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.


“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.”


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

SEC Requests Comment on Bitcoin Futures ETFs

Updates: Yet again, the SEC instituted proceedings on April 5, 2018 to determine whether it will approve or disapprove a proposal by Cboe BZX Exchange on behalf of GraniteShares Bitcoin ETF and GraniteShares Short Bitcoin ETF (see our discussion of the Cboe Order above).  On June 28, 2018 the SEC extended its period of review for the Cboe Order (the “Cboe Extension”).  The existing period of review was set to expire on July 17, 2018; however, under the Cboe Extension, the SEC has now extended its period of review by an additional 60 days until September 15, 2018.  The SEC must now either approve or disapprove the proposed rule change by this new deadline.

On June 15, 2018 the SEC extended its period of review for the Order (the “Extension”). The existing period of review was set to expire on June 24, 2018; however, under the Extension, the SEC has now extended its period of review by an additional 60 days until August 23, 2018. The SEC must now either approve or disapprove the proposed rule change by this new deadline.

On April 23, 2018, the SEC published a third order instituting proceedings to determine whether it will approve or disapprove another proposal for Bitcoin futures ETFs (the “Direxion NYSE Arca Order”).

On April 5, 2018, the SEC published a second order instituting proceedings to determine whether it will approve or disapprove another proposal for Bitcoin futures ETFs (the “Cboe Order”).

On March 23, 2018, the U.S. Securities and Exchange Commission (“SEC”) issued an order instituting proceedings to determine whether it will approve or disapprove a proposal for Bitcoin futures exchange-traded funds (“ETFs”) (the “Order”).

Commenters will have until April 19, 2018 to submit comments.  Those with rebuttals to the comments will have until May 3, 2018 to submit rebuttals.

Read more on our sister blog Derivatives & Repo Report

Senior SEC Officials Provide Regulatory Clarity for Digital Assets

From Uncertainty toward Regulatory Clarity: Senior SEC Officials Provide Regulatory Clarity for Digital Assets

Summary is below, please click here for the full alert narrative.

On June 14, 2018, the Director of the Division of Corporation Finance of the Securities and Exchange Commission delivered a speech outlining the framework used by the SEC Staff in evaluating whether a given token sale qualifies as a securities offering.  The Director clarified that a token sale may qualify as a securities offering but subsequent sales of the same token may constitute non-securities based on a facts-and-circumstances analysis.  Later statements by the Chairman of the SEC and SEC Staff confirmed that the SEC will consider the factors outlined in the Director’s speech when evaluating token sales.  These factors include, among  other things, whether:

  • a sponsor or promoter’s efforts play a significant role in the development and maintenance of the token or token network;
  • a sponsor or promoter retains a stake or interest in the tokens such that the person or entity is motivated to expend efforts to cause an increase in value of the token;
  • purchasers are motivated by a financial return when purchasing the token; and
  • persons or entities other than the promoter or sponsor exercise governance rights or influence.

The SEC Director also commented that the SEC is “happy to help promoters and their counsel work through . . . issues . . . [and] . . . stand[s] prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use.”

For questions regarding these developments and how they might apply to you or your business, please contact experienced counsel.


