The International Swaps and Derivatives Association (ISDA) has published the first in a series of guidelines for what it colloquially refers to as “smart derivatives contracts” (the Guidelines).* A smart derivatives contract is a derivative that incorporates software code to automate aspects of the derivative transaction and operates on a distributed ledger, such as a blockchain. This series of papers is intended to “provide high-level guidance on the legal documentation and framework that currently governs derivatives trading, and to point out certain issues that may need to be considered by technology developers when introducing technology into that framework.” Read the full post on our sister blog, Derivatives and Repo Report.
Florida Court of Appeals Rules That Direct Sales of Bitcoin Constituted Money Transmission and the Sale of Payment Instruments
Reversing the order issued by the Miami-Dade County Circuit Court, the Florida Court of Appeals issued an opinion on January 30 in the case of Florida v. Espinoza in which the appellate court ruled that an individual’s sale of bitcoin for cash constituted money transmission and the sale of payment instruments. Largely basing its conclusions on definitional interpretation of the terms “payment instrument” and “money transmitter” under Florida statute, the court of appeals found that the sales of bitcoin involved a “medium of exchange” with “monetary value,” and thus bitcoin fell within the definition of “payment instrument.” The court of appeals relied on similar analysis to conclude that Mr. Espinoza’s sales qualified as money transmission and that, since Mr. Espinoza was not licensed to act as a money services business, he could be charged with engaging in unlawful money transmitter services. Continue Reading
Arizona’s financial technology (“fintech”) sandbox (“Sandbox”), the first of its kind in the United States, has been open for several months and has accepted three participants. A month after the program’s launch, Arizona’s Attorney General announced his approval of the first participant, payment platform Omni Mobile, Inc. Two other companies providing consumer lending services, Sweetbridge NFP, Ltd. and Grain Technology, Inc., joined Omni as Sandbox participants shortly thereafter. Arizona’s Sandbox may serve as a helpful illustration of what entrepreneurs can expect in Arizona (should they also wish to participate in the Sandbox) as well as in other states that decide to implement similar programs. To that end, this client update provides an overview of regulatory sandboxes generally, Arizona’s Sandbox, and potential future developments. Continue Reading
Kik Publicizes Response to Possible SEC Enforcement
On January 27, the Wall Street Journal published an article describing the impending legal battle over cryptocurrency Kin and its 2017 ICO. That same day, Ted Livingston, the founder and CEO of Canadian company Kik Interactive (Kik) and the developer behind Kin, published the Wells Notice he received from the Securities and Exchange Commission (SEC) on November 16, 2018, as well as Kik’s response. Continue Reading
Cboe Withdraws and Then Submits a Proposed Rulemaking for a Bitcoin ETF
On January 22, 2019, Cboe BZX Exchange (Cboe) withdrew its proposed rulemaking with the U.S. Securities and Exchange Commission (SEC). Had the proposal been approved, Cboe would have been allowed to list shares of bitcoin electronically-traded funds (ETFs) backed by VanEck and SolidX. On January 30, 2019, Cboe submitted a new proposed rulemaking to list the VanEck and SolidX bitcoin ETFs. Continue Reading
Flood of State Virtual Currency Legislation
Since the start of the new year there have been roughly nine virtual currency bills introduced or passed in four different states. Overall, the bills demonstrate a growing interest among the states in supporting virtual currency businesses through the codification of blockchain terminology for legal effect or by proposing regulatory exemptions for certain virtual currency activities. The bills also show that many state legislatures are interested in learning about how blockchain and distributed ledger technology (DLT) can support state governments.
Texas Clarifies that Stablecoins Backed by Sovereign Currency Qualify as “Money” Under Money Transmission Statute
The Texas Department of Banking recently issued a Supervisory Memorandum clarifying how its money transmission statute applies to stablecoins backed by sovereign currency. The Department reiterated—consistent with its 2014 guidance—that Texas’s money transmission statute only regulates “money” or “monetary value” and that most virtual currencies fall outside the statute’s scope. But the Department stated that stablecoins backed by sovereign currency, such as Tether, qualify as “money” or “monetary value.” Under Texas’s statute, money or monetary value includes either sovereign-issued currencies or claims that can be converted into such currencies. The Department concluded that, unlike most virtual currencies, stablecoins backed by sovereign currency are money or monetary value because they represent claims that can be redeemed for currency. The Department explained that, as a result, entities doing business in Texas that hold stablecoins backed by sovereign currency for third parties—such as custodial wallet providers or intermediated exchanges—will most likely need a Texas money transmission license.
