Tag: cryptocurrency

Is Crypto Collapsing?

November 11, 2022, brought news of yet another massive crypto bankruptcy filing. One of the largest crypto exchanges, FTX, filed a petition for bankruptcy protection in Delaware. FTX, Alameda, and other affiliates estimated in their filings that they have more than 100,000 creditors. With their estimated range of between $10 and $50 billion worth of assets and liabilities, this could well be the largest crypto-related bankruptcy ever filed.

This follows a slew of other big names in crypto which have filed bankruptcy petitions recently, including lender Three Arrows Capital (3AC) and the Celsius crypto exchange. Others have sought similar protections overseas, such as Zipmex’s proceeding in Singapore.

Why are these companies filing bankruptcy? The reasons vary.

  • Business models built on unsustainable growth rates in cryptocurrency prices
  • Collapse in cryptocurrency prices, leading to “runs on the bank”
  • Financial irregularities

Is your crypto safe? That depends on what it is and where you park it. Some newer tokens and wallet software may not have been extensively tested, and so may have weak points that an attacker might exploit. Even “safe” currencies like Bitcoin can be hacked if stored in a hot wallet. Of particular interest, customers of a bankruptcy exchange may find it difficult to recover their crypto deposits because their investments may be treated as mere unsecured claims against the exchange, drastically reducing the odds of recovery.

Filings by crypto-based entities come with a host of thorny issues. The most obvious is whether a crypto exchange’s bankruptcy estate owns the tokens it holds for others. But there are many others, including privacy concerns with respect to what previously were anonymous transactions and questions about the propriety of large financial withdrawals by high-ranking individuals in the days surrounding the filing of bankruptcy petitions.

For More FinTech Legal News, click here to visit the National Law Review.

© 2022 Miller, Canfield, Paddock and Stone PLC

OFAC Offers Guidance in the Wake of Tornado Cash Sanctions

The U.S. Treasury Department’s Office of Foreign Asset Control (OFAC) updated its “frequently asked questions” (FAQs) Tuesday, providing guidance relating to the sanctions against Tornado Cash, the Ethereum “mixer” it blacklisted in August, following allegations that North Korea used Tornado Cash to launder stolen digital assets. The updated information from OFAC comes as a welcome snippet of communication, allowing for clarity on the scope of the action taken against Tornado Cash, as well as providing guidance for U.S. persons affected by the blacklisting who, through no fault of their own, were caught up in federal action.

The updated FAQs provide guidance on four points: (1) the ability to withdraw funds from wallets associated with the Tornado Cash blacklist; (2) whether the OFAC reporting obligations apply to “dusting” transactions; (3) whether U.S. persons can engage in transactions involving addresses implicated in the blacklist without a license; and (4) what, more generally, is prohibited in the wake of the OFAC blacklisting of Tornado Cash.

(1)        Withdrawing Funds

If a U.S. person sent virtual currency to Tornado Cash, but did not complete the mixing transaction or otherwise withdraw such virtual currency prior to August 8, 2022 (the effective date of the OFAC blacklist), such person can request a specific license from OFAC to engage in transactions involving that virtual currency (assuming such person conducts the contemplated transactions within U.S. jurisdiction).

In order to obtain this license, such persons will need to provide, “at a minimum, all relevant information regarding these transactions with Tornado Cash, including the wallet addresses for the remitter and beneficiary, transaction hashes, the date and time of the transaction(s), as well as the amount(s) of virtual currency.”

OFAC indicates that they will embrace a favorable licensing policy towards such applications, so long as the contemplated transactions did not involve conduct that it deems to be otherwise sanctionable, and that licensing requests can be submitted by visiting the following link: https://home.treasury.gov/policy-issues/financial-sanctions/ofac-license-application-page.

(2)        “Dusting” Transactions

Dusting is the act of sending unsolicited and nominal amounts of virtual currency or other digital assets to third parties. This can be done in order to cause consternation on the part of the recipient, particularly in a situation where there is confusion as to the legality of receiving such funds or actions.

OFAC indicates that it has been made aware of Dusting involving virtual currency or other virtual assets from Tornado Cash, and indicates that while, technically, OFAC’s regulations would apply to these transactions, to the extent that these Dusting transactions have no other sanctions associated with them other than Tornado Cash, “OFAC will not prioritize enforcement against the delayed receipt of initial blocking reports and subsequent annual reports of blocked property from such U.S. persons.”

