Navigating Digital Asset Platform Reforms: An AFS Licence Guide for Crypto Businesses

Introduction

The Australian government is actively working to regulate digital asset platforms (DAPs), recognising their increasing role in the financial landscape. These reforms are designed to establish a robust regulatory framework for DAPs, aiming to foster innovation in the crypto space while safeguarding Australians and Australian businesses. This new regulatory regime addresses consumer harms and ensures market integrity within the digital asset ecosystem.

Understanding the Australian Financial Services Licence (AFSL) implications of these reforms is paramount for crypto businesses navigating this evolving landscape. This guide provides essential information on the proposed regulatory framework for DAPs, focusing on how the AFSL will apply to digital asset facilities (DAFs) and what crypto businesses need to know to prepare for these changes.

Understanding the Need for Digital Asset Platform (DAP) Regulation

Addressing Consumer Harms and Market Integrity

Introducing reforms to regulated digital asset platforms (DAPs) is necessary to mitigate risks and address consumer harms in the digital asset ecosystem. Recent collapses of DAPs have highlighted significant consumer losses. For instance, the failure of FTX alone impacted approximately 50,000 Australians.

These failures often share common traits, including:

• Substantial losses of assets held on behalf of customers
• Ineffective management
• Inadequate governance
• Poor operational resilience
• Fraudulent activities
• Widespread conflicts of interest

These issues are symptomatic of unregulated asset-holding intermediaries. These risks are amplified by the vertically integrated nature of DAPs, where functions like trading and holding assets are combined within a single entity.

Such failures underscore the urgent need for a robust regulatory framework to protect consumers and maintain market integrity. Without proper oversight, DAPs that do not deal in financial products remain outside the scope of financial services laws, leaving consumers vulnerable.

Aligning with International Standards and Fostering Innovation

In addition to addressing consumer protection and market integrity, the reforms are driven by the need to align Australia’s digital asset regulatory framework with international standards. International bodies such as the Financial Stability Board (FSB) and the International Organisation of Securities Commissions (IOSCO) have advocated for regulatory frameworks that ensure a level playing field between traditional and emerging financial intermediaries. These organisations endorse an ‘activities-based’ approach to regulation, targeting specific activities that pose risks.

By aligning with international best practices, the Australian government aims to foster innovation while ensuring appropriate safeguards are in place. The proposed framework seeks to strike a balance by enabling Australians and Australian businesses to safely explore the benefits of digital assets and distributed ledger technology, while mitigating the risks associated with unregulated DAPs.

Key Components of the Proposed Regulatory Framework

Digital Asset Facilities (DAFs) as Financial Products

The Australian government is proposing a regulatory framework that recognises certain asset-holding arrangements as financial products, specifically termed Digital Asset Facilities (DAFs). This framework aims to regulate entities that provide access to and hold digital assets for Australians and Australian businesses. Under the Corporations Act 2001 (Cth), a DAF is defined as an asset-holding arrangement and classified as a new type of financial product.

DAFs are intended to encompass a broad spectrum of arrangements, including:

• Custody-only arrangements: These arrangements are solely for holding digital assets on behalf of another person.
• DAPs: These are multilateral DAFs where multiple customers engage in platform entitlements transactions.

Furthermore, the proposed framework leverages the concept of factual control to identify and regulate asset-holding arrangements. Businesses that possess the authority to exercise, coordinate, or direct factual control over assets in a real and immediate sense will fall within the regulatory perimeter. This technology-agnostic approach is designed to capture risks associated with reliance on third parties for asset holding, regardless of the specific technology used.

AFSL Requirements for DAPs

Under the proposed regulatory framework, obtaining an AFSL will be mandatory for entities operating DAPs that exceed certain thresholds. This requirement is central to the Australian government’s strategy to regulate DAPs and ensure consumer protection.

The Australian Securities and Investments Commission (ASIC) will be the primary body responsible for administering and enforcing the AFSL requirements for digital asset businesses. To legally operate and offer financial services related to DAFs in Australia, platform providers and intermediaries—including brokers, arrangers, agents, market makers, and advisors—will be required to hold an AFSL.

The specific thresholds that will trigger the AFSL requirement are proposed as:

• Total value of platform entitlements: If the total value of platform entitlements held by a platform provider exceeds A$5 million at any given time.
• Value of platform entitlements per client: If the total value of platform entitlements held for any single client exceeds A$1,500 at any given time.

These thresholds are designed to exempt smaller businesses and startups from the immediate burden of AFSL requirements. This exemption allows them space for innovation and experimentation in their early stages. Additionally, the exemption for low-value facilities mirrors similar exemptions for non-cash payment facilities, aiming to balance consumer protection with fostering innovation.

Understanding Financialised Functions and Their Regulation

Defining Financialised Functions: Token Trading, Staking, and Tokenisation

Financialised functions are central to the proposed regulatory framework for digital assets. These functions encompass specific activities conducted by DAPs that, although they do not involve financial products directly, require regulation due to their financial nature and associated risks. Addressing financialised functions is essential to protect consumers in a rapidly evolving digital asset ecosystem.

Key examples of financialised functions targeted for regulation include:

• Token Trading: Platforms that facilitate the exchange of platform entitlements between account holders fall under this category. These platforms enable the buying and selling digital assets, even those not classified as financial products, aiming to ensure that token marketplaces operate with necessary safeguards.
• Token Staking: This involves platforms that manage an account holder’s participation in validating transactions on a public network. Staking is crucial for the security of many digital asset networks. When platforms facilitate and manage this process, it becomes a financialised function, especially due to the potential financial returns.
• Asset Tokenisation: Platforms that create, and exchange platform entitlements backed by tangible and intangible non-financial product assets are considered to engage in asset tokenisation. This includes scenarios where real-world assets like collectibles or fine wine are tokenised, and the platform facilitates trading.
• Funding Tokenisation: This pertains to platforms that sell platform entitlements to fund the development of non-financial products and services. It addresses situations where digital assets are used for crowdfunding, even when the underlying projects are not financial.

