This is our eleventh 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, 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.
Infrastructure bill, including crypto "broker" rules, becomes law
By Tom Geraghty and Kali McGuire
On November 15, 2021, President Joe Biden signed the Infrastructure Investment and Jobs Act (HR 3684) into law. The legislation includes roughly $550 billion in new spending, of which, $28 billion is expected to be paid for through expanded cryptocurrency and digital asset reporting rules. Read more.
- FDIC Chair discusses work on roadmap for bank engagement with crypto assets. On October 26, Jelena McWilliams, Chair of the Federal Deposit Insurance Corporation (FDIC), reportedly stated that a team of US bank regulators is trying to provide a roadmap for banks to engage with crypto assets, which may include clearer rules over holding cryptocurrency in custody, using it as collateral or holding it on bank balance sheets. McWilliams acknowledged that, "If we don't bring this activity inside the banks, it is going to develop outside of the banks. ... The federal regulators won't be able to regulate it" to appropriately manage and mitigate risks. McWilliams identified the challenge of valuation of crypto assets, as the fluctuation in value can occur almost on a daily basis, and "You have to decide what kind of capital and liquidity treatment to allocate to such balance sheet holdings."
- Joint Economic Committee hearing on digital assets. On November 17, the US Congress Joint Economic Committee will hold a hearing entitled Demystifying Crypto: Digital Assets and the Role of Government. The hearing will be held at 2:30pm EST at the Cannon House Office Building in Washington, DC, and will be streamed on the committee's YouTube channel. Testimony is scheduled to be heard from Alexis Goldstein, Director of Financial Policy for the Open Markets Institute; Tim Massad, Research Fellow at Harvard Kennedy School and Adjunct Professor of Law at Georgetown Law Center; Kevin Werbach, Professor of Legal Studies and Business Ethics and Director of the Blockchain and Digital Asset Project at the University of Pennsylvania; and Peter Van Valkenburgh, Director of Research of Coin Center.
- SEC Commissioner responds to comments of SEC Chair on crypto. On October 12, at the Texas Blockchain Summit, US Securities and Exchange (SEC) Commissioner Hester Peirce responded to SEC Chair Gary Gensler’s characterization of the crypto landscape as the “Wild West,” which Peirce interprets as a “lawless” “society in which the gunslinger with the best reflexes and worst morals wins at everyone else’s expense.” Peirce instead characterized the crypto as the "Western frontier" – "a place for the adventurous, the rough around the edges, the idealists, the free-thinkers, and the restless," where society was "created by the inhabitants." Pierce explained that this environment included "an array of private organizations dedicated to maintaining order," and argued that these self-regulatory mechanisms implemented in the crypto frontier include calls for clarity from the absent public sector. Those calls include a need for “clarity as to when crypto assets are securities” and Peirce suggested her proposed “safe harbor” provision as a proposed structure.
- SEC Commissioner addresses digital assets. On October 12, SEC Commissioner Caroline Crenshaw also spoke on regulation of digital assets and called for a "meaningful exchange of ideas between innovators and regulators." Crenshaw explained that "to sustain growth, markets need more accountability and a consistent set of rules that apply to all" so as to avoid fraud and to create a level playing field between traditional, compliant offerings and digital offerings based on new technology. Crenshaw further asserted that a safe harbor, such as that proposed by Commissioner Pierce, which permits unlimited capital raising with limited disclosures and no registration requirement, is not in the best interests of investors.
- SEC Commissioner addresses risks of DeFi. In a statement by SEC Commissioner Caroline Crenshaw published on November 9, the Commissioner discusses investor risks in decentralized finance (DeFi) and how the DeFi community and SEC should combat them. The Commissioner noted that DeFi is “fundamentally about investing," and many DeFi products have close analogs with securities under the SEC’s jurisdiction. Additionally, risks associated with traditional financial products, such as fraud, self-dealing, information asymmetry and manipulation, also exist with DeFi products. To protect investors in DeFi, Crenshaw proposes that the DeFi community work with the SEC to ensure a fair market and a level playing field. If a DeFi development team is not sure whether its project is within the SEC’s jurisdiction, the team "should reach out to the Strategic Hub for Innovation and Financial Technology … before proceeding to market."
- SEC rejects VanEck spot bitcoin ETF. On November 12, the SEC issued an order disapproving the VanEck Bitcoin Trust ETF. The SEC concluded that Choe BZX Exchange has not addressed market manipulation concerns and therefore not demonstrated that its proposal is consistent with the requirement of the Exchange Act Section 6(b)(5) that the rules of a national security exchange be "designed to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest."
