Cryptocurrency Derivatives, Funds and Advisers: Key Considerations Under U.S. Commodity Laws (Part 2: The Regulation of Commodities – Quite Substantial, Even If Not Substantive)

This post originally appeared in The Derivatives and Repo Report, and can be accessed here.:

This post is the second in a series that outlines key considerations for investment funds and their advisers regarding the application of the U.S. commodity laws to cryptocurrency derivatives.  In Part 1, we focused on the status of cryptocurrencies as commodities and how that status relates to the jurisdiction of the U.S. Commodity Futures Trading Commission (the “CFTC”). Here, in Part 2, we provide an overview of the regulation of commodities and the commodity markets under the Commodity Exchange Act.


Blockchain Week in Review: Week of September 10-14, 2018

The following summary is available in our sister blog, The Fintech Report.

State Bank Regulators and NYDFS to renew litigation against OCC

Blockchain Week in Review: Week of September 10-14, 2018

U.S. Developments

Regulatory Updates

U.S. Judge Says Initial Coin Offerings May Be Covered by Securities Law

On September 11, U.S. District Judge Raymond Dearie ruled that U.S. securities laws may cover an initial coin offering and stated that a reasonable jury should be able to apply the “Howey Test” to determine whether the ICO at issue was a security. The ruling came in criminal prosecution of Maksim Zaslavskiy, a Brooklyn businessman charged with conspiracy and two counts of securities fraud for his role in allegedly defrauding investors in two initial coin offerings.  Zaslavskiy’s attorneys had argued that securities law didn’t apply because the ICOs at issue were currencies, not securities and that federal securities laws are unconstitutionally vague as applied to cryptocurrency. In allowing the criminal charges to proceed, Judge Dearie rejected those arguments. However, acknowledging the early procedural stage of the case, the Court made no ruling on whether the virtual currencies offered by REcoin and DRC were securities under the U.S. Supreme Court’s Howey test. The Court did provide some discussion in the dicta previewing a possible Howey analysis. Additional thoughts on this case can be found in Perkins Coie’s latest client update. In March, another federal judge in Brooklyn ruled that cryptocurrencies could be regulated as commodities by the U.S. Commodity Futures Trading Commission. These cases underscore the importance of fact-specific and contextual analysis when addressing the regulatory treatment of any token or token sale.

FINRA Issues First Cryptocurrency-related Disciplinary Action

On September 11, the Financial industry Regulatory Authority (FINRA) issued its first cryptocurrency-related disciplinary action when it charged Timothy Ayre, owner of Rocky Mountain Ayre Inc., with securities fraud and the unlawful distribution of Hempcoin. HempCoin claimed to be “the first minable coin backed by marketable securities” and “the world’s first currency to represent equity ownership.” However, according to FINRA, the token was never registered as a security nor did it file for an exemption. Ayre could be facing a fine or suspension from the securities industry and will have an opportunity to file a response and request a hearing.   

News release can be found here.

SEC Temporarily Suspends Trading in Swedish Bitcoin and Ether Exchange Traded Notes (ETN’s)

On September 9, 2018 the Securities Exchange Commission announced that it would be temporarily suspending trading in the securities Bitcoin Tracker One (CXBTF) and Ether Tracker One (CETHF) through September 20, 2018. The two securities are structured as exchange traded notes (ETN’s) and are non-equity backed certificates that provide investors with access to the returns on the the performance of securities based on the performance of the underlying tokens (CXBTF for Bitcoin and CETHF for Ether) and are listed on the Nasdaq exchange in Stockholm. The SEC stated that it would be halting trading of both CXBTF and CETHF in the interests of “the protection of investors” because the specific structuring of the securities had caused some confusion for market participants. The Commission pointed towards contradictory descriptions of the two securities across Broker-Dealer application documents, online resources and the issuers own offering materials as the reason for the temporary suspension in trading. The suspension applied to the trackers themselves, not bitcoin or ether, and as of the time of this review had not impacted the cryptocurrency markets. 

More on the story can be found here.

International Developments

Republic of the Marshall Islands Warned Against Its Plans to Create Digital Currency

The International Monetary Fund (IMF) warned the Republic of the Marshall Islands (RMI) against its plans to create a government-issued digital currency. RMI had solidified plans earlier this year for its digital currency to act as a second legal tender for the network of islands alongside the US dollar. RMI plans to avoid the anonymity of other digital currencies so as to make it suitable for a regulated banking system and plans to be distributed via an initial coin offering. The IMF issued a press release encouraging RMI to be cautious about issuing a decentralized digital currency and to consider the all the potential risks.  The IMF also warned that RMI could be at risk of losing the last banking relationship with the US dollar.

More on the story can be found here.

