Why Blockchain Custody Is So Difficult—The Simple Part

Why Blockchain Custody Is So Difficult—The Simple Part” was recently posted on Perkins Coie’s Asset Management ADVocate blog. The post begins with an analysis of the difficult question of how to comply with regulations requiring independent custody of cryptocurrency. This series will focus 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. We propose a simple legal answer, while exploring the difficulties custodians will face when implementing this approach.

Blockchain Week in Review – Week of August 6 – 10, 2018

U.S. Developments

Regulatory Updates

Ohio Enacts Cybersecurity Law with addition of Blockchain to Ohio’s Uniform Electronic Transactions Act

On August 7, 2018 Ohio Governor John Kasich signed SB 220, which adds “blockchain technology” to the definition of “electronic record” and “electronic signature” under Ohio’s Uniform Electronic Transactions Act. Generally, SB 220 provides an update for cybersecurity and gaming under the Ohio’s Uniform Electronic Transaction Act. However, in the definitions section, the bill also adds “blockchain technology” to “electronic record” and “electronic signature.” Specifically, SB 220 explicitly states that a record or contract secured through blockchain technology is a valid electronic record. Additionally, SB 220 includes a signature secured through blockchain technology to be a valid electronic signature.

The Ohio legislation comes on the heels of a joint statement on April 4, 2018 by the Chamber of Digital Commerce and the Electronic Signature and Records Association, in which both organizations warned against such legislation that defines “blockchain technology” or “smart contracts.” In the joint statement, the organizations state that although such legislation is well-intentioned, it has the potential to be harmful because it may be redundant with existing laws, it causes inconsistencies across the various states, and it may be federally pre-empted by existing laws such as the Federal Electronic Signatures in Global National Commerce Act.

Please click here to find the text of SB 220. The joint statement of the Chamber of Digital Commerce and the Electronic Signature and Records Association can be found here.

SEC Extends its Period of Review for the VanEck SolidX Bitcoin Trust

VanEck Securities Corporation amended its previously filed registration statement for a bitcoin investment pool on June 6, 2018 (the “VanEck SolidX Bitcoin Trust”). On June 20, 2018, Cboe BZX Exchange, Inc. (“BZX”) filed a rule change proposal to allow for the trading of the VanEck SolidX Bitcoin Trust. On July 31, members of the SEC Staff met with representatives of VanEck Securities Corporation, SolidX Management LLC (“SolidX”), and BZX to discuss BZX’s proposal on behalf of the VanEck SolidX Bitcoin Trust. In the meeting, SolidX and the others provided a presentation to the SEC staff, which included the Director of Corporate Finance, William Hinman, and Valerie Szczepanik, the SEC’s Senior Advisor for Digital Assets and Innovation, on reasons for approval of the investment product. Focusing on four main discussion topics, SolidX especially highlighted how the VanEck SolidX Bitcoin Trust would address the concerns raised by the January 18, 2018 Staff Letter from the SEC’s Division of Investment Management on cryptocurrency funds (separately, VanEck also submitted a comment letter to the SEC on July 20, 2018 in response to the January 18 Staff Letter regarding the viability of bitcoin futures exchange-traded funds). For instance, SolidX argues that because the VanEck SolidX Bitcoin Trust will use over-the-counter (“OTC”) markets to trade bitcoin, the OTC markets will provide investors just as much protection in the bitcoin context as they would for securities.

On the heels of the July 31 meeting, on August 7, 2018, the SEC extended its period for Commission action on the VanEck SolidX Bitcoin Trust, designating September 30, 2018 as the new date by which it will either approve, disapprove, or institute formal proceedings on the proposal.

Effective Date for New NFA Disclosure Requirements for NFA Members Engaging in Virtual Currency Activities

As we previously mentioned in our Blockchain Weeks In Review for the Weeks of July 16th and 23rd, by letter dated July 20, 2018, the National Futures Association (“NFA”) submitted an interpretive notice (“Interpretive Notice”) proposal to the Commodity Futures Trading Commission (“CFTC”) for the adoption of certain disclosure requirements with respect to NFA members engaging in virtual currency activities.

The NFA’s Interpretive Notice includes heightened disclosure obligations related to the lack of regulatory involvement of the NFA (for futures commission merchants and introducing brokers) and the unique features of virtual currencies, price volatility, challenges with respect to valuation and liquidity, cybersecurity risks, and asset verification risks associated with the opaque nature of the underlying or spot virtual currency market, among others (for commodity pool operators and commodity trading advisors). On August 9, 2018, the NFA announced that the Interpretive Notice will become effective on October 31, 2018.

The NFA’s Interpretive Notice can be found here.

WSJ: Cryptocurrency Traders are Conducting Pump-and-Dump Schemes

On August 5, 2018, the Wall Street Journal published on an in-depth statistical survey in which it found that a number of groups are conducting pump-and-dump schemes on cryptocurrency exchanges. In a pump-and-dump scheme, a trader tells others that the price of an asset is going to go up. Knowing that the price is likely incorrect, once the price of the asset has risen, the original trader sells before a price crash. According to the WSJ report, such schemes with crypto-assets likely cost unsuspecting investors hundreds of millions of dollars in losses over the last six months.

A link to the WSJ article can be found here.

Litigation

Judge Allows Class Action Against Tezos Foundation to Move Forward

On August 7, 2018, the federal judge in a class action lawsuit regarding the Tezos initial coin offering (“ICO”) allowed the lawsuit to move forward against most, but not all defendants.  In 2017, the Tezos Foundation launched an ICO for Tezos tokens.  Since the time of the ICO, a number of lawsuits have been filed alleging that the Tezos ICO involved the sale of unregistered securities.  The cases were have since been consolidated into two class action suits, one of which was remanded back to the California state courts for jurisdictional reasons, and one remained in federal court.  The remaining federal class action suit has four distinct groups of defendants, all of whom have moved to have the lawsuit dismissed as it pertains to them.

In his August 7 order, Judge Richard Seeborg separated the four groups of defendants and ruled separately for each.  For two defendants, the Judge dismissed the claims against them: (1) a foreign service provider that helped provide administrative services during the ICO had the case against it dismissed entirely; and (2) a prominent investor who had invested in the Tezos ICO had the case against it dismissed, but the Judge allowed the class action plaintiff the opportunity to amend its allegations and try again.  More notably, the Judge allowed the claims against the key persons, company, and foundation related to the Tezos ICO to continue.  Now past the “Motion to Dismiss” stage, the Tezos ICO litigation can proceed to the discovery phase.

The grounds for dismissal were based primarily upon personal jurisdiction, forum non conveniens, and the application of U.S. federal law to foreign transactions.  The Tezos Foundation oversaw the Tezos ICO and is a Switzerland domiciled non-profit organization.  In denying the motion to dismiss against the Tezos Foundation and the company integrally involved with the Tezos ICO, Judge Seeborg focused on several factors:

  • Personal Jurisdiction:  The California-based founders of both the Tezos Foundation and the Tezos-related company were the “de facto U.S. marketing arm of the Tezos Foundation,” the Foundation “engaged in little to no marketing” of the Token Sale “anywhere other than in the U.S.,” and “an accordingly significant portion” of the Token Sale contributors were U.S. citizens.
  • Forum non conveniens:  The ICO’s terms of sale included a forum selection clause that required all Tezos Foundation litigation to occur in Switzerland.  Judge Seeborg highlighted the difference between a “browsewrap” agreement, where user content 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 a website).  Based upon the facts alleged, Judge Seeborg determined that the terms of the Tezos ICO on the website could be construed to lack sufficient inquiry notice to be binding upon purchasers.  Also using a traditional forum non conveniens analysis, the judge concluded that private interest factors did not warrant dismissal, noting that the “vast majority” of evidence, litigants, and other practical efficiencies were present or most easily accessible in the United States.
  • Extraterritorial Application of the Securities Exchange Act of 1934:  Judge Seeborg also evaluated whether the Securities Exchange Act of 1934 (the “Exchange Act”) could be applied to the Tezos ICO, considering it was overseen by a Swiss foundation.  Judge Seeborg focused on the ‘actual rather than the ‘contractual’ situs of the Token Sale transactions in determining that the transactions with U.S.-based purchasers occurred on U.S. soil and therefore implicated U.S. securities laws and the Exchange Act.

