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 fourth monthly bulletin for 2020, 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 also report on the legal developments to support the infrastructure and ecosystems enabling 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 review the Financial Stability Board Report on Stablecoins and its implications for the global and national regulation of all cryptoassets.
For related information regarding digital transformation, please see our monthly bulletin, eSignature and ePayment News and Trends.
The Financial Stability Board Report on Stablecoins – implications for the international regulation of cryptocurrencies and other cryptoassets
By Marius Domokos
On April 14, 2020, the Financial Stability Board released a report focused on global stablecoin (GSC) frameworks and related cryptoassets. The report was released as a “consultative document” in light of the non-binding international regulatory function performed by the FSB, but it is nevertheless an important publication because it inherently reflects views within G20 governments. Companies and financial institutions that contemplate operating in the cryptocurrency and digital asset space in the foreseeable future should review this report and understand its approach to both national and international regulation of cryptoassets. Read more.
- SEC solicits comments on proposal for tokenized securities exchange. On April 1, the US Securities and Exchange Commission (SEC) issued an order instituting proceedings to determine whether it should approve or disapprove a proposed rule change requested by BOX Exchange LLC (BOX) for operations of the Boston Security Token Exchange (BSTX) to list and trade tokenized securities. The SEC seeks feedback on whether the proposed exchange’s operations are consistent with the 1934 Exchange Act. Interested parties must provide comments within three weeks from publication of the order in the Federal Register, and another two weeks to provide rebuttals to others’ submissions.
- CFTC publishes guidance on delivery of digital assets. On March 24, the US Commodity Futures Trading commission (CFTC) announced it has approved final interpretive guidance concerning retail commodity transactions involving certain digital assets. Specifically, the guidance clarifies the CFTC’s views regarding the “actual delivery” exception to Section 2(c)(2)(D) of the Commodity Exchange Act (CEA) in the context of digital assets that serve as a medium of exchange, colloquially known as “virtual currencies.”
- Possible US tax exemption for certain gains from “personal transactions.” In late January, US Representatives Suzan DelBene (D-WA) and David Schweikert (R-AZ) introduced a bill in the House of Representatives entitled “The Virtual Currency Tax Fairness Act of 2020.” At present, the IRS generally treats all cryptocurrencies as property for US federal income tax purposes. This treatment makes using cryptocurrency for everyday transactions (for example, buying a cup of coffee) very cumbersome, because any such transaction is treated as in effect two separate transactions: (1) before buying her coffee, the cryptocurrency owner is treated as selling the cryptocurrency, which generally creates capital gain or loss for the thirsty patron, and (2) then the cryptocurrency owner is technically using the cash received from that sale to pay for the coffee. As a result, anyone using cryptocurrency in everyday transactions must report such transactions on his or her US federal income tax return and pay tax on all net gains recognized. If enacted, the bill would establish an exemption from gross income for gains less than $200 recognized when cryptocurrency is used in any “personal transaction,” which is defined as any transaction other than a transaction which results in a trade or business expense or an expense for a for-profit activity. The bill does not resolve how losses recognized on such “personal transactions” would be treated or how such personal transactions would be reported.
- Congressional Research Service reports on CBDCs. On March 20, the Congressional Research Service issued a report titled “Financial Innovation: Central Bank Digital Currencies” which examines the approaches of foreign central banks and the Federal Reserve to CBDCs.
- FBI warns of cryptocurrency scams. The FBI warned on April 13 that fraudsters are expected to leverage the uncertainty related to the coronavirus disease 2019 (COVID-19) pandemic to initiate cryptocurrency scams. Specifically, the FBI advised consumers to be on the lookout for blackmail attempts, work-from-home scams, and investment scams, among others.
- Washington Governor vetoes bill to establish blockchain work group. Last month we reported that Washington state had enacted SB6065 to establish a blockchain work group. However, the governor vetoed the bill on April 3, 2020, citing concerns over the impact of COVID-19 on the state economy and the need to prepare for the effect of revenue lost due to the pandemic.
