U.S. Developments

Facebook Announces Formation of Calibra and Launch of Libra

On June 18, 2019, Facebook announced the launch of Libra, a new cryptocurrency designed to have a stable value and be widely accepted internationally, and the formation of a new subsidiary, Calibra, which will provide digital wallets and other services for users in the Libra network.  The Libra network will be administered by the Libra Association, a Swiss nonprofit organization whose initial members are anticipated to include Calibra and 27 other organizations. 

Although the Libra network’s validator nodes will initially be limited to Libra Association members, the Association aims to develop a path toward permissionless and decentralized governance of the network.  According to the Libra whitepaper, Libra will be fully backed by a reserve of low-volatility assets, such as bank deposits and short-term government securities in currencies from stable and reputable central banks.

The Libra Association is still recruiting members and plans to continue engaging with regulators, policymakers, and other experts to prepare the network for the official launch of Libra, which is scheduled to occur in the first half of 2020.  In the interim, the U.S. Senate Committee on Banking, Housing, and Urban Affairs scheduled a hearing on Libra for July 16, 2019, titled “Examining Facebook’s Proposed Digital Currency and Data Privacy Considerations,” and Reuters reports that France is creating a G7 task force to review Libra and other cryptocurrencies.

QuadrigaCX’s CEO Used Customer Funds to Create Fake Accounts

QuadrigaCX filed for bankruptcy in Canadian court on January 31, 2019, following the unexpected death of its Chief Executive Officer, Gerald Cotten, in December 2018.  In a report dated June 19, 2019, from court-appointed monitors Ernst & Young (“EY”), EY identifies many serious concerns, including QuadrigaCX’s failure to segregate its own assets from users’ funds or to maintain adequate safeguard procedures with respect to security.

Notably, the report states that users’ “[c]ryptocurrency [was] transferred off Platform . . . to competitor exchanges into personal accounts controlled by Mr. Cotten” and that users’ currency was further “traded on these exchanges and in some circumstances used as security for a margin trading account established by Mr. Cotten.”  EY found that “Mr. Cotten created [accounts on the Platform] under aliases” where deposits were registered and used to trade in the platform; however, the original fiat and cryptocurrency deposits in such accounts could not be verified and their use resulted “in inflated revenue figures, artificial trades with Users and ultimately the withdrawal of Cryptocurrency deposited by Users.”

EY continues its search for missing funds, and U.S. authorities recently announced that they are investigating the losses as well.

CFTC Accuses Control-Finance Limited of Running Ponzi Scheme

In a complaint filed in the U.S. District Court for the Southern District of New York on June 17, the Commodity Futures Trading Commission (“CFTC”) accused Control-Finance Limited and its sole director, Benjamin Reynolds, of “exploit[ing] public enthusiasm for Bitcoin by operating a fraudulent scheme to misappropriate at least 22,858.822 Bitcoin—which reached a valuation of at least $147 million—from more than 1,000 members of the public.”  The CFTC alleges, in part, that Control-Finance Limited and Mr. Reynolds fabricated weekly trade reports, giving the impression that the company was successfully engaging in virtual currency trading, “when in reality Defendants made no trades on customers’ behalf and earned no trading profits for them.”  The complaint goes on to state that “Defendants . . . manufactured an aura of profitability by diverting portions of new customers’ Bitcoin deposits to other customers in the manner of a ’Ponzi’ scheme, falsely representing that these misappropriations were in fact profits derived from virtual currency trading” and that the defendants “intentionally or recklessly” engaged in the acts and practices described in the complaint.

FINRA Broker-Dealer Applications Remain in Limbo

According to the Wall Street Journal, a backlog of broker-dealer applicants seeking Financial Industry Regulatory Authority (FINRA) approval to effect transactions in digital or tokenized securities has developed over the last several months.  In a recent statement, FINRA indicated that “[m]embership applications from firms proposing to engage in digital asset businesses present new, complex issues and we are in the process of working through them.”  Some of the more complex issues revolve around how broker-dealers transacting in digital or tokenized securities would comply with existing interpretations of Securities and Exchange Commission (“SEC”) rules and regulations.  For example, the Customer Protection Rule requires broker-dealers to maintain physical possession or control of securities held for the account of customers.  To date, the SEC has not officially approved a method by which broker-dealers transacting in digital or tokenized securities can comply with the rule.  Many broker-dealer applicants have begun to actively engage with the Office of Financial Responsibility in the SEC’s Division of Trading and Markets, among others, to find a viable path forward while meeting the policy goals of the various rules and regulations.  Consistent with the SEC’s mission, it will likely assess and work toward solutions that protect investors, ensure market integrity, and facilitate capital formation.  Until there is clarity and certainty around how broker-dealers can comply with existing rules and regulations when applied to digital or tokenized securities, this backlog is likely to persist.  For more information, please see the related article found here.

FATF Releases New Regulatory Standards for Crypto Companies

The Financial Action Task Force (“FATF”) announced on June 21 that it adopted and issued an Interpretive Note to further clarify the standards for international regulation of digital assets.  These standards, though nonbinding, are intended to prevent misuse of digital assets for money laundering, terrorist financing, and financing of proliferation of weapons of mass destruction.  In relevant part, the FATF states that countries should require crypto businesses to “obtain and hold . . . accurate originator information and . . . beneficiary information and submit the information to the beneficiary institutions,” which mirrors FinCEN’s existing “travel rule.”  The FATF will monitor implementation of the new requirements over a one-year period.

As previously reported, crypto industry participants have expressed technical concerns regarding compliance relative to the practical limitations of blockchain technology.

International Developments

Malaysia Piloting Work Visa Project for Blockchain Developers

According to reports from Malaysian newspaper The Star, Malaysia Digital Economy Corporation, a Malaysian government-owned institution, is piloting a new visa program to fulfill demand for blockchain professionals.  The Star reports that the program will enable foreign professionals to enter and work in Malaysia for up to a year and that the number of visas issued will ultimately depend on the demand from local projects.

Lithuania Amends AML Rules

Lithuanian news outlet Delfi is reporting that Lithuania’s government recently amended its anti-money laundering rules in order to bring existing laws into compliance with the provisions set out in the fifth European Union Anti-Money Laundering Directive.  The new rules require cryptocurrency businesses in Lithuania to register with the government and to take actions necessary to identify their customers.

For more information regarding Delfi’s reporting, please see here.