Please click here for a link to the Judge’s order (a paywall may apply).

International Developments

Germany’s Second-Largest Stock Exchange Launches a Cryptocurrency and ICO Trading Platform

Following on its announcement that it is creating a cryptocurrency trading application called BISON, Boerse Stuttgart, the second largest exchange in Germany, announced on August 2, 2018 that it is also planning to launch a trading venue for cryptocurrencies and ICO tokens. According to Boerse Stuttgart, the trading venue would allow the issuance of digital tokens for corporate financing or to represent rights and assets. In addition, the trading venue will allow tokens launched on the platform to be traded on a secondary market. The trading venue will also allow for the trading of more established cryptocurrencies such as bitcoin and ether. Lastly, through the trading platform, Boerse Stuttgart plans to provide custody solutions for the digital assets.

The move to create an “end-to-end” digital asset trading platform comes on the heels of a survey conducted by Boerse Stuttgart in which the exchange found that investors want easy access to the crypto markets.

A press release to the Boerse Stuttgart announcement can be found here.

UK and other Foreign Financial Regulators Announce Creation of Global Financial “Sandbox”

On August 7, 2018, the United Kingdom’s Financial Conduct Authority (“FCA”) announced the creation of the Global Financial Innovation Network (“GFIN”). GFIN is a collaborative effort with twelve financial regulators from around the world to create a network that will provide an efficient way for FinTech firms to interact with, and navigate financial regulators while building new and innovative ideas.

According to the announcement, GFIN has three main functions:

  • Act as a network of regulators to collaborate and share experience of innovation in respective markets, including emerging technologies and business models;
  • Provide a forum for joint policy work and discussions; and
  • Provide firms with an environment in which to trial cross-border solutions.

GFIN’s consultation document specifically lists out the types of innovative businesses that could seek out GFIN, including businesses focused on big data, artificial intelligence, and blockchain.

The countries and regulators that currently comprise GFIN are:

  • Abu Dhabi Global Market (UAE)
  • Autorite des marches financiers (Quebec, Canada)
  • Australian Securities & Investments Commission (Australia)
  • Central Bank of Bahrain (Bahrain)
  • Consumer Financial Protection Bureau (USA)
  • Dubai Financial Services Authority (UAE)
  • Financial Conduct Authority (UK)
  • Guernsey Financial Services Commission (Guernsey)
  • Hong Kong Monetary Authority (Hong Kong)
  • Monetary Authority of Singapore (Singapore)
  • Ontario Securities Commission (Ontario, Canada)

Consultative Group to Assist the Poor (global partnership housed at the World Bank)A link to the press release for GFIN can be found here. A link to the Consultation Document for GFIN can be found here.

Bank of Thailand Allows Banks to Create Subsidiaries for Cryptocurrency Business

According to a regulatory announcement on August 3, 2018 by the Bank of Thailand, Thai banks will be allowed to issue digital tokens, provide crypto-brokerage services, be involved with crypto-related businesses, and invest in cryptocurrencies through subsidiaries. However, according to a report in the Coin Telegraph, Thai banks and other financial institutions are still banned from directly dealing with cryptocurrencies. There are also limits on the crypto-business allowed by the subsidiaries, according to the Coin Telegraph report. The subsidiaries will only be allowed to interact with businesses that are approved by Thailand’s Securities and Exchange Commission (“Thailand SEC”) and the Office of Insurance Commission.

The Coin Telegraph article about the announcement can be read here.

Applications to the Thailand SEC for ICO and Exchange Licenses Draw Interest

In a report on August 9, 2018, the Bangkok Post reported that about fifty ICO projects have shown interest in applying for licenses from the Thai government and about twenty digital asset exchanges have applied for their own respective licenses. On May 14, 2018, the Thai government issued a decree that placed the Thailand SEC in charge of cryptocurrency regulations. After the decree, the Thailand SEC opened up applications for digital asset exchange licenses until August 14, 2018. To qualify for a license, a company must be registered in Thailand and there is an upfront fee of roughly USD$156,000. There are also annual fees for exchanges and brokerage firms along with minimum capital levels.

An article on the Thai licenses can be found here. The Bangkok Post article can be found here.

The Philippines is Reportedly Researching Whether to Issue Its Own Cryptocurrency

On August 7, 2018, Business World reported that the central bank of the Philippines, Bangko Sentral ng Pilipinas (“BPS”) is researching the question of whether it should issue its own central bank-issued digital currency (“CBDC”). BSP Governor Nestor A. Espenilla, Jr. stated in a recent speech that while CBDCs may not be appropriate for the Philippines yet, BPS is monitoring other countries and the impact of CBDCs on the local financial system. Specifically, BPS is looking into CBDCs and “what [they mean] for the supply of credit and the impact on the financial system.”

Some countries, such as Ecuador, Senegal, and Venezuela, have started to experiment with the idea of CBDCs. Recently, a government official from Iran also announced that the Islamic Republic was in the early stages of creating a CBDC.

The Business World article about BPS can be read here.

Japan Virtual Currency Exchange Association Applies to Become a Self-Regulatory Body

On August 7, 2018, CCN reported that the Japan Virtual Currency Exchange Association (“JVCEA”) applied with the Japanese Financial Services Agency (“FSA”) to become a self-regulatory body. The JVCEA, formed in March 2018, is comprised of sixteen Japanese licensed cryptocurrency exchanges, all of which are licensed with the FSA. According to the CCN report, the JVCEA has now applied to become a “certified fund settlement business association,” which would allow it to create self-regulatory rules regarding cryptocurrency trading. Also according to the report, the processing time with the FSA for an application to become a certified fund settlement business association is one to two months.

The CCN article about the JVCEA 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.

Blockchain in Review – Week of July 30 – August 3, 2018

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

OCC Begins Accepting National Bank Charter Applications from Financial Technology Companies

New York Department of Financial Services Voices Opposition to Regulatory “Sandboxes” and OCC Charters for Fintech Companies


Blockchain in Review – Week of July 30 – August 3, 2018

U.S. Developments

Regulatory Updates

New York Stock Exchange Owner to Offer New Ways to Invest in Digital Assets

On August 3, the Intercontinental Exchange, the parent company of the New York Stock Exchange, announced that it will be forming a new company which will offer a federally regulated market for Bitcoin. The new company, called Bakkt, aims to create a simple means of allowing institutional money managers to offer Bitcoin-regulated investment vehicles, including mutual funds, pension funds and ETFs. Bakkt initially plans to offer one-day physically delivered Bitcoin contracts along with physical warehousing in November of this year, subject to Commodity Futures Trading Commission review and approval.

Please click here for the press release.

Token Alliance Issues First Edition of Comprehensive Set of Guidelines for the Token Ecosystem

On July 30, the Token Alliance, a working group within the Chamber of Digital Commerce, released a collaborative report entitled “Understanding Digital Tokens: Market Overviews & Guidelines for Policymakers & Practitioners.” The report gives a regulatory overview of digital token markets in five countries and provides industry best practice guidelines for those distributing digital tokens or engaging in digital token businesses. The report was developed as part of an industry-led initiative comprised of over 350 industry participants, including blockchain and token experts, technologists, economists, former regulators and law firms. Notably, six Perkins Coie attorneys are included as expert contributing authors in the report.

Please click here for the press release and report.

