U.S. Developments

Regulatory Updates

CFTC Staff Issues Advisory to Exchanges and Clearinghouses on Virtual Currency Derivatives

On May 21, the Commodity Futures Trading Commission’s (CFTC) Division of Market Oversight and Division of Clearing and Risk released an advisory that provides guidance to designated contract markets (DCM), swap execution facilities (SEF), and derivatives clearing organizations (DCO) that offer derivatives with virtual currency underliers (the Advisory). The key take-aways are summarized below:

  • The Advisory notes that virtual currencies are distinct from other commodities because, although “serious, good faith efforts are underway to implement many potential uses of virtual currencies,” they are currently bought and sold primarily for investment rather than commercial purposes.
  • The Advisory deputizes DCMs and SEFs as spot market monitors. Platforms that wish to list virtual currency derivatives are expected to enter into information sharing agreements with the spot market exchanges that make up the cash-settlement price, continuously monitor data from these markets, and investigate individual spot market traders. This is novel. DCMs and SEFs are required to monitor the pricing of the index to which the derivative contract will be settled but not spot market trading for other commodities. DCMs and SEFs are expected to meet with the CFTC’s Division of Enforcement surveillance group regularly and provide CFTC staff with data upon request. This might better enable the CFTC to police fraud and manipulation in crypto asset spot markets.
  • CFTC staff recommends DCMs and SEFs set the threshold for filing large trader reports under Part 17 of the CFTC’s regulations at five bitcoin (or the equivalent for other virtual currencies) for virtual currency derivatives.
  • CFTC staff expects each DCM and SEF to engage CFTC staff and solicit comments prior to listing a virtual currency derivative contract. As part of its submission to the CFTC for listing of the contract, the DCM or SEF should provide an explanation of any opposing views raised by CFTC staff and how the DCM or SEF addressed them.
  • For cleared contracts, the Advisory explains that CFTC staff will request that DCOs provide information related to the governance process for approving virtual currency contracts.
  • CFTC staff may notify a DCM or SEF of its concerns in writing and make such writing public or transmit it to other regulators if it is unable to confirm that a contract submitted for self-certification complies with the CEA and CFTC’s regulations.CFTC Staff Advisory No. 18-14 5.21.18; CFTC Statement 5.21.18CFTC and NASAA Sign Mutual Cooperation AgreementCFTC Press Release 7730-18 5.21.18; CFTC Remarks 5.21.18CFTC Commissioner Behnam Emphasizes the Need for a Policy Roadmap for Regulation of FinTechCFTC Keynote 5.3.18SEC Statement Defining Financial Instruments by Function and Not Their FormSEC Speech 5.2.18Board of Governors of the Federal Reserve System Discussion on CryptocurrenciesFederal Reserve Speech 5.15.18Congress Holds a Hearing on Several Practical Applications for Blockchain Technology Committee on Science, Space, & Technology – Hearing 5.8.18
  • On May 8, the House Subcommittee on Oversight and House Subcommittee on Research and Technology held a hearing entitled “Leveraging Blockchain Technology to Improve Supply Chain Management and Combat Counterfeit Goods.” The panel included the following witnesses: (1) Dr. Douglas Maughan (Cybersecurity Division Director, Science and Technology Directorate, Department of Homeland Security (“DHS”)), (2) Robert Chiaviello (IPR Counsel, Nuby Law), (3) Michael White (Head of Global Trade Digitization, Maersk), and Chris Rubio (Vice President Global Customs Brokerage Staff, UPS). The hearing conducted an overview of various industry specific benefits associated with the use of blockchain technology. Dr. Douglas Maughan described DHS efforts to implement blockchain into boarder security programs and transportation networks. He emphasized the rapid pace of development of these systems and saw DHS implementations of blockchain technology as a promising method of furthering DHS objectives. In the private sector, witnesses were optimistic regarding the benefits of blockchain implementations for supply networks, particularly in their ability to identify counterfeit goods and improve logistics management. Chris Rubio, explained the use of blockchain technology as a means of digitizing physical asset information to provide real-time tracking, streamlining the flow of goods. According to Michael White, the U.S. is at the forefront of embracing blockchain technology, but he cautioned that the U.S. must remain open and neutral and strive for common global standards.
