Blockchain Transport Applications, Public Sector Initiatives, Protocol and Market Developments
By: Diana J. Stern and Simone O. Otenaike
Transportation, oil and gas industry players have put the pedal to the metal to push blockchain pilots. According to reports, the Abu Dhabi National Oil Company (ADNOC) is working on a blockchain-based system that automates the accounting process for oil and gas production from end to end. In addition, Maritime Blockchain Labs has announced plans to further develop its blockchain-based platform for tracking marine fuel quality and quantity assurance, with the goal of facilitating data-driven decision-making and alleviating industry-wide pain points. National Transport Insurance, a truck and transport insurer, is taking part in a trial to improve food safety, better animal welfare and monitor exports by leveraging blockchain technology, innovative packaging and IoT systems to secure supply chain provenance for Australian beef. Finally, State Farm is testing whether blockchain technology can streamline the manual process of subrogation, the legal right to seek damages from a third party responsible for a loss suffered by the insured.
In the public sector, the U.S. Department of Homeland Security is soliciting applications for a funding program that provides blockchain startups and small businesses with the opportunity to receive grants of up to $800,000 for the development of anti-counterfeiting solutions. At the state level, Vermont’s Attorney General has established a working group to study blockchain technology by engaging with stakeholders, associations, industry experts and state agencies. On the international front, UNICEF’s Innovation Fund will invest up to $100,000 in six companies selected from more than 100 applications to fund open-source blockchain prototypes aimed at solving global challenges such as transparency in healthcare delivery and access to mobile phone connectivity. Early this week, the European Union Blockchain Observatory & Forum published a report that sets out use cases, advantages and challenges for deploying blockchain technology in government and public service applications – urging that experimentation needs to continue and that digital identity and blockchain-based central bank digital currencies (CBDCs) are fundamental building blocks.
Last Friday, Ethereum core developers agreed to launch the Constantinople hard fork (Constantinople) at block 7,080,000. Constantinople incorporates five separate Ethereum Improvement Proposals that soften Ethereum’s transition from proof-of-work (PoW) consensus to a more energy-efficient proof-of-stake (PoS) consensus algorithm. This upgrade to a PoS consensus algorithm has the potential to fundamentally change the Ethereum blockchain system. Meanwhile, earlier this week, Hyperledger announced that 16 more organizations have joined its project as general members and four as associate members. According to a leading accounting firm, the price of bitcoin is down more than 80 percent from its December 2017 high, the total market value of all cryptocurrency has fallen 87 percent from its early January high, and about 86 percent of the ICOs from 2017 are trading below their listing price while 30 percent have lost nearly all of their value. According to reports, these market declines are causing investors to put pressure on crypto-based and blockchain-based enterprises to produce revenue-generating products.
A major online retailer’s investment arm may soon become its core business. Yesterday, the retailer’s founder announced that the publicly traded company is seeking to sell its flagship retail site by February and keep its portfolio companies, many of which have business models based on blockchain. These include the security token trading platform tZERO, enterprise technology provider Symbiont, voting application Voatz, lending startup Ripio and data managing platform Factom, among others.
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Capital Markets Initiatives Continue as US Congress Issues New Research and Two New Bills
By: Jonathan D. Blattmachr
This week brought a slew of developments in the block and crypto capital markets space, largely in Europe. In Germany, solarisBank is working with the Boerse Stuttgart Group to create full-spectrum infrastructure for digital assets. The two entities are seeking to launch a crypto trading venue by the first half of 2019, with bitcoin and ether initially available for trading and an eye toward providing a platform for ICOs and secondary market trading for tokens. Blockchain consortium R3 has partnered with several major European banks to produce live commercial paper transactions, which follows a simulated transaction conducted last year. The program aims to cut inefficiencies from current models. The Gibraltar Stock Exchange subsidiary is now providing insurance coverage for crypto assets (both online and offline) traded on the Gibraltar Blockchain Exchange. This makes the Gibraltar Blockchain Exchange at least the third digital exchange offering such insurance, but coverage remains insufficient to cover all trades made daily worldwide. To quell concerns that its stablecoins may not be backed one-to-one with euros, Malta-based Stasis has hired an outside auditor to provide assurance to investors. In October, similar concerns led to Tether’s USDT tokens losing parity with the dollar. Outside Europe, a major South Korean bank announced it will begin blockchain recordkeeping to reduce human error and increase efficiency.
While bipartisanship can feel unfathomable these days, congressmen from different sides of the aisle have introduced two bills focused on cryptocurrency market manipulation. The lawmakers say the proposed legislation will help shape regulations that will also promote competitiveness. The Congressional Research Service (CRS), which operates for and under the direction of Congress, has issued a report on cryptocurrencies, economics and policy issues. The CRS report notes that cryptocurrencies’ “role and value … remain highly uncertain,” largely because of functionality questions. The report also notes cryptocurrency-related concerns about consumer protections, proper regulatory schemes, potential facilitation of crime and the effect on monetary policy. CRS also wrote that central bank digital currencies could provide certain benefits, including allowing individuals to have accounts at central banks, which could improve systemic stability and cause commercial banks to offer interest rates to entice customers.
