As the new year is in full swing, digital asset legal developments have picked up as well. In a surprising turn of events, it was revealed that the theft of $400 million in assets as FTX was going through their change in leadership prior to bankruptcy was allegedly the result of a sim swap, with three American charged in the theft. The Department of Energy is also looking into the energy usage if cryptocurrency mining, and there appears to be bipartisan support to overrule the SEC’s proposed digital asset custody rule. These developments and a few other brief notes are discussed below. Alleged FTX Hackers Indicted Over $400 Million Hack: January 24, 2024 Background: Three Americans have been charged with a series of sim-swap hacks which included the hack of certain FTX accounts during the disorganized period around the time that control of the exchange was handed over to attorneys. While the victims are not listed in the indictment, media outlets are reporting that Victim Company-1 is FTX, and access was obtained through a sim swap of an FTX employee’s phone who had access to various FTX digital wallets. Summary: In the days after FTX's collapse, hundreds of millions of dollars in cryptocurrencies were moved out of FTX's accounts. Many believed at the time this was an inside job, with a high-level employee moving those funds as a nest egg to preserve against government seizure. After not hearing many updates on this in the years following, it is interesting to find out it was three Americans behind the heist. SIM swapping is not an especially sophisticated form of hacking, so to hear these three allegedly got over $400 million through relatively unsophisticated forms of fraud shows how lax the security and compliance was at FTX around the time of its collapse. Energy Department Issues “Emergency” Collection of Information Regarding Bitcoin Mining Energy Consumption: January 26, 2024 Background: The U.S. Energy Information Administration (“EIA”) “authorized the survey on January 26, 2024, as an emergency collection” for commercial cryptocurrency miners to respond to. The agency stated in a press release. “We will specifically focus on how the energy demand for cryptocurrency mining is evolving, identify geographic areas of high growth, and quantify the sources of electricity used to meet cryptocurrency mining demand.” Summary: The science is fairly well established that Bitcoin and other cryptocurrency mining is a net positive for stabilizing electrical grids, especially for renewable energy sources which often have high outputs that need consumption because factories and other energy consumers (unlike mining) cannot be turned on and off when the wind is high/low or the sun is bright/covered. Despite these benefits, this is just the latest step taken by the current administration with the intent of curbing crypto mining activity, along with the proposed Digital Asset Mining Energy (DAME) 30% excess tax on crypto miners.  That said, while this was an “emergency” order that sidestepped normal regulatory agency due process it still is little more than an information-gathering measure, albeit one the EIA intends to use to develop a new standard collection. Bipartisan Joint Resolution Issued to Repeal SEC Crypto Custody Guidance: February 1, 2024 Background: Senator Lummis (R-WY) along with Congressman Nickel (D-NC) and Flood (R-NE) introduced S.J.Res.59 under the Congressional Review Act which authorizes Congress to rescind agency rules through joint resolutions. The Joint Resolution would repeal the SEC’s Staff Accounting Bulletin (“SAB”) 121 which requires listed companies that custody digital assets to list those assets as liabilities on balance sheets unlike cash and other assets custodied by those custodians. The Government Accountability Office has previously ruled that SAB 121 failed to abide by the Congressional Review Act. Summary: Senator Lummis seems to believe she has the votes to pass this through the Senate because Joint Resolutions only require a simple majority and not the 60 votes required to end debate on other bills. This will almost certainly pass the House if it gets there. It is an accounting rule that makes no sense and results in there being fewer trusted fiduciaries who can protect customer’s digital assets from theft. It will be interesting to see if the President’s current digital asset stance is important enough to him to use his veto power on this Joint Resolution if it passes the House and Senate.  The SEC’s passage of SAB 121 was always odd as the purpose of SEC staff bulletins is to establish internal policies on how to implement already existing rules (and inform the general public about those internal policies), while SAB 121 goes well beyond the usual purpose of a staff bulletin and establishes new policy rather than interpreting an existing rule.  Even if SAB 121 is overturned, it would not affect the SEC’s proposed “Safeguarding Rule” which would overhaul the Investment Advisers Act Custody Rule and make non-security crypto assets subject to custody requirements that could be difficult, if not impossible, to fulfill for many digital assets. Briefly Noted: SEC Delays Decision on Spot ETH ETF: Well this is a shocker!  Some analysts are predicting that a spot ETH ETF could be approved as early as May if the SEC doesn’t reject the rule change required to approve the ETF, but later seems more realistic.  While the SEC was bench-slapped over its failure to approve a BTC ETF, Gary Gensler has telegraphed that the SEC will argue that the holding in that case only applies to BTC and that, with a significantly lower market cap and different blockchain validation mechanics, ETH could be significantly more prone to manipulation than BTC.  After having approved an ETH futures ETF, it could be difficult for the SEC to stall for too long.  That said, every objection made by Commissioner Crenshaw (who still voted against the ETF despite a court order to the contrary) to the BTC ETF would also be true for an ETH ETF (even though most of those objections are also true for nearly all single-asset ETFs). Article on DeFi As Critical Infrastructure Released: Various legal practitioners in the space issued an academic paper proposing that DeFi be regulated as a critical infrastructure provider rather than as a financial intermediary assuming it meets certain technical thresholds. It is not a final proposal, but is an interesting starting point in thinking of DeFi as technology first. SEC Commissioner Dissents to Rule Prohibiting Denial of Charges by Settling: SEC Commissioner Hester Peirce has issued a dissent to the Commission’s decision to reject a proposed rule change that would allow settling parties to continue to claim innocence after accepting a settlement. It raises the question if a government agency while acting in civil litigation, has the ability to restrict speech to such a degree. FTX Expected to Pay Customers in Full/Will Not Restart Exchange: FTX issued an update to the bankruptcy court stating that it expected to be able to pay back all depositors in the exchange prior to its collapse, but will not be restarting the business following the bankruptcy proceedings. It is yet to be determined if depositors will be paid back in kind or, more likely, based on the price of the applicable cryptocurrency at the time of bankruptcy (which was near 2-year lows for many digital assets). Industry Opposed FinCEN Rulemaking Proposal: Chamber of Digital Commerce, Coinbase, Paradigm, and others all submitted comments to FinCEN’s Notice of Proposed Rulemaking which would result in bulk data collection and reporting requirements for all transactions involving any crypto mixing even with no indication of suspicious activity. Conclusion: As the digital asset landscape continues to evolve, the first month of this year has brought to light significant legal, regulatory, and ethical challenges facing the industry. From the shocking revelation of the alleged FTX hack to the ongoing debates over energy consumption and regulatory oversight, each development underscores the complex interplay between innovation, security, and governance in the digital age. The bipartisan effort to overrule the SEC’s digital asset custody rule highlights a growing recognition of the need for nuanced, balanced policies that safeguard both the industry's potential and the public's interest. As we navigate these turbulent waters, it's clear that the path forward requires a collaborative approach, one that embraces the transformative possibilities of digital assets while addressing the vulnerabilities and ethical considerations they can also represent. The rest of the year promises to be a critical period for shaping the future of digital assets, as stakeholders across the spectrum strive to find common ground in building a resilient, equitable, and sustainable digital economy. 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.

The Bi-Weekly updates took a break during the holiday season, but the Web3 developments did not. It was a busy month in both litigation and regulatory changes, including what is expected to be a wave of approvals for various spot bitcoin exchange traded funds which will make exposure to bitcoin as a store of value more available to institutional and other investors.  It is possible that by the time this is posted the first round of approvals will be granted which we will cover in the next Bi-Weekly installment. These developments and a few other brief notes are discussed below. Mango Markets “Profitable Trading” Strategist Loses Early Dismissal Bid: December 18, 2023 Background: Avraham (“Avi”) Eisenberg lost on his Motion to Dismiss the criminal Complaint against him regarding his October 2022 exploit of the Mango Markets trading protocol. The Order is available here. Avi is facing criminal charges of commodities fraud, commodities manipulation and wire fraud. The Court specifically rejected Avi’s Major Question defense, stating “Eisenberg cites no authority for applying the major-questions doctrine in the context of a single criminal case.” It went on to hold, though, that “this denial is without prejudice to Eisenberg raising his arguments by way of a Rule 29 motion for judgment of acquittal after the close of the government’s evidence…” Summary: As you may remember, in October of 2022, Avi used what he referred to on Twitter as a “highly profitable trading strategy,” using a combination of leveraged trades which resulted in the protocol (Mango Markets) becoming insolvent. This case will determine important issues going forward on what level of human interaction is needed for “wire fraud” in a protocol exploit like this, where the main fraud is being perpetrated against an algorithm. While the Court denied dismissal at the Motion to Dismiss stage, it also demonstrated in its Order the need to see additional facts to resolve disputed issues which isn’t proper at this stage in litigation but may be proper later. The development company behind Mango Markets is also having its own regulatory issues in the fallout from the events leading up to the aforementioned criminal prosecution. Elizabeth Warren Sends Letter to Trade Associations Who Oppose Her Bill: December 18, 2023 Background: Elizabeth Warren sent a letter to the Blockchain Association, Coin Center and various advocacy groups “regarding a troubling new report that your association and other crypto interests are ‘flexing a not-so-secret weapon: a small army of former defense, national security and law enforcement officials.’” Sen. Warren’s letter requests further information on the employment of former government officials by digital asset advocacy groups and industry participants. Summary: It is disheartening that a sitting Senator would send a threatening letter demanding information she has no legal right to regarding former government officials working at advocacy organizations after leaving government. Especially considering her former staffer just left the Whitehouse to go to work directly with an advocacy group that previously lobbied him while in his official capacity. Coin Center’s official response was well put: “Engaging like-minded experts to advocate against legislative proposals that one sincerely believes are unconstitutional and detrimental to the nation's welfare does not constitute 'undermining bipartisan efforts in Congress.' Rather, it is the exercise of the fundamental right to freely associate and petition the government. It’s everyone’s right and no one should apologize for doing it. Resorting to questioning motives often reflects an inability to prevail on the merits of an argument itself.” SEC Wins (Mostly) in Terraform Labs Case: December 28, 2023 Background: The SEC was granted summary judgment against Terraform Labs regarding the SEC’s allegation that the UST, LUNA, wLUNA and MIR tokens are investment contracts under the Howey test while being a bit more nuanced about the UST stablecoin and leaving the possibility open that the investment contract is UST in conjunction with the protocols that allowed it to earn interest. Terraform Labs was granted summary judgment dismissing the SEC’s allegations that it engaged in illegal security-based swaps. The issue of whether Terraform Labs’ actions constitute fraud was left for trial. Summary: The Court held that LUNA and MIR were securities, in large part due to statements from founder Do Kwon indicating that LUNA purchasers were effectively putting their money in a common enterprise with expectations of profits from the efforts of Terraform Labs and Kwon. However, the Court also ruled that Terraform’s Mirror Protocol, which allowed users to mint “mAssets,” mirroring real-world assets on the blockchain, were not security-based swaps under the law. Interestingly, the Court did not even cite Judge Torres’ Ripple ruling, despite previously being critical of it on Motion to Dismiss. 2024 Crypto Tax Reporting Unclear Under Infrastructure Investment and Jobs Act: January 1, 2023 Background: The Infrastructure Investment and Jobs Act, which passed Congress in November of 2021, included a provision amending the Tax Code (“6050I”) to require anyone who receives $10,000 or more in cryptocurrency in the course of their trade or business to make a report to the IRS about that transaction. The law became effective as of January 1, 2024, leaving many unclear as to their reporting obligations. Coin Center filed a lawsuit challenging the law in the summer of 2022 and has posted its current thoughts about it here. Summary: Jason Schwartz had a great thread breaking down the reporting obligations. He and others have reported that the IRS appears to believe that the 6050I reporting requirement doesn't come into effect for crypto until after regulations are issued. This also only applies to receipts of one or more related transactions that were received in business and amount to over $10,000. So, 10,000 people buying a jpg for $100 each is not something that should trigger reporting obligation, nor is most day trading, even at a large scale. Additionally, failure to file is a $50 fine unless intentional (and hard to say it would be intentional here in most cases without clarifying rules). In the meantime, at a minimum, we think it would be prudent to maintain accurate books and records while awaiting further guidance from the IRS or for a market practice to develop.” Briefly Noted: There Will Be No Second Sam Bankman-Fried (“SBF”) Criminal Trial: It looks like there will not be a second SBF trial. Charges on campaign finance fraud would not have looked great and could have had collateral effects on the level of trust in our political and judicial system. That said, SBF is most likely going to jail for at least the next decade or two on his existing convictions, so having another trial on matters that would be much more difficult to prove likely would have been a waste of time and resources. BarnBridge DAO Settles with the SEC: BarnBridge DAO, which you may remember had an attorney purporting to represent the DAO post in their Discord about the SEC investigation and had a DAO vote on how to respond to the investigation, settled with the SEC last week. This is an interesting case study in response of DAOs to criminal and civil investigations. Interestingly, the settlement raised the issue of possible registration under the Investment Company Act for the first time since the Blockfi Settlement. Conclusion: The latest updates in blockchain law reveal a dynamic and evolving intersection of blockchain technology, regulation and legal challenges. From the significant developments in the Mango Markets criminal case to the intriguing nuances of the Terraform Labs ruling, these stories underscore the complexities facing the blockchain and crypto industries. Senator Elizabeth Warren's recent actions and the ongoing ambiguity in crypto tax reporting further highlight the intricate dance between innovation and regulation. As we anticipate further developments, particularly regarding the impact of these events on institutional investment in cryptocurrencies, it's clear that the landscape of blockchain technology and law remains as vibrant and challenging as ever. 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.

Amidst the recent excitement surrounding bitcoin’s price rally, the past two weeks have been unusually quiet for industry legal updates. Which is a welcome relief, after a very busy few weeks leading up to Thanksgiving. But there were still developments in multiple criminal cases in the space, Congress was busy despite the growing consensus that digital asset regulation won’t get past the House until 2024, and the SEC has asked for a ruling as a matter of law regarding the assets in the Terraform Labs case. These developments and a few other brief notes are discussed below. Finance Founder Ordered to Remain in U.S. Pending Sentencing: November 27, 2023 Background: Binance’s former CEO Changpeng Zhao (“CZ”) was ordered to remain in the U.S. while he awaits sentencing on his guilty plea to one count of violation of the Bank Secrecy Act. The Order was temporarily entered by the magistrate judge overseeing his criminal case and associated plea agreement before being affirmed as the correct determination by District Court Judge Richard Anthony Jones. CZ’s sentencing is set for February 23. Summary: It seemed odd that the DOJ would enter the plea agreement with CZ if they did not trust him to return for his sentencing. But the fact that CZ’s domicile country the United Arab Emirates does not have an extradition treaty with the United States and his large amount of resources weighed in favor of keeping him in the United States until sentencing. We covered the CZ plea agreement and its associated impact on the industry in our previous BitBlog Bi-Weekly post available here. SEC Ask Judge to Rule Assets are Securities as a Matter of Law in Terraform Labs Case: December 4, 2023 Background: The SEC has filed a letter with the Court in the SEC v. Terraform Labs case pending in the Southern District of New York that asks the judge determine that the digital assets in question are investment contracts as a matter of law. If successful, this would remove that determination from consideration by a jury. The SEC’s letter argues that the legal nature of digital assets at issue, particularly in the context of the Howey test, is not a matter which should be presented for jury determination in any trial on this issue. Summary: The SEC has hedged its position, stating the assets at issue are securities as a matter of law or, in the alternative, there is no genuine issue of fact precluding the Court from ruling on the issue prior to trial. Smart considering Judge Rakoff’s previous Order on the Motion to Dismiss indicated he views the issue of efforts of others to hinge on a reasonable investor standard which would be an issue for the jury. Meanwhile, Terraform Labs founder Do Kwon is facing extradition for DOJ charges related to the Terra/Luna collapse in the Spring of 2022, although he may be extradited to Korea instead. House Financial Services Subcommittee on Digital Assets Holds Hearing on Fostering Innovation: December 5, 2023 Background: The House Financial Services Subcommittee on Digital Assets held a hearing titled “Fostering Financial Innovation: How Agencies Can Leverage Technology to Shape the Future of Financial Services.” The focus of the hearing was the government’s approach to new and emerging technologies like digital assets, distributed ledgers, quantum computing, and greater use of artificial intelligence. Witnesses included representatives from the SEC, FDIC, the Federal Reserve, and other administrative agencies. Summary: The biggest takeaway was Representative Emmer’s questioning of the SEC representative witness, who also was a commentator on the now-infamous Hinman speech (those comments were publicly released on June 13). There was also a call from Representative Waters for a smaller session specific to the operation of digital asset companies. Despite attempts by Representative McHenry to include digital asset bills which had passed through committee in the omnibus defense authorization bill, those attempts failed to be attached to larger spending measures, making it unlikely for any substantive digital asset regulations to pass in 2024. Notably, Representative McHenry also recently announced that he will not run for re-election at the end of this term. Briefly Noted: House Committee Unanimously Passes Digital Asset Bill: the Deploying American Blockchains Act was unanimously voted through the House Committee on Energy and Commerce. The bill’s substantive provisions are not expected to have a large impact on the industry, but it shows a growing consensus that these assets are something the government needs to gain a better understanding of. Report on Web3 Gaming Released: Colleen Sullivan of Brevan Howard Digital has released an over 150-page essay on the impact of Web3 digital ownership principles on the rising gaming economy. Well worth the read for anybody wishing to gain better insight into this growing industry sector. Bitzlato Founder Plead Guilty: The Founder of Bitzlato has pled guilty and agreed to not participate in any digital asset exchange venture as a part of the deal. The DOJ brought charges against the founder in January, and despite only having an all-time peak of $6 million held on the exchange at any given time, it was accused of being used in laundering over $700 million over its business lifetime. Department of Treasury Seeks Expanded Powers from Congress: The Department of Treasury sent a letter in response to the Senate’s request for information regarding Treasury’s existing powers and what powers the agency needed to fight illicit use of digital assets. Interestingly, the original draft in which the agency stated it did not have the power to designate smart contracts or protocols under existing powers was replaced with a less comprehensive letter which was released to the public. Federal Reserve Manuel Includes Section on Crypto Activities: The Federal Reserve’s recently released updated bank examination manual includes a new section (Section 5330) focused on crypto-related activities. The section also highlights key Federal Reserve guidance on crypto-asset related risks to banking organizations and supervisory considerations in assessing banks engaged in crypto-asset-related activities. Conclusion: In wrapping up this edition of the Blockchain+ Bi-Weekly, even in a relatively calm period for legal developments it's clear that the blockchain and crypto landscapes are rapidly evolving under the watchful eye of U.S. regulators and lawmakers. From the courtroom drama involving Binance's ex-CEO to the SEC's strategic moves in the Terraform Labs case, these developments paint a vivid picture of the intricate dance between legal structures and the ever-advancing world of digital assets. As we observe the unanimous support for the Deploying American Blockchains Act and other regulatory strides, it's evident that the journey towards a more regulated and understood digital asset sphere is well underway. Stay tuned for more insights as we continue to navigate these exciting and uncharted waters of blockchain and crypto regulation. 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.

The week leading up to Thanksgiving was a busy one in blockchain law, with the SEC instituting another lawsuit against a major U.S.-based cryptocurrency exchange, the DOJ and CFTC reaching a settlement in their cases against international exchange Binance and Tether cooperating with the DOJ to freeze almost a quart of a billion dollars in its stablecoin linked to illicit finance. This all came a week after the House of Representatives held a subcommittee hearing to discuss the links between digital assets and criminal operations. These developments and a few other brief notes are discussed below. House Financial Services Subcommittee on Digital Assets Debates Issues Surrounding Illicit Use of Cryptocurrencies: November 15, 2023 Background: The House Financial Services Subcommittee on Digital Assets met on November 15 to ask questions from industry experts on the scale and use of digital assets in terror and other illegal financing. This was largely due to a wave of false or misleading reporting which is described well in this Forbes article, How Misinformation On Hamas And Crypto Fooled Nearly 20% Of Congress. As stated by Senator Lummis, “Crypto is not the problem, bad actors that exist in every industry are.” This hearing followed a letter that was sent from a bipartisan group of lawmakers asking for an executive study on the use of digital assets in Hamas financing. Summary: The testimony of Gregory Lisa and Jane Khodarkovsky are both worth reading, and by all accounts, this hearing was a fair and honest look at digital assets which didn’t overplay its use in terror financing or underplay the serious security threat it represents. At the end of the day, anything of value, be it art, land, fiat currency, gold, crypto or anything similar, is going to be used by people we do not support for purposes that we do not endorse. However, of all the forms of illicit finance, only the movement of digital assets on a public blockchain can be traced in real-time by anyone with access to the internet. There is no means of exchange that is more anonymous than cash, which truly leaves no footprint, and there is no blockchain for cash. We certainly need to do what we can to limit the use of any asset in terror financing, but we also need to do it in a way that doesn’t abridge the rights of Americans to privacy and financial inclusion. SEC Files Lawsuit Against Cryptocurrency Exchange Kraken: November 20, 2023 Background: The SEC has filed a lawsuit accusing the second-largest cryptocurrency exchange in the US of violating federal securities laws. Payward Inc. and Payward Ventures Inc., which operate the cryptocurrency exchange known as Kraken, are the latest to be accused of “unlawfully facilitating the buying and selling of crypto asset securities.” Summary: It was odd this wasn’t filed when the Coinbase/Binance lawsuits were filed. Many assumed that Kraken’s prior $30 million settlement got the exchange some level of approval from the SEC for its remaining operations. That was wrong. While the SEC alleges that Kraken co-mingled customer funds, this is something Kraken self-reported years ago as an accounting issue which happened when Kraken switched accounting systems and they resolved thereafter. Kraken’s founder has pointed out that its cooperation and settlement with the SEC did not help the exchange avoid further litigation, and encouraged others in the space to avoid the U.S. under its current regulatory regime. Many of the tokens named in the lawsuit are used daily as utility tokens and are up big on the year, creating the question of exactly who the SEC is protecting in these actions? Also, the timing of this is certainly suspicious with SEC Chair Gary Gensler potentially front-running the major Binance settlement news his agency wasn’t a part of. Tether Freezes $225 Million in Cryptocurrency Linked to Pig Butchering Scams and Human Trafficking: November 20, 2023 Background: Tether, working in concert with the DOJ and Chainalysis, has frozen $225 million worth of its own stablecoin linked to an international human trafficking syndicate in Southeast Asia. The freeze occurred across 37 self-custodial wallets. The funds were primarily linked to pig butchering scams, where users are tricked into thinking they are sending funds to a cryptocurrency trading platform only to be robbed and refused the ability to cash out. Summary: It appears that Tether is working closely  with the DOJ based on this and other recent cooperative asset freezes. This coincides with the recent push, at the request of Senator Lummis and Representative French Hill, to crack down on major offshore players in the digital asset space. With the Binance settlement discussed below and the DOJ working with a cooperative Tether, that request for attention was seemingly abided by. This is good for the space and shows when there are lawful reasons and court orders to freeze funds, that an asset freeze can still be done without over-intrusive financial surveillance. Head of Binance Pleads Guilty to Bank Secrecy Act Charge and Steps Down: November 21, 2023 Background: On November 21, Binance and its CEO Changpeng Zhao (“CZ”) admitted to violations of anti-money laundering laws along with sanctions violations and operating as an unlicensed money transmitter. You can read the indictment here and the plea document here. As a part of the deal, CZ agreed to step down as CEO, have no involvement with Binance for 3 years, and Binance is required to appoint an independent compliance monitor for three years. Total fines and sanctions were just under $4 billion. CZ will plead guilty to a single count of failure to maintain an effective Anti-Money Laundering program under the Bank Secrecy Act, which carries a maximum sentence of five years. But due to various sentencing guidelines and downgrades, he is likely looking at a maximum of 18 months. CZ primarily lives in the United Arab Emirates, which is a non-extradition country with the U.S., making CZ’s agreement to appear in Seattle for sentencing all the more impactful. Summary: There were rumors leading up to the eventual press conference regarding the charges and plea deal.  The $4 billion is a massive fine but it looks like Binance was already getting ready to pay that for weeks now. CZ’s departure tweet is available here and the Binance official statement is here. Notably, the SEC was not a part of this settlement so its case against the exchange and CZ continues. It was well-known in the industry that Binance took some regulatory shortcuts in its rise to power, so this is not entirely surprising.  This article provides a neat timeline of events leading up to this settlement. Hopefully the new CEO Richard Teng can continue on the path started by his predecessor of compliance with basic AML/KYC obligations. It is also interesting and likely smart that Binance tapped a former compliance officer and regulator to lead the new era of Binance instead of the other co-founder who is conspicuously absent from the settlement. Briefly Noted: Coinbase Funded Challenged to Mixing Service Sanctions  Decision Appealed: The decision in the Coinbase funded challenge to the Tornado.cash sanctions have been appealed. As you may recall, back in August the lower court hearing that matter ruled in favor of the Treasury Department and issued summary judgment. The Blockchain Association has filed a brief in support of the Tornado Cash request for appeal. This was a solid article breaking down the decision behind the filing and its implication on the larger industry. Blackrock and Fidelity File Spot Ether ETF Applications: the Blackrock Spot Ether ETF application has officially been filed along with a matching filing from Fidelity. This comes at the same time as the SEC delays deciding on a variety of Bitcoin Spot ETF applications. Lawmakers Send Letters to State Agencies on Digital Asset Issues: Patrick McHenry, Richie Torres, and a bipartisan group of other lawmakers sent multiple letters this the past two weeks including this letter expressing concerns with the proposed IRS digital asset broker reporting rules and this letter urging agencies not to enforce SAB 121 after the Government Accountability Office’s finding that the SAB violated the Administrative Procedures Act. Domain Service Providers Fight over Patent Applications: The Ethereum Name Service (“ENS”) is in a fight with Unstoppable Domains over the aggressive patent application approach taken by the latter. ENS claims these patents are based on prior technology invented by ENS and others and intentionally put into the public domain for all to use. Conclusion: The past two weeks have been a whirlwind of activity in blockchain law, illustrating the complex interplay between cryptocurrency, regulation, and enforcement. From the SEC's latest lawsuit against a major U.S. crypto exchange to Tether's proactive measures in freezing funds linked to criminal activities, these events highlight the evolving landscape of digital finance. The House Financial Services Subcommittee's balanced discussion on the use of digital assets in illicit finance, along with significant legal developments involving major players like Kraken and Binance, underscores the ongoing challenge of ensuring security and compliance in a rapidly changing sector. As the industry continues to grapple with these issues, it becomes increasingly clear that the path forward requires a delicate balance between innovation, privacy rights, and the imperative to thwart financial crimes. The above events serve as a powerful reminder of the importance of vigilance, cooperation, and thoughtful regulation in shaping the future of digital currencies and their impact on global finance. 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.

