For the first time, the crypto industry has useful guidance on the application of certain financial product definitions to crypto products and services following the recent judgement in Australian Securities and Investments Commission v Web3 Ventures Pty Ltd [2024] FCA 64 (Case), but not all issues have been resolved.
We highlight below the key takeaways and what it may mean for you. Following the judgment, we have answered some key questions relating to the case including:
- What was the Block Earner case about?
- What was the “Earner” product?
- Was the Earner product a financial product?
- What was the “Access” product?
What was the Block Earner case about?
ASIC commenced proceedings against Web3 Ventures Pty Ltd trading as Block Earner for carrying on a financial services business without an Australian Financial Services Licence (AFSL) in contravention of the Corporations Act 2001 (Cth) (Act) as a result of Block Earner’s “Earner” and “Access” products, which provided customers with access to crypto staking in different ways.
ASIC contended that Block Earner’s “Earner” and “Access” products involved the provision of:
- a managed investment scheme (MIS);
- a facility by which a person makes a financial investment (Investment Facility); or
- a derivative,
which are financial products requiring an AFSL.
The Court ultimately held that the products were regulated as follows:
| Financial Product | Earner | Access |
| MIS | ✓ | X |
| Investment Facility | ✓ | X |
| Derivative | X | X |
What was the “Earner” product?
The Earner product enabled customers to lend certain crypto tokens to Block Earner. Block Earner then paid a fixed interest rate (a yield) to customers for the loaned crypto tokens. Block Earner used the loaned crypto tokens to generate income for itself by on-lending those crypto tokens to third parties, but irrespective of what Block Earner made, customers only received the fixed interest rate in crypto tokens as agreed. Block Earner was required to pay the yield and return the loaned crypto tokens to customers even if the loans Block Earner had made were never repaid. Block Earner closed the Earner product following ASIC engagement.
Importantly, Block Earner made representations to customers on its website, some of which contradicted the Terms of Use. In particular, the website contained representations about how the yield for customers was generated by pooling funds and lending it to third parties.
Was the Earner product a financial product?
The Court considered the requirements of each of the financial products and the application of these requirements to the Earner product.
Managed Investment Schemes (MIS)
For MIS, the court found that the Earner product was a managed investment scheme as all three characteristics were met for the following reasons:
| Requirement | Met | Why |
| MIS | ||
| People contribute money or money’s worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether the rights are actual, prospective or contingent and whether they are enforceable or not) | ✓ | This requirement of “contribution” suggests some element of pooling. Justice Jackman found this first requirement was met because of the representations made to customers on the website. These Representations effectively provided that Block Eaner was able to generate returns by pooling customer funds and on-lending those funds. This was despite the fact that:
|
| Any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits, or benefits consisting of rights or interests 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) | ✓ | Justice Jackman noted that this requirement implied an objective intention. The court held that this second requirement was met based on the representations that customer funds would be pooled and the purpose of pooling the funds was to generate returns by lending the funds to third parties in return for a favourable yield rate. This finding was not changed by the fact that:
|
| 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 to give directions) | ✓ | This requirement was met because customers could only control when they joined or left the scheme, not how the scheme was operated i.e. they controlled when they invested and divested |
Facility for making an investment (Investment Facility)
The court found that the Earner product was a facility for making an investment as both requirements were met for the following reasons:
| Investment Facility | Met | Why? |
The investor gives money or money’s worth (the contribution) to another person and any of the following apply:
|
✓ | This first requirement is met if any one of the three alternatives is satisfied. Justice Jackman took the view that all three were satisfied, albeit for slightly different reasons. For the first and third alternatives, Block Earner made representations that customer funds were pooled and on-lent to third parties to generate a favourable yield with which to pay customers their fixed interest rate. The second alternative was harder to establish as it requires evidence of the customers’ intention. Any determination of intention for this purpose is not limited to the terms of the agreement but may have regard to the context of all of the relevant circumstances, including representations. In the present case, even though there was no direct evidence of customers’ intentions, it was more likely than not that customers had the requisite intention given the prominence of the representations. |
| The investor has no day-to-day control over the use of the contribution to generate the return or benefit. | ✓ | Justice Jackman did not consider this requirement in his judgment. However, the reasoning used for an MIS above equally applies and we suspect that is why it was not separately addressed. We note that Justice Jackman used this reasoning for the Access product below. |
Derivative
The court held that the Earner product cannot be a derivative for the following reasons:
- the Earner product was an MIS;
- the scheme was an unregistered MIS that had 20 or more members; and
- such schemes are excluded from the definition of a derivative.
What was the “Access” product?
The Access product was marketed to customers as providing them with access to DeFi protocols that provide a platform for users to lend their cryptocurrency holdings and earn interest. Importantly, crypto tokens remained the customer’s property at all times and were not lent to Block Earner. Block Earner placed customers’ crypto into each DeFi protocol in an omnibus account and maintained ledgers to manage this. Essentially, Block Earner acted as a technology solution to provide simplified access to a platform.
The Court considered whether the Access product was an MIS, investment facility or derivative.
MIS
ASIC alleged that the first two MIS requirements were met as Block Earner aggregated customers’ crypto tokens in the omnibus account. The court rejected this on the basis that:
- the money which they paid to Block Earner for the Access product, and the financial performance of the tokens purchased with it, were treated on an individual basis;
- customers at all times retained ownership of the crypto tokens and returns paid in respect of them; and
- there must be a ‘purposive link’ between the pooling and financial benefits having regard to statutory interpretation principles, that is, the pooling must be what gives rise to the benefits. In this case, lower fees were not necessarily apparent to customers and, on that basis, there wasn’t a purposive link.
For these reasons, the Access product is not an MIS.
Investment Facility
Justice Jackman was of the view that the first requirement was not met in relation to the Access product as:
- Block Earner did not generate the returns. It simply provided services that enabled customers to access Aave and Compound DeFi protocols to earn a yield. Essentially, Block Earner acted as a ‘broker’ effecting transactions on behalf of clients and passing on returns to customers. That is, Block Earner was not a product issuer; and
- There was no intention on the part of Block Earner or customers that contributions would be used by Block Earner to generate a return given Block Earner’s role as a broker.
Derivative
The Court also considered whether the Access product was a derivative but concluded it was exempt as the Access Service was a future provision of services.
Key Takeaways
- Any disclosure or representation about what a provider will do with any crypto tokens lent to it can change the nature of a product or service (including staking services) as described in the terms of use. It is critical that the terms and disclosures are consistent and reflect the nature of the product or service offering.
- It continues to remain unclear whether cryptocurrency is property under common law although nothing turned on this for this case.
- Careful consideration needs to be had about the structure of a staking or earn product to ensure that it is not offered as a regulated financial product.
- The upcoming DAF regulation will likely capture and regulate those platforms offering currently unregulated earn and staking products.
For more information, please contact Jaime Lumsden, Michele Levine or Nicholas Pavouris.
