On January 19, 2021, the American Bar Association (ABA) Derivatives and Futures Law Committee’s Innovative Digital Products and Processes Subcommittee (IDPPS) Jurisdiction Working Group released an update to its comprehensive white paper addressing jurisdictional issues associated with digital products, including cryptocurrencies and other digital assets, and digital processes, such as blockchain.[1]
The updated white paper gives an in depth analysis of several current issues in the cryptocurrency and digital asset space that have developed since the March 2019 publication of the first white paper, including:
- rapid development of Stablecoins;
- growth of the decentralized finance movement and the increasing number of state central banks exploring the creation of virtual currencies;
- 2020 guidance from the CFTC concerning “actual delivery” of digital assets and related litigation;
- The SEC’s Digital Asset Framework, its first issuance of digital asset-related no-action letters, and further developments in its key enforcement actions targeting significant digital asset projects;
- SEC staff guidance on the custody of digital asset securities under the rules applicable to broker-dealers;
- Recent case law developments in certain CFTC enforcement actions involving digital assets;
- New developments regarding the Travel Rule’s application to virtual asset service providers;
- FinCEN’s first assessment of civil money penalties against a peer-to-peer virtual currency exchanger; and
- International developments, including the EU’s recent approval of the Sixth Anti-Money-Laundering Directive.
The need for this update reflects the rapid evolution of the digital asset and cryptocurrency space. As regulators worldwide endeavor to keep pace with this ever-developing industry, it is imperative that market participants continue to keep themselves informed of the applicable legal and regulatory landscape, as detailed in this update. Several key developments merit further discussion below, as we expect that regulators will focus on these areas in the coming years.
A. Stablecoins
Stablecoins were developed in response to the price volatility of bitcoin and other cryptocurrencies.[2] As their name suggests, Stablecoins aim to “increase price stability,” given that their value is tied to fiat currencies, which typically are “stable and liquid.”[3] The stability of Stablecoins should increase their market acceptance, particularly for payment purposes.[4]
In 2019, the Swiss Financial Market Supervisory Authority (FINMA) released Stablecoin guidelines.[5] This guidance noted that while Swiss law lacks specific provisions to regulate Stablecoins, they would be treated the same as any other blockchain-based tokens. The specific characteristics of Stablecoins can influence which financial laws apply. For example, if a token is linked to a particular fiat currency, it likely would be categorized as a deposit under the banking laws. The updated white paper explores FINMA’s and other regulators’ evolving approaches to Stablecoins in more depth.
B. Actual Delivery
The Commodity Exchange Act (CEA) provides that agreements, contracts, or transactions in commodities—other than foreign currencies or securities—entered into by or offered to retail customers on a leveraged, margined, or financed basis must be regulated as or “as if” they were futures, unless covered by an exemption.[6] This effectively means that a non-exempt transaction may be executed only on or subject to the rules of a CFTC-regulated exchange, and persons providing services in connection with nonexempt transactions may be covered by one of the CEA’s registration categories for professionals.
One oft-discussed exception to this requirement is for contracts for commodity sales that result in actual delivery of the commodity within 28 days. The CFTC has been grappling for years with its interpretation of the term “actual delivery.”[7] The need to clarify the meaning of actual delivery in virtual currency transactions became more pronounced in 2016, when the CFTC brought its first enforcement action against a trading platform that offered retail commodity transactions in virtual currency without registering with the CFTC.[8] In its settlement order against that platform, Bitfinex, the CFTC took the position that delivery of bitcoin purchased with borrowed funds to a private, omnibus settlement wallet where the coins were held for the benefit of the buyer but also as collateral for the loan did not constitute actual delivery, because the buyer did not have any rights to access or use the purchased bitcoin until released by Bitfinex following satisfaction of the loan. In March 2020, the CFTC addressed the uncertainty surrounding the concept of “actual delivery” in the context of digital asset transactions by issuing an interpretation that aligns with the approach it employed in Bitfinex. This guidance provides, in part, that the actual delivery exception applies only when a customer secures possession and control of, and has the ability to use freely in commerce, the entire quantity of the digital asset no later than 28 days from the date of the transaction, rendering any lien on the digital asset as a means to secure repayment incompatible with actual delivery.[9] The updated white paper examines the CFTC’s actions in this area in greater depth.
