Blockchain and Digital Assets News and Trends - June 2023
This is our sixth monthly bulletin for 2023, aiming to help companies identify important and significant legal developments governing the use and acceptance of blockchain technology, smart contracts and digital assets.
While the use cases for blockchain technology are vast, this bulletin will be primarily on the use of blockchain and or smart contracts in the financial services sector. With respect to digital assets, we have organized our approach to this topic by discussing it in terms of traditional asset type or function (although the types and functions may overlap), that is, digital assets as:
- Virtual currencies
- Deposits, accounts, intangibles
- Negotiable instruments
- Electronic chattel paper
- Digitized assets
In addition to reporting on the law and regulation governing blockchain, smart contracts and digital assets, this bulletin will discuss the legal developments supporting the infrastructure and ecosystems that enable the use and acceptance of these new technologies.
DAC8 brings compliance burden to EU cryptoasset companies
On May 16, the EU finance ministers provisionally agreed to a new rule that would require cryptoasset operators not covered by other regulations as cryptoasset service providers to report the transactions of their EU clients to tax authorities starting in 2026. This new rule is part of the EU Directive on Administrate Cooperation and accordingly is known as DAC8. DAC8 is the latest provision aimed at creating tax transparency and is meant to bring transparency to crypto transactions, particularly with regard to trading using cryptoasset service providers or cryptoasset operators located in another country, or when trading takes place directly between individuals or entities established in another jurisdiction. Read more.
New regulatory framework for cryptoassets in the EU
The new EU cryptoassets regulation has been published in the Official Journal of the European Union on June 9, 2023. This new regulatory framework consists of two regulations. Read more.
STATUTORY AND AGENCY DEVELOPMENTS
Release of discussion draft of statutory framework for digital asset regulation. On June 2, Patrick McHenry (R-NC), Chair of the House Financial Services Committee, and Glen Thompson (R-PA), Chair of the House Committee on Agriculture, announced the release of a discussion draft of legislation providing a statutory framework for digital asset regulation. According to Rep. McHenry, the draft bill "represents a common approach to digital asset regulation that would bring existing consumer and investor protections to digital asset-related activities and intermediaries under the principle of ‘same risk, same regulation." Moreover, the bill purportedly "establishes a functional framework to fill the gaps in the regulatory process between the CFTC and the SEC," and clarifies the CFTC's jurisdiction over digital asset commodities and the SEC's authority over digital asset investment contracts, as well as providing a path for digital asset issuers to later request that the asset be deemed a commodity if certain conditions are met.
Various groups submit comments on SEC proposed rulemaking. The SEC reopened the comment period for its proposed rulemaking modifying the definition of an "exchange" subject to the Exchange Act Rule 3b-16. The comments discussed below join a number of other high-profile submissions. For more information on the SEC's proposed rulemaking, see our April 2023 issue.
- Republicans on House Committee on Financial Services ask the SEC to rescind proposed rulemaking. On June 13, the Chair of the House Committee on Financial Services, Patrick McHenry (R-NC), and all 28 Republicans on the committee wrote to the SEC to urge it to rescind the proposed rulemaking. The letter argues that the amendments run contrary to the SEC's mission to promote capital formation and exceed its statutory authority. According to the letter, "The Proposed Rule significantly expands the definition of exchange in the Exchange Act to include systems that ‘bring […] together buyers and sellers of securities using trading interest’ and ‘make […] available [communication protocols] under which buyers and sellers can interact and agree to the terms of a trade.’ For digital assets, the Proposed Rule would go well beyond regulating centralized digital asset platforms and apply to persons acting ‘in concert’ with each other. This could capture a wide range of individuals in the digital asset ecosystem, including software developers and participants in a blockchain network’s consensus mechanism.” The letter asserts that "[t]he Proposed Rule will stifle innovation and harm digital asset market participants and the U.S. economy more broadly," and calls for a "comprehensive analysis regarding the economic impact of this Proposed Rule."
