To remain competitive, companies find themselves increasing their efforts to digitally transform their businesses by developing new offerings based on emerging technologies and integrating these technologies into existing product and service offerings.
This is our fourth monthly bulletin for 2021, 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, from copyright protection to voting, most of the current adoption is in the financial services section and the focus of this bulletin will be primarily on the use of blockchain and or smart contracts in that 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:
- Virtual currencies
- Deposits, accounts, intangibles
- Negotiable instruments
- Electronic chattel paper
- Digitized assets
Digital assets can themselves be assets or instead can reflect the ownership of an underlying asset. For example, electronic records that are the equivalents of negotiable instruments and electronic chattel paper would be digital assets, as would an electronic recording of a security interest in the underlying asset, such as recording title to real or personal property and the use of tokens to represent revenue streams from otherwise illiquid assets such as patents and commercial real estate (sometimes referred to as a tokenized or digitized asset).
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.
Each issue will feature in-depth insight on a timely and important current topic. In this issue, we discuss developments in the UK on the tax treatment of cryptoassets, and the SEC’s updates to its token safe harbor proposal.
To build on our recent increasing recognition in the fintech and blockchain space, the DLA Piper IPT and Real Estate teams joined up to contribute to the inaugural edition of the Chambers and Partners Blockchain Guide 2020. Led by partner Scott Thiel and supported by Jonathan Gill and Kenny Tam, the team wrote the Hong Kong and China “Law and Practice” sections of the guide detailing the blockchain market and key legal and regulatory issues to note in each jurisdiction.
For related information regarding digital transformation, please see our monthly bulletin, eSignature and ePayment News and Trends.
Update to tax treatment of cryptoassets to incorporate staking
On March 30, 2021, Her Majesty’s Revenue & Customs (HMRC) updated its Cryptoassets Manual to take into account staking in proof-of-stake networks. HMRC confirmed that such passively earned cryptoassets will likely be subject to capital gains tax or corporation tax on chargeable gains when the cryptoassets are subsequently sold. This position is largely the same as the established tax treatment of cryptoasset mining activities. Read more.
SEC Commissioner Peirce issues revised token safe harbor proposal
On April 13, Securities and Exchange Commission (SEC) Commissioner Hester Peirce announced she has issued an update to her 2020 token safe harbor proposal. The updated proposal includes a draft of proposed Securities Rule 195 which would provide a time-limited exemption for tokens. The safe harbor would last for three years and only apply if certain conditions are met. Read more.
Biden Executive Order on Russian harmful activities blocks use of digital currencies to circumvent sanctions. President Joe Biden issued an Executive Order on April 15 which empowers the Secretary of the Treasury, with the Secretary of State and in consultation with the Attorney General, to block the “deceptive or structured transactions or dealings to circumvent any United States sanctions, including through the use of digital currencies or assets or the use of physical assets” by any person acting for on or behalf of the Government of the Russian Federation.
US Postal Service approves NFT postage. On April 13, CaseMail announced it was certified by the United States Postal Service as the first producer of blockchain-generated ePostage labels, using CaseMail’s non-fungible token (NFT) mail technology. The initial rollout of the service is intended for government agencies and legal professionals. You may also be interested in our article Non-fungible tokens: emerging issues in the emerging marketplace.
DOT and EU regulators publish statement on joint financial regulatory forum meeting. On March 29, the US Department of the Treasury (DOT) published a Joint Statement on the US-EU Joint Financial Regulatory Forum which reviewed the Forum’s themes, including COVID-19 recovery and mitigating financial stability risks, sustainable finance, multilateral and bilateral engagement in banking and insurance, regulatory and supervisory cooperation and developments in capital markets and financial innovation, and anti-money laundering and counter-terrorism financing. Participants exchanged views on recent developments and regulatory proposals involving new forms of digital payments, including cryptoassets, stablecoins, and central bank digital currencies.
