Blockchain Week in Review - July 2019

Perkins Coie

Perkins Coie

U.S. Developments

Regulatory Developments

SEC and FINRA Issue Joint Statement on Digital Asset Custody Issues

On July 8, 2019, the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) (collectively, “the Staffs”) issued a joint statement addressing questions each has received from market participants regarding proper custody of digital assets under both federal securities laws and FINRA’s rules.

The joint statement highlights the importance of the Customer Protection Rule to protect investors from loss of assets and to help the SEC monitor for potential fraud. The joint statement discusses both broker-dealers seeking to have custody of digital assets and broker-dealers seeking to conduct noncustodial activities. For the latter, the Staffs mention several noncustodial models and note in the statement that generally these noncustodial activities “do not raise the same level of concern among the Staffs, provided that the relevant securities laws, SRO rules, and other legal and regulatory requirements are followed.”

As for broker-dealers seeking to have custody of digital assets for investors, the Staffs highlight several areas of federal securities laws where the nature of digital assets and their underlying blockchain technology could make it difficult to show compliance. These include a demonstration that no other party has access to the private key for any wallet holding the digital asset and the ability to reverse or cancel mistaken or unauthorized transactions involving digital assets and to track and report certain required records to the Staffs and independent auditors.

SEC Approves First Reg A+ Digital Token Offerings

The SEC has approved two digital token offerings under Regulation A+ (“Reg A+”). Reg A+ was created in 2012 as part of the Jumpstart Our Business Startups Act as an alternative to traditional initial public offerings to help startups and smaller businesses raise capital.

The first approval was granted to Blockstack, a decentralized computing network startup. Blockstack says it will start selling its token, Stacks, on July 11. The tokens will not represent ownership interest in the company, but instead will be a utility token within Blockstack’s software platform. Blockstack says it worked closely with the SEC to create a protocol for a Reg A+ digital token offering, spending roughly $2 million to get its approval.

The second approval was granted to Props, a spin-off of live-streaming company YouNow. Props is seeking to create a rewards network using a token, also called Props. The approved utility token can be earned or mined by engaging with apps in the Props ecosystem. Props says it worked with SEC officials for two years before getting approval and, according to its filing, also spent close to $2 million on its application.

IRS Reportedly Updating Its Crypto Guidance

According to a report in The Wall Street Journal, the Internal Revenue Service (IRS) will be issuing new guidance on the tax treatment of digital assets in the next several weeks. The updated guidance appears to be in response to a recent request from a bipartisan group of 20 U.S. legislators. The only other published IRS guidance, released in 2014, treats digital assets that meet the definition of convertible “virtual currency” as property for taxation purposes.

CFTC Provides Update on Its Data Protection Initiative

In a statement from Commissioner Dawn Stump, the Commodity Futures Trading Commission (CFTC) provided an update on its Data Protection Initiative. Announced in March 2019, the initiative seeks to update the CFTC’s data protection measures and its regulatory data needs.

The initiative has been divided into five phases and the update announced completion of the first phase, Scope. This phase involved a review of data collected and used by the CFTC to carry out its mandates, resulting in the creation of a Data Catalogue. The Scope phase also called for an evaluation of the need to collect sensitive data and implementation of ongoing tracking of data usage. The CFTC will now move on to the next phases: Accessibility; Security; Response; and Retention.

Federal Reserve Chairman Powell Comments on Bitcoin as Stored Value Asset

During testimony before the U.S. Senate Banking Committee, Federal Reserve Chairman Jerome Powell was asked about the potential effect a popular cryptocurrency might have on reserve currencies. Powell responded that there could be a possible effect, but no cryptocurrency has had widespread enough adoption to date. Powell went on to compare Bitcoin to gold, noting that he considers both to be speculative stores of value.

Legislative Developments

Continued Public Discussion on Libra and Calibra

Several members of the U.S. government recently commented on the newly announced Libra and Calibra projects. First, members of the U.S. House of Representatives sent a letter to project participant Facebook’s COO Sheryl Sandberg and Calibra CEO David Marcus asking for a freeze on development of both projects until government officials can hold hearings and collect information on how the projects would operate and protect consumer privacy.

Federal Reserve Chairman Jerome Powell also called for a pause on both projects until more information could be gathered and understood. During a hearing with the House Financial Services Committee, Powell was asked several times about Libra and Calibra. Powell stated that he believed the projects could not continue “without there being broad satisfaction with the way the company has addressed money laundering . . . data protection, consumer privacy—all of those things will need to be addressed very thoroughly and carefully, and again, in a deliberate process that will not be a sprint to implementation.” Jessica Smith, Powell: Libra ‘cannot go forward’ without addressing serious concerns, Yahoo! News (July 10, 2019), Powell also provided that the Federal Reserve has created a working group to look into both projects and that Facebook officials met with the Federal Reserve before they publicly announced the projects.

Second, President Donald Trump tweeted about the project on July 11, stating that the projects should be required to obtain a “new Banking Charter and become subject to all Banking Regulations.” It is unclear why President Trump believes the projects are conducting banking activities requiring a bank charter. It is also important to note that Calibra has registered as a money services business with the Financial Crimes Enforcement Network.

