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Top Blockchain Regulatory Stories of 2019

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Stories about alleged crypto fraudsters and other get-rich-quick schemes continued to dominate blockchain legal news in 2019, but foundations for legal order may have been laid. Photo by Jon Glittenberg | CC By 2.0

2019 was another year in which crazy-get-rich cryptocurrency schemes led not to #WhenLambo but instead to #WhenHandcuffs. Stories about disappearing crypto and government crackdowns were among the top news stories about blockchain regulation. But, 2019 was also a year in which the foundations for legal order may have been laid.

Here are 2019’s top 10 stories about developments in blockchain regulation:

10. American Footballer Falls Afoul of Feds: Former professional football player and co-owner of the Minnesota Vikings (hopefully, not Lizzo’s new man) is charged with violating federal law in connection with the alleged operation of a “shadow banking”  service for cryptocurrency startups. According to news reports, Fowler is planning to plead guilty at a hearing in January. 

9. HMU on KIK: You may know it as the way to DM your BAE on the down-low, but the U.S. Securities and Exchange Commission (SEC) claims KIK went too low in issuing $100 million worth of unregistered crypto tokens. KIK claimed the SEC was “playing dirty” and “trying to make [KIK] look bad.” Insert smiley face emoji here.

8. Disappearing Act: A team of lawyers and accountants began unraveling the mystery surrounding the untimely death of Gerald Cotten in 2018 and the disappearance of more than $100 million in cryptocurrency held by Cotten’s Canadian crypto-exchange, Quadriga. A prediction for 2020: the only people who will see any real money from the unwinding of Quadriga will be the lawyers and accountants and you can bet they won’t be paid in crypto.

7. Wyoming Stakes Claim: It may be a state where the buffalo roam and the deer and the antelope play, but Wyoming passed a series of laws aimed at making it a utopia for blockchain-based businesses.  Seldom was heard a discouraging word, except about that hell pit of blockchain regulation, New York state.

6. Rise of Enterprise Blockchain: Although it’s not purely legal news, the emergence of enterprise blockchain solutions, including from Blue Chip firms such as IBM, Amazon and Oracle, carries the potential to change the narrative about blockchain regulation from stories about cryptocurrency shenanigans to stories about fraud reduction and trust-building.

5. British Barristers Bless Blockchain: The U.K. Jurisdiction Taskforce of the Lawtech Delivery Panel issued a report that concluded that cryptocurrency should be considered legal property, which means that it can receive the same treatment under the law as other assets in circumstances such as bankruptcy or theft.  The panel also recognized that smart contracts can be treated as legally enforceable in the same manner as other more traditional contracts.

4. China Continues to Cool Crypto Flame: China’s central banking authority announced a further crackdown on cryptocurrency. The People’s Bank of China said in a statement that “the issuance, financing and trading of virtual currencies involve multiple risks.”  The crackdown comes shortly after officials in Shenzhen announced a similar crackdown and as the RBOC prepares to offer its own cryptocurrency. 

3. SEC Acts on Token Offering; Noone Goes to Jail: The SEC qualifies a token offering from Blockstack, which operates a decentralized computing platform.  The approval of Blockstack’s $40 million token offering was the first time that the SEC qualified an offering of blockchain digital assets, and demonstrated a path to compliance. 

2. SEC Releases Long-Awaited Guidelines: The SEC announced a framework for analysis of digital assets and at the same time issued a no-action letter for tokens offered by a charter jet service. An article in Harvard Law Review described the framework and no-action letter as indicating “that the SEC is open to excluding some blockchain-based digital assets from securities regulations. This development is meaningful because it marks a shift away from the former uncertainty, which was likely a function of the SEC’s desire to promote innovation.”

1.  Bitcoin Bounces Back: It’s not a pure regulatory story, but to many people Bitcoin = blockchain. As long as Bitcoin gives the appearance of being a means for get-rich schemes and as long as it has value to scammers, it will drive a narrative that associates blockchain with illegal behavior. After being on the ropes at the end of 2018 when it was valued at about $3,700, the price of Bitcoin grew about 97% in 2019, ending at a price over $7,000. Bitcoin remains a fascinating experiment in an asset that is, at its best, a currency alternative and an investment opportunity but, at its worst, a tool for fraudsters.