As expected with Congress on break, the news the past two weeks was dominated by updates in major industry litigation efforts. While there was some action on the House’s stablecoin bill in the wake of the major announcement by PayPal that it released its own fully backed stablecoin, most of the focus has stayed on the Coinbase litigation against the SEC and the SEC’s decision to appeal the adverse rulings against the agency in Ripple. These developments and a few other brief notes are discussed below. PayPal Announces Launch of U.S. Dollar-Pegged Stablecoin, PYUSD: August 7, 2023 Background: As we noted in the Briefly Noted section of the last Bi-Weekly update, on August 7 PayPal announced it would be launching a fully-backed dollar-denominated stablecoin, PayPal USD (“PYUSD”). The planned token is an ERC-20 token, which means it can be transferred to self-custodial wallets, but similar to USDC and USDT, it does have freezing functionality and can be seized. Summary: Due to the follow-up news from Washington D.C. on this hotly debated issue of regulated stablecoin issuers, the Blockchain+ team wanted to provide a more in-depth background on the payment processing giant PayPal entering the stablecoin issuer field. Republicans have used the PayPal announcement to make a renewed push to pass the Clarity for Payment Stablecoins Act in the House. Democrat Maxine Waters was reportedly “deeply concerned” about PayPal’s new stablecoin. This may just be the first of many private stablecoins to come, as the issuer of the PayPal stablecoin, Paxos, is reportedly working on other white label stablecoins as well. Senator Lummis and Others File Amicus in Coinbase Litigation: August 11, 2023 Background: On August 11, there was an expected bevy of amicus filings in Coinbase’s litigation against the SEC, with filings in support of Coinbase coming from Senator Cynthia Lummis, the Blockchain Association, a16z/Paradigm, the Chamber of Digital Commerce, the DeFi Education Fund, and a group of securities law professors. The SEC has until October 3 to file its opposition. Summary: Most of the focus was on Senator Lummis’ brief which argues that the SEC is overstepping its authority by treating all crypto assets as securities, which contradicts legislative efforts in Congress and requires proper legislation. Senator Lummis is the co-sponsor of currently pending digital asset legislation titled the Responsible Financial Innovation Act. The brief's importance lies in its representation of a congressional perspective that challenges the SEC's approach and urges the court to defer to the legislative branch for creating a holistic crypto regulatory framework. While all the briefs are well-written and worth a read, the group of securities law professors’ brief also provides a cogent argument supporting the idea that and “investment contract” requires both an “investment” and “contract” to fall under the Howey test for a scheme. SEC Files Intent to File Interlocutory Appeal in Ripple and Ripple Responds: August 16, 2023 Background: On August 9, the SEC filed a letter request to file a motion for leave to file an interlocutory appeal of the Court’s July 13, 2023 Summary Judgment ruling. On August 16, Ripple responded with its own letter of intent to oppose the SEC’s request.  The SEC was given until August 18 to actually file its motion for leave to appeal with all briefing on the subject to be completed by September 8. The SEC’s arguments largely followed its letter, claiming the Court erred in its ruling regarding programmatic sales and “other distributions” to employees and charitable organizations as securities offerings. Summary: Seeking this interlocutory appeal is an aggressive move from the agency. Many thought the current leadership would be inclined to ride the issue out until trial, knowing that uncertainty would be better than a potential sped up major loss on appeal. For more background on the Ripple decision which the SEC seeks to appeal, read our breakdown on the BitBlog available here. As we noted at the time, the Court’s ruling as to “other distributions” was the most cursory of the decision, and there may be a factual record at play which was the reason for such a terse decision on a major aspect of the litigation. Court Issues Summary Judgment in Favor of Treasury Department in Tornado Cash Matter: August 17, 2023 Background: In September of 2022, Coinbase funded a lawsuit brought by six individuals challenging the U.S. Treasury Department’s sanctions of digital wallets linked to the Tornado Cash smart contracts. On August 17, the Court hearing that matter ruled in favor of the Treasury Department and issued summary judgment against the six individuals. The ruling found that Tornado Cash – a protocol comprised of a set of smart contracts with no formal organizational structure – is a “person” for purposes of the International Emergency Economic Powers Act, and that an “association” can be comprised of any group of people with a common purpose.  It further found that the smart contracts comprising the protocol are property in which that association has an interest even though nobody has ownership of the smart contracts, in part because of the fees generated by transactions on Tornado Cash.  This was one of two major lawsuits challenging the sanctions, the other brought by CoinCenter and still pending in the Northern District of Florida. Summary: Coinbase Chief Legal Officer took to Twitter in the wake of the decision saying “[w]e’ve always known that Fifth Circuit review is required to resolve these issues, and we continue to support them on appeal.” The language from the ruling is fairly expansive and does not seem to be limited to smart contracts of a type that comprise the Tornado Cash protocol. That said, smart contract can memorialize legally binding promises, facilitate the performance of legally binding promises, or may just be executable code having nothing to do with promises (legally binding or otherwise). Not all smart contracts act or should be treated the same. The Court seems to have missed this nuance when claiming all smart contracts are like vending machines (which, to be fair, is an example used by blockchain innovator Nick Szabo in explaining one of the functions of smart contracts). Briefly Noted: Celsius Network Plan and Disclosure Statement Approved for Voting by Creditors:  On August 17, the Bankruptcy Court approved the Celsius Network Plan of Reorganization for it to be voted on by eligible creditors. Please see our Bitblog post setting out the relevant timelines as well as our highlighting the terms of the Plan of Reorganization.  With this approval “Earn” creditors are significantly closer to getting repaid at least some of their claims. Eligible creditors should expect to be getting ballets to vote on the plan in the very near future. It Is important for any eligible to vote as one’s recovery may be impacted on whether a creditor voted. Federal Reserve Announced Program Directed Towards Blockchain: The Federal Reserve has announced a new program to “novel activities” for banks related to crypto-assets, distributed ledger technology, and complex, technology-driven partnerships with nonbanks. This level of advanced supervision for banking partners of the digital asset industry has been troubling to many and raises questions as to the legality of such practices. Bittrex Settles with SEC: Bittrex settled with the SEC and agreed to pay a $25 million fine. The release points out the fact that Bittrex told token issuers to scrub statements regarding promises of future returns and such prior to listing the asset. Of note was the SEC’s focus on Bittrex advising token issuers to remove statements which may induce others to rely on the efforts of others and/or expect profits in their decisions to buy tokens. Creating a “once a security always a security” issue for token issuers who made early marketing foot faults. Coinbase Gets CFTC Approval: Coinbase announced that it has received regulatory approval from the National Futures Association (the self-regulatory body governing the US commodities derivative industry) to operate a Futures Commission Merchant (FCM) to offer and sell crypto futures.  While there are a number of approved FCMs that were born from traditional commodities businesses or broker-dealers, this is the first time a retail crypto exchange operator has received a US FCM license. Prime Trust Files for Bankruptcy Protection: Nevada based cryptocurrency custodian Prime Trust filed for bankruptcy protection on August 15 in United States Bankruptcy Court for the District of Delaware. This filing comes as no surprise as Prime Trust has had a number of problems and setback over last the few months. These problems include Nevada's Financial Institutions Division attempting to take over the company in June by declaring them insolvent as well as a failed transaction where they were to be taken over by BitGo. Prime Trust stated in its filing that it has assets of between $50 and $100 million with liabilities of between $100 and $500 million with between 25,000 and 50,000 creditors. SEC Brings First Charges for Violating new Marketing Rule: The SEC’s first crackdown regarding the relatively new “Marketing Rule” under the Investment Advisers Act relates to a crypto fund manager.  Allegations include that the manager extrapolated three weeks of performance into a full year to get to 2700% hypothetical annualized return under a certain strategy, as well as inconsistent disclosure regarding custody of cryptoassets. A big part of the problem was that the manager allegedly buried disclaimers and assumptions used in calculating hypothetical performance behind embedded hyperlinks.  Just as a friendly reminder, an attorney or compliance professional should review any performance information (including hypotheticals, case studies, projections and track record) included in investment adviser marketing materials, even if it’s a tool located on a website or within an app. Conclusion: Over the past two weeks, major developments in the digital asset industry's litigation landscape dominated the headlines. PayPal's announcement of its new fully-backed U.S. dollar-pegged stablecoin, PYUSD, further ignited the ongoing discussions about regulated stablecoin issuers in Washington D.C. Additionally, Coinbase's litigation against the SEC saw support pouring in from influential entities, challenging the SEC's broader approach towards crypto assets. The SEC's decision to pursue an interlocutory appeal against Ripple and the summary judgment in favor of the Treasury Department regarding the Tornado Cash issue reflect the increasing complexity of the legal environment surrounding digital assets. With significant updates from Celsius Network, Federal Reserve, Bittrex, Coinbase, Prime Trust, and the SEC's enforcement actions, it's evident that the intersection of digital assets and regulatory frameworks is in a state of flux. These developments underscore the importance of attorneys for the digital asset industry to navigate and help shape the ever-evolving legal landscape. 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.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. As the end of the year approaches, the biggest news story was founder of the now defunct FTX cryptocurrency exchange, Sam Bankman-Fried (“SBF”), being found guilty on all counts in the criminal trial brought against him in the wake of the exchange’s collapse. The SEC stayed busy in their digital asset enforcement actions responding in opposition to cryptocurrency exchange Binance’s request for an early dismissal and bringing new actions with the DOJ against the founders and executives involved in the SafeMoon project. But while these allegations of digital asset fraud dominated the headlines, traditional financial firms have quietly begun taking steps to expand their cryptocurrency-backed ETF offerings and the Presidential Executive Order on AI mentioned cryptographic proofs as an essential tool to preserve privacy in an increasingly digital world. These developments and a few other brief notes are discussed below. SafeMoon Founders Hit with DOJ and SEC Complaints: November 1, 2023 Background: The SEC has brought a civil action against SafeMoon LLC and executives Kyle Nagy, John Karony and Thomas Smith for securities fraud and unregistered sales of securities. At the same time, the DOJ has also brought criminal securities fraud, wire fraud and money laundering charges against Nagy, Karony and Smith. Summary: SafeMoon previously faced private securities fraud actions last year, so this is not the first time these founders have faced legal challenges to their project. However, while the SEC has been active in the space, the DOJ has largely refrained from bringing criminal actions except in the most egregious situations and the allegations in the complaints here are serious, even if currently unproven. One important takeaway is the amount of marketing statements that the SEC and DOJ relied on to support their securities fraud claims, underscoring the importance of legal compliance training for social media managers involved in projects. Sam Bankman-Fried Trial Comes to an End; Guilty on All Counts: November 3, 2023 Background: SBF’s defense team closed out their defense on October 31, and the trial reached its conclusion with jury instructions set and closing arguments concluded. After these weeks of litigation, it only took the jury just a few hours to come back with a guilty verdict on all counts. These verdicts carry a maximum sentence of 110 years, with sentencing scheduled for March 28, 2024. There is also still a trial scheduled for next year on five more charges, plus potential state criminal charges to come. Summary: While there is still sentencing left and there will almost certainly be appeals and ongoing actions, it is a relief for the industry to have the SBF saga mostly in the rearview mirror. His fraud was a stain on the digital asset industry, so this seems cathartic for it to be over. As the prosecutor stated in closing “This is not about complicated issues of cryptocurrency. It’s not about hedging. It’s not about technical jargon. It’s about deception, it’s about lies, it’s about stealing, it’s about greed.” Consumer Financial Protection Bureau (“CFPB”) Proposed Digital Wallet Regulations: November 7, 2023 Background: The CFBP has proposed new federal oversight rules for non-banks which provide digital wallet or payment applications. Read the proposed rule and request for public comment here. In the release announcing the proposal, CFPB Director Rohit Chopra stated "Today's rule would crack down on one avenue for regulatory arbitrage by ensuring large technology firms and other nonbank payments companies are subjected to appropriate oversight." House Financial Services Committee Chair Patrick McHenry released a statement vehemently opposing the proposed rule. Summary: The CFPB estimates that this rule will affect 17 non-bank financial institutions, but of course, it doesn’t name those and the definitions are broad enough that this number seems low. Assumedly they only mean to encompass payment processors in the traditional sense without focusing on digital assets, but they expressly include bitcoin transfers as a payment so any company which allows for digital asset transfers would seemingly also fall in these rules. SEC Responds to Binance Motion to Dismiss: November 7, 2023 Background: The SEC has responded to the Motions to Dismiss filed by the various Binance entities back in September. While Binance was sued a day before Coinbase, due to some strategic lawyering from Coinbase’s attorneys, Coinbase has led the way in the briefing on the cryptocurrency exchange litigation. This latest briefing kept with that theme with the SEC largely restating the points they made against Coinbase in its case against Binance. Summary: The SEC predictably led with their arguments that securities laws are intentionally flexible, without stating any actual limiting principal on what separates a security from something that a person subjectively buys with at least some profit motivations (like a car, house, our countless other assets which value largely comes from actors other than the purchaser/owner). Interestingly, on page 47 of the briefing, the SEC seems to have finally backed off its position that ETH is a security, stating BTC and ETH are the “largest crypto assets in existence but [are] not at issue here.” Briefly Noted: Update in Digital Asset Bankruptcies: If you are having trouble keeping up with all the digital asset bankruptcy cases, you aren’t alone. Luckily, Stephen Rutenberg and Michael DiPietro break them all down in their recent publication with David Brill. Highly recommend reading to get caught up on what is happening in these cases and what to look forward to in the upcoming year. ETH Spot ETF Application on the Horizon: Financial giant BlackRock has registered a corporate entity "iShares Ethereum Trust" in Delaware, hinting at the imminent submission of a spot Ether ETF filing. Similar to the spot Bitcoin ETF filings, ETH has been approved to be trading in futures products but this would be the first offering of an ETH spot ETF. It will be interesting if the SEC resists this product, or if in the wake of the Grayscale decision, an approval is granted without needing judicial intervention. President Releases Executive Order on AI: While not directly focused on digital assets, the Presidential Executive Order on Safe, Secure, and Trustworthy Artificial Intelligence did include some focus on digital assets, including listing strengthening “privacy-preserving research and technologies, such as cryptographic tools…” as an area of emphasis. To read more on the Executive Order, check out the Polsinelli client alert on this subject. SEC Notes Difficulty in Recruiting Talent Due to Crypto Divesting Requirements: The SEC cannot find people to hire in crypto because of an Office of Inspector General rule which says an individual cannot own any crypto at all if they participate in crypto enforcement actions. As aptly stated in an article published by Paradigm Policy: you can’t regulate what you don’t understand. DeFi Education Fund Issues Tax Proposal Comment Letter: The DeFi Education Fund issued its tax proposal comment letter which lists all the ways the proposed rules would have potentially unanticipated and disastrous consequences. With over 115,000 comments so far, the IRS has some work to do on these proposed rules. SEC's Staff Accounting Bulletin No. 121 (“SAB 121”) Rejected by GAO: The Government Accountability Office (“GAO”) rejected the SEC’s attempt at rulemaking-without-rulemaking by ruling that SAB 121, which required custodied digital assets be listed as liabilities on balance sheets, failed to abide by the Congressional Review Act. Conclusion: The recent developments in the blockchain and crypto ecosystems illustrate a dynamic and evolving landscape at the intersection of technology, finance, and law. The guilty verdict in Sam Bankman-Fried's trial and the SEC's ongoing enforcement actions, including those against the founders of SafeMoon, underscore the legal complexities and regulatory challenges in the digital asset space. Meanwhile, traditional financial firms expanding their cryptocurrency-backed ETF offerings and the Presidential Executive Order on AI recognizing the role of cryptographic proofs highlight the growing mainstream integration and significance of blockchain technology. These developments, along with others discussed, reflect a pivotal moment in the digital asset industry, balancing regulatory scrutiny with innovative expansion. 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.

Stephen Rutenberg and Michael DiPietro, real estate finance attorneys in the firm's Miami and Wilmington offices, discuss the collapse of major crypto companies like Voyager, Celsius, 3AC, BlockFi, and FTX in 2022, revealing their involvement in crypto asset investments and loans. Read more about the recent crypto insolvencies.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. In a blistering dissent against SEC overreach in digital asset enforcement actions, SEC Commissioner Hester Peirce stated “[the LBRY] case illustrates the arbitrariness and real-life consequences of the Commission’s misguided enforcement-driven approach to crypto.” Polsinelli previously covered the LBRY decision, and Polsinelli attorney Jonathan Schmalfeld is quoted in the dissent, noting the LBRY avoided the questionable fundraising pitfalls of many in the cryptocurrency space at the time and still felt the wrath of the SEC levied against it. However, despite the statements of Commissioner Pierce, the agency has continued in its enforcement agenda the past two weeks. The agency continues to pursue litigation against cryptocurrency exchange Coinbase, and dismissed certain aspects of the ongoing litigation in Ripple to seemingly gain quicker access to appellate review of earlier decisions in that case. There were also important developments in civil cases such as the trademark infringement case brought by Yuga Labs, and an action brought against the owners of the MetaMask wallet technology by certain alleged early developers. The criminal case against FTX founder Sam Bankman-Fried (“SBF”) also continued the past two weeks, with SBF taking the stand in his own defense. These developments and a few other brief notes are discussed below. SEC Dismissing Remaining Claims Against Executives in the Ripple Case: October 19, 2023 Background: The SEC has agreed to dismiss the remaining claims in the agency’s litigation against Ripple regarding the alleged aiding and abetting of securities law violations by Ripple executives Christian Larsen and Brad Garlinghouse. This means the only remaining issues for the underlying case would be measures of damages related to the SEC’s summary judgment win against the company for certain non-programmatic sales. Summary: While Ripple is calling this a win (which it certainly is), the case against the executives was always weak, so it seems like this is just a strategic move by the SEC to allow them to appeal after their request for interlocutory appeal was denied. So when we previously wrote there was “no chance of appellate review prior to 2024 as the SEC hoped for,” that was under the mistaken belief that the SEC would continue to vigorously pursue its case against the executives. In the absence of Congressional action in the near future, which seems unlikely given the House’s current struggles, an appeal of this case seems like the fastest path to anything resembling regulatory clarity. It also shows how motivated the agency is to remove the programmatic sales ruling from the ether. ConsenSys Sued by Former Employees Regarding Transfers of Assets which Devalued Employees’ Equity: October 19, 2023 Background: Joseph Lubin, one of the founders of the Ethereum Blockchain, formed a company in 2014 to develop tools for that network. These tools included the hugely popular MetaMask wallet. As many start-ups do, early contributors were granted equity in the original companies (which were a Delaware entity, and a Swiss “hub” entity”). However, in 2020 The Swiss entity transferred a vast majority of its assets to a new Delaware entity (CSI) in a $46.6 million sale. Even at the time, this was a controversial sale. The employees of the first two entities are now suing, saying this deal was a way to rob them of their equity. Summary: Back in August a similar lawsuit was filed by a former employee, and Joel Dietz also filed a lawsuit in August claiming invention of the MetaMask wallet, so this is another round of expected litigation over a highly successful start-up. Considering CSI raised in a Series D at $7B valuation last year, it is unclear if these are rightfully upset early developers or vultures circling, but time will tell. Either way, the earlier Swiss litigation is going to raise some early jurisdictional challenges for the employees to overcome. Coinbase Files Final Reply in Motion for Judgment vs. SEC: October 24, 2023 Background: Coinbase filed their Reply Memorandum in response to the SEC in what should be the final substantive briefing on the Coinbase Motion for Judgment on the Pleadings. While there may be requests from the parties to supplement their briefings, such as if there is a development in other cases to alert the Court to, this sets the stage for Coinbase’s attempt to gain an early dismissal of some or all of the SEC’s case against them.  Oral arguments on Coinbase’s Motion are scheduled for January 17, 2024. Summary: The Coinbase filing is well-written, but the exchange still faces an uphill battle to get the entire case dismissed at this stage. The briefing does a good job of pointing towards the SEC’s changed stance as to what the word “investment contract” means. However, the SEC names a litany of assets as being “crypto asset securities” and Coinbase concedes that some assets (such as the DAO Report tokens) would be securities which could not be traded on the platform. This means all the SEC had to do was name a single asset which, as plead, could plausibly be an unregistered security listing to survive this Motion for Judgment. Either way, even if Coinbase does not get a complete win on its Motion, even a partial win or a loss which educates the Court on these issues is a step in the right direction for the exchange. Yuga Labs Wins $1.6 Million in Trademark Infringement Lawsuit: October 26, 2023 Yuga Labs, the company behind Bored Ape Yacht Club and owners of the Crypto Punk intellectual property had damages decided in their trademark infringement case against Ryder Ripps and Jeremy “Pauly” Cahen.  Yuga had previously won on all its claims at summary judgment, and a trial was held to determine measures of damages. Yuga was awarded $1,575,362.92 in damages and its attorneys’ fees and costs in an amount still to be determined. Yuag was also granted an injunction over the defendants, which required all the associated domain names, social media accounts, and smart contract controls be handed over to Yuga and to permanently cease infringing on the Yuga trademarks. Tl;dr: Bad day to be an internet troll. The Court through the book at defendants here, in large part due to their conduct throughout the proceeding, stating “Defendants unnecessarily and inappropriately made disgraceful and slanderous statements about Yuga, its founders, and its counsel during litigation, including calling Yuga’s counsel criminals who support racism, antisemitism, beastiality (sic), pedophilia and accusing them of using cartoons to market drugs to young children. These statements were egregious and far exceed the bounds of acceptable conduct.” (internal quotes omitted). The pending appeal for the Rogers test issues which was pursued concurrently with the damages issues being decided in this case was also heard recently, with the judges appearing skeptical of defendants’ claims before ruling in Yuga’s favor. SBF Takes the Stand in Criminal Case Against Him: October 26, 2023 Background: SBF has taken the stand in his defense of the DOJ charges against him.  His first day of testimony largely occurred outside the presence of the jury, with the Court hearing testimony to determine certain pre-trial admissibility motions including details surrounding his proposed advice of counsel reliance testimony. The second day, the jury got to hear SBF’s side of the story on direct exam. As of writing this, the cross examination of SBF has just begun, and we will cover that along with the expected conclusion of the case on the next BitBlog Bi-Weekly  to be published on November 16, 2023. Summary: Most criminal defendants do not take the stand in their own criminal trials for good reason. The Fifth Amendment protects citizens from being compelled into giving self-incriminating testimony. Testifying waives that right, create potential additional charges for perjury, and that testimony can be pointed to by a judge during sentencing if convicted. Here, SBF apparently decided the risk of digging a deeper hole through his testimony was worth the chance he could convince the jury that his mistakes were not made knowingly (i.e., they lacked the requisite level of mens rea for conviction).  Time will tell if this strategic decision works out for the founder of the now-defunct cryptocurrency exchange FTX. Briefly Noted: Treasury Extends Comment Period on Proposed Crypto Reporting Rules: The IRS has extended its crypto tax rule comment period. Industry participants have criticized the proposed rules as unreasonably burdensome and unworkable. Industry group LeXpunK has also developed an AI-enabled tool to facilitate the drafting of comment letters in opposition to certain aspects of the proposed Treasury Regulations. FinCEN Proposed Mixer Designations Released: The United States Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) have published an 80-page proposal arguing that US financial institutions should “implement certain recordkeeping and reporting requirements” on transactions linked to convertible virtual currency mixing. Disproven Narrative on Crypto’s Use in Terrorism Financing Persists: The Wall Street Journal published an article on October 10 titled Hamas Militants Behind Israel Attack Raised Millions in Crypto. Elliptic has said its data was misinterpreted by the Wall Street Journal article, and Chainalysis also released data correcting the record on this issue (Hamas has requested its supporters not donate through digital assets, due to the ease and public traceability of digital asset transfers). Still, the Wall Street Journal article has been cited in multiple letters from legislators recently. dYdX Converts to Public Benefit Corporation: dYdX Trading Inc. has converted its corporate form to a public benefit corporation such that, under its new charter, it will not generate trading fee revenue under v4 of its DeFi trading platform.  As one of the few DeFi platforms that is reportedly incorporated in the United States, we wonder whether this may be an initial step towards being able to utilize any number of exemptions under securities and commodities laws that are available to persons organized exclusively for “religious, educational, benevolent, fraternal, charitable, or reformatory purposes and not for pecuniary profit, and no part of the net earnings of which inures to the benefit of any person, private stockholder, or individual.” If so, is it possible that dYdX (which currently does not allow users located in the U.S.) is looking for an alternative path to open its offering to U.S. persons without registration under SEC and CFTC regulations? SEC Enforcement Direct Gives Remarks: the SEC Director of Enforcement gave some remarks at the New York City Bar Associations’ Compliance Institute focusing on how companies can create a culture of compliance through education, engagement and execution. Firms in regulated industries should ensure they become aware of legal developments (which we can help with if you subscribe to the BitBlog), make applicable employees aware of the rules that might be applicable to them, and proactively executing policies necessary to maintain compliance with the law.  In a lot of areas, the path to compliance is clear; in many others, this is easier said than done in the absence of clear guidance that is supported by the law. Conclusion: The regulatory and legal landscape in the cryptocurrency sector remains both convoluted and volatile. Hester Peirce's outspoken dissent encapsulates a broader sentiment of skepticism towards the SEC's aggressive enforcement strategy, a stance clearly not hindering the agency's ongoing litigation efforts. Civil cases, too, are adding layers of complexity, underscoring the myriad challenges that innovators in the space face. The various unfolding legal sagas—be they criminal cases like that against FTX founder Sam Bankman-Fried or regulatory entanglements involving asset transfers—are emblematic of a sector still grappling with its place in the legal framework. Still, exciting legal and technological developments are occurring every day in the industry, and the attorneys are Polsinelli are excited to continue to assist individuals and entities working in or around the blockchain technology space. 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.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. For the past two weeks, all eyes have been on the trial of Sam Bankman-Fried, the disgraced founder of the defunct digital asset exchange FTX. Of course, it’s only natural for peoples’ attention to be drawn to the biggest alleged financial fraud trial since Bernie Madoff; but the SBF story is more of a story of unchecked power than anything specific to digital assets. While many were focused on that front-page criminal trial, the SEC has been busy the past two weeks as well—to far less media fanfare.  The agency’s request for an interlocutory appeal in Ripple was denied, and it also did not file an appeal in the Grayscale matter signaling potential digital asset financial product approvals in the future. The agency also filed its response to Coinbase’s motion for judgement on the pleadings and had a range of amicus come out in support of its motion. These developments and a few other brief notes are discussed below. Criminal Trial of FTX Founder Sam Bankman-Fried Begins: October 3, 2023 Background: The Sam Bankman-Fried (“SBF”) trial started on October 3, 2023, and is the biggest financial fraud trial since Bernie Madoff. SBF was the founder of the now-defunct digital asset exchange FTX. He is accused of seven counts of fraud, conspiracy and money laundering centering on his alleged use of customer deposits on the crypto trading platform FTX to cover losses at his hedge fund, Alameda Research, and on personal expenses. The trial is expected to last six weeks. Summary: The first two weeks of trial resulted in some headline-grabbing moments, as did the Michael Lewis book “Going Infinite” which follows SBF and was published the weekend before SBF’s trial began. It will be impossible to tell the story of Web3 law in 2023 without mentioning the SBF trial, but this is less a story about cryptocurrency and more a story about standard financial fraud, albeit on a larger scale than most. While we will continue to cover the trial in these updates, we will likely keep the ongoing updates in the Briefly Noted section to not distract from the real developments in blockchain law. SEC’s Request for Interlocutory Appeal in Ripple Denied: October 3, 2023 Background: The SEC was denied its request for an interlocutory appeal at the trial court level, meaning the agency will need to take up its arguments on appeal after the trial on remaining merits issues scheduled for April 23, 2024. This means there is no chance of appellate review prior to 2024 as the SEC hoped for, and there is virtually no chance any decision could reach the Supreme Court before 2026 Summary: The judge in Ripple clarified her Order that a Howey analysis is a facts and circumstances analysis, and her ruling was based on the facts and circumstances specific to this case and not the laws of digital assets generally. Any loss for the SEC is good for the industry at this point. However, there is no way to know if the 2026 or beyond SCOTUS will be made up of justices who are as hostile to agency overreaches as the current SCOTUS is. This leaves lower courts to continue to decide one-off issues until there is Congressional movement, the SEC changes its enforcement strategies or SCOTUS decides the issue in 2026 or beyond. SEC’s Files Response in Opposition to Coinbase Motion for Judgment: October 3, 2023 Background: The SEC has filed their opposition to the Coinbase Motion for Judgment under Rule 12(c). The agency came out swinging, calling the Coinbase argument flawed and attempting to distance itself from prior statements by the agency which seem to contradict its current litigation posture. There were also three amicus filed in support of the SEC—the first from a group of administrative law scholars; the second from the New Finance Institute (which appears to be a blog); and the third from the North American Securities Administrators Association. Summary: The SEC claims in their briefing that both (1) the rights conferred by digital assets are inherent in the code itself (fn. 5); and (2) the SEC is merely there to assure investors receive adequate disclosures (pg. 23). Which is contradictory on its face but does not take digital assets necessarily outside the jurisdiction of the SEC. The agency also claims its briefing in Edward where it said: “‘investment contract’ makes clear that instruments of that name include those in which a return—whether labeled income or profit—is promised in a contract” (emphasis in their briefing) does not mean they were stating a contractual promise is required (fn. 7). That said, despite logical inconsistencies, the briefing is overall strong as could be expected from the top litigators in the agency, so it remains an uphill battle for Coinbase to get a dismissal this early in the case. Amicus Come Out in Support of SEC: October 10, 2023 There were three amicus filed in support of the SEC this week —the  first from a group of administrative law scholars; the second from the New Finance Institute (which appears to be a blog); and the third from the North American Securities Administrators Association. The securities administrators focused on the regulation of digital assets at large, the administrative law scholars focused on major question doctrine issues and the bloggers focused on seemingly just disliking cryptocurrencies generally. Tl;dr: The blogger’s brief is…interesting. It claims that viewing gold as an investment vehicle is incorrect and that the reason there are no cases of an “investment contract” without some contractual arrangement for future work or profits is due to the “base rate fallacy” and not because the SEC is moving the goalpost. It also cites the academic literature of “Wikipedia” and a total of five cases in the briefing.  The administrative law scholars focus on the major question doctrine claiming the doctrine does not apply to agency enforcement actions, even though the Administrative Procedures Act does apply to such situations. The securities regulators of course argue that securities regulations are clear and the SEC’s enforcements have been consistent. In sum, it appears that (as could be expected) the Coinbase amicus with interested industry filers were seemingly stronger than the SEC amicus, as it is rare to see administrate agencies gain support at the trial level for enforcement actions over any industry actors. SEC Lets Appeal Deadline Pass in Grayscale Matter: October 13, 2023 Background: We previously covered the D.C. Circuit’s decision in Grayscale, which found the agency acted arbitrarily and capriciously in denying the Grayscale spot Bitcoin ETF. The Court ruled that there was no basis for the SEC to claim that a Bitcoin Spot ETF would be any more subject to potential manipulation than the Bitcoin futures ETF which had already been granted by the agency. The SEC’s deadline to appeal that decision was October 13, 2023, and the agency apparently decided against filing an appeal in the Grayscale matter, which signals a likely approval for one of the various spot Bitcoin ETFs in the near future. Summary: While the SEC’s failure to appeal the Grayscale matter is an important indicator of the likelihood of future approvals, it does not mean approvals are imminent. It certainly does not help that a recent and since retracted leak of an early approval caused Bitcoin price to quickly rise, only to fall when it was revealed to be false reporting. It is possible the SEC will point to that as evidence of spot market manipulation ability. It is important to note that, at minimum, any decision for approvals or denials on products like a spot Bitcoin ETF would come from a closed meeting of the Commission and is not something that the SEC would delegate this for random approval. Briefly Noted: U.S. Registered ETH Futures Trading Begins: The ETH futures ETF has started trading in the U.S., making it clear that even the SEC does not consider ETH a security, otherwise it would never be allowed to trade in securities markets. The playbook for a spot ETF is clear, with Grayscale again leading the way. SEC Updated Third Circuit on Rulemaking: The SEC sent their Court-mandated update on the status of digital asset rulemaking, and it technically meets the Court’s order but just barely. I can’t imagine this is the expected level of transparency the Third Circuit was expecting when they kept this case on their docket to babysit the agency. Coinbase filed their own reply in response, accusing the SEC of more delays and gamesmanship. California Passes Comprehensive Digital Asset Registration Law: California Governor Newsom has signed the state’s “Bitlicense” bill into law which will go into effect on July 1, 2025. California joins New York as a state with fairly comprehensive regulatory regimes for digital assets. Any companies in the space operating in California should begin working towards compliance now. SEC Includes Crypto Assets on Examination Priorities Report: The SEC released its Division of Examinations Priorities Report outlining the Division's examination priorities for the coming year. Crypto is once again an exam priority for registered investment advisers and broker-dealers. The Division said it will keep monitoring firms and conduct exams "when appropriate," in light of "the continued volatility of, and activity around, the crypto asset markets." Conclusion: In the midst of the high-profile trial of Sam Bankman-Fried and the buzz surrounding the cryptocurrency world, it becomes evident that this legal landscape is evolving rapidly. The SBF trial serves as a stark reminder of the perils of unchecked power, transcending the digital asset realm to illuminate broader issues of financial fraud. Meanwhile, the SEC's recent developments, from the denial of its interlocutory appeal in Ripple to its response in the Coinbase case, hint at the complex and ever-changing regulatory environment for cryptocurrencies. As the legal saga continues to unfold, it is clear that the future of blockchain law will be shaped by these pivotal moments, and we'll be here to keep you updated on these critical developments. 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.

