On 23 August 2024, the Federal Court of Australia delivered a landmark judgment against Bit Trade Pty Ltd, the operator of the Kraken cryptocurrency exchange in Australia. In the judgment, the apex court found that Bit Trade had failed to comply with critical design and distribution obligations (DDO) under the Corporations Act 2001 when offering its margin trading product, known as the “margin extension,” to Australian customers. This judgment marks a significant victory for the Australian Securities and Investments Commission (ASIC) in its ongoing efforts to regulate the cryptocurrency sector and protect consumers.
Bit Trade Pty Ltd, a subsidiary of the U.S.-based Payward Inc., operates the Kraken digital currency exchange in Australia. Since its acquisition by Payward in 2020, Bit Trade has provided Australian customers access to the Kraken Exchange, allowing them to trade digital assets such as Bitcoin and other cryptocurrencies. Central to the case was Bit Trade’s “margin extension” product, introduced on 5 October 2021, which enabled customers to receive margin extensions in the form of digital assets or legal tender, which could be used to facilitate spot trading on the Kraken platform.
The Terms of Service (TOS) governing the margin extension product outlined several key provisions. Customers were required to maintain a specified level of collateral in their Kraken accounts while a margin extension was active. If the collateral fell below the required level, Bit Trade was authorized to liquidate assets in the customer’s account to restore the necessary collateral or to terminate the margin extension. Importantly, the margin extension could be repaid in either digital assets, such as Bitcoin, or national currencies, such as U.S. dollars.
ASIC’s case against Bit Trade centered on whether the margin extension product qualified as a financial product under the Corporations Act, specifically under Part 7.8A, which imposes design and distribution obligations on issuers of financial products. ASIC argued that before offering such a product to retail customers, Bit Trade was legally required to make a target market determination, a mandatory public document that sets out the class of consumers for whom the product is likely appropriate and outlines the conditions for its distribution and review.
Each time Bit Trade made the margin extension product available to a customer without such a determination, ASIC alleged, it contravened section 994B(2) of the Corporations Act. Bit Trade, on the other hand, contended that the product was exempt from this requirement under regulation 7.8A.20 of the Corporations Regulations, which exempts certain credit facilities from the DDO requirements. The company argued that the obligations under the margin extension did not constitute a “debt” as defined in the relevant regulations, particularly because repayment could be made in digital assets, which Bit Trade asserted did not amount to a monetary obligation.
Justice Nicholas, who presided over the case, meticulously examined the statutory framework, the specific terms of the margin extension product, and the arguments presented by both parties. The Court determined that the margin extension product did indeed fall within the definition of a financial product under the Corporations Act. He found that the product’s provision of financial accommodation, especially when denominated in national currencies like Australian or U.S. dollars, created a deferred debt obligation for customers. This finding meant that Bit Trade was required by law to issue a target market determination before offering the product.
The court rejected Bit Trade’s argument for exemption under regulation 7.8A.20. Justice Nicholas clarified that the obligation to repay margin extensions in a national currency constituted a “deferred debt,” which is recognized as a financial product under the relevant legislation. His Honour also addressed the nature of the repayment obligations under the TOS, noting that while an obligation to repay in digital assets did not constitute a monetary obligation, the obligation to repay in national currencies did.
In his judgment, Justice Nicholas made a crucial distinction between obligations to repay in digital assets versus national currencies. While he agreed with ASIC that a margin extension in a national currency created a deferred debt and thus fell under the purview of the financial product regulations, he found that an obligation to repay in digital assets, such as Bitcoin, did not constitute an obligation to repay money and therefore was not a deferred debt.
The Federal Court did not immediately determine the specific penalties to be imposed on Bit Trade. The judgment primarily established that Bit Trade had contravened the Corporations Act by failing to comply with design and distribution obligations.
ASIC has indicated that it will seek financial penalties against Bit Trade, with the penalty hearing scheduled for a future date. The court has ordered ASIC and Bit Trade to agree on the appropriate form of declarations and injunctions within seven days.
ASIC Deputy Chair Sarah Court said, ‘This is a significant outcome for ASIC involving a major global crypto firm. We initiated proceedings to send a message to the crypto industry that we will continue to scrutinise products to ensure they comply with regulatory obligations in order to protect consumers.’ He further added ‘Today’s outcome sends a salient reminder to the crypto industry about the importance of compliance with the design and distribution obligations. It is a legal requirement for financial products to be distributed to consumers appropriately. Consumers should receive the full protection of the law when dealing in crypto-asset products and we will continue to take action to ensure this happens.’
This judgment has direct implications for the cryptocurrency industry, particularly for entities offering financial products in Australia. It establishes the need for firms to ensure that their products are designed and distributed in compliance with the DDO framework, which is designed to protect consumers. Entities involved in providing crypto-related products should take heed of the court’s findings and ensure that they are fully compliant with their obligations under the Corporations Act and other such applicable act as per the nature and scope of their virtual asset. The ruling also highlights the complexities surrounding the regulation of digital assets and the importance of understanding the legal characterization of various financial obligations within this space.
(Source: https://download.asic.gov.au/media/ikmfvobk/24-186mr-asic-v-bit-trade-pty-ltd-judgment-23-august-2024.pdf, https://asic.gov.au/about-asic/news-centre/find-a-media-release/2024-releases/24-186mr-asic-wins-case-against-kraken-crypto-exchange-operator-for-design-and-distribution-failure/?altTemplate=betanewsroom)
