United States: The Crypto Weekly - August 10, 2022 Issue

The below articles and industry developments have been identified by Kelley Drye and Warren's Blockchain and Cryptocurrency practice group as relevant during the week of August 3 – August 9. We hope you find this useful. Access may require subscription.

Regulatory Updates

U.S. Lawmakers Look to Digital Dollar to Compete With China

WSJ, August 8, 2022

Lawmakers are pushing the Federal Reserve to move swiftly toward issuing a digital dollar, to combat steps from China and others they say could one day threaten the U.S. status as the global reserve currency.

The bipartisan group of lawmakers, including Reps. Maxine Waters (D., Calif.) and French Hill (R., Ark.), has sought for the U.S. to counter global competitors launching digital versions of their currencies. The House Financial Services Committee, which both serve on, might vote on related legislation as soon as next month. Ms. Waters has framed competition over new forms of central-bank money as "a new digital assets space race." The Biden administration and the Fed don't share a sense of urgency.

Unlike private cryptocurrencies such as bitcoin, a Fed-issued central bank digital currency would be backed by the U.S. central bank, just like the Fed backs physical currency. Fed Chairman Jerome Powell has indicated the central bank isn't in a rush, as it confronts inflation and a slowing economy.

Read more here.

Crypto Lender Hodlnaut Freezes Withdrawals, Citing Market Conditions

CoinDesk, August 8, 2022

Cryptocurrency lending platform Hodlnaut has frozen withdrawals, deposits and token swaps after facing "difficult market conditions," according to an Aug. 8 announcement. The Singapore-based firm, founded in 2019, said the decision was taken to focus on stabilizing liquidity and preserving assets while it works on a long-term solution.

Hodlnaut also withdrew its license application to the Monetary Authority of Singapore (MAS) having received in-principle approval from the central bank in March.
The company is the latest in a line of crypto lenders that have buckled under market pressure this year, with Celsius Network and Voyager Digital both declaring bankruptcy. The total crypto market cap has slumped to about $1 trillion from more than $3 trillion in November.

Read more here.

Mixing Service Tornado Cash Blacklisted by US Treasury

CoinDesk, August 8, 2022

The Treasury Department has banned all Americans from using decentralized crypto-mixing service Tornado Cash.

The Office of Foreign Assets Control (OFAC), a watchdog agency tasked with preventing sanctions violations, on Monday added Tornado Cash to its Specially Designated Nationals list, a running tally of blacklisted people, entities and cryptocurrency addresses. As a result, all U.S. persons and entities are prohibited from interacting with Tornado Cash or any of the Ethereum wallet addresses tied to the protocol. Those who do may face criminal penalties.

Tornado Cash has been a key tool for the Lazarus Group, a North Korean hacking group tied to the $625 million March hack of Axie Infinity's Ronin Network, according to the Treasury Department. Blockchain analysis showed that tens of millions of dollars' worth of crypto stolen from Ronin flowed through Tornado Cash, which is designed to obfuscate the source of funds.

Read more here.

Crypto Finds a Bright Spot in a Stormy Summer: Congress

The Washington Post, August 7, 2022

It's been an ugly summer for the cryptocurrency industry everywhere but on Capitol Hill.

Despite a pileup of a bad news — layoffs at major companies, ongoing hacks, and the collapse of several high-profile crypto projects that have devastated Main Street investors — the sector is on a hot streak in Congress.

In just the last two weeks, a bipartisan group of senators unveiled a proposal to hand oversight of cryptocurrency spot markets to the Commodity Futures Trading Association, the third bipartisan bill since April that would codify a leading role for the industry's preferred regulator.

Sens. Patrick J. Toomey (R-Pa.) and Kyrsten Sinema (D-Ariz.) teamed up to pitch exempting crypto used for everyday purchases, like buying a sandwich, from capital gains taxes. And that pair, along with Sens. Mark R. Warner (D-Va.) and Cynthia M. Lummis (R-Wyo.), proposed limiting the reach of a provision signed into law last year that tightened tax reporting requirements on crypto transactions. In announcing the bill, the senators included praise from eight industry representatives.

"The mounting stack of legislative proposals is a signal that Washington is taking crypto seriously, and that is a good thing for all sides," said Sheila Warren, CEO of the Crypto Council for Innovation, an industry trade group.

Taken together, the flurry of crypto-friendly legislation represents a dramatic turnaround from what the industry confronted on the Hill a year ago.

Read more here.