In short, while not a desirable transaction to take place, OFAC does not intend to pursue action against persons simply because they are the target of Dusting.

(3)        Engaging in Transactions With Tornado Cash

OFAC clarified that, without explicit license from OFAC, U.S. persons are prohibited from engaging in any transaction involving Tornado Cash, including any transaction done via currency wallet addresses OFAC has identified as part of the blacklist.

Specifically, “[i]f U.S. persons were to initiate or otherwise engage in a transaction with Tornado Cash, including or through one of its wallet addresses, such a transaction would violate U.S. sanctions prohibitions, unless exempt or authorized by OFAC.”

(4)        Further Tornado Cash Guidance

Referencing FAQs 561 and 562, OFAC reemphasized their authority to include as identifiers on the Specially Designated Nationals and Blocked Persons List (SDN List) specific virtual currency wallet addresses associated with blocked persons, and that such SDN List entry for Tornado Cash included as identifiers certain virtual currency wallet addresses associated with Tornado Cash, as well as the URL address for Tornado Cash’s website.

While the Tornado Cash website has been deleted, it remains available through certain Internet archives, and accordingly OFAC emphasized that engaging in any transaction with Tornado Cash or its blocked property or interests in property is prohibited for U.S. persons.

Interacting with open-source code itself, in a way that does not involve a prohibited transaction with Tornado Cash, is not prohibited. By way of example, “U.S. persons would not be prohibited by U.S. sanctions regulations from copying the open-source code and making it available online for others to view, as well as discussing, teaching about, or including open-source code in written publications, such as textbooks, absent additional facts.  Similarly, U.S. persons would not be prohibited by U.S. sanctions regulations from visiting the Internet archives for the Tornado Cash historical website, nor would they be prohibited from visiting the Tornado Cash website if it again becomes active on the Internet.”

While this update to FAQs come as a welcome bit of clarity, Web3 investors, entrepreneurs, and users should continue to tread carefully when engaging with opportunities and technologies on the periphery of Tornado Cash and the accompanying OFAC action. When questions arise, it is important to seek out informed counsel, to discuss the risks of proposed actions and how best to mitigate that risk while working to pioneer new and emerging technologies.

Article By David A. Lopez-Kurtz of Dinsmore & Shohl LLP

For more finance and cryptocurrency legal news, click here to visit the National Law Review.

© 2022 Dinsmore & Shohl LLP. All rights reserved.

Federal Reserve Doubles Down on Oversight of Crypto Activities for Banks

The Federal Reserve Board (the “FRB”) issued Supervision and Regulation Letter 22-6 (“SR 22-6”), providing guidance for FRB-supervised banking organizations (referred to collectively herein as “FRB banks”) seeking to engage in activities related to cryptocurrency and other digital assets.  The letter states that prior to engaging in crypto-asset-related activities, such FRB banks must ensure that their activities are “legally permissible” and determine whether any regulatory filings are required.  SR 22-6 further states that FRB banks should notify the FRB prior to engaging in crypto-asset-related activities.  Any FRB bank that is already engaged in crypto-asset-related activities should notify the FRB promptly regarding the engagement in such activities, if it has not already done so.  The FRB also encourages state member banks to contact state regulators before engaging in any crypto-asset-related activity.

These requirements send a clear message to FRB banks and in fact to all banks that their crypto-asset related activities are considered to be risky and not to be entered into lightly.

Indeed, the FRB noted that crypto-asset-related activities may pose risks related to safety and soundness, consumer protection, and financial stability, and thus a FRB bank should have in place adequate systems, risk management, and controls to conduct such activities in a safe and sound manner and consistent with all applicable laws.