Ether is not a security: Summary of SEC Remarks Today

In a speech today during a crypto conference in San Francisco, a top Securities and Exchange Commission official expressed his view that, at this point, sales of Ether are not securities transactions. Speaking from prepared remarks, Bill Hinman, Director of the Division of Corporation Finance said: “Based on my understanding of the present state of Ether, the Ethereum network, and its decentralized structure, current offers and sales of Ether are not securities transactions.” Hinman also said that, in his view, Bitcoin is not a security either, reinforcing what SEC Chairman, Jay Clayton, stated in his remarks recently on CNBC.  The main topic of Hinman’s speech focused on whether a digital asset offered as a security can, over time, become something other than a security. To this point, Hinman noted that where a digital asset is “sold only to be used to purchase a good or service available through the network on which it was created . . . the answer is a qualified ‘yes.’” Hinman also discussed some of the factors to consider in assessing whether a digital asset is offered as an investment contract in a securities transaction. In particular, Hinman focused on the third prong of Howey and whether the efforts of an identifiable third party – be it a person, entity or coordinated group of actors – drives the expectation of a return. Also noteworthy was Hinman’s comment that the SEC is “happy to help promoters and their counsel work through . . . issues . . . [and] . . . stand prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a proposed use.” Finally, in a footnote included in the written version of the remarks, Hinman, referencing SAFTs, stated his view that a token once offered in a security offering can, depending on circumstances, later be offered in a non-securities transaction.

Accounting Group Again Requests Guidance From The IRS on Virtual Currency Tax Issues

The primary professional organization for accounting professionals (AICPA) recently renewed their requests to the Internal Revenue Service for U.S. virtual currency guidance on key tax issues. The IRS has not shown any willingness to publish more advice in this area, so a response to the letter may not be forthcoming. The IRS has ignored the AICPA’s previous letter for 2 years now. That said, it provides thoughtful commentary, and recommendations for frequently asked questions, covering key topic areas including, among others:

  • Deductions for mining expenses
  • Acceptable valuation and documentation
  • Computation of gains and losses
  • Valuation for charitable contributions
  • Taxable and non-taxable events
  • Traders and dealers of virtual currency
  • Holding virtual currency in retirement accounts
  • Foreign reporting of virtual currency

Thus far, tax professionals have been forced to work from limited IRS guidance (Notice 2014-21), and informal public statements from government officials. The AICPA letter provides thoughtful ideas that reflect positions common among tax professionals. Their recent letter also reiterates a direct request from the ABA’s Tax Section for guidance on chain splits/hard forks (see American Bar Association Letter from March 2018).

ERC-721 Tokens Shake Up Blockchain Technology

The most prevalent tokens on the Ethereum blockchain are ERC-20-compliant (ERC-20 Tokens). However, there are many other ERC, or Ethereum Request for Comment, standards available. Recently, companies like Launch Labs, Inc. d/b/a Axiom Zen (Axiom Zen) have launched new endeavors utilizing ERC-721-compliant tokens (ERC-721 Tokens). ERC-721 Tokens each have unique characteristics, unlike fungible ERC-20 Tokens.

This post will discuss the rise of CryptoKitties, the exciting aspects of ERC-721 Tokens, and possible use cases for ERC-721 Tokens.

The CryptoKitties Revolution

Axiom Zen pioneered the ERC-721 standard for non-fungible tokens, which ultimately led to their application, CryptoKitties. CryptoKitties is an exemplary use case for how companies can utilize the ERC-721 standard. Each CryptoKitty is a ERC-721 Token that is one-of-a-kind and owned by the purchaser; it cannot be replicated, taken away, or destroyed. CryptoKitties can be purchased with Ether in descending-clock auctions. Owners can then “breed” the CryptoKitties, resulting in a completely new CryptoKitty, which is a new one-of-a-kind ERC-721 Token. The “genetic” makeup of the child ERC-721 Token is a combination of the genetic makeups of the two parent ERC-721 Tokens. The ERC-721 Tokens’ uniqueness allows for the creation of a whole new category of crypto creations. The ability for users to combine ERC-721 Tokens to generate completely new, but genetically traceable, ERC-721 Tokens allows for self-sustaining, growth-oriented networks.

What’s Next?

Since the birth of CryptoKitties, there are now over 100 CryptoKitty variants. Blockchain users can now buy, sell and trade a myriad of self-created digital collectibles, from cats to dogs to cartoons. While the proliferation of copycats (pun intended) does not show any signs of slowing, there are many other possible uses for ERC-721 Tokens. Below we discuss a few of those use cases.


