Blockchain and Digital Assets News and Trends - February 2024

This monthly bulletin is designed to help companies identify important 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 focuses on uses of blockchain and 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

New SEC rule may sweep DeFi participants into the definition of “dealer”

By: Michael Fluhr, James Williams, Deborah Meshulam, and Eric Hall

In early February, the SEC announced a final rule amending the agency’s interpretation of the term “dealer” in Section 2 of the Securities Exchange Act of 1934. The new rule broadens the SEC’s definition in a way that some commentators, including SEC Commissioner Hester Pierce, suggest may encompass liquidity providers and automated market makers which are vital participants in the decentralized finance, or DeFi, ecosystem.

The new rule leaves open questions about who—or what—may be required to register as a “dealer” under the Act, and the future stability of DeFi protocols that may rely on anonymous liquidity providers. Read more.

STATUTORY AND AGENCY DEVELOPMENTS

FEDERAL DEVELOPMENTS

House Financial Services hearing sheds light on congressional approach to cryptocurrency and illicit finance. At a congressional hearing on February 15, members of the House Financial Services Committee questioned experts on ways to prevent cryptocurrency from being used to fund illicit activities. The hearing, titled “Crypto Crime in Context Part II: Examining Approaches to Combat Illicit Activity,” featured Michael Mosier, a former US Treasury Department official who now serves as general counsel to a blockchain company developing privacy for digital assets, and Ari Redbord, global head of policy at blockchain analytics firm TRM Labs. Representatives asked Mosier for his opinion on a bill introduced by Senator Elizabeth Warren (D-MA) that would apply the requirements of the Bank Secrecy Act to miners and validators. Mosier likened miners and validators to Internet service providers and stated that regulating them like money services businesses would do nothing to stop illicit finance. For his part, Redbord appeared to suggest that the trackable nature of blockchain technology already makes illicit finance using cryptocurrency more difficult.

FINRA finds potential violations in majority of crypto asset communications. On January 23, the Financial Industry Regulatory Authority (FINRA) announced the release of the results of a targeted examination of certain member firms that had actively communicated with their retail customers about crypto assets and related services. According to the published report, FINRA investigators were reviewing these retail communications for compliance with FINRA Rule 2210, which requires fair and balanced communications with the public and prohibits “claims that are false, exaggerated, promissory, unwarranted or misleading” and the omission of material facts that would cause a communication to be misleading. These communications could take many forms, including podcasts and television commercials. Among other findings, FINRA found that some firms had failed to differentiate when virtual currencies were being offered through the member firm, an affiliated entity, or a third party; falsely implied that certain virtual currencies functioned like cash; and misleadingly explained how certain virtual currencies operate. Overall, the report found potential violations in more than 70 percent of the materials it reviewed.

ENFORCEMENT ACTIONS AND LITIGATION

FEDERAL

Securities

SEC settles fraud charges against fraudulent crypto hedge fund. On February 2, the SEC announced it had settled fraud charges against Brian Sewell and his company Rockwell Capital Management. According to the SEC’s complaint, Sewell ran a crypto trading course called American Bitcoin Academy, through which he solicited hundreds of students to invest in his “Rockwell Fund.” To induce investment, Sewell promised his fund would use technology such as AI to trade crypto using advanced strategies which would generate returns. He allegedly received approximately $1.2 million from 15 students but never launched the fund. Instead, he converted the funds to bitcoin, which he claimed was later stolen through a hack of his wallet. As part of the settlement, Rockwell Capital Management has agreed to pay disgorgement and prejudgment interest totaling more than $1.6 million plus a civil penalty of $223,229.

TradeStation charged with unregistered offer and sale of security. On February 7, the SEC announced it had settled charges against Florida-based crypto lending protocol TradeStation Crypto, Inc. According to the SEC’s order, TradeStation Crypto started offering its interest-bearing crypto lending product in August 2020, marketing it as a way for investors to earn interest while TradeStation retained complete discretion over how to deploy investor assets. SEC alleged this lending product constituted a securities transaction which TradeStation was required to register with the SEC. As part of the settlement, TradeStation agreed to cease offering all crypto-related products and pay a $1.5 million penalty. In parallel actions brought by state regulators, the company agreed to pay an additional $1.5 million in fines.

