Blockchain and the Law

When is a Token More Than a Token? SEC Settlement over Anti-Touting Provision Raises Familiar Questions

On July 14, 2021, the Securities and Exchange Commission (“SEC”) settled an action against the operator of a platform that promoted current and upcoming digital token offerings for violations of the anti-touting provision of the Securities Act of 1933.  In the Matter of Blotics Ltd. f/d/b/a Coinschedule Ltd. (July 14, 2021).  The SEC claimed that the primary source of revenue for the platform operator, Coinschedule Ltd., was compensation received from issuers that paid to list, market, and rate their token offerings on the platform. The SEC charged that Coinschedule’s failure to disclose the consideration it received from token issuers for promoting their token offerings was a violation of the anti-touting provisions (Section 17(b)) of the Securities Act.  The respondent, Blotics Ltd. (successor to Coinschedule Ltd.), was ordered to pay disgorgement of $43,000, plus interest, and a civil penalty of $154,434.

The settlement order does not shed any light on when a digital token is a security.  The anti-touting provisions of Section 17(b) apply only if the instrument being touted is a security, and the order states that some portion of the digital tokens offered and sold on the Coinschedule platform were securities in the form of investment contracts.  However the settlement order does not address how many or which of the 2,500 individual token offerings profiled on the Coinschedule platform involved securities, providing no analysis and only a conclusory statement that “[t]he digital tokens publicized by Coinschedule included those that were offered and sold as investment contracts, which are securities pursuant to Section 2(a)(1) of the Securities Act.” Continue Reading

DOJ Tax Division Shows Sustained Interest in Cryptocurrency

On May 5, 2021, another federal district court, this time for the Northern District of California, permitted the IRS to proceed with a John Doe summons very similar to the one served on Circle last month (the subject of a recent post).  This time, the Summons seeks information on customers of a San Francisco-headquartered digital currency exchange company called Payward Ventures Inc. and Subsidiaries, d/b/a Kraken.  As in the Circle case, the Summons only applies to customers who have engaged in a total of $20,000 or more in transactions with the company between 2016 and 2020.  Also like in Circle, thus far, DOJ is not alleging any wrongdoing by Kraken or its customers.

Read the full post on our Corporate Defense and Disputes blog.

NFTs Are Interesting but Fractionalized Non-Fungible Tokens (F-NFTs) May Present Even More Challenging Legal Issues

Except for the extensive coverage surrounding Coinbase’s IPO last week and the volatility in the price of cryptocurrencies, much of the air in the crypto space in the last few months has been taken up by the meteoric rise of non-fungible tokens (NFTs). At this point, we will assume that readers have at least a basic familiarity with NFTs. If not, we suggest a review of this SNL skit, as it is actually a pretty good summary.

It seems like new articles appear on a daily basis addressing some aspect of the legal issues associated with the NFT phenomenon. Interestingly, however, there have been few articles and little attention paid to what ultimately might be the most interesting development in this space, that is, the rise of fractional NFTs (F-NFTs).

F-NFTs Stir Up New Issues

Given that many NFTs are selling for significant amounts of money (in both fiat and digital currencies), the idea of fractionalization is taking shape to allow smaller investors to pool resources to purchase fractional interests of a NFT.  Additionally, there is great interest in the opportunity to buy fractional interests of large NFT collections. For example, it was recently reported that a collection of fifty CryptoPunks, which are early, now valuable NFT pixel art collectibles, were fractionalized into millions of tokens. The interest in fractionalization is not surprising given the high sale price of some NFTs and the widespread adoption of crowdfunding in many areas in e-commerce and investing.

Beyond mere entry into the market, purchasers can hold onto an F-NFT in the hope of seeing investment gains or realizing dividends, or else sell the F-NFT (from a technical perspective, referred to as a “shard”) to another investor. Several entities have emerged to facilitate the sale of F-NFTs to unlock liquidity in the market and create and trade fractions of NFTs.  For example, the NFT trading platform Niftex states that it allows owners to break NFTs into shards for purchase at a fixed price, with the fractions able to be subsequently traded in the market. The site also states that it allows shard owners some local governance rights on the platform with respect to a particular fraction set and provides an investor with a certain percentage of shards who wishes to own the entire digital asset with a method to bid on the remaining shards.

