This is our eighth 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 passed by the Senate would impose new information reporting requirements on cryptocurrency transactions
By Thomas Geraghty
On August 10, 2021, the US Senate passed the Infrastructure Investment and Jobs Act (HR3684, or the Infrastructure Bill) that, if enacted, would provide for significant investments in roads, bridges, ports, airports, electric grids, water systems and broadband. In order to fund this expanded investment in infrastructure, the Infrastructure Bill provides for numerous revenue-raising proposals, the largest of which would impose information reporting on cryptocurrency transactions similar to those in effect now for stock and securities transactions. Learn more.
- Elizabeth Warren wants CFPB involved in cryptocurrency oversight. On July 19, Senator Elizabeth Warren (D-MA) spoke at an online event hosted by Americans for Financial Reform and the Center for Responsible Lending, among other advocacy groups, and asserted that the Consumer Financial Protection Bureau (CFPB) should be part of the regulatory response to emerging cryptocurrency risks. “We’re seeing an essentially unregulated market grow by the day and financial scams are growing with it,” Warren said. “Crypto is an area that I think all of our financial regulators are going to need to work together to address, and that means the CFPB needs a seat at the table in those discussions.”
- President’s Working Group on Financial Markets discusses stablecoins. On July 19, Janet Yellen, Secretary of the Treasury, convened the President’s Working Group on Financial Markets (PWG), joined by the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), to discuss stablecoins and the PWG’s Statement on Key Regulatory and Supervisory Issues Relevant to Certain Stablecoins. The meeting attendees discussed the rapid growth of stablecoins, potential uses of stablecoins as a means of payments, and potential risks to end users, the financial system and national security. The Secretary underscored the need for a US regulatory framework for stablecoins. The PWG expects to issue recommendations in the coming months.
- NCUA seeks comments on use of DLT and DeFi by credit unions. On July 22, the National Credit Union Administration (NCUA) approved a request for information and comment on “the current and potential impact digital assets, cryptocurrency, decentralized finance and other related technologies will have on federally insured credit unions … and what risks they could pose.” Comments on the request for information must be received no later than 60 days after publication in the Federal Register. According to the request, the NCUA seeks comments on the current and potential uses of distributed ledger technology and decentralized finance applications and “the role the NCUA can play in safeguarding the financial system and consumers in the context of these emerging technologies.”
- Senator Warren and SEC Chair assert need for additional regulatory oversight of crypto. On July 7, Senator Elizabeth Warren, Chair of the Senate Banking, Housing, and Urban Affairs Committee’s Subcommittee on Economic Policy, sent a letter to SEC Chair Gary Gensler requesting information about the SEC’s “authority to properly regulate cryptocurrency exchanges and to determine if Congress needs to act to ensure that the SEC has the proper authority to close existing gaps in regulation that leave investors and consumers vulnerable to dangers in this highly opaque and volatile market.” Gensler responded by letter on August 5, stating his position that investors using cryptocurrency platforms “are not adequately protected” and that he believes the SEC “need[s] additional authorities to prevent transactions, products, and platforms from falling between regulatory cracks,” and “more resources to protect investors in this growing and volatile sector.” He further asserted, “Regulators would benefit from additional plenary authority to write rules for and attach guardrails to crypto trading and lending.”
- SEC Chair asserts all digital asset platforms should register with the SEC. On July 21, Gary Gensler, Chair of the Securities and Exchange Commission (SEC) spoke before the American Bar Association Derivatives and Futures Law Committee. At the conclusion of his speech, Chair Gensler discussed the intersection of security-based swaps and financial technology with respect to platforms “offering crypto tokens or other products that are priced off of the value of securities and operate like derivatives.” Gensler asserted, “Make no mistake: It doesn’t matter whether it’s a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These platforms – whether in the decentralized or centralized finance space – are implicated by the securities laws and must work within our securities regime. If these products are security-based swaps, the other rules I’ve mentioned earlier, such as the trade reporting rules, will apply to them. Then, any offer or sale to retail participants must be registered under the Securities Act of 1933 and effected on a national securities exchange.”
- SEC Chair identifies need for investor protection in cryptocurrency. On August 3, SEC Chair Gensler spoke at the Aspen Security Forum, discussing the need for increased investor protection in the cryptocurrency markets. The Chair asserted that “we have a crypto market now where many tokens may be unregistered securities, without required disclosures or market oversight.” He further stated that, “It doesn’t matter whether it’s a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These products are subject to the securities laws and must work within our securities regime.” With respect to cryptocurrency trading platforms, he stated that, “To the extent that there are securities on these trading platforms, under our laws they have to register with the Commission unless they meet an exemption. … If a lending platform is offering securities, it also falls into SEC jurisdiction.” He concluded that the SEC “stand(s) ready to work closely with Congress, the Administration, our fellow regulators, and our partners around the globe to close some of these [regulatory framework] gaps.”
