Blockchain and Digital Assets News and Trends - July 2021Achieving Digital Transformation and Securing Digital Assets
To remain competitive, companies find themselves increasing their efforts to digitally transform their businesses by developing new offerings based on emerging technologies and integrating these technologies into existing product and service offerings.
This is our seventh monthly bulletin for 2021, 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, from copyright protection to voting, most of the current adoption is in the financial services section and the focus of this bulletin will be primarily on the use of blockchain and or smart contracts in that 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
Digital assets can themselves be assets or instead can reflect the ownership of an underlying asset. For example, electronic records that are the equivalents of negotiable instruments and electronic chattel paper would be digital assets, as would an electronic recording of a security interest in the underlying asset, such as recording title to real or personal property and the use of tokens to represent revenue streams from otherwise illiquid assets such as patents and commercial real estate (sometimes referred to as a tokenized or digitized asset).
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.
Each issue will feature in-depth insight on a timely and important current topic. In this issue, we discuss the recent IRS memorandum which concluded that Section 1031 tax-deferred “like-kind” exchange treatment is not available for cryptocurrency trades.
To build on our increasing recognition in the fintech and blockchain space, the DLA Piper IPT and Real Estate teams joined up to contribute to the inaugural edition of the Chambers and Partners Blockchain Guide 2020. Led by partner Scott Thiel and supported by Jonathan Gill, the team wrote the Hong Kong and China “Law and Practice” sections of the guide detailing the blockchain market and key legal and regulatory issues to note in each jurisdiction.
For related information regarding digital transformation, please see our monthly bulletin, eSignature and ePayment News and Trends.
IRS concludes Section 1031 tax-deferred “like-kind” exchange treatment is not available for cryptocurrency trades
The IRS has issued IRS Legal Memo 202124008 in which it concludes that swaps of certain cryptocurrencies cannot qualify as tax-deferred “like-kind” exchanges under Section 1031 of the Code as it existed prior to its amendment in 2017. While the Memo only addresses exchanges of three specific cryptocurrencies, it seems reasonable to assume that the IRS would apply its analysis in the Memo to most other cryptocurrencies. Learn more.
- Copyright issues continue to plague NFTs. The question of who has the right under copyright law to sell non-fungible tokens (NFTs) continues to cause controversy. Roc-a-Fella Records, Inc. (RAF), a record label for Jay-Z, filed suit in the Southern District of New York against Damon Dash to prevent the sale of an NFT of the copyright for Reasonable Doubt, Jay-Z’s debut album. According to the complaint, RAF, not Damon Dash, owns the copyright in Reasonable Doubt. RAF is owned equally by Jay-Z, Damon Dash and Kareem Burke. The original auction on SuperFarm was cancelled, but RAF was concerned that Damon Dash would try again. Judge Cronan issued a temporary restraining order. Ironically, Jay-Z sold an animated digital representation of the cover of Reasonable Doubt created by a digital artist, Derrick Adams. The digital representation was named “Heir to the Throne” and was auctioned by Sotheby’s for $139,000. Separately, A Tribe Called Quest objected to an NFT representing a 1.5 percent stake in the royalties from the five studio albums of the band on the Royalty Exchange auction site. Band member Ali Shaheed Muhammed stated that the band had not authorized the sale but that a company known as PPX Enterprises did own royalty share in their albums and had apparently sold it to an individual who auctioned his interest on Royalty Exchange. These cases are a reminder of the complex issues of determining who can mint NFTs for existing works; they likely presage more disputes in this market as the interest in NFTs continues to expand.
- NFT being used to sell or transfer patent rights. One of the first attempts to use blockchain technology to sell or transfer patent rights as an NFT is ongoing via live auction. The sellers, True Return Systems LLC and Boag Law PLLC, promote the technology as a transparent and simple manner to identify ownership of patent rights. Others in the field have warned against using public or non-private blockchain technology for such transfers, particularly when considering the lack of safeguards or the ability to roll back transactions. Transactions within a blockchain environment tend to be final, a prospect that has led to caution in corporate entities when considering their adoption. Despite these reservations about public blockchains, the development and integration of private blockchain projects (eg, projects that are deployed and managed internally to one or more companies) continue to show progress and innovation.
