18 April 202250 minute read

Blockchain and Digital Assets News and Trends

Achieving Digital Transformation and Securing Digital Assets

This is our fourth monthly bulletin for 2022, 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:

  • Securities
  • Virtual currencies
  • Commodities
  • 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.

INSIGHT

Money laundering in trading works of art – Treasury report addresses NFT marketplaces

By Margo H.K. TankR. David WhitakerAndrew W. Grant and Liz Caires

The US Department of Treasury has released “Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art,”  seeking to identify market participants and segments of the high-value art market that may present money laundering and terrorist financing risks to the US financial system. While the Treasury report noted “[m]ost art market participants, including some entities that provide financial services within the high-value art market, are not subject to anti-money laundering/countering the financing of terrorism (AML/CFT) obligations” – the report includes a section addressing the “emerging digital art market.”  Read more.

FDIC issues new crypto-asset guidance and notification requirements

By Margo H.K. TankR. David WhitakerAndrew W. Grant and Liz Caires

On April 7, the Federal Deposit Insurance Corporation (FDIC) issued a financial institution letter, Notification of Engaging in Crypto-Related Activities FIL-16-2022 (FIL), applicable to all FDIC-supervised institutions. The FIL requires all such covered institutions that intend to engage in, or that are currently engaged in, any activities involving or related to crypto-assets to notify the FDIC and provide certain required information. The FDIC will review the information and provide relevant supervisory feedback. Covered institutions will need to evaluate their crypto-asset and digital asset activities and provide notice of such activities to the FDIC. Read more.

HAPPENING SOON

DC Blockchain Summit, May 24, 2022, Washington, DC

FEDERAL DEVELOPMENTS

NFTs

  • SEC scrutinizes NFT market. In early March, the US Securities and Exchange Commission (SEC) reportedly initiated a probe into creators of non-fungible tokens (NFTs) and the crypto-exchanges on which they trade to determine if some of the NFTs represent securities. Over the past several months, attorneys in the SEC’s enforcement unit have sent subpoenas demanding information about NFT offerings. The SEC is seeking information on fractional NFTs, which involve breaking down the assets into units that can be easily bought and sold.

Distributed ledger technology

  • Federal Reserve speaks on DLT and defi. “Novel technology like distributed ledger and decentralized finance have the potential to improve efficiency of the payment system and encourage a more competitive financial landscape,” Federal Reserve Chairman Jerome Powell said at the Bank of International Settlements (BIS) Innovation Summit on March 22. "There are also potential financial stability concerns for some products,”  he continued. “In particular, we don’t know how some digital products will behave in times of market stress, which could lead to large destabilizing flows, nor do we know how stresses in crypto markets could potentially spill over into the traditional finance system."

Virtual currency

  • OFAC sanctions Russian-based darknet market and virtual currency exchange. On April 5, the Office of Foreign Assets Control (OFAC) sanctioned the world’s largest and most prominent darknet market, Hydra Market (Hydra), and the Garantex virtual currency exchange operating out of Moscow and St. Petersburg, in a coordinated international effort to disrupt proliferation of malicious cybercrime services, dangerous drugs, and other illegal offerings available through Hydra or funded through Garantex. The operation was a collaborative initiative joined by the US Department of Justice, Federal Bureau of Investigations, Drug Enforcement Administration, Internal Revenue Service Criminal Investigation, and Homeland Security Investigations, with cooperation from the German Federal Criminal Police. OFAC noted that “approximately 86 percent of the illicit Bitcoin received directly by Russian virtual currency exchanges in 2019 came from Hydra,” and over $100 million in [Garantex] transactions are associated with illicit actors and darknet markets, including nearly $6 million from Russian RaaS gang Conti and also including approximately $2.6 million from Hydra.”
  • OFAC updates FAQs with guidance on compliance with Russia-related sanctions regarding virtual currency transactions. On March 11, OFAC issued several new Frequently Asked Questions to provide clarity on a number of issues under the newly imposed Russia-related sanctions, including regarding the application of sanctions to virtual currencies. Under FAQ 1,021, OFAC asserts that US persons’ compliance with OFAC regulations applies regardless of whether a transaction is denominated in traditional fiat currency or virtual currency, and warns US persons, including US financial institutions, virtual currency exchanges, virtual wallet hosts, and other service providers, to be vigilant against attempts to circumvent OFAC regulations through virtual currency transactions in which blocked persons have an interest. According to the FAQ, “OFAC is closely monitoring any efforts to circumvent or violate Russia-related sanctions, including through the use of virtual currency, and is committed to using its broad enforcement authorities to act against violations and to promote compliance.” For more information on the sanctions against Russia, see our alerts, US announces new trade restrictions against Russia as well as a new round of sanctions against Russian political elites and Latest sanctions block Russia’s largest banks, cyber actors and more; Biden’s executive order prohibits investments in Russia by US persons.
  • US Treasury calls for government regulation of cryptocurrency. On April 7, US Treasury Secretary Janet Yellen stated that “Taxpayers should receive the same type of tax reporting on digital asset transactions that they receive for transactions in stocks and bonds, so that they have the information they need to report their income to the IRS.” The Secretary spoke at American University. As banks and other traditional financial firms become more involved in digital asset markets, Yellen said, “regulatory frameworks will need to appropriately reflect the risks of these new activities.”
  • OCC speaks on tail risks of trading crypto derivatives. On March 31, Michael Hsu, Acting Comptroller of the Currency for the Office of the Comptroller of the Currency (OCC), spoke at the American Bankers Association Risk 2022 Conference, and discussed managing low probability, high impact risk events, or tail risks, associated with the trading of crypto-related derivatives. Hsu identified the following risks:
    • limited or unreliable price histories of crypto-assets
    • crypto positions being netted in risk aggregation for risk reporting, regulatory capital and risk management
    • heightened potential for wrong-way risk with crypto derivatives
  • DOL issues compliance assistance on 401(k) plan investments in cryptocurrencies. On March 10, the US Department of Labor (DOL) issued Compliance Assistance Release No. 2022-01, 401(k) Plan Investments in “Cryptocurrencies.” In the release, the DOL cautions plan fiduciaries “to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plans’ investment menu for plan participants. … At this early stage in the history of cryptocurrencies, the Department has serious concerns about the prudence of a fiduciary's decision to expose a 401(k) plan's participants to direct investments in cryptocurrencies, or other products whose value is tied to cryptocurrencies. These investments present significant risks and challenges to participants' retirement accounts, including significant risks of fraud, theft, and loss.” Reasons for the DOL’s recommendation include investment volatility, challenges to participant investment decision-making, custodial and recordkeeping concerns, valuation issues, and the evolving regulatory environment. The DOL also announced that the Employee Benefits Security Administration will “conduct an investigative program aimed at plans that offer participant investments in cryptocurrencies and related products, and to take appropriate action to protect the interests of plan participants and beneficiaries with respect to these investments.”