- BlockFi files for spot bitcoin ETF. On November 8, BlockFi filed for a spot bitcoin ETF known as “BlockFi NB Bitcoin ETF” which would hold bitcoin and be traded on the New York Stock Exchange.
- Members of Congressional Blockchain Caucus seek answers on bitcoin spot ETFs. On November 3, Congresspersons Tom Emmer (R-MN) and Darren Soto (D-FL) announced they sent a letter to the Chair of the SEC setting forth reasons why the SEC should approve bitcoin spot ETFs, similar to the recent SEC approvals of bitcoin futures ETFs. The letter states that, although the SEC's allowance of trading in two bitcoin futures ETFs "is a step forward for millions of Americans who are demanding access to simple ways to invest in bitcoin, these products are potentially much more volatile than a bitcoin spot ETF and may impose substantially higher fees on investors due the premium at which bitcoin futures typically trade, as well as the cost of rolling futures contracts each month." The letter asserts that, "Bitcoin spot ETFs are based directly on the asset, which inherently provides more protection for investors," and " Spot-based ETFs have proven more efficient and are strongly preferred by investors, as evidenced by their commercial success; we believe the same will be true for Bitcoin exposure in an ETF wrapper." The letter closes by clarifying that the congressmen do not view one method of bitcoin ETF as better than the other, but that "investors should have a choice over which product is most suitable for them and their investment objectives."
- PWG on Financial Markets reports on stablecoins. The President's Working Group (PWG) on Financial Markets announced on November 1 the issuance of its Report and Recommendations on Stablecoins. The PWG was joined by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) in issuing the report which proposes to address the risk of payment stablecoins by recommending that Congress enact legislation to address the following key concerns:
Notably, the report recommends that stablecoin issuers be insured depository institutions. The report also recommends that, in the absence of Congressional action, the Financial Stability Oversight Council consider actions it may take to address the above concerns and risks. In the interim, the report supported enforcement activities of the SEC and the Commodity Futures Trading Commission (CFTC), to the extent the activity falls under their jurisdiction. Additionally, to prevent misuse, the report asserted that the Department of the Treasury would continue to lead efforts at the Financial Action Task Force (FATF) to encourage countries to implement AML/CFT standards and regulations. The report also noted that the Financial Stability Oversight Council (FSOC) may need to take action by declaring stablecoin arrangements as "systemically important financial market utilities" or “systemically important financial institutions."
- Risks to stablecoin users and guard against stablecoin runs
- Payment system risk
- Systemic risk and concentration of economic power
- Federal Reserve financial stability report reviews stablecoins. On November 8, the Federal Reserve published its Financial Stability Report which compared the risks of stablecoins to those of money market funds. The report noted that stablecoins can suffer from "structural vulnerabilities," noting that certain stablecoins "are, in part, backed by assets that may lose value or become illiquid." However, the report noted that the market capitalization of stablecoins has grown about fivefold over the past 12 months, referencing the PWG Report and Recommendations on Stablecoins. Additionally, the poll of industry participants showed that cryptocurrencies and stablecoins rose to rank fifth in perceived salient shocks to financial stability.
- White House releases joint statement from counter ransomware initiative meeting. On October 14, the White House published a Joint Statement of the Ministers and Representatives from the Counter Ransomware Initiative Meeting which noted that "virtual assets" were "the primary instrument criminals use for ransomware payments and subsequent money laundering." The statement further acknowledged that "uneven global implementation of the standards of the FATF to virtual assets and virtual asset service providers (VASPs) creates an environment permissive to jurisdictional arbitrage by malicious actors seeking platforms to move illicit proceeds without being subject to appropriate anti-money laundering (AML) and other obligations."
- OCC Acting Chief calls for extending bank supervision to crypto. In a speech at the American Fintech Council Fintech Policy Summit on November 3, Michael Hsu, acting Chief of the OCC, proposed, "To build long-term trust with the public and avoid [risk and instability] in the future, large, universal crypto firms – especially issuers of highly-circulated stablecoins – should embrace comprehensive, consolidated supervision. At the same time, federal and state bank regulators should prioritize the development of policies, staff, and supervisory approaches to bring such firms safely into the bank regulatory perimeter. This would clearly differentiate safe and sound crypto firms from those that are regulated only partially and have a history of control lapses, such as Binance and Tether."
