The Office of the Attorney General for the State of New York obtained an ex parte order from a New York State court prohibiting companies associated with the management of the cryptoasset exchange Bitfinex as well as the stablecoin tether from accessing, loaning or encumbering in any way US dollar reserves supporting tether digital coins. The NY AG claimed that the same individuals ultimately own and operate all the companies.

The NY AG had applied for such order without giving respondents notice or having an opportunity to object, claiming such emergency action was necessary because of the potential danger of respondents compromising tether’s supporting balances to help fund Bitfinex's operations.

Stablecoins backed by fiat currency such as tether are a type of virtual currency that are intended to be supported 1:1 by the relevant fiat currency or cash equivalents held in escrow, typically at a bank or other financial institution (e.g., US $1,000 of US dollar stablecoins should be backed by at least US $1,000 of fiat currency or cash equivalents held in a bank or other financial institution in a segregated account solely to support the stablecoins).

According to papers filed by the NY AG, by mid-2018 Bitfinex experienced “extreme difficulty” satisfying clients’ requests to withdraw money from their trading accounts because a payment processor, Crypto Capital Corp. (a Panamanian entity) – where it maintained customer and proprietary funds –, failed to process customer withdrawal requests and would not or could not remit any funds to the cryptoasset exchange. Specifically, as alleged by the NY AG, Bitfinex was unable to retrieve US $851 million from Crypto Capital because the payment processor claimed that the “funds [had been] seized by governmental authorities in Portugal, Poland and the United States.” The NY AG claimed that Bitfinex did not believe Crypto Capital’s explanation. In October 2018, said the NY AG, Bitfinex publicly denied rumors of difficulty meeting customer withdrawal requests despite public rumors to the contrary.

In response, charged the NY AG, executives of Bitfinex and the company managing tether (“Tether”) agreed for Tether to provide Bitfinex a line of credit of up to US $900 million sourced from the US dollar reserves supporting the tether stablecoin in order to help meet Bitfinex’s customers’ withdrawal demands. However, this arrangement, asserted the NY AG, was made without disclosure to tether holders. To date, claimed the NY AG, Bitfinex has already borrowed US $700 million from Tether utilizing tether supporting balances.

The court’s order also required respondents to safeguard certain records, and provide certain documents to the NY AG. Other than requesting the specific relief granted in the court’s order, the NY AG did not seek to interfere in any manner with Bitfinex’s or Tether’s day-to-day operations.

In a press release issued on April 26, Bitfinex said that the NY AG’s filings “were written in bad faith and are riddled with false assertions … Both Bitfinex and Tether are financially strong – full stop.” Bitfinex expressly denied the NY AG’s allegations that it did not believe Crypto Capital’s explanation regarding the US $851 million, saying “that these Crypto Capital amounts are not lost but have been, in fact, seized and safeguarded. We are and have been actively working to exercise our rights and remedies and [sic] get those funds released.” (Click here to access the full Bitfinex press release.)

A court hearing on this matter is scheduled for May 3, 2019.

Earlier this month, the New York Department of Financial Services cancelled Bittrex Inc.’s temporary authority to conduct a virtual currency business in New York, denied its application to obtain a BitLicense, and explained its actions in a letter to Bittrex that the agency publicly disseminated. Bittrex and Bitfinex are not related entities. (Click here for background in the article “New York State Department of Financial Services Revokes Crypto Exchange’s Safe Harbor to Operate Without BitLicense” in the April 14, 2016 edition of Bridging the Week.) Last year the NY AG issued a report claiming that cryptoasset trading facilities often (1) engage in several lines of business that may pose conflicts of interest; (2) have not implemented “serious efforts to impede abusive trading activity”; and (3) have “limited or illusory” protection for customer positions. It also claimed that at least three cryptoasset exchanges were operating in New York without an appropriate license. Bitfinex was one of nine cryptoasset exchanges that voluntarily participated in NY AG’s information request that resulted in the agency’s report. (Click here for more details in the article “NY Attorney General Says Investors Risk Abusive Trading and More on Crypto Platforms” in the September 23, 2018 edition of Bridging the Week.)

In other legal and regulatory developments regarding cryptoassets:

  • Public Sniping Continues – Denied NY BitLicense Applicant Claims NY DFS Information Regarding Supposed North Korean Accounts Was Wrong: The public sparring between Bittrex and the NY DFS following DFS’s April 10, 2019 denial of Bittrex for a NY BitLicense continued last week when the firm claimed on Twitter that the New York State agency was wrong to accuse it of opening two accounts for North Korean persons. In fact, claimed Bittrex, the firm had investigated and learned in October 2017 that both accounts were for South Korean residents who had incorrectly selected North Korea in a country dropdown menu. The DFS in its April 18, 2019 commentary on a CoinDesk blog had cited Bittrex accounts opened on behalf of residents of North Korea and Iran as examples of the firm’s purported “customer due diligence failures.” Bittrex did not address DFS’s allegations about the Iranian accounts in its Twitter response. (Click here for background on the public sparring between DFS and Bittrex in the article “Thrilla in Manhattan – NY Regulator and Declined BitLicense Applicant Engage in Extraordinary Public Brawl in Media Blog” in the April 21, 2019 edition of Bridging the Week.)
  • France to Implement Voluntary Regime for Issuers of Cryptoassets for Fundraising: Legislation approved by the French National Assembly on April 11 would empower the Autorité des marchés financiers – the French financial services regulator – to offer a “visa” to issuers of digital tokens that would not otherwise constitute financial instruments (e.g., securities or derivatives) to raise funds from France on a voluntary basis. As proposed, issuers of qualified digital assets would have to be incorporated in France; provide an information document to all investors describing the company, the token offering and the project to be financed; establish a system “for monitoring and safeguarding the assets raised during the offer”; and comply with anti-money laundering and terrorist financing rules. Companies that do not obtain a visa could still conduct initial coin offerings in France, but could not do so through general solicitation activity.

The approved legislation would also permit digital assets service providers to be voluntarily licensed and supervised by AMF. However, this proposed regime would not apply to service providers who provide digital assets custody services to third parties or purchase or sell digital assets in exchange for fiat currency; these persons are subject to mandatory registration with AMF. Additionally, the new legislation expressly authorizes two types of funds to invest in digital assets – professional specialized investment funds subject to applicable liquidity and valuation requirements and professional private equity investment funds subject to a 20 percent limit.

The legislation passed by the National Assembly must be formally enacted into law before becoming effective.

  • Two Non-US Persons Indicted for Alleged Online Cryptoasset Fraud: The United States Attorney’s Office for the District of Oregon indicted Onwuemerie Ogor Gift and Kelvin Usifoh – two non-US nationals – for wire fraud and conspiracy to commit wire fraud for engaging in an online scheme to defraud individuals of bitcoin. According to the US Attorney’s Office, from December 2017 through June 2018, the defendants allegedly induced three persons, including one Oregon resident, to transfer 50 bitcoins in aggregate to them for investment purposes; however, the defendants are charged with misappropriating the bitcoin for their own use.
  • FINRA Joins CFTC and SEC in Creating Fintech Hub: The Financial Industry Regulatory Authority established an Office of Financial Innovation to serve as a central point of coordination for novel fintech issues by member firms. The office appears designed to fulfill a similar purpose as LabCFTC at the Commodity Futures Trading Commission (click here for more details) and the Strategic Hub for Innovation and Financial Technology (FinHub) at the Securities and Exchange Commission (click here for background).​

Memory Lane: Bitfinex was involved in one of the first enforcement actions by the CFTC involving spot virtual currencies. In June 2016, Bitfinex agreed to settle charges brought by the Commission that, from approximately April 2013 through at least February 2016, it allegedly engaged in prohibited, off-exchange commodity transactions with retail clients and failed to register as a futures commission merchant, as required. According to the CFTC, during the relevant time period, Bitfinex “operated an online platform for exchange and trading cryptocurrencies, mainly Bitcoins.” The CFTC said that Bitfinex’s platform allowed users that were not eligible contract participants to borrow funds to purchase bitcoins from other platform users. Bitfinex agreed to pay a fine of US $75,000 to resolve the CFTC’s charges and to cease and desist from future violations. (Click here for more details in the article “Bitcoin Exchange Sanctioned by CFTC for Not Being Registered” in the June 5, 2016 edition of Bridging the Week.)

The CFTC’s first enforcement action involving spot virtual currencies was in September 2015 against Coinflip, Inc. and Francisco Riordan, its founder and chief executive officer, for operating a trading facility for bitcoin options – Derivabit – without it being registered as a swap execution facility or a designated contract market. According to the CFTC, because bitcoin and other virtual currencies are “properly” defined as “commodities” under applicable law, all trading facilities for commodity options on bitcoin must be registered with it as a SEF or a DCM. Coinflip was not so registered. To settle this matter, Coinflip and Mr. Riordan agreed to cease and desist from violating applicable law. No financial penalty was required as part of the settlement. (Click here for more background in the article “CFTC Says Virtual Currencies Are a 'Commodity' Under Federal Law, Files Charges Against Coinflip for Operating an Unregistered Bitcoin Options Trading Platform” in the September 20, 2015 edition of Bridging the Week.)