Tag: cryptocurrency

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

For more technology and internet legal news, click here to visit the National Law Review.

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.

US Crypto Regulatory Enforcement Ramps Up – NFTs Now More in Focus

For the past decade the crypto space has been described as the wild west. The crypto cowboys and cowgirls have innovated and moved the industry forward, despite some regulatory certainty. Innovation always leads regulatory clarity. There’s a new sheriff in crypto town – the US government and its various regulatory agencies. They seem intent on taming the wild west.

According to a recent report, the IRS Has Sent 10,000 Letters on Taxpayer Digital Assets seeking to collect taxes on gains from crypto assets including NFTs. This is no surprise and we have cautioned on this dating back to 2017. While many people have focused on the tax issues with crypto currencies, the IRS is also focusing on NFTs as reported here.

This comes on the heels of another report this week that the SEC is now targeting certain NFT uses. According to the report, the SEC is probing whether NFTs are being utilized to raise money like traditional securities. The SEC has reportedly sent subpoenas related to the investigation and is particularly interested in information about fractional NFTs. As we discussed here, fractionalization is just one of the potential securities law concerns with certain NFT business models. NFTs that represent a right to a revenue stream and NFT presales can also presents issues in some cases.

Other recent regulatory activity relating to NFTs includes the following. The Department of the Treasury published a study on the facilitation of money laundering and terrorist financing through the art trade, including NFTs. See our report on this here.  The Treasury Department’s Office of Foreign Assets Control (OFAC) sanctioned a Latvia-based digital asset exchange and designated 57 cryptocurrency addresses (associated with digital wallets) as Specially Designated Nationals (SDNs). These designations appear to be the first time NFTs have been publicly impacted as “blocked property” – as one of the designated cryptocurrency addresses owns non-fungible tokens (NFTs). See our report on this here. A number of NFTs are also being used to facilitate illegal gambling.

In addition to the regulatory issues, the number of NFT-related lawsuits and other legal disputes continues to increase. Many of these disputes relate to IP ownership, IP infringement, failure to apply an clear or enforceable license to the NFT, among others.

Most of these issues are avoidable with proper legal counseling early on.

The use of NFT technology to tokenized and record ownership of physical and digital assets, as well as entitlements (e.g., tickets, access, etc.) is just getting started. We believe this technology will see wide scale adoption across many industries. The vast majority of the NFT business models are legal.

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.
For more about cryptocurrency regulations, visit the NLR Cybersecurity, Media & FCC section.

Crossing the Wires of Energy and Cryptocurrency Policy: U.S. Congress Investigates the Environmental Impact of Crypto Mining

The rapid adoption of cryptocurrency and other popular blockchain applications has captured our global economy’s attention. Even as the value of cryptocurrencies slid from their all-time highs, the promise of these digital assets and the infrastructure being developed to support them has been transformative.

As with most emerging technologies, policymakers are still exploring the best approaches to regulating these new digital assets and business models. Questions about consumer protection, security, and the applicability of existing laws are to be expected; however, the environmental impact of these energy-intensive business practices has prompted considerable study and regulatory activity across the globe, including attention in the United States.

To understand the increasing energy demands associated with major cryptocurrencies – predominantly, Bitcoin and Ethereum – it is important to understand how many cryptocurrencies are generated in the first instance. Many countries, including China, have banned cryptocurrency mining, and, with the United States becoming the largest source of cryptocurrency mining activity, Congress began active investigations and hearings into the energy demands and environmental impacts in January 2022.

Proof of What? Why certain cryptocurrencies create high energy demands. 

Not all cryptocurrencies – or blockchain platforms, for that matter – are created equal in their energy demands. The goal of most major cryptocurrency platforms is to create a decentralized, distributed ledger, meaning that there is no one authority to verify the authenticity of transactions and ensure that assets are not spent twice, for example. There needs to be a trustworthy mechanism – a consensus system – to verify new transactions, add those transactions to the blockchain, and to confirm the creation of new tokens. Bitcoin alone has well over 200,000 transactions per day,[1] so it should not come as a surprise that these platforms take an enormous amount of processing power to maintain.

