Weekly Focus

  • U.S. Treasury Foreshadows “Significant New Requirements”
  • Enforcement Actions Brought Against Allegedly Fraudulent Digital Asset Investment Scheme
  • Department of Justice Charges Darknet-Based “Mixer” With Laundering Over $300 Million, Operating an Unlicensed Money Transmitting Business, and Money Transmission Without a License
  • Report Finds Crypto Crime Losses Double to $4.5 Billion in 2019
  • J.P. Morgan Discusses Merger With ConsenSys
  • Aragon Court Launches Precedence Campaign
  • IBM Claims Blockchain Expenditures Yield 15x for Cloud
  • IOSCO Releases Updated Report on Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms
  • German Bank Develops Special-Purpose Euro Stablecoin
  • Blockchain-Based Financial Instruments Utilized in Wake of Coronavirus
  • Fed Reserve Governor Discusses the Digitalization of Payments and Currency

U.S. Developments – Regulatory

U.S. Treasury Foreshadows “Significant New Requirements”

In testimony before the Senate on Wednesday, Secretary of the Treasury Steven Mnuchin eluded to new regulation. Mnuchin said that “…we’re about to roll out some significant new requirements at FinCEN [Financial Crimes Enforcement Network]. We want to make sure that technology moves forward but on the other hand, we want to make sure that cryptocurrencies aren’t used for the equivalent of old Swiss secret number bank accounts.” Secretary Mnuchin explained that “you’ll be seeing a lot of work coming out very quickly.”

Mnuchin’s comments came in response to Senator Maggie Hassan (D-N.H.), who asked how the Treasury’s proposed budget increases might contribute to “monitoring suspicious cryptocurrency transactions and prosecuting terrorists and other criminal organizations financing illicit activities with cryptocurrency?”

The comments also come on the heels of Mnuchin’s previous characterization of cryptocurrencies as a national security threat, and in the same week as a Trump budget proposal which includes relocating the Secret Service back to the Treasury Department from the Department of Homeland Security, something Mnuchin has advocated for previously.

In a separate hearing this week, the Chair of the Federal Reserve, Jerome Powell, said that the central bank had been taking a close look at the costs and benefits of a country developing its own digital currency, citing that Libra had “lit a fire” in the area and in response to questions from Rep. Foster about China’s progress on the same issue.

Further coverage is available from Bloomberg and the NYT.

Enforcement Actions Brought Against Allegedly Fraudulent Digital Asset Investment Scheme

The SEC, CFTC, and DOJ have announced the filing of related, but separate, civil and criminal charges against Q3 Holdings, LLC, Q3 I, LP, and their principal, Michael Ackerman. The CFTC’s civil enforcement action, filed in the Southern District of New York, charges the defendants with fraudulently soliciting more than $33 million in a scheme to purportedly trade digital assets while misappropriating a substantial portion of that sum.

According to the CFTC complaint (also available via link here), the defendants allegedly did not earn the profits they claimed, misappropriated funds, and contributed only a portion of the funds to digital asset trading accounts. The CFTC also alleges that the defendants provided customers with false account statements, fictitious screenshots supposedly demonstrating the amount of money under management, and misleading newsletters containing false trading returns.

In related actions, the U.S. Attorney’s Office for the Southern District of New York announced the arrest of Ackerman on one count of wire fraud, and the Securities and Exchange Commission also announced the filing of a civil complaint against Q3 and Ackerman alleging securities fraud and misappropriation.

Department of Justice Charges Darknet-Based “Mixer” With Laundering Over $300 Million, Operating an Unlicensed Money Transmitting Business, and Money Transmission Without a License

Federal Prosecutors have charged an Ohio man with conspiracy to commit money laundering, operating an unlicensed money transmitter business, and money transmission without a license, allegedly in connection with the now defunct site AlphaBay, according to Cleveland.com and the matter’s docket.

AlphaBay, shut down in 2017, was previously described by the Justice Department as “the largest criminal marketplace on the Internet[.]” According to the article, federal prosecutors allege that the operation, named “Helix,” partnered with AlphaBay to provide money laundering by exchanging at least 354,468 bitcoins, the equivalent of about $311 million at the time of the transactions. In addition to AlphaBay, the Helix service is alleged to have contributed to the scrambling of transactions for other marketplaces. In a statement Thursday, U.S. Attorney Timothy J. Shea and Don Fort, Chief of IRS Criminal Investigation, said: “This indictment underscores that seeking to obscure virtual currency transactions in this way is a crime,” and that “the sole purpose of [the] operation was to conceal criminal transactions from law enforcement on the Darknet, and because of our growing expertise in this area, he could not make good on that promise.” The investigation, which spanned multiple federal agencies, involved the Belize Ministry of the Attorney General and the Belize Police Department.

