CryptoLaw Newsletter #14 - 10 August 2021

Why crypto discussions on US Infrastructure Bill matter beyond the US – and for DeFi. Tether has ‘estimated leverage of 383-to-1’, says The Economist. SEC’s Peirce warns against ‘shadow’ DeFi.

Digital assets

  • South Korea– The Financial Services Commission reportedly will shut down 11 crypto exchanges. (Cointelegraph)

  • Hong Kong – Binance announced it will discontinue its derivatives offerings to Hong Kong users. The crypto exchange stopped opening new derivatives accounts with immediate effect. Existing account holders have 90 days to close their position. The news comes soon after Binance announced it would cease derivatives trades in Europe. (Coindesk)

  • US – A crypto-provision in the Infrastructure Bill proposes to impose tax reporting requirements on crypto ‘brokers’. Who’s a broker in the crypto industry was hotly debated. Despite intense lobbying from the crypto community (with thousands of phone calls made to lawmakers), the original language was retained by the Senate. The provision defines a broker as”any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” This is broad enough to cover not just centralized crypto exchanges but potentially also developers, miners, stakers and other validators. See our Spotlight below and our blog for why this discussion matters beyond the US and why it matters to DeFi.

  • US – The IRS has seized $1.2 billion worth of cryptocurrency this fiscal year, according to CNBC.  The government turned to the private sector to help it custody the seized digital assets. The DoJ offered a crypto custody contract to Anchorage Digital, a federally chartered crypto bank. Initially the contract was awarded to BitGo, but it got disqualified ‘on a technicality’, according to Coindesk: ‘the firm was simply too big to win a small business contract’.

  • USPoloniex agreed to a $10 million settlement with the Securities and Exchange Commission (SEC). The securities regulator alleged that the crypto-exchange operated an unregistered online digital asset exchange, in violation of US securities law. Poloniex facilitated transfers of digital assets, some of which were securities, according to the SEC.  It said Poloniex decided in July 2018 to continue the trading of digital assets categorized as ‘medium risk’ of being considered securities, on order to reap the ‘business rewards’ of these trades. The charges related to activities between July 2017 through November 2019, when Poloniex ‘sold its platform’. Circle bought Poloniex and in a recent Investor Presentation Circle mentioned the SEC’s pending enforcement action among its risk factors.

  • Commissioner Hester Peirce penned her own statement criticizing the SEC’s ‘enforcement-centric approach to crypto’. She had harsh words for the SEC’s decision in the Poloniex case: ‘There is just one minor problem—during the period at issue here (mid 2017 through 2019), the Commission was moving very cautiously with respect to regulated entities’ engagement with crypto assets. Sure, Poloniex could have tried to register as a securities exchange or, more likely, as a broker-dealer to operate an alternative trading system (…). Had it done so, it likely would have waited . . . and waited . . . and waited some more,’ Peirce wrote. ‘Given how slow we have been in determining how regulated entities can interact with crypto, market participants may understandably be surprised to see us to come onto the scene now with our enforcement guns blazing.’

  • US – And yet more SEC news. The regulator wants more data from Ripple. It filed a motion asking Judge Sarah Netbrun at the Southern District of New York to order Ripple to hand over more Slack messages from its employees. The SEC accused Ripple of previously giving only incomplete records, omitting ‘terabytes’ of data. Ripple in turn asked an extension to respond to the SEC’s request until 16 August. (Cointelegraph)

  • US – The Biden Administration is vetting Cornell law prof. Saule Omarova for the top job at the Office of the Comptroller (OCC). Previous picks Michael S. Barr and Mehrsa Baradaran were withdrawn as they were unlikely to receive the necessary support on Capital Hill. (New York Times)

  • US – The SEC charged Blockchain Credit partners and two of its executives for violating securities law through the unregistered sale of securities and for misleading investors. Although the company promoted its DeFi Money Market fund as a decentralized business, the venture does not appear to be DeFi at all.

