Australia, will you be custodying digital assets?

Australia’s national Treasury’s recently released Regulating Digital Asset Platforms Consultation Paper proposes a framework for regulating digital assets that leverages the existing Australian financial services (AFS) licensing regime and introduces a new financial product called a digital asset facility (DAF).

While it is possible the proposal may still change, at present, and importantly, a facility will be a DAF if it is an asset holding arrangement or if it performs any one or more “financialised functions”, being token trading, token staking, asset tokenisation and crowdfunding. It is likely that asset holding will remain the central theme and anchor point for regulation, notwithstanding any tweaks Treasury may make. This is because asset holders are the primary gateway to crypto products and services, as well as the function of asset holding presenting one of the largest risks a person trading digital assets can face i.e. loss of those assets.

What is asset holding?

The Consultation Paper recognises two types of asset holding arrangements:

• DAFs that hold tokens; and
• DAFs that hold real world assets that back tokens.
• DAFs that will hold tokens are part of Australia’s $21.6bn of Australia’s crypto industry and it is presently unknown the scale of asset holding that may be required in relation to real world assets.

When it comes to tokens, it is proposed that a person will hold assets in custody where they have ‘factual control’. Factual control as a concept is broad and seeks to capture all cases where digital assets are at risk with providers. It is unclear whether factual control will require both positive control (can transact with the token e.g. use, disport or transfer) and negative control (excluding others from using the token). This is likely to be further considered and clarified as part of the legislative drafting process as there may be instances where a DAF has positive control but not negative control.

Either way, it is safe to assume that you will be a DAF if you store customer tokens in a hot, warm or cold wallet owned and operated by you. If your wallet solution is provided by, or utilises, third party technology, this will not change the outcome. It also doesn’t matter if you hold the tokens in an omnibus wallet or segregated wallets.

What digital assets are caught?

When it comes to the custody rules for digitals assets, not all digital assets are equal. Currently we expect digital assets custody rules to apply as follows:

• All digital assets that are not financial products, including where held through a financial product structure e.g. BTC held by ETF
• Any digital assets that are financial products of themselves (e.g. a token that is a derivative)

It is possible this may change as part of the legislative drafting process. This is because it may make more sense for all digital assets to be subject to the same custody requirements given:

• traditional custodians are not currently set up to provide custody solutions for digital assets and it is unclear whether or how quickly this will change;
• any differential treatment may engender opportunities for regulatory arbitrage as businesses may decide to artificially design a product to fall inside or outside of traditional financial services; and
• digital assets have a different risk profile to other traditional financial products.

If you currently custody digital assets (that are not financial products) in Australia, we recommend you familiarise yourselves with the upcoming changes, as they may have significant impacts on your business and you may need to make decisions to prepare. Get in touch with our friendly Zodia Custody team in Australia if you’re considering delegating or outsourcing custody as a value-add to your clients, and we can have a chat about how we can help you keep their assets safe with a true, qualified custodian.

Watch out for the second blog in this series “What are the digital asset custody requirements?” to further inform your decision-making.

This blog series on regulating digital asset platforms in Australia is produced in collaboration with Hamilton Locke, an award-winning team of lawyers advising forward-thinking businesses and innovators on their most pressing challenges. Special thanks to Michele Levine and Jaime Lumsden.