FinCEN publishes findings from Innovation Hours Program. On March 26, the Financial Crimes Enforcement Network (FinCEN) announced publication of FinCEN Innovation Hours Program: Emerging Themes and Future Role in AML Act Implementation (May 2019 – February 2021). The report describes emerging themes in the FinCEN Innovation Hours program, which include the availability of AML/CFT solutions, particularly supporting compliance with existing requirements for convertible virtual currency exchangers, as well as the lack of anonymized financial crime data which would enable AML/CFT solution providers to properly train and test applications – a gap FinCEN’s SAR statistics database attempts to fill. The report also describes FinCEN’s future plans regarding the program.
SEC receives multiple applications to approve bitcoin EFTS. The following is a non-inclusive listing of firms seeking approval from the SEC to offer a bitcoin exchange-traded fund (ETF) in the US. The SEC has yet to approve any bitcoin EFT:
- Wise Origin Bitcoin Trust
- Galaxy Digital
- SkyBridge Capital
The Ontario Securities Commission in Canada approved the Purpose Bitcoin EFT on February 11, and on March 19 the Brazilian Securities and Exchange Commission reportedly approved QR Capital’s QBTC11 as Latin America’s first bitcoin ETF.
IRS memorandum clarifies guidance on hardforks and cryptocurrency valuation. As discussed in a prior issue of this newsletter, in Revenue Ruling 2019-24, the IRS ruled that a holder of cryptocurrency who experienced a hardfork followed by an airdrop (in which the new currency emerging from the hardfork was distributed) had taxable income equal to the value of the currency received. In order to clarify some confusion sown by Revenue Ruling 2019-24 and other IRS guidance, on April 9, 2021, the IRS released Chief Counsel Memorandum 202114020 (dated March 22, 2021) (the ILM).
- First, the IRS clarified that taxpayers who received Bitcoin Cash as a result of the Bitcoin hardfork in 2017 had taxable income if they had “dominion and control” over the Bitcoin Cash they received. Revenue Ruling 2019-24 had concluded that whether taxpayers have gross income as a result of a hardfork depends on whether new cryptocurrency is airdropped to the taxpayer’s account. However, airdrops are not the way in which people generally get access to forked cryptocurrency; airdrops occur when a person receives free cryptocurrency in their wallet or custodial account. The ILM concludes that “The specific means by which the new cryptocurrency is distributed or otherwise made available to a taxpayer following a hardfork does not affect the Revenue Ruling’s holding.” In short, cryptocurrency received as a result of either a hardfork or an airdrop is taxable to the recipient, provided the recipient has dominion and control at the time of receipt.
- Second, the ILM clarifies earlier guidance on determining a cryptocurrency’s fair market value. In discussing the value of Bitcoin Cash received as a result of the 2017 hardfork, the ILM provide a taxpayer “can determine the Bitcoin Cash’s fair market value using any reasonable method, such as adopting the publicly published price value at a cryptocurrency exchange or cryptocurrency data aggregator.” In FAQ 27 of the IRS’s FAQ page relating to cryptocurrency, the IRS provided that, in determining fair market value, it would “accept as evidence of fair market value the value as determined by a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time.” As many now, “blockchain explorers” do not generally track cryptocurrency transactions. The ILM’s use of the term “cryptocurrency data aggregator” acknowledges that publicly available data aggregators exist and provide values for cryptocurrency, and implicitly revises the FAQ.
IRS reveals intent to pilot AI, ML and RPA for analyzing cryptocurrency transactions. On April 2, the Internal Revenue Service (IRS) announced its intent to issue a pilot solicitation for technology solutions using artificial intelligence (AI), machine learning (ML) and robotic process automation (RPA) to gather data for analysis of virtual currency transactions.
J5 countries challenge FinTech companies to identify tax criminals. On March 25, the IRS announced that the Joint Chiefs of Global Tax Enforcement (J5) had issued The Challenge, a coordinated event bringing together investigators, cryptocurrency experts and data scientists form each country to optimize data from open and investigative sources to generate leads and find tax offenders using cryptocurrency. This year, The Challenge focuses on FinTech companies, according to the announcement, “due to the online nature of the products, the novelty and the lack of regulation and compliance in some areas, the FinTech industry can be used by tax avoiders and money launderers to commit crimes.”