- DOT announces actions against ransomware. On November 8, the US Department of the Treasury (DOT) announced "a set of actions focused on disrupting criminal ransomware actors and virtual currency exchanges that launder the proceeds of ransomware.” The actions include the designation of Chatex, a virtual currency exchange, and its associated support network, for "facilitating financial transactions for ransomware actors,” and the announcement of a Transnational Organized Crime Reward offer of up to $110 million for information leading to the identification or location of any individual(s) who hold a key leadership position in the Sodinokibi/REvil ransomware variant transnational organized crime group, and a Department of State reward of up to $5 million for information leading to the arrest and/or conviction in any country of any individual involved in a Sodinokibi variant ransomware incident. Additionally, the Financial Crimes Enforcement Network (FinCEN) issued an update to its 2020 Advisory on Ransomware and the Use of the Financial System to Facilitate Ransom Payments.
- FBI issues PSA warning about fraudulent crypto schemes. On November 4, the Federal Bureau of Investigations (FBI) issued a Public Service Announcement (PSA) warning about fraud schemes that utilize cryptocurrency ATM machines and digital QR codes to complete payment transactions. The PSA describes the schemes and the difficulty of trying to recover stolen funds due to the decentralized nature of cryptocurrency.
- Proposed CFTC Chair testifies at confirmation hearing. On October 27, Acting CFTC Chair Rostin Behnam, proposed Chair of the CFTC, indicated that the CFTC was ready to become the regulatory agency for digital assets in testimony at his confirmation hearing before the Senate Agriculture Committee, asserting that, "nearly 60% [of the $2.7 trillion digital asset market] were commodities. So with that in mind, I think it's important for this Committee to reconsider and consider expanding authority for the CFTC. … I think it's critically important to have a primary cop on the beat, and certainly the CFTC is prepared to do that."
- Chamber of Digital Commerce makes recommendations on stablecoins to the PWG. On October 18, the Chamber of Digital Commerce, a blockchain and digital asset trade association, submitted a letter to members of the PWG and the FSOC which detailed the Chamber's recommendations for the regulatory treatment of stablecoins. The Chamber asserted that US stablecoin payments systems do not currently pose a systemic risk to the US financial system, and advised that current federal and state regulatory regimes should remain in place to allow US-headquartered, US dollar-pegged stablecoin payments systems to be regulated in the same manner as other US digital payments platforms. Additionally, the Chamber identified opportunities to enhance the US regulatory approach for stablecoins via a policy framework that is principles-based and flexible, which would allow for new and innovative payments system structures to grow, while appropriately addressing potential risks. Specifically, the Chamber recommended that:
- Federal agencies provide clarity that most stablecoins are a type of retail-focused digital payments instrument, not an investment product.
- The tax treatment of stablecoin transactions be simplified due to their stable-value nature.
- State governments and federal agencies work to expand upon the best practices of states that have enacted laws allowing well-designed stablecoin payments system businesses to qualify for state-level special purpose charters.
- Federal regulators create a federal-level special purpose charter for stablecoin companies that meet certain regulatory requirements, and policymakers consider providing properly regulated entities with the ability to back stablecoins with US central bank reserves.
- FTX US announces limitations on its NFT marketplace due to US regulations. On October 15, US-based cryptocurrency exchange FTX US reportedly announced that its recently launched NFT marketplace will not list projects that reward holders with a share of secondary market sales in the form of cryptocurrency payments. According to reports, FTX US President, Brett Harrison, explained that such mechanisms which provide ongoing passive income to holders via revenue-sharing make the NFTs act like securities and puts them under potential regulatory risk from the SEC. Other NFT projects have since made similar announcements.
- Global Blockchain Business Council releases International Journal of Blockchain Law. On November 9, the Global Blockchain Business Counsel released the first issue of the first volume of the International Journal of Blockchain Law. According to its editor in chief, the IJBL is "written by lawyers for lawyers and professionals dealing with blockchain technology. The IJBL is published online and available to GBBC members and non-members. It aims to cover thrilling legal topics related to blockchain, and across various jurisdictions."
ENFORCEMENT ACTIONS AND LITIGATION
- SEC halts registration of Wyoming DAO tokens. On November 10, the SEC announced the institution of proceedings against American CryptoFed DAO LLC, a Wyoming-based decentralized autonomous organization, which halted the effectiveness of the DAO's registration of two digital tokens as securities. In the SEC's order, the SEC alleges that the DAO's registration form was "materially deficient and misleading" and failed to contain required information about the tokens as well as about the DAO's business, management and financial condition, including audited financial statements. The SEC further alleges that the registration form contained "materially misleading statements and omissions" in the form of "inconsistent statements about whether the tokens are securities," and statements related to the DAO's purported intention to distribute one of the tokens to the public using a Form S-8 applicable to employee benefit plans, without disclosing that the token may not be legally distributed pursuant to a Form S-8. The DAO's registration of the tokens is stayed pending a determination whether to deny or suspend the registration of the tokens.