Founders of HyperFund charged with $1.89 billion fraud scheme. On January 29, the Justice Department announced it had charged two individuals and secured a guilty plead from a third in connection with an alleged $1.89 billion fraud scheme that involved nonexistent cryptocurrency mining operations. Working together with the Department of Homeland Security and the IRS Criminal Investigation division, the DOJ alleges that the defendants ran a platform called HyperFund which promised daily passive rewards that would double or triple an investor’s initial capital through returns from a large-scale crypto mining operation. In reality, the indictment alleges, the mining operation did not exist and, after about a year, HyperFund began blocking investors from making withdrawals. In a parallel civil action, the SEC announced charges against two of the individuals for violating anti-fraud and registration provisions of the federal securities laws. According to the SEC’s complaint, the “memberships” HyperFund sold to investors were securities the sales of which were required to be registered under Section 5 of the Securities Act.

Final judgment entered against downstream promoters of CoinDeal. On February 7, the SEC announced it had secured final judgments against two downstream promoters of a cryptocurrency scam called CoinDeal. According to the SEC’s complaint, the two promoters did not create the CoinDeal scam but actively solicited more than $3 million from hundreds of investors in multiple states while misappropriating hundreds of thousands of dollars for themselves. The scam involved promising outlandish returns to investors based on an apparently fictional sale of an anonymous blockchain technology to a cohort of wealthy buyers. The promoters, and the founders of the scheme who were separately charged earlier this year, repeatedly generated excuses when the sale never closed, and no investors received a distribution. For more information on allegations related to CoinDeal, see our January 2023 and June 2023 issues.

Crowd Machine and Metavine ordered to disgorge nearly $20 million. On January 23, the SEC announced that a federal district court in the Northern District of California had issued a final judgment ordering Crowd Machine, Inc. and Metavine, Inc. to disgorge $19,676,401 raised through an allegedly fraudulent and unregistered sale of securities known as Crowd Machine Compute Tokens (CMCTs). According to the complaint, CMCTs were a digital asset that purported to compensate contributors to a decentralized “Crowd Computer.” In reality, the SEC alleges, the Crowd Computer never materialized, and the defendants instead used the funds to invest in gold mining operations in Africa that never returned revenue. For more information on the history of the complaint, see our January 2022 issue.

Virtual currency

CFTC charges trading platform that lured customers with romance scams. On January 19, the CFTC announced a civil enforcement action against Debiex, a purported digital asset trading platform, that allegedly use romance scams (also known as pig butchering) to lure customers to open and fund accounts on the platform. According to the complaint, Debiex solicited and misappropriated roughly $2.3 million from approximately five customers since March 2022. Debiex agents allegedly targeted Asian American victims by befriending them on social media and inducing them to open an account on Debiex, which then mimicked the features of a real trading platform while the victim’s assets were misappropriated. In a separate statement, Commissioner Kristin Johnson touted the CFTC’s vigorous pursuit of romance scams which, according to FBI statistics, have increased “a staggering 183% from $907 million in 2021 to $2.57 billion in reported losses by 2022.”

FDIC issues cease-and-desist letters to virtual currency companies. On January 19, the FDIC announced it had sent cease-and-desist letters to Bybitcoin Ex, ORGANO Payment, and Horizon Globex, among others, demanding immediate corrective action to address false or misleading representations that the virtual currency companies were FDIC insured or affiliated with FDIC-insured banks. The letters exercise authority under a final rule the FDIC adopted in December 2023 which updated FDIC regulations regarding false advertising, misrepresentations of deposit insurance coverage, and misuse of the FDIC’s name and logo. For more information on FDIC’s updated rules, see our March 2023 issue.

Anti-money laundering

BTC-e founder charged in international money laundering conspiracy. On February 1, the DOJ announced it had indicted a Belarusian and Cypriot national for his role in operating BTC-e which, according to the indictment, was a cybercrime and online money laundering platform that provided high levels of anonymity for users to trade bitcoin. BTC-e allegedly received criminal proceeds from hackers, ransomware scams, and narcotics rings, among others. BTC-e had no anti-money laundering controls or KYC verification and had not registered as a money services business, despite operating in the United States. For more information on BTC-e, see our August 2022 and June 2023 issues.