 South Korean Police and FBI Bust Phishing Scammers

The Seoul Police cybercrimes division and the FBI conducted a joint operation to bust individuals responsible for the theft of over $800,000 worth of XRP from dozens of victims in South Korea and Japan. A computer programmer and his employer were the alleged masterminds behind the operation to replicate a Ripple exchange website. The scam involved spoofing or impersonating the real exchange’s email account and contacting users saying their funds had been frozen. The emails included links to a fake website where users entered their login details which were then recorded by the scammers and used to gain access to the user’s funds on the real exchange site. The scam exclusively targeted Korean and Japanese citizens, but the FBI may have gotten involved due to the fact that Ripple is an American company. The incident is South Korea’s first cryptocurrency phishing case.

More on the story can be found here.

Brazil’s Avai Becomes First Football Club to Launch its Own Cryptocurrency

Brazilian football club Avai Futebol Clube has become the first football club to launch its own cryptocurrency with in Initial Coin Offering (ICO) targeting a $20 million capital raise. The football club has teamed up with SportCo and Blackbridge Sports to leverage blockchain technology for financing and the club’s infrastructure. The token sale will begin on October 3, 2018 and conclude exactly one month later on November 3, 2018.

More on the story can be found here.

The above is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

Cryptocurrency Derivatives, Funds and Advisers: Key Considerations Under U.S. Commodity Laws (Part 1 – Cryptos Are Commodities (Except When They Are Not))

This post originally appeared in The Derivatives and Repo Report, and can be accessed here.:

In this multi-part posting, we outline key considerations for investment funds and their advisers regarding the application of the U.S commodity laws to cryptocurrency derivatives.   Part 1 focuses on the status of cryptocurrencies as commodities and how that status relates to the jurisdiction of the U.S. Commodity Futures Trading Commission. 

The full post is available at our sister publication, The Derivatives and Repo Report, and can be accessed here.

U.S. v. Zaslavskiy: Federal District Court Upholds Indictment for ICOs and Defers Final Howey Determination for Trial

Federal District Court Upholds Securities Indictment for ICOs but Defers Final Howey Determination in United States v. Zaslavskiy

This week, liberal pleading standards were applied to uphold the indictment in United States v. Zaslavskiy, the first criminal case examining whether ICOs are securities under U.S. law.

  • Analyzing virtual currencies and ICOs under the Supreme Court’s test for a security in Howey involves highly fact-based questions that courts may determine are “best left to the finder of fact.”
  • The District Court made no ruling that the virtual currencies offered by REcoin and Diamond Reserve Club were securities, and application of the Court’s decision is likely limited given its narrow procedural posture and the unique facts of the case.

In the client update, we examine details of the case and how the District Court’s preview of a Howey analysis, albeit dicta, provides insight into how courts may assess virtual currencies and ICOs under the Howey test for a security in the future.

Blockchain Week in Review: Week of September 3-7, 2018

The following summary are available in our sister blog, The Fintech Report.

Varo Bank Receives Preliminary Approval for a National Bank Charter

Blockchain Week in Review: Week of September 3-7, 2018

U.S. Developments

New Appointments to the SEC and CFTC Have Their Eyes on Virtual Currency

The U.S. Senate voted this week to confirm Dawn Stump (R) and Dan Berkovitz (D) as commissioners of the Commodity Futures Trading Commission (“CFTC”), and Elad Roisman (R) as a commissioner of the Securities and Exchange Commission (“SEC”). These appointments fill the remaining commissioner vacancies at both agencies bringing the political party balance at the SEC and CFTC to 3 to 2 in favor of Republicans.

The two recently appointed commissioners at the CFTC are generally reserved regarding their opinions on virtual currency regulation. However, Dan Berkovitz has been clear that he is familiar with and interested in the topic. Prior to joining the CFTC, Berkovitz was a partner at Wilmer Cutler Pickering Hale and Dorr LLP in Washington, D.C., where he advised on virtual currency issues as chair of the firm’s futures and derivatives practice. In August 2017, Berkovitz co-authored an article on virtual currencies and token sales that summarized various CFTC positions. During his confirmation hearing, Berkovitz briefly mentioned virtual currency as an emerging issue facing the CFTC:  “The emerging markets for cryptocurrencies are just the latest example of new market conditions that the CFTC has begun to address through its regulatory and enforcement programs. Similarly, as new information develops about existing markets, the CFTC must examine its existing regulations to determine whether they continue to serve their intended function and Congressional directives in the most efficient and effective manner.”

