Senate report on Australia as a technology and financial centre

In October 2021, the Select Committee on Australia as a Technology and Financial Centre (Committee) published its final report on the regulation of crypto assets. The Committee made eight recommendations, which seek to achieve three key objectives:

1. Providing a framework for regulators and governments to better understand digital assets.
2. Bringing Australia in line with leading digital-asset jurisdictions.
3. Providing the best platform for Australian industry to lead select aspects of this emerging industry.

The Committee's recommendations appear to have bipartisan support, which indicates they may have a real impact on future reform in the area.

The Committee's eight recommendations are explored below.

1. That a Market Licensing Regime be introduced for Digital Currency Exchanges (DCEs). As a minimum, this would include capital adequacy, auditing and responsible persons tests.

In arriving at this recommendation, the Committee considered two key issues:

• The Australian Securities and Investments Commission (ASIC) Info Sheet 225 provides that trading in crypto-assets may involve the operation of a financial market. However, under the current regime, the application for a market licence is highly complex and onerous for smaller start-ups due to large capital and operational requirements.
• The current requirement for DCEs to register with the Australian Transaction Reports and Analysis Centre (AUSTRAC) for anti-money laundering and counter-terrorism financing (AML/CTF) regulation is "light touch" in practice and imposes minimal obligations.

While the Committee was of the view that a more thorough AML/CTF licensing regime is required, it also recommended the creation of a new category of market licence for DCEs. The view is that an enhanced AML/CTF licensing regime would promote business confidence, and a DCE specific market licence would not impose onerous obligations on local DCEs that might cause these businesses to be forced out by larger international operators.

The Committee recommended that, at minimum, a DCE market licence should include requirements regarding capital adequacy, auditing requirements and responsible person tests. Further, these requirements should be scalable with business size, so that obligations are not overly onerous on newer operators.

2. That a custody or depository regime be established with minimum standards for digital assets.

The Committee recognised the importance of depository and custodial functions through on-platform wallets. However, in recognising this, the Committee noted prominent examples of cybersecurity vulnerability of DCEs in the past, and the current limited consumer protections available for users of custody services provided for crypto-assets.

While Australia has a large and well-established custodial services market with respect to traditional and physical assets, the Committee recognised that custody arrangements for crypto-assets present their own unique risks ─ such as controlling the vulnerability of private wallet keys, as this depends on their method of storage, whether online, offline or on paper. As such, the Committee recommended that a new regulatory framework be introduced for custody arrangements for crypto-assets.

Further, the Committee expressed the view that Australia is well placed to build off its experience in traditional custodial services to become a leading jurisdiction in the emerging market for digital-asset custody arrangements.

3. That a token mapping exercise be undertaken to determine the best way digital assets ought to be categorised to enable a more tailored regulatory framework.

The Committee recognised that in order to build a regulatory framework to appropriately address crypto-assets, regulators need to develop an understanding and articulation of the different types of digital assets.

The Committee noted that only a limited number of crypto-assets being developed or traded in Australia meet the definition of a "financial product" or "financial service" within the meaning of those terms in the Corporations Act. However, this does not mean that such assets are not subject to ASIC's regulation.

To alleviate such regulatory uncertainty, further work needs to be undertaken to arrive at definitions and regulations that better reflect the reality of the crypto-asset market. The Committee recommended, as a first step in the development of this new regulatory framework, that there be a government-led token mapping exercise, which would consider approaches in other jurisdictions to the regulation of crypto-assets. This would lead to a clear typology of digital assets that is flexible enough to account for changing crypto-asset technologies, and which could continue to be refined in light of future developments.

4. That a "Decentralised Autonomous Organisation" (DAO) be recognised as a company structure.

A DAO is a new category of business organisation that is self-governing and whose operations are pre-determined via blockchain technology and the use of smart contracts. DAOs have become increasingly popular with decentralised finance projects.

However, DAOs do not fall within Australia's existing company structures, and thus are not entities which are recognised to have a separate legal personality or limited liability.

It is the Committee's view that a new company structure should be established to provide DAOs with separate legal identity, and DAO token holders with limited liability. It is envisioned that such an approach would attract DAO innovation to Australia. As a starting point in drafting new laws governing DAOs, the Committee suggested that reference be made to the Coalition of Automated Legal Applications model law for DAOs, together with the approach taken by the U.S. state of Wyoming.

5. That Anti-Money Laundering and Counter-Terrorism Financing regulations be fit for digital assets and consider the driver of the Financial Action Task Force's (FATF) "Travel Rule".

AUSTRAC is responsible for implementing international guidelines released by the intergovernmental FATF, and a chief concern is the future implementation of FATF's "Travel Rule" in Australia. The rule requires financial institutions to pass on customer and transaction information to the receiving financial institution.

This rule, introduced in 2019, is at odds with the pseudonymous world of digital assets. Industry players have expressed concern that strict implementation of the rule would significantly curtail the digital assets industry.

As such, the Committee suggested that AUSTRAC needs to strike a balance between managing risks and not imposing costs that would undermine legitimate digital asset businesses. To do so, AML/CTF regulations should be clarified to ensure that they are fit for DCEs and other crypto-asset business.

6. That the Capital Gains Tax (CGT) regime be amended so that a CGT event only occurs when there is a genuine capital gain or loss.

Australia's tax regime is much less favourable to crypto-asset businesses than a number of other alternative jurisdictions. For instance, Singapore has much more favourable income tax laws and does not have CGT or a goods and services tax (GST). The Committee recognised that this will play an important factor in Australia's ability to attract crypto businesses to be based here.

Moreover, the application of the present laws is not always clear. For instance, the Committee heard that CGT may be triggered at various times when a crypto-asset interacts with protocols where it is swapped, burned, accessed or staked ─ even though there is no material change in ownership.

As such, the Committee recommended that CGT rules be amended so that digital asset transactions only result in a CGT event when there is a genuine, and clearly defined, capital gain or loss. In recommending this, the Committee noted that this might require creating new CGT asset classes and events in the tax legislation. The Committee also recommended that Australian Taxation Office (ATO) guidance be updated in this area every six months to keep pace with innovation.

7. That businesses conducting digital asset "mining", or similar, receive a company tax discount of 10% if they source their own renewable energy for their activity.

The Committee considered the high energy demands of crypto-asset "mining" and the large amount of greenhouse gases emitted as a consequence.

The Committee, considering Australia's greenhouse emissions targets, recommended that companies engaging in crypto-asset mining ought to be incentivised to pursue renewable sources of energy, such as through a tax discount. It is also suggested that such incentives would help leverage Australia's vast supplies of renewable energy and enable the country to become a global leader in green crypto-asset mining.

8. That the Treasury conduct a policy review into the viability of a retail Australian Central Bank Digital Currency (CBDC).

Considerable research into CBDCs is occurring around the world, with the Bahamas already operating a CBDC and the People’s Bank of China conducting advanced testing of a retail "digital yuan". The number of jurisdictions around the world issuing CBDCs will likely increase in coming years. The Committee was of the view that Australia should continue to actively investigate the possibility of a CDBC so as to keep pace with global developments.

Whilst there has been limited research by the Reserve Bank of Australia into the area to date, the Committee encouraged further exploration to ensure that Australia maximises any potential benefits in the area.