Blockchain Week in Review - February 2020

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Weekly Focus

  • SEC Commissioner Proposes Safe Harbor for Token Offerings
  • Crypto Company Must Place Investors Back in Their Pre-Investment Position
  • American Council on Education to Explore Blockchain Optimization
  • Two Men Charged in Crypto Ponzi Scheme
  • Australia to Launch Blockchain Roadmap
  • Telangana, India To Launch Blockchain Incubator
  • Bermuda to Explore Digital Currency Payment System

U.S. Developments

SEC Commissioner Proposes Safe Harbor for Token Offerings

In a speech on February 6th at the International Blockchain Congress in Chicago, Securities and Exchange Commission (“SEC”) Commissioner Hester Peirce outlined an informal proposal for a new safe harbor for token projects, which has been labeled “Rule 195.”

The SEC previously recognized that, though a token may initially have the hallmarks of a security, tokens, and the associated network, may mature over time such that the tokens mutate into non-securities.  However, this analysis results in an ambiguous gap in time before the token has utility and puts startups in a difficult position where they cannot achieve sufficient decentralization and functionality until they distribute tokens that the SEC may qualify as securities at the time of launch.

Commissioner Peirce’s proposal attempts to address this risk to blockchain projects while at the same time protecting purchasers from fraud.  Though the proposal remains a work in progress, Rule 195 contemplates a three-year grace period, after which the exemption would expire, and requires disclosures relating to source code, transaction history, token economics, the development roadmap, among others.  Rule 195 would not be available if teams did not comply with other private sale offering requirements in advance of the launch.  Interestingly, the proposal requires that development teams commit to creating liquidity for users, which Commissioner Peirce noted is “necessary both to get tokens into the hands of people that will use them and offer developers and people who provide services on the network a way to exchange their tokens for fiat or crypto currency.”

If adopted by the majority of the SEC’s commissioners, Rule 195 would address longstanding regulatory uncertainty in the U.S., which remains the primary issue for companies working in the cryptocurrency and digital asset industry according to The Block report published last week.  However, Rule 195 needs to be submitted to and go through the SEC’s formal process and important questions remain, such as what will happen if a token does not reach sufficient decentralization by the end of the grace period.  Though we do not expect a formal safe harbor to become available anytime soon, Commissioner Peirce’s proposal is a welcome step forward in this critical discussion.

The full text of Commissioner Peirce’s speech can be read here and, for more coverage of Commissioner Peirce’s speech and Rule 195, click here, here, and here.

Crypto Company Must Place Investors Back in Their Pre-Investment Position

On December 13, 2019, a judge in the U.S. District Court for the Southern District of Florida granted investors’ motion for default judgment against Centra Tech Inc. (“Centra”), awarding the plaintiffs approximately $3 million.  Centra moved for reconsideration of the damages, claiming that the plaintiffs should receive roughly $183,000.

The plaintiffs invested digital currencies in the company in 2017.  In determining the value of their investments in U.S. dollars, however, the plaintiffs used the highest, subsequent price of each digital currency.  Centra argued that the value of each investment should be calculated at the time each investor purchased their respective cryptocurrencies.  Counsel for the company also argued that the price of cryptocurrencies has fallen since their peak and that it would be “nonsensical” to calculate damages based on hypothetical scenarios.

On February 4th, the court declined to reconsider the damages awarded to the plaintiffs.  The judge noted that the basis for Centra’s motion “is that the court should calculate damages using the dollar value of the cryptocurrency originally paid by each plaintiff… [t]he plaintiffs, however, did not use U.S. dollars to pay for the [tokens] and this measure of damages would not place investors back in their pre-investment position.”

The company’s motion for reconsideration did not refer to contractual provisions relating to the treatment of currencies other than U.S. dollars and, regardless of the court’s decision in this case, companies should confirm whether their own investment agreements contain such provisions when accepting digital currencies.

For more information regarding Centra’s motion and the court’s decision, click here and here.  As previously reported here, Centra is also the subject to an SEC securities fraud action and to criminal prosecution in New York.

American Council on Education to Explore Blockchain Optimization

The American Council on Education (“ACE”) announced on Thursday that it received funding to support an initiative exploring the use of blockchain technology in education.  ACE is forming the Education Blockchain Initiative to “identify and evaluate ways that blockchain technology can improve the flow of data among educational institutions and employers while empowering individuals to translate educational outcomes into economic opportunity.”

According to ACE and the Department of Education, creating “seamless transitions between and across K-12, higher education, and the workforce” and the “ability to demonstrate skills and knowledge is key to translating education into economic opportunity.”

For more information regarding the initiative, click here.

Two Men Charged in Crypto Ponzi Scheme

On January 30th, John Michael Caruso and Zachary Salter, the founders of Zima Digital Assets (“Zima”) were arrested and subsequently charged with conspiracy to commit wire fraud and money laundering in the U.S. District Court for the District of Arizona.

The complaint alleges that Messrs. Caruso and Salter (the “Defendants”) defrauded investors, who thought that they were investing in a private cryptocurrency fund of at least $7.5 million.  The complaint goes on to allege that, instead of reinvesting the funds as promised, the Defendants used the funds to make extravagant purchases, to gamble and, what is more, bragged about such activity on social media.

Though the complaint is interesting for numerous reasons, including the alleged fraud against major league baseball players and the brazen nature of the Defendant’s reported activities, the broad scope of the government’s investigation highlights the government’s interest in pursuing fraud in the industry.  The investigation leading up to the arrest included in-person surveillance of the Defendants, forensic accounting, a review of publicly available social media, and, after obtaining warrants, a review of private social media accounts and bank records.

The full text of the complaint can be found here.

International Developments

Australia to Launch Blockchain Roadmap

Australia is set to launch its national strategy for the country’s use of blockchain technologies on Friday.  The government believes that the five-year roadmap will lay an important groundwork for the technology’s use and development in an industry worth up to approximately US $175 billion.  The roadmap describes a collaborative relationship between industry and the government, though the government has not yet allocated funding to execute on the concepts in the plan.

More reporting on the roadmap can be found here.

Telangana, India To Launch Blockchain Incubator

The southern Indian state of Telangana is reportedly launching several blockchain-related initiatives, including the creation of a blockchain accelerator called “T-Block.”  The local government is pursuing blockchain solutions to civic issues and expects to take a position as an industry leader within the country as a result of these programs.

Click here for more coverage on the developments in Telangana.

Bermuda to Explore Digital Currency Payment System

In an interview on February 2nd, Denis Pitcher, the chief financial technology adviser to the Premier of Bermuda, explained his proposal for a Bermuda platform that would let the island’s residents pay for government services using digital currency.  Mr. Pitcher explained that, by accepting such currencies, the government hopes to connect Bermuda to the global financial ecosystem, which often ignores and excludes the island and its relatively small population.

Additional coverage of Mr. Pitcher’s interview can be found here.

[View source.]

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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