Elad Roisman has also made public statements regarding the regulation of virtual currency including the controversial topic of token sales. During a speech given to the Senate Committee on Banking, Housing, and Urban Affairs in July, Roisman regarded initial coin offerings and blockchain as being areas that require fairness and transparency. He also stated that the SEC should provide greater clarity regarding its positions on virtual currency to investors in the broader market. Among Roisman’s first decisions as a commissioner will be his vote regarding the upcoming VanEck Bitcoin ETF determination on September 30.

ShapeShift to Begin Collecting Customer Information for New Membership Program

On September 4, the cryptocurrency exchange, ShapeShift announced that it would gradually require customer identification information as part of several changes in the company’s business model. Historically, ShapeShift has allowed users to trade virtual currencies without collecting customer information and has generally allowed users access to its website and services anonymously. In 2015, ShapeShift discontinued services in New York following the passage of the BitLicense regulation, due in part to the customer identification obligations the regulation would impose on the company as a virtual currency business.

The new program will gradually implement membership tiers and place restrictions on trading for users who choose to divulge less of their customer information. This practice is similar to many other cryptocurrency exchanges that implement anti-money laundering and “Know Your Customer” onboarding procedures as part of their obligations as money service businesses with the United States Department of the Treasury’s Financial Crimes Enforcement Network and/or as money transmitters under relevant state financial services licensing regimes.

Please click here for the press release.

PwC Research Survey Identifies Regulatory Uncertainty and Counterparty Trust as the Primary Impediments to Blockchain Adoption

A recent survey conducted by PricewaterhouseCoopers (“PwC”) of 600 executives in 15 territories, found that 84% of respondents were actively involved with blockchain in some way, with 32% of respondents having projects in active development. PwC also identified several impediments to greater adoption and use of blockchain technology among respondents. Of those surveyed, 48% identified regulatory uncertainty as a primary concern and 45% identified lack of trust among users. Interestingly, only 29% of respondents identified the inability of blockchain technology to scale as a primary concern.

Please click here for the research survey.

International Developments

Convicted Owner of BTC-e Extradited to Russia

On September 4, the Supreme Civil and Criminal Court of Greece ruled to extradite Alexander Vinnik to Russia in connection with his ownership and operation of the BTC-e cryptocurrency exchange. Vinnik was arrested by Greek authorities following his conviction by the U.S. Department of Justice in July, 2017. Vinnik was charged with fraud and money laundering involving at least $4 billion in Bitcoin during BTC-e’s operation. As the owner of BTC-e, Vinnik received the criminal proceeds from numerous high-profile hacking and ransomware scams including the proceeds from the hack of the now-defunct Mt. Gox cryptocurrency exchange and the Crypto Wall ransomware attack. French authorities have also charged Vinnik with fraud and in June received confirmation from a lower Greek court that Vinnik would be extradited to France. It is unclear why the Supreme Civil and Criminal Court chose to change Vinnik’s extradition from France to Russia. Greece plans to issue the written judgment of the case on September 14.

For more information regarding Vinnik and BTC-e please see our regulatory update here.

Australian Financial Regulator Provides New Framework for Cryptocurrency Exchanges

On September 7, the Australian Securities and Investments Commission (“ASIC”) released its corporate plan for 2018-2022. In the report ASIC detailed a new framework that included oversight of cryptocurrency exchanges and token sales. Cryptocurrency exchanges in Australia are already required to comply with new anti-money laundering and counter terrorist financing rules under AUSTRAC, the country’s financial intelligence agency. The framework emphasizes greater cross-departmental collaboration on cryptocurrency issues and will apply regulatory principles to cryptocurrency exchanges that are similar to those that apply to conventional forms of market infrastructure.

The corporate plan can be found here.

Australian Company Aims to Be First Publicly Traded Company to Launch a Cryptocurrency

On September 5, the Byte Power Group (“BPG”), a nationally listed technology company in Australia, submitted a response to the Australian Securities Exchange (“ASX”) related to an ongoing ASX investigation into BPG’s plans for a token sale. In the response, BPG provided the ASX with details regarding the use of the “BPX Token” in a loyalty program that would provide discounts to users of BPG’s cryptocurrency exchange. BPG alleges that the BPX Tokens would not constitute securities under Australia’s Corporations Act of 2001.

The complete query letter response can be found here.

The above is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

Key Takeaways From the Tezos Litigation

On August 7, Judge Richard Seeborg of the U.S. District Court for the Northern District of California denied in part a motion to dismiss (the “Order”) sought by the defendants in In Re Tezos Securities Litigation (the “Tezos Case”). Among other important insights, the Order’s reasoning illustrates the potentially broad reach of the U.S. federal securities laws to blockchain token sellers outside the United States.