Polsinelli is partnering with the Wall Street Blockchain Alliance for an engaging series of panels and discussions exploring the ever-evolving realm of cryptoassets and their profound influence on the global financial landscape. The Crypto Investors Summit will take place in person on October 23, 2023, at the Players Club in New York. Polsinelli Fintech and Blockchain co-heads, Stephen Rutenberg and Daniel McAvoy will each be speaking on panels related to the regulatory crackdown on crypto and recent crypto bankruptcy. This event is free for Wall Street Blockchain Alliance members and Polsinelli will also be providing CLE for two panels for all qualified attendees. Date: Monday, October 23rd, 2023 Time: 1:00 PM – 6:00 PM Eastern Time Agenda: 1:00 pm - Panel 1 – Exploring the Cryptoasset Market: Current and Future Prospects In this panel, seasoned industry experts will delve into the developments of the past year, the evolving landscape of the crypto market, emerging challenges and opportunities, the tokenized future and the transformative impact on the traditional financial sector in the wake of these events. 2:00 pm - Panel 2 – Navigating the Regulatory Crackdown on Crypto In this session, seasoned industry experts will scrutinize regulatory stances on ongoing activities within the crypto space, industry reactions to these measures, impacts on global banking and the potential evolution of the market to maintain compliance while fostering innovation and expansion. 3:15 pm - Panel 3 - Crypto Insolvencies: Unraveling the Impact of Industry Failures and the Evolving Role of the Bankruptcy Courts Our panelists, representing various stakeholders in these cases, will offer valuable insights and lessons gleaned from these distinctive restructurings within the cryptocurrency realm. 4:15 pm - Panel 4 - The Empire Strikes Back – Legal Updates and Analysis of the SEC’s Cases Against Ripple and Coinbase In this session, a panel of experts will comprehensively examine these cases, scrutinizing the strategies employed by both parties and highlighting the pivotal significance of these cases for the future of cryptoassets in America. 5:10 pm – Networking & Cocktails Panelists: Phil Berg — Chair of Corporate Practice, Otterbourg P.C. David Brill — Former Deputy General Counsel at Voyager; Chair of the WSBA Cryptoasset Working Group Francesca Don Angelo — Deputy General Counsel - Galaxy Digital Samson Enzer — Partner, Cahill Gordon & Reindel LLP Jason Gottlieb — Partner & Chair, White Collar and Regulatory Enforcement, Morrison Cohen LLP Richard Johnson — Chief Executive Officer, Texture Capital Joshua Ashley Klayman Kuzar — U.S. Head of Fintech and Head of Blockchain and Digital Assets, Linklaters LLP; WSBA Board Member Pat LaVecchia — Chief Executive Officer, Oasis Pro Daniel McAvoy — Shareholder, Polsinelli Ron Quaranta — Chairman, Wall Street Blockchain Alliance Stephen Rutenberg — Shareholder, Polsinelli Kayvan Sadeghi — Partner, Jenner & Block LLP Jamie Solano — Partner, Ford O'Brien Landy LLP Robert Stark — Partner, Brown Rudnick LLP

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. Litigation and various digital asset legislative actions moved forward since our last Bi-Weekly update, as the digital asset industry prepares for the sensational (by legally unremarkable) criminal case against disgraced FTX founder Sam Bankman-Fried to dominate the headlines. Binance has moved to dismiss the SEC’s lawsuit against both its foreign and U.S. entities and has gained support for that dismissal effort amongst industry amicus filers. Compound DAO, on the other hand, was unable to obtain the dismissal it sought in a private securities class action. There was also legislative movement, with SEC Chair Gary Gensler on the hot seat in front of the House Financial Services Committee, and members of that Committee submitting a bill to curb SEC’s Staff Accounting Bulletin (“SAB”) 121 which required financial institutions treat digital assets held under custody for third parties as liabilities. **Note: After this post was finalized for publication, there were important developments in the Ripple and Coinbase cases against the SEC. Those developments will be covered in the next Bi-Weekly update to be published on October 19, 2023. These developments and a few other brief notes are discussed below. The Compound DAO Securities Lawsuit Continues After Judge Denies Motion to Dismiss: September 20, 2023 Background: The Compound DAO securities lawsuit was allowed to continue after a Northern District of California judge denied the defendants’ Motion to Dismiss. The named Plaintiffs own less than $100 in the tokens in question, and are also named Plaintiffs in the Intuit and Juul Labs class actions. Compound previously attempted to get the case tossed under the Private Securities Litigation Reform Act. Summary: The Motion to Dismiss focused on the lack of contractual privity between certain Compound partners and the Plaintiffs in this case, who brought their tokens on Coinbase. The Court disagreed, holding that certain statements identified raised a plausible claim to make the partners statutory sellers due to solicitations under the Ninth Circuit standard, which is broader than the solicitation standard used to dismiss claims recently in UniSwap. The Motion to Dismiss standard is an extremely high bar, so this isn’t the end of the road for those defenses available to the defendants in this action. It does, however, create a cloud of liability over DAO participants even when they are neither the issuers nor sellers of the tokens in question. Binance Moves to Dismiss SEC Lawsuit Against Various Entities: September 21, 2023 Background: Binance Holdings Limited (“BHL”) and its founder Changpeng Zhao  (“CZ”) filed a Motion to Dismiss in the SEC case against them. Its U.S. counterparts also filed their own Motion to Dismiss. Both motions stated the secondary trading in digital assets at issue do not meet the “investment contract” standard from Howey, and that the SEC’s overreach into the digital asset industry represents a violation of the Major Questions Doctrine. The U.S. entities also argue that the SEC failed to adequately plead its fraud allegations, and BHL argues that as an international entity it is jurisdictionally immune to most of the SEC’s claims. Summary: The motions follow largely the same format at the motion for judgment raised by Coinbase. The primary arguments are that blind bid-ask secondary sales cannot be seen as an investment into a common enterprise as there is no way to know the money is going to some entrepreneurial effort, that there cannot be an “investment contract” if there is no contractual ongoing obligations on some third party, and that if this definition of “investment contract” is to be expanded to fit those asset classes then Congress must be the entity to do so rather than an administrative agency. The BHL motion also raises interesting jurisdictional challenges, and that the SEC must allege the transactions at issue are not “predominantly foreign” to survive. It will be interesting to see if a Court ever addresses what a website must do to block U.S. users to avoid U.S. jurisdiction, especially given the prevalence of VPNs. This is all occurring while the SEC and Binance continue to exchange jabs in their pending litigation regarding discovery and other issues. SEC Chair Gary Gensler Testifies Before House Financial Services Committee: September 27, 2023 Background: SEC Chair Gary Gensler testified before the United States House of Representatives Committee on Financial Services, largely in an effort to tout his own accomplishments during his time with the agency. These include passing comprehensive private fund rules that very few were asking for (under attack as an overreach by numerous trade groups), proposing climate-related disclosures (which still hasn’t been enacted more than 18 months after originally proposed) and bringing numerous crypto-related enforcement actions (which have been a mixed bag). On the bright side, Gensler reiterated that Bitcoin does not meet the definition of security under the Howey test. On the other hand, he wasn’t willing to commit to saying that Pokémon cards, when tokenized, aren’t securities. Summary: The GOP House Financial Services Committee’s X (Twitter) account pinned this April post to the top of their page ahead of the hearing, which demonstrates where that side of the aisle spent a good amount of their time to question the SEC head. Ire for the Chair wasn’t reserved to the Republican side of the aisle, as Democratic representative Ritchie Torres also expressed his frustration in Gensler’s inability to give a straight answer about what does and does not constitute a security. This confusion and seeming unwillingness to answer basic questions stands in stark contrast with the Chair’s frequently repeated statements that the law is clear on digital assets. Bipartisan Uniform Treatment of Custodial Assets Act Proposed: September 27, 2023 Background: Mike Flood (R-NE), along with French Hill (R-AR), Ritchie Torres (D-NY) and Wiley Nickel (D-NC) have introduced legislation titled the Uniform Treatment of Custodial Assets Act to the House of Representatives. The bill would prohibit certain federal agencies from requiring certain institutions to include assets held in custody as a liability. This is in response to the SEC’s Staff Accounting Bulletin 121 (SAB 121) which would require banks list digital assets they held in custodial services to be kept on the banks’ balance sheets as liabilities. Summary: SAB 121 effectively bans banking providers from providing secure custody of digital assets. If the goal is investor protection, it makes zero sense to make it prohibitively difficult for investors to deposit their assets in a trusted institution. There is no surprise as to the sponsors, as Representatives Flood and Hill have long been digital asset proponents and Representatives Nickel and Torres were two of the six Democrats who crossed party lines to vote for the FIT For 21st Century Act. Briefly Noted: SEC Delays Decisions on Bitcoin ETFs: The SEC has delayed reaching a determination on various Bitcoin Spot ETFs which gives the agency further time to consider the applications. After Grayscale won their appeal of the SEC’s denial for their Bitcoin Spot ETF product, it is unsurprising that the SEC is delaying its determination on these similar projects. SEC Objects to Celsius Bankruptcy Distribution: The SEC has objected to using Coinbase as a service provider in the distribution of Celsius bankruptcy assets. The SEC claims this needs to be done by a registered broker/dealer, but there are not any registered broker dealers for the assets in question, because the issuers of the assets cannot comply with reporting obligations. Circle Files Amicus in SEC v. Binance Arguing Stablecoins Aren’t Securities: Circle has requested the Court in Binance reject the SEC’s attempts to regulate stablecoins as securities, filing an amicus brief on the issue in support of Binance. Circle, as the issuer of popular stablecoin USDC, has a vested interest in the outcome of that issue. Paradigm also filed an amicus brief on the matter, focusing primarily on the securities law arguments. Conclusion: Navigating the convergence of code, smart contracts and US law reveals a dynamic terrain of ongoing legal and legislative developments in the digital asset sector. High-profile legal proceedings involving entities like Binance and Compound DAO underscore the prevailing complexities and regulatory nuances within this evolving ecosystem. Furthermore, legislative undertakings, notably by SEC Chair Gary Gensler and via bipartisan efforts like the Uniform Treatment of Custodial Assets Act, emphasize the continuous, and at times contentious, recalibration of legal frameworks surrounding digital assets and smart contracts. These developments are pivotal, highlighting the inherent intertwining of legal considerations and technological innovations in shaping the future landscape of digital assets within the US legal system. 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.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. Over the past two weeks, several government agencies have expanded their reach into digital assets. Notably, the Commodity Futures Trading Commission (“CFTC”) increased its enforcement jurisdiction into decentralized finance (“DeFi”) providers in potential conflict with the recent ruling in UniSwap as to the liability of protocol developers for actions of their users, and the Securities and Exchange Commission (“SEC”) brought enforcement action against a non-fungible token seller that involved individualized tokens intended to be used as “profile pictures” on social media. There was also important digital asset news coming out of Congress, with Representative Emmer reintroducing his Central Bank Digital Currency (“CBDC”) legislation in the House, and the SEC Chair testifying in front of the Senate Committee on Banking, Housing, and Urban Affairs. These developments and a few other brief notes are discussed below. CFTC Issues Orders Against Operators of Three DeFi Protocols: September 7, 2023 Background: ZeroEx (the developer of 0x Procotol), Opyn, and Deridex all entered into consent judgments with the CFTC after being charged with failing to register as a swap execution facilities and other similar charges. The charges were brought against the U.S. development companies for these DeFi protocols, and all agreed to fines and to implement changes to block access to U.S. users. Commissioner Mersinger was the sole commissioner to dissent to the actions. Summary: Understandably, these entities chose to settle rather than spend funds litigating against the U.S. government. However, Opyn in particular already had geoblocks against access to U.S. users, had no fees on the user-created leveraged futures contract pools in question and very limited powers over the protocol through the developer multi-signature wallet. It is possible that a challenge by one or all of these entities could have limited the CFTC from pursuing these types of primarily extraterritorial enforcement actions, but that is an expensive fight so the industry is left with still unsettled questions regarding the necessary level of geoblocking for protocol developers and when developers of protocols can be liable for actions of their users. LBRY Files Notice of Appeal of Summary Judgment: September 7, 2023 Background: LBRY, Inc. has filed a Notice of Appeal of the final judgment entered into against it on July 11, 2023.  LBRY, Inc. was the developer of a project which aimed to create a Web3 version of YouTube, where individuals could pay in tokens to upload videos, and others could pay to those creators for access to the videos or to tip their favorite creators. LBRY argued that, under the precedent set in United Hous. Found., Inc. v. Forman, security laws do not apply when a buyer purchases an asset primarily to use or consume that asset. The Court disagreed, siding with the SEC and ruling that nothing in the case law suggested to the Court that a token with both consumptive and speculative uses cannot be a security. Summary: We covered the LBRY decision on the BitBlog when it was first issued in November of last year.  After the ruling, the SEC lowered its requested damages from $44 million to just over $100,000 due in large part to the fact that LBRY did not have any further funds to cover a greater damages award. That raises questions as to who will be funding and litigating this appeal, which has the potential to create a powerful and groundbreaking appellate-level precedent. House Majority Whip Tom Emmer Reintroduces CBDC Legislation: September 12, 2023 Background: Majority Whip Tom Emmer reintroduced his legislation, the Central Bank Digital Currency (CBDC) Anti-Surveillance State Act, in the House of Representatives. The bill is co-sponsored by 50 other Republicans in the House. The bill prohibits the Federal Reserve from issuing a CBDC directly to individuals, to prevent surveillance into the personal financial information of Americans. Summary: CBDC’s are hot-button issues, as they are undeniably more efficient than the current system which relies on financial service providers like banks to serve as middlemen between the issuer of currencies and the users of those currencies. However, it also would create a government-controlled single point of financial information which raises obvious security and privacy concerns. It is expected that up to 2% of the global money supply could be tokenized in CBDCs and stablecoins by 2028 so this will remain a hot-button issue as state and private actors determine the best form of digital currencies. SEC Chair Gary Gensler Testifies to Congress on Digital Assets: September 12, 2023 Background: SEC chair Gary Gensler testified in front of the Senate Committee on Banking, Housing and Urban Affairs on September 12. His opening statement is available here. He has a follow-up hearing before the House Financial Services Committee scheduled for September 27. Summary: The big news from the hearing was the statement that the SEC was “still reviewing” the Grayscale spot Bitcoin ETF filing after the D.C. Circuit struck down the SEC’s rejection of the Grayscale application. With the Senate largely seen as behind the House in terms of digital asset legislation, it was not surprising that much of the testimony was focused on other aspects of the SEC, including rulemaking regarding environmental disclosures and mutual fund settlement rules. The House Financial Services Committee is expected to cover more digital asset-specific issues when they question the SEC Chair on September 27. SEC Brings Enforcement Action Against “Profile Picture” NFT Project: September 13, 2023 Background: On September 13, the SEC released a Consent Order for an immediate cease-and-desist along with monetary fines for the creators of the “Stoner Cats” NFT project, through which NFTs were sold to fund the creation of an animated series.  Similar to the prior NFT enforcement action, Commissioners Peirce and Uyeda dissented comparing the sales of the NFTs to sales of Star Wars merchandise. The project creators agreed to settle the dispute without admitting or denying any wrongdoing. Summary: The SEC’s first NFT enforcement action was covered in our last Bi-Weekly update. This most recent action is notable not only because of the names behind the project (Mila Kunis and Ashton Kutcher, among others) but also due to this being the first “profile picture project” named for NFTs which have unique artwork for each token in the collection intended to be used as social media profile pictures. As with any regulation by enforcement, this still leaves questions as to when a product sale is an unregistered security offering as opposed to something more properly under the FTC or other agency’s jurisdictional oversight. Certain aspects of the Order, such as pointing to secondary sales royalties, coordination of verification with secondary sales platforms and the requirement that tokens be “destroyed” rather than prohibited from resale are all potentially problematic features of this Order which could do more harm than good to consumers and artists on a going-forward basis. However, NFT creators should carefully consider how they market their products and how they discuss the use of sales proceeds to avoid potential regulatory pitfalls. Briefly Noted: Industry Groups and Participants Write to Senate Regarding Digital Asset Taxation:  The Wall Street Blockchain Alliance (of which Polsinelli is a member) submitted the following letter to the Senate in response to its request for the appropriate treatment of digital assets under federal tax law. Polygon Labs and others in the industry also submitted letters. New York Department of Financial Services (DFS) Updates Listing Guidelines: DFS announced proposals for new guidance for coin listings and a framework for green listed coins that include heightened risk assessment standards for coin-listing policies and tailored, enhanced requirements for retail consumer-facing products or service offerings, along with new requirements for coin delistings.  Each regulated virtual currency licensee would need to have these policies approved by DFS.  DFS is seeking public comment through October 20.  As most of the major US crypto exchanges are regulated by DFS, either as trust companies or through a “BitLicense”, these guidelines could have a significant impact on what coins get listed.  This also seems to run counter to recent efforts by the New York Attorney General to further regulate cryptocurrencies and label most of them (including Ethereum) as securities under the Martin Act. Ethereum Founder Pushes for Compliant Mixing Services: Ethereum founder Vitalik Buterin released a paper with others titled Blockchain Privacy and Regulatory Compliance: Towards a Practical Equilibrium. It argues for the use of a permissioned mixing service, using zero knowledge proofs to only allow participants who confirm their funds were acquired legally to use the service. IOSCO Issues DeFi Policy Recommendations: The Board of the International Organization of Securities Commissions (IOSCO) issued a consultation report regarding decentralized finance (DeFi). The report was largely written by member organizations, the SEC, so the recommendations largely follow the SEC’s policy recommendations on the subject. Advocacy Group Files Action to Invalidate Oracle Patent:  DeFi Education Fund is petitioning to cancel the patent claiming the invention of oracle-like tech and being used to sue MakerDAO and Compound. You can read a blog post about the challenge here. Conclusion: From the CFTC's actions against DeFi protocols to the SEC's groundbreaking enforcement of NFTs, it's evident that the U.S. government is taking significant steps to gain a better grasp on this rapidly evolving ecosystem. What's more, these activities have set the stage for ongoing debates around digital asset taxation, blockchain privacy, and international policy recommendations. Yet, despite all these regulatory moves, numerous questions remain unanswered. The tension between fostering innovation and enforcing compliance continues to be a pivotal concern. This creates an uncertain environment, not just for entrepreneurs and developers, but also for consumers and investors. As we move forward, one thing is clear: the dialogue between the digital asset industry and regulatory bodies is more crucial than ever. It is this dialogue that will ultimately shape the opportunities and limitations of blockchain technology in the years to come. 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

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. The past two weeks have been big for digital asset issues in courts, with Grayscale winning its appeal to the D.C. Circuit and UniSwap obtaining a dismissal of a proposed class action in front of the same judge hearing the SEC v. Coinbase matter. Coinbase Chief Legal Officer Paul Grewal recently stated “when it comes to protecting the rule of law, the courts remain our last, best hope” in regards to the state of digital asset regulation. It wasn’t all good news for the industry, though. The DOJ brought criminal charges against the Tornado Cash developers, the SEC reached a consent judgment with an NFT issuer, and the IRS issued proposed digital asset reporting rules which could dramatically change how digital assets are exchanged in the United States. These developments and a few other brief notes are discussed below. Criminal Charges Brought Against Tornado Cash Developers: August 23, 2023 Background: The U.S. Attorney’s Office for the Southern District of New York has brought criminal charges against Tornado Cash protocol developers Roman Storm and Roman Semenov for the protocol’s role in allegedly “more than $1 billion in money laundering transactions” including transactions by North Korean hackers known as the Lazarus Group. The Department of Treasury’s OFAC has also now sanctioned Roman Semenov as a Specially Designated Blocked Person. Roman Storm was arrested in Washington, while Roman Semenov remains at large. Summary: This action raises serious Fourth Amendment privacy concerns as well as First Amendment free speech issues regarding the line between protected speech in the form of creating software code and unprotected actions in deploying or using that software code in allegedly illegal ways. The DOJ criticizes the developers for creating help guides on how to best protect their privacy through the protocol, but also criticize the use of the protocol by sophisticated hackers that do not need assistance with navigating a user interface and can interact with the code directly. Coin Center, which is currently funding a lawsuit in Florida challenging the sanctions against the protocol itself by OFAC, came out against the criminal charges. As stated in Bernstein “[v]iewed from this perspective, the government’s efforts to retard progress in cryptography may implicate the Fourth Amendment, as well as the right to speak anonymously.” Fellow developer Alexey Pertsev is still awaiting trial for similar charges on house arrest in Amsterdam. IRS Issues Proposes Rules Regarding Reporting of Digital Asset Transactions: August 25, 2023 Background: The Treasury Department released its long-awaited proposal for digital asset reporting obligations. Miners and validators are not required to submit the new Form 1099-DA for reporting non-employment income from digital assets, but most other participants in the transactions will be required to do so. This includes transactions via DeFi, self-custodial wallet providers, and any entity that in any way “facilitates a digital asset sale on behalf of a customer” even if the transaction is peer-to-peer. These proposed rules will now go through the comment and finalization process and would go into effect in the 2025 tax year with “broker” reporting in 2026. Summary: The proposed regulations define “digital assets” and “broker” in ways which would turn website developers into brokers if the websites "facilitate" digital asset sales. These websites are often just appealing user interfaces which allow people to transact directly with the applicable smart contracts. It then becomes an issue of “how helpful is too helpful”? If one website creates the necessary smart contract inputs and initiates a function to do what a person wants, that website would likely be considered a broker. Whereas if another website is doing the same thing, with the exception that the user is copying and pasting the code themselves, that would likely not be considered a broker. The public comment period for the proposed rules is open until Oct. 30, 2023, and many industry groups are expected to weigh in on these proposed rules. SEC Reaches First Settlement for Unregistered Sales of NFTs: August 28, 2023 Background: On August 28, the SEC brought its first enforcement action against NFT issuer Impact Theory, LLC, charging the company with conducting an unregistered offering of crypto asset securities in the form of NFTs. Without admitting or denying the SEC’s findings, Impact Theory agreed to a cease-and-desist order and agreed to pay a combined total of more than $6.1 million in disgorgement, prejudgment interest and a civil penalty. Summary: This is less about Impact Theory and more about the SEC using a consent judgment to sneak in a new legal theory. This time, the theory is that creator royalties are evidence of a security instrument. Commissioners Peirce and Uyeda dissented to the judgment, stating “[w]e do not routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items.” The reality is this: in any form of sale, if an asset is sold in exchange for an investment of money in a common enterprise, and there is an expectation of profit arising from the efforts of a promoter or a third party, that is most likely a security transaction. However, it seems like the shadow factor of “is this something we traditionally regulate as a security” is grinding away. UniSwap Obtains Dismissal in Southern District of New York Class Action: August 29, 2023 Background: The plaintiffs in this case had been allegedly defrauded with a number of memecoins that were the subject of rug pulls and pump-and-dump schemes to which the plaintiffs gained exposure through Uniswsap liquidity pools. Due to Uniswap’s decentralized and anonymous nature, the plaintiffs were unable to locate the scam artists and tried to go after Uniswap (or more precisely, the Uniswap Foundation, Uniswap Labs, Uniswap’s founder and a couple of investors in the Uniswap ecosystem) instead.  The court granted the defendants’ motions to dismiss after finding that the defendants didn’t have liability under Section 29(b) of the Securities Exchange Act of 1934 or Section 12(a) of the Securities Act of 1933. Summary: Although this is a big win for DeFi, the basis for dismissal had nothing to do with decentralization. Section 29(b) is usually used to nullify provisions of agreements that violate securities laws, or entire agreements if the nature of the agreement itself violates securities laws. The court found that the Uniswap smart contract does not de facto violate securities laws. Section 12(a) allows for a cause of action against “statutory sellers” of a security, which can include a) someone from whom title to the security transfers and b) someone who promotes the sale of the security for pecuniary gain.  The court found that title to the tokens didn’t transfer (at least not from the defendants) as a result of Uniswap’s liquidity pool mechanics and that the defendants didn’t promote the sale transaction, and thus the defendants were not statutory sellers against whom the plaintiffs could bring a cause of action.  The court also mentioned several times that if this has created a gap in securities laws, it should be up to Congress to fill that gap.  We’re not sure there actually is a gap here – plaintiffs could have brought an action against the actual fraudsters; they were just unable to find them. Grayscale Wins Appeal of SEC’s Denial of their Application for a Spot Bitcoin ETF: August 29, 2023 Background: Grayscale won their appeal of the SEC’s denial for their Bitcoin Spot ETF product, with a unanimous ruling from a three-judge panel that the SEC’s denial was arbitrary and capricious. The Court ruled that there was no basis for the SEC to claim that a Bitcoin Spot ETF would be any more subject to potential manipulation than the Bitcoin futures ETF which had already been granted by the agency. Summary: This is more egg on the SEC’s face, with three respected judges of differing political backgrounds all looking at the SEC’s actions towards a digital asset product and deeming the SEC as acting “arbitrary and capricious” which is a high standard to meet. It will be interesting if the SEC uses this decision as a way out of a losing battle, or if the agency finds alternative reasons to deny the Grayscale petition along with requests for similar products from financial giants like Blackrock. It is also unclear if this decision will change the agency’s stance on the ETH futures ETF, which was previously expected to be granted. Briefly Noted: OpenSea “Insider Trading” Defendant Gets Sentenced to 3 Months in Prison:  Nathanial Chastain (“Chastain”), the former OpenSea employee accused of front running purchases of NFTs prior to those NFTs being featured on the OpenSea featured page, was sentenced to three months in prison after being convicted of fraud and money laundering. According to the FBI, Chastain made roughly $50,000 “using his knowledge of confidential information to purchase dozens of NFTs in advance of them being featured on OpenSea’s homepage…”. Ripple Opposes SEC’s Request for Appeal: Ripple filed its opposition to the SEC’s request for interlocutory appeal, claiming the SEC’s attempt to frame the issue as a purely legal issue rather than a fact specific application of law to facts Second Circuit Affirms that Syndicated Loans Are Not Securities: On August 24, the United States Court of Appeals for the Second Circuit, in a unanimous decision, affirmed the prevailing market view that notes representing syndicated loans are not securities. This is a case which the SEC refused to weigh in on, despite being asked to by the Second Circuit.   This case is relevant to the digital asset industry regarding tokenized loan products, as well as to the digital asset market as a whole as an example of an asset class with many of the elements of traditional securities but which does not fall under SEC purview. You can read our recent Bitblog post on the decision here. Conclusion: In a rapidly evolving landscape, the past two weeks have illuminated the complexities of digital asset regulation. From Grayscale's landmark appeal to UniSwap's court victory, the digital asset industry has experienced its share of triumphs. However, the criminal charges against Tornado Cash developers, IRS's proposed reporting rules, and the SEC's actions reveal that not all is smooth sailing. These developments have profound implications for privacy, free speech, and the very architecture of decentralized systems. Paul Grewal's assertion that "the courts remain our last, best hope" is not merely an eloquent statement; it is a sobering reminder that legal engagement is indispensable for the maturation and survival of the digital asset industry. The potential repercussions—whether they concern your tax liabilities, your rights as a developer, or the viability of your investment—underscore the importance of staying abreast of legal developments. Now more than ever, it is crucial to maintain a nuanced, well-informed perspective as we navigate the intricate web of legislation, litigation, and regulatory oversight. Ignorance is not bliss; it's a risk that no stakeholder in the digital asset ecosystem can afford to take. 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.

