Cha-Ching...Bitcoin? The rise of FinTech and the policy implications of Cryptocurrencies on the Australian financial and regulatory landscape

Sonia attended the 2017 World Bank and IMF Forum. She is studying a Bachelor of Commerce at the University of New South Wales. 

Abstract

FinTech is rapidly transforming the financial sector. Public awareness of cryptocurrencies is increasing and in turn, the industry is poised for changes to the status quo (IMF, 2017). Whilst the Australian Government released a report ‘Backing Australian FinTech’ in June 2016, there is very limited legislation and regulation of the FinTech space. This has created a significant void in consumer protection and severely weakens the opportunity for Australian businesses to capitalise on this new digital financial era. The changes brought by FinTech are inevitable and Australian regulators can no longer ignore its widespread adoption and ramifications.

This paper will recommend policies to create a prosperous and positively impactful FinTech sector within the Australian community. It will explore the use and challenges associated with cryptocurrencies from a regulatory perspective. Opportunities to establish Australia as a regional hub that fosters FinTech innovation and defines the trajectory of this era will also be investigated.

Proposed Recommendations

Broadly, my policy recommendations are as follows:

1.     Adopt and implement international standards and operational regulations for all DLT transactions

2.     Create a pool of a Government approved cryptocurrency wallets

3.     Invest in the creation of a ‘Digital Australian Dollar (DAD)’

4.     Establish an Indo-Pacific FinTech panel to create an evolving strategy to oversee its implementation, with a goal to foster cross-border payments and bridge regional markets

Introduction & Context

The rise of FinTech is revolutionising monetary systems. The IMF’s published FinTech discussion in June 2017, signals the importance of a country’s response to these emerging technologies and the effect it has on a domestic and global scale. In order to embrace this new digital era, an understanding of Australia’s current digital monetary environment is vital. Additionally, it is essential to create policies around standards harmonisation, technical alignment and regulatory adherence.

The Australian Government released a report titled ‘Backing Australian FinTech’ in June 2016, outlining preliminary policy reforms. However, gaps in the report’s recommendations exist on the specificity of digital currency regulations and the nature of FinTech ventures. Thus to ensure an upward trajectory for the Australian FinTech industry, this paper will aim to develop an assessment on the following two questions:

1.     What regulatory frameworks, industry and consumer safeguards need to be implemented to address the use of cryptocurrency’s and their associated challenges in Australia?

2.     How can Australian public policy enable a landscape conducive to digital currency use and global recognition as a major hub?

Policy Recommendations

1.     Distributed Ledger Technology (DLT) to disseminate digital currency

Distributed Ledger Technology (DLT), often referred to as blockchain, records and tracks information via a decentralised or ‘distributed’ system in which information is independently updated by unique approval nodes across a network (Zuberi, 2017). This protocol was first used by Nakamoto’s Bitcoin (Nian & Cheun, 2015), and has since formed the basis for digital currency and financial instrument transactions. The self-authenticating nature of DLT suggests strong transaction accuracy, paving the road for its high adoption rate as the monetary movement infrastructure of choice (Zuberi, 2017).

There are currently limited Australian regulatory frameworks that provide guidance on DLT transactions and monitor the potentially contentious points that may occur during the process. It is noted that ASIC does not classify digital currencies as legal tender (ASIC, 2017). Thus, individuals and/or businesses do not have to accept digital currency as a form of payment. Its value is not guaranteed by the Government, and users are not protected from loss nor do they have access to statutory recourse should the platform be compromised. Australian regulators must move to rectify this by shaping DLT regulations and creating frameworks that pre-empt legal uncertainties during monetary and asset transfers in order to protect the individuals ownership rights.

 1.1 Create a framework to determine legal settlement finality

Legal settlement finality is core to guaranteeing monetary transaction validity. Current financial systems provide a clear point at which settlement occurs and funds cannot be revoked by any party (Chiu, 2017). This validates the transaction as entirely complete and unconditional.

This point of settlement finality is blurred in DLT transactions. The ‘consensus algorithm’ on which DLT transactions rely on, create an arbitrary time-influenced confirmation of irrevocability (Bank for International Settlements, 2017). Hence, parties are currently unable to determine the exact point at which the funds have successfully changed ownership and are irrevocable. This ambiguity leaves cryptocurrency transactions vulnerable to participant insolvency and creates uncertainty between monetary ownership.

To mitigate this, Australian regulators must define legal settlement finality for DLT transactions. This can be achieved by the creation of an Australian DLT legal settlement finality framework. The framework must detail the moment at which a transfer becomes legally enforceable for different settlement system levels and ledger recorded state changes during DLT transactions (IMF, 2017).

