Blockchain Week in Review - August 2019 #2

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U.S. Regulatory

Kik Files Answer to SEC Complaint

On August 7, Canadian messaging company Kik Interactive Inc. (“Kik”) filed its answer to the U.S. Securities and Exchange Commission’s (“SEC”) complaint filed in the Southern District of New York.  In its 131-page answer, Kik argues for a narrow reading of the Howey test and maintains that the SEC has taken quotes out of context and misrepresented documents and testimony in its treatment of the facts in the complaint.

Kik responds to each of the allegations asserted by the SEC in its complaint, in turn, denying those that support the view that Kin tokens constitute securities under the Howey test and that Kik violated the securities laws in any way.  Kik maintains that, although the Howey test is a “flexible” standard, it is “far from limitless” and should not be broadly interpreted by the court.  In addition, Kik argues that the DAO Report should not be considered fair warning to Kik as a digital currency issuer because the facts are meaningfully distinguishable as a community currency.

To demonstrate that the SEC took quotes and statements out of context, Kik sets out many of the excerpts of quotes and documents in their full context in its response and provides contextual explanation.

Kik also rebuts the SEC’s characterization of the sale of Kin tokens as an effort to raise money to support a failing business.  The answer explains that Kik could have raised funds through traditional means but chose to issue Kin tokens as a “bold idea that could solve the monetization challenges faced by all developers (not just Kik) in the existing advertising-based economy, by changing the way people buy and sell digital products and services.”

Texas State Securities Board Issues Cease-and-Desist against “Forex and Bitcoin Trader”

On August 7, the Texas State Securities Board issued a cease-and-desist order to Forex and Bitcoin Trader (“FBT”), a New York–based trading firm promising substantial returns to Texas customers.  FBT represented that it was a “licensed broker authorized to trade in derivatives, securities, and foreign currency.”  The company marketed to investors through Craigslist and made several alleged misrepresentations to prospective investors, including claiming that it could offer investors a 900% return on their principal in 14 days through cryptocurrency trading.

New Jersey Bureau of Securities Issues Two Cease-and-Desist Orders in “Operation Cryptosweep”

On August 7, the New Jersey Bureau of Securities issued two cease-and-desist orders as part of a crackdown on cryptocurrency businesses.  The first business, Zoptax LLC, raised $3.4 million in an initial coin offering of Zoptax Coins to finance the development of a blockchain-based Voice Over Internet Protocol.  The second business, Unocall, had plans to sell Unocall Tokens to raise funds to develop a UNOpay Mobile Wallet and Decentralized Application.

Christopher W. Gerold, the Bureau Chief, is also the president-elect of the North American Securities Administrators Association (“NASAA”) and is conducting this crackdown on cryptocurrency businesses in coordination with NASAA’s “Operation Cryptosweep.”  In a public statement, Gerold noted that “[w]ith the price of Bitcoin increasing over the last few months and the announcement of Facebook’s Libra, there has been a sharp increase in public solicitations to invest in crypto-related products that appear on their face to be suspect.”  At least 85 enforcement actions have been brought as part of Operation Cryptosweep to date.  A complete list of the actions is available here.

U.S. Litigation

OneCoin Class Action Alleging $4 Billion Crypto Fraud Filed

A class of investors in cryptocurrency marketing company OneCoin Ltd. filed a complaint in federal court alleging that the company engaged in a $4 billion Ponzi scheme.  The complaint alleges that OneCoin defrauded investors in a Ponzi scheme whereby promotors would market to investors who would thereby invest funds that were used to pay out previous investors.  Each promotor would be rewarded for referring a new purchaser of OneCoin’s token.  However, the complaint alleges that the tokens were not issued on a distributed ledger and were therefore nothing more than book entries.  The complaint alleges that OneCoin misrepresented to its investors that the tokens were issued on a blockchain that did not exist.

Federal prosecutors have separately brought fraud charges against the founders of OneCoin, Ruja Ignatova and Konstantin Ignatov.

Court Allows Bitcoin Cash Listing Lawsuit Against Coinbase to Move Forward

A Northern District of California court rejected Coinbase’s motion to dismiss the negligence claims brought by plaintiffs alleging fraud and insider trading in connection with the listing of Bitcoin Cash on Coinbase.  In addition to negligence, the plaintiffs had claimed that Coinbase engaged in insider trading of Bitcoin Cash prior to its listing of the digital asset, resulting in a price surge in the leadup to the listing.  The court dismissed the insider trading claim due to a lack of causation given the volatility of digital assets.  Furthermore, the court dismissed Coinbase’s motion to move the case to arbitration and therefore the negligence claims will proceed in federal court.

The plaintiffs will need to demonstrate that Coinbase had a duty to maintain an orderly market and was negligent in listing Bitcoin Cash on its exchange, which resulted in damage to the plaintiffs.  The judge views Coinbase’s choice to halt trading within three minutes of the Bitcoin Cash listing as “indicative of dysfunction” and potentially in violation of a duty of trust owed to traders that Coinbase “encouraged traders to enter the market” by promoting the listing.  It is worth noting that the California negligence standard will be considered in this case.

Industry

CME Group to Incorporate Gemini Exchange Data into its Digital Asset Indices

CME will be obtaining market data from Gemini, a digital asset exchange, to bolster its Bitcoin and ether reference rate and real-time indices, which also incorporate data from Coinbase, Bitstamp, Kraken, and itBit.  The addition of Gemini data is the result of a decision by CF Benchmarks, the provider of the reference rates to CME Group, to expand the number of exchanges that it collects data from to include Gemini.  CME hopes that the addition of Gemini data will “capture wider market participation and increase the robustness of the pricing indices at a time when customers are increasingly using our Bitcoin futures to trade and manage underlying spot market price risk.”

International

Countries Collaborate to Establish a Global Digital Asset Monitoring System

Around 15 countries, including Singapore, Australia, and several members of the G7, have  joined forces to establish a system to monitor digital asset transactions for money laundering and terrorism financing.  The Financial Action Task Force (“FATF”), an international anti-money laundering body comprised of 30 countries, plans to  design the system before turning it over to the private sector.  The countries aim to have the system completed by 2020 and implemented a few years later.

South Korea Announces a “Regulation-Free Zone” for Blockchain Development

The South Korean government has declared the city of Busan to be a “regulation-free zone” for blockchain development.  Blockchain businesses operating in Busan will receive relief from 11 regulations that would otherwise be applicable to the businesses.  Busan is among six other jurisdictions in South Korea that received “regulation-free zone” status for various commercial purposes.  Several companies plan to test blockchain technology within the sandbox environment, including Busan Bank, Hyundai Pay, and BPN Solution.

Seychelles Stock Exchange Lists a Security Token

The MERJ Exchange of the Seychelles became the first stock exchange in the world to list a tokenized security for trading this week.  The exchange listed the MERJ-S token, based on the Ethereum blockchain, which represents equity in the MERJ Exchange.  MERJ views the token as a means to minimize costs for investors and issuers of digital assets because it will enable MERJ to streamline numerous processes, such as issuance, shareholder registers, compliance, distribution, and voting.

British Tax Authority Demands Data from Digital Asset Exchanges

HM Revenue & Customs, the British tax authority, is demanding that digital asset exchanges provide customer information to assist it in investigating unpaid taxes.  The authority sent letters requesting the information to at least three exchanges to date, Coinbase, eToro, and CEX.IO, in the past week.  It has indicated that it is only reviewing data dating back three years at this time.  The authority is following in the footsteps of the U.S. IRS, which began sending warning letters last month to persons who did not properly report their virtual currency transactions.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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