I. Biden Orders Studies On Crypto Regulation
On March 9, 2022, President Joe Biden signed an executive order titled “Ensuring Responsible Development of Digital Assets” laying out a national policy for digital asset regulation. The order calls for the Justice Department, Treasury, Securities and Exchange Commission, Federal Trade Commission and the Consumer Financial Protection Commission to begin studying the legal and economic ramifications of regulating cryptocurrency and establishing a central bank digital currency. Specifically, the Justice Department will investigate whether a new law is required in order to create a new digital currency, while the Treasury, Securities and Exchange Commission, Federal Trade Commission and the Consumer Financial Protection Commission will study the impact the new currency and regulations will have on consumers. Additionally, further studies are ordered on the impact of central bank digital currency on competition, the market and technical infrastructure required to support it and the environmental impact of bitcoin mining. According to the official White House press release the United States will play a leading role in global governance and engagement of digital assets:
“The United States must maintain technological leadership in this rapidly growing space, supporting innovation while mitigating the risks for consumers, businesses, the broader financial system, and the climate.”[i]
While these reports will be the first of their kind given the new relevance of cryptocurrencies in our nation’s economic landscape, it is far from the first time some of these agencies have recognized and interacted with digital assets as part of their jurisdiction. The following lays out how various governmental and regulatory bodies have thus far addressed cryptocurrencies as an emerging asset class.
II. Generally
Cryptocurrencies (“Crypto”)[ii] are the subject of heightened attention in the United States, both at the Federal and state level. The Securities and Exchange Commission (“SEC”), the Commodity Futures Trading Commission (“CFTC”), the Internal Revenue Service (“IRS”), the Office of Comptroller Currency (“OCC”), and the Financial Crimes Enforcement Network (“FinCEN”) are the Federal agencies paying the most attention to Crypto. At the state level, New York has one of the most comprehensive Crypto regulatory stances in the nation, requiring any person that engages in virtual currency business activity to acquire a BitLicense.[iii] By contrast, Florida is still in the early stages of a regulatory regime, requiring Crypto businesses to apply for money service business licenses only. Within each of those states, new mayoral administrations have pitched New York City and Miami as new potential crypto-friendly hotspots. In short, federal, state, and local governments are all stakeholders in Crypto’s evolving legal and regulatory landscape. This article is a brief look into current legislation, regulation, and enforcement actions existing at the Federal and state level concerning Crypto.
III. Legislation
A. Federal
The Infrastructure Investment and Jobs Act (the “Act”), included a provision that would allow the IRS to collect a projected $28 billion in tax revenue from Crypto “brokers.”[iv] The revenue would be collected via reporting requirements for some Crypto transactions. A couple of key takeaways from the new law are:
- The Act requires reporting transactions involving “digital assets,” including cryptocurrencies.
- The Act may require businesses to collect new types of information and report to the IRS details of Crypto transactions, lest those businesses be subject civil and criminal penalties.
The provision in the Act represents the greatest legislative treatment Crypto has received from the U.S. Congress to date.
B. State Level
At the state level, some governments have proposed, and in some instances have passed, laws affecting Crypto and blockchain technology. Some States’ legislatures have passed laws designed to leverage the emerging technology and to stimulate local economies. Wyoming passed legislation allowing for a special purpose depository institution that can act in both a custodial and a fiduciary capacity to allow business to hold digital assets legally in the state. Colorado’s legislature exempted Crypto from state securities regulation altogether. Ohio became the first state to accept Crypto to pay state taxes. Other States have passed more restrictive laws surrounding Crypto.[v] For example, New York State requires commercial and nonprofit entities holding and/or trading crypto to have a BitLicense. Louisiana passed the Virtual Currency Business Act, making it the second state to require Crypto operators to apply for a license. In total, as of December 2021, Thirty-three states and Puerto Rico have pending legislation regarding Crypto and Seventeen have enacted legislation or adopted resolutions.[vi]
IV. Federal Crypto Regulation
Under Federal law, Crypto sales presently are generally regulated by the SEC, FinCEN, or the CFTC. If the sale of Crypto constitutes the sale of a security then Crypto is regulated by the SEC. Or, if its sale is conduct making the person a money services business then Crypto is regulated by FinCEN. If Crypto is referenced in a futures, derivatives, swaps, or options contracts it may be considered a commodity and subject to the CFTC’s jurisdiction. The CFTC’s jurisdiction is further implicated where there are attempts to engage in market manipulation with respect to Crypto that is considered a commodity. Notably, the CFTC deemed Bitcoin and Ethereum, the two main cryptocurrencies, commodities in 2015. Therefore, any alleged market manipulation in the BTC or ETH markets and any futures, derivatives, swaps or options contracts referencing Bitcoin and Ethereum are within the CFTC’s jurisdiction.
