29 March 2024 • 20 minute read

Blockchain and Digital Assets News and Trends - March 2024

Editors:Margo Tank James Williams Elizabeth (Liz) Caires Eric Hall

Contributors:Raphaël Béra Menad Benseghir Giovanni Iaselli

Identifying important legal developments governing the use and acceptance of blockchain technology, tokenization, and digital assets.

While the use cases for blockchain technology are vast, this bulletin focuses on uses of blockchain and 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.

INSIGHTS

New IRS hires signal increasing focus on cryptocurrency and digital finance sectors

By: Tom Geraghty and Kali McGuire

The IRS has announced the addition of two private-sector experts to bolster its efforts in building service, reporting, compliance, and enforcement programs focused on digital assets.

Acknowledging that it needs help in these areas, the IRS noted in its February 27 announcement that “[p]ulling in expertise from the private sector to work with the IRS team is critical to successfully building the agency’s efforts involving digital assets and helping us do it in a way that works well for everyone.” The avalanche of industry comments the IRS received in response its proposed regulations on digital asset broker reporting may have hastened these hires. Read more.

Biden Administration 2025 FY budget proposes Wash Sale Rule for digital assets and crypto mining tax

By: Tom Geraghty and Kali McGuire

The Biden Administration’s proposed FY 2025 budget, released on March 11, 2024, includes proposals for (i) applying wash sale rules to digital assets; (ii) expanding information reporting requirements for financial institutions and digital asset brokers; (iii) requiring reporting for certain foreign digital asset accounts; and (iv) applying existing mark-to-market rules to cryptocurrency. The budget estimates that these proposals, if enacted, would generate in excess of $42 billion of additional tax revenue over a 10-year period. Read more.

New white paper proposes framework for combating illicit finance while preserving DeFi’s permissionless, neutral character

By: Eric Hall and David Stier

A trio of experienced crypto lawyers, among them former acting director of FinCEN and former CTO of Chainalysis Michael Mosier, have proposed a novel approach to regulating decentralized finance (DeFi) “while preserving the technology as permissionless, neutral infrastructure.” Their paper – Genuine DeFi as Critical Infrastructure: A Conceptual Framework for Combating Illicit Finance Activity in Decentralized Finance – starts with the premise that DeFi’s decentralized character makes it a promising innovation that is difficult to regulate with traditional tools because there are no centralized actors. To accommodate DeFi, the authors propose that future regulations adopt a three-part approach. Read more.

STATUTORY AND AGENCY DEVELOPMENTS

FEDERAL DEVELOPMENTS

IRS

IRS announces first criminal cryptocurrency-related tax evasion charge. The Internal Revenue Service (IRS) announced on February 7 its first criminal charge for cryptocurrency-related tax evasion. The press release provides that the charges relate to an individual’s failure to report the sale of $4 million worth of bitcoin in 2017 and 2019 and the associated gains. This is the first time that a person has been charged solely for failing to report or for underreporting cryptocurrency gains on a tax return. Should the case go to trial, the prosecution must explain cryptocurrency and the transactions at issue to a lay jury.

SEC

SEC and CFTC jointly adopt amendments to private fund reporting requirements. On March 12, the SEC and CFTC published joint final rules to amend Form PF which, starting next year, will require private funds to report, among other items, more detailed information about the fund’s investment strategies, including more granular strategy categories and descriptions including digital assets. The agencies’ stated goal for the amendment is to reflect strategies more commonly pursued by hedge funds.

Finance groups, members of Congress, and state banking regulators ask SEC to amend crypto accounting bulletin. On February 14, in a joint letter to the SEC, the Bank Policy Institute, American Bankers Association (ABA), the Financial Services Forum, and the Securities Industry and Financial Markets Association (SIFMA) requested modifications to Staff Accounting Bulletin Number 121 (SAB 121), on crypto accounting. The industry groups argued that SAB 121 has posed undue challenges to US banks since its introduction nearly two years ago. They blame SAB 121 for “a chilling effect on banking organizations’ ability to develop responsible use cases for distributed ledger technology (DLT) more broadly.” The letter further cites recent changes, such as the SEC’s approval of a bitcoin exchange traded product (ETP), as reasons to modify the rules. The letter followed on the heels of a resolution under the Congressional Review Act to overturn SAB 121 that US Senator Cynthia Lummis (R-WY) and US Representatives Wiley Nickel (D-NC) and Mike Flood (R-NE) introduced on February 1. Finally, on February 28, the Conference of State Bank Supervisors issued an open letter to the House Financial Services Committee expressing the state banking regulators’ strong concerns with the SEC’s “[f]ailure to take public comment or consult with other regulators,” and unprecedented treatment of crypto assets under SAB 121.