U.S. Developments – Industry

Report Finds Crypto Crime Losses Double to $4.5 Billion in 2019

A new study by CipherTrace reports that losses from cryptocurrency crime rose to $4.52 billion in 2019, purportedly due to a rise in insider theft and despite a decline in hacking losses. In total, the report claims, losses from fraud, misappropriation of funds, exchange hacks, and thefts added up to more than $4.5 billion. Compared to 2018, fraud and misappropriation increased by 533%, while hacks and thefts decreased by 66%. A brief interview with Reuters and reporting on the analysis is available here.

J.P. Morgan Discusses Merger With ConsenSys  

Various news outlets have reported that JPMorgan Chase is in talks to merge its open source Quorum project with ConsenSys, a deal likely to be formally announced within the next six months with as-yet unclear financial terms (Reuters).

JPMorgan’s Quorum is an Ethereum based payments network that according to CNBC involves more than 300 banks.

Meanwhile, ConsenSys itself announced this week that its platform Activate would go live with SKALE, an Ethereum scaling project, as its first partner. Activate’s “proof-of-use” protocol aims to discourage speculation via a AlphaBay 90 day proof-of-use period and other means. The requirements have been compared to those outlined last week by U.S. Securities and Exchange Commissioner Hester Peirce in a speech on February 6th at the International Blockchain Congress in Chicago.

ConsenSys’ press release regarding SKALE is available here.

Aragon Court Launches Precedence Campaign

Dispute resolution protocol Aragon Court launches its Precedence Campaign, billing itself as “the world’s first digital jurisdiction.” The campaign will be a series of simulated disputes to stress-test the dispute resolution protocol, similar to the stress-test performed by Kleros, known then as “Doges on Trial.” CoinTelegraph Magazine previously summarized the rise of decentralized dispute resolution mechanisms.

IBM Claims Blockchain Expenditures Yield 15x for Cloud

Jerry Cuomo, IBM’s VP of Blockchain, claims $15 is spent for cloud services on every $1 spent on blockchain, illuminating the web of interrelated technical services that drive the economy for enterprise blockchain applications and development.

International Developments

IOSCO Releases Updated Report on Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms

The Board of the International Organization of Securities Commissions announced the publication of a report titled “Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platform.” The IOSCO work program has identified the development of crypto-assets as an ongoing priority in 2020. As the title suggests, the report describes the issues and risks associated with the rise in crypto-asset trading platforms and sets out key considerations to assist regulators in addressing these issues.

The announcement and report detail that while many of the issues related to the regulation of crypto-asset trading platforms (CTPs) are common to traditional securities venues, the issues may be heightened by the business models used by CTPs. The report, which updates IOSCO’s February 2017 “Research Report on Financial Technologies (FinTech),” highlights the guidance of IOSCO for regulatory authorities that have “determined that a crypto-asset or an activity involving a crypto-asset falls within its jurisdiction…in considering the novel and unique issues and risks that arise in this new market.” IOSCO guidance included in the report summarizes surveys of various jurisdictions and offers a toolkit for assessment in the following key areas: (1) access and onboarding; (2) safekeeping of participant assets; (3) identification and management of conflicts of interest; (4) transparency of operations; (5) market integrity; (6) price discovery mechanisms; and (7) technology, including resilience and cyber security.

Analysis of the report and its context as related to the “travel rule” is available here.

German Bank Develops Special-Purpose Euro Stablecoin

A German Bank announced plans to issue tokenized securities as well as issue its own stablecoin based on the Euro. Bank von der Heydt announced that it had partnered with Bitbond to tokenize digital securities. The Bank’s announcement cites to recent updates to the German Banking Act (KWG) which came into force January 1, 2020 and requires digital asset custodians to be licensed by the German Federal Financial Supervisory Authority (BaFin). A further description of the regulations is available here.