Former law firm partner sentenced for laundering OneCoin proceeds. On January 25, the US Attorney’s Office for the Southern District of New York announced that Mark Scott, a former partner at an international law firm, had been sentenced to 10 years in prison for his role in laundering approximately $400 million in proceeds from the OneCoin fraud scheme. Scott was convicted in November 2019. The OneCoin scheme began operating in 2014 and involved a fraudulent cryptocurrency sold to more than 3.5 million victims through a multi-level marketing program. In total, the scheme took in more than $4 billion. Scott’s role was to form a series of fake private equity funds in the British Virgin Islands which he then used to disguise transfers from the OneCoin scheme to its founders. Scott was himself paid more than $50 million, which he used to purchase such extravagances as a fleet of luxury cars, a yacht, and three seaside homes in Cape Cod, all of which he was ordered to forfeit. For more information on OneCoin, see our November 2023 issue.

Bitcoin kiosk operator ordered to pay restitution to romance scam victims. On February 13, the US Attorney’s Office for the District of New Hampshire announced that a court had ordered the operator of a bitcoin ATM service to pay restitution of more than $3.5 million to 29 victims of romance scams, many of whom were elderly. According to the press release, the defendant took money from victims and charged them exorbitant fees to convert their money into bitcoin that could then be sent to scammers. To cater to these fraudsters, the defendant disabled KYC requirements on his kiosks and failed to register his business with the Financial Crimes Enforcement Network. A parallel press release from the IRS further reported that the defendant concealed his income and paid no taxes. Earlier this year, he was sentenced to 96 months in prison for these crimes.

STATE

Securities

Texas securities regulator settles charges with crypto lender Abra. On January 22, the Texas State Securities Board announced that it had settled charges against a group of companies known as Abra that offered cryptocurrency lending products known as Abra Boost and Abra Earn. Through these products, investors could deposit digital assets that Abra would lend to institutional borrowers to generate interest that Abra would share with investors. The settlement enables withdrawals for Texas customers and permits other state regulators to participate on the same terms. In total, the regulator estimated deposits in Abra were worth approximately $13.6 million. Abra previously settled federal charges with the SEC and CFTC in 2020. For more information on Abra, see our July 2020 and July 2023 issues.

Eight state securities regulators secure settlement against TradeStation. On February 7, eight state securities regulators, representing California, Washington, Alabama, Mississippi, North Carolina, Ohio, South Carolina, and Wisconsin, announced they had entered a multistate consent order with TradeStation Crypto, Inc. on behalf of 51 US jurisdictions. The announcement came the same day as the SEC’s announcement that it had settled related federal charges against the same company. As in the federal case, the action brought by the state regulators—each a member of the North American Securities Administrators Association (NASAA)—alleged that TradeStation was engaged in the unregistered offer and sale of securities in the form of interest-bearing crypto asset lending products. Through the products, investors could deposit virtual currencies which TradeStation would then use to generate revenue through lending and other means. The consent order requires TradeStation to pay $1.5 million in penalties.

SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS

Canadian Securities Administrators seek public comment on funds that invest in crypto. On January 18, the Canadian Securities Administrators (CSA) published a Notice and Request for Comment seeking public comment on restrictions pertaining to investment funds that plan to invest in virtual currency. According to the Notice, the CSA seeks to amend national rules to provide greater clarity regarding the types of digital assets that funds should be permitted to buy, use, and hold; and to establish custody requirements for entities holding digital asset on behalf of those funds. These amendments would form part of the CSA’s long-term initiative to develop a regulatory framework that properly accounts for the “unique aspects of crypto assets.” Among other restrictions, the amended rules as proposed would permit only funds registered as “alternative mutual funds” to invest in crypto assets directly and would limit the types of assets registered funds could invest in to those assets listed on exchanges recognized by securities regulatory authorities in Canada.