SEC declines to reconsider settlement “Gag Rule.” On January 30, the SEC issued a letter response to a rulemaking petition filed in 2018 by an organization called the New Civil Liberties Alliance. The petition urged the SEC to reconsider its policy barring defendants who have settled SEC enforcement actions from publicly denying the allegations against them. The petitioners argued this “Gag Rule” infringes on First Amendment rights. In response, a majority of the Commission’s five-member voting body voted to deny the petition. Explaining his reasoning, Chair Gary Gensler said permitting defendants to deny allegations “muddies the message to the public” as to “what conduct is violative of the securities laws.” Commissioner Hester Pierce, the sole dissenting vote, found the majority’s reasoning flawed. She urged that the Commission’s investigative work should stand on its own regardless of public scrutiny. She further criticized the Gag Rule’s chilling effect on speech critical of the government.

Energy

Energy Information Administration blocked from collecting data from crypto miners. On January 31, the US Energy Information Administration (EIA), an agency within the US Department of Energy, announced it had received authorization from the White House Office of Management and Budget to initiate an “emergency collection of data” from identified commercial cryptocurrency miners. According to EIA analysis published the next day, cryptocurrency mining may account for between 0.6 percent and 2.3 percent of US electricity consumption. Only weeks later, however, a US District Court in Texas blocked the EIA from proceeding with its collection in response to a complaint filed by a Texas crypto miner and the Texas Blockchain Association. The court issued a 14-day temporary restraining order on February 23 and, on February 26, the EIA withdrew its emergency collection effort and instead implemented notice-and-comment procedures. According to agency’s notice to the Texas court, the EIA’s notice will soon be published in the Federal Register.

STATE

California cracks down on bitcoin ATM operators. March 15 marked the deadline for operators of crypto kiosks to report a list of their kiosk locations to the California Department of Financial Protection & Innovation (DFPI). Crypto kiosks allow users to buy and sell cryptocurrencies – often without identification. The reporting requirements are part of the state’s Digital Financial Assets Law, which became effective January 1, 2024. Kiosk operators are also required to submit updates to the DFPI any time they move or change kiosks.

Utah passes law protecting private keys. On March 18, the governor of Utah signed into law House Bill 118. The novel bill protects digital asset holders from being compelled to produce their private keys in any civil, criminal, administrative, legislative, or other proceeding in the state “that relates to a digital asset, digital identity, or other interest or right to which the private key provides access.” On its face, the law is unclear about its application to civil or criminal proceedings that do not “relate[] to a digital asset,” such as a prosecution where criminal proceeds were paid in crypto. The law also provides an exception permitting disclosure of a private key to be compelled where “a public key is unavailable.” The law goes into effect on May 1.

Wyoming passes Stable Token Act amendments. On March 18, the governor of Wyoming signed into law Senate Bill 52 which amends the Wyoming Stable Token Act. The Wyoming Stable Token Act is part of the state’s effort to create a legal and business environment tailored to blockchain businesses and digital assets. The act allows Wyoming to issue the United States’ first government-issued stablecoin, which will be fully backed by US dollar reserves. The amendments permit the state to invest its US dollar reserves in cash and government securities, authorize issuance of multiple types of stable tokens, and authorize the state’s stable token commission to contract with financial institutions.

ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Securities

SEC faces backlash from senators and federal court in case against DEBT Box. The SEC has faced criticism from two branches of the federal government over its enforcement action against Digital Licensing, Inc., known as DEBT Box. First, on February 7, five US senators sent an open letter to the SEC expressing concern regarding the SEC’s enforcement action against DEBT Box after a Utah federal court found “the Commission made materially false and misleading representations … and undermined the integrity of the proceedings.” The senators faulted the SEC for freezing defendants’ personal and business assets, shutting down DEBT Box, and causing its native token to crash by more than 56 percent. The letter further notes that SEC Enforcement Division Director Grubir Grewal admitted to these misrepresentations in its request that the court refrain from levying sanctions. Then, on March 18, in an 80-page order, the US District Court for the District of Utah denied the SEC’s motion to voluntarily dismiss its case and ordered sanctions against the Commission finding that it had acted in bad faith. The SEC is required to pay DEBT Box’s legal fees in opposing the temporary restraining order the Commission had secured.

SEC charges 17 in crypto Ponzi scheme targeting Latino community. On March 14, the SEC announced charges against 17 individuals allegedly involved in a $300 million Ponzi scheme involving a Texas-based company called CryptoFX LLC which the SEC accuses of targeting more than 40,000 Latino investors in the US and other countries. According to the SEC’s complaint, the scheme promised investors life-changing wealth from “risk-free” crypto investments. The 17 individuals, from Texas, California, Louisiana, Illinois, and Florida, were allegedly leaders in the scheme who solicited investments by promising 15 to 100 percent returns. In reality, investor funds were used to pay out earlier investors and fund the schemers’ bonuses and lavish lifestyles. The SEC seeks injunctive relief, disgorgement, and civil penalties against each defendant.