V. Crypto and Securities Laws
A. Is Crypto as a Security?
The threshold question is whether a given Crypto is a security. The SEC has jurisdiction/authority over any Crypto issuance or resale that meets the definition of a security as an investment contract. Under the Howey Test, an investment contract is a security subject to SEC regulation if it is an investment of money in a common enterprise with a reasonable expectation of profits predominantly derived from the efforts of others.[vii] The SEC has been clear that an initial coin offering (“ICO”) will be considered a security if the elements of the Howey Test are met. Integral to this inquiry is the manner in which the Crypto or ICO is marketed and distributed. Does the firm releasing the Crypto imbue in their investors an expectation that they will be able to sell their purchased tokens at a profit? Is that profit derived from the efforts of the firm distributing the tokens? Do the marketing materials and promoters emphasize the Crypto’s potential secondary market trading value? If the answer to all of these questions is yes, the Crypto is likely a security. Accordingly, it must be registered or offered via an exemption (see § IV(C) below)
B. SEC Chair Gensler on Crypto
In August 2021, SEC Chairman Gary Gensler spoke regarding Crypto and called for increased regulatory and enforcement scrutiny. He stated that in the Crypto market many tokens may be securities not registered with the SEC escaping required disclosures and oversight. Gensler suggested the asset class is “rife with fraud, scams and abuse in certain applications,” and explained how Crypto prices are open to manipulation potentially leaving investors vulnerable. He also noted that the SEC will pursue more authority from Congress to “prevent transactions, products and platforms from falling between regulatory cracks.” Gensler further reiterated his position that he would ask Congress to help legislate a solution to fill regulatory gaps in an interview with the Wall Street Journal.[viii] In 2021, Congress introduced 35 Bills focused on Crypto policy, ranging from distribution and trading regulations to the issuance of a central bank digital currency. For example, the Eliminate Barriers to Innovation Act passed the House in 2021, which would create a SEC and CFTC Working Group on Digital Assets responsible for clarifying differences in blockchain tokens between the two agencies and report its findings to Congress.
C. Federal Enforcement in 2021, a Glimpse
- Undisclosed Promotion: On July 14, 2021, the SEC entered into a settlement agreement with Coinschedule Ltd. (now named “Bloctics Ltd.”) resulting from Coinschedule’s alleged violations of Section 17(b) of the Securities Act. Coinschedule’s primary source of income came from token issuers who would pay the website to list, rank and promote their upcoming token offerings. The SEC found that the token offerings Coinschedule promoted on its “listing” website constituted offerings of unregulated securities under the Securities Act. Accordingly, the SEC contended that Coinschedule’s failure to disclose the compensation it received from issuers in exchange for the promotion of those token offerings violated Section 17(b)’s anti-touting provisions.
- Sale of Unregistered Securities: On August 6, 2021, the SEC entered into a settlement agreement with Blockchain Credit Partners, doing business as DeFi Money Market, relating to its alleged sale of over $30 million of unregistered securities on its platform. Investors could buy two types of tokens on the DeFi Money Market platform: mTokens, which were interest bearing, and DMG. DMG was a governance token that gave holders voting rights and a share of DeFi Money Market’s profits. The SEC found that DMG tokens were offered and sold unregistered securities as investment contracts because they created a reasonable expectation of profit, as holders were able to sell the tokens on secondary markets. It also found that the mTokens were notes and also offered and sold as investment contracts. Further, the SEC took issue with DeFi Money Market’s claims that the platform’s revenue paid the interest demanded by mToken holders, when the founders behind the platform knew that was not the case. These findings may form the basis for future DeFi regulation by the SEC, as many similar platforms still exist in the crypto universe.
- Failure To Register As A Securities Exchange: On August 9, 2021, the SEC entered into a settlement agreement with Poloniex stemming from its failure to register as a national securities exchange under Section 5 of the Securities Exchange Act. The SEC determined that Poloniex was an “exchange” because it provided potential investors with the nondiscretionary means for trade orders on digital assets to be executed. As Poloniex served U.S. investors and did not qualify for an exemption the SEC maintained that Poloniex had violated the Securities Exchange Act’s registration requirements.[ix]
- FinCEN and CFTC Registration: On August 10, 2021, FinCEN and the CFTC entered into a settlement agreement with BitMEX, a cryptocurrency exchange and derivatives trading platform, related to BitMEX’s offering of cryptocurrency derivatives. The CFTC alleged that BitMEX offered these derivatives without registering as a Futures Commission Merchant and operated a facility to process swaps without being approved as a Designated Contract Market or a Swap Execution Facility. Additionally, BitMEX had violated CFTC regulations relating to Customer Information Programs, Know-Your-Customer procedures and Anti-Money Laundering safeguards. Additional proceedings are ongoing.
- Coinbase’s Token Halted: On September 1, 2021, the SEC sent a Wells notice to Coinbase, a publicly traded cryptocurrency on-ramp and exchange, stating it would sue to halt the release of Coinbase’s “Lend” protocol if the company continued development. Lend was meant to allow investors to earn interest on their cryptocurrencies held in Coinbase accounts, which the SEC stated it would treat as running afoul of federal securities laws. Shortly after the Wells notice, Coinbase canceled the launch of Lend.[x]
D. Crypto State Regulatory and Enforcement Actions.
State regulators are focusing on Crypto exchanges and the offering of interest-bearing Crypto accounts. The states blue sky laws are not automatically preempted by Federal laws. An exemption under Federal law does not necessarily preempt application of a state’s security laws’ requirements.
