Blockchain and Digital Assets News and Trends - January 2022

This is our first monthly bulletin for 2022, aiming to help companies identify important and significant legal developments governing the use and acceptance of blockchain technology, smart contracts and digital assets.

While the use cases for blockchain technology are vast, this bulletin will be primarily on the use of blockchain and or smart contracts in the financial services sector. With respect to digital assets, we have organized our approach to this topic by discussing it in terms of traditional asset type or function (although the types and functions may overlap), that is, digital assets as:

• Securities
• Virtual currencies
• Commodities
• Deposits, accounts, intangibles
• Negotiable instruments
• Electronic chattel paper
• Digitized assets

In addition to reporting on the law and regulation governing blockchain, smart contracts and digital assets, this bulletin will discuss the legal developments supporting the infrastructure and ecosystems that enable the use and acceptance of these new technologies.

INSIGHTS

CFTC settles enforcement action against DeFi platform Polymarket

By Michael Fluhr and Evan North

The Commodity Futures Trading Commission (CFTC) recently announced a settlement with the company that operates Polymarket, a blockchain-powered online trading platform that allows users to bet on the outcomes of binary events. 

The agency’s order is its first major enforcement action in the blockchain space since the Commission’s new chair, Rostin Behnam, proposed making the agency the government’s “primary cop on the beat” of digital asset markets.  While the order is short on legal analysis, it provides important insights for developers and operators of DeFi (decentralized finance) markets.  Read more.

FEDERAL DEVELOPMENTS

Blockchain

• NIST seeks public comment on blockchain investigation report. On December 20, the National Institute of Standards and Technology (NIST) announced the release of Blockchain for Access Control Systems for public comment. The report investigates blockchain technology and its applications for use in access control mechanisms - systems for authenticating legitimate users for a system. The report also calls for information regarding any patent claimed to be essential to complying with the blockchain systems described. Public comments must be emailed to ir8403-comments@nist.gov and are due by February 7, 2022. 

Digital assets

• NCUA clarifies guidance on third-party providers of digital asset services for members. On December 16, the National Credit Union Administration (NCUA) issued Relationships with Third Parties that Provide Services Related to Digital Assets, a statement clarifying existing authority of federally insured credit unions (FICUs) to establish relationships with third party providers that offer digital asset services to the FICU's members. Such third-party services may allow FICU members to buy, sell, and hold uninsured digital assets with the third party provider outside of the FICU. The statement clarifies that a FICU’s relationship with third parties offering these digital asset services and related technologies will be evaluated by the NCUA in the same manner as all other third-party relationships. NCUA cautions that the FICU must exercise sound judgment, conduct the necessary due diligence, risk assessment, and planning, and establish effective risk measurement, monitoring, and control practices for such third party arrangements.

Virtual currency

• FreddieMac issues mortgage credit underwriting requirements related to cryptocurrency. On December 1, 2021, FreddieMac issued a bulletin updating its mortgage selling guide to include credit underwriting requirements related to the use of cryptocurrency in the mortgage qualification process. Pursuant to the updated guide, income paid to a borrower in cryptocurrency may not be used to qualify for a mortgage, other income-generating assets (eg, retirement account distributions and dividend and interest income) may not be in the form of cryptocurrency, and cryptocurrency holdings may not be included in the calculation of assets as a basis for repayment of mortgage obligations. However, payments on debts secured by cryptocurrency must be included in a borrower's debt payment-to-income ratio. Cryptocurrency must be converted into US dollars if needed for the mortgage transaction.

• Federal Reserve issues white paper on CBDCs. On January 20, the Board of Governors of the US Federal Reserve System announced the release of Money and Payments: The US Dollar in the Age of Digital Transformation, a white paper examining the pros and cons of a potential US central bank digital currency (CBDC). Public comments on the paper will be accepted for 120 days and may be submitted on the Federal Reserve website feedback form.