Congress Introduces Valley Fever Legislation to Utilize Blockchain

On July 26, Congressman Kevin McCarthy introduced H.R. 6562, the bipartisan FORWARD Act, with fellow co-sponsor, Congressman David Schweikert. The FORWARD Act seeks to strengthen research and help advance treatment and vaccine development for Coccidioidomycosis, commonly known as Valley Fever, as well as other orphan endemic fungal diseases. The legislation plans to establish a blockchain pilot program to assist medical researchers in accessing clinical data while preserving patient privacy.

Please click here for the press release.

A House Bill Advances Designed to Target Virtual Currency Use by Terrorists

On July 27, the House of Representatives Financial Services Committee advanced the Financial Technology Protection Act, introduced by Congressman Ted Budd of North Carolina. The Act would establish several efforts designed to combat terrorist use of virtual currencies, including a Fintech Leadership in Innovation and Financial Intelligence Program, which would provide grants for innovative ideas for combatting terrorism financing. The Act would also offer incentives for information leading to convictions related to the use of virtual currencies for terrorism.

Please click here for the complete text of the bill.

Delaware Passes into Law New Legislation to Accommodate Virtual Currency Businesses

The state of Delaware passed three new bills into law designed to specifically address the legal status of blockchain records. The new laws, SB182, SB183 and SB 194, amend the state’s statutory trust, limited liability company and partnership laws, authorizing the use of distributed ledger technology for corporate recordkeeping purposes and as a means of “electronic transmission” for corporate purposes, such as to obtain or record consents. These statutory updates provide clarity regarding the use of blockchains in legal instruments and open the door for efficient use of private blockchains for operating purposes, which could also satisfy corporate recordkeeping obligations.

Please click the following links for SB182, SB183 and SB194

Litigation

The SEC Subpoenas Another Pivoting Blockchain Company

In a recent public filing, Long Blockchain disclosed that it received a subpoena from the U.S. Securities and Exchange Commission (“SEC”) seeking the production of company documents related to an ongoing investigation into the company. Long Blockchain, formerly known as Long Island Iced Tea Corp., is a beverage company that was recently delisted from the Nasdaq stock exchange following its name change and pivot into the blockchain industry. The company indicated in its public filing that it was in the process of complying with the July 10 subpoena and could not predict or determine whether any proceeding may be instituted by the SEC. Long Blockchain is the second publicly listed company this year to come under scrutiny by the SEC following a sudden decision to shift its business toward the blockchain industry. A similar subpoena was received by Riot Blockchain, formerly known as Bioptix Inc., in April of this year. Both cases reflect a broader effort by the SEC to investigate disclosures by public companies that may be attempting to benefit from the excitement around blockchain technology.

Please click here for the Long Blockchain Form 8-K discussing the SEC subpoena.

International Developments

Securities Regulators in the Philippines Proposes Rules for Virtual Currencies

On August 2, the Philippines Securities and Exchange Commission (“SEC”) published draft rules governing token sales and digital currencies. The draft rules, entitled “Rules and Regulations Governing Initial Coin Offerings (“ICO”), provide a road toward compliance for all digital tokens offered for sale through an ICO in the country. As part of issuing a new token in the Philippines, an issuer must first submit an initial assessment request with the SEC. The application would include extensive descriptions of the token’s business plan, its leadership and an opinion from legal counsel, among other things. A complete application would then be assessed by the SEC 20 days from receipt, extendible for another 20 days depending on the nature and complexity of the business model. In the event that a token is deemed to be a security token, the issuer would be required to register in accordance with the draft rules within 45 days. The SEC is seeking public feedback regarding the draft rules before they go into effect on August 31.

The complete draft rules can be found here.

Iran to Fully Legalize Virtual Currencies in Near Future

On July 31, the Iranian Financial Tribune reported that it is likely that Iran will fully legalize digital currencies. According to the report, Abolhassan Firouzabadi, head of the High Council of Cyberspace, stated that cryptocurrencies will “probably” be legalized in Iran in the near future, “The final decision has not been made yet, but a working group in the Majlis Social Commission is studying it to establish online exchanges for virtual currencies, mining of virtual currencies and what currencies will be declared legal.”

This news comes just days after Alireza Daliri, the deputy for management and investment affairs of the Directorate for Scientific and Technological Affairs of the Presidential Office, was quoted by the local ISNA news media and translated by PRESSTV, saying, “We are trying to prepare the grounds to use a domestic digital currency in the country. This currency would facilitate the transfer of money (to and from) anywhere in the world. Besides, it can help us at the time of sanctions.”

Please click here for the Financial Tribune report and here for the PRESSTV report.

Chinese Court Recognizes Blockchain as a Means of Evidence

A recent copyright dispute judgment in the Hangzhou Internet Court in China relied on a blockchain-based evidence preservation solution provided by Baoquan.com to confirm that key evidence had been infringed by the defendant. The plaintiff demonstrated through the use of Baaoquan.com software, the Factom blockchain and the Bitcoin blockchain that the defendant had republished the plaintiff’s article without a license. The court analyzed the technology used to capture and preserve custody of the infringing content and concluded that the methods used were reliable. The court also concluded that blockchain technology satisfies relevant standards to preserve and secure electronic data and ensure the integrity of the same. In its closing remarks, the court emphasized that the use of blockchain to secure data should be analyzed and determined on a case-by-case basis and should not be dismissed due to the novelty or complexity of the technology.

Please click here for a link to the judgement.

South Korean Regulators Investigating the Use of Blockchain for Stock Trading

On August 2, the Financial Supervisory Service (“FFS”), a South Korean financial regulator, published a report encouraging other South Korean regulatory agencies and companies to collaborate on the development of blockchain-based stock trading systems. The study concluded that the use of blockchain systems could substantially increase efficiency integrity and security of tracking and storing transactions. The study also emphasized the importance of cooperation between government and private companies in developing future blockchain-based systems.

Please click here for more information regarding this development.

Vietnam Announces Industry Ban for Many Virtual Currency Activities

On July 26, Vietnam’s State Securities Commission (“Commission”), the country’s financial security regulatory body, announced that it would not allow many companies and businesses to engage in virtual currency business activity. The Commission banned public companies, investment advisors and fund management companies from using or investing in any virtual currency. The announcement is in keeping with the prime ministerial directive from earlier this year prohibiting the use of virtual currencies as a means of payment within Vietnam.

Please click here for more information regarding this development.

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.

SEC Denies for the Second Time a Proposal for a Bitcoin Exchange-Trade Product

On July 26, 2018, the U.S. Securities and Exchange Commission (“SEC” or “Commission”) issued an order, by a 3-1 vote, disapproving a proposed rule change (the “Proposal”) that would have allowed for a bitcoin exchange-traded product (“ETP”) (the “Order”).  In the Order, the SEC re-asserted many of its prior concerns and reasons for denying the same proposal for a bitcoin ETP back in March 2017. Read the full article on our sister blog Derivatives and Repo Report.

Dissent on the SEC’s Re-Disapproval of a Bitcoin Exchange-Traded Product

On July 26, 2018, the U.S. Securities and Exchange Commission (“SEC” or “Commission”) issued an order disapproving a proposed rule change that would have allowed for a bitcoin exchange-traded product (“ETP”) (the “Order”).  However, the Order was not unanimous amongst the SEC’s Commissioners.  Commissioner Hester M. Peirce issued a stand-alone dissent against the Order, arguing that the SEC mischaracterized their worries with the ETP and that the Commission was teetering on stifling the innovation of new investment products in the United States (in this context-bitcoin). Read the full article on our sister blog Derivatives and Repo Report.

