Proof of Case

What’s the case about?

Whether cryptocurrency lending products called “Earner” and “Access” offered by Web3 Ventures Pty Ltd were a managed investment scheme, a facility by which a person made a financial investment and/or a derivative for the purposes of the Corporations Act 2001 (Cth).   

Background

In Australian Securities and Investments Commission v Web3 Ventures Pty Ltd [2024] FCA 64, the Australian Securities & Investments Commission (ASIC) sought declarations and orders against Web3 Ventures Pty Ltd trading as Block Earner (Block Earner) in relation to alleged contraventions of the Corporations Act 2001 (Cth) (Corporations Act).

Block Earner operated an online platform through its website. The proceedings related to two products offered by Block Earner, known as “Earner” and “Access”, and whether those products were financial products for the purposes of the Corporations Act. ASIC contended that the products were financial products because each product was one or more of a managed investment scheme, a facility by which a person makes a financial investment (Investment Facility) or a derivative. Block Earner did not hold or have the benefit of an Australian financial services licence.

His Honour Justice Jackman of the Federal Court noted (at [10]) there was a legal controversy as to whether cryptocurrency is “property” as that concept is understood by the common law. His Honour considered it was not necessary to form a view as to that controversy and did not express any opinion on it. His Honour used language referring to “ownership” of cryptocurrency in a neutral sense, to refer to the factual ability to control cryptocurrency and used language referring to “lending” cryptocurrency in a similarly neutral sense. His Honour noted the concept of “lending” cryptocurrency was a misnomer, as in reality the “lending” of cryptocurrency merely involves the conferral of an ability to control it.

The Earner product allowed customers to lend to Block Earner and receive a fixed rate return over the term of the loan. In the usual case, Block Earner converted the customer’s Australian dollars (AUD) into a cryptocurrency nominated by the customer and at the end of the loan the customer was entitled to a return of AUD calculated by reference to the price of the cryptocurrency plus the fixed rate return. Block Earner used the loaned cryptoassets to generate income for itself by lending the cryptoassets to third parties. Under the terms of use, Block Earner was required to pay the fixed interest rate to users regardless of the amount of income it earned.

The Block Earner website contained the following text in response to the question “How is fixed yield generated?”:

Deposits into the Block Earner 7% fixed option, automatically convert your Australian dollars into the USD-backed stablecoin (USDC) via our exchange services and these stablecoins are then lent to us. Block Earner delivers risk-adjusted, high returns by working exclusively with partners whose investment strategies are proven, sustainable and measured.

Block Earner is able to generate returns by pooling customer funds and lending it to our trusted partners, who are all vetted in accordance with our risk policy, thereby receiving a favourable yield rate.

The Access product provided users with streamlined access to two decentralised finance (DeFi) yield generating protocols, Aave and Compound, which in turn provided a platform for users to lend their cryptocurrency and earn interest on their loans.

Justice Jackman considered, in turn, whether each product was a managed investment scheme, an Investment Facility and/or a derivative.

The Earner Product

Was the Earner product a managed investment scheme?

The matters which ASIC identified as constituting a scheme included:

• the effect of the terms of use was that the consumer, in acquiring, investing in or using the Earner product deposited money with or “lent” money to Block Earner, and Block Earner undertook to repay that money;
• the Earner product was marketed as making use of the cryptoassets known as USDC, PAXG and BTC;
• the representation on the Block Earner website that “Block Earner is able to generate returns by pooling customer funds and lending it to our trusted partners, who are all vetted in accordance with our risk policy, thereby receiving a favourable yield rate” as well as other material on the website;
• for a consumer to acquire, invest in or use the Earner product, they must have had an account with Block Earner into which they deposited AUD, which process included agreeing to the terms of use, and by using the Earner product, the consumer then provided that AUD to Block Earner;
• from the consumer’s perspective, when they participated in the Earner product, any AUD deposited appeared in their Block Earner cash account, at which point the user could select the relevant Earner product and nominate the amount of AUD in their account to be deposited into the product. The user was shown the equivalent amount of relevant cryptoassets, the exchange rate and any fees for the conversion, and the fixed yield they would receive for the deposit. Block Earner’s platform then displayed the user’s case balance, holdings in the Earner product, any yield earned to date (in AUD) and the annualised percentage yield, and the user’s Block Earner accounts were credited with their yield on a daily basis;
• once the user clicked “Transfer In”, Block Earner converted the nominated amount of AUD to the relevant cryptoasset through an overseas crypto exchange platform. The newly converted cryptoassets were automatically “loaned” to Block Earner on an unsecured basis and Block Earner then lent those cryptoassets to a third party under a pre-existing commercial arrangement, for which it received a fixed yield;
• the terms of use provided that by using the Earner product, consumers “lend” the cryptoassets to Block Earner, in return for daily interest which was paid in the same cryptoasset loaned to Block Earner and users agreed to grant Block Earner all rights and title to those cryptoassets for Block Earner to use at its sole discretion during the term of the loan.

