This chapter outlines the committee's conclusions and recommendations on the issues examined during the committee's inquiry. Taken together, the committee's recommendations will address significant issues of concern and increase Australia's competitiveness as a technology and financial hub in our region.
Cryptocurrency and digital assets
With a global market totalling in the trillions of dollars, crypto-assets are a phenomenon that is rapidly moving from the periphery towards the centre of technology development and financial markets. The tremendous potential of blockchain technology and decentralised finance are becoming recognised in jurisdictions all over the world.
As noted in Chapter 2, survey data shows that 17 per cent of Australians currently own cryptocurrency, with a further 13 per cent of survey respondents stating they plan to buy cryptocurrency in the next 12 months. This makes Australia one of the world's most significant adopters of cryptocurrencies on a per capita basis. The Australian Taxation Office (ATO) has noted a 'dramatic increase' in trading of cryptocurrencies and other digital assets by Australians since the beginning of 2020.
Despite the significant number of Australians already investing in cryptocurrencies and other digital assets, and new jobs being created by innovative businesses in this industry, the digital assets sector is still poorly understood by regulators and governments in Australia. The committee has sought to help rectify this throughout this phase of its inquiry, by engaging extensively with businesses and peak bodies in the digital assets sector, as well as academics and regulators.
The potential economic opportunities are enormous if Australia is able to create a forward-leaning environment for new and emerging digital asset products. It is clear that Australia needs a robust policy and regulatory framework for digital assets, in order to protect consumers, promote investment in Australia and deliver enhanced market competition.
As with any new area of technological innovation, some of the early models and products in the digital assets space will not stand the test of time, while others will prove to be the foundation upon which new waves of innovation and opportunity are unleashed. Government's role is not to pick winners but to provide a steady framework within which innovation can thrive.
Governments and regulators the world over are grappling with the best way to bring digital assets within a suitable regulatory framework. While there is a need for regulation to ensure trust in the industry and protect consumers, the global nature of digital businesses means that overly burdensome requirements in a jurisdiction such as Australia will simply drive companies elsewhere.
As such, there must be a balance between bringing digital assets into the regulated world while preserving their dynamism. The committee is proposing a range of complementary reforms that seek to accomplish this goal and set Australia up for the future, bringing it into line with the leading jurisdictions in the world.
The committee's recommendations cover: market licensing for digital currency exchanges; custodial and depository services; token mapping; a new regulatory structure for Decentralised Autonomous Organisations; Anti-Money Laundering and Counter-Terrorism Financing guidelines; tax arrangements for digital assets; Central Bank Digital Currencies; and issues relating to the energy intensity of crypto-asset generation.
These recommendations represent an ambitious agenda. It is important that Australia takes concrete action to move our position forward.
Market licensing regime for Digital Currency Exchanges
The committee heard that Australian Digital Currency Exchanges (DCEs) are currently subject to limited regulatory oversight, despite some of these exchanges managing billions of dollars' worth of trades annually and holding hundreds of millions worth of client assets in custody.
While DCEs are required to register with AUSTRAC for the purposes of meeting anti-money laundering and counter-terrorism financing (AML/CTF) obligations, the committee also heard concerns that the current registration process with AUSTRAC appears in practice to be 'light touch' and imposes minimal obligations on DCEs. It was suggested that rather than registration there should be a licensing regime with appropriate obligations and requirements around the custody of digital assets.
The committee is of the view that a more thorough regulatory framework will assist the industry to mature. Indeed, many in the industry are calling for increased regulation so as to ensure that consumers can have increased confidence in their businesses and shoddy operators are weeded out. A licensing regime will demonstrate that comprehensive consumer protections are in place, and can also help to address bank concerns about risks posed by individual digital asset providers.
The existing Market Licence regime under the Corporations Act 2001, which is currently applied to a limited number of stock exchanges and other financial markets, is not well suited to become directly applicable to DCEs. As such, the committee is recommending the creation of a new category of market licence that enables DCEs to demonstrate a high level of commitment to consumer protection and operational integrity, without imposing obligations that are so onerous as to drive local operators out of the market.
The key requirements of a new DCE Market Licence category should include, at a minimum, requirements relating to capital adequacy, auditing and responsible person tests. These requirements should be scalable with the size of the business, so that newer operators are still able to function in accordance with licence requirements as they scale up their operations.
The committee recommends that the Australian Government establish a market licensing regime for Digital Currency Exchanges, including capital adequacy, auditing and responsible person tests under the Treasury portfolio.
Custodial and depository services for digital assets
Submitters and witnesses to the inquiry emphasised the need for clear arrangements in relation to custodial and depository services for digital assets.