Blockchain Weeks in Review: Weeks of July 16th and 23rd

U.S. Developments

Regulatory Updates

CFTC Issues Customer Advisory Urging Public to Use Caution When Buying Virtual Currencies

On July 16, 2018, the U.S. Commodity Futures Trading Commission (“CFTC”) issued a customer advisory about virtual currencies, urging customers to use caution and perform research before purchasing digital coins or tokens, including self-described “utility coins” or “consumption coins.” Without providing specific citations, the CFTC referenced a broad range of estimates of fraud, ranging from 5% to 80% of initial coin offerings, and encouraged customers to exercise caution and conduct extensive due diligence prior to investing.

The advisory also provides a list of factors that could impact the future value of a digital coin or token that customers should keep in mind, including:

  • the potential for forks in open-source applications that could split away market participants, increase the number of digital coins, or make coins obsolete;
  • decreasing mining or validation costs (if price is tied to those factors);
  • acceptance of other currencies, coins, or tokens for offered goods and services;
  • the link between the value of a digital coin or token and the offered product or service;
  • adoption of the digital coin or token as a broad medium of exchange or store of value;
  • future competitors or technological changes that could disrupt the underlying business;
  • future demand or uses for an application, network, product, or service;
  • liquidity in the market for a specific digital coin or token;
  • changes to the underlying technology that could devalue digital coins or tokens; and
  • risk of theft from hacking.

This is the fourth customer advisory that the CFTC has issued about virtual currencies.

Please click here for the CFTC press release. Click here for the full text of the customer advisory.

New York Approves BitLicense Application of Virtual Currency Payment Processor BitPay

On July 16, 2018, New York’s Department of Financial Services (“DFS”) approved BitPay, Inc.’s application for a BitLicense, making BitPay the first wholesale payment processor to be approved for a BitLicense, and the eighth recipient of a BitLicense. Other BitLicense holders include Square, Inc., Xapo, Inc., Genesis Global Trading Inc., bitFlyer USA, Coinbase Inc., XRP II and Circle Internet Financial.

Please click here for a link to the press release.

FinCEN Improvement Act of 2018 Introduced in the House of Representatives

On July 17, 2018, the FinCEN Improvement Act of 2018 (“Act”) was introduced in the U.S. House of Representatives. As part of the proposed legislation, the Act would include a provision allowing for cooperation with Tribal law enforcement agencies and another section responding to terror-related financial crimes. The Act as drafted, however, would not contain any substantive revisions to existing law with respect to virtual currencies. The Act, sponsored by U.S. Representative Ed. Perlmutter (D-CO) and co-sponsored by U.S. Representative Stevan Pearce (R-NM), is currently pending in the House Committee on Financial Services

Please click here to find the text of H.R. 6411.

House Agriculture Committee Holds Hearing on Virtual Currencies

On July 18, 2018, the House Agriculture Committee held a hearing entitled “Cryptocurrencies: Oversight of New Assets in the Digital Age.” Panelists included Joshua Fairfield, Professor of Law at Washington and Lee University; Amber Baldet, CEO of Clovyr; Scott Kupor, Managing Partner of Andreessen Horowitz; Daniel Gorfine, Director of LabCFTC; Gary Gensler, former CFTC Chairman and Senior Lecturer at MIT Sloan School of Management; and Lowell Ness, Managing Partner of the Palo Alto office of Perkins Coie.

On July 18, 2018, the House Financial Services Subcommittee on Monetary Policy and Trade held a hearing entitled “The Future of Money: Digital Currency.” Panelists included Dr. Rodney J. Garratt, Professor of Economics at the University of California Santa Barbara; Dr. Norbert J. Michel, Director of the Center for Data Analysis at The Heritage Foundation; Dr. Eswar S. Prasad, Professor of Trade Policy at Cornell University; and Mr. Alex J. Pollock, Distinguished Senior Fellow at the R Street Institute.

Please click here for a link to footage of the hearing.

House Financial Services Subcommittee Holds Hearing on Virtual Currencies

On July 18, 2018, the House Financial Services Subcommittee on Monetary Policy and Trade held a hearing entitled “The Future of Money: Digital Currency.” Panelists included Dr. Rodney J. Garratt, Professor of Economics at the University of California Santa Barbara; Dr. Norbert J. Michel, Director of the Center for Data Analysis at The Heritage Foundation; Dr. Eswar S. Prasad, Professor of Trade Policy at Cornell University; and Mr. Alex J. Pollock, Distinguished Senior Fellow at the R Street Institute.

U.S. Representative Brad Sherman (D-CA) kicked off the hearing with opening remarks that included calling for a blanket ban on all buying and mining of cryptocurrencies for U.S. citizens. Discussion topics included general monetary policy and history, along with the question of whether central banks should introduce a central bank digital currency, to which Pollock suggested that, while “quite conceivable,” “hav[ing] a central bank digital currency is one of the worst financial ideas of recent times,” while Prasad noted the potential for crypto to have a positive impact on the financial services industry, including “mak[ing] transactions much easier…and bring[ing] down the cost.”

Please click here for a link to footage of the hearing.

Chairman of the Federal Reserve Discusses Cryptocurrencies in Testimony to Congress

On July 18, 2018, Chairman of the Federal Reserve, Jerome Powell, testified before the House Financial Services Committee in a hearing entitled “Monetary Policy and the State of the Economy.” Chairman Powell reportedly noted that the cryptocurrency market is not a priority and that the U.S. central bank isn’t looking to regulate it while also expressing concerns about investor and consumer protections with respect to cryptocurrencies, particularly with respect to unsophisticated investors. Chairman Powell also distinguished between fiat currency and cryptocurrency by noting that cryptocurrency has no intrinsic value.

Please click here for a link to the archived webcast.

University of Pennsylvania Study Finds Centralized Control in ICOs

Findings in “Coin-Operated Capitalism,” a new paper authored by researchers from the University of Pennsylvania published July 18, 2018, indicate that a significant number of initial coin offering (“ICO”) issuers retained centralized control through undisclosed code. The researchers collected information on the 50 ICOS of 2017 that raised the most capital and analyzed “the relationship between the ‘paper’ promises made by ICO promotors in their offering documents, and the actual functionality of the cryptoassets” they delivered. Their basic finding was that the code and the contracts very often did not align. Most notably, while 37 firms promised vesting in their marketing documents or white papers, only 7 of those firms coded the vesting rules into their tokens. Additionally, of the 42 firms that promised a supply restriction, 10 did not deliver coded limits, and of the 17 firms that promised to burn supply, 6 failed to code that promise. The researchers summarized their findings by noting that while “[p]rojects are making governance claims that look to be modeled off of offline VC or traditional equity-based rules intended to reduce agency costs…they are not encoding those promises into the sort of trustless, decentralized systems which undergird their networks’ purported sky-high values.”

Please click here for a link to the full paper.

CFPB Launches Regulatory Sandbox for Fintech Firms

On July 18, 2018, the acting chief of the Consumer Financial Protection Bureau (“CFPB”), Mick Mulvaney, announced that the CFPB has launched a regulatory “sandbox” to help fintech firms develop new products and services. Mulvaney also announced on July 18 that he has selected Paul Watkins to lead the CFPB’s new Office of Innovation, which will oversee the project and “will focus on creating policies to facilitate innovation, engaging with entrepreneurs and regulators, and reviewing outdated or unnecessary regulations.” Watkins joins the CFPB from the Arizona attorney general’s office, where he helped manage the nation’s first state-level fintech sandbox.

Please click here for a link to the press release.

NFA Proposes Heightened Disclosure Requirements for NFA Members Engaging in Virtual Currency Activities

By letter dated July 20, 2018, the National Futures Association (“NFA”) submitted an interpretive notice proposal to the Commodity Futures Trading Commission (“CFTC”) for the adoption of certain disclosure requirements with respect to NFA members engaging in virtual currency activities.

