Blockchain and Digital Assets News and Trends - August 2023
This is our eighth 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.
Federal court upholds OFAC designation of Tornado Cash
By Eric Hall
On August 17, 2023, Judge Robert Pitman of the federal district court for the Western District of Texas granted summary judgment for the US Treasury Department in a case brought by users of Tornado Cash, a so-called cryptocurrency mixing service that allowed users to obscure the movements of cryptocurrency on the blockchain. The order affirms a decision by the Treasury Department’s Office of Foreign Assets Control (OFAC) to add Tornado Cash to its Specially Designated Nationals list. Being added to this list means that Tornado Cash would be effectively inaccessible in the US. According to OFAC, Tornado Cash had been used to launder money cybercriminals had stolen in high-profile hacks, including $455 million stolen by the Lazarus Group, a DPRK-affiliated hacker ring. Read more.
IRS rules that taxable income includes certain staking rewards
In Revenue Ruling 2023-14, the IRS has ruled that rewards received by a cash-method taxpayer “staking” cryptocurrency in connection with validating blockchain transactions must be included in the taxpayer’s taxable income in the year the taxpayer gains control over the staking rewards. Read more.
STATUTORY AND AGENCY DEVELOPMENTS
GAO issues report on need for oversight of crypto. On June 22, the US Government Accountability Office (GAO) announced the issuance of Blockchain in Finance: Legislative and Regulatory Actions Are Needed to Ensure Comprehensive Oversight of Crypto Assets. The report "examines regulatory gaps and coordination in regulating" "blockchain-related financial products and services." The GAO "recommends Congress consider legislation for federal oversight of nonsecurity crypto asset spot markets and stablecoins,” and also makes recommendations to seven federal regulators "to establish (or adapt an existing) coordination mechanism to identify and address blockchain-related risks." The regulators include the CFPB, the CFTC, the FDIC, the Federal Reserve, the Office of the Comptroller of the Currency, and the SEC. Notably the report found gaps in regulatory authority, and observes, "No federal financial regulator has comprehensive authority to regulate the spot market for crypto assets that are not securities … By providing for more comprehensive oversight of these [crypto asset securities trading] platforms, Congress could better ensure users’ protection from unfair and manipulative trading practices."
SEC Chief Accountant speaks on crypto "assurance" work. On July 27, Paul Munter, Chief Accountant of the SEC, issued a statement directed to the accounting profession, The Potential Pitfalls of Purported Crypto "Assurance" Work, in which he discussed the practice of accountants' review of business aspects of crypto asset platforms being touted by such platforms as an "audit." Munter noted that these "[n]on-audit arrangements are neither as rigorous nor as comprehensive as a financial statement audit, and may not provide any reasonable assurance to investors" and requested that accounting firms remain aware of their potential liability for antifraud violations due to the firms' statements about the scope of work performed and the procedures followed, which could result in potential violation of Rule 102(e) of the SEC's Rules of Practice, which could then result in censure or suspension of the firm from appearing or practicing before the Commission.
FINRA discusses crypto asset work. On August 3, Jason Foye, Chief of the Financial Industry Regulatory Authority (FINRA) Crypto Hub, posted An Inside Look into FINRA's Crypto Asset Work. The blog post describes FINRA’s Crypto Hub, which was designed as a center to manage FINRA's regulatory work related to crypto assets. Additionally, FINRA has established a Crypto Asset Investigations (CAI) team which conducts complex investigations related to crypto asset fraud and collaborates with FINRA's exam program to conduct risk-based examinations of firms' compliance with FINRA rules and federal securities laws and regulations. FINRA has also established The Blockchain Lab as a central point for the development of blockchain-related regulatory initiatives and help build or source technology to facilitate oversight of blockchain-related activities. Finally, FINRA has established a Crypto Asset Surveillance Team which supports FINRA's ability to conduct surveillance of crypto asset markets and works in collaboration with the Hub.
The post also provided an update on FINRA member firms' crypto asset activities. As of the date of the post, 26 firms were approved by FINRA to engage in crypto asset securities business, including engaging in private placements of crypto asset securities, operating Alternative Trading Systems for crypto asset securities, and acting as a Special Purpose Broker-Dealer regarding custody of digital asset securities.
