Weekly Focus

  • California Appellate Court Upholds Coinbase Summary Judgement
  • California Issues Opinion on Crypto Escrow Services under the Money Transmission Act
  • The Federal Reserve Is Testing a Digital Dollar and Distributed Ledgers
  • New York Updates Cryptocurrency Greenlist
  • SEC Charges Issuer with Fraudulent ICO
  • Wealthsimple Receives Approval for Canadian Regulatory Sandbox
  • Russian Monitoring Service Planning to Create Cryptocurrency Tracking System
  • MicroStrategy Adopts Bitcoin as Treasury Reserve Asset
  • Coinbase Announces Crypto-Backed Loans
  • Grayscale Ethereum Trust Files Registration Statement

U.S. Developments

California Appellate Court Upholds Coinbase Summary Judgement

On August 10, California’s First Appellate Court sustained a summary judgment from a lower court in favor of Coinbase against plaintiff Darrell Archer, who alleged in 2018 that Coinbase violated its contractual agreement with users after the Bitcoin Gold hard fork. As alleged by Archer, when Bitcoin Gold was created, Coinbase decided it would not support the new cryptocurrency and refused Archer access to Bitcoin Gold purportedly in his Coinbase account. Archer sued claiming negligence, conversion, and breach of contract. The trial court granted Coinbase a summary judgment.

The appellate court upheld the summary judgment on all three counts. The opinion noted that “the recovery of damages for failure of a cryptocurrency exchange to provide access to a forked digital currency created by a third party” is an issue of first impression in California. The court quoted as persuasive a ruling from a Georgia court dealing with a similar issue: “The Court would be imposing a major new duty on all cryptocurrency exchanges operating in Georgia to affirmatively honor every single bitcoin fork. Bitcoin investors are aware they are operating in an unregulated market, and therefore it seems more reasonable to place the burden to ensure access to forked currency on the investors themselves.”

The court’s opinion can be found here.

California Issues Opinion on Crypto Escrow Services Under the Money Transmission Act

Recently, the California DBO opined on certain crypto escrow services under the Money Transmission Act (MTA). Sticking to its ongoing position that cryptocurrency does not trigger the application of the MTA, the DBO held that brokerage accounts that used cryptocurrency exchanges would not be considered licensable activity under the MTA. This does not mean that cryptocurrency activities could not trigger any licensing regime under California law, and the DBO in its opinion cautions that some of the services proposed in the opinion-requesting letter could trigger obligations under the California Escrow Law (Financial Code 17000 et seq.).

The opinion-requesting company presented two proposed business models to the DBO for evaluation—a tri-party repurchase transaction model and a prime brokerage model.

In the tri-party repo model, the company would act as a third party to a repurchase transaction related to borrowing and lending cryptocurrency. The borrowing and lending parties would agree to the terms of the transaction and place the agreed-upon amount of margin from their digital wallet into an escrow account held by the company, which is empowered to move the funds between the accounts and send funds to the originating wallet. At the conclusion of the transaction, the company would send the escrow balances back to the originating wallet, or, in the event of a default, to the non-defaulting party’s escrow account.

In the prime brokerage model, customers would open accounts through the company to facilitate exchanges on a number of cryptocurrency exchanges with the company maintaining corporate accounts at the exchange. The customers could fund the brokerage account with cryptocurrency from the customer’s wallet to the company’s corporate account at the exchange, or the customers can wire fiat currency to the company’s bank account, which is then transferred to the company’s account at the exchange. The company has control and ownership over the funds in the accounts, but only moves those funds at the customers’ direction.

As the CA MTA does not consider cryptocurrencies to be a form of money, neither of these business models triggers licensure requirements under the MTA. However, these business models, and particularly the tri-party repo model, could be escrow activity requiring licensure under the California Escrow Law.