The $1.4-trillion leveraged loan market1 yet again breathed an immense sigh of relief on August 24, 2023, with the United States Court of Appeals for the Second Circuit’s unanimous affirmation2 of the Southern District of New York’s 2020 Kirschner v. JPMorgan Chase Bank, N.A.3(“Kirschner”) decision.  The latest decision affirmed the prevailing market view that notes representing syndicated loans do not constitute “securities.”4 The leveraged loan market had operated for decades under the assumption that syndicated loans are not securities, but without firm judicial or regulatory certainty as to such assumption.  Although the Second Circuit’s latest decision is not necessarily the final word (or binding law throughout the country), it provides strong legal guidance to the industry that loans are not securities. The historical lack of certainty stemmed in part from the fact that “notes” and “evidences of indebtedness” are enumerated types of securities in the federal securities laws’ “security” definition, leading to a plausible assumption that such instruments are, in fact, securities. Furthermore, under the seminal Howey test,5an instrument is deemed to be a security if it involves an investment of money in a common enterprise with an expectation of profits from others’ efforts. The Howey test could certainly be interpreted to consider a note or syndicated loan to be an investment contract, with the act of syndication itself causing the noteholders to be reliant on the efforts of others and thus an SEC-regulated “security”. Many loan-related products (e.g., letters of credit) exist that are known not to be securities. In recognition of this, in the seminal Reves6case, the U.S. Supreme Court first acknowledged that notes are not necessarily securities,  even though they are specifically included in the Securities Act’s “security” definition. In 1992, in Banco Espanol de Credito v. Security Pacific National Bank7, the Second Circuit Court of Appeals expanded Reves’ ruling in holding that loan participations are not securities. The U.S. Supreme Court refused to address the Banco Espanol ruling on appeal, allowing it to become the law (at least in the Second Circuit) for the past three decades. While Banco Espanol and Reves led to the accepted market practice that syndicated loans are not securities, uncertainty has remained. Some of this uncertainty relates to the fact that in the intervening decades, the syndicated loan market has grown exponentially (particularly in volume of secondary market transactions), leading some to question whether Banco Espanol would still be upheld in light of the resemblance in some ways of the current syndicated loan market to a securities marketplace. Further, Banco Espanol did not expressly address more current types of loan transactions, which are syndicated and involve a purchase and immediate resale to investors. The Case As discussed in our July 2020 advisory8,Kirschner involved a $1.775 billion syndicated loan transaction in which Millennium Laboratories LLC syndicated a term loan to investors. The Kirschner defendants9 had served as arrangers and underwriters in the transaction. Two months after the loan facility closed, Millennium was found liable for violating the Physician Self-Referral (Stark) law and anti-kickback statutes. Millennium also was the target of other proceedings, including a Department of Justice investigation in connection with False Claims Act violations, all of which impacted Millennium’s valuation. In light of such actions and other issues, Millennium filed for bankruptcy protection in New York. After Millennium’s bankruptcy filing, Marc Kirshner, the bankruptcy trustee of the Millennium Lender Claim Trust, filed suit in the United States District Court for the Southern District of New York, alleging securities and other violations. The case considered whether the origination and distribution of a syndicated bank loan were subject to state securities (“blue sky”) laws in California, Colorado, Illinois and Massachusetts. The District Court granted the defendants’ motion to dismiss on the ground that a syndicated bank loan is not a “security.” Sidestepping the Howey test completely, the District Court applied the “family resemblance” test outlined in Reves to determine whether the Millennium notes were securities. Under Reves and its progeny, a note is presumed to be a security unless it bears a strong family resemblance to instruments that are denominated as notes but nonetheless not legally categorized as securities. Mortgage loans, consumer financing loans, accounts receivable factoring agreements, notes evidencing debt incurred in the ordinary course of business (particularly if collateralized) and notes evidencing loans by commercial banks for current operations fall within such category. The four factors of the Reves “family resemblance” test are: motivations that would prompt a reasonable seller and buyer to enter into the transaction; the instrument’s plan of distribution; the investing public’s reasonable expectations; and whether some factors, including the existence of another regulatory scheme, significantly reduce the instrument’s risk, thereby rendering Securities Act application unnecessary10. Ultimately, the District Court concluded (and the Second Circuit court ultimately agreed) that the second, third and fourth Reves test factors weighed in favor of finding that the notes were “analogous to the enumerated category of loans issued by banks for commercial purposes” and, as such, not securities11. Given the determination that the notes at issue in the Kirschner case satisfied three out of the four Reves test prongs, the District Court dismissed the action in May 2020, granting summary judgment to the defendants. For more details as to how the District Court analyzed these factors, please see our 2020 advisory. The Kirschner plaintiff appealed to New York’s Second Circuit, arguing (among other things) that the District Court should disregard the Reves test’s presumption that the loan was a security. Prior to making its decision, the Second Circuit issued an order to “solicit any views that the [SEC] may wish to share” regarding the status of the syndicated term loan notes as securities under Reves. Interestingly, even given the current SEC’s activism, and despite the court’s prodding, the SEC declined to weigh in with its own arguments in the case after indicating a prior intention to file an amicus brief (and procuring extensions on the filing deadline12), leading to speculation that the SEC was unable to muster internal policy consensus to submit an amicus brief that the loans were (or were not) securities (especially given the gravity of a possible policy change).  This is in contrast with the Banco Espanol case, in which the SEC filed a short amicus brief asking the court to rule that the notes were purchased in investment transactions and, therefore, were securities13. Notwithstanding (or maybe due to) the SEC’s lack of amicus guidance in the case, the Second Circuit affirmed the Kirschner’s lower court ruling that the notes at issue were not securities. In particular, the Second Circuit observed that the third prong had been satisfied since the lenders purchasing the notes had to certify that they (a) were sophisticated and experienced in extending credit to entities similar to Millennium, (b) had independently (and without reliance upon any agent or lender, and based on documents and information that they deemed appropriate) made their own appraisal of (and investigation into) Millennium’s business, operations, property, financial and other condition and creditworthiness and (c) made their own decisions to make loans thereunder. The Second Circuit again noted a parallel with Banco Espanol, under which a substantively identical certification was central to the court’s determination that the buyers could not have reasonably perceived the loan participations to be securities. Takeaways From The August 2023 Ruling It is hard to overestimate the profound effect that would come about should syndicated loans be re-classified as securities. Indeed, the market as we know it would cease to exist. The transaction at issue involved a loan facility that was similar to other syndicated loan facilities. If the Second Circuit had deemed such loan a security, it would have been difficult to differentiate it from most other syndicated loans – which could have brought the entire loan market’s operations under SEC scrutiny (thus disrupting the loan markets and likely changing their economics). It also is likely that the structure of the collateralized loan obligation (CLO) market (which currently purchases about 70% of all U.S. syndicated loans issued14) would not transition well to a regulatory environment where loans are deemed securities. Another unintended consequence of classifying notes as securities is the possibility that more borrowers would seek financing from less desirable sources, such as entirely unregulated private lenders. The Kirschner opinions (together with the prior case law) suggest that a transaction’s facts and circumstances will largely determine whether a note will be deemed a “security,” with the application of the Reves family resemblance test to a transaction being analyzed on a case-by-case basis. To minimize the risk of a particular loan becoming considered a security, leveraged loan products should be structured in a manner that is consistent with general principles in the Loan Syndications and Trading Association (LSTA) Code of Conduct and the Reves family resemblance test15. One reason why the leveraged loan market has been able to thrive thus far without being regulated as a security is that loan syndications have steered clear of the retail market and have done a good job of policing themselves. While the Second Circuit’s Kirschner decision was favorable to the loan market, it does not constitute binding precedent for other districts and, therefore, does not create certainty. Accordingly, the characteristics of syndicated loans will continue be analyzed on a case-by-case basis, even in light of the recent decision. That said, the Court’s application of the Reves test rather than the Howey test solidifies the legal consensus that debt instruments should be analyzed using the Reves test. Other industries (in particular “network” or “utility” digital assets) have looked at syndicated loans and the Kirschner ruling with a bit of envy, wondering if digital assets could be structured to similarly avoid SEC scrutiny16. The loan market could be seen as evidencing a historical anomaly, partly based on its resemblance to instruments that are not securities and cannot be compared with other financial instruments. It would be prudent for any industry or asset class that wants to avoid SEC scrutiny to follow the lead of syndicated loans - with a relatively strict code of conduct, few failed transactions and possibly limited retail involvement. The Kirschner reassurance that syndicated loans do not constitute securities could erode as other courts weigh in on this issue and/or other and new financial instruments are tested in court.  For instance, advancement to create efficiencies in the loan market (such as continued automation of the loan trading process, potentially through the use of a blockchain) may require further analysis. It also will need to be clarified whether an instrument with identical characteristics to a syndicated loan would be considered a security simply because the debt is tokenized rather than represented by a note. [1] As of June 30, 2023, according to the Loan Syndications and Trading Association.  See, e.g., https://www.lsta.org/news-resources/2q23-the-dog-days-of-summer/#:~:text=In%20light%20of%20this%2C%20it,2023%20and%202022%20highs%2C%20respectively. [2]Kirschner v. JP Morgan Chase Bank, N.A., No. 21-2726, 2023 WL 5437811 (2d Cir. Aug. 24, 2023). [3]Kirschner v. JP Morgan Chase Bank, N.A., 2020 U.S. Dist. LEXIS 90797 (S.D.N.Y., May 22, 2020). [4] The Second Circuit first analyzed and agreed with the District Court with respect to the lower Court’s jurisdiction over the case pursuant to the Edge Act (§12 U.S.C. 632) based on the engagement by JPMorgan Chase Bank, N.A., in international or foreign banking in connection with the transaction. [5] SEC v. W.J. Howey Co., 328 U.S. 293 (1946). [6] Reves v. Ernst & Young, 110 S. Ct. 945 (1990) (“Reves”). [7] Banco Espanol de Credito v. Security Pacific National Bank, 973 F.2d 51 (2nd Cir. 1992). [8] Court Provides Additional Guidance On When Notes Are Not Securities- The Kirschner Case (July 13, 2020.  https://www.polsinelli.com/publications/court-provides-additional-guidance-on-when-notes-are-not-securities-the-kirschner-case. [9] The defendants were JPMorgan Chase Bank, N.A., JPMorgan Securities LLC, Citigroup Global Markets Inc., Citibank, N.A. and BMO Capital Markets Corp. [10] Reves, 494 U.S. at 67. [11] Banco Espanol, 973 F. 2d 51, 56 (1992). [12] See, e.g., https://www.lsta.org/app/uploads/2023/08/AFR-letter-re-SEC-Punt.pdf. [13] See https://casetext.com/case/banco-espanol-de-credito-v-sec-pac-nat-bank.  The Banco Espanol dissent noted that the SEC had submitted a brief amicus curiae advocating the use of the Howey test rather than the Reves test. [14] As of March 2023, according to Pitchbook. [15] Factors in the Kirschner transaction that could help weigh against classification of the transaction as a “loan” and not a “security,” including the following: (1) the transaction documents language should use the explicit language of loan transactions; e.g., references to “loan” and “lender” throughout the governing documents weighed against classification as a security in Kirschner; (2) the composition of purchasers and potential purchasers that are solicited should be sophisticated, and ideally qualified institutional buyers; (3) parties should consider the minimum hold requirements that preclude retail investors; (4) transfer/assignment restrictions should be at least as stringent as were found in the Kirschner and Banco Espanol loans; and (5) the administrative agent and/or the borrower should have control of who becomes a lender. [16] Certain tokenized loan products have been drafted so as to comply with Reves and its progeny.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. As expected with Congress on break, the news the past two weeks was dominated by updates in major industry litigation efforts. While there was some action on the House’s stablecoin bill in the wake of the major announcement by PayPal that it released its own fully backed stablecoin, most of the focus has stayed on the Coinbase litigation against the SEC and the SEC’s decision to appeal the adverse rulings against the agency in Ripple. These developments and a few other brief notes are discussed below. PayPal Announces Launch of U.S. Dollar-Pegged Stablecoin, PYUSD: August 7, 2023 Background: As we noted in the Briefly Noted section of the last Bi-Weekly update, on August 7 PayPal announced it would be launching a fully-backed dollar-denominated stablecoin, PayPal USD (“PYUSD”). The planned token is an ERC-20 token, which means it can be transferred to self-custodial wallets, but similar to USDC and USDT, it does have freezing functionality and can be seized. Summary: Due to the follow-up news from Washington D.C. on this hotly debated issue of regulated stablecoin issuers, the Blockchain+ team wanted to provide a more in-depth background on the payment processing giant PayPal entering the stablecoin issuer field. Republicans have used the PayPal announcement to make a renewed push to pass the Clarity for Payment Stablecoins Act in the House. Democrat Maxine Waters was reportedly “deeply concerned” about PayPal’s new stablecoin. This may just be the first of many private stablecoins to come, as the issuer of the PayPal stablecoin, Paxos, is reportedly working on other white label stablecoins as well. Senator Lummis and Others File Amicus in Coinbase Litigation: August 11, 2023 Background: On August 11, there was an expected bevy of amicus filings in Coinbase’s litigation against the SEC, with filings in support of Coinbase coming from Senator Cynthia Lummis, the Blockchain Association, a16z/Paradigm, the Chamber of Digital Commerce, the DeFi Education Fund, and a group of securities law professors. The SEC has until October 3 to file its opposition. Summary: Most of the focus was on Senator Lummis’ brief which argues that the SEC is overstepping its authority by treating all crypto assets as securities, which contradicts legislative efforts in Congress and requires proper legislation. Senator Lummis is the co-sponsor of currently pending digital asset legislation titled the Responsible Financial Innovation Act. The brief's importance lies in its representation of a congressional perspective that challenges the SEC's approach and urges the court to defer to the legislative branch for creating a holistic crypto regulatory framework. While all the briefs are well-written and worth a read, the group of securities law professors’ brief also provides a cogent argument supporting the idea that and “investment contract” requires both an “investment” and “contract” to fall under the Howey test for a scheme. SEC Files Intent to File Interlocutory Appeal in Ripple and Ripple Responds: August 16, 2023 Background: On August 9, the SEC filed a letter request to file a motion for leave to file an interlocutory appeal of the Court’s July 13, 2023 Summary Judgment ruling. On August 16, Ripple responded with its own letter of intent to oppose the SEC’s request.  The SEC was given until August 18 to actually file its motion for leave to appeal with all briefing on the subject to be completed by September 8. The SEC’s arguments largely followed its letter, claiming the Court erred in its ruling regarding programmatic sales and “other distributions” to employees and charitable organizations as securities offerings. Summary: Seeking this interlocutory appeal is an aggressive move from the agency. Many thought the current leadership would be inclined to ride the issue out until trial, knowing that uncertainty would be better than a potential sped up major loss on appeal. For more background on the Ripple decision which the SEC seeks to appeal, read our breakdown on the BitBlog available here. As we noted at the time, the Court’s ruling as to “other distributions” was the most cursory of the decision, and there may be a factual record at play which was the reason for such a terse decision on a major aspect of the litigation. Court Issues Summary Judgment in Favor of Treasury Department in Tornado Cash Matter: August 17, 2023 Background: In September of 2022, Coinbase funded a lawsuit brought by six individuals challenging the U.S. Treasury Department’s sanctions of digital wallets linked to the Tornado Cash smart contracts. On August 17, the Court hearing that matter ruled in favor of the Treasury Department and issued summary judgment against the six individuals. The ruling found that Tornado Cash – a protocol comprised of a set of smart contracts with no formal organizational structure – is a “person” for purposes of the International Emergency Economic Powers Act, and that an “association” can be comprised of any group of people with a common purpose.  It further found that the smart contracts comprising the protocol are property in which that association has an interest even though nobody has ownership of the smart contracts, in part because of the fees generated by transactions on Tornado Cash.  This was one of two major lawsuits challenging the sanctions, the other brought by CoinCenter and still pending in the Northern District of Florida. Summary: Coinbase Chief Legal Officer took to Twitter in the wake of the decision saying “[w]e’ve always known that Fifth Circuit review is required to resolve these issues, and we continue to support them on appeal.” The language from the ruling is fairly expansive and does not seem to be limited to smart contracts of a type that comprise the Tornado Cash protocol. That said, smart contract can memorialize legally binding promises, facilitate the performance of legally binding promises, or may just be executable code having nothing to do with promises (legally binding or otherwise). Not all smart contracts act or should be treated the same. The Court seems to have missed this nuance when claiming all smart contracts are like vending machines (which, to be fair, is an example used by blockchain innovator Nick Szabo in explaining one of the functions of smart contracts). Briefly Noted: Celsius Network Plan and Disclosure Statement Approved for Voting by Creditors:  On August 17, the Bankruptcy Court approved the Celsius Network Plan of Reorganization for it to be voted on by eligible creditors. Please see our Bitblog post setting out the relevant timelines as well as our highlighting the terms of the Plan of Reorganization.  With this approval “Earn” creditors are significantly closer to getting repaid at least some of their claims. Eligible creditors should expect to be getting ballets to vote on the plan in the very near future. It Is important for any eligible to vote as one’s recovery may be impacted on whether a creditor voted. Federal Reserve Announced Program Directed Towards Blockchain: The Federal Reserve has announced a new program to “novel activities” for banks related to crypto-assets, distributed ledger technology, and complex, technology-driven partnerships with nonbanks. This level of advanced supervision for banking partners of the digital asset industry has been troubling to many and raises questions as to the legality of such practices. Bittrex Settles with SEC: Bittrex settled with the SEC and agreed to pay a $25 million fine. The release points out the fact that Bittrex told token issuers to scrub statements regarding promises of future returns and such prior to listing the asset. Of note was the SEC’s focus on Bittrex advising token issuers to remove statements which may induce others to rely on the efforts of others and/or expect profits in their decisions to buy tokens. Creating a “once a security always a security” issue for token issuers who made early marketing foot faults. Coinbase Gets CFTC Approval: Coinbase announced that it has received regulatory approval from the National Futures Association (the self-regulatory body governing the US commodities derivative industry) to operate a Futures Commission Merchant (FCM) to offer and sell crypto futures.  While there are a number of approved FCMs that were born from traditional commodities businesses or broker-dealers, this is the first time a retail crypto exchange operator has received a US FCM license. Prime Trust Files for Bankruptcy Protection: Nevada based cryptocurrency custodian Prime Trust filed for bankruptcy protection on August 15 in United States Bankruptcy Court for the District of Delaware. This filing comes as no surprise as Prime Trust has had a number of problems and setback over last the few months. These problems include Nevada's Financial Institutions Division attempting to take over the company in June by declaring them insolvent as well as a failed transaction where they were to be taken over by BitGo. Prime Trust stated in its filing that it has assets of between $50 and $100 million with liabilities of between $100 and $500 million with between 25,000 and 50,000 creditors. SEC Brings First Charges for Violating new Marketing Rule: The SEC’s first crackdown regarding the relatively new “Marketing Rule” under the Investment Advisers Act relates to a crypto fund manager.  Allegations include that the manager extrapolated three weeks of performance into a full year to get to 2700% hypothetical annualized return under a certain strategy, as well as inconsistent disclosure regarding custody of cryptoassets. A big part of the problem was that the manager allegedly buried disclaimers and assumptions used in calculating hypothetical performance behind embedded hyperlinks.  Just as a friendly reminder, an attorney or compliance professional should review any performance information (including hypotheticals, case studies, projections and track record) included in investment adviser marketing materials, even if it’s a tool located on a website or within an app. Conclusion: Over the past two weeks, major developments in the digital asset industry's litigation landscape dominated the headlines. PayPal's announcement of its new fully-backed U.S. dollar-pegged stablecoin, PYUSD, further ignited the ongoing discussions about regulated stablecoin issuers in Washington D.C. Additionally, Coinbase's litigation against the SEC saw support pouring in from influential entities, challenging the SEC's broader approach towards crypto assets. The SEC's decision to pursue an interlocutory appeal against Ripple and the summary judgment in favor of the Treasury Department regarding the Tornado Cash issue reflect the increasing complexity of the legal environment surrounding digital assets. With significant updates from Celsius Network, Federal Reserve, Bittrex, Coinbase, Prime Trust, and the SEC's enforcement actions, it's evident that the intersection of digital assets and regulatory frameworks is in a state of flux. These developments underscore the importance of attorneys for the digital asset industry to navigate and help shape the ever-evolving legal landscape. 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.

In a major step forward for the reorganization of Celsius Network LLC and its affiliated debtors (the "Debtors"), the United States Bankruptcy Court for the Southern District of New York approved the adequacy of the Debtors’ fourth amended disclosure statement and the solicitation and voting procedures for their joint plan of reorganization (the "Plan") on August 17, 2023. The court order (the “Order”) sets forth the key dates and deadlines relating to the confirmation process, such as filing objections, voting on the Plan, and attending the confirmation hearing. The Order approving the disclosure statement can be found here. A hearing on confirmation of the plan is tentatively scheduled for October 2, 2023, at 2:00 p.m. ET. Prior to the confirmation hearing, creditors will have a chance to vote on the Plan and those Creditors eligible to vote will be receiving solicitation materials, likely in the next few days. The Plan that creditors are going to be voting on is substantially the same as the one that we analyzed in our prior post. The following is a summary of some of the key terms contained in the Order and the Solicitation Procedures related to voting and confirmation of the Plan. The Order establishes the following key dates and deadlines for the Plan confirmation process: The Order also approved the Debtors’ Solicitation Procedures, which govern the distribution of solicitation packages and the Plan voting process. The Solicitation Procedures provide for the following: Solicitation packages will include a cover letter, a letter from the official committee of unsecured creditors, the Solicitation Procedures, the applicable ballot form, a notice of claims settlement, the Disclosure Statement and its exhibits (including the Plan), the Order, the notice of the Confirmation Hearing, and any additional court-ordered documents. Solicitation packages will be distributed primarily via email (e.g., for account holders and other holders with email addresses on file). The Debtors will also cause a “push” notification to be delivered via their mobile application to holders of certain claims. Physical packages will be provided upon request. Holders of claims entitled to vote on the Plan may submit their Ballots via (a) the Claims, Noticing, and Solicitation Agent's online voting platform at https://case.stretto.com/Celsius/balloting, or (b) mail or hand-delivery to the Claims, Noticing, and Solicitation Agent at Celsius Ballot Processing c/o Stretto, 410 Exchange, Suite 100, Irvine, CA 92602. Non-voting notices will be provided in lieu of Solicitation Packages for unimpaired claims, claims deemed to reject the Plan, disputed claims, and unclassified claims. On the voting ballot, applicable creditors will have the option to opt out of the settlement, whereby claims are increased by 5% in exchange for waiving fraud claims. Assumption and rejection notices will be provided to contract counterparties. Irregular ballots will be subject to the Debtors' discretion (in consultation with the Committee). Amendments to plan documents will be allowed, subject to Bankruptcy Court approval and notice requirements. One potentially noteworthy revision to the amended disclosure statement is pointing out that the Debtors have yet to settle with the CEL Token Holders and, to the extent that they have not done so by the time of the Confirmation Hearing and the CEL Token Holders vote to reject the Plan, they will look to the Court for guidance.  Repayment to Earn and most other creditors will not take place until after the Plan is confirmed. The Plan provides better treatment for those Creditors who actively vote for the plan, as such creditors should carefully review the Solicitation Procedures and the instructions on the ballot forms before voting on the Plan and consult with their legal advisors regarding their rights and obligations under the Plan. Creditors should also monitor the Debtors' case website at https://cases.stretto.com/celsius/ for any updates or amendments to the Plan, the Order, or the Solicitation Procedures. In particular, if there is any discrepancy in your claim type or amount you should reach out to Stretto, the company, or your legal counsel.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. The past two weeks were filled with legislative activity as members of Congress worked to get digital asset legislation through committees prior to Congress going on its August break. The Securities and Exchange Commission (“SEC”) also had a busy week, bringing charges against Hex Founder Richard Heart, successfully staving off dismissal in the agency’s pending litigation against Terraform Labs, and facing a Motion for Judgement in its case against cryptocurrency exchange Coinbase. With Congress on break, we expect the next few weeks to be primarily focused on the ongoing litigation efforts in the industry with very little movement on the regulatory and legislative fronts. These developments and a few other brief notes are discussed below. House Committees Advance FIT for 21st Century Act After Markup: July 27, 2023 Background: On July 26, the House Financial Services Committee held a hearing to markup the Financial Innovation and Technology (“FIT”) for the 21st Century Act. As covered in prior updates, this is the House’s attempt at comprehensive digital asset market structure regulation. Those hearing materials are available here. After an over seven-hour hearing in the Financial Services Committee and a two-hour hearing in the Agriculture Committee the following day, the bill passed committee review and will now proceed to the full House for consideration. Summary: The Financial Services Committee members voted through the FIT for the 21st Century Act with a 35-15 majority.  6 Democrats of the 23 on the committee voted in favor of the bill. The average age of the Democrats who voted for the bill was 46, while the average age who voted against was 61, marking a stark generational divide on the issue among Democrats. The Agriculture Committee also passed the effort with less fanfare by voice vote. Representative Torres came out in strong support of the bill from the Democrat side, there was expected support from Republicans like Representatives Emmer, Hill, and McHenry, and there was the usual hemming and hawing from both sides of the aisle. Time will tell if the bill has enough support in the House to get consideration from a Democrat controlled Senate. Stablecoin Legislation Clears House Financial Services Committee Amidst Controversy: July 27, 2023 Background: On July 27, the House Financial Services Committee met to markup the Clarity for Payment Stablecoins Act of 2023. The July 27 hearing materials are available here. After a last-minute breakdown in negotiations due to White House concerns regarding the lack of Federal Reserve oversight over state and non-bank stablecoin issuers, the bill proceeded to markup as the original Republican drafted bill to which the Democrats on the Committee strongly objected. Summary: Many expected the stablecoin bill scheduled for markup on July 27 to be a bipartisan effort after Financial Services Committee Chair Patrick McHenry and Ranking Member Maxine Waters signaled being close to agreement on the bill in days leading up to the markup. However, CoinDesk has reported that the White House’s National Economic Council, led by Lael Brainard, resisted reaching an agreement due to the bill not providing federal regulators in a strong enough role in stablecoin issuer oversight. Rather than delaying the bill further until after the August Congressional break, McHenry submitted the bill in its original Republican drafted form for markup. Democrats on committee attempted to stop the proceedings, but the markup went forward. While the bill did pass committee with some Democrat votes, it was certainly a step back in the process while also being a step forward. SEC Charges Hex Founder Richard Heart with Securities Law Violations: July 31, 2023 Background: On July 31, Hex Founder Richard Heart and three unincorporated entities that he allegedly controls were charged by the SEC with conducting unregistered offerings of crypto assets that allegedly raised more than $1 billion from investors. The SEC’s press release announcing the case is available here and the SEC’s Complaint is available here. Summary: Richard Heart (real name, Richard Schueler) is known for his public displays of wealth such as his purchase of a rare ‘Enigma’ black diamond and displays of wealth in social media posts.  The SEC alleges that "Heart called on investors to buy crypto asset securities in offerings that he failed to register. He then defrauded those investors by spending some of their crypto assets on exorbitant luxury goods.” Interestingly, this case is brought by the SEC’s Fort Worth regional office but was brought in the Eastern District of New York. These jurisdictional allegations have raised eyebrows, as one basis for the jurisdiction is Heart’s use of opensource code from Uniswap, the developer of which is headquartered in the Eastern District of New York. While the nature of the allegations makes this seem like a straightforward securities fraud claim, the Complaint placed special emphasis on the protocol’s staking mechanism as being a means through which investors would have an expectation of profits under the Howey test. Terraform Labs Loses Motion to Dismiss in Case Against SEC: July 31, 2023 Background: On July 31, Judge Rakoff in the District Court for the Southern District of New York denied Terraform Labs and its founder Do Kwon’s (“Defendants”) Motion to Dismiss. The Opinion and Order can be found here. The SEC has brought civil claims against Defendants for alleged fraud and sale of unregistered securities in the form of cryptocurrency LUNA, stablecoin UST, and three other types of crypto assets. Summary: Many commentators have focused on the Order’s seeming dissent from the reasoning of fellow Southern District of New York Judge Torre’s ruling in her Ripple Summary Judgment Order which we broke down on the BitBlog here. While that is certainly something worth pointing out, the Defendants in this case brought their Motion to Dismiss under Rule 12(b)(6) as opposed to a Motion for Summary Judgment, so at this stage, Judge Rakoff had to accept all of the SEC’s allegations as true and the Howey test is an inherently fact-intensive standard for dismissal. However, a less discussed portion of the ruling is the Court’s denial of Defendants’ Major Questions Doctrine defense. In it, the Court held the Major Questions Doctrine only applies if the industry in question resembles in political and economic significance of prior Supreme Court cases on the issue such as the tobacco industry at issue in FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120 (2000). With proper factual record, Defendants may be able to establish that digital assets in the United States are as economically significant today as tobacco was in the United States in the early 2000’s. Coinbase Files Motion for Judgment on Pleadings in Case Against SEC: August 4, 2023 Background: As we covered in a prior update, on June 28, Coinbase filed its Answer early and a letter of intent to move for Judgment on the Pleadings in the SEC’s lawsuit against the popular cryptocurrency exchange. On August 4, Coinbase filed their Rule 12(c) Motion for Judgment on the Pleadings. Amicus briefs in support of Coinbase’s motion are due on August 11, and the SEC has until October 3 to respond. Summary: Coinbase’s arguments predictably focused on the Coinbase claim that none of the digital assets sold on its exchange are “investment contracts” under Howey and thus are not securities.  While Ripple presented an “essential ingredients” argument in its litigation, Coinbase took a more subtle approach arguing that an “investment contract” requires both an investment and a contract, and the SEC’s attempt to read out “contract” from the test is an impermissible expansion of Howey. Coinbase also raised a Major Question Doctrine defense, which may be an extension of Coinbase’s strategy when it brought its separate mandamus action against the SEC asking for either approval or denial of the exchange’s request for rulemaking for digital assets. It can be expected that many of the mandamus amicus filers will similarly focus on the investment contract and Major Question Doctrine arguments in their supporting filings in this matter rather than Coinbase’s other arguments regarding its digital wallet and staking services. Briefly Noted: IRS Issues Guidance on Taxation of Staking: The US Internal Revenue Service (IRS), via Revenue Ruling 2023-14, issued formal guidance providing that cash-method taxpayers must report staking income as current gross income as of the date and time at which it is reduced to undisputed possession.  This is consistent with the position the IRS took in Jarrett v. US, where the plaintiffs argued that staking was more akin to baking a cake and the income should only be realized when the rewards are subsequently sold.  That case was eventually rendered moot when the IRS voluntarily refunded the plaintiffs the disputed taxes. While the Revenue Ruling mentioned slashing, it did not address the tax treatment of slashing. SEC Warns Accountants About Digital Asset Audits: The SEC’s Chief Accountant issued a warning for accounting firms against “The Potential Pitfalls of Purported Crypto ‘Assurance’ Work” in recent guidance. Commissioner Hester questioned the purpose of this guidance on Twitter. Binance Files Motion to Dismiss in Case Against CFTC: In addition to the SEC’s case against Binance we previously covered, the exchange is also facing a lawsuit filed by the CFTC currently pending in the Northern District of Illinois. On July 27, Binance filed a Motion to Dismiss in that CFTC case, claiming the CFTC’s lawsuit suffers from jurisdictional defects and improperly alleges extraterritorial conduct as the basis for this U.S. lawsuit. SEC Requires Reporting Companies to Report Data Breach Incidents: Our data breach team at Polsinelli broke down the new reporting obligations under the SEC’s recently published rule. It is unclear how companies with digital asset exposure will need to report things like token or protocol specific code exploits and if those are “breaches” under this new policy. PayPal Announces Stablecoin Launch: PayPal announced the launch of PayPal USD (“PYUSD”), a stablecoin pegged to the U.S. dollar and 100% backed by U.S. dollar deposits, short-term U.S. Treasuries, and similar cash equivalents. “PayPal USD will be available to consumers, merchants and developers to seamlessly connect fiat and digital currencies” according to the company’s press release. As an ERC-20 token, PYUSD will be transferable to external digital wallets. Conclusion: With the current regulatory uncertainty and Congress now on break, it should be no surprise that litigation will dominate the news for the $2 trillion digital asset industry. With limited time left in the Congressional calendar to push through legislation, it is looking to be another year where the industry is left to take its direction primarily from regulatory and judicial actions. In the ever-shifting legal landscape of blockchain and cryptocurrency, understanding and navigating the complexities can be a daunting task. The recent developments highlighted here underscore the importance of remaining vigilant and informed. Whether you are an individual investor, a burgeoning startup, or an established entity within the industry, these changes may impact your operations and strategic decisions. For stakeholders at all levels, seeking appropriate legal guidance and keeping abreast of regulatory shifts is not just beneficial but essential. As the industry continues to evolve, its intersection with law and governance will undoubtedly remain a critical and compelling facet of Web3. 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.

