It was a busy two weeks in Web3 law, as Binance lost in an appeal that could have wide-ranging jurisdictional implications outside of just digital assets. Coinbase also went on the offensive against the SEC in appealing the SEC’s denial of rulemaking, and Coinbase was supported by many industry stakeholders as amicus a week later. This all came around the same time as the House of Representatives held a hearing titled “SEC Overreach: Examining the Need for Reform” and the administrative agencies overseeing U.S. intellectual property registration released their long-awaited study on non-fungible tokens (“NFTs”). These developments and a few other brief notes are discussed below. Binance Loses Appeal With Far Ranging Jurisdictional Implications: March 8, 2024 Background: Binance lost on an appeal that previously dismissed the cryptocurrency exchange from a class action lawsuit on jurisdictional grounds. While Binance has requested a rehearing en banc in front of the Second Circuit, this was a blow to an exchange that recently settled with the DOJ/CFTC and is still facing a lawsuit against the SEC. The case was previously dismissed at the district court level under the presumption against extraterritorial application of U.S. securities laws to foreign entities. Summary: Binance denied having a principal place of business in any jurisdiction, which was the basis for the appellate court overruling the prior dismissal. The Second Circuit determined that because plaintiffs’ alleged (1) Binance’s use of Amazon Web Services for much of its infrastructure made that U.S. centric; and (2) Binance’s U.S. infrastructure made it more likely to be used by U.S. individuals, that Binance’s lack of physical offices made that the best thing to look to when looking at where a transaction was completed. This was a Motion to Dismiss, so the Court was required to accept the infrastructure claims as true, and it’s very possible that these claims will be rebutted through evidence on discovery. But this is still a blow, which makes it more likely for decentralized companies to be subject to U.S. securities laws based on their web services infrastructure even if they put into place attempts to weed out U.S. buyers. Coinbase Appeals SEC’s Denial of Rulemaking for Digital Assets: March 11, 2024 Background: In July of 2022, Coinbase petitioned the SEC for rulemaking regarding digital assets, requesting sufficient rules to create market certainty on whether the Commission would view a particular digital asset to be an “investment contract” subject to registration and oversight by the SEC. After challenging the SEC’s lack of action on the exchange’s petition, the SEC formally denied the request, clearing the way for judicial review of that denial. Coinbase has now filed a 78-page brief seeking such a judicial review. Summary: You can look at the chart on page 12 of the brief (document page 16) to get the gist of the argument. The primary author is Eugene Scalia, who has played a part in overturning numerous recent laws and regulations and gets more leeway on stylistic decisions. Pages 40-46 explaining the unworkable nature of existing securities laws with blockchain functionalities was probably the best part of the briefing (and reads like a summary of the Paradigm 3-part series on the subject). As expected, Coinbase continues to avail itself to all avenues of judicial review of the SEC’s actions (and inactions). The wheels of justice turn slowly but grind exceedingly fine. Copyright, Patent, and Trademark Offices Release Study on NFTs: March 12, 2024 Background: The U.S. Copyright and U.S. Patent and Trademark Offices released their collaborative study on the impact of NFTs on IP law and policy. The big takeaways were (1) the recognition of the value NFTs can bring to artists and brands and (2) the insistence that existing law is sufficient to address infringement concerns related to NFT applications. Summary: This study was the result of the President’s Executive Order on Digital Assets from September 2022. The study determined that incorporating NFTs into existing intellectual property registration and recordation practices is not necessary or advisable at this time, as these technologies can be registered under existing laws without the need for specialized carve-outs. The main takeaway from the study was the executive agencies’ willingness to interact and receive feedback from interested stakeholders through various roundtable discussions and open-door meetings. It will be interesting to see if existing doctrines, such as the first sale doctrine, will continue to apply to digital works when the change of ownership of those digital works does not require the creation of a “copy” of that digital work. Amici Support Coinbase Appeals SEC’s Denial of Rulemaking for Digital Assets: March 18, 2024 Background: The industry continues to show up in filing amicus briefs on