THE LAST DECADE has experienced extraordinary growth in technological innovation. The emergence of blockchain technology – and distributed ledger technology more broadly – has led to a range of innovations in areas such as financial services.
These include new ways to raise funds, 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 Decentralized Autonomous Organizations (DAOs).
Previous columns have considered related issues (see Review of business law in China volume 7, volume 8: Fintech and smart contracts; volume 8, volume 9: Cryptocurrencies; and volume 12, volume 9: Decentralized autonomous bodies).
While 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 the regulation of crypto assets with reference to the current regulatory framework in Australia and other jurisdictions, and concludes by outlining the current situation in mainland China.
WHAT ARE CRYPTOASSETS?’
Crypto assets have been defined in different ways. A recent consultation paper released by the Australian Treasury Department 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 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 banking and payments systems regulator, the Reserve Bank of Australia. A legislative definition of “digital currency” in the Anti-Money Laundering and Counter Terrorist 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 assets:
- Exchange Tokens, intended for use as a means of payment, including Bitcoin;
- Utility Tokens, allowing the holder to access particular goods or services on a platform, typically using distributed ledger technology;
- Security tokens, giving the holder of a security token special rights or interests in a business, such as ownership, reimbursement of a specific amount of money, or the right to a share of future profits; and
- Stablecoins, which are cryptocurrencies pegged to something that has stable value like fiat currency (government backed, e.g. US dollar) or precious metals like gold.
The proposed European Crypto-Asset Markets Regulation (MiCAR) adopts a slightly different taxonomy for crypto-assets. If passed, it would regulate the following:
- Tokens referenced by assets, including stablecoins;
- Electronic money tokens, a type of cryptographic asset whose main purpose is to be used as a medium of exchange aimed at stabilizing their value by referencing a single fiat currency; and
- Cryptographic 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 Markets in Financial Instruments Directive (commonly referred to as MiFID2). In addition, central bank digital currencies are exempt from MiCAR if they are issued by central banks acting in their capacity as monetary authority, or by other public authorities.
It is pertinent 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 scrutiny and debate in many jurisdictions (for a discussion of ICOs, see Chinese Journal of Business Law Volume 8, Number 9: Cryptocurrencies).
HOW SHOULD CRYPTOASSETS BE REGULATED?
There are a number of issues relating to the regulation of crypto assets that all jurisdictions must consider. These include the following five key questions:
(1) Should the regulatory framework for cryptoassets, especially 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, which all regulate tokens and ICOs with reference to the existing regulatory framework; and Japan, which began developing a bespoke regulatory framework for cryptocurrencies in 2014 and is developing specific guidelines for ICOs. In contrast, South Korea has imposed a ban on ICOs since 2017. To integrate ICOs into the regulatory framework.
Furthermore, India’s central bank, the Reserve Bank of India, issued a circular in 2018 prohibiting banks from providing services related to cryptocurrencies. This ban was later overturned by the Supreme Court, in 2020. In November 2021, the government presented the Cryptocurrency Bill and Official Digital Currency Regulation to parliament. If enacted, the legislation will provide a framework for the creation of a central bank digital currency and ban all private cryptocurrencies in India, subject to certain exceptions “to promote the underlying cryptocurrency technology. and its uses”. It is unclear what the ban and its exceptions would mean for the development of DAOs and ICOs in India.
(2) How to classify cryptographic tokens or assets, and what taxonomy to use for this purpose?
This is a fundamental question because 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 how best to characterize different types of tokens.
(3) Who or what should be the target of regulation?
Since it is very difficult, if not practically impossible, to regulate the technology itself, the focus of regulation inevitably shifts to those who use the technology or provide services, such as distributed ledger technology services or “crypto-asset services” as referred to in the MiCAR. A particularly important related question is who should take responsibility if things go wrong.
(4) What style or method of regulation should be adopted for the regulation of crypto assets?
For example, should jurisdictions favor a principles-based approach rather than 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 an authorized DLT provider to “conduct its business with honesty and integrity”; and “have effective arrangements in place for the protection of clients’ assets and money when responsible for them”.
(5) Should crypto assets be subject to tailor-made (i.e. separate) regulation or rather be integrated into an integrated regulatory framework?
For example, to date, Australia has regulated crypto assets by referring 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”. According to this approach, the legislation defines a financial product as a facility through which a person makes a financial investment, manages a financial risk or makes non-cash payments.
This means that if crypto-assets or tokens function as financial products, they will be regulated as such and will be subject to relevant obligations, including licensing and disclosure. One of the advantages of the functional approach is that it recognizes the challenges of designing regulation by reference to labels, as opposed to the function of a particular product or activity. It also tends to result in a more integrated regulatory framework.
In contrast, many other jurisdictions rely on comprehensive 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 this suggest in terms of the direction of reform? First, the impact of technology is likely to result in a move away from a prescriptive, rules-based approach to regulation towards a more principles-based approach, one supported by clear outcomes. Second, the regulatory network is likely to expand to include a wider range of parties than has traditionally been the case, including crypto-asset service providers. Third, it seems inevitable that regulators will need more powers and flexibility to adapt to the challenges posed by technology and will also need greater regulatory discretion in order to ensure adequate consumer protection without stifling consumerism. ‘innovation.
WHAT IS THE POSITION IN MAINLAND CHINA?
In September 2021, the People’s Bank of China declared cryptocurrency trading illegal and banned related activities, including fundraising through ICOs. In mainland China, it will therefore be difficult to establish and operate private cryptocurrencies and crypto assets in general until the ban is lifted.
However, as seen in the recent Winter Olympics, China has started testing its central bank digital currency, the digital renminbi. In accordance with its regulatory approach of “crossing the river by feeling the pebbles” [摸着石头过河]it is likely that China will gradually adopt a more permissive regulatory framework for crypto-assets.
This article is adapted from the presentation “The Australian Reform Agenda” given by the author during a webinar entitled Regulating Digital and Crypto-finance: A Conversation Across Borders, organized by the UCL Center for Ethics and Law on March 22, 2022. For a recording of the webinar, see HERE
Andrew Godwin previously practiced 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 a Senior Fellow (Honorary) at the Asian Law Center at Melbourne Law School and a consultant to various organizations including Linklaters, the Australian Law Reform Commission and the World Bank.