- Montana officials require crypto energy offsets. Reportedly, on March 26 officials in Missoula County, Montana voted unanimously to extend interim zoning regulations to reduce the environmental effects of high-energy-consumption crypto mining operations until April 3, 2021. Missoula County requires all mining operations to either purchase or build renewable sources of energy that completely offset the electricity they consume. The measure additionally restricts mining operations to designated industrial districts. Officials are considering whether to make the changes permanent.
- Wyoming to allow insurers to invest in digital assets. On February 26, Wyoming enacted SF125 amending its insurance code to expressly allow domestic insurers to invest in “digital assets,” defined as “a representation of economic, proprietary or access rights that is stored in a computer readable format, and includes digital consumer assets, digital securities, and virtual currency.” Notably, the definition excludes “digital consumer assets” such as utility tokens which may be used to purchase goods and services.
- Hawaii launches Digital Currency Innovation Lab. On March 17, Hawaii initiated its pilot Digital Currency Innovation Lab. The Lab allows digital currency issuers to do business in Hawaii without obtaining a state money transmitter license. In partnership with the Hawaii Division of Financial Institutions (DFI), this program is expected to:
- Create economic opportunities for Hawaii through early adoption of digital currency
- Offer consumer protection by providing guidance to issuers of digital currency
- Provide data to shape legislation supporting digital currency
- United States found “largely compliant” with anti-money laundering FATF criteria. On March 31, the Financial Action Task Force (FATF), an intergovernmental standards group, published its 3rd Enhanced Follow-up Report & Technical Compliance Re-Rating on anti-money laundering and counter-terrorist financing measures in the United States. The report determined that the United States has kept its “largely compliant” status, including amendments to FATF standards for virtual assets and virtual asset service providers (VASPs). The report also concludes that US law enforcement agencies are aware of the AML/CFT risks for virtual assets, and regulatory agencies have provided guidance regarding convertible virtual currency.
- Big 4 firm releases M&A Crypto Report. PwC recently issued its Global M&A Crypto Report for 2019. PwC reported that in 2019, fundraising increased to later-stage companies year over year. Also, the number of merger and acquisition deals and deal size dropped substantially. The report concludes with the top 10 M&A deals of the year and the top investors in crypto companies.
GS1 publishes standards for use of blockchain in supply chains. The GS1 US Blockchain Cross Industry group published new guideline titled “Applying GS1 Standards for Supply Chain Visibility in Blockchain Applications,” a resource that can help industry enable supply chain visibility and traceability in blockchain implementations by showing how those GS1 standards can be used in a blockchain ecosystem to enhance data sharing.
- Court confirms Telegram injunction covers non-US purchasers. In the ongoing enforcement action SEC v. Telegram Group, Inc. and TON Issuer, Inc., Judge P. Kevin Castel has denied an application by Telegram and TON Issuer (collectively, Telegram) that, if granted, would have allowed Telegram to distribute its cryptocurrency, Grams, to non-US based purchasers. Telegram’s application asked the court to limit the scope of the court’s recently issued preliminary injunction. The injunction prohibited Telegram from distributing Grams, reasoning that the initial purchasers would likely resell the Grams in a public market that could include US persons. Telegram sought clarification that the order did not prohibit the distribution to foreign initial purchasers. The court rejected Telegram’s request, reiterating its finding that Telegram’s distribution, even if made only to foreign initial purchasers, would likely result in a distribution back to the US. Read more about this developing case here and here.
- Amended lawsuit claims tokens are not a security. XRP cryptocurrency investors filed an amended complaint on March 25 against Ripple Labs, a blockchain payments company, with the US District Court for the Northern District of California. The lawsuit alleges that Ripple violated federal securities laws by its sale of XRP tokens, allegedly an unregistered security, and claims that Ripple and its CEO violated California unfair competition and false advertising laws.