Factual and Procedural Background
The Tezos Case arises out of the Tezos blockchain project’s token sale (“Token Sale”), which commenced in July 2017 and raised the equivalent of $232 million in Bitcoin and Ether from purchasers, including many who resided in the United States. In October 2017, token purchasers brought lawsuits against various project participants claiming that the tokens were sold as unregistered securities. In March 2018, the lawsuits were consolidated into a single putative class action, the Tezos Case, in the U.S. District Court for the Northern District of California. The defendants included Arthur and Kathleen Breitman, the founders and creators of Tezos, and their company, Dynamic Ledger Solutions (collectively, the “DLS Defendants”); the Tezos Foundation, a Swiss nonprofit organization that served as the issuer during the Token Sale; Bitcoin Suisse AG, a Swiss organization that assisted purchasers during the Token Sale; and Timothy Draper, an early investor in Tezos.

The Motion to Dismiss
The defendants each moved to dismiss the Tezos Case on one or more of the following grounds: (1) lack of personal jurisdiction; (2) forum non conveniens; (3) improper extraterritorial application of the Securities Exchange Act of 1934 (the “Exchange Act”); (4) failure to plead “statutory seller” liability under Section 12 of the Exchange Act; and (5) failure to plead “control person” liability under Section 15 of the Exchange Act.

Order on the Defendants’ Motion to Dismiss
Judge Seeborg refused to dismiss the DLS Defendants and the Tezos Foundation. But, he did dismiss Bitcoin Suisse for lack of personal jurisdiction and Timothy Draper because the complaint contained no facts showing that he was a statutory seller or control person.

Personal Jurisdiction.
Bitcoin Suisse and the Tezos Foundation—the two Swiss entities—both argued that the court lacked personal jurisdiction over them, but only Bitcoin Suisse was successful. In assessing Bitcoin Suisse’s contacts with the United States, Judge Seeborg relied on Bitcoin Suisse’s uncontradicted evidence that it had not provided services for the Token Sale directly to any U.S. investors. As a result, Judge Seeborg dismissed Bitcoin Suisse from the action.

The Tezos Foundation, on the other hand, had sufficient contact with the United States. In arriving at this determination, Judge Seeborg emphasized that, even though the Tezos Foundation was a Swiss entity, (1) the California-based Breitmans were the “de facto U.S. marketing arm of the Tezos Foundation”; (2) the Tezos Foundation “engaged in little to no marketing” of the Token Sale “anywhere other than in the U.S.”; and (3) “accordingly significant portions” of the Token Sale contributors were U.S. citizens. Notably, Judge Seeborg remarked that a “different conclusion might be warranted” if the plaintiff “were one of a small number of well-informed Americans who managed to learn about and participate in an ICO exclusively marketed in some foreign country.” But in this case, the Tezos Foundation had encouraged U.S. persons to participate in the Token Sale and “made it easy for them to do so.”

Forum Non Conveniens.
The Tezos Foundation next insisted that the suit should be dismissed in favor of Switzerland as a more convenient forum. Moreover, the Token Sale terms named Switzerland as the venue for all Tezos-related litigation.

While courts typically balance various private and public factors when weighing a forum non conveniens motion, a valid forum-selection clause generally controls except under exceptional circumstances. The Tezos Foundation therefore argued that, under U.S. Supreme Court precedent, the forum-selection clause required dismissal. But Judge Seeborg found that the forum-selection clause was not even enforceable in the first place. He highlighted the difference between a “browsewrap” agreement, where user assent is inferred by visiting the website, and a “clickwrap” agreement, where user assent specifically requires engagement with the website in a way to establish assent to the terms (typically by checking a box on the website). Finding the Token Sale terms consistent with a “browsewrap” agreement, the judge concluded that the Token Sale website failed to place users on inquiry notice of the agreement’s terms, and thus was not binding.

Without a valid forum-selection clause, the judge turned to a traditional forum non conveniens analysis and easily concluded that the relevant factors weighed against dismissal because the “vast majority” of evidence, litigants, and other practical efficiencies were present or most easily accessible in the United States. Notably, the judge denied the motion without prejudice, stating that the Tezos Foundation could renew the motion if facts unearthed in discovery warranted it.

The Tezos Foundation further argued that the Exchange Act did not apply to the Token Sale because, under Morrison v. National Australia Bank Ltd.,[1] the Supreme Court held that certain provisions of the Exchange Act regulate only domestic transactions, and under the terms of the Token Sale, all transactions took place in Alderney in the Channel Islands. Whether a transaction is domestic or foreign depends on where a transfer of title or instance of “irrevocable liability” to purchase or pay for a security occurred. Judge Seeborg focused on the “actual” rather than the “contractual” situs of the Token Sale transactions and outlined the key question as follows: “[W]here does [delivery of] an unregistered security, purchased on the internet, and recorded ‘on the blockchain,’ actually take place?” He then enumerated several factors that, taken together, supported an inference that the actual situs of the transaction was the United States: (1) the Token Sale website was hosted in Arizona; (2) the website was run primarily by Arthur Breitman in California; (3) the plaintiff presumably participated in the sale in response to marketing that almost exclusively targeted United States residents; and (4) the purchaser contributions were validated, rendering transactions irrevocable, by a network of global nodes clustered more densely in the United States than in any other country. Therefore, Judge Seeborg concluded that the Exchange Act applied.