important cases, this time with amicus briefing filed in support of Coinbase’s appeal of the SEC’s denial of digital asset rulemaking. Briefs were filed by Paradigm, LEJILEX, the Texas Blockchain Council, the Crypto Council for Innovation, and the U.S. Chamber of Commerce. This level of legal activism is not something often seen in commercial endeavors, but is becoming commonplace in the digital asset industry, where collaboration of unaffiliated stakeholders and decentralization are part of the industry’s fabric. Summary: As we previously stated in our breakdown of the Coinbase briefing, the key to many of these briefings is demonstrating the illogical nature of the SEC’s “come in and register” talking points while failing to provide a route to registration that is possible based on the technology at issue. Paradigm’s brief especially weighed in and crystalized this point with specific cites to applicable Code of Federal Regulations sections. The Chamber of Commerce’s support was also strong. “The SEC’s belated, conclusory denial is a textbook example of agency action that is arbitrary, capricious, and an abuse of discretion—in other words, action that must be set aside under the APA. Whatever discretion agencies ordinarily possess, a refusal to undertake rulemaking cannot stand if it is ‘plainly misguided.’ House Subcommittee Holds Hearing on SEC Oversight: March 20, 2024 Background: The House Subcommittee on Capital Markets held a hearing titled “SEC Overreach: Examining the Need for Reform,” which included witnesses from the Cato Institute, the Heritage Foundation, the Center for American Progress, and the Committee on Capital Markets Regulation. While the hearing did not focus specifically on digital assets, the topic was hit on at various points throughout the hearing. Summary: The witness from the Heritage Foundation had especially strong words against the agency, stating, “Perhaps the leading area in which the Commission has been irresponsible is the area of digital assets, or crypto assets… If you were to write a book on how not to regulate, the Commission’s modus operandi in this area would be the first chapter.” There were also remarks from Congressman French Hill, the potential next head of the Financial Services Committee, regarding the SEC’s approach to digital assets and recent court decisions involving digital assets. KuCoin Charged With Violating BSA and Commodity Exchange Act: March 26, 2024 Background: The CFTC and Department of Justice filed parallel civil and criminal actions against the companies operating the KuCoin exchange. In the civil complaint, the CFTC alleges that KuCoin illegally dealt in off-exchange commodity futures transactions and leveraged, margined, or financed retail commodity transactions, operating in the US without registering as a futures commission merchant, swap execution facility, or designated contract market.  The criminal complaint reportedly is charging them with violating the Bank Secrecy Act, operating an unlicensed money transmitter business, and conspiracy to violate the Bank Secrecy Act and operate as an unlicensed money transmitter business. Summary: This isn’t the first time KuCoin has landed in hot water, as it was recently barred from operating in New York and was effectively kicked out of Canada. It shouldn’t be a huge surprise that an exchange offering otherwise regulated products without either geofencing US IP addresses or requiring basic KYC verification would get in trouble. Interestingly, the CFTC press release provides that they “failed to impose any IP address restrictions during the relevant period to prevent U.S. customers from trading commodity interests or account for commonly used technology such as virtual private networks (VPNs) that could potentially circumvent IP address restrictions.” It is unclear how one would prevent VPN users from accessing the exchange short of blocking all VPNs (which is untenable for many reasons, not the least of which is that about 30% of all internet users are using a VPN, usually for completely legitimate reasons), or why someone would need to block VPNs when they’re not geofencing to begin with. The CFTC also made it a point to clarify that Ether is a commodity subject to CFTC jurisdiction, perhaps to prevent the SEC from asserting regulatory jurisdiction over the asset. Briefly Noted: Ethereum Foundation Reportedly Under Investigation: While not independently confirmed, numerous sources have reported that the Ethereum Foundation may be under investigation by the SEC, purportedly relating to Ethereum’s shift from a proof of work validation mechanism to a proof of stake mechanic. This could also involve an effort for the SEC to classify ETH as a security since earnings from staking are easier to analogize to some traditional securities products than earnings from work. This may also be an effort for the SEC to distance itself from the Hinman Speech, where the then-head of the Division of Corporate Finance declared that “current offers and sales of Ether are not securities transactions,” particularly given the looming May deadline for the SEC to approve or deny a potential Ethereum exchange traded fund.  