Enforcement and Litigation Developments
Craig Wright Faces Sanctions
Craig Wright, the self-proclaimed inventor of Bitcoin, has been tied up in litigation since February 2018 related to his partnership with the late David Kleiman. The case alleged that Wright worked to seize bitcoin owned by Kleiman after his death. On August 27, 2019, in response to plaintiffs’ motion to compel, a magistrate judge ordered sanctions against Wright for his “continued non-compliance” with court orders to provide information about Wright’s bitcoin holdings.
Many news reports are stating that the court ordered Wright to forfeit half of his bitcoin holdings. But the order is more nuanced than that. The sanctions at issue were issued under Federal Rule of Civil Procedure 37(b)(2)(A)(ii). If a party defies a court’s discovery order, which the court found Wright did, that section allows the court to sanction the defying party by resolving disputed factual issues against that party. And, here, the court resolved key disputed facts against Wright, namely that:
(1) Dr. Wright and David Kleiman entered into a 50/50 partnership to develop Bitcoin intellectual property and to mine bitcoin; (2) any Bitcoin-related intellectual property developed by Dr. Wright prior to David Kleiman’s death was property of the partnership, (3) all bitcoin mined by Dr. Wright prior to David Kleiman’s death (‘the partnership’s bitcoin’) was property of the partnership when mined; and (4) Plaintiffs presently retain an ownership interest in the partnership’s bitcoin, and any assets traceable to them.
The court stated that a lesser sanction would not be adequate because Wright “intentionally submitted fraudulent documents to the Court, obstructed a judicial proceeding, and gave perjurious testimony.”
The order does not actually resolve the plaintiffs’ claims against Wright. Instead, the Magistrate Judge ruled that certain facts favorable to the plaintiffs would be taken as established for purposes of the litigation. Similarly, the Magistrate Judge also ordered that several of Wright’s affirmative defenses would be stricken, or removed from the case, preventing Wright from pursuing them further. This order, if upheld by the District Court, will significantly increases the likelihood that plaintiffs will prevail in the litigation. However, because the order was issued by a federal magistrate judge, Wright can challenge the ruling before the district court judge presiding over the case in an attempt to have the order set aside, which Wright has indicated in court filings that he will do.
In issuing his sanctions order, the magistrate judge noted that the court was not required to decide, and was not deciding, whether Wright was the inventor of Bitcoin, or how much Bitcoin, if any, Wright currently controls. For purpose of the order, however, the court found that Wright’s claim that he has lost the ability to access the billions of dollars’ worth of Bitcoin he claims to have mined, and does not care, is “inconceivable.”
The case before the Southern District of Florida is: Kleiman v. Wright, No. 18-CIV-80176-Bloom/Reinhart.
Chase Files Answer to Crypto Fees Class Action
On August 22, 2019, Chase filed its answer to an April 2018 class action amended complaint that alleged that Chase Bank USA N.A. (“Chase”) breached its cardholder agreement when it charged fees for credit card purchases of cryptocurrency. Over a period of 10 days in January 2018, Chase charged cash advance fees for credit card purchases of cryptocurrencies instead of treating these as regular purchases of goods, and then subsequently blocked these types of transactions. Cash advance transactions carry additional fees and interest compared to regular credit card transactions. The proposed class action seeks refunds of the cash-advance charges, $1 million in statutory damages under the Truth in Lending Act, and an order declaring that Chase’s cardholder agreements do not impose cash advance charges on cryptocurrency purchases.
In its answer, Chase claimed that “Plaintiffs’ damages, to the extent they suffered any, are the result of their own conduct and/or the conduct of third parties over whom Chase exercises no control.” As an example, Chase argues that it changed its treatment of cryptocurrency purchases in January 2018 because the cryptocurrency exchange from which the purchases were made changed the merchant category code (MCC) for these transactions from “purchase” to “cash advances.” Further, Chase argues that cryptocurrency is “cash-like” because it is a medium of exchange, store of value, and method of payment, and therefore treating cryptocurrency purchases as “cash-like transactions” is appropriate under the terms of the cardholder agreement.
The case before the Southern District of New York is: Tucker v. Chase Bank USA, N.A., No. 1:18-cv-03155-KPF.
DOJ Brings First Federal Criminal Case Involving a Bitcoin ATM
The Department of Justice (“DOJ”) recently announced that a California man has agreed to plead guilty to criminal charges stemming from the defendant’s operation of an unlicensed money transmitting business where he exchanged up to $25 million in cash and virtual currency for customers, some of whom were criminals selling narcotics on the Darknet for Bitcoin. Some of these exchanges occurred at a Bitcoin ATM kiosk that the defendant admits he operated and that did not require customers to verify their identities. The DOJ characterized the matter as the likely the “first federal criminal case charging an unlicensed money remitting business that used a Bitcoin kiosk. According to the DOJ’s press release, the defendant agreed to plead guilty to felonies that included “operating an unlicensed money transmitting business, laundering of monetary instruments, and failure to maintain an effective anti-money laundering program.” The DOJ also announced that the defendant was agreeing to plead guilty to criminal charges in a separate matter in which the defendant is alleged to have been involved in a conspiracy to launder money for a drug trafficking network.
