Cryptocurrency exchanges will need licences to operate in Australia as the government looks to fold crypto into existing financial services legislation in the hopes of mitigating the risk of exchanges leaving behind a trail of creditors when they collapse.

On Monday, Treasury opened consultation on its proposal for a cryptocurrency regulatory framework that treats asset holding as an “anchor point” and will focus on licensing requirements for large custodial and trading platforms.

“Collapses of crypto platforms, both locally and globally, have seen Australians lose their assets or be forced to wait their turn amongst long lines of creditors,” Treasurer Jim Chalmers and Financial Services Minister Stephen Jones said in a joint statement.

“The proposed reforms seek to reduce the risk of these collapses happening by lifting the standard of the operation of platforms and increasing oversight.”

Under the proposed regulatory framework, all crypto exchanges or intermediaries would need to have an Australian Financial Services Licence and adhere to minimum standards.

Those standards would “include requirements to have adequate organisational structure, staffing capabilities, and capacity and resource to perform core administrative activities” and the need for custody software to be “continuously monitored and routinely audited”.

A business would be exempt from needing a licence if it doesn’t hold more than $1,500 on behalf of any one client and holds less than $5 million worth of assets.

The Treasury paper tries to tread the line between clamping down on the worst parts of the cryptocurrency ecosystem – scams, uncertainty, theft, and marketplace collapse – while allowing for further innovation and the ‘tokenisation’ of our financial system.

Merely making blockchain software or creating NFTs for video games won’t fall within the scope of the regulatory proposal, rather it is targeting “businesses the ability to exercise, coordinate, or direct ‘factual control’ over the assets in a real and immediate sense”.

“The broad approach is intended to be technology agnostic,” Treasury said. “It aims to capture the risk consumers are exposed to when relying on any third party to hold assets.”

The risks of third-party custodial arrangements – like storing your crypto on an exchange – have been known throughout the history of crypto and were especially visible last November when trusted exchange FTX collapsed spectacularly, leaving around 50,000 Australians among a long line of international creditors.

In its paper, Treasury said the failure of platforms like FTX was “symptomatic” of an unregulated industry and had been “further amplified by the vertically integrated nature of digital asset platforms – where various functions, like trading and holding assets, are managed within a single organisational structure”.

FTX was a prime example of this problem, as has been highlighted during the recent trial of its co-founder Sam Bankman-Fried who orchestrated a backdoor in the platform’s code that let him move customer funds to a related arm of the business.

While regulation has generally been welcomed, even encouraged, by the crypto industry, critics say the government’s approach has been too slow.

Dr Dimitrios Salampasis, a senior lecturer with Swinburne University, said the framework was “marked by numerous and often unnecessary delays” which he characterised as being “quite detrimental both for the industry and the users”.

“Australia is already way behind compared to other jurisdictions in relation to putting together crypto regulatory frameworks, raising questions about Australia’s international competitiveness.”

Indeed, Monday’s Treasury paper is just the latest in a long, and as-yet-incomplete, process of consultation and consideration.

Consultation for this paper closes on 1 December, 2023 and there will be yet another round when draft legislation is circulated next year.