Crypto expert charged with violating U.S. Sanctions against North Korea

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Virgil Griffith faces charges for allegedly traveling to North Korea and providing guidance on cryptocurrency. Supporters, though, are backing Griffith. Photo by Lulu Lorien | CC BY-SA 4.0

An American technologist is facing U.S. charges for allegedly violating economic sanctions against North Korea.

Virgil Griffith, who lives in Singapore, is accused of traveling to North Korea to deliver a presentation and provide technical advice on using cryptocurrency and blockchain technology to evade sanctions. He was arrested at Los Angeles International Airport on Nov. 27. 

“Despite receiving warnings not to go, Griffith allegedly traveled to one of the United States’ foremost adversaries, North Korea, where he taught his audience how to use blockchain technology to evade sanctions,” said Assistant Attorney General John Demers.

Some, though, are coming to Griffith’s support, including starting a petition to free him.

Griffith is represented by an L.A. lawyer, Brian Klein.

Counselor convicted; panel recognizes crypto & smart contracts; China cracks down on illicit currency

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Lawyer Mark S. Scott was convicted of a money-laundering scheme, the proceeds of which he used to purchase luxury homes, cars and yachts. Photo by Marco Verch

Counselor Convicted of Crypto Crimes: A former law firm partner who aimed to earn $50 million by age 50 has found himself facing up to 50 years in prison for his role in a crypto-related money laundering scheme.  Mark S. Scott, a former partner at international firm Locke Lord, was convicted in U.S. federal court in New York of laundering $400 million in proceeds of a massive international fraud scheme known as “OneCoin” through fraudulent investment funds that Scott set up and operated for that purpose, according to the U.S. Attorney’s Office.  Scott received more than $50 million for his money laundering services, which he used to buy luxury cars, a yacht, and several seaside homes.

“Scott … used his specialized knowledge as an experienced corporate lawyer to set up fake investment funds, which he used to launder hundreds of millions of dollars of fraud proceeds.  He lined his pockets with over $50 million of the money stolen from victims of the OneCoin scheme. Scott, who boasted of earning ‘50 by 50’ now faces 50 years in prison for his crimes.”

Manhattan U.S. Attorney Geoffrey S. Berman

Recognizing Crypto and Smart Contracts: A U.K. panel issued a report this week on the legal status of cryptocurrency and smart contracts. The U.K. Jurisdiction Taskforce of the Lawtech Delivery Panel concluded that cryptocurrency should be considered legal property, which means that it can receive the same treatment under the law as other assets in circumstances such as bankruptcy or theft.  The panel also recognized that smart contracts can be treated as legally enforceable in the same manner as other more traditional contracts.

China Cracks Down on Crypto:  China’s central banking authority has announced a further crackdown on cryptocurrency, according to a report from Reuters. The People’s Bank of China said in a statement that “the issuance, financing and trading of virtual currencies involve multiple risks.”  The crackdown comes shortly after officials in Shenzhen announced a similar crackdown and as the RBOC prepares to offer its own cryptocurrency.    

Is the SEC Bullying Kik?

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Is the SEC lawsuit against Kik a step too far? Photo by PlusLexia.com | CC By 2.0

The Securities and Exchange Commission has filed what could be a landmark lawsuit accusing messaging app maker Kik with violating U.S. securities laws.

The lawsuit stems from Kik Interactive’s sale of blockchain-based tokens, which raised about $55 million for Kik, which had been struggling financially.  The SEC alleges that Kik failed to register the tokens, as required by U.S. law.

“By selling $100 million in securities without registering the offers or sales, we allege that Kik deprived investors of information to which they were legally entitled, and prevented investors from making informed investment decisions,” said Steven Peikin, Co-Director of the SEC’s Division of Enforcement in a press release.  “Companies do not face a binary choice between innovation and compliance with the federal securities laws.”

The lawsuit, though, may help to establish clarity in what has been a murky area: are issuers of initial coin offerings required to comply with the same registration and disclosure requirements that traditional securities, such as stocks and bonds, must fulfill. Congress has not addressed the issue with legislation, and the SEC’s directives and litigation has not offered much clarity. Until the filing of the Kik lawsuit, the SEC had focused its litigation efforts on cases that involved not only unregistered tokens but also alleged fraud.

Some are questioning whether the lawsuit against Kik goes too far by seeking punishment for behavior that fell into a gray zone.

