Australia’s Cryptocurrency Exchange Law

The collapse of the cryptocurrency exchange FTX in November 2022 negatively affected 50,000 Australians, which provides a clear need for ongoing regulation in this emerging financial space.

Cryptocurrency exchanges have become an integral part of the global financial landscape, enabling users to buy, sell, and trade digital assets with ease. However, the rise of these platforms has also introduced significant challenges, particularly in terms of regulation, consumer protection, and the prevention of illegal activities. In Australia, the regulatory environment for cryptocurrency exchanges is evolving rapidly as the government seeks to strike a balance between fostering innovation and ensuring market integrity.

Currently, Australia maintains a moderate approach to cryptocurrency regulation, requiring exchanges to register with AUSTRAC and adhere to anti-money laundering and counter-terrorism financing laws. However, with the increasing prominence of digital assets and high-profile failures in the crypto market globally, the demand for more comprehensive regulation has intensified. Over the next two years, Australia is expected to introduce new legislation that will impose stricter requirements on cryptocurrency exchanges, covering areas such as licensing, custody, and financial reporting.

In October 2023, the Australian Government Treasury released the “Regulating Digital Asset Platforms” proposal paper which aims to update the law surrounding cryptocurrency exchanges in Australia.

This article aims to provide a detailed overview of the current laws governing cryptocurrency exchanges in Australia and to explore the proposed regulations that are anticipated to come into effect sometime after 2024. By examining these developments, we will gain insight into how Australia is preparing to regulate the rapidly expanding digital asset market, with a particular focus on enhancing consumer protection and ensuring market stability.

Overview of Current Cryptocurrency Exchange Regulations in Australia:

In 2018, Australia introduced a significant regulatory framework for cryptocurrency exchanges, marking a crucial step in bringing digital currency transactions under the purview of national financial laws. This regulatory effort was spearheaded by AUSTRAC (the Australian Transaction Reports and Analysis Centre) as part of amendments to the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (AML/CTF Act). These amendments aimed to mitigate the risks associated with cryptocurrencies, such as their potential misuse for money laundering or financing illegal activities. The law came into effect on 3 April 2018 and imposed a new set of obligations on digital currency exchanges (DCEs).

The 2018 law covered any service involved in the exchange of fiat currencies, such as Australian dollars or foreign currencies, to cryptocurrencies and vice versa, provided the service was operated as a business. This regulatory framework recognized cryptocurrencies as "digital representations of value" that could be used as a medium of exchange, a store of value, or a unit of account. The law applied specifically to digital currencies that were publicly available, interchangeable with money, and used for transactions involving goods, services, or other financial dealings. Notably, the law excluded closed-loop digital currencies, such as those used in gaming environments, and any potential future government-issued digital currencies.

The 2018 regulatory changes required DCEs to comply with AML/CTF obligations, which introduced several key responsibilities for the exchanges:

1. Registration with AUSTRAC: DCEs were required to register with AUSTRAC by 14 May 2018 to continue operating legally. The registration had to be renewed every three years. New exchanges entering the market after this date were required to register before commencing operations.

2. KYC Requirements: DCEs had to identify and verify their customers’ identities, following Know Your Customer (KYC) protocols, to ensure that individuals using the exchanges were properly vetted.

3. Monitoring Suspicious Activity: Exchanges were required to implement systems that could detect suspicious trading or transactions, including those exceeding a value of AUD 10,000. Suspicious activities were to be reported to AUSTRAC as part of the broader AML/CTF compliance measures.

4. Establishment of an AML/CTF Program: DCEs had to create and maintain an AML/CTF compliance program, which involved internal controls to prevent the use of cryptocurrencies for money laundering or financing terrorism. This program included training staff, monitoring transactions, and reporting any potential risks.

   
   

These 2018 regulations laid the foundation for how digital currency exchanges operate in Australia today. They focused on creating transparency, accountability, and consumer protection in the rapidly evolving digital currency market, while also helping to deter criminal activity. However, as cryptocurrency markets have grown and evolved, further regulatory adjustments are now being considered to address emerging challenges and ensure continued oversight of the sector.

Current Challenges and Gaps in the Regulatory Framework:

While Australia's regulatory framework for cryptocurrency exchanges provides some oversight, there are notable challenges and gaps that expose both consumers and the broader market to risks. These shortcomings have become more pronounced in recent years, as the cryptocurrency market has expanded and high-profile incidents, such as exchange collapses and fraud, have brought the vulnerabilities of the current system to the forefront.