  • On May 15, Governor Lael Brainard of the Board of Governors of the Federal Reserve System appeared before the Decoding Digital Currency Conference to discuss the research being done at the Federal Reserve into blockchain technology. Governor Brainard emphasized that the Federal Reserve is evaluating developments in blockchain technology through a multidisciplinary lens, “combining information technology and policy analysis to study the potential implications for payments policy, supervision and regulation, financial stability, monetary policy, and the provision of financial services.” Discussion also turned to the topic of a central bank sponsored digital currency. She expressed skepticism regarding the possibility of a central bank digital currency due primarily to concerns associated with cybersecurity and money laundering risks. She also described the damage that the adoption of a central bank digital currency would have on bank operations due to the removal of depositary functions and the corresponding effect such removal would have on the loan market. The discussion concluded with Governor Brainard stating that she remains optimistic that the financial sector will find valuable ways to employ distributed ledger technology in the area of payments, clearing and settlement in coming years.
  • The Securities and Exchange Commission (SEC) Commissioner Hester M. Peirce appeared before the Medici Conference on May 2 to discuss blockchain tokens and the SEC’s role as a responsible regulator in this rapidly developing industry. The Commissioner described the various efforts the SEC is undertaking to better understand the challenges posed by distributed ledger technologies. The Commissioner also reiterated the SEC’s approach to treat cryptocurrencies based upon their function and not their form via a facts-based determination. Importantly, the Commissioner recognized several of the key challenges associated with analyzing various virtual currencies, including the question of whether a virtual currency could be a security at one point in time and then become some other instrument once the infrastructure surrounding the virtual currency is further developed. She closed her discussion by stating that although many questions remain open in the eyes of the SEC, she is confident that open communication between innovators and regulators could occur without the need for a government-sponsored regulatory sandbox.
  • On May 3, CFTC Commissioner Behnam spoke at the Futures Industry Association’s Law and Compliance conference about the regulation of FinTech. He stated that “policymakers . . . need to prioritize the discussions and policy roadmap for the oversight and regulation of FinTech.” Commissioner Behnam proposed that the U.S., through the Financial Stability Oversight Council (FSOC), lead the international effort to address legal issues related to FinTech and craft appropriate regulations before financial stability concerns arise. He explained that “the FSOC has authority to (i) convene all key U.S. financial regulators; (ii) establish a mutually agreed lexicon for discussing crypto-assets and related FinTech; (iii) convene public hearings; and (iv) propose policy direction and guide jurisdictional responsibility based on input from regulators, stakeholders, academics, and the public.”
  • On May 21, the CFTC and North American Securities Administrators Association (NASAA) executed a mutual cooperation agreement. The agreement is intended to facilitate information sharing amongst the CFTC and state securities regulators and state attorneys general. CFTC Chairman Giancarlo noted that “with this MOU, we turn speech into action. As we discuss digital assets and the future, we must prepare for the present and future needs of oversight, law enforcement and consumer education. This MOU provides a much-needed resource for the CFTC and state securities authorities. It gives us scaffolding that builds upon a firm foundation for the future.”
  • Commissioner Behnam noted in a public statement that he remains interested in amending the regulations currently in place to bar self-certification of virtual currency derivatives in certain contexts. He stated: “I look forward to continuing to explore our options, which I hope will include some parameters for determining when self-certification may not be appropriate, and for determining when such matters are appropriately brought before the Commission.”

