Blockchain and Digital Assets News and Trends - February 2022

This is our second monthly bulletin for 2022, 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:

• 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

The Jarretts raise the stakes on the tax treatment of staking rewards

By Tom Geraghty and Kali McGuire

The current tax treatment of cryptocurrency as property provides no direct guidance on the taxation of staking rewards. The pending case of Jarrett v. United States, filed in the US District Court for the Middle District of Tennessee, is unlikely to provide clarity on this pressing issue. Read more.

SEC settles with BlockFi crypto lending platform

By Deborah Meshulam and Mark Radcliffe

The SEC announced a settlement of charges against BlockFi Lending LLC (BlockFi) with respect to its BlockFi Interest Account (BIA) product. According to the SEC:

• investors lent crypto assets to BlockFi through the BIAs
• BlockFi used investors’ crypto assets to make investments, including loans to institutional investors and
• investors received interest paid monthly in crypto assets. 

The SEC’s order found that the BIAs were unregistered securities and charged BlockFi with failing to register its offering, violations of negligence-based antifraud provisions of the securities laws and violating the Investment Company Act by operating as an unregistered investment company. Read more.

Treasury signals helpful limitations on “broker” definition under new cryptocurrency reporting rules

By Tom Geraghty and Kali McGuire

The US Treasury Department (Treasury) recently sent a letter to six senators signaling a limitation on the definition of a “broker” to potentially exclude stakers, miners, and software providers in the blockchain and cryptocurrency space. Read more.

FEDERAL DEVELOPMENTS

Securities

• SEC approves first blockchain exchange. On January 27, the SEC filed a notice in response to the filing of BSTX LLC and BOX Exchange LLC for a proposed rule change to enable a blockchain-based exchange for the trading of securities. The notice sets forth the SEC's findings that the proposed rule change, as amended, "is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to a national securities exchange." According to the BSTX press release, the SEC's notice approved “the first fully-automated, price/time priority execution exchange for trading securities that is both regulated by the SEC and leverages private blockchain technologies.” The BSTX exchange “will use a secure, private-permissioned blockchain that it controls to make participant market data available to them and to make general market data available to industry participants.”
• SEC seeks information on bitcoin ETFs. On February 1, the SEC issued an order in response to the application of NYSE Arca, Inc., for a proposed rule change to list and trade shares of the Bitwise Bitcoin ETP Trust, and exchange-traded fund (ETF). The order seeks information on how the ETF is "designed to prevent fraudulent and manipulative acts and practices" as well as information on the suitability of bitcoin as an underlying asset for the ETD. The order requests that interested persons provide comments on the proposed rule change and on the issues and concerns identified in the order.

Virtual currency

• SEC publishes investor alert on crypto asset deposit interest accounts. On February 14, SEC published Investor Bulletin: Crypto Asset Interest-bearing Accounts to educate investors about risks with accounts that pay interest on crypto asset deposits. The bulletin notes that such interest-bearing accounts are not regulated by banking regulators and are not FDIC or NCUA insured. Additionally, the SEC asserts that the accounts bear many of the same underlying risks associated with direct ownership of crypto assets.
• Federal Reserve releases discussion paper on CBDC. On January 20, the Federal Reserve Board announced the release of a discussion paper that examines the pros and cons of a potential US central bank digital currency (CBDC). The paper summarizes the current state of the domestic payments system and discusses the different types of digital payment methods and assets that have emerged in recent years, including stablecoins and other cryptocurrencies. It then analyzes the potential benefits and risks of a CBDC, identifying specific policy considerations. The Federal Reserve seeks public comment on various questions, and responses are due by May 20, 2022.
• Federal Reserve Bank of Boston and MIT release CBDC research. On February 3, the Federal Reserve Bank of Boston and the Digital Currency Initiative at the Massachusetts Institute of Technology released the findings of their initial technological research into a central bank digital currency (CBDC). The research “describes a theoretical high-performance and resilient transaction processor for a CBDC that was developed using open-source research software,” which processor “produced one code base capable of handling 1.7 million transactions per second.”
• Acting Comptroller speaks on the future of crypto-assets and regulation. On January 13, 2022, before the BritishAmerican Business Transatlantic Finance Forum, Michael Hsu, the acting Comptroller of the Office of the Comptroller of the Currency, spoke on crypto-assets and regulation. Hsu began by highlighting how crypto has gone mainstream – from credit card issuers offering bitcoin rewards programs to large corporations accepting cryptocurrency payments. Of particular note, the acting Comptroller pointed to a study indicating that the underbanked are more involved in cryptocurrency than the fully banked.
  