DOJ reorganizes to increase pursuit of crypto crime. In a speech on July 20, Principal Deputy Assistant Attorney General Nicole M. Argentieri announced that the US Department of Justice (DOJ) Computer Crime and Intellectual Property Sections (CCIPS) will be merged with the National Cryptocurrency Enforcement Team (NCET), "creating a single office that consolidates the Criminal Division's expertise in all aspects of fighting cybercrime." The merger is expected to "more than double" the number of DOJ attorneys available to work on criminal cryptocurrency matters and "elevates cryptocurrency work within the Criminal Division by giving it equal status to computer crime and intellectual property work." The merger will also "multiply the [DOJ's] ability to trace cryptocurrency, to charge cases involving the criminal use of cryptocurrency, and to seize legally forfeitable cryptocurrency."
Federal Reserve issues information on supervision of "novel activities." On August 8, the US Federal Reserve Board of Governors announced the issuance of two Supervision and Regulation Letters providing information on its program to supervise “novel activities” (eg, activities involving crypto assets, DLT, and FinTech partnerships) in the banks it oversees. One of the Letters discusses the supervisory nonobjection process for member banks seeking to engage in activities related to stablecoins, including a requirement to demonstrate that the banks have controls in place to conduct the activity "in a safe and sound manner." The other Letter describes the focus of the Fed's program, to include supervision of crypto asset custody, crypto-collateralized lending, crypto asset trading, and engaging in stablecoin issuance or distribution.
ENFORCEMENT ACTIONS AND LITIGATION
SEC settles with Bittrex and former CEO accused of operating unregistered exchange, broker, and clearing agency. On August 10, the SEC announced it had reached a settlement with crypto trading platform Bittrex Inc., and its co-founder and CEO William Shihara. In its complaint, SEC had charged Bittrex with operating an unregistered national securities exchange, broker, and clearing agency in violation of Sections 5, 15(a), and 17A of the Securities Exchange Act of 1934. SEC had further alleged that Bittrex advised token issuers who sought to have their tokens listed on Bittrex to remove public statements that would attract regulatory scrutiny. If the court approves the settlement, Bittrex will not be required to admit the SEC’s allegations, but would pay $24 million including $14.4 million in disgorgement, $4 million in prejudgment interest and $5.6 million in civil penalties. For more information on the complaint, see our May 2023 issue. Separately, Bittrex remains engaged in bankruptcy proceedings which we described in our prior article.
SEC secures emergency injunctive relief against DEBT Box crypto scheme. On August 3, the SEC announced it had obtained a temporary asset freeze and restraining order against a Utah company doing business as DEBT Box and each of the company's four principals. Defendants are charged with selling unregistered securities they called “node licenses.” According to the complaint, the defendants promised investors that these node licenses would generate passive income through mining activity but, in reality, the defendants were themselves minting tokens and distributing them to investors. The SEC further alleged that the defendants lied about the existence of revenue-generating businesses that would drive value for the “mined” tokens. The SEC is seeking disgorgement and civil penalties.
SEC charges North Carolina man with securities fraud in connection with sham crypto exchange. On July 21, the SEC charged Alexander Elbanna of North Carolina with violating Sections 5 and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. According to the SEC announcement, Elbanna created a series of sham companies to start a digital asset exchange platform with an "in-house exchange token." Elbanna allegedly courted investors by materially misrepresenting his technological ability and wealth. In total, he is alleged to have taken $1 million from investors. Elbanna and several co-defendants have already agreed to a settlement subject to court approval.
Quantstamp, Inc. agrees to settle SEC charges following ICO. On July 21, the SEC announced an agreement to settle charges against Quantstamp, Inc. for its unregistered initial coin offering (ICO). According to the SEC's order, Quantstamp raised over $28 million in October and November 2017 through an ICO for the company’s automated smart contract auditing platform. SEC alleged that Quantstamp led investors to expect the value of their tokens to increase based on the company’s efforts to develop a promising platform, but Quantstamp failed to register its offers and sales which, in the SEC’s view, constituted securities. Quantstamp has agreed to disgorge nearly $2 million from the proceeds of the ICO and to pay nearly $1.5 million in civil penalties and prejudgment interest.
