The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law.
The Bi-Weekly updates took a break during the holiday season, but the Web3 developments did not. It was a busy month in both litigation and regulatory changes, including what is expected to be a wave of approvals for various spot bitcoin exchange traded funds which will make exposure to bitcoin as a store of value more available to institutional and other investors. It is possible that by the time this is posted the first round of approvals will be granted which we will cover in the next Bi-Weekly installment.
These developments and a few other brief notes are discussed below.
Mango Markets “Profitable Trading” Strategist Loses Early Dismissal Bid: December 18, 2023
Background: Avraham (“Avi”) Eisenberg lost on his Motion to Dismiss the criminal Complaint against him regarding his October 2022 exploit of the Mango Markets trading protocol. The Order is available here. Avi is facing criminal charges of commodities fraud, commodities manipulation and wire fraud. The Court specifically rejected Avi’s Major Question defense, stating “Eisenberg cites no authority for applying the major-questions doctrine in the context of a single criminal case.” It went on to hold, though, that “this denial is without prejudice to Eisenberg raising his arguments by way of a Rule 29 motion for judgment of acquittal after the close of the government’s evidence…”
Summary: As you may remember, in October of 2022, Avi used what he referred to on Twitter as a “highly profitable trading strategy,” using a combination of leveraged trades which resulted in the protocol (Mango Markets) becoming insolvent. This case will determine important issues going forward on what level of human interaction is needed for “wire fraud” in a protocol exploit like this, where the main fraud is being perpetrated against an algorithm. While the Court denied dismissal at the Motion to Dismiss stage, it also demonstrated in its Order the need to see additional facts to resolve disputed issues which isn’t proper at this stage in litigation but may be proper later. The development company behind Mango Markets is also having its own regulatory issues in the fallout from the events leading up to the aforementioned criminal prosecution.
Elizabeth Warren Sends Letter to Trade Associations Who Oppose Her Bill: December 18, 2023
Background: Elizabeth Warren sent a letter to the Blockchain Association, Coin Center and various advocacy groups “regarding a troubling new report that your association and other crypto interests are ‘flexing a not-so-secret weapon: a small army of former defense, national security and law enforcement officials.’” Sen. Warren’s letter requests further information on the employment of former government officials by digital asset advocacy groups and industry participants.
Summary: It is disheartening that a sitting Senator would send a threatening letter demanding information she has no legal right to regarding former government officials working at advocacy organizations after leaving government. Especially considering her former staffer just left the Whitehouse to go to work directly with an advocacy group that previously lobbied him while in his official capacity. Coin Center’s official response was well put: “Engaging like-minded experts to advocate against legislative proposals that one sincerely believes are unconstitutional and detrimental to the nation's welfare does not constitute 'undermining bipartisan efforts in Congress.' Rather, it is the exercise of the fundamental right to freely associate and petition the government. It’s everyone’s right and no one should apologize for doing it. Resorting to questioning motives often reflects an inability to prevail on the merits of an argument itself.”
SEC Wins (Mostly) in Terraform Labs Case: December 28, 2023
Background: The SEC was granted summary judgment against Terraform Labs regarding the SEC’s allegation that the UST, LUNA, wLUNA and MIR tokens are investment contracts under the Howey test while being a bit more nuanced about the UST stablecoin and leaving the possibility open that the investment contract is UST in conjunction with the protocols that allowed it to earn interest. Terraform Labs was granted summary judgment dismissing the SEC’s allegations that it engaged in illegal security-based swaps. The issue of whether Terraform Labs’ actions constitute fraud was left for trial.
Summary: The Court held that LUNA and MIR were securities, in large part due to statements from founder Do Kwon indicating that LUNA purchasers were effectively putting their money in a common enterprise with expectations of profits from the efforts of Terraform Labs and Kwon. However, the Court also ruled that Terraform’s Mirror Protocol, which allowed users to mint “mAssets,” mirroring real-world assets on the blockchain, were not security-based swaps under the law. Interestingly, the Court did not even cite Judge Torres’ Ripple ruling, despite previously being critical of it on Motion to Dismiss.
2024 Crypto Tax Reporting Unclear Under Infrastructure Investment and Jobs Act: January 1, 2023
Background: The Infrastructure Investment and Jobs Act, which passed Congress in November of 2021, included a provision amending the Tax Code (“6050I”) to require anyone who receives $10,000 or more in cryptocurrency in the course of their trade or business to make a report to the IRS about that transaction. The law became effective as of January 1, 2024, leaving many unclear as to their reporting obligations. Coin Center filed a lawsuit challenging the law in the summer of 2022 and has posted its current thoughts about it here.
Summary: Jason Schwartz had a great thread breaking down the reporting obligations. He and others have reported that the IRS appears to believe that the 6050I reporting requirement doesn't come into effect for crypto until after regulations are issued. This also only applies to receipts of one or more related transactions that were received in business and amount to over $10,000. So, 10,000 people buying a jpg for $100 each is not something that should trigger reporting obligation, nor is most day trading, even at a large scale. Additionally, failure to file is a $50 fine unless intentional (and hard to say it would be intentional here in most cases without clarifying rules). In the meantime, at a minimum, we think it would be prudent to maintain accurate books and records while awaiting further guidance from the IRS or for a market practice to develop.”
Briefly Noted:
There Will Be No Second Sam Bankman-Fried (“SBF”) Criminal Trial: It looks like there will not be a second SBF trial. Charges on campaign finance fraud would not have looked great and could have had collateral effects on the level of trust in our political and judicial system. That said, SBF is most likely going to jail for at least the next decade or two on his existing convictions, so having another trial on matters that would be much more difficult to prove likely would have been a waste of time and resources.
BarnBridge DAO Settles with the SEC: BarnBridge DAO, which you may remember had an attorney purporting to represent the DAO post in their Discord about the SEC investigation and had a DAO vote on how to respond to the investigation, settled with the SEC last week. This is an interesting case study in response of DAOs to criminal and civil investigations. Interestingly, the settlement raised the issue of possible registration under the Investment Company Act for the first time since the Blockfi Settlement.
Conclusion:
The latest updates in blockchain law reveal a dynamic and evolving intersection of blockchain technology, regulation and legal challenges. From the significant developments in the Mango Markets criminal case to the intriguing nuances of the Terraform Labs ruling, these stories underscore the complexities facing the blockchain and crypto industries. Senator Elizabeth Warren's recent actions and the ongoing ambiguity in crypto tax reporting further highlight the intricate dance between innovation and regulation. As we anticipate further developments, particularly regarding the impact of these events on institutional investment in cryptocurrencies, it's clear that the landscape of blockchain technology and law remains as vibrant and challenging as ever.