California DFPI issues opinion letter on purchase and sale of cryptocurrency. On February 9, the DFPI published a final opinion letterstating that a company that sold cryptocurrency from its inventory to clients, or purchased cryptocurrency from clients using its funds, is not engaged in the business of money transmission because its activities are limited to buying and selling virtual currency.
New York announces blockchain-based COVID-19 passport. On March 26, New York Governor Andrew Cuomo announced the launch of Excelsior Pass, described as a blockchain-based, free and voluntary platform developed in partnership with IBM which confirms an individual’s recent negative COVID-19 test or proof of vaccination. Through use of the Excelsior Pass Wallet app, an individual may use their smartphone to produce a QR code readable by participating businesses and venues to enable reopening and admission in accordance with New York State Department of Health guidelines for large gatherings.
California court orders IRS to show cause supporting issuance of John Doe summons on Kraken. On March 31, the United States District Court for the Northern District of California ordered the IRS to show cause why its petition to serve a John Doe summons against Payward Ventures Inc. DBA Kraken should not be denied. The IRS’s petition seeks information on virtual currency transactions of Kraken users to assess the tax liability of such users. The IRS must respond by April 14, explaining how its petition is narrowly tailored to the IRS’s investigative needs, “including whether requests for more invasive and all-encompassing categories of information could be deferred until after the IRS has reviewed basic account registration and transaction histories.”
Industry questions whether cryptocurrency is subject to unclaimed property laws. On April 7, a blog post issued by Sovos, a global tax solution provider, discusses the application of unclaimed property laws to cryptocurrency now that the IRS has defined virtual currency as property (IRS Ruling Notice 2014-21). The post notes that the 2016 Revised Uniform Unclaimed Property Act includes virtual currency in its definition of property subject to unclaimed property laws, and reviews the laws of states that have not adopted RUUPA.
BIS issues report on supervising cryptoassets for AML. On April 7, the Bank for International Settlements (BIS) issued Supervising Cryptoassets for Anti-Money Laundering, a report assessing emerging regulatory approaches and supervisory practices and identifying policy priorities to address common challenges faced by financial authorities in regulating and supervising cryptoasset service providers.
BIS issues paper on multi-CBDC arrangements and cross-border payments. On March 19, the BIS issued Multi-CBDC Arrangements and the Future of Cross-Border Payments, a paper which discusses enabling interoperating central bank digital currencies (CBDCs) through multi-CBDC arrangements, and advising central banks to incorporate cross-border considerations in the CBDC development and international coordination.
Coinbase share price jumps on NASDAQ. On April 14, Coinbase reportedly went live with its direct listing on NASDAQ, resulting in a closing share price of $378 per share, which is 52 percent above the NASDAQ published reference price of $250. For information on the history of the listing, see our March issue.
SEC files complaint against digital content marketplace for unregistered offering. On March 29, the SEC announced the filing of a complaint in the US District Court for the District of New Hampshire against LBRY, Inc., a digital content marketplace, for the offer and sale of more than $15 million in digital tokens called LBRY Credits (LBC) between 2016 and 2020, purportedly to fund the business and build the platform. The SEC asserts that LBC is an unregistered security which was issued and sold to investors in violation of the Securities Act of 1933. The SEC seeks an injunction, disgorgement, and civil monetary penalties.
CFTC announces default judgment against bitcoin fraudster. On March 26, the CFTC announced it obtained a default judgment against Benjamin Reynolds in the US District Court for the Southern District of New York for charges related to a fraudulent investment and pyramid scheme to solicit bitcoin. The order requires Reynolds to pay nearly $143 million in restitution and a $429 million civil monetary penalty. For information on the complaint, see our July 2019 issue.