SR 22-6 is similar to guidance previously issued by the OCC and FDIC; in all cases, the agencies require banks to notify regulators before engaging in any kind of digital asset activity, including custody activities. The three agencies also released a joint statement last November in which they pledged to provide greater guidance on the issue in 2022.  Further, in an August 17, 2022 speech, FRB Governor Bowman stated that the FRB staff is working to articulate supervisory expectations for banks on a variety of digital asset-related activities, including:

  • custody of crypto-assets
  • facilitation of customer purchases and sales of crypto-assets
  • loans collateralized by crypto-assets, and
  • issuance and distribution of stablecoins by banking organizations

Interestingly, SR 22-6 comes a few days after a group of Democratic senators sent a letter to the OCC requesting that the OCC withdraw its interpretive letters permitting national banks to engage in cryptocurrency activities and a day after Senator Toomey sent a letter to the FDIC questioning whether it is deterring banks from offering cryptocurrency services.

Although past guidance already required banks to notify regulators of crypto activity, this guidance likely could discourage additional banks from entering into crypto-related activities in the future or from adding additional crypto services. In the end, it could have the unfortunate effect of making it more difficult for cryptocurrency companies to obtain banking services.

Article By Grant F. Butler, Jeremy M. McLaughlin, Anthony R.G. Nolan, and Judith E. Rinearson of K&L Gates

For more finance and banking legal news, click here to visit the National Law Review.

Copyright 2022 K & L Gates

Government Brings First Cryptocurrency Insider Trading Charges

In a series of parallel actions announced on July 21, 2022, the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) initiated criminal and civil charges against three defendants in the first cryptocurrency insider trading case.

According to the criminal indictment, DOJ alleges that a former employee of a prominent cryptocurrency exchange used his position at the exchange to obtain confidential information about at least 25 future cryptocurrency listings, then tipped his brother and a friend who traded the digital assets in advance of the listing announcements, realizing gains of approximately $1.5 million. The indictment further alleges that the trio used various means to conceal their trading, and that one defendant attempted to flee the United States when their trading was discovered. The Government charged the three with wire fraud and wire fraud conspiracy. Notably, and like the Government’s recently announced case involving insider trading in nonfungible tokens, criminal prosecutors did not charge the defendants with securities or commodities fraud.

In its press release announcing the charges, US Attorney for the Southern District of New York Damian Williams said: “Today’s charges are a further reminder that Web3 is not a law-free zone. Just last month, I announced the first ever insider trading case involving NFTs, and today I announce the first ever insider trading case involving cryptocurrency markets. Our message with these charges is clear: fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street. And the Southern District of New York will continue to be relentless in bringing fraudsters to justice, wherever we may find them.”

Based on these facts, the SEC also announced charges against the three men in a civil complaint alleging securities fraud. In order to assert jurisdiction over the matter, the SEC alleges that at least nine of the cryptocurrencies involved in the alleged insider trading were securities, and the compliant traces through the Howey analysis for each. The SEC has not announced charges against the exchange itself, though in the past it has charged at least one cryptocurrency exchange that listed securities tokens for failure to register as a securities exchange. Perhaps coincidentally, on July 21 the exchange involved in the latest DOJ and SEC cases filed a rulemaking petition with the SEC urging it to “propose and adopt rules to govern the regulation of securities that are offered and traded via digitally native methods, including potential rules to identify which digital assets are securities.”

In an unusual move, Commissioner Caroline Pham of the Commodity Futures Trading Commission (CFTC) released a public statement criticizing the charges. Citing the Federalist Papers, Commissioner Pham described the cases as “a striking example of ‘regulation by enforcement.’” She noted that “the SEC’s allegations could have broad implications beyond this single case, underscoring how critical and urgent it is that regulators work together.” Commissioner Pham continued, “Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input—through notice-and-comment rulemaking pursuant to the Administrative Procedure Act.” She concluded by stating that, “Regulatory clarity comes from being out in the open, not in the dark.” The CFTC is not directly involved in either case, and it is atypical for a regulator to chide a sister agency on an enforcement matter in this fashion. On the same day, another CFTC Commissioner, Kristin Johnson, issued her own carefully-worded statement that seemed to support the Government’s actions.

Article By Scott H. Kimpel of Hunton Andrews Kurth

For more criminal law and business crimes legal news, click here to visit the National Law Review.

Copyright © 2022, Hunton Andrews Kurth LLP. All Rights Reserved.

Could the Crypto Downturn Lead to a Spike in M&A?

In 2021, we saw a cryptocurrency boom with record highs and a flurry of activity. However, this year, the cryptocurrency downturn has been significant.  We have seen drops in various cryptocurrencies ranging from 20 to 70 percent, with an estimated $2 trillion in losses in the past few months.

