Blockchain and the Law

First Decision in Class-Action Context Concludes Digital Tokens Can Be Securities

For digitally savvy investors itching to know whether U.S. courts would treat crypto-tokens as securities subject to the regulatory requirements of the Securities Act of 1933, the wait is over—sort of. The first federal judge to decide the issue in the class-action context landed on the same side as the SEC did back in 2017, finding that the virtual tokens in the case could be characterized as securities. We discussed the SEC’s 2017 report in a previous articleSee Margaret A. Dale and Mark D. Harris, The SEC Concludes that Digital Tokens May Be Securities, NYLJ, Aug. 8, 2017.

On June 25, 2018, Magistrate Judge Andrea M. Simonton of the Southern District of Florida issued this cutting-edge opinion in Rensel v. Centra Tech. Her Report and Recommendation (R&R) considered a motion for a temporary restraining order to safeguard the proceeds from an initial coin offering (ICO). The underlying shareholder class action alleged that Centra Tech, a Florida-based technology start-up company, and several of its founders and executives, had violated various provisions of the Securities Act. To reach her decision, Judge Simonton analyzed whether the tokens Centra Tech offered during the course of its ICO were securities for purposes of the Securities Act (despite the defendants conceding the point for purposes of the motion). Continue Reading

Modernizing Real Estate Records With Blockchain

Despite dealing in one of the most valuable asset classes in the world, the real estate industry largely relies on outdated real estate interest recording systems requiring paper-based filings with local government offices. The administrative burdens, inaccuracies and security issues raised by such systems are well known. Increasingly, both government actors and private parties have recognized the potential for key attributes of blockchain technology to modernize real property conveyance and improve processes for recording deeds and other related instruments:

  • Greater efficiency due to digitization. The deed recording processes currently employed by many U.S. localities impose burdensome administrative costs. Typically, a physical deed must be delivered to a government employee at the local recording office, where it is subsequently scanned onto the county’s centralized database. Data points from the deed are then manually input onto a public index, which is relied upon to determine ownership of each piece of property recorded thereon. Any subsequent transfers of, or claims to, real property must be manually reconciled with this public index. Blockchains, on the other hand, are entirely electronic data structures. As such, their implementation could greatly reduce, if not eliminate, the constant need for scanning documents, printing labels and organizing physical files in local recording offices – enabling local governments to reallocate human resources to areas where they can be employed more productively.
  • Accurate record of ownership that updates in real time. The manual indexing process described above is not just costly and time-consuming. It is also prone to human error, where inputting mistakes may cause future difficulties in accurately tracing chain of title. Since blockchains have the potential to consolidate conveyance and recording of real property rights into a transaction, they can greatly increase the likelihood that the public record accurately represents each conveyance, and do so in real time.
  • Tamper-proof and disaster-resistant decentralized ledger. Finally, centralized databases, where recorded deeds are currently stored, are vulnerable to malicious attacks by third parties (or government insiders) seeking to steal, erase, forge or alter existing records. By design, blockchains may ensure that any such endeavor to corrupt the information contained “on-chain” is prohibitively costly. Further, localities typically do not have the resources available to implement a robust back-up system for their property records. Therefore, in the case of a natural disaster destroying physical files or a malicious cyberattack wiping a database, the entirety of the record could be permanently lost. A blockchain, meanwhile, may store recorded data on nodes spanning both geographies and populations, alleviating concerns of lost records, while concurrently reinforcing the integrity and security of the data with each additional node.

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New York State Department of Financial Services Eases Backlog and Approves More BitLicense Applications

On June 14, 2018, the New York State Department of Financial Services (the “DFS”) announced that the agency granted a virtual currency license (or “BitLicense”) to bitcoin wallet and vault provider Xapo, Inc., and authorized the blockchain financial services company Paxos Trust Company LLC to expand their business to offer exchange and custodial services to cryptoassets beyond bitcoin. Days later, the DFS announced that it had approved the BitLicense application of financial services and mobile payment provider Square, Inc. (which already possessed a state money transmitter license and whose Cash App offers a method to trade bitcoin). These developments followed last month’s approval of Gemini Trust Company to provide additional virtual currency products and services (including custodial services and trading of Zcash, Litecoin and Bitcoin Cash). With the latest approval of Square, the DFS has granted a total of nine virtual currency charters or licenses. Continue Reading

SEC Director William Hinman: “Current offers and sales of Ether are not securities transactions”

At last week’s Yahoo! All Markets Summit in Palo Alto, SEC Division of Corporation Finance Director William Hinman delivered a speech sure to send shockwaves through the crypto world. Applying the Howey test (which sets forth the elements necessary for determining whether a transaction involves the offer or sale of an “investment contract” and thus, a security, under the federal securities laws) to cryptoasset transactions, Director Hinman concluded that:

  1. To determine whether a token sale satisfies Howey, market participants should “primarily” consider whether the network on which the token operates is “sufficiently decentralized.”
  2. Alternatively it is possible, through technological or contractual means, to design cryptoassets so that they function more like a consumer item and less like a security; however, the economic realities of a given token transaction (specifically the manner in which the token is offered and sold and the reasonable expectations of purchasers) controls any such determination.
  3. Cryptoassets originally offered in a securities offering can later be sold in a manner that does not constitute an offering of a security.
  4. Current offers and sales of Ether are not securities transactions.

Although in no way officially binding as a matter of SEC policy or federal securities law, Director Hinman’s comments are tremendously important to the evolving cryptoasset marketplace in the United States. They provide guidance on a number of critical questions that exist at the margins of SEC Chairman Jay Clayton’s position that he has not seen a single token issued through an ICO that is not a security, and warrant deep and careful consideration.

Another SEC Enforcement Action against Allegedly Fraudulent ICO

On May 29, the SEC announced that it had secured injunctive relief halting an allegedly “ongoing fraud” involving an unregistered, non-exempt ICO that raised as much as $21 million in cryptoassets.

The SEC’s complaint charges Titanium Blockchain Infrastructure Services, Inc., EHI Internetwork and Systems Management, Inc. and Michael Stollery, (collectively, the “Titanium defendants”) with fraud in connection with the purchase, offer or sale of securities under Sections 10 and 17 of the Securities Exchange Act and the unregistered offer and sale of securities under Section 5 of the Securities Act.  Continue Reading

Ripple Faces Class Action Lawsuit Alleging Sale of Unregistered Securities

A class action lawsuit was filed on May 3rd against Ripple Labs Inc.—a fintech startup that controls the third-largest cryptocurrency in the world—and its CEO Brad Garlinghouse, alleging that Ripple sold unregistered, non-exempt securities in violation of federal and California state securities laws.

In their complaint, Plaintiffs characterized the sale of XRP (Ripple’s native token) as “a scheme by Defendants to raise hundreds of millions of dollars through the unregistered sale of XRP” and “what is essentially a never-ending initial coin offering (ICO).” In addition to attorney fees, costs of the suit, and punitive damages, the plaintiffs also request a declaration from the court that the sale of XRP is an unregistered securities sale and to enjoin defendants from further violating securities laws. Continue Reading

SEC Flexes Funny Bone in Fictional Token Offering

The Securities and Exchange Commission (the “SEC”) has taken to using humor and sarcasm to educate retail investors about the potential risks of purchasing tokens in initial coin offerings (“ICOs”).

This week, the SEC issued a press release presenting “a hot investment opportunity.”  The release pointed to a website touting the HoweyCoin—a fictional crypto token intending to disrupt the luxury travel industry—as “one of the largest cryptocurrency platforms ever built” and promising that it would provide potential investors with “excitement and guaranteed returns.” The website closely mimics common components of ICO issuer websites, including offers for tiered pre-sale purchaser discounts and an invitation to review a whitepaper, and contains egregious claims that the tokens are SEC-compliant, images of opulence, and fake celebrity endorsements for good measure.

For those of you who are not securities lawyers, the name “Howeycoin” is a reference to the seminal Supreme Court decision in SEC v. W.J. Howey Co., which first set forth the test for what constitutes an “investment contract” (and thus, a security) under the U.S. federal securities laws.

HoweyCoin is marketed as a token directly redeemable for travel services or merchandise, in addition to being an investment vehicle. Presenting HoweyCoin as a token with purported functionality highlights the SEC’s position that even tokens with “utility”(e.g., eligibility to be exchanged for goods or services) remain subject to SEC scrutiny.

Clicking on “Buy Coins Now!” takes the visitor to a SEC information page that warns retail investors as to the risks of ICOs.

This education effort comes as the SEC, along with various state securities commissions, remain vigilant in shutting down fraudulent, unregistered and non-exempt ICOs.

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