1.2 Define the legal status of asset-backed tokens during/post in-flight data transfers

At its foundation, DLT transactions are recorded using the movement of ‘digital tokens’ as units in a ledger (Mills et al, 2016). These digital tokens can be classified as deriving value from intrinsic or extrinsic means. Intrinsic tokens are resources with utility built into the Blockchain as incentives (Bacina & Kassra, 2017), for example Bitcoin. Asset-backed tokens are digital representations of real assets, and provide users ownership to these securities (Bacina & Kassra, 2017). In Australia, security ownership is currently recorded on electronic registers (ASX, 2017). However, with DLT providing a secure platform to trade asset-backed tokens, the definition of ‘point of ownership’ and the legal effect of the token transfer must be mapped out. With the token representing an external monetary asset and the need for identification of individual ownership increases, the existence of secondary corporate registries to record transactions are uncertain (Mills et al, 2016). Thus, Australian regulators must define the legal status of these tokens and clearly outline the procedures for their use.

2.   The issue of ‘Trust’

Digital currency currently operates as an unregulated market without any Australian Government or bank protection. For example, if the platform were to fail users would have no legal avenue to recover lost funds. It’s global prevalence and ubiquitous use, without strict regulation, leaves users vulnerable to third-party operators. The importance of a users trust in the utilisation of a digital currency or interaction with DLT is vital in substantiating digital currency usage. As flagged by the IMF, users need to trust the security of exchanges, wallet providers and the stability of the technology underlying the cryptocurrency (IMF, 2017).

Privacy and security policies for all parties are of utmost importance. The safe storage of consumer data and information is not currently guaranteed for use of digital wallets. Additionally, there is an abyss of official information on reliable vendors (ASIC, 2017).  Thus, creating a pool of Government approved wallets will better equip users to do this. This pool of wallets will be sourced from providers who adhere to comprehensive security protocols and regulatory mandates. This is not expected to act as a guarantee of the wallets safety by the Government. Rather it would provide a strong guide to prevent individuals and/or businesses from using fraudulent providers when choosing their online wallet provider. 

2.1 Maximising cryptocurrency safety for the majority of users

Both Government and regulating bodies have lost the ability to implement and maintain controls around digital money. Values fluctuate, and no Australian safeguards currently exist should the platform fail or is hacked (ASIC, 2017). Pre-approved wallets with strong cyber protection can minimise the risk of individual fraud by insincere providers or platform failure. As of 1 July 2017, Australian taxation laws will change to exempt the purchase of digital currency from the GST (Australian Taxation Office, 2017). Altering this to only exempt digital currencies from GST, if using a pre-approved wallet, will incentivise the majority of users to switch. It will provide regulators and officials a closer degree of control with the ability to monitor transactions and digital money use albeit de-identified from the individual. As cryptocurrency use becomes mainstream, it will also protect a larger number of individuals and businesses against a higher risk of fraud.

2.2 Allow use of approved wallets only for merchant and business transactions

The anti-money laundering and counter-terrorism financing Act (2006) places obligations on financial entities, including customer identification and record keeping, to monitor the legal flow of funds through their systems (AUSTRAC, 2016). The anonymity offered by digital currencies provides an increased avenue for cryptocurrency use to enable money laundering and terrorism financing. This is a large source of concern for Governments across the world, and any oversight that can be provided into fund transfer could work towards the management of this issue. The decentralised design of the DLT was created to guarantee the de-identification of all parties involved in transactions (Zuberi, 2017). However, pre-approved wallets will, at its core, allow Australian law enforcement and regulators insight into the flow of funds and potential malicious use based on transfer patterns.

3.   The ‘Digital Australian Dollar (DAD)’

Industry body ‘FinTech Australia’ have constantly lobbied the Reserve Bank of Australia for the creation of the Digital Australian Dollar (DAD) (Yoo, 2017). The DAD would be a digital version of the Australian dollar that is transacted on the DLT, with its value derived from the fiat currency. This will mitigate the volatility and uncertainty of current digital currencies, which are not based on tangible or regulated valuations. DLT provides immensely secure transactions, and the creation of the DAD will enable Australia to “grow the digital currency marketplace” (Yoo, 2017). Payments can be made in real time, the risk of loans and repayment cash flows are lowered, and the creation would enable FinTech start-ups unprecedented access and ability to unleash the power of blockchain. Similar processes such as Government taxation and revenue collection can be automated, and evasion dramatically reduced. This is all done with an in-built trust that private digital currency offers could never match (Sadler, 2017).