After considering the requirements of a “scheme”, as expressed by Barrett J in Australian Securities & Investments Commission v Takaran Pty Ltd [2002] NSWSC 834; (2002) 43 ACSR 46, his Honour accepted that a scheme existed at the relevant time.

Justice Jackman then considered the elements of the definition of “managed investment scheme” in section 9 of the Corporations Act, being relevantly:

(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 considering paragraph (a)(i) of the definition, his Honour accepted that the word “contribution” connotes that investors pay money or money’s worth jointly with others or to furnish a common fund. His Honour regarded that element and the other elements of (a)(i) of the definition as satisfied by the Earner product. In doing so, His Honour particularly referred to the statement on the Block Earner website to the effect that Block Earner was able to generate returns by pooling customer funds and lending it to third parties, thereby receiving a favourable yield rate. That reasoning was consistent with the reasoning of White J in Australian Securities & Investments Commission v Great Northern Developments Pty Ltd [2010] NSWSC 1087; (2010) 79 ACSR 684, where White J reviewed a number of cases in which it was held that loans with fixed interest returns can fall within the definition of “managed investment scheme” and that the right to interest and repayment of principal can be a right to “benefits produced by the scheme”.

In considering paragraph (a)(ii), it was clear from the statement which appeared on the Block Earner website that the contributions made by users were to be pooled. The purpose of that pooling was represented to enable Block Earner to generate returns by lending the funds to third parties in return for a favourable yield rate. Further, the purpose of that pooling was clearly represented to provide Block Earner with the wherewithal from which it would pay users the fixed yield promised to them under the Earner product. The payment of the fixed yield to users was obviously a financial benefit to them, as too was the capacity of Block Earner to earn revenue from which that yield would be paid. Accordingly, subparagraph (a)(ii) was also satisfied.

As to paragraph (a)(iii), the users of the Earner product did not have day-to-day control over the operation of the scheme, which was operated and controlled by Block Earner.

Block Earner also submitted that it was legitimate and appropriate to consider the potential difficulties in the application of the regulatory regime concerning managed investment scheme in deciding whether the definition of “managed investment scheme” was satisfied. Justice Jackman was of the view that there was a potential difficulty in the application of that regulatory regime to the Earner product, but only if it were to be found that cryptocurrency is a kind of property. As neither party advanced an argument to the effect that cryptocurrency is property and both parties accepted that it was not necessary for the Court to decide that question, it was not appropriate for His Honour to pursue the question further.

In light of those matters, his Honour concluded that the Earner product was a managed investment scheme.

Did users of the Earner product make a financial investment?

Section 736B of the Corporations Act provides that:

For the purposes of this chapter, a person (the investor) makes a financial investment if:

(a) the investor gives money or money’s worth (the contribution) to another person and any of the following apply:

(i) the other person uses the contribution to generate a financial return, or other benefit, for the investor;

(ii) the investor intends that the other person will use the contribution to generate a financial return, or other benefit, for the investor (even if no return or benefit is in fact generated);

(iii) the other person intends that the contribution will be used to generate a financial return, or other benefit, for the investor (even if no return or benefit is in fact generated); and

(b) the investor has no day-to-day control over the use of the contribution to generate the return or benefit.

