Weekly Focus:

• Kik & SEC Agree to $5M Judgment
• CFTC Releases Advisory on Futures Commission Merchants
• New York “Techsprint” Focuses on Virtual Currency Companies
• Powell Considers U.S. Digital Dollar at IMF Virtual Panel
• Ripple Considers Leaving U.S. over Lack of Regulatory Clarity
• New Jersey “Digital Asset and Blockchain Technology Act” Moves Forward in State Legislature
• IMF Issues New Report on CBDCs and GSCs
• The Bahamas Rolls Out First CBDC, the “Sand Dollar”
• Bank of Spain Releases CBDC Research Plan

U.S. Developments

Kik & SEC Agree to $5M Judgment

On October 20, 2020, Canadian messaging company Kik Interactive Inc. (Kik) and the U.S. Securities and Exchange Commission (SEC) agreed to resolve an ongoing enforcement case related to Kik’s digital coin offering.  The resolution came in the form of a joint proposed judgment filed before Judge Alvin K. Hellerstein of the U.S. District Court for the Southern District of New York.  Judge Hellerstein signed off on the judgment in an order filed on October 21.  The judgment comes on the heels of an earlier judgment handed down by Judge Hellerstein at the end of September that ruled Kik’s 2017 sale of $100 million worth of its own cryptocurrency, Kin, “constituted an unregistered offering of securities that did not qualify for exemption.”

Back in March, Kik argued in its summary judgment brief that the Howey test was not met in this case because (a) there was no common enterprise between the purchasers and Kik, (b) Kik did not owe any ongoing contractual obligations to the token (Kin) purchasers, (c) the purchasers assumed full control of the Kin, (d) there was no expectation of profits from the managerial efforts of others, as Kik promoted use and consumption of the token as a “medium of exchange,” and (e) the initial coin offering was conducted in reliance on Rule 506(c) of Regulation D.  The SEC disagreed and argued in its summary judgment brief that, among other things, Kik did not comply with Rule 506(c) and engaged in an unlawful public distribution of securities.  Judge Hellerstein ultimately ruled in the SEC’s favor, setting the stage for the joint Kik+SEC proposed judgment.

This judgment brings an end to the three-year litigation between Kik and the SEC.

To read our prior coverage of the Kik lawsuit in 2020, see Week in Review posts for October 2, March 27, and January 24; for 2019 coverage, see September 27, August 9, June 7, and January 28.

CFTC Releases Advisory on Futures Commission Merchants

On October 21, 2020, the Division of Swap Dealer and Intermediary Oversight (DSIO) of the Commodity Futures Trading Commission (CFTC) issued an Advisory to futures commission merchants (FCMs).  FCMs are entities involved in soliciting and accepting buy or sell orders for futures, options on futures, or swaps, and they accept money or other assets from customers to support such orders.  The Advisory addresses virtual currency specifically as one of the potential “other assets” held by FCMs, and provides guidance to the FCMs regarding the holding of virtual currency in segregated accounts, such as how to hold and report deposited virtual currency from customers in connection with futures contracts or swaps.

The Advisory sets forth 12 specific points that FCMs “must adhere to . . . when holding virtual currency as customer funds.” The points touch on a number of areas, mainly related to maintaining risk management programs concerning the acceptance of virtual currencies, virtual currency custodians, and ensuring segregation of customer funds.  For example, the Advisory reminds FCMs that: “Virtual currency held as customer funds by an FCM must be deposited only with a bank, trust company, or another FCM, or with a clearing organization that clears virtual currency futures, options on futures, or cleared swap contracts.”

The Advisory concludes that “virtual currencies present a degree of custodian risk that is beyond what is currently present with depositories, such as banks and trust companies.”  In reaching this conclusion, the Advisory relies on provisions of the Commodity Exchange Act (specifically, sections 4d(a)(2) and 4d(f)), the Bankruptcy Code, and CFTC Regulation 1.11.  This Advisory is limited to U.S. markets and does not address virtual currency held by FCMs on behalf of customers trading futures or options on foreign exchanges, nor does it address virtual currency held by FCMs on their own behalf, such as in a proprietary account.

“At the CFTC, one of our core values is to provide clarity to market participants,” said DSIO Director Joshua B. Sterling.  “As Chairman Tarbert has stated, the CFTC is committed to fostering responsible fintech innovation and improving the regulatory experience of registered firms where doing so is consistent with our rules.  This advisory furthers these critical goals and will provide additional certainty on these issues as the Commission works to establish a holistic framework for digital asset derivatives.”

The advisory can be read in its entirety here.

