U.S. Developments

 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.

The year began with five bills introduced in the North Dakota House of Representatives (HCR 3002, HCR 3004, HB 1043, HB 1045, and HB 1048), covering a range of virtual currency–related topics. On January 8, HCR 3002 and 3004 were introduced, requesting that legislative management study the benefits of DLT for the state government. Interestingly, a similar bill was also introduced in the Oregon House of Representatives (HB 2487) on January 14 that also seeks to study the benefits of DLT for government use. On January 9, North Dakota introduced HB 1045, amending the electronic transaction definitions under state law to include signatures secured through blockchain technology. HB 1045 also seeks to acknowledge the enforceability of smart contracts employed in blockchain systems. On January 11, HB 1043 was introduced, seeking to exempt certain “open blockchain tokens” from specified securities transactions requirements and excluding certain virtual currency activities from money transmission licensing requirements. Finally, on January 11, HB 1048 passed out of committee (after being introduced on January 3). HB 1048 tasks the North Dakota Information Technology Department with establishing a DLT system for data transfer and storage for use by various North Dakota state agencies.

In Colorado, SB 19-023 was introduced in the Senate on January 4. SB 19-023 seeks to exempt persons dealing in “digital tokens” from state securities registration, broker-dealer and salesperson licensing requirements. In SB 19-023, the primary purpose for the digital token must be a “consumptive purpose” and the issuer must market the token to be used for a consumptive purpose rather than as an investment. The consumptive purpose of the digital token must also be available at the time of sale, with certain exceptions, including for tokens with resale/transfer restrictions and where the purchaser provides an acknowledgement that they are purchasing the digital token for consumption.

In Wyoming, HB 57 was passed in the House of Representatives on January 14. HB 47 Establishes a financial technology sandbox that allows for applicants to develop innovative financial products and services available to Wyoming consumers for up to 24 months under a waiver from complying with certain statutory and regulatory requirements.

The final bill in this recap, HB 2488, was introduced in the Oregon House of Representatives on January 14. HB 2488 seeks to prohibit the Oregon state government from accepting payments using cryptocurrency and would also prohibit candidates for public office from accepting campaign contributions using cryptocurrency. Notably, HB 2488 appears to follow a trend of similar restrictions that have been proposed or implemented in several other states. In September of last year, a California campaign regulator banned the use of Bitcoin for political donations and in November, the Michigan Secretary of State formally barred the use of cryptocurrencies for campaign donations.

Please click on the following links for the text of each bill:

U.S. Congressman Introduces Legislation for Money Transmission Safe Harbor

On January 16, U.S. Representative Tom Emmer (R-MN) introduced House Resolution 528, which aims “to provide a safe harbor from licensing and registration for certain non-controlling blockchain developers and providers of blockchain services,” from state money transmission laws. In essence, the proposed safe harbor would be available to certain virtual currency businesses that do not custody or store virtual currency, although the specifics of the safe harbor are not yet known. These businesses otherwise would be required to register as money service businesses with the U.S. Department of the Treasury Financial Crimes Enforcement Network and as money transmitters with each state financial regulator in the states that they offer services. The text of the bill is not yet available.

Please click here for the current status of HR 528.

Government Shutdown Impacting Virtual Currency Businesses

The impact of the partial government shutdown is being felt among blockchain and virtual currency startups. Specifically, the regulatory approval process with the Securities and Exchange Commission (SEC) for capital raising has been put on hold during the pendency of the shutdown. Delays are impacting all companies planning initial public offerings (IPOs) or exempted securities offerings that require approval with the SEC. Some pre-IPO companies facing significant delays may ultimately withdraw from their public offerings as a result of the shutdown. Similarly, digital currency startups seeking to raise funds through an exempted securities offering under Regulation A of the Securities Act of 1933 are significantly impacted. Currently, dozens of Regulation A applications cannot be reviewed or processed. The applications for exchange-traded funds for digital currencies and digital asset–related products are similarly affected.

In addition to the SEC, the Commodity Futures Trading Commission (CFTC) is operating at reduced capacity. In early December, the CFTC requested comments on the use of the Ethereum Network. Due to the shutdown, the CFTC staff will not be able to undertake review of these comments. Virtual currency businesses seeking to raise capital through crowdfunding portals are fortunately spared, however; crowdfunding portal applications are primarily processed by the self-regulatory body, the Financial Industry Regulatory Authority, which is functioning as normal.