Statutory Seller and Control Person Arguments.
Judge Seeborg dismissed Timothy Draper, finding that the plaintiff had failed to allege that Draper was a “statutory seller” who actually solicited the plaintiff’s purchase, because the plaintiff had not alleged that he was even aware of Draper’s involvement in the Token Sale. Moreover, the plaintiff failed to plead that Draper was a “control person” having day-to-day interactions with the Tezos project. The DLS Defendants, on the other hand, unsuccessfully raised similar arguments.

Key Takeaways
The Order provides insight into the broad reach of U.S. law for blockchain token sellers. The defendants (except one that had not provided any services to any U.S. investors) remained subject to U.S. securities laws despite structuring the Tezos Foundation in Switzerland, selecting Switzerland as the forum for litigation in the Token Sale terms, and designating the location of the transactions on foreign soil. As the Tezos Case moves to discovery, there might be later opportunities for the defendants to assert jurisdictional or statutory challenges, but at this stage there are several lessons to learn from the Order:

  • Blockchain token sellers cannot simply avoid U.S. securities law by structuring legal entities abroad. If a token seller or any of its affiliates engage in marketing or other promotional activities directed at U.S. persons, then U.S. securities law may apply to those activities.
  • Token sellers should present contractual sale terms using a “clickwrap” agreement or similar function that requires them to confirm and document customer assent in an enforceable manner. When “browsewrap” methods are used instead, sellers are less likely to demonstrate that purchasers clearly and demonstrably assented to sale terms, meaning that any forum-selection clause might not be enforceable in litigation.
  • Judges may look to the actual situs of a transaction to determine whether the Exchange Act applies. This inquiry goes beyond contractual terms and examines whether the purchaser or seller incurred irrevocable liability to buy or sell the token in the United States. Foreign entities should consider these broad principles when designing and carrying out a token sale.

[1] 561 U.S. 247 (2010).

SEC Staff Rejects Bitcoin Futures Based ETFs – Commission Stays Rejections Pending Its Review

For those of you who have been following along thus far, the U.S. Securities and Exchange Commission (“SEC”) and the SEC’s Division of Trading and Markets (“SEC Staff”) have been wrestling since December 2017 with whether to approve or disapprove exchange-traded funds (“ETFs”) that invest in bitcoin futures contracts.  On August 22, 2018, the SEC Staff decided to reject three proposals that included a total of nine bitcoin futures ETFs, possibly.  Just one day later, the SEC issued stays of all three rejections and elected to review the SEC Staff’s decisions.  With no clear decision, it is worth looking at the reasons for the SEC Staff’s rejection of the three proposals, particularly in light of the SEC’s recent split decision on the rejection of a bitcoin ETF (the “Bitcoin ETF”).

The three rejection orders came against two proposals by NYSE Arca, Inc. (“NYSE Arca”) and one by Cboe BZX Exchange, Inc. (“Cboe BZX”).  The ETFs themselves would predominantly hold bitcoin futures contracts in lieu of holding “physical” bitcoin.  The result would create exposure to the price fluctuations of bitcoin, but the futures-based ETFs would seek to invest in a more “traditional” asset (i.e., a futures contract) that is traded on established futures markets such as the Chicago Mercantile Exchange (“CME”) and Cboe Options Exchange, Inc. (“Cboe”). Read the full article on our sister blog, Derivatives & Repo Report.

Blockchain Week in Review: August 20-24, 2018

The following summary are available in our sister blog, The Fintech Report.

U.S. Chamber of Commerce Announces FinTech Innovation Initiative

Blockchain in Review – Week of August 20 – 24, 2018

U.S. Developments

Regulatory Updates

SEC Rejects Nine Bitcoin ETF Proposals

On August 22, 2018, U.S. Securities and Exchange Commission (“SEC”) issued three orders rejecting nine bitcoin exchange-traded fund (“ETF”) proposals, including the ProShares Bitcoin ETF and ProShares Short Bitcoin ETF; the Direxion Daily Bitcoin Bear 1X Shares, Direxion Daily Bitcoin 1.25X Bull Shares, Direxion Daily Bitcoin 1.5X Bull Shares, Direxion Daily Bitcoin 2X Bull Shares, and Direxion Daily Bitcoin 2X Bear Shares; and the GraniteShares Bitcoin ETF and the GraniteShares Short Bitcoin ETF.  As in previous SEC orders rejecting bitcoin ETF proposals, the SEC explains that each exchange failed to meet “its burden . . . to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.”  On August 23, the Commission stayed the orders.  The full Commission will review them.