Japan Banks are already rumoured to be in the midst of creating an official version of the Yen in digital currency. Named the ‘J-Coin’, it is thought to be launched for the 2020 Tokyo Olympics (Kharpal, 2017). It is evident that the DAD will further facilitate and complement the adoption toward the cashless society that we are fast moving toward (Smith, 2017). ATM withdrawals are declining in Australia, with RBA figures showing a 7.7% drop from January 2016-2017

The use of a DAD can be seen to directly mitigate regulatory concerns on currency stability and monetary policy. Users still have access to the implicitly secure and convenient nature of digital currency transactions, whilst regulators can guarantee the stability of the funds used and better regulate the market as the direct issuers of the DAD.

4.   International cooperation and cross-border payments

Standards Australia, an independent non-for-profit organisation, recognised by the Australian Government as the peak non-government standards body, are primary facilitators in the international push to develop and adopt a ‘Blockchain Standards Roadmap’ (Standards Australia, 2017). Australia is the current Secretariat of the International Technical Committee for Blockchain Standards (ISO/TC 307) on the back of Standard Australia’s proposal for the creation of international standards on blockchain. This demonstrates the strong position of Australia to shape the future of DLT standards globally. Yet a gap exists on the creation of specific FinTech standards, especially within our region.

Australia’s future is deeply aligned with that of our region and this is equally true in the FinTech space. China and India hold leading positions in the world cryptocurrency trade. Capitalising on this to create policies to maintain oversight and stability, without stunting growth, is imperative. In particular, the facilitation of cross-border payments via DLT is a highlighted request by the IMF, and requires global support and partnership that cannot be undertaken without regulatory agreements on an international level (IMF,2017).

Australia is in a unique position to drive the shaping of regional policy and creation of partnerships amongst cross-border FinTech industries. This is due to our strong trade relationships with regional countries, the significant growth of the Australian FinTech sector and diverse ecosystem of FinTech subsectors (Swan 2017, KPMG, 2017). This is the moment at which standards are defined, and an Indo-Pacific FinTech panel will provide Australian industries the opportunity to create an environment that will magnify these benefits brought about by digital currency.

Singapore and Japan are two regional countries whose FinTech industries are experiencing strong growth, with the two countries already having introduced a FinTech Cooperation Framework (Monetary Authority Singapore, 2017). In line with this, the Indo-Pacific FinTech panel will enable a regional facilitation of information and lessons learnt from each country’s industrial adoption and regulatory decisions. Australia can and should take the lead for the creation of this multi-lateral hub. The knowledge capital available and sharing of resources will be invaluable. Invaluable in the creation of domestic and international policies that are successful, scalable and manage the risks associated with digital currency.

Recommendation Limitations

It is acknowledged that the recommendations outlined in this paper are limited by certain factors. At its core, cryptocurrencies enable for anonymity without compromising on transaction trust. Regulations, which aim to add a layer of identification to DLT transactions by adding external checkpoints, can moot its very nature as a self-authenticating single-source of truth. This must be appropriately managed so as not to undermine DLT’s core proposition.

Security associated with digital currencies is a limitation that must be addressed before the creation of a fiat currency such as the DAD. Should wallet-hosting websites be hacked or passwords leaked, the consequence of lost funds would be significant. Likewise, sensitive consumer financial data could be exposed as all their transactions would be evident in the blockchain (Wijaya, 2017). Similarly, government endorsement of third party cryptocurrency wallets must be caveated with strict legal controls that mitigate governmental responsibility of failures or security breaches.

Conclusion

The FinTech industry, DLT and digital currencies are disrupting traditional methods of commerce. Australian regulators can no longer ignore the widespread adoption and increased use of cryptocurrencies and must move to embrace and pro-actively respond. Mapping digital currency integration into new regulatory frameworks and protecting consumers without stifling growth, is the underpinning of a future trajectory of cryptocurrency use in Australia.

It is vital that Australia does not let the cryptocurrency wave bypass opportunities for future industrial growth. As stated by FinTech Australia CEO Danielle Szetho, the creation of a DAD “would be a huge step to grow our vibrant blockchain and digital currencies industry” (Yoo, 2017), without undermining Australia’s currency stability and monetary policy goals. 

Digital currencies have further shrunk barriers to cross-border payments and the collaboration between countries will enable true international standards that will further cement the advantages of our increasingly globalised and connected world. Regional co-operation is key, and FinTech is an industry that Australia is geographically, academically and politically well placed to partner with. Thus Australia has the potential to be a leading country in the Indo-Pacific as we enter the ‘Asian Century’. The opportunity for Australia to become the Indo-Pacific’s FinTech Hub must be acted upon now. 

Technology is rapidly advancing, and the Australian Government and regulatory bodies must act to cement Australia’s place as a FinTech hub and digital economy of the future.

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