One of the main challenges is the inconsistent application of regulations across different types of cryptocurrency platforms. While AUSTRAC enforces AML/CTF compliance, not all exchanges are subject to the same level of scrutiny, particularly those that deal with assets not classified as financial products under ASIC's jurisdiction. This creates a regulatory grey area where smaller or emerging exchanges might evade stringent oversight, leading to a lack of consumer protection. As such, many consumers who store their assets on these platforms are left vulnerable to risks like hacking or liquidity shortfalls, with limited recourse in the event of a platform failure.

Another significant issue is the lack of a dedicated licensing regime for cryptocurrency exchanges, unlike in traditional financial markets. Currently, exchanges that do not offer financial products are not required to hold an Australian Financial Services Licence (AFSL), meaning they are not subject to the same consumer protection standards that apply to banks and other financial institutions. This gap leaves consumers at a disadvantage, as cryptocurrency exchanges can operate without the same level of regulatory oversight or financial accountability. As a result, the public is at greater risk of falling victim to scams, fraud, or mismanagement by these exchanges.

The absence of a clear custody regime for digital assets further compounds the issue. Without proper custody regulations, cryptocurrency users who store their assets on exchanges face uncertainty over who is responsible for securing their funds. This lack of clarity becomes especially problematic in the event of an exchange's insolvency, where users may struggle to recover their assets due to unclear ownership or safeguarding measures. High-profile exchange collapses, both in Australia and internationally, have demonstrated the urgent need for better-defined custody rules to ensure that users' digital assets are protected from misappropriation or loss.

Additionally, the speed at which cryptocurrency markets evolve often outpaces regulatory developments. This has created an environment where regulatory bodies struggle to keep up with the technological advancements and the rapid introduction of new financial products in the crypto space. For example, certain token offerings and innovative products, such as decentralized finance (DeFi) platforms, often fall outside the scope of existing regulations, leaving regulators with the challenge of retrofitting rules that were not designed for these novel assets.

Lastly, consumer education remains an issue. Many Australian investors are still unfamiliar with the risks involved in cryptocurrency trading and may not fully understand the implications of using unregulated exchanges or engaging in speculative investments. The lack of comprehensive consumer protection mechanisms exacerbates this problem, as users may not realize the potential for losses or the absence of legal protections until it is too late.

The Digital Assets Bill 2022 and Token Mapping:

One of the most significant steps toward strengthening cryptocurrency regulation in Australia is the introduction of the Digital Assets Bill 2022. Proposed by Senator Andrew Bragg, this bill represented an early attempt to provide a more comprehensive framework for regulating digital asset exchanges, stablecoins, and digital asset custody services. Although the bill is not expected to pass under the current Labor government, it has set the tone for the regulatory discussions that are likely to shape the future of crypto regulation in Australia.

The Digital Assets Bill 2022 specifically targets areas of concern within the crypto industry, such as the lack of oversight around stablecoins and digital asset custody services. The bill also calls for the regulation of cryptocurrencies pegged to foreign currencies, particularly focusing on the Chinese digital yuan. This aspect of the bill demonstrates how geopolitical concerns are influencing cryptocurrency regulation, as the Australian government seeks to limit the influence of foreign state-backed digital currencies within its financial system. While the bill may not be passed in its current form, its provisions are likely to influence the final shape of future regulations as Australia seeks to safeguard its financial sovereignty and protect consumers.

Another key regulatory development is the token mapping exercise initiated by the Australian government in 2023. This initiative is one of the first of its kind globally and aims to classify digital assets by identifying their key features and categorizing them according to their function. Token mapping is a crucial step in determining how different types of digital assets, including cryptocurrencies, non-fungible tokens (NFTs), and decentralized finance (DeFi) products, should be regulated under Australian law.

Token mapping is expected to provide much-needed clarity on whether certain digital assets should be classified as financial products, and therefore subject to regulation by the Australian Securities and Investments Commission (ASIC). This process will help define which tokens fall under existing financial product regulations and which do not, allowing the government to apply more specific regulatory measures based on the nature of the asset. For example, tokens used in loyalty programs or marketing initiatives by businesses may not require the same level of regulatory oversight as tokens that serve as investment products.

