Does Your Crypto Business Need an Australian Financial Services (AFS) Licence?

Introduction

For businesses operating with crypto-assets in Australia, understanding Australian financial services (AFS) licensing requirements is crucial. The Australian Securities and Investments Commission (ASIC) has released guidance to clarify the regulatory implications for those involved in the crypto industry, as crypto-assets become increasingly prevalent in financial services. This is particularly important because if crypto-assets are considered financial products under the Corporations Act 2001 (Cth), businesses dealing with them may need to hold an AFS licence.

This guide is designed to help crypto startups navigate the complexities of AFS licensing. It will clarify when crypto-assets, such as cryptocurrencies and tokens, are classified as financial products, potentially requiring an Australian financial services licence. By understanding these regulatory requirements, crypto businesses can ensure they operate compliantly within Australia’s financial services regime.

Understanding When Crypto-assets are Considered Financial Products

ASIC’s Definition of Crypto-assets

The ASIC defines a crypto-asset as a digital representation of value or rights. This includes rights to property where ownership is cryptographically evidenced and electronically transferred. Such transfers occur via distributed ledger technology or similar verifiable data structures. ASIC specifically uses this definition when authorising registered managed investment schemes holding crypto-assets.

ASIC’s definition is intentionally broad, covering a range of digital assets commonly found in the crypto industry, including:

• Cryptocurrency: For example, Bitcoin, which operates as a medium of exchange secured by cryptography for financial transactions.
• Tokens: Typically issued during Initial Coin Offerings (ICOs) to raise funds for various projects.
• Stablecoins: Designed to maintain a stable value by pegging to an asset like fiat currency or another cryptocurrency.

Determining if a Crypto-asset is a Financial Product

For businesses dealing with crypto-assets, it is critical to determine whether those assets are classified as financial products under the Corporations Act 2001. If they are, providing related services generally necessitates obtaining an AFSL. To aid this determination, ASIC offers a checklist evaluating whether a crypto-asset or ICO falls under the category of a financial product. 

When assessing this status, businesses must consider all rights and features of the crypto-asset. ASIC stresses the need for a broad interpretation of rights, requiring businesses to conduct a thorough analysis of each crypto-asset they issue or distribute. Importantly, this analysis should be well-documented to support their conclusions—particularly if the decision is made to classify the asset as not being a financial product.

Key factors to consider when determining if a crypto-asset is a financial product include its ability to fall into the following classifications:

• Interests in a managed investment scheme: This applies if individuals contribute money or assets to acquire interests in a scheme, their contributions are pooled to generate returns, and they lack day-to-day control over the scheme’s operations.
• Security: ICO-issued crypto-assets may be deemed securities if they confer rights such as ownership, voting authority, or profit participation, akin to shares.
• Derivative: A crypto-asset may fall into this category if its value depends on another financial product, market index, or fluctuations in asset prices.
• Non-cash payment facility: If a crypto-asset enables payments to multiple payees or transactions that begin in crypto and are converted to fiat currency for settlement, it might be considered a non-cash payment facility.

Crypto-assets as Managed Investment Schemes Requiring an AFS Licence

The Three Elements of a Managed Investment Scheme

Under the Corporations Act 2001, a managed investment scheme is a type of collective investment vehicle that meets three distinct criteria. If a crypto-asset arrangement exhibits these core elements, it may be classified as a managed investment scheme, requiring an AFSL to operate. These key elements include:

• Contribution of money or assets: Individuals contribute money or assets—which may include cryptocurrency or other crypto-assets—in exchange for an interest in the scheme. These contributions form the foundation of a shared investment pool.
• Pooling of contributions and common enterprise: Contributions are pooled together or used in a common enterprise to generate financial benefits or interests in property for the contributors. A typical example is using pooled funds to develop a platform, with the primary goal of increasing the value of tokens held by investors.
• Lack of day-to-day control by contributors: Investors do not have day-to-day control over the scheme’s operations. While they may retain certain voting or similar rights, operational and management decisions are made solely by the scheme operators.

