Category Archives: Financial Services

Crypto Regulation in Australia

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You wait ages for a bus, then several come along at the same time. The past week has seen three major developments in Australia regarding the regulation of cryptocurrencies, digital assets and the industry in which they operate.

First, there was the Final Report of the Senate Select Committee on Australia as a Technological and Financial Centre. Among other things, the Committee has recommended a specific regulatory framework for Digital Currency Exchanges, a formal custody regime for digital assets, a classification (or “token mapping exercise”) for the various types of digital assets, and a legal framework to recognize Decentralised Autonomous Organisations as a form or company structure.

Second, AUSTRAC issued a Statement on De-banking, that urges banks and financial institutions to take a case-by-case approach when reviewing potential risks associated with clients engaged in Blockchain and cryptocurrencies. Rather than applying a blanket ban or refusal to deal with Blockchain and crypto businesses, banks and other providers should exercise more discretion, and adopt workable and practical solutions to meet their risk management and KYC/AML obligations. Echoing the overarching theme of the Senate Select Committee, AUSTRAC recognises that de-banking crypto risks stifling innovation, and/or forcing crypto businesses to resort to less than ideal alternative service providers.

Third, ASIC released its Response to submissions made under the recent consultation on Crypto-assets as underlying assets for ETPs (aka Report 705 on CP 343). While there is some overlap with the scope and terms of reference of the Senate Select Committee, ASIC maintains its position that it does not want to be responsible for developing policy on regulating digital assets (that’s the role of Government); while at the same time stating in very clear terms how it believes cryptocurrencies should or shouldn’t be classified (and regulated). For example, ASIC did not accept the view of many respondents that crypto-assets which are not deemed financial products should be treated as commodities. In part, because there is no definition of “commodity” in the Corporations Act; but also because the discussion has been more about market operators, rather than the specific nature of the assets themselves.

Meanwhile, ASIC remains very prescriptive about the criteria for approving certain cryptocurrencies as the underlying assets for exchange traded products (ETPs) – including criteria which received push back from the industry as being too restrictive or inflexible. On the other hand, ASIC does appear to accept that if crypto-assets cannot be defined as financial products (or commodities), then a distinct category is required. This is the case that has often been put forward by the industry, namely the need to define instruments commonly known as utility tokens. To its credit, ASIC has made a fair stab at coming up with a workable definition of crypto-asset as:

“a digital representation of value or rights (including rights to property), the ownership of which is evidenced cryptographically and that is held and transferred electronically by:
(a) a type of distributed ledger technology; or
(b) another distributed cryptographically verifiable data structure.”

While the overall tone of these developments is encouraging, they still reveal a need for greater consistency (and inter-agency co-ordination), and the lack of a well-articulated policy on this fast-growing FinTech sector.

Next week: Is crypto finally going mainstream?

 

To be or NFT?

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If there’s one consistent lesson to be learned from Blockchain and crypto is that the enabling technology often outpaces our understanding of the viable use case, commercial application or sustainable business model. For example, smart contracts have only recently proven their value with the rise of decentralized finance (DeFi). Even then, they are not perfect and if not well-coded can result in hacks, losses or other damage. Plus, until scaling (transaction throughput) and gas fees (transaction costs) are properly resolved, mass adoption is still some way off.

CryptoPunk #7523 (Image sourced from Reuters)

The latest crypto phenomenon is the market for NFTs (non-fungible tokens). Artworks in the form of digital files are being created, auctioned and traded for serious (or very silly?) amounts of money – just Google EtherRock, Beeple, CryptoPunk or Rare Pepe for recent examples.

NFTs are not just confined to digital art – animation, video, music and text are all being created in the form of NFTs. In addition, NFTs are being minted to represent ownership or other IP rights for physical artworks, real estate assets, collectibles and luxury goods.

Why would anyone pay the best part of US$12m for the original digital file of CryptoPunk #7523, a copy of which I have displayed above?

Perhaps we need to consider the following:

First, the image above is simply a low-res web image, easily reproduced via copy and paste – it’s not the “real” image as represented by the code or digital file embedded in the NFT. The original file is owned by the NFT buyer, and if it is an edition of one, then that is the only authentic version. Scarcity (as well as kudos) is a key market driver in NFTs – but only if someone else attaches financial value to the work (just as in any art market).

Second, owning the NFT does not necessarily mean you own the copyright or other rights associated with the art work. (I may own a Picasso painting, but I don’t own the image contained in the work.) So, apart from holding an NFT in your digital wallet or displaying it in a virtual art gallery, the only right you have is to re-sell the work. This means you can’t commercialise the image for t-shirts, on-line redistribution or reproduction (unless the owner has agreed to grant such rights within the NFT). (My use of the image here would be covered by the “fair use” principle, for the purposes of illustration and/or critical analysis.)

