In the wake of the recent Federal Court ruling in the Qoin case, the question of whether digital wallet products qualify as non-cash payment facilities (NCPFs) under Australian law has become more important than ever in terms of regulatory compliance. The decision notes that the defendant in that matter identified their digital wallet as a financial product on their website, but the court drew a distinction between the wallet and the blockchain to which the wallet sent commands for balances of crypto-assets to change. This division has potentially significant implications for the regulatory classification of digital wallets, particularly as the Australian Securities and Investments Commission did not highlight that distinction in their press release about the matter.
Are digital wallet products non-cash payment facilities?
The Federal Court's judgment in the Qoin case provides a pivotal reference point for examining whether a blockchain could be considered a non-cash payment facility or part of one. The court found that the Qoin Wallet, as part of the "Qoin Wallet App", was a financial product because it facilitated non-cash payments by allowing users to send and receive Qoin tokens, a matter which was not in dispute in the matter and accepted by Qoin.
The court distinguished between the Qoin Wallet and what was called the broader "Qoin Facility", which included the Qoin Wallet App, the Qoin Blockchain, and the smart contracts necessary for the broader facility to function. This distinction raises important questions about the scope and definition of non-cash payment facilities under the Corporations Act.
Analysis of the Qoin Wallet Product
Her Honour Justice Downes described the Qoin Wallet in paragraphs [36]-[48] of the judgment. The WayBackMachine shows the Financial Services Guide (FSG) and Product Disclosure Statement (PDS) available on the Qoin website as at 3 November 2022 (shortly before ASIC commenced their initial action against Qoin). The PDS and FSG explicitly state that Qoin's services "allow you to securely and conveniently make payments".
How did the Qoin Wallet actually function?
The Qoin Wallet was a component of the broader Qoin App (which was required to be installed for the Qoin Wallet to function), and the data for the Qoin Wallet was stored on a user's personal device. The Qoin Wallet used a specific application programming interface (API) gateway to send requests to, and receive responses from, the Qoin blockchain's nodes in order to process transactions.
Each Qoin Wallet has its own public key/address which a user can provide to another user either by transcribing the string of letters and numbers comprising the public key, or by providing them with a QR to scan which contains the address information. The private key was stored on the user's mobile device.
The Qoin Wallet component of the Qoin App had the function of both viewing the balance of Qoin each user had in their Qoin Wallet address recorded on the blockchain, and also the payment facility (i.e., the ability of the user to send and receive Qoin). Users could only send Qoin from their Qoin Wallet to another Qoin Wallet.
A user's Qoin balance in a newly created Qoin Wallet started at 0, with the only way to increase Qoin was if they acquired it froom other users, or by purchasing Qoin directly from BPS Financial Pty Ltd.
Her Honour extracted several sections of the PDS, FSG, and Whitepaper that explicitly referenced the payment functionality of the Qoin Wallet. The completion of a transaction through the Qoin Wallet was also described paragraph [56] of the judgment. For illustrative purposes, the process for sending Qoin was described as follows:
A user opens the Qoin Wallet on the Qoin App and presses a button marked "Send". This brings up the payment screen.
To create a transaction, the user fills out necessary information in accordance with the send prompts displayed on the payment screen, being the recipient's Qoin Wallet address, and the amount of Qoin to be transferred.
To sign or validate the transaction, the private key stored on the user's mobile device is used. The private key is safeguarded by biometric security or a PIN authentication system, which the user is prompted to provide when clicking the "Confirm" transaction button.
The private key is then used internally by the wallet software to sign the transaction, and a unique transaction hash for the transaction on the Qoin blockchain is created.
Once signed, the transaction information is sent to the Qoin blockchain as a raw transaction.
Once received by the Qoin blockchain's nodes, the transaction data is broadcasted to the network participants and validated.
If the transaction is verified, it is then processed and the state of the blockchain is updated to reflect the transfer.
The transaction details are then recorded in the user's respective Qoin Wallets and their Qoin balances are updated.
What is a non-cash payment facility?
