This is our sixth monthly bulletin for 2022, 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:
- Virtual currencies
- 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.
Bankruptcies begin for crypto firms as “crypto winter” settles in
The recent crash in cryptocurrency prices has erased nearly $2 trillion in market value and forced three large firms into bankruptcy proceedings in the United States Bankruptcy Court for the Southern District of New York (SDNY). These bankruptcy cases will likely present many novel questions related to the status of cryptocurrency under federal and state law. Read more.
Implementation of crypto reporting rules delayed
In November 2021, Congress passed the infrastructure bill containing the so-called “broker rules.” The broker rules require that crypto firms collect customer transaction data and was set to commence in 2023 with full reporting to occur in 2024 (for calendar year 2023). Recently, it has been reported that the IRS is considering a delay in implementing the reporting, although no official statement has been made or confirmed. Read more.
Pennsylvania and Washington enact rules explicitly bringing income from sales of non-fungible tokens (NFTs) within the sales’ tax base
Washington and Pennsylvania have become the first US states to address taxation of NFTs. Read more.
Chinese court rules in first NFT copyright infringement case
NFTs (non-fungible tokens) are probably the most popular digital asset to have emerged in the past two years. The creation and sale of NFTs have attracted a large number of artists, musicians, collectors and investors, with the sales of NFTs resulting in a billion-dollar marketplace. But the laws and regulations around this specific asset class are failing to keep up with the fast pace of development and fall short in addressing many key issues and controversies surrounding NFTs in traditional legal areas, notably in copyright law. Read more.
Stablecoin Transparency Act introduced in Congress
Senator Bill Hagerty (R-TN) has introduced a bill in the US Senate (S.3970) called the Stablecoin Transparency Act; Representative Trey Hollingsworth (R-IN) also introduced a companion bill (H.R.7328) in the House. Senator Hagerty stated, “this legislation aims to provide much-needed clarity without giving the keys away to unaccountable bureaucrats who threaten to choke off innovation.” If passed by Congress, the Stablecoin Transparency Act would be the first congressional statute to regulate stablecoins. Read more.
New European Markets in Crypto-Assets regulation
The European Council presidency and the European Parliament have reached a provisional agreementon the controversial markets in crypto-assets (MiCA) proposal. This regulation will bring crypto-assets, crypto-assets issuers and crypto-asset service providers (CASPs) under an EU-wide regulatory framework intended to protect investors and preserve financial stability. By being a “leader in regulation,” the EU also hopes that more legal certainty in the crypto sector will help fostering innovation. Read more.
Pentagon report finds vulnerabilities in blockchain. On June 28, a report commissioned by the Defense Advanced Research Projects Agency (DARPA) of the Pentagon concluded that the blockchain is not decentralized. The report, Are Blockchains Decentralized? Unintended Centralities in Distributed Ledgers, was issued by Trail of Bits, a security assessment and advisory services firm engaged by DARPA. According to the report, “a subset of participants can garner excessive, centralized control over the entire system” due to use of outdated code, unencrypted communications, only three ISPs for 60 percent of all bitcoin traffic, and lack of mining.
DOJ audit of Marshals Service’s management of seized cryptocurrency. On June 14, the Department of Justice (DOJ) Office of the Inspector General issued its Audit of the United States Marshals Service’s Management of Seized Cryptocurrency. The objective of the audit was to evaluate the US Marshals Service’s management of seized cryptocurrency over fiscal years 2017 through 2021. Among other findings, the audit report states that the Marshals Service faces challenges in the management and tracking of seized cryptocurrency and lacks documented operating procedures and important inventory management controls. The audit report provides seven recommendations to address these deficiencies.
SEC Commissioner speaks on crypto regulation. On June 14, SEC Commissioner Hester M. Peirce called for more cooperative and transparent regulation of the cryptocurrency ecosystem. “Watching the SEC refuse over the past four years to engage productively with crypto users and developers has prompted feelings of disbelief at the SEC’s puzzling, out-of-character approach to regulation,” said Commissioner Peirce in her statement. She further criticized the SEC’s reliance on enforcement actions in lieu of more comprehensive rulemaking, stating that “one-off enforcement actions that represent the first time the Commission has addressed a particular issue publicly, however, are not the right way to build a regulatory framework.” Commissioner Peirce concluded, “Regardless of what one thinks of crypto, it is in both investors’ and the SEC’s interest to take a more productive approach.”
DOT publishes paper addressing CBDC stability. On July 12, the US Department of the Treasury’s Office of Financial Research (OFR) published Central Bank Digital Currency: Stability and Information, a paper addressing central bank digital currencies (CBDCs). The paper studies how introducing a CBDC would affect the stability of the US banking system. The paper highlighted two countervailing effects: how depositor access to CBDCs leaves banks “less exposed to runs” and how monitoring the flow of funds into CBDCs “allows policymakers to identify and resolve weak banks sooner.” The “results suggest that a well-designed CBDC may decrease rather than increase financial fragility.”