Commodities

• Members of Congress write to CFTC for clarity on digital asset markets. On January 12, a bipartisan group of legislators from the Senate and House Committees on Agriculture announced the group wrote to the chair of the CFTC requesting that the CFTC respond to questions and provide information regarding the scope and size of digital asset markets, the benefits and risks presented by these emerging technologies and the role of the CFTC. The questions and requests for information set forth in the letter include:
  • In what ways are digital asset markets and intermediaries different than the existing markets and intermediaries under the CFTC's jurisdiction? In what ways are they similar? Are there principles for market regulation that can be applied to both?
  • How has LabCFTC been working with stakeholders in the digital asset and DeFi space to support innovation and development, while also ensuring customer protection and financial market integrity?
  • Discuss how the CFTC has collaborated with other federal financial regulators regarding digital assets.
  • Do you foresee any shortfalls in the Commission's authorities to protect customers and ensure market integrity as the digital asset marketplace grows in volume and scope?

INDUSTRY DEVELOPMENTS

• SWIFT to explore interoperability in market capitalization of tokenized assets. On December 21, 2021, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) announced that it is "exploring how it can enable and improve interoperability between participants and systems during the transaction lifecycle of tokenized assets." SWIFT plans a series of experiments in Q1 2022 "leveraging its trusted role as a central platform to explore the issuance, delivery versus payment (DVP), and redemption processes, to support a frictionless and seamless tokenized asset market” using both established forms of payment and central bank digital currencies.
• Fitch Ratings reports on regulatory approaches for stablecoins. On December 21, 2021, Firth Ratings issued a special report, Stablecoins: Regulatory Approaches and Credit Considerations, which highlights regulatory approaches taken by international financial regulators and the risk they seek to tackle. The report also examines credit considerations around stablecoins (SCs) in light of the evolving regulatory environment. The report notes that "We regard the US regulatory approach as particularly important to the sector’s medium-term development, as the vast majority of major SCs traded today are linked to the US dollar and we expect this to remain so over the medium term." According to the report "Greater regulatory certainty over the status of SCs and their issuers could create market opportunities for the operating entities as well as for other financial institutions, many of which have so far been deterred from engaging with SC operators due to regulatory risk."
• PwC releases 2021 annual global crypto tax report. Recently Price Waterhouse Coopers released its PwC Annual Global Crypto Tax Report 2021 which tracks the increasing number of jurisdictions issuing crypto tax guidance and compares the comprehensiveness of tax guidance between jurisdictions. The report also discusses tax implications of key, newly emerging areas such as of the markets for non-fungible tokens (NFTs) and decentralized finance (DeFi), and includes insights from more countries.

STATE DEVELOPMENTS

Digital assets

• Texas and Alabama announce top investor threats for 2022. On January 10, The Texas State Securities Board and Alabama Securities Commission each released an annual list of top investor threats and urged caution before purchasing popular and volatile unregulated investments — especially those involving cryptocurrency and digital assets.

ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Virtual currency

• DOJ files civil action to return $150 million in embezzled funds. On December 20, 2021, the US Department of Justice (DOJ) announced that the FBI seized $150 million in funds embezzled from a subsidiary of Sony Group Corporation; those funds had been converted into 3,879.16 bitcoins. All the bitcoins traceable to the theft have been recovered and fully preserved, and the DOJ filed a civil forfeiture compliant to protect Sony's interest in the property. The employee who embezzled the funds has been criminally charged in Japan.

Securities

• SEC charges ICO issuer and founder with fraud. On January 6, the SEC announced the filing of a complaint against Craig Sproule, an Australian citizen, and two companies he founded, Crowd Machine Inc. and Metavine, Inc., for making false and misleading statements in connection with an unregistered offer and sale of digital asset securities. According to the SEC’s complaint, Sproule claimed to have raised $40.7 million through his companies in an initial coin offering (ICO) of Crowd Machine Compute Tokens (CMCTs) in 2018. Sproule told investors that the proceeds would be used to develop new blockchain technology. Instead, the funders were diverted to South African gold-mining entities. The SEC also alleges Sproule did not register the token offering and sale as required by applicable securities laws.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

• IMF calls for global crypto regulation. On December 9, 2021, the International Monetary Fund (IMF) issued a blog post asserting that crypto assets are profoundly changing the international monetary and financial system, creating financial system risks which underscore the need for “comprehensive international standards that more fully address risks to the financial system from crypto assets, their associated ecosystem, and their related transactions, while allowing for an enabling environment for useful crypto asset products and applications.”
  