CFTC announces settlement against J Squared. On April 20, the CFTC announced it issued an order filing and settling charges against Jozef Gherman of Florida and J Squared LLC, for making misleading statements or omitting material facts in the solicitation of more than $300,000 from over 40 individuals to invest in digital assets. The order requires the defendants to pay a $150,000 civil monetary penalty and $247,110 in restitution and imposes a 10-year ban on engaging in any activities requiring registration with the CFTC.
CFTC announces default judgment for cryptocurrency fraud. On April 8, the US Commodity Futures Trading Commission (CFTC) announced the US District Court for the District of Nevada entered a default judgment against Circle Society, Corp. and its owner David Saffron for a virtual currency options fraud scheme. The final judgment compels defendants to pay restitution of $14,841,280, to disgorge $15,815,967 and to pay a civil monetary penalty of $1,484,128. For information on the complaint, see our November 2019 issue.
New Jersey man pleads guilty to operating an unlicensed bitcoin exchange. On April 5, the DOJ announced that William Green of New Jersey pled guilty to one count of running an unlicensed money transmitting business in the form of an illegal bitcoin exchange. The DOJ alleged Green operated a website called Destination Bitcoin through which he received money from customers which he converted to bitcoin and deposited the bitcoin into wallet addresses provided by customers. The charge carries a maximum penalty of 5 years in prison and a $250,000 fine. For information on the indictment, see the DOJ’s July 2019 announcement.
Man pleads guilty to extorting cryptocurrency from startup company. On April 5, the DOJ announced that Michael Hlady of New York pled guilty to conspiring to extort a startup company for millions of dollars of ether (ETH). According to court filings, while the startup was planning its initial coin offering in November 2017, Hlady and a co-conspirator repeatedly threatened company executives that they would destroy the company if the startup did not send funds and company tokens. The company transferred 10,000 ETH to the co-conspirator as a result of the threats. Hlady faces up to 20 years in prison and a fine.
Montana securities regulator issues cease and desist order against pyramid scheme. On March 22, the Montana Commissioner of Securities and Insurance (CSI) announced the issuance of a cease and desist order against Forsage, a web-based platform based in the Philippines that operates using Ethereum, to cease operating a pyramid scheme in violations of the Montana Securities Act. The order outlines that the CSI will impose a fine not to exceed $5,000 for each violation, a fine not to exceed $20,000 per violation of a vulnerable person and restitution.
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
Bahamas’ central bank discusses provisions under draft regulations for CBDC. On March 26, the Central Bank of The Bahamas published Consumer-Centric Aspects of the Proposed Regulations for the Bahamian Digital Currency. The paper discusses “key consumer-centric provisions” under the draft regulations and the integration of the Bahamian digital “Sand Dollar” into the financial system, including KYC/AML requirements, financial inclusion, interoperability and stability, confidentiality, and cybersecurity, The Central Bank plans to finalize the regulations by May 1.
Canadian securities administrators and regulatory organization issues joint guidance for cryptoasset trading platforms. On March 29, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) jointly issued Staff Notice 21-329 Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements. The notice sets forth guidance on how Canadian securities legislation applies to trading platforms that trade in cryptoassets that are securities or in instruments or contracts involving cryptoassets.
Six Chinese banks allow public digital yuan wallets applications. On March 25, it was announced that six state-owned Chinese banks are reportedly allowing public users to apply to activate digital yuan wallets in Shanghai and Beijing, indicating that digital yuan CBDC testing is widening in scope. The six banks are the Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, Postal Savings Bank of China, and Bank of Communications.
Dubai securities regulator seeks public consultation on proposed framework for regulation of tokens. On March 29, the Dubai Financial Services Authority (DFSA) announced the publication of the Framework for Regulating Security Tokens for public consultation over a period of 30 days. The Framework enables the use of DLT for various investments, including derivatives, and covers activities of offer, trading and the provision of financial services relating to Security Tokens.