- Congressional subcommittee holds hearing on cryptocurrency. On June 30, the US House Committee on Financial Services, Subcommittee on Oversight and Investigations, held a hearing entitled America on “FIRE”: Will the Crypto Frenzy Lead to Financial Independence and Early Retirement or Financial Ruin? The following members of the Digital Asset Working Group provided opening statements which expressed concern regarding cryptocurrencies and their use: Maxine Waters (D-CA), Chairwoman, Financial Services Committee; Brad Sherman (D-CA), Chairman, Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets; and Nikema Williams (D-GA), Vice Chair, Oversight and Investigations Subcommittee. Topics of discussion included regulatory oversight for cryptocurrency markets, concern regarding financial stability and consumer protection, and the potential development of a US central bank digital currency (CBDC).
The Committee on Financial Services also announced an upcoming hearing, to be held on July 27 at 10 am ET by the Subcommittee on National Security, International Development and Monetary Policy, entitled The Promises and Perils of Central Bank Digital Currencies.
- FinCEN publishes AML/CFT priorities. On June 30, the Financial Crimes Enforcement Network (FinCEN) announced the issuance of a policy setting forth government-wide priorities for anti-money laundering and countering the financing of terrorism (AML/CFT). The policy was developed in consultation with the Department of the Treasury, Federal and state regulators, law enforcement and national securities agencies, and describes significant AML/CFT threats facing the US to include: cybercrime, including virtual currency considerations, corruption, terrorist financing, fraud, transnational criminal organizations, drug trafficking organizations, human trafficking and smuggling, and proliferation financing.
- Senator raises concerns regarding FinCEN counterparty rule. On June 10, Senator Pat Toomey (R-PA), ranking member of the Senate Committee on Banking, Housing and Urban Affairs, wrote a letter to Janet Yellen, US Treasury Secretary, cautioning that a proposed FinCEN counterparty rule and the FATF draft guidance on cryptocurrencies and VASPs could have a detrimental effect on FinTech, the privacy of Americans and efforts to combat illicit activity. Senator Toomey asserted that cryptocurrencies have the potential to significantly improve consumers’ privacy and access to financial services, and that the proposed regulation could negatively impact financial technology, among other pitfalls. For more information on the FinCEN counterparty rule, see our January issue, and see our March issue for information on the FATF draft guidance.
- Texas creates work group on blockchain matters. On June 7, 2021, the governor of Texas signed HB 1576, which created a work group that will develop a plan for expanding the blockchain industry in Texas. The work group must submit its report no later than October 31, 2022.
- Delaware includes virtual currency as unclaimed property. Delaware recently signed into law SB103 which adds “virtual currency” to the definition of “property” subject to the reporting and remitting requirements of Delaware’s unclaimed property law. Effective August 1, 2021, virtual currency is presumed abandoned five years after the owner’s last indication of interest in property. At that point, the holder of the abandoned virtual currency must report it to Delaware as unclaimed property. Within 90 days prior to filing the report, the holder of the virtual currency must liquidate the virtual currency and remit the proceeds. The owner of the virtual currency has no recourse against the Delaware Escheator to recover gains in value that would have been realized had the virtual currency not been liquidated. For more information on the 2016 Revised Uniform Unclaimed Property Act, see our April issue.
ENFORCEMENT ACTIONS AND LITIGATION
- DOJ announces guilty plea in illegal cash-to-crypto scheme. On June 29, the Department of Justice (DOJ) announced that Mark Hopkins, AKA Doctor Bitcoin, pleaded guilty to illegally operating a cash-to-cryptocurrency conversion business without obtaining a license as a money transmitting business. Over a year, Hopkins conducted 37 transactions, converting between $550,000 and $1.5 million. Hopkins faces up to five years in prison.
- New Orleans man selling bitcoin charged by DOJ. On June 24, the DOJ announced charges against Michael Yusko III, for operating an unlicensed money transmitting business in connection with his ownership and management of Nervous Light Capital LLC, a company that sold virtual currency to customers. If convicted, Yusko may receive a maximum of five years in prison, up to three years of supervised release, a $250,000 fine, and a $100 mandatory special assessment.
- CFTC obtains judgment against foreign trading platform for offering illegal leveraged transactions in virtual currency. On July 9, Commodity Futures Trading Commission (CFTC) announced the entry of a default judgment against Laino Group Limited d/b/a PaxForex, a company registered in St. Vincent and the Grenadines. The order imposes permanent trading, solicitation, and registration bans against PaxForex entering into transactions involving commodity interests and prohibits it from violating provisions of the Commodity Exchange Act (CEA), as charged. The order also requires the defendant to pay a civil monetary penalty of $374,864. For more information on the complaint, see our October 2020 issue.
