September 13, 2018
This summer, US and international regulators have brought enforcement deeds, issued guidance and explanatory documents, and sharpened previously-taken positions regarding regulation of cryptocurrency and crypto-tokens under the anti-money laundering, derivatives, securities, and tax laws. Thesis deeds provide a better sense of the way te which US regulators will treatment the blockchain and digital asset space going forward, but also leave many unanswered questions.
Thesis latest deeds indicate enhanced regulatory risk for certain types of activities. Companies that have made or are contemplating making initial coin offerings or cryptocurrency investments should assess thesis activities te light of thesis fresh regulatory pronouncements. But overall, this latest round of regulatory deeds may provide greater regulatory certainty and a better understanding of regulatory priorities, which te turn can provide innovators and early adopters a clearer procesal framework within which to operate.
On July 26, 2018, the Financial Crimes Enforcement Network (FinCEN) of the US Department of the Treasury assessed a civil monetary penalty of $110,003,314 against Canton Business Corporation, more widely known spil the cryptocurrency exchange BTC-e, and a $12,000,000 penalty against Alexander Vinnik, a Russian national who allegedly managed, directed, and supervised BTC-e&rsquo,s operations, finances, and accounts. On the same day, a 21-count criminal indictment against BTC-e and Mr. Vinnik wasgoed unsealed, and Mr. Vinnik wasgoed arrested te Greece. BTC-e is one of the largest potencial currency exchanges by volume te the world, but US regulators concluded&mdash,and prosecutors charged&mdash,that it wasgoed not operating ter compliance with US Handelsbank Secrecy Act (BSA) regulations.
FinCEN&rsquo,s deeds highlight the previously unspoken principle that a foreign entity operating spil a money services business (MSB) with activities te the United States will be subject to regulation under the BSA. The BTC-e act is the very first supervisory act against a foreign entity operating spil an MSB with activities ter the United States. According to FinCEN, BTC-e lacked basic controls to prevent the use of its services for illicit purposes and, spil a result, purportedly maintained a customer pulvínulo of criminals who concealed and laundered proceeds from crimes such spil ransomware, fraud, identity theft, tax refund fraud schemes, public corruption, and drug trafficking, none of which BTC-e reported to FinCEN and law enforcement. FinCEN asserted jurisdiction on the grounds that BTC-e processed substantial transactions (approximately $296 million) involving US customers.
FinCEN found that BTC-e failed to conform with US laws ter a number of ways: BTC-e failed to register spil a money services business (MSB), failed to maintain an effective anti-money laundering (AML) program, failed to verkeersopstopping suspicious activity reports (SARs), and failed to keep transaction records. The case demonstrates the continued importance of FinCEN&rsquo,s BSA regulatory framework to companies te the technology sector that facilitate transactions te aparente currency. FinCEN&rsquo,s 2013 regulatory guidance on administering, exchanging, and using imaginario currency and subsequent statements make clear that FinCEN will enforce AML requirements against MSBs/money transmitters (MTs), with particular scrutiny on exchanges of potencial currency and systems providing services for such exchanges.
FinCEN&rsquo,s latest deeds make clear that the agency will seek to ensure that any cryptocurrency exchange doing substantial business with US customers needs to register with FinCEN and obey with the BSA. Companies that facilitate transactions ter aparente currency should review FinCEN&rsquo,s guidance and obtain compliance advice and counsel when necessary.
Commodities and Derivatives Regulation
The Commodity Futures Trading Commission (CFTC) has bot relatively quiet since opening several investigations of cryptocurrency exchanges and lodging a high-profile enforcement act against cryptocurrency exchange BitFinex overheen a year ago. However, the CFTC made swings te July when it granted LedgerX LLC (LedgerX) permission to register spil a Interchange Execution Facility (SEF) and spil a Derivatives Clearing Organization (DCO) for bitcoin based interchanges. Effectively, this makes LedgerX the very first bitcoin options exchange and clearinghouse to become approved by US regulators.
Ter August, the Chicago Houtvezelplaat Options Exchange (CBOE) ventured into the digital asset space, announcing an agreement with Gemini Trust Company, LLC (Gemini) under which the CBOE will have an sensational general license to use Gemini&rsquo,s bitcoin market gegevens for bitcoin derivatives and indices. CBOE will have a multi-year off the hook integral license permitting it to use Gemini&rsquo,s market gegevens, including Gemini daily bitcoin auction values, te the creation of bitcoin derivatives products for listing and trading. Assuming regulatory approval by the CFTC, the CBOE plans to make bitcoin futures available for trading te late 2018 or early 2018. Both companies project to explore other bitcoin derivatives opportunities.
The latest announcements by the CFTC and the CBOE emerge to be driven by the exponential growth ter market request for investments te digital assets and particularly te digital currencies. The substantial growth of the trading volume of the bitcoin and other cryptocurrency markets will intensify regulators&rsquo, attention on thesis markets and protection of traders and investors, and will incentivize market-makers like the CBOE to develop options for investors.