- SEC charges former pastor and his wife with fraud. The SEC announced on April 2 that it filed charges against Texas resident and former pastor Larry Donnell Leonard, II, his wife Shuwana Leonard, and two related entities for defrauding hundreds of retail investors. The SEC's complaint alleges that the Leonards and their two businesses targeted investors with three separate fraudulent offerings, raising nearly $500,000 from over 500 investors across the United States. According to the complaint, the Leonards first sold bogus stock certificates in Teshuater, a company that bottled and sold alkaline water. Larry Leonard then allegedly tried to raise $20 million by selling a valueless cryptocurrency called TeshuaCoin, which he falsely claimed was backed by Teshuater's water products. Finally, the complaint alleges that Larry Leonard raised funds for a non-existent bitcoin mining investment, promising exorbitant returns, and then used the funds to make speculative options trades. The complaint, filed in the US District Court for the Southern District of Texas, charges the defendants with violating the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The SEC seeks permanent and conduct-based injunctions, disgorgement of allegedly ill-gotten gains with prejudgment interest, and civil penalties.
- SEC charges former state senator in digital asset scheme. On March 16, the SEC announced it had obtained an asset freeze to halt an ongoing securities fraud committed by a former state senator and two others. The SEC’s complaint alleges that Florida residents Robert Dunlap and Nicole Bowdler worked with former Washington state senator David Schmidt to market and sell a purported digital asset called the Meta 1 Coin in an unregistered securities offering conducted through the Meta 1 Coin Trust. The complaint alleges that the defendants made numerous false and misleading statements to potential and actual investors, including claims that the Meta 1 Coin was backed by a $1 billion art collection or $2 billion of gold and that an accounting firm was auditing the gold assets. The SEC seeks disgorgement of allegedly ill-gotten gains with prejudgment interest.
- CFTC charges Florida resident with fraudulent digital asset scheme. On April 16, the CFTC announced it had filed a complaint in the US District Court for the Middle District of Florida charging Alan Friedland and his companies, Fintech Investment Group, Inc. (Fintech) and Compcoin LLC, with fraudulently soliciting more than $1.6 million from their customers in connection with a leveraged or margined off-exchange foreign currency (forex) scheme. According to the complaint, starting in at least 2016 and proceeding through 2018, Friedland and his companies fraudulently solicited customers and prospective customers to purchase a digital asset known as Compcoin. The defendants falsely promised, among other things, that Compcoin would allow customers to gain access to Fintech’s proprietary forex trading algorithm, known as ART, and falsely advertised that ART would deliver high rates of return. The CFTC seeks civil monetary penalties, restitution, permanent registration and trading bans, and a permanent injunction against further violations.
- Canadian nationals sentenced for bitcoin fraud. On March 17, the US Attorney’s Office for the District of Oregon announced the sentencing of two Canadian residents to 24 months in prison and three years of supervised release after the defendants pled guilty to conspiring to commit wire fraud and money laundering in a scheme to steal bitcoin. Posing as customer service representatives from HitBTC, a Hong Kong website that supplies cryptocurrency wallets, the defendants used Twitter to steal cryptocurrency funds from the victims’ wallets, ultimately transferring 23.2 bitcoin from victims’ accounts. The defendants were also required to pay a total of $184,511 in restitution.
- Securities class actions filed against cryptocurrency exchanges and issuers. On April 3, 2020, two plaintiffs’ law firms filed 11 securities class action suits in the Southern District of New York against various cryptocurrency exchanges and issuers. Plaintiffs allege that the defendants violated state and federal securities laws by selling certain ERC-20 tokens that meet the definition of securities without a registration statement or exemption and, in the case of the exchange defendants, by operating an unregistered securities exchange and broker-dealer. Some complaints also allege violations of federal commodities laws as well. The complaints plead several classes and subclasses of token purchasers, who allegedly suffered losses when the tokens declined in value. Coming on the heels of a seminal decision in the Telegram litigation, these cases will again test the application of Howey to digital assets, may open the door to more claims under the Commodities Exchange Act and related CFTC rules − at least where plaintiffs can specifically allege that they suffered actual damages from the defendants’ conduct, and may create an additional avenue of litigation by plaintiffs’ attorneys.
- OneCoin plaintiffs must show cause. On April 10, the US District Court for the Southern District of New York issued a Memorandum Opinion and Order in the class action against OneCoin and its founders, requiring the lead plaintiffs to show why their failure to file agreed monthly updates on the progress of serving court papers on the identified defendants should not result in a dismissal with prejudice for failure to prosecute. For more information on the complaint, see our May 2019 issue.