  • US – The Commodities and Exchange Commission (CFTC) made two crypto-related announcements in a day. First, it reported that the District Court for the Southern District of Texas ordered three defendants to pay nearly $1.75 million in a digital asset scheme. A few hours later, it announced a $100 million order against five BitMEX entities by the District Court for the Southern District of New York, for operating without the necessary approvals and registrations, and for failing to comply with KYC rules. The CFTC’s litigation against BitMEX’s founders, including Arthur Hayes, continues.


Stablecoins

  • The Economist ran 3 pieces on crypto-assets, including one on why stablecoins should be regulated like banks. It states that Tether has ‘estimated leverage of 383-to-1’ and that ‘Tether would be unable to honour all its tokens after losses of just 0.26%’.

  • Tether published an assurance opinion that confirmed the breakdown of its reserves, first published in May as part of a settlement with the New York Attorney General. (Decrypt)


DeFi

  • The competing amendments for the definition of ‘brokers’ in the US Infrastructure Bill really revolves around the regulatory challenge of DeFi, tweeted Wharton’s Kevin Werbach (see also his Medium post).

  • SEC Commissioner Peirce, affectionately known as Crypto Mum in the industry, says true decentralization from launch is the only hope for DeFi to bypass regulation. She warned against rampant ‘shadow decentralization’ in the sector. (Cointelegraph)

  • What is DeFi? Kevin Werbach talks about key risks and opportunities in The Conversation. Among the opportunities: ‘DeFi eliminates the distinction between ordinary customers and wealthy individuals or institutions’ and ‘because DeFi services run on open-source software code, they can be combined and modified in almost endless ways’. The risks? A few, such as ‘there isn’t any banker or regulator who can send back funds transferred in error’, ‘[n]or is there necessarily someone to repay investors when hackers find a vulnerability in the smart contracts or other aspects of a DeFi service.’ ‘Some DeFi services appear to violate regulatory obligations’ and it’s not even clear how existing rules can be enforced in DeFi without traditional intermediaries. Moreover, ‘DeFi makes it easier than ever to create hidden interconnections that have the potential to blow up spectacularly.’ In case we forgot: that got us into trouble before with the Financial Crisis.

  • What is holding back institutional investors from diving into DeFi? FTX’s Sam Bankman-Fried ‘highlighted the lack of regulations as one of the big issues concerning institutional investors.’ (Decrypt)


CBDC

  • Venezuela – Banco Central de Venezuela announced plans to introduce the digital bolivar as from October this year. The country’s central bank will remove six zeros as compared to the current, physical bolivar for its CBDC, without changing the value of the physical bolivar. The country had already issued the petro in 2018, a cryptocurrency allegedly backed by oil and other commodity reserves, but that never got off the ground. (Blockchain News)

  • Jamaica – Bank of Jamaica minted its first batch of central bank digital currency. (Cointelegraph)


Trading places

  • US – Brian Brooks resigned as CEO of Binance.us. In a tweet Brook mentioned ‘differences over strategic direction’. CZ commented on CNBC that his departure was ‘nothing regulatory-related’.


Spotlight: Crypto debates on Infrastructure Bill matter beyond the US – and matter to DeFi

US lawmakers received more than 35,000 calls over the past few days (CNBC) over a single word in the Infrastructure Bill: broker.

The debate matters beyond the US: it shows the level of confusion created when we copy-paste familiar concepts from traditional finance to the context of crypto-assets and blockchain, which many lawmakers are still unfamiliar with.

We know what ‘broker’ means for traditional activities, but who is a broker in the world of blockchain and crypto-assets? And, even more challenging, are there any brokers in Decentralized Finance (DeFi)?

The ‘broker’ negotiations were really about DeFi, argued Wharton’s Kevin Werbach. He tweeted that ‘the debate over the infrastructure bill is not about regulating proof of work vs. proof of stake. Nor is it about banning crypto As I said earlier in the week, it’s about DeFi.’

A proposed amendment attempted to exclude much of DeFi from the Bill’s scope, and therefore from the Bill’s tax reporting obligations…

Read more on our blog

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