- CFTC charges 12 entities for failing to register as FCMs for crypto transactions. On September 29, the CFTC announced that it filed charges against 12 entities for failing to register as futures commission merchants (FCMs) while acting as FCMs by offering to the general public the opportunity to purchase binary options based off the value of cryptocurrencies including bitcoin, and encouraging customers to transfer money or assets to them.
- CFTC settles claims against Tether and Bifinex. On October 15, the CFTC announced the issuance of an order settling charges against Tether Holdings Limited, Tether Limited, Tether Operations Limited, and Tether International Limited (dba Tether) for making untrue or misleading statements and omissions of material fact in connection with the US dollar tether token (USDT) stablecoin. The order requires Tether to pay a civil monetary penalty of $41 million and to cease and desist from any further violations of the Commodity Exchange Act (CEA) and CFTC regulations, as charged. The announcement also disclosed a second order settling charges against iFinex Inc., BFXNA Inc. and BFXWW Inc. (dba Bitfinex) in connection with their operation of the Bitfinex cryptocurrency trading platform. The order finds Bitfinex engaged in illegal, off-exchange retail commodity transactions in digital assets with US persons on the Bitfinex trading platform and operated as a futures commission merchant (FCM) without registering as required. The order requires Bitfinex to pay a $1.5 million civil monetary penalty. It also prohibits Bitfinex from further violations of the CEA, as charged, and requires Bitfinex to implement and maintain additional systems reasonably designed to prevent unlawful retail commodity transactions.
CFTC Commissioner Dawn Stump issued a concurring statement in which Stump cautioned that "because this is the first time the CFTC has applied the CEA’s broad definition of 'commodity' to a stablecoin, I wish to reiterate my concern that enforcement actions such as this involving digital assets may cause confusion about the CFTC’s role in this area." Stump further stated that the CFTC "should seek to ensure the public understands that we do not regulate stablecoins and we do not have daily insight into the businesses of those who issue such."
- CFTC charges Texas resident with cryptocurrency fraud. On October 20, the CFTC announced the filing of charges against Abner Tinoco and his company, Kikit & Mess Investments, LLC, for fraudulent solicitation and misappropriation of over $3.9 million in connection with solicitation of investors for cryptocurrency and forex trading services. The defendants allegedly misappropriated the funds for personal purposes or to pay false "profits" to other clients – similar to a Ponzi scheme. The CFTC seeks restitution, disgorgement, civil monetary penalties, permanent trading and registration bans, and a permanent injunction.
- CFTC announces award of $7 million in disgorgement against Florida man and foreign defendants. On November 17, the CFTC announced that the US District Court for the Southern District of Florida issued orders granting permanent injunctions against Daniel Fingerhut, a Miami resident, and Itay Barak, Tal Valariola and Digital Platform Limited, residents of Israel, and requiring the defendants to pay a combined $7 million in disgorgement and civil monetary penalties for violations of the Commodity Exchange Act (CEA) and CFTC regulations. The orders also impose permanent trading and registration bans, resulting from the defendants' fraudulent solicitation of tens of millions of customers and prospective customers to open and fund off-exchange binary options and digital assets trading accounts. These accounts traded foreign exchange currency pairings, metals, and digital assets through websites operated by unregistered binary options and digital asset brokers. For more information on the complaint, see our May 2020 issue.
- Founders of cryptocurrency company plead guilty to tax evasion. On October 12, the Acting US Attorney for the Northern District of Texas announced that Bruce Bise and Samuel Mendez, the owners of Bitqyck, a cryptocurrency company, pled guilty to tax evasion in connection with Bitqyck's initial coin offering which raised approximately $24 million from more than 13,000 investors. Bise and Mendez were alleged to have used the funds on personal expenses. According to the plea documents, the total tax loss joint and severally to the US government between Bise and Mendez is more than $1.6 million. Both men now face up to five years in federal prison.
The guilty plea followed a civil settlement with the SEC, in which Bise, Mendez and Bitqyck, without admitting or denying the allegations, consented to final judgments agreeing to injunctive relief. Bitqyck consented to paying disgorgement, prejudgment interest and a civil penalty of $8,375,617 while each of Bise and Mendez consented to the entry of an order that required them to pay disgorgement, prejudgment interest and a civil penalty of $890,254 and $850,022, respectively.
