Achieving Digital Transformation and Securing Digital Assets

Blockchain and Digital Assets News and Trends

This is our ninth monthly bulletin for 2021, aiming to help companies identify important and significant legal developments governing the use and acceptance of blockchain technology, smart contracts and digital assets.

While the use cases for blockchain technology are vast, this bulletin will be primarily on the use of blockchain and or smart contracts in the financial services sector. With respect to digital assets, we have organized our approach to this topic by discussing it in terms of traditional asset type or function (although the types and functions may overlap), that is, digital assets as:

• Securities
• Virtual currencies
• Commodities
• Deposits, accounts, intangibles
• Negotiable instruments
• Electronic chattel paper
• Digitized assets

In addition to reporting on the law and regulation governing blockchain, smart contracts and digital assets, this bulletin will discuss the legal developments supporting the infrastructure and ecosystems that enable the use and acceptance of these new technologies.

INSIGHTS

Proposed infrastructure bill would subject cryptocurrencies to wash sale and constructive sale rules

In a report outlining its proposals to raise revenue to finance infrastructure spending, the House Ways and Means Committee proposed explicitly subjecting cryptocurrency to the “wash sale” and “constructive sale” rules of the Internal Revenue Code. Read more.

FEDERAL DEVELOPMENTS

Digital assets

• CFTC clarifies scope of its regulatory and enforcement authority. On August 23, Commissioner Dawn Stump of the US Commodity Futures Trading Commission (CFTC) issued a statement on the CFTC’s regulatory oversight and enforcement authority over digital assets. The Commissioner described 10 points stating how and what the CFTC regulates – clarifying that the CFTC does not regulate commodities, but rather it regulates derivatives. The 10 points also explain how Congress has distinguished the CFTC’s enforcement authority.
• SEC issues investor alert on digital assets and crypto. On September 1, the US Securities and Exchange Commission (SEC) issued Digital Asset and “Crypto” Investment Scams – Investor Alert, urging consumers to take time to understand how digital asset and cryptocurrency investments work and evaluate their risks before investing. The alert identified “red flags of fraud,” including “guaranteed” high returns, unlicensed or unregistered sellers, “skyrocketing” account values, and fake testimonials.

Securities

• SEC Chair speaks to European Parliament on risks of cryptocurrency. On September 2, SEC Chair Gary Gensler spoke before the European Parliament Committee on Economic and Monetary Affairs. He expressed concern about the need for regulation in the field of crypto assets and restated that the asset class is “rife with fraud, scams and abuse.” He focused on the potential risks from crypto trading and lending platforms, both centralized and decentralized and stablecoins. Gensler expressed concern regarding crypto asset trading platforms and the need for regulation, saying, “Therefore, absent clear investor protection obligations on these platforms, the investing public is left vulnerable.” He also focused on stablecoins and the risks that they posed to the financial regulatory structure. “Thus, the use of stablecoins on these platforms may facilitate those seeking to sidestep a host of public policy goals connected to our traditional banking and financial system: anti-money laundering, sanctions, and more.” The discussion was consistent with his other public statements.

INDUSTRY DEVELOPMENTS

• Deloitte publishes Global Blockchain Survey. Deloitte announced publication of its fourth annual Global Blockchain Survey. The survey polled a sample of 1,280 senior executives and practitioners in the financial services industry in 10 countries. Respondents had at least a general understanding of blockchain, cryptocurrencies, and digital assets. The survey found that “global FSI leaders see digital assets – and their underlying blockchain technologies – as a strategic priority now and in the near future: … 80% of overall respondents say that digital assets will be ‘very/somewhat important’ to their respective industries in the next 24 months.”
• Microsoft awarded patent for a ledger-independent custom token creation system. Microsoft has recently been awarded a patent related to an interface for creating custom tokens that is independent of the underlying blockchain technology. Many distributed ledger technologies (eg, Ethereum, IOTA, Cardana, Enjin, and Solana, just to name a few) allow developers to create custom tokens using their specific blockchain technology. A custom token created on a specific blockchain can take advantage of the underlying technologies, such as consensus determination, record keeping, smart contracts, etc. However, each distributed ledger technology has different processes and requirements related to creating these custom tokens. Microsoft’s patent describes a uniform process of creating (and presumably accepting) custom tokens across multiple different blockchain technologies, “help[ing] users develop blockchain applications by making it easier and more efficient to create crypto tokens for different distributed ledgers.”
• Bitcoin ATM operators forge Cryptocurrency Compliance Cooperative. On August 25, leaders in converting cash to cryptocurrency, including bitcoin ATM operators and blockchain analysis platforms, announced the formation of the Cryptocurrency Compliance Cooperative (CCC), a collaborative association created to bolster compliance standards and allow its members to “stay abreast of regulatory updates, new industry standards and research[,] … share best practices and learn how to … enforce deeper and more robust compliance protocols.” Organizations such as cash-based cryptocurrency MSBs, regulatory bodies, financial institutions, suppliers, non-governmental and law enforcement agencies, are encouraged to join the CCC.

ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Digital assets

• DOJ announces Ackerman pleads guilty to wire fraud. On September 8, the US Attorney for the Southern District of New York announced that Michael Ackerman pled guilty to wire fraud in connection with a fraudulent cryptocurrency investment scheme which raised $35 million from over 100 investors. Ackerman agreed to make restitution of at least $30,667,738.79; agreed to forfeiture of $36,268,515; and faces a potential maximum prison sentence of 20 years. Ackerman awaits sentencing. For more information on the complaint, see our March 2020 issue.

Virtual currency

• Cryptocurrency CEO sentenced to five years. On August 25, the Department of Justice (DOJ) announced that the inventor of cryptocurrency AriseCoin was sentenced to five years in prison for defrauding investors out of more than $4 million. Jared Rice, Sr., CEO of AriseBank, was also ordered to pay more than $4 million in restitution. Rice received the sentence as a result of his plea of guilty to one count of securities fraud in connection with lying to potential investors, claiming that AriseBank would be the world’s “first decentralized banking platform based on the proprietary digital currency AriseCoin and could offer consumers FDIC-insured accounts and traditional banking services.” AriseBank was not authorized to conduct banking in Texas and was not FDIC insured.

Securities

• SEC pursues BitConnect. On September 1, the SEC announced it launched an enforcement action against BitConnect, its founder, Satish Kumbhani, and certain promoters for their roles in defrauding investors of over $2 billion. According to the SEC complaint, beginning in January 2017, Kumbhani and BitConnect offered investors the opportunity to participate in a series of schemes or transactions that would purportedly give them the opportunity to earn daily interest payments by essentially tendering Bitcoin to BitConnect in return for “interest” payments, ie, the “Lending Program.” The investors transferred bitcoin to a wallet controlled by BitConnect and agreed to “lock up” such bitcoin for varying periods in return for payment of interest. BitConnect also held an ICO, selling BCC in 2016. The SEC claims that the sale of BCC and the “Lending Program” were securities and that BitConnect was running a Ponzi scheme. Given the focus on the allegations of fraud, the complaint has little relevance for our analysis except that the “Lending Program” has a surface resemblance to some of the DeFi projects which we have analyzed but with the major difference that BitConnect rather than the investors determined how the money was to be invested. It is also interesting that the SEC analyzes the Lending Program under the Howey test rather than the Reves test.
• BitConnect director pleads guilty. In a related matter, the DOJ announced on September 1, that Glenn Arcaro, director and promoter of BitConnect, pled guilty in federal court for his participation in fraudulently marketing BitConnect’s initial coin offering, digital currency exchange and trading bot. Arcaro admitted that he earned at least $24 million from the BitConnect fraud conspiracy, all of which he must repay to investors. Arcaro faces a maximum penalty of 20 years in prison, and a fine equal to $250,000 or twice the gross gain or loss from the offense, whichever is greater.
• SEC charges issuers and CEO in ICO. On September 8, the SEC announced it filed a complaint charging Rivetz Corp., Rivetz International SEZC, and Steven Sprague, President and CEO of Rivetz International, with conducting an unregistered offering of securities through an initial coin offering. According to the complaint, between July and September 2017, the defendants offered and sold digital tokens known as RvT tokens for the purpose of capitalizing Rivetz, and marketed RvT as an investment opportunity. The offering raised $18 million from investors and was not registered with the SEC nor did it qualify for an exemption from registration. The SEC seeks injunctive relief, return of ill-gotten gains plus prejudgment interest, and a civil penalty.
• SEC charges media companies with unregistered offering of digital asset securities. On September 13, the SEC announced charges against GTV Media Group Inc. and Saraca Media Group Inc. with conducting an unregistered offering of a digital asset security known as G-Coins or G-Dollars, as well as an unregistered offering of GTV common stock. According to the settlement order, the respondents received approximately $487 million from more than 5,000 investors. Without admitting or denying the findings, GTV and Saraca agreed to a cease and desist order, to pay disgorgement of more than $52 million plus prejudgment interest of nearly $2 million, and to pay a civil penalty of $5 million.