The outcome of token mapping will have far-reaching implications for both exchanges and investors. For exchanges, it will help clarify their obligations regarding which digital assets they can legally list and trade, and under what regulatory conditions. This, in turn, will lead to more certainty for investors, who will have a better understanding of the risks associated with different types of tokens. It is also likely to influence how new tokenized products are developed and marketed, as clearer regulatory guidance will enable businesses to innovate within a defined legal framework.

In his speech at the Australian Financial Review Summit, Financial Services Minister Stephen Jones highlighted the importance of token mapping, stating that it would help focus regulation where it is most needed. The government’s approach emphasizes that not every token in every scenario requires regulatory oversight. Instead, the focus will be on platforms that hold or manage Australian consumers' digital assets, such as cryptocurrency exchanges and digital asset platforms. This entity-focused approach ensures that the most critical areas of consumer protection are addressed while allowing room for innovation in the broader digital asset space.

While token mapping has provided a foundation for future regulations, it is not without its challenges. The rapid evolution of the cryptocurrency market means that digital assets are constantly being developed and redefined, which complicates the process of categorizing them under existing legal frameworks. As a result, the token mapping process may need to be continuously updated to keep pace with technological advancements and market changes.

The Digital Assets Bill 2022 and the token mapping initiative mark crucial steps toward developing a robust regulatory framework for the Australian cryptocurrency market. They signal a shift toward more comprehensive oversight, focusing on areas such as stablecoins, digital asset custody, and exchange operations. These efforts are laying the groundwork for the next phase of cryptocurrency regulation, which will be further detailed in the upcoming proposed regulations for 2024 and 2025.

Regulating Digital Asset Platforms Proposal Paper – October 2023

As cryptocurrency continues to grow in popularity, the Australian government is poised to introduce more stringent regulations to address the risks and challenges associated with digital asset trading. The proposed regulations, as discussed in the Regulating Digital Asset Platforms Proposal Paper – October 2023 represent a significant evolution in Australia’s approach to cryptocurrency exchanges, with a focus on enhancing consumer protection, ensuring market integrity, and fostering innovation within a controlled environment.

The proposed framework for regulating digital asset facilities in Australia expands the application of the Australian Financial Services Licence (AFSL) framework to digital assets, recognizing certain asset-holding arrangements as financial products. This extension ensures that those who offer services related to digital asset facilities, such as brokers, custodians, and platform providers, are required to hold an AFSL. A digital asset facility refers to a platform that manages digital assets for customers under a structured, transparent set of rules (non-discretionary arrangements) agreed upon in a written contract.

One of the central components of the new regulatory framework is the introduction of a licensing regime for cryptocurrency exchanges. Under the proposed rules, all exchanges that hold digital assets on behalf of their customers will be required to obtain an Australian Financial Services Licence (AFSL). This requirement will bring cryptocurrency exchanges in line with other financial service providers, ensuring that they meet the same standards of transparency, accountability, and solvency. The AFSL will impose a range of obligations on exchanges, including:

1. Acting honestly, fairly, and efficiently: Exchanges will be required to operate with integrity and avoid engaging in deceptive or unfair practices.

2. Managing conflicts of interest: Exchanges will need to implement mechanisms to identify and manage any conflicts of interest that may arise between their operations and the interests of their customers.

3. Dispute resolution: Platforms will be required to have systems in place to resolve customer complaints and disputes in a timely and transparent manner.

4. Solvency and cash reserves: Exchanges must maintain adequate financial resources to ensure their solvency and the protection of customer assets. This will likely include specific cash reserve requirements to ensure they can meet customer withdrawal requests, even during periods of market stress.

5. Financial record-keeping and reporting: Exchanges will need to maintain accurate financial records and provide regular reports to regulators, ensuring ongoing compliance with the AFSL requirements.

   
   

The introduction of these licensing requirements is expected to significantly reduce the risks associated with unregulated exchanges, particularly those that may not have the financial resources or operational controls necessary to protect their customers. By subjecting exchanges to the same regulatory standards as traditional financial institutions, the Australian government aims to create a safer and more transparent environment for cryptocurrency trading.

Key aspects of the proposed framework include:

1. Licensing Requirements: Any person carrying on a financial services business in relation to a digital asset facility in Australia must hold an AFSL. This includes platform providers responsible for customer obligations and intermediaries like brokers or agents. Even intermediaries outside Australia would need an AFSL if they provide services that involve Australian customers.