FTC Explains “How to Avoid a Bitcoin Blackmail Scam”

The Federal Trade Commission (“FTC”) released a consumer-focused blog post on “how to avoid a bitcoin blackmail scam.”  In short, “[i]f you — or someone you know — gets a letter [demanding that you pay bitcoin to an extortionist], report it immediately to your local police, and the FBI.”

Industry Updates

Virtual Commodity Association Working Group Established

On August 20, 2018, the Virtual Commodity Association (“VCA”) announced the formation of the VCA Working Group, which includes Bitstamp, Inc., bitFlyer USA, Inc., Bittrex, Inc., and Gemini Trust Company, LLC.  A press release by the VCA states that VCA Working Group “will work towards the goal of establishing an industry-sponsored, self-regulatory organization (SRO) to oversee virtual commodity marketplaces.”  The VCA tapped former NYDFS Executive Deputy Superintendent Maria Filipakis as interim Executive Director.  The VCA Working Group will hold an inaugural meeting to discuss guidelines for membership in the VCA, virtual commodity market best practices, and staffing of the VCA.

U.S. Commodity Futures Trading Commission (“CFTC”) Commissioner Brian Quintenz subsequently released a statement in support of the initiative, communicating that “an independent and empowered SRO-like entity could have a meaningful impact on the integrity and credibility of this young marketplace.  Today’s announcement is a positive step towards that realization.”

Legislative Updates

U.S. Senate Committee on Energy and Natural Resources Hearing on Blockchain Technologies

On August 21, 2018, the U.S. Senate Committee on Energy and Natural Resources conducted its first hearing on blockchain, focusing on energy-related blockchain applications and the environmental impact of the technology.  Senator Lisa Murkowski (R-Alaska), the Chairman of the Committee, expressed concern about the energy demand of mining associated with blockchains.  She explained, “[t]his type of computer-driven industry needs electricity, and a lot of it. Miners have flocked to places with the cheapest electric rates, but an overnight demand for more power can cause serious stress on a local utility and impact the grid.”  The panelists discussed grid efficiency, cybersecurity, and the potential of secure energy transaction platforms.

Litigation Updates

CFTC Wins Over $1.1 Million Judgment in Virtual Currency Fraud Case

On August 23, 2018, the U.S. District Court for the Eastern District of New York issued a final judgment and order of permanent injunction in CFTC v. McDonnell, ordering Patrick McDonnell and his company CabbageTech, Corp. (d/b/a Coin Drop Markets) to pay over $1.1 million in civil monetary penalties and restitution for perpetrating fraud involving virtual currencies.  This case involved a scheme whereby the defendants induced customers to provide them with fiat and virtual currency in exchange for real-time virtual currency trading advice and for the management by defendants of customer trading accounts.  The defendants misappropriated these customer funds and never provided the trading advice or traded managed account services.  Moreover, the defendants attempted to conceal the scheme by removing their website and social media materials from the Internet.  CFTC Director of Enforcement Jamie McDonald stated that “. . . the CFTC will continue to act aggressively to identify bad actors involved in virtual currencies and hold them accountable.  This case also shows the CFTC’s readiness to prove its case at trial.”

International Developments

Regulatory Updates

Chinese Regulators to Block Access to 124 Foreign Virtual Currency Exchanges

Shanghai Securities Times reported that the China National Fintech Risk Rectification Office identified 124 overseas virtual currency exchanges that are accessible within the country and plans to block access to these platforms within the country.  The Office will also permanently disable access to domestic websites and accounts on WeChat (a text messaging app) that provide virtual currency trading and token sale services.

Beijing District Bans Commercial Properties from Hosting Events Related to Virtual Currency in Financial District

On August 17, 2018, Beijing’s Chaoyang district government issued a notice that bans hotels, office buildings, and shopping malls from hosting events that  involve “talks and promotion” or virtual currencies and tokens.

Chinese Regulators Issue Warning Against Token Sales and Trading

On August 24, 2018, Chinese regulators issued a warning against illegally raising funds through crypo token sales and trading tokens.  The warning targets celebrity endorsements of token sales, overseas offerings into China, airdrops, and market manipulation.