Securities

  • SEC Chair speaks on crypto markets. On April 4, SEC Chair Gary Gensler spoke at the Penn Law Capital Markets Association Annual Conference, addressing crypto trading and lending platforms, stablecoins and tokens. Gensler asserted that crypto platforms “likely are trading securities,” and asked staff to urge platforms to get registered and regulated like exchanges, particularly to handle custody issues and trading of securities and non-securities, as well as market making functions. Gensler also expressed concerns regarding the use of stablecoins to impact financial stability and monetary policy, reasserting his position that “most crypto tokens are investment contracts under the Howey test.”
  • Members of Congressional Blockchain Caucus seek SEC accountability in crypto regulation. On March 16, representatives Tom Emmer (R-MN) and Darren Soto (D-FL) announced they sent a letter to SEC Chair Gensler asking him to provide details about the frequency and manner of the Commission’s voluntary document requests to private, non-SEC regulated crypto and blockchain firms. The letter argues that, while the SEC has the authority to secure transparent information from market participants for rulemaking purposes, it must ensure that these inquiries do not infringe on the standards established in the Paperwork Reduction Act, which limits the burden the federal government imposes on private businesses and citizens. According to the letter, “Crypto startups must not be weighed down by extra-jurisdictional and burdensome reporting requirements. The SEC must ensure that its information-seeking requests to private crypto and blockchain firms are not overburdensome, unnecessary, and do not stifle innovation.”
  • SEC issues guidance on safeguarding crypto-assets. On March 31, the SEC issued Staff Accounting Bulletin Number 121 (SAB121) which adds interpretive guidance for entities to consider when they have obligations to safeguard crypto-assets held for their platform users. SAB 121 requires, among other things, that such entities should include in notes to their financial statements a clear disclosure of the nature and amount of crypto-assets that the entity is holding for its platform users, with a separate disclosure for each significant crypto-asset, and the vulnerabilities the entity has due to any concentration in such activities. Disclosures regarding fair value measurements for the crypto-assets should also be included. Such entities should also include disclosures regarding the significant risks and uncertainties associated with the holding of crypto-assets for platform users outside the financial statements as required under existing Commission rules, such as in the description of business, risk factors, or management’s discussion and analysis of financial condition and results of operation.

    SEC Commissioner Hester Peirce issued a response to SAB121, calling it “yet another manifestation of the [SEC’s] scattershot and inefficient approach to crypto.”

Taxation

  • IRS reminds taxpayers to report virtual currency transactions. On March 18, the IRS released updated guidance to US taxpayers on how to properly report virtual currency holdings and transactions on their 2021 Form 1040s. All taxpayers filing Form 1040 must answer yes or no to the question, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” Persons holding virtual currency in their own accounts, transferring virtual currency between their own accounts, or purchasing virtual currency using real currency may answer “No.”

STATE DEVELOPMENTS

Blockchain

  • Wyoming amends law on decentralized autonomous organizations. On March 9, Wyoming enacted SF0068, which amends Wyoming’s current laws establishing decentralized autonomous organizations to clarify the formation, ownership, management, status, and dissolution of DAOs and their use of smart contracts. For more information on DAOs, see our March 2021 issue.

Digital assets

  • Utah enacts Digital Asset Management Act. On March 24, Utah enacted SB182 entitled the Digital Asset Management Act to establish a framework for the ownership of digital assets. The new law establishes two types of digital assets – a “digital security,” defined as a digital asset which constitutes a security under the state Uniform Commercial Code, and a “digital user asset” which is “a digital asset that is used or bought primarily for consumptive, personal or household purposes.” Digital securities are deemed intangible personal property and securities and investment property for purposes of the state Uniform Commercial Code, and ownership of digital user assets may be established through control.
  • Virginia allows state-charted banks to offer digital asset custody services. On April 11, Virginia Governor Glen Youngkin signed HB263 which becomes effective July 1. The new law enables banks in Virginia to provide cryptocurrency currency custody services. The custody services may be provided on a fiduciary basis whereby the bank holds the private keys to the depositor’s digital wallet, or may be provided on a on a nonfiduciary basis with the bank serving as a bailee taking possession of the virtual currency wallet, but allowing the depositor to retain legal title and control over the keys. When determining to provide custody services, the bank must first “carefully examine the risks involved in offering such services through a methodical self-assessment process.”  Once a bank determines to provide virtual currency custody services, the bank shall:
    • Have adequate protocols in place to effectively manage risks and comply with applicable laws;
    • Implement effective risk management systems and controls to measure, monitor, and control relevant risks associated with custody of digital assets such as virtual currency;
    • Confirm that it has adequate insurance coverage for such services; and
    • Maintain a service provider oversight program, to the extent that the bank engages with a service provider to provide virtual currency custody services, to address risks to service provider relationships as a result of engaging in virtual currency custody services.