Industry watchers had already predicted a spike in crypto M&A from the beginning of 2022, and in a recent interview with Barron’s, John Todaro, a senior crypto and blockchain researcher at Needham & Company, said he believes this downturn could lead to a wave of mergers and acquisitions in the crypto space for the second half of this year and even into 2023.

Valuations have dropped across the board this year as the market has faced incredible volatility, and Todaro told Barron’s, “The valuations for public crypto companies have fallen by about 70% this year.”  These lower valuations could make these companies increasingly attractive targets for acquisition, and this activity has already started to pick up.

According recent coverage from CNBC, some larger crypto companies are already looking for acquisition targets in order to drive industry growth and to help them acquire more users. Todaro feels most of the M&A activity we will see will be this kind of crypto to crypto acquisition as opposed to traditional buyers, although there is still opportunity for non-crypto companies to capitalize on these lower valuations and some are already doing so.

With more government regulation coming for the crypto sector this year, it could also impact the activity level as well.  Achieving some legal and regulatory clarity could have implications for this uptick in M&A for crypto companies. Our analysis of the SEC’s recent proposed regulations, other government activity in this area, and their potential implications can be found here.

We could of course see a growing number of acquisitions across industries as valuations remain lower than a year ago, but as the crypto sector continues to see this kind of a downturn, the level of activity in this area could be much greater than it has previously seen.  With that said, both the target company and the acquirer should be looking at any transactions with the same level of due diligence instead of rushing into any deal fueled by panic or haste.

Article By Louis Lehot of Foley & Lardner LLP

For more mergers and acquisitions legal news, click here to visit the National Law Review.

© 2022 Foley & Lardner LLP

Are You Being Served? Court Authorizes Service of Process Via Airdrop

In what may be the first of its kind, a New York state court has authorized service via token airdrop in a case regarding allegedly stolen cryptocurrency assets. This form of alternative service is novel but could become a more routine practice in an industry where the identities of potential parties to litigation may be difficult to ascertain using blockchain data alone.

Background on the Dispute

According to the Complaint in the case, the plaintiff LCX AG (“LCX”) is a Liechtenstein based virtual currency exchange. As alleged in the Complaint, on or about January 8, 2022, the unknown defendants (named in the Complaint as John Does 1-25) illegitimately gained access to LCX’s cryptocurrency wallet and transferred $7.94 million worth of digital assets out of LCX’s control. Cryptocurrency wallets are similar in many ways to bank accounts, in that they can be used to hold and transfer assets. In the same way a thief can transfer funds from a bank account if they gain access to that account, thieves can also transfer cryptocurrency assets if they gain access to the keys to the wallet holding digital assets.

Following the alleged theft, LCX and its third-party consulting firm determined that the suspected thieves used “Tornado Cash,” which is a “mixing” service designed to hide transactions on an otherwise publicly available blockchain ledger by using complicated transfers between unrelated wallets. While Tornado Cash and other mixing services have legal purposes such as preserving the anonymity of parties to legitimate transactions, they are also utilized by criminals to launder digital funds in an illicit manner.

Even the use of these mixing services, however, can often also be unwound. This is especially true in transactions of large amounts of cryptocurrency, similar to how transactions utilizing complex money laundering schemes in the international banking system can be unwound. According to the blockchain data platform Chainalysis, although Illicit crypto transactions reached an all-time high of $14 billion in 2021, these suspected nefarious transactions accounted for 0.15% of crypto volume last year, down from 0.62% in 2020.

While the Complaint alleges the suspected thieves used Tornado Cash, LCX believes its hired consultants were able to unwind those mixing services to identify a wallet which is alleged to still hold $1.274 million of the allegedly stolen assets.

Unlike bank accounts which have associated identifying information, there are often no registered addresses or other identifying information connected to digital wallets. This makes it difficult to provide the actual proof of service required to institute an action or obtain a judgement against an individual where the only known information is their digital wallet addresses. Service via token airdrop into those wallet addresses solves that issue.