Bitcoin Fog Developer Convicted: Roman Sterlingov was convicted on all four counts of money laundering for his involvement with crypto-mixer BitcoinFog. This conviction is likely to be appealed, particularly over some claimed logical leaps taken by the DOJ’s cryo-tracing experts. Court Determines Craig Wright is not Bitcoin Creator: A Court determined Craig Wright is not Satoshi, despite his sister’s testimony that he pretended to be a ninja well into his adulthood. This is the result of a multi-year litigation battle over Mr. Wright’s claims of being the primary author of the Bitcoin Whitepaper, attributed to the pseudonymous “Satoshi Nakamoto.” SEC Issued Sanctions in Digital Asset Case: While we will not comment on the contents of the Court’s Order, it is a development worth noting that the Court in SEC v. Debt Box issued an Order requiring the SEC to pay certain costs and fees as a sanction in that case. Conclusion: The past two weeks have marked a pivotal period for Web3 law, characterized by significant legal developments that highlight the ongoing tension between regulatory bodies and the rapidly evolving digital asset industry. The appeal loss by Binance not only sets a precedent for jurisdictional reach over decentralized entities but also emphasizes the complexities of applying traditional securities law to the unique nature of digital assets. Coinbase's bold move to challenge the SEC’s stance on rulemaking, backed by considerable industry support, underscores the sector's call for clear, applicable regulations that foster innovation while ensuring market integrity. Moreover, the House of Representatives' hearing on "SEC Overreach" and the release of the study on NFTs by U.S. IP agencies collectively signal a growing recognition of the need to adapt legal frameworks to the realities of the digital age. As the legal landscape continues to evolve, these developments serve as a reminder of the delicate balance that must be struck between regulation and innovation in the digital asset ecosystem. The industry’s resilience and willingness to engage in legal battles reflect its commitment to establishing a regulatory environment that is both fair and conducive to growth. This period may well be looked back upon as a watershed moment in the journey towards achieving a harmonious coexistence between digital asset innovations and regulatory oversight. In addition, SDNY denied Coinbase summary judgment on most of its claims in their case against the SEC, though they did succeed in getting the claim regarding self-custodial wallets dismissed.  We’ll have more on this decision soon.  If you have any questions about how the above developments affect your blockchain plans or any other questions regarding the legalities around various aspects of this rapidly developing industry, contact any member of the Polsinelli Blockchain+ team to set up a time to talk and see how we can be of assistance. Also, please subscribe to the BitBlog for alerts when new stories or updates are posted by our attorneys.

I. What We Saw in 2021 The year 2021 saw enormous growth in the use, interest and diversification of blockchain technologies. From the rise of non-fungible tokens (NFTs) as a digital art medium to the establishment of numerous bespoke cryptocurrencies, blockchain stood at the nexus of intellectual property, content creation and finance. The year 2022 will be another exciting year in blockchain as the gap between traditional contracting and contracting using blockchain continues to narrow.  Polsinelli’s Technology Transactions team was at the forefront of bridging that gap in 2021 through a novel fusion of Ethereum’s smart contracting capabilities with sophisticated in-bound and out-bound content licensing. This article sets forth the fundamentals of how Ethereum blockchain was used to navigate complex licensing issues arising from the creation and hypothecation of digital assets. II. How Ethereum Smart Contracts Work Foundationally, Ethereum blockchain is a platform that uses distributed ledger technology to execute and validate smart contract transactions. Each transaction is called a “block” and connects with the previous transaction as the next link in the chain of transactions (hence the term “blockchain”). Each participant in a blockchain holds a complete copy of the entire ledger and all of its transactional history (NFTs use this feature, for example, to prove digital art ownership and provenance). When a new transaction or a change occurs to the blockchain, the new transaction must be approved by the blockchain network using a consensus mechanism.  