Blockchain and the Law

Kraken Becomes First Digital Asset Company to Receive U.S. Bank Charter

Kraken recently announced that it “is the first digital asset company in U.S. history to receive a bank charter recognized under federal and state law, and will be the first regulated, U.S. bank to provide comprehensive deposit-taking, custody and fiduciary services for digital assets.”

Kraken obtained a charter from the State of Wyoming to operate the world’s first special purpose depository institution (SPDI). In 2019, Wyoming enacted a law to authorize the chartering of SPDIs as a new form of bank, to facilitate the establishment of financial institutions with the requisite expertise to provide banking services to blockchain innovators.

Kraken currently operates one of the largest cryptocurrency exchanges, and it noted that its SPDI’s banking services “will be seamlessly integrated into the existing exchange services, providing clients better funding infrastructure, a better experience and enhanced regulatory clarity.”

According to Kraken’s blog post, during its first year of operations, the SPDI’s services will include digital asset custody, demand/deposit accounts, and wire transfer and funding services. Kraken noted, over the next few years, it plans to support additional services such as enhanced digital asset custody offerings, services specific to individual accounts and corporate clients, including, with respect to the former, a debit card to spend crypto funds and a complete online and mobile banking suite of products, as well as additional retail, wealth management and treasury services.

Kraken will operate its bank via an online and mobile-first banking model, initially offering accounts to only U.S. residents, with plans to expand globally—as stated in its announcement, “Kraken’s vision is to become the world’s trusted bridge between the crypto economy of the future and today’s existing financial ecosystem.”

New York Proposes Conditional BitLicense Framework

The New York State Department of Financial Services (the “NYDFS”), as a part of a series of virtual currency initiatives, proposed in June a framework for applying for and obtaining a virtual currency Conditional BitLicense. The framework is aimed at easing the process for businesses to enter the New York virtual currency marketplace and providing further clarity in a complex area of regulation.

In 2015, the NYDFS issued its first comprehensive rules for regulating firms dealing in virtual currency, 23 NYCRR Part 200. That regulatory regime outlined the NYDFS’s authority to grant licenses to operate a virtual currency business in New York (“BitLicenses”) and a conditional version of that license (“Conditional BitLicenses”). The NYDFS had not, however, established clear rules for applicants to obtain a Conditional BitLicense. As a result, New York virtual currency businesses have, as a practical matter, relied on the BitLicense path, despite its high bar (for example, see here and here).

The NYDFS’s regulatory approach to virtual currency businesses had received criticism from industry players, particularly with respect to the BitLicense’s challenging application process. The NYDFS, in its request for comments on the proposed framework, “recognize[d] that some firms may face actual or perceived hurdles in obtaining a BitLicense. These include a rigorous application process, which can involve a significant expenditure of time and resources for applicants fulfilling the regulatory requirements for strong governance, operational and compliance controls, and capital, among others.” To provide firms an alternative to the BitLicense application process not only in regulation, but also in practice, the NYDFS has proposed a framework to guide applicants to obtain and utilize a Conditional BitLicense.

The proposed framework would permit a firm to engage in virtual currency business activity under a Conditional BitLicense, provided that the firm collaborates with an authorized BitLicensee (i.e., a firm that holds a BitLicense or a New York limited purpose trust charter) for “various services and support, such as those relating to structure, capital, systems, personnel, or any other support needed.”

According to the NYDFS, “the framework can be utilized by a variety of entities, such as startups, growth-stage companies, established New York companies not yet conducting any virtual currency business activity, and established virtual currency companies now operating outside of New York.” While the framework permits a new entrant to initially skip the full BitLicense application process, the NYDFS’s intent is for firms to only temporarily operate under a Conditional BitLicense and eventually apply for a full BitLicense.

The NYDFS provided a general overview of the proposed process a business would follow to obtain a Conditional BitLicense. Among other requirements, an applicant firm must first provide the NYDFS a draft service level (or similar) agreement between it and a fully licensed entity governing the proposed collaboration, and later enter into a supervisory agreement with the NYDFS, which would outline, for example, the allocation of responsibilities and liabilities between the applicant firm and the fully licensed entity, the activities the applicant firm will be permitted to engage in, and the NYDFS’s continued oversight of the applicant firm.

Interested parties and the general public have until August 10, 2020 to submit comments to the NYDFS with respect to the proposed framework, an opportunity for the blockchain and virtual currency industry to help calibrate regulations in this evolving area of law.