- Connecticut government incorporates blockchain. On July 12, the governor of Connecticut signed SB1039 which requires the state Department of Administrative Services to issue a request for information for the incorporation of blockchain technology to make the state administrative function more efficient and cost effective. The new law took effect immediately and the required action by the Department is due on January 1, 2022.
- Wyoming grants another special purpose bank charter. On August 10, Commercium Financial, Inc. announced that it received approval from the Wyoming Banking Board of its charter application for a Special Purpose Depository Institution (SPDI). Commercium joins Kraken, Avanti and Wyoming Deposit and Transfer with an SPDI charter to allow banking between digital assets and traditional banking systems.
- FASB seeks comments on adding digital assets to standards agenda. On June 24, the Financial Accounting Standards Board (FASB) published an Agenda Consultation inviting comments on its proposed standard-setting agenda. The proposed agenda includes discussion regarding accounting for crypto assets as an emerging area in financial reporting, specifically seeking comments on the following:
- Investors: How significant are holdings in digital assets, such as crypto assets, in the companies you analyze? What type of financial reporting information about holdings in digital assets do you use in your analysis of a company? How does that information influence your decisions and behaviors? If there is other financial reporting information about digital assets that would be decision useful, what is that information and why would it be decision useful?
- Preparers and practitioners: Does your company (or companies that you are involved with) hold significant digital assets, such as crypto assets? What is the purpose of those holdings?
- If the FASB were to pursue a project on digital assets, which improvements are most important, what types of digital assets should be included within the scope, and should this guidance apply to other nonfinancial assets?
The FASB Agenda Consultation was issued a month after members of the Congressional Blockchain Caucus, led by Congressman Tom Emmer (R-MN), sent a letter to the FASB encouraging it to establish accounting standards for digital assets. Comments are due by September 22.
- US Marshals Service selects Anchorage Digital for custody services. On July 28, Anchorage Digital issued a press release announcing that it “has been selected to provide digital asset custody and financial services to the United States Marshals Service (USMS),” under the USMS’s 2019 Request for Proposal for a partner to handle the full lifecycle of seized digital assets. Anchorage anticipates providing “a full suite of cryptocurrency services, including custody, liquidation, and ‘such activities as accounting, customer management, audit compliance, managing blockchain forks, wallet creation, transformation of token assets into coin assets, etc., as well as future actions associated with the virtual currency forfeiture process.’”
ENFORCEMENT ACTIONS AND LITIGATION
- CFTC obtains consent order in digital assets scheme. On August 10, the Commodity Futures Trading Commission (CFTC) announced that the US District Court for the Southern District of Texas entered a consent order against Mayco Alexis Maldonado Garcia, and a separate consent order against Cesar Castaneda and Joel Castaneda Garcia, in connection with false representations made to potential customers for their company Global Trading Club (GTC). GTC was asserted as employing “master traders” who have years of experience trading cryptocurrency, and used “cutting edge trading robots” to trade bitcoin. The orders impose a permanent injunction and require the defendants to pay $989,550 in restitution, and a total of $760,000 in civil money penalties.
- CFTC and FinCEN assess penalties against BitMEX. On August 10, the Financial Crimes Enforcement Network (FinCEN) announced the assessment of a civil monetary penalty of $100 million against the BitMEX convertible virtual currency derivative exchange for violations of the Bank Secrecy Act and FinCEN regulations. According to the announcement, “for over 6 years, BitMEX failed to implement and maintain a compliant anti-money laundering program and a customer identification program, and it failed to report certain suspicious activity.” This FinCEN action is part of a global settlement with the CFTC which announced entry of a consent order by the US District Court for the Southern District of New York against five companies charged with operating the BitMEX cryptocurrency derivatives trading platform. The order requires the BitMEX entities to pay a $100 million civil monetary penalty, and provides that up to $50 million of the penalty may be offset by payments the BitMEX entities make or are credited pursuant to the FinCEN Consent to Assessment of Civil Monetary Penalty. The order also prohibits BitMEX from further violations of the Commodity Exchange Act (CEA) and CFTC’s regulations as charged. For information on the original CFTC enforcement action against the BitMEX entities and their founders, see our October 2020 issue. CFTC litigation against the founders continues.
