This is our eleventh monthly bulletin for 2023, aiming to help companies identify important 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 focuses on uses of blockchain and 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

Thousands of comments submitted in response to proposed regulations covering brokers’ tax reporting of cryptocurrency transactions

By Tom Geraghty and Kali McGuire

The IRS and Treasury Department have received tens of thousands of comments in response to their proposed regulations concerning the reporting by “brokers” of tax information relating to digital assets (Proposed Regulations). Released on August 25, 2023, the Proposed Regulations would effectively subject brokers of digital assets to the same information reporting rules as brokers for securities and other financial instruments. The Proposed Regulations were issued in response to the 2021 Infrastructure Investment and Jobs Act’s (IIJA) expansion of Section 6045 of the Internal Revenue Code to require tax reporting by brokers of transactions involving the sale or exchange of digital assets. Read more.

STATUTORY AND AGENCY DEVELOPMENTS

FEDERAL DEVELOPMENTS

Commodities

CFTC Commissioner speaks on pilot program for digital asset markets. In remarks before the Atlanta Economics Club on November 13, CFTC Commissioner Kristin Johnson previewed coming reforms in both the crypto and carbon offset markets. Commissioner Johnson’s speech highlighted similarities in these markets, including the potential for tremendous innovation paired with the risk of abuse. She called for a “clear and comprehensive regulatory framework,” and suggested that the CFTC need not wait for Congress to take a greater role in regulating these markets.

CFTC announces record year for digital asset enforcement. On November 7, the CFTC released its FY 2023 enforcement results. The report reveals CFTC brought 96 enforcement actions in FY 2023, resulting in over $4.3 billion in penalties, restitution, and disgorgement. A significant portion of the CFTC’s enforcement work focused on digital assets. The CFTC brought 47 actions involving conduct related to digital asset commodities, representing more than 49 percent of all actions filed this year.

CFTC Commissioner Goldsmith Romero issues Statement on the importance of whistleblowers. On October 31, marking the CFTC’s Annual Report on the Whistleblower Program and Customer Education Initiatives, CFTC Commissioner Christy Goldsmith Romero issued a public statement expressing support for CFTC whistleblowers. Her remarks highlighted that CFTC has awarded more than $16 million to whistleblowers this year alone, with the majority involving cryptocurrency. Simultaneously, she recognized the agency’s Office of Customer Education and Outreach for its role in educating consumers about crypto scams.

CFTC Commissioner delivers remarks to Consumer Federation of America. On November 16, CFTC Commissioner Goldsmith Romero spoke at the Consumer Federation of America’s Financial Services Conference, focusing on the importance of financial stability for consumer protection. In particular, she focused on the perceived conflicts of interest “arising from a market structure common to the cryptocurrency industry involving affiliated companies.” The Commissioner addressed the rise in cryptocurrency players acting as exchange, broker, and clearinghouse contrary to the traditional model in which those entities are separated, pointing to market turmoil over the past year as an example of the risks. In particular, she proposed two substantive changes: redefining the definition of retail customer to separate high-net-worth customers from household customers, and a National Fraud Registry that would serve as a comprehensive record of federal fraud convictions and civil fines that the public could easily search before entrusting someone with their money or cryptocurrency.

Treasury

FinCEN publishes proposed rule on virtual currency mixers, opens public comment period. On October 23, following the Notice of Proposed Rulemaking covered in depth here, FinCEN published its proposed rule to the Federal Register and began accepting public comments. The rule, which would require Bank Secrecy Act regulated financial institutions to report detailed information about any customer who has transacted with a virtual currency “mixing” service, designates such transactions a “Primary Money Laundering Concern,” and deploys a seldom-used authority under the USA PATRIOT Act (Section 311). Comments will be accepted until January 22, 2024 and can be submitted here.

Treasury Secretary Janet Yellen delivers remarks at APEC Finance Ministers’ Meeting. In San Francisco on November 13, Treasury Secretary Janet Yellen addressed digital assets among a list of key priorities for the Asia-Pacific Economic Cooperation Finance Ministers’ Meeting. Her remarks suggested collaboration in developing policies to foster “responsible development and use of digital assets, including unbacked crypto-assets, stablecoins, and central bank digital currencies.”

Treasury under Secretary Brian Nelson hosts roundtable with industry representatives on countering terrorism. In remarks on November 9, Treasury Under Secretary Brian Nelson addressed illicit finance with money services businesses, virtual asset service providers, payment processors, and blockchain analytic companies. The roundtable’s topic was preventing Hamas from leveraging virtual currency tools to fund its operations while also permitting humanitarian aid to reach the people of Gaza. Secretary Nelson acknowledged that virtual currency was only one of many ways Hamas raises revenue.

ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Sanctions

Treasury sanctions Russian national for laundering virtual currency on behalf of Russian elites. On November 3, the Department of Treasury’s Office of Foreign Asset Control (OFAC) announced it had sanctioned Ekaterina Zhdanova, a Russian national accused of laundering and moving funds using virtual currency on behalf of Russian elites and ransomware actors. Zhdanova allegedly employed virtual currency to facilitate large cross-border transactions, evading sanctions, and providing access to the international financial system for sanctioned Russian individuals and entities. She has also been accused of providing services to individuals connected with the Russian Ryuk ransomware group. The designation will freeze all of Zhdanova’s assets in the United States and prohibit US persons from engaging in any transactions with her.

OFAC sanctions Hamas members and a Gaza-based virtual currency exchange. On October 18, OFAC announced it had sanctioned key Hamas terrorist group members, operatives, and financial facilitators including a Gaza-based virtual currency exchange called “Buy Cash” which provided money transmission and exchange services. According to OFAC, Buy Cash was used to transfers funds between terrorist groups including al-Qa’ida and ISIS. The sanctions prohibit any US persons from interacting with the entity.

Securities

SEC charges crypto exchange Kraken with registration violations. On November 20, the SEC announced charges against the Kraken virtual currency exchange. Many of SEC’s allegations are reminiscent of its cases against other major centralized exchanges – that Kraken operated as a broker, dealer, exchange and clearing agency without SEC registration. However, the complaint also alleges that Kraken commingled customer assets with exchange assets, used customer assets to pay for operational expenses, and had inadequate internal controls and record keeping. ADA, AXS, ALGO, ATOM, CHZ, COTI, DASH, FIL, FLOW, ICP, MANA, MATIC, NEAR, OMG, SAND, and SOL are among the specific tokens that SEC alleges were unregistered securities Kraken offered.

SEC releases 2023 enforcement results. On November 14, the SEC announced its enforcement results for FY 2023. According to the release, SEC brought 501 standalone enforcement actions and 784 total enforcement actions this year, reflecting increases of eight and three percent respectively. The SEC also obtained orders barring 133 individuals from serving as officers and directors of public companies, the highest number of officer and director bars obtained in a decade. In addition, the SEC distributed $930 million to harmed investors in FY 2023, marking the second consecutive year with more than $900 million in distributions. Though the results did not offer specific numbers, crypto-related actions spanned the gamut of SEC’s enforcement activities.

SafeMoon virtual currency founders charged with securities fraud and money laundering conspiracy. On November 1, the US Attorney’s Office for the Eastern District of New York and the SEC concurrently announced charges against Braden John Karony, Kyle Nagy, and Thomas Smith for conspiracy to commit securities fraud, conspiracy to commit wire fraud, and money laundering conspiracy. The three men were indicted for their roles in promoting SafeMoon a popular cryptocurrency. While the market capitalization grew to more than $8 billion, the defendants allegedly appropriated “locked” liquidity for their own benefit while lying about it to their investors. The SafeMoon token featured a unique gimmick through which every transaction was subject to a 10-percent tax that would be distributed back to all other SafeMoon holders and SafeMoon’s “locked” liquidity pools. Defendants took more than $200 million in assets from these liquidity pools to buy luxury vehicles and real estate.

SEC Commissioner Peirce delivers belated dissent in LBRY case. On October 27, 2023, SEC Commissioner Hester Peirce issued a dissent to the SEC’s enforcement action against LBRY, Inc., just shy of the one-year anniversary of the district court’s summary judgment ruling for the SEC. In LBRY, the SEC alleged that LBC tokens, used to share and store videos on LBRY’s blockchain-based video-sharing platform, were unregistered securities. In her dissent, Commissioner Peirce questioned whether shutting down LBRY really made the public any safer. She described it as a “company that had build a functioning blockchain with a real-world application,” and compared it to the myriad “fraudulent crypto projects.” She asked, “Why go after a company that sold a token for a functioning blockchain with an established use when we could have pursued plenty of other projects that were outright frauds and did not attempt to comply with the securities laws?” Next, Commissioner Pierce faulted the SEC for its unclear regulations of illusion of registration. She suggested that the SEC’s action actually hurt LBRY investors who would have been better off had LBRY continued to support the blockchain. Finally, Commission Peirce expressed concern that the LBRY decision would discourage innovators from experimenting with blockchain technology.

NFTs

Mutant Ape Planet NFT founder pleads guilty to rug-pull scheme. On November 14, the US Attorney’s Office for the Eastern District of New York announced it had obtained a guilty plea from Aurelien Michel, a French national behind the Mutant Ape Planet NFT project. Michel admitted that he conspired with others to launch an NFT project through which he amassed nearly $3 million before he abandoned the project and his promises to provide rewards and benefits to NFT holders.

Virtual currency

DOJ seizes $9 million of USDT stolen through “pig butchering” scams. On November 21, the Department of Justice announced it had seized $9 million worth of Tether, a stablecoin pegged to the value of the US dollar. The funds were stolen from more than 70 victims of so-called “pig butchering” schemes in which scammers prey on ordinary investors, often befriending them, to induce them to connect their virtual currency wallets to scam websites that eventually drain their assets. In this case, US Secret Service agents were able to trace the victim’s deposits through “chain hopping” by which the thieves obfuscate their trail of money through bridges between different blockchains. The Secret Service worked with the Department of Justice and Tether to identify and transfer the assets.