Many companies followed CryptoKitties into the blockchain game silo. New basic games are popping up around other digital collectibles, such as trading cards, which allow the movement of physical collectibles into the virtual space. These games and other CryptoKitty adaptations prove ERC-721’s utility in basic gameplay. But now there is room to see if the ERC-721 standard can be utilized on more sophisticated gaming platforms. Some smaller gaming companies recently started to create more comprehensive games and universes with ERC-721; however, the big gaming companies have yet to include this technology on their platforms. Nonetheless, we can see the potential opportunity to grow new gaming universes and expand or extend existing franchises utilizing ERC-721 Tokens.


One of the touted promises of blockchain technology is the blockchain’s ability to ensure product authenticity. With ERC-721 Tokens, in conjunction with a blockchain, users can help prove non-fungible product authenticity. For example, if an art gallery owner encoded an ERC-721 Token into each gallery painting, the token could track everything from the painting’s original artist to its current owner. As a result, the token would allow artists to easily copyright their works. It would also ensure buyers that they own authentic products. ERC-721 is thus useful to individuals who want to protect their intellectual property and to individuals concerned about product authenticity.

Social Networks

ERC-721 Tokens allow for the creation of unique avatars, but at present there is no way for these avatars to interact, aside from breeding. Including a social interaction layer could dramatically increase the usability of the avatars and help enhance the growth of the ecosystem in which the avatars reside.

Moving Forward

We are at the forefront of not only a CryptoKitty revolution but also a ERC-721 revolution. Yes, ERC-721 offers application developers the ability to create fun, cute games. But, like other uses of blockchain technology, ERC-721 offers an opportunity to find solutions to complex real-world problems. As we push forward into the ERC-721 space, we must be cognizant of the endless possible uses for this new token standard.

We believe the future is bright for ERC-721 Tokens and we look forward to helping companies develop thriving businesses utilizing this token standard.

Blockchain in Review – Weeks of May 7th through May 25th, 2018

U.S. Developments

Regulatory Updates

CFTC Staff Issues Advisory to Exchanges and Clearinghouses on Virtual Currency Derivatives

On May 21, the Commodity Futures Trading Commission’s (CFTC) Division of Market Oversight and Division of Clearing and Risk released an advisory that provides guidance to designated contract markets (DCM), swap execution facilities (SEF), and derivatives clearing organizations (DCO) that offer derivatives with virtual currency underliers (the Advisory). The key take-aways are summarized below:

  • The Advisory notes that virtual currencies are distinct from other commodities because, although “serious, good faith efforts are underway to implement many potential uses of virtual currencies,” they are currently bought and sold primarily for investment rather than commercial purposes.
  • The Advisory deputizes DCMs and SEFs as spot market monitors. Platforms that wish to list virtual currency derivatives are expected to enter into information sharing agreements with the spot market exchanges that make up the cash-settlement price, continuously monitor data from these markets, and investigate individual spot market traders. This is novel. DCMs and SEFs are required to monitor the pricing of the index to which the derivative contract will be settled but not spot market trading for other commodities. DCMs and SEFs are expected to meet with the CFTC’s Division of Enforcement surveillance group regularly and provide CFTC staff with data upon request. This might better enable the CFTC to police fraud and manipulation in crypto asset spot markets.
  • CFTC staff recommends DCMs and SEFs set the threshold for filing large trader reports under Part 17 of the CFTC’s regulations at five bitcoin (or the equivalent for other virtual currencies) for virtual currency derivatives.
  • CFTC staff expects each DCM and SEF to engage CFTC staff and solicit comments prior to listing a virtual currency derivative contract. As part of its submission to the CFTC for listing of the contract, the DCM or SEF should provide an explanation of any opposing views raised by CFTC staff and how the DCM or SEF addressed them.
  • For cleared contracts, the Advisory explains that CFTC staff will request that DCOs provide information related to the governance process for approving virtual currency contracts.
  • CFTC staff may notify a DCM or SEF of its concerns in writing and make such writing public or transmit it to other regulators if it is unable to confirm that a contract submitted for self-certification complies with the CEA and CFTC’s regulations.CFTC Staff Advisory No. 18-14 5.21.18; CFTC Statement 5.21.18CFTC and NASAA Sign Mutual Cooperation AgreementCFTC Press Release 7730-18 5.21.18; CFTC Remarks 5.21.18CFTC Commissioner Behnam Emphasizes the Need for a Policy Roadmap for Regulation of FinTechCFTC Keynote 5.3.18SEC Statement Defining Financial Instruments by Function and Not Their FormSEC Speech 5.2.18Board of Governors of the Federal Reserve System Discussion on CryptocurrenciesFederal Reserve Speech 5.15.18Congress Holds a Hearing on Several Practical Applications for Blockchain Technology Committee on Science, Space, & Technology – Hearing 5.8.18
  • On May 8, the House Subcommittee on Oversight and House Subcommittee on Research and Technology held a hearing entitled “Leveraging Blockchain Technology to Improve Supply Chain Management and Combat Counterfeit Goods.” The panel included the following witnesses: (1) Dr. Douglas Maughan (Cybersecurity Division Director, Science and Technology Directorate, Department of Homeland Security (“DHS”)), (2) Robert Chiaviello (IPR Counsel, Nuby Law), (3) Michael White (Head of Global Trade Digitization, Maersk), and Chris Rubio (Vice President Global Customs Brokerage Staff, UPS). The hearing conducted an overview of various industry specific benefits associated with the use of blockchain technology. Dr. Douglas Maughan described DHS efforts to implement blockchain into boarder security programs and transportation networks. He emphasized the rapid pace of development of these systems and saw DHS implementations of blockchain technology as a promising method of furthering DHS objectives. In the private sector, witnesses were optimistic regarding the benefits of blockchain implementations for supply networks, particularly in their ability to identify counterfeit goods and improve logistics management. Chris Rubio, explained the use of blockchain technology as a means of digitizing physical asset information to provide real-time tracking, streamlining the flow of goods. According to Michael White, the U.S. is at the forefront of embracing blockchain technology, but he cautioned that the U.S. must remain open and neutral and strive for common global standards.
  • On May 15, Governor Lael Brainard of the Board of Governors of the Federal Reserve System appeared before the Decoding Digital Currency Conference to discuss the research being done at the Federal Reserve into blockchain technology. Governor Brainard emphasized that the Federal Reserve is evaluating developments in blockchain technology through a multidisciplinary lens, “combining information technology and policy analysis to study the potential implications for payments policy, supervision and regulation, financial stability, monetary policy, and the provision of financial services.” Discussion also turned to the topic of a central bank sponsored digital currency. She expressed skepticism regarding the possibility of a central bank digital currency due primarily to concerns associated with cybersecurity and money laundering risks. She also described the damage that the adoption of a central bank digital currency would have on bank operations due to the removal of depositary functions and the corresponding effect such removal would have on the loan market. The discussion concluded with Governor Brainard stating that she remains optimistic that the financial sector will find valuable ways to employ distributed ledger technology in the area of payments, clearing and settlement in coming years.
  • The Securities and Exchange Commission (SEC) Commissioner Hester M. Peirce appeared before the Medici Conference on May 2 to discuss blockchain tokens and the SEC’s role as a responsible regulator in this rapidly developing industry. The Commissioner described the various efforts the SEC is undertaking to better understand the challenges posed by distributed ledger technologies. The Commissioner also reiterated the SEC’s approach to treat cryptocurrencies based upon their function and not their form via a facts-based determination. Importantly, the Commissioner recognized several of the key challenges associated with analyzing various virtual currencies, including the question of whether a virtual currency could be a security at one point in time and then become some other instrument once the infrastructure surrounding the virtual currency is further developed. She closed her discussion by stating that although many questions remain open in the eyes of the SEC, she is confident that open communication between innovators and regulators could occur without the need for a government-sponsored regulatory sandbox.
  • On May 3, CFTC Commissioner Behnam spoke at the Futures Industry Association’s Law and Compliance conference about the regulation of FinTech. He stated that “policymakers . . . need to prioritize the discussions and policy roadmap for the oversight and regulation of FinTech.” Commissioner Behnam proposed that the U.S., through the Financial Stability Oversight Council (FSOC), lead the international effort to address legal issues related to FinTech and craft appropriate regulations before financial stability concerns arise.   He explained that “the FSOC has authority to (i) convene all key U.S. financial regulators; (ii) establish a mutually agreed lexicon for discussing crypto-assets and related FinTech; (iii) convene public hearings; and (iv) propose policy direction and guide jurisdictional responsibility based on input from regulators, stakeholders, academics, and the public.”
  • On May 21, the CFTC and North American Securities Administrators Association (NASAA) executed a mutual cooperation agreement. The agreement is intended to facilitate information sharing amongst the CFTC and state securities regulators and state attorneys general. CFTC Chairman Giancarlo noted that “with this MOU, we turn speech into action. As we discuss digital assets and the future, we must prepare for the present and future needs of oversight, law enforcement and consumer education. This MOU provides a much-needed resource for the CFTC and state securities authorities. It gives us scaffolding that builds upon a firm foundation for the future.”
  • Commissioner Behnam noted in a public statement that he remains interested in amending the regulations currently in place to bar self-certification of virtual currency derivatives in certain contexts. He stated: “I look forward to continuing to explore our options, which I hope will include some parameters for determining when self-certification may not be appropriate, and for determining when such matters are appropriately brought before the Commission.”

