Treasury released its much anticipated 'token mapping' consultation paper on 3 February 2023. The paper is said to represent "a foundational step in the Government's multi-stage reform agenda". The Government is seeking submissions by 3 March 2023.
Many would have expected that through this paper Treasury would seek to fulsomely identify and explore the various types of crypto assets with input from industry, before mapping those into appropriate classifications. However, it would appear Treasury has already drawn its token map and is now seeking affirmation from industry regarding its classifications.
It therefore follows that after completing this 'token mapping' exercise, the Government aims to release a consultation paper proposing a licensing and custody framework for crypto asset service providers in mid-2023 prior to the introduction of legislation. In fact, one key topic of discussion in the paper is how the existing financial services regulatory framework regulation would and should apply based on Treasury's proposed token map.
How did we get here?
In early 2022, the previous Government commenced consultation on a new licensing framework for the crypto assets industry. Read MinterEllison's submission to that consultation.
However, following the federal election in May 2022, the new Labor government announced that it would undertake a token mapping exercise before deciding on how to regulate crypto assets.
Treasury based its approach on the Bank for International Settlements' suggestion that token mapping is a foundational step to regulating the crypto ecosystem. Treasury considers this approach as being consistent with the principles of technology neutrality and a functional approach to regulation which are the basis of our existing financial services regulatory framework.
Treasury's new token mapping paper does not refer to the submissions and work from the consultation undertaken by the previous government. Instead, another consultation on the licensing and custody of crypto assets is planned to be undertaken in mid-2023. Hopefully, that consultation will take the previous work into account and provide greater clarity about the path to regulation.
What is token mapping?
Token mapping is "the process of identifying the key activities and functions of products in the crypto ecosystem and mapping them against existing regulatory frameworks." We explored token mapping and the approach taken by other jurisdictions in our article on Decrypting crypto regulation.
Mapping the token ecosystem
The token mapping framework proposed by Treasury relies on three intertwined concepts to be assessed against the functional perimeter – tokens, token systems and functions.
Tokens are physical or digital units of information that have a role in a token system. A token system is a collection of steps involved in performing a function. A function can be any benefit received or obtained by the token holder which is ensured or facilitated by the token system.
According to Treasury, these concepts can be used to consider the various products within the crypto ecosystem and to assess them against the functional perimeter, i.e. the financial services regulatory framework and, in particular, the regulation of facilities through which a person undertakes general financial functions.
The paper discusses the application of the functional perimeter to the token ecosystem at a high level, explaining that it is not a question of whether a crypto token meets the financial product definition, but whether a token system does. This is explored through a two-part question:
- Is the token system a facility?
- If so, is the facility one through which a person makes a financial investment, manages financial risk and/or makes non-cash payments?
If the answer to both is 'yes', then the facility is a financial product.
The paper goes on to discuss how the token, token system, function concepts can be used to identify the crypto token creator and the crypto asset issuer, ensuring any regulatory obligations and responsibilities fall on the correct ‘issuing’ party.
Essential concepts and taxonomy
As part of the token mapping exercise, Treasury has defined and outlined three key concepts that it seeks feedback on and refers to throughout the paper:
- Crypto networks (e.g. Bitcoin and Ethereum networks) – a distributed computer system capable of hosting crypto tokens. These networks are the platforms on which crypto tokens and smart contracts are recorded, with a primary function of storing information and processing user instructions.
- Crypto tokens – a unit of digital information that can be exclusively used or controlled by a person, despite that person not controlling the host hardware where that token is recorded.
- Smart contracts – computer code that has been published to a crypto network's database, i.e. a type of software that can be guaranteed to run in a predefined and deterministic manner without risk of intervention.
Instead of outlining a detailed breakdown of every crypto asset currently available, the paper proposes a high-level taxonomy of four categories that can be grouped under the two kinds of token systems, being:
1. for intermediated token systems (which involve intermediaries or agents performing functions pursuant to promises or other arrangements), the following two categories:
- crypto asset services; and
- intermediated crypto assets; and
2. for public token systems (which involve functions being performed by crypto networks in the absence of intermediaries and agents), the following two categories:
- network tokens; and
- public smart contracts.
Treasury acknowledges the breadth of possible functions for each category. As such, they have refrained from creating an exhaustive taxonomy on the basis that it could lead to inconsistent regulatory treatment and regulatory arbitrage.
Implications for regulation
The paper considers how some existing crypto asset services and intermediated crypto assets may be financial products under existing financial services legislation, and asks if any kinds of intermediated crypto assets or crypto asset services should specifically be defined as financial products to provide certainty.
The paper does not consider financial services specifically. However, the view put forward is that as financial services are closely tied to the concept of ‘financial product’, if a ‘crypto asset service’ is provided in respect of crypto assets that are financial products, the service provider would likely be providing a ‘financial service’.
We agree with Treasury's observations that public token systems cause several issues for legal and regulatory framework. That is because existing regulatory frameworks create regulatory boundaries, obligations, protections, and regulatory powers that do not map to public token systems.
Accordingly, one of the questions posed by Treasury regarding the development of smart contracts refers to these developments commonly being open-source, and asks what regulatory and policy levers can:
- encourage development of smart contracts to comply with existing regulatory frameworks; and
- ensure smart contract applications comply with existing regulatory frameworks.
This may allude to the issues around open-source code faced by Tornado Cash.
This consultation is a positive development from the Government demonstrating that it wants to better understand the crypto ecosystem in order to effectively regulate it. At the same time, the complexity and fast-paced nature of the industry makes it challenging for regulation to operate effectively without hindering innovation or becoming out of date. Any new laws that are introduced to regulate the sector will therefore need to be principles-based to match the breadth of the existing 'functional perimeter' and that seems consistent with the Government’s intent based on the paper.
Regardless, it is the next phase of consultation on licensing and custody which industry is waiting on to determine the direction of Australian regulation of the sector and whether the Government will make good on previous promises to facilitate a thriving and well-regulated industry.
Next steps
Submissions on the consultation paper are due by 3 March 2023. If you are involved with the cryptocurrency or digital asset sector, you should consider how your business may be affected by the proposals within the consultation paper and the impending regulation within this space.
We will provide further updates as the consultation proceeds. In the meantime, please let us know if you would like us to assist you to make a submission.
