Blockchain and Digital Assets News and TrendsAchieving Digital Transformation and Securing Digital Assets
This is our first 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.
Terms of service are instrumental in determining rights to digital assets – the holding in Celsius Network LLC
On January 2, 2023, the US Bankruptcy Court of the Southern District of New York issued a Memorandum Opinion and Order Regarding Ownership of Earn Account Assets in the Celsius Network LLC Chapter 11 bankruptcy case.
At issue were various versions of the Celsius website Terms of Service that addressed ownership of Earn account assets and were used by Celsius to contract with its customers. The court held that these Terms of Service were drafted, presented and accepted by Celsius customers, and subsequently amended by Celsius, in such a manner as to form a valid and binding contract which dictated that title to and ownership of the $4.2 billion of assets in the 600,000 Earn Program accounts was transferred to Celsius upon deposit into the Earn account, thereby making the assets part of the debtors' bankruptcy estate. Effectively, this relegated the customers' claims to the Earn account assets to those of general unsecured creditors under US bankruptcy law. Read more.
Implementation of reporting rules for brokers with respect to digital assets delayed, but regulations may be on the way
In Announcement 2023-2, the IRS and the Treasury Department effectively delayed the implementation of rules that would treat many cryptocurrency and digital asset market participants as brokers subject to burdensome information reporting and compliance rules. While this delay is welcome, it may be short-lived, as a regulations package that would implement these rules is currently under review by the White House Office of Information and Regulatory Affairs (ORIA). Read more.
International spotlight: Cryptoassets – The English law position in January 2023
While cryptoasset enthusiasts likely wish to forget 2022, the year marked some significant legal developments in the recognition and treatment of this recalcitrant asset class. The market matured in 2022 and the implementation of a forward-looking regulatory infrastructure and legal decision making will build on understanding the failures that occurred.
In this article, we analyze the current status of English law as well as proposed regulation which reflects a more mature understanding and the potential for cryptoassets to move into a more accepted mainstream infrastructure. Read more.
STATUTORY AND AGENCY DEVELOPMENTS
National Defense Authorization Act requires national strategy on DLT. On December 23, President Biden signed into law the National Defense Authorization Act (HB 7776). Included within the lengthy bill was a provision that requires the Director of the Office of Science and Technology Policy to develop a national strategy for the research and development of distributed ledger technologies and their applications, including applications of public and permissionless distributed ledgers. The national strategy will include application of distributed ledger technology to preserve privacy, facilitate delivery of government services, modernize regulatory compliance and facilitate access to financial services for underserved and underbanked populations.
Federal Election Commission issues advisory opinion on NFTs in political fundraising. On December 15, the US Federal Election Commission issued an advisory opinion allowing the use of non-fungible tokens (NFTs) for political committee fundraising efforts by DataVault Holdings, Inc. The opinion concludes that the sale by DataVault Holdings of "NFTs to political committees in the ordinary course of business, at the usual and normal charge, and under the same terms and conditions as its non-political clients … would not result in prohibited in-kind contributions and are, therefore, permissible" under the Federal Election Campaign Act, 52 USC § 20101-45. The opinion further provided that "any person involved in any specific transaction or activity which is indistinguishable in all its material aspects from the transaction or activity with respect to which this advisory opinion is rendered may rely on this advisory opinion."
Boston Fed and MIT complete CBDC research effort. On December 22, the Federal Reserve Bank of Boston announced the completion of Project Hamilton - a joint research effort with the Massachusetts Institute of Technology into the technical feasibility of a potential central bank digital currency (CBDC). The project focused on better understanding the capabilities and limitations of different technologies that might be used to manage and transfer CBDCs. Researchers at the Boston Fed and MIT said they plan to release additional retrospectives on Project Hamilton’s findings in the coming months.
FinCEN issues notice of proposed rulemaking. On December 16, the US Financial Crimes Enforcement Network (FinCen) issued a notice of proposed rulemaking (NPRM). The NPRM, Beneficial Ownership Information Access and Safeguards, and Use of FinCEN Identifiers for Entities, implements the Corporate Transparency Act (CTA) and governs which entities may access corporate beneficial ownership information (BOI) that certain entities will soon be required to report to FinCEN under the CTA. The NPRM limits access to BOI to government agencies and certain financial institutions. By doing so, it prevents access to BOI by non-financial institutions, due diligence firms and software providers, as well as financial institutions not subject to FinCEN's customer due diligence rules. The NPRM would prevent money services businesses and most blockchain companies from accessing BOI for purposes of performing due diligence on their customers or for other reasons. Written comments to the NPRM may be submitted on or before February 14.
