To remain competitive, companies find themselves increasing their efforts to digitally transform their businesses by developing new offerings based on emerging technologies and integrating these technologies into existing product and service offerings.

This is our eleventh monthly bulletin for 2020, 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, from copyright protection to voting, most of the current adoption is in the financial services section and the focus of this bulletin will be primarily on the use of blockchain and or smart contracts in that 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

Digital assets can themselves be assets or instead can reflect the ownership of an underlying asset. For example, electronic records that are the equivalents of negotiable instruments and electronic chattel paper would be digital assets, as would an electronic recording of a security interest in the underlying asset, such as recording title to real or personal property and the use of tokens to represent revenue streams from otherwise illiquid assets such as patents and commercial real estate (sometimes referred to as a “tokenized” or digitized asset).

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.

Each issue will feature in-depth insight on a timely and important current topic. In this issue, we review the regulatory framework for CBDCs and GSCs by analyzing the IMF’s policy paper and we assess the SEC's response to the Wyoming Division of Banking's no-action letter on the application of the Custody Rule to digital assets.

For further information on the status of Blockchain regulation, see “Blockchain Regulation: Speedbumps, Roadblocks and Superhighways,” a September 3 CoinTelegraph article by our partners Margo Tank and Michael Fluhr.

To build on our recent increasing recognition in the fintech and blockchain space, the DLA IPT and Real Estate teams joined up to contribute to the inaugural edition of the Chambers and Partners Blockchain Guide 2020. Led by partner Scott Thiel and supported by Jonathan Gill and Kenny Tam, the team wrote the Hong Kong and China “Law and Practice” sections of the guide detailing the blockchain market and key legal and regulatory issues to note in each jurisdiction.

For related information regarding digital transformation, please see our monthly bulletin, eSignature and ePayment News and Trends.

Announcement

DLA Piper launches high value asset token platform

On November 5, DLA Piper announced the launch of TOKO, a blockchain-based token platform for buying and selling high value assets, developed by DLA Piper in collaboration with Aldersgate Digital Ledger Solutions. TOKO launched as a proof-of-concept by tokenizing a piece of fine artwork commissioned and purchased by a group of DLA Piper partners based in Hong Kong. Read more.

INSIGHTS

Regulatory framework for CBDs and GSCs: IMF’s policy paper “Digital Money Across Borders: Macro-Financial Implications”

The International Monetary Fund (IMF) has published a new policy paper, “Digital Money Across Borders: Macro-Financial Implications” which discusses the pros and cons of two important virtual currencies: central bank digital currencies (CBDCs) and global stable coins (GSCs). In particular, it 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.” Such incentives include financial inclusions of unbanked, hygienic disbursement of government funds to households and firms during emergencies such as the coronavirus disease 2019 (COVID-19) pandemic, and lower cross-border transaction costs, especially for small transactions. In the case of GSCs, they may widen access to services on social networking and e-commerce platforms of global scale. Read more.

SEC invites feedback on application of Custody Rule to digital assets

The Staff of the Securities and Exchange Commission’s Division of Investment Management has published a statement inviting feedback from investment advisers, custodians, and other market participants on application of the SEC Custody Rule to digital assets – specifically, whether non-depository firms such as state-chartered trust companies can act as qualified custodians for digital assets. The statement follows an October 23, 2020 no-action letter issued by the Wyoming Division of Banking (DOB), which determined that a Wyoming-chartered public trust company is permitted under Wyoming law to provide custodial services for digital assets, including virtual currency and tokenized securities, and stated that such entity may serve as a “qualified custodian” under the Investment Advisers Act of 1940 and the SEC Custody Rule. The SEC’s statement was issued to encourage dialogue directly with the Staff regarding the application of the Custody Rule to digital assets. Read more.

FEDERAL DEVELOPMENTS

Blockchain

  • White House issues national strategy for critical and emerging technologies. On October 15, The White House published its “National Strategy for Critical and Emerging Technologies” report, which identifies distributed ledger technologies as one of the 20 “critical and emerging technologies” (C&ET) that US government departments and agencies identified to the National Security Council as priorities for their missions. The National Strategy states that the US “government is unified behind this common National Strategy for C&ET and will effectively encourage the private sector to consider and address the national security implications of C&ET.”
  • FATF seeks input on use of new technologies for data sharing and compliance. The Financial Action Task Force (FATF) has issued a survey seeking input on two studies: “Opportunities and Challenges of New Technologies for AML/CFT” and “Data Pooling, Analysis and Data Protection.” The studies seek to use new technologies, including distributed ledger technology and artificial intelligence, for information sharing and compliance by financial institutions. Survey responses are due by COB December 7.

Virtual currency

  • FRB and FinCEN issue proposed rule that would amend the Recordkeeping Rule and Travel Rule under the Bank Secrecy Act, including by clarifying that “money” includes convertible virtual currency. On October 27, the Board of Governors of the Federal Reserve System (FRB) and the Financial Crimes Enforcement Network (FinCEN) proposed a rule that would amend the Recordkeeping Rule and the Travel Rule under the Bank Secrecy Act (BSA) by reducing the threshold from $3,000 to $250 for international transfers. Further, the FRB and FinCEN propose that the term “money” as used in those rules apply to domestic and cross-border transactions involving convertible virtual currency, which is a medium of exchange that either has an equivalent value as currency or acts as a substitute for currency but lacks legal tender status.
  • FinCEN penalizes bitcoin mixer for violating AML. October 19, the Financial Crimes Enforcement Network (FinCEN) announced it assessed a $60 million civil money penalty against Larry Dean Harmon, the founder, administrator, and primary operator of Helix and Coin Ninja, two virtual currency “mixers” or “tumblers,” for violations of the Bank Secrecy Act. For more information on the charges facing Harmon, see our August and March issues.
  • CFTC issues advisory on virtual currency for futures commission merchants (FCMs). On October 21, the US Commodity Futures Trading Commission (CFTC) announced it issued an advisory for FCMs regarding the holding of virtual currency in segregated accounts. The advisory provides guidance to FCMs on how to hold and report certain deposited virtual currency from customers in connection with physically delivered [DLA1]futures contracts or swaps, and how to design and maintain risk management programs concerning the acceptance of virtual currencies as customer funds.

Taxation

  • Draft IRS guidance on reporting cryptocurrency activity. As we have noted in prior issues of our newsletter, under US tax law, cryptocurrency is treated like property and not like actual currency. Under this treatment, when a person sells cryptocurrency (including when the person uses cryptocurrency to purchase another asset), there is a taxable event to which capital gains tax applies. The IRS remains concerned that taxpayers are not reporting these taxable cryptocurrency transactions. To address this concern, for the 2019 tax year, the IRS revised the standard individual tax return, Form 1040, to include the following question: “At any time . . . did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” However, on the 2019 Form 1040, the question concerning cryptocurrency appeared only on Schedule 1 to the standard form, which many taxpayers do not use. For the 2020 tax year, the IRS has repositioned the cryptocurrency question so that it will now appear as the first question on the standard Form 1040, following the taxpayer’s name and address, and must be answered by all taxpayers. Additionally, in draft instructions to the 2020 Form 1040 released on October 23, the IRS gives guidance regarding which taxpayers need to answer “yes” to this question. Generally, a taxpayer need not answer “yes” if the taxpayer merely holds cryptocurrency in a wallet or an account, or if the taxpayer transfers cryptocurrency between wallets or accounts s/he owns or controls. A taxpayer must answer “yes” if the taxpayer (i) receives cryptocurrency without providing any consideration for it, including from an airdrop or a hard fork; (ii) exchanges cryptocurrency for goods, services, or other property (including other cryptocurrency); or (iii) sells cryptocurrency.

STATE DEVELOPMENTS

Virtual currency

  • Texas cracks down on cryptocurrency fraud: 2020 developments. Texas continues to be a leader in the United States when it comes to cracking down on fraudulent cryptocurrency offerings, and the COVID-19 pandemic has not curtailed these efforts. In 2017, the Texas State Securities Board (the TSSB) became the first state securities regulator to issue a cease-and-desist order against a promoter of a cryptocurrency investment scheme. The TSSB has since issued 26 administrative orders involving 79 individuals and entities for illegally, fraudulently or deceptively offering cryptocurrency investments to Texas investors. Read more.
  • DFS grants first conditional Bitlicense. On October 21, the New York Department of Financial Services (DFS) announced it granted its first conditional Bitlicense to PayPal, in partnership with Paxos Trust Company, to launch a new service enabling its customers to buy, sell, and hold certain virtual currencies. Paxos will provide cryptocurrency trading and custodial services to PayPal for PayPal customers.

Digital assets

  • DFS and CSBS to host techsprint on digital regulatory reporting for virtual currency companies. On October 15, the New York DFS announced that it would collaborate with the Conference of State Bank Supervisors to work towards a common goal of digital regulatory reporting, with the first area of focus being virtual currency companies.
  • Wyoming Division of Banking issues no-action letter on digital asset custody. On October 23, the Wyoming Division of Banking (DB) issued a no-action letter to Two Ocean Trust, regarding the DB’s determination that Two Ocean may provide custodial services for digital assets under Wyoming law, including virtual currency and tokenized securities. The letter further states the DB’s opinion that Two Ocean is a “qualified custodian” under the Investment Advisers Act of 1940 and the SEC Custody Rule.

INDUSTRY DEVELOPMENTS

Virtual currency

  • Anchorage applies for OCC national bank charter. On November 9, Anchorage, the digital asset platform and custodian for institutions, applied to the US Office of the Comptroller of the Currency to convert to a national bank. If the application is approved, Anchorage would be the first crypto company to get a national bank charter, allowing it to do business in all 50 states.

ENFORCEMENT ACTIONS

FEDERAL

Virtual Currency

  • DOJ seeks forfeiture of more than $1 billion in cryptocurrency. On November 5, the Department of Justice (DOJ) announced it filed a civil complaint seeking the forfeiture of bitcoin valued at over $1 billion which was seized on November 3 in connection with the successful prosecution of the Silk Road marketplace.
  • DOJ indicts two men for scheme to steal digital currency and social media accounts. On October 28, the US Attorney’s Office for the District of Maryland announced that a federal grand jury indicted Jordan Milleson of Maryland and Kyell Bryan of Pennsylvania on charges of wire fraud and conspiracy, among others, in connection with their unauthorized takeover of victims’ wireless phone and other electronic accounts to seal digital currency and social media accounts, using phishing emails and SIM swapping.

Commodities

  • Federal court orders Colorado company to pay more than $900,000 for digital asset and forex Ponzi scheme. On November 4, the CFTC announced the US District Court for the District of Colorado entered a judgment against Venture Capital Investments LLC and its principal, Breonna Clark for fraudulently soliciting and misappropriating funds from clients in a digital asset and forex Ponzi scheme. The order requires the defendants to pay $450,302 in restitution, a civil monetary penalty of $450,302 and the CFTC’s costs, and enters a permanent injunction.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

  • Canadian intellectual property office issues practice notice regarding patentable subject matter. On August 21, the Canadian Federal Court released its decision in Choueifaty v. Canada (Attorney General), 2020 FC 837, that overturned the problem solution approach adopted by the Canadian Intellectual Property Office (CIPO) to evaluate patentable subject matter. For more information on this decision, please see our earlier article. While updates to the overturned sections of the Manual of Patent Office Practice (MOPOP) are expected to be revised at some point in the future after the normal consultation process, CIPO issued a practice notice on November 3, “Patentable Subject-Matter under the Patent Act,” which supersedes portions of the MOPOP that have been overturned by Choueifaty. To further explain the analysis, CIPO also published some Examples of Patentable Subject-Matter Analysis which may be used as a reference tool when preparing claims for a Canadian patent application. The expectation is that it will be easier to obtain patents on computer-implemented inventions under the ‎new guidance.
  • Cayman Islands enacts regulatory framework for virtual asset service providers (VASPs). On October 31, the Cayman Islands Ministry of Financial Services announced the enactment of legislation to allow for the supervision of VASPs. The framework is being implemented in two phases:
  • Phase 1 launched on October 31 and focuses on AML and CFT and
  • Phase 2 launches on June 2021 and will implement licensing requirements and supervision.
  • Korean Financial Services Commission proposes new rules on AML requirements for virtual assets. On November 3, the Republic of Korea’s Financial Services Commission announced it introduced a proposal of new rules setting forth AML requirements on virtual assets, which are scheduled to go into effect on March 25, 2021. The rules require VASPs to use “real-name accounts” in their financial transactions with customers, and apply the “travel rule” to VASPs conducting transfers of virtual assets. Comments on the proposal may be submitted through December 14.
  • Pakistani securities regulator issues position paper on regulation of digital asset trading. On November 6, the Pakistan Securities and Exchange Commission (SECP) published a position paper on Regulation of Digital Asset Trading Platforms, proposing that the SECP regulate digital assets based upon the CFTC’s do-not-harm approach.
  • Spanish police arrest operator of token trading firm for fraud. On October 22, the Spanish National Police reportedly arrested Santiago Fuentes, the founder of Arbicorp, which operates the bitcoin bot investment platform Arbistar 2.0. Although formal charges have not yet been disclosed, Fuentes is expected to be charged with allegedly running a Ponzi scheme after customers’ funds were frozen in September and the trading bot was shut down. It is estimated that up to 120,000 customers were affected by the scheme, and those customers had invested up to $520 million in Arbicorp.
  • Swiss Department of Finance issues consultation on regulatory framework for blockchain. On October 19, the Swiss Federal Department of Finance (FDF) announced that it initiated a consultation on amendments to the Swiss Financial Services Act and Financial Institutions Act. The consultation period ends February 2, 2021.