U.K. Endorsing Entrepreneur Visas for Blockchain Startup

The U.K. Department for International Trade announced through guidance that a U.K. pre-seed investment company is funding blockchain startups.  It encourages startups to apply for entrepreneur visas and launch their businesses in the U.K.  The guidance document states that the accelerator “is particularly interested in founders who want to solve hard technical problems. Their alumni are having an impact in fields such as artificial intelligence, drones, security, virtual reality and the blockchain and have raised funding from the world’s leading venture investors.”

The Singapore Stock Exchange Working with Monetary Authority of Singapore to Utilize Blockchain for Trade Settlement

The Singapore Stock Exchange issued a release on August 24, 2018 announcing that it is working with the Monetary Authority of Singapore to allow incorporate blockchain technology into its trade settlement and processing systems.  The release states that this will “allow financial institutions and corporate investors to carry out simultaneous exchange and final settlement of tokenised digital currencies and securities assets, improving operational efficiency and reducing settlement risks.”

The above is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.

Why Is Blockchain Custody So Hard–Part 3

Why Blockchain Custody Is So Difficult—Paths Forward?” was recently posted on Perkins Coie’s Asset Management ADVocate blog. The blog post completes the analysis of the difficult question of how to comply with regulations requiring independent custody of cryptocurrency. This series focuses on the custody requirements for registered investment companies in an attempt to respond to important questions raised by the SEC’s Director of Investment Management. This installment discusses three possible approaches to trading cryptocurrency while complying with these custody requirements.

Blockchain Week in Review: Week of August 13-17, 2018

U.S. Developments
Regulatory Updates

SEC Bars Perpetrator of Initial Coin Offering Fraud

On August 14, 2018, the SEC obtained permanent officer-and-director and penny stocks bars against David T. Laurance of Tomahawk Exploration LLC (“Tomahawk”), who perpetrated a fraudulent ICO to fund oil exploration and drilling in California. According to the SEC’s order, Mr. Laurance and Tomahawk attempted to raise money through the sale of blockchain-based digital tokens called “Tomahawkcoins.” While the ICO failed to raise money, the SEC’s order found that Tomahawk’s promotional materials used inflated projections of oil production that were contradicted by the company’s own internal analysis and misleadingly suggested that Tomahawk possessed leases for drilling sites when it did not. The SEC also found that Tomahawk claimed that token owners would be able to convert the Tomahawkcoins into equity and potentially profit from the anticipated oil production and secondary trading of the tokens.

The SEC’s Press Release regarding its Order can be found here. The SEC’s Office of Investor Education and Advocacy (“OIEA”) issued an Investor Alert on August 14th to encourage investors to check the background of anyone selling or offering an investment.

Update on the SEC’s Decision to Approve a Bitcoin or Cryptocurrency ETF

As we previously mentioned in our Blockchain Week In Review for the Week of August 6, the SEC extended its decision to approve or disapprove a proposed rule change that would allow Cboe BZX Exchange, Inc. (“BZX”) to list a bitcoin exchange-traded fund (“ETF”) until September 30, 2018. The SEC and other regulators have been hesitant to approve bitcoin ETFs, mostly for security concerns. On August 14, San Francisco-based asset manager Bitwise joined the race to launch a regulated ETF for cryptocurrency. The company filed an application with the SEC for an ETF that would track a basket of 10 cryptocurrencies, including bitcoin. While other companies, including VanEck, SolidX and Gemini, have filed for bitcoin-only ETFs, Bitwise is the first to apply for one that would track multiple digital assets. The SEC’s new deadline is September 30, 2018; however, some speculate that the market regulator could push it back into 2019.

The SEC Release dated August 7, 2018 can be found here.


Crypto Investor Michael Terpin Sued AT&T for $224 Million

Crypto Investor Michael Terpin sued AT&T in the Central District of California claiming the company’s failure to protect his cellphone data led to hackers stealing $23.8 million in cryptocurrencies. Mr. Terpin alleges that AT&T employees have been complicit in a SIM swap fraud, wherein criminals pose as the owner of their victims’ mobile phone numbers and convince telecom providers to grant them access to the victims’ phones. Mr. Terpin seeks $23.8 million in compensatory damages and $200 million in punitive damages.

A copy of the Complaint can be found here.

International Developments

The World Bank Has Mandated the Commonwealth Bank of Australia to Arrange the World’s First Blockchain Bond
The World Bank has mandated the Commonwealth Bank of Australia (“CBA”) to arrange the first ever blockchain bond. Named Blockchain Offered New Debt Instrument (or “Bond-i”), this blockchain bond will be created and managed with distributed ledger technology. The two organizations issued a joint release stating that “[b]lockchain has the potential to streamline processes among numerous debt capital market intermediaries and agents. This can help simplify raising capital and trading securities; improve operational efficiencies; and enhance regulatory oversight.” The World Bank advised that investor interest in the bond has thus far been strong. Together with CBA, it intends to launch the transaction after consultation with more investors.