Third, unless you are able to export the NFT from the marketplace or platform that sold it, the NFT may “vanish” if the platform goes offline for any reason. (Doubtless, platforms need to enable token transfers to other market places and to users’ own digital wallets, otherwise there could be a lot of stranded and/or worthless NFTs in years to come.)

Fourth, the creator of the original work may be entitled to a % of the resale value of the NFT. This is obviously an important consideration for artists and other content creators, and I see this as a positive development. By extension, musicians, authors, film-makers and designers can more easily track and control the downstream revenue generated by the use and licensing of their works by third-party marketplaces, streaming platforms or 3D printing and fabrication services.

Fifth, NFTs support improved authentication, provenance and chain of ownership, as well as bringing more transparency to the world of art auctions – valuations, bidding and prices could all be hashed on the Blockchains that track the NFTs.

Finally, if NFTs are seen as a form of bearer bond (linking ownership to whomever controls the token), they could also be used to package up a portfolio of different crypto or digital assets, and auctioned as a single lot. The buyer could then unlock the disparate assets, and combine them into subsequent bundles – bringing a new dimension to block trades and the transfer of large bundles of stocks.

Next week: I got nothing

 

Accounting for Crypto

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The period leading up to June 30 saw the usual raft of end of financial year updates, special offers and reminders from equipment suppliers, business service providers, accountants, tax specialists and even the ATO itself.

Crypto is certainly getting a lot of attention in Australia at the moment.

First, there is a Senate Select Committee on Australia as a Technology and Financial Centre, including “opportunities and risks in the digital asset and cryptocurrency sector”. The Select Committee is also looking at ways to define and/or potentially regulate crypto assets.

Second, ASIC has launched a public consultation process on crypto ETFs. This follows a desire from the regulator for more policy guidance from the Federal Government on the “regulatory perimeter” for crypto assets.

Third, the CPA published an op ed on the need for more clarity in crypto asset accounting. Not just in Australia, but across the world of International Financial Reporting Standards.

None of this should be surprising, as governments, regulators, tax authorities, professional bodies and institutional investors are still struggling to comprehend this new asset class, and the technology that underpins it.

Do crypto and digital assets represent currency, commodity, real estate, software license, network membership, utility access, payment mechanism, store of value, financial security, or unique property rights? Depending on the design, use case and origination of a token and its economic properties, the answer could be “yes” in each case – albeit not all at the same time.

In my consulting work with Brave New Coin, I get to speak to clients on a daily basis about their own crypto activities – be they exchanges, asset managers, accountants, tax authorities, regulators or investors. A lot of the discussion involves education – helping them to make sense of the technology and its potential. Some of the time they are simply asking our advice about how to address a particular issue, or they need a recommendation for a custodian or broker. A few share the regulatory challenges they face, and seek our perspective in how to navigate them. Others need more technical help, in building software solutions, or with on-chain analysis and wallet tracking (even though “free” block explorers already do a pretty good job in that regard). While many simply need a source of market data and indices for price discovery and NAV calculations, or a process to capture and track the crypto equivalents of corporate actions.

If anyone wonders how we are doing to make the reporting of crypto holdings as simple as equities or fixed income assets, my own experiences suggest we have a way to go. Legacy accounting and portfolio tools struggle with crypto: for example, can they calculate to 8 decimal places? how do they deal with an air drop? and how do they distinguish between Ether and Ethan Minerals (both use ETH as their ticker symbols), or Cardano and Adacel Technologies (both use ADA). And if I am an accountant, auditor, financial planner or adviser, how can I make sure I understand my clients’ portfolio of crypto investments, if I don’t have the appropriate tools?

Next week: Goya – allegories and reportage for the modern age

Startup Vic FinTech Pitch Night

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The Australian tech sector, especially at the startup end of the industry, is having to grapple with what is fast becoming a major structural and operational challenge: how to hire, remunerate and retain staff. With closed international borders cutting off the supply of overseas students and graduates, and a lack of sufficient home-grown skills, it’s a problem that established businesses and startup ventures alike are having to address. Just last week, the AFR reported that some wages in the tech sector have gone up 30% in the past 12 months. Perhaps this issue was on the minds of the four founders who presented at the recent Startup Victoria FinTech Pitch Night.