Currently some crypto-asset businesses such as DCEs perform custodial and depository functions on behalf of their customers, while some consumers effectively self-manage custody of their crypto-assets. Unlike for traditional financial assets, there are limited consumer protections in place for custody services provided for consumers holding crypto-assets.
Custody arrangements for digital assets present some unique risks that are not analogous to traditional assets (for example, there are particular vulnerabilities around the exposure of private keys for crypto-assets to loss or theft, depending on the storage solution utilised). Introducing a regulated framework for these arrangements will enhance consumer confidence and encourage investment.
Having a clear framework in place will also spur the development of a custodial industry for digital assets in Australia. There are significant economic opportunities in this space if Australia can become a leading jurisdiction. Australia already has a large custody sector for traditional financial and physical assets, with approximately AUD $4 trillion in value held by custodial service providers, so it makes sense to leverage this advantage into the emerging world of custodial arrangements for digital assets.
While custody arrangements for digital assets do pose some unique risks, many of the general risks and market constructs required are broadly similar to those for traditional assets. The committee has received detailed submissions on how a custodial framework for digital assets should work. These will assist the government in developing a bespoke custodial or depository regime for digital assets, which aligns with the general principles for custody of traditional assets while dealing with the unique features of digital assets. This reform should be implemented as soon as possible to help Australia become a global leader in this space.
The committee recommends that the Australian Government establish a custody or depository regime for digital assets with minimum standards under the Treasury portfolio.
Token mapping exercise to better characterise digital assets
Any rigorous regulatory framework in Australia needs to appropriately classify the various types of crypto-asset tokens and other digital assets being developed in the market.
Very few digital assets being traded and/or developed in Australia currently meet the legislative definitions for financial products and services under the Corporations Act that would bring them within ASIC's regulatory perimeter. ASIC has made it clear, however, that any crypto-assets which do meet these legislative criteria are subject to its regulation, meaning that issuers of these products can be required to meet Australian Financial Services Licence obligations.
The current uncertainty around when particular digital assets fall within ASIC's regulatory perimeter needs to be addressed to give investors and market participants the clarity they need to operate efficiently. While ASIC's current consultation process in relation to the development of exchange-traded products with crypto-assets as underlying assets is welcome, further work is needed in relation to other crypto-asset products.
Submitters and witnesses to the inquiry proposed a variety of definitions or classifications that could be inserted into the Corporations Act to bring relevant digital assets within the existing financial services regulatory regime. In the committee's view, the first step required is to conduct a government-led token mapping exercise to assist in developing an appropriate regulatory model.
It is worth noting that jurisdictions around world have taken a range of approaches to classifying digital assets for the purpose of developing appropriate regulatory frameworks. A token mapping exercise here should take account of the emerging approaches worldwide. It should lead to a clear typology of digital assets for the purposes of financial regulation in Australia, that is flexible enough to account for changing technologies and is able to be refined as developments continue into the future.
The committee recommends that the Australian Government, through Treasury and with input from other relevant regulators and experts, conduct a token mapping exercise to determine the best way to characterise the various types of digital asset tokens in Australia.
Regulatory structure for Decentralised Autonomous Organisations
The committee heard evidence about the rapid uptake of Decentralised Finance (DeFi) applications in recent times, particularly in the last 18 months. DeFi protocols seek to replicate or supersede traditional financial services and products, by utilising a decentralised structure that removes the need for intermediaries and centralised control.
Many DeFi protocols and other blockchain projects are now being set up with a decentralised ownership structure, through a model known as a Decentralised Autonomous Organisation (DAO). These structures represent a new category of organisation that operates on decentralised blockchain infrastructure, whose operations are pre-determined in open source code and enforced through smart contracts.
The fact of decentralised ownership, control and operation among network participants means that DAOs do not clearly fall within any of Australia's existing company structures. Legal liability for members (i.e. token holders) for these organisations is currently unclear, and this regulatory uncertainty is preventing the establishment of projects of significant scale in Australia.
Several submitters and witnesses have proposed that a new legal structure should be established in Australia to give DAOs separate legal identity, with DAO token holders given limited liability.
The committee is of the view that this innovation will drive economic activity in this space and be a magnet for Australian innovation for DAOs, driving local jobs and tax revenue. There are limited examples internationally of a legal DAO structure being implemented, with the US state of Wyoming a recent example of a jurisdiction that has legislated in this area. Already Wyoming's proactive stance has seen it attract significant business activity, with companies looking for regulatory certainty in this area. Australia should be at the forefront of this area.