DOT Fact Sheet on framework for international engagement on digital assets. On July 7, the Secretary of the Treasury, in consultation with the Secretary of State, the Secretary of Commerce, the Administrator of the US Agency for International Development (USAID), and the heads of other relevant agencies, delivered to President Joe Biden a framework for interagency engagement with foreign counterparts and in international fora as directed in the President’s Executive Order on Ensuring Responsible Development of Digital Assets (March 9, 2022). The framework aims to ensure that, with respect to the development of digital assets, America’s core democratic values are respected; consumers, investors, and businesses are protected; appropriate global financial system connectivity and platform and architecture interoperability are preserved; and the safety and soundness of the global financial system and international monetary system are maintained. The announcement also stressed the crucial role international cooperation among public authorities, the private sector and other stakeholders will play in order to maintain high regulatory standards.
DOT seeks comment on risks and opportunities presented by digital assets. On July 12, the DOT released a notice seeking public comment on the opportunities and risks presented by developments and adoption of digital assets as part of its work under Section 5 of President Joe Biden’s digital assets Executive Order. The request for comment period will close on August 8, 2022.
ENFORCEMENT ACTIONS AND LITIGATION
Yuga Labs sues for NFT intellectual property infringement. In one of the first lawsuits between NFT projects, Yuga Labs, Inc. sued two named individuals, Ryder Ripps and Jeremy Cahen, and others on June 24, for trademark infringement, false designation of origin, false advertising, cybersquatting, unfair competition, unjust enrichment, conversion and tortious interference. Yuga Labs is the creator of one of the most well known and successful NFT collections, known as the Bored Ape Yacht Club (a/k/a BAYC). The defendants started selling a similar collection of NFTs called RR/BAYC NFTs. The defendants use BAYC marks to sell their collection, frequently on the same platforms as Yuga Labs; they have sold over $3.5 million in NFTs and claim that their NFT collection is satire. We are likely to see more such lawsuits in the future.
FBI adds CryptoQueen to Ten Most Wanted list. On June 30, the FBI announced the addition of Ruja Ignatova to its Ten Most Wanted Fugitives list. Ignatova is being sought for her alleged leadership of a massive fraud scheme that affected millions of investors worldwide. The FBI is offering a reward of up to $100,000 for information leading to her arrest. Ignatova and her partner founded OneCoin, a Bulgarian-based company that was marketed as a new virtual currency that would be the “Bitcoin killer.” Ignatova allegedly made false statements and representations about OneCoin to draw people to invest in OneCoin packages. According to investigators, Ignatova and her partner also promoted OneCoin through a multi-level marketing strategy that urged OneCoin investors to sell additional packages to friends and family. OneCoin is believed to have defrauded victims all over the world out of billions.
DOJ announces enforcement action charging six persons with cryptocurrency fraud offenses involving more than $100 million in losses. On June 30, the US DOJ announced criminal charges against six defendants in four separate cases for their alleged involvement in cryptocurrency-related fraud, including the largest known NFT scheme charged to date, a fraudulent investment fund that purportedly traded on cryptocurrency exchanges, a global Ponzi scheme involving the sale of unregistered crypto securities, and a fraudulent initial coin offering. All investor victims of the Baller Ape Club, EmpiresX, TBIS, and Circle Society schemes are encouraged to visit this webpage to identify themselves as potential victims and obtain more information on their rights as victims, including the ability to submit a victim impact statement.
- Le Anh Tuan, a Vietnamese national, was charged with one count of conspiracy to commit wire fraud and one count of conspiracy to commit international money laundering in the Central District of California in connection with a scheme involving the Baller Ape NFT.
- Emerson Pires and Flavio Goncalves, both of Brazil, and Joshua David Nicholas, of Florida, were each charged in the Southern District of Florida with one count of conspiracy to commit wire fraud and one count of conspiracy to commit securities fraud in connection with a global cryptocurrency-based Ponzi scheme that generated approximately $100 million from investors. Pires and Goncalves also were charged with conspiracy to commit international money laundering. The indictment alleges that Pires and Goncalves, both founders of EmpiresX, along with Nicholas, the so-called “Head Trader” for EmpiresX, fraudulently promoted EmpiresX, a cryptocurrency investment platform and unregistered securities offering, by making numerous misrepresentations regarding, among other things, a purported proprietary trading bot and fraudulently guaranteeing returns to investors and prospective investors in EmpiresX.
