Australian Senate report proposes new corporate entity in model to regulate the crypto economy

Computer code as new corporate citizen? 7 min read

The Senate Select Committee on Australia as a Technology and Financial Centre has released a report (the Report) which makes 12 recommendations largely focused on the 'digital asset/crypto' economy. These include a proposal for legal recognition of a new decentralised, code-driven corporate structure – the 'DAO' – as well as significant reforms to the regulation of aspects of the digital asset economy generally.

If adopted, these reforms would position Australia as a world leader in regulating the digital asset economy.

Key takeaways

• The crypto and digital asset economy is a large and growing part of the global financial system. Governments and regulators around the world have been grappling with how to apply existing regulatory frameworks, or develop new ones, in this space and how to allow innovation while protecting consumers and maintaining stability in the financial system.
• While many of the recommendations are only preliminary and will require significant additional work and detail, they represent a significant effort to address the key challenges presented by these emergent industries, while seeking to position Australia as a potential global leader in managing digital assets.

Regulatory framework for DAOs

In recent years, there has been a trend in the blockchain ecosystem towards the creation and use of types of computer protocols known as Decentralised Autonomous Organisations (DAOs). These protocols operate in accordance with the rules that are coded into them, and the direction of their decentralised membership, as determined by the processes programmed into the DAO. Recently, these have been particularly popular for use in 'decentralised finance' applications, which seek to bypass traditional financing ecosystems. However, their legal status has been unclear.

In a significant recommendation, the Report proposes the Government investigate the establishment of a new DAO legal structure, in order to bring these entities within the fold of Australian corporate law. It canvasses potentially treating DAOs like a limited liability company, such that they will be able to hold property and enter into contracts, and giving DAO members or 'token-holders' the benefit of limited liability.

While this recommendation is still at an early stage, this potentially represents a major step forward in Australia's regulatory sophistication regarding the rapidly evolving crypto ecosystem, which could see it becoming a more attractive jurisdiction in which to establish DAO investment entities. The detail of this proposal will need to be fleshed out considerably and, based on what's occurred with the policy proposals to introduce corporate collective investment vehicles in Australia, this could take a number of years. But, if introduced, they would be a significant development for the Australian corporate law system. Existing corporate entities may find themselves interacting with a legally recognised, code-governed decentralised organisation. There remain a number of critical questions, such as how a purely digital entity that is governed by code will be accountable for its actions, and when (if ever) it would be appropriate to reach past the coded veil to the decentralised membership base behind it.

Other key recommendations to regulate the crypto economy

In addition to the recommendations on DAOs, a number of other recommendations were made, which would have a significant impact on the broader issues of regulating the crypto-economy:

Market licensing requirements for DCEs

Currently, Digital Currency Exchanges (DCEs) are subject to very limited regulatory oversight through a 'light touch' registration process with AUSTRAC, despite some transacting billions of dollars' worth of assets. The Report calls for a new market licence category for DCEs, which would require certain capital adequacy levels, auditing and responsible person tests, at a minimum. This would be a significant step up in regulatory oversight of DCEs, which represent a key gatekeeper and often custodial function in the digital asset ecosystem.

Custody arrangements of digital assets

Limited consumer protections exist around custody services for crypto-assets. Such arrangements present unique risks, including vulnerabilities around the exposure of private keys for crypto-assets to loss or theft. The Report recommends the development of a clear regulatory framework for custody arrangements of digital assets, which will align with general principles for custody arrangements while dealing with the unique features of digital assets.

Token mapping exercise for digital assets

Most digital assets fall outside the legislative definition for 'financial product' and, accordingly, fall outside ASIC's purview. The Report recommends that the Government undertake a token mapping exercise to understand the various types of digital assets available in the market, noting the approach of other jurisdictions' mapping exercises in recent years. This would likely inform the regulatory model that would follow. Such an exercise would bring significant clarity for projects seeking to operate in this space, which currently deal with significant uncertainty as to their regulatory status.

Additonal recommendations

The Report also makes recommendations to clarify Capital Gains Tax (CGT) rules for crypto transactions, and review potential challenges with aspects of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (AML/CTF) rules that apply to digital asset businesses.

Interactions with mainstream banks and 'de-banking'

The Report also addresses the challenges that the FinTech industry more broadly, and crypto based businesses in particular, have with 'de-banking' – the inability to obtain, or difficulty with obtaining, core banking services from mainstream financial institutions. It is particularly concerned about such challenges hampering innovation and limiting options for industry.

While acknowledging that there are a diverse set of reasons why certain business classes may have difficulty obtaining banking services (including assessments of risk appetite for certain customers, and AML/CTF regulation), the Report recommends the implementation of a due diligence scheme for banks by no later than June 2022. It also recommends the development of a 'de-banking' process involving the Australian Financial Complaints Authority, with an appeals mechanism.

This will be an area to watch closely, and is likely to have the most immediate impact of all the recommendations. While providing a framework for due diligence may potentially facilitate better risk assessments by banks of the crypto industry, it will remain to be seen whether this can successfully ameliorate the underlying complexities.

The 12 recommendations

Actions you can take now

Consider the impact of proposed reforms

Businesses – particularly within the digital asset industry, as well as banks and other financial services providers – should reflect on the proposed recommendations and their likely impact, and consider key further consultation input as the regime continues to develop.