U.S. Developments

Regulation

Upcoming Bitcoin exchange-traded funds (“ETF”) Decisions

On January 4, 2018, NYSE Arca filed a proposed rule change to list 9 Bitcoin ETFs. Subsequently, the time for the Security Exchange Commission (“SEC”) to approve or disapprove was pushed back in March, April, July, and September. On August 22, 2018, the SEC disapproved the listings and the rule change. The following day, the SEC notified NYSE that it would be reviewing the ETFs pursuant to Rule 431 and staying the August 22 order. The ETF applications came from ProShares, Direxion, and GraniteShares.

On October 4, the SEC issued a corrected order saying that the window for filing statements of support or opposition to the disapproval of the Bitcoin ETFs would close on November 5. A final decision has not been made, but now that the November 5 deadline has passed, a decision could come at any time.

This set of applications is separate from the listing application for the VanEck SolidX Bitcoin Trust, which has been under scrutiny since the SEC originally rejected its listing in March 2017. A proposed rule change by Cboe BZX Exchange, Inc. in June 2018 to list and trade shares of SolidX Bitcoin Shares is currently under SEC consideration.

Please click here for the August 23 order. Please click here for the October 4 order.

Upcoming Plain English initial coin offering (“ICO”) Guidance

On November 5, SEC director William Hinman spoke to the D.C. Fintech Week conference about upcoming SEC “plain English” guidance on planning an ICO. The goal will be to allow token developers to determine on their own whether a potential token offering will be classified as a security. Hinman noted that this was a starting place, and that more rigorous guidance would be forthcoming. Additionally, the SEC’s new FinHub portal will continue to provide a deeper dive into SEC FinTech regulations and guidance.

Speaking to whether or not tokens will be classified as securities, Hinman noted that, based on one of the Howe factors, “If someone’s offering an instrument for money or other consideration to a third party, and that third party expects the offeror to generate a return or … something that will increase the value of the coin or token or whatever they want to call it, and there’s that expectation of return, we’re generally going to see that as a securities offering.” This could signal that the SEC will be taking a broad view of what makes certain tokens “securities,” if indeed investor expectation of a return will weigh heavily in the analysis.

CFTC Chairman Address at FinTech Conference

On November 7, CFTC Chairman J. Christopher Giancarlo spoke at George Washington University Law School during FinTech Week. He spoke about the need for the CFTC to be more agile in utilizing quantitative data analysis to pioneer what he called “quantitative regulation.”

More advanced trading markets can mean more efficiency and lower costs. Chairman Giancarlo noted that, “when paired with systems inspired by [distributed ledger technology] that standardize and distribute data to market actors—and even regulators—we begin to see a world where the majority of standard tasks are managed by machines.”

Distributed ledgers and smart contracts also have a home with regulators. “We can also envision the day where rulebooks are digitized, compliance is increasingly automated or built into business operations through smart contracts, and regulatory reporting is satisfied through real-time [distributed ledger technology] networks.”

With respect to usable “big data,” Chairman Giancarlo added: “Indeed, the forced standardization of data formats and fields and collective use of the system by multiple actors may prove to be some of the most compelling aspects of [distributed ledger technology]. . . . In many ways, [distributed ledger technology] and blockchain-inspired database systems may help move us to a 2.0 version of back-office computing infrastructure that paves the way for advances in automation and machine learning.”

Please click here for the transcript of the speech.

Litigation

SEC Charges EtherDelta with Operating Unregistered Exchange

On November 8, the SEC announced an enforcement action charging Zachary Coburn, founder of EtherDelta, for operating an unregistered national securities exchange. The SEC has previously brought enforcement actions against unregistered ICOs and unregistered broker-dealers.

EtherDelta is an online platform for secondary market trading of ERC20 tokens, which are tokens designed for the Ethereum platform. EtherDelta used a smart contract system to validate order messages, confirm terms, execute orders, and direct the distributed ledger to be updated. From July 2016 to December 2017, EtherDelta handled 3.6 million orders.

The SEC explained that Coburn caused EtherDelta to violate Section 5 of the Exchange Act because he “[1] wrote and deployed the EtherDelta smart contract to the Ethereum Blockchain, and [2] exercised complete and sole control over EtherDelta’s operations, including over the operations constituting the violations described [in the order].” The EtherDelta website “had features similar to online securities trading platforms” and provided a marketplace “for bringing together the orders of multiple buyers and sellers in tokens that included securities.”