Implications for Crypto Startups and ICO Issuers

For crypto startups and Initial Coin Offering (ICO) issuers, having their crypto-assets classified as interests in a managed investment scheme carries significant regulatory implications. Specifically, businesses operating such schemes and offering them to retail investors must comply with various legal obligations under Australian law. These obligations are in place to protect investors and promote the integrity of financial markets.

The compliance obligations include:

• Registration of the scheme with ASIC: Any managed investment scheme must be formally registered with the ASIC. Registration ensures the scheme adheres to regulatory and legal standards.
• Development of a constitution and compliance plan: Issuers must establish a detailed constitution and compliance plan for the scheme. These documents outline the rules for its operation and the measures to ensure compliance with legal requirements.
• Obtaining an AFS licence to act as a responsible entity: The entity operating the scheme must secure an AFS licence authorising it to act as a responsible entity. This ensures that the operator is qualified and capable of managing the scheme.
• Preparation and issuance of a compliant Product Disclosure Statement (PDS): A compliant PDS must be prepared and provided to prospective investors. This critical document discloses key information about the scheme, such as its operation, risks, and other relevant details, allowing investors to make informed decisions.

Further, even wholesale managed investment schemes—those not made available to retail clients—may still require the operator to obtain an AFS licence. Issuers of such schemes must implement robust procedures to ensure they only accept investments from wholesale clients.

Given the complexities and potential regulatory repercussions, crypto startups and ICO issuers are strongly advised to consult legal professionals. Proper legal guidance ensures compliance with Australian financial services laws and helps confirm whether their crypto-assets qualify as managed investment schemes under the law.

Other Classifications of Crypto-assets as Financial Products

Crypto-assets as Securities

Under the Corporations Act 2001, crypto-assets—particularly those issued via Initial Coin Offerings (ICOs)—may be classified as securities if their attached rights mirror those associated with traditional shares. These rights might include ownership, voting authority, or an entitlement to participate in a company’s profits.

When a crypto-asset is deemed a security, prospectus obligations under Australian law are triggered. Specifically, issuers of ICOs that fall into this category are typically required to prepare a prospectus. This document should provide all necessary information that prospective investors would reasonably need to make informed investment decisions.

Crypto-assets as Derivatives

A crypto-asset or ICO may also be classified as a derivative if its value is directly linked to an underlying asset or financial product. This classification applies when the price of a crypto-asset is dependent on another factor, such as:

• The value of another financial product,
• A market index, or
• Movements in the price of an underlying asset.

For example, a crypto-asset might be considered a derivative if it incorporates a self-executing contract that triggers payment arrangements based on changes in the price of an underlying asset.

When a crypto-asset is classified as a derivative and offered to retail investors, the issuer must prepare a compliant Product Disclosure Statement (PDS). Additionally, providing services related to such crypto-assets—such as offering, advising, dealing, or market making—requires holding an Australian Financial Services (AFS) licence.

Crypto-assets as Non-Cash Payment (NCP) Facilities

Some crypto-assets may fall under the classification of a non-cash payment (NCP) facility, particularly if they enable payments to multiple payees. An NCP facility is broadly defined as an arrangement that allows individuals to make payments without the physical transfer of currency.

The determination of whether a crypto-asset qualifies as an NCP facility depends on its attached rights and obligations. For instance:

• If the holder of the crypto-asset is granted the right to make payments, it is likely to meet the criteria for an NCP facility.
• Similarly, if a crypto-asset facilitates payments that are subsequently converted to fiat currency for recipients, it is also likely to be deemed an NCP facility.

In cases where an ICO involves an NCP facility, it may trigger the requirement for an AFS licence. This classification underscores the necessity for issuers to carefully assess the nature of their crypto-assets and consult legal experts to navigate potential regulatory obligations.

AFS Licensing and Operating a Crypto-asset Trading Platform

When a Crypto Trading Platform Becomes a Financial Market

A financial market is defined as a venue where offers to buy or sell financial products are made on a regular basis. If a platform facilitates the trading of crypto-assets that are classified as financial products, it may be deemed to be operating a financial market within Australia.

