U.S. Developments

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.

A press release from Rep. Davidson’s office on H.R. 7356 can be found here.

FDIC Issues a Final Rule for a Limited Exception for a Capped Amount of Reciprocal Deposits from Treatment as Brokered Deposits

On December 18, 2018, the Federal Deposit Insurance Corporation (“FDIC”) approved a new final rule that implements changes created by Section 202 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which became law on May 24, 2018.  Prior to Section 202, only well-capitalized institutions could accept or solicit brokered deposits without restrictions.  With the passage of Section 202, less-than-well-capitalized institutions can now receive a capped amount of reciprocal deposits without the funds being considered brokered deposits.  The FDIC’s final rule amends its regulations to incorporate the statutory changes in Section 202 of the Act and specify the amount of the caps .

If smaller institutions were to be allowed to accept reciprocal deposits, a legislative and regulatory change was needed.  Reciprocal deposits result from a bank placing a deposit with another bank in order for customers to receive insurance coverage for the entire amount of their deposits.  Through this practice, banks can meet the definition of a “deposit broker” and cause the deposits themselves to become “brokered deposits.”  Thus, without an excepted amount for smaller institutions, only well-capitalized institutions could clearly participate in the reciprocal deposit networks.  The FDIC’s new final rule also incorporates a second change related to interest rates.  Section 202 confirmed that the current statutory and regulatory interest rate restrictions for smaller institutions continue to apply to any deposit, including a reciprocal deposit.

On December 18, 2018, the FDIC also issued an advance notice of proposed rulemaking to seek comment on all aspects of the brokered deposit and interest rate restriction regulations.

A link to the press release for both FDIC actions can be found here.

SEC Digital Asset Official Comments on the No-Action Process for Tokens

On December 14, 2018, in an event in New York, Valerie Szczepanik, the SEC’s Senior Advisor for Digital Assets and Innovation, reportedly spoke about the regulatory options for token issuers under the federal securities laws.  According to a report on her comments by Coindesk, Ms. Szczepanik explained that token issuers generally have three regulatory options when launching a token: register under the federal securities laws, seek an exemption, or ensure that the tokens are not a security.  However, Ms. Szczepanik reportedly acknowledged that token issuers could also seek no-action relief from the SEC staff.  No-action relief is rare, is nonbinding, and only applies to a narrow set of facts specified in the request.  To date, the SEC staff has not issued any no-action relief in the digital-asset context.

A link to the Coindesk report can be found here.

CFPB Proposes New Sandbox Concept and Seeks Comment on No-Action Letter Policy

On December 13, 2018, the Consumer Financial Protection Bureau (“CFPB”) sought comment on a new no-action letter policy as well as a new proposed sandbox program.  First, regarding its no-action letter policy, the CFPB explained that it is seeking comment on a set of proposed changes because it has issued only one no-action letter since it first instituted its no-action policies in 2016.  In particular, the CFPB is seeking comment on how to streamline the application process and how to expand the types of statutory and/or regulatory relief available.  Second, the CFPB is proposing to create the “ Product Sandbox.”  The Sandbox would include no-action relief as well as two additional forms of relief: (a) approvals by order under statutory safe harbors; and (b) exemptive orders.  Relief for Sandbox participants would be provided for a limited period of time, such as two years.  All written comments must be submitted by February 11, 2019.

A link to the proposed policy guidance can be found here.

UCLA Law Professor Publishes Paper on ICOs and the “Hinman Paradox”

In a research paper dated December 10, 2018, James J. Park, a Professor of Law at the UCLA School of Law, examined a series of questions related to the SEC’s approach to the regulation of initial coin offerings (“ICOs”), including when and how a blockchain project is functional.

Professor Park closely examined the SEC’s treatment of Ether under the federal securities laws to extract answers on how and when a token might mutate from a security token into a utility token.  He identified a few elements that might suggest a successful mutation: (a) a token has become widely accepted in ICO transactions; (b) a token has become completely independent of its founders (to the extent that it is possible); and (c) a token has achieved wide distribution.  However, Professor Park asserted that a compliant token can still fall into a trap that he coined the “Hinman Paradox.”  In the words of Professor Park, “[F]or a utility token to be distributed freely without regulation by the securities laws, it must be functional.  But many utility tokens are only functional if they are distributed widely enough so that a de-centralized system arises.”  In addition, a successful token must achieve its wide distribution without engaging in “selling tactics that would encourage a speculative market” in the token.