NY Department of Financial Services Approves Custody and Trading of Zcash, Litecoin, and Bitcoin Cash on Gemini

On May 14, the New York Department of Financial Services (DFS) authorized Gemini Trust Company, LLC to offer custodial services and trading of Zcash, Litecoin, and Bitcoin Cash. Notably, Gemini is the first New York licensed exchange to offer custody and trading of Zcash, a privacy coin.

DFS Press Release 5.14.18

NY Department of Financial Services Grants Virtual Currency License to Genesis Global Trading

On May 17, the New York DFS granted a virtual currency license to Genesis Global Trading, Inc. Genesis is the fifth company to receive a virtual currency license from DFS. Genesis is an over-the-counter crypto asset trading platform for institutional buyers and sellers.

DFS Press Release 5.17.18

Enforcement Update

Three Indicted In $25M Crypto Card ICO Fraud Scheme

On May 14, a federal grand jury in New York indicted three Florida residents with securities and wire fraud, based on allegations that they defrauded investors of $25 million by lying about their cryptocurrency debit card ahead of its initial coin offering (ICO). Robert Khuzami, deputy U.S. attorney for the Southern District of New York, said the three men sought to “capitalize on investor interest in the burgeoning cryptocurrency market.” The men allegedly made false claims about their products and relationships that they had with credible financial institutions including Bancorp, Visa and Mastercard. They also allegedly paid celebrities to promote their ICO, including musician DJ Khaled and professional boxer, Floyd Mayweather Jr. The criminal indictment came following several actions by the US Securities and Exchange Commission including civil charges brought last month. US Attorney SDNY Press Release 4.20.18

International Developments

Korean Government Agrees to Regulate Cryptocurrencies Under G20 Rubric

Top financial policymakers in South Korea, including the country’s Financial Supervisory Service (FSS), have agreed to recognize cryptocurrencies as financial assets and regulate them based on the unified regulations set forth by the G20 nations. This represents a reversal of South Korea’s position on cryptocurrency, which previously classified cryptocurrencies as non-financial products because of their perceived speculative value. Additionally, Korean regulators have agreed to adopt the standards of the intergovernmental Financial Action Task Force in revising its own policies. The G20 financial policymakers have set a deadline of July 2018 to make “the first step toward ‘unified regulation’ of cryptocurrencies.” China Money Network 5.18.18