- Texas and Alabama regulators allege securities fraud. The Texas State Securities Board and Alabama Securities Commission filed an emergency cease-and-desist order on April 8 against Ultramining.io, A/K/A Ultra BTC Mining, and its agent, Laura Branch, ordering the respondents to cease the offer for sale of investments in hash power, which the court found to be securities under Texas law, without appropriate registration or exemption, and cease all fraud and the making of misleading and deceptive statements related to such investments. The order describes respondents as having promised to double investors' funds and claimed to donate to COVID-19 charity efforts, without providing evidence of such donations. The respondents allegedly raised more than $18 million in the scheme.
- Class-action filing against decentralized finance firm. On April 14, a class action lawsuit was filed in the Northern District of California against the Maker Foundation, developer of MakerDAO, a decentralized Ethereum (ETH)-powered lending facility. The complaint alleges the Foundation intentionally misrepresented the risks to investors and failed to preserve user assets, after a sharp drop in the price of ether resulted in a loss in value of $8.325 million by investors. The complaint seeks $8.325 million in compensation and an additional $20 million in punitive damages.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
- French financial regulator responds to European Commission consultation on cryptoassets. On April 7, the Autorité des marchés financiers (AMF) has published its response to the EU Consultation on the development of a European framework for cryptoasset markets. The AMF supports the Consultation’s approach and seeks to foster the development of blockchain projects at the European level. The AMF proposes to base the classification of cryptoassets on the existing categories and distinguish between cryptoassets that qualify as financial instruments and those that do not. Further, the AMF supports the development at European level of a new regime for cryptoassets that are not financial instruments, and proposes to create a “Digital Lab” to test projects in the field of security tokens. Additionally, the AMF supports the creation of an interbank settlement asset in central bank money to facilitate delivery.
- WEF white paper on use of blockchain by supply chains. This month, the World Economic Forum (WEF) published a white paper entitled “Inclusive Deployment of Blockchain for Supply Chains: Part 6 – A Framework for Blockchain Interoperability” addressing blockchain and distributed ledger technology concepts as they relate to interoperability considerations for supply chains. The white paper discusses approaches to achieving interoperability, the current state of interoperability solutions, and presents sample “real-world use cases,” among other things.
- Bank of England paper defines digital bank note. On March 17, the Bank of England published a discussion paper on the potential opportunities and threats related to the adoption of a central bank digital currency (CBDC). The paper defines CBDC as a digital version of a traditional bank note that can be used to carry out payment transactions and store value; it would have the equivalent value of pound sterling.
- EU Parliament publishes study on developments related to cryptoassets. On April 7, the European Parliament Policy Department for Economic, Scientific and Quality of Life Policies published “Cryptoassets – Key Developments, Regulatory Concerns and Responses,” a study that reviews recent developments related to cryptoassets, including continuing use of cryptoassets for money laundering and terrorist financing, the growth of private tokens to raise funds and the emergence of stablecoins and CBDC. The report defines “cryptoassets” broadly to include stablecoins and private tokens issued to raise funds. The report proposes amending the EU’s 5th Anti-Money Laundering Directive (AMLD5) and its financial services laws, and introducing cybersecurity standards for cryptoasset custodians.
- New Zealand court rules cryptocurrency are assets. New Zealand’s High Court in Christchurch ruled on April 8 that the remaining digital assets of the former cryptocurrency exchange Cryptopia will be distributed, after having been placed into liquidation in May 2019. The court decided the cryptocurrency should be classified as "property," as it was held in separate user accounts akin to a trust, and should be returned to the exchange’s more than 800,000 users.
- Canadian financial regulator improves anti-money laundering rules. The Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) announced, as part of its 2020-2021 Departmental Plan, new anti-money laundering and counter-terrorist financing (CTF) regulations which include updated cryptocurrency guidelines. Beginning on June 1, 2020, companies must report the type and amount of cryptocurrencies used in transactions or remittances valued over CA$1,000. Companies must also list the source of the funds and the entities involved in those transactions. Companies that deal with CA$10,000 or more in cryptocurrency must register as a money service business.