His Honour noted that whilst it was only necessary to establish one of the three alternatives in subsection (a), all three were satisfied in relation to the Earner product.

In respect of subsection (a)(ii), there was no evidence from any investor as to intention and (to the contrary) there was an acknowledgment by each investor that they did not intend for Block Earner to use the loaned cryptocurrency to generate a financial benefit or act as an investment for the user. His Honour noted that the question as to the investors’ intended use of the funds was to be answered in the context of all of the relevant circumstances, including what the investors were told about the transaction.

It remained a matter of fact as to the actual intention of the investors. In that regard, although the investors were bound by the terms of use irrespective of whether they read and understood them, it did not mean that the intention imputed to them for the purpose of contract law was their actual intention as a matter of fact. In the Court’s view, it was more likely than not that a substantial proportion of the users of the Earner product would have formed the intention required by subsection (a)(ii) based on having read and understood the representation on the website and not having read or understood the apparently contrary acknowledgment in the terms of use.

His Honour concluded that users of the Earner product made a financial investment within the meaning of that term in section 763B of the Corporations Act.

Was the Earner product a derivative?

Given that the Earner product was a managed investment scheme, was not registered and had more than 20 members, it was not a derivative by operation of sections 761D(3)(c), 764A(1)(ba) and 601ED(1) of the Corporations Act.

The Access Product

The Access product was marketed as providing users with access to the Aave and Compound protocols, being third party DeFi lending protocols. Block Earner’s website stated that Aave and Compound connect borrowers and lenders in decentralised finance and the users’ deposits are lent to borrowers, who pay an annualised yield on the funds borrowed.

Both Aave and Compound provide a platform for users to lend out their cryptocurrency holdings and earn interest on their loans. Aave and Compound could be accessed directly by individuals without using the Access product. However, by using the Access product, users could access Aave and Compound without entering into a series of separate transactions to exchange cryptocurrency to DeFi-specific digital tokens before interacting with the relevant DeFi protocol.

Block Earner aggregated the DeFi-specific digital tokens of all users who had nominated Aave or Compound and held those tokens in its Block Earner omnibus account on each protocol on behalf of users. At all times, users retained ownership of their DeFi-specific tokens.

Block Earner did not receive any yield from the DeFi protocols on its own behalf and Block Earner did not operate, and had no influence over, the DeFi protocols. While Block Earner qualified for incentive payments from Aave and Compound, Block Earner had not claimed any tokens offered by way of incentives and no funds had ever been claimed by Block Earner from the DeFi platforms.

Was the Access product a managed investment scheme?

His Honour considered that the elements contended by ASIC were in fact implemented and they constituted a scheme.

It was then necessary to consider whether subparagraph (a) of the definition of “managed investment scheme” (extracted above) was satisfied. As to subparagraph (a)(i), ASIC contended that the aggregation of tokens by Block Earner into an omnibus account satisfied this requirement. However, His Honour noted that the money users paid to Block Earner for the Access product and the financial performance of tokens purchased with it, were treated on an individuated basis. Further, at all times, users retained “ownership” of their De-Fi tokens. Accordingly, the court was not satisfied that users “contributed” money or money’s worth, in the requisite sense of doing so jointly with others or to furnish a common fund.

As to paragraph (a)(ii), ASIC again relied on the use of the Block Earner omnibus account. ASIC submitted that it need only establish that contributions are to be pooled and there are financial benefits through the scheme to those who hold interests in the scheme, and that it need not establish there is any link between the pooling and the financial benefits, other than the pooling and financial benefits both being elements of the scheme. This submission was rejected by the Court, given that the statutory language clearly required a link by use of the word “to” in the expression “any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits … for the people … who hold interests in the scheme”.

ASIC contended in any event that there was a link between the “pooling” in the omnibus account and financial benefits to those who hold interests in the scheme by reason of the saving of account fees by use of the omnibus account. His Honour considered there were three “insuperable obstacles” to that submission (including that it was not expressed in ASIC’s amended concise statement) and it was not accepted. Accordingly, subparagraph (a)(ii) was not satisfied.