There are currently two primary ways that network participants lend their processing power, which are framing part of the modern energy policy debates around cryptocurrency. The first form is “proof of work,” which is the original method that Bitcoin and Ethereum 1.0 employ. When a group of transactions (a block) needs to be verified, all of the “mining” computers race to solve a complex math puzzle, and whoever wins gets to add the block to the chain and is rewarded in coins. The competitive nature of proof of work consensus systems has led to substantial increases in computing power provided by institutional cryptocurrency mining operations and, with that, higher energy demands.

The second form is “proof of stake,” which newer platforms like Cardano and ETH2 use, promises to require considerably less energy to operate. With this method, validators “stake” their currency for a chance at verifying new transactions and updating the blockchain. This method rewards long-term investment in a particular blockchain, rather than raw computing power. A validator is picked based on how much currency they have staked and how long it has been staked for. Once the block is verified, other validators must review and accept the data before it’s added to the blockchain. Then, everyone who participated in validating the block is rewarded with coins.

While proof of stake consensus systems are becoming more common, the dominant – and most valuable – cryptocurrencies are still generated through energy-intensive proof of work systems.

Turning out the lights on Crypto: China bans domestic mining and other countries follow.

China has been incredibly influential in the modern cryptocurrency debate around energy use. For several years, China was the cryptocurrency mining capital of the world, providing an average of two-thirds of the world’s processing power dedicated to Bitcoin mining through early 2021.[2] In June 2021, however, China banned all domestic cryptocurrency mining operations, citing the environmental impacts of Bitcoin mining energy demands among its concerns.[3]

As Bitcoin miners fled China, many relocated to neighboring countries, such as Kazakhstan, and the United States became the largest source of mining activity – an estimated 35.1% of global mining power.[4] The surge in Bitcoin mining activity in Kazakhstan has not been without its controversy. Many Kazakhstan-based crypto mining operations are powered by coal plants, and there has been considerable unrest sparked by rising fuel costs.[5]

With some countries experiencing negative impacts from cryptocurrency mining operations, several countries have followed China’s lead in banning cryptocurrencies. According to a 2021 report prepared by the Law Library of Congress, at least eight other countries – Egypt, Iraq, Qatar, Oman, Morocco, Algeria, Tunisia, and Bangladesh – have banned cryptocurrencies.[6] Many other countries have impliedly banned cryptocurrency or cryptocurrency exchanges, as well.[7]

U.S. Congress shines its spotlight on the energy demands of cryptocurrency mining.

Now home to over a third of the global computing power dedicated to mining bitcoin, the United States has turned its attention to domestic miners and their impacts on the environment and local economies.

In June 2021, U.S. policymakers were still predominantly focused on the consumer protection and security concerns raised by digital currencies; however, Senator Elizabeth Warren alluded to her growing concerns about the environmental costs of, particularly, proof of work mining.[8] On December 2, 2021, Senator Warren sent a letter requesting information on the environmental footprint of New York-based Bitcoin miner Greenridge Generation.[9] The letter observed that, “[g]iven the extraordinarily high energy usage and carbon emissions associated with Bitcoin mining, mining operations at Greenridge and other plants raise concerns about their impacts on the global environment, on local ecosystems, and on consumer electricity costs.”[10] Senator Warren’s concerns sparked several rounds of congressional oversight and inquiries into the environmental impacts of, particularly, proof of work cryptocurrencies, over the past month.

Committee Hearing on “Cleaning up Cryptocurrency” begins oversight and investigation into the energy impacts of blockchains.

On January 20, 2022, the U.S. House of Representatives Committee on Energy and Commerce’s Subcommittee on Oversight and Investigations held a hearing, where the externalities of cryptocurrency mining were the focus of the agenda. An early indicator of the Subcommittee’s views on the issue, the title for the hearing was “Cleaning up Cryptocurrency: The Energy Impacts of Blockchains.”[11]

The hearing focused heavily on the amount of energy used to power proof of work cryptocurrency mining. Bitcoin Mining has been widely criticized for the massive amounts of power it consumes – globally, more than 204 terawatt-hours as of January 2022. Although some operations are attempting to utilize renewable energy, the machines executing these algorithms consume enormous amounts of energy primarily sourced from fossil fuels.

