At a time when states are jockeying for position to become digital asset and cryptocurrency hubs and we’ve witnessed turmoil and regulatory uncertainty within the cryptoasset industry, the New York Department of Financial Services (“NYDFS”) on December 15, 2022 released its final Guidance (the “Guidance”) to banking organizations seeking to engage in “new or significantly different” virtual currency-related activities. As stated in the Guidance, “virtual currency-related activity” includes all “virtual currency business activity,” as defined under the BitLicense regulation (23 NYCRR § 200.2(q)), as well as “the direct or indirect offering or performance of any other product, service, or activity involving virtual currency that may raise safety and soundness concerns for the Covered Institution or that may expose New York customers of the Covered Institution or other users of the product or service to risk of harm.” At a high level, the Guidance reminds state-regulated banks (“Covered Institutions”) that, as a “matter of safety and soundness,” they must apply for approval before engaging in digital asset-related activities and outlines the types of information the NYDFS deems most relevant in assessing a proposal and the potential risks that such virtual currency-related activities may pose for the institution, consumers and the market in general (note: The Guidance expressly states that it does not interpret existing laws nor take a position on the sorts of activities that may be permissible for Covered Institutions to take).

Notably, the Guidance further increases the scope of NYDFS oversight by expanding the types of virtual currency activity requiring approval: “virtual currency-related activities” must receive approval, whereas previously only “virtual currency business activity” required prior approval from the NYDFS.  In a footnote, the Guidance explains the difference – virtual currency-related activity” essentially means any “virtual currency business activity” as defined under the BitLicense rules, plus certain additional activities that the NYDFS believes might raise “safe and soundness concerns.”

On November 30, 2022, amidst the tumult roiling the cryptocurrency industry following the latest collapse of a major crypto exchange and its reverberations throughout the crypto economy, European Central Bank (ECB) Director General Ulrich Bindseil and Adviser Jürgen Schaaf published a post on the ECB Blog, “Bitcoin’s last stand,” declaiming that Bitcoin “has never been used to any significant extent for legal real-world transactions” and that its market valuation is “based purely on speculation” and, on top of that, “the Bitcoin system is an unprecedented polluter.”  The scathing rebuke of Bitcoin, the largest crypto asset by market cap, was hurled at what the ECB officials see as Bitcoin’s technological shortcomings that make it “questionable as a means of payment” and “rarely used for legal transactions,” given that real Bitcoin transactions are “cumbersome, slow and expensive.” With the current price of Bitcoin having fallen since it peak of $69K in November 2021, the ECB officials described its current price (below $20K) as “an artificially induced last gasp before the road to irrelevance.” The remarks echo statements made by Fabio Panetta, Member of the Executive Board of the ECB, back in April 2022 where he decried the entire “crypto gamble,” seeing crypto-assets as “bringing about instability and insecurity – the exact opposite of what they promised.” (See also recent statements by a Bank of England deputy governor noting that cryptocurrency was a “gamble” that needs to be regulated similar to the traditional financial sector, echoing his own remarks from November 2022 that urged “bringing the activities of the crypto world within the relevant regulatory frameworks”).

At 2:43am EST on September 15, 2022, the first Ethereum block was validated using Proof of Stake, signaling the success of the Ethereum Merge, one of the most anticipated events in blockchain and computer science history. The Merge shifted the Ethereum blockchain (native token ETH, or ether) from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) consensus mechanism, which has reduced the network’s energy usage by about 99.5%. Ethereum now facilitates a 7-day average of over one-million transactions per day, at a volume of over $600 million per day, making the Merge an engineering feat akin to swapping a car’s engine while it’s driving on the Autobahn.

On September 22, 2022, the CFTC announced an order simultaneously filing and settling charges against bZeroX, LLC (“bZeroX”) and its creators for illegally offering leveraged and margined retail commodity transactions in digital assets, operating as an unregistered futures commission merchant and failing to conduct KYC on its customers. According to the CFTC, a month prior to this settlement announcement, bZeroX transferred control of the bZx Protocol to the bZx DAO, a decentralized autonomous organization (“DAO”), which later renamed itself as the Ooki DAO.  On the same day as the bZeroX settlement was announced, the CFTC filed an enforcement action against the Ooki DAO (successor to bZeroX) for violating those same regulations.  The CFTC stated that bZeroX and its creators engaged in this unlawful activity in connection with their decentralized blockchain-based software protocol that functioned in a manner similar to a trading platform.  The transactions executed on bZeroX, and subsequently on the Ooki DAO, were required to take place on a registered designated contract market.  Additionally, the complaint asserted that bZeroX and Ooki DAO were operating as unregistered futures commission merchants by soliciting and accepting orders from customers, accepting money or property as margin and extending credit.

The structure of Ooki DAO, and the CFTC’s enforcement action against the DAO itself, has garnered a lot of media attention (and industry reaction) and raised novel legal issues.

In late October, a New York district court refused to dismiss the Department of Justice’s (DOJ) indictment against defendant Nathaniel Chastain, who was charged with wire fraud and money laundering relating to his using insider knowledge to purchase non-fungible tokens (NFTs) prior to them being featured on OpenSea, an online NFT marketplace, and later selling them at a profit. (U.S. v. Chastain, No. 22-cr-305 (S.D.N.Y. Oct. 21, 2022)). Despite the headlines and the fact that the DOJ’s press release labeled this enforcement as charges brought in “the first ever digital asset insider trading scheme,” the Chastain indictment was not actually based on the typical insider trading statutes involving securities law violations, but instead the federal wire fraud statute.  Indeed, despite having an insider trading flavor, the word “security” does not appear in the indictment and the court, in refusing to dismiss the DOJ’s wire fraud claim, ruled that the Government’s wire fraud claim does not require the presence of a “security.”

On October 3, 2022, the Financial Stability Oversight Council (“FSOC”) – a collaborative body formed under the Dodd-Frank Act composed of state and federal regulators and tasked with identifying risks and responding to emerging threats to financial stability – released its 100+-page Report on Digital Asset Financial Stability Risks and Regulation (the “Report”). In the Report – a response to President Biden’s Executive Order 14067 on digital assets, which, among other things, directed various agencies to promote innovation and R&D while calling for measures to mitigate risks – the FSOC reviewed what it deems to be, “specific financial stability risks and regulatory gaps posed by various types of digital assets.”

At the core, the FSOC Report is a call to arms, with the council citing what it sees as a host of regulatory and industry shortfalls that have not kept up with the rapid growth of digital asset activities.  For example:

  • The FSOC report noted that stablecoins and the lending and borrowing on digital asset trading platforms are now an “important emerging vulnerability.”
  • The Report’s basic thesis is that crypto-asset activities “could pose risks to the stability of the U.S. financial system if their interconnections with the traditional financial system or their overall scale were to grow without being paired with appropriate regulation, including enforcement of the existing regulatory structure.” This point was reiterated in the Federal Reserve’s November 2022 “Financial Stability Report,” which presents the Federal Reserve Board’s current assessment of the stability of the U.S. financial system.
  • The FSOC Report also expresses the position that federal comprehensive digital asset legislation is needed to address complex, systemic economic risks, as, in its opinion, “many crypto-asset platforms are not registered or chartered under regulatory frameworks that would address these risks.”