The SEC lawsuit is not a surprise, but still it’s a shame. Unlike many other companies that held ICOs, Kik was not a scam or a fly-by-night operation. As Fortune reported in 2017, the company had been experimenting with tokens for years with “Kik Points,” a type of digital money that traded hands up to 300,000 times a day. The SEC’s decision to come down heavy on Kik came in the name of protecting investors, but it also risks punishing early innovators in the blockchain economy.

Does the SEC’s Lawsuit Against Kik Go Too Far?

Predictably, Kik thinks the SEC’s legal arguments are flawed:

And some thorough analysis:

Justice Fears Flight of Former Footballer

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The Department of Justice is seeking to detain Reginald Fowler in connection with his involvement in cryptocurrency scheme. Prison by Neticola | CC By-ND 2.0

The legal woes of former football player and Minnesota Vikings co-owner Reginald Fowler continued to mount this week as the U.S. Department of Justice filed a motion to detain him pending a trial on numerous charges relating to the operation of several crypto exchanges including Bitfinex.

The DOJ announced earlier in the week that Fowler and an Israeli woman had been charged in connection with the alleged operation of an illegal bank and unregistered money transmitter operation.

Fowler and the Israeli woman also were indicted by the New York Attorney General’s Office.

Among other factors, the DOJ cited access to funds as one of the reasons it believes Fowler poses a risk of fleeing before trial.

This scheme involves a staggering amount of money, and the government believes that some of that money remains available to Defendant, especially in overseas jurisdictions. That, combined with Defendant’s international ties, would give him the means to flee to avoid prosecution.

Motion in U.S. v Fowler

From A to W: A survey of state blockchain laws says …

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Survey of state blockchain laws shows a broad stretch of differing regulations.
In the Distance by Angus MacRae| CC By 2.0

JD Supra released the results of its updated survey of state laws relating to blockchain.  The best state for blockchain businesses: Wyoming is a leader, having enacted a series of regulations that exempts tokens from securities laws and virtual currencies from money transmitter laws. The worst: Possibly, New York, which has chased away blockchain-based companies with its BitLicense scheme..

One of the key issues with state blockchain regulation is that few states have addressed whether their money transmitter laws apply to virtual currencies.

Some states have issued guidance, opinion letters, or other information from their financial regulatory agencies regarding whether virtual currencies are “money” under existing state rules, while others have enacted piecemeal legislation amending existing definitions to either specifically include or exclude digital currencies from the definition. To use a pun those in the blockchain space should understand, there is a complete lack of consensus as to whether they do or not. This uncertainty is made all the more complicated by potentially contradictory guidance from the Federal government. 

JD Supra

Check out the complete survey here.

Quadriga: Bankruptcy proceedings begin; Claims of ties with money laundering and withdrawals from other exchanges

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Black hole Photo by NASA Goddard Space Flight Center| CC By 2.0

The Nova Scotia court that is overseeing the Quadriga morass ordered the start to bankruptcy proceedings, which could lead to the liquidation of assets and settlement of claims.

The court order came in response to a report from Ernst & Young, the accounting firm that was appointed as a monitor. In the report, the firm said, “Given the present circumstances, the possibility that Quadriga will restructure and emerge from [bankruptcy] protection appears remote.”

Separately, news reports are tying Gerald Cotton with Liberty Reserve, a currency that was shut down by U.S. law enforcement in 2013 for its alleged connection to money laundering.

Reddit users claim QuadrigaCX withdrawals came from other exchanges.

New information shows QCX has been a SCAM all along and the SCAM continues, even today. from QuadrigaCX2

Quadriga: Representatives appointed, co-founder allegedly has criminal past, cold wallets empty

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The Quadriga mystery continues to unfold as news outlets report a cofounder served time in the US on criminal charges under another name. Photo by Patrice Puig | CC BY-SA 2.0

Events continue to unfold in the Quadriga saga.  Quadriga is a crypto exchange that was run by a 30-year-old Canadian named Gerald Cotten who allegedly died in India in December.  His widow alleges that the exchange was run by Cotten from a single encrypted laptop for which no one has the password. Consequently, about 115,000 customers of the exchange cannot access their funds, totaling more than $140 million, according to an article on NDTV.com.

Here’s the latest:

The law firms appointed by the Nova Scotia Supreme Court to represent Quadriga’s customers have a established a committee of users who will help the lawyers represent others who were affected by Quadriga’s shutdown.  The seven member committee includes a banker, an engineer and an economic policy adviser.