Some state regulators have issued cease and desist orders against Crypto exchanges offering interest-bearing accounts. Beginning in July 2021, the securities regulators of five states — Alabama, Kentucky, New Jersey, Texas, and Vermont — have issued cease-and-desist or show cause orders against BlockFi, Inc., BlockFi Lending, LLC and BlockFi Trading, LLC regarding the BlockFi companies’ interest-bearing cryptocurrency accounts. BlockFi is a financial services firm that purports to generate revenue through cryptocurrency trading, lending and borrowing and by engaging in proprietary trading, and its interest-bearing cryptocurrency accounts have raised at least $14.7 billion worldwide. In general, the states have alleged that BlockFi’s interest-bearing accounts are unregistered securities whose sale violates the states’ securities laws. Similarly, three of those states, Alabama, New Jersey, and Texas announced a cease-and-desist action against Celsius Network, another trading and lending platform, on September 17, 2021. As in the BlockFi order, these state regulators take the stance that Celsius’s “Earn Rewards” interest-bearing accounts program constitutes an offering of unregistered securities. All three orders flag the fact that the “Earn Rewards Investor relinquishes control over the deposit cryptocurrency to Celsius and that Celsius is free to use those assets as it sees fit”[xi] as problematic under their respective regulatory regimes.
State Attorneys General have also signaled that they are paying attention to the emerging asset class of virtual currency. In February 2021, New York Attorney General Letitcia James settled a claim that Tether, a cryptocurrency platform, had made false statements that its “stablecoin” USDT was backed by the U.S. Dollar. Tether agreed to pay $18.5 million under the settlement agreement in addition to other penalties.
VI. Local Governments
While Federal and State regulators have taken firm stances on Crypto’s entry into the United States, some city governments are attempting to lure newly-wealthy crypto investors and creators into their domain. Prime examples of this trend are Miami and New York City, where both Mayors Francis Suarez and Eric Adams have opted to be paid their salaries in Bitcoin. Both Suarez and Adams have expressed interest in releasing Cryptos specific to their city, appropriately named MiamiCoin and CityCoin respectively, as a means of fostering interest and understanding of Crypto-technology among their residents. Both Mayors have also stated that they desire for their cities to be seen as future hubs for crypto investing. While the success of these approaches remains to be seen, the disparity in interests between local governments and State and Federal regulators is worth considering in analyzing what is to come for these burgeoning issues.
Crypto is clearly here to stay. A number of broker-dealers in the United States and worldwide have started to offer access to Crypto trading to their customers. State governments are increasing their efforts to regulate crypto ventures. And now, with President Biden’s anticipated executive order, regulatory clarity on how these new assets will be treated seems imminent. It is imperative to remain abreast of what legislation and regulation is in effect or in the works in this space to best provide guidance to clients.
[i] See White House Press Release “Fact Sheet: President Biden to Sign Executive Order on Ensuring Responsible Development of Digital Assets”, March 9, 2022 available at https://www.whitehouse.gov/briefing-room/statements-releases/2022/03/09/fact-sheet-president-biden-to-sign-executive-order-on-ensuring-responsible-innovation-in-digital-assets/ (last visited 03.09.2022)
[ii] There isn’t a generally accepted definition of Crypto as an asset class.
[iii] For more information on BitLicense, consult New York State Gov BitLicense FAQs available at: https://www.dfs.ny.gov/apps_and_licensing/virtual_currency_businesses/bitlicense_faqs (last visited 01.19.2022).
[iv] “[A]ny person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” See Internal Revenue Code § 6045(c)(1)(D) (“Returns of Brokers: Definitions”).
[v] Iowa introduced a bill prohibiting state entities from accepting payment in Crypto, and many other states have issued general warnings about Crypto investing.
[vi] See The National Conference of State Legislatures website available at: https://www.ncsl.org/research/financial-services-and-commerce/cryptocurrency-2021-legislation.aspx (last accessed on 1.24.2022).
[vii] See SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946).
[viii] See The Wall Street Journal, “SEC Chairman on New Regulations on Cryptocurrencies and Climate Risk,” available at: https://www.wsj.com/articles/sec-chairman-on-regulations-on-cryptocurrency-and-climate-risk-11639165931, last accessed on 1.24.2022.
[ix] Under Section 5 of the Securities Act, all issuers must register non-exempt securities with the SEC. Section 5 5regulates the timeline and distribution process for issuers who offer securities for sale. 15 U.S. Code § 77e.
[x] https://www.skadden.com/insights/publications/2021/09/quarterly-insights/cryptocurrency-regulation-and-enforcement-at-the-us-federal-and-state-levels
[xi] https://asc.alabama.gov/Orders/2021/SC-2021-0012.pdf