STATE

Securities

• California DFPI publishes opinion letters on Bitcoin ATMs. This past month, the California Department of Financial Protection and Innovation (DFPI) published two opinion letters (August 11 and September 1) concerning whether companies that operated a bitcoin ATM were acting as a money transmitter and required licenses under the Money Transmission Act (MTA). In each opinion letter, the company enabled customers to use the kiosk ATM to insert US dollars and direct the kiosk to send the bitcoin to the customer’s personal bitcoin wallet. The company did not hold virtual currency for the customer and sold bitcoin from its own inventory. The DFPI stated that because the company’s activities are limited to selling bitcoin, the company does not require an MTA license because it does not involve the sale or issuance of a payment instrument, the sale or issuance of stored value, or receiving money for transmission.
• New York AG obtains judgment against Coinseed. On September 13, Letitia James, New York Attorney General, announced a default judgment was entered against Coinseed, a virtual currency trading platform, and its CEO, granting a permanent injunction halting operations and establishing a permanent receiver to protect investors’ funds. The court also awarded a monetary judgment against the defendants in excess of $3 million. For more information on the case, see our May issue.
• Texas TSSB issues emergency cease and desist order against fraudster. On August 11, the Texas State Securities Board (TSSB) issued an emergency cease and desist order against Prestige Assets Mgnt, LLC and Oscar Hill, a resident of Iceland. According to the order, Prestige Assets and Hill misappropriated the identity of Prestige Asset Management, LLC, a registered investment advisor, to deceive clients while promoting securities digital asset investments. The TSSB also published an investor alert warning consumers about fraudulent actors impersonating registered and licensed firms.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

• BIS works with central banks to test CBDCs. On September 2, the Bank for International Settlements (BIS) Innovation Hub announced that it will join forces with the Reserve Bank of Australia, Bank Negara Malaysia, Monetary Authority of Singapore, and the South African Reserve Bank, as part of Project Dunbar, to test the use of central bank digital currencies (CBDCs) for international settlements. Project Dunbar “aims to develop prototype shared platforms for cross-border transactions using multiple CBDCs… eliminating the need for intermediaries and cutting the time and cost of transactions.”
• Cuban central bank to grant crypto licenses. On August 26, the Central Bank of Cuba reportedly issued a resolution asserting it may authorize the use of cryptocurrencies in commercial transactions and to license virtual asset service providers to conduct certain financial activities.
• Russian central bank presents strategy for financial market development. On September 13, the Ministry of Finance of the Russian Federation and the Bank of Russia reportedly presented a Strategy for the Development of the Financial Market until 2030 for public discussion. The Strategy reportedly states that “One of the key projects in digitalization until 2030 will be the launch of the digital ruble, which is the third form of money issued and guaranteed by the Bank of Russia. … The launch of the digital ruble will help to further develop the payment infrastructure, stimulate competition and procure innovative financial instruments, as well as make financial services cheaper and more easily available to individuals and businesses.”
• Singapore bank receives in-principle approval to provide digital payment services. On August 12, DBS Vickers, the brokerage arm of DBS Bank, announced it “has received in-principle approval from the Monetary Authority of Singapore (MAS) … to provide digital payment token services as a major payment institution.” According to the press release, “[o]nce licensed, DBSV, as a member of DBS Digital Exchange (DDEx), will be able to directly support asset managers and companies to trade in digital payment tokens through DDEx.”
• Thai SEC proposes new rules for digital asset custodians. On August 25, the Securities and Exchange Commission of Thailand (T-SEC) announced a public hearing on proposed amendments to the regulations on digital asset custody businesses, which includes keeping custody of fiat money and seeking benefits from the clients’ assets for the clients’ interest. The proposed amendments aim to enhance protection for digital asset investors. The regulations address custody of fiat money, custody of fiat money and digital assets, and seeking benefits from clients’ assets. Public comments must be delivered by September 22.

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• DLA Piper attorneys Michael Malloy, Ilya Bulgakov, Alexei Kolesnikov and Alexander Klochkov have contributed a chapter on Russia: Law and Practice to the Chambers Blockchain 2021 Global Practice Guide, published in summer 2021. The guide provides the latest legal information on decentralised finance; updates to tax systems to consider blockchain and cryptocurrencies; non-fungible tokens; initial coin offerings; smart contracts; data privacy and protection; and mining and staking.
• Listen to our podcast, Episode 1: Non-fungible tokens and their potential application in the financial services sector, featuring DLA Piper partner Anthony Lloyd and Macgregor Duncan, General Manager – Corporate & Business Development of Westpac and CEO of Westpac’s new digital bank.
• Listen to excerpts from the NACD Northern California Chapter’s program on How the Future of Blockchain will Impact the Boardroom Level Set, featuring DLA Piper partner Mark Radcliffe .
• You may also enjoy our podcast, FinTech: Cashless societies and post-pandemic growth, featuring DLA Piper partner Bryony Widdup and Tom Hambrett, Group General Counsel and Company Secretary of Revolut.