Crypto-assets and crypto-businesses a regulatory and legal issues Commercial Court CPD seminar 13 February 2019 Mark Sneddon Adjunct Professor of Law Monash University Partner, Holley Nethercote and Principal Sneddon Legal marks@hnlaw.com.au markasneddon@gmail.com
Blockchain and Distributed Ledger Technology DLT is a set of technology components that records and tracks information in a 'distributed' (as opposed to 'centralised') manner. Enterprise blockchain applications either replace existing centralised ledgers (eg ASX) interbank settlement accounts with DLTs OR create new uses for DLTs eg managing patient medical records or supply chain records, smart contracts Transferable tokens (really ledger entitlements) are issued to raise funds(icos) and create new online markets and products or securitise existing assets and bypass banks and securities exchanges Token Exchanges provide (largely unregulated) markets for trading tokens enabling investing and speculation and significant volatility in price Token and blockchain businesses of many types based on the above
Blockchain A blockchain is a type of distributed ledger: With copies of the ledger at many nodes (multiple, geographically separate computers on the Internet which participate) Changes are made by a node proposing to add a block of new transactions to the existing blocks (like a register of a chain of deeds). Each new block is time stamped and digitally signed Consensus mechanism: The ledger copies are kept in sync by each node agreeing with each other that each new added block is correct Record integrity is secured by cryptography ( a PKI private key held by the owner/controller of a ledger entitlement (eg for Joe s 2 BTC) must be used to authorise a change in that ledger entitlement)
Blockchain (cont) Private keys are held in a wallet (a software repository) which may be connected to the internet (hot storage) or not connected (cold storage more secure). If the private key is lost, no access loss in QuadrigaCX - alleged owner of exchange died with no copy of key to C$137m in cold storage. Now in creditor protection as class actions organise. If a key is stolen by hacking, what recourse for holder or customers of an exchange holder? A blockchain may be publicly readable or private, permissioned or not. Blockchains can be used for almost anything - land titles, shares, medical records, Uber ride prepay, spare filing space on PCs, derivatives, contracts with self-executing rules.
Cryptotokens on a Blockchain ledger A cryptotoken is not a token or transferable digital file but an entry in a digital ledger. It is a unitised entitlement to a thing (a bundle of rights) recorded in a blockchain ledger. The entitlement is a record on a blockchain found at a unique address. The ledger units at that address can be transferred by use of a PKI private key kept in a wallet.
Value and Hype Like the dotcom boom there is real transformation and opportunity and also much vapourware, well intentioned hype and scams DLT and blockchain replacement systems will have to be lower cost or more profitable than current ID verification, asset registers, transfer systems and central counterparty systems DLT and blockchain may create new online record systems that offer compelling value but this needs to be shown Eg Vechain cold logistics supply chain information derived from IoT sensors monitors and locks in record of condition of perishables at points in the chain In the meantime there is endless innovation, real value being created and a new speculative asset classes in cryptotokens creating huge volatility in price and market manipulation arising from rampant speculation and poor information about issuers and market depth and who holds what and the ability of whales to distort quoted prices.
The Crypto Economy Our clients include: Cryptocurrency brokers and exchange operators Bloomberg estimated in March 2018 that the top 10 exchanges in the world generate as much as $US3m in fees a day ICO promoters and traders of tokens BTC market cap is USD 64 bn Crypto investment funds 170 started in 2017, fewer in 2018 Crypto miners or financiers/suppliers of mining capacity New token creators and fintech businesses undertake an ICO for capital raising and then run an ongoing token community and set of applications based around the token eg in logistics, investments, asset securitisation, proof of ownership or provenance, social investing, noncash payments instrument Advisers and financiers and consultants to crypto projects
Blockchain applications and the law Ripple Nov 2017, Ripple Labs and AMEX partnered to create a Blockchain-based payment infrastructure to provide real-time trackable B2B payments. Ripple Labs also created 100 billion XRP tokens. There are 41 billion on issue. Feb 19 market cap for tokens is $12,533,530,144 USD, price is USD 0.30. Several class actions by investors allege they have incurred losses due to breaches by Ripple Labs of US securities law eg no prospectus, market manipulation DAO built on Ethereum blockchain investment syndicate governed by smart contracts with token holders voting on investments. One investor found a code feature to pay themselves out $70 million
Financial Services/ Investment regulation Worldwide trend is to greater regulation eg SEC, FCA ASIC says classic cryptocurrency is not a financial product but some cryptotokens are. Similar but not same as US Howey test of an investment contract. Exchanges and Brokers - If a cryptocurrency broker or exchange deals in a non-classic cryptotoken it may need an AFSL and/or a markets licence. Even if it only deals in classic cryptocurrency, it may provide add-on financial services eg non-cash payment facility or a forward forex contract or derivative -need an AFSL. Advisers and Commentators if carrying on a business of providing opinion or recommendation on a token which is a financial product financial product advice
Financial Services/ Investment regulation New token creators and ICO promoters ASIC Info Paper says based on the rights attached to the tokens and the broader system operated, may be regulated as a managed investment scheme or an offer of securities or a financial service requiring an AFSL. Managed mining and investment services - same Complex and broad tests is there a contribution made to a person to generate a financial return or benefit or rights in property and no day to day control
USA: Security Tokens and Utility Tokens USA - SEC regulates offers and trading of a security including an investment contract. Howey test = an investment of money (or moneys worth) in a common venture with a reasonable expectation of profits to be derived from the managerial efforts of others. SEC ruled that Ethereum DAO Tokens were a security in July 2017. Popular view is that utility tokens - which provide holders with a right to future access to goods or services - are not securities. Eg Filecoins can be used to purchase storage space from Filecoin once its decentralised cloud storage system is up.
2. Anti money Laundering Regulation From April 2018 the exchange of digital currency for fiat is a designated service and digital currency exchange businesses must: (a) (b) (c) (d) (e) (f) register on AUSTRAC s Digital Currency Exchange Register adopt and maintain an AML/CTF program to identify, mitigate and manage risks; perform Know-Your Customer (KYC) procedures to identify and verify the identities of customers and perform ongoing customer due diligence; have an employee due diligence program and an AML/CTF risk awareness training program; report suspicious matters Otherwise comply as a reporting entity
Australian Digital Commerce Association Holley Nethercote helped ADCA draft its Code of Conduct which sets out Best Practice Standards for the operation of a digital currency business which facilitates: the purchase or sale of digital currency purchase or sale of fiat in connection with digital currency storage of digital currency
Crypto-assets and crypto-businesses - regulatory and legal issues Commercial Court CPD seminar 13 February 2019 Mark Sneddon Adjunct Professor of Law Monash University Partner, Holley Nethercote and Principal Sneddon Legal marks@hnlaw.com.au markasneddon@gmail.com