Blockchain Week in Review - July 2019 #3

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U.S. Developments

Regulatory Developments

SEC Issues Second No Action Letter for Blockchain-Based Project

On July 25, 2019, the staff of U.S. Securities and Exchange Commission (SEC) issued its second ever no-action letter to a company planning to issue blockchain-based tokens. The letter was issued to Pocketful of Quarters (PoQ), a gaming start-up. PoQ seeks to issue an Ethereum-based ERC-20 stablecoin, “Quarters,” for use within its gaming platform.

No action-letters are public letters from the SEC staff to specific projects, stating that the agency will not recommend enforcement if the project follows and meets certain requirements and commitments stated in the letter. They can be useful for other companies seeking to set up similar projects, laying out the perimeters that the SEC desires from blockchain projects.

In the no-action letter, the SEC staff stated that it reached its position because of several facts related to Quarters, including the facts summarized below:

  • No proceeds from the sale of Quarters will be used to develop the Quarters technology;
  • The Quarters technology was fully developed, functional and ready for use upon launch;
  • Technological and contractual provisions governing the Quarters restrict the transfer of Quarters to PoQ or to wallets on the Quarters platform;
  • Gamers will only be able to transfer Quarters from their Quarters wallets for gameplay to addresses of game developers with approved accounts or to PoQ in connection with participation in e-sports tournaments;
  • Only game developers and certain social media influencers with approved accounts will be capable of exchanging Quarters for ETH at pre-determined exchange rates by transferring their Quarters to the Quarters smart contract;
  • To create an approved account, game developers and social media influencers will be subject to KYC/AML checks at account initiation as well as on an ongoing basis;
  • Quarters will be made continuously available to gamers in unlimited quantities at a fixed price;
  • There will be a correlation between the purchase price of Quarters and the market price of accessing and interacting with games on the Quarters platform; and
  • PoQ will market and sell Quarters to gamers solely for consumptive use as a means of accessing and interacting with participating games.

Several of the facts highlighted by the SEC staff in the PoQ no-action letter echo similar facts in the no-action letter issued to Turn Key Jet, Inc. earlier this year. For example, both letters require digital asset transferability restrictions and price stabilization. Notably, the PoQ letter is the first instance of an Ethereum-based ERC20 token and will be transacted on a public blockchain.

IRS Sends Warning Letters to Thousands of U.S. Cryptocurrency Holders

According to a news release on the Internal Revenue Service (IRS) website, the IRS has started sending letters to more than 10,000 suspected cryptocurrency holders, alerting them to possible penalties for failing to report income from cryptocurrency transactions on their federal tax filings. It is unclear how the IRS has selected the recipients of the letters.

The IRS is sending three different versions of the letter, with one version asking recipients that believe they have properly followed federal tax law to sign a statement to that effect under the penalty of perjury. The news release quotes IRS Commissioner Chuck Rettig, saying that “Taxpayers should take these letters very seriously.” It should be noted that taxpayers may not be under legal obligation to respond to the letters and it could be advisable to speak with legal counsel prior to responding.

Enforcement Developments

Money Laundering Charges Brought Against Alleged Silk Road Participant

An Ohio man has been arrested and accused of trying to launder more than $19 million in bitcoin allegedly acquired from drug deals conducted on the dark web site Silk Road. According to the U.S. Attorney for the Southern District of New York and the U.S. Immigration and Customs Enforcement’s Homeland Security Investigations (HIS), the defendant, Hugh Brian Haney, earned the bitcoin by selling narcotics such as OxyContin, fentanyl, and ketamine. The complaint alleges that the defendant moved the bitcoin to a crypto exchange and converted it into U.S. dollars. When questioned about the sources of the funds, the defendant purportedly stated that he earned the bitcoin by mining and from people he met online. HIS then obtained a judicial warrant and seized the money once it had been transferred from the exchange to a bank.

Haney was charged with one count of concealment money laundering and one count of engaging in a financial transaction in criminally derived property, which carry maximum sentences of 20 years and 10 years, respectively.

Bitcoin Escrow Company Charged with Fraud

The U.S. Attorney’s Office of the Southern District of New York has charged the head of Volantis Escrow Platform LLC and Volantis Market Making LCC, Jon Barry Thompson, with several counts of fraud. Thompson allegedly claimed to be an expert investor and custodian of bitcoin, convincing at least two companies to wire him millions of dollars to purchase bitcoin. According to the complaint, Thompson never gave the companies any bitcoin, and he misappropriated thousands of dollars from the investor funds and falsified account statements to conceal the fraud.

The charges are two counts two counts of commodities fraud and two counts of wire fraud, with each count carrying maximum sentences of 10 years and 20 years, respectively.

Charges Brought Against Alleged Unlicensed Crypto Business

The U.S. Attorney’s Office for the District of New Jersey has charged a New Jersey resident with running an unlicensed money transmitting business involving bitcoin. According to the complaint, the defendant, William Green, accepted over $2 million in cash from various individuals via a website called “Destination Bitcoin,” which he converted to bitcoin. Purportedly, Green did not register as a money-transmitting business with the Financial Crimes Enforcement Network, either in his own name or in the name of a business, as is required by law.

The charges against Green carry a maximum penalty of 5 years in prison and up to a $250,000 fine.

Litigation Developments

Bitfinex, Tether, and NYAG Continue Their Legal Dispute

In the latest development in the legal saga among Bitfinex, Tether, and the New York Attorney General (NYAG), attorneys for Bitfinex and Tether argue that the NYAG’s recent filing, which asserted that the two companies were offering their services to New York residents and companies longer than the companies claim in their court filings, are “inaccurate and misleading.” In a submission to the Supreme Court of the State of New York, Bitfinex and Tether argue that any New York–based individuals or companies using their services were “foreign eligible contract participants,” which are permitted under the companies’ Terms of Service.