  Hsu directed the majority of his remarks to stablecoins. He noted that stablecoins present unique risks, especially if a “run” were to occur, but added that there is an effective tool to mitigate the risk – bank regulation. He stated that regulating stablecoin issuers as banks may enable more crypto innovation. The acting Comptroller also advocated for a coordinated and collaborative regulatory approach, highlighting how large crypto intermediaries act globally, have tens of millions of users and handle hundreds of billions of dollars of transactions every month.
• House Committee holds hearing on digital assets and stablecoins. On February 8, the US House Committee on Financial Services convened for a hearing on Digital Assets and the Future of Finance: The President’s Working Group on Financial Markets’ Report on Stablecoins. The hearing focused on stablecoin risk and benefits, state regulation, and financial inclusion.
• DOT study on illicit finance in the high value art market. On February 2, the US Department of the Treasury (DOT) announced release of a study on the facilitation of money laundering and the financing of terrorism through the trade in works of high-value art. The study notes the new risks presented by the emerging digital art market, including the use of non-fungible tokens (NFTs), including:

• “Depending on the nature and characteristics of the NFTs offered, [NFT trading] platforms may be considered virtual asset service providers (VASP) by FATF and may come under FinCEN’s regulations”
• “NFTs … that are used for payment or investment purposes in practice may fall under the virtual asset definition”
• “[P]latforms or other persons doing business transferring virtual assets during the buying or selling of NFTs may have US AML/CFT obligations under FinCEN’s rules for money service businesses”
• “NFTs can be used to conduct self-laundering, where criminals may purchase an NFT with illicit funds and proceed to transact with themselves to create records of sales on the blockchain”
• “The ability to transfer some NFTs via the internet without concern for geographic distance and across borders nearly instantaneously makes digital art susceptible to exploitation by those seeking to launder illicit proceeds of crime”

• FDIC releases 2022 priorities. On February 7, the Federal Deposit Insurance Corporation (FDIC) announced its key priorities for 2022, including the evaluation of crypto-asset risks, stating, “The rapid introduction of a variety of crypto-asset or digital asset products into the financial system could pose significant safety and soundness and financial system risks. It is imperative that the federal banking agencies carefully consider the risks posed by these products and determine the extent to which banking organizations can safely engage in crypto-asset-related activities. To the extent such activities can be conducted in a safe and sound manner, the agencies will need to provide robust guidance to the banking industry on the management of prudential and consumer protection risks raised by crypto-asset activities.”

Commodities

• CFTC Chair speaks on digital asset risk and regulation. On February 9, 2022, Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam presented testimony before the US Senate Committee on Agriculture, Nutrition and Forestry, entitled Examining Digital Assets: Risks, Regulation, and Innovation. Behnam discussed the "unique elements" of the digital asset commodity cash market which distinguish it from other cash commodity markets and suggested that the digital asset commodity cash market would "would benefit greatly from CFTC oversight" and asserted that the CFTC is "well situated to play an increasingly central role in overseeing the cash digital asset commodity market."