FINMA Issues Guidance on Blockchain Payments and Grants Licenses to Blockchain Companies
On August 26, 2019, the Swiss Financial Market Supervisory Authority (“FINMA”) released guidance on regulatory requirements for payments on the blockchain under FINMA supervision.
FINMA notes that its own regulatory environment complies with the Financial Action Task Force’s (“FATF”) digital asset regulation issued in June 2019, and discussed in this blog here. FINMA reiterates that blockchain businesses under FINMA’s supervision are subject to Switzerland’s Anti Money Laundering Act, and, as a result, must verify customer identities, apply a risk-based approach to monitoring for money laundering risks, and report suspicious activity identified on their platforms. In other words, laws that apply to payment orders effected through banking institutions apply equally to blockchain payments as they do to payments conducted through banking institutions.
FINMA’s guidance makes clear, however, that its anti-money laundering regulations are more stringent than FATF’s guidance. FATF’s guidance recommends that countries require that regulated entities pass along certain customer information to the next regulated entity when a customer initiates a payment transaction on a blockchain. FATF’s guidance only applies when the blockchain transaction is between addresses controlled regulated entities. It does not apply when the receiving address belongs to an unregulated entity.
FINMA notes that its regulations are more stringent than FATF’s guidance because they do not exempt blockchain payments between a FINMA-supervised institution and an unregulated wallet providers, even though FINMA recognizes that there is not yet a system by which regulated entities can reliably transmit identification data for payments on the blockchain. As a result, if a FINMA-supervised institution is not able to send and receive information required for regulated payment transactions, then those transactions may only be sent from and to external wallets if the external wallets belong to one of the institution’s own customers (including between different customers of the same institution). The customer’s ownership of the external wallets must be proven using suitable technical means.
Further, if a customer is conducting an exchange (fiat-to-virtual currency, virtual-to-fiat currency, or virtual-to-virtual currency) from or to an external wallet, the supervised institution must prove the customer’s ownership of the external wallet. In order to initiate transfers from or to external wallets belonging to a third party, a supervised institution must verify the identity of the third party, establish the identity of any beneficial owner, and prove the third party’s ownership of the external wallet through suitable technical means.
On the same day that FINMA issued its guidance, it also granted banking and securities dealers’ licenses to two blockchain companies – SEBA Crypto AG and Sygnum AG. SEBA Crypto AG plans on providing asset management with crypto custodial services and transaction services. Sygnum AG plans on providing wealth management and traditional banking services using blockchain technology.
European Central Bank Releases Stablecoin Paper
On August 28, 2019, the European Central Bank (“ECB”) released a research paper (called an “Occasional Paper”), titled “In search for stability in crypto-assets: are stablecoins the solution?”. The paper proposes a stablecoin taxonomy, discusses multiple market examples of stablecoins, and describes the role of stablecoins in the crypto-asset marketplace. The paper states that less innovative stablecoins in the marketplace seem to provide a solution for users seeking a stable store of value, but that it is not yet clear whether there is a future role for more innovative stablecoins outside their core user base.
The stablecoin taxonomy classifies stablecoins based on three key dimensions: “(i) accountability of issuer, (i) decentralisation or responsibilities, and (iii) what underpins the value of the asset.” To that end, the taxonomy provides for four types of stablecoins:
Tokenized funds – stablecoins that are backed by funds, which are held by an issuer or custodian for safekeeping.
Off-chain collateralized stablecoins – stablecoins “backed by other traditional asset classes” and, as a result, require a custodian.
On-chain collateralized stablecoins – stablecoins that are backed by decentralized assets, typically crypto-assets, and do not need an issuer or a custodian.
Algorithmic stablecoins – stablecoins whose operations are decentralized and not backed by an underlying asset.
China Central Bank to Issue Digital Currency
A recent report stated that China’s central bank intends to issue a state-backed digital currency called DC/EP (Digital Currency/Electronic Payments) to seven entities – three banks, the Industrial and Commercial Bank of China, the Bank of China, and the Agricultural Bank of China; three technology companies, Alibaba, Tencent, and Union Pay; and an association of Chinese banks.
The digital currency is designed to be used for payments currently managed in Renminbi, China’s fiat currency. Of note, unlike decentralized cryptocurrencies like bitcoin, the DC/EP is reported to be centrally managed by China’s central bank, which will control the digital currency’s supply.
The central bank has denied this report.
Portugal’s Tax Authority States that VAT Does Not Apply to Cryptocurrency
In a ruling issued by the Portuguese Tax Authority to a cryptocurrency mining company, the agency held that cryptocurrency transactions and payments are exempt from the Value Added Tax (“VAT”). The mining company sought clarification of the tax status in advance of an intended investment in cryptocurrency mining. According to the ruling, payment or remuneration with cryptocurrency is treated as exempt from VAT just as payment in “real” currency.