The Coalition of Automated Legal Applications (COALA) has published a model law for DAOs, which is a useful starting point for developing a legal DAO structure in Australia. It is worth noting that there are other already existing company structures in Australia (for example, the no-liability mining company structure) that manage liability differently to standard company arrangements. Introducing a new DAO entity structure in the Corporations Act, regulated under the Treasury portfolio, would not be uncommon in Australia; for example, the Treasury has just finished a consultation process on draft legislation that would introduce a Collective Corporate Investment Vehicle structure in the Corporations Act.
The government should examine the COALA model and other international examples in developing a DAO company structure that suits Australia's specific corporate frameworks.
The committee recommends that the Australian Government establish a new Decentralised Autonomous Organisation company structure.
Anti-Money Laundering and Counter-Terrorism Financing guidelines
The committee heard that AUSTRAC has taken a proactive approach in engaging with the digital assets industry in development and implementation of AML/CTF measures for DCEs.
AUSTRAC is responsible for implementing guidelines released by the international Financial Action Task Force (FATF) on virtual asset service providers. In particular, the 'travel rule' has been the subject of much debate, with jurisdictions that have sought to strictly implement this rule to date encountering numerous implementation issues.
AUSTRAC's interpretation of the AML/CTF regulations and FATF guidelines need to strike a balance between appropriately managing risks, without implementing the travel rule in a way that undermines the operation of legitimate digital asset businesses. Industry participants have expressed well founded concerns that the implementation of the travel rule will place unnecessarily burdensome cost pressures on business, particularly if implementation is rushed. The committee considers that technological solutions to address the driver of the travel rule should be adopted at the earliest opportunity, rather than relying on a punitive approach.
Given the above, the committee's view is that Australia's AML/CTF regulations should be clarified to ensure they are fit for purpose for DCEs and any other relevant crypto-asset businesses. These regulations should not undermine innovation and should give consideration to the driver of the travel rule.
The committee recommends that the Anti-Money Laundering and Counter-Terrorism Financing regulations be clarified to ensure they are fit for purpose, do not undermine innovation and give consideration to the driver of the Financial Action Task Force 'travel rule'.
Taxation arrangements for digital assets
The committee heard that Australia's current taxation regulations and guidance relating to cryptocurrencies and other digital assets need updating in order to keep pace with the rapid evolution of technology. In particular, the rapid uptake and innovation in Decentralised Finance (DeFi) applications since 2019 was raised as an area for which there is significant uncertainty around the application of tax rules.
Australia's current tax regime for digital assets compares less favourably with other jurisdictions such as Singapore, which may be a significant factor in determining whether potential projects choose to domicile in Australia. In the words of one witness, our tax laws 'unavoidably complicate the establishment of Digital Asset Projects compared to competing jurisdictions like Singapore that have favourable income tax laws and do not have CGT or GST'.
A number of stakeholders expressed concern about a lack of clear guidance from the ATO about the application of existing principles in the tax law to new and emerging technologies. While the ATO has provided general guidance around taxation points for crypto-crypto and crypto-fiat disposals, industry and legal submitters called for more specific and detailed guidance.
Capital Gains Tax treatment of digital assets
Particular concerns were raised about the Capital Gains Tax (CGT) treatment of digital assets when they are held as an investment.
Because many digital asset transactions take place several steps away from a crypto-to-fiat-currency trade, it can be very difficult for taxpayers to correctly assess their CGT liabilities under the current tax law and ATO guidance for these transactions.
The lack of clarity on these issues is compounded for newer DeFi digital assets, which can operate in ways that fall outside of the scope of what the CGT regime is generally equipped to deal with. The committee heard that one of the most considerable barriers to entry for DeFi products is the numerous taxable events that may arise when a crypto-asset token interacts with a DeFi protocol. Industry stakeholders argued that many of these interactions are features of the way the technology operates and do not result in material changes to asset ownership; as such they should not constitute taxable events for CGT purposes.
The committee considers that the CGT rules need updating to enable digital asset transactions to be undertaken with confidence as to their tax implications. The rules need to be structured in a way that does not undermine new technology applications such as those seen in DeFi projects.
Some submitters to the inquiry argued that CGT taxation points should be removed altogether for crypto-to-crypto transactions; that is, CGT should only be applied at the 'on and off ramp' points where digital assets are traded for fiat currency or similar. While the committee agrees that this would simplify the CGT rules for digital assets considerably, this approach may risk leakage of tax revenue in cases where significant crypto-to-crypto transactions are occurring in ways that accrue a clearly definable capital benefit.