INDUSTRY DEVELOPMENTS

• Consortium established for banks to mint USDF stablecoins. On January 12, an association of FDIC-insured financial institutions announced the launch of the USDF Consortium. The Consortium’s mission is "to build a network of banks to further the adoption and interoperability of a bank-minted stablecoin (USDF™), which will facilitate the compliant transfer of value on the blockchain, removing friction in the financial system." Founding members include New York Community Bank, NHB Bank, FirstBank, Sterling National Bank, Synovus Bank, Figure Technologies, Inc. and JAM FINTOP.  USDF will be minted exclusively by US banks and will be redeemable on a 1:1 basis for cash from a member bank.
• Crypto.com suffers $34 million hack and implements restoration program. On January 20, Crypto.com, a crypto exchange, shared its security report and findings resulting from a January 17^th hack of nearly $35 million from users.  483 users were affected by the hack and the unauthorized withdrawals totaled 4836.26 ether, 443.93 bitcoin and $66,200 in US dollars. No customers experienced a loss of funds. The exchange also introduced the worldwide Account Protection Program which restores up to $250,000 for qualified users if a third party gains unauthorized access to their account and withdraws funds without the user's permission.
• Facebook sells Libra blockchain technology. On January 31, the Diem Association, a consortium founded in 2019 by Facebook, announced the sale of its assets to Silvergate Capital Corporation, a California bank that serves bitcoin and blockchain companies. The sale reportedly totals approximately $200 million. The consortium was founded under the name Libra to build a blockchain-based payments network using stablecoin, but it encountered issues with regulators. Diem's press release noted that “despite giving us positive substantive feedback on the design of the network, it nevertheless became clear from our dialogue with federal regulators that the project could not move ahead. As a result, the best path forward was to sell the…assets.” 

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

• Canada invokes economic measures under the Emergencies Act.   On February 15, the Government of Canada invoked the Emergency Economic Measures Order and the Emergency Economic Measures Regulations under the Emergencies Act.  The measures aim to restrict the flow of funds to groups and individual supporting the “Freedom Convoys” and related protests.  Subject to the restrictions are banks, trust companies, money service businesses, entities that provide a platform to raise funds or virtual currency through donations, and entities that perform a variety of payment processing functions. Learn more.
• Singapore central bank shuts down crypto ATMs. On January 17, 2022, the Monetary Authority of Singapore (MAS) issued guidelines to discourage cryptocurrency trading by the general public which asserted the MAS's expectations that crypto service providers should not promote their services to the general public in Singapore. The new guidelines prohibit marketing or advertising, including through the provision of physical crypto ATMs and the use of social media influencers. Crypto service providers are limited to marketing on their corporate websites, mobile applications and official social media accounts.
• UK tax authority updates guidance on DeFi lending and staking. On February 2, HM Revenue & Customs (HMRC), the UK tax authority, updated its Cryptoassets Manual to provide guidance on the tax implications of decentralized finance (DeFi) lending and staking of cryptocurrency, including the provision of guiding principles to determine whether income earned from such activities is considered capital or revenue. The guidance instructs taxpayers that a return is considered revenue where it is earned by providing a service or is in the form of interest, and capital where it is realized from capital appreciation of an asset.

PUBLICATIONS

Anti-Money Laundering (AML) Bulletin Regulatory News Update, Winter 2022. In this issue, DLA provides updates on AML developments in the UK, the EU and internationally.

Trending

US Department of Justice, aided by cryptocurrency exchanges, seizes over $3.6 billion in stolen bitcoin

Read

Is blockchain the key to a more ESG-compliant supply chain?

TOKO issues digital private debt on Hedera public network with Hex Trust custody » Interview with Margo H.K. Tank by Börsen-Zeitung on cryptocurrency regulation.

Listen

Listen to our podcast, Crypto Savvy – Bringing a Token to Life, featuring HashKey Group, which discusses TOKO and its tech. The podcast is now available on on Spotify, Apple and Google Podcasts. Feel free to check out more on LinkedIn.

More

Transferring property rights in digital property – a look at the ongoing development of UCC Article 12

Contacts

Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:

Margo H.K. Tank
Mark Radcliffe
Liz Caires
Martin Bartlam
Guy E. Flynn

Contributors to this Issue

Diana Erbsen
Tom Geraghty
Andrew W. Grant
Kali McGuire
Deborah R. Meshulam
Ellis Reemer