ShapeShift AG Crypto charged with operation as in unregistered dealer. On March 5, the SEC announced it had brought and settled charges against ShapeShift AG, a Swiss company, for acting as an unregistered dealer through its operation of an online crypto asset trading platform. According to the Commission’s order, ShapeShift allowed users of its website ShapeShift.io to trade up to 79 crypto assets including some that the SEC alleges were offered and sold as securities. The SEC’s order does not, however, identify which of those assets were securities. ShapeShift, which shut down operations and dissolved in July 2021, has agreed to pay a $275,000 penalty.

NFTs

Undead Apes NFT founders indicted for rug pull. On February 21, the US Attorney’s Office for the Middle District of Florida announced the indictment of two men with conspiracy to commit wire fraud and money laundering. According to the indictment, the two men minted two NFT collections on the Solana blockchain, Undead Apes and Undead Lady Apes, in March 2022, generating more than $300,000 in mint funds and royalties from secondary sales. Following the mint, the price of the NFTs rose sharply and the pair announced a third mint for so-called Undead Tombstones. Despite making several promises for the future of the project, the two men abandoned the project’s social media accounts and moved the proceeds from the Solana blockchain to the Ethereum blockchain. Prosecutors allege these acts were a “rug pull” scam and their movement of crypto from one blockchain to another was an attempt to obfuscate their transactions.

Virtual currency

FTX customers sue for custody of deposited assets. On January 31, a group of international customers of the now-defunct crypto exchange FTX sued for a declaratory judgment that, according to the terms of the FTX terms of service, FTX deposits are customer property and, therefore, cannot be treated as part of the debtor’s estate in Chapter 11 proceedings. The complaint relies on the following language in the terms of service: “Title to your Digital Assets shall at all times remain with you and shall not transfer to FTX Trading.” This language, the customers contend, should have barred FTX from treating customers as unsecured creditors and blocking access to their funds. The customers’ position echoes the reasoning of the US Bankruptcy Court presiding over Celsius Network’s bankruptcy proceedings. Read more about that case in our January 2023 edition.

Meta-1 Coin founder charged with defrauding investors of $10M. On March 19, the US Attorney’s Office for the Northern District of Illinois announced charges against Robert Dunlap in connection with his marketing and sale of an allegedly fake digital asset called Meta-1 Coin. According to the indictment, Dunlap represented that the Meta-1 Coin was backed by $44 billion in gold and art including Picassos, Dalis, and Van Goghs. Meta-1 Coin was tradeable only on the “Meta Exchange” which was a website Dunlap created. In reality, Dunlap had no assets backing the coin. He faces four counts of mail fraud.

Anti-money laundering

Treasury argues to Fifth Circuit that Tornado Cash is a corporate entity. On March 13, in an appellate brief to the Fifth Circuit Court of Appeals, the US Department of Treasury argued that sanctioned cryptocurrency mixing service Tornado Cash was a “corporation in all but name” rather than a set of decentralized ownerless smart contracts. Treasury likened the mixing service’s core developers to a board of directors and its DAO to a group of shareholders. Like shareholders, according to Treasury, holders of the TORN token see the value of their holdings rise with the success of the product. The argument opposes an appeal Tornado Cash users filed in the Western District of Texas with backing from Coinbase. The users have championed a theory that the smart contracts comprising the Tornado Cash protocol cannot be sanctioned because they are not owned by any centralized entity. At the trial court level, however, that theory did not survive summary judgment. For more on Treasury’s actions against Tornado Cash and mixing services generally, see our September 2022, and August, September, and November 2023 issues.

Bitcoin Fog founder convicted for money laundering. On March 12, a jury convicted Roman Sterlingov for his operation of Bitcoin Fog, the longest running bitcoin mixing service. Prosecutors had charged Sterlingov with money laundering conspiracy, sting money laundering, and operating an unlicensed money transmitting business. According to the announcement, Sterlingov operated Bitcoin Fog from 2011 to 2021 as a well-known laundering service that mixed more than 1.2 million bitcoin, much of which was tied to narcotics sales, computer crime, identity theft, and child sexual abuse material. According to reports of the trial, the government elicited the testimony of two convicted crypto criminals, Ilya Lichtenstein and Larry Harmon, regarding cryptocurrency mixing services.