Interagency Joint Statement on Crypto-Asset Risks to Banking Organizations. On January 5, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency announced issuance of a Joint Statement on Crypto-Asset Risks to Banking Organizations. The statement asserts that the agencies will continue to closely monitor cryptoasset-related exposures of banking organizations and will issue additional statements related to engagement by banking organizations in cryptoasset-related activities. The statement highlights key risks associated with cryptoassets including risk of fraud and scams, legal uncertainties related to custody practices, redemptions and ownership rights, in accurate or misleading representations and disclosures from cryptoasset companies, and significant volatility in cryptoasset markets.
Alaska expands money transmission to include virtual currency. The Alaska Division of Banking and Securities (ADBS) has adopted amendments to the Alaska Administrative Code that clarify that regulated money transmission activities include such activities using virtual currency that are effective January 1, 2023. Additionally, money transmission licenses will be required for companies engaged in money transmission involving virtual currency to, from or within Alaska. The amendments include a new definition of virtual currency and an expansion of the definition of monetary value. This is a shift from the prior position of the ADBS. As a result of the expansion of the license requirement, the “Limited Licensing Agreements” previously offered will be phased out and those previously entered into with the ADBS will be void.
New York DFS issues guidance for prior approval for virtual currency activities. The New York State Department of Financial Services (NYDFS) issued an Industry Letter on December 15, 2022 applicable to all New York banking organizations, branches and agencies of foreign banking organizations licensed by NYDFS reiterating expectations for approval that is required prior to engaging in “new or significantly different virtual currency-related activity” as a matter of safety and soundness. The procedure outlined includes the initiation of the approval process a minimum of 90 days before the date the institution intends to begin such activity as well as the scope of information required by NYDFS. The guidance also outlines requirements, including the submission of a business plan, risk management, consumer protection, financials, and a legal and regulatory analysis.
California agencies report to Governor Newsom on progress with cryptoasset and blockchain. In December, the California Governor's Office of Business and Economic Development, Business Consumer Services and Housing Agency, Department of Financial Protection and Innovation and Government Operations Agency issued Towards Responsible Innovation: An Interagency Web2, Crypto Asset, and Blockchain Progress Report to the Governor of California. The interagency report was issued pursuant to Governor Newsom’s Executive Order N-9-22 to ensure California engages early and proactively with nascent blockchain and Web3 industries; it reflects his administration's work to implement the Executive Order. The report makes six recommendations to continue engagement and exploration in the field.
ENFORCEMENT ACTIONS AND LITIGATION
SEC charges four individuals in crypto pyramid scheme targeting Spanish-speaking communities. On December 15, the Securities Exchange Commission (SEC) announced the filing of a complaint against Francisley Valdevino Da Silva, Juan Antonio Tacuri Fajardo, Ramón Antonio Perez Arias, and Jose Ramiro Coronado Reyes for creating and promoting a fraudulent crypto-asset pyramid scheme named Forcount Trader Systems, Inc. The scheme raised more than $8.4 million from hundreds of retail investors, primarily from Spanish-speaking communities throughout the United States and other countries. According to the SEC, the defendants defrauded investors by falsely promising guaranteed returns resulting from investments in "memberships" in Forcount Trader Systems, which gave investors interest in profits from Forcount's alleged cryptoasset trading and mining operations. The SEC charges include violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The SEC also noted that the US Attorney's Office for the Southern District of New York announced the filing of criminal charges against defendants Da Silva and Tacuri in a parallel action.
SEC charges issuer, CEO, and former CTO for $2.6 million unregistered cryptoasset securities offering. On December 21, the SEC announced the filing of a complaint against Thor Technologies, Inc., David Chin, Thor's co-founder and CEO, and Matthew Moravec, Thor's co-founder and former CTO, alleging they conducted an unregistered offering of securities through an initial coin offering of cryptoassets known as "Thor Tokens." The defendants offered and sold Thor Tokens to the public to fund Thor's business, which was to develop a software platform for gig economy workers and companies. The defendants promoted the potential increase in value of the Thor Tokens and claimed that the tokens would be made available on cryptoasset trading platforms. However, at the time of the offering, no development work had yet occurred on the Thor platform, and there was no other platform for use of the Thor Tokens. The SEC's complaint charges Thor and Chin with violating the securities registration provisions of Sections 5(a) and (c) of the Securities Act of 1933. Moravec has agreed to settle the complaint charging him with violation of Sections 5(a) and (c) of the Securities Act. If the settlement is approved by the court, a judgment against Moravec will be entered imposing permanent and conduct-based injunctions, ordering him to disgorge $407,103 plus prejudgment interest of $72,209.45, and imposing a civil penalty of $95,000. The settlement is subject to court approval.
