Is my crypto asset deemed a ASIC regulated “financial product”?

Tokenisation isn’t a new concept. Having emerged many decades ago, the concept is being rebirthed and given new life thanks to distributed ledger technology (DLT). The digitisation and fractionalisation of real-world assets is revolutionising the financial landscape and improving the way investments are managed. However, ambiguity within the current licensing regime is causing confusion on whether tokens and crypto assets are classified as a “financial assets”.

As a result, the Australian Government undertook a ‘Token Mapping’ exercise to determine how the existing regulatory framework could be used to regulate the new crypto ecosystems and how to protect consumers while encouraging innovation.

While Australia has a unique and strict regulatory framework for protecting consumers in the sale, marketing, and advice on financial assets, unlike other jurisdictions globally, there is currently no dedicated regulatory framework for crypto assets in the country. As a result, much confusion has ensued within the startup community. 

ASIC has warned that even though a regulatory framework on crypto assets has not yet been established, it does not imply that the sector is unregulated. Some crypto assets ARE classified as “financial assets,” placing them directly under their supervision.

So what does this mean?

It means, as an entrepreneur you will need to determine whether your crypto asset fits within the Treasury proposed framework for a financial product which relies on the following 3 concepts:

1. The token (i.e. the unit of information);
2. The token system (i.e. a business, social or physical protocols, or mechanism which is designed to ensure or facilitate a function); and
3. The function (i.e. any benefit ensured or facilitated by the token system)

The proposed token mapping framework relies on three intertwined concepts to be assessed against the functional perimeter (being the definition of ‘financial product’ within financial services regulation) – tokens, token systems, and functions. For example, on Ethereum, Ether (token) is used to pay the Network fee (token system) in exchange for using the Ethereum network (function).

According to the Token Mapping Consultation paper, it’s not a question of whether the token or the function meet the financial product definition but rather a question about the token system. The token system is the crypto asset as it is made up of both the token and the benefits provided by its token system which includes smart contracts and business rules. 

Therefore, the token system is what determines if the crypto asset is a financial product. This is where things get a little bit more detailed. A token system can be divided into four categories that can be grouped under two kinds of token systems, being:

1. Intermediated token systems (which involve intermediaries or agents performing functions under promises or other arrangements), the following two categories:

• a. Crypto asset services – A token system
  that accepts crypto tokens as part of performing a function. The arrangement
  will involve a customer transferring crypto assets to a service provider that
  will then credit the consumer’s ‘wallet’.

• b. Intermediated crypto assets – Tokenisation of a real-world asset. A crypto asset where the link between the crypto token and the token system is created by legal agreement. Examples of assets connected to crypto tokens include, intellectual property, reward programs, consumer goods and services, fiat money, non-financial assets, government bond coupons and units in a member-directed venture capital fund.

2. Public token systems – These involve functions being performed by crypto networks in the absence of intermediaries and agents. The following two categories apply:

• a. network tokens; and

• b.  public smart contracts

Token mapping is simply the process of identifying the key activities and functions of products in the crypto ecosystem and mapping them against existing regulatory frameworks.

According to a consultation paper released by MinsterEllison, “The paper discusses the application of the functional perimeter to the token ecosystem at a high level, explaining that it is not a question of whether a crypto token meets the financial product definition, but whether a token system does.”

The paper examines this by asking a two part question:

1. Is the token system a facility?

2. If so, is the facility one through which a person makes a financial investment, manages financial risk and/or makes non-cash payments?

If the answer to both is ‘yes’, then the facility is a financial product.

Here are some examples of crypto assets that would fall under the ‘financial product’ category:

• Issuers of crypto-assets (e.g. tokens)

• Crypto assets that involve an ICO, will depend on the token system and facility. 

• Crypto assets that involve a STO will be a financial product. 

• Crypto-asset intermediaries (giving advice, dealing, providing insurance, or providing other intermediary services for crypto-assets that are financial products).

• Miners and transaction processors are part of the clearing and settlement (CS) process for tokens that are financial products 

• Crypto-asset exchange and trading platforms (Australian markets licence is required).

• Wallet providers and custody service providers, will depend on the token system.

Note – If your token system is deemed a financial product and your company is conducting “financial services”, then it will need to hold an AFSL, be authorised under an AFSL or qualify for an exemption and it will involve interests in a managed investment scheme. Both AFSL and MIS requirements are a topic for another day, which we will cover separately. 

At no point does any of the above contents in this article be considered as financial advice. Please consult with your financial advisor or accountant for appropriate advice on crypto assets and financial product licensing.