Operating a financial market in Australia requires obtaining an Australian market licence unless an exemption applies. Failing to hold the necessary licence while enabling the trading of financial products constitutes a serious breach of Australian law. Platform operators must therefore closely evaluate the nature of the crypto-assets traded on their platforms to determine whether they fall under this regulatory framework.

Obligations for Unlicensed Overseas or Decentralised Platforms

For overseas platforms or those employing decentralised structures, it is critical to ensure they are not inadvertently operating as unlicensed financial markets within Australia unless they qualify for an exemption. To comply with regulatory requirements and avoid unlawful operation, such platforms may need to implement measures to restrict Australian users from accessing financial products on their platforms. These measures can include:

• Removing references and links targeting Australian users: Ensuring that marketing materials, website content, and metadata do not address or appeal to Australian clients.
• Posting clear warnings and disclosures: Displaying notices on websites and applications informing users that the platform does not offer services to Australian clients.
• Implementing geographically based IP restrictions: Using geo-blocking to restrict access from Australian IP addresses, thereby preventing Australian users from trading financial products on the platform.

By taking these precautionary steps, overseas and decentralised platforms can safeguard themselves against breaching Australian financial market laws and maintain compliance with regulatory expectations.

Compliance and Avoiding Misleading Conduct in Crypto Offerings

Misleading or Deceptive Conduct under Australian Law

Misleading or deceptive conduct is firmly prohibited under Australian law, including the Corporations Act 2001 and the Australian Consumer Law. This prohibition extends to the promotion and sale of crypto-assets, irrespective of whether the business operates offshore or utilises decentralised structures. Engaging in such conduct is considered a serious violation of the law and can lead to significant consequences.

Under the Australian Consumer Law, businesses must ensure that all promotional materials and statements regarding crypto-assets are accurate and do not mislead the public. For crypto-assets classified as financial products, similar prohibitions exist under the Australian Securities and Investments Commission Act 2001 (Cth) and the Corporations Act 2001. Therefore, regardless of the classification of the crypto-asset, businesses must act honestly, fairly, and transparently to avoid misleading or deceiving consumers.

Examples of Misleading Conduct to Avoid

To remain compliant and uphold ethical standards, crypto businesses must steer clear of practices that could be deemed misleading. Several examples illustrate what constitutes misleading or deceptive conduct:

• Misrepresenting the regulatory status: Incorrectly stating or implying that a crypto-asset or Initial Coin Offering (ICO) is not a financial product when it is, or falsely claiming that a trading platform does not deal in financial products if it does.
• Creating false impressions of market interest: Using social media or other platforms to exaggerate public interest in a crypto-asset or ICO. This may mislead potential investors into believing there is higher demand than actually exists.
• Manipulating trading activity: Coordinating or engaging in strategies that create a false impression of high trading activity. For example, artificially inflating buying and selling activity can give the illusion of market liquidity or strong investor interest.
• Insufficient disclosure: Failing to provide clear and adequate information about the ICO or crypto-asset. Investors require comprehensive details to make informed decisions, and withholding key information can be deceptive.
• False claims of regulatory approval: Suggesting or implying that a crypto-asset or ICO is regulated or approved by an authority, such as ASIC, when it is not. Such claims can give investors an unwarranted sense of security and legitimacy.

By consistently prioritising accuracy and transparency in their communications and actions, crypto businesses can avoid breaches of Australian law and operate in compliance with regulatory standards. Remaining vigilant against misleading practices not only helps avoid legal penalties but also fosters trust and credibility within the market.

Conclusion

For crypto businesses in Australia, determining whether crypto-assets are classified as financial products is a crucial step, as this dictates whether an AFSL is required. ASIC defines financial products broadly, including managed investment schemes, securities, derivatives, and non-cash payment facilities under the Corporations Act 2001. Failing to comply with these regulations can lead to significant legal risks while also undermining the integrity of Australia’s financial markets

To ensure your crypto business operates compliantly within Australia’s financial services regime, it is vital to accurately assess your crypto-assets against ASIC’s guidelines and seek professional legal advice. Contact AFSL House today to book a consultation with our team of legal experts, who possess unparalleled expertise in Australian financial services licensing and regulatory requirements for the crypto industry, and let us guide you through the application process to obtain the necessary AFS licence for your business.

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