Japan’s Financial Services Agency (“FSA”) Announced the Results of On-Site Inspections of 23 Exchanges

Japan’s top financial regulator, the FSA, started inspecting cryptocurrency exchanges after the hack of Coincheck in January 2018. On Friday, August 10, the FSA announced the results of the on-site inspections of 23 cryptocurrency exchanges operating in the country. Seven out of the 23 are fully licensed crypto exchanges; the rest are “deemed dealers,” which are exchanges that have been allowed to operate while their applications are being reviewed by the agency. Notably, the Agency found that “the total assets of the exchanges rapidly expanded to more than 6 times in one year.” The FSA is also concerned that there are fewer than 20 executives and employees at most places, with assets under custody of 3.3 billion yen (~$30 million) per person on average. The FSA will make use of the findings from the inspections when reviewing new applicants. Since the hack of Coincheck, the agency has not approved any cryptocurrency exchanges.

The FSA’s Report can be found here (in Japanese).

Saudi Arabia Deems Bitcoin Trading as “Illegal in the Kingdom”

The Saudi Arabian Monetary Authority (“SAMA”) published a statement on August 12, 2018 advising that the Standing Committee for Awareness on Dealing in Unauthorized Securities Activities in the Foreign Exchange Market (“ForEx”) warns that “unauthorized virtual currencies are illegal inside the Kingdom of Saudi Arabia.” The committee assured “that virtual currency including, for example but not limited to, the Bitcoins are illegal in the kingdom and no parties or individuals are licensed for such practices.” The committee warned against trading in the digital currencies “for their negative consequences and high risks on traders as they are out of government supervision.” The committee did not specify any penalties or fines for cryptocurrency trading.

The CCN article about the statement can be read here.

African Regulators Taking a “Wait-and-See” Approach on Cryptocurrency

According to a news report from Ecobank, the leading independent regional banking group that serves nearly 40 countries in West and Central Africa, African countries want to regulate cryptocurrency, but regulators in most jurisdictions are taking a “wait-and-see” approach, hoping to learn from the mistakes of others before taking action themselves. Of the 39 regulatory regimes surveyed, more than half—21 countries—had yet to make a public stance on cryptocurrency.

The CCN article about the report can be read here.

South Africa Released a Draft Cryptocurrency Tax Law

The South African Revenue Services (“SARS”) recently released a draft cryptocurrency tax legislation. The draft defines the framework of virtual currency taxation in the country. The SARS’ stance on the tax treatment of cryptocurrencies is that it will continue to apply normal income tax rules to cryptocurrencies and will expect affected taxpayers to declare cryptocurrency gains or losses as part of their taxable income.

The draft legislation can be read here.

Vienna Rolls Out Blockchain Platform to Reduce Bureaucracy
Austria’s capital announced that it has been steadily rolling out blockchain use to validate and secure the city’s Open Government Data, including public transport routes, train schedules and voting results. The city has been working on a pilot to simplify and automate administrative processing as part of its digitalization initiative DigitalCity.Wien. One of the first to be launched in Europe, the networks secure official documents by storing hashtags of the data sets on the public blockchains, allowing city employees as well as citizens to review the documents’ authenticity, when they were created, and when and if the data was modified.

Ulrike Huemer, CIO, City of Vienna, said the project makes the city a pioneer in Europe in the implementation of blockchain: “[W]e are committed to an open and participatory city with reduced bureaucracy,” she said. “We will continue teaming with experienced professionals such as EY to pool knowledge and establish Vienna as a center of competence for blockchain—as well as one of the most forward-looking technology cities in Europe and worldwide.”

The EY news release can be read here.

Jamaica Stock Exchange to Trade Crypto Assets in 2018
On August 14, 2018, the Jamaica Stock Exchange (“JSE”) announced that it had signed a memorandum of understanding with blockchain startup Blockstation for the creation of a new digital assets trading platform. While it is not clear which tokens will be initially listed, the platform is set to go live before 2019. JSE managing director Marlene Street Forrest said that “The end game at the end of the day is to trade tokens, the end game is smart contacts, the end game is to provide that area of the market that would like this product, to start to do so in a secure manner.” Blockstation co-founder and chief enterprise architect Jai Waterman told CoinDesk that the startup has been working with the JSE for roughly six months in order to develop a custom version of its platform for the exchange. He noted that specific requests from the JSE have included tools to track market manipulation and other regulatory needs.

The JSE announcement can be read here.

The above is a summary of some of the significant legal and regulatory actions that occurred over the past week. This alert is not intended to be a comprehensive list of all such developments, but rather a selection of publicly-reported news that may be of particular interest.