As such, the committee is recommending that the CGT rules be amended so that digital asset transactions only result in a taxable event for CGT purposes when they genuinely result in a clearly definable capital gain or loss. This may require the creation of a new CGT asset or event class that enables specific concessions or exemptions to be applied. Treasury and the ATO need to proactively work with industry to develop the relevant changes and provide clarity in this area, including by ensuring that ATO guidance is updated at least every six months to keep pace with new technology developments.
The committee recommends that the Capital Gains Tax (CGT) regime be amended so that digital asset transactions only create a CGT event when they genuinely result in a clearly definable capital gain or loss.
Other tax proposals
The committee received several other tax-related proposals from submitters, such as changes to the tax treatment of stablecoins and reviewing certain cryptocurrencies' status as their use becomes more closely aligned to that of a foreign currency. The committee considers that Treasury and the ATO should keep a watching brief on these issues to determine the need for future reform.
Several industry bodies recommended a root-and-branch review of Australia's tax laws to ensure that it is fit-for-purpose for the emerging digital asset economy. While the committee is not inclined to recommend a wholesale review at this time, these views emphasise the importance of governments, policymakers and the ATO adopting a proactive approach in this area to ensure that Australia does not get left behind.
Energy intensity of cryptocurrency 'mining'
Some submitters raised concerns about the energy consumption associated with some digital asset protocols, in particular the energy intensity of Bitcoin mining.
It is important that where cryptocurrency mining and related activities are taking place in Australia, these activities should not undermine Australia's net zero emissions obligations. As such, the committee considers that companies engaging in these activities should be incentivised to source their own renewable energy, via a company tax discount.
The committee recommends that the Australian Government amend relevant legislation so that businesses undertaking digital asset 'mining' and related activities in Australia receive a company tax discount of 10 per cent if they source their own renewable energy for these activities.
Review of Central Bank Digital Currencies
Central Bank Digital Currencies are likely to be implemented in a growing number of jurisdictions in the coming years, at both the wholesale level and the retail level. It is important that Australia continues to actively investigate and pilot potential options for a CBDC so that the opportunity is not lost should this become a pressing concern in future.
The committee notes the work the Reserve Bank of Australia (RBA) is currently undertaking exploring options for a wholesale CBDC, building on the 2019 development of a limited proof-of-concept of a DLT-based interbank payment system using a tokenised form of CBDC backed by exchange settlement account balances held at the RBA.
The committee further notes the evidence of the RBA that while it has an open mind as to whether a case could be developed for a retail or general use CBDC, it does not currently see a public policy case for implementing a retail CBDC in Australia.
The committee considers that the viability of a retail CBDC should continue to be further investigated, through a review led by the Treasury. This will help ensure that Australia maximises any potential opportunities in this area. The committee notes that the recent Payments system review undertaken by Mr Scott Farrell recommended that Treasury’s payments policy function should be enhanced, including in relation to implementing a strategic plan for the payments ecosystem. Treasury leading a review of the viability of a retail CBDC would be consistent with this approach.
The committee recommends that the Treasury lead a policy review of the viability of a retail Central Bank Digital Currency in Australia.
Throughout the inquiry the committee has been concerned to hear about the de-banking of Fintech businesses, particularly those highlighted during this phase of the inquiry in remittance, payments and the digital assets sectors. De-banking affects not only the business itself; the committee was told of the effects on individuals and their families as well as customers.
The committee recognises the power banks have over their customers in this regard and the time and possible reputational effects of having to find an alternate services, if they can be found. The committee also understands that it is difficult for individuals and businesses to say on the public record that they have had challenges with financial institutions, as they fear creating even more challenges for themselves.
The committee is concerned that the lack of banking options for digital assets companies in particular is not only hampering innovation and investment in Australia but is potentially creating a single point of failure for the industry (with only a small number of ADIs willing to bank these businesses) and also leading to ineffective competition and a concentration of risk. De-banking may also push businesses and consumers to engage with less regulated or unregulated channels which are not subject to AML/CTF laws.
The committee recognises that de-banking is a complex problem occurring for a number of reasons. A key issue is underdeveloped regulatory arrangements, particularly in the digital asset space. Currently banks can point to the lack of a digital assets framework as a reason to de-bank a business.
Another issue contributing to de-banking is the risk of severe penalties associated with a breach of AML/CTF obligations. This leads to risk aversion where banking services are ceased or not entered into at all. For example, the committee heard instead that banks have taken policy decisions not to engage with crypto businesses even if they have been successfully operating for some time.
De-banking is a global issue. The committee notes that Australia is a member of the Financial Action Task Force (FATF) which sets international standards to prevent money laundering and terrorist financing. These standards require banks to take a risk based approach to enforcement and guidance has been issued. However, FATF emphasised that this approach should not result in the de-banking of entire sectors. There should be appropriate consideration of the risk and risk mitigation strategies of individual applicants.