- DOJ announces sentencing of cryptocurrency fraudster for securities fraud and wire fraud. On July 8, the DOJ announced that Roger Nils-Jonas Karlsson was sentenced to 15 years in prison for securities fraud, wire fraud and money laundering charges that defrauded thousands of victims of more than $16 million. Karlsson had pled guilty to the charges on March 4. For more information on the case, see our March issue and our December 2019 issue.
- SEC charges ICO issuer with fraud and unregistered securities offering. On June 22, the Securities and Exchange Commission (SEC) announced that it charged and settled the charges against Loci Inc. and its CEO John Wise for making false and misleading statements in connection with an unregistered offer and sale of digital asset securities. According to the SEC's order, Loci and Wise raised $7.6 million from investors by offering and selling digital tokens called LOCIcoin. In promoting the ICO, Loci and Wise made numerous materially false statements to investors and potential investor regarding the company's revenues, employees and user base. The order also finds that LOCIcoins constituted securities, Loci's offering wasn't registered and no exemption to registration applied. Without admitting or denying the order, Loci and Wise agreed to a cease and desist order, agreed to destroy their remaining tokens and request removal of the tokens from trading platforms, and refrain from participating in further offerings. The order also imposes a $7.6 million civil penalty against Loci, and an officer and director bar as to Wise.
- SEC charges Coinschedule.com with unlawfully touting digital asset securities. On July 14, the SEC announced it settled charges against UK-based Blotics Ltd., the operator of Coinschedule.com, a website that profiled offerings of digital asset securities. According to the SEC's order, Coinschedule.com profiled digital token offerings including a “trust score” which purportedly reflected the offering's credibility and operational risk as calculated by a proprietary algorithm. However, Coinschedule.com failed to disclose that token issuers paid Coinschedule.com to profile their token offerings. Without admitting or denying the SEC’s findings, Blotics has agreed to cease and desist from committing or causing any future violations of the anti-touting provisions of the federal securities laws, and to pay $43,000 in disgorgement, plus prejudgment interest, and a penalty of $154,434.
- SEC charges individuals with insider trading related to blockchain business. On July 9, the SEC announced it charged Eric Watson, Oliver Barret-Lindsay and Gannon Giguire with insider trading in advance of a press release by Long Blockchain Company (formerly known as Long Island Iced Tea Co.) announcing that it was going to “pivot” from its existing beverage business to blockchain technology, which caused the company’s stock price to soar. The SEC's complaint charges Watson, Barret-Lindsay, and Giguiere with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and seeks permanent injunctions and civil penalties as to all defendants, and, additionally, an officer and director bar as to Watson. Additionally, the SEC revoked the registration of Long Blockchain's securities on February 19, pursuant to Section 12(j) of the Exchange Act.
- SEC charges additional individuals in $30 million ICO fraud. On June 15, the SEC announced it filed charges against Ali Asif Hamid, Michael Gietz and Cristine Page in connection with their leadership roles in the $30 million ICO spearheaded by Boaz Manor and Edith Pardo, and their companies CG Blockchain, Inc. and BCT Inc. SEZC. The additional defendants allegedly concealed the involvement of Manor in the ICO to hide Manor's prior criminal convictions. The SEC's complaint charges Hamid, Gietz, and Page with violating and aiding and abetting violations of the antifraud provisions of the federal securities laws and with violating securities registration requirements. The complaint seeks disgorgement of ill-gotten gains plus interest, penalties, and injunctive relief. Without admitting or denying the SEC's allegations, Page has agreed to a settlement, subject to court approval, that includes permanent injunctions, disgorgement of the digital assets that she received in connection with her misconduct, and a civil penalty of $192,768.
For more information on the original Manor/Pardo complaint, see our February 2020 issue.
- New Hampshire man appeals ruling permitting IRS to seize cryptocurrency data. On July 12, James Harper appealed to the First Circuit the dismissal of his lawsuit by a New Hampshire federal court which attempted to prohibit the IRS from retaining his financial records obtained from unknown cryptocurrency platforms. Harper seeks the IRS to expunge these financial records and claims that his lawsuit violates neither the Anti-Injunction Act nor the Declaratory Judgment Act as ruled by the lower court – each act bars lawsuits that would restrain tax collection or that implicate federal tax liabilities. For more information on the lawsuit challenging IRS information-gathering practices through the use of John Doe warrants, see our July 2020 issue.