The Office of the Comptroller of the Currency Solicits Public Comments on the “Digital Activities” of Banks

On June 3, 2020, the Office of the Comptroller of the Currency (OCC) published an advance notice of proposed rulemaking (ANPR) to solicit public input on the “digital activities” of banks and the impact of emerging technologies on the banking industry. Among other technologies, the ANPR includes questions focused on distributed ledgers, cryptocurrencies and cryptoassets. The OCC, which is an independent bureau of the U.S. Department of the Treasury that regulates and supervises all national banks and federal savings associations, may use public comments received in response to the ANPR to inform its rulemaking activities – an opportunity for the blockchain industry to potentially influence regulations. The OCC’s recent hiring of its new Acting Comptroller of the Currency, Brian Brooks, who was formerly the Chief Legal Officer at a major digital currency exchange, could signal increased attention of the OCC to the future of blockchain technology and cryptocurrency in banking.

Banks, regulators, companies and other organizations that are involved in money transfers or deposits, trading and hedging or the use of digital assets should carefully consider this ANPR, as the ANPR will likely lead to regulations that directly impact their respective businesses. Generally, anyone submitting comments should suggest changes in regulations to appropriately address the new considerations that the deployment of blockchain technology in banking raise and identify regulations that would undesirably stifle technological developments or inadequately protect participants.

The subject matter of the ANPR can be broadly categorized into two groups – questions about future regulations and questions about current regulations.

Regarding future regulations, the OCC seeks to understand technological advancements in areas related to banking, with a goal of better meeting customers’ evolving needs and ensuring that regulations “continue to evolve with developments in the industry.” Some questions that the ANPR invites comments on are geared towards the OCC gaining deeper insight into how the public uses new technologies. For example, one question asks what type of “cryptocurrencies or cryptoassets” an individual is engaged with as well as what distributed ledger technology the individual is using in, or believes could be used in, banking activities. Other questions encourage the public to conceptualize future regulations in light of digital activities. For example, the ANPR invites comments on crypto-related activities that “should be addressed in regulatory guidance.”

Aside from future regulations, the OCC is also evaluating current regulations to determine if they are sufficiently “flexible and clear” or “create unnecessary hurdles” to technological advances in banking. For example, the public will be able to comment on the assessment the OCC uses to determine whether an activity is “convenient or useful,” the threshold test that the OCC employs to determine whether a national bank’s investment activity is sufficiently necessary to the business of banking that it falls within banks’ incidental powers. (Under the current regulations, an activity is convenient and useful if it improves the efficiency, production, or delivery of the bank’s products or services and increases capacity for other bank activities – a broad definition.) Technological advances relevant to various areas of regulations promulgated by the OCC, such as advances in the areas of cryptomining and “layer 2 protocols” may, for example, draw public comments on areas of regulation such as the sale of excess electronic capacity and data processing.

Any potential revisions must satisfy three OCC principles. Any regulation adopted: (1) needs to be technology-neutral so that products, services, and processes can evolve regardless of the enabling technology; (2) should facilitate appropriate levels of consumer protection and privacy; and (3) should be principle-based rather than prescriptive, to manage evolving risks and guard against regulations quickly becoming outdated.

Any comments submitted in response to the ANPR are due by August 3, 2020 and may be used by the OCC to propose revisions or additions to the OCC’s rules. Public input will improve the ability of the OCC to tailor its rulemaking to the needs of different stakeholders and develop a more coherent set of regulations that is in line with technological developments.

Since 2000, the OCC has solicited public comments to calibrate the regulation of national banks’ digital activities. In the rapidly evolving areas of blockchain technology and cryptocurrency, where new implementations, applications and variations are continuously being developed and deployed, the ANPR provides a timely opportunity for the OCC to obtain a more thorough understanding of which changes in regulations may be desirable in continuing to further its mission of fostering the safe, sound and fair operation of national banks and federal savings associations.

Another Blockchain Supply Chain Shipping Consortium Files for Federal Antitrust Exemption

In late May, the Global Shipping Business Network (GSBN), a consortium of ocean carriers and terminal operators, filed a petition with the Federal Maritime Commission (FMC) to obtain an antitrust exemption under the U.S. Shipping Act of 1984. The Act seeks to promote efficient ocean commerce and industry response to international shipping practices by, among other things, providing for antitrust immunity for ocean common carrier agreements filed with the FMC that concern activities outlined in the Act. The FMC is the independent agency charged with regulating oceanborne transportation related to foreign commerce and monitoring agreements among carriers for anti-competitive effects. If the FMC takes no action on a submitted agreement, that agreement becomes effective and federal antitrust laws do not apply to activities undertaken pursuant to the agreement.