- Bank of France calls for applications on CBDC. On March 27, the Banque de France issued a Call for Applications Package seeking willing participants to conduct experiments testing the integration of a central bank-issued digital currency (CBDC) for the exchange and settlement of tokenized financial assets between financial intermediaries. The experiments will be conducted with support from the Banque de France's open innovation laboratory (LAB). Applications must be received by May 15 at 3 pm CET at firstname.lastname@example.org.
- Monetary Authority of Singapore provides regulatory certainty for digital payment. The Monetary Authority of Singapore (MAS) issued a set of guidelines for digital payment token providers that details anti-money laundering and anti-terrorism requirements for risk assessment and mitigation, due diligence of customers, reliance on third parties, wire transfers, record keeping, and reporting suspicious transactions.
- Monetary Authority of Singapore allows payments license exemptions. The Monetary Authority of Singapore (MAS) has listed several cryptocurrency firms as exempted from holding a payments license in Singapore until this summer. These companies will be allowed to continue operating without a payments license until July 28, 2020. The exemption will end after that date, or if firms registered in Singapore send a license application under the Payments Services Act 2019 or are approved or rejected for a license by MAS.
- Philippines securities regulator warns of crypto scam. On April 14, the Philippines Securities and Exchange Commission issued an advisory warning potential investors of a cryptocurrency scam called The Billion Coin (TBC), operated by Kris Kringle, which is issuing “TBCoin,” a purported “abundance-based cryptocurrency,” without authorization by the Commission. The advisory warns of false claims including that the value of TBCoin will never drop and will increase daily by 1 percent to 5 percent, resulting in a return of 100 percent every 25 days. The advisory warns investors not to invest in any offering of TBC, including TBCoin
- Spanish tax agency sends notices to virtual currency holders. The Agencia Estatal de Administración Tributaria (AEAT) on April 1 reportedly began to send notices to virtual currency holders reminding them of their tax obligations. Such notices will continue to be sent through June 30.
- Swiss regulator releases annual report. The Swiss Financial Market Supervisory Authority (FINMA), released its 2019 annual report which provides a review of the activities of FINMA in 2019, including FINMA’s efforts to address stable coins and related projects.
- BIS bulletin on COVID-19 and the future of payments. On April 3, the Bank for International Settlements (BIS) issued bulletin No 3 “Covid-19, cash, and the future of payments,” reviewing the impact of the pandemic on the use of cash and digital payment forms. The bulletin included as a key takeaway that the pandemic may amplify calls for CBDCs due to public concerns that the virus could be transmitted by cash.
- FSB warns of unknown risks with global stablecoins. On April 14, the Financial Stability Board, the G20 supervisory body, issued “Addressing the regulatory, supervisory and oversight challenges raised by ‘global stablecoin’ arrangements,” a consultative document warning of risks associated with global stablecoins which remain unaddressed by the existing global regulatory framework, and those which may only culminate after general adoption by consumers. The FSB seeks comments on the document and various questions by July 15, which comments should be sent to email@example.com.
- IOSCO publishes report on implications of global stablecoin. On March 23, the International Organization of Securities Commissions (IOSCO) published a report on Global Stablecoin Initiatives in which it presents a hypothetical case study of a stablecoin. The report details how IOSCO’s principles and standards may apply, and it evaluates the implications for securities regulators. Additionally, as stablecoins are often used for payments, such activity could be a regulated payment and banking activity. Furthermore, if adopted on a large scale, stablecoin activity could be considered a financial market infrastructure (FMI) and would be expected to follow the relevant principles for FMIs.
Margo Tank presented at DLA Piper’s FinTech 2020 and beyond: eContracts and Asset Backed Securities event in New York on February 12, 2020.
Margo Tank presented at the Structured Finance Conference in Las Vegas on February 25, 2020, speaking on a panel entitled “eNotes, eClosings, and eVaults.”
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Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:
Margo H.K. Tank
Please visit our Intellectual Property and Technology, Data Protection, Privacy and Security, and Blockchain and Digital Assets pages.