2. Facility Contracts: Digital asset facilities must operate under non-discretionary, transparent agreements between the provider and customers, detailing the platform’s operational standards. These contracts include minimum standards for asset holding, transactional functions, and platform entitlements. Platform entitlements, which reflect ownership or beneficial ownership of assets, must be simple and cannot include complex securities-like entitlements.

3. Minimum Standards for Holding Assets: Digital asset facilities are required to meet minimum standards similar to those for traditional financial products, with tailored provisions for holding tokens. The framework also allows additional custody arrangements, such as bailment, enabling these platforms to hold various types of assets safely.

4. Platform Entitlements: The framework allows for issuing transferable platform entitlements, maintaining records via account-based or token-based systems, and facilitating transactions. These entitlements reflect ownership and can be used to transfer assets off the platform. The entitlements must remain simple, ensuring they don't interfere with existing regulatory frameworks for securities.

5. Transactional Functions: Platforms can include transactional functions, such as asset transfers, which must comply with existing financial laws for financial products. For non-financial product assets, the framework introduces "financialised functions" such as token trading, staking, asset tokenization, and crowdfunding. These functions are subject to additional standards but do not transform the assets into financial products, preserving the flexibility for platforms to handle both financial and non-financial assets.

6. Existing Regulatory Frameworks: The framework is designed to supplement, not replace, Australia’s existing regulatory structures. Activities such as token-based gambling, ticket sales, or providing non-cash payment services remain regulated under existing state and federal laws. Digital assets and tokens used for these purposes would continue to follow the legal principles already in place, while the financial services laws would apply only when relevant to asset holding or financialised functions.

   
   

In summary, the proposed framework integrates digital asset facilities into the existing AFSL regime, imposing requirements for asset custody, transactional transparency, and regulatory oversight to ensure safe and structured management of digital assets. This framework preserves flexibility for non-financial assets while reinforcing protections for customers through stringent standards for holding and handling digital assets.

Another key aspect of the proposed regulations is the establishment of a custody regime for digital assets. Under the new rules, exchanges will be required to implement robust custody solutions to safeguard the digital assets they hold on behalf of their customers. This custody regime is designed to address one of the most pressing issues in the cryptocurrency market: the risk of losing assets due to exchange insolvency, fraud, or hacking. By imposing strict requirements around how exchanges manage and store customer assets, the government aims to protect consumers from the financial losses that have occurred in past exchange failures.

The custody regime will likely include specific measures such as:

• Segregation of customer assets: Exchanges will be required to keep customer assets separate from their own operational funds, ensuring that customer assets are not used to cover the exchange’s liabilities in the event of insolvency.

• Third-party custodians: In some cases, exchanges may be required to use independent, third-party custodians to store customer assets, further reducing the risk of fraud or mismanagement.

• Regular audits: Exchanges will need to undergo regular audits to verify the security and accuracy of their custody arrangements, providing an additional layer of oversight and protection.

  
  

In addition to licensing and custody requirements, the proposed regulations will also address financial reporting and disclosure obligations. Cryptocurrency exchanges will be required to provide clear and accurate information about the services they offer, including detailed risk disclosures. This will ensure that consumers are fully informed about the risks associated with using a particular exchange, allowing them to make better decisions about where to trade and store their digital assets.

The regulations also place a strong emphasis on market conduct. Exchanges will be expected to monitor and disrupt any market misconduct, such as insider trading or market manipulation, which has been a growing concern in the cryptocurrency market. By enforcing these rules, the government aims to create a level playing field and ensure that all participants in the market adhere to the same standards of fairness and transparency.

The timeline for implementation of these proposed regulations has also been clearly outlined. Once the legislation is passed, expected in 2024, cryptocurrency exchanges will have a 12-month transition period to comply with the new rules. This will give exchanges time to adjust their operations, obtain the necessary licenses, and implement the required systems to meet the new regulatory standards. The transition period is critical to ensuring that exchanges, particularly smaller platforms, are not unduly burdened by the regulatory changes and can continue operating while bringing their practices into compliance.

Additionally, there is a strong focus on ensuring that Australia’s cryptocurrency regulations are aligned with international standards. As cryptocurrency is a global market, the government is keen to ensure that its regulatory framework is consistent with those being developed in other major markets, such as the United States and the European Union. This global alignment is essential for fostering cross-border collaboration and ensuring that Australian exchanges remain competitive on the international stage.

