15 November 2021

Cryptocurrencies - love them or fear them, there's no ignoring them

Are you ready for a surprising fact? One in four Australians hold, or have held, one or more cryptocurrencies.

So says the just released Senate Select Committee report on Australia as a Technology and Financial Centre, adding that this makes Australia one of the world’s biggest adopters of cryptocurrencies on a per capita basis.

Whether we should be impressed or concerned by this time will tell. What I can state with confidence – and the backing of the Senate report – is that Australia sorely needs a strong legislative framework around cryptocurrencies in order to both protect people from financial risk and also allow people the freedom to trade in legitimate forms of currency (even if they are not fully understood by all).

The term “cryptocurrency” is actually something of a misnomer. “Currency” in its generally understood usage is legal tender recognised by national laws and regarded as an official unit of money. Those $20 notes and 50 cent coins in your wallet meet that definition, but “crypto” currencies do not. They are forms of tender recognised by some, but not all, individuals and organisations, and not recognised by government agencies in most countries.

This is easily tested by trying to pay your taxes or rates bill with a cryptocurrency.

However, digital currency or payment methods is widely used or recognised, and when a new ‘form’ pops up, regardless of its status as a legal form or tender, governments must take note and consider the implications of its use. So, it is with cryptocurrencies.

China’s response has been to ban trading in cryptocurrency while turning something of a blind eye to it. That is, until September this year when its central bank warned that all cryptocurrency trades are not only illegal, but also “seriously endanger the safety of people’s assets.”

In the wake of this announcement, the price of Bitcoin fell by more than $US2,000 – highlighting the fact that China is one of the world’s largest cryptocurrency markets.

One reason for the crackdown is that China has developed a digital version of its currency, the yuan. As stated by website qz.com, “users can make payments by scanning QR codes or using wearable devices, including physical wallets that are embedded with digital yuan chips.”

By June this year, around 20 million digital yuan wallets were in existence, and transactions had reached the equivalent of $US5.3 billion.

What China has created is something of a hybrid – a cryptocurrency with a regulatory framework in digital infrastructure wrapped around it. That takes the digital yuan out of the realm of a speculative investment into that of “fiat” currency; that is, something that users can be at least reasonably confident won’t wildly fluctuate in value according to the whims of those who trade in it, or the capriciousness of those with the power to issue more of it. It also gives the government a greater ability to bring the use of that form of currency within its fiscal regulatory framework and other forms of regulation of transactions.

As long as cryptocurrencies in Australia exist in their current form (as opposed to the form introduced by China), government regulation has little option but to treat them as a form of speculative investment. And that’s exactly what the Senate report recommends, with the overarching aim of “promot[ing] innovation and attract[ing] investment while providing appropriate safeguards for investors and consumers.”

Among its 12 recommendations:

  • The creation of a Market Licence for digital currency exchanges so that businesses can trade through them with confidence.

  • An appropriate regime for custodial and depository services of digital assets. Such regimes already exist for other assets, such as land, and doing the same for digital assets will create real business opportunities for Australia.

  • A new Decentralised Autonomous Organisation legal structure to allow legitimate blockchain-based organisations to operate in Australia.

  • A review of the Anti-Money Laundering and Counter-Terrorism Financing regulations to ensure they are fit for purpose with regard to digital assets without undermining innovation.

Time will tell whether the committee’s recommendations are implemented and, if so, whether they will successfully negotiate the delicate path between protecting investors and allowing people sufficient freedom to take risks and earn potentially large rewards.

Whether states or state agencies will ever accept any type of cryptocurrency as legal tender is still an open question, if not doubtful. By June this year, the only country to recognise Bitcoin as legal tender was El Salvador. The rest of the world is not in a great hurry to do so.

It’s to Australia’s credit that it is responding to cryptocurrencies as not simply a short-lived fad and, given their widely fluctuating values, as something that could potentially cause investors significant losses. For good or ill, they are indeed a serious phenomenon, and considering how to manage their potential threats while also embracing the opportunities they present is a wise move.

List of Recommendations

The committee recommends that the Australian Government:

1. establish a market licensing regime for Digital Currency Exchanges, including capital adequacy, auditing and responsible person tests under the Treasury portfolio.

2. establish a custody or depository regime for digital assets with minimum standards under the Treasury portfolio.

3. through Treasury and with input from other relevant regulators and experts, conduct a token mapping exercise to determine the best way to characterise the various types of digital asset tokens in Australia.

4. establish a new Decentralised Autonomous Organisation company structure.

The committee recommends that:

5. the Anti-Money Laundering and Counter Terrorism Financing regulations be clarified to ensure they are fit for purpose, do not undermine innovation and give consideration to the driver of the Financial Action Task Force ‘travel rule’.

6. the Capital Gains Tax (CGT) regime be amended so that digital asset transactions only create a CGT event when they genuinely result in a clearly definable capital gain or loss.

7. the Australian Government amend relevant legislation so that businesses undertaking digital asset ‘mining’ and related activities in Australia receive a company tax discount of 10 per cent if they source their own renewable energy for these activities.

8. The Treasury lead a policy review of the viability of a retail Central Bank Digital Currency in Australia.

9. the Australian Government, through the Council of Financial Regulators, enact the recommendation from the 2019 ACCC inquiry into the supply of foreign currency conversion services in Australia that a scheme to address the due diligence requirements of banks be put in place, and that this occur by June 2022.

10. in order to increase certainty and transparency around de-banking, the Australian Government develop a clear process for businesses that have been de-banked. This should be anchored around the Australian Financial Complaints Authority which services licensed entities.

11. in accordance with the findings of Mr Scott Farrell’s recent Payments system review, common access requirements for the New Payments Platform should be developed by the Reserve Bank of Australia, in order to reduce the reliance of payments businesses on the major banks for the provision of banking services.

12. the Australian Government establish a Global Markets Incentive to replace the Offshore Banking Unit regime by the end of 2022.

Author: Norman Donato