INDUSTRY DEVELOPMENTS

  • Chainalysis launches sanctions screening tools. On March 10, Chainalysis, a blockchain data platform, announced the launch of two sanctions screening tools to assist decentralized platforms and their customers in compliance with the global sanctions imposed on Russia. The tools are an on-chain oracle and an API which will be provided free of charge to the cryptocurrency industry.
  • ApeCoin token linked to Bored Ape Yacht Club is launched. On March 18, Bored Ape Yacht Club (BAYC) announced the launch of ApeCoin ($APE) as “a token for culture, gaming, and commerce used to empower a decentralized community building at the forefront of web3.” The token is owned and operated by ApeCoin DAO, and BAYC has adopted ApeCoin as the official currency of the BAYC ecosystem. Yuga Labs also reportedly plans to “adopt ApeCoin as the primary token for all new products and services.” For more information on Yuga Labs and NFT project Bored Ape Yacht Club, see our March 2022 issue.
ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Commodities

  • CFTC announces settlement with Florida man for $1.8 million in digital asset scheme. On April 7, the Commodity Futures Trading Commission (CFTC) announced the US District Court for the Middle District of Florida entered an order for permanent injunction, monetary sanctions, and equitable relief against Alan Friedland of Florida and his Florida-based companies, Fintech Investment Group, Inc. (Fintech), and Compcoin LLC, for fraudulently soliciting customers to purchase a digital asset they falsely promised would allow customers to gain access to a proprietary foreign currency (forex) trading algorithm. The order requires the defendants to pay $1.2 million in restitution and a $600,000 civil monetary penalty. In addition, the order imposes a permanent ban on Friedland, Compcoin LLC, and Fintech from soliciting or trading in commodity interests or registering with the CFTC in any capacity.
  • Court enters consent order against El Paso man for defrauding forex and cryptocurrency clients. On March 29, the CFTC announced that a consent order was entered in the Western District of Texas in an enforcement action against defendants Abner Alejandro Tinoco, and his company, Kikit & Mess Investments, LLC, a self-styled investment firm, finding that they misappropriated in excess of $7.2 million from investors who intended to trade forex or cryptocurrency in managed accounts. The order imposes injunctive relief, including bans relating to trading and registration.

NFTs

  • Two men charged with NFT fraud and money laundering. On March 24, the DOJ announced it had charged Ethan Nguyen and Andre Llacuna with conspiracy to commit wire fraud and conspiracy to commit money laundering in connection with a million-dollar scheme to defraud purchasers of NFTs advertised as “Frosties.” According to the announcement, “[r]ather than providing the benefits advertised to Frosties NFT purchasers, Nguyen and Llacuna transferred the cryptocurrency proceeds of the scheme to various cryptocurrency wallets under their control.” The DOJ alleged that Nguyen and Llacuna “promised investors the benefits of the Frosties NFTs, but when it sold out, they pulled the rug out from under the victims, almost immediately shutting down the website and transferring the money.” The defendants face maximum sentences of 20 years in prison for each count.

Virtual currency

  • Former Canadian government employee extradited to US on charges of ransomware attacks. On March 10, the Department of Justice announced the extradition of Sebastien Vachon-Desjardins, a former Canadian government employee, to the US on charges of conspiracy to commit computer fraud and wire fraud, intentional damage to a protected computer, and transmitting a demand in relation to damaging a protected computer arising from his alleged participation in a sophisticated form of ransomware known as NetWalker. NetWalker ransomware has targeted dozens of victims all over the world, including companies, municipalities, hospitals, law enforcement, emergency services, school districts, colleges, and universities.

    According to court documents, from April through December 2020, Vachon-Desjardins conspired to and did intentionally damage a protected computer and transmit a ransom demand in connection with doing so. The indictment also alleges that the US intends to forfeit more than $27 million, which is alleged to be traceable to proceeds of the offenses. The extradition was the result of a joint FBI-RCMP ransomware investigation that netted tens of millions of dollars' worth of seized bitcoin – believed to be the largest cryptocurrency seizure in Canada to date. Vachon-Desjardins has already received a seven-year prison sentence in Canada on numerous charges arising from these crimes.
  • DOJ announces guilty plea related to BitClub. On March 24, the US Attorney’s Office for the District of New Jersey announced Gordon Brad Beckstead, a Nevada resident, pled guilty to one count of conspiracy to commit money laundering and one count of aiding in the preparation of a false tax return in connection with his role in the BitClub Network, a cryptocurrency mining scheme worth at least $722 million. Beckstead further admitted to controlling bank accounts associated with BitClub Network and to directing transfers to and from the accounts exceeding $50 million. For more information on BitClub and other defendants, please see our September 2020, July 2020 and January 2020 issues.

STATE

Virtual currency

  • California DFPI issues two interpretive opinions regarding money transmission.
    • Digital currency trading platform.

      An entity requested an interpretive opinion from the Department of Financial Protection & Innovation (DFPI) regarding the entity’s digital currency trading platform. Customers create accounts with the entity and can transfer in digital currency or fiat currency, which is held in the customer’s wallet issued by the entity. When a customer initiates a buy or sell order, the customer transfers the relevant digital currency or fiat amounts to another wallet held by the entity designated for trading those assets. The entity then matches and fills the order. Customers can only withdraw fiat or digital currency to their own bank account or digital wallet. They cannot send fiat or digital currency to others, except as part of a sale.

      The DFPI stated that it has not determined whether trading digital currency or digital currency wallets are money transmission and therefore does not require the entity to obtain a money transmitter license to perform trading services or issues wallets to hold digital currencies. The entity’s wallets that hold fiat currency meet the definition of stored value, but the entity offers such wallets to customers solely to facilitate the trade of digital currency. Based on those facts, the DFPI is not requiring the entity to be licensed as a money transmitter.
    • Purchase and sale of digital assets; payment processing services.