News outlets are reporting that Quadriga co-founder Michael Patryn was formerly known as Omar Dhanani who had spent time in federal prison in the United States on charges of conspiracy to commit credit-and-bank card fraud in 2005. Dhanani was an operator of shadowcrew.com, a now defunct marketplace for trafficking stolen credit and bank card numbers. Dhanani also admitted guilt in 2007 in California to separate criminal cases for burglary, grand larceny and computer fraud, according to Bloomberg.  Patryn was deported to Canada, where he became involved in cryptocurrency and later co-founded Quadriga with Cotten.

Ernst & Young, the court-appointed accounting firm that is examining Quadriga reported its discovery that the cold wallets that Quadriga is known to have used were empty, leaving open the question of what happened to more than a hundred million dollars in funds deposited by Quadriga customers.

Wyoming Continues Push to Be Blockchain Haven

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Although it may be known better for mountains and buffalo on the Great Plains, Wyoming’s legislators are hoping there will be a pot of gold at the end of the blockchain rainbow.
Photo by Always Shooting | CC BY 2.0

While New York, arguably the world’s financial capital, piddles with a study commission, Wyoming, one of the most rural of American states, continues to advance some of the most forward-thinking blockchain-related legislation.

Within the past week, Wyoming has pushed forward two pieces of legislation that would help to make it one of the world’s regulatory havens for blockchain.  The legislation includes the following:

Digital Assets — Existing Laws: Categorizes digital assets as property under existing laws, including the Uniform Commercial Code, authorizes security interests in digital assets,  and establishes an opt-in framework for banks to provide custodial services for digital assets.

Corporate Stock Certificates: Authorizes corporations to issue blockchain-based certificate tokens in lieu of traditional stock certificates.

The new legislation was celebrated by numerous blockchain advocates, including Caitlin Long, a member of the Wyoming Blockchain Coalition.

The new legislation comes on heels of several other pieces of legislation that position Wyoming as a haven for blockchain and cryptocurrency.

It’s “impressive and inspirational – the work that has been done by a number of key figures, including the Wyoming Blockchain Coalition and state legislators – in a very short period of time,” said Scott Burke, CEO of Canadian-based BlockCrushr Labs in a Newsweek article published last year. “It’s incredible to see common sense embraced and enacted in what could and should be an example-setting approach.”

NY State Addresses Crypto Regulatory “Failure” with Task Force

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New York is one of the world’s financial capitals, but it’s struggling in how to regulate cryptocurrency. Times Square Photo by Yoann JEZEQUEL | CC BY 2.0

New York’s cryptocurrency regulation has been “an absolute failure,” but state lawmakers have responded with a task force that will take nearly two years to even issue a report.

The Digital Currency Study Bill, A8783B/S901 was signed in to law by NY Gov. Andrew Cuomo on Dec. 21.  The task force will include various stakeholders including technologists, consumers, investors, business representatives and academics.  A report from the task force is due Dec. 15, 2020, and will cover digital/cryptocurrency and blockchain technology.

“New York leads the country in finance. We will also lead in proper fintech regulation,” said  Clyde Vanel, NYS Assemblyman, Chair of Subcommittee on Internet and New Technologies in a press release. “The task force of experts will help us strike the balance between having a robust blockchain industry and cryptocurrency economic environment while at the same time protecting New York investors and consumers.”

Despite being a world financial leader, New York regulates cryptocurrency perhaps more heavily than any other U.S. state.  In 2015, New York began requiring businesses that engage in cryptocurrency activities to obtain a “BitLicense.”

The BitLicense regime has come under considerable criticism.  ““Let’s call the BitLicense what it is—an absolute failure” is how Erik Voorhees, the CEO of cryptocurrency exchange ShapeShift, described the New York regulatory regime.  Voohees’ business, along with others, pulled out of New York in response to the regulation.    

Only about a dozen businesses have obtained a BitLicense, and some have blamed the regulation for stifling blockchain-related innovation.  “Applying for the BitLicense is an expensive and difficult process, as many have noted,” George Frost, Chief Legal Officer, of Bitstamp was quoted as saying by BTC Manager.  “Some other firms have chosen to abandon the New York market entirely, rather than comply. We do not fault them for doing so.”  

The New York situation highlights a challenge facing lawmakers and regulators:  New technologies can be used to harm others; over-regulation can crush innovation; and the speed with which Fourth Industrial Revolution technologies, including blockchain, are developing makes traditional regulatory processes (such as a task force that has nearly two years to release a report) inadequate.

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