  Calls for such a global regulatory framework, the IMF says, should include the following elements:
  • Licensing for crypto asset service providers
  • Tailored requirements for main use cases of crypto assets and stablecoins
  • Clear requirements on regulated financial institutions concerning exposure to and engagement with crypto.
    
• UK FCA issues consumer warning on risks of cryptoasset investment. On November 1, 2021, the Financial Conduct Authority (FCA) issued a warning to consumers of the risks of investments advertising high returns based on cryptoassets. The alert highlighted FCA concerns about high-return investments based on cryptoassets:
  • Consumer protection – some investments may not be subject to regulation beyond anti-money laundering requirements
  • Price volatility – significant price volatility place consumers at high risk of losses
  • Product complexity – no guarantees that cryptoassets may be converted back into cash
  • Charges and fees – may be more than those of regulated investment products
  • Marketing materials – may overstate the returns or understate the risks involved
• UK advertising authority bans crypto ads as misleading. On January 5, the UK Advertising Standards Authority (ASA) issued a ruling against Forisgfs UK Ltd t/a Crypto.com, a cryptocurrency trading platform, finding that two in-app ads were misleading, in part because neither ad included any risk warning making consumers aware that cryptocurrency could go down as well as up, or that the cryptocurrency was unregulated in the UK. Crypto.com removed the ads when it first heard of the ASA's concerns and began drafting a new UK marketing policy. Despite these actions, the ASA issued its ruling and required Crypto.com to ensure that all “future marketing communications did not irresponsibly take advantage of consumers’ lack of experience or credulity by irresponsibly encouraging investing in cryptocurrency using a credit card, and by not making clear that [capital gains tax] was not due in some circumstances on cryptocurrency profits.”
  
  In December 2021, the ASA issued rulings against advertisements issued by several other firms regarding promotions of cryptocurrencies or other tokens which the ASA found misleading, among them Arsenal Football Club plc, Skrill Ltd, CoinBurp Ltd, Exmo Exchange Ltd, Luno Money Ltd t/a Luno, and Payward Ltd t/a Kraken.  The rulings banned the advertisements based on allegations of “irresponsibly taking advantage of consumers’ inexperience and for failing to illustrate the risk of the investment.”
• ISDA issues paper on standards for digital asset derivatives. On December 14, 2021, the International Swaps and Derivatives Association (ISDA) announced the publication of Contractual Standards for Digital Asset Derivatives, which:
  • Identifies novel technology and market-driven events that could disrupt the operation of a digital asset derivatives transaction and provides a framework for dealing with these events;
  • Explores how digital assets (and the derivatives that reference them) can be valued and what happens when a valuation cannot be obtained; and
  • Analyzes how digital assets might interact with the existing ISDA documentation architecture, including the ISDA Master Agreement and industry standard collateral documentation.
  ISDA also produced a supplement to the paper that sets out a granular, technical analysis of different ISDA product definitions and their potential applicability to digital asset derivatives.

PUBLICATIONS

• Embracing digital evolution: Our new business report

Read

• TOKO issues digital private debt on Hedera public network with Hex Trust custody
• Interview with Margo H.K. Tank by Börsen-Zeitung on cryptocurrency regulation.

Listen

• Listen to our podcast, Crypto Savvy – Bringing a Token to Life, featuring HashKey Group, which discusses TOKO and its tech. The podcast is now available on on Spotify, Apple and Google Podcasts. Feel free to check out more on LinkedIn.
• Listen to our podcast, Non-fungible tokens and their potential application in the financial services sector, featuring DLA Piper partner Anthony Lloyd and Macgregor Duncan, General Manager – Corporate & Business Development of Westpac and CEO of Westpac's new digital bank

More

• Transferring property rights in digital property – a look at the ongoing development of UCC Article 12
• Non-fungible tokens Q&A
• Non-fungible tokens: What are the legal risks?

Contacts

Learn more about our Blockchain and Digital Assets practice by contacting any of our editors:

Margo H.K. Tank 
Mark Radcliffe 
Liz Caires 
Martin Bartlam 
Guy E. Flynn 

Contributors to this Issue

Michael Fluhr 
Andrew W. Grant 
Evan North