- NY AG directs unregistered crypto lending platforms to cease operations. On October 18, New York Attorney General, Letitia James, announced that she directed two cryptocurrency lending platforms "to immediately cease their unregistered and unlawful activities in New York." She also directed three other platforms "to immediately provide information about their activities and products."
- NJ securities regulator issues cease and desist orders against crypto investment companies. On October 27, the New Jersey Bureau of Securities announced the issuance of five summary cease and desist orders against companies “touting fraudulent investment opportunities relating to cryptocurrencies” in violation of New Jersey law. In the orders, the companies are alleged to promote fraudulent statements and omissions, and have failed to register with the Bureau to offer or sell securities or to act as a broker-dealer in the state. The companies were found by the Bureau to have defrauded investors out of nearly $90,000.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
- FATF updates its guidance for virtual assets. On October 28, the Financial Action Task Force FATF announced the issuance of its Updated Guidance for a Risk Based Approach for Virtual Assets and Virtual Asset Providers (VASPs). The updated guidance contains some material changes from the prior version, and includes updates focusing on:
For more information on prior versions of the FATF guidance, see our March 2021 issue.
- Clarification of the definitions of virtual assets and VASPs
- Guidance on how the FATF Standards apply to stablecoins
- Additional guidance on the risks and the tools available to countries to address the money laundering and terrorist financing risks for peer-to-peer transactions
- Updated guidance on the licensing and registration of VASPs
- Additional guidance for the public and private sectors on the implementation of the “travel rule” and
- Principles of information-sharing and co-operation amongst VASP Supervisors.
- G7 publishes statements on CBDCs and digital payments. On October 14, the G7 announced the publication of Public Policy Principles for Retail Central Bank Digital Currencies and Finance Ministers and Central Bank Governors’ Statement on Central Bank Digital Currencies and Digital Payments. The publications discuss factors that should be considered when designing and potentially delivering a central bank digital currency (CBDC), including monetary and financial stability; legal and governance frameworks; data privacy; competition; operational resilience and cybersecurity; illicit finance; spillovers; energy and environment; innovation; financial inclusion; payments to and from the public sector; cross-border functionality; international development; and dependencies that may be encountered in designing a retail CBDC ecosystem. The reports note that "careful consideration of the potential policy implications will continue.”
- Australia issues ransomware action plan. On October 31, the Minister for Home Affairs announced the Australian government's Ransomware Action Plan. The plan outlines the capabilities and powers that the country will use to combat ransomware. The plan’s proposed initiatives include “tackling cryptocurrency transactions associated with the proceeds of ransomware crimes.”
- Australian securities regulator issues guidance on crypto exchange-traded products. On October 29, the Australian Securities and Investments Commission (ASIC) released new regulatory requirements for funds seeking to offer crypto ETFs and other crypto products. In associated guidance, the ASIC stated that " bitcoin (BTC) and ether (ETH) appear likely to satisfy all five factors identified above to determine appropriate underlying assets for an ETP. We expect the range of non-financial product crypto-assets that can satisfy these factors will expand over time." In a Response to Submissions on CP 343 Crypto-assets as underlying assets for ETPs and other investment products, ASIC stated that it will not mandate as legal requirements the good practices recommendations it previously proposed for crypto custody, to allow flexibility in this fast-changing industry and to avoid unfairly limiting competition.
- Canadian securities and investor protection regulators issue joint guidance for crypto-trading platforms. On September 23, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) published a Joint Staff Notice 21-330 - Guidance for Crypto-Trading Platforms: Requirements relating to Advertising, Marketing and Social Media Use. The notice provides guidance for trading platforms on how the requirements of securities legislation and IIROC rules related to advertising, marketing and the use of social media apply to the platform's operations.
- Canadian province proposes to fine un-approved bitcoin mine. Reportedly, on September 20, the Alberta Utilities Commission has proposed a more than $7.1 million penalty for Vancouver-based Link Global which set up two bitcoin mining power plants without permission. At one plant, the generators drew power from a dormant natural gas well owned by a third party to run the mining computers. Canadian laws require a power plant to be set up without approval if they meet several conditions in advance, including proving that the plant has no adverse effects on people or the environment. Global Link is reportedly responding to the Commission's allegations.
- Russia legislature to form working group on cryptocurrencies. On November 11, the Chairman of the State Duma reportedly directed his Deputy to create an inter-committee working group on cryptocurrency, to be headed by Andrey Lugavoy, currently on the Committee on Security and Corruption Control.
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Margo H.K. Tank
Guy E. Flynn
Contributors to this Issue
Andrew W. Grant