THE PAST DECADE has seen extraordinary growth in technological innovation. The emergence of blockchain technology – and more broadly, distributed ledger technology – has led to a range of innovations in areas such as financial services.
These include new ways of raising finance such as initial coin offerings (ICOs); new means of exchange for payment purposes such as cryptocurrencies; new asset classes such as crypto assets (including cryptocurrencies and tokens); and new forms of business, such as decentralised autonomous organisations (DAOs).
Previous columns have considered related issues (see China Business Law Journal volume 7, issue 8: Fintech and smart contracts; volume 8, issue 9: Cryptocurrencies; and volume 12, issue 9: Decentralised autonomous organisations).
As new terminologies and taxonomies have emerged alongside these innovations, presenting challenges for both regulators and regulatory design, this column first examines the definition of crypto assets. It then discusses regulation of crypto assets by reference to the current regulatory framework in Australia and other jurisdictions, and concludes by outlining the current position in mainland China.
WHAT ARE CRYPTO ASSETS?’
Crypto assets have been defined in a number of different ways. A recent consultation paper issued by Australia’s Department of the Treasury defines a “crypto asset” as follows:
A crypto asset is a digital representation of value that can be transferred, stored, or traded electronically. Crypto assets use cryptography and distributed ledger technology.
The above-mentioned definition is similar to that adopted by financial regulators in Australia including the market conduct regulator, the Australian Securities and Investments Commission, and Australia’s central bank and payment systems regulator, the Reserve Bank of Australia. A legislative definition of “digital currency” in the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 is similar to the definition published by the Financial Action Task Force. Singapore has adopted a legislative definition of “digital payment token” in its Payment Services Act.
The UK Government has identified the following main types of crypto asset:
- Exchange Tokens, intended to be used as a means of payment, including Bitcoin;
- Utility Tokens, providing the holder with access to particular goods or services on a platform, usually using distributed ledger technology;
- Security Tokens, providing the holder of a security token particular rights or interests in a business, such as ownership, repayment of a specific sum of money, or entitlement to a share in future profits; and
- Stablecoins, which are cryptocurrencies pegged to something that has a stable value such as a fiat currency (government-backed, for example US dollars) or precious metals such as gold.
The proposed EU Markets in Crypto-Assets Regulation (MiCAR) adopts a slightly different taxonomy for crypto assets. If enacted, it would regulate the following:
- Asset-referenced tokens, including stablecoins;
- E-money tokens, a type of crypto asset with its main purpose being use as a means of exchange aimed at stabilising their value by referencing only one fiat currency; and
- Crypto assets other than asset-referenced tokens or e-money tokens, which include utility tokens issued for non-financial purposes and may include cryptocurrencies such as Bitcoin.
MiCAR does not apply to security tokens, which are regulated as a “financial instrument” under the Directive on Markets in Financial Instruments (commonly known as MiFID2). In addition, central bank digital currencies are exempted from MiCAR if they are issued by central banks acting in their monetary authority capacity, or by other public authorities.
It is relevant to note that crypto assets, such as cryptocurrencies and tokens more broadly, are often created and issued by ICOs. The regulation of ICOs has also been the subject of examination and debate in many jurisdictions (for a discussion of ICOs, see China Business Law Journal volume 8, issue 9: Cryptocurrencies).
HOW SHOULD CRYPTO ASSETS BE REGULATED?
There are a number of questions relevant to the regulation of crypto assets that all jurisdictions need to consider. These include the following five key questions:
(1) Should the regulatory framework in respect of crypto assets, particularly private cryptocurrencies, be prohibitive or permissive?
Jurisdictions in the region that are permissive in nature include Australia, Singapore and the Hong Kong Special Administrative Region, all of which regulate tokens and ICOs by reference to the existing regulatory framework; and Japan, which began to develop a bespoke regulatory framework for cryptocurrencies in 2014 and is developing specific guidelines for ICOs.By contrast, South Korea has imposed a ban on ICOs since 2017. However, the government is reported to be considering removing the ban and bringing ICOs within the regulatory framework.