Professor Park posits a few ideas as to how to potentially circumvent the Hinman Paradox.  For instance, he suggests that a project could be so compelling that potential users are intrigued despite having no prospect of any immediate financial gains.  Smaller projects may be able to meet a discrete goal faster and thereby achieve full functionality without a need for wide distribution.

A link to a re-posting of Professor Park’s research paper on the Harvard Law School Corporate Governance Blog can be found here.

Vermont Agencies Launch a Working Group to Study Blockchain Technology

On December 10, 2018, four Vermont state agencies announced that they were forming a working group to study blockchain technology.  The working group will be composed of the State Attorney General’s Office, the Department of Financial Regulation, the Secretary of State, and the Agency of Commerce and Community Development.  According to the Vermont Attorney General, the working group will convene to seek answers to these issues: “1) what opportunities, challenges, and concerns blockchain may present; 2) whether blockchain-specific regulation or legislation is necessary and, if so, of what type; and 3) how best to protect consumers who may use Blockchain technology or be affected by it.”  The working group will seek input from stakeholders and industry experts and will commence in January 2019.

A link to a press release from the Vermont Attorney General can be found here.

International Developments

South Korean Prosecutors Indict Executives of Token Trading Platform

On December 21, 2018, Coindesk reported that three executives of UPbit, a South Korean cryptocurrency exchange, were formally charged with fraud by the Prosecutors’ Office of the Southern District of Seoul.  According to the report, the three executives are alleged to have made fraudulent transactions with a fake corporate account in order to artificially inflate trading volume on the exchange.  In addition, the three executives are accused of selling cryptocurrency to customers by means of fraudulent transactions.  UPbit reportedly denied the allegations in a statement, although it did acknowledge that it engaged in some early transactions.

A link to the Coindesk article can be found here.

UK Revenue & Customs Issues a Policy Paper on the Taxation of Cryptoassets  for Individuals

On December 19, 2018, Her Majesty’s Revenue & Customs (“HMRC”) issued a policy paper on the taxation of cryptoassets for individuals (the “Policy Paper”).  The document updates Brief 9, the prior HMRC guidance  published in March 2014.  The scope and content of the Policy Paper follows the framework in Notice 2014-21, published by the Internal Revenue Service in the United States.  However, it discusses updated topics that can help inform the U.S. Treasury as it prepares additional guidance.  Similar to Notice 2014-21, the Policy Paper addresses only the taxation implications for individuals who acquire or dispose of “exchange tokens,” a term that the Policy Paper defines as tokens “intended to be used as a method of payment” and that “encompasses ‘cryptocurrencies’ like bitcoin.”

In general, the Policy Paper explains that in most cases where an individual holds cryptoassets as a personal investment or to make particular purchases, the individual will be liable to pay capital gains tax when he or she disposes of his or her cryptoassets.  The paper does not define which “particular purchases” will trigger recognition, but the phrasing suggests that the tax will not apply universally to all barter transactions.  The Policy Paper does also explain how individuals may be liable to pay income tax and National Insurance contributions on cryptoassets that they receive from employers as a form of non-cash payment, or from mining, transaction confirmation, or airdrops. In several places, the Policy Paper provides more up-to-date analysis than Brief 9 or Notice 2014-21.  The Policy Paper provides an exemption for airdrops received by passive investors.  The Policy Paper also recommends that taxpayers treat forks similar to a stock split.

A link to the HRMC Policy Paper can be found here.

Two Hong Kong Regulators Express Hesitation Concerning IPO by Cryptocurrency-Related Business

On December 19, 2018, the South China Morning Post reported that Hong Kong’s stock market regulator and Hong Kong’s stock market operator both expressed hesitation concerning the initial public offering (“IPO”) proposal by a prominent cryptocurrency-related business that is pending in Hong Kong.  The company, Bitmain Technologies, manufactures and assembles mining hardware.  According to the report, both regulators cited two general reasons for their hesitation.  First, new rules are reportedly pending in Hong Kong for cryptocurrency trading platforms, and the regulators suggested that an IPO for a cryptocurrency-related business is not ripe until such new rules are promulgated.  Second, the report cited a source that explained that Hong Kong’s sandbox program is currently testing rules for token trading platforms and that it also would not be appropriate to approve an IPO related to a cryptocurrency-related business when rules and regulations could change after the expiration of the sandbox.  According to the report, the company’s IPO application is scheduled to lapse on March 26, 2019.