Importantly, Zachary Coburn was charged under Section 21C(a) of the Exchange Act for causing EtherDelta to violate Section 5 of the Exchange Act by not registering as a national securities exchange. Charging under Section 21C(a) carries a lower burden of proof than, for example, aiding and abetting under Section 10(b), which generally requires proof of intent.

Please click here to read the order. Further analysis can be found here.

International Developments

UK Cryptoassets Taskforce: Final Report

The UK’s Cryptoassets Taskforce was formed in May 2018 with the goal of exploring the impact of cryptoassets, potential benefits and challenges of applying distributed ledger technology to financial services and assessing the need for regulatory responses. The Taskforce includes members from HM Treasury, the Financial Conduct Authority (“FCA”), and the Bank of England. They will be convening every 6 months to continue considering developments and review the UK’s approach to cryptoassets.

The Taskforce broke down its, and the UK government’s, response to cryptoassets into several categories:

• To help prevent financial crime, the UK government intends to broaden its application of the EU Fifth Anti-Money Laundering Directive (“5MLD”) so that cryptoasset-to-cryptoasset exchanges, peer-to-peer exchanges, cryptoasset ATMs, and wallet providers fall within Anti-Money Laundering/combating the financing of terrorism (“AML/CTF”) regulations. The UK government is also considering requiring firms outside of the UK to comply with these regulations when providing services to UK customers.
• With respect to cryptoasset derivatives, the FCA will consider prohibiting the sale to retail consumers of all derivatives referencing exchange tokens such as Bitcoin, including contract for differences (“CFD”), futures, options and transferable securities. However, this prohibition would not cover cryptoassets that are considered securities. The FCA also plans to not authorize or approve the listing of a transferrable security or fund that references exchange tokens unless the FCA is confident in the integrity of the underlying market.
• With respect to security tokens (or utility tokens), the FCA plans to consult on new guidance by the end of 2018. And with respect to Initial Coin Offerings (“ICOs”), the UK government will issue a consultation in early 2019, and it stands ready to draft legislation to put ICOs within FCA regulations.
• In early 2019, the UK government will issue a consultation about exchange tokens (e.g., Bitcoin) and related service providers (e.g., exchanges and wallets). Furthermore, the Taskforce emphasizes that it wants to take an international approach and coordinate with other jurisdictions.
• Finally, the Bank of England will continue to monitor linkages between cryptoassets and systematically important financial institutions in the UK, so that it can identify implications for financial stability in the future. Importantly, the Bank of England is working with HM Treasury to the widen regulatory reach of non-interbank payment systems (e.g., distributed ledger payment systems).

Please click here to read the report.

Swiss Risk Weighting for Bank Crypto Trading

A confidential letter from the Swiss Financial Market Supervisory Authority (“FINMA”) to EXPERTsuisse, a specialist association for Swiss trustees and accountants, has revealed the regulator’s internal view on cryptoassets risk. Although FINMA has not yet taken a public view on merging cryptoassets into Basel III capital requirements, they suggested in the October letter that financial institutions assign a flat risk weight of 800% to cryptoassets to cover risks. FINMA also wants a cap on crypto trading activities of 4% of total capital.

Although it makes clear that FINMA is wary of the stability of cryptoassets, it also means that Swiss banks are starting to broaden client services to include cryptoassets. In February, FINMA published guidance on ICOs. The Basel Committee met in September and discussed, among other things, banks’ exposures to cryptoassets and the risks such assets may pose. As the next Basel Committee meeting is scheduled for November 26 and 27, there may be more concrete guidance at that point.

Taiwan Amends Anti-Money Laundering Act to Regulate Virtual Currencies

On November 2, Taiwan’s Legislative Yuan passed an amendment to the country’s Money Laundering Control Act and the Terrorism Financing Prevention Act, giving Taiwan’s Financial Supervisory Commission (“FSC”) the power to require operators of virtual currency platforms to implement a “real-name system” requiring users to register their real names. Banks will also be required to report suspicious anonymous transactions to regulators. These rules are similar to those implemented earlier this year in South Korea and they follow the trend of weaving cryptocurrencies into regular financial regulations. In October, the chairman of the FSC announced the intention to draft regulations by mid-2019 to simplify the initial coin offering process.

Implementation of a real-name system has already happened at Bitoex, a crypto exchange that claims to control the lion’s share of the Taiwanese market. Importantly, the real-name requirements only apply when fiat currency is part of a transaction. Crypto-to-crypto transactions do not fall under the new rules.

Further amendments may come after evaluation by the Asia/Pacific Group on Money Laundering, which is reviewing Taiwan’s laws through November 16.

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