The five industry experts testifying before the House Energy and Commerce Oversight Subcommittee had competing views on how regulators should address the energy consumption of cryptocurrencies—with some experts opining that the computational demands were a “feature, not a bug.”[12] Two of the experts – Brian Brooks, CEO of Bitfury Group, and Professor Ari Juels, Faculty member at Cornell Tech – debated the technical merits between proof of work and proof of stake systems, described earlier in this article.[13] Similarly, Gregory Zerzan, an attorney with Jordan Ramis, P.C. who previously held senior positions in the United States Government, encouraged the Subcommittee not to lose sight of the fact that cryptocurrencies are but “one aspect of a larger innovation, blockchain.”[14] Although the viewpoints of the experts varied considerably, there was a clear consensus among the experts: energy-efficient alternatives should guide the path forward.

John Belizaire, the founder and CEO of Soluna Computing, said that cryptocurrency mining could further accelerate the transition to renewable energy sources from an energy perspective.[15] Renewables currently suffer from one significant deficiency – intermittency. An example of this challenge is the so-called “duck curve,” which illustrates major differences between the demands for electricity as compared to the amount of renewable energy sources available throughout the day. For example, when the sun is shining, there is significantly more power than consumers need for a few hours per day; however, solar energy does not provide nearly enough energy when demand spikes in the late afternoon and evening.[16] While there has been progress in the development of lithium battery storage – a critical piece in solving the issues mentioned above– for the time being, deploying these batteries at scale is still too expensive.

In addressing gaps in battery storage, Belizaire testified that “Computing is a better battery.”[17] Computing, he states, “is an immediately deployable solution that can allow renewables to scale to their full potential today.”[18] Belizaire highlighted that, unlike other industrial consumers, cryptocurrency miners can turn their systems off when necessary, giving miners the ability to absorb excess energy from a given area’s electrical grid rather than straining it. This ability to start and stop or pause computing processes can increase grid resilience by absorbing excess energy from renewable resources that provide more power than the grid can handle. Brooks shared similar hopes for how Bitcoin mining could help stabilize electric grids, support the viability of renewable energy projects, and drive innovation in computing and cooling technology.[19]

Steve Wright, the former general manager of the Chelan County Public Utility District in Washington, testified that “the portability of cryptocurrency operations could be a benefit in terms of locating operations based on underutilized transmission and distribution capacity availability.”[20] Still, with ambitious goals to expand transmission and increase and integrate large amounts of carbon-free emitting generation, Wright testified that “substantial collaboration and coordination will be necessary to avoid cryptocurrency mining exacerbating an already very difficult problem.”[21]

Congressional Democrats continue the investigation into domestic mining operations and the Cryptomining Industry response.

The January 20, 2022 Hearing made clear that policymakers are doing their due diligence into the impact that the United States could experience as the number of domestic cryptocurrency mining operations increase. Commentary from the Hearing forecasted that scrutinizing the sources and costs of energy used in cryptocurrency mining would be a priority for Democrat members of Congress.

To that end, on January 27, 2022, eight Democrat members of Congress led by Senator Elizabeth Warren “sent letters to six cryptomining companies raising concerns over their extraordinarily high energy uses.”[22] Citing the same concerns raised in her December 2021 letter to Greenridge, Senator Warren and her colleagues observed that “Bitcoin mining’s power consumption has more than tripled from 2019 to 2021, rivaling the energy consumption of Washington state, and of entire countries like Denmark, Chile, and Argentina.”[23] To assist Congress in its investigation, Riot Blockchain, Marathon Digital Holdings, Stronghold Digital Mining, Bitdeer, Bitfury Group, and Bit Digital were all asked for information related to their mining operations, energy consumption, possible impacts on the climate and local environments, and the impact of electricity costs for American consumers.[24] Senator Warren and her colleagues requested written responses by no later than February 10, 2022, so this increased oversight will likely continue.

Even with increased oversight, current trends in crypto mining and renewables could soon make such inquiries a moot point. Amid the heated debate over the environmental impact of cryptocurrencies, miners are increasingly committed to changing the negative reputation that it has built over the years – especially as these operations move to the United States. In November of last year, Houston-based tech company Lancium announced that it raised $150 million to build bitcoin mines across Texas that will run on renewable energy.[25] In 2022, the company plans to launch over 2,000 megawatts of capacity across its multiple sites.[26] Bitcoin mining company Argo Blockchain, a company listed on the London Stock Exchange, secured a $25 million loan to fund its “green” mining operation.[27] The 320-acre site will only use renewable energy, the majority being hydroelectric.[28] This deal is set to transform Argo’s mining capacity and is expected to be completed in the first half of 2022.[29]