- Former Solicitor General responds on behalf of DeFi developer. On June 13, former Solicitor General Don Verrilli, Jr., submitted a letter comment to the SEC on behalf of his firm’s client Uniswap Labs, a developer of decentralized finance (DeFi) software, in response to the SEC's proposed rulemaking which Verrilli asserts would "dramatically expand" the definition of an "exchange" in a manner which is overbroad, vague, and arbitrary, which unlawfully interprets the Exchange Act and would be unconstitutional if adopted. The 28-page letter argues that the SEC’s proposed interpretation is unlawful because it conflicts with the statutory definition by expanding it to plausibly include technology communication platforms, such as email platforms and DeFi protocols, which are not, by their nature, centralized markets designed to sell securities. He posits that token trades on DeFi platforms are removed from the promises of promoters and originators which might otherwise subject them to Howey analysis. Verrilli further asserts that the SEC’s proposed interpretation, if adopted, threatens to end a billion-dollar industry in violation of constitutional separation of powers principles. Additionally, the letter also questions the SEC’s understanding of the technology behind DeFi; Verrilli explains that problematic DeFi protocols cannot be shut down after they are deployed, and that “forking” is not a viable solution. Finally, Verrilli asserts that the proposed interpretation would be arbitrary and capricious in violation of the Administrative Procedure Act for, among other things, failing to consider the proposed interpretation’s impact on competition as the SEC is required to do under the Exchange Act.
CFTC issues staff advisory on risks associated with expansion of derivatives clearing organization clearing of digital assets. On May 30, the CFTC announced the issuance of a Staff Advisory on the risks associated with the expansion of Derivatives Clearing Organization (DCO) clearing of digital assets. The Staff Advisory “reminds registrants and applicants that when expanding lines of business, changing business models, or offering new and novel products, [the CFTC Division of Clearing and Risk] (DCR) will remain focused on the potentially heightened risks that may be associated with certain of those clearing activities. DCR expects DCOs and applicants to actively identify new, evolving, or unique risks and implement risk mitigation measures tailored to the risks that these products or clearing-structure changes may present.” The Staff Advisory "specifically notes" that “because of the increased cyber and other risks that may be associated with digital assets, DCR will emphasize DCO applicant and registrant compliance with the DCO Core principles related to system safeguards, conflicts of interest, and physical delivery.”
Celsius selects Fahrenheit LLC as winning bidder in bankruptcy auction. On May 25, Celsius Network LLC announced that Fahrenheit LLC was selected in its court-approved competitive auction process to acquire the debtor's assets and take over business operations pursuant to a Chapter 11 plan. The plan will include a distribution of Celsuis' liquid cryptocurrency to account holders on the plan's effective date, and the creation of a new company to manage the illiquid assets and other business operations for the benefit of account holders. On June 13, Celsius announced the filing of voluntary petitions for Chapter 11 protection and that the company initiated a financial restructuring. The plan will be filed by the end of June. For more information on the Celsius bankruptcy, see our article Bankruptcies begin for crypto firms as “crypto winter” settles in.
Florida and Indiana amend UCC to exclude CBDCs from "money." On May 4, Indiana Governor Eric Holcomb signed SB468 and on May 12, Florida Governor Ron DeSantis signed SB7054. Each of these laws explicitly exclude a central bank digital currency (CBDC) from the definition of "money" under the state's Uniform Commercial Code – effectively banning the use of CBDCs as money in the state. Both laws define CBDC to include any CBDC issued by the US Federal Reserve or any foreign government. For more information on this topic, see our prior article, Action on 2022 amendments to the Uniform Commercial Code – South Dakota governor vetoes act.
NY Fed issues results of CBDC project. This past month, the Federal Reserve Bank of New York (FRBNY) announced issuance of a report on the Phase II results of Project Cedar. Phase II of the Project Cedar experiment explored the interlinking of distinct central bank currency ledgers via hashed timelock contracts (HTLCs), which are time-bound smart contracts. The experiment tested whether HTLCs could act as a bridge between the ledgers and allow settlement of digital assets using wholesale CBDCs. The findings demonstrated that distributed ledger technology (DLT) could support enhancements to cross-border multi-currency payments and settlements, enabling interoperability and autonomy, atomic settlement and near real-time settlement. For information on Phase I of the Project, see our November 2022 issue.