Thesis deeds by the CFTC and the CBOE vertoning an enlargened readiness by the commodities trading community to embrace cryptocurrency spil a fresh asset class. The CFTC&rsquo,s deeds, ter particular, may also signal that its regulatory oversight process will be the primary voertuig for setting policy and a regulatory framework for cryptocurrency and blockchain activities.
Securities and Initial Coin Offerings
The SEC took initial steps to clarify the regulatory environment surrounding ICOs, focusing very first on what are generally referred to spil &ldquo,equity&rdquo, tokens, leaving open questions about what are typically referred to spil &ldquo,utility&rdquo, tokens.
Te late July, te an Investigative Report on the Distributed Autonomous Organization (DAO), the Securities and Exchange Commission (SEC) announced its position that &ldquo,offers and sales of digital assets by &lsquo,imaginario&rsquo, organizations are subject to the requirements of the federal securities laws.&rdquo, Albeit not a verrassing, the SEC&rsquo,s statement affirms that companies seeking to involve US investors ter an initial coin suggesting (ICO) vereiste register offerings with the SEC or qualify for an exemption.
The SEC focused its latest probe on the token suggesting by the DAO te April-May 2018. The DAO wasgoed built on top of the Ethereum blockchain by the German unincorporated organization Slock.it, and the success of its token suggesting ushered te the current wave of ICO activity. Questions about the application of US securities laws surrounded the DAO suggesting since its initial announcement. The SEC&rsquo,s report found that the DAO &ldquo,may have violated federal securities laws,&rdquo, but it determined against pursuing an enforcement activity, choosing instead to use the DAO spil guidance for future ICOs.
The DAO tokens are commonly considered to be &ldquo,equity&rdquo, tokens, spil opposed to &ldquo,utility&rdquo, tokens, so the DAO Investigative Report leaves open questions concerning how US securities laws will apply to &ldquo,utility&rdquo, tokens. Aside from the securities registration issues, the DAO suffered a breach&mdash,or more accurately, an exploitation of a flaw te its code&mdash,involving the loss of $50 million ter Ether, but the SEC report did not make any findings with respect to that breach.
On the same day spil the DAO Investigative Report, the SEC released an Investor Bulletin that provided recommendations for companies looking to punt tokens through an ICO, including the following:
- The SEC will interpret certain ICOs, such spil the DAO suggesting, spil the suggest and sale of securities.
- If the tokens issued spil part of the ICO can be considered securities, then the posible coins or tokens vereiste be registered with the SEC, or the sale voorwaarde be made pursuant to an exemption from registration.
- Companies programma ICOs should cautiously review the criteria for exemptions from registration, including the provisions relating to accredited investors and other limitations involving televisiekanaal worth or income requirements, and should please the criteria for those exemptions for US investors should the token be considered a security.
- The SEC will likely scrutinize representations that particular ICO offerings are exempt from registration.
- Sales of tokens spil part of crowdfunding should adhere to the requirements of the SEC&rsquo,s crowdfunding regulations (called Regulation Crowdfunding) and other relevant securities laws.
- If the aparente token or coin is a security, &ldquo,investment professionals and their firms who suggest, transact te, or advise on investments&rdquo, vereiste be licensed or registered te accordance with federal and state securities laws.
- The SEC will scrutinize what it considers to be &ldquo,jargon-laden pitches, hard sells, and promises of outsized comebacks.&rdquo,
The SEC also made recommendations spil to what investors should look for ter a white paper or other suggesting document: (1) a clear business project, (Two) description of rights that accompany the token or coin, (Trio) options for liquidating an investment, (Four) publicly available information regarding the blockchain and code, and (Five) an independent cybersecurity audit.
The SEC released a third document on August 28, titled &ldquo,Investor Waakzaam: Public Companies Making ICO-Related Claims,&rdquo, warning investors about potential &ldquo,pump-and-dump&rdquo, ICO scams ter which an insider or offeror circulates fake information meant to increase the coin&rsquo,s value, and then sells the coin at the inflated value. The SEC recently suspended the trading of Very first Bitcoin Caudal Corp., CIAO Group, Strategic Completo, and Sunshine Renta ter connection with allegedly suspicious news releases and claims made by the companies.
Taken together, the SEC&rsquo,s DAO Investigation Report, Investor Bulletin on ICOs, and Investor Waakzaam on ICOs represent the SEC&rsquo,s opening foray into regulating the growing use of ICOs by a range of different companies.