In this instance, the requested exemption would allow the members of the GSBN to participate in the operation of a “blockchain-enabled, global trade digitized process” that will enable shippers, authorities and others within the consortium to exchange supply chain-related event data and documents and collaborate with the software provider, CargoSmart. According to the filed Cooperative Working Agreement, the GSBN platform will: (1) provide APIs to the parties for publication of event data with respect to cargo moving through the supply chain; (2) allow for storing and sharing of documents on the platform; and (3) display a user interface for viewing event data, documents and access permissions. Additionally, the agreement places limitations on the handling and internal disclosure of confidential information exchanged among the parties, and also prohibits the parties from sharing intimate details about particular customer agreements or practices or confidential pricing. The GSBN petition was filed on May 26, 2020 (and opened to public comment), and will become effective on July 10, 2020, unless the FMC moves to block the exemption.

This petition comes on the heels of the FMC’s granting of a similar antitrust exemption to another blockchain based shipping consortium, TradeLens, in February 2020. The popularity of blockchain-based shipping consortia is no surprise given the potential for cost savings and efficiencies in a space which is ripe for modernization. However, as one can see, it’s not just technology that is required to establish a blockchain platform for supply chain – parties to a blockchain consortium must ensure all of the appropriate governance is in place as well, which might include operating agreements, antitrust and regulatory approvals, and other related agreements. For deeper insight into the legal and practical issues in this area, please see our Practice Note, Blockchain and Supply Chain Management.

Issuers of Digital Securities May Benefit from Proposed Changes to Regulation A

In March, the Securities and Exchange Commission (SEC) announced proposed rule amendments to “harmonize, simplify, and improve the exempt offering framework to promote capital formation and expand investment opportunities while preserving and enhancing important investor protections,” which may increase the viability of conducting issuances of digital securities. Under the Securities Act of 1933, every offer and sale of securities must either be registered with the SEC or qualify for an exemption from the SEC’s registration requirements. Where appropriate, an offering conducted pursuant to the exempt offering framework may be more efficient and less expensive than a registered offering. The SEC’s proposed amendments aim to facilitate such efficiency, by “[addressing] gaps and complexities in the exempt offering framework that may impede access to investment opportunities for investors and access to capital for issuers.”

In the proposed rule are certain amendments to Regulation A, which the SEC updated in 2015 with “Regulation A+” amendments pursuant to the Jumpstart Our Business Startups Act of 2012. The “Regulation A+” amendments were intended to offer an exemption for small issuances, providing startups and small firms an easier way to raise funds from investors, and established a two-tiered framework for Regulation A offerings. Under Tier 1, issuers may offer and sell up to $20 million of securities over twelve months. Under Tier 2, issuers may offer and sell up to $50 million of securities over twelve months, subject to ongoing reporting obligations.

Last year, the SEC qualified the first Regulation A offering of blockchain-native digital assets: Blockstack PBC raised more than $23 million through its qualified offering under Regulation A and its offering to non-U.S. investors under Regulation S. Offering digital assets pursuant to Regulation A provides certain benefits to issuers. For example:

  • Securities offered and sold under the exemption are not “restricted securities.” Therefore, digital assets purchased in a Regulation A offering generally can be freely transferred by investors after purchase, subject to restrictions on the resale of such securities by affiliates of the issuer.
  • Issuers are permitted to offer and sell securities to a broad U.S. investor base, subject to certain limits on the amount of securities non-accredited investors may purchase under Tier 2 of Regulation A when the offered securities will not be listed on a national exchange.
  • Issuers may “test the waters” using general solicitation before and after the offering circular is filed with the SEC. Any solicitation materials used prior to the public filing of an offering circular that has been qualified must be included as exhibits to the circular – and, in all cases, materials are subject to the SEC’s solicitation rules regarding fraud.

The proposed amendments aim to further the SEC’s initiative to expand and facilitate capital raising opportunities to meet evolving market needs, while also balancing investor protections. SEC Chairman Jay Clayton stated, “[e]merging companies—from early-stage start-ups seeking seed capital to companies that are on a path to become a public reporting company—use the exempt offering rules to access critical capital needed to create jobs and scale their businesses… [t]hese proposals are intended to create a more rational framework that better allows entrepreneurs to access capital.”

The proposed amendments, among other things:

  • Raise the maximum offering amount from $50 to $75 million under Tier 2 of Regulation A and raise the maximum offering amount from $15 to $22.5 million for secondary sales under Tier 2 of Regulation A.
  • Simplify disclosure requirements of Regulation A to establish greater consistency with the requirements for registered offerings.
  • Expand and harmonize certain issuer eligibility qualifications and bad actor disqualification provisions in Regulation A with other sections of the federal securities laws.

The blockchain industry continues to navigate compliance with federal securities laws. Recently, the SEC has taken action against blockchain startups for engaging in initial coin offerings to raise significant amounts of money allegedly without complying with the requirements of the Securities Act. The SEC’s proposed amendments to Regulation A may provide digital asset issuers a more viable alternative for legally raising funds.

Major Italian News Agency Uses Blockchain-Based Label to Verify the Origin of Its Articles

The leading Italian news agency, Agenzia Nazionale Stampa Associata (ANSA), which represents 24 major Italian newspapers and distributes over 3,000 news articles daily, announced in early April that it has begun using a blockchain-based solution run on the Ethereum public blockchain to verify the origin of news stories that appear on ANSA platforms or are distributed to other sites, such as social media pages. Stories actually originating from the ANSA platform (without modification) now bear a green digital “ANSAcheck” certificate that informs readers that the preceding story is a verified ANSA news article and is not manipulated or spoofed content or a story that has been altered to spread disinformation. (An image of the ANSAcheck stamp is below; for an example of the certificate on the Internet, look for the digital stamp at the end of this ANSA story).

ANSA Check Stamp

Under the ANSAcheck program, each news item from ANSA is reduced to a cryptographic hash using EY OpsChain Traceability technology and stored as a digital token on the public Ethereum blockchain. When a reader opens an ANSA story on a web browser, the browser compares the text of the article with the parameters recorded on the blockchain and displays the ANSAcheck digital seal if there is a match. If clicked on, the digital seal displays certain data, such as the date the story was published and other block information, as well as an ANSA Certificate, an example of which is shown below. Continue Reading

Hawaii is Latest State to Implement a Regulatory Sandbox to Attract Cryptocurrency Business

On March 17, 2020, the governor of Hawaii announced the Digital Currency Innovation Lab, a collaborative effort between Hawaii’s Department of Commerce and Consumer Affairs, the Division of Financial Institutions (DFI) and Hawaii Technology Development Corporation, to regulate business transactions utilizing cryptocurrencies. The two-year pilot program allows selected companies to conduct business transactions using digital currency that otherwise would require a Hawaii Money Transmitter License under the state’s Money Transmission Act. The announcement of this program came just weeks after SB2594 was proposed in the Hawaiian Senate to allow banks to hold digital assets for their customers.

The Application Process

Applicants must provide financial disclosures based on their legal entity structure. For example, firms organized as corporations would be required to submit their most recent audited financial statements and financial statements for the preceding two years. Applicants must also provide entity structure charts and anti-money laundering disclosures regarding beneficial owners.

Beyond the initial and yearly fees, the application process requires an extensive list of disclosures. If an applicant is accepted, they must provide annual reports to DFI by December 31 of each year during which the accepted applicant participates in the Virtual Currency Pilot Program, including (1) the number of transactions for the year ending October 31, (2) the value of those transactions, (3) the number of complaints received, and (4) any pending or current regulatory enforcement orders against the applicant.

Hawaii’s Changing Policy

Hawaii’s pilot program represents a shift in policy in favor of digital currency innovation. Previously, in 2017, Hawaii had imposed cash reserve requirements on companies using digital currencies to hold an equal amount of government-backed currency. This prompted some cryptocurrency firms to re-evaluate their strategy in Hawaii. Before this program was launched, the DFI could pursue enforcement actions against actors conducting unlicensed money transmission activity. Under this program, companies will have the benefit of a “no action” directive issued by DFI in favor of the Digital Currency Innovation Lab’s participants.

Other State Programs

Notably, unlike other states’ cryptocurrency initiatives such as Utah and Wyoming, Hawaii is creating this “sandbox” initiative not through the state’s legislature, but rather through DFI’s broad regulatory authority. While this does potentially allow for more administrative flexibility, DFI is vested with unchecked discretion, as evidenced by the lack of appeal if an applicant is rejected and the fact that DFI can terminate any company’s participation in the sandbox on any, or no, basis without explanation.

Other states are following the trend and are flirting with the idea of a similar digital sandbox initiative. Rhode Island legislators introduced the Rhode Island Economic Growth Blockchain Act in March, which calls for “a comprehensive regulatory sandbox”. RI H7989 provides for a blockchain technology advisory council to conduct research and promote entrepreneurial development. Rhode Island’s sandbox would allow for a waiver of statutes and rules that otherwise would not permit for a specific financial technology. In comparison with Hawaii and other states, companies seeking a waiver in Rhode Island would need to provide certain disclosures regarding capital requirements and risks to consumers, as well as a detailed proposal about the financial service or product.

While the Digital Currency Innovation Lab offers a sign that Hawaii will allow innovative business solutions with respect to digital currency, the current proposal is fraught with uncertainty. DFI may grant or deny applications in its sole discretion and there is no right of appeal. Similar to other sandboxes, no plan exists for what happens after the two-year incubator period concludes in 2022. In light of these and other concerns, digital currency companies may not participate until a more certain regulatory and legal framework is proposed over a longer time horizon. Applicants must apply for this program by May 1, 2020; however, due to uncertainty surrounding COVID-19, the commencement date for accepted applicants is still undetermined.

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