Representatives of the projects have sought to clear up possible public confusion. Calibra CEO David Marcus published a lengthy post on Facebook addressing popular questions regarding both projects. Marcus noted that the projects were announced early in the production cycle so that an open and public discussion about the projects could take place. He also touched on concerns about Facebook’s involvement with the projects, noting that Facebook will not control Libra, but is one of many members of the independent Libra Association. Marcus also noted that while Calibra will be a subsidiary of Facebook, Calibra will not share any of its financial data with Facebook. Marcus echoed these points in letters to both the House and Senate, where he will be testifying in front of committees later this month.

Enforcement Developments

CFTC Gets $800K Default Judgment Against Purported Bitcoin Fraud Scheme

Two individuals accused of a Bitcoin-related fraud were ordered by a federal District Court judge to pay almost $400,000 each to the CFTC and victims of the alleged fraud. The CFTC alleged that the defendants used Facebook to find customers with Bitcoin, claiming they would invest it in various trading vehicles, including foreign currency contracts, binary options, and diamonds. The defendants reportedly stole the investors’ Bitcoins, using fake account statements and forged CFTC documents to perpetuate the scheme. The court entered a default judgment against the defendants after they failed to respond to the suit. The court order also imposes on the defendants a lifetime ban on commodities trading and an injunction against further violations of CFTC regulations and the Commodity Exchange Act.

Industry Developments

President Trump Tweets About Crypto

President Donald Trump’s first public comments on cryptocurrencies as president were largely negative, tweeting that he was “not a fan” of Bitcoin and other cryptocurrencies. Trump pointed to the price volatility of many cryptocurrencies along with the use of cryptocurrencies by some criminals to facilitate illegal activities as reasons for his opinion. Trump also expressed concerns about the Libra stablecoin project and ended his tweets by voicing his continued support of the United States Dollar.

VCA Seeks to Become SRO for Virtual Commodity Marketplaces

The Virtual Commodity Association (VCA) is planning to become the first crypto-focused, self-regulatory organization (“SRO”). SROs are nongovernmental organizations that create rules and regulations for the companies that operate in the SRO’s specific industry. Examples of other SROs in the financial industry include FINRA and the National Futures Association.

The VCA, which counts many major U.S. crypto exchanges as members, has created six committees tasked with establishing best practices and oversight structures for virtual commodity marketplaces. The six committees each cover a particular area of concern: Bank Secrecy Act/anti-money laundering; custody and security; enforcement; insurance; market integrity; and tax.

International Developments

Venezuela Undertakes Several Measures to Spur Use of State-Sponsored Cryptocurrency

Venezuelan President Nicolás Maduro recently ordered the Bank of Venezuela to allow its customers to access the country’s state-sponsored cryptocurrency, the petro. While the order only applies to the Bank of Venezuela, reports state that private banks operating in the country could also be under a similar requirement soon. The requirement is reportedly part of an effort to popularize use of the coin within the country. In another move designed to spur adoption of petro, Maduro approved the distribution of one million crypto wallets preloaded with petro to students and youth registered with the country’s Plan Chamba Juvenil, a work program sponsored by the government.

Cuba Exploring Use of Cryptocurrency to Fight International Sanctions

Cuba is reportedly interested in using cryptocurrency to combat international sanctions against the country. While appearing on state-run television, President Miguel Diaz-Canel stated that cryptocurrency could be part of a collection of economic measures aimed at increasing income for Cuban residents through boosts in production and increased economic growth. It is unclear if Cuba will seek to create its own state-sponsored cryptocurrency or will use an existing cryptocurrency.

In a related story, controversial tech entrepreneur John McAfee has offered to help Cuba design and implement any cryptocurrency it might create. It is unknown if Cuba has accepted McAfee’s offer.

UK Financial Regulatory Body Proposes Ban on Crypto Derivatives

The United Kingdom’s Financial Conduct Authority (FCA) is proposing a prohibition on cryptocurrency-based derivatives. According to a March 7, 2019, press release, the FCA alleges that these types of financial products are inappropriate for retail investors “who cannot reliably assess the value and risks of derivatives or ETNs that reference certain cryptoassets” and a ban is necessary to protect investors. FCA officials estimate that the prohibition could provide a £75 million to £234.3 million a year benefit to retail investors.

The FCA also announced plans to publish its final guidance on Cryptoassets later this summer. The guidance seeks to help market participants better understand how the FCA’s regulations apply to cryptocurrencies. We discussed this guidance in a previous blog post.

Canada Makes Changes to Its Anti-Money Laundering Rules, Affecting Crypto Exchanges

Canada has amended its anti-money laundering laws, creating new compliance and reporting obligations for crypto exchanges operating in the country. Under the new rules, Canadian and foreign exchanges operating in Canada must register as money services businesses with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and implement a full anti-money laundering compliance program. In addition, exchanges in the country must now record and report any cryptocurrency transaction of $10,000 CAD or more to FINTRAC.

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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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