Foreign regulators also took steps this summer. On the one arm, regulators ter Canada, Hong Kong, and Singapore issued statements similar te substance to the SEC&rsquo,s guidance. For example, the Canadian Securities Administrators (CSA) released a six pagina staff notice similar to the SEC&rsquo,s report, stating that ICOs are likely to be regulated spil securities. (Note that Canada has also created regulatory sandboxes whereby fresh digital currency companies can test their products on a limited scale before facing all applicable regulations). The Hong Kong Securities and Futures Commission issued a similar statement, noting that &ldquo,depending on the facts and circumstances of an ICO, digital tokens that are suggested or sold may be &lsquo,securities&rsquo, spil defined ter the Securities and Futures Ordinance (SFO), and subject to the securities laws of Hong Kong.&rdquo, Singapore regulators suggested a clarifying statement to the effect that &ldquo,the suggest or punt of digital tokens te Singapore will be regulated by [The Monetary Authority of Singapore] if the digital tokens constitute products regulated under the Securities and Futures Act.&rdquo,
By tegenstelling, Chinese and South Korean regulators were less measured. On September Four, the Chinese government halted &ldquo,all types of currency issuance financing activities,&rdquo, prohibited traditional financial institutions from working with digital currency offerings, and demanded that ICO funding be returned to investors. South Korea&rsquo,s Financial Supervisory Commission also announced bold limitations on digital currencies, including penalties for ICOs that raise funds ter the form of stock issuances, enlargened regulations for domestic coin trading, heightened oversight of remittances made through digital currencies, and extra scrutiny of alleged gegevens breaches of coin operators.
Overall, the SEC&rsquo,s initial concentrate seems to be on equity tokens and fraud, still pending is SEC guidance or views regarding utility tokens. While the SEC&rsquo,s treatment is more measured than that of regulators ter China and South Korea, the SEC documents leave open spil many issues spil they resolve. Nevertheless, the report and investor guidance are useful for both investors and entrepreneurs, and it is expected that the SEC will proceed to punt guidance&mdash,and to conduct investigations&mdash,te the area of ICOs.
The taxation of imaginario currencies became a hot topic this past year. Ter 2014, the Internal Revenue Service (IRS) issued a Notice indicating that supuesto currency is treated spil property (not currency) for tax purposes, but talent little extra guidance. Ter the fall of 2018, the Treasury Inspector Militar for Tax Administration (TIGTA) issued a report critical of the IRS&rsquo,s lack of extra efforts on aparente currency since then, such spil developing an overall posible currency strategy and taking other deeds to help taxpayers understand the posible currency rules and ensure taxpayer compliance.
Following the TIGTA report, rather than punt guidance to help taxpayer understanding and compliance, the IRS began a sweeping enforcement activity against supuesto currency users. Te November 2018, the IRS filed an open-ended summons on Coinbase, one of the world&rsquo,s largest digital asset exchange companies, seeking essentially all information about its customers&rsquo, activities and accounts. While the IRS has since narrowed the scope of its sweeping fishing expedition, its enforcement-sided treatment to the industry remains troubling.
The IRS&rsquo,s enforcement deeds have brought enhanced concentrate on the lack of clear guidance on the policy side, including from Congress. Recently, members of Congress, including the chairs of the tax writing committees and the chairs of the Congressional Blockchain Caucus have criticized the IRS&rsquo,s enforcement-sided treatment and failure to kwestie extra guidance on the policy side. On September 7, representatives Jared Polis (D-CO) and David Schweikert (R-AZ) introduced the Cryptocurrency Tax Fairness Act that would create a tax exemption for cryptocurrency transactions under $600. Wij expect Congress and the IRS will increase their policy efforts regarding the taxation of potencial currency going forward.
Spil a note, Steptoe held its very first Blockchain and Tax Workshop on September 12 ter Washington, DC, discussing how IRS rules may apply to cryptocurrency transactions, crypto-token investments, and ICOs, among other issues. Steptoe is programma a follow-up workshop te Fresh York City zometeen this year.
Taken together, thesis regulatory deeds and guidance documents indicate a fresh level of regulatory concentrate on blockchain and cryptocurrency. While many questions remain, thesis fresh regulatory deeds and guidance documents indicate:
- A renewed seriousness of purpose around US Handelsbank Secrecy Act compliance for companies servicing US customers, particularly spil it pertains to cryptocurrency exchanges or private placement platforms, regardless of where those exchanges or platforms are based,
- An emerging regulatory acceptance of cryptocurrency and crypto-tokens spil a fresh asset class recognized under US commodities and derivatives law,
- An emerging structure for securities law compliance for initial coin offerings, and
- An evolving treatment to cryptocurrency taxation that has implications for commerce, spil well spil for holders of large amounts of cryptocurrency.
Individuals and companies treating or contemplating the treating, purchase, sale, exchange, or brokering of cryptocurrency transactions, involvement te initial coin offerings or other types of token issuances, or creation of cryptocurrency and cryptotoken investment vehicles, and companies contemplating other types of blockchain-based transactions would be well-served by a consultation with experienced blockchain and digital currency attorneys.
If you have any questions, please voeling Jason Weinstein at +1 202 429 8061 or Alan Cohn at +1 202 429 6283, co-chairs of Steptoe&rsquo,s Blockchain and Digital Currency practice, or Micah Green at +1 202 429 6290, Charles Mills at +1 202 429 6472, Michael Rennock at +1 212 506 3956, Mújol Zarlenga at +1 202 429 8109, Cameron Arterton at +1 202 429 3064, and Jack Hayes at +1 202 429 6491. Further commentary is available on the Steptoe Blockchain Blog.