C. SEC Digital Asset Framework and Other Enforcement Issues
In April 2019, the SEC’s Strategic Hub for Innovation and Financial Technology (FinHub) published the Digital Asset Framework,[10] which provides guidance regarding FinHub’s view as to whether a given digital asset would be considered a security—and thus subject to SEC regulation—under the test set forth in SEC v. W.J. Howey Co.[11] The SEC staff also recently issued its first digital-asset-related no-action letters, confirming that two digital assets that essentially function as stored-value cards would not be deemed securities. The Framework and other developments concerning the SEC’s regulation of digital assets are discussed in detail in the updated white paper.
The white paper also addresses the regulatory uncertainty attending digital assets, which could potentially frustrate law enforcement and innovation. The CFTC and the SEC appear to be coordinating in combatting perceived fraudulent activity involving cash market transactions in digital assets, but their coordination does not necessarily mean that where only one agency initiates an action, only that agency has jurisdiction. One legislative attempt to address this regulatory uncertainty is the Digital Commodity Exchange Act of 2020 (DCEA), which was introduced to fill regulatory gaps that exist between the CFTC and the SEC and to provide a clear means by which market participants could ensure that their transactions in digital assets comply with the law. The updated white paper includes more detailed discussion of the DCEA.
D. Travel Rule
FinCEN’s Travel Rule has been a recent focus of international attention, with the Financial Action Task Force (FATF) adopting an interpretive note in June 2019 confirming that countries should apply provisions similar to the Travel Rule to virtual asset services providers.[12] In the United States, FinCEN has confirmed that the Travel Rule is the most commonly cited violation by the IRS against money services businesses engaged in virtual currency money transmission.[13] The updated white paper expands on this topic in detail.
[1] By Michael Spafford and Katherine Berris of Paul Hastings, Jonathan Marcus of Skadden, and Daren Stanaway of Interactive Brokers.
[2] Tim Swanson, Why Bitcoin Needs Fiat (And This Won’t Change in 2018), Coindesk (Jan. 4, 2018), https://www.coindesk.com/bitcoin-still-needs-fiat-currency-wont-change-2018/.
[4] FINMA, Supplement to the Guidelines for Enquiries Regarding the Regulatory Framework for Initial Coin Offerings (ICOS) (2019), https://www.finma.ch/en/news/2019/09/20190911-mm-stable-coins/.
[6] 7 U.S.C. § 2(c)(2)(D)(iii).
[7] American Bar Association Derivatives and Futures Law Committee Innovative Digital Products and Processes Subcommittee Jurisdiction Working Group, Digital and Digitized Assets: Federal and State Jurisdiction Issues 61 (2020), https://www.americanbar.org/content/dam/aba/administrative/business_law/buslaw/committees/CL620000pub/digital_assets.pdf.
[8] See In re BFXNA Inc., CFTC No. 16-19 [2016-2017 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 33,766 (June 2, 2016).
[9] Retail Commodity Transactions involving Certain Digital Assets, 85 Fed. Reg. 37,734, 37,742–43 (June 24, 2020).
[10] SEC, Strategic Hub for Innovation and Financial Technology, Framework for “Investment Contract” Analysis of Digital Assets (Apr. 3, 2019), https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets.
[11] SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
[12] See FATF, Outcomes FATF Plenary, 16-21 June 2019 (June 21, 2019), https://www.fatfgafi.org/publications/fatfgeneral/documents/outcomes-plenary-june-2019.html. FinCEN subsequently “applauded” FATF’s interpretation. See FinCEN, Prepared Remarks of FinCEN Director Kenneth A. Blanco at Chainalysis Blockchain Symposium (May 13, 2020), https://www.fincen.gov/news/speeches/prepared-remarks-fincen-directorkenneth-blanco-delivered-consensus-blockchainsymposium.
[13] See FinCEN, Prepared Remarks of FinCEN Director Kenneth A. Blanco at Chainalysis Blockchain Symposium (Nov. 15, 2019), https://www.fincen.gov/news/speeches/prepared-remarks-fincen-director-kenneth-blancochainalysis-blockchain-symposium.