DOJ charges major exchange KuCoin with BSA violations. On March 26, DOJ announced criminal charges against major centralized exchange KuCoin for violating the Bank Secrecy Act (BSA), and against two of its founders for conspiracy to violate the BSA, by failing to maintain an anti-money laundering (AML) program or adequate KYC procedures and allegedly never filing any Suspicious Activity Reports. The indictment alleges the exchange and its founders were also charged with operating an unlicensed money transmitter (MT) business under 18 USC § 1960. DOJ alleges that KuCoin received and sent billions of suspicious and criminal transactions while KuCoin allegedly tried to hide the number of US customers it had to justify its lack of AML and KYC requirements. In reality, DOJ alleges, US customers are 17 percent of KuCoin’s userbase. The two founders, who are both Chinese citizens, each face one count of conspiracy to violate the BSA and one count of operating an unlicensed MT business, each of which carries a five-year maximum sentence. The CFTC also announced a parallel action for Commodity Exchange Act violations.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

Hong Kong Monetary Authority issues standards for institutions to offer digital asset custody services. On February 20, the Hong Kong Monetary Authority (HKMA) issued a guidance letter for authorized institutions interested in offering custody services for digital assets. The “Expected Standards” guidance advises institutions to adopt comprehensive risk assessment policies to minimize the risk of losing custodied digital assets to fraud, theft, negligence or other “acts of misappropriation.” The guidance letter instructs institutions to conduct independent systems audits and use cold storage for a substantial portion of client digital assets. In addition, institutions will be required to make records available to HKMA upon request.

French tax authority releases public ruling regarding the VAT treatment of NFTs. On February 14, French tax authorities decreed that NFTs are subject to general VAT rules and, where they are used as a certificate of ownership of a tangible or intangible asset, VAT applies in accordance with the supply of that asset. In addition, the authority ruled that transactions involving NFTs are not to be treated as exempt banking or financial transactions as NFTs are, by definition, not fungible unlike payment, utility, usage or investment tokens. The French tax authorities also provided examples of transactions involving NFTs, including the creation and sale of digital trading cards as NFTs, which can be stored in an electronic wallet to be resold or used to play on the seller's website. Such NFTs are treated by the French tax authorities as a service. When the issuance of these cards is largely automated with minimal human intervention, the service is viewed as an electronically supplied service. Read more.

Italian Tax Authority clarifies tax treatment of NFTs. Late last year, in line with the EU Crypto-Asset Reporting Framework, the Italian Tax Authority clarified that the VAT regime for the supply of services by electronic means may apply to the supply of NFTs. In Circular Letter No. 30/2023, the authority provides several clarifications on the taxation of crypto-assets and NFTs for income tax and VAT purposes, in accordance with the OECD Crypto-Asset Reporting Framework, the MiCA regulation, and the VAT Committee. As clarified by Italian Law No. 197/2022, a crypto asset qualifies from a tax perspective as “a digital representation of value or rights that can be transferred or stored electronically, using distributed ledger technology or similar technology.” Accordingly, crypto assets and NFTs are taxed for income tax purposes at the time of disposal, retention or exchange of the NFTs. The Circular Letter offers additional details on specific classes of crypto assets. Read more.

Basel Committee proposes amendments to global standards for bank exposure to crypto assets. On March 28, public comment will close on proposed amendments to the Basel Committee’s global standards on the prudential treatment of banks’ exposures to crypto assets. The Committee which sets standards for banking regulations worldwide, first published its crypto asset standards in 2022. Among other things, the standard requires banks to meet certain capital requirements when they hold or have exposure to stable coins. The amendments would separate stablecoins into different categories, each with with different capital requirements depending on the nature of the stablecoin.

DLA Piper news

The Financial Times recognizes DLA Piper as one of the Most Innovative Law Firms in North America.
The Legal 500 ranks DLA Piper Tier 1 in FinTech: Crypto. DLA Piper was also ranked in Tier 2 for FinTech, and Margo Tank was ranked as a "Leading Individual."
Chambers FinTech Legal ranks DLA Piper in all four categories including Band 2 for Blockchain and Digital Assets, with Margo Tank individually recognized in Band 3 in the Blockchain & Digital Assets and Payments & Lending areas.
DLA Piper’s Commodities, Digital Assets, and Carbon Compliance and Enforcement team draws on decades of collective experience in the commodities and securities industry to help companies navigate new and complex commodities enforcement matters, including those related to agriculture, metals, energy, digital assets, and carbon/sustainable commodities, among others.

RECENT AND UPCOMING EVENTS

On April 5, David Stier, Vice Chair of the ABA’s Banking Law Committee – Bank Secrecy Act and Anti-Money Laundering subcommittee, will be speaking on a panel titled “Cryptocurrency & Illicit Finance: Risk Mitigation Strategies” at the ABA’s Business Law Section Spring 2024 meeting in Orlando, Florida.

You may also enjoy:

AI ChatRoom, a DLA Piper video series hosted by Danny Tobey,JD, MD, covering various topics in AI.

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