Minimum Standards and Compliance for Financialised Functions

Platforms incorporating financialised functions into their services must adhere to additional minimum standards and compliance requirements. These standards ensure responsible operation and consumer protection, even when dealing with digital assets not classified as financial products.

Key aspects of minimum standards and compliance for financialised functions include:

• Additional Rules: Platforms performing financialised functions must comply with extra regulations tailored to the specific risks associated with each function. For example, token trading platforms must guard against market manipulation, while token staking platforms must address the inherent risks.
• No Separate AFSL Authorisations: Issuers of DAFs that include financialised functions do not require separate AFSL authorisations. However, a single facility is generally restricted from performing more than one financialised function to maintain regulatory clarity and focus.
• Separate Facilities for Each Function: Platforms offering multiple financialised functions may need to establish distinct facilities for each function. For instance, a platform that provides asset tokenisation and funding tokenisation would likely need to operate these as separate facilities to comply with regulatory requirements.
• Facility Guide Requirements: Platforms must provide a facility guide that transparently outlines the non-financial nature of the investment or donation, along with details about the specific product or service being created. This ensures that users are fully informed about the nature of their engagement with the platform.
• Focus on Consumer Protection: These minimum standards aim to protect consumers by applying appropriate safeguards to activities that, while not traditional financial services, carry financial risks within the digital asset context.

Implications and Next Steps for Crypto Businesses

Preparing for AFSL Application and Compliance

For crypto businesses, particularly startups and fintechs, the proposed reforms necessitate a proactive approach to adapt to the evolving regulatory landscape. Understanding the requirements for obtaining and maintaining an AFSL is crucial for businesses operating DAPs within Australia.

To prepare for the AFSL application and ensure ongoing compliance, crypto businesses should consider the following steps:

1. Assess Current Operations: Begin by evaluating existing operations to determine if they fall under a DAF definition and whether they exceed the thresholds that trigger the AFSL requirement. This assessment should include the total value of platform entitlements held and the value held for individual clients.
2. Seek Professional Advice: Engage with legal and compliance professionals specialising in Australian financial services law and digital assets. These experts can provide tailored guidance on navigating the complexities of the new regulatory framework and preparing a robust AFSL application.
3. Develop Robust Compliance Frameworks: Start developing comprehensive compliance frameworks that align with AFSL obligations. This includes establishing robust systems for:
   • Risk management
   • Cybersecurity
   • Custody of digital assets
   • Financial record-keeping and reporting
   • Internal dispute resolution
4. Prepare Detailed Documentation: The AFSL application process requires extensive documentation. Begin preparing detailed information about your operations, financial resources, and the competence of your responsible managers. This preparation will streamline the application process once the legislative framework is finalised.

Transitional Arrangements and ASIC Consultation

Recognising that implementing a new regulatory framework requires time for businesses to adapt, the Australian government proposes transitional arrangements to facilitate a smooth transition. These arrangements aim to provide a reasonable timeframe for industry participants to adjust their operations, seek necessary licences, and ensure compliance.

Key aspects of the proposed transitional arrangements include:

• Transitional Period: A 12-month transitionary period is proposed after the legislation receives Royal Assent. This period is intended to provide industry participants sufficient time to plan and implement compliance changes and obtain an AFSL if required.
• ASIC Consultation and Support: ASIC is expected to support businesses through this transition. This may include providing updated guidance, conducting information sessions, and offering a dedicated point of contact for businesses seeking to understand and comply with the new requirements.
• Potential Class ‘No-Action’ Position: ASIC is considering a class ‘no-action’ position for businesses that have already commenced operations and are actively applying for an AFSL or a licence variation in good faith. This position would provide conditional relief from enforcement action for licensing breaches during the application process, offering regulatory certainty during the transition.
• Ongoing Engagement with ASIC: Crypto businesses are encouraged to engage proactively with ASIC throughout the transitional period and beyond. This includes consultations, seeking clarification on specific aspects of the regulatory framework, and maintaining open communication with the regulator to ensure ongoing compliance.

By following these steps and actively engaging with regulatory bodies, crypto businesses can navigate the upcoming reforms effectively and position themselves for continued success in the Australian market.

Conclusion

The Australian government’s proposed reforms for Digital Asset Platforms (DAPs) represent a significant step towards establishing a clear and robust regulatory framework. These reforms, centred around the Australian Financial Services License (AFSL), aim to address consumer protection and market integrity within the burgeoning digital asset ecosystem.

By leveraging the existing financial services framework and introducing tailored regulations for Digital Asset Facilities (DAFs), the government intends to foster innovation while mitigating the risks associated with unregulated DAPs. Crypto businesses must proactively prepare for these changes to operate compliantly within the evolving regulatory landscape.

Navigating these upcoming changes can be complex; however, expert guidance is available to ensure a smooth transition. To understand how these reforms apply to your crypto business and ensure you are prepared for the new AFSL requirements, we encourage you to contact AFSL House. Our team possesses unparalleled expertise in Australian financial services licensing. It is ready to assist you in navigating the digital asset regulatory landscape, ensuring your business is well-positioned for future success.

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