Despite assurances from banks that engagement occurs with individual customers to conduct risk assessments, the personal stories provided to the committee disputed that there are appropriate risk assessments undertaken and/or that it occurs consistently.
The committee is not about forcing banks to take on businesses, but a clearer regulatory framework will provide banks confidence in dealing with crypto businesses.
Work by the Australian Competition and Consumer Commission (ACCC) in 2019, through its inquiry into the supply of foreign currency conversion services in Australia, recommended that the government establish a working group to consult on the development of a scheme through which the due diligence requirements of the banks can be addressed. The Council of Financial Regulators (CFR) has now established a cross-agency working group in June 2021 to further examine issues relating to de-banking and potential policy responses. However, there is no current timeframe on when this working group will finalise any policy recommendations.
The committee is of the view that this work should be progressed and concluded as soon as possible. This work would more easily allow the ACCC to examine whether the denial of banking or payment services raises concerns under the Competition and Consumer Act 2010. A due diligence scheme should be implemented no later than June 2022.
The committee recommends that the Australian Government, through the Council of Financial Regulators, enact the recommendation from the 2019 ACCC inquiry into the supply of foreign currency conversion services in Australia that a scheme to address the due diligence requirements of banks be put in place, and that this occur by June 2022.
Need for greater transparency
The committee is concerned that there appears to be a disturbing lack of transparency around decisions taken by banks to de-bank businesses, even taking into account an explanation provided by the ABA about the anti-tipping off provisions under the AML/CTF Act preventing them from providing details to potential customers.
The committee was also concerned by suggestions that banks may find it convenient to de-bank businesses which could provide competition. However, with the opacity around de-banking decisions, it is not possible to determine whether businesses are being de-banked for valid reasons. While acknowledging the anti-tipping off provisions, the committee is concerned about the lack of detail provided to some customers which means they can take no corrective action and they have no recourse.
The committee is of the view that in order to provide increased certainty and transparency, a de-banking process involving the Australian Financial Complaints Authority should be developed and this should include an appeals mechanism.
The committee recommends that in order to increase certainty and transparency around de-banking, the Australian Government develop a clear process for businesses that have been de-banked. This should be anchored around the Australian Financial Complaints Authority which services licensed entities.
The committee also notes the recent review of the payments system undertaken by Mr Scott Farrell (Farrell Review), which included similar findings in relation to the issue of de-banking. The review includes recommendations which would facilitate better access to key payment systems such as the NPP, allowing payment service providers the ability to circumvent the need to rely on a bank for access to payments systems.
In particular, the Farrell Review recommended that the RBA should develop common access requirements for payments systems in consultation with the operators of payment systems, and that these common access requirements form part of a new payments licence to facilitate access for licensees to those systems. The committee notes that consultation is underway on the recommendations of the Farrell Review in order to finalise a government response.
The committee recommends that, in accordance with the findings of Mr Scott Farrell's recent Payments system review, common access requirements for the New Payments Platform should be developed by the Reserve Bank of Australia, in order to reduce the reliance of payments businesses on the major banks for the provision of banking services.
Other issues raised during the inquiry
The committee also took evidence on several other issues during this phase of its inquiry, including the policy environment for neobanks, the impact of corporate law on new investment, and options for replacing the Offshore Banking Unit.
Policy environment for neobanks
Given the recent changes in the neobank sector, including the closure of Xinja and the acquisition of 86 400, the committee wanted to discuss these developments to see if they may threaten increasing competition or signal the need for regulatory changes.
After speaking with the key regulators the committee was pleased to hear that the ACCC did not see these changes as indicative of competition substantially lessening and noted that they would continue to closely scrutinise any proposed acquisitions of emerging competitors or challengers. APRA told the committee about its updated approach to licensing and supervising new ADIs following the review of APRA's ADI licensing regime which found there should be a greater focus on longer term sustainability to increase the ability to assert competitive pressure on incumbents. The committee expects that this updated approach will lead to positive outcomes in the future for prospective banking licensees.
Options for replacing the Offshore Banking Unit
The committee's issues paper for this phase of the inquiry sought options to replace the Offshore Banking Unit (OBU) that would maintain and enhance Australia's global position. After considering the suggestions put forward by submitters and witnesses, the committee is supportive of the suggestion by the Australian Financial Markets Association to replace the OBU with a Global Markets Incentive.
The committee recommends that the Australian Government establish a Global Markets Incentive to replace the Offshore Banking Unit regime by the end of 2022.
Senator Andrew Bragg