      An entity requested an interpretive opinion from the DFPI regarding two types of transactions that would be conducted on the entity’s trading platform: (1) customers can purchase and sell digital assets from the entity in exchange for fiat currency and (2) merchants can use the platform as a payment processor to allow merchants to accept digital assets from customers in exchange for non-fungible tokens (NFTs).

      For the first category, the entity will own the digital assets that the customer purchases; if the entity does not yet own the digital asset, the entity will purchase it using its own funds and then sell it to the customer. The DFPI stated that the purchase and sale of digital assets does not require an MTA license.

      For the second category, the entity works with merchants that mint and sell NFTs for digital assets; the merchant will sell the NFTs through the entity’s platform. The entity will have an agreement with each merchant whereby the entity acts the merchant’s authorized agent to accept payments for the merchant for NFTs.

      The DFPI stated that because it has “not yet determined that payment processing transactions involving digital assets constitute receiving money for transmission, [it] decline[s] to address whether the transactions would qualify for the agent of payee exemption. However, at this time, the [DFPI] does not require licensure under the MTA for the Company to receive fiat currency from the customer for the transfer in the form of digital assets to the merchant.”

    For more information on recent DFPI interpretive opinions, see California DFPI issues interpretive opinions regarding money transmission.

  • States issue cease and desist orders against Canadian cryptocurrency trading platform. The states of Alabama, Indiana, Kentucky, New Jersey, Oklahoma, Texas, Vermont and Washington have issued orders to show cause or cease and desist orders against Voyager Digital LLC, alleging that Voyager’s Earn Program and Earn Accounts constitute unregistered securities. Voyager’s Earn Program and the Earn Accounts enable customers to earn rewards on their crypto balances. Voyager asserts that it “is firmly convinced that its Earn Program and the Voyager Earn Accounts are not securities and intends to demonstrate its position and defend it as necessary and appropriate. Of course, Voyager supports appropriate regulation and will do its best to demonstrate to these regulators that Voyager has complied with the law.”
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
  • ANZ becomes first Australian bank to mint stablecoin. On March 23, the Australia and New Zealand Banking Group (ANZ) reportedly announced that it launched its own stablecoin (A$DC) backed 1:1 by the Australian dollar. ANZ stated that it has minted 30 million A$DC.
  • BIS Innovation Hub and central banks develop experimental multi-CBDC platform for international settlements. On March 22, the Bank for International Settlements (BIS) Innovation Hub announced the completion of prototypes for a common platform enabling international settlements using multiple CBDCs. The project, Project Dunbar, was developed in conjunction with the Reserve Bank of Australia, Bank Negara Malaysia, the Monetary Authority of Singapore, and the South African Reserve Bank. For more information on Project Dunbar, see our September 2021 issue.
  • Belgium introduces new legal framework for virtual assets. In February 2022, Belgium introduced a new legal framework regulating the provision of certain services related to virtual assets in Belgium. This initiative runs ahead of the regulatory initiatives at the European level, notably the “MiCa” proposal, and significantly strengthens the supervision on professional services related to virtual assets. As the regulatory framework provides for only limited transitional measures, immediate action by virtual asset service providers is required. Read more.
  • Swedish mining company launches clean energy farm. On March 3, Genesis Digital Assets announced a new self-hosted bitcoin mining data center in Sweden. The new data center expects to have up to 100 megawatts of power capacity by 2024 to be derived entirely from clean energy sources.
  • Swiss city to make bitcoin and tether legal tender. On March 3, Lugano, Switzerland reportedly announced the formation of a partnership with Tether to establish bitcoin, tether and Lugano’s LVGA points token as “de facto legal tender” in the city. While the Swiss franc will remain the city’s actual legal tender, Lugano seeks to become the first Swiss locality aiming for all businesses to transact in cryptocurrency.
  • Ukraine legalizes crypto. On February 17, the Ukrainian Parliament announced that President Volodymyr Zelenskyy signed the Law on Virtual Assets, which allows the launch of a legal market for virtual assets in Ukraine and  determines the legal status and classification of cryptocurrencies. Virtual assets will be regulated by Ukraine’s National Commission on Securities and the Stock Market and the National Bank of Ukraine. Additionally, the Ministry and Committee on Digital Transformation is developing appropriate amendments to the Ukrainian Tax and Civil Codes to accommodate virtual assets.
  • UK HM Treasury publishes response to consultation on regulatory approach to cryptoassets, stablecoins and DLT. This month, the UK public finance and economic policy department, Her Majesty’s Treasury, published UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: Response to the consultation and call for evidence. The report confirms the government’s intention to take the necessary legislative steps to bring activities that issue or facilitate the use of stablecoins used as a means of payment into the UK regulatory perimeter, primarily by amending existing electronic money and payments legislation.
PUBLICATIONS

Cryptocurrency and Digital Asset Regulation, published by the American Bar Association and co-edited by our partners Deborah Meshulam and Michael Fluhr, including chapters also prepared by Meshulam and Fluhr and by Margo H.K. Tank and Andrew W. Grant.  Read more about this publication and get a 20 percent discount for its purchase on LinkedIn.

Anti-Money Laundering (AML) Bulletin Regulatory News Update, Winter 2022. In this issue, DLA Piper provides updates on AML developments in the UK, the EU and internationally.

Read

Shyft Network Federation’s due diligence attestation verifications to be carried out via DLA Piper using digital asset creation engine TOKO

Is blockchain the key to a more ESG-compliant supply chain? 

Listen

Listen to our podcast, Crypto Savvy Bringing a Token to Life, featuring HashKey Group, which discusses TOKO and its tech. The podcast is now available on Spotify, Apple and Google Podcasts. Feel free to check out more on LinkedIn.

More

Transferring property rights in digital property – a look at the ongoing development of UCC Article 12

Contacts

Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:

Margo H.K. Tank

Mark Radcliffe

Liz Caires

Martin Bartlam

Guy E. Flynn

Contributors to this Issue

Andrew W. Grant

R. David Whitaker

This is our fourth monthly bulletin for 2022, 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:

  • Securities
  • Virtual currencies
  • Commodities
  • 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.