The development will occur in partnership with Bitbond, which in 2019 became the first German company to receive approval from BaFin to issue a tokenized bond, being Germany’s first regulated security token offering (STO). Bitbond uses its license to provide an online lending platform for small businesses to gain access to capital. Like Bitbond’s first token, the new partnership with Bank von der Heydt will utilize the Stellar blockchain. According to reporting, the offering, which will allow clients to securely store tokenized equity in a custody solution developed by Bitbond, will be for institutional clients via private placement and not broadly available to the public. Investors will purchase tokenized equity using a Euro-linked stablecoin that will be issued by the bank.

Blockchain-Based Financial Instruments Utilized in Wake of Coronavirus

Multiple blockchain-based financial instruments have been cited as alleviating some damages of the recent coronavirus outbreak. Blockchain-based payout methods have purportedly sped up the claims process for Xiang Hu Bao, a Chinese online mutual risk sharing platform, which recently added coronavirus to its list of eligible claims and enabled a one-time payout for those affected by the virus. Xiang Hu Bao is not an insurer, but a mutual risk pooling platform owned by a financial company.

Blue Cross Insurance (Asia-Pacific), a subsidiary of the Bank of East Asia (BEA), has also apparently adopted blockchain technology to ease pressure on healthcare services by shortening the time it takes to verify back-end data.

Meanwhile, China’s “cross-border finance blockchain services platform pilot,” launched in March of 2019, has now processed $15.9 billion in loans to nearly 2,500 businesses, with $200 million in loans occurring since the Lunar New Year holiday. The capital injections come at a time where Chinese businesses are struggling with the impact of the virus outbreak on their businesses.

Interestingly, China has simultaneously taken the additional step of quarantining cash for sanitization and even destroying some old notes, a measure that supporters of cryptocurrencies see as an advantage to the cash alternative.

Fed Reserve Governor Discusses the Digitalization of Payments and Currency

At the Symposium on the Future of Payments, Federal Reserve Governor, Lael Brainard, discussed the benefits and risks associated with the digitalization of payments and currency. Ms. Brainard highlighted how digitalization enables consumers and businesses to transfer value instantaneously, resulting in greater convenience at a lower cost. However, Ms. Brainard cautioned that there are new participants that fall outside of the financial system’s regulatory guardrails that pose unique challenges with regard to illicit finance, privacy, stability, and money policy generally.

She noted that the public sector must determine whether the traditional regulatory perimeters need to be redrawn or new approaches are needed in these developing areas– particularly with regard to consumer data, identity authentication, and the role of central bank digital currencies. Moreover, Ms. Brainard noted the importance of sovereign currencies staying at the center of each nation’s financial system and specifically noted that central bank money represents “a safe settlement asset, allowing users to exchange central bank liabilities with confidence.”

Ms. Brainard noted how technology has enabled payments to transition from trusted intermediaries like banks to new platforms with massive networks like Alipay and WeChat Pay in China. While there are benefits of convenience, accessibility, and low transaction costs, she indicated that many of these new solutions do not offer consumers the same protections or recourse as traditional products. Ms. Brainard also hypothesized that a review of the United States’ oversight framework for retail payment systems might be helpful to identify important gaps as payments technology continues to expand.

She proceeded to discuss the benefits of a real-time infrastructure including the speed of refunds and the access to funds generally, while noting the Clearing House’s RTP and FedNow’s developments. However, Ms. Brainard also noted that the digitalization of payments, and the development of new mediums of exchange, have created new potential challenges relating to illicit activity and consumer risk. As an example, Ms. Brainard discussed Bitcoin and other cryptocurrencies. In that regard, Ms. Brainard noted that Bitcoin has not achieved widespread acceptance as a means of payment or unit of account due to its extreme volatility, limited throughput capacity, unpredictable transaction costs, limited governance, and limited transparency. Thereafter, she noted that the design of stablecoins came about to specifically overcome the volatility of first-generation cryptocurrencies by tying the digital currency to an asset or basket of assets.

Lastly, Ms. Brainard discussed the prospect of a rapid adoption of a global stablecoin payment system. She cited a Bank for International Settlements survey that found more than 80% of central banks were engaged in some type of central bank digital currency work and that the motivations for this development ranged from payments safety to robustness to efficiency. Ms. Brainard concluded by noting the dollar’s important role in the world and the criticality of remaining on the frontier of research and policy.

The full text of Ms. Brainard’s speech can be found here.