By Freeman Lewin and Alexandra Levin Kramer
It was a busy couple of weeks for legislators and public service personnel in the United States.
On July 18, 2018, Congress held two separate hearings concerning cryptocurrencies and distributed ledger technologies. In one, held by the House Committee on Agriculture, Committee Chairman Michael Conaway (R-TX) made it clear that the Committee has a vested interest in shaping blockchain’s regulatory ecosystem, stating that the definition of a security “directly impacts the definition of a commodity,” and therefore, if a particular token is not a security, “there is a good chance it’s a commodity and subject to the requirements of the Commodity Exchange Act.” Witnesses to the hearing included the Managing Partner at Andreessen Horowitz, Scott Kupon, and notable alumnus of the Commodity Futures Trading Commission (the “CFTC”), Ex-CFTC Chair Gary Gensler who said that the Securities and Exchange Commission (the “SEC”) could need 2-4 years to address the “thousands” of “noncompliant” actors in the ICO space. Mr. Genlser has been an active commentator on blockchain and cryptocurrencies. In an April 23, 2018 statement at the MIT Technology Review Business of Blockchain event, he detailed the history of the Bitcoin, Bitcoin Cash and Ethereum Foundations, and surmised that retroactive registration with rescission rights may be a way to bring thousands of past ICOs into compliance.
The second hearing, held by the House Financial Services Committee’s Monetary Policy and Trade Subcommittee, discussed the future of money and how digital currency will feature in it. The central question in that hearing was whether digital currencies are “simply a new way to hold and transfer value...or will it have a far-reaching transformative effect that will change our economy.” Rep. Brad Sherman (D-CA) generated the most controversy by stating, “We should prohibit U.S. persons from buying or mining cryptocurrencies. Mining alone uses electricity which takes away from other needs and/or adds to the carbon footprint. As a medium of exchange, cryptocurrency accomplishes nothing except facilitating narcotics trafficking, terrorism, and tax evasion.” That said, the committee's questions and remarks did not as a whole feature such suspicion. In his closing remarks, Hearing Chairman Andy Barr (R-KY) stated, “Given the fact that digital currencies and cryptocurrencies will continue to have a greater and greater impact on our financial system and the broader economy, I’m sure we’ll be revisiting this topic further in the future.”
Following its litigation with Coinbase to seek the names of clients engaging in cryptocurrency transactions during 2013-2015, the Internal Revenue Service (the “IRS”) continued to focus its attention on cryptocurrency transactions by announcing on July 2, 2018, an audit campaign focusing on virtual currency transactions. According to a statement released by the IRS, the Virtual Currency Compliance campaign “will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations.” As part of this announcement, the IRS urged taxpayers with unreported virtual currency transactions to correct their tax returns, but also cautioned that it has no plans to offer a voluntary disclosure program in this area.
The Financial Industry Regulatory Authority (“FINRA”) issued Regulatory Notice 18-20 to encourage its member firms to notify FINRA of involvement related to digital assets. The types of activities of interest to FINRA include actions by members, associated persons, or affiliates to:
This Notice follows FINRA’s warning to retail investors in December 2017, which urged investors to be cautious with such investments after the SEC suspended trading in a number of securities due to questions regarding the accuracy of cryptocurrency-related activities.
The Wall Street Journal reported on July 18, 2018, that the Consumer Finance Protection Bureau (the “CFPB”) has launched a “regulatory sandbox” to help financial technology firms “develop new products and services.” In an interview with the Journal, Mick Mulvaney, the CFPB’s acting chief, said he “expects the bureau’s new innovation office to look closely at cryptocurrencies, other financial technology based on blockchain, private currencies and microlending, or lending by individuals rather than institutions.” The former Republican congressman and longtime critic of the CFPB said, “You can make a strong argument...that new technology actually offers new and innovative ways to protect consumers.” While the CFPB, under its previous leadership, had a small team to promote financial technology innovation, the creation of this sandbox emphasizes Mr. Mulvaney’s business-friendly approach. There is no word yet about the nature of the sandbox, but heading up the team will be Paul Watkins, formerly of the Arizona State Attorney General’s office, who set up the nation’s first state-level sandbox program for companies to open a dialogue with government officials.