INSIGHT

Money laundering in trading works of art – Treasury report addresses NFT marketplaces

By Margo H.K. TankR. David WhitakerAndrew W. Grant and Liz Caires

The US Department of Treasury has released “Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art,”  seeking to identify market participants and segments of the high-value art market that may present money laundering and terrorist financing risks to the US financial system. While the Treasury report noted “[m]ost art market participants, including some entities that provide financial services within the high-value art market, are not subject to anti-money laundering/countering the financing of terrorism (AML/CFT) obligations” – the report includes a section addressing the “emerging digital art market.”  Read more.

FDIC issues new crypto-asset guidance and notification requirements

By Margo H.K. TankR. David WhitakerAndrew W. Grant and Liz Caires

On April 7, the Federal Deposit Insurance Corporation (FDIC) issued a financial institution letter, Notification of Engaging in Crypto-Related Activities FIL-16-2022 (FIL), applicable to all FDIC-supervised institutions. The FIL requires all such covered institutions that intend to engage in, or that are currently engaged in, any activities involving or related to crypto-assets to notify the FDIC and provide certain required information. The FDIC will review the information and provide relevant supervisory feedback. Covered institutions will need to evaluate their crypto-asset and digital asset activities and provide notice of such activities to the FDIC. Read more.

HAPPENING SOON

DC Blockchain Summit, May 24, 2022, Washington, DC

FEDERAL DEVELOPMENTS

NFTs

  • SEC scrutinizes NFT market. In early March, the US Securities and Exchange Commission (SEC) reportedly initiated a probe into creators of non-fungible tokens (NFTs) and the crypto-exchanges on which they trade to determine if some of the NFTs represent securities. Over the past several months, attorneys in the SEC’s enforcement unit have sent subpoenas demanding information about NFT offerings. The SEC is seeking information on fractional NFTs, which involve breaking down the assets into units that can be easily bought and sold.

Distributed ledger technology

  • Federal Reserve speaks on DLT and defi. “Novel technology like distributed ledger and decentralized finance have the potential to improve efficiency of the payment system and encourage a more competitive financial landscape,” Federal Reserve Chairman Jerome Powell said at the Bank of International Settlements (BIS) Innovation Summit on March 22. "There are also potential financial stability concerns for some products,”  he continued. “In particular, we don’t know how some digital products will behave in times of market stress, which could lead to large destabilizing flows, nor do we know how stresses in crypto markets could potentially spill over into the traditional finance system."

Virtual currency

  • OFAC sanctions Russian-based darknet market and virtual currency exchange. On April 5, the Office of Foreign Assets Control (OFAC) sanctioned the world’s largest and most prominent darknet market, Hydra Market (Hydra), and the Garantex virtual currency exchange operating out of Moscow and St. Petersburg, in a coordinated international effort to disrupt proliferation of malicious cybercrime services, dangerous drugs, and other illegal offerings available through Hydra or funded through Garantex. The operation was a collaborative initiative joined by the US Department of Justice, Federal Bureau of Investigations, Drug Enforcement Administration, Internal Revenue Service Criminal Investigation, and Homeland Security Investigations, with cooperation from the German Federal Criminal Police. OFAC noted that “approximately 86 percent of the illicit Bitcoin received directly by Russian virtual currency exchanges in 2019 came from Hydra,” and over $100 million in [Garantex] transactions are associated with illicit actors and darknet markets, including nearly $6 million from Russian RaaS gang Conti and also including approximately $2.6 million from Hydra.”
  • OFAC updates FAQs with guidance on compliance with Russia-related sanctions regarding virtual currency transactions. On March 11, OFAC issued several new Frequently Asked Questions to provide clarity on a number of issues under the newly imposed Russia-related sanctions, including regarding the application of sanctions to virtual currencies. Under FAQ 1,021, OFAC asserts that US persons’ compliance with OFAC regulations applies regardless of whether a transaction is denominated in traditional fiat currency or virtual currency, and warns US persons, including US financial institutions, virtual currency exchanges, virtual wallet hosts, and other service providers, to be vigilant against attempts to circumvent OFAC regulations through virtual currency transactions in which blocked persons have an interest. According to the FAQ, “OFAC is closely monitoring any efforts to circumvent or violate Russia-related sanctions, including through the use of virtual currency, and is committed to using its broad enforcement authorities to act against violations and to promote compliance.” For more information on the sanctions against Russia, see our alerts, US announces new trade restrictions against Russia as well as a new round of sanctions against Russian political elites and Latest sanctions block Russia’s largest banks, cyber actors and more; Biden’s executive order prohibits investments in Russia by US persons.
  • US Treasury calls for government regulation of cryptocurrency. On April 7, US Treasury Secretary Janet Yellen stated that “Taxpayers should receive the same type of tax reporting on digital asset transactions that they receive for transactions in stocks and bonds, so that they have the information they need to report their income to the IRS.” The Secretary spoke at American University. As banks and other traditional financial firms become more involved in digital asset markets, Yellen said, “regulatory frameworks will need to appropriately reflect the risks of these new activities.”
  • OCC speaks on tail risks of trading crypto derivatives. On March 31, Michael Hsu, Acting Comptroller of the Currency for the Office of the Comptroller of the Currency (OCC), spoke at the American Bankers Association Risk 2022 Conference, and discussed managing low probability, high impact risk events, or tail risks, associated with the trading of crypto-related derivatives. Hsu identified the following risks:
    • limited or unreliable price histories of crypto-assets
    • crypto positions being netted in risk aggregation for risk reporting, regulatory capital and risk management
    • heightened potential for wrong-way risk with crypto derivatives
  • DOL issues compliance assistance on 401(k) plan investments in cryptocurrencies. On March 10, the US Department of Labor (DOL) issued Compliance Assistance Release No. 2022-01, 401(k) Plan Investments in “Cryptocurrencies.” In the release, the DOL cautions plan fiduciaries “to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plans’ investment menu for plan participants. … At this early stage in the history of cryptocurrencies, the Department has serious concerns about the prudence of a fiduciary's decision to expose a 401(k) plan's participants to direct investments in cryptocurrencies, or other products whose value is tied to cryptocurrencies. These investments present significant risks and challenges to participants' retirement accounts, including significant risks of fraud, theft, and loss.” Reasons for the DOL’s recommendation include investment volatility, challenges to participant investment decision-making, custodial and recordkeeping concerns, valuation issues, and the evolving regulatory environment. The DOL also announced that the Employee Benefits Security Administration will “conduct an investigative program aimed at plans that offer participant investments in cryptocurrencies and related products, and to take appropriate action to protect the interests of plan participants and beneficiaries with respect to these investments.”