SEC charges creator of Coindeal crypto scheme and seven others in $45 million fraud. On January 5, the SEC announced the filing of a complaint against Neil Chandran, Garry Davidson, Michael Glaspie, Amy Mossel, Linda Knott, AEO Publishing Inc., Banner Co-Op, Inc., and BannersGo, LLC for their involvement in a fraudulent investment scheme named CoinDeal. The defendants allegedly lured investors by falsely claiming that they could generate extravagant returns by investing in a blockchain technology called CoinDeal, which would be sold for trillions of dollars to a group of prominent and wealthy buyers. According to the complaint, no sale of CoinDeal occurred, and the defendants used the investor’s funds for personal use. The SEC charged the defendants with violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.
SEC charges Ellison and Wang with defrauding investors in cryptoasset trading platform FTX. On December 21, the SEC announced the filing of charges against Caroline Ellison, the former CEO of Alameda Research, and Zixiao (Gary) Wang, the former Chief Technology Officer of FTX Trading Ltd., for their roles in a multiyear scheme to defraud equity investors in FTX, the crypto trading platform co-founded by Samuel Bankman-Fried and Wang. According to the complaint, between 2019 and 2022, Ellison, at the direction of Bankman-Fried, furthered the scheme by manipulating the price of FTT, an FTX-issued exchange crypto security token, by purchasing large quantities on the open market to prop up its price. FTT served as collateral for undisclosed loans by FTX of its customers’ assets to Alameda, a crypto hedge fund owned by Wang and Bankman-Fried and run by Ellison. The complaint alleges that, by manipulating the price of FTT, Bankman-Fried and Ellison caused the valuation of Alameda’s FTT holdings to be inflated, which in turn caused the value of collateral on Alameda’s balance sheet to be overstated, and misled investors about FTX’s risk exposure.
Ellison and Wang have consented to bifurcated settlements, which are subject to court approval, under which they will be permanently enjoined from violating the federal securities laws, the above-described conduct-based injunctions, and officer and director bars. The court will also determine whether and what amount of disgorgement of ill-gotten gains plus prejudgment interest and/or a civil penalty is appropriate.
CFTC charges Alameda CEO and Alameda and FTX co-founder with fraud in action against Sam Bankman-Fried and his companies. On December 21, the Commodity Futures Trading Commission (CFTC) announced that it amended the complaint filed on December 13 against Sam Bankman-Fried and his companies, to charge Caroline Ellison and Gary Wang with engaging in a fraudulent scheme, along with the previously charged defendants. The amended complaint charges Ellison with fraud and material misrepresentations concerning the sale of digital asset commodities in interstate commerce. It also charges Wang with fraud concerning the sale of digital asset commodities in interstate commerce. According to the amended complaint, Wang created features in the code underlying the FTX trading platform that allowed Alameda to maintain an essentially unlimited line of credit on FTX, and Ellison directed Alameda to use billions of dollars of FTX funds, including FTX customer funds, to trade on other digital asset exchanges and to fund a variety of high-risk digital asset industry investments. Ellison and Wang agreed to the entry of consent orders of judgment as to their liability for engaging in fraud in violation of Section 6(c)(1) of the Commodity Exchange Act and CFTC Regulation 180.1. For more information on the original complaint, see our December 2022 issue.
CFTC charges man with scheme to misappropriate over $110 million from digital asset exchange. On January 9, the CFTC announced the filing of a complaint against Avraham Eisenberg for establishing a fraudulent and manipulative scheme to unlawfully obtain over $110 million in digital assets from Mango Markets, a purported decentralized digital asset exchange. The scheme devised by Eisenberg aimed to artificially increase the price of MNGO, the native token of Mango Markets, by rapidly purchasing substantial quantities of MNGO on three digital asset exchanges that were the inputs for the “oracle,” or data feed, that Mango Markets used to determine the value of Eisenberg’s swap positions. Eisenberg then cashed out his profits, draining the platform of most of the assets that other users had deposited. The complaint seeks civil monetary penalties, disgorgement of ill-gotten gains, and restitution, among other types of relief. The announcement notes that this is the CFTC’s first enforcement action for a fraudulent or manipulative scheme involving trading on a supposed decentralized digital asset platform, and its first involving a scheme that is sometimes called “oracle manipulation.”