Capital Markets also appear to have a growing appetite for the development of green crypto mining. In April of last year, Gryphon Digital Mining raised $14 Million Series A to launch a zero-carbon footprint Bitcoin mining operation powered exclusively by renewables.[30] In a raise that closed in just over two weeks, institutional investors – who were significantly oversubscribed – accounted for over thirty percent of the round.[31]

As congressional, social, and economic pressures grow, it is evident that there is going to be a big focus on the sustainability of Bitcoin mining. As such, we may very well see announcements, like the deals mentioned above, well into 2022 and beyond.

FOOTNOTES

[1] Bitcoin Transactions Per Day, YCharts, https://ycharts.com/indicators/bitcoin_transactions_per_day (last visited Jan. 29, 2022).

[2] Bitcoin Mining Map, Cambridge Centre for Alternative Finance, https://ccaf.io/cbeci/mining_map (last visited Jan. 29, 2022) [“Bitcoin Mining Map”].

[3] Samuel Shen & Andrew Galbraith, China’s ban forces some bitcoin miners to flee overseas, others sell out, Reuters, June 25, 2021, https://www.reuters.com/technology/chinas-ban-forces-some-bitcoin-miners-flee-overseas-others-sell-out-2021-06-25/ (last visited Jan. 29, 2022).

[4] See Bitcoin Mining Map.

[5] Tom Wilson, Bitcoin network power slumps as Kazakhstan crackdown hits crypto miners, Reuters, Jan. 7, 2022, https://www.reuters.com/markets/europe/bitcoin-network-power-slumps-kazakhstan-crackdown-hits-crypto-miners-2022-01-06/ (last visited Jan. 29, 2022).

[6] Regulation of Cryptocurrency Around the World: November 2021 Update, Global Legal Research Directorate, The Law Library of Congress, available at https://tile.loc.gov/storage-services/service/ll/llglrd/2021687419/2021687419.pdf (last visited Jan. 29, 2022).

[7] Id.

[8] Press Release, United States Senate Committee on Banking, Housing, and Urban Affairs, At Hearing, Warren Delivers Remarks on Digital Currencies (June 9, 2021), https://www.banking.senate.gov/newsroom/majority/at-hearing-warren-delivers-remarks-on-digital-currency (last visited Jan. 29, 2022).

[9] Elizabeth Warren, Letter to Greenridge Generation on Crypto, Dec. 2, 2021, available at https://www.warren.senate.gov/imo/media/doc/2021.12.2.%20Letter%20to%20Greenidge%20Generation%20on%20Crypto.pdf (last visited Jan. 29, 2022).

[10] Id. at p.2.

[11] Hearing Notice, United States House Committee on Energy & Commerce, Hearing on “Cleaning Up Cryptocurrency: The Energy Impacts of Blockchains” (Jan. 20, 2022), https://energycommerce.house.gov/committee-activity/hearings/hearing-on-cleaning-up-cryptocurrency-the-energy-impacts-of-blockchains (last visited Jan. 29, 2022) [the “January 20 Hearing”].

[12] January 20 Hearing Testimony. See also Statement of Brian P. Brooks before House Committee (Jan. 20, 2022), available at https://energycommerce.house.gov/sites/democrats.energycommerce.house.gov/files/documents/Witness%20Testimony_Brooks_OI_2022.01.20_0.pdf  (last visited Jan. 29, 2022) [the “Brooks Statement”].

[13] See, e.g., Brooks Statement; Statement of Prof. Ari Juels before House Committee (Jan. 20, 2022), available at https://energycommerce.house.gov/sites/democrats.energycommerce.house.gov/files/documents/Witness%20Testimony_Juels_OI_2022.01.20.pdf (last visited Jan. 29, 2022) [the “Juels Statement”].

[14] Statement of Gregory Zerzan before House Committee (Jan. 20, 2022), available at https://energycommerce.house.gov/sites/democrats.energycommerce.house.gov/files/documents/Witness%20Testimony_Zerzan_OI_2022.01.20.pdf (last visited Jan. 29, 2022).