Securities

  • SEC Chair speaks on crypto markets. On April 4, SEC Chair Gary Gensler spoke at the Penn Law Capital Markets Association Annual Conference, addressing crypto trading and lending platforms, stablecoins and tokens. Gensler asserted that crypto platforms “likely are trading securities,” and asked staff to urge platforms to get registered and regulated like exchanges, particularly to handle custody issues and trading of securities and non-securities, as well as market making functions. Gensler also expressed concerns regarding the use of stablecoins to impact financial stability and monetary policy, reasserting his position that “most crypto tokens are investment contracts under the Howey test.”
  • Members of Congressional Blockchain Caucus seek SEC accountability in crypto regulation. On March 16, representatives Tom Emmer (R-MN) and Darren Soto (D-FL) announced they sent a letter to SEC Chair Gensler asking him to provide details about the frequency and manner of the Commission’s voluntary document requests to private, non-SEC regulated crypto and blockchain firms. The letter argues that, while the SEC has the authority to secure transparent information from market participants for rulemaking purposes, it must ensure that these inquiries do not infringe on the standards established in the Paperwork Reduction Act, which limits the burden the federal government imposes on private businesses and citizens. According to the letter, “Crypto startups must not be weighed down by extra-jurisdictional and burdensome reporting requirements. The SEC must ensure that its information-seeking requests to private crypto and blockchain firms are not overburdensome, unnecessary, and do not stifle innovation.”
  • SEC issues guidance on safeguarding crypto-assets. On March 31, the SEC issued Staff Accounting Bulletin Number 121 (SAB121) which adds interpretive guidance for entities to consider when they have obligations to safeguard crypto-assets held for their platform users. SAB 121 requires, among other things, that such entities should include in notes to their financial statements a clear disclosure of the nature and amount of crypto-assets that the entity is holding for its platform users, with a separate disclosure for each significant crypto-asset, and the vulnerabilities the entity has due to any concentration in such activities. Disclosures regarding fair value measurements for the crypto-assets should also be included. Such entities should also include disclosures regarding the significant risks and uncertainties associated with the holding of crypto-assets for platform users outside the financial statements as required under existing Commission rules, such as in the description of business, risk factors, or management’s discussion and analysis of financial condition and results of operation.

    SEC Commissioner Hester Peirce issued a response to SAB121, calling it “yet another manifestation of the [SEC’s] scattershot and inefficient approach to crypto.”

Taxation

  • IRS reminds taxpayers to report virtual currency transactions. On March 18, the IRS released updated guidance to US taxpayers on how to properly report virtual currency holdings and transactions on their 2021 Form 1040s. All taxpayers filing Form 1040 must answer yes or no to the question, “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” Persons holding virtual currency in their own accounts, transferring virtual currency between their own accounts, or purchasing virtual currency using real currency may answer “No.”

STATE DEVELOPMENTS

Blockchain

  • Wyoming amends law on decentralized autonomous organizations. On March 9, Wyoming enacted SF0068, which amends Wyoming’s current laws establishing decentralized autonomous organizations to clarify the formation, ownership, management, status, and dissolution of DAOs and their use of smart contracts. For more information on DAOs, see our March 2021 issue.

Digital assets

  • Utah enacts Digital Asset Management Act. On March 24, Utah enacted SB182 entitled the Digital Asset Management Act to establish a framework for the ownership of digital assets. The new law establishes two types of digital assets – a “digital security,” defined as a digital asset which constitutes a security under the state Uniform Commercial Code, and a “digital user asset” which is “a digital asset that is used or bought primarily for consumptive, personal or household purposes.” Digital securities are deemed intangible personal property and securities and investment property for purposes of the state Uniform Commercial Code, and ownership of digital user assets may be established through control.
  • Virginia allows state-charted banks to offer digital asset custody services. On April 11, Virginia Governor Glen Youngkin signed HB263 which becomes effective July 1. The new law enables banks in Virginia to provide cryptocurrency currency custody services. The custody services may be provided on a fiduciary basis whereby the bank holds the private keys to the depositor’s digital wallet, or may be provided on a on a nonfiduciary basis with the bank serving as a bailee taking possession of the virtual currency wallet, but allowing the depositor to retain legal title and control over the keys. When determining to provide custody services, the bank must first “carefully examine the risks involved in offering such services through a methodical self-assessment process.”  Once a bank determines to provide virtual currency custody services, the bank shall:
    • Have adequate protocols in place to effectively manage risks and comply with applicable laws;
    • Implement effective risk management systems and controls to measure, monitor, and control relevant risks associated with custody of digital assets such as virtual currency;
    • Confirm that it has adequate insurance coverage for such services; and
    • Maintain a service provider oversight program, to the extent that the bank engages with a service provider to provide virtual currency custody services, to address risks to service provider relationships as a result of engaging in virtual currency custody services.