The Southern District of New York also filed a parallel action against Eisenberg on December 23.
Louvre sues for infringement. On December 1, the Musée du Louvre filed a trademark and copyright infringement action against See Global Attractions in federal district court in Illinois. See Musée du Louvre v. See Global Attractions, Inc. and See Global Entertainment, Inc., No. 22-cv-6733 (US Distr Ct ND Ill. December 1, 2022). The dispute arises out of See Global Attractions’ operation and promotion of “Louvre Fantastique,” which is allegedly an art-themed experience that displays reproductions of items from the Louvre’s famous collection. See Global Attractions did not obtain permission from the museum to use the Louvre trademark or a pyramid design which the museum asserts is associated with the Louvre. This forms the basis for a variety of trademark claims from the museum. While the museum does not claim that artworks housed by the Louvre were unlawfully copied, the complaint does assert a copyright claim based on allegations that a promotional video used by See Global Attractions to promote the virtual experience is a copy of a video from the museum’s website. It will be interesting to watch how this case develops, but it serves as a reminder that use of another’s intellectual property in connection with a virtual experience is likely to be challenged by the rights holder if there could be confusion as to whether the rights holder is affiliated with or serves as the source of the experience.
Co-founder of OneCoin pleads guilty. On December 16, the US Attorney for the Southern District of New York announced that Karl Sebastian Greenwood, who co-founded OneCoin with Ruja Ignatova aka the Cryptoqueen, pled guilty in Manhattan federal court to wire fraud and money laundering charges in connection with his participation in OneCoin. Ignatova remains at large and on the FBI's Ten Most Wanted List. For more information on OneCoin, see our July 2022 issue.
Sentencing in cryptocurrency insider trading case. On January 10, the US Attorney for the Southern District of New York announced that Nikhil Wahi was sentenced to 10 months in prison for his participation in a scheme to commit insider trading in cryptocurrency assets using confidential information from his brother, a former product manager at Coinbase Global, Inc., about which cryptocurrency assets were scheduled to be listed on Coinbase's exchanges. Wahi previously pled guilty to one count of conspiracy to commit wire fraud. Wahi was also ordered to pay $892,500 in forfeiture.
Genesis files Chapter 11. On January 19, Genesis Global Capital, LLC filed for Chapter 11 restructuring in the Southern District of New York. According to the petition, Genesis’ has both assets and liabilities in the range of $1 billion to $10 billion and estimated it had more than 100,000 creditors. Reportedly, Genesis Global Holdco, the parent group of Genesis Global Capital, also filed for bankruptcy protection, along with Genesis Asia Pacific, another lending unit. It was also reported that Genesis' derivatives and spot trading, broker dealer, and custody businesses were not part of the bankruptcy process, and would continue their client trading operations.
FTX signs consent order with Alabama Securities Commission to end money transmission in Alabama. On December 29, the Alabama Securities Commission (ASC) announced it suspended the money transmission license previously granted to West Realm Shires Services Inc., also known as FTX US, for its failure to meet the licensing requirements set forth in Alabama’s Monetary Transmission Act. The suspension shall remain in place until FTX US provides evidence satisfactory to ASC that it meets the minimum licensing requirements and passes an examination conducted by ASC.
New York DFS announces $100 million settlement with Coinbase. On January 4, the New York DFS announced that Coinbase, Inc. entered into a consent order requiring it to pay a $50 million penalty to New York State for failures in its compliance program that violated the New York Banking Law and the NYDFS virtual currency, money transmitter, transaction monitoring, and cybersecurity regulations. In addition to the penalty, Coinbase has agreed to invest an additional $50 million in its compliance function over the next two years to remediate the issues and to enhance its compliance program pursuant to a plan approved by NYDFS. The consent order follows an examination and enforcement investigation in which the Department found that Coinbase’s Bank Secrecy Act/Anti-Money Laundering program – including its Know Your Customer/Customer Due Diligence, Transaction Monitoring System, suspicious activity reporting, and sanctions compliance systems – were inadequate for a financial services provider of Coinbase’s size and complexity.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
EU – NFT and regulation: Time to take stock. Two years after the first European legislative proposal on cryptoassets, the draft – which should be definitive but will still have to go through two votes – of the MiCA Regulation has been published as result of trilateral negotiations between the institutions. Much attention from observers has been focused on non-fungible tokens (NFTs), ie, tokens characterized by a unique identification code and linked to digital or physical assets. This is because NFTs have gone through a tortuous legislative path, made up of second thoughts, additions, modifications and deletions in the text of the Regulation. Read more.