Amicus briefs filed in support of Coinbase in SEC action. On August 11, the DeFi Education Fund and the Crypto Council for Innovation, along with the Blockchain Association, Chamber of Progress, and Consumer Technology Association filed an amicus brief in SEC v. Coinbase. The DeFi Education brief dissects two technical issues that are often misunderstood:
- A Coinbase Wallet (like all non-custodial wallets) does not actually hold anything. Wallets do not store assets, nor do assets pass through wallets. Crypto assets are entries on a digital ledger (a blockchain) and these assets never leave the blockchain. The wallet is merely a set of public and private cryptographic keys which a holder uses to "sign" transactions (ie, change the record on the ledger). Only the wallet owner has access to private keys. Coinbase cannot generate signatures for Coinbase Wallet users and therefore Coinbase has no ability to effect, control, or even participate in, transactions. Accordingly, Coinbase does not meet the definition of a broker with respect to Coinbase Wallets.
- Coinbase’s staking program is not an investment contract because Coinbase does not ultimately influence what rewards, if any, are received by the user (the proof of state (PoS) protocol does), therefore there is no efforts of others. Fees generated by Coinbase cannot be reinvested to improve user results since the PoS protocol, not Coinbase, dictates rewards. The brief argues that the pooling of delegators for use in Coinbase's validator merely grants users access to the opportunity. The brief analogizes to a solo validator who stakes its own assets using a cloud service. The cloud service is essential to the solo staker receiving rewards, but it is only providing a ministerial IT service. Likewise, the brief argues, Coinbase's staking services is a ministerial IT service and not an investment contract.
The Crypto Council brief argues that digital assets sold on the secondary market, such as Coinbase, are not investment contracts under federal securities laws because these transactions involve no contract and no ongoing contractual obligations beyond the sale itself.
CFTC charges husband and wife in national commodity pool scheme. On July 25, the CFTC announced charges against a husband and wife in Tennessee for defrauding over 100 people across the US through a commodity pool scheme they began running in July 2022. According to the complaint, the couple solicited colleagues and clients of their real estate business to pool their money and invest in digital asset commodity futures contracts. The scheme, which they called "Blessings of God Thru Crypto," received more than $6 million. The couple allegedly lost more than $4 million as soon as they began trading. They used another $1 million to pay their own debts and purchase luxury goods. The remaining funds were used to pay out earlier investors. The CFTC seeks restitution, civil money penalties, and permanent injunctive relief.
CFTC announces restraining order and asset freeze against algorithmic trading platform Fundsz. On August 11, the CFTC announced it had filed a complaint against the founders of an unincorporated entity called "Fundsz" who allegedly solicited more than 14,000 investors for a fake algorithmic cryptocurrency and precious metal trading platform. According to the complaint, the defendants told investors that a one-time $2,500 investment could turn into $1 million within two years while also supporting charitable causes such as humanitarian aid. In reality, the CFTC alleges, Fundsz never traded any funds and simply fabricated reported returns to investors. The CFTC has secured a temporary restraining order and asset freeze, and will seek restitution, disgorgement, and civil monetary penalties.
DOJ secures nine-year sentence for EminiFX fraudster. On July 18, the US Attorney’s Office of the Southern District of New York announced that Eddy Alexandre, the head of a crypto trading platform called EminiFX, had been sentenced to nine years in prison for defrauding more than 25,000 investors of more than $248 million. The scheme involved inducing members of Alexandre’s church and community to invest in his fake AI investing platform. To perpetuate the fraud, Alexandre generated fake returns and encouraged his victims to re-invest them. Alexandre was further ordered to forfeit $248 million and pay more than $213 million in restitution.
Couple pleads guilty to money laundering in crypto theft. The DOJ announced on August 2, that a married couple, Ilya Lichtenstein and Heather Morgan, pled guilty to money laundering conspiracies arising from the hack and theft of approximately 120,000 bitcoin from Bitfinex, a global cryptocurrency exchange. The press release asserts that Lichtenstein "used a number of advanced hacking tools and techniques to gain and access to Bitfinex's network, … to fraudulently authorize more than 2,000 transactions in which 119,754 bitcoin was transferred … to a wallet in Lichtenstein's control." After the hack, Lichtenstein enlisted the help of Morgan in laundering the $3.6 billion in stolen funds.