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Blockchain Payments Networks Evolve, New Cryptocurrency Exchange Lands in US
By: Joanna F. Wasick
Financial services firms in the Middle East, Europe and Asia continue to build on cryptocurrencies’ ability to facilitate domestic and cross-border payment transactions. According to reports, the United Arab Emirates’ (UAE) central bank and the Saudi Arabian Monetary Authority are collaborating to issue a cryptocurrency that will be used exclusively by banks for transactions between the two countries. In Germany, cryptocurrency payments startup Bitwala and German fintech startup solarisBank are reportedly launching a banking system that enables users to manage bitcoin and euro deposits in one place, with the same services, safety and convenience of a traditional German bank account. In Asia, Coinone Transfer, a subsidiary of Coinone, recently introduced Cross, South Korea’s first blockchain-based remittance app and web service, which can be used regardless of whether the user has a bank account. Cross is enabled by RippleNet, blockchain technology from U.S. startup Ripple, and is being launched with support from the Siam Commercial Bank in Thailand and Cebuana Lhuillier in the Philippines. The UAE Exchange and Ripple announced plans to launch another cross-border remittance service in Asia by the first quarter of 2019.
On the domestic front, Amplify Exchange has announced plans to open U.S. operations in Knoxville, Tennessee. Amplify Exchange reportedly operates on a decentralized internet system enabled by its sister company, Substratum, and allows users to access the internet privately and irrespective of certain government use restrictions. Also reflecting a premium on privacy, Mastercard recently applied for a patent on a system that obfuscates the point of origin and amount of certain cryptocurrency transactions. In other payments news, U.S.-based cryptocurrency exchange Kraken, following a recent valuation of $4 billion, is reportedly preparing for an initial private offering targeted to high-net-worth investors.
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SEC Achieves Settlements, FATF Evaluates UK, Regulator Actions in Denmark and New Zealand
By: Marc D. Powers
The SEC was successful this week in two enforcement settlements. It obtained an order from a federal court in Texas requiring the former CEO and COO of AriseBank to pay $2.7 million to settle registration and anti-fraud violations. The case arose from the ICO of AriseCoin, where AriseBank executives falsely claimed their company was a first-of-its-kind decentralized bank offering a variety of cryptocurrency-related services. As part of the settlement, the executives agreed to an Officer and Director bar. The former CEO was criminally charged for the same conduct shortly before the settlement was finalized. In another settlement, CoinAlpha Advisors LLC (CoinAlpha) settled registration violation charges when it agreed to return $600,000 raised from 22 investors from several U.S. states. The SEC alleged that CoinAlpha engaged in a general solicitation of unregistered securities and took no reasonable steps to ensure only accredited investors purchased interests in its fund.
Also this week, in a class action alleging sales of unregistered securities related to an ICO, a district court denied the defendants’ motion to dismiss, finding the defendants were unable to demonstrate that the tokens subject to the lawsuit were not “investment contracts” subject to SEC registration requirements. In a voluntary action, a well-funded startup, Basis, announced that it would return its funding to investors and cancel its project to build a stablecoin that would maintain a stable price based on algorithmic functions. As reported by Forbes, Basis decided to cancel the project after a meeting with the SEC left the company and its lawyers believing that the proposed stablecoins would be deemed unregistered securities. In another item of note this week, the CFTC published a request for information seeking public comment and feedback on the underlying technology, opportunities, mechanics, use cases and markets related to Eether and the Ethereum Network to benefit its LabCFTC, created in May 2018.
In international news, a new report was published last week by the Financial Action Task Force (FATF) that evaluated anti-money laundering and counter-terrorist financing (AML/CFT) measures in place in the United Kingdom. The report pointed out that “virtual currency exchange providers are not yet covered by AML/CFT requirements” and cited this as an “emerging risk.” The report also stated that “there is not yet evidence to suggest that broad scale ML/TF is occurring in the UK through this relatively small sector.” According to another recent report, Denmark has identified 2,700 individuals that it claims owe substantial taxes on bitcoin profits from 2015 to 2017. Meanwhile, New Zealand has blacklisted three more cryptocurrency platforms as scams. Harking back to the days of Mt. Gox, prosecutors in Japan are seeking a 10-year prison sentence for Mark Karpeles, who they claim stole $3 million from customer accounts in late 2013, months before the exchange collapsed in the wake of a hack. In a recent cybersecurity incident, hackers reportedly have set in motion a massive campaign that scans for internet-exposed Ethereum wallets and mining equipment, stealing the ether. Finally, a Dec. 12 blog post from the University of Oxford noted that an interesting precedent may have been set in a recent Canadian court case, where the court ordered a substantial amount of ether to be returned to the plaintiff after the plaintiff demonstrated, using blockchain analysis, that the ether had been transferred in error.
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Tax Analysis: Securitized Tokens Backed by Real Property or Other Assets
By: Roger M. Brown and Heather K. P. Fincher
In October 2018, an asset management company, Elevated Returns, reportedly raised $18 million through securitized tokens backed by commercial real estate. Other asset managers are thinking of similar token issuances.
Many investors in such token issuances may think the asset they hold is a new token. However, the U.S. tax law likely would treat the investors in these types of token issuances as owning an interest in the underlying real estate. This can be important for a number of reasons, including where a token holder is not a U.S. tax resident.
In such an instance, the investor not only may be subject to U.S. tax on the sale of a token but also may be required to comply with special tax rules applicable to transfers by a non-U.S. resident of a U.S. real property interest. Moreover, under these rules, the purchaser of the token could be responsible for withholding and depositing with the IRS 15 percent of the proceeds they transfer to the seller. Special tax filing obligations can also apply to the non-U.S. resident, and certain pre-certifications may be needed prior to any sale – regardless of whether the token seller is a U.S. or non-U.S. person.
These results are generally different from the normal rules that would apply to a sale of a token, such as bitcoin or ether. In other words, the federal and state tax consequences on the sale of a token may vary based on whether and what assets back a particular token. Similar rules may apply in other countries, as well, where the real estate or other assets backing the token are outside of the United States.