Introduction After multiple delays, on June 27th, Celsius Network, LLC and certain of its affiliates as debtors and debtors in possession (collectively, the “Debtors” the “Company”or “Celsius”)filed a disclosure statement to provide creditors and other parties in interest with information regarding the Debtors’Joint Chapter 11 Plan of Reorganization of Celsius Network LLC and Its Debtor Affiliates (the “Plan”). The court has set the hearing to approve the Disclosure Statement for August 10th. The Disclosure Statement, which we summarize below, contains projected recoveries for creditors under the scenario of a “NewCo Transaction” and also an alternative “Orderly Wind Down” scenario if the NewCo Transaction cannot be consummated. Additionally, since the filing of the Disclosure Statement the Company has entered into a few settlement agreements which hopefully will pave the way to the end of this case and a recovery for creditors. The Chapter 11 Bankruptcy Process A bankruptcy case voluntarily initiated by a company under Chapter 11 of the United States Bankruptcy Code, with the hope or intent to emerge as a going concern, is frequently referred to as a "reorganization" bankruptcy. In Chapter 11 cases, the debtor remains “in possession”, and has the powers and duties often granted to a trustee under other bankruptcy regimes. The debtor may continue to operate its business in the ordinary course; however, for any material transactions such as taking on post-petition debt or the sale of assets outside of the ordinary course of business, bankruptcy court approval is required.  During the bankruptcy process, creditors generally cannot proceed with foreclosure or other enforcement actions. This broad, statutory injunction (commonly referred to as the “automatic stay”) aims to give the debtor breathing room to plan an effective reorganization of its business, which will provide the maximum recovery for all stakeholders. Furthermore, in Chapter 11 cases, the debtor has an exclusive period to file and solicit a plan of reorganization. Once a plan is proposed, creditors whose rights are affected are entitled to vote on the plan. If a sufficient number of creditors (often organized into separate “classes” based on the nature and priority of their claims) vote to accept, then the plan may be confirmed by the court so long as it satisfies other legal requirements. Importantly, unless the exclusivity period expires, other parties in interest have no ability to propose a competing plan of reorganization. At this moment in the Celsius case, the Disclosure Statement has been submitted for approval but has not yet been approved by the Bankruptcy Court. Accordingly, the current draft of the Disclosure Statement is subject to revision and may ultimately be rejected by the Court at the upcoming hearing. NewCo Transaction: Plan Proposed by the Debtors and Creditors Committee Prior to filing the Plan and Disclosure Statement, the Debtors entered into an agreement with the Fahrenheit Group (“Fahrenheit”), which would allow Fahrenheit to become a plan sponsor with the goal of providing the Debtors with funding and operational expertise. The agreement with Fahrenheit will allow the Debtors to enter into a restructuring transaction with a new company, which the Debtors allege will maximize the recovery for stakeholders.  According to the Debtors, if they were to sell all assets (including their cryptocurrency assets) now, the recovery for creditors will be far lower than if a new entity is set up to continue to operate certain aspects of the Debtors’ businesses. Specifically, the Debtors argue that the Plan provides for “(a) the distribution of a significant amount of the Debtors’ Liquid Cryptocurrency to creditors on or around the Effective Date of the Plan, and (b) the creation of NewCo —a new public-reporting, compliant entity, which will be owned by the Debtors’ customers when the Debtors exit bankruptcy. NewCo will be governed by a board of directors, a majority of which will be appointed by the Debtors’ creditors. NewCo intends to be engaged in two business lines: Mining and Staking.” Expected Recovery Under NewCo Transaction Through the NewCo transaction, the Debtors believe that creditors will receive some form of the following three types of distributions: (a) Liquid Cryptocurrency (namely, BTC and/or ETH); (b) NewCo Common Stock; and (c) Litigation Proceeds. a.  Liquid Cryptocurrency Under the plan, the Debtors will distribute either BTC and/or ETH to creditors. The Debtors have estimated that the total amount of cryptocurrency to be distributed to creditors is approximately $1.98 billion. However, due to price instability, the recovery estimated by the Debtors is subject to change depending on the value of the Cryptocurrency as of the Effective Date. Creditors will receive further details on their distributions in a revised form of disclosure schedules, once the Debtors finalize their agreement with the distribution agent. b. NewCo Common Stock Additionally, the NewCo transaction aims to provide certain creditors[1] with a distribution of NewCo common stock. The Debtors intend to list NewCo stocks on NASDAQ. Therefore, once the creditors receive their NewCo common stock distributions, they can (a) hold their shares in NewCo, or (b) easily sell their stake in NewCo via a liquid public marketplace. The creditors entitled to NewCo stock will receive their pro rata share of stock regardless of whether they voted to accept the Plan, reject the Plan, or abstained from voting on the Plan altogether. Holders that vote to accept the plan may indicate a preference to receive a greater share of the NewCo common stock in lieu of their share of the “Liquid Cryptocurrency”. Alternatively, creditors entitled to NewCo stock that vote to accept the Plan may request to receive a greater share of Liquid Cryptocurrency distribution in lieu of their NewCo Common stock. c. Litigation Proceeds The Litigation Proceeds represent certain anticipated rights to litigation claims that the Debtors have against third parties including former executives of the Debtors. The Debtors will establish a Litigation Administrator and a Litigation Recovery Account. The Legal Administrator will litigate against former directors of Celsius including Alex Mashinsky, and Shalomi Daniel Leon. Additionally, the Litigation Administrator will also pursue the claims that the Debtors have against third parties. The potential litigation proceeds have not been valued while calculating the estimated recovery under the NewCo transaction anticipated by the Plan. As such, the litigation proceeds are supplemental to any projected recoveries for the holders of the claims entitled to a share of the litigation proceeds. Orderly Wind Down: A Backup Plan In the event that the NewCo transaction is not approved by the creditors, the Debtors have proposed an alternative, which they are calling the “Orderly Wind Down Plan.” The Orderly Wind Down plan will be conducted on the terms set forth in the Backup Plan Sponsor Agreement that the Debtors have negotiated with the Backup Plan Sponsor. The Backup Plan Sponsor is the Blockchain Recovery Investment Consortium, which includes Van Eck Absolute Return Advisers Corporation and GXD Labs LLC (collectively, “BRIC”). Alternatively, the backup plan may be on terms that provide a better recovery to the Debtors’ creditors than the Backup Plan Sponsor Agreement, which terms may utilize a different Backup Plan Sponsor than BRIC The BRIC transaction anticipates providing recoveries to creditors in the following ways: “(a) 100 percent of the equity interests in a publicly traded mining business with a potential management contract with GXD Labs LLC; (b) a Liquid Cryptocurrency distribution on or as soon as practicable after the Effective Date; and (c) a timely monetization of the remaining assets of the Debtors’ Estates and subsequent Liquid Cryptocurrency distributions to creditors from the proceeds thereof, likely through the creation of a liquidating trust.  Exhibit A provides for the estimated recovery under the Orderly Wind Down Plan. Who is eligible to vote on the Plan? The Debtors’ Plan categorizes various creditors who are entitled to receive distributions into different “classes”. Whether a Creditor is eligible to vote on the Plan is contingent on which class they belong to. This system of voting is allowable pursuant to section 1122 of the Bankruptcy Code. There are 16 classes in total. Pursuant to the Debtors’ current proposed Plan, the classes that are eligible to vote are Class 2, Class 4, Class 5, Class A, Class 7, Class 8, and Class 9. (the “voting classes”).  The next section explains what these classes are and what type of claims and interests are in that particular class. Types of Voting Classes: What Class do I belong to? The following Classes will be permitted to vote on the approval of the plan: Class 2 - Retail Borrower Deposit Claims Retail Borrowers are the account holders that have borrowed money from the Debtors. As a Retail Borrower, to be able to borrow from the Debtors, the creditors had to deposit cryptocurrency with the Debtors.  Creditors in this class have claims against the cryptocurrency that they transferred to the Debtors while borrowing from the Debtors. Therefore, if you deposited Crypto Currency with the debtors, and in exchange, borrowed money from the Debtors, your claim will likely fall within Class 2. Class 4 - Convenience Claims A Creditor will have a convenience claim if the aggregate monetary value of the claims of such creditor is greater than $10 and less than or equal to $5000.[2] Creditors also have the option to opt for Convenience Claims even if they exceed the threshold. Therefore, if the total monetary value of your claim is more than $10, but less than $5,000, your claim will likely fall within Class 4. Class 5 - General Earn Claims Creditors that participated in the Debtors’ “Earn Program” fall within Class 5 General Claims. The Earn Program is a program through which the Debtors’ account holders could earn rewards in exchange for transferring their cryptocurrency to the Debtors pursuant to Section 4D of the Debtor’s General Terms of Use. Therefore, if your claims relate to your participation in a rewards program while exchanging or transferring cryptocurrency with Celsius, your claim will likely fall within Class 5. Class 6A - General Custody Claim Creditors that have a general custody claim are creditors that used the Debtors’ services to store cryptocurrency on the Debtors’ platform. The General Custody Claims class covers all the cryptocurrency that is not eligible for withdrawal under the Custody Settlement Order issued by the Bankruptcy Court in March, which approved a settlement agreement giving Celsius custody account holders the right to receive 72.5% of their crypto-based claims. Therefore, if you had deposited cryptocurrency with Celsius, and your cryptocurrency was not eligible for withdrawal under the Custody Settlement Order, your claim will likely fall within Class 6A. Class 7 - Withhold Claims If a creditor attempted to transfer cryptocurrency in jurisdictions where the Debtors did not provide a Custody Program, such transfers were held in “Withhold Accounts”. Withhold Claims comprise all claims arising out of the attempted transfer of cryptocurrency held in Withhold Accounts. Similar to the General Custody Claims class, this class of claims also consists of cryptocurrency that is not eligible for withdrawal under the Custody Settlement Order. Class 8 - Unsecured Loan Claims Unsecured Loan Claims are essentially the claims arising out of agreements under which the Debtors are a borrower and which loan is not secured by any lien or any property interest of the Debtors. Therefore, if you lent money to the Debtors without any form of collateral/security, you likely have an Unsecured Loan Claim. Class 9 - General Unsecured Claim Put simply, the General Unsecured Claims class consists of all Unsecured Claims that have not been specifically classified by the debtors. The Plan specifically notes that no “Account Holder Claims” will be in this class, thus your claim will only fall into this class if it is unsecured and does not meet the definitions of any other class categorized by the Plan. How are Claims Valued under the Plan? All Claims under the plan relating to cryptocurrency associated with the Earn Program and Withhold Accounts — Class 4 Convenience Claims, Class 5 General Earn Claims, and Class 7 Withhold Claims—are valued based on the dollar value of the applicable cryptocurrency that underlies such Claims on the Petition Date. Projected Recovery Under the NewCo Transaction: Currently, the Debtors’ Plan anticipates creditor recoveries pursuant to the NewCo Transaction totaling:   86.9% for Holders of Retail Borrower Deposit Claims   70% for Holders of Convenience Claims;   69.7% for Holders of General Earn Claims;   72.5% of the Cryptocurrency coins for Holders of General Custody Claims (creditors who accept the Custody Settlement as described further herein); and   74.2% for Holders of Withhold Claims. It is crucial to emphasize that the percentages mentioned above are not a definitive representation of the actual amounts’ creditors will receive under the Plan. Rather, they serve as an indication of what the Debtors anticipate the potential recovery to creditors might be if the NewCo transaction is successfully executed. It may be relevant that these numbers are being provided by the Debtors in an effort to obtain approval of the Plan and that the claims are currently not trading near this price. Furthermore, it is important to note that the value of NewCo common stock in the secondary market and the potential “Litigation Proceeds” are subject to uncertainty and cannot be accurately predicted. Class 2 - Retail Borrower Deposit Claims Creditors belonging to Class 2 are expected to recover 86.9% of their claims and to receive a combination of cryptocurrency, NewCo Common Stock, and Litigation proceeds. Class 2 claim holders, specifically retail borrowers of Celsius who deposited their cryptocurrency in exchange for a loan, will undergo Set-Off treatment. This means that the amount owed to Celsius will be deducted from their total claim against Celsius. Consequently, Class 2 – Retail Borrower Deposit Claims will not have any outstanding debt to Celsius and will not be required to repay their loan. After the set-off is applied, these claims may receive a combination of (a) Liquid Cryptocurrency (in the form of BTC and ETH), (b) NewCo Common Stock, and (c) Litigation Proceeds. However, if the post-set-off claims qualify for the Convenience Class Distribution discussed above, the creditors will only receive Liquid Cryptocurrency. Exhibit B provides an illustrative example demonstrating the potential recoveries that an account holder with a Retail Borrower Deposit Claim might receive for their Retail Borrower Claim if the NewCo Transaction is successfully completed. Class 4 — Convenience Claims. Creditors belonging to Class 4 are expected to recover 70% of their claims. Holders of claims in this class will receive their recovery in the form of Liquid Cryptocurrency. Exhibit C provides a reference to understand the treatment outlined by the Plan for holders of Convenience Claims, including their rights and instructions for voting to accept or reject the Plan. Class 5 — General Earn Claims. Creditors belonging to the General Earn Claim are expected to recover 69.7% Of their claims. Class 5 Creditors will receive Liquid Cryptocurrency, NewCo Common Stock, and Litigation Proceeds. Creditors in Class 5 will be categorized as “Unsecured Claim Distribution Consideration recipients”. As a result, they will receive a combination of the following: (a) Liquid Cryptocurrency (in the form of BTC and/or ETH), (b) NewCo Common Stock, and (c) Litigation Proceeds. Exhibit E below illustrates a potential recovery scenario for holders of General Earn Claims if the NewCo Transaction is successfully executed. Class 6A — General Custody Claims. Creditors belonging to Class 6A are expected to recover 72% of their claims. Holders of claims in this class will likely receive Liquid Cryptocurrency. As previously stated, the Bankruptcy Court issued a settlement order pertaining to General Custody Claims. Holders of General Custody Claims are given the chance to partake in the Custody Settlement by voting in favor of the Plan.  Exhibit D presents a table showcasing a potential recovery scenario under Class 6A. Class 7 — Withhold Claims. Account holders who have a "Withhold Account" are likely to have either a Withhold Claim or a Convenience Claim, with the determination dependent on the total amount of their claim. Estimated recovery for Withhold Claims - if the creditors vote to participate in the Settlement Order is 74.2%. Class 7 Creditors will receive Liquid Cryptocurrency, NewCo Common Stock, and Litigation Proceeds. If the value of the claim at issue is less than or equal to  $5,000, it will be classified as a Convenience Claim. As previously mentioned, Custody Claims bear similarities to Withhold Claims. Consequently, holders of a Withhold Claim have the opportunity to participate in the Withhold Settlement by voting in favor of the Plan. By choosing the Withhold Settlement, account holders will be entitled to receive an in-kind distribution equivalent to fifteen percent (15%) of the value of their Withhold Distribution Claims. Moreover, the remaining eighty-five percent (85%) of the Withhold Distribution Claim will be treated as a General Earn Claim. The Plan refers this to as “Treatment A”. However, in the event that the majority of Class 7 does not vote in favor of accepting the Plan, regardless of an individual's own vote to accept Treatment A or the Withhold Settlement, they will not be granted Treatment A under the Plan. Instead, all Class 7 members, regardless of their vote, will receive Treatment B. Treatment B entails their claim being treated on an equal footing with a General Earn Claim. The table in Exhibit F provides illustrative examples of potential recoveries that a Holder of a Withhold Claim might receive for their Withhold Claim if the NewCo Transaction is completed, based on two scenarios: (a) Class 7 voting to accept the Plan, or (b) Class 7 voting to reject the Plan. Exhibit F provides a summary of the various types of distributions entitled to each voting Class. Conclusion and Other Settlements In anticipation of the August 10, 2023 hearing, a number of objections to the Disclosure Statement have been filed. Many of these objections are from individual creditors. Additionally, over the last few weeks, the Debtors have agreed to a number of other settlement agreements which will hopefully pave the way for creditors to be paid in an efficient manner. The Debtors have also requested approval of a proposal aimed at resolving a class action fraud claim against the company and other fraud claims. The claim was filed by the unsecured creditor’s committee on behalf of around 600,000 Celsius customers who alleged they were deceived into depositing their cryptocurrency with Celsius through fraud and misrepresentation. Additionally, many of the proofs of claims filed by creditors listed additional fraud allegations. The proposed settlement suggests that customers can add 5% to their Chapter 11 recovery if they agree to drop claims regarding alleged fraudulent inducement to deposit cryptocurrency with Celsius. The Debtors and the Creditors Committee jointly submitted the settlement motion, stating that it would result in significant cost savings and expedite the return of cryptocurrency to customers. The settlement does not apply to "Custody" account holders who previously reached a separate deal with Celsius. The option to opt out of the settlement and pursue individual proofs of claim against the company is also provided to account holders. The Debtors have also agreed to a settlement with the Federal Trade Commission. [3] As part of this settlement, the Debtors have agreed to pay a record $4.7 billion fine. Finally, the Debtors have agreed to a settlement with “Borrow claim holders” who gave cryptocurrency collateral in order to borrow funds. Pursuant to the settlement, such claim holders will be able to receive a portion of the collateral netted against any outstanding cryptocurrency loans, along with shares of NewCo. [1] These creditors include those with claims classified in the following classes under the Debtors’ proposed Plan: “Retail Borrower claims, Convenience Claims, General Earn Claims, Withhold Claims, Unsecured Loan Claims, General Unsecured Claims”. [2] Creditors who have a “General Custody Claim” or “Retail Borrower Deposit Claim” under the Plan will not be classified as holding a Convenience claim. [3] https://www.ftc.gov/news-events/news/press-releases/2023/07/ftc-reaches-settlement-crypto-platform-celsius-network-charges-former-executives-duping-consumers.

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. In the wake of the summary judgment decision in SEC v. Ripple, legislators and litigants have rushed to clarify what the SEC’s first loss against a digital asset issuer means for the larger Web3 industry in the United States. This Ripple decision spurred congressional calls for an updated digital asset regulatory framework. Multiple legislative efforts are underway, including reintroducing the Responsible Financial Innovation Act in the Senate, to bring financial innovations under consumer protection norms. Senators also proposed the Crypto-Asset National Security Enhancement and Enforcement Act to extend the Bank Secrecy Act to certain digital asset transactions, stirring debates on its potential to criminalize software publishing. Lastly, the House introduced the Financial Innovation and Technology for the 21st Century Act, a comprehensive law proposal developed after extensive hearings, marking significant legislative progress in the digital asset space. These developments and a few other brief notes are discussed below. Summary Judgment in SEC v. Ripple Sends Shockwaves Through Industry: July 13, 2023 Background: On June 13, a Motion for Summary Judgment Order in the SEC v. Ripple case was released, with a ruling many in the industry have been advocating for: “XRP, as a digital token, is not in and of itself a contract, transaction, or scheme that embodies the Howey requirements of an investment contract.” (internal quotes omitted). This wasn’t a complete win for Ripple, as over $700 million in contractual sales to institutional investors were ruled to be unregistered securities transactions. But for “programmatic sales” through digital asset exchanges, the Court ruled that buyers did not understand objectively that their funds would go to Ripple to increase the price of XRP, so those were not deemed to be securities transactions. Summary: We provided a full breakdown of the case and the Court’s Order in an article on the BitBlog, which you can read here.  The Court rejected the Ripple “essential elements” arguments and fair notice defense (for institutional sales). However, the Court went on to apply the Howey transaction-by-transaction analysis and reached a determination that some transactions involving the XRP token were securities sales in their totality, and some were not. This ruling has led members of Congress to call for renewed efforts toward creating a workable digital asset regulatory framework in the United States. Senate Digital Asset Legislation Reintroduced: July 14, 2023 Background: On July 14, the Lummis-Gillibrand Responsible Financial Innovation Act (“RFIA”) was re-introduced into the Senate, after failing to get past committee last Congressional session. Senator Lummis tweeted an infographic describing what is new in this version of the legislation. The revised RFIA maintains much of the broad scope of the 2022 version but is updated to reflect developments since then, like the collapse of FTX. Summary: This bill has not received the same level of industry support as the Digital Asset Market Structure bill in the House, but this is a bipartisan effort with seemingly some support in the Senate. While most of the momentum is on the House’s bill, it would not be surprising to see features of the RFIA make their way into any final legislation on the topic. Especially the aspects regarding consumer protection, which may hit home with legislators who saw a lack of consumer protections lead to the implosion of FTX and other prominent digital asset service providers. Senate Introduced Legislation Aimed at DeFi AML Compliance: July 18, 2023 Background: On July 18, Senators Reed, Rounds, Warner, and Romney introduced the Crypto-Asset National Security Enhancement and Enforcement (“CANSEE”) Act in the Senate. The legislation seeks to extend obligations and penalties under the Bank Secrecy Act to persons who (1) “makes available an application designed to facilitate transactions using a digital asset protocol”; and (2) who “control a digital asset protocol, as determined by the Secretary of the Treasury.” Summary: This bill is an attempt to find a way to apply traditional finance’s protections for anti-money laundering (“AML”) and know your customer (“KYC”) to decentralized finance as those rules apply to traditional finance. Coin Center has alleged that the bill is unconstitutional because it creates potential for criminal prosecution against individuals for merely publishing software and failing to register with FinCEN. Any regulation for the space will create pain points for digital asset services providers who have developed those services largely without regulatory burdens thus far. House Introduced the Financial Innovation and Technology for the 21st Century Act: July 20, 2023 Background: On July 20, after a process that included hearings in both the Agriculture and Financial Services Committees in the House, the proposed digital asset market structure law, titled the Financial Innovation and Technology for the 21st Century Act, is finally here. While the Discussion Draft was a comprehensive 162 pages, this checks in at 212 pages. The Agriculture Committee’s press release and all associated documents (including a fact vs. myth breakdown) are available here. Summary: As stated above, the House is seemingly much further along with its legislation than the Senate, with months of hearings on a discussion draft bill leading up to this proposed legislation. Additionally, as Chair of the House Financial Services Committee, Patrick McHenry may have more power to push the House’s bill past committee. However, the House’s bill will need to gain support from across the aisle, potentially from industry proponents like Representative Ritchie Torres, to get this bill to a point where it can pass in the Senate and be signed into law by the President. Briefly Noted: Senators Propose Digital Asset Amendments to National Security Legislation: Senators Warren/Marshall (generally anti-crypto), and Lummis/Gillibrand (generally pro-crypto) proposed a crypto-focused amendment to pending national security legislation. It puts AML reporting burdens on crypto kiosks and some obligations on FinCEN and Treasury to come up with compliance regimes for stablecoins/mixers. Coinbase Litigation Against SEC Update: Coinbase filed its letter response to the SEC’s intent to strike Coinbase’s affirmative defenses, and the parties had a hearing with the Court for over 2 hours as well. Polsinelli Blockchain+ Team Updates: The Blockchain+ team got a big upgrade with the hire of Albert “Bert” W. Stemmler as a shareholder in the firm’s growing Nashville office. Prior to joining Polsinelli, Bert served as Head of Legal and Compliance at a VC fund manager and operator of an accelerator for early-stage companies in crypto/digital assets. Additionally, Jeanne Solomon and William Quick wrote this great article published in Law360 regarding what the Corporate Transparency Act means for DAOs. Conclusion: The ruling in Ripple finding that digital assets are not securities in certain circumstances underscores the need for legislative and regulatory clarity. It shows that a reasonable court could find that there are regulatory gaps in the sale of these instruments, which supports the renewed push from all sides of the issue to put clarifying legislation into place. While Congress traditionally moves slowly on issues of major significance, such as the regulation of a completely new industry, it is possible that the Ripple decision and other developments in the courts could spur legislators to move quickly instead of allowing these issues to be decided piecemeal by the judicial branch rather than through lawmaking from the legislative branch. 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.