ENFORCEMENT ACTIONS AND LITIGATION
SEC settles digital asset fraud charges. On May 30, the SEC announced that Ishan and Nikhil Wahi agreed to settle the SEC’s insider trading charges against them. The Wahis settled the SEC’s fraud charges after pleading guilty to criminal wire fraud conspiracy charges related to their trading of certain digital assets in advance of the listing of those assets on a cryptocurrency exchange. The brothers agreed to settle with the SEC even though both said during their criminal pleas that they did not believe that any of the relevant digital assets were securities. In his SEC consent agreement, Ishan Wahi recited admissions he had made during his criminal plea that (i) by reason of his employment at the exchange, he had learned which cryptoassets would be made available for trading the exchange in advance of the public listing of those assets; (ii) he conspired with his brother and another defendant to misappropriate and did misappropriate that confidential business information; and (iii) he provided that confidential business information to his brother and friend knowing that they would use the information to make trading decisions and buy those assets. In his SEC consent agreement, Nikhil Wahi recited plea admissions that (i) he received confidential business information from his brother in the form of which cryptoassets would be made available for trading the exchange in advance of the public listing of those assets; (ii) he conspired with his brother and another defendant to misappropriate and did misappropriate that confidential information for personal use; and (iii) he used that confidential business information to make trading decisions and buy those assets. Neither brother admitted that the digital assets were securities. The settlement ends the case without any judicial determination of whether the digital assets at issue are securities. For more information on the SEC's case against the Wahis, see our March 2023 and August 2022 issues.
Nevada man charged for participation in $45 million CoinDeal scheme. On May 19, the Department of Justice announced the filing of charges against Bryan Lee for his alleged participation in CoinDeal, an investment fraud scheme that defrauded more than 10,000 victims of over $45 million. The indictment alleges that Lee conspired with Neil Chandran and others in companies controlled by Chandran which operated under the banner of “ViRSE,” and included ViMarket Inc., among others. The companies were supposedly developing virtual-world technologies, including their own cryptocurrency, for use in a metaverse. Chandran allegedly misled investors by falsely promising extremely high returns on the premise that his companies were about to be acquired by a consortium of wealthy buyers. As further alleged, Lee was the nominee owner and director of ViMarket, and took direction from Chandran for how to disburse investor funds received into ViMarket’s bank accounts. Among the charges Lee faces are conspiracy, mail fraud, and wire fraud.
Massachusetts man charged with laundering bitcoin. On June 12, the US Attorney's Office for the District of Massachusetts announced the arrest of Trung Nguyen on charges for operating an unlicensed money transmitting business and money laundering of more than $1 million in bitcoin. According to the indictment, between September 2017 and October 2020, Nguyen owned and operated National Vending, LLC and did not register National Vending with FinCEN. Through National Vending, Nguyen accepted cash from customers and, in exchange for a fee, sent them bitcoin in return. Nguyen's customers included an alleged methamphetamine dealer, romance scam victims, and undercover law enforcement agents.
SEC secures default judgment against alleged unregistered brokers for conducting fraudulent and unregistered offering of cryptoassets. On May 18, the SEC announced it had obtained a default judgment against Chicago Crypto Capital LLC (CCC), and two individuals associated with it. The SEC’s complaint alleged that CCC and the individuals acted as unregistered brokers and conducted an unregistered offering of BXY token that relied on materially false and misleading statements in violation of Sections 5 and 17(a) of the Securities Act of 1944, and Section 15(a) and 10(b) of the Securities Exchange Act of 1934. The default judgment orders more than $1 million in disgorgement and prejudgment interest, and awards more than $1.5 million in civil money penalties.
CFTC pursues charges against alleged fraudulent digital asset trading scheme. On May 24, the CFTC announced it had filed civil charges against five defendants doing business under the name Icomtech. The complaint alleges that from August 2018 to December 2019, the defendants fraudulently solicited of hundreds of thousands of dollars with the promise of investing in Bitcoin and other digital assets and producing daily returns between 0.9 percent and 2.8 percent. Instead, the CFTC alleges the defendants misappropriated the investor funds to pay themselves commissions and bonuses while investors got nothing. The complaint parallels a separate criminal action brought by the DOJ on October 13, 2022.