- Texas regulator issues emergency cease-and-desist orders. The Texas State Securities Board (TSSB) announced it issued emergency cease-and-desist orders against the following entities:
– Bitles Limited AKA ₿itle$, Janis Lacis, C3 Data Services and Edward Carter in connection with an illegal scheme to advertise, hype and sell fraudulent investments in a cryptocurrency trading program (April 16)
– Affort Projects S.A., AlgorAndTrade24, TradeFlow24 and 13 other entities in connection with the offer and sale of investment plans purportedly tied to stocks, foreign currencies and/or commodities which offer an “X2,” “X5,” or “X10 Bitcoin increase” and pay between 5 percent to 20 percent per week resulting from high-frequency bitcoin trading (April 27)
– Hyperion Trust LLC, Roberto Patrizio, and 3 others in connection with the fraudulent sale of investments in service packaged tied to stock, cryptocurrencies and foreign exchange trading which purported to pay guaranteed daily returns (April 29)
– EscoCapital and Anthony Jerome AKA Anthony Vitale in connection with the offering and sale of investment plans tied to binary options, cryptocurrency, stock trading and cryptocurrency mining (April 30)
– Avoid These “Investment Plans” When Planning Your Investments In connection with the offering and sale of cryptocurrency investments that purportedly earn returns of at least 40 percent per month (June 17)
Additionally, in April the TSSB issued an investor alert to Avoid These “Investment Plans” When Planning Your Investments, which warned the public about unregistered online platforms selling “investment plans” which are often tied to blockchain technology, artificial intelligence, or foreign currency and promise guaranteed returns paid over very short periods.
- Crypto venture investments continue to accelerate. On July 9, The Block Research issued an Overview of Q2' 21 Private Funding of Crypto Companies, reporting that venture capital investments in crypto firms continued to accelerate in the second quarter of 2021 with a total of 497 blockchain-related venture deals, a 50 percent increase over the 331 venture deals in the first quarter. Excluding Block.one’s $9.7 billion investment into Bullish Global in May – The Block Research noted that about $6.2 billion was invested with an approximately a 90 percent increase in venture funding over the first quarter of 2021. DeFi companies led the number of deals with 127 investments followed by NFTs/gaming companies with 98 investments. Bullish Global, a new cryptocurrency exchange, was launched by Block.one with an investment of 64,000 bitcoins (BTC) valued at around $9.7 billion, $100 million in cash, and 20 million EOS tokens (the native token of the Block.one blockchain), and soon raised an additional $300 million in a strategic round with other investors. Bullish Global also announced that it is going public by raising $9 billion through an SPAC merger.
- Cointelegraph publishes security token report. In June, Cointelegraph published its first report on security tokens. The report assessed the potential and desire for security tokens – blockchain based digital representations of shares in investment vehicles – and concludes that most securities will eventually be tokenized due to demands for greater transparency, instant settlement and liquidity. The report also provides a survey of the current regulatory frameworks applicable to security tokens.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
- BIS reports on CBDC cross-border adoption. On July 9, that Bank for International Settlements (BIS) announced the publication of Central Bank Digital Currencies for Cross-Border Payments, a joint report to the G20 by the Committee on Payments and Market Infrastructures, the BIS Innovation Hub, the International Monetary Fund (IMF) and the World Bank. The report concludes that Central Bank Digital Currencies (CBDCs) “have the potential to enhance the efficiency of cross-border payments, as long as countries work together.” The analysis further highlights both the need for multilateral collaboration on macro-financial consequences as well as the importance of interoperability between CBDCs. This report follows an earlier survey of central banks, CBDCs Beyond Borders: Results from a Survey of Central Banks, which found that “28% of surveyed central banks are considering options to make CBDCs interoperable by forming multi-CBDC arrangements”; however, “[t]hey have a cautious approach to allowing use of a CBDC beyond their own jurisdiction.”
- European Central Bank announces investigation phase of digital euro. On July 14, the European Central Bank (ECB) announced the start of the investigation phase of the ECB's digital euro project which is slated to last 24 months and aims to address key issues regarding design and distribution, as well as identifying changes needed to the EU regulatory framework for digital euro adoption.
- FATF announces plenary outcomes. On June 25, the Financial Action Task Force (FATF) announced the outcomes from its June 2021 plenary, including updates to its statements on AML/CFT compliance:
– High-Risk Jurisdictions Subject to a Call for Action (unchanged from February 2020) and
– Jurisdictions Under Increased Monitoring (adding Haiti, Malta, the Philippines and South Sudan, and removing Ghana).