The long battle between the U.S. Securities and Exchange Commission (“SEC”) and Ripple reached a partial resolution with the Court ruling the digital asset at issue (“XRP”) is not itself a security and certain sales of the asset are not securities transactions. This is one of the most significant rulings in digital asset cases thus far and the first final disposition by a court that was in favor of a digital asset issuer and against the SEC. Introduction A federal judge ruled on July 13, 2023, that sales of XRP by Ripple and its affiliates (i) to the general public through anonymous exchanges did not constitute sales of securities but (ii) to institutional investors through contractual arrangements did constitute securities transactions.[1] As will be discussed in more detail below, Ripple is a network for the global transmission of payments, primarily between financial institutions with XRP being the “in network” token used for processing transfers between different currencies. During the period from 2013 to 2020, more than $1.3 billion of XRP was sold by Ripple primarily through two different methods: (i) sales to institutional investors through some sort of subscription documents and (ii) sales to the public anonymously via digital asset exchanges. U.S. District Court Judge for the Southern District of New York (S.D.N.Y.) Analisa Torres ruled in SEC v. Ripple Labs, Inc. that Ripple’s sales of XRP to sophisticated buyers and hedge funds (“Institutional Buyers”) pursuant to written contracts (“Institutional Sales”) were securities because, considering the totality of the circumstances, these buyers would have purchased XRP expecting to profit from Ripple’s efforts.[2] In contrast, sales to the general public anonymously through digital asset exchanges (“Programmatic Sales”) were not securities because there was no evidence demonstrating these buyers (“Programmatic Buyers”) had the same expectation.[3] The Court also found that distributions of XRP as employee compensation or to third parties as a way to develop new applications for Ripple’s platform (“Other Distributions”) were not securities because there was no investment of money.[4] It remains to be seen whether this decision will have a significant “ripple” effect for the crypto industry because other jurisdictions are not bound by the court’s decision and the SEC may appeal the decision once it is able to do so. For now, it marks the first significant judicial headwind to what is perceived by many as the SEC’s attempt to impose rules on crypto entities through enforcement. This ruling also provides some hope that courts will provide material clarity on the regulatory status of digital assets and shape future regulations. Ripple Background Ripple was founded to create a less expensive means of transferring between currencies by creating a more efficient alternative to the Bitcoin blockchain, which it launched in 2012 and was labeled the XRP Ledger (the “Ledger”).[5] The Ledger requires XRP, the native token, to operate and XRP is intended to be used to build software products on top of the Ledger.[6] Unlike Bitcoin where additional Bitcoin is consistently created through “mining,” all XRP was created at the time the Ledger was launched, with 80% of the token supply given to Ripple and 20% given to its founders. Ripple’s stated mission is to revolutionize international financial transactions by reducing both transaction fees and the time to complete a transaction. For instance, Ripple’s network, RippleNet, employs the blockchain to create a payment network designed to provide faster and cost-effective international transactions by enabling financial institutions to transact directly with one another.[7] Likewise, XRP acts as a bridge currency to other currencies to facilitate fast and inexpensive international transfers.[8] Between 2013 and 2020, Ripple allegedly raised more than $1.3 billion from selling or distributing XRP through Institutional Sales, Programmatic Sales, and Other Distributions.[9] During this time, Ripple allegedly marketed XRP as an opportunity for people to invest and grow XRP’s value and use cases. Some of these marketing efforts included informational brochures, public blog posts, or Ripple leaders publicly commenting on XRP’s value.[10] Specifically, Ripple raised approximately $730 million by selling XRP to Institutional Buyers pursuant to written contracts in Institutional Sales.[11] These written contracts often contained resale restrictions and required the Institutional Buyers to indemnify Ripple for claims resulting from selling or distributing XRP. Ripple raised approximately $758 million from Programmatic Sales through blind bid/ask transactions—XRP was sold on digital asset exchanges and neither party knew who was selling or buying the XRP.[12] Further, Ripple allegedly raised approximately $609 million in value from Other Distributions which were distributions of XRP in the forms of grants, charitable giving, and employee rewards.[13] Ripple’s co-founder, Chris Larsen, and Ripple’s CEO, Brad Garlinghouse, each allegedly sold XRP via Programmatic Sales and earned a combined $600 million. Throughout this time, Ripple did not file any registration or financial statements or periodic reports with the SEC.[14] Case Background In 2020, the SEC filed a lawsuit against Ripple, Larsen, and Garlinghouse alleging that the sale of XRP was an unregistered security offering in violation of Sections 5(a) and 5(c) of the Securities Act (15 U.S.C. §§ 77e(a) and 77e(c)).[15] In its motion for summary judgment, the SEC alleged that selling XRP qualified as an “investment contract” under securities law.[16] The SEC advanced an “embodiment” theory in which the token itself embodied the securities transaction it was allegedly being sold under.[17] The SEC supported their assertions, among other things, by citing Ripple’s marketing promises to increase the value of XRP for the benefit of XRP owners and for Ripple, and by pointing to the economic expectations XRP purchasers had for Ripple to increase XRP’s value.[18] In response, Defendants countered in their own motion for summary judgment that XRP transactions did not constitute investment contracts, claiming that the transactions did not have the “essential ingredients” of an investment contract.[19] Defendants also focused on the Blue-Sky laws from which the term “investment contract” originated to support their defense that there are certain essential elements of every investment contract such as privity of contract between the promotor/investor, and contractual post-sale obligations on the promotor/its affiliates.[20] Defendants focused on the transactions where there was no consideration, aiming to demonstrate that not all distributions of XRP fulfilled the necessary elements.[21] Additionally, for all XRP transactions, Defendants underscored the fact that XRP sales lacked a written contract explicitly designating the purchase of XRP as an investment and imposing obligations on Ripple to enhance the value of XRP.[22] Defendants also raised the affirmative defense that Defendants did not have fair notice of the violations by the SEC, alleging the SEC failed to offer clear guidance regarding the sale of cryptocurrencies like XRP, making it unreasonable for individuals to know that XRP qualifies as a security.[23] The Order Under the pinnacle Howey test, the Court laid out the relevant analytical framework: “under the Securities Act, an investment contract is “a contract, transaction[,] or scheme whereby a person [(1)] invests his money [(2)] in a common enterprise and [(3)] is led to expect profits solely from the efforts of the promoter or a third party.”[24] Further, the Court highlighted the requirement for a transaction-by-transaction analysis according to the substance, economic reality, and the totality of the circumstances.[25] The Court’s ruling focused on three key issues. First, determining the applicable test to ascertain whether the sale of XRP constituted an investment contract. Second, establishing a clear distinction between the various transactions Ripple conducted for distributing XRP and determining which transactions were in violation of the Securities Act, if any. Lastly, addressing whether the Defendants had a valid fair notice defense. Is XRP a “Security”? Rejection of Defendants’ “Essential Ingredients” Test and SEC Embodiment Theory The Court declined to accept the Defendants’ “essential ingredients” test, where the Defendants claimed, in addition to the Howey elements, investment contracts must be “‘(1) a contract between a promoter and an investor that establishe[s] the investor’s rights as to an investment,’ which contract (2) ‘impose[s] post-sale obligations on the promoter to take specific actions for the investor’s benefit’ and (3) ‘grant[s] the investor a right to share in profits from the promoter’s efforts to generate a return on the use of investor funds.’”[26] The Court rejected this idea and found the relevant inquiry must focus on whether it was objectively reasonable for XRP purchasers to expect a financial return or profit based on Ripple’s efforts.[27] Additionally, the Court found the current test effectuates the Securities Act’s fundamental policy of giving broad protection to investors regardless of whatever scheme human ingenuity produces.[28] The Court also rejected the SEC’s embodiment theory, that the token itself embodies an investment contract scheme. In a previous digital asset case ruling, the Court in SEC v. Telegram held that the “security” was neither the token nor the sales contracts for those tokens, but rather the entire scheme.[29] The Ripple decision seems to take it a step further holding that the digital asset itself is not a security, but rather the scheme under which the digital asset is sold is the important consideration and is something which needs to be done on a transaction-by-transaction basis. Institutional Sales The Court ultimately found the Institutional Sales were investment contract sales subject to the Securities Act.[30] Under Howey’s first element, the Court found the Institutional Buyers invested money because they provided fiat currency in exchange for XRP thereby providing Ripple with capital.[31] The Court also found the “common enterprise” element was satisfied because Ripple pooled all the proceeds from the Institutional Sales and the Institutional Buyers’ fortune benefitted from XRP’s success.[32] Lastly, the Court concluded there was a reasonable expectation to profits from Ripple’s entrepreneurial and managerial efforts. Utilizing an objective approach, the Court reasoned Ripple’s communications, marketing efforts, and the substance of the written contracts between Ripple and the Institutional Buyers would cause investors to believe Ripple would invest the money received from the Institutional Sales to enhance XRP’s value, which in turn would generate profits for the Institutional Buyers.[33] For instance, Ripple’s marketing brochures conveyed XRP’s value would increase as more people adopted XRP or as XRP’s popularity grew. Notably, the Court rejected the Defendants’ claim that XRP was akin to buying or selling a commodity, like gold or silver.[34] The Court explained that even selling gold or silver could be sold as an investment contract, under certain circumstances.[35] Programmatic Sales On the other hand, the Court determined that the Programmatic Sales of XRP did not constitute the offer and sale of investment contracts.[36] Without evaluating the other two prongs, the Court ruled that the Programmatic Sales did not establish the third Howey prong because Programmatic Buyers could not reasonably expect that Ripple would use the capital from the Programmatic Sales to increase the value of XRP.[37] These buyers were not aware they were buying XRP from Ripple in the first place. In fact, the majority (about 99%) of Programmatic Buyers purchased XRP from secondary owners, meaning Ripple did not directly receive the proceeds from these transactions.[38] The decision is similar to Hocking v. Debois, in which a 9th Circuit Court of Appeals found that the sales of condos with rental service contracts would be a securities transaction if sold by the original developer, but which required a facts and circumstances analysis when sold on the secondary market.[39] Unlike stocks and bonds which are de facto securities,[40] the existence of an investment contract is determined on a transaction-by-transaction basis taking into account the asset purchaser’s objectively reasonable understanding at the time of purchase: it could be an asset (which they could subjectively believe will increase in value, like a car or horse) or an investment contract (in which they are objectively relying on the efforts of others to make the value increase). Here, the Court found there wasn’t an objectively reasonable understanding that some of the purchase price for XRP bought on secondary markets would go to Ripple to increase XRP’s value. “Whereas the Institutional Buyers reasonably expected Ripple would use the capital it received from its sales to improve the XRP ecosystem and thereby increase the price of XRP…Programmatic Buyers could not reasonably expect the same.”[41] The Court used that and other factors, such as lack of contractual lockup provisions for those XRP purchases and lack of evidence that Programmatic Buyers saw or understood the marketing materials of Ripple prior to purchasing XRP on secondary marketplaces, to find the Programmatic Sales were not investment contract transactions.[42] Notably, the Court explicitly rejected the SEC’s arguments that managerial efforts of others could be inferred because Ripple targeted speculative investors or because Ripple “understood that people were speculating on XRP as an investment.”[43] Instead, the Court applied the objectively reasonable understanding standard from Howey, rejecting the arguments by both sides regarding subjective intent to use or subjective belief that the value of XRP would increase after purchase. Other Distributions The Court also ruled that Ripple’s grants of XRP to charities, Ledger developers, and as employee compensation did not constitute an “investment of money” under Howey.[44] While the Court cited to caselaw which establishes that “investment of money” does not need to be fiat currency but can be other forms of tangible and definable consideration, the Court found there was no such investment of money in the Other Distributions.[45] This section of the Court’s ruling is the most cursory, and it is unclear if this is based on the Court’s belief that these particular Other Distributions didn’t meet the “investment of money” standard or if the SEC simply failed to produce a record showing the consideration provided by employees and XRP Ledger developers were tangible and definable. Did Defendants Have Fair Notice? The Court did not accept Defendants’ defense under the Due Process Clause of the Fifth Amendment that they lacked fair notice of what conduct was forbidden or required, asserting that the caselaw provides a clear test for determining what constitutes an investment contract.[46] In alleging their defense, the Defendants focused on the SEC’s lack of clear guidance on digital assets, but the law does not require the SEC to warn all potential violators.[47] The Court found there was sufficient due process because caselaw that defines an investment contract provides a person of ordinary intelligence a reasonable opportunity to understand what conduct it covers, and cases subsequent to Howey show how that test would be applied in various situations.[48] However, in footnote 20, the Court stated its holding was “limited to the Institutional Sales because the SEC’s theories as to the other sales in this case are potentially inconsistent with its enforcement in prior digital asset cases.”[49] What This Means for the Industry Similar to the ruling in LBRY, this is a single decision from a single court with limited precedential value.[50] It is likely to be appealed by the SEC, Ripple, or both, although the courts would need to exercise a fair amount of discretion for the decision to be appealed before the remaining portions of the case – pertaining to aiding and abetting violations – are finally decided or otherwise disposed of. However, unlike LBRY, the Ripple ruling handed the SEC its first true loss against the digital asset industry. It provides both a potential framework on how to structure certain distributions of digital assets and a cogent argument against the “embodiment theory” pushed by the agency that once a token is sold in a securities transaction then it and all other tokens like it are securities. It also provides some additional guidance on how to conduct an offering and sale of digital assets in compliance with applicable laws. While not explicitly stated, the decision provides some vindication to the view that tokens without equity-like characteristics are not themselves securities, but an investment contract could be formed when that token is paired with a transaction. This is similar to Howey itself, which related to the sale of plots of orange groves combined with a service agreement to pick and sell the fruit. That combination created an investment contract, but the oranges weren’t securities. This puts tokens in a category with a myriad of other asset classes – beavers, construction equipment, gold, condominiums, and cattle among them – which, if paired with a contract, the sale could become a securities transaction.[51] By finding that digital assets are not securities in certain circumstances, this case also underscores the need for legislative and regulatory clarity. It shows that a reasonable court could find that there are regulatory gaps in the sale of these instruments – a position that the SEC itself acknowledged as recently as 2021,[52] until changing its tune and stating that the entire crypto industry outside of Bitcoin can be regulated by the SEC.[53] There was already a rising push for some form of digital asset regulation, even amongst detractors, as the industry’s longevity has become less and less deniable. We hope this ruling spurs Congress to work diligently to pass digital asset framework legislation. Currently, both the House and Senate are discussing comprehensive digital asset bills along with other digital asset bills like the stablecoin legislation in the House.[54] It is possible this Ripple decision spurs forward motions on some of these legislative efforts. This decision alone, however, does not substantially change the regulatory and legal environment applicable to digital asset businesses. All it means is that certain anonymous sales of XRP when sold on secondary marketplaces do not constitute securities transactions (for now). It does not necessarily mean any other token is not a security when sold on a secondary marketplace, or that selling through a secondary marketplace is an endorsed end-around to securities laws for other token issuers. Each investment contract case still requires a transaction-by-transaction analysis and not every case will have identical facts to Ripple. That said, when combined with other developments, such as large financial services, companies openly embracing digital assets, and movement amongst members of Congress on digital asset policy, it is hard not to be optimistic for the industry’s growth in the U.S. where previously such optimism was hard to come by. [1] Order 22, ECF No. 874. [2] Order 16, ECF No. 874. [3] Order 25, ECF No. 874. [4] Order 27, ECF No. 874. [5] Order 2, ECF No. 874. [6] Order 2, ECF No. 874. [7] Order 3, ECF No. 874. [8] See Order 3, ECF No. 874. [9] See Order 4-5, ECF No. 874. [10] Order 4-5, ECF No. 874. [11] Order 4, ECF No. 874. [12] Order 4, ECF No. 874. [13] Order 5, ECF No. 874. [14] Order 5, ECF No. 874. [15] Pl’s Memo in Supp. Summ. J. 63, ECF No. 640. [16] Pl’s Memo in Supp. Summ. J. 49, ECF No. 640. [17] See Pl’s Memo in Supp. Summ. J. 49-52, ECF No. 640. [18] Pl’s Memo in Supp. Summ. J. 53-56, ECF No. 640. [19] Def. Memo in Supp. Summ. J. 2, ECF No. 643. [20] Def. Memo in Supp. Summ. J. 2, ECF No. 643. [21] Def. Memo in Supp. Summ. J. 26-28, ECF No. 643. [22] Def. Memo in Supp. Summ. J. 29-30, ECF No. 643. [23] Pl’s Memo in Supp. Summ. J. 69, ECF. No. 640. [24] SEC v. W.J. Howey Co., 328 U.S. 293, at 298–99 (alterations in original). [25] Order 16, ECF No. 874. [26] Order 11-12, ECF No. 874. [27] Order 13, ECF No. 874. [28] Order 12-13, ECF No. 874. [29] SEC v. Telegram, 448 F. Supp. 3d 352, 366 (S.D.N.Y. 2020). [30] Order 16-17, ECF No. 874. [31] Order 16, ECF No. 874. [32] Order 17-18, ECF No. 874. [33] Order 18-22, ECF No. 874. [34] Order 22, ECF No. 874. [35] Order 22, ECF No. 874. [36] Order 22, ECF No. 874. [37] Order 23, ECF No. 874. [38] Order 23, ECF No. 874. [39] Hocking v. Debois, 885 F.2d 1449 (9th Cir. 1989). [40] 15 U.S.C.A § 77B; 15 U.S.C.A. § 78c; & 15 U.S.C.A. § 80a-2. [41] Order 23, ECF No. 874. [42] Order 24, ECF No. 874. [43] Order 22, ECF No. 874. [44] Order 26, ECF No. 874. [45] Order 26-27, ECF No. 874. [46] Order 29-30, ECF No. 874. [47] Order 30, ECF No. 874. [48] Order 29-30, ECF No. 874. [49] Order 29, ECF No. 874. [50] SEC v. LBRY, Inc, No. 21-cv-260-PB, 2022 U.S. Dist. 2022 WL 16744741 (D.N.H. Nov. 7, 2022). [51] Lewis Cohen et al., The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets are Not Securities, DLxLaw. Nov. 2022, at 56-58. [52] Chair Gary Gensler, Testimony at Hearing before the Subcommittee on Financial Services and General Government U.S. Appropriations Committee, U.S. Securities and Exchange Commission (May 17, 2022), https://www.sec.gov/news/testimony/gensler-testimony-fsgg-subcommittee. [53]  Chair Gary Gensler, Testimony of Chair Gary Gensler before the United States House of Representatives Committee on Financial Services, U.S. Securities and Exchange Commission (Apr. 18, 2023), https://www.sec.gov/news/testimony/gensler-testimony-house-financial-services-041823. [54] H.R. 4662 118th Cong. (2023); Responsible Financial Innovation Act S. 4356 118th Cong. (2023); Stablecoin Transparency Act S. 3970 117th Cong. (2022).

The application of the Corporate Transparency Act to decentralized autonomous organizations raises novel legal issues. DAOs are a relatively new type of business association that lack statutory governance and liability protections for participants because they have not been formed as traditional legal entities. As a result of legislative enactments seeking to fit DAOs into traditional entity structures to promote protections for them, DAOs operated through business entities will need to comply with the CTA's disclosure obligations. What the CTA Requires: Beginning Jan. 1, 2024, reporting companies operating in the U.S. must file Beneficial Ownership Secure System, or BOSS, reports with the U.S. Department of the Treasury's Financial Crimes Enforcement Network, including owners' names, birthdates, addresses and copies of government-issued photo identification. A reporting company is an entity like a corporation, limited liability company, limited partnership or business trust that is created or registered to do business in the U.S. through a secretary of state filing. Heavily regulated businesses — such as public companies and their regulated advisors, financial institutions, insurance providers and Section 501(c)(3) nonprofits — are exempt. Also exempt are large operating companies — i.e., those with a U.S. physical street address, 21 or more full-time employees, and more than $5 million in annual gross receipts or sales as reported in a prior-year tax filing. Wholly owned subsidiaries of an otherwise exempt entity are also excluded. Companies formed by Dec. 31 must initially file BOSS reports by Dec. 31, 2024, with companies formed starting Jan. 1, 2024, having 30 days to file — with changes due within 30 days. BOSS reports may be accessed by federal, state, local and tribal law enforcement, and by financial institutions with customer consent — but will not be publicly accessible, including by Freedom of Information Act request. Beneficial owners include persons with substantial control over — and those who directly or indirectly own 25% or more of — the company's equity. Every reporting company must report at least one person, and an owner's refusal to disclose may signal their noncompliance to the Financial Crimes Enforcement Network. Fines and penalties for nonreporting or false reporting can be steep. DAO Framework: A DAO is an association of persons represented in part by rules encoded as a transparent computer program, usually controlled by the association and not influenced by a central governance body, and blockchain technology managing the DAO by decentralized autonomous means — often including a proprietary digital asset. A DAO is set up by programing the organizational structure onto blockchain technology by smart contract, with preprogrammed code setting forth the decision-making structure and governance — and a smart contract often serving as de facto governing document. DAOs typically fundraise by issuing tokens allowing for voting rights to make rule changes and take action. DAO members may view transactions on the blockchain — including a timeline of contributions and use of funds — with tokens usually purchased on decentralized platforms or directly through peer-to-peer transactions. As of June, there were reportedly approximately 2.5 million active voting DAO members and almost 7 million DAO governance token holders worldwide. As of spring 2023, only Tennessee, Utah, Vermont and Wyoming recognized DAOs, with various other states considering legislation. Many DAOs form as Delaware LLCs, and state cooperative law statutes, e.g., in Colorado or New York, or alternative DAO structures, such as benefit LLCs, also may provide a framework. As of 2022, the Republic of the Marshall Islands approved legislation recognizing DAOs as LLCs. Other popular countries for DAOs include the Bahamas, British Virgin Islands, Cayman Islands, Gibraltar, Liechtenstein, Panama, Singapore and Switzerland. DAOs' challenges, constraints and risks include those relating to: Governance; Intellectual property ownership; Contract enforceability; Infrastructure and scaling; Proper taxation and procuring insurance; Application of bankruptcy, insolvency and securities rules and antitrust; Fraud and error; Cryptocurrency risks; and Dealing with know-your-customer and anti-money laundering rules. How the CTA May Apply To and Affect DAOs: The CTA assumes that a reporting company is a legal entity with a system of beneficial ownership and governance that a DAO may not possess. Traditional partnership-based DAOs will not fall within CTA purview, but those DAOs subject to traditional state formations are considered legal entities in DAO legislation states and will need to consider CTA compliance. CTA reporting requirements will be particularly burdensome for DAOs given their structure and framework — i.e., DAOs lack managers, directors or officers — so each member, and not the DAO as an organization, may need to determine whether they have substantial control or own 25% of the DAO. A DAO that is a state-law, member-managed LLC would require each member to file a BOSS report. The CTA prohibits blank stock and anonymous reporting company ownership, in direct opposition to DAOs' compelling feature of anonymity. The Financial Crimes Enforcement Network has provided nontraditional entities with advice that substantial control includes control exercised in novel and less conventional ways, advising that control could apply to varying and flexible governance structures such as DAOs — for which different control indicators may be more relevant. While the Financial Crimes Enforcement Network is unsure of how the CTA applies, the CTA applies to state-formed DAOs nonetheless. The CTA does not address certain DAO-specific matters such as whether membership by token ownership is beneficial ownership for CTA purposes. Realistically, without directors and officers, DAOs will have trouble naming compliance personnel. Wrapping DAOs into traditional structures has exposed DAOs to reporting requirements and compliance protocols, now expanding to include CTA compliance. Using traditional DAO parameters to regulate nontraditional businesses may be incompatible with DAOs' innovative and changing nature and autonomy. DAOs required to be CTA compliant will need to monitor CTA guidance as the rollout continues. A state-registered DAO may have easier CTA compliance or may lack personnel to track CTA requirements, but be expected to track them nonetheless. Wrapped-entity DAOs should set up CTA compliance protocols — including point persons — and track ongoing compliance. Since DAOs operate through the blockchain and smart contracts, structuring a DAO to adopt CTA-disclosure procedures may be unrealistic. Traditional DAOs operated as common law partnerships do not face CTA exposure, whereas DAOs operated as or through entities established through state law filings must be CTA-compliant. The inherent characteristics of DAOs and blockchain technology will make CTA compliance challenging. Takeaways: As the CTA rollout ramps up in late 2023 and in 2024, many questions likely will arise as to how DAOs that are wrapped or state-registered should properly comply with the CTA. We would expect the Financial Crimes Enforcement Network to issue more guidance as to the application of the CTA to DAOs as the CTA rollout continues. In the meantime, the CTA rollout could lead states to slow their efforts to pass DAO-related legislation pending a better understanding of the interplay between the CTA and state-registered DAOs. Because DAOs are traditionally self-governed and self-regulated by their participants, burdensome CTA compliance requirements and rigid state regulation may further incentivize self-regulation in the DAO industry. DAOs also may be driven away from registering — or staying registered — in U.S. states if their status imposes reporting obligations with which they cannot legally comply. The CTA's compliance requirements may further the perception of the U.S. as an unfavorable environment for blockchain and DAOs, pushing DAOs toward registering or focusing operations in countries with laws that are perceived as more welcoming. In upcoming months, in anticipation of the CTA's effectiveness, proper DAO formation will require sophisticated formation and operational advice that is mindful of CTA compliance and potential pitfalls. *This article first appeared on Law360.

Highlights of the Last Two Weeks in Blockchain+: The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. In this latest Blockchain+ Bi-Weekly, we were planning to welcome a slowdown in Web3 legal developments with Congress on the Fourth of July break and federal agencies also largely quiet. However, directly before this blog was scheduled for release on July 13, possibly the most important court ruling related to digital assets came down. The dueling motions for summary judgment by the parties in the highly anticipated SEC vs. Ripple Labs case were decided. In a split ruling, the SEC was granted summary judgment regarding "institutional sales" of XRP and summary judgment was granted to Ripple with a ruling that "programmatic sales" of XRP to the public "did not constitute the offer and sale of investment contracts."  Overall, the decision is being viewed as an immensely positive milestone for digital assets in the United States.  We are working on a full BitBlog post breaking down the decision and its industry implications, which should be out next week. In this update, we highlight an interesting strategic move made by counsel for Coinbase in its litigation defense against the SEC, an unexpectedly stout defense by crypto exchange Bittrex in its own battle with the agency, an update on comprehensive digital asset legislation meandering forward in both the House and Senate, and a few other brief notes. Coinbase Files Early Answer in Legal Fight Against SEC: June 28, 2023 Background: On June 7, Coinbase waived formal service in the SEC’s lawsuit against it, giving Coinbase until early August to Answer or otherwise plead. In a shock to many, Coinbase, instead this past week, filed its Answer, and local rule required a letter of intent to move for judgment on the pleadings under FRCP 12(c). Due to the Fourth of July holiday weekend overlapping with the SEC’s applicable due date under the local rules, the SEC was given until July 7 to respond, which they did, announcing their expected intent to oppose. Summary: This move is the fruition of months of strategic legal decisions by Coinbase going back to its amicus in the Wahi case and the Writ of Mandamus action Coinbase filed against the SEC in April. In football terms, Coinbase was running a hurry-up offense and ran a trick play/Hail Mary with its first possession in the game. And Coinbase ran months of decoy plays to set it up. The unique use of FRCP 12(c) and the use of a 33-page "Preliminary Statement" in its Answer to save page space, later on, is just some of the impressive lawyering that went into this strategy by Coinbase. This also puts Coinbase on a separate scheduling track from Binance, which is not expected to answer or otherwise plead in its separate action until September 21, 2023. Bittrex Files Motion to Dismiss in SEC Lawsuit Against Departing US Entity: June 30, 2023 Background: Back in March, Bittrex announced it would be winding down US operations after nine years due to regulatory uncertainty.  The SEC brought its lawsuit against them shortly thereafter, which caused Bittrex to convert its orderly winddown into bankruptcy. Bittrex has now filed a Motion to Dismiss the SEC’s lawsuit against it, arguing the secondary sales of the tokens at issue are not securities transactions and that the SEC lacks the authority to bring its lawsuit under the Major Question Doctrine. Summary: As an initial matter, one could question how the SEC protects investors by bringing a lawsuit and forcing a company into bankruptcy where it was already winding down its US operations with the intent to return investor funds. One explanation is that winddown may be why the SEC took a seemingly aggressive approach in the case. For example, the SEC’s lawsuit alleges that DASH, a token with none of the usual securities hooks like a sale of pre-mined tokens and/or funding from investors instead of funding by validators out of block rewards, is a digital asset security. It is surprising to see Bittrex put up the stout defense it has under these circumstances, and it will be interesting to see how the Major Question Doctrine issue is argued after the recent SCOTUS ruling in Biden v Nebraska. The Major Question Doctrine is a recently revived legal principle that limits the executive branch’s power on issues of major economic or political significance unless there is a clear congressional delegation of power over that issue to an administrative agency. The Major Question Doctrine is often brought up regarding executive orders, and it’s unclear if it applies to enforcement actions like those brought by the SEC against Bittrex. Treasury Department and SEC to Provide Opinions on Digital Asset Market Structure Bill: June 30, 2023 Background: Ranking House Financial Services Member Maxine Waters requested input on the Digital Asset Market Structure Bill discussion draft from both the Treasury Department and the SEC. Representative Waters is not known to be a proponent of the bill or the digital asset industry in general. Still, she is expected to be heavily involved in bill edits after her own stablecoin legislation died during the last Congressional session. Summary: Congresswoman Waters requested the feedback by June 30, 2023, but nothing has been publicized regarding the agencies’ findings as of the publication of this blog post. With an expected bi-partisan digital asset bill to be introduced into the Senate in the near future, it appears there is a real possibility that legislation gets done this session, and previous opponents are looking to get their fingerprints on whatever that bill is rather than kill it completely. Briefly Noted: Unchained Podcast Hosts Debate on Crypto Compliance: Laura Shin hosted Rodrigo Seira of Paradigm and Aaron Kaplan of  Prometheum on the Unchained Podcast to discuss the path to compliance for digital asset marketplaces. It was a hotly debated podcast and is worth listening to hear alternative sides of the regulatory debate amongst industry attorneys. Blockchain Association Asks for Gensler Recusal: The Blockchain Association has taken the position that Gary Gensler should recuse himself from all digital asset enforcement decisions due to his alleged inability to stay impartial on such matters. This comes as even former SEC and CFTC Chairs criticize the litigation strategy taken by the current SEC. Celsius Disclosure Hearing Date Set: The Bankruptcy Court in the Celsius case set August 8, 2023, as the hearing date for the court to consider and potentially approve and Disclosure Statement and proposed plan of reorganization of the Celsius Network. Objections are due by Aug 3, 2023. Senate Finance Leaders Ask for Input on Crypto Taxation: In a letter dated July 11, 2023,  the Republican and Democratic leaders of the Senate Finance Committee requested input regarding many aspects of taxation crypto and other digital assets from members of the digital asset community and other interested parties. LBRY Gets no Relief from Federal Judge: On July 11, 2023, a Federal Judge in New Hampshire refused to provide any relief to LBRY and allowed for the SEC to impose an injunction and civil fines on them. We have previously written about the SEC’s success in obtaining Summary Judgment against LBRY and how this ruling shows the difficulty that many blockchain businesses have even when they are trying to comply with regulations. With this ruling, LBRY is all but certain to shut down and the question is if this ruling will have any impact on the expected upcoming decision in the Ripple case. Corporate Transparency Act Compliance for DAOs: Polsinelli’s own Jeanne Solomon and William Quick authored a great article regarding the applicability of the Corporate Transparency Act to DAOs and anticipated legal pain points with compliance by decentralized and often anonymously run organizations. Worth a read for anybody in the industry who hasn’t previously considered these mandatory disclosure obligations beginning in 2024. Conclusion: The summer break in Web3 legal developments is ending, and industry legal developments will pick up as litigation advances and legislative efforts move forward. The next update is expected to have many more developments, including an expected bi-partisan Senate bill on digital assets. If there was one major takeaway from the past two weeks, it looks like even some of the cryptocurrencies’ biggest prior detractors have accepted the inevitability of the technology’s use in everyday finance. Traditional finance is making more public moves into the sector, and it is increasingly likely that some form of digital asset legislation will reach the President’s desk this year. It is still unclear, however, what that legislation will look like or how the ongoing litigation will affect demand for the technology in the United States. 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 from our attorneys. JULY 14, 2023