INDUSTRY DEVELOPMENTS

  • Chainalysis launches sanctions screening tools. On March 10, Chainalysis, a blockchain data platform, announced the launch of two sanctions screening tools to assist decentralized platforms and their customers in compliance with the global sanctions imposed on Russia. The tools are an on-chain oracle and an API which will be provided free of charge to the cryptocurrency industry.
  • ApeCoin token linked to Bored Ape Yacht Club is launched. On March 18, Bored Ape Yacht Club (BAYC) announced the launch of ApeCoin ($APE) as “a token for culture, gaming, and commerce used to empower a decentralized community building at the forefront of web3.” The token is owned and operated by ApeCoin DAO, and BAYC has adopted ApeCoin as the official currency of the BAYC ecosystem. Yuga Labs also reportedly plans to “adopt ApeCoin as the primary token for all new products and services.” For more information on Yuga Labs and NFT project Bored Ape Yacht Club, see our March 2022 issue.
ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Commodities

  • CFTC announces settlement with Florida man for $1.8 million in digital asset scheme. On April 7, the Commodity Futures Trading Commission (CFTC) announced the US District Court for the Middle District of Florida entered an order for permanent injunction, monetary sanctions, and equitable relief against Alan Friedland of Florida and his Florida-based companies, Fintech Investment Group, Inc. (Fintech), and Compcoin LLC, for fraudulently soliciting customers to purchase a digital asset they falsely promised would allow customers to gain access to a proprietary foreign currency (forex) trading algorithm. The order requires the defendants to pay $1.2 million in restitution and a $600,000 civil monetary penalty. In addition, the order imposes a permanent ban on Friedland, Compcoin LLC, and Fintech from soliciting or trading in commodity interests or registering with the CFTC in any capacity.
  • Court enters consent order against El Paso man for defrauding forex and cryptocurrency clients. On March 29, the CFTC announced that a consent order was entered in the Western District of Texas in an enforcement action against defendants Abner Alejandro Tinoco, and his company, Kikit & Mess Investments, LLC, a self-styled investment firm, finding that they misappropriated in excess of $7.2 million from investors who intended to trade forex or cryptocurrency in managed accounts. The order imposes injunctive relief, including bans relating to trading and registration.

NFTs

  • Two men charged with NFT fraud and money laundering. On March 24, the DOJ announced it had charged Ethan Nguyen and Andre Llacuna with conspiracy to commit wire fraud and conspiracy to commit money laundering in connection with a million-dollar scheme to defraud purchasers of NFTs advertised as “Frosties.” According to the announcement, “[r]ather than providing the benefits advertised to Frosties NFT purchasers, Nguyen and Llacuna transferred the cryptocurrency proceeds of the scheme to various cryptocurrency wallets under their control.” The DOJ alleged that Nguyen and Llacuna “promised investors the benefits of the Frosties NFTs, but when it sold out, they pulled the rug out from under the victims, almost immediately shutting down the website and transferring the money.” The defendants face maximum sentences of 20 years in prison for each count.

Virtual currency

  • Former Canadian government employee extradited to US on charges of ransomware attacks. On March 10, the Department of Justice announced the extradition of Sebastien Vachon-Desjardins, a former Canadian government employee, to the US on charges of conspiracy to commit computer fraud and wire fraud, intentional damage to a protected computer, and transmitting a demand in relation to damaging a protected computer arising from his alleged participation in a sophisticated form of ransomware known as NetWalker. NetWalker ransomware has targeted dozens of victims all over the world, including companies, municipalities, hospitals, law enforcement, emergency services, school districts, colleges, and universities.

    According to court documents, from April through December 2020, Vachon-Desjardins conspired to and did intentionally damage a protected computer and transmit a ransom demand in connection with doing so. The indictment also alleges that the US intends to forfeit more than $27 million, which is alleged to be traceable to proceeds of the offenses. The extradition was the result of a joint FBI-RCMP ransomware investigation that netted tens of millions of dollars' worth of seized bitcoin – believed to be the largest cryptocurrency seizure in Canada to date. Vachon-Desjardins has already received a seven-year prison sentence in Canada on numerous charges arising from these crimes.
  • DOJ announces guilty plea related to BitClub. On March 24, the US Attorney’s Office for the District of New Jersey announced Gordon Brad Beckstead, a Nevada resident, pled guilty to one count of conspiracy to commit money laundering and one count of aiding in the preparation of a false tax return in connection with his role in the BitClub Network, a cryptocurrency mining scheme worth at least $722 million. Beckstead further admitted to controlling bank accounts associated with BitClub Network and to directing transfers to and from the accounts exceeding $50 million. For more information on BitClub and other defendants, please see our September 2020, July 2020 and January 2020 issues.

STATE

Virtual currency

  • California DFPI issues two interpretive opinions regarding money transmission.
    • Digital currency trading platform.

      An entity requested an interpretive opinion from the Department of Financial Protection & Innovation (DFPI) regarding the entity’s digital currency trading platform. Customers create accounts with the entity and can transfer in digital currency or fiat currency, which is held in the customer’s wallet issued by the entity. When a customer initiates a buy or sell order, the customer transfers the relevant digital currency or fiat amounts to another wallet held by the entity designated for trading those assets. The entity then matches and fills the order. Customers can only withdraw fiat or digital currency to their own bank account or digital wallet. They cannot send fiat or digital currency to others, except as part of a sale.

      The DFPI stated that it has not determined whether trading digital currency or digital currency wallets are money transmission and therefore does not require the entity to obtain a money transmitter license to perform trading services or issues wallets to hold digital currencies. The entity’s wallets that hold fiat currency meet the definition of stored value, but the entity offers such wallets to customers solely to facilitate the trade of digital currency. Based on those facts, the DFPI is not requiring the entity to be licensed as a money transmitter.
    • Purchase and sale of digital assets; payment processing services.