In response to concerns that virtual currencies and virtual currency derivatives “may be attracting customers that do not fully understand their nature, the substantial risk of loss that could arise from trading them and the limitations of NFA’s oversight role,” the NFA’s proposed interpretive notice includes heightened disclosure obligations related to the lack of regulatory involvement of the NFA (for futures commission merchants and introducing brokers) and the unique features of virtual currencies, price volatility, challenges with respect to valuation and liquidity, cybersecurity risks, and asset verification risks associated with the opaque nature of the underlying or spot virtual currency market, among others (for commodity pool operators and commodity trading advisors).

Please click here to find the full text of the proposed interpretive notice.

House Committee Approves Financial Technology Protection Act for Consideration by the House of Representatives

On July 24, 2018, the House Financial Services Committee unanimously passed H.R. 5036, the Financial Technology Protection Act (“FTPA”), 57-0, which will now go the full U.S. House of Representatives to be considered. The FTPA would establish an Independent Financial Technology Task Force “to provide rewards for information leading to convictions related to terrorist use of digital currencies” and “establish a FinTech Leadership in Innovation Program to encourage the development of tools and programs to combat terrorist and illicit use of digital currencies.”

Please Click here for a press release from the bill’s sponsor, U.S. Representative Ted Budd (R-NC). Click here to find the text of H.R. 5036.

SEC Commissioners Vote 3-1 to Reject Winklevoss Bitcoin ETF

On July 26, 2018, the U.S. Securities and Exchange Commission (“SEC”) issued an order that blocks the listing of shares of what would have been the first-ever bitcoin ETF on a regulated exchange. In the order, which relied heavily on concerns regarding fraud and market manipulation, the SEC found that Bat BZX Exchange, Inc.’s proposal to list and trade shares of the Winklevoss Bitcoin Trust was not consistent with the Securities Exchange Act of 1934 (“Exchange Act”) Section 6(b)(5), which requires that “the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.”

Commissioner Hester M. Peirce dissented from the SEC’s order, finding the proposed rule change consistent with the Exchange Act, and voicing concerns that the SEC’s approach “undermines investor protection by precluding greater institutionalization of the bitcoin market” and “sends a strong signal that innovation is unwelcome in [U.S.] markets.”

Please click here to find the text of the order. Click here for Commissioner Peirce’s dissent.

Litigation

Operator of Defunct Bitcoin Exchange Pleads Guilty to Lying, Securities Fraud and Obstruction

Jon E. Montroll, former operator of BitFunder.com and WeExchange Australia, Pty. Ltd., pled guilty to one count of securities fraud and one count of obstruction of justice as announced by the United States Attorney for the Southern District of New York on July 23, 2018. He is currently awaiting sentencing. Montroll has been accused of misappropriating user funds, failing to disclose the theft of users’ bitcoins while soliciting investments, and providing falsified information and materially false and misleading responses to the government in the course of its investigation.

Montroll operated the BitFunder platform from December 2012 to November 2013. The U.S. Securities and Exchange Commission (“SEC”) alleges that the BitFunder platform was run as an unregistered securities exchange through which users could buy and sell virtual shares of various virtual currency-related enterprises in exchange for bitcoins. Customers’ bitcoins were commingled in an online wallet maintained by WeExchange, an Australian virtual currency exchange owned by Montroll, from which he withdrew funds belonging to the platform’s users. During July and August of 2013, a group of BitFunder users hacked into the platform and stole more than 6,000 bitcoins, then valued at approximately $775,075 and worth over $69 million when Montroll was arrested on February 21. BitFunder allegedly lacked the bitcoins to cover user losses; however, Montroll continued to operate the platform until finally closing it in November 2013. In a resulting SEC probe about the cyberattack, Montroll denied that that the hack had been successful and allegedly produced a screenshot that misrepresented the amount of bitcoins available to users on the platform.

Please click here for a link to the press release. Click here for a link to the Information filed in the United States District Court, Southern District of New York. Click here for a link to our earlier coverage on the SEC lawsuit.

Commodity Pool Operator Ordered to Pay More than $1.9 Million in Connection with Bitcoin and Binary Options Fraud Scheme

In a press release issued July 23, 2018, the U.S. Commodity Futures Trading Commission (“CFTC”) reported that on July 9, 2018, a New York federal court ordered Dillon Michael Dean and his UK-registered company, The Entrepreneurs Headquarters Limited (collectively, “Defendants”), to pay approximately $1.5 million in civil monetary penalties and approximately $430,000 in restitution to customers who had been solicited, in part, from YouTube videos and Facebook posts, in connection with a civil enforcement suit filed by the CFTC in January 2018. The court found that from April 2017 to January 2018, Defendants had “engaged in a fraudulent scheme to solicit Bitcoin from members of the public, misrepresented that customers’ funds would be pooled and invested in products including binary options, and misappropriated pool participants’ funds.” In addition, the court found that Defendants had failed to register with the CFTC as a Commodity Pool Operator and Associated Person of a Commodity Pool Operator, respectively.

Please click here for a link to the press release. Click here for a link to our earlier coverage on the enforcement action filed in January 2018.

International Developments

FSB Publishes Report on its Work and Standard-Setting Bodies on Crypto-Assets

On July 16, 2018, the Financial Stability Board (“FSB”) published its report to the July 2018 G20 Finance Ministers and Central Bank Governors’ meeting on the work of the FSB and standard-setting bodies with respect to crypto-assets. The FSB noted that it did not believe crypto-assets pose a material risk to global financial stability at this time and recognized the need for vigilant monitoring. In connection with the report, the FSB outlined a framework it created in collaboration with the Committee on Payments and Market Infrastructures, to monitor the financial stability implications of developments in crypto-asset markets.

Please click here for a summary and a link to the report.

FATF Releases New Guidance on Virtual Currency and Risks Related to Money Laundering and Terrorist Financing

On July 18, 2018, the Financial Action Task Force (“FATF”), published its report to the July 2018 G20 Finance Ministers and Central Bank Governors’ meeting. The report sets out the FATF’s ongoing work to fight money laundering and terrorist financing, and in particular the FATF’s work programme on virtual currencies, including the money laundering and terrorist financing risks of virtual currencies, the regulatory environment for virtual currencies, and the revision of global standards and guidance to accommodate virtual currency business activity.

Please click here to read our coverage on this topic, which highlights the findings of the FATF report and provides a few key takeaways for market participants from recent regulatory activity designed to fight money laundering and terrorist financing. Click here for a link to the full text of the report.

Malta Announces World’s First Blockchain and Cryptocurrency Stock Exchange

On July 19, 2018, Malta announced the inauguration of the world’s first blockchain and cryptocurrency stock exchange and the creation of a new subsidiary which will become the Fintech and Digital Asset arm of the Malta Stock Exchange.

Please click here for a link to the announcement issued by the Malta Stock Exchange’s official twitter account. Click here for a link to a news article on the topic.

Russia Provides Some Clarification on Taxation of Cryptocurrencies

The Chairman of the Russian State Duma Committee on Financial Markets announced that a new bill on cryptocurrencies was being considered and that it would not include a separate section on taxation specifically for cryptocurrency trading or mining, meaning no special tax status would apply to cryptocurrencies, although he did not rule out separate taxation systems for the mining and trading of cryptocurrencies in the future.

Please click here for a link to a news article on this topic.

Iran Preparing to Develop its Own Digital Currency

With U.S. economic sanctions looming, the Iran Directorate for Scientific and Technological Affairs of the Presidential Office announced this week through Alireza Daliri, its deputy for management and investment affairs, its plan to work with domestic companies and the Central Bank of Iran to create a “domestic digital currency.” The timeline for integration is reportedly within the next three months.

An article on this topic can be read here.