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. The summer solstice has not led to a slowdown of regulatory interest and challenges to the digital asset ecosystem. The House Financial Services Committee held a hearing on the future of digital assets as it hopefully works to craft bills to provide a workable framework for regulating digital assets while the European Union moves ahead with its separate digital asset regulatory framework law. The legal battle between Coinbase and the SEC on Coinbase’s mandamus action continues, with both sides litigating strategically to advance their positions in the separate lawsuit by the SEC against Coinbase. Binance also continues to litigate fiercely against the SEC, even in the face of recent consent order limiting the United States Binance entity’s ability to transfer certain assets during the pendency of the litigation. These developments, together with a few other brief notes, are discussed below. EU’s Comprehensive Digital Asset Legislation is Published: June 9, 2023 Background: In April 2023, the European Parliament voted through landmark legislation on cryptocurrency titled EU’s Markets in Crypto Assets (“MiCA”) with 517 votes in favor and 38 against. MiCA does not attempt to fit digital assets into an existing framework, but instead creates an entirely new disclosure and registration regime specific to digital assets. On June 9, the official version of the bill was published in the EU’s Official Journal, signaling formal passage of a bill onto the EU’s statute book. Summary: Europe is one of largest digital asset markets in the world, so it is an important step for this industry for the EU to draft a specially tailored digital asset framework for fungible digital assets and other common assets such as stablecoins. This is particularly the case when the United States is still in the very early stages of creating any form of digital asset framework.  When finalized, MiCA will apply directly across the EU without the need for special national implementation laws which many  EU consumer protection initiatives that are passed are directives require. . Due to the official publication, MiCA’s provisions will primarily begin to apply on December 30, 2024, with certain provisions taking effect slightly earlier on June 30, 2024. House Financial Services Committee Holds Hearing on Stablecoin and Digital Asset Market Structure Draft Bills: June 13, 2023 Background: On June 13, the House Financial Services Committee held a hearing titled, “The Future of Digital Assets: Providing Clarity for the Digital Asset Ecosystem” to discuss the Digital Asset Market structure discussion draft bill and the new stablecoin bill. Both hope to provide a framework for regulating digital assets. The House Financial Services Committee oversees the country’s economy through supervision of banks, the United States Treasury, capital markets, and currency production and distribution. The details on the hearing, including opening statements of the witnesses and committee memorandum are available here. Summary: On June 6, it was the Committee on Agriculture holding a hearing on the draft digital asset legislation; this week the Financial Services Committee got their chance to analyze the Digital Asset Market Structure discussion draft bill. Coy Garrison, who was former counsel to SEC Commissioner Hester M. Peirce, answered a wide range of questions, ranging from what requirements trading platforms must meet to register with the SEC to the timeframe for how assets should transition from securities to commodities. Notable moments from the hearing include Chairman McHenry’s opening statement and witness questions. Representative French Hill also pointed out that both the Secretary of Treasury and the Chairman of the CFTC have emphasized the need for Congressional action to fill regulatory gaps over the market. An increasing number of Democrats (including Ritchie Torres, Josh Gottheimer, and others) are acknowledging the enduring presence of the crypto industry and need for regulations tailored to the industry. Even if this legislation is passed in Congress, there will still be several questions to be answered by regulators regarding the interpretation and implementation of the legislation. SEC and Coinbase Provide Further Briefing in Coinbase Mandamus Action Asking SEC to Give Regulatory Clarity: June 13, 2023 Background: Back in April, Coinbase filed a mandamus action asking the Third Circuit to Order the SEC to respond to Coinbase’s Petition for Rulemaking, either agreeing to provide a regulatory framework for digital assets through tailored rulemaking or denying Coinbase’s request and standing by the SEC Chair Gary Gensler’s assertion that the rules are clear as is. The three-judge panel issued a letter order asking for answers on three questions from the SEC, and both sides have now responded. The SEC’s response is available here, while Coinbase’s rebuttal to that response is available here. Summary: After the three-judge panel asked the SEC for clarification on certain issues, the SEC was firm in their assertion that there was no merit to those issues and asked for the panel to dismiss or issue a 120-day stay for SEC staff to further consider the Petition for Rulemaking. Coinbase responded, asking the panel to deny the SEC’s stay request or limit the stay to 60 days, after which the SEC would need to have a firm answer to the Petition for Rulemaking. Both sides are litigating strategically. The SEC’s 120-day stay request would not require the SEC to file anything additional in this mandamus action until after Coinbase’s expected Motion to Dismiss is fully briefed in a separate action by the SEC against Coinbase. Coinbase’s requested deadline would fall in the middle of that briefing. The panel ended up retaining jurisdiction over the matter as requested by Coinbase but granting the SEC’s 120-day stay to allow the SEC staff to further consider Coinbase’s Petition for Rulemaking. “Hinman Speech” Documents Unsealed: June 13, 2023 Background: In June of 2018, then acting Director of the SEC’s Division of Corporate Finance gave a now-famous speech titled Digital Asset Transactions: When Howey Met Gary (Plastic) in which he (in his personal capacity) opined that “sufficiently decentralized” opined that digital assets such as Bitcoin and Ethereum were not securities and should be exempt from securities disclosure regimes. After a protracted legal battle, the SEC was forced to unseal comments made by SEC staff to draft versions of the “Hinman Speech” documents, and those comments were publicly released on June 13. Summary: The documents unsealed had some expected, but interesting comments from members of the SEC staff from 2018 when the industry was still in its very early stages. Those comments included apparent recognition of “regulatory gap[s]” in the space regarding decentralization, and the SEC staff not believing an issuer holding a large amount of tokens is of any significance in a Howey analysis (an issue which LBRY got dinged on in dicta). But largely, these were the types of comments which would be expected from the SEC staff at the time and does not significantly change the regulatory environment for digital assets in 2023. Binance.US Has Asset Transfer Limited by Consent Order: June 17, 2023 Background: On June 5, 2023, the SEC filed 13 charges against various Binance entities, including its U.S. entity Binance.US. The full complaint can be reviewed here. The SEC alleges that Binance has been operating as an unregistered securities exchange against U.S. law. This comes at the same time that Binance entities and Binance’s founder Changpeng Zhao are defending against a separate action brought against them by the CFTC. The SEC also requested that Binance.US’s funds be held in a U.S. bank for potential freezing during the legal proceedings. Summary: Even though they are in a challenging position, Binance.US is litigating fiercely in their defense on many issues alleged by the SEC and CFTC. On June 12, Binance.US added four more attorneys to its defense team, including George Canellos, a former co-director of the SEC’s enforcement division. Binance.US also opposed the SEC’s motion to freeze their assets in an emergency motion on June 12. After that hearing, at the direction of the Court for the parties to reach an agreement without requiring the Court issue its own ruling,  the parties filed a Consent Order. The Consent Order prevents Binance.US from spending corporate assets except for ordinary business purposes and gives the SEC expedited discovery into how Binance.US custodies its assets. Additionally, Binance.US must transfer control of the access keys for its digital wallets to the U.S. within 14 days.  Binance has also filed a motion taking issue with the SEC’s press release following entering of the agreed Consent Order by the parties. Briefly Noted: Celsius Discloser Statement Filed: On June 27, the greatly anticipated Disclosure Statement for the Joint Chapter 11 Plan of Reorganization of Celsius Network LLC and certain of its affiliates was filed. The statement and related plan of reorganization outlines the expected recovery for among others the “Earn” creditors. We are analyzing these documents and will be sending a separate update about it. Coinbase Supreme Victory: Though not related directly to digital assets, it’s good to see a digital asset company winning at the Supreme Court level. The Supreme Court recently ruled in favor of Coinbase, holding that Coinbase’s mandatory arbitration provision was binding and consumers seeking to sue the entity would need to resolve those disputes in arbitration rather than public courts. Conclusion: The digital asset market and regulatory landscape has experienced significant developments in the last few weeks. The SEC continues its legal efforts against industry actors who they view as non-compliant. Congress also gets one step closer in its legislative efforts to provide regulatory clarity. These develops are expected to slow down as Coinbase and Binance prepare initial responsive pleadings to the SEC’s actions against them and as Congress goes on break from June 24 until July 9. Then a rapid succession of further developments can be expected again. These events highlight the evolving regulatory landscape surrounding digital assets and set the stage for further discussions and legal battles. 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 from our attorneys.

Highlights of the Last Two Weeks in Blockchain+ The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law. The past two weeks have seen a rapid succession of blockchain legal developments, a few of which we touch on below. On a positive note, the US House of Representatives released a comprehensive 162-page Digital Asset Market Structure Bill discussion draft, marking a significant step towards a regulatory framework for digital assets. The House Committee on Agriculture also held a hearing to discuss the Digital Asset Market Structure discussion draft. On the less positive side of things, while the Securities and Exchange Commission (“SEC”) settled its insider trading case against a former Coinbase employee and it also filed lawsuits against Binance and Coinbase, alleging that these two prominent businesses in the industry operated unauthorized securities exchanges. Each of those developments is broken down below. US House of Representatives Releases Discussion Draft on Digital Asset Market Structure Bill: June 2, 2023 Background: On June 2, a comprehensive 162-page Digital Asset Market Structure Discussion Draft was released, accompanied by a concise 2-page summary of the bill and a detailed 9-page section-by-section breakdown. A hearing was scheduled for Tuesday, June 6, with the House Committee on Agriculture, responsible for overseeing the CFTC, under the title “The Future of Digital Assets: Providing Clarity for Digital Asset Spot Markets.” This hearing discussed the draft in detail, and you can read more about the hearing results below. Notably, this bill stands out as the most comprehensive proposal on digital assets put forth by Congress to date. Summary: This bill fulfills the pledge made by House Financial Services Committee Chair Patrick McHenry in late April to present a regulatory framework bill for digital assets through the House in the coming months. While it is likely that a significantly amended version of this bill will pass the House, its chances of successfully passing the Senate and obtaining the President’s approval are uncertain. Nonetheless, we hope there may be a change of perspective in the Senate and Executive branches concerning their current stance on cryptocurrencies. You can read more about this bill in our in-depth breakdown on the BitBlog, available here. SEC Reaches Settlement in Insider Trading Case Involving Former Coinbase Employee: May 30, 2023 Background: The SEC recently sought a consent judgment (i.e., settlement) in its legal battle against a former Coinbase employee, Ishan Wahi, and his brother, Nikhil Wahi. The case revolves around allegations of insider trading concerning specific digital assets listed on the Coinbase platform. Prior to the SEC’s announcement of the settlement, the Wahi brothers had filed a Motion to Dismiss, with several industry players offering strong amicus support. Summary: While the SEC is positioning this settlement as a victory, the settlement doesn’t admit any conclusions about whether the tokens themselves are securities. Additionally, the settlement does not impose any fines on the Wahi brothers, as they are already subject to penalties through their criminal pleas to the Department of Justice (“DOJ”). One could speculate that the SEC recognized the weaknesses in its case regarding the secondary sales of digital assets and chose to retreat from the unexpectedly robust opposition. Alternatively, a more realistic perspective suggests that the SEC recognized the need to allocate resources for a significant legal battle against Coinbase and decided not to use those resources for a relatively insignificant fight against the Wahi brothers. SEC Files Lawsuit Against Binance: June 5, 2023 Background: The SEC has filed 13 charges against Binance, including its US entity and its primary platform, its founder Changpeng Zhao (known as “CZ”), and several related companies. The full complaint can be reviewed here. Binance has disputed the allegations, expressing its intention to challenge the claims in court. The lawsuit contains several alleged and potentially damaging internal communications from the prior CFTC lawsuit and an additional quote where the Binance Chief Compliance Officer in 2018 allegedly stated, “we are operating as a [expletive] unlicensed securities exchange in the USA, bro.” The SEC is requesting that Binance.us’s funds be held in a US bank for potential freezing during the legal proceedings. Summary: Ever since the unflattering communications were disclosed in the CFTC lawsuit, the industry has been awaiting follow-up SEC/DOJ legal actions. The SECs focus on the publicly traded and relatively compliant US firm, Coinbase rather than the overseas entity Binance has always been somewhat perplexing. Binance’s alleged strategic decision to separate operations from Binance.us, at least in part to buffer its international operations from US enforcement actions, will be tested. The SEC lawsuit allegations name ten tokens as securities: SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, and COTI. SEC Files Lawsuit Against Coinbase: June 6, 2023 Background: The SEC has also formally initiated anticipated charges against Coinbase, with the SEC accusing Coinbase of functioning as an unauthorized securities exchange, broker, and clearing agency. The full complaint can be accessed here. In response, Coinbase’s CEO, Brian Armstrong, issued a statement via Twitter, available here. The SECs lawsuit alleges 13 digital tokens as securities: SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, DASH, and NEXO. The collective market value of these 13 tokens amount to $37 billion. Summary: The SEC v. Wahi settlement, which was speculated to conserve resources for the impending Coinbase lawsuit, proved accurate. While the allegations against Coinbase list several new tokens as opposed to Wahi, the Coinbase Complaints format is predominantly consistent with the allegations in the Binance and Wahi lawsuits. Noteworthy allegations include claims by the SEC that the Coinbase non-custodial wallet and staking-as-a-service offerings operate as unauthorized broker/dealer services/products. Further state actions are anticipated. The industry has been gearing up for this significant lawsuit, so initial reactions will likely be intense, followed by a protracted legal battle. House Committee on Agriculture Holds Hearing on Digital Asset Legislation Proposal: June 6, 2023 Background: On a notably active Tuesday, the same day the Coinbase lawsuit was announced, the House Committee on Agriculture conducted a hearing titled “The Future of Digital Assets: Providing Clarity for Digital Asset Spot Markets.” The hearing focused on the above-discussed Digital Asset Market Structure discussion draft. Access to the hearing can be found here, and the materials, including written versions of the opening statements by the witnesses, are available here. Summary: This two-part hearing featured influential witnesses, including CFTC Chairman Rostin Behnam (during Part 1), followed by Coinbase CLO Paul Grewal, Robinhood CCO Dan Gallagher, and others (during Part 2). Committee Chair Glenn “GT” Thompson (R-PA) began with a statement addressing the SEC’s legal actions against Coinbase. Without discussing specifics, he noted that this type of regulatory action underscores the need for the hearing. There was broad agreement at the hearing that legislative measures for the industry are necessary, and the conversation focused on the form of this legislation. There was also a Financial Services Committee hearing on Tuesday, June 13, but that hearing occurred after the drafting of this bi-weekly update was finalized and is expected to be covered in the following update. Conclusion: The digital asset market and regulatory landscape has experienced significant developments in the last few weeks. The SEC has redoubled its legal efforts against its viewed industry non-compliance, and Congress’s prospective legislative efforts are rapidly developing. These events highlight the evolving regulatory landscape surrounding digital assets and set the stage for further discussions and legal battles. 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.

The Digital Asset Market Structure (“DAMS”) discussion draft bill attempts to provide regulatory clarity on crucial blockchain industry issues. These issues include when a blockchain is legally considered decentralized, the relationships between the differing administrative agencies responsible for overseeing the industry, and a realistic path for legally compliant blockchain development and token sales in the US. But where will this regulation get in the way of development, and what areas of industry concern are missing from DAMS? Here is background on how this bill came to be, what aspects of DAMS are most important/most likely to be heavily debated, and what can be expected going forward. Background on DAMS On June 2, 2023, Patrick McHenry, Chairman of the House Financial Services Committee, and Glenn “GT” Thompson, Chairman of the House Committee on Agriculture, released a discussion draft of a proposed legislation, intending to provide the first statutory framework for digital asset regulations in the United States. The goal of the legislation is to “provide clarity, fill regulatory gaps, and foster innovation while providing adequate consumer protections.” Such legislation comes at a time when the US has not adopted any nationwide digital asset regulation, while at least 30 countries have done so. The DAMS bill is a culmination of the work between the House Financial Services Committee, which is responsible for overseeing the Securities and Exchange Commission (“SEC”) and other financial regulatory agencies, and the House Committee on Agriculture, which is responsible for overseeing the Commodities Futures Exchange Committee (“CFTC”). A comprehensive digital asset legislation proposal has been expected for months. In April, Representative McHenry made multiple appearances, including at the blockchain industry conference Consensus, where he promised that the House would have a crypto legislation passed in the next few months. In May, the House held a joint Financial Services/Agriculture Subcommittee hearing entitled “The Future of Digital Assets: Measuring the Regulatory Gaps in the Digital Asset Markets.” The discussion draft bill is 162 pages and is available here. A section-by-section summary can be found here, along with a two-page summary. Since this is only a discussion draft, many changes and iterations can be expected between the current version and the final executable version. However, the amount of work that went into this discussion draft is typically reserved for legislation the drafters hope will be signed into law. The theory that this draft is intended to become passible legislation is further supported by the draft’s constructive and nuanced approach to digital assets. Most Important Features of DAMS One of the major issues preventing further development of the over $1 trillion blockchain industry in the US is the lack of clarity on whether a digital asset is a security, a commodity, or a currency. If a digital asset is a security, it needs to be registered with the SEC or otherwise meet certain exemptions to registration. In comparison, if it is a commodity, it will be regulated by different administrative agencies like the CFTC and the Federal Trade Commission (“FTC”). This proposed legislation seeks to provide clarity in two ways. The first is to create an SEC exemption specifically tailored to the initial sale of digital assets in the same way that crowdfunding framework was specifically tailored for smaller businesses as a result of the JOBS Act. The DAMS summary included a flowchart (see below) that shows what the drafters envision this exemption to look like, and how it compares to more traditional capital raising efforts such as through Initial Public Offerings (“IPOs”). This exemption provides a road map for blockchain developers to build their blockchain projects and raise funds using Initial Coin Offerings (“ICOs”) while still providing investor protections in the form of disclosures and transferability restrictions. It also allows developers to eventually fall outside of the disclosure regime when the blockchain underlying the digital asset becomes “decentralized” and the original issuers are no longer the key drivers of the continued building or growth of the network. One way to provide investor protection is by making the sale of tokens by “insiders” (i.e., the token issuers or developers and their close affiliates) regulated by a set of rules modeled after the traditional structures for private company equity securities with lock-up periods and limited exchanges to which those tokens can be sold. DAMS also seeks to clarify when a blockchain network is “decentralized.” In other words, at which point the blockchain’s native tokens would be presumed to be commodities and fall outside of various disclosure and reporting regimes. DAMS defines a “Decentralized Network” as one where: (1) no single entity (excluding DAOs) has unilateral control over for the past year; (2) the issuer/affiliates have not owned or had voting power of more than 20% of tokens for the past year; (3) has not had its code substantially changed by issuer or affiliates in the past 3 months; (4) has not been marketed by issuer or affiliates in the past 3 months; and (5) all tokens issued in the past year were done programmatically (i.e., through mining/consensus rewards). The draft provides guidelines on the regulations applicable to a blockchain network once it is deemed a “Decentralized Network” as defined in DAMS. Without these DAMS-provided guidelines (as developers are currently working under), blockchain networks considering whether to register their tokens as securities with intent to eventually decentralize that network run into a Catch-22. Since once the network is decentralized, there is no central actor with the practical ability to comply with the SEC’s ongoing reporting rules while the SEC has no rules regarding a token issuing company’s compliance requirements when its blockchain network is decentralized. This is the problem Blockstack ran into back in 2020, when its claim to no longer have reporting obligations due to the decentralized nature of its blockchain network was neither approved nor denied by the agency. Other Significant DAMS Features While the biggest issues revolve around the securities versus commodities structuring and related definitions, there are also other important features of DAMS. Firstly, digital assets are defined as being “fungible,” assumedly making it clear that non-fungible tokens (“NFTs”) are not intended to be covered under this regulatory framework. It also defines a decentralized organization to exclude any organization that is “directly engaged in an activity that requires registration” with the SEC or CFTC. Secondly, DAMS makes it clear that software that simply creates a digital asset does not qualify as an issuer. This seemingly indicates that the DAMS drafters are aware of the distinction between a fund-raising effort in the form of digital assets and the digital assets or code itself. It also provides a safe harbor for issuance in the form of airdrops and network participation rewards through its definition of the “end user distribution” and an explicit carve out of the end user distributions from securities laws. Areas of Concern A vast majority of industry participants would generally agree that some form of a workable industry framework is necessary for this industry to continue growing in the US. That said, even well-intentioned and reasonable regulatory guidelines can create potentially negative externalities as industry participants seek to meet those guidelines rather than do what is in the best interest of the blockchain network in question. Some fear this bill is trying to do too much too fast by including SEC exemptions for public sales instead of focusing solely on the core decentralization and technology issues. For example, while it makes sense to limit the “decentralized network” to one that the issuer has not substantially changed in the prior three months as evidence of actual decentralization and functionality, it might also prevent an issuer from applying changes to their networks to address flaws for fear of regulatory noncompliance. Additionally, while ensuring issuers do not own or control 20% or more of the network’s outstanding tokens appears to be a protection against centralized control, it also promotes the quickening of complete token issuance, which may not be in the best interest of every blockchain network depending on the networks’ goals and functionalities. Similarly, it will be hard to comply with some of the requirements, including the crowdfunding exemptions, without some level of anonymity forfeiture. It is also unclear how the lockup requirements will work in a system which often requires giving up control over tokens to participate meaningfully in many blockchains (through delegation of voting rights, staking to participate in the consensus mechanism, or other token functions). Furthermore, DAMS does not attempt to create an entire new regulatory regime, as was done in the European approach in MiCA. Instead, it tries to find a home for digital assets in the existing US legal frameworks. The DAMS approach of not setting up a new class of digital asset regulation is likely the only practical one in at least the near term, given the political reality that this is still a relatively small industry as well as the general difficulty to pass broad legislation in the United States.  However, this approach has its limitations as the Securities Acts are from the 1930s and the seminal cases defining classes of securities are from the 1940-50s. As such, using existing securities and commodities regimes to regulate digital assets will inevitably run into square-peg-round-hole problems trying to fit digital asset rules into World War II-era laws. Another general critique of DAMS is that it is focused on the issue of fund-raising by doing an ICO, which today is no longer as important an issue as it was a few years ago. Today, most new projects raise funds through selling rights to future tokens to accredited investors or selling them to non-US persons under an exemption from registration. If DAMS would instead focus on secondary sales and decentralization, it might have a greater chance of passing and thus be more useful. Conclusion While DAMS appears to be a well-intentioned and thoroughly reasoned approach to a functional digital asset framework in the US, it is still in its very early stages in the legislative process, and it is possible that it will not get passed as a law. In particular, the partisan nature of the bill is problematic. McHenry noted that this “discussion draft is the first step toward delivering on Republicans’ commitment to develop clear rules of the road for the digital asset ecosystem.” Given the current political environment of a divided government, its success will depend on bi-partisan support for the bill, something that it does not publicly have yet. Although statements that the proposed legislation being a Republication proposal could lead one to conclude that it was drafted without serious plan of getting it passed, the length and level of thought that went into the discussion draft bill lend weight to the claim by Representatives McHenry and others that they intend to pass comprehensive digital asset policy in at least the House. Whether it is DAMS this year or some other bill in 2024, it seems that the legislative clarity the industry has been clamoring for remains a real possibility. It is yet to be seen whether that legislative clarity will be a boon for the industry or create a “be careful what you ask for” moment that may further drive the industry overseas. As a final thought, although this legislation is not perfect, it is likely to provide at least some level of regular assistance to a number of blockchain and digital asset projects, such that it is worthwhile for the industry to engage with it if not to support it.

On February 9, 2023, the U.S. Securities and Exchange Commission (the “SEC”) charged Kraken with offering and selling Kraken’s Staking Program – its staking-as-a-service product – as an unregistered security. Kraken, more formally known as Payward Ventures Inc. and Payward Trading Ltd is among the more significant and reputable crypto trading platforms in the United States. To settle these charges, Kraken has agreed to immediately and permanently cease offering or selling securities through any crypto asset staking services or staking programs as well as to pay $30 million in disgorgement, prejudgment interest, and civil penalties. Numerous blockchains, including Ethereum and Solana, operate their consensus mechanisms at least in part based on something called “proof of stake.” This differs from the original blockchain of the Bitcoin protocol, which generates rewards by obtaining a consensus to validate transactions based on a complicated math problem called “proof of work.” In contrast, proof of stake generates rewards by requiring validators to lock up a certain amount of their crypto tokens for a period of time. Usually, staking is not available to the average retail cryptocurrency customer, and more lucrative results are obtained when crypto is staked in larger quantities. One reason is that typically, a minimum number of tokens is required to be staked to become a validator eligible for rewards. Also, the more that is staked, the greater the chance of rewards for properly validating new blocks on the chain. Further, staked amounts may be at risk of ‘slashing’ if the validator fails to validate transactions properly. Many chains also charge transaction fees at the start of or during staking to incentivize longer staking periods and higher staking amounts. They often include on-ramps and off-ramps known as ‘bonding’ during which such crypto is not actually staked but also unable to otherwise be used.  These impediments have led many service providers to launch staking-as-a-service platforms, such as the Staking Program, to allow individual retail customers to benefit from the rewards of staking. The SEC specifically noted several ways the Staking Program differed from how staking would work should a proof-of-stake cryptocurrency holder itself stake its crypto, making it more closely resemble an investment product than a tech platform. Rather than using the staking payouts determined by the proof-of-stake protocols, Kraken itself determined the amount that would be paid out for staking crypto through the Staking Program. These returns did not necessarily correlate with the amount that Kraken actually earned by staking the customer’s crypto, and Kraken was able to keep any positive differential between advertised returns and actual staking returns. Payouts of rewards were to occur continuously – generally once or twice a week – rather than on a variable basis dependent on when staking rewards are earned. Unlike staked crypto, which cannot be withdrawn while staked and is often subject to lengthy ‘bonding’ and ‘unbonding’ periods before and after the crypto is staked, crypto assets locked into the Staking Program was able to be withdrawn at any time. A portion of crypto provided by customers to the Staking Program was not actually staked at all and instead maintained as a “liquidity reserve” to permit the withdrawal of assets from the Staking Program. Staking was not subject to transaction and deposit fees imposed by many staking protocols and was not subject to any minimum amount as is typical across staking protocols. Kraken’s platform, which included cybersecurity and proof of reserves, allowed users to stake in a way that would not have been possible had customers directly staked crypto assets themselves. These distinctions help show that the Rewards Program was clearly a different product than direct staking itself. According to the SEC’s allegations, these distinctions show that the Staking Program met each of the prongs of the test outlined in SEC v. W.J. Howey Co., 328 U.S. 293, 299 (1946), making the Staking Program an investment contract that is a security. Under Howey, an investment contract is a security if it involves an investment of money into a common enterprise with a reasonable expectation of profits or returns derived from the entrepreneurial or managerial efforts of others. Of note, Kraken allegedly touted the Staking Program as an investment opportunity, using words like “earn” and “returns” in its marketing materials, and the Staking Program indeed generated well over a hundred million dollars in investment returns. The CEO of Kraken himself conceded that “some product/marketing/ToS differences might make a different decision” on whether to challenge the SEC’s allegations. The SEC complaint never alleges that staking itself is an offer or sale of securities. It is also questionable whether other staking-as-a-service models might not be securities. For instance, it is unclear if the result may have been different if, rather than offering a product where Kraken set different terms than the staking protocols, Kraken had merely facilitated the aggregation of customer crypto to stake that crypto on their behalf directly. The SEC complaint also makes a novel argument that could have wider-range implications in the DeFi space. In a seemingly out-of-place allegation, the SEC claims that Kraken’s managerial efforts of others included “[p]roviding a user-friendly, one-stop-shop investor interface” and “simplifying a complex staking process with an easy-to-use interface in a secure and trustworthy environment operated by technical experts.” In addition to raising the question as to why the SEC is focusing on activities that it does not deny lowers risk, this raises the question of whether the SEC might take the position that merely providing a user interface that provides access to a blockchain-based protocol could be either an investment contract or evidence of sufficient ‘efforts of others’ to meet that prong of the Howey test. Such a position would seem at odds with the SEC’s long-standing position that it is technology-neutral and seeks to govern securities rather than tech platforms. Also of note was the relatively high amount of the penalty that Kraken agreed to pay in respect of the Staking Program. While investors had staked over $2.7 billion through the Staking Program and earned nearly $150 million in total rewards, Kraken’s reported net income attributable to U.S. investors was just under $15 million. This means the penalty being paid by Kraken is slightly more than double its profits from engaging with the Staking Program with U.S. persons.

On February 8, 2023, a federal jury awarded Hermès International and Hermès of Paris, Inc. (“Hermès”) $133,000 in its trademark lawsuit against designer Mason Rothschild. Hermès sued Rothschild for selling non-fungible tokens (NFTs) of METABIRKINS in the metaverse, thereby infringing and diluting Hermès’ BIRKIN mark that is used for luxury handbags. A New Frontier: The Metaverse and NFTs NFTs are exchanged in the metaverse. The metaverse is a virtual place teeming with many of the same activities that occur in the physical world – spending time with friends, playing games, shopping and going to sporting events or concerts. This case is the first to provide some guidance in the U.S. as consumers navigate the metaverse and NFT market, while proprietors scramble to protect their valuable trademarks. What makes the Hermès case significant is that the infringing goods are virtual, not physical, replicas of Hermès’ BIRKIN® bags. Rothschild created the MetaBirkin bags as NFTs, which are digital assets that are rare, unique collectibles and can be extremely valuable. To put the value of owning an NFT into perspective, think of the value of owning the physical original of the Mona Lisa or perhaps The Beatles’ masters. Hermès Bags a Win A federal jury sitting in U.S. District Judge Jed S. Rakoff’s court in the Southern District of New York found Rothschild liable for trademark infringement, dilution, and cybersquatting (due to his registration of the domain name MetaBirkins.com). Hermès filed its lawsuit against Rothschild in January 2022. Hermès alleged that Rothschild intentionally sought to seek his fortune by swapping out Hermès “real life” rights for “virtual rights.” Rothschild admitted that he chose to sell his NFTs as METABIRKINS because a BIRKIN handbag is extraordinarily valuable in the physical world. Additionally, he used the BIRKIN mark not only to identify his NFTs but also for his social media accounts and his Discord channel, and he registered the MetaBirkins.com domain name. Rothschild first sold a single NFT, known as the “Baby Birkin NFT”, that consisted of an animation of Hermès’ BIRKIN handbag with a fetus shown on top of a transparent version of the bag. The Baby Birkin NFT was sold for $23,500 and later resold for $47,000. Due to the success of the Baby Birkin NFT, Rothschild then created a line of 100 digital collectibles created on the Ethereum blockchain and featuring BIRKIN handbags covered in fur and listed for sale under the METABIRKINS mark. Rothschild was rewarded handsomely for selling the METABIRKIN NFTs. By January 6, 2022, the METABIRKINS NFTs surpassed $1.1 million in sales. Rothschild argued he was an artist and, therefore, he was entitled to a First Amendment “fair use” defense. According to Rothschild, like Andy Warhol’s work of art, Campbell Soup Cans, selling his METABIRKINS NFTs was not his attempt to pass off his artwork as being associated with BIRKIN handbags; he was simply selling the “expression” of a Birkin.1 However, in the trial, Hermès presented evidence of news reports that falsely stated that METBIRKINS was connected to or approved by Hermès which bolstered its claims that the NFT artwork was causing confusion, a key element in establishing trademark infringement. The Hermès jury disagreed with Rothschild and, in handing Hermès a victory, gives both metaverse designers and brand owners some indication of how to avoid liability and how to prevail against infringers, respectively. However, brand owners should keep in mind that trademark decisions are fact specific, and some of the facts in the Hermès case may have swayed the jury in finding for Hermès. Minding the Metaverse for Brand Protection As demonstrated by this case, brand owners like Hermès that are not interested in participating in the metaverse can nonetheless be drawn into it, and forced to expend resources to protect their brands in that virtual venue. Policing brands in the metaverse presents a significant challenge. While the metaverse is still developing, sales that rely on the goodwill of a brand can accrue to someone other than the brand owner. Brand owners interested in offering their goods and services virtually in the metaverse should consider taking proactive measures to protect their marks, such as filing trademark applications. Even brand owners without immediate plans to enter the metaverse should diligently police their brands in that space and issue takedown notices to platforms where their protected brands are being infringed. 1 Andrew Rossow, Esq., The Hermès Lawsuit May Dictate the Future of NFTs, NFT NOW, Jan. 30, 2023, https://nftnow.com/guides/how-the-hermes-lawsuit-could-determine-the-future-of-trademark-rights-in-nfts/

