Tracking ASIC’s 2023 enforcement priorities one year on: Crypto assets

For 2023, ASIC included “misconduct involving high risk products including crypto assets” in its list of enforcement priorities. This foreshadowing of action against non-compliant crypto businesses became a reality for a small number of companies who have been the recent subjects of enforcement action by ASIC. These businesses include Web3 Ventures Pty Ltd trading as Block Earner; Bobbob Pty Ltd; Bit Trade Pty Ltd which operated the Kraken crypto exchange; Helio Lending Pty Ltd; and Oztures Trading Pty Ltd, the Australian subsidiary of the now-infamous exchange, Binance.

This article looks closely at the first judgment obtained by ASIC against a crypto business –Block Earner.

The decision of Jackman J of Australia’s Federal Court in Australian Securities Investment Commission v Web3 Ventures Pty Ltd [2024] FCA 64 represents the corporate regulator’s first successful case against a business operating in the crypto industry, and for this reason, warrants close attention for any businesses operating in this space.

The matter is currently adjourned pending a further hearing on the issue of penalties to be imposed on Block Earner.

The Block Earner Business

Block Earner was founded in 2021 in Australia and operated products on its online platform, including:

• The “Earner product” from around 17 March 2022 to 16 November 2022. Users of the Earner product could access through Block Earner’s online platform the Aave and Compound DeFi lending protocols which operated on the Ethereum blockchain.
• The “Access product” from around March 2022 to at least the date of the final hearing. Users of the Access product were able to lend cryptocurrency to Block Earner in exchange for a fixed interest rate.

Block Earner also operates a digital currency exchange registered with AUSTRAC that allows users to exchange AUD into over 100 cryptocurrencies including USD Coin, Paxos Gold, Bitcoin and Ethereum.

The Enforcement Proceedings

ASIC commenced proceedings in the Federal Court alleging that both the Earner and Access products were “financial products” – specifically, managed investment schemes – that could not be provided to customers in Australia without Block Earner holding an Australian Financial Services Licence. ASIC emphasised that both services involved the pooling of user funds and/or the use of user funds to generate a financial return for users, being the hallmarks of a managed investment scheme or a facility requiring an AFSL.

Section 9 of the Corporations Act defines “managed investment scheme” as:

(a) A scheme that has the following features;

(i) people contribute money or money’s worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether the rights are actual, perspective or contingent and whether they are enforceable or not);

(ii) any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits, or benefits consisting of rights or interest in property, for the people (the members) who hold interests in the scheme (whether as contributors to the scheme or as people who have acquired interests from holders);

(iii) the members do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or give directions) …

In its defence, Block Earner submitted that the services did not constitute a managed investment fund or scheme and/or a derivative on the basis that:

• under the Earner product, users were entitled to a fixed yield notwithstanding Block Earner’s performance with its institutional partners;
• the Access product was designed to help users access DeFi lending protocols wherein the ownership of the digital assets was maintained by the user and all yield from such protocols was given to the user by Block Earner; and
• users were able to use their own cryptocurrency to use the services instead of exchanging AUD through Block Earner.

The Court’s Reasoning

First, the Court considered whether the Earner product constituted a “scheme” – that is, the essence of being a coherent and defined purpose in the form of a “program” or “plan of action”, coupled with a series of steps or course of conduct to effectuate the purpose and pursue the program or plan. The unique features of the Earner product (set out in [36] of the judgment) were evidence of a scheme.

Second, the Court found that the investors of the Earner product effectively contributed their money jointly to furnish a common fund which was, in turn, pooled and lent to third parties to generate a return. While the terms of use did not mention pooling, the Court considered that Block Earner had represented to its customers that their funds were being pooled for the purpose of generating a return. Finally, the customers did not have day-to-day control over how the pooled funds were managed; they could only decide to deposit or withdraw funds.

By contrast, the Access product involved individual customers retaining ownership of their tokens – so there was no pooling. The funds held by Block Earner on behalf of customers were not used in a common enterprise to produce financial benefits. For these reasons, the Court found that the Earner product did not comprise a managed investment scheme.

The outcome of this reasoning was that the claims made in relation to the Access service were dismissed. In respect of the Earner product, the court made declarations that it constituted a management investment scheme which could not be operated without an AFSL.

ASIC has indicated that it will now seek orders from the court to impose a pecuniary penalty on Block Earner in respect of its operation of the Earner service without an AFSL.

Our Insights

This decision is significant for two reasons.

First, for the narrow class of crypto business operating decentralised financial services in the nature of investment products it provides clarification about what will be considered a managed investment scheme. This decision (and the detailed reasoning of Jackman J) will assist business in deciding whether they ought apply for an AFSL.

Second, for the broader class of businesses operating businesses providing any sort of crypto product in Australia the decision demonstrates ASIC’s willingness to test the boundaries of its regulatory ambit through litigation. The fact that each party had some success in this matter shows that it is not only the most flagrant breaches that will attract regulatory proceedings. ASIC is also signalling that it is prepared to take action where there are reasonable arguments on both sides for the purpose of testing the limits of what can and cannot be regulated. The international uncertainty around crypto exchange in particular will likely continue to motivate the corporate regulator in protecting consumers from unlicensed businesses providing harmful financial services.

Our Australian team has experts who can advise at all stages of corporate regulatory compliance. Please reach out anytime to discuss these important issues.