The consensus mechanism used depends on whether the blockchain is privately or publicly accessible. A blockchain is public when it is open to all participants and does not require permission from others. A private blockchain requires permission to transact from a private party authorized to transact on the network. Because of this permission structure, private blockchains may be subordinated to written agreements between parties related to the use of the blockchain. III. A Novel Approach to Content Licensing Leveraging the ability to establish top-level written agreements on a private blockchain, Polsinelli developed a novel licensing model for digital assets (Assets) on behalf of an independent gaming platform (Platform). The process starts with a traditional content license and hosting agreement (License Agreement) that transfers Assets to the Platform which are then published on the Platform’s web-based digital asset marketplace. The License Agreement further establishes key transactional issues such as intellectual property rights, the division of royalties between the Platform and content creator, the number of License Tokens (described below) available per Asset, the cost of each License Token to an end user and the overall process by which the Platform will sublicense and market the Assets to end users. Once the Asset is published on the Platform, an end user can procure access to the Asset by purchasing a License Token. The License Token serves as the gatekeeper for accessing Assets. If the end user does not have the required License Token, the Platform provides the end user with ability to purchase said License Token and once the License Token is added to the end user’s digital wallet, the end user can access the Asset (subject to any stipulations on use e.g., end user license agreements). This process is executed via Ethereum smart contract, which manages both the distribution of the Asset to the end user and the real-time payment of royalties to the content creator and the Platform. IV. A Bottom-Up Approach to Content Creation End user use and consumption of Assets is not the only benefit the Platform offers. Through the Platform, content creators can list, sell or license their Assets, which can then be leveraged by other content creators to build new digital content in a collaborative or derivative manner. As digital content creators generate new content, the Ethereum smart contracts tied to the underlying Assets comprising the new content are again leveraged to facilitate real-time royalty payments for the licensing and sale of the new digital content as whole. This process creates a decentralized model allowing for a bottom-up approach to content creation and monetization. This, in turn, creates additional incentive for independent creators to develop new and diverse content. Content creators also have the option of developing new content as a “work made for hire” directly for the Platform under a content authoring agreement. This approach can award a larger initial payment to the creator but a smaller royalty on sublicenses to end users. That gives flexibility to how content creators engage in the development and monetization of their works. V. Looking Ahead in 2022 We expect the model above will be further refined in 2022 and deployed in other unique ways for the distribution and monetization of digital content. We foresee, for example, the creation and management of decentralized autonomous organizations (DAOs) that leverage smart contracts to raise capital for the creation and sale of digital assets. In theory, a DAO could award voting share tokens (similar to the License Tokens discussed above) to investors according to their respective contributions to the DAO. Investors would then be able to vote their tokens on unique content creation proposals with smart contracts reviewing the votes and the corresponding tokens to determine if the proposal is approved. If approved, funds from the DAO would then flow in real time to content creators to fund their digital asset creation. Naturally, royalties resulting from the sale of these digital assets would be automatically distributed to investors according to their respective voting share tokens. VI. Conclusion Using Ethereum smart contracts and distributed ledger technology to execute transactions on the blockchain to establish rights in the use and distribution of content allows both content creators and content hosting services to financially benefit from sublicensing of content to end users and relicensing content to other creators. In 2022, Polsinelli will both assist digital content creators in refining and deploying this model in the distribution of their content and guide platforms through the process of leveraging private blockchains to manage the distribution of digital content to consumers and royalties to content creators. To read the full 2022 Tech Trans & Data Privacy Report, please click here.