International Comparisons and Global Alignment:

As cryptocurrency regulations evolve globally, Australia’s efforts to regulate digital assets are taking place within a broader international context. Given the inherently borderless nature of digital currencies, the success of any national regulatory framework, including Australia's, depends largely on its alignment with global standards and practices. Countries around the world are grappling with similar challenges related to consumer protection, market stability, and innovation, and Australia's regulatory approach is reflective of a wider trend toward tighter oversight.

In countries like the United States and European Union, regulators have been moving rapidly to establish comprehensive rules for cryptocurrency exchanges and digital assets. For instance, the European Union’s Markets in Crypto-Assets (MiCA) regulation, which is set to come into effect by 2024, introduces a detailed regulatory framework for crypto-asset service providers. It covers licensing, consumer protection, and market abuse, setting a standard that Australia’s proposed regulations could align with. MiCA's focus on financial stability, transparency, and investor protection mirrors the goals of Australia's proposed reforms, particularly in areas like licensing and custody requirements for exchanges. By implementing a similar framework, Australia aims to ensure its cryptocurrency market remains competitive on a global scale.

The United States has also been active in shaping its cryptocurrency regulations, though its approach has been fragmented across various federal and state regulators. Agencies like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have taken steps to oversee different aspects of digital assets, particularly in determining whether certain cryptocurrencies qualify as securities. Australia’s token mapping initiative shares similarities with the SEC’s efforts to classify tokens based on their characteristics and use cases, which is crucial for determining their regulatory treatment. By aligning its regulatory approach with practices in the U.S., particularly in terms of how tokens and exchanges are categorized, Australia could foster smoother cross-border cooperation and regulatory consistency for companies operating internationally.

Moreover, Australia’s focus on consumer protection and licensing requirements for exchanges echoes efforts in other leading markets, such as Singapore and Japan, both of which have established comprehensive regulatory frameworks for cryptocurrency. In Singapore, the Payment Services Act requires digital payment token providers to obtain a license and comply with stringent anti-money laundering and counter-terrorism financing (AML/CTF) rules, similar to Australia’s AUSTRAC requirements. Japan, being one of the first countries to fully regulate cryptocurrency exchanges, has stringent licensing and capital requirements, ensuring exchanges maintain solvency and protect user assets. These measures serve as models for Australia’s own regulatory advancements, especially in areas like custody and financial reporting.

One of the key aspects of international regulatory efforts is the focus on global cooperation and standardization. Given the global nature of cryptocurrency markets, individual countries cannot regulate in isolation without creating potential regulatory arbitrage, where companies might move their operations to less regulated jurisdictions. As mentioned by industry experts, including Loretta Joseph, a global authority in digital asset regulation, global alignment in standards is essential to avoid fragmented and conflicting regulatory regimes. Australia has been actively participating in international discussions, such as those held at the G20, to ensure its regulatory framework aligns with global best practices. This alignment will enable Australian exchanges to operate more seamlessly across borders, while ensuring that international exchanges meet the same standards when offering services to Australian consumers.

Australia’s regulatory efforts also extend to the ongoing debate surrounding central bank digital currencies (CBDCs). In 2024, the Australian Treasury and Reserve Bank of Australia are expected to publish a joint report examining the feasibility of a CBDC, aligning with similar research being conducted by major central banks globally. Although Australia has not made a firm decision on adopting a CBDC, the government’s commitment to studying the potential role of digital currencies in the national economy reflects its broader goal of staying in step with international developments in the digital asset space.

As Australia moves toward implementing its proposed regulations, its ability to harmonize with international frameworks will be key to maintaining competitiveness and ensuring its exchanges can operate smoothly in the global market. By aligning its rules with those of major global players, such as the U.S., the EU, and Asia-Pacific countries, Australia can attract international investors and foster a secure environment for its domestic exchanges. However, the challenge remains in striking the right balance between regulation and innovation, ensuring that Australia can both protect its consumers and encourage growth in the digital asset sector.

In summary, while Australia's proposed regulations for 2024-2025 are tailored to address domestic concerns, they are part of a broader global effort to regulate cryptocurrency markets effectively. By aligning with international standards and participating in global regulatory discussions, Australia aims to create a secure and transparent environment for its cryptocurrency exchanges while remaining competitive in the global marketplace. This global alignment will be critical to the success of its regulatory reforms and the long-term stability of its digital asset market.