New IPO Filing for Bitcoin Treasury Investment Trust

On January 11, Wilshire Phoenix Funds, LLC announced that it has sponsored the filing of a registration statement with the SEC relating to the proposed initial public offering of common shares of the United States Bitcoin and Treasury Investment Trust. The purpose of the Trust is to provide investors with exposure to Bitcoin and will have no assets other than Bitcoin, short-term duration U.S. Treasury Bills, and U.S. Dollars. The filing follows in the footsteps of several other asset management firms that have sought approval for a bitcoin-backed exchange-traded fund (ETF). Regulators have yet to approve any ETF filings, citing concerns relating to the immaturity of the market and volatility.

Please click here for the registration statement.

International Developments

OECD Report on ICOs for SME Financing

On January 15, the Organisation for Economic Co-Operation and Development (OECD) released a report on initial coin offerings (ICOs) for small and medium enterprise (SME) financing. The report highlights the recent use of distributed ledger technology for fundraising and analyzes the regulatory challenges and economic tradeoffs the new technology presents. The report acknowledges that ICOs have the potential to offer a new way to raise capital and that SMEs can benefit from the technological efficiencies, cost savings, and speed of execution that ICOs offer, if appropriately regulated and supervised. The report also states that a properly regulated ICO could be an “inclusive financing vehicle by allowing small retail investors to participate in the financing of businesses and start-ups.”

The economics of ICO issuances (called “tokenomics”) are discussed in detail throughout the report. The OECD stresses the inherent conflict created by an ICO issuance, whereby a token may resemble both the future value of a company and the ability to transact or use the token for some utility. This tension makes it difficult to assign a fair value to tokens issued in ICOs and may be a limitation for the wider use of ICOs as a financing mechanism for SMEs. The report also describes the risks and limitations of the current ICO landscape, including the conflicts of interest created by issuers, market volatility, and the absence of disclosure requirements.

The report addresses the question of whether ICOs can become a “mainstream” SME financing mechanism by stating the following: “ICOs are particularly beneficial for products and services that are founded on the basis of a network. Token issuance allows for quicker adoption of the product/service and the creation of a customer-base before the launch of the project. Most importantly, maximising value creation through the network effects present in newly-created networks of investors purchasing tokens is one of the major comparative advantages of ICOs when compared to other forms of financing. In the absence of a business model that can benefit from such network effects, launching an ICO offering may not be a viable and sustainable financing solution.”

The report concludes by emphasizing the role that policymakers must play in articulating the rules for conducting ICOs in a safe and fair manner. The report emphasizes that the most important factor in the safe creation of an ICO market is clarity with respect to a regulatory and supervisory framework: “Given the global nature of ICOs issuing and cross-border trading, cooperation at the international level is warranted for a coordinated global approach that will prevent regulatory arbitrage and allow ICOs to deliver their potential for the financing of blockchain-based SMEs, while adequately protecting investors.”

Please click here for the full OECD report.

South Africa Plans to Start Tracking Bitcoin

On January 16, the South African Reserve Bank (SARB) released a consultation paper regarding its approach to virtual currency regulation. In the paper, the SARB recognizes that virtual currency regulation must occur to protect consumers and investors, while allowing the virtual currency industry to grow. The SARB plans to implement a registration scheme for crypto asset service providers including exchanges and wallet providers that offer services to South African customers. The report also recommends that virtual currency remain without legal tender status within the country for now. A more detailed process of registration is expected to be announced in Q1 2019.

Please click here for the consultation paper.

Malaysia Set to Release Rules Regulating Digital Currency Sales

The Malaysian Securities Commission (SC) announced that its digital currency and digital token regulatory rules will go into effect on January 15. The new rules require any issuer or exchanger of digital tokens to apply for approval from the SC prior to commencing business in Malaysia. In the SC’s notice regarding its new regulatory policies, the SC also indicated that it was working with the Central Bank of Malaysia to develop a robust framework for digital asset compliance. The framework is expected to be published in Q1 2019.

Please click here for more information about the announcement