Norwegian Banks Considering Issuing Digital Currency

The Central Bank of Norway announced in a working paper this month that it is considering developing its own cryptocurrency. Noting the decline in cash usage in the country, the report sets forth several uses and advantages of a digital currency issued by a central bank, including providing a “reliable alternative to deposits in private banks,” a solution for electronic payment systems, and an alternative method for bank customers to store financial assets.  Norges Bank Report 5.18.18

Zimbabwe Central Bank Bans Banking of Crypto

The Reserve Bank of Zimbabwe has directed all banks to refrain from providing banking services to anyone dealing with or settling virtual currencies, citing fears of money laundering and other criminal activity. Cryptocurrency exchanges are not affected by the ban for now. The ban is not expected to hinder peer-to-peer transactions; merely settling between banks. Reuters 5.14.18

Russian Justice Minister Takes Position that Cryptocurrency is Property

Which cryptocurrencies remain unregulated in Russia, the country’s Ministry of Justice has Alexander Konovalov has indicated that he considered cryptocurrency to be “other property” under the law and that digital coins should not be considered electronic money. Russia’s Civil Code does not mention “cryptocurrency” at all, but two drafts of legislation addressing cryptocurrency are pending in the lower house of the Russian parliament. One bill addresses this issue and would amend the Civil Code to include regulation of cryptocurrency payments; the second involves legalizing initial coin offerings (ICOs). Separately, a bankruptcy case involving Bitcoin holdings is pending in Russian courts that will determine whether cryptocurrencies have “real value” in Russia. 5.25.18

Taiwan Confirms New Regulatory Guidance on Cryptocurrencies is Forthcoming

The Justice Minister of Taiwan has reaffirmed the country’s plans to move ahead in passing new regulatory guidance on trading cryptocurrencies and has directed the new regulation to be in effect by November 2018. The goal is for Taiwan’s central bank, the Ministry of Interior, and the Bureau of Investigation to determine how each entity will regulate cryptocurrencies. A primary focus of the new regulation will be strengthening Taiwan’s AML rules. Asia Times 4.26.18

Philippines Permits Virtual Currency Operations in Special Economic Zone

In February, regulators in the Philippines legalized the entry of 10 virtual currency companies into an economic zone within the country. On April 25, the regulators gave permission for those companies to begin operations following licensure, which the economic zone regulator, CEZA, said would be forthcoming shortly. The central bank of the Philippines has not officially endorsed the use of any cryptocurrency. Reuters 4.25.18

Vietnam Directs Banks to Tighten Oversight on Cryptocurrency Activities

Following a crypto fraud resulting in the loss of 15 trillion Vietnamese dong ($658 million), the Vietnamese government issued a directive to six government ministries, in addition to financial institutions including Vietnam’s central bank, to tighten oversight and management of cryptocurrency activities within the country. The prime minister of Vietnam reiterated in a separate statement that transacting in cryptocurrencies remains illegal in Vietnam. Directive 4.11.18; Vietnam 4.11.18

Bitcoin Futures Volatility and Total Volume Since the Start of 2018

According to recent data provided by CBOE and CME Group, the volatility and total volume of bitcoin futures in 2018 have been in a gradual decline.  As displayed in the chart below, the Cboe bitcoin futures contract (XBT) volatility for the lead month declined in each month to begin 2018.  In addition, according to data as of a May 22, 2018 trading date, the trading volume for CME bitcoin futures contracts (BTC) in prospective lead months is also low, with as few as 5 trades for September 2018 contracts.  There have been a few instances of volume surges such as in late April when the average daily volume of XBT rose to 8800 in the single-most active session of the CBOE Global Market, according to CBOE.  However, as shown in the final chart below with data from CME Group as of May 22, 2018, the daily exchange volume of bitcoin futures contracts has remained below 6000 for the last month with one exception.