A non-cash payment facility is defined in section 763D of the Corporations Act. It refers to a facility through which a person makes payments, or causes payments to be made, other than by the physical delivery of Australian or foreign currency in the form of notes and/or coins.
What did the parties argue?
ASIC's primary case was that the broader "Qoin Facility", being the Qoin App, the Qoin Wallet, Qoin tokens (including the means of acquiring Qoin from BPS), the Qoin Blockchain, and related software, comprised a financial product in the form of a NCPF.
BPS did not dispute that the Qoin Facility included a NCPF, but contended that the financial product was specifically the Qoin Wallet (which was merely a component of the overall facility) and the balance of the arrangement were not a financial product.
Noting that both parties agreed there was a financial product, the court's analysis focused on what constituted a "facility" within the definition of a NCPF under section 763D(1) of the Corporations Act 2001 (Cth). Under s762B of the Corporations Act, if a financial product is a component of a facility that also has other components, the financial services regulations only apply in relation to the facility to the extent it consists of the component that is the financial product.
Despite ASIC's contention that the financial product in question was effectively the entire Qoin scheme (which ASIC argued was a "single scheme which has been implemented by BPS for a substantial purpose of enabling customers [to make payments] otherwise than by the physical delivery of cash"), her Honour found that the financial product in question was specifically, and only, the Qoin Wallet.
Her Honour's reasons
Justice Downes' reasoning stemmed from two primary considerations. First, her Honour stated that simply because a financial product's functionality requires integration with another thing does not necessarily mean that other thing forms part of the financial product. Although the Qoin Blockchain was integral to the overall operation of the Qoin Wallet, it was a single piece of structural software that existed separately to each Qoin Wallet and therefore was not part of the financial product.
Second, her Honour clarified that a system by means of which a facility operates is not itself a financial product that is capable of being "issued" or "acquired" as contemplated in the Corporations Act. Accordingly, the identification of the financial product should focus upon the point at which a person makes a non-cash payment. Her Honour posted the framing question:
what is the direct mechanism or thing which is allowing the person to [make a non-cash payment]?
Applying this to the question at hand, the Qoin Blockchain, Qoin itself as a token, and the means of acquiring Qoin from others or from BPS were not components of, nor were not themselves, aspects of the direct mechanism which allowed the user to make a non-cash payment. Her Honour stated that one could not "deal" in these aspects of the overall system, which could be contrasted against the ability to issue Qoin Wallets to users.
Her Honour drew comparison to the examples of NCPFs given in the Corporations Act definition, one of which was "making payments by means of a facility for a direct debit of a deposit account". Her Honour found that the Qoin Wallet was analogous to the direct debit facility example and that the systems with which it was integrated and in relation to which it functions were separate considerations to the actual facility itself.
Take-aways
The decision has helped to clarify the scope of the NCPF definition by finding that simply because a financial product's functionality requires other elements, it does not mean those other elements form part of the financial product in question. Although the blockchain (and other aspects) in this instance were necessary for the wallet's operation, they were separate from the wallet itself as a financial product.
By way of analogy, the underlying internet software and infrastructure necessary for an online banking applications to operate cannot be included in the definition of the financial product which is used over the internet.
The Need for Legal Advice in a Complex Regulatory Environment
This judgment underscores the critical importance of obtaining specialised legal advice when navigating complex regulatory landscapes. The case highlights the nuanced approach that Australian courts may take in applying existing financial services laws to emerging technologies and broad arguments the regulator is bringing in their enforcement actions.
The recent decision in the Block Earner case is worth mentioning as well, where the Federal Court relieved Block Earner from civil penalties for its unlicensed financial product due to the company's honest and fair attempt to comply with the law. Part of the reason for that decision, which is under appeal by ASIC was that the defendant had sought legal advice in addressing an inherent complex and uncertain area of financial services legislation. The take-away is that legal advice isn't only useful in the careful design of products, but could be useful if a product is found to be infringing despite efforts to ensure it is not.
By Luke Higgins and Michael Bacina