Crypto Becomes Next Financial Sector Under US Lawmakers' Diversity Lens

CoinDesk, August 5, 2022

Rep. Maxine Waters (D-Calif.), the chairwoman of the House Financial Services Committee, has asked 20 of the largest cryptocurrency firms doing business in the U.S. to explain their hiring practices as the panel adds the digital assets industry to the financial sectors it has questioned about employment diversity.

Waters, who is also leading an effort alongside the panel's ranking Republican to write legislation to regulate stablecoins, signed the letters alongside other committee Democrats, sending the requests to prominent crypto companies, including Binance.US, Circle, FTX and Coinbase, plus companies investing in the industry such as Andreessen Horowitz and Digital Currency Group, the parent company of CoinDesk.

"There is a concerning lack of publicly available data to effectively evaluate the diversity among America's largest digital assets companies, and the investment companies with significant investments in these companies," according to the letters.

Read more here.

The Three Words Driving the Crypto Policy Debate

protocol, August 5, 2022

The latest flashpoint comes in the form of the Securities and Exchange Commission's civil lawsuit alleging insider trading by a Coinbase employee. The SEC's explosive assertion that nine of the 25 cryptocurrencies involved in the alleged insider scheme are securities could have significant consequences for the industry. Placing that claim within the lawsuit has prompted Coinbase, a high-ranking U.S. senator and even fellow federal regulators to bemoan that the SEC is regulating by enforcement.

The complaints are "basically saying that the SEC is not providing enough clarity on a particular issue," said James Park, a UCLA Law professor and securities regulation expert. "Instead of passing a regulation that would provide sufficient specificity and give the industry notice, the SEC instead is bringing enforcement actions that are interpreting broadly worded statutory phrases to develop the law case-by-case."

Within the crypto industry, the argument against regulation by enforcement is that digital assets don't fit neatly within the SEC's existing rule book. Critics believe Congress needs to act to pass clear rules for when a crypto asset should be considered a security placed under the SEC's jurisdiction, or when it should be considered a commodity, overseen by the Commodity Futures Trading Commission. Barring congressional action, critics say, the regulators themselves need to set more formal rules.

Gensler has said he encourages crypto companies to "come in and talk to us," but he has also implied that most cryptocurrencies — outside of bitcoin — are securities. He has expanded the SEC's enforcement division and pledged to pursue "high-impact" cases.

Read more here.

Coinbase's Rapid Rise Left It Exposed in Crypto's Collapse

WSJ, August 5, 2022

Brian Armstrong, an early devotee of blockchain technology, built the cryptocurrency exchange Coinbase Global Inc. COIN 4.67%? to be big.

He hired employees by the hundreds, pushed into new markets and scaled up the number of digital tokens available on the platform. Coinbase became the largest crypto exchange in America and went public in spring 2021 with a market value of nearly $86 billion.

This year's crypto collapse has dropped that value to roughly $21 billion. And it has left Mr. Armstrong to wrestle with a sprawling business now faced with high expenses, dwindling cash and, more recently, a challenge from federal regulators.

Coinbase now finds itself at odds with the Securities and Exchange Commission, which has taken the position that several crypto coins traded on Coinbase's platform are securities. Coinbase, which isn't licensed to operate as a securities exchange, denies they are. But a potential lawsuit from the securities regulator could lead to a delisting of some coins and greater hesitation about adding new ones in the future.

If a court agrees with the SEC that some of the digital tokens are securities, Coinbase would likely have to stop trading them on its exchange. Coinbase itself could potentially face liability, such as fines, if the SEC eventually sues Coinbase over its decision to list the assets.

Either step could have a chilling effect on Coinbase's future listing decisions, while its overseas competitors would have fewer constraints on their growth. Binance.US, the U.S. arm of Binance Holdings, earlier this week delisted one of the alleged securities.

Read more here.

States Face Tax Losses from Unreported Cryptocurrency Gains

Bloomberg Tax, August 5, 2022

States are losing significant tax revenue attributable to gains from cryptocurrency transactions, but shifting tens of millions of digital currency investors into full compliance could take years, tax authorities learned this week, Bloomberg Tax's Michael J. Bologna writes.

The state cryptocurrency tax gap is likely in the billions of dollars, Norm Hannawa, director of tax strategy at Chainalysis Inc., told a meeting of the Multistate Tax Commission. Hannawa, whose company specializes in blockchain compliance services, presented data on the growth of cryptocurrency investment gains as an indicator of the tax losses suffered by the states. Realized digital currency gains in the US over centralized exchanges, he noted, totaled $47 billion last year. Those gains attributable at the state level come to $6.9 billion in California, $4.1 billion in Texas, and $3.8 billion in New York. Only a small portion of those gains are taxed by state and federal authorities, he said.