- SEC issues cease and desist order against DeFi Money Market. On August 6, the Securities and Exchange Commission (SEC) announced the issuance of an order compelling Blockchain Credit Partners DBA DeFi Money Market and its founders to cease and desist the offer and sale of unregistered security offerings by using smart contracts and decentralized finance technology to sell more than $31.6 million in digital tokens. The order also requires disgorgement of more than $12.8 million plus prejudgment interest and a civil money penalty of $250,000. Respondents consented to entry of the order without admitting or denying the findings.
- SEC issues cease and desist order against Poloniex. On August 9, the SEC announced the issuance of an order finding Poloniex, LLC, a second-tier subsidiary of Circle Internet Financial Limited, operated a digital asset trading platform which met the definition of an “exchange” under the federal securities laws without registering as a national securities exchange with the SEC. The order requires Poloniex to pay in excess of $10.3 million in disgorgement, prejudgment interest and civil money penalties. Poloniex consented to the entry of the order without admitting or denying the findings. Also on August 9, SEC Commissioner Hester Pierce issued a public statement questioning the Poloniex enforcement action because “during the period at issue here (mid 2017 through 2019), the Commission was moving very cautiously with respect to regulated entities’ engagement with crypto assets” such that an attempt at that time by Poloniex to register as an exchange or an alternative training system would not likely have been processed or accepted by the SEC.
- SEC issues statement on Coinschedule. Commissioner Pierce, in conjunction with Commissioner Elad Roisman, also issued a separate public statement on July 14 in the matter of Coinschedule, an enforcement action discussed in our July issue. The Commissioners expressed disappointment that the SEC’s order failed to explain which digital assets touted by Coinschedule were securities – resulting in a failure of guidance on how to determine whether a token is being sold as part of a securities offering or as a security. For information on the Coinschedule action, see our July issue.
- SEC files emergency action and TRO against fraudulent crypto investment scheme. On July 19, the SEC announced the filing of an emergency action and a temporary restraining order and asset freeze against Profit Connect Wealth Services Inc., and its founders Joy Kovar and Brent Kovar, which raised more than $12 million from at least 277 investors. According to the complaint, the Kovars assured investors that their investment funds would be invested in securities trading and cryptocurrencies based on recommendations made by an “artificial intelligence supercomputer.” The SEC alleges that those funds were instead misappropriated. The complaint seeks permanent injunctions, disgorgement, prejudgment interest and civil penalties.
- Promoter of foreign cryptocurrency companies pleads guilty of securities fraud. On July 30, the US Department of Justice (DOJ) announced that John DeMarr of California pled guilty in the Eastern District of New York for his participation in a cryptocurrency and securities fraud scheme. DeMarr conspired with others to induce investment in an online investment platform providing cryptocurrency mining, trading and digital asset services, and a platform for the trading of B2G tokens, and other digital and fiat currencies, and the provision of digital wallet staking services. DeMarr pled guilty to one count of conspiracy to commit securities fraud and faces a maximum sentence of 5 years in prison.
Harmon pleads guilty to money laundering. On August 28, the DOJ announced that Larry Dean Harmon pled guilty to a money laundering conspiracy arising from his operation of Helix, a Darknet-based cryptocurrency “mixer” or “tumbler” designed to enable customers to send bitcoin to recipients in a manner designed to conceal the source or owner of the bitcoin. Harmon admitted that Helix partnered with several Darknet markets, including AlphaBay, Evolution, Cloud 9 and others, to provide bitcoin money laundering services for market customers. In total, Helix moved more than 350,000 bitcoin – valued at more than $300 million at the time of the transactions – on behalf of customers. As part of his plea, Harmon agreed to the forfeiture of more than 4,400 bitcoin, valued at more than $200 million at today’s prices, and other seized properties that were involved in the money laundering conspiracy. Harmon will be sentenced at a date to be determined and faces a maximum penalty of 20 years in prison, a fine of $500,000 or twice the value of the property involved in the transaction, a term of supervised release of not more than three years, and mandatory restitution. For information on other charges involving Harmon and the history of this case, see our November 2020, August 2020 and March 2020 issues.