FDIC issues cease and desist regarding false representations of FDIC insurance. On August 4, the Federal Deposit Insurance Corporation (FDIC) announced it demanded that Unbanked, Inc. and certain of its officers cease and desist from making false and misleading statements about FDIC insurance. According to the release, Unbanked made false representations on its website, in promotional materials, and on social media platforms stating or suggesting its crypto-related products and services are FDIC-insured. "These representations included claims that Unbanked offered FDIC-insured 'crypto accounts,' without any disclaimer that cryptocurrency is not FDIC-insured or guaranteed."
Los Angeles SIM Swap hacker pleads guilty to USAO charges. On July 19, the US Attorney's Office for the Central District of California, announced it had obtained a guilty plea from 24-year-old Amir Golshan of Los Angeles. Golshan pled guilty to three felony charges in connection with "SIM Swap" attacks he used to steal money and digital assets from several victims. The attack involved using social engineering to convince wireless carriers to "swap" a victim’s phone number to a device controlled by Golshan. In one instance, Golshan spoofed an official Apple Support hotline number to induce a victim to disclose a two-factor authentication code. Golshan was then able to access the victim’s iCloud account and take control of the victim's digital asset wallet. Golshan stole and liquidated assets worth nearly $400,000, including an NFT valued at $319,000.
Florida court grants default judgment based on NFT service on defendant. In a cryptocurrency theft and fraud case, Bowen v. Li, 2023 WL 4623594 (USDC SD Fla. July 18, 2023) the US District Court for the Southern District of Florida granted a final default judgment in the amount of $2,215,118 for the theft of 2,215,118 units of Tether USDT, a stablecoin pegged to the US dollar. The defendant failed to respond to the complaint after the court had permitted the plaintiff to effect service of process on the foreign defendant through an NFT delivered to the blockchain addresses of the defendant's crypto wallets. The NFT contained a notice of the action with summons language and a hyperlink to the plaintiff's website URL, which contained a notice of the action and hyperlinks to the summons, complaint, and all filing and orders in the action.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
Italy: Voluntary disclosure for crypto-assets and related income is now available. On August 7, the Italian Revenue Agency issued the instructions and time frame for accessing the regularization provided for in the most recent Budget Law (No. 197/2022). The measure also approves the outline of an explanatory report to be attached to the application, which, given the complexity of the matter, may be prepared with the assistance of a tax lawyer. The application must be submitted by November 30, along with the payment of taxes on income from crypto-assets and penalties for violating tax monitoring obligations. Read more.
UK: Crypto, consumers, and arbitration: English public policy grounds for refusing enforcement of arbitral awards. In a rare decision, the English High Court refused to enforce a Californian-seated arbitral award for contravening English public policy (Payward v. Chechetkin). The claim, brought against a British citizen resident in England under section 101 of the Arbitration Act 1996 (AA 1996), sought enforcement of a New York Convention arbitral award made in relation to a dispute over cryptocurrency trading losses. The High Court refused enforcement, deciding that the presence of an arbitration clause in the agreement providing for foreign-seated arbitration and for disputes to be governed by foreign law cannot prevent the English court from adjudicating on matters concerning UK consumer protection rights. Read more.
DLA Piper ranks Tier 1 in FinTech: Crypto by The Legal 500. DLA Piper was also ranked in Tier 2 for FinTech, and Margo Tank was 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.
Global Digital Forum – Adapting to a digital future for real world assets and content, taking place September 28, 2023, brings together leading representatives from government, regulatory bodies, and international business to discuss the implications from operating in the new digital environment and how this is likely to change the way products and services are structured, traded, held, and delivered in global markets and economies.
DLA Piper attorneys presented at the following events:
- Creating and monetizing carbon assets for financing, trading, and retirement, July 26, 2023, with Drew Young and Deanna Reitman.
- 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. Key takeaways from the webinar may be found here.
- 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 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
SEC adopts final rules on cybersecurity risk management, strategy, governance and incident...
31 July 2023 .19 minute read
Proposed legislation would subject cryptocurrency to tax rules for wash sales
28 July 2023 .6 minute read