Read more here.

New Crypto Oversight Legislation Arrives as Industry Shakes

NBC News, August 4, 2022

After 13 years, at least three crashes, dozens of scams and Ponzi schemes and hundreds of billions of dollars made and evaporated, cryptocurrencies finally have the full attention of Congress, whose lawmakers and lobbyists have papered Capitol Hill with proposals on how to regulate the industry.

The latest bipartisan proposal came Wednesday from Sens. Debbie Stabenow, D-Mich., and John Boozman, R-Ark. It would hand the regulatory authority over bitcoin and ether to the Commodities Futures Trading Commission. Stabenow and Boozman lead the Senate Agriculture Committee, which has authority over CTFC.

Bills proposed by other members of Congress and consumer advocates have suggested giving the authority to the Securities and Exchange Commission.

The Stabenow-Boozman bill would be a win for the cryptocurrency industry, which sees the CFTC as more industry-friendly regulator than the SEC. The CFTC, which had a budget last year of $304 million with roughly 666 employees, is a fraction of the size of the SEC, which had a budget of nearly $2 billion and 4,500 full-time employees.

Read more here.

CFTC Would Become Primary Crypto Regulator Under New Senate Committee Plan

CoinDesk, August 3, 2022

The Senate Agriculture Committee, which oversees the Commodity Futures Trading Commission, introduced a bipartisan bill Wednesday that would grant the CFTC "exclusive jurisdiction" over cryptocurrency trades that meet commodities law.

The Digital Commodities Consumer Protection Act of 2022, sponsored by Senators Debbie Stabenow (D-Mich.), John Boozman (R-Ark.), Cory Booker (D-N.J.) and John Thune (R-S.D.), would create a definition of "digital commodity" that would include cryptocurrencies like bitcoin and ether but not anything that may be a security, giving the CFTC the ability to oversee both digital commodity transactions and force registration of digital commodity platforms, according to a section-by-section breakdown of the bill.

The crypto industry has been pushing for either a federal agency or Congress to create a clear definition of "digital commodity" or a digital security, which could give companies greater clarity on when and how they must register with the CFTC or the Securities and Exchange Commission. The bill doesn't provide that definition. The CFTC would have some ability to define digital commodities, and the bill appears to still defer to the SEC on what a security is.

Much of the bill is dedicated to detailing how digital commodity brokers would be treated similarly to their traditional finance counterparts.

Read more here.

Senate Plan Would Put Bitcoin, Ether Under Commodity Regulator's Watch

WSJ, August 3, 2022

Leaders of a Senate committee are pitching legislation that would assign oversight of the two largest cryptocurrencies, bitcoin and ether, to the federal agency that regulates milk futures and interest-rate swaps.

Senate Agriculture Committee Chairwoman Debbie Stabenow (D., Mich.) and top-ranking Republican John Boozman of Arkansas unveiled a plan Wednesday that would empower the Commodity Futures Trading Commission to regulate spot markets for digital commodities, a newly created asset class. Currently the CFTC has authority to police derivatives, such as futures and swaps, rather than underlying commodities.

The bill marks the latest salvo in an intensifying battle among federal agencies and congressional committees that oversee them over who will regulate crypto. Thirteen years after bitcoin was created, cryptocurrencies remain largely unregulated by the federal government, leaving investors without key protections from fraud and market manipulation.

At the heart of the turf war are questions about how cryptocurrencies fit into the definition of a security, the legal classification that includes stocks and bonds. A 1946 Supreme Court case created a test that focuses on whether investors buy an asset in hopes of profiting from the efforts of other people. If so, the issuer is required to register with the SEC and publicly disclose any information that may be material to the security's price.

Even though investors in bitcoin and ether rely on a network of users and programmers to validate transactions and perform software updates, cryptocurrency enthusiasts insist those groups are too decentralized for the assets to be regulated like securities. Instead, they argue, the assets should be considered commodities, which have a broader definition and no full-time regulator.

Read more here.

News Articles

The news articles cover relevant content from August 3 through August 9. Access may require subscription.

Ethereum Layer 2s Could Take Revenue From the Blockchain as They Become More Competitive: Coinbase

CoinDesk, August 9, 2022

The Ethereum blockchