairly.
- The RBA should develop common access requirements and standards for the New Payments Platform (itself a competition law issue the ACCC is familiar with) in order to reduce the dependency that payments businesses have on the major banks for account services.
These are ground-breaking recommendations, especially with regard to the long story of de-banking complexity and distress. The ball clearly sits with Federal Government now, to decide if it has enough incentive to run with the pass from the Select Committee and its submitters.
