Blockchain and Digital Assets News and Trends

This is our twelfth monthly bulletin for 2021, aiming to help companies identify important and significant legal developments governing the use and acceptance of blockchain technology, smart contracts and digital assets.

While the use cases for blockchain technology are vast, this bulletin will be primarily on the use of blockchain and or smart contracts in the financial services sector. With respect to digital assets, we have organized our approach to this topic by discussing it in terms of traditional asset type or function (although the types and functions may overlap), that is, digital assets as:

• Securities
• Virtual currencies
• Commodities
• Deposits, accounts, intangibles
• Negotiable instruments
• Electronic chattel paper
• Digitized assets

In addition to reporting on the law and regulation governing blockchain, smart contracts and digital assets, this bulletin will discuss the legal developments supporting the infrastructure and ecosystems that enable the use and acceptance of these new technologies.

INSIGHTS

Google files groundbreaking civil suit to disrupt massive botnet with blockchain backup system

Google has filed a groundbreaking civil suit this week against two Russian hackers who allegedly control the massive Glupteba botnet, which utilizes a blockchain backup mechanism and which has infected more than 1 million Windows computers worldwide. The action illustrates how private entities are increasingly taking legal and technical actions without the aid of law enforcement agencies to disrupt and deter cybercrime. Read more.

FEDERAL DEVELOPMENTS

Digital assets

• OCC, FDIC and Federal Reserve issue joint statement on crypto-asset policy sprint initiative. On November 23, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance corporation (FDIC) (the agencies) announced the issuance of a Joint Statement on Crypto-Asset Policy Sprint Initiative and Next Steps. The statement summarizes the agencies’ interagency policy sprints focused on crypto-assets and provides a roadmap of future work related to crypto-assets. The policy sprint in 2022 will focus on providing greater clarity on whether certain activities related to crypto-assets conducted by banking organizations are legally permissible, and expectations for safety and soundness, consumer protection, and compliance with existing laws and regulations related to:
  1. Crypto-asset safekeeping and traditional custody services
  2. Ancillary custody services
  3. Facilitation of customer purchases and sales of crypto-assets
  4. Loans collateralized by crypto-assets
  5. Issuance and distribution of stablecoins
  6. Activities involving the holding of crypto-assets on balance sheet

  Commissioner Dawn Stump of the Commodity Futures Trading Commission (CFTC) issued a statement applauding the agencies’ Joint Statement as an effort to provide greater clarity around the impact of existing laws and regulations on certain crypto-asset activity. Commissioner Stump’s statement conforms with her stated opposition to “regulating through enforcement,” under which agencies bring enforcement actions without providing clear compliance guidelines.

• OCC clarifies bank authority to engage in cryptocurrency activities. On November 23, the OCC announced the issuance of Interpretive Letter #1179 clarifying the activities addressed in previous Interpretive Letters 1170, 1172 and 1174. Letter #1179 states that a bank may legally engage in the activities addressed in those letters provide the bank can demonstrate, to the satisfaction of its supervisory office, that it has controls in place to conduct such activities in a safe and sound manner. To demonstrate such satisfaction, the bank should notify its supervisory office in writing of its intention to engage in the specified activities and the bank should not engage in activities until it receives written notification from the supervisory office of its non-objection.
• Committee on Financial Services hearing with crypto industry leaders. On December 8, the US House Committee on Financial Services held a full Committee hearing entitled Digital Assets and the Future of Finance: Understanding the Challenges and Benefits of Financial Innovation in the United States. Testimony was heard from the following witnesses:
  • Jeremy Allaire, Co-Founder, Chairman and CEO, Circle
  • Samuel Bankman-Fried, Founder and CEO, FTX
  • Brian P. Brooks, CEO, Bitfury Group
  • Charles Cascarilla, CEO and co-Founder, Paxos Trust Company
  • Denelle Dixon, CEO and Executive Director, Stellar Development Foundation
  • Alesia Jeanne Haas, CEO, Coinbase Inc. and CFO, Coinbase Global Inc.

  Chair Waters’s opening statement explained that “[t]his hearing and subsequent hearings on this topic will help this Committee consider how to support responsible innovation that protects consumers and investors, safeguards our financial system from systemic risks, promotes financial inclusion, addresses environmental concerns, as well as to consider a potential Central Bank Digital Currency.”

