Crypto Token Mapping A good idea or a map without a compass

What you need to know

• The token mapping process is intended to operate as a foundational step for developing appropriate regulatory settings for the crypto ecosystem in Australia.
• Token mapping involves identifying the key functions of products in the crypto ecosystem and mapping them against specific aspects of the financial services regulatory framework to determine where there may be regulatory gaps.
• Treasury has proposed a high-level taxonomy of four product types that can be grouped under two kinds of token systems:
  • Intermediated token systems: crypto asset services and intermediated crypto assets
  • Public token systems: network tokens and public smart contracts

What you need to do

• Carefully consider the proposals in the Consultation Paper and their impact on any proposed or existing services you offer in the crypto asset sector.
• Examine whether the crypto products you offer are more likely to be considered intermediated token systems or public token systems, as well as whether these products are likely to sit within the existing regulatory perimeter.
• Ensure that you submit your responses to the consultation questions by 3 March 2023.

Background

Treasury has released a Consultation Paper on the Government's proposed "token mapping" exercise.  The paper relevantly considers the need for token mapping, as well as the crypto ecosystem's interaction with Australia's existing regulatory frameworks, with a view to building a shared understanding of the ecosystem and informing future policy development in the crypto asset sector.  

Set out below are some of the key takeaways from the Consultation Paper and an overview of the timeline for when further developments can be expected.

What is token mapping?

The token mapping process is intended to operate as a foundational step for developing the policies that will govern the crypto ecosystem in Australia.  It involves identifying the key activities and functions of products in the crypto ecosystem and mapping them against existing regulatory frameworks to determine where the current regime applies and where further regulation may be required.  

The Consultation Paper relevantly proposes a framework for token mapping that relies upon three key concepts:

• Tokens: physical or digital units of information that have a role in a token system;
• Token systems: anything designed to ensure or facilitate a function (e.g. the procedures used to create and meet contractual obligations to customers); and
• Functions: any benefit ensured or facilitated by the token system to the token holder.

This framework is specifically aimed at assisting with conceptualising when a crypto product might fall within the "functional perimeter" of the existing financial services regulatory framework – that is, when would a token system be viewed as a facility through which a person either: (a) makes a financial investment; (b) manages financial risk; and (c) makes non-cash payments.  It also assists in assessing crypto products against the specific financial product definitions in the Corporations Act 2001 (Cth).

Furthermore, this process identifies the functions and activities of crypto products that sit beyond the existing financial services regime and for which a fundamentally different regulatory framework will be required.

Key takeaways

• Treasury has refrained from creating an exhaustive, bespoke crypto asset taxonomy and instead proposes a high-level taxonomy of four product types that can be grouped under two kinds of token systems:
  • Intermediated token systems:
    
    • Crypto asset services – token systems that accept crypto tokens as part of performing a function under a legal agreement or other arrangement; and
    • Intermediated crypto assets – a crypto asset where the link between the crypto token and the token system is created by legal agreement or another arrangement (i.e. "tokenising").  Examples include fiat-backed stablecoins and wrapped real-world assets.
  • Public token systems:
    • Network tokens – tokens that are created as part of the "consensus mechanism" on public crypto networks which are used by holders for various other functions.  These tokens reward participants who contribute to ensuring all participants agree to the same database; and
    • Public smart contracts – smart contracts (and associated crypto tokens) which are created for the purpose of enabling unknown parties to enter transactional relationships.
• A unique feature of intermediary token systems is that they can create links between crypto systems and the traditional financial system, including where these systems facilitate trading between fiat money and crypto tokens or involve the issuance of crypto-linked debit/credit cards.
• The existing regulatory framework may apply to intermediary token systems in circumstances where these systems are facilitating general financial functions, noting that these systems involve intermediaries or agents performing functions pursuant to promises or other arrangements (which is akin to traditional financial services offerings).  Further regulatory reform, including in respect of custody and licensing, may nevertheless be required to ensure of good consumer outcomes and financial stability. 
• Further to the above, the Consultation Paper specifically considers the scope for crypto asset services to constitute financial products, with Treasury seeking feedback on whether specific arrangements should be included in the definition of "financial product" to prevent service providers from using complex structures which deliberately complicate an assessment of whether or not they fall within the regulatory perimeter;
• Public token systems, on the other hand, operate without a promise that an intermediary will perform a function.  Instead, they involve functions being ensured by a crypto network directly and result in transactional relationships being created by the relevant parties themselves.  Many of these systems therefore do not map to the existing regulatory framework, noting that this broadly applies in the context of products that do involve promises, intermediaries and agents. 
• A fundamentally different approach to regulating certain public token systems may subsequently be required, though it will still firstly be necessary to consider whether any such systems fall within the existing framework.

This paper signals an intention to at least uplift guidance from the current technology neutral, "you have to work it out yourself" regulatory stance, which has been the norm for a number of years. However, with many layers of complexity in the cryptoasset industry, and more innovation likely to take place, there is a risk that guidance may not work as intended, or may become out of date very quickly. Amendments to the "financial product" definition to specifically address crypto are likely to be fraught with complexity and consensus on exactly what features would mean a crypto is inside that definition may be difficult (or even impossible).  

Next steps

Treasury is presently seeking feedback on the Consultation Paper and considers that the responses it receives will inform a fact-based, consumer conscious and innovation friendly approach to policy development.  In particular, Treasury has outlined that it will consider industry feedback when drafting its proposed framework for the custody and licensing regimes, which it expects will be released for public comment in mid-2023.

Submissions are due to Treasury by 3 March 2023.