Service Via Airdrop

Service of lawsuits is traditionally made on the defendant personally at a home or business address via special process servers. In cases where service on the individual is not possible for some reason, many states authorize alternative means of service if the plaintiff can show that the alternative means of service likely to provide actual notice of the litigation to the defendant. For example, courts have historically allowed notice via newspaper publication as an alternative means of service where the defendant cannot be serviced personally.

Here, the Court permitted service via “airdrop” in which a digital token is placed in a specific cryptocurrency wallet, similar to how a direct deposit can place funds in a traditional bank account. This particular token contained a hyperlink to the associated court filings in the case, and a mechanism which allowed the data of any individual who clicked on the hyperlink to be tracked. While this is a novel way to serve notice of a lawsuit, similar airdrops have been used to communicate with the owners of otherwise anonymous cryptocurrency wallet owners. Such was the case recently when actor Seth Green had his Bored Ape non-fungible token (“NFT”) stolen and the unknowing buyer of the stolen NFT was otherwise difficult to locate.

While this type of digital service is new, it could be implemented in many disputes in the future regarding digital assets. Similar to the authorization of service that was seen recently in the Facebook Biometric Information Privacy Act litigation (where notice was served on potential class members via email and directly on the Facebook platform), service via airdrop may be the most efficient way to inform potential lawsuit participants of the pending dispute and how they can protect their rights in that dispute.

This type of airdropped service is not without issues, though. First, transactions on the blockchain are largely publicly available, meaning any individual with the wallet address would also be able to see service of the lawsuit notice. Additionally, many users are hesitant to click on unknown links (such as the one in the airdropped LCX) due to legitimate cybersecurity concerns.

While service via airdropped token is unlikely to replace traditional methods of service, it may be a useful means of serving process on unknown persons where there is a digital wallet linked to the acts which the applicable lawsuit relates.

Article By Bryan M. Westhoff, Daniel L. McAvoy, and Jonathan E. Schmalfeld of Polsinelli PC

For more litigation legal news, click here to visit the National Law Review.

© Polsinelli PC, Polsinelli LLP in California

Hackers Go Phishing in Beeple’s Deep Pool of Twitter Followers

“Stay safe out there, anything too good to be true is a … scam.” Beeple, a popular digital artist, tweeted to his followers, addressing the phishing scam that took place on May 23, 2022, targeting his Twitter account. The attack reportedly resulted in a loss of more than US$400,000 in cryptocurrency and NFTs, stolen from the artist’s followers on the social media website.

After hacking into Beeple’s Twitter account, perpetrators tweeted links from the artist’s page, promoting a fake raffle for unique art pieces. The links would reportedly take the user to a website that would drain the user’s cryptocurrency wallet of their digital assets.

Phishing scams for digital assets, including NFTs or non-fungible tokens, have steadily increased, with funds as large as $6 million being stolen. Various jurisdictions have adopted privacy and security laws that require companies to adopt reasonable security measures and follow required cyber incident response protocols. A significant part of these measures and protocols is training for employees in how to detect phishing scams and other hacking attempts by bad actors. This incident is a reminder to consumers to exercise vigilance, watch for red flags and not click on links without verifying the source.

The remaining summaries of news headlines are separated by region for your browsing convenience. 

UNITED STATES

Relaxed Deaccessioning COVID-19 Exemptions Expire

The global COVID-19 pandemic brought many changes, including dire financial consequences of the shutdowns for museums. In April 2020, the Association of Art Museum Directors (AAMD) made a decision to ease the rules that dictate how museums may use proceeds from art sales. Until April 2022, museums were permitted to use the funds for “direct care of collections” rather than to procure new artworks for their collections.

This relaxed policy and some of the museums that followed it met with backlash on more than one occasion; others, however, advocate for its continuation, citing considerations of diversity and inclusion. Some further argue that a policy born out of financial desperation should be continued to provide museums with the means to overcome any future financial issues that may arise.

Given that “direct care” is vague and open to interpretation, opponents of the relaxed rules counter giving museums such latitude to decide on the use of the proceeds, as it can lead to abuses and bad decisions. While AAMD has returned to its pre-pandemic regulations, and museums have followed suit, it appears that the public debate around deaccessioning is far from over.