The Office of that Comptroller of the Currency (“OCC”) announced on July 31, 2018, that it would be accepting “applications for national bank charters from non-depository financial technology (“fintech”) companies engaged in the business of banking,” effective immediately. The move, coming hours after the Treasury Department endorsed the concept of a U.S. regulatory sandbox for fintech companies, opens the door for online and peer-to-peer lenders to operate nationwide under a singled licensing and regulatory regime. However, the usual regulatory restrictions related to bank holding companies and changes in bank control will still be applicable based on the Federal Reserve regulations.
At the G20 Finance Ministers & Central Banking Governors Meeting held on July 21-22, 2018, G20 members reiterated their position on a plan for “vigilant” monitoring of cryptocurrencies. Specifically, they expressed that while crypto-assets can “deliver significant benefits to the financial system,” they “raise issues with respect to consumer and investor protection, market integrity, tax evasion, money laundering and terrorist financing.” They also called upon the Financial Action Task Force (the “FATF”), an intergovernmental body formed to fight money laundering and terrorist financing, to clarify how its existing AML standards can apply to cryptocurrency within three months. To that end, Coindesk reported in June 2018 that the FATF was planning to develop binding rules for the world’s cryptocurrency exchanges.
In our July 6, 2018 blog, we reported on Malta’s new cryptocurrency framework. On July 20, 2018 Malta’s Financial Services Authority (the “MFSA”) released a press release clarifying that while the Virtual Financial Assets Act (“the Act”) has been published, “it is not yet in force and will take effect on such date as the Minister for Digital Economy may establish by notice in the Government Gazette.” To that end, the MFSA is currently developing a framework which will underlay and complement the Act.
The South Korean Financial Services Commission (the “FSC”) will establish a department exclusively for policymaking initiatives in the nation’s blockchain industry, called the Financial Innovation Bureau (the “FIB”). The Korean Times reported on July 19, 2018, that this move comes as part of South Korea’s plan to lead financial innovation in the coming “Fourth Industrial Revolution” era.
That said, the FIB will be a temporary body with a two-year lifespan. This initiative is in line with a recent report from the Korean Financial Stability Board which claimed that crypto assets “do not pose material risk to global financial stability.”
According to an FSC official who spoke to The Korean Times, “[t]he new Financial Innovation Bureau will also be tasked with policy initiatives for financial innovation, such as innovating financial services using fintech or big data, and responses to new developments and challenges such as cryptocurrencies.
Canada continues to develop as a leader in blockchain banking innovation. In a staff research paper published by the Bank of Canada on July 26, 2018, Mohammad Davoodalhosseini, a Senior Economist in the Bank’s Funds Management and Banking Department, highlighted that a central bank digital currency (“CDBC”) may be able to co-exist with cash, thereby creating an “optimal” monetary policy. Specifically, the paper studies how monetary policy is affected by the introduction of CBDC, and the circumstances under which its use is desirable. Finally, Davoodalhosseini argues that a country's economic welfare – at least for Canada and the U.S. – might be better off by substituting cash with a CBDC, provided implementation is not extremely costly.
As part of an ongoing effort to update British law and “make it relevant to the challenges of modern technology,” the UK Law Commission (the “Law Commission”) is in the process of codifying the use of smart contracts into British law. The effort is a part of a push by the Law Commission to “ensure that the law is sufficiently certain and flexible to apply in a global, digital context and to highlight any topics which lack clarity or certainty.” The Law Commissions’ annual report, published on July 19, 2018 indicates that the Law Commission favorably views the use of smart contracts as being mechanisms to execute legal contracts to “increase efficiency in business transactions,” and when combined used with blockchain technology, they may “increase trust and certainty.”
Japan’s Financial Services Agency (“FSA”) is looking into tightening its regulation of cryptocurrency exchanges by regulating them under the Financial Instruments and Exchange Act (“FIEA”) rather than the Payment Services Act (“PSA”) after determining that current customer protection mechanisms afforded by the PSA are insufficient when the management of the exchanger has deteriorated. According to the Japanese publication Sankei, the FSA is finalizing details on a report studying the virtual currency exchange industry which “discusses the regulation of the virtual currency exchange industry and the problems of the existing legal system.” If cryptocurrency exchanges come under the FIEA, exchanges will have to establish strict investor controls and manage customer funds and securities separately from corporate assets. This investigation comes on the heels of the “NEM” hack which leaked about 58 billion yen (USD $518 million) from their exchange, “coincheck”.
Please contact Alexandra Levin Kramer, the Chair of CKR Law's Blockchain Technology & Digital Currency practice group, if you have any questions. She can be reached at email@example.com or +1 (212) 259-7300.