In addition, India’s central bank, the Reserve Bank of India, issued a circular in 2018 prohibiting banks from providing services in connection with cryptocurrencies. This ban was later set aside by the Supreme Court, in 2020. In November 2021, the government introduced the Cryptocurrency and Regulation of Official Digital Currency Bill into parliament. If enacted, the legislation would provide a framework for the creation of a central bank digital currency and prohibit all private cryptocurrencies in India, subject to certain exceptions “to promote the underlying technology of cryptocurrency and its uses”. It is uncertain what the prohibition and its exceptions would mean for the development of DAOs and ICOs in India.
(2) How should tokens or crypto assets be classified, and what taxonomy should be used for this purpose?
This is a fundamental question as it is difficult to know how to regulate something if it is difficult to classify it for regulatory purposes. Some jurisdictions have undertaken token mapping exercises to determine the best way to characterise the different types of token.
(3) Who or what should be the target of regulation?
Given that it is very difficult, if not impossible, in a practical sense to regulate technology itself, the target of regulation inevitably shifts to those who utilise the technology or provide services, such as distributed ledger technology services or “crypto-asset services” as referred to in MiCAR. A particularly important related question is who should bear responsibility if things go wrong.
(4) What regulatory style or method should be adopted for the regulation of crypto assets?
For example, should jurisdictions favour a principles-based approach, over a prescriptive, rules-based approach? An example of a jurisdiction that has adopted a principles-based approach to the regulation of distributed ledger technology (DLT) providers is Gibraltar, where a DLT provider is required at all times to comply with specified regulatory principles. The principles include the requirement for a licensed DLT provider to “conduct its business with honesty and integrity”; and “have effective arrangements in place for the protection of customer assets and money when it is responsible for them”.
(5) Should crypto assets be subject to bespoke (i.e. separate) regulation, or instead be incorporated into an integrated regulatory framework?
For example, to date Australia has regulated crypto assets by reference to the existing legal and regulatory framework and has not enacted bespoke laws or legal provisions. In addition, it adopts a functional approach to the definition of “financial product”. Under this approach, the legislation defines a financial product as a facility through which a person makes a financial investment, manages financial risk, or makes noncash payments.
This means that if crypto assets or tokens function as financial products, they will be regulated as such and will attract the relevant obligations, including those in respect of licensing and disclosure. One of the benefits of the functional approach is that it recognises the challenges in designing regulation by reference to labels, as distinct from the function of a particular product or activity. It also tends to result in a more integrated regulatory framework.
By contrast, many other jurisdictions rely on exhaustive lists of financial products or services to regulate securities, financial products or investment products. This tends to result in a more fragmented regulatory framework.
What does all of this suggest in terms of the direction of reform? First, it is likely that the impact of technology will result in a move away from a prescriptive, rules-based approach to regulation in favour of a more principles-based approach – one supported by clear outcomes. Second, the regulatory net is likely to expand to include a broader range of parties than was traditionally the case, including providers of crypto-asset services. Third, it appears inevitable that regulators will need to be given greater powers and flexibility to adapt to challenges brought about by technology and will also need greater regulatory discretion in order to achieve adequate consumer protection without stifling innovation.
WHAT IS THE POSITION IN MAINLAND CHINA?
In September 2021, the People’s Bank of China declared that trading in cryptocurrencies was illegal and banned related activities, including fundraising through ICOs. In mainland China, therefore, it will be difficult to establish and operate private cryptocurrencies and crypto assets generally until the ban is removed.
As seen during the recent Winter Olympics, however, China has started to trial its central bank digital currency, the digital renminbi. In line with its regulatory approach of “crossing the river by feeling the stones” [摸着石头过河], it is likely that China will gradually adopt a more permissive regulatory framework in respect of crypto assets.
This article is adapted from “The Australian Reform Agenda” presentation delivered by the author at a webinar titled, Regulating Digital and Crypto-finance: A Conversation Across Borders, hosted by the UCL Centre for Ethics and Law on 22 March 2022. For a recording of the webinar, see HERE
Andrew Godwin previously practised as a foreign lawyer in Shanghai (1996-2006) before returning to his alma mater, Melbourne Law School in Australia, to teach and research law (2006-2021). Andrew is currently Principal Fellow (Honorary) at the Asian Law Centre, Melbourne Law School, and a consultant to various organisations, including Linklaters, the Australian Law Reform Commission and the World Bank.