Inigo Philbrick Sentenced to a Prison Term

Former contemporary art dealer Inigo Philbrick was sentenced by a federal court in New York to serve seven years in prison for a “Ponzi-like” art fraud, said to be one of the most significant in the history of the art market, with more than an estimated US$86 million in damages. Philbrick stood accused of a number of bad acts, including forging signatures, selling shares in artworks he did not own and inventing fictitious clients.

New York Abolishes Auction House Regulations

As the U.S. government is studying whether the art market requires further regulations to increase transparency and to combat money laundering, New York City repealed its local law that required auctioneers to be licensed and required disclosures to bidders, including whether an auction house had a financial stake in the item being auctioned. While the abolition of the regulation was ostensibly to improve the business climate after the pandemic, some commentators note that the regulations were outdated and not serving their purpose in any event. As an illustration, a newcomer to an auction will likely struggle to understand the garbled pre-action announcements or their significance. Whether the old regulations are to be replaced with new, clearer rules remains to be seen.

EUROPE

Greece and UK to Discuss Rehoming of Displaced Parthenon Marbles

The Parthenon marbles, also known as the Elgin marbles, have been on display in London’s British Museum for more than 200 years. These objects comprise 15 metopes, 17 pedimental figures and an approximately 250-foot section of a frieze depicting the birthday festivities of the Greek goddess Athena. What museum goers might not know is that these ancient sculptures were taken from the Acropolis in Greece in 1801 by Lord Elgin.

Previously, the British government, seeking to retain the sculptures, relied on the argument that the objects were legally acquired during the Ottoman Empire rule of Greece. However, for the first time, the UK has initiated formal talks with Greece to discuss repatriation of the Parthenon sculptures. These discussions are expected to influence future intergovernmental repatriation negotiations.

ASIA

Singapore High Court Asserts Jurisdiction over NFTs after Ruling Them a Digital Asset

The highest court in Singapore has granted an injunction to a non-fungible token (NFT) investor, Janesh Rajkumar, who sought to stop the sale of an NFT that once belonged to him and was used as collateral for a loan. The subject NFT from the Bored Ape Yacht Club Series is a rarity, as it depicts the only avatar that wears a beanie. Rajkumar now is seeking to repay the loan and have the NFT restored to his cryptocurrency wallet. The loan agreement specified that Rajkumar would not relinquish ownership of the NFT, and should he be unable to repay the loan in a timely manner, an extension would be granted. Instead of granting Rajkumar an extension, the lender, who goes by an alias “chefpierre,” moved to sell the NFT. The significance of the Singapore court’s decision is two-fold: the court has (1) recognized jurisdiction over assets cited in the decentralized blockchain, and (2) allowed for the freezing order to be issued via social media platforms.

THE MIDDLE EAST

Illegal Trading Leads to Raiding of Antique Dealer by the Israeli Authorities

A recent raid on an unauthorized antiquities dealer in the city of Modi’in by the Israel Antiquities Authority recovered hundreds of artifacts of significant historical value, including jewelry, a bronze statue and approximately 1,800 coins. One the coins is a nearly 2,000-year-old silver shekel of great historical significance. The coin is engraved with the name Shimon, leader of the 132–136 C.E. Bar Kokhba revolt.

Investigations are ongoing to determine where the antiquities were obtained. The Antiquities Robbery Prevention Unit intends to charge the dealer and their suppliers upon obtaining this information.

Article By Jana S. Farmer and Meenka Maharaj of Wilson Elser Moskowitz Edelman & Dicker LLP

For more entertainment, art, and sports news, click here to visit the National Law Review.

© 2022 Wilson Elser

SEC Targets Companies Conducting Cryptomining

The SEC recently doubled the size of its Crypto Assets and Cyber Unit.  Since its inception in 2017, the SEC’s Crypto Assets and Cyber Unit has launched more than 80 investigations resulting in over $2 billion in monetary penalties.  With more dedicated investigative attorneys, trial counsel, and fraud analysts, the SEC’s cryptocurrency-related investigations are expected to substantially rise in the months and years ahead.

The tip of the spear will include the areas that the SEC said would be its focus moving forward:

  • crypto asset offerings
  • crypto asset exchanges
  • crypto asset lending and staking products
  • decentralized finance (DeFi) platforms
  • non-fungible tokens (NFTs); and
  • stablecoins

View SEC press release here.