The judges for this on-line event, sponsored by LaunchVic, were: Nicole Small, Investment Director at Rampersand; Kim Hansen, Co-founder and CEO of Cake Equity; Caitlin Zotti, Operations Manager at Pin Payments; and “the people’s judge,” Eike Zeller, Community Lead at Stone & Chalk Melbourne. Compered by Josh Sharma, Head of Labs & Startups at LUNA, the evening also featured a virtual fireside chat between Rebecca Schot-Guppy, CEO of FinTech Australia, Dom Pym, Co-Founder of Up, and Julia Bearzatto, Head of Technology for Financial Services at MYOB.

The four startups in order of presentation were (links in the names):

Elbaite

Claiming to be the “first non-custodial cryptocurrency exchange“, part of Elbaite’s mission is to prevent theft or misappropriation of crypto assets held in exchange wallets. What makes Elbaite different from other decentralized exchanges (DEXs) and peer-to-peer platforms is that they escrow the fiat involved in any transaction. While they may not be charging the fees of centralized exchanges (CEXs), they are charging a 1% on crypto purchases (although there is 0% commission on sales). Elbaite is hoping to target institutional clients who may not be as comfortable trading on “traditional” crypto exchanges – although in my experience, many institutional clients actually need third-party custody services as part of their governance and compliance obligations. The judges felt that this is a crowded space (there are more than 250 crypto exchanges globally, plus numerous fiat on/off ramps, brokers, OTC desks and P2P platforms).

Sequrr

Speaking of custody and escrow, who would have guessed that stolen house purchase deposits are such a major issue, unless the team at Sequrr had told us? Despite the use of Real Estate Trust Accounts within the industry, apparently there is not much to stop the account holders from walking off with the deposits. Which rather begs the question why the industry does not already use something like multi-signature digital wallets, which mean that the funds can only be moved once all parties to the transaction agree. Even though this is a tech solution using a 3-way verification model (innovation patent pending), the different real estate laws in each State means that it’s not that simple to roll out nationally. However, the team also see opportunities for other professional and commercial sectors: solicitors, builders, aged care. (Note to the founders: I know that invented brand names were once flavour of the month for tech startups, but I question the wisdom of adopting a word that reads like a spelling error, and sounds like someone coughing up phlegm – especially if you want to be taken seriously by banks and solicitors. Just a thought.)

Nextround

Another issue of trust exists between employers and employees when it comes to reward and recognition schemes. There’s always a risk that whatever structure and incentives companies use, someone will try to game the system (or collude with colleagues) especially if the stakes are high; or, if the rewards are simply handed out for turning up and doing your job, their currency becomes debased. Then there’s the (ill-advised) link between rewards and recognition on the one hand, and performance reviews (plus bonuses and salary adjustments) on the other. It’s a balancing act which Nextround are addressing by making it easier (and less expensive) to reward and recognise all of your staff, not just the usual top 5-15%. They do this by offering managers and team leaders access to rewards of a smaller (yet still meaningful) value, which can be easily redeemed by the recipients, for hospitality rewards, events and experiences. The commercial model relies on an annual corporate subscription fee, and taking a cut of the reward vouchers. Nextround consults with employers on their preferred merchants and suppliers, who don’t necessarily see the vouchers as eroding their margins – rather, it’s another sales channel. This is not a hospitality app (e.g., loyalty program), more of a procurement app. And although there are numerous competitors for reward and recognition schemes, the “smarts” are in the way managers and HR teams can budget and allocate accordingly, without the need for onerous expense form claims because the transactions can all be tracked from the point of redemption back to the point of issuance. The resulting data will also generate a further revenue stream from the valuable analytics, although would I want my employer to know how I used my vouchers (assuming they are not tied to a specific reward)? My other reservation is that if the rewards really are as small as a cup of coffee, or even a round of drinks at the pub, isn’t it a bit like tipping?

SpendAble

Letting people make their own financial decisions is also a form of trust. Most of us would feel we can be trusted to spend our own money how we like. But this assumption may be challenged when it comes to people with a disability. SpendAble is developing payment, saving and investment solutions for people who face physical, societal and intellectual barriers to managing the financial affairs. Starting with a budget-based spending app, SpendAble helps users to allocate, identify and track their purchases more easily, and with much of the payment friction removed. The team will also develop specific applications such as voice-controlled functions for the visually impaired. Largely reliant upon the NDIS for funding and end users to cover transaction costs, SpendAble will plug into existing banking platforms – which might be a better way to underwrite the app? However, some of the online chat on the night suggested that SpendAble could provide well-needed general financial education to school kids as part of its offering, as well as helping to address financial inclusion.

Such was the enthusiasm for SpendAble that they took out the Peoples’ Choice as well as the Judges’ Award.

Next week: Accounting for Crypto