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Blockchain in Review – Weeks of April 21st through May 4th, 2018

Below is a summary of some of the significant legal and regulatory actions that occurred over the past weeks. 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.

U.S. Developments

Regulatory Updates

SEC Chairman Testifies Before the House Committee on Appropriations

U.S. Securities and Exchange Commission (SEC) Chairman Jay Clayton testified on the issue of cryptocurrencies on April 26 in a hearing before the Financial Services and General Government Subcommittee of the House Committee on Appropriations. In his testimony, Chairman Clayton clarified his position on how the SEC approaches regulatory oversight of cryptocurrencies.  Clayton divided cryptoassets into two categories: (i) a “pure medium of exchange,” e.g. Bitcoin, which he indicated is considered to not be a security; and (ii) tokens, which are used to finance projects.  Referencing a statement he made earlier this year about ICOs, Clayton stated that there are very few tokens, and none that he has seen, that aren’t securities.  He said that the SEC should continue to regulate tokens deemed to be securities, as securities, based on the information provided in disclosures from financial firms and individuals. SEC Clayton Testimony 4.26.18; Hearing Webcast

SEC Director Testifies Before the House Committee on Financial Services

On the same day as SEC Chairman Clayton testified before the House Committee on Appropriations, SEC Director of the Division of Corporation Finance, William Hinman, testified before the House Committee on Financial Services Subcommittee on Capital Markets, Securities, and Investment, discussing the role of his Division in the areas of cybersecurity, cryptocurrencies, and initial coin offerings (ICOs). Congressman Emmer (R-MN) specifically addressed ICOs, asking whether a utility token sale could ever be considered not to be a security, noting that the purpose of issuing such tokens is not capital formation.  Director Hinman stated his position that it is “hard to have an initial sale without a securities offering.”  Consequently, initial sales will likely require registering as a security or operating under an exemption.  He clarified that it is possible for a token to not have the hallmarks of a security, in which case the holder has purchased the token solely for its functional use, not as an investment. He noted that in certain instances, the fundraising is intended to eventually build a platform where a token is exchanged for a good or service on a decentralized network.  In such decentralized networks, he noted, there wouldn’t be an asymmetry of information between a central actor and investors. (Instead, the issuer of the token and the token holder share the same information.)  Questioned how to improve regulatory clarity so that entrepreneurs would not come under unwarranted SEC scrutiny (e.g. when issuing utility tokens), Director Hinman stated that the SEC is meeting with issuers of non-security/utility tokens to discuss how such token sales might be structured to avoid SEC action.

Director Hinman’s opening remarks addressed the Division of Corporation Finance’s roles and priorities with respect to cybersecurity, cryptocurrency and ICOs more broadly. The Division of Corporation Finance is authorized under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), and is tasked with reviewing the disclosures and financial statements of reporting companies to ensure compliance with disclosure and accounting requirements, and conduct selective review of filings that it deems warrant additional scrutiny. Among the Division’s current priorities are:

  1. Cybersecurity: Director Hinman referenced the SEC’s press release in February 2018, which issued guidance to assist companies in preparing disclosures about cybersecurity risks and incidents, reminding companies of the importance of the disclosure controls and their role in ensuring that a company’s policies and procedures guard against insider trading during the period between the discovery of a cybersecurity breach and public disclosure.
  2. Cryptocurrencies and ICOs: Director Hinman noted that his Division is dedicating significant attention and resources to these areas, stating that ICOs have the potential to facilitate capital formation, but must comply with federal securities law to prevent fraud and abusive market practices. He stated that the Division’s primary goal regarding ICOs is to ensure investors are protected and are receiving adequate information to make investment decisions.