A link to the South China Morning Post article can be found here.

European Parliament Issues a Resolution Promoting Blockchain for Trade Policy

On December 13, 2018, the European Parliament issued a resolution entitled “Blockchain: a forward-looking trade policy” (the “Resolution”).  In the Resolution, the European Parliament instructs the European Commission to proactively track developments in the area of blockchain, especially with regards to initiatives in the international supply chain.  The Resolution notes that there are at least 202 government blockchain initiatives in 45 countries relating to the use of blockchain technology for international trade.  The Resolution calls on the European Commission to develop a set of guiding principles for blockchain application to international trade.  The Resolution also asks the European Commission to create an advisory group to develop a concept note for private permissioned pilot projects on the end-to-end use of blockchain in the supply chain, involving customs and other cross-border authorities.  The Resolution acknowledges some of the potential difficulties of using blockchain for trade policy, including complying with the General Data Protection Regulation; however, it concludes with a reminder that the European Union has an opportunity to become a leading actor in blockchain and international trade despite any difficulties.

A link to the European Parliament Resolution can be found here.

Central Bank of Bahrain Issues Draft Rules for Token Trading Platforms

On December 13, 2018, the Central Bank of Bahrain issued new draft rules for “crypto-asset platform operators.”  The draft rules would provide a regulatory framework for the licensing and supervision of crypto-asset roles that might be provided by a crypto-asset platform operator, such as a “principal, agent and . . . custodian.”  More generally, the Central Bank of Bahrain explained that the draft rules seek to protect customers by instituting reporting requirements and providing technology and cybersecurity standards.  The Central Bank of Bahrain is accepting feedback on the draft rules until December 31, 2018.

A link to the release for the draft rules can be found here.

Official from Central Bank of UAE Highlights Fintech Initiatives

On December 12, 2018, Mubarak Rashed al-Mansouri, the Governor of the Central Bank of the United Arab Emirates (“CBUAE”), spoke at the Arab #FinTex Symposium and highlighted several fintech initiatives being undertaken by the CBUAE.  According to Mr. al-Mansouri, the CBUAE is developing a fintech roadmap to be able to proactively support development while incorporating updated regulatory schemes.  As part of these initiatives, Mr. al-Mansouri highlighted four specific applications of technological innovation by the CBUAE:

  • CBUAE is finalizing a national payment systems strategy that will be a payments ecosystem that supports “cashless society objectives” and creates “consumer-centric, cost effective and safe e-payment solutions.”
  • CBUAE issued new regulations for stored valued facilities offering specific digital payment services.
  • CBUAE is finalizing new crowdfunding regulation.
  • CBUAE is collaborating with the Saudi Arabian Monetary Authority to issue a joint digital currency for cross-border transactions between the UAE and Saudi Arabia. The joint digital currency would be backed by the fiat currencies of both countries.

A link to Mr. al-Mansouri’s speech can be found here .

Cayman Islands Monetary Authority Issues 2018 Guidance Notes for AML Compliance

In November 2018, the Cayman Islands Monetary Authority (“CIMA”) issued new guidance on the prevention and detection of money laundering and terrorist financing (“2018 Guidance”).  Specifically, CIMA sought to amend a number of provisions in its 2017 AML guidance  by updating its guidance for financial service providers (“FSPs”), such as regulated funds (e.g., mutual funds) and unregulated investment funds (e.g., private funds).

The 2018 Guidance generally provides updates in three areas.  First, the 2018 Guidance provides an additional explanation on when and how an FSP can meet its Anti-Money Laundering Compliance Officer (“AMLCO”) obligations through delegation or reliance.  Second, the 2018 Guidance describes low-risk scenarios where the verification of the identity of a customer/applicant is unnecessary for the receipt of a payment, even through electronic means.  Third, the 2018 Guidance provides specific guidance for mutual funds and mutual fund administrators on how to comply with the CIMA’s Anti-Money Laundering Regulations (2018 Revision) (“2018 AMLR”).

The 2018 AMLR applies to private funds that are domiciled in the Cayman Islands due to their status as “exempted companies” under Section 4(4) of the Cayman Islands Mutual Funds Law.  The new 2018 Guidance provides some explanation as to how a private fund domiciled in the Cayman Islands might be able to accept subscriptions in digital tokens as opposed to fiat currency.

A link to the 2018 Guidance can be found here.