- States act against BlockFi for failure to register securities offering. On July 20, New Jersey Acting Attorney General announced the issuance of a summary cease and desist order against BlockFi, Inc., prohibiting the sale of unregistered securities in the form of interest-earning cryptocurrency accounts. That same day, the Alabama Securities Commission issued a show cause order against BlockFi to prove an exemption from registration or an exception with respect to the BlockFi interest-earning cryptocurrency accounts. Since then, the Texas State Securities Board on July 22 filed a notice of hearing against BlockFi for the purposes of determining whether to issue a cease and desist order. The hearing will be held October 13. Also, on July 26, the Vermont Department of Financial Regulation issued a show cause order against BlockFi with respect to the interest earning cryptocurrency accounts, and the Kentucky Department of Financial Institutions (DFI) also issued an emergency cease and desist order against BlockFi on July 30.
- Alabama issues cease and desist orders. On January 7, the Alabama Securities Commission issued a cease and desist order against True Reflect Bitcoin LTD for sale of unregistered securities in the form of crypto trading and data mining interests, and Goldbitmining.com for sale of unregistered securities in the form of cryptocurrency mining plans.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
- Bank of Canada issues discussion paper on CBDC. On July 20, the Bank of Canada published The Positive Case for a CBDC, a staff discussion paper addressing “the competition and innovation arguments for issuing a central bank digital currency (CBDC).” According to the paper, “CBDCs foster the public policy objectives of competition and innovation in the growing digital economy” and “competition and innovation are supporting arguments for issuing a CBDC.”
- Hong Kong arrests four men in cryptocurrency money laundering syndicate. On July 14, Hong Kong customs authorities reportedly shut down a local money laundering syndicate that used cryptocurrency to process illegal funds totaling HK$1.2 billion (US$155 million) by arresting four men allegedly involved in using e-wallet accounts and a local platform to trade in “privacy coins.” The scheme allegedly charged criminal clients a commission of 3-5%.
- Bank of Jamaica mints CBDC. On August 9, the Bank of Jamaica announced that it minted Jamaica’s first batch of CBDC, and will issue a total of J$230 million in CBDC to deposit-taking institutions and authorized payment service providers during the CBDC pilot which ends in December.
- Japan arrests four men in cryptocurrency scheme. On July 14, Japanese police reportedly arrested four men on suspicion of fraud in connection with the Oz Project, a cryptocurrency trading scheme which purportedly conducted automatic trades using AI. The police assert that the scheme collected ¥6 billion from 20,000 investors.
- UK finance ministry issues public consultation on FATF Travel Rule for crypto transactions. On July 22, the HM Treasury issued a consultation seeking input on its proposed implementation of the Financial Action Task Force (FATF) “travel rule” for cryptocurrency transactions. The Treasury stated that it delayed formal adoption of the travel rule “in order to allow compliance solutions to be developed” by cryptocurrency firms. The consultation further “proposes that the threshold for cryptoasset transfers should be GBP 1,000. It will therefore be necessary for firms to calculate the value in GBP of, for example, a transfer of Bitcoin.” A few days prior, on July 20, the European Commission revealed its own draft legislation for formally adopting the FATF travel rule for transfers of funds and certain cryptoassets, as part of a package of legislative proposals designed “to strengthen the EU’s anti-money laundering and countering the financing of terrorism rules.”
The DLA Piper IPT and Real Estate teams joined up to contribute to the inaugural edition of the Chambers and Partners Blockchain Guide 2020. Led by partner Scott Thiel and supported by Jonathan Gill and Kenny Tam, the team wrote the Hong Kong and China “Law and Practice” sections of the guide detailing the blockchain market and key legal and regulatory issues to note in each jurisdiction.
On July 20, 2021, DLA Piper lawyers Michael Malloy, Ilya Bulgakov, Alexei Kolesnikov and Alexander Klochkov contributed a chapter on Russia: Law and Practice to the Chambers Blockchain 2021 Global Practice Guide, first published in June 2021. The guide provides the latest legal information on decentralized finance; updates to tax systems to consider blockchain and cryptocurrencies; non-fungible tokens; initial coin offerings; smart contracts; data privacy and protection; and mining and staking.
- Listen to our podcast, Episode 1: Non-fungible tokens and their potential application in the financial services sector, featuring DLA Piper partner Anthony Lloyd and Macgregor Duncan, General Manager – Corporate & Business Development of Westpac and CEO of Westpac’s new digital bank.
- Listen to excerpts from the NACD Northern California Chapter’s program on How the Future of Blockchain will Impact the Boardroom Level Set, featuring DLA Piper partner Mark Radcliffe.
- You may also enjoy our podcast, FinTech: Cashless societies and post-pandemic growth, featuring DLA Piper partner Bryony Widdup and Tom Hambrett, Group General Counsel and Company Secretary of Revolut.