In July of 2022, the United States Department of Justice (“DOJ”) and the Securities and Exchange Commission (“SEC”) each alleged insider trading violations against a former Coinbase employee Ishan Wahi (“Ishan”), his brother Nikhil Wahi (“Nikhil”) (collectively the “Wahi Defendants”), and another alleged acquaintance Sameer Ramani (“Sameer”). For background on the matter, read our BitBlog post from when those allegations dropped here. At the time, we noted the unusual nature of the parallel actions stating: When the DOJ indicts defendants on criminal charges of insider trading, it is not uncommon for the SEC to also bring a parallel civil action which typically gets stayed during the pendency of the criminal action.  This matter is unusual, however, because the DOJ alleged insider trading under traditional wire fraud laws rather than under securities laws.  Still, the SEC decided to file a civil complaint for securities insider trading against the same parties.  Because the charges being brought by the SEC are not identical, and there are major questions of law (such as whether the tokens are securities) that are unlikely to be addressed in the DOJ matter, it is unclear whether these proceedings will stay during the DOJ prosecution. At the time, we suggested that because civil matters often become secondary to criminal matters and because the criminal case here did not rely on the tokens being considered securities, that it was likely the SEC’s characterization of the traded tokens as securities would go unchallenged. Much to our surprise, this week the Wahi Defendants, almost concurrent with resolving their criminal cases[1], filed a Motion to Dismiss (the “Motion”) which, if granted, has the potential to set back the SEC’s apparent plan to regulate digital assets through enforcement actions alone. To quote from the movie A Bronx Tale, not all goes as planned with adversaries and sometimes even if you want to…“Now Yous Can’t Leave.” The full Motion is available here. Continue reading for a tl;dr summary of the arguments presented in that 81 page Motion. Introduction The well drafted Motion begins by harshly criticizing the SEC’s refusal to engage in rulemaking for the digital asset industry; a process which would result in final rules which could be contested in court if the regulated parties disagreed with the SEC’s rulemaking. The Motion classifies the SEC ‘s one-off enforcement actions like the one against the Defendants in this case “a process designed to produce more heat than light.” Wahi MTD, pg. 3. The Motion then provides a cogent background on cryptocurrencies and the value that decentralized transactions can provide in a system currently dependent on centralized intermediaries. It then goes on to explain how blockchain technologies are often built on top of other blockchain technologies, in the same way phone apps are built on top of Apple iOS or Android technologies. The introduction section concludes by summarizing how the nine tokens named in the SEC’s Amended Complaint were initially distributed, how digital asset exchanges work, and the SEC’s allegations against the Defendants. Argument 1: There Can Be No Investment Contracts Without Certain “Essential Ingredients” In all of the SEC’s previously litigated digital asset matters, the primary defendant(s) have been token developers who then sold some amount of tokens issued by themselves, or entities that they controlled or were affiliated with, by means of Initial Coin Offerings (“ICO”s) or some other sale of pre-mined tokens (as was the case in the LBRY case and is the case in the ongoing Ripple litigation). The SEC has won its cases litigated so far against token selling developers by convincing courts that the sales of tokens from the tokens’ creators and ongoing developers are the types of fundraising efforts which securities laws were enacted to regulate. See SEC v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020); SEC v. Telegram Grp. Inc., 448 F.Supp. 3d 352 (S.D.N.Y. 2020). The Motion counters this claim, and argues, similar to the Motion for Summary Judgment in the Ripple case, that the essential ingredients in an “investment contract” is a contract plus something else. A land sale plus the promises to manage orange groves on it (as was the case in SEC v. W.J. Howey Co., 328 U.S. 293 (1946)). Or the sale of beavers plus the promise to raise them for fur (Continental Marketing Corp. v. SEC, 387 F.2d 466 (10th Cir. 1967)). This goes back to the “blue sky” laws which predate federal securities laws and is where the term “investment contract” comes from. These “essential ingredients” listed by both Ripple and these Defendants are: (1) a contract; (2) a post-sale obligation on the initial seller; and (3) a right to share in the venture’s profits. While these same arguments were largely raised in Ripple, they are at least somewhat more compelling when coming from individuals other than the “issuers” of the tokens themselves. Here, it is unlikely the Court can look at the “economic realities” of the transactions and conclude the funds that went to the Wahi Defendants were for the advancement of the underlying token project. The Wahi Defendants here sold assets in peer-to-peer transactions in the same way sneaker aficionados sell sneakers or baseball card collectors sell their collections on secondary markets. Similar to in Hocking v. Dubois, 885 F.2d 1449 (9th Cir. 1989), when an asset is sold in a secondary transaction, removed from the original potential “issuer” and without the “essential ingredients” of an investment contract, it is easier for a Court to find that transaction lacked the elements required to turn an ordinary asset sale into a securities transaction. Argument 2: The Major Question Doctrine and Basic Principles of Fair Notice Foreclose the SEC’s Attempted Enforcement in This Case The major question doctrine is the legal principle that administrative agencies require clear Congressional authority before those agencies can institute rulemaking on questions of vast economic or political significance. Under the major question doctrine, courts should “hesitate before concluding that Congress meant to confer such authority” to an administrative agency over such significant issues. West Virginia v. EPA, 142 S. Ct. 2587, 2607–2608 (2022). As the Wahi Defendants put it in their Motion: “here, the SEC is pressing a novel construction of an isolated term from a Depression-era law to assert regulatory authority over a trillion dollar industry built upon revolutionary technology poised to define the next generation of the internet…” Wahi MTD, pg. 33. The Wahi Defendants go on to explain that: (1) existing SEC laws and regulations which focus on centralized actors for compliance are not well-suited for decentralized networks; (2) the fact that Congress is currently debating how to regulate digital assets demonstrates this is a major question which should be left to Congress to legislate rules for instead of administrative agencies; and (3) if the SEC is allowed to expand “investment contracts” to digital assets such as those at issue in this litigation that would turn everything from baseball cards to beanies babies to sneakers into securities. This referred to in the Motion as “an SEC-invented ‘fifth shadow factor [of Howey]’: whether the SEC wants to regulate the asset.”  Wahi MTD, pg. 39 (quoting SEC Commissioner Hester Pierce). The section concludes by pointing to evidence that sophisticated counsel at Coinbase and many others have no idea what digital assets the SEC considers are securities vs. non-securities. Expecting the Wahi Defendants to know what legal experts don’t know is unreasonable and unconstitutional. The Defendants in Ripple also raised similar fair notice defense arguments in their Opposition to the SEC’s Motion for Summary Judgment but this is again slightly more persuasive coming from individuals selling tokens on a publicly traded company’s secondary marketplace rather than from a well-funded token-issuer. Argument 3: Even Under Howey, Secondary Sales of Digital Assets from Third-Party Sellers Are Not Investments in Common Enterprises The Motion’s second-to-last argument follows the traditional securities law investment contract analysis to argue that none of the tokens at issue in this litigation satisfy the horizontal or strict vertical commonality factors and argues there is no common enterprise invested in when tokens are bought on the secondary market. The Wahi Defendants then argue all the tokens at issue here are utility tokens with consumptive use being the motivation for people to purchase. “The fact that tokens may also have investment value—or that some people may have bought tokens for investment reasons—does not alter the analysis.” Wahi MTD, pg. 51 (citing Rice v. Branigar Org. Inc., 922 F.2d 788, 790-91 (11th Cir. 1991)). While the “bona fide consumptive purpose” argument and associated supporting case law doesn’t appear to be a heavily endorsed defense in existing securities jurisprudence and comes primarily from dicta in United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975), that argument is presented well here. The Motion then presents arguments similar to those in Ripple that the tokens’ values are driven primarily from outside market forces and not from the managerial efforts of others. Again, here that argument has additional weight where the very crux of the SEC’s case is that inside information regarding the listing of assets on a secondary exchange, a decision which is entirely outside the control of the token’s developers or managers, heavily drives the price of those assets. The Wahi Defendants distinguish between the ability of managers to affect tokens’ price from the ability of those efforts to influence those prices. Argument 3 ends by trying to disarm any attempt by the SEC to apply case law from ICO cases to this matter which involves entirely secondary market transactions. Because Howey requires a transaction-by-transaction analysis, even if the initial fundraising transactions can be considered “investment contracts” the underlying token sold in those fundraising efforts isn’t necessarily a security. Argument 4: The SEC Cannot Prove Scienter The last argument, largely a throw-away argument included to buttress the lack of fair notice defense, is that the SEC cannot prove the Wahi Defendants possessed the necessary scienter for the SEC to win. That is, that the Wahi Defendants could not have known or been recklessly indifferent to the possibility that the information they traded on “was material for securities trading purposes.” Wahi MTD, pg. 59 (emphasis in original). Here, there was no way for the Wahi Defendants to know that the assets which a sophisticated legal team at Coinbase didn’t believe were securities were, in fact, securities. Final Thoughts In sum, the Wahi Defendants’ Motion to Dismiss is an unexpectedly stout and well-reasoned legal defense offered by individuals in a case where many (these writers included) expected the SEC’s claims to go unchallenged. While many of the arguments in this Motion raise issues which were also briefed in Ripple, this case has the benefit of seeing those SEC arguments fully briefed and the ability to cut them off affirmatively before the SEC even has a chance to respond, which is a powerful advantage in litigation. If the Wahi Defendants are successful in dismissing the SEC’s claims against them, that caselaw would provide powerful precedent for individuals buying and selling digital assets on secondary marketplaces and could allow for businesses to build upon existing blockchain networks with less fear that the underlying blockchain network being built upon would be rendered unworkable due to SEC actions. However, even if this Motion is granted, it does nothing to allow digital asset developers to financially support their development through the primary sales of tokens. While the SEC may have thought they could further chill the digital asset market by bringing an action that they might not have to litigate against vulnerable and seemingly unsympathetic defendants, it is now clear they have picked a fight against a well-funded and sophisticated legal team intent on making the SEC win based on the law and not unopposed enforcement. Legal scholars reasonably disagree on whether digital asset developers form actual (or implied-in-fact) contracts for continued development with the primary purchasers of their tokens, which would satisfy even Howey’s “essential ingredients” interpretation. When it comes to secondary transactions though, where there is not even an arguably implied contract between the parties, the SEC will have a hard time proving an “investment contract” transaction under Howey’s required transaction-by-transaction analysis. [1] Nikhil pled guilty to the DOJ charges against him in September 2022 and was subsequently sentenced to 10 months in prison. Ishan pled guilty to the DOJ charges against him on February 7, 2023; the day after the Motion to Dismiss was filed.

As Celsius Network LLC, et al., Case Number: 22-10964 (MG), proceeds in the Bankruptcy Court for the Southern District of New York (the “Court”), the highly anticipated examiner report was released on January 31st. Shoba Pillay, a former prosecutor, was appointed by U.S. Bankruptcy Judge Martin Glenn, who is overseeing the Chapter 11 case, as an independent examiner and tasked with investigating the conduct of the company. The highly detailed report covering 689 pages is highly critical of Celsius and its management. Providing support to what many creditors have alleged, the report found that Celsius was far from transparent about a number of its procedures and operations in a way that could be construed as fraudulent. Among the most troubling findings is how the company used its own token called CEL in a way that enriched itself at the expense of its users and other stakeholders. The report alleges that the company bought in the open market over $558 million of CEL tokens, not to distribute as an interest to depositors, as they said, but in order to artificially increase the price of the tokens through market manipulative purchase timing. Many insiders, including Celsius CEO and founder Alex Mashinsky, took advantage of this inflated price to sell their allocation of CEL tokens. As quoted in the report, the then Celsius Chief Financial Officer appeared to be very aware that what the company was doing was deceptive. “Just to clarify between us three: The last 3-4 months, we always bought more CEL than what we pay as interest per week, but we did not buy it for the interest payments, that is just what we told the community.” Another employee reportedly said in internal Slack conversations, “[w]e are using users USDC to pay for employees worthless CEL…All because the company is the one inflating the price to get the valuations to be able to sell back to the company.” This conduct of which was called “very Ponzi-like” in the report. This is not the same as concluding that the company operated a Ponzi scheme but provided information that could cause the bankruptcy judge or other regulators to do. Also of note is that the report found that Celsius’s problematic and non-transparent conduct did not start with the recent decrease in crypto prices but was there from the start including in the 2018 Celsius initial coin offering, although they didn’t raise the $50 million as anticipated they never publicly reveal this nor did Mr. Mashinky personally purchase the 11.7 million token shortfall as he committed to doing. As troubling as these findings are, it’s unclear how these findings will affect creditors and other stakeholders of Celsius as the report did not give direct recommendations to the court. As a reminder, the deadline to file a proof of claim is February 9, 2023 (the “Bar Date”), as we have noted in previous updates, in order for a creditor to reserve their rights for a fraud claim against Celsius. They should include that in a proof of claim filed on or before the Bar Date.

Court rules that Earn Account Cryptocurrency is owned by Debtors and will not be returned In our latest Bitblog update regarding the Celsius Network LLC, et al. (the “Debtors”) bankruptcy proceeding (Case No. Number: 22-10964 (MG), in the Bankruptcy Court for the Southern District of New York (the “Court”)),  we discuss the recent Court decision (i) confirming that the cryptocurrency assets held in Debtors’“ Earn Accounts” are property of the Debtors and (ii) permitting the Debtors to sell $18 million of stable coins, some of which were deposited by Earn Account holders. This ruling decides definitively that the only recourse for crypto holders in the Bankruptcy Court will be receiving payment as a creditor under a plan of reorganization. Although this ruling will disappoint many account holders, having hoped for a ruling that would require Celsius to return crypto deposited by account holders, even if at a discount, this ruling is not unexpected and comports with applicable bankruptcy statutes and case law. As mentioned in our prior posts, one of the Debtors’ primary businesses was their Earn Account program, whereby cryptocurrency assets were deposited with Debtors, and depositors “earned” interest on the assets deposited.  As of July 10, 2022, there were approximately 600,000 accounts in the Earn program with a market value of about $4.2 billion in crypto assets.  These “Earn Assets,” when considered part of the Debtor’s estate, constitute a huge portion of its total assets. A grating central question from the start of the case has been whether or not ownership of these “Earn Assets” were transferred to the Debtors when cryptocurrency was placed in an Earn Account or if the assets are still owned by the depositors. Per the Court, once cryptocurrencies were invested in Earn Accounts, those coins became assets of the estate, turning the investors into unsecured creditors of the bankruptcy estates once the Debtors filed for bankruptcy. In this case, the Debtors would be allowed to sell the Earn Account assets (with the Court’s permission) in order to fund its bankruptcy operations. Procedural History and Case Discussion of the Terms of Service: On September 15, 2022, the Debtors requested permission from the Court and the Unofficial Creditors Committee (the “UCC”), the official group appointed in the case to represent the interest of all creditors, to sell certain of the stable coins held by the Debtors. At this point, the Debtors had not asked for a ruling on the status of the Earn Accounts. However, the Debtors received objections to this request which raised the issue of who owns the Earn Account assets. Following these objections, Debtors amended their motion to request a ruling from the Court as to the legal status of the Earn Accounts, as it was becoming clear that it would be difficult for the case to move forward until such a determination was made. The key factor used by the Court in determining the ownership of the Earn Account assets is a contract question related to the terms of service for the Earn Accounts (the “Terms”). These Terms were agreed to by means of an online “clickwrap contract” by most Earn Account holders before their coins were deposited into Earn Accounts.  The Debtors argued, and the Court agreed, that the Earn Account Terms clearly granted the ownership of the Earn Assets to the Debtors: Most notably, the Debtors pointed to the most recent version of the Terms, which state: In consideration for the Rewards payable to you on the Eligible Digital Assets using the Earn Service . . . and the use of our Services, you grant Celsius . . . all right and title to such Eligible Digital Assets, including ownership rights, and the right, without further notice to you, to hold such Digital Assets in Celsius’ own Virtual Wallet or elsewhere, and to pledge, re-pledge, hypothecate, rehypothecate, sell, lend, or otherwise transfer or use any amount of such Digital Assets, separately or together with other property, with all attendant rights of ownership, and for any period of time, and without retaining in Celsius’ possession and/or control a like amount of Digital Assets or any other monies or assets, and to use or invest such Digital Assets in Celsius’ full discretion. You acknowledge that with respect to Digital Assets used by Celsius pursuant to this paragraph: 1. You will not be able to exercise rights of ownership; 2. Celsius may receive compensation in connection with lending or otherwise using Digital Assets in its business to which you have no claim or entitlement; and 3. In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws. Additionally, all prior Terms since 2020 included some similar language about losing the title to assets deposited and each version of the Terms allowed the Debtors to update the terms of service at any time. Ruling: Though it received a number of objections, the Court was not convinced by creditor and State arguments. In granting the Debtors’ motion, the Court decided that there was at least a presumption of a binding contract between the Earn Account holders and the Debtors and that this contract unequivocally gave title to the crypto deposited into the accounts to the Debtors. In this regard, the Court was moved by the Debtors’ uncontroverted evidence showing that 99.86% of the Earn Account holders accepted Terms Version 6 or a later version of the Terms. The Terms starting with version 6, clearly state that the account holder is losing their title to the deposited assets. Additionally, the court found that in New York State, it is settled law that agreeing to a contact via “clickwrap” such that one needs to click on something to proceed to the next page creates a valid contact, disregarding another argument that the onscreen click agreement wasn’t valid. Additionally, regarding the original question that led to this ruling,  the Court allowed the Debtor to sell $18 million worth of stable coins, notwithstanding the many objections to such a sale. In the Court’s view, even if this sale would be considered outside the ordinary course, thus requiring permission of the Court, the Debtors’ reasons for wanting the sale are reasonable and thus should be given deference. In general, United States Bankruptcy Courts give Debtors a wide amount of deference to run their businesses, even under Chapter 11 protection. Status of Creditors After these Rulings While many of the creditors were disappointed by this ruling, it does not mean that creditors need to give up on obtaining a meaningful recovery. As the Court points out, this ruling is not the end of the case, and as unsecured creditors, the Earn Account holders are likely to receive at least a portion of their claim back as part of a plan of reorganization. It should be noted that, had the Debtors been forced to return the crypto tokens held by Earn Account holders, Celsius would not have had the chance to reorganize and remain in business, which is not off the table. Additionally, a return of crypto would have likely impeded the recovery of deposited collateral for the loans Celsius took out. Further, the current process ensures that all crypto holders will likely be treated equally under the reorganization. This ruling states that there is a presumption of a valid contract. The ruling does not state that each party has a valid contract but rather that there is a presumption that there is a valid contract. This ruling does not prevent a creditor from claiming damages based on fraud or other problems in their contract. For example, if an Earn Account creditor did not believe that they were giving up title to their crypto assets, this ruling does not prevent them from arguing such to the Court. However, such claims must be filed or rights for such claims reserved prior to the claims bar date (which was just extended to February 7, 2023). This is one of the reasons why it is recommended that creditors file a proof of claim even if they are not mandated to do so. Conclusion and Relevance to Other Cases: While this ruling may not create a legal precedent, it is likely to be relevant in looking at other bankruptcies of entities holding crypto assets. Other Debtors with similar terms of service to the Celsius Terms are likely to find comfort here that title to the assets was effectively transferred to the Debtors’ bankruptcy estate.  In locations where “clickwrap contracts” are not accepted as a binding contract, there may be more reasons to differentiate from this ruling. On the other hand, the fact that this ruling was so closely based on the wording of the Terms should hopefully provide some protection to holders of digital assets in other cases where similar terms do not exist.

As discussed in the prior Bitblog update regarding the Celsius Network LLC, et al., (the “Debtor”) bankruptcy proceeding (Case No. 22-10964 (MG) in the Bankruptcy Court for the Southern District of New York (the “Court”)),  the last date for non-governmental creditors to file a proof of claims was set for today, January 3, 2023, at 5:00 p.m. Eastern Time (the “Claim Deadline”). The bar date for government-related claims was set as January 10, 2023. However, late last week, the Debtors filed a motion with the Court requesting an extension of the Claims Deadline. Though the Court won’t decide on the Debtors’ Motion to extend the bar date until January 10, 2023, the revised bar date is likely to be set as February 9, 2022, at 5:00 p.m., Eastern Time, for both general and governmental claims. In the meantime, the Debtors have stated that creditors can rely on the bar date being extended until at least January 10, 2023. Such bar date extensions are not unheard of, and given the general deference that bankruptcy courts give to debtors for such matters, it will almost certainly be granted. The Debtors argue that this extension of the Claim Deadline benefits all creditors, and not just those late to file since the report by the bankruptcy examiner is expected to be filed on January 17, 2023, prior to the expected new bar date. The Court-appointed examiner, Shoba Pillay, is tasked with investigating several topics related to the Debtors, including whether the company or its officers committed criminal acts in addition to asset tracing. The Debtors suggest that there might be information in this report that would affect what claimants may include on their proofs of claim. Therefore, delaying the Claim Deadline until after its publication has a theoretical benefit. For claims already filed, to the extent that the examiner report changes anything, a revised proof of claim can be filed if warranted. A possible explanation for the last-minute request to extend the Claim Deadline is that it was requested by one or more government regulators who want to file a proof of claim. It is likely that federal and state regulators are going to file claims for damages and/or fines for violations against the Debtors. Unfortunately for all other creditors, to the extent that any governmental claims are accepted by the Debtors, it may lower recovery for individual creditors by increasing the size of the overall claim pool. As mentioned in our prior updates, if a creditor is in complete agreement with their claim amount as listed by the Debtors on the Debtors’ Schedules, they have a valid claim against the Debtors in the amount listed in the Schedules pertaining to their claim, even if they do not file a proof of claim. In any event, it is still advisable to file a proof of claim regardless.

As Celsius Network LLC, et al., Case Number: 22-10964 (MG), proceeds in the Bankruptcy Court for the Southern District of New York (the “Court”), recent case updates relating to the approaching claims bar date: As discussed in a previous Bitblog entry, the last date to file a proof of claim in the Celsius bankruptcy case is January 3, 2023, at 5:00 p.m. Eastern Time (the “Claim Deadline”). Any holder of a claim that fails to file a proof of claim[1] by the Claim Deadline cannot assert a claim against the Debtors at a later time and cannot vote on a plan of reorganization. Part of the purpose of the Claim Deadline is to give the Debtors a full picture of what their liabilities are so that they can fashion a plan of reorganization to repay and/or compensate their creditors, at least in part. Since many of the claims in the Celsius case are filed on behalf of cryptocurrency account holders, there are a few particularities to the proof of claim process that are worth mentioning: If a creditor is in complete agreement with their claim amount as listed by the Debtors’ on the Debtors’ Schedules, they do not need to file a proof of claim. This means that these creditors will still have a valid claim against the Debtors in the amount listed in the Schedules pertaining to their claim, even if they do not file a proof of claim. In any event, it is still advisable to file a proof of claim regardless. One of the advantages of filing a proof of claim in this bankruptcy case is that it allows claim holders to preserve their rights to additional claims against the Debtors in addition to their cryptocurrency claim. An example of such a claim could be an allegation of fraud based on how the Debtors marketed the cryptocurrency lending products.  In this regard, when drafting a proof of claim it is recommended that the claimant be as specific as possible in identifying which statements by Celsius or its executives were fraudulent or misleading. Additionally, it is recommended that a creditor have its claim lodged against all of the debtor entities and not just against Celsius LLC in order to give the claim holder a claim against the assets of all the Debtor entities instead of just one. The proof of claim should also mention any airdropped tokens that a creditor believes that they are entitled to have received during the period that their crypto wallet was given to Celsius. It is recommended that one retain counsel to assist with drafting the proof of claim and any addendum and supporting documentation, as well as filing the proof of claim. Claimants can attach an addendum to their proof of claim explaining the claim, preserving rights, and attaching any important documentation to the claim. The claims process will be handled and monitored by Stretto, the Debtors’ Claims and Noticing Agent. Proof of claim forms can be mailed to Stretto (and must be received by January 3, 2023, at 5:00 PM Eastern Time). Alternatively, the proof of claim can be filed electronically. For Celsius customers, the electronic filing process requires the use of your Celsius account email address and your customer claim number. Unfortunately, filing a proof of claim does not obligate the Debtors to pay your claim and does not initiate proceedings to demand payment. Instead, all claims will be considered together and worked out as part of a plan of reorganization during the bankruptcy proceedings. Customers with outstanding loans to Celsius in which the Debtors hold collateral should also file a proof of claim noting the existence of the collateral granted to Celsius and held by them. There is a developing market for Celsius claims under which a third party may buy a claimant’s claim(s). Currently, the market for these claims is priced at a very large discount to the face value of the claims. Third party claims buyers will almost certainly demand that a claim has a proof of claim filed before the Claim Deadline with an added reservation of rights  and may not simply rely on the Debtors having scheduled the claim (another reason why filing a claim with the court is advantageous to the claimant). [1] Some creditors are not required to file a proof of claim. To determine if this may apply to you, review the Order Setting Bar Dates for Submitting Proofs of Claim at Docket No. 1368 on the Court’s docket.

In conjunction with the publication of the Multilaw FinTech Guide, Stephen A. Rutenberg, Co-Chair of Polsinelli's FinTech and Blockchain practice, spoke at a Multilaw Webinar on November 10th. Cryptocurrency & Blockchain: When do the benefits outweigh the risks? Featuring Polsinelli’s Shareholder Stephen Rutenberg The panel discussion gathered experts from across the network to discuss the development of cryptocurrency and blockchain usage in their jurisdictions, how the technology adoption is being received by regulators, its impact on wider initiatives (e.g. ESG), the current status in the tokenization of assets (e.g., financial streams, real estate, music rights, etc.) in the respective countries and what trends are likely to be important in the future. To view a recording of this webinar, click here. Panelists: Jill Wong, Howse Williams, Hong Kong Andreas Walter, Schalast, Germany Stephen Rutenberg, Polsinelli, USA Oded Ofek, M.Firon & Co., Israel Moderator: Jacob Kirkham, Growth Manager, Multilaw Multilaw is a global network of law firms bound together by enduring relationships. Across industries and practices, Multilaw shares client advice and active referrals, combining the highest legal standards and local expertise. Multilaw recently released its Global FinTech Guide. Put together by industry experts from member firms across the network, it presents a multi-jurisdictional analysis of the relevant legal framework and economic conditions under which FinTech services can be provided. A great resource for individuals and organizations involved in the FinTech sector from founders, companies, investors and advisors to other stakeholders across the industry. "We're proud to have partnered with Multilaw to draft the U.S. portion of the FinTech Guide and to collaborate with other highly-valued members of our global network," said Daniel L. McAvoy, Co-Chair of Polsinelli's FinTech and Blockchain practice. Multilaw also hosts a program of in-person and virtual events, both member-only meetings and webinars open to clients, covering some of the latest topics and sharing knowledge from across our global network.

As Celsius Network LLC, et al., Case Number: 22-10964 (MG), proceeds in the Bankruptcy Court for the Southern District of New York (the “Court”), the following summarizes two important case updates as of November 18, 2022: Setting of Bar Date for Filing Proofs of Claim: On November 16, 2022, the Court entered an order (the “Bar Date Order”) setting the date and time by which all creditors must file their proof of claim(s) in the Chapter 11 Cases. Proof of claim forms must be submitted and received by the Debtors by 5:00 p.m., prevailing Eastern Time on January 3, 2023 (the “General Claims Bar Date”). Proofs of Claims submitted by governmental units, on the other hand, must be actually received by 5:00 p.m., prevailing Eastern Time on January 10, 2023 (the “Governmental Claims Bar Date”). As outlined in the Bar Date Order, with few exemptions, any claim that is not filed by the respective bar dates listed above will be barred from being asserted against the Debtors unless such claim is already listed on the Debtor’s Schedules.  If the Debtor has listed a claim as contingent, unliquidated, or disputed, it is critical that a proof of claim be filed in order to reserve a right to the claim. What must be included in the proof of claim: The proof of claim must be in English; For any cryptocurrency claims held in an account on the Debtors’ platform, the claim must state the type of cryptocurrency and the number held; For any non-cryptocurrency claims, the claim must include an amount denominated in U.S. Dollars; Must be signed or electrically submitted via the claim agent’s webpage; Include as much supporting documentation as can be provided unless voluminous, in which case an explanation should be provided as to what was not included; Form must conform substantially with the form provided by the Debtors. Personal information not to be included: The proof of claim should not include a complete social security or tax ID number but only the last 4 digits; Should not include a full birthday (only the year); If the creditor is a minor, only initials should be used; Only the last 4 digits of financial account numbers should be used. As we have mentioned before, given the complexity of the claim it remains our recommendation that all parties file a proof of claim regardless of how their claim is scheduled. Approval of action procedures for retail assets: As mentioned in our previous updates, the Court has approved procedures for an auction of the Debtors’ assets (in particular, the Debtors’ retail assets). Part of the controversy behind this auction is that parties are being asked to submit bids prior to a determination of how the company plans to treat the Custody accounts with a decision on the Earn accounts not even on the near horizon. The Debtor has made it clear that the approval of these auction procedures is not a commitment to sell assets and is at least purporting to be considering restructuring and remaining a standalone entity as an alternative. Note the proposed sale here would take place under a plan of reorganization and not as a separate asset sale under Section 363 of the Bankruptcy Code. Though the dates and deadlines are subject to change, the current deadlines are as follows: Initial Bid: The initial bid deadline for retail assets is set for November 21, 2022, at 4:00 p.m. ET. This non-binding initial bid must include a price including for both cash and non-cash components as well as any conditions. Submitting this initial bid does not obligate the bidding party to bid further, nor will it definitely allow one to submit a final bid as the Debtor still needs to approve final bid candidates prior to giving them confidential information about the Debtor. Final Bid: Final bids are due on December 12, 2022. In the final bid, the Debtors are looking for bids that, in theory, the Debtors can be ready to sign. This includes a signed transaction document with any markup that the bidder requests as well as committed financing, a good faith deposit of the greater of 10 percent of the bid or 20 million dollars.  Under these bid procedures, the Debtors are unwilling to accept any financing or other conditions There are several other requirements including that bids provide information on how with a potential buyer of the assets will deal with the Debtors. It is highly unlikely that any particular bid made on December 12, 2022, will be accepted in its form as submitted. Auction and Sale Hearing: If needed, a virtual auction may take place on December 15, 2022, and a sale hearing is set to take place on December 22, 2022. If other cases in this area are a guide, it is likely that these deadlines are likely to be extended. Many creditors are hoping that the auction will lead to a buyer taking over accounts that will include Earn accounts, thus allowing creditors to keep their accounts or a percentage of them intact. While this is in the realm of possibility, it is not a likely outcome. An important element of the approved bid procedures is that it will allow the Debtors to sell the assets in question free and clear of liabilities. In many ways, these bid procedures give the Debtors the ability to test the waters to gauge the interest of buyers in their assets without committing themselves to anything. As such, there is little that we can learn from here (for now) as to the final direction that the case is going to take or how claimants are going to be paid back. A full listing of action deadlines is as follows, though may be subject to change: