U.S. Federal Regulatory Developments
CFTC, FinCEN, and SEC Leaders Release a Join Statement on Digital Assets
On October 11, 2019, the heads of the Commodity Futures Trading Commission (“CFTC”), Securities and Exchange Commission (“SEC”) and Financial Crimes Enforcement Network (“FinCEN”) issued a joint statement reminding those involved with digital assets about their obligations to protect against money laundering and terrorist financing, as required by the Bank Secrecy Act (“BSA”). The statement clarifies that AML/CFT regulations apply to “financial institutions” as defined under the BSA and includes certain introducing brokers, broker-dealers, money services businesses, and SEC-registered mutual funds. Financial institutions under the BSA definition must, among other things, establish and implement anti-money laundering programs and certain recordkeeping and reporting programs, according to the statement.
The joint statement emphasizes that market participants should focus on the facts and circumstances involving an asset, service, or activity, rather than the term or label used to describe it, in categorizing the asset for regulatory compliance purposes. According to the statement, the nature of the activities is a “key factor” in determining if a person is subject to SEC, CFTC, or FinCEN registration, and certain applicable BSA obligations apply “very broadly” regardless of whether the applicable transaction involves a commodity or a security.
Please click here to read the full statement.
CFTC Chairman States Ether Is a Commodity
On October 10, 2019, in an interview at the Yahoo! Finance All Markets Summit, CFTC’s Heath Tarbert said that, in addition to Bitcoin, Ether is a commodity subject to regulation by the CFTC under the Commodity Exchange Act. This marks the first time that the CFTC has confirmed Ether’s status as a commodity. Tarbert also said that he guesses that Ether-related futures contracts and other related derivatives will be traded within the next 12 months, or even sooner. He also discussed various topics including treating forked digital assets the same as the forked asset when conducting regulatory analysis, the CFTC’s authority to investigate fraud and manipulation in the spot market, and its FinTech based initiative, LabCFTC.
Please click here to watch the full interview.
SEC Rejects Proposal to List Bitwise Bitcoin ETF Trust
On October 9, 2019, the SEC rejected NYSE Arca, Inc.’s (“NYSE Arca”) application proposing a rule change to list and trade shares of Bitwise Bitcoin ETF Trust, an exchange-traded product that trades in Bitcoin. According to the SEC, NYSE Arca did not meet its burden of showing that its proposal is consistent with requirements that national securities exchange rules be “designed to prevent fraudulent and manipulative acts and practices.” This is consistent with the SEC’s earlier denials of similar Bitcoin-related, exchange-traded products. Among other things, the SEC highlighted the lack of surveillance-sharing agreements with regulated markets of significant size relating to the underlying assets. The staff rejected NYSE Arca’s position that surveillance-sharing agreements are unnecessary as Bitcoin and related markets are “uniquely resistant to manipulation and fraudulent activity” and noted that although Bitwise asserted that 95% of trading data in spot markets represents “fake” and non-economic trading, Bitwise did not establish that the surveilled markets constituted the “real” spot market for Bitcoin or that the “real” market is isolated from the fraudulent and manipulative activity. The staff also noted that the markets identified as “real” were not registered with a U.S. regulator and half lacked internal or third-party market surveillance tools. It further noted that the exchange and the sponsor provided no data showing that the prices in the “fake” market did not affect prices on the “real” market. The staff discussed some of the data deficiencies and noted that the sponsor would need to address the issue of partially real volume on “fake” platforms and the depth of institutional market activity.
In denying the application, the SEC emphasized that it is not weighing in on the “utility or value” of Bitcoin or blockchain technology.
Please click here to read the order.
IRS Issues Guidance on Tax Treatment of Virtual Currencies
On October 9, 2019, the Internal Revenue Service (“IRS”) issued Revenue Ruling 2019-24 describing its position regarding the tax treatment of hard forks and released updated frequently asked questions (“FAQs”) supplementing Notice 2014-21.
The revenue ruling starts by defining cryptocurrencies, which the IRS considers to be a form of virtual currency. The revenue ruling discusses the tax consequences of a hard fork, making a distinction between those persons who do not receive the new cryptocurrency resulting from the hard fork and those persons who are “airdropped” the resulting new cryptocurrency. The revenue ruling was drafted by attorney Suzanne R. Sinno of the Office of the Associate Chief Counsel.
Similar to Notice 2014-21, the FAQs discuss a range of topics, including the tax treatment of virtual currencies exchanged or sold for other property, or received for or paid in exchange for services. The new FAQs expand the discussion to include the tax treatment of cryptocurrencies received as part of a hard fork, based on Revenue Ruling 2019-24. The FAQs also suggest certain methods for determining tax basis in virtual currencies. However, the legal weight of these suggestions is unclear and the tax law discussed in the FAQs remains open to interpretation. What is clear is that these FAQs reflect a more sophisticated understanding of the technology within the IRS.
In the news release accompanying the guidance, the IRS also referred to the 10,000-plus “educational letters” it sent to taxpayers. The IRS reiterated that taxpayers who incorrectly report their transactions or do not report them at all may be subject to monetary fines and criminal prosecution.
Please click here for the IRS release.
Facebook CEO to Testify Before Congress on Libra Project
On October 9, 2019, the House Financial Services Committee (the “Committee”) of the U.S. House of Representatives announced that Facebook CEO and Chairman Mark Zuckerberg will appear for testimony before the Committee on October 23, 2019. The hearing entitled “An Examination of Facebook and Its Impact on the Financial Services and Housing Sectors” is a follow up to the Committee’s previous letter to Facebook requesting that it halt its cryptocurrency and digital wallet projects, Libra and Calibra, respectively. In July 2019, the Committee also heard testimony on this topic from Calibra’s CEO David Marcus, where they discussed, among other things, the “Keep Big Tech Out of Finance Act,” a draft bill advocating for the prevention of large platforms from operating as, or being affiliated with, a chartered financial institution.
Please click here for the press release.
Members of Congress Write a Letter Warning Certain Payment Processors from Participating in Facebook’s Libra Project
On October 8, 2019, two members of the U.S. Senate sent a letter to each of Visa, Stripe, and Mastercard, highlighting their concerns about Facebook’s Libra project. Citing public reporting, the Senators highlighted their concerns that “key questions remain unanswered about the risks the project poses to consumers, regulated financial institutions, and the global financial system.” The letter, among other things, warned the companies that if they participated in the project, they could expect a “high level of scrutiny from regulators,” including with respect to all of their non-Libra related payment activities. The letter concluded by urging the companies to proceed with caution until Facebook provided answers “on how it will manage the various and significant risks posed by Libra.”
A few days after the issuance of the letter, Visa, Stripe, and Mastercard announced their withdrawals from the Libra project.
Please click here to read the letter.
Singapore Citizen Charged with Theft of Cloud Computing Power to Mine Cryptocurrency
On October 9, 2019, the U.S. Attorney’s Office for the Western District of Washington indicted a Singapore citizen for allegedly stealing cloud computing power from California and Texas residents to mine cryptocurrencies. The defendant allegedly obtained stolen credit card information and related identities of a prominent video game developer in California, a resident in Texas, and a tech company founder in India and used this information to open accounts with several cloud service providers to mine Bitcoin and Ether between October 2017 and February 2018, according to the indictment. The government alleged that as part of this scheme, defendant used more than $5 million worth of unpaid cloud services.
Please click here to read the indictment.
Bitfinex and the New York Attorney General—Court Rules Against the Attorney General on Discovery Dispute But Extends Injection
On October 10, 2019, in another chapter in the ongoing legal dispute between iFinex (the company behind Bitfinex and Tether) (collectively, “defendants”) and the New York Attorney General (“NYAG”), the New York Supreme Court denied the NYAG’s request that defendants collect all data and documents related to the NYAG’s lawsuit against them during the pending appeal. The court, however, granted NYAG’s request to extend the existing injunction order in place for an additional 90 days. This latest dispute arrives on the heels of the New York Appellate Division’s order staying the case pending the appeal of an earlier ruling denying the defendants’ motion to dismiss.
Plaintiffs File Class Action Lawsuit Alleging Bitfinex and Tether Manipulated Virtual Currency Market
On October 6, 2019, a group of individuals who owned cryptocurrencies (collectively, the “plaintiffs”) filed a class action lawsuit in federal court in New York City against iFinex (the company behind Bitfinex, Tether, and other affiliates) (collectively, the “defendants”) alleging, among other things, that the defendants engaged in a fraudulent, deceptive, and sophisticated scheme to manipulate the cryptocurrency markets and conceal illicit proceeds. According to the plaintiffs, defendants “commingled their corporate identities and customer funds” while covering up their joint efforts to successfully manipulate a decentralized industry. The complaint alleges that the defendants created the “largest bubble in human history” when they used an “extraordinary amount of” their USDT coin, a cryptocurrency, which they fraudulently claimed was backed by the U.S. dollar on a 1:1 ratio basis, to flood the market and manipulate it at an “unprecedented” level. Plaintiffs contend that defendants’ potential liability to the putative class could likely surpass $1.4 trillion.
Please click here to read the complaint.
Bank of England Sets Out Principles for Facebook’s Libra
On October 9, 2019, the Bank of England issued its “Financial Policy Summary and Record of the Financial Policy Committee Meeting on 2 October 2019” (the “Report”) which included principles for payment systems and discusses Facebook’s virtual currency project Libra. According to the Financial Policy Committee (the “FPC”), focusing on the financial stability risk of payment activities (as opposed to the legal form) and ensuring payment chains’ operational and financial resilience from end-to-end will help to ensure payment systems support financial stability. The FPC also highlighted the need to obtain sufficient information to monitor payment activities to identify and address any emerging risks to financial stability. While noting “Libra has the potential to become a systematically important payment system,” the FPC calls on U.K. authorities to use their powers so that the project is subject to appropriate supervisory oversight, meets the highest standard of resilience, and complies with set-out principles “in advance of any launch.” The resilience, the FPC explains, should not only include elements of the Libra Association and related reserve currencies but also other relevant participants “such as validators, exchanges or wallet providers.”
Please click here to read the report.
UNICEF Launches a Crypto Fund
On October 9, 2019, UNICEF, the United Nations Children’s Fund, announced that it will be able to accept and distribute donations of cryptocurrency through its newly launched cryptocurrency fund—a first for United Nations organizations. The fund will accept Bitcoin and Ether and will use its assets to invest in “open source technology benefiting children and young people around the world.” The Ethereum Foundation will be the first donee to the fund, and the proceeds will be used to fund three UNICEF funds and a project to bring Internet to schools across the world, according to the UNICEF.
Please click here to read the announcement.
Hong Kong Securities Regulator Issues Terms and Conditions for Funds Investing in Virtual Assets
In October 2019, the Securities and Futures Commission (“SFC”) issued rules for SFC-licensed corporations that manage investments in virtual assets. The release touches on certain general principles such as honesty and fairness, diligence, capabilities, conflicts of interest, safeguarding of fund assets, disclosures and compliance. It clarifies that senior management of a virtual currency fund manager bears the primary responsibility of compliance with the rules and sets out detailed requirements as to the organization and management structure; management and custody of the fund’s assets; certain recordkeeping, auditing, valuation and other operational matters; certain dealings with the fund and fund investors, including marketing activities and fees and expenses; and reporting to the SFC. A manager is within the scope of the regulation if the manager’s fund has a stated objective to invest in virtual assets or if more than 10% of a fund is invested in virtual assets (unless the fund exceeds the 10% threshold due to market appreciation and the manager acts to reduce the fund’s exposure).
Please click here to read the announcement.