British Columbia court confirms public utility companies can deny service to cryptocurrency mining operations. On February 2, the Supreme Court of British Columbia issued a decision in Conifex Timber v. British Columbia confirming that the BC government has authority to direct its public utilities regulator to issue orders relieving public electricity utility companies from their obligation to supply service to cryptocurrency mining projects for a “freeze” period of 18 months (which started in December 2022). The case involved two data center projects planned by Conifex Timber as it looked to diversify from its timber operations into crypto mining projects. According to the utility company, BC Hydro and Power Authority, the centers were projected to use about 2.5 million megawatt-hours of electricity annually, roughly two-and-a-half times more than the company’s next largest electricity consumers. The provincial government allowed BC Hydro to suspend service to new cryptocurrency mining projects for 18 months, which led to Conifex Timber filing a petition to the Supreme Court. The Court held that the statute authorizing public utility freeze orders was designed for the comprehensive regulation of public utilities for the benefit of the public, focusing on sustainable energy management for all of BC, and that the government’s decision fell within that mandate. Though Confinex asserted the decision was unduly discriminatory, the Court concluded that cryptocurrency mining's intensive energy use, requiring continuous operation of high-performance computers and cooling systems, sets these operations apart from those of other BC Hydro customers. Thus, any differential treatment was justified.

EU DORA Regulation: First steps in secondary legislation. January 17, 2025, will mark the entry into force of Regulation (EU) 2022/2554, known as the Digital Operational Resilience Act, or simply DORA. Along with the Regulation on crypto-asset markets, it’s part of the digital finance package. DORA represents a revolutionary step for the financial sector and ICT service providers, introducing significant obligations to strengthen digital operational resilience. The Regulation also mandated the European supervisory authorities (EBA, EIOPA, and ESMA – the European Supervisory Authorities or ESAs) to develop the implementing technical standards (ITS) and the regulatory technical standards (RTS). These secondary standards aim to harmonize, clarify, and specify the rules of DORA. On January 17 this year, the ESAs published the first set of ITS and RTS, which is now under the scrutiny of the European Commission. Read more.

DLA Piper news

• The Financial Times recognizes DLA Piper as one of the Most Innovative Law Firms in North America.
• The Legal 500 ranks DLA Piper Tier 1 in FinTech: Crypto. DLA Piper was also ranked in Tier 2 for FinTech, and Margo Tank was ranked as a "Leading Individual."
• Chambers FinTech Legal ranks DLA Piper in all four categories including Band 2 for Blockchain and Digital Assets, with Margo Tank individually recognized in Band 3 in the Blockchain & Digital Assets and Payments & Lending areas.
• DLA Piper’s Commodities, Digital Assets, and Carbon Compliance and Enforcement team draws on decades of collective experience in the commodities and securities industry to help companies navigate new and complex commodities enforcement matters, including those related to agriculture, metals, energy, digital assets, and carbon/sustainable commodities, among others.

RECENT AND UPCOMING EVENTS

On April 5, David Stier, Vice Chair of the ABA’s Banking Law Committee – Bank Secrecy Act and Anti-Money Laundering subcommittee, will be speaking on panel titled “Cryptocurrency & Illicit Finance: Risk Mitigation Strategies” at the ABA’s Business Law Section Spring 2024 meeting in Orlando, Florida.

DLA Piper attorneys presented at the following:

• AI ChatRoom, a DLA Piper video series hosted by Danny Tobey covering various topics in AI.
• American Bar Association Futures & Derivatives Law Committee. On January 26, Deanna Reitman presented at the winter meeting of the ABA’s Futures & Derivatives Law Committee. Her panel discussed ethical considerations in digital assets and AI.

PUBLICATIONS

• Cryptocurrency and Digital Asset Regulation, published by the American Bar Association and co-edited by Deborah Meshulam and Michael Fluhr, includes chapters by Meshulam, Fluhr, and Margo Tank

READ

The Corporate Transparency Act is coming: What you should know

CPA releases draft rules for automated decision-making technology

Digital Services Act Tracker

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

Margo Tank
James Williams
Liz Caires
Eric Hall

Contributors to this issue
Edoardo Bardelli
Michael Fluhr
Deborah Meshulam