Given the heightened scrutiny, however, even companies outside of the traditional cryptocurrency industry may find themselves subject to enforcement actions and penalties.  For example, the SEC recently announced that it reached a $5.5 million settlement with technology company NVIDIA Corporation for the company’s alleged failure to disclose on its Form 10-Q for fiscal year 2018 that cryptomining was a significant element of its revenue growth. View release here.

NVIDIA is not a cryptocurrency-related company, but rather is a technology company that markets and sells accelerated computing technologies, including graphics processing units (GPUs) for PC gaming, the company’s largest specialized market.  The SEC alleged that, as interest in cryptocurrencies began to increase in 2017, NVIDIA customers increasingly began using gaming GPUs for cryptomining of Ether (ETH), which rose in price from under $10 to nearly $800 between 2017 and 2018.

In its Form 10-Q for fiscal year 2018, despite knowledge (discerned by the SEC from internal company documents and communications) of cryptomining as a significant driver of its GPU sales growth in its gaming division, the SEC alleged that NVIDIA failed to disclose that this growth was largely driven by demand for gaming GPUs to use in cryptomining.  The SEC further alleged that this failure to disclose misled investors about the growth of NVIDIA’s gaming business in violation of Section 17(a)(2) and (3) of the Securities Act of 1933 and the disclosure provisions of the Securities Exchange Act of 1934.

As the SEC steps up its cryptocurrency related investigation and enforcement actions, publicly traded companies must exercise increased diligence in disclosure of activities that touch cryptocurrency assets.   Even internal dialogue about revenues or other disclosable material that touches cryptocurrencies, as happened to NVIDIA, could subject companies to increased scrutiny and significant monetary penalties.

Copyright ©2022 Nelson Mullins Riley & Scarborough LLP
For more articles about cryptomining, visit the NLR Financial Institutions & Banking section.

Cryptocurrency As Compensation: Beware Of The Risks

A small but growing number of employees are asking for cryptocurrency as a form of compensation.  Whether a substitute for wages or as part of an incentive package, offering cryptocurrency as compensation has become a way for some companies to differentiate themselves from others.  In a competitive labor market, this desire to provide innovative forms of compensation is understandable.  But any company thinking about cryptocurrency needs to be aware of the risks involved, including regulatory uncertainties and market volatility.

Form of Payment – Cash or Negotiable Instrument

The federal Fair Labor Standards Act requires employers to pay minimum and overtime wages in “cash or negotiable instrument payable at par.”  This has long been interpreted to include only fiat currencies—monies backed by a governmental authority.  As non-fiat currencies, cryptocurrencies therefore fall outside the FLSA’s definition of “cash or negotiable instrument.”  As a result, an employer who chooses to pay minimum and/or overtime wages in cryptocurrency may violate the FLSA by failing to pay workers with an accepted form of compensation.

In addition, various state laws make the form of wage payment question even more difficult.  For example, Maryland requires payment in United States currency or by check that “on demand is convertible at face value into United States currency.”  Pennsylvania requires that wages shall be made in “lawful money of the United States or check.”  And California prohibits compensation that is made through “coupon, cards or other thing[s] redeemable…otherwise than in money.”  It is largely unclear whether payment in cryptocurrency runs afoul of these state requirements.

Of note, the U.S. Department of Labor (“DOL”) allows employers to satisfy FLSA minimum wage and overtime regulations with foreign currencies as long as the conversion to U.S. dollars meets the required wage thresholds.  But neither the DOL nor courts have weighed in on whether certain cryptocurrencies (e.g., Bitcoin) are the equivalent, for FLSA purposes, of a foreign currency.

Volatility Concerns

When compared to the rather stable value of the U.S. dollar, the value of cryptocurrencies is subject to large fluctuations.  Bitcoin, for example, lost nearly 83% of its value in May 2013, approximately 50% of its value in March 2020, and recently lost and then gained 16% of its value in the span of approximately 15 minutes one day in February 2021.

Such volatility can give payroll vendors a nightmare and can, in some instances, lead to the under-payment of wages or violation of minimum wage or overtime requirements under the FLSA.