El Salvador passes framework for digital assets. On January 11, the National Bitcoin Office of El Salvador announced the passage of legislation claimed to establish "a legal framework for all digital assets that are not bitcoin… as well as those issued on bitcoin." Additionally, the legislation supports the issuance of "volcano" bonds, which are reportedly bitcoin-backed bonds to pay down sovereign debt and for other purposes.
Web3 and metaverse hearing in Germany. The Bundestag (Germany’s parliament) held an expert hearing on web3 and the metaverse on December 14, 2022. Ahead of the hearing, preparatory questions that had been published tended to be skeptical in tone, focusing on data and consumer protection. Also, the majority of the selected experts chosen to speak in the expert hearing were critics and opinion leaders known for their opposition to crypto and web3 projects. During the hearing, only a few individual comments discussed possible use cases and advantages of the new technologies. Some observers objected to the overall structure of the event, asking why a better balance had not been sought. The hearing as well as the experts' statements are available on the Bundestag's website (in German).
UK High Court grants the first Bankers Trust Order against overseas cryptocurrency exchanges using new 'gateway' for service out of the jurisdiction. In November, Mr Justice Butcher handed down judgment in LMN v Bitflyer Holdings Inc. and others  EWHC 2954 (Comm), the first successful Bankers Trust application against overseas cryptocurrency exchanges based on the new gateway for service out of the jurisdiction at CPR Practice Direction 6B §3.1(25) (known as the disclosure gateway). A DLA Piper team of Chris Harvey, Sam Gokarn-Millington and Atacan Aydinli acted for one of the defendant exchanges. Read more.
The Edinburgh Reforms – guide to the proposals. In December, the Chancellor of the Exchequer, Jeremy Hunt, travelled to Scotland’s capital to announce a package of reforms to UK financial services regulation billed as the Edinburgh Reforms. In the words of the Chancellor, these reforms aim to “deliver an agile and home-grown regulatory regime that works in the interest of British people and our businesses,” following the UK’s exit from the EU Single Market. Various new and in-train initiatives have now been packaged within the Edinburgh proposals, to include the following:
- the government has published terms of reference for a new Accelerated Settlement Taskforce, with a view to following the US and Canada in their move towards at least T+1 settlement, and exploring the potential to moving towards T+0 with the support of settlement through distributed ledger technology and other forms of digital settlement
- the government intends shortly to consult in the next few weeks on the introduction of a central bank digital currency (CBDC), in collaboration with the Bank of England. Read more.
DLA Piper ranked in 2023 Chambers FinTech Guide. DLA Piper is pleased to announce that the firm's FinTech Legal: Blockchain & Cryptocurrencies practice has been ranked nationwide by the prestigious legal publisher Chambers and Partners. Margo Tank and Mark Radcliffe each received individual rankings. Overall, the firm received 21 practice rankings and 16 individual lawyer rankings in the Chambers FinTech 2023 edition.
DLA Piper attorneys will be presenting at the following events:
- Legal Matters in the Web3 Economy Conference, University of Chicago Law School, invitation only, January 20, 2023, with Michael Fluhr
- Future Economic and Legal Issues in Digital Assets, February 9, 2023, 12:00 ET, with Mark Radcliffe
Cryptocurrency and Digital Asset Regulation, published by the American Bar Association and co-edited by Deborah Meshulam and Michael Fluhr, includes chapters by Meshulam and Fluhr and by Margo H.K. Tank and Andrew Grant.
Listen to our podcasts and webinars
Casey Sobhani joined Neil Mandt, Founder and CEO of Metaverse Rights, and Steve Weikal, Industry Chair at MIT Real Estate Technology Initiative (RETi), for Digital & Physical: What the Metaverse Means for Real Estate.
Tech Disputes – Looking to the Future – podcasts
- In the first episode of Tech Disputes – Looking to the Future, Phillip Kelly and Dan Jewell discuss NFTs from an English law perspective, covering issues relating to the rights acquired when purchasing NFTs, the risk of fraud and how to guard against it, and the regulatory framework applicable to NFTs and how it might develop. The podcast is on Apple Podcasts, Spotify, LinkedIn, and the DLA Piper website.
- In the second episode of Tech Disputes – Looking to the Future, Phillip Kelly and Dan Jewell discuss smart legal contracts from an English law perspective and the issues businesses need to be aware of when embedding smart contract technology into their legal agreements. The podcast is available on Apple Podcasts, Spotify, LinkedIn, and the DLA Piper website.
Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:
Contributors to this issue