On Wednesday, December 12, 2018, the D.C. Bar hosted a panel to discuss current developments in the world of crypto. Among the panelists were two senior SEC officers: Jonathan Ingram, Deputy Chief Counsel, Division of Corporation Finance, and Jennifer Leete, Assistant Director, Division of Enforcement. Also participating on the panel was Era Anagnosti, a former senior manager in the Division of Corporation Finance of the SEC who in part oversaw the process relating to, among other things, various crypto-related registration filings. The following is a summary of certain topics discussed at the panel regarding both corporate finance and enforcement as well as some key takeaways.
Congressmen Introduce Legislation to Define “Digital Token” Under the Securities Laws
On December 20, 2018, two congressmen introduced the “Token Taxonomy Act” (H.R. 7356) before the 115th Congress in an effort to define “digital token” under the federal securities laws. H.R. 7356 was introduced by Rep. Warren Davidson (R-Ohio) and Rep. Darren Soto (D-Florida) and seeks to clarify that the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”) would not apply to cryptocurrencies if they meet a new definition of “digital token” that H.R. 7356 would add to the Securities Act. H.R. 7356’s definition of “digital token” encompasses decentralized tokens that are not a representation of a financial interest in a company (i.e., equity, debt, or revenue share).
H.R. 7356 also makes several changes related to the custody of “digital tokens.” For instance, H.R. 7356 adds the phrase “provides custodial services” to the definition of “bank” under both the Investment Advisers Act of 1940 (the “Advisers Act”) and the Investment Company Act of 1940 , which in turn could affect potential “qualified custodians” for digital tokens under the Custody Rule (Rule 206(4)-2) of the Advisers Act. H.R. 7356 also instructs the U.S. Securities & Exchange Commission (“SEC”) to amend Exchange Act Rule 15c3-3, which addresses the custody of securities by broker-dealers, by asserting that a broker-dealer’s requirement to maintain a satisfactory control location for clients’ digital assets is fulfilled through public key cryptography and following commercially reasonable cybersecurity practices. Finally, H.R. 7356 would direct the Internal Revenue Service to address the taxation of cryptocurrencies resulting from certain exchanges of virtual currencies.
H.R. 7356 has been referred to both the House Committee on Financial Services and the House Ways and Means Committee; however, the 115th Congress will formally come to a close on January 2, 2019 and any legislation still pending would need to be reintroduced before the 116th Congress for renewed consideration.
On September 24, 2018, the French data protection authority, Commission Nationale de l’Informatique et des Libertés (CNIL), became the first data protection authority to issue written guidance on the intersection of the use of blockchain technology and the General Data Protection Regulation (GDPR). Due to the decentralized and permanent nature of the blockchain, there is an inherent tension between blockchain technology and the GDPR, particularly with respect to data subject rights and data storage limitation principles. Therefore, the CNIL guidance provides some welcome clarification on how it views these inherent tensions, although the CNIL left open certain important issues that will require deeper analysis and explanation in the future. The summary below has been updated to reflect the English translation of the CNIL guidance released on November 8, 2018. Our high-level takeaways based on the CNIL guidance are as follows:
- The legal analysis of whether the GDPR applies to a blockchain must be conducted on a participant-by-participant basis. Some participants on a blockchain may be subject to the GDPR while others may not.
- The greater the ability of a participant to intervene and influence blockchain transactions, the more likely such a participant is subject to the GDPR.
- Whether a participant is a controller or a processor as such terms are defined under the GDPR is a determination based on the particular facts and circumstances, influenced by the architecture of the blockchain and the types of users who engage with it.
- Data minimization principles apply to some but not all aspects of blockchain technology. Notably, there is no data minimization requirement for public addresses and public keys.