Tax and Benefits Considerations

Aside from wage and hour issues, the payment of cryptocurrency implicates a host of tax and benefits-related issues.  The IRS considers virtual currencies to be “property,” subject to capital gains tax rates.  It has also confirmed in guidance materials that any payment to employees in a virtual currency must be reported on a W-2 based upon the value of the currency in U.S. dollars at the time it was delivered to the employee.  This means that cryptocurrency wage payments are subject to Federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax.

For 401k plan fiduciaries, the Department of Labor recently issued guidance that should serve as a stern warning to any fiduciary looking to invest 401k funds into cryptocurrencies.  Specifically, the DOL wrote: “[a]t this early stage in the history of cryptocurrencies, the Department has serious concerns about the prudence of a fiduciary’s decision to expose a 401(k) plan’s participants to direct investments in cryptocurrencies, or other products whose value is tied to cryptocurrencies.”  Given the risks inherent in cryptocurrency speculation, the DOL stated that any fiduciary allowing such investment options “should expect to be questioned [by the DOL] about how they can square their actions with their duties of prudence and loyalty in light of the risks.”

Considerations for Employers

Given the combination of uncertain and untested legal risks, employers should consider limiting cryptocurrency compensation models to payments that do not implicate the FLSA or applicable state wage and hour laws.  For example, an employer might provide an exempt employee’s base salary in U.S. dollars and any annual discretionary bonus in cryptocurrency.

Whether investing in cryptocurrencies themselves to pay employees or utilizing a third-party to convert US dollars into cryptocurrency, employers should also stay abreast of the evolving tax and benefits guidance in this area.

Ultimately, the only thing that is clear about cryptocurrency compensation is that any decision to provide such compensation to employees should be made with a careful eye towards the unique wage, tax, and benefits-related issues implicated by these transactions.

Article By Daniel J. Butler and Kevin J. White of Hunton Andrews Kurth

For more cryptocurrency and finance legal news, click here to visit the National Law Review.

Copyright © 2022, Hunton Andrews Kurth LLP. All Rights Reserved.

French Insider Episode 12: Navigating the Metaverse with Jim Gatto [PODCAST]

Joining host Sarah Aberg is Jim Gatto. Jim joins us today to discuss the metaverse, the technology and business models involved in these virtual worlds, the role of NFTs and cryptocurrency in the digital economy, and the legal, regulatory, and governance issues that can arise when companies seek to enter that space.

Jim Gatto is a partner in Sheppard Mullin’s Washington, D.C. office, where he leads the  Blockchain & Fintech Team, Social Media & Games Team, and Open Source Team. Jim’s practice focuses on blockchain, interactive entertainment, digital art, AI, and online gambling. He advises clients on IP strategies, development and publishing agreements, licensing and technology transaction agreements, and tech regulatory issues. Jim has been involved with blockchain since 2012 and has been recognized as a thought leader by leading organizations including as a Cryptocurrency, Blockchain and Fintech Trailblazer by the National Law Journal.

Sarah Aberg is special counsel in the White Collar Defense and Corporate Investigations Group in Sheppard Mullin’s New York office. Sarah’s practice encompasses litigation, internal investigations and white collar defense.  Her areas of focus include financial services and securities, as well as corporate fraud in a variety of industries, including technology, construction, and non-profits.  Sarah’s regulatory practice encompasses market regulation, foreign registration and disclosure requirements, supervisory procedures, and sales practices.  Sarah represents corporations, financial services companies, and associated individuals in connection with investigations and regulatory matters before the U.S. Department of Justice, the Securities and Exchange Commission, the Commodity Futures Trading Commission, FINRA, the New York Stock Exchange, the New York State Department of Financial Services, and the New York Attorney General’s Office.

What We Discussed in This Episode:

  1. What is the Metaverse?
  2. How Do Metaverses Differ from Earlier Virtual Worlds?
  3. What Role Do NFTs Play in the Digital Economy?
  4. Investing in a Metaverse: What are the Risks?
  5. What are Legal, Regulatory, and Tax Considerations?
  6. What Governance Issues Exist for Brands Operating in a Metaverse?
  7. What are the Inflationary and Deflationary Aspects of the Virtual Economy?
  8. How Might Blockchain and Cryptocurrency Alter International Financial Transactions?
  9. Is the World Moving into a Virtual/Digital Economy?

Article By Sarah E. Aberg and James G. Gatto of Sheppard, Mullin, Richter & Hampton LLP

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