CFTC claims victory in Ooki DAO litigation. On June 8, the US District Court for the Northern District of California granted the CFTC a default judgment in its case against Ooki DAO, a decentralized autonomous organization that CFTC charged with operating an illegal trading platform that doubles as an unlawful futures commission merchant (FCM). The judgment orders Ooki DAO to cease operation and requires any web-hosting or domain-name registration service to shut down the Ooki DAO’s website. The judgment required the Court to recognize the DAO as a ”person” for purposes of the Commodities Exchange Act and thereby held each member of the DAO liable for monetary penalties totaling $643,542. In the CFTC press release, Division of Enforcement Director Ian McGinley called the order a “wake-up call to anyone who believes they can circumvent the law by adopting a DAO structure.” For information on other Ooki DAO litigation, see our April 2023 issue.
Former Minnesota Vikings co-owner sentenced for providing “shadow banking” to crypto exchanges. On June 5, The US Attorney’s Office of the Southern District of New York announced that the federal courts for that district had sentenced Reginald Fowler, former co-owner of the Minnesota Vikings, to 75 months in prison for his role in processing more than $700 million in unregulated transactions for several Israeli cryptocurrency companies in violation of federal anti-money laundering laws and lying to US banks to do so. Fowler’s scheme involved opening dozens of bank accounts in the US and globally without disclosing that his business was associated with the cryptocurrency companies and including false information on wire transfer instructions to mislead the banks about the nature of his transactions. In addition to the prison time, Fowler was ordered to pay forfeiture of more than $740 million.
DOJ unseals indictment related to Russian nationals behind Mt. Gox hack. On June 1, the DOJ announced it had unsealed indictments related two Russian nationals Alexey Bilyuchenko and Aleksandr Verner, both associated with the 2011 hack of the cryptocurrency exchange Mt. Gox. That hack caused the theft of 647,000 Bitcoin and led to the bankruptcy of Mt. Gox. The indictment alleges that the ill-gotten gains were then used to develop the BTC-e cryptocurrency exchange which allegedly laundered funds for cyber criminals, narcotics rings, and corrupt public officials worldwide. At its peak, BTC-e served more than a million users worldwide and was one of the largest cryptocurrencies in the world. In 2017, law enforcement shut down the exchange. The two unsealed indictments are before courts in the Southern District of New York, charging both men with conspiracy to commit money laundering, and the Northern District of California, charging Bilyuchenko with money laundering conspiracy and operating an unlicensed money services business.
DOJ seeks forfeiture of crypto stolen in business email scheme. On May 23, the US Attorney’s Office of the District of Massachusetts announced it had filed a civil forfeiture action against seven consumer cryptocurrency accounts that allegedly contain the proceeds of a “business email compromise,” or “BEC,” scheme. The scheme involved a fraudulent email that allegedly tricked a Massachusetts business into wiring $898,342 to an account in California, whereupon the funds were converted to cryptocurrency and laundered through a series of intermediaries before being deposited in a commercial cryptocurrency exchange account. The government seized the assets in August and September 2022.
NY AG reaches $4.3 million settlement with fraudulent cryptocurrency company. On May 18, New York Attorney General Letitia James announced that the Office of the Attorney General (OAG) secured a $4.3 million settlement from Coin Cafe for defrauding investors. Coin Cafe "agreed to the OAG's findings that it routinely charged and increased fees without properly informing investors." Coin Cafe is required to pay restitution to all investors, including more than $508,000 to more than 340 New York investors who were charged fees without their knowledge. The OAG allegations included that Coin Cafe charged its customers "exorbitant and undisclosed fees" to use its wallet storage – despite marketing its wallet storage as "free" on its website.