 

 

Chamber of Digital Commerce’s newest whitepaper “Understanding Digital Tokens: Market Overviews & Guidelines for Policymakers & Practitioners”

Proud to be a part of the Chamber of Digital Commerce’s newest whitepaper “Understanding Digital Tokens: Market Overviews & Guidelines for Policymakers & Practitioners” Special thanks to the Perkins team: Joseph Cutler, Michael Didiuk, Dax Hansen, Fred Fedynyshyn, Stephen Keen, Tom Ahmadifar and Michael Selig for contributions to the Chamber’s Token Alliance guidelines for policymakers.

Click here to download the whitepaper.

Virtual Currency: Anti-Money Laundering and Terrorist Financing Update

On July 18, 2018, the Financial Action Task Force[1] (“FATF”), published its report to the July 2018 G20 Finance Ministers and Central Bank Governors’ meeting.[2] The report sets out FATF’s ongoing work to fight money laundering and terrorist financing, and in particular FATF’s work programme on virtual currencies, including the money laundering and terrorist financing risks of virtual currencies, the regulatory environment for virtual currencies, and the revision of global standards and guidance to accommodate virtual currency business activity. This post briefly highlights the findings of the FATF report and provides a few key takeaways for market participants from recent regulatory activity designed to fight money laundering and terrorist financing.

The FATF report begins by identifying the patchwork regulatory approaches among G20 participants towards virtual currency. The report found that most G20 participants are still preparing laws designed to respond to virtual currency and only seven participants have adopted comprehensive regulation of virtual currencies. A summary of the report’s findings is below:

In response to the risk of regulatory arbitrage or flight to unregulated safe havens, the FATF stated that they are reviewing their standards, including their virtual currency guidance from 2015, and will consider detailed proposals to clarify the application of standards involving virtual currency. [3] The proposals will be particularly focused on the standards applicable to customer due diligence, money or value transfer services, wire transfers, supervision, and enforcement. Following these proposals, the FATF plans to release updated standards for virtual currencies in October of 2018 for all G20 participants. The standards, while lacking the force of law, are important benchmarks against which national regulators are likely to measure the reasonableness and adequacy of anti-money laundering (“AML”) programs in virtual currency businesses.

The FATF report reflects a growing concern among regulators and government organizations regarding the use of virtual currency for terrorism and other illegal activities. Shortly following the FATF report, U.S. Congressmen, Ed Perlmutter and Steve Pearce, introduced the FinCEN Improvement Act (“H.R. 6411”) designed to extend the mandate of the Financial Crimes Enforcement Network (“FinCEN”) to include “matters involving emerging technologies or value that substitutes for currency, and similar efforts.”[4] H.R. 6411 hopes to modernize FinCEN’s operations in light of new technological developments, including the use of virtual currency for illegal activity.

Similarly, the European Union’s (“EU”) Fifth Anti-Money Laundering Directive (“5AMLD”) was formally published in the European Union’s Office Journal, following its adoption by the European Parliament and Council in May of this year.[5] 5AMLD is the first EU regulatory framework specifically dealing with the regulation of virtual currency exchanges and marks a significant departure from previous guidance regarding virtual currency. 5AMLD largely reflects current AML requirements in the US under the U.S. Bank Secrecy Act.

The results of the FATF standards meeting in October may also further augment AML requirements as new regulations are adopted amongst G20 participants. Should you have any questions regarding these developments and how they might apply to you or your business, please contact one of the authors of this update or another member of the Perkins Coie Blockchain Technology and Digital Currency team.

[1] The Financial Action Task Force is an independent inter-governmental body that develops standards to protect the global financial system against money laundering, terrorist financing, and the financing and proliferation of weapons of mass destruction.

[2] FATF (2018), FATF Report to G20 Finance Ministers and Central Bank Governors, FATF, Paris, France,

www.fatf-gafi.org/publications/fatfgeneral/documents/report-g20-fm-cbg-july-2018.html.

[3] See FATF (2015), Guidance for a Risk-Based Approach to Virtual Currencies, FATF, http://www.fatf-gafi.org/media/fatf/documents/reports/Guidance-RBA-Virtual-Currencies.pdf; See also Perkins Coie Client Alert – FATF Issues 2015 Update on Last Year’s Virtual Currency Guidance (July 16, 2015), available at https://www.virtualcurrencyreport.com/2015/07/fatf-issues-2015-update-on-last-years-virtual-currency-guidance/.

[4] FinCEN Improvement Act of 2018, H.R. 6411, 115th Cong. (2018) available at https://www.congress.gov/bill/115th-congress/house-bill/6411/text.

[5] Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.L_.2018.156.01.0043.01.ENG&toc=OJ:L:2018:156:TOC.

Blockchain Week in Review: Week of July 9, 2018

The following update is on our Fintech Legal Report:

FINRA Issues a Regulatory Notice for Firms to Let FINRA Know About Digital Asset Activities

Blockchain Week in Review: Week of July 9, 2018

U.S. Developments

Regulatory Updates

Vermont Enacts Blockchain Business Development Bill

On May 30, Vermont Governor Phil Scott signed SB 269 (thereby becoming Act number 205), which creates several mechanisms intended to stimulate the growth of blockchain business in Vermont.  The new blockchain legislation became effective on July 1, 2018.

SB 269 creates and requires several items related to blockchain, businesses engaged in blockchain technology, and the growth of blockchain technology in Vermont.  After amending the definitions of blockchain and blockchain technology in the Vermont statutory code, the bill first creates a new type of business entity in Vermont, called a blockchain-based limited liability company (“BBLLC”).  Intended for businesses that utilize blockchain technology, a BBLLC can customize its governance structure using blockchain technology.  SB 269 also creates a second kind of business entity called a personal information protection company (“PIPC”).  PIPCs act as fiduciaries and are designed to provide personal information protection services to consumers.  Finally, SB 269 requires that various Vermont state agencies conduct a study on the applications of blockchain, particularly in the finance and insurance sectors, and it requires that several state agencies hold a fintech summit.

Please click here to find the text of SB 269.

Litigation

“Bitcoin Maven” is Sentenced to One Year in Prison in Her Bitcoin Money Laundering Case

In a July 9 press release, the U.S. Department of Justice, through the U.S. Attorney’s Office for the Central District of California, publicly announced that the court sentenced the “Bitcoin Maven” to a year in federal prison in addition to a number of financial penalties after she plead guilty to one count of operating an unlicensed money transmitting business and one count of money laundering.

According to court documents, the guilty plea stems from the “Bitcoin Maven” offering bitcoin-for-cash exchange services without registered as a money services business with the Financial Crimes Enforcement Network (“FinCEN”), and without implementing anti money-laundering mechanisms.  As a result of her unregistered business, she facilitated laundering for one individual who is suspected of receiving bitcoin from unlawful activity on the dark web.

Please click here for a link to the press release.

SEC Obtains Final Judgements for Illegal Stock Sales of Blockchain Company Stock

On July 9, the U.S. Securities and Exchange Commission (“SEC”) obtained final judgements against two defendants in federal court after the defendants entered into a settlement.  The defendants were alleged to have profited from the illegal sale of stock in a company claiming to have a blockchain-related business.

On July 2, the SEC initially alleged in the Southern District of New York that two Nevada men had received restricted shares in a company that was purported to have a blockchain-related business.  The restrict shares allowed the two men to resell at a specific fixed price.  According to the SEC’s allegations, when the price of the blockchain company spiked, the two men allegedly sold their shares at much higher prices than both the market price and their fixed-price obligation.  In a separate action back on January 5, 2018, the SEC had temporarily suspended trading of the same blockchain-related company’s stock due to concerns about the accuracy of assertions in its filings and because of unusual market activity.  Under the terms of the settlement, the two defendants must return approximately $1.4 million of allegedly ill-gotten gains, and pay $188,682 in civil penalties.

Please click here for a link to the SEC’s litigation release.  Click here for a link to the January 5, 2018 release on the suspension of trading in the blockchain-related company’s shares.