[15] See, e.g., Statement of John Belizaire before House Committee (Jan. 20, 2022), available at https://energycommerce.house.gov/sites/democrats.energycommerce.house.gov/files/documents/Witness%20Testimony_Belizaire_OI_2022.01.20_0.pdf (last visited Jan. 29, 2022) [the “Belizaire Statement”].

[16] Office of Energy Efficiency & Renewable Energy, Confronting the Duck Curve: How to Address Over-Generation of Solar Energy (October 12, 2017)

https://www.energy.gov/eere/articles/confronting-duck-curve-how-address-over-generation-solar-energy (last visited Jan. 29, 2022).

[17] See, e.g., Belizaire Statement, p.4.

[18] Id.

[19] See generally Brooks Statement, pp.8-10.

[20] See, e.g., Statement of Steve Wright before House Committee, p.5 (January 20, 2022) available at https://energycommerce.house.gov/sites/democrats.energycommerce.house.gov/files/documents/Witness%20Testimony_Wright_OI_2022.01.20.pdf (last visited Jan. 29, 2022) [the “Wright Statement”].

[21] Id. p.9.

[22] Press Release, Office of Senator Elizabeth Warren, Warren, Colleagues Press Six Cryptomining Companies on Extraordinarily High Energy Use and Climate Impacts (Jan. 27, 2022), available at https://www.warren.senate.gov/newsroom/press-releases/warren-colleagues-press-six-cryptomining-companies-on-extraordinarily-high-energy-use-and-climate-impacts (last visited Jan. 29, 2022).

[23] Id.

[24] Id.

[25] MacKenzie Sigalos, This Houston Tech Company wants to build renewable energy-run bitcoin mines across Texas CNBC (November 23, 2021), https://www.cnbc.com/2021/11/23/lancium-raises-150-million-for-renewable-run-bitcoin-mines-in-texas.html (last visited Jan 31, 2022).

[26] Id.

[27] Namcios Bitcoin Magazine, Argo blockchain buys Hydro data centers to realize Green Bitcoin Mining Vision, (May 13, 2021), https://www.nasdaq.com/articles/argo-blockchain-buys-hydro-data-centers-to-realize-green-bitcoin-mining-vision-2021-05-13 (last visited Jan 31, 2022).

[28] Id.

[29] Id.

[30] GlobeNewswire News Room, Gryphon Digital Mining raises $14 million to launch bitcoin mining operation with zero carbon footprint, (April 13, 2021), https://www.globenewswire.com/newsrelease/2021/04/13/2209346/0/en/Gryphon-Digital-Mining-Raises-14-Million-to-Launch-Bitcoin-Mining-Operation-with-Zero-Carbon-Footprint.html (last visited Jan 31, 2022).

[31] Id.

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

SEC Rejects Listing of Two Bitcoin ETFs

The SEC rejected two proposals to list and trade shares in two Bitcoin exchange-traded funds (“ETFs”).

The SEC rejected a proposal from NYSE Arca, Inc. (“Arca”) to list and trade shares of the Valkyrie Bitcoin Fund. The SEC also rejected a proposal from CBOE BZX Exchange, Inc. (“BZX”) to list and trade shares of the Kryptoin Bitcoin ETF Trust.

The SEC assessed whether the exchanges (i) had a comprehensive surveillance-sharing agreement with a significant, regulated market, and (ii) could effectively prevent fraudulent and manipulative activity. In the rejected proposals, the SEC noted its concerns over the abilities of the exchanges to adequately meet the requirements under SEA Section 6(b)(5) (“Determination by Commission Requisite to Registration of Applicant as a National Securities Exchange”) in protecting investors and the public interest by preventing fraudulent and manipulative practices.

The SEC rejected Arca’s argument that (i) liquidity, (ii) price arbitrage, and (iii) frameworks to value assets would be sufficient to mitigate potential manipulation.

Similarly, the SEC rejected BZX’s proposal, concluding “that BZX has not established that it has a comprehensive surveillance-sharing agreement with a regulated market of significant size related to bitcoin,” and “that BZX has not established that other means to prevent fraudulent and manipulative acts and practices are sufficient to justify dispensing with the requisite surveillance-sharing agreement.”

As a result, the SEC found that both exchanges had failed to prove that they could meet their burdens under SEA Section 6(b)(5).

© Copyright 2021 Cadwalader, Wickersham & Taft LLP
For more articles on cryptocurrency exchanges, visit the NLR Financial Securities & Banking.