- Michael Alan Stollery, of California, was the CEO and founder of Titanium Blockchain Infrastructure Services (TBIS), a purported cryptocurrency investment platform. Stollery was charged in an information filed in the Central District of California with one count of securities fraud for his role in a cryptocurrency fraud scheme involving TBIS’s initial coin offering, which raised $21 million from investors in the United States and overseas. As alleged, in order to lure investors, Stollery falsified TBIS white papers, planted fake testimonials on TBIS’s website, and fabricated business relationships with the US Federal Reserve Board and dozens of prominent companies to create the appearance of legitimacy.
- David Saffron of Nevada was the owner of Circle Society, a cryptocurrency investment platform. Saffron used Circle Society to solicit investors to participate in an unregistered commodity pool, which is a fund that combines investors’ contributions to trade on the futures and commodity markets. Saffron was charged in the Central District of California with one count of conspiracy to commit wire fraud, four counts of wire fraud, one count of conspiracy to commit commodities fraud, and one count of obstruction of justice.
Crypto advocacy center sues federal government on tax reporting. On June 11, Coin Center, a nonprofit research and advocacy center focused on cryptocurrency public policy issues, announced it filed suit against the US Treasury Department and others asserting that the amendment of Section 6050I of the US Tax Code was unconstitutional on its face. The amendment was part of the Infrastructure Investment and Jobs Act passed in 2021 and will require individuals and businesses who receive $10,000 or more in cryptocurrency to report to the government the name, date of birth and Social Security number of the person who sent those funds. The complaint alleges that this requirement violates the Fourth Amendment and the right of privacy by forcing people to collect highly sensitive information about others, and it violates the First Amendment by forcing politically active organizations to create and report lists of their donors’ names and identifying information.
CFTC charges South African pool operator with $1.7billion in bitcoin fraud. On June 30, the Commodity Futures Trading Commission (CFTC) announced the filing of a civil enforcement action charging Cornelius Johannes Steynberg of Stellenbosch, Western Cape, Republic of South Africa and Mirror Trading International Proprietary Limited (MTI), a company organized and operated under the laws of the Republic of South Africa, with fraud and registration violations in the CFTC’s largest fraud scheme case involving bitcoin. Steynberg created and operated, through MTI, a global foreign currency commodity pool that only accepted Bitcoin to purchase a participation in the pool, which was valued at over $1.7 billion. The CFTC seeks full restitution to defrauded investors, disgorgement of ill-gotten gains, civil monetary penalties, permanent registration and trading bans, and a permanent injunction against future violations of the Commodity Exchange Act and CFTC Regulations.
Federal court orders Texas man to pay more than $290,000 for digital asset pump-and-dump scheme. On July 18, the CFTC announced entry of a consent order for a permanent injunction, monetary sanctions, and disgorgement of ill-gotten proceeds against Jimmy Gale Watson of Dallas, Texas. The consent order resolves the claims against Watson in the CFTC action filed against Watson and John David McAfee on March 5, 2021 that alleged they engaged in a manipulative and deceptive digital asset “pump-and-dump” scheme. The order requires Watson to disgorge over $146,000 he received in ill-gotten gains from the scheme and also to pay an equal amount in a civil monetary penalty. The order also permanently prohibits Watson from engaging in further violations of the Commodity Exchange Act and CFTC regulations as charged, and it imposes registration and trading bans.
California DFPI investigating crypto-interest accounts. On July 12, the California Department of Financial Protection and Innovation (DFPI) announced it is investigating multiple companies nationwide that offer customers interest-bearing crypto asset accounts. A crypto-interest account allows customers to lend crypto assets to the company and, in exchange, receive interest paid in crypto assets. Due to market conditions, some of these companies are preventing customers from withdrawing from and transferring between their accounts. The DFPI is investigating whether other crypto-interest account providers are violating laws under the DFPI’s jurisdiction or whether the providers may not have adequately disclosed risks customers face when they deposit crypto assets onto these platforms.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
New transparency rules for transfers of crypto assets in the EU. On 29 June 2022, negotiators from the Council presidency and the European Parliament have reached a provisional agreement on transfer of funds (TFR) requirements that will apply to the transfer of crypto assets.
Despite industry concerns over the new rules harming privacy and innovation, this will introduce an obligation for crypto asset service providers (such as exchanges) to collect and make accessible certain information about the originator and the beneficiary of the transfers of crypto assets they operate. In particular, this will require that the full set of originator information travel with the crypto-asset transfer (“travel rule”), regardless of the amount of crypto assets being transacted. The legislator’s intention is to ensure financial transparency on exchanges in crypto-assets as part of the EU Anti-Money Laundering (AML) rules.
In addition, there will be specific requirements for crypto-asset transfers between crypto-asset service providers and un-hosted (self-custody) wallets. The new rules will not apply to mere transfers between un-hosted wallets.
The timetable for application of the amended TFR regulation is to be aligned with the MiCA regulation. But the now reached provisional agreement still needs to be confirmed by the Council and the Parliament before it can be formally adopted.