New York “Techsprint” Focuses on Virtual Currency Companies

On October 15, 2020, the New York Department of Financial Services (DFS) announced that it will host a multi-day hackathon event at which fintech companies, regulatory and compliance groups, and others will work to develop new “digital regulatory reporting” (DRR) mechanisms aimed at virtual currency companies.  The objective of DRR is to make supervisory data more accessible and more efficient to report.  Financial institutions are required to regularly report data on their operations, but given the recent coronavirus pandemic, some regulatory reports that were submitted could not be processed efficiently because they were in an older format that required manual processing, according to DFS.

“The future of financial supervision is digital and needs to happen now,” DFS Superintendent of Financial Services Linda A. Lacewell said in a statement.  “With this first-ever techsprint series, the Department is making progress towards automating the reporting of financial and operational data by our regulated entities, enhancing collaboration between the Department and industry, and helping to foster a safer marketplace for the consumers who depend on it.”

DFS said that it elected to focus on cryptocurrency companies for this techsprint because of their “advanced digital capabilities operating in this space.”  “Ultimately, DFS aims to leverage what is learned to develop a set of common standards and an open source technical framework for DRR that could be adopted by DFS and other regulatory agencies,” the agency said in its announcement.

The DFS announcement can be read here.

Powell Considers U.S. Digital Dollar at IMF Virtual Panel

On October 19, 2020, the International Monetary Fund (IMF) held a virtual panel on cross-border payments and digital currencies.  The panel consisted of Dr. Ahmed Abdulkarim Alkholifey (Governor of Saudi Arabian Monetary Authority, Central Bank of Saudi Arabia), Agustin Carstens (Governor of the Bank of Mexico, 2010-2017), Nor Shamsiah Yunus (Governor of Bank Negara Malaysia), and U.S. Federal Reserve Chairman Jerome Powell.  The panel was moderated by Kristalina Georgieva, the Managing Director of the IMF.

On the same day as the panel, the IMF also published a report on central bank digital currencies (CBDCs).  The IMF report is discussed under the International Developments section below.

Powell discussed the impact of a U.S.-issued CBDC and how it could affect financial stability in America and across the globe.  “We do think it’s more important to get it right than to be first and getting it right means that we not only look at the potential benefits of a CBDC, but also the potential risks,” Powell said during the panel discussion.  “Also recognize the important trade-offs that have to be thought through carefully.  We have a responsibility both to the U.S. and to the world that any steps taken for a U.S. digital currency be taken safely,” he said.

Powell also emphasized that any future U.S. digital dollar would not replace current forms of the dollar but rather complement the “soundness of the dollar.”  Powell indicated that he intends to work with both private and public stakeholders, noting that “[a]ny CBDC will necessitate roles for the public and private sectors.”

You can view a recording of the IMF virtual panel here.

Ripple Considers Leaving U.S. over Lack of Regulatory Clarity

In a series of interviews with Bloomberg on October 21, 2020, Chief Executive Officer Brad Garlinghouse of Ripple Labs Inc. (Ripple) stated that Ripple is considering moving its headquarters out of the United States due to a lack of regulatory clarity.

“Regulation shouldn’t be a guessing game,” Garlinghouse said.  “Ripple is definitely a proud U.S. company and we’d like to stay in the U.S. if that was possible, but we also need regulatory clarity in order for us to invest and grow the business.”

Garlinghouse has identified five potential countries as the new future home of Ripple: Japan, Singapore, Switzerland, the United Kingdom, and the United Arab Emirates.  He explained that the “common denominator” among these countries “is that their governments have created a clarity about how they would regulate different digital assets, different cryptocurrencies.”

You can read more about the Garlinghouse interviews with Bloomberg here.

New Jersey “Digital Asset and Blockchain Technology Act” Moves Forward in State Legislature

On October 21, 2020, the New Jersey Assembly Science, Innovation and Technology Committee approved bill A-2891, known as the Digital Asset and Blockchain Technology Act (the Bill), to regulate growing cryptocurrency companies and transactions in New Jersey.  The Bill includes proposed regulations that aim to protect consumers through a licensing structure for both operators and consumers engaging in virtual currency transactions in the state of New Jersey.  Specifically, the Bill proposes that a virtual currency company must be licensed by the New Jersey Department of Banking and Insurance in order to operate in New Jersey or be licensed by another state with a reciprocity agreement with New Jersey.  The bill details, among other things, a 16-point application process, consumer disclosures, license renewal requirements, and the Department of Banking and Insurance’s right to audit a licensee.