In a separate filing, Bitfinex and Tether argue that the case should be dismissed for a number of reasons, including improper service, an absence of personal jurisdiction, and that Tether’s USDT is not a security or commodity as defined under New York’s state anti-fraud law, the Martin Act. The parties are due back in court later this month.

SIM-Swap Lawsuit Against AT&T Continues

A $24 million suit against AT&T Mobility (AT&T) arising from an alleged SIM-swap hack of crypto-investor Michael Terpin will continue after a federal judge’s ruling. In his 2018 suit against AT&T, Terpin alleged that company employees twice allowed hackers to transfer his cell phone service and number to a SIM card that they controlled. Terpin says that the SIM-swap allowed hackers to steal nearly $24 million worth of cryptocurrency from him. In his suit, Terpin also alleges that AT&T violated provisions of the Federal Communications Act and seeks to invalidate certain provisions of AT&T’s customer agreement, including a disclaimer of liability for its own negligence and a mandatory arbitration clause. AT&T sought to dismiss the suit, arguing Terpin did not sufficiently plead how the SIM-swap led to his loss of cryptocurrency and that it cannot be held responsible for the illegal actions of the hackers.

District Court Judge Otis Wright dismissed claims related to the SIM-swap, agreeing with AT&T that the current pleadings were not sufficient to show AT&T was responsible for the loss of cryptocurrency. According to the judge, although Terpin alleged sufficient details concerning how the hackers had AT&T assistance in getting access to his phone, he did not allege in sufficient detail how the hackers accessed his account, whether they sold the cryptocurrency and transferred the proceeds, or whether they transferred the cryptocurrency to another wallet. The claims were dismissed “with leave to amend,” which gives Terpin 21 days to amend his complaint with more details regarding the loss. Wright also ruled that Terpin’s claims against AT&T’s customer agreement could move forward, finding Terpin’s pleadings sufficient to survive the motion to dismiss.

State Developments

A Third Municipality to Offer Blockchain-Based Voting

Utah County in the state of Utah is poised to be the third U.S. municipality to begin pilot testing of blockchain-based voting. The trial will allow county residents currently living abroad to use a mobile app, created by startup Voatz, to cast their vote in an upcoming primary election in August. In addition to Voatz, the county is working with Tusk Philanthropies and the National Cybersecurity Center to conduct the trial.

The city of Denver and the state of West Virginia have previously conducted voting trials using the Voatz service.

NYDFS Creates New Division to Handle Crypto Licensing

New York’s Department of Financial Services (NYDFS) has created a new division responsible for licensing and supervising companies in the virtual currency space as well as regulating emerging financial technology companies. The new Research and Innovation Division was announced by the NYDFS’s newly appointed superintendent, Linda Lacewell. The division will handle the review and approval of applications for the state’s BitLicenses for companies buying, selling, or issuing cryptocurrency to residents of the state. Lacewell also announced four appointments to the new division, including its head, executive superintendent, Matthew Homer.

Industry Developments

Bakkt Starts Testing its Bitcoin Futures Contracts

Bakkt, the bitcoin futures platform owned by Intercontinental Exchange (which also owns the New York Stock Exchange), began testing its bitcoin futures contracts this week. Bakkt said it is testing both daily and monthly contracts. The contracts will differ from the bitcoin futures contracts currently offered by the Chicago Mercantile Exchange in that they will be physically settled future contracts, giving investors actual bitcoin when the contract’s value expires.

Bakkt’s testing comes as the company waits on regulatory approvals necessary to make its contracts available to the public.

International Developments

Indian Panel Recommends Fines and Jail for Crypto Use

A panel tasked with reviewing how India should regulate cryptocurrency use has proposed fines and up to 10 years in prison for individuals found using crypto in the country. To support its recommendations, they pointed to the fact that the majority of global cryptocurrencies originate outside of India and argue that cryptocurrencies “are inconsistent with the essential functions of money/currency” and cannot replace fiat currencies.

In addition to its recommended penalties, the panel suggested that India explore creating its own sovereign cryptocurrency, along with exploring using blockchain technology to enable cross-border payments as well as recording land deeds. The panel was created by the Ministry of Electronics and Information Technology, the Securities and Exchange Board of India, and the Reserve Bank of India. The ban and suggested penalties mirror language in a draft bill created by India’s Economic Affairs Secretary last month.

Iran Recognizes Crypto Mining

The Iranian government’s economic commission has approved cryptocurrency mining for the first time. Central Bank of Iran Governor Abdolnaser Hemmati issued a statement saying that the mining of digital coins has been approved and will be discussed at a future cabinet meeting. In addition, Iranian Deputy Energy Minister Homayoun Haeri said that government ministers will discuss and approve an electricity rate for mining businesses, which will likely restrict miners from using the subsidized internal energy system. In recent years, a number of “mining” farms moved to Iran to take advantage of the low cost of electricity; according to news reports, many of those miners come from China, and China has allegedly encouraged Iran to legalize mining activity.

The legalization comes just months after the country cracked down on two crypto mining farms, seizing their equipment. At the time, the crackdown was reportedly due to the adverse impact of cryptocurrency mining activity on the country’s energy supply. Electricity in Iran is both subsidized by the government and resource-stressed as a result of international sanctions. Iran provides cheap electricity in part to stimulate internal agricultural and industrial activity.

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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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