Blockchain and the Law

Registration Requirements for “Decentralized” Exchanges under the Federal Securities Laws: The Case of EtherDelta

On November 8, the SEC announced that it settled charges against Zachary Coburn, founder of EtherDelta, a type of non-custodial digital asset trading platform commonly referred to as a “decentralized exchange” or “DEX.” Coburn was charged with causing EtherDelta to operate as an unregistered securities exchange in violation of Section 5 of the Securities Exchange Act of 1934 (the “Exchange Act”) during the period between July 12, 2016 (the date Coburn launched EtherDelta’s website) and December 15, 2017 (the date Coburn ceased collecting fees from EtherDelta users following its sale to foreign buyers).

The conclusions set forth in the SEC’s order contain several key components, including that, during the relevant period:

  1. EtherDelta operated as an “exchange” within the meaning of the Exchange Act;
  2. Coburn “caused” EtherDelta to violate the Exchange Act; and
  3. At least some of the digital assets bought and sold on EtherDelta were “securities.”

We analyze these findings in more depth below. Continue Reading

CFTC Commissioner: Code Developers May be Accountable for Smart Contracts

Recently at a conference in Dubai, Brian Quintenz, who is a Commodity Futures Trading Commission (CFTC) Commissioner, expressed his personal opinion (rather than the views of the CFTC) on the conceptual challenges in applying the CFTC’s regulatory oversight to, and fostering accountability for, smart contracts that reside on decentralized blockchains. In particular, Quintenz conveyed his belief that smart contract developers could potentially be held liable for aiding and abetting activity that violates CFTC regulations through the use of a smart contract that they programmed, if they “could reasonably foresee, at the time they created the code, that it would likely be used by U.S. persons in a manner violative of CFTC regulations.”

At a high level, a smart contract is computer code encoded on a blockchain that is programmed to automate the execution of a transaction upon the occurrence of a triggering event. The CFTC regulates the U.S. derivatives markets and thus has oversight authority over futures and swaps markets, including derivatives on commodity cryptocurrencies. Among the many potential applications of smart contracts, Quintenz identified as a regulatory concern the ability of smart contracts to emulate traditional financial products, such as binary options or derivative contracts. For example, through a smart contract on a blockchain, one could bet on the outcome of a sporting event and, if the prediction is correct, the smart contract could be programmed to automatically settle the bet using a cryptocurrency transfer without the involvement of an intermediary. Applications such as this, Quintenz stated, resemble “prediction markets” and “event contracts,” which may fall within the CFTC’s purview and raise regulatory issues. Continue Reading

SEC Launches FinHub

On October 18, the SEC announced the launch of a new Strategic Hub for Innovation and Financial Technology (the “FinHub”). The FinHub provides an online portal for market participants to engage with the SEC on a range of FinTech-related issues, including distributed ledger technology and digital assets.

The FinHub contains a comprehensive repository of information relating to the SEC’s position on the issuance and transfer of blockchain-based digital assets, including links to key public statements by the SEC and its staff, prior enforcement actions, investor notices and opportunities for public input.

By clicking “Engage with FinHub” on the portal’s homepage, visitors are directed to a request form that enables them to provide the SEC with information about themselves and their projects and request a meeting or other assistance from the SEC staff. While a welcome indication of the SEC’s openness to communicate and collaborate with stakeholders in the blockchain ecosystem, developers, entrepreneurs and other market participants should carefully review the SEC’s Web Site Privacy and Security Policy and consult legal counsel to understand how the Commission may use the information you provide through the request form and for assistance with the SEC outreach process.

Ohio and California Join Other States in Passing Blockchain-Friendly Legislation

This past summer, Ohio adopted legislation (SB220) that primarily provides for a legal safe harbor from certain data-breach related tort claims to covered entities that implement a specified cybersecurity program that “reasonably conforms” to a recognized cybersecurity framework for the protection of personal information and “restricted information” or comply with certain industry-specific federal privacy laws. This legislation is intended incentivize businesses to adopt heightened levels of cybersecurity through voluntary action.

Beyond cybersecurity, SB220 also includes language amending Ohio’s version of the Uniform Electronic Transactions Act (UETA) to incentivize blockchain investment and innovation in the state by allowing transactions recorded on the blockchain to be recognized under it. Ohio’s UETA generally stipulates that records or signatures may not be denied legal effect solely because they are in electronic form and that a contract may not be denied legal effect because an electronic record was used in its formation (a discussion of the extent to which any provision of Ohio’s UETA is preempted by the Federal E-Sign Act (15 U.S.C. § 7001) is beyond the scope of this post). In pertinent part, SB220 amends the definition of “electronic record” under the UETA to provide that “a record or contract that is secured through blockchain technology is considered to be in an electronic form and to be an electronic record.” It also amends the definition of “electronic signature” to clarify that a signature that is “secured through blockchain technology is considered to be in an electronic form and to be an electronic signature.” While one could argue that signatures secured using blockchain are already presumably valid under the UETA, such a law expressly takes up this issue and signals the state’s pro-blockchain stance. Continue Reading

Virtual Currencies Can Be Regulated by CFTC as a “Commodity”

In a notable ruling, a Massachusetts district court declined to dismiss a complaint filed by the Commodity Future Trading Commission (“CFTC”) against an entity over an alleged fraudulent virtual currency offering, ruling that cryptocurrencies fall under the definition of “commodity” under the Commodity Exchange Act (“CEA”) and therefore may be duly regulated by the CFTC. (CFTC v. My Big Coin Pay, Inc., No. 18-10077 (D. Mass. Sept. 26, 2018)). Given that the CFTC has stated its intention to actively police the virtual currency markets, this decision is important in reinforcing the CFTC’s legal authority and jurisdiction over cryptocurrency offerings. Moreover, given that earlier this year a New York district court affirmed the CFTC’s jurisdiction over virtual currencies, this latest ruling is additional precedent in this regulatory area.

In January 2018, the CFTC brought suit against the defendant My Big Coin Pay, Inc. (“My Big Coin”), creator of the My Big Coin virtual currency (“MBC”), alleging that it was engaged in a fraudulent “virtual currency scheme” in violation of the CEA and a CFTC implementing regulation banning fraud or manipulation in connection with the sale of a commodity (17 C.F.R. §180.1(a)). Specifically, the CFTC alleged that the defendants fraudulently solicited customers by making false claims about MBC’s value, usage and trade status, and false statements that the virtual currency was backed by gold. The defendants also told investors that MBC was being “actively traded” on several currency exchanges, but, according to the CFTC, My Big Coin made up and arbitrarily changed the price of the MBC virtual currency to mimic the fluctuations of a legitimate, actively-traded virtual currency. As asserted by the CFTC, the defendants allegedly misappropriated over $6 million from customers for personal gain. The court previously issued a restraining order freezing the defendants’ assets. Continue Reading

Crypto Crackdown – SEC Imposes Broker-Dealer and Investment Company Registration Provisions on Token Traders and a Crypto Fund

The SEC announced a pair of settled orders on Tuesday extending additional provisions of the securities laws over ICOs and other digital assets – the agency’s first ever enforcement actions of their kind. As the SEC has been suggesting for over a year, because digital assets offered and sold in initial coin offerings (“ICOs”) are likely to fall under the definition of securities, businesses that invest in them, or that offer, sell or trade them need to consider their obligations under the Investment Company Act, the Advisers Act and the Securities Act. Continue Reading

Betting Big on Blockchain

Blockchain and sports gambling seem to be a natural fit. Sports gambling has been at the forefront of the news cycle since the U.S. Supreme Court struck down a federal statute that banned states from authorizing sports gambling in Murphy v. NCAA. Since then, New Jersey, Delaware, Mississippi and West Virginia have passed laws allowing wagering on the results of certain sporting events. New York, Pennsylvania and Rhode Island are quickly moving towards the legalization of sports gambling and a number of other states are expected to follow.

Blockchain has already proven to be a reliable partner for online casino gambling. In the past few years, a fruitful relationship between online casino gambling platforms and blockchain technologies has developed. Satoshi Dice, which first gained popularity in 2012, allows users to gamble their cryptocurrency through a blockchain-based, peer-to-peer dice prediction game. Virtue Poker, a ConsenSys-backed, decentralized poker platform, uses blockchain to ensure that casino operators (the “house”) cannot tamper with the integrity of a wager. And ZeroEdge uses smart contracts and blockchain to eliminate the “house” fee that is typically passed on to gamblers.

Thus, given the opening for sports gambling, it is easy to imagine a relationship forming between sports betting and blockchain technologies. Blockchain may allow casino operators and other entities to reduce transaction fees, speed up payment processing, increase gambler anonymity and flag problematic transactions. Some sports betting entities, such as daily fantasy sports behemoth FanDuel, have already begun exploring such opportunities.

However, even within states that have already legalized sports gambling, there are still a number of factors to consider for those aiming to utilize blockchain technologies within their sports betting platforms. Such considerations include, for example: Continue Reading

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