International Developments

New UK Regulatory Sandbox Cohort Includes Numerous Blockchain-Related Pilots

The United Kingdom’s Financial Conduct Authority (“FCA”) recently announced its fourth cohort of regulatory sandbox pilot programs.  The FCA’s regulatory sandbox is a program that allows certain businesses, selected from a list of applicants, to engage with the FCA and launch a limited pilot version of their business in order to test innovative products, services, business models, and delivery mechanisms.

The most recent cohort of businesses selected includes businesses that offer a variety of blockchain-related products and services, including some of the following:

  • A platform that facilitates the issuance and manages the lifecycle of regulated bonds using blockchain technology.
  • The creation of an identity token that supports customers who lack traditional forms of ID to allow them to access bank account services.
  • A blockchain-based platform that allows companies to issue and administer debt and equity securities, including bonds backed by crypto-assets.
  • A governance model based on blockchain technology.
  • A global trade payments and settlement system using an asset-linked smart token that utilizes a permissioned blockchain network.

The full list of sandbox businesses can be found here.

Philippines Regulator Issues First Cryptocurrency Exchange License

On July 10, a Hong Kong-based company launched its cryptocurrency exchange business in the Philippines after it had secured the first cryptocurrency exchange license issued by the Cagayan Economic Zone Authority (“CEZA”).  The CEZA is a government-owned and controlled corporation tasked to manage and supervise the development of the Cagayan Special Economic Zone and Freeport (“CSEZA”), which is itself a special economic zone in Cagayan Province, northern Luzon, in the Philippines.  The license issued to the Hong Kong company is a provisional license that expires after six months; however, the company can acquire a permanent license if it is able to fully comply with the CEZA license requirements.

CEZA’s requirements to obtain a cryptocurrency exchange license include an investment of at least $1 million U.S. dollars over two years and a company must have at least a back-up office in the Philippines.  CEZA officials have stated that they plan to issue 24 more financial technology solutions and offshore virtual currency (“FTSOVC”) licenses.

A Philippines government article on the FTSOVC license can be read here.

India’s Top Court Denies a Stay on the Central Bank’s Ban on Virtual Currencies

On July 3, India’s Supreme Court refused to grant a stay on the Reserve Bank of India’s (“RBI”) ban on lenders dealing in cryptocurrencies.  On April 6, the RBI issued a circular in which it decided that entities regulated by the RBI cannot deal in or provide services connected to virtual currencies (the “Circular”).  The types of services mentioned in the Circular included maintaining accounts, registering, trading, settling, clearing, giving loans against “virtual tokens,” accepting virtual currencies as collateral, and opening accounts of exchanges dealing with virtual currencies.  Any regulated entity already providing such services had to stop by July 5, 2018.

The petitioner in the case had previously filed a motion to stay the RBI’s ban pending a judicial review of the Circular. However, in its order following the July 3 hearing, the Supreme Court of India refused to act on the request for a stay, and instead, scheduled a new hearing for July 20.  As a result, RBI’s virtual currency ban went into effect on July 5.  Media reports have stated that there are four other petitions on the virtual currency ban scheduled in the Supreme Court of India on July 20.

The case is entitled Internet and Mobile Association of India v. Reserve Bank of India (Writ Petition (Civil) No. 528/2018).

Please click here for a link to the July 3, 2018 Supreme Court of India order.  Please click here for a link to the April 6, 2018 Circular from the RBI.  For further information on the virtual currency ban and the cases before the Supreme Court of India, here are links to two different articles.

Jersey Financial Services Commission Issues ICO Application Process

On July 12, the Jersey Financial Services Commission (“JFSC”), the financial regulator of the Isle of Jersey, issued a Guidance Note in which it detailed its new application process for the issuers of initial coin offerings (“ICOs”).  In the Guidance Note, JFSC states that most ICOs are unlikely to be regulated by the JFSC; however, the JFSC places some conditions on an issuer of an ICO through powers conferred on the JFSC by a particular Jersey statute entitled the Control of Borrowing (Jersey) Order 1958 (“COBO”).  Relying on the requirements of COBO, JFSC lays out specified requirements for ICO issuers based in Jersey to follow to maintain regulatory compliance.  The general requirements on Jersey ICO issuers in the Guidance Note are as follows:

  • Be incorporated as a Jersey company.
  • Receive consent under the COBO from JFSC before any action is taken (the consent process is detailed further in the Guidance Note).
  • Comply with JFSC’s Sound Business Practice Policy.
  • Apply relevant anti-money laundering and other such requirements to ICO purchasers.
  • Appoint and maintain a trust company business (“TCSP”).
  • Appoint and maintain a Jersey resident director.
  • Be subject to an ongoing audit requirement.
  • Implement procedures and processes to mitigate and manage the risk of retail investors investing inappropriately in the ICO, and to ensure that retail investors understand the risks involved.
  • Prepared and submit an Information Memorandum such as a white paper or prospectus.
  • Ensure that marketing materials are fair and not misleading.

The Guidance also provides a description of the different classifications of ICOs in Jersey.  It splits ICOs into “security tokens” and “non-security tokens,” although both types of tokes are treated the same by the JFSC.  JFSC goes further with “non-security tokens” by specifying that “utility tokens” and “cryptocurrency tokens” are non-security tokens.

Please click here for a link to the JFSC Guidance Note for ICO Issuers.

UK Regulators Issue “Dear CEO Letters” On Crypto-assets

Over the past month, the two leading United Kingdom financial regulators each issued “Dear CEO” letters on the topic of crypto-assets.  On June 28, the Bank of England Prudential Regulation Authority (“PRA”) followed up a June 11 letter by the FCA on the risks and obligations of providing services to clients relating to crypto-assets.

In its June 11 letter, the FCA asked that banks ensure that they have enhanced scrutiny of clients who offer services related to crypto-assets.  The FCA suggested that banks might want to take the following types of steps:

  • Develop staff knowledge and expertise on crypto-assets.
  • Ensure that existing financial crime frameworks adequately reflect crypto-asset activity.
  • Carry out due diligence on key individuals.
  • If providing services to crypto-exchanges, assess the exchanges own due diligence policies and procedures.

The FCA also asked that firms use the same criteria that would be applied to other sources of wealth or funds.

In its June 28 letter, the PRA followed up on the FCA’s letter by adding three risk strategies and risk management systems that it considers to be the most appropriate to crypto-assets:

  • First, recognition by firms that crypto-assets represent a new, evolving asset class with risks which should be considered fully by the board and highest levels of executive management.
  • Second, firms’ remuneration policies and practices should ensure that the incentives provided for engaging in this activity do not encourage excessive risk-taking.
  • Third, firms ensuring that their risk management approach is commensurate to the risks of crypto-assets.

The PRA letter can be read here.  The FCA letter 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.

Blockchain Week in Review: Week ending – June 29

U.S. Developments

Regulatory Updates

SEC and CFTC Announce New Cooperation Agreement

On June 28, the Commodity Futures Trading Commission and the Securities and Exchange Commission announced a new Memorandum of Understanding meant to allow two agencies to further coordinate in areas of common interest.

Under the MOU, the two agencies agreed to identify areas of regulatory interest to either party and cooperate in those areas of common interest, notify the other agency, to the extent practical, of issues that affect areas of common interest, and share information. The MOU specifically contemplates sharing non-public information related to entities registered with both the CFTC and SEC, such as entities registered as Futures Commission Merchants with the CFTC and Broker-Dealers with the SEC. However, it also contemplates sharing non-public data or information about entities where the two agencies regulatory interests overlap. And non-public information that an agency receives under the MOU can be used for rulemaking, in investigations, and, with consent of the other agency, in any proceeding or civil action.