SEC Hinman Testimony 4.26.18; SEC Guidance 2018-22 on Cybersecurity 2.26.18

FinCEN Issues Advisory on FATF’s List of Jurisdictions with AML/CFT Deficiencies

On April 27, the Financial Crimes Enforcement Network (FinCEN) issued an advisory directed at U.S. financial institutions to take note of the Financial Action Task Force’s (FATF’s) updated list of countries with regulatory deficiencies in international anti-money laundering and combatting the financing of terrorism (AML/CFT) standards. The FATF released the updated list of jurisdictions on February 23, 2018 in a public statement and publication on its website. FinCEN recommends U.S. financial institutions review the updated list and comply with the existing UN Security Council Resolutions on each jurisdiction where deficiencies in AML/CFT were found. Countries remaining on the list and which were of particular focus in the FinCEN advisory include Iran and North Korea. Serbia has been added to the list; Bosnia-Herzegovina has been removed.  To safeguard against money laundering and terrorist financing, the FATF urges to financial institutions to apply countermeasures (e.g. against North Korea) and/or implement enhanced due diligence policies (e.g. against Iran).  The remaining countries identified on the list are Ethiopia, Iraq, Serbia, Sri Lanka, Syria, Trinidad and Tobago, Tunisia, Vanuatu, and Yemen.  With respect to these countries, the FATF reminds U.S. financial institutions to comply with general due diligence obligations for foreign financial institutions under 31 CFR § 1010.610(a) and 31 U.S.C. § 5318(h). FinCEN Advisory 4.27.18; FATF Public Statement 2.23.18; FATF Publication 2.23.18

International Developments

France Reclassifies Cryptocurrency

The French Council of State announced that it has changed the tax rate of cryptocurrency sales from 45 to 19 percent because of a reclassification of cryptocurrencies, which will now be considered movable property. The exception to this classification are coins earned directly from mining operations, which will be taxed as income. Le Monde article 4.26.18 

Japanese Regulators Pressure Exchanges to Drop Cryptocurrencies

Japan’s Financial Services Agency (FSA) is discouraging cryptocurrency exchanges to stop handling certain cryptocurrencies, including Monero, Zcash and Dash, that it believes are widely used by, and gaining popularity with, criminal actors. According to the FSA, it has identified certain cryptocurrencies as vulnerable to use by bad actors because of the difficulty of tracing them and identifying the recipients.  After the hack of Coincheck in February 2018, the FSA shutdown two cryptocurrency exchanges and has boosted its regulatory actions and inspection procedures. Forbes article 4.30.18

Iran Bans Cryptocurrencies but Continues Developing its Own Local Currency

On April 22, Iran’s Central Bank banned trading of digital currencies identified by Iran’s anti-money laundering body in December 2017, including Bitcoin, citing money laundering concerns. The Bank issued a statement in which it directed banks and currency exchanges to refrain from engaging in any sale or purchase of the identified cryptocurrencies. Reuters article 4.22.18

On April 28, a government minister of Iran stated that the country has developed an experimental local cryptocurrency, which would not be affected by the country’s wider ban on cryptocurrencies. Iran’s Central Bank clarified that the existing ban on cryptocurrencies does not apply to domestically-developed cryptocurrencies. Reuters article 4.28.18

Kenya Hints at Establishing Blockchain Task Force

On April 25, the Kenyan Capital Markets Authority (CMA) released a Capital Market Soundness Report, which proposed creating a task force to address challenges related to digital currencies and ICOs. The special unit would be a special unit under the purview of all relevant regulators including the CMA and the Central Bank of Kenya (CBK).  This marks a shift in the CMA’s and CBK’s previous position in ICOs.  In February 2018, the CMA warned investors against ICOs and stated that all offerings were unapproved, unregulated and highly speculative investments.  The CBK Deputy Governor spoke at the Euromoney East Africa Conference in early April and stated that the country’s approach to blockchain technologies should be to cautiously embrace while addressing potential risks. CMA Report Vol. VI, Quarter 1 2018

For additional International Updates, see Perkins Coie’s International Tracker.