Securities

• SEC Chair speaks on need for token regulation. On December 2, Securities and Exchange Commission Chair Gary Gensler spoke at the Investor Advisory Committee, emphasizing the need for regulation of many tokens as securities. Chair Gensler again asserted: “unfortunately, this [crypto] asset class is rife with fraud, scams, and abuse in certain applications. There’s a great deal of hype and spin about crypto assets and crypto projects. In many cases, investors aren’t able to get rigorous, balanced, and complete information on tokens or trading and lending platforms. Fourth, right now, we just don’t have enough investor protection in crypto. The American public is buying, selling, and lending crypto on trading, lending, and decentralized finance (DeFi) platforms, where there are significant gaps in investor protection. This leaves markets open to manipulation. This leaves investors vulnerable. If we don’t address these issues, I worry a lot of people will be hurt. Fifth, many of these tokens are offered and sold as securities. There’s actually a lot of clarity on that front. In the 1930s, Congress established the definition of a security, which included about 20 items, like stock, bonds, and notes. … I believe we have a crypto market now where many tokens may be unregistered securities, without required disclosures or market oversight.”
• SEC Commissioner calls for more regulatory clarity on crypto. On December 2, SEC Commissioner Hester Pierce called for more regulatory clarity relating to crypto in her remarks before the Investor Advisory Committee, stating: “When a regulator clearly delineates rules, people trying to do the right thing can work within those rules and investors can more distinguish the fraudsters from the legitimate actors. The SEC has not provided clarity in response to repeated questions on crypto from reputable players, but has instead embraced an approach that has been described aptly to me as ‘strategic ambiguity.’ Such an approach facilitates enforcement actions, but it is costly and treacherous for well-intentioned developers and their lawyers.” Commissioner Pearce further commented on the Commission’s prohibition of applications for bitcoin spot exchange traded products, noting the “unsatisfactory reasoning the Commission has relied on in allowing bitcoin futures-based products, but prohibiting spot products” and further stated that “Our denials, … hint that spot products are not getting approved because we do not regulate bitcoin trading venues. Forcing investors who want exposure to crypto through traditional investment products into more expensive and less efficient wrappers is hardly the hallmark of an investor protection-focused regulatory scheme.”
• SEC Commissioners disappointed in SEC fall 2021 regulatory agenda. On December 13, SEC Commissioners Hester Pierce and Elad Roisman issued a joint Statement on Chair Gensler’s Regulatory Agenda, noting, “The Agenda also comes up short on furthering the investor protection prong of our mission by failing to provide more clarity on digital assets. First, the Agenda makes no mention of any regulation with respect to digital assets. In the last several years, this sector has grown in size, complexity, diversity, and investor interest. Rather than taking on the difficult task of formulating rules to allow investors and regulated entities to interact with digital assets, including digital asset securities, the Agenda – through its silence on crypto – signals that the market can expect continued questions around the application of our securities laws to this area of increasing investor interest. Such silence emboldens fraudsters and hinders conscientious participants who want to comply with the law.”
• SEC announces enforcement results for FY 2021. On November 18, the SEC announced that it filed 434 new enforcement actions in fiscal year 2021, representing a 7 percent increase over the prior year. “The new actions spanned the entire securities waterfront, including against emerging threats in the crypto and SPAC spaces. For example, the SEC charged a company for operating an unregistered online digital asset exchange, [and] charged a crypto lending platform and top executives alleging a $2 billion fraud.”

INDUSTRY DEVELOPMENTS

• Bitcoin announces Taproot upgrade. On November 14, Bitcoin Network’s Taproot upgrade was reportedly activated to improve scripting capabilities, network security and privacy. Taproot, the first major upgrade to the Bitcoin Network since August 2017, was implemented via soft fork. “[T]he soft fork introduces the concept of Merkelized Abstract Syntax Tree (MAST) … [which] can help make smart contracts more efficient and private by only revealing the relevant parts of the contracts when spending.” Additional information can be found at a report produced by Chainalysis, a blockchain data platform, Everything You Need to Know About Bitcoin’s Taproot Upgrade.
• Chainalysis releases 2021 NFT market report. On December 6, Chainalysis announced the issuance of its report The 2021 NFR Market Explained. According to the report, so far in 2021, at least $26.9 billion worth of cryptocurrency was sent to Ethereum smart contracts associated with NFT marketplaces and collections, with significant increases noted in both total value sent and average transaction size. The report also reviews NFT collection transactions by marketplace over time as well as the web traffic data of popular NFT marketplaces to determine where most NFT users are located.

ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Securities

• SEC charges Latvian citizen with digital asset fraud. On December 2, the SEC announced it charged Ivars Auzins, a Latvian citizen, with defrauding hundreds of retail investors out of at least $7 million through two separate fraudulent digital asset securities offerings. According to the civil complaint, Auzins defrauded US and foreign investors through the unregistered offer and sale of digital asset securities in an initial coin offering of Denaro, a “multi-currency debit card platform” and a purported digital asset cloud mining program known as Innovamine. Auzins allegedly used fake names, fictitious entities, and fraudulent profiles to perpetrate his schemes, and misappropriated nearly all of the investor funds that were raised. The complaint seeks permanent injunctions, including conduct-based injunctions, disgorgement plus prejudgment interest, civil penalties, and an officer-and-director bar against Auzins.
• SEC charges promoter with cryptocurrency investment scam. On November 18, the SEC announced it charged against Ryan Ginster of California with conducting two unregistered and fraudulent securities offerings that raised over $3.6 million in cryptocurrency from retail investors through use of two online platforms – MyMicroProfits.com and Social Profimatic. The platforms promises “astronomical rates of return” by falsely claiming returns through, among other things, “cryptocurrency trading and advertising arbitrage.” The SEC’s complaint seeks permanent injunctions, disgorgement with prejudgment interest, and civil penalties.

Virtual currency

• DOJ sells seized cryptocurrency to compensate BitConnect victims. On November 16, the Department of Justice announced that a judge granted the request of the DOJ and the US Attorney’s Office for the Southern District of California for authority to liquidate approximately $56 million in fraud proceeds seized from Glenn Arcaro, the promoter of BitConnect, who consented to the seizure. The government will sell the cryptocurrency hold the proceeds in US dollars in cryptocurrency wallets, and use these funds to provide restitution to the victims pursuant to a future restitution order by the court at sentencing. All potential victims of the BitConnect scheme are encouraged to visit US v Glenn Arcaro: Seeking Victims in BitConnect Investigation for information on rights they may possess as a victim, the opportunity to submit a victim impact statement, and to identify themselves as a potential victim.

Taxation

• IRS Criminal Investigation releases annual report. On November 18, the Internal Revenue Service (IRS) Criminal Investigation division announced the release of its IRS-Criminal Investigation (IRS-CI) Fiscal Year 2021 Annual Report which included disclosure of the seizure of $3.5 billion in cryptocurrency during fiscal 2021 – or 93 percent of all criminal investigation seizures. $1 billion of the seized funds originated from the case against Silk Road creator, Ross Ulbricht.

STATE

Securities

• Texas enters cease and desist order against cryptocurrency cloud mining firm. On November 19, the Texas State Securities Board (TSSB) announced it entered an emergency cease and desist order against Treasure Growth LLC aka Treasure Growth investments, a cryptocurrency cloud mining firm that claims to be organized in Oregon and located in Florida. The order also names its Chief Investment Officer and sales agents. According to the order, Treasure Growth has been soliciting Texans to invest in various cryptocurrency cloud mining programs through public advertisements and easily accessible online platforms. It is allegedly claiming these cryptocurrency cloud mining investments generate lucrative returns over very short terms – one plan purportedly promises returns of 10 percent over a term of 30 days and another plan purportedly promises returns of 80 percent over a term of 120 days. The order alleges that Treasure Growth has violated Section 7 of the Securities Act by offering unregistered securities. Additionally, persons offering these investments who are not registered as dealers or agents and who do not qualify for an exemption are in violation of Section 12 of the Securities Act.
• Alabama enters cease and desist order against cryptocurrency trading platform. On November 17, the Alabama Securities Commission issued a cease and desist order against Acoin Trading, a UK-based cryptocurrency platform, and its owner, known as Sir Philip Zuka, According to the order, the investment plans of Acoin which require the investment of money from which the investor expected profits to be derived from the efforts of Acoin are securities, and Zuka is an investment advisor, required to be registered with the state.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

• IMF warns El Salvador against adoption of bitcoin. On November 23, the International Monetary Fund (IMF) published an assessment of El Salvador’s financial state which asserts that El Salvador’s recognition of bitcoin as legal tender creates risks for consumer protection and the country’s financial stability, and El Salvador should consider narrowing its bitcoin law. The IMF report states, “Given Bitcoin’s high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity and financial stability. Its use also gives rise to fiscal contingent liabilities. Because of those risks, Bitcoin should not be used as a legal tender. Staff recommends narrowing the scope of the Bitcoin law and urges strengthening the regulation and supervision of the new payment ecosystem.” Just prior to publication of the report, the President of El Salvador reportedly announced plans to issue $1 billion in bitcoin bonds in a deal with Bitfinex and Blockstream.

WE ARE PLEASED TO ANNOUNCE

DLA Piper lawyers ranked in Chambers FinTech 2022. DLA Piper is pleased to announce that the editors of this newsletter, Mark Radcliffe and Margo Tank, have been ranked by Chamber & Partners in the area of USA FinTech Legal: Blockchain & Cryptocurrencies. In total, the firm received 19 firm rankings and 14 individual lawyer rankings in the Chambers FinTech 2022 guide.