House Passes Bill Requiring Study of How Virtual Currencies and Online Marketplaces are Used for Illicit Purposes

On June 25, 2018, the House unanimously passed the Fight Illicit Networks and Detect Trafficking Act of 2018 (H.R. 6069), which if signed into law would commission a study into how virtual currencies and online marketplaces are used to facilitate sex and drug trafficking. The bill says that while Congress recognizes the virtual currencies meet a “’legitimate market demand,” virtual currencies have become “a prominent method to pay for goods and services associated with illegal sex and drug trafficking . . . .” Because of these findings, the bill would require the Comptroller General of the United States to study both how virtual currencies are used to facilitate such sex and drug trafficking and how the “immutable and traceable nature of virtual currencies” can be used to deter, detect and aid in the prosecution of such illicit uses.

The bill has been sent to the Senate for consideration.

Senate Holds Hearing on Cryptocurrencies As “Avenues for Foreign Interference”

On June 26, the Senate Subcommittee on Crime and Terrorism held a hearing focusing on the risk that virtual currencies could be a mechanism for foreign agents to interfere in elections. The hearing, entitled “Protecting Our Elections: Examining Shell Companies and Virtual Currencies as Avenues for Foreign Interference, included testimony from David Murray of the Financial Integrity Network, Scott Dueweke of DarkTower, and Sheila Krumholz of the Center for Responsible Politics.

Of the three witnesses, Mr. Dueweke’s written testimony was most focused on virtual currencies. Although he emphasized the world-changing aspects of blockchain technology, he warned that blockchain’s pseudonymity and the ease by which cryptocurrencies can be transacted outside of financial institutions complicate identifying the true source of political donations. Indeed, according to a report from CoinTelegraph, Mr. Dueweke said that virtual currencies were “’tailor made’ for affecting the U.S. political process, and, in particular, warned of efforts by Russians to use virtual currency to meddle in U.S. elections.

Ohio Legislature Passes Blockchain Records Bill

On June 27, the Ohio legislature passed SB 220, which, if signed by Ohio Governor John Kasich would amend Ohio’s implementation of the Uniform Electronic Transactions Act to add blockchain records and blockchain signatures to the statute’s definitions of “electronic records” and “electronic signatures,” respectively. Although the bill is meant to ensure that blockchain records and blockchain signatures have the same legal force as paper contracts signed by hand, prominent organizations, including the Uniform Electronic Transactions Act Drafting Committee, the Chamber of Digital Organizations, and the Electronic Signature and Records, are on record opposing bills like SB 220 because, in their view, such bills are redundant and ultimately hinder innovation. If Governor Kasich signs SB 220, Ohio would follow in the footsteps of other states that have implemented similar legislation, including Arizona and Nevada.

Click here to find the joint statement issued by the Uniform Electronic Transactions Act Drafting Committee, the Chamber of Digital Organizations, and the Electronic Signature and Records.

Florida to Hire Virtual Currency Czar

On June 26, Florida’s Chief Financial Officer, Jimmy Patronis, announced in a press release that the state was creating a new position in the Florida Office of Financial Regulation to oversee the state’s virtual currency industry.

Mr. Patronis said the move was spurred on by the efforts of regulators in other states to stop bad actors within Florida’s virtual currency industry. He said that Florida could no longer remain on the “sidelines” and needed to protect its own residents from scams involving virtual currencies.

Mr. Patronis said that the new czar would oversee Florida’s efforts to take positions as to how ICOs and cryptocurrencies apply to the state’s securities and insurance laws and help shape future virtual currency regulations in the state. The state’s ultimate goal, Mr. Patronis said, is to “keep pace with demand and not deter innovation while monitoring for fraudulent behavior and scams.”

Litigation

Federal Agencies Announce Sting Targeting Vendors on the Darkweb

In a June 26 press release, the U.S. Department of Justice, U.S. Immigration and Customs Enforcement’s Homeland Security Investigations, the U.S. Secret Service, the U.S. Postal Inspection Service, and the U.S. Drug Enforcement Administration, publicly announced their multi-agency sting operation targeting vendors of illicit goods on the Darkweb.

As part of the operation, undercover agents posed as money launderers, offering to convert the virtual currency the vendors received from their illicit goods to fiat currency. The investigation—which is ongoing—has so far resulted in the arrest of 35 alleged vendors and the seizure of, among other things, more than $20 million worth of bitcoin and other cryptocurrencies.

District Court Judge Concludes that CTR Tokens are Likely Securities

On June 25, in a putative class action involving allegations of a fraudulent sale of a security token, a Magistrate Judge held that the token at issue-the CTR token-is likely a security.

According to the complaint, defendants conducted an ICO for the CTR tokens, which defendants told users that they would use the ICO proceeds to build a suite of financial products, including a “crypto debit card” that defendants said was Visa and Mastercard when, in fact, it was not. And holding defendants’ CTR token would entitle the token holder to a share of the enterprises revenue.

Plaintiffs alleges that defendants’ ICO—which was backed by boxer Floyd Mayweather—was an unregistered sale of a security in violation of Sections 12(a) and 15(a) of the Securities Act. In granting plaintiffs’ motion for a temporary restraining order, the Court concluded that plaintiffs were likely to succeed on his unregistered securities claim. In so concluding, the Court applied the Howey test commonly used for investment contracts. Under the Court’s formulation of a test, a token is a security if three elements are met: (1) there is an investment of money (2) in a common enterprise (3) with an expectation to profit from the efforts of others. The Court swiftly concluded that the three elements were easily met. The Court found there was an investment of money because plaintiffs invested bitcoin or ether. The common enterprise element was satisfied, as well, because the Court found that the fortunes of investors were tied to the success of yet-to-be developed products. Finally, the Court found that the third prong was satisfied because the success of the CTR token was based entirely on defendants’ efforts to build the financial products.

Please click here to read our coverage of the SEC’s enforcement action against the token issuers and the related criminal action.

International Developments

Korean Regulator Revises its Virtual Currency Anti-Money Laundering Guidelines

This week the Korea Financial Intelligence Unit announced revisions to its Virtual Currency Anti-Money Laundering Guidelines, which we’re originally introduced in January. The revisions stem from the regulator’s efforts to monitor compliance with the Guidelines, which identified insufficiencies in how financial institutions, like banks, were implementing the Guidelines.

Previously financial institutions were only required to conduct enhanced customer due diligence on the trust accounts—i.e. those bank accounts in which virtual currency exchanges held customer funds. The revisions to the Guidelines, which take effect on July 10, require financial institutions to conduct enhanced due diligence on operating accounts—those bank accounts virtual currency exchanges use to conduct business operations—if the financial institution finds signs of suspicious transactions in such accounts. The revised Guidelines also require financial institutions to share a list of domestic and overseas virtual currency exchanges to guard against tax evasion and money laundering. Finally, the revised Guidelines clarify that financial institutions must reject transactions when they report suspicious transactions involving the accounts of virtual currency exchanges to the Korea Financial Intelligence Units.

Cambodian Regulators Ban Trading Cryptocurrencies without Licensure

In a joint statement published June 19, three of Cambodia’s top financial authorities announced that any individual or legal entity must obtain licensure from “competent authorities” before engaging in the “propagation, circulation, buying, selling, trading, and settlement” of cryptocurrencies. The National Bank of Cambodia, the Securities and Exchange Commission of Cambodia, and the General-Commissariat of National Police jointly issued the statement, which indicated that engaging in the activities listed above without proper licensure is illegal. This ostensibly could apply to initial coin offerings (“ICOs”) as an activity that “propagates to mobilize funds,” although ICOs were not specifically mentioned. The brief statement also included a warning to the public about the potential risks of cryptocurrencies from the perspective of the three authorities:

  • Cryptocurrencies are not backed by collateral
  • Volatility of cryptocurrencies may result in investment losses
  • Exchanges are susceptible to cyber-attacks resulting in loss of funds
  • No customer protection
  • Risks of money laundering and terrorist financing
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