“While many people see and hear about Bitcoin, few know how the virtual currency industry works.  Many people have invested large sums of money without knowing the cryptocurrency market can be volatile and can subsequently lead to irreparable financial harm,” said Assembly Democrat Yvonne Lopez, a co-sponsor of the bill.  “We must take steps to protect consumers looking to invest in cryptocurrency, while also allowing the sector to continue to develop and expand in New Jersey.”

The Bill was first introduced back in February and, after the latest committee approval, has now been reported and referred to the Assembly Appropriations Committee.

You can read more about the proposed New Jersey bill here.

International Developments

IMF Issues New Report on CBDCs and GSCs

On October 19, 2020, the International Monetary Fund (IMF) published a new policy paper titled “Digital Money Across Borders: Macro-Financial Implications.”  The paper focuses on global adoption of central bank digital currencies (CBDCs) and global stable coins (GSCs).  The paper discusses the incentives to adopt these virtual currencies and the potential risks and macroeconomic effects such currencies may have on the world.  In particular, the paper concludes that CBDCs “do not qualitatively change the economic forces that lead to the international use of currencies but quantitatively could reinforce the incentives behind currency substitution and currency internationalization.”   The paper cautions that the rise of GSCs may be risky because GSCs “could affect financial stability as they may suffer from bouts of confidence crisis” and notes CBDCs and GSCs could make it harder for country authorities to run independent monetary policies and control domestic financial conditions.

However, the paper also concludes that CBDCs and GSCs could make cross-border payments less costly and allow households and small firms to have easier access to financial services.

Some of the situations the paper considered included scenarios where the issuance of a CBDC was used only as a niche tool for cross-border payments, a tool for currency substitution, a primary unit of account/payments, and a widely adopted currency used for both international and domestic transactions.

“If the local currency suffers from instability and provides a poor unit of account, issuing CBDC is unlikely to change that.  More broadly, the case for CBDC issuance is likely to depend on country circumstances,” the paper stated.

The paper also looked at GSCs and noted that big technology companies could employ a bait-and-switch technique by launching their stablecoins as pegged to fiat reserves only to later de-peg them.  Such a de-pegging could result in a “stateless” currency, where the big tech company behind the GSC assumes the role of a central bank.  “At some stage, once adoption reaches some critical mass, the peg to existing reserve currencies may no longer be needed to generate trust in the value of the GSC, and the GSC could become a fiat currency,” the IMF said.  The paper warns of a future where the mass adoption of a GSC in a country leads to a situation in which the private company (or companies) issuing the GSC ultimately end up directing the monetary policy of the GSC to which the country would be a subject.

You can read the full IMF policy paper here.

The Bahamas Rolls Out First CBDC, the “Sand Dollar”

On October 21, 2020, the Central Bank of the Bahamas announced the country’s central bank digital currency (CBDC) called the “Sand Dollar.”  The state-backed virtual currency is now available nationwide and makes the Bahamas the first country in the world to roll out a CBDC.  According to a tweet from the Central Bank of the Bahamas, the Sand Dollar was released nationwide to all 393,000 residents of the Bahamas at approximately 10:00 p.m. UTC.

According to the Sand Dollar website FAQs, the motivation behind the launch of the Sand Dollar was “[t]o advance more inclusive access to regulated payments and other financial services for under-serviced communities and socio-economic groups as well as to reduce service delivery costs and increase transactional efficiency for financial services across the Bahamas.”

The Sand Dollar is backed 1:1 to the Bahamian dollar (BSD), which is pegged to the U.S. dollar.

You can read more about the Sand Dollar here.

Bank of Spain Releases CBDC Research Plan

On October 16, 2020, the Bank of Spain released a four-year strategic plan for researching the economic implications of issuing a central bank digital currency (CBDC) in Spain.  The plan says that researchers will “consider different design proposals” and analyze digital currency’s financial and systemic risks as it pertains specifically to Spain.

In recent years, Spain has seen a strong movement around the use of blockchain beyond just token speculation.  For example, its telecom corporation, Telefonica, deployed the largest private blockchain in the country in January of this year, setting up nodes that would allow 8,000+ Spanish companies to pilot its technological infrastructure.  Also, the Alastria Association has developed multiple blockchain applications for digital identity, supply chain tracking, and enterprise solutions, including combating academic fraud at regional Spanish universities.

In light of these recent developments, the Bank of Spain has fast-tracked research for CBDCs.  However, as a member of the eurozone, the Bank of Spain cannot unilaterally introduce its own sovereign CBDC.  It appears that, instead, Spain’s research will supplement the ongoing CBDC research from the European Central Bank, which is also currently exploring the viability of a CBDC, specifically the creation of a “digital euro.”

You can read the full CBDC plan from the Bank of Spain here (Spanish only).

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