NY Department of Financial Services Approves Custody and Trading of Zcash, Litecoin, and Bitcoin Cash on Gemini

On May 14, the New York Department of Financial Services (DFS) authorized Gemini Trust Company, LLC to offer custodial services and trading of Zcash, Litecoin, and Bitcoin Cash. Notably, Gemini is the first New York licensed exchange to offer custody and trading of Zcash, a privacy coin.

NY Department of Financial Services Grants Virtual Currency License to Genesis Global Trading

On May 17, the New York DFS granted a virtual currency license to Genesis Global Trading, Inc. Genesis is the fifth company to receive a virtual currency license from DFS. Genesis is an over-the-counter crypto asset trading platform for institutional buyers and sellers.

Enforcement Update

Three Indicted In $25M Crypto Card ICO Fraud Scheme

On May 14, a federal grand jury in New York indicted three Florida residents with securities and wire fraud, based on allegations that they defrauded investors of $25 million by lying about their cryptocurrency debit card ahead of its initial coin offering (ICO). Robert Khuzami, deputy U.S. attorney for the Southern District of New York, said the three men sought to “capitalize on investor interest in the burgeoning cryptocurrency market.” The men allegedly made false claims about their products and relationships that they had with credible financial institutions including Bancorp, Visa and Mastercard. They also allegedly paid celebrities to promote their ICO, including musician DJ Khaled and professional boxer, Floyd Mayweather Jr. The criminal indictment came following several actions by the US Securities and Exchange Commission including civil charges brought last month. US Attorney SDNY Press Release 4.20.18

International Developments

Korean Government Agrees to Regulate Cryptocurrencies Under G20 Rubric

Top financial policymakers in South Korea, including the country’s Financial Supervisory Service (FSS), have agreed to recognize cryptocurrencies as financial assets and regulate them based on the unified regulations set forth by the G20 nations. This represents a reversal of South Korea’s position on cryptocurrency, which previously classified cryptocurrencies as non-financial products because of their perceived speculative value. Additionally, Korean regulators have agreed to adopt the standards of the intergovernmental Financial Action Task Force in revising its own policies. The G20 financial policymakers have set a deadline of July 2018 to make “the first step toward ‘unified regulation’ of cryptocurrencies.” China Money Network 5.18.18

Norwegian Banks Considering Issuing Digital Currency

The Central Bank of Norway announced in a working paper this month that it is considering developing its own cryptocurrency. Noting the decline in cash usage in the country, the report sets forth several uses and advantages of a digital currency issued by a central bank, including providing a “reliable alternative to deposits in private banks,” a solution for electronic payment systems, and an alternative method for bank customers to store financial assets. Norges Bank Report 5.18.18

Zimbabwe Central Bank Bans Banking of Crypto

The Reserve Bank of Zimbabwe has directed all banks to refrain from providing banking services to anyone dealing with or settling virtual currencies, citing fears of money laundering and other criminal activity. Cryptocurrency exchanges are not affected by the ban for now. The ban is not expected to hinder peer-to-peer transactions; merely settling between banks. Reuters 5.14.18

Russian Justice Minister Takes Position that Cryptocurrency is Property

Which cryptocurrencies remain unregulated in Russia, the country’s Ministry of Justice has Alexander Konovalov has indicated that he considered cryptocurrency to be “other property” under the law and that digital coins should not be considered electronic money. Russia’s Civil Code does not mention “cryptocurrency” at all, but two drafts of legislation addressing cryptocurrency are pending in the lower house of the Russian parliament. One bill addresses this issue and would amend the Civil Code to include regulation of cryptocurrency payments; the second involves legalizing initial coin offerings (ICOs). Separately, a bankruptcy case involving Bitcoin holdings is pending in Russian courts that will determine whether cryptocurrencies have “real value” in Russia. Bitcoin.com 5.25.18

Taiwan Confirms New Regulatory Guidance on Cryptocurrencies is Forthcoming

The Justice Minister of Taiwan has reaffirmed the country’s plans to move ahead in passing new regulatory guidance on trading cryptocurrencies and has directed the new regulation to be in effect by November 2018. The goal is for Taiwan’s central bank, the Ministry of Interior, and the Bureau of Investigation to determine how each entity will regulate cryptocurrencies. A primary focus of the new regulation will be strengthening Taiwan’s AML rules. Asia Times 4.26.18

Philippines Permits Virtual Currency Operations in Special Economic Zone

In February, regulators in the Philippines legalized the entry of 10 virtual currency companies into an economic zone within the country. On April 25, the regulators gave permission for those companies to begin operations following licensure, which the economic zone regulator, CEZA, said would be forthcoming shortly. The central bank of the Philippines has not officially endorsed the use of any cryptocurrency. Reuters 4.25.18

Vietnam Directs Banks to Tighten Oversight on Cryptocurrency Activities

Following a crypto fraud resulting in the loss of 15 trillion Vietnamese dong ($658 million), the Vietnamese government issued a directive to six government ministries, in addition to financial institutions including Vietnam’s central bank, to tighten oversight and management of cryptocurrency activities within the country. The prime minister of Vietnam reiterated in a separate statement that transacting in cryptocurrencies remains illegal in Vietnam. Directive 4.11.18; Vietnam 4.11.18