- FATF issues review of implementation of revised standards. On July 2, the FATF announced the publication of its Second 12-Month Review of Revised FATF Standards - Virtual Assets and VASPs, a report that assesses how jurisdictions and the private sector have implemented the revised FATF Standards, as well as the changes in risks and market structure of the virtual assets sector. The report finds that many jurisdictions have continued to make progress in implementing the revised FATF Standards, and market metrics indicate that a potentially significant amount of virtual assets is transferred on a peer-to-peer basis, without use of a VASP.
- UK detectives announce seizures of cryptocurrency. On June 24, detectives from the London Metropolitan Police Economic Crime Command announced the seizure of cryptocurrency worth £114 million in connection with an investigation on the transfer of criminal assets. The Met asserted the seizure is the largest in the UK and likely the largest globally. Subsequently, on July 13, detectives from the Met’s Economic Crime Command announced the seizure of cryptocurrency worth nearly £180 million as part of an ongoing investigation into international money laundering.
- Ontario Securities Commission pursues trading platform for failure to register. On June 21, the Ontario Securities Commission (OSC) filed a Statement of Allegations against Bybit Fintech Limited for operating an unregistered cryptoasset trading platform, allowing Ontario residents to trade cryptoasset products that the OSC asserts are securities and derivatives. The enforcement proceeding has been scheduled for a hearing on July 15. See our June issue for other enforcement actions of the OSC.
- Bank of China encourages banks to cease virtual currency activities. On June 21, the People’s Bank of China (PBOC) issued a notice which asserted that “the speculation of virtual currency disturbs the normal order of economy and finance, breeds the risk of illegal cross-border transfer of assets, money laundering and other illegal and criminal activities, and seriously infringes on the safety of people's property.” The PBOC encouraged banks and payment institutions to “strictly implement regulatory provisions” and fulfill customer identification obligations and stop facilitating cryptocurrency transactions. This notice follows the June 10 arrest of more than 1,100 people who allegedly used virtual currencies to provide money laundering services.
- Ghana to pilot CBDC in 2 months. On July 12, the Bank of Ghana (BoG) reportedly announced that it will start its pilot of a CBDC in September. The BoG First Deputy Governor stated: “We have to take our time to design it with all the security features and so have started it in a pilot phase through what we call a sand-box to learn lessons before we open it up to the general public.”
- Indian court calls for standardized disclaimers on crypto asset TV advertising. On July 14, the High Court of Delhi in India reportedly issued a notice requesting the Securities and Exchange Board of India (SEBI) and other regulatory bodies to issue appropriate guidelines against crypto asset exchanges advertising on national television without adequate standardized disclaimers. The court also sought responses from SEBI, the Ministry of Information and Broadcasting and others, such as crypto exchanges, scheduling the matter for August. The court's notice comes after two lawyers petitioned for SEBI to issue guidelines mandating disclaimer text covering 80 percent of the screen, with a voiceover read over five seconds.
- Israel seizes cryptocurrency associated with Hamas. On June 30, the National Bureau for Counter Terror Financing of Israel (NBCTF) issued a seizure order against 82 cryptocurrency addresses allegedly the property of Hamas or otherwise used in connection with terrorism. These addresses reportedly collectively received over $7.7 million in cryptocurrencies.
- Portugal grants first crypto exchange licenses. On June 18, the Banco de Portugal announced it issued its first two licenses to two cryptocurrency exchanges – Mind the Coin and Criptoloja.
- South African financial regulator publishes position paper on crypto assets. On June 11, the South African Ministry of Finance, National Treasury, Intergovernmental Fintech Working Group (IFWG) announced the publication of a position paper on crypto assets and related FAQs. The paper makes 25 recommendations on how to develop and implement crypto asset regulation in a phased and structured approach in three main areas: AML/CFT, cross-border financial flows, and application of financial sector laws.
- South Korean investigators pursue 33 people for illicit overseas cryptocurrency transactions. On July 15, The Korea Times reported a press briefing held by Lee Dong-hyun, Director of Investigation at Seoul Central Customs, in which he announced that 33 people were found to have engaged in over 1.69 trillion won (or $1.48 billion) worth of illicit overseas transactions involving cryptocurrency over the prior two months: 14 of them were referred for prosecution, 15 were fined and 4 remain under investigation for violations of South Korea's ban on overseas cryptocurrency trading.
Register for DLA Piper’s European Technology Summit 2021: A new era of technology-driven resilience, being held Tuesday, October 5, 2021.
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Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:
Andrew W. Grant
Guy E. Flynn