As most anything can be reduced to an NFT, it’s interesting to think of the possibilities of fractionalization. Now that the buying and trading of cryptocurrency has become mainstream, with major fintech platforms having begun to allow users to buy, sell or hold crypto and more and more decentralized finance (or DeFi) and decentralized applications (DApps) being developed to offer new digital solutions for various financial transactions, the continued fractionalization of NFTs is almost inevitable.

But is it legal? Continue Reading

A Warning to Cryptocurrency Users from the Justice Department’s Tax Division

As you might expect during tax season, the Justice Department’s press releases seem particularly focused on tax-related issues these days.  At the start of this month, DOJ sent a stern reminder to the public that non-traditional currency users should not expect to escape federal tax law enforcement.

Read the full blog post on Proskauer’s Corporate Defense blog.

Antitrust Enforcers Preview Incoming Spotlight on Blockchain

The tide of regulation of cryptocurrency and blockchain could be turning in the United States. Following comments by newly-confirmed Treasury Secretary (and former Federal Reserve Chair) Janet Yellen describing Bitcoin as “inefficient” and “extremely volatile,” the price of the coin dropped 10% in 24 hours. During her confirmation hearings, Yellen described cryptocurrencies as a “particular concern” and signaled that the Treasury would begin examining blockchain-based financial networks. On the heels of Secretary Yellen’s comments, Congressman Patrick McHenry (R-NC), head of the House Financial Services Committee, and Congressman Stephen F. Lynch (D-MA), Chair of the Financial Technologies Task Force, introduced H.R. 1602, bipartisan legislation which directs the CFTC and the SEC to “jointly establish a digital asset working group” to “provide regulatory clarity” and to “create a critical collaboration [between the two agencies to] create fair and transparent markets.” Notably absent from this proposed collaboration is any mention of antitrust enforcement or involvement of the DOJ antitrust division or the FTC.  However, recent comments by outgoing DOJ chair Makan Delrahim provide clues as to how antitrust may play a part in the regulatory framework for blockchain and cryptocurrency.

Read the full post on Proskauer’s Minding Your Business blog.

SEC Division of Examinations Releases Risk Alert for Digital Asset Securities

On February 26, 2020, the Security and Exchange Commission’s (“SEC”) Division of Examinations (the “Division”) published a Risk Alert, “The Division of Examinations’ Continued Focus on Digital Asset Securities.” In the Risk Alert, the Division offered insight into its current examination focus with respect to the activities of market participants, including investment advisers, concerning digital assets that are securities (“Digital Asset Securities”) and distributed ledger technologies.

The Alert outlines the observations of the Division, which were the product of examinations of investment advisers, broker-dealers, and transfer agents and their use of Digital Asset Securities. At only eight pages, the Alert is not an exhaustive compliance document for market participants and does not detail explicitly how firms might remain in compliance with securities laws and regulations.  The Division’s outline of the risks it has observed from recent examinations is, however, a useful roadmap, outlining the areas of focus for the Division’s future examinations and compelling firms to take another look at their relevant compliance practices.  It also raises some questions about the scope of the applicability of federal securities to digital assets that have yet to be explored. Continue Reading

Three Critical Questions That Will (Hopefully) be Answered by the SEC’s Lawsuit against Ripple

Late last year, the SEC filed a litigated action in the U.S. District Court for the Southern District of New York against Ripple Labs Inc. and two of its executive officers (collectively, “Ripple”), alleging that Ripple raised over $1.3 billion in unregistered offerings of the digital asset known as XRP. Ripple opted not to file a motion to dismiss the complaint, and based on recent filings it appears that the parties do not believe a pre-trial settlement is likely.

The Ripple case raises three very important questions regarding digital assets, and may provide a vehicle for the SEC or the court to offer answers to those questions.

Read the full post on our The Capital Commitment blog.

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