      An entity requested an interpretive opinion from the DFPI regarding two types of transactions that would be conducted on the entity’s trading platform: (1) customers can purchase and sell digital assets from the entity in exchange for fiat currency and (2) merchants can use the platform as a payment processor to allow merchants to accept digital assets from customers in exchange for non-fungible tokens (NFTs).

      For the first category, the entity will own the digital assets that the customer purchases; if the entity does not yet own the digital asset, the entity will purchase it using its own funds and then sell it to the customer. The DFPI stated that the purchase and sale of digital assets does not require an MTA license.

      For the second category, the entity works with merchants that mint and sell NFTs for digital assets; the merchant will sell the NFTs through the entity’s platform. The entity will have an agreement with each merchant whereby the entity acts the merchant’s authorized agent to accept payments for the merchant for NFTs.

      The DFPI stated that because it has “not yet determined that payment processing transactions involving digital assets constitute receiving money for transmission, [it] decline[s] to address whether the transactions would qualify for the agent of payee exemption. However, at this time, the [DFPI] does not require licensure under the MTA for the Company to receive fiat currency from the customer for the transfer in the form of digital assets to the merchant.”

    For more information on recent DFPI interpretive opinions, see California DFPI issues interpretive opinions regarding money transmission.

  • States issue cease and desist orders against Canadian cryptocurrency trading platform. The states of Alabama, Indiana, Kentucky, New Jersey, Oklahoma, Texas, Vermont and Washington have issued orders to show cause or cease and desist orders against Voyager Digital LLC, alleging that Voyager’s Earn Program and Earn Accounts constitute unregistered securities. Voyager’s Earn Program and the Earn Accounts enable customers to earn rewards on their crypto balances. Voyager asserts that it “is firmly convinced that its Earn Program and the Voyager Earn Accounts are not securities and intends to demonstrate its position and defend it as necessary and appropriate. Of course, Voyager supports appropriate regulation and will do its best to demonstrate to these regulators that Voyager has complied with the law.”
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
  • ANZ becomes first Australian bank to mint stablecoin. On March 23, the Australia and New Zealand Banking Group (ANZ) reportedly announced that it launched its own stablecoin (A$DC) backed 1:1 by the Australian dollar. ANZ stated that it has minted 30 million A$DC.
  • BIS Innovation Hub and central banks develop experimental multi-CBDC platform for international settlements. On March 22, the Bank for International Settlements (BIS) Innovation Hub announced the completion of prototypes for a common platform enabling international settlements using multiple CBDCs. The project, Project Dunbar, was developed in conjunction with the Reserve Bank of Australia, Bank Negara Malaysia, the Monetary Authority of Singapore, and the South African Reserve Bank. For more information on Project Dunbar, see our September 2021 issue.
  • Belgium introduces new legal framework for virtual assets. In February 2022, Belgium introduced a new legal framework regulating the provision of certain services related to virtual assets in Belgium. This initiative runs ahead of the regulatory initiatives at the European level, notably the “MiCa” proposal, and significantly strengthens the supervision on professional services related to virtual assets. As the regulatory framework provides for only limited transitional measures, immediate action by virtual asset service providers is required. Read more.
  • Swedish mining company launches clean energy farm. On March 3, Genesis Digital Assets announced a new self-hosted bitcoin mining data center in Sweden. The new data center expects to have up to 100 megawatts of power capacity by 2024 to be derived entirely from clean energy sources.
  • Swiss city to make bitcoin and tether legal tender. On March 3, Lugano, Switzerland reportedly announced the formation of a partnership with Tether to establish bitcoin, tether and Lugano’s LVGA points token as “de facto legal tender” in the city. While the Swiss franc will remain the city’s actual legal tender, Lugano seeks to become the first Swiss locality aiming for all businesses to transact in cryptocurrency.
  • Ukraine legalizes crypto. On February 17, the Ukrainian Parliament announced that President Volodymyr Zelenskyy signed the Law on Virtual Assets, which allows the launch of a legal market for virtual assets in Ukraine and  determines the legal status and classification of cryptocurrencies. Virtual assets will be regulated by Ukraine’s National Commission on Securities and the Stock Market and the National Bank of Ukraine. Additionally, the Ministry and Committee on Digital Transformation is developing appropriate amendments to the Ukrainian Tax and Civil Codes to accommodate virtual assets.
  • UK HM Treasury publishes response to consultation on regulatory approach to cryptoassets, stablecoins and DLT. This month, the UK public finance and economic policy department, Her Majesty’s Treasury, published UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: Response to the consultation and call for evidence. The report confirms the government’s intention to take the necessary legislative steps to bring activities that issue or facilitate the use of stablecoins used as a means of payment into the UK regulatory perimeter, primarily by amending existing electronic money and payments legislation.
PUBLICATIONS

Cryptocurrency and Digital Asset Regulation, published by the American Bar Association and co-edited by our partners Deborah Meshulam and Michael Fluhr, including chapters also prepared by Meshulam and Fluhr and by Margo H.K. Tank and Andrew W. Grant.  Read more about this publication and get a 20 percent discount for its purchase on LinkedIn.

Anti-Money Laundering (AML) Bulletin Regulatory News Update, Winter 2022. In this issue, DLA Piper provides updates on AML developments in the UK, the EU and internationally.

Read

Shyft Network Federation’s due diligence attestation verifications to be carried out via DLA Piper using digital asset creation engine TOKO

Is blockchain the key to a more ESG-compliant supply chain? 

Listen

Listen to our podcast, Crypto Savvy Bringing a Token to Life, featuring HashKey Group, which discusses TOKO and its tech. The podcast is now available on Spotify, Apple and Google Podcasts. Feel free to check out more on LinkedIn.

More

Transferring property rights in digital property – a look at the ongoing development of UCC Article 12

Contacts

Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:

Margo H.K. Tank

Mark Radcliffe

Liz Caires

Martin Bartlam

Guy E. Flynn

Contributors to this Issue

Andrew W. Grant

R. David Whitaker

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