ECB publishes results of public consultation on digital euro. On April 14, the European Central Bank (ECB) published an analysis of the results of its public consultation on a digital euro. The results indicate that Europeans seek the following from a digital euro: privacy, security, the ability to pay across the euro area, no additional costs and offline usability.
Germany announces successful test of DLT securities settlement. On March 24, the Deutsche Börse, Deutsche Bundesbank, and Germany’s Finance Agency announced the successful testing of a settlement interface for electronic securities using distributed ledger technology (DLT), enabling a “technological bridge between blockchain technology and conventional payment systems to settle securities in central bank money with no need to create central bank digital currency.” A member of the Bundesbank executive board asserted that the Eurosystem should be able to implement such a solution in a relatively short space of time – at least in far less time than it would take to issue central bank digital security.”
India Ministry of Corporate Affairs orders corporate reporting of crypto holdings. On March 24, India’s Ministry of Corporate Affairs reportedly issues amendments to India’s Companies Act which requires all public and private companies in India to identify all crypto involvement in all public financial reporting, specifically including profits and losses from investment or trading in cryptocurrency.
Japan’s central bank begins CBDC testing. On April 5, the Bank of Japan reportedly announced it began phase 1 CBDC testing, focusing on the basic functions of a CBDC, such as issuance, distribution and redemption, in a proof of concept. Testing will continue through March 2022, before moving into phase 2.
Japan to adopt travel rule for virtual currency industry. On March 31, the Japanese Financial Services Agency (FSA) reportedly announced that the adoption of the Financial Action Task Force (FATF) Travel Rule to the transfer of crypto assets by virtual asset service providers. The FSA requested the Japanese Crypto Asset Trading Association to establish a system to comply with the requirements.
Russia expects launch of digital ruble in 2023. On April 8, leaders in the Central Bank of Russia reportedly announced in a virtual press conference plans for this release of a Russian CBDC, with a timeline for full launch in 2023.
South Korea to issue blockchain vaccine passports. On March 31, South Korean Prime Minister Chung Sye-kyun reportedly stated that in late April it will launch a mobile app that utilizes blockchain technology to allow international travelers to show digital proof of COVID-19 vaccination.
Swedish central bank completes phase 1 CBDC testing. On April 6, the Swedish Riksbank announced the successful pilot of a blockchain based e-krona CBDC and published a report on its findings. The pilot testing results present concerns including scalability, security, offline functionality, and need for infrastructure.
Thai central bank seeks feedback on a retail CBDC. On April 2 the Bank of Thailand announced the Bank’s proposed approach to the development of a retail CBDC for public use, in a paper entitled The Way Forward for Retail Central Bank Digital Currency in Thailand, and seeks public feedback on the plan, which must be submitted by June 15.
Thai financial regulator says mandatory virtual currency training could replace annual income requirement in restrictions on virtual currency trading. On Thursday, April 1, Thai Security and Exchange Commission (Thai SEC) Secretary-General Ruenvadee Suwanmongkol reportedly proposed that citizens trading virtual currencies should have additional training to include a test to prove their foundational knowledge, which could potentially replace an annual income requirement proposed for virtual currency trading. Suwanmongkol announced a free training course, Crypto 101, hosted by the Thai SEC for new investors, and said the agency would hold hearings on virtual currencies in the near future.
Turkish central bank announces ban on crypto asset conversions. On April 16, the Central Bank of the Republic of Turkey reportedly announced that, effective April 30, Turkish payments companies will be prohibited from enabling the direct or indirect use of crypto assets in the provision of payment services and electronic money issuance, including facilitation of fiat-to-crypto currency transfers, as well as trading, custody and issuance services. Banks are excluded from the ban.
UK FCA expands financial crimes reporting obligations to digital asset companies. On March 31, the UK Financial Conduct Authority (FCA) announced publication of a policy statement entitled Extension of Annual Financial Crime Reporting Obligation, which extends financial crime reporting obligations to include cryptoasset exchange providers and custodian wallet providers, effective as of March 30. Reporting companies must submit their first annual report on the due date after January 10, 2022.
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