NY AG reaches $1.7 million settlement with unregistered crypto exchange. On June 15, the NY AG announced the OAG's $1.7 million settlement with CoinEx for failing to register as a securities and commodities broker-dealer and for falsely representing itself as a crypto exchange. The settlement requires CoinEx to refund thousands of New York investors more than $1.1 million and pay more than $600,000 in penalties to the state. CoinEx is also banned from offering, selling, or purchasing securities and commodities in New York and is prohibited from making its platform available in the state. In response to the lawsuit, CoinEx publicly announced that it would withdraw its platform and services from the United States.
NY DFS enters consent order with crypto trading platform. On May 1, the New York State Department of Financial Services (NYDFS) entered into a consent order with bitFlyer USA, a cryptocurrency trading platform that also provides custodial wallet services. The order alleges bitFlyer suffered multiple deficiencies in its cybersecurity program, violating 23 NYCRR Part 500, the NY Cybersecurity Regulation. The order assessment a civil monetary penalty of $1.2 million and requires bitFlyer to implement a remediation plan approved by the NYDFS.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
FATF urges G7 members to adopt and implement FATF Recommendations. On May 18, the President of the Financial Action Task Force (FATF), a global financial crimes watchdog, issued a letter entitled “An end to the lawless crypto space,” urging G-7 leaders to “lead by example" in "fully and effectively implementing the FATF Recommendations" which are global standards on combating money laundering, terrorism financing and proliferation financing. The letter specifically requests G7 members to implement the "travel rule," asserting that the use of cryptoassets to evade sanctions has increased over time, however, cryptoassets "continue to operate in a virtually lawless global environment.
UK targets crypto ATMs. The UK Financial Conduct Authority (FCA) announced that it has inspected multiple sites suspected of hosting illegally operated crypto ATMs. In the UK, cryptocurrency ATMs must be registered with the FCA and operators must comply with UK Money Laundering Regulations. The FCA will review evidence gathered during the inspections and consider further action as necessary.
DLA Piper ranked Tier 1 in FinTech: Crypto by The Legal 500. DLA also ranked Tier 2 for FinTech, and Margo Tank ranked as a "Leading Individual."
DLA Piper’s Commodities, Digital Assets, and Carbon Compliance and Enforcement team draws on decades of collective experience in the commodities and securities industry to help companies navigate new and complex commodities enforcement matters, including those related to agriculture, metals, energy, digital assets, and carbon/sustainable commodities, among others.
DLA Piper attorneys presented at the following events:
- Cryptoassets: Emerging legal trends in common law and civil law jurisdictions. How international courts are dealing with cryptoasset disputes, June 20, 2023, panel chaired by Christina Sharma and Michael Fluhr, with speaker Ewald Netten, Dan Jewell, Andrea Pantaleo, Matthew Miller and Deborah Meshulam
- NFT legal overview: Copyright, trademark, and Uniform Commercial Code (Articles 2 & 12) [Part I], available on demand, with Mark Radcliffe and Tom K. Ara
- NFT Legal Deep Dive: Copyright, trademark, and Uniform Commercial Code (Articles 2 & 12) [Part II], available on demand, with Mark Radcliffe, Margo H.K. Tank and Gina Durham
- NFT Legal Deep Dive: Securities law, entertainment unions, and licensing [Part III], available on demand, with Mark Radcliffe, Martin Bartlam, Katherine Imp and Michael Fluhr
- New UCC Article 12 and transfers of interests in digital assets, Federal Bar Association webinar, March 15, 2023, with Margo Tank and David Whitaker
- "Chuck Yates needs a job" podcast on Digital Wildcatters, with Deanna Reitman, discussing trends in the voluntary carbon markets, including the creation of digital carbon commodity assets and platforms to trade such assets
Terms of service are instrumental in determining rights to digital assets – the holding in Celsius Network LLC, published in The Computer & Internet Lawyer, May 2023, by Margo Tank, David Whitaker, Liz Caires and Emily Honsa Hicks
Digital Digest, the inaugural edition of our bi-monthly newsletter from Martin Bartlam, Dan Jewell, Sam Gokarn-Millington, and Marina Troullinou of the UK DLA Piper Finance and Litigation teams. Digital Digest provides updates on key issues to be considered when doing business in the digital and crypto space in or from the UK
Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:
Contributors to this issue