His Honour was of the view that the requirement in (a)(iii) of the definition, that the members do not have day-to-day control over the operation of the scheme, was satisfied. However, given that ASIC had not established the requirements of subparagraphs (a)(i) and (a)(ii), the Access product was not a managed investment scheme.

Did users of the Access product make a financial investment?

His Honour considered that users of the Access product did not make a financial investment within the meaning of section 736B of the Corporations Act, because:

• as to subparagraph (a)(i), in substance Block Earner was doing no more than providing services which involved, in the first place, exchanging AUD for cryptocurrency, and second, connecting users’ cryptocurrency to smart contracts on DeFi protocols to earn yield. Block Earner did nothing with the cryptocurrency other than deposit it into a smart wallet connected to the applicable DeFi protocol on instructions from the user; and
• as to subparagraphs (a)(ii) and (a)(iii), there was no evidence that investors or Block Earner intended that the contribution would be “used” in the requisite sense to generate a financial return or other benefit for the investor.

Was the Access product a derivative?

ASIC contended that the Access product was a derivative because, in the usual case of the user being repaid in AUD, the amount of AUD to be paid will vary according to the value of the tokens and the value of the cryptocurrency into which those tokens are converted.

His Honour was of the view there was considerable force to ASIC’s submissions to the effect that section 761D(1) was satisfied. However the Court did not need to decide that question, because his Honour concluded that the Access product constituted a contract for the future provision of services within the meaning of section 761D(3)(b) and was therefore excluded from being a derivative. The exemption in section 761D(3)(b) requires focus on the purpose or object of the contract, objectively ascertained from the contractual terms, and involves looking at the substance of the contract.  

Here, the future provision of services (including the exchanging of AUD and cryptocurrency to tokens and aggregating and holding users’ tokens in an omnibus account) was at least the primary, if not the only, subject matter of the Access product. The future provision of those services could not be regarded as merely incidental or ancillary to some other purpose. In those circumstances, the exclusion from the definition of derivative relating to a contract for the future provision of services applied, meaning the Access product was not a derivative.

Conclusion

In respect of the Earner product, ASIC succeeded in establishing contraventions of:

• sections 601ED(5) and (8) of the Corporations Act, by Block Earner operating an unregistered managed investment scheme; and
• sections 911A(1) and (5B) of the Corporations Act by Block Earner carrying on a financial services business without holding an Australian financial services licence covering the provision of financial services.

In relation to the Access product, ASIC failed to establish a contraventions of sections 601ED and 911A and that part of the proceedings was dismissed.

The costs of the proceedings were reserved and the judgment did not address any pecuniary penalty, which was to be determined at a later stage.  

Take aways

The decision is notable because:

• to my knowledge, it is the first judgment delivered by an Australian court which gives detailed consideration to the application of financial services provisions of the Corporations Act to cryptocurrency related products and the operation of those products;
• for that reason, the judgment illustrates how Courts may apply existing case law on managed investment schemes, Investment Facilities and debentures to cryptocurrency products. The court’s consideration of those issues is something which many have been awaiting, given that in Australia, products such as Earner and Access are regulated by existing financial services provisions, rather than “crypto specific” provisions;
• the decision (again) highlights the potential importance of statements contained on websites of cryptocurrency service providers. Certain statements here were found to be crucial in the Court’s determination that users of the Earner product made a financial investment within the meaning of that term in section 763B of the Corporations Act;
• despite Block Earner preparing details terms of use, such terms will not be conclusive of relevant factual positions in proceedings by ASIC asserting breaches of the financial services law. Here, the court found that despite the terms of use containing express wording as to the intention of investors, that intention was ultimately a question of fact for the court. The court found that a substantial proportion of users would have formed a different intention, having regard to content on Block Earner’s website.

Finally, while the court noted there is an existing controversy as to whether cryptocurrency is “property” under common law concepts in Australia, it was not necessary to form a view on that issue in these proceedings.

Where can I find the case? [2024] FCA 64