US seizes $54 million virtual currency related to narcotics distribution. On November 2, the US Attorney’s Office for the District of New Jersey announced it had filed a civil forfeiture action to recover $54 million of cryptocurrency seized in connection with a narcotics distribution scheme. According to the complaint, Christopher Castelluzzo began selling narcotics for Bitcoin online around 2013 and purchased 30,000 Ether at its initial coin offering in July 2014. Though he tried to launder the tokens outside of the US while serving a 20-year prison sentence, federal authorities caught on and seized them in 2021. The Ether tokens are worth roughly $54 million today.

Head of OneCoin pyramid scheme pleads guilty. On November 9, the US Attorney for the Southern District of New York announced that Irina Dilkinska had pled guilty to wire fraud and money laundering charges in connection with her involvement in the OneCoin fraud scheme which was a global multi-level-marketing network used to sell a fake cryptocurrency called OneCoin. According to the US Attorney, Dilkinska, whose title was Head of Legal and Compliance, laundered millions of dollars for OneCoin, though over the course of the scheme, OneCoin generated profits exceeding EUR2.7 billion. For more information on OneCoin, see our September and April issues.

Virginia man sentenced to two years for defrauding virtual currency trading platforms. On November 17, the US Attorney’s Office for the Eastern District of Virginia announced that Rayan Sharaf had been sentenced to two years in prison for defrauding three cryptocurrency trading platforms of more than $300,000. According to the complaint, Sharaf would deposit fiat currency from his bank account into the trading platforms before claiming to his bank that the transfers were unauthorized, which induced the banks to issue refunds.

Sam Bankman-Fried convicted in connection with collapse of FTX. On November 2, the US Attorney’s Office for the Southern District of New York secured a guilty verdict against Sam Bankman-Fried, former CEO of the FTX virtual currency exchange. After a month-long trial and deliberating for only four and a half hours, the jury found Bankman-Fried guilty on all seven charges including wire fraud and conspiracy to commit money laundering. The verdict comes exactly one year after revelations of mismanagement caused FTX to collapse. In a statement, US Attorney Damian Williams called it “one of the biggest financial frauds in American History” and called the conviction a “warning to every fraudster who thinks they’re untouchable, that their crimes are too complex for us to catch ….” Bankman-Fried is due to be sentenced in March 2024.

Serbian national extradited for $70-million crypto and binary options scheme. On November 3, the Department of Justice announced it had secured extradition of Serbian national Kristijan Krstic who, along with a dozen co-conspirators, allegedly defrauded investors of more than $70 million through fraudulent cryptocurrency and binary options investment platforms. According to the indictments, Krstic’s platforms promised secure platforms for trading digital assets while Krstic was actually stealing millions of dollars in customer funds. Krstic faces charges in both the Northern District of Texas and the Eastern District of New York.

Oyster Pearl crypto founder sentenced for fraud and tax evasion. On October 31, the US Attorney’s Office for the Southern District of New York announced that Amir Bruno Elmaani, also known as Bruno Block, had been sentenced to four years in prison for evading taxes on millions of dollars of crypto profits and, in 2018, minting additional tokens on the protocol he controlled called “Oyster Protocol” which he then sold on the open market despite publicly representing that the protocol had a fixed supply of tokens. Elmaani was further ordered to pay more than $5 million in restitution.

Ponzi scammer posing as crypto investor sentenced to seven years. On October 31, the US Attorneys’ Office for the Western District of Texas announced the sentencing of Abner Tinoco, an El Paso resident who operated a Ponzi scheme in which he claimed to use investor funds to deal in cryptocurrency and foreign exchange markets. Tinoco took in approximately $9 million from investors and used more than half on personal extravagances. He used another portion of the funds to pay off early investors. Separately, the CFTC secured a consent decree against him.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

European banking authorities rethink regulatory frameworks for stablecoins. On November 6, the Bank of England (BOE) proposed a new regulatory framework for stablecoins and related service providers. The framework is designed to ensure the safety of money and payments and focuses on GBP denominated coins that could be widely used in the UK for payments between users and retail. Meanwhile, on November 8, the European Banking Agency (EBA) issued draft guidelines for establishing common reference parameters for liquidity stress testing required of issuers of significant assets referenced tokens. Regular stress testing is a requirement for so-called “e-money” institutions that issue “assets references” tokens – in other words, stablecoin issuers. Further, the Bank for International Settlements (BIS) published a paper that reviews the evolution of the stablecoin market over the past ten years. The BIS paper concludes that current stablecoins do not meet the key criteria for being a safe store of value and a trustworthy means of payment in the real economy.