The Federal Reserve Is Testing a Digital Dollar and Distributed Ledgers

On August 13, 2020, Federal Reserve Governor Brainard gave a speech during a webcast of the Federal Reserve Bank of San Francisco’s Innovation Office Hours, discussing the Federal Reserve’s development work and experiments with a digital dollar or Central Bank Digital Currency (CBDC). Governor Brainard noted that the Federal Reserve “is active in conducting research and experimentation related to distributed ledger technologies and the potential use cases for digital currencies.” To study the potential of technologies offering digital currencies or digital equivalents of cash, the Federal Reserve has been conducting in-house experiments with digital currencies for the past few years through the Federal Reserve’s Technology Lab, including building and testing distributed ledger platforms to understand the risks and opportunities in the technology. Notably, Governor Brainard did not promise the issuance of a digital dollar and emphasized the significant policy process necessary to operationalize a CBDC as well as the high demand for the current U.S. dollar.

New York Updates Cryptocurrency Greenlist

The New York State Department of Financial Services (“DFS”), which regulates the state’s Bitlicense program, published a “Greenlist” of cryptocurrencies in June that licensed entities may use without prior DFS approval. The Greenlist now includes 10 cryptocurrencies approved for custody and eight approved for exchange listing. On August 7, Binance USD (a stablecoin issued in partnership between Binance and Paxos) was added to the Greenlist. This list is the fulfillment of a proposed framework DFS published in December 2019.

A virtual currency business in New York can adopt or list virtual currencies in multiple ways, but use of the virtual currencies on the Greenlist only requires prior notice to DFS. The coins approved for custody are: Binance USD (BUSD), Bitcoin (BTC), Bitcoin Cash (BCH), Ethereum Classic (ETC), Ethereum (ETH), Gemini Dollar (GUSD), Litecoin (LTC), Pax Gold (PAXG), Paxos Standard (PAX), and Ripple (XRP). The same set of coins are also approved for listing except for Ethereum Classic and Ripple.

The Greenlist can be found here.

SEC Charges Issuer with Fraudulent ICO

On August 13, the Securities and Exchange Commission (“SEC”) published an order (“Order”) against Kelvin Boon, LLC and Rajesh Pavithran (“Respondents”) for an unregistered and fraudulent initial coin offering (“ICO”) of Boon Coin. As set out in the Order, Kelvin Boon, LLC (doing business as Boon.Tech) and Pavithran (the founder and CEO of Boon.Tech) offered Boon Coins in late 2017 to raise capital to build a decentralized job marketplace platform, and Boon.Tech raised approximately $5 million through the ICO.

The SEC found in the Order, which Respondents did not admit or deny, that Respondents violated Sections 5(a) and 5(c) of the Securities Act of 1933 (“Securities Act”) by conducting an unregistered offering of securities. The SEC alleges that Boon Coins were investment contracts because they were offered in exchange for an investment in Boon.Tech with a reasonable expectation of profits. Boon.Tech used the credentials of the management team as a selling point for Boon Coins. Boon Coin’s white paper had a section describing “Why Invest In the Boon Coin”. Pavithran stated publicly in interviews that he wanted Boon Coins listed on exchanges to help sustain investor value, and he spent several months contacting exchanges trying to get them to list Boon Coins. The SEC described Respondents’ actions as trying to “create demand and market appreciation for Boon Coins independent of any consumptive value for the tokens.”

Additionally, the SEC found, and Respondents did not admit or deny, that Respondents violated Section 17(a) of the Securities Act and Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder by making materially false and misleading statements about Boon Coins during the ICO. Specifically, the SEC pointed to claims in the Boon Coin white paper about patent pending hedging technology, which did not exist. The white paper also claimed Boon.Tech created its own blockchain and was more advanced than competitor platforms, neither of which were true.

In addition to destroying all Boon Coins and pulling them from trading platforms, Pavithran is ordered to pay a civil money penalty of $150,000 and Boon.Tech is ordered to pay a civil money penalty of $5,000,000 plus prejudgment interest.

The Order can be found here.

International Developments

Wealthsimple Receives Approval for Canadian Regulatory Sandbox

Wealthsimple, an online investment manager, has received approval for two years of exempt operations under the Canadian Securities Administration (“CSA”) Regulatory Sandbox. Wealthsimple Crypto is still in its pre-beta phase and will allow users to buy and sell cryptocurrencies. Cryptocurrency custody will be handled by Gemini Trust Company. There will be certain restrictions on Wealthsimple Crypto’s operations during the two-year sandbox, such as a maximum of 30,000 Canadian Dollars funding per client account per year.

The CSA Regulatory Sandbox was formed in 2017 for innovative Canadian fintech companies to offer products and services in Canada exempt from certain Canadian securities laws. This program is similar to other sandbox initiatives around the world and in many states in the United States, such as Arizona’s FinTech Sandbox.

The CSA’s August 7 approval for Wealthsimple Crypto can be found here.

Russian Monitoring Service Planning to Create Cryptocurrency Tracking System

According to local Russian media, Russia’s Federal Financial Monitoring Service (Rosfinmonitoring) is planning to create an artificial intelligence system to analyze and track cryptocurrency transactions in Russia. Originally developed to fight drug trafficking, the system will purportedly track and analyze cryptocurrency transfers and payments to fight money laundering and terrorism financing. As previously reported, Vladimir Putin recently signed a much-anticipated law defining and regulating cryptocurrencies. Local media (in Russian) has also been reporting on the implementation of rules requiring deposits into certain online wallets (e.g., Yandex and VK Pay) be done from bank accounts instead of with cash, making those transactions more traceable.

A Russian news article about the AI system can be found here (in Russian).

Industry Developments

MicroStrategy Adopts Bitcoin as Treasury Reserve Asset

MicroStrategy, a publicly-traded business intelligence company, announced on August 11 that it purchased 21,454 bitcoins for $250 million. The purchase was part of a two-prong capital allocation strategy whereby MicroStrategy launched a $250 million tender offer in combination with the investment of $250 million into Bitcoin. After this purchase, Bitcoin is now the principal holding in MicroStrategy’s treasury reserve strategy. According to MicroStrategy CEO Michael Saylor, part of the rationale for the large cryptocurrency purchase is because the company believes that Bitcoin “is a legitimate investment asset that can be superior to cash…”

MicroStrategy’s press release can be found here.

Coinbase Announces Crypto-Backed Loans

On August 12, Coinbase announced an upcoming program to allow users to borrow up to $20,000 using up to 30% of a user’s holdings of Bitcoin as collateral. Loans will be available at an 8% APR without a credit check, and repayment of the principal can be delayed up to one year.

As of this writing, the borrowing program is only available in the following states: Alaska, Arkansas, Connecticut, Florida, Georgia, Illinois, Massachusetts, New Hampshire, New Jersey, North Carolina, Oregon, Texas, Virginia, Nebraska, Utah, Wisconsin and Wyoming. Coinbase is pursuing licenses in other states to expand the borrowing program. Cryptocurrency borrowing is an expansion of crypto-related services and offerings by key players in the industry.

Grayscale Ethereum Trust Files Registration Statement

On August 6, asset manager Grayscale filed a Form 10 with the SEC for its Ethereum Trust to become a reporting company with the SEC and register shares of the Ethereum Trust under the Securities Exchange Act of 1934. The Form 10 will become effective within 60 days of filing unless the SEC acts otherwise. The Ethereum Trust already received approval from the Financial Industry Regulatory Authority in May to trade on over-the-counter markets.

When registered, the Ethereum Trust would join Grayscale’s Bitcoin Trust, which became an SEC reporting company in January 2020. The Bitcoin Trust was the first cryptocurrency investment vehicle to attain reporting company status with the SEC.

Grayscale’s announcement can be found here. The filed Form 10 can be found here and the filed Information Statement can be found here.