Regulation: Federal

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On April 11, Blockstack Token LLC (“Blockstack”) filed a preliminary offering circular with the SEC for a $50 million token offering under Regulation A of the Securities Act. The offering circular is now under review with the SEC and must be qualified (i.e., cleared) by the SEC before sales of Blockstack’s tokens (“Stacks Tokens”) can be effectuated under the program.

Blockstack’s offering circular is notable because it treats the Stacks Tokens as securities today but discloses that the issuer expects the Stacks Tokens will, at some point in the future, no longer be required to be treated as securities under the federal securities laws. This approach is consistent with recent SEC staff guidance, which stated that the analysis of whether a digital asset represents an investment contract (and thus, a security) may change over time, depending on how the asset is used, offered and sold. Blockstack states that it will refer to the Framework for “Investment Contract” Analysis of Digital Assets, recently published by the SEC’s Strategic Hub for Innovation and Financial Technology, for regulatory guidance in connection with making this determination.

If the SEC qualifies Blockstack’s offering under Regulation A, it will be the first time the SEC has done so for the offer and sale of a blockchain-native digital asset.

Following up on their recent introduction of the Token Taxonomy Act, Representatives Darren Soto (D-FL) and Warren Davidson (R-OH) have teamed up again to introduce a new slate of bipartisan bills related to virtual currency. The two new bills, H.R. 922 and H.R. 923, were introduced on January 30, 2019 and are cosponsored by Representatives Ted Budd (R-NC) and Bonnie Watson Coleman (D-NJ).

Two recent proposals for bitcoin exchange-traded funds (“ETFs”) are vying to become the first to receive approval from the U.S. Securities and Exchange Commission (“SEC”) – one filed by CBOE BZX Exchange, Inc. (“CBOE”) and the other by NYSE Arca, Inc. (“NYSE Arca”). The SEC has yet to approve a cryptocurrency ETF, although several applications were filed throughout 2018.

A bitcoin ETF would allow investors to easily invest in bitcoin without needing to directly buy and manage the cryptocurrency themselves, potentially ushering in additional capital and enabling a wider range of institutional investors to tap into the market.

Once the proposals are published in the Federal Register, the SEC has an initial 45 days from the date of publication to issue a decision or request an extension, with total time not to exceed 240 days.

The SEC recently announced its settlement of charges against boxer Floyd Mayweather and producer DJ Khaled for their failure to disclose payments they received for promoting Initial Coin Offerings (ICOs) on their social media accounts.

The federal securities laws contain an “anti-touting provision,” which regulates paid promotions of securities offerings. Specifically, Section 17(b) of the Securities Act of 1933 makes it unlawful for a person to “publish, give publicity to, or circulate any notice…or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received…without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.” Importantly, the provision applies even to those not directly offering a security for sale. The SEC’s orders instituting cease-and-desist proceedings against Mayweather and Khaled both cited violations of Section 17(b).

According to the charges, Mayweather failed to disclose $300,000 he received from three ICO issuers. He received $100,000 from Centra Tech Inc. for posting on his social media accounts that “Centra’s…ICO starts in a few hours. Get yours before they sell out, I got mine and as usual I’m going to win big with this one!” Mayweather promoted ICOs on his social media accounts a number of other times and even dubbed himself “Floyd Crypto Mayweather” in one post (not to be confused with his usual moniker, Floyd “Money” Mayweather). Khaled also received $50,000 from Centra for posts calling Centra an “ultimate winner” and a “game changer.” Centra has been the subject of its own SEC scrutiny, with the SEC filing a civil action against Centra’s founders and the U.S. Attorney’s Office for the Southern District of New York filing corresponding criminal charges.

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.

Despite the recent setback of having their Bitcoin ETF rejected by the SEC for the second time, the Winklevoss brothers remain undeterred in their efforts to bring cryptocurrency into the investment mainstream.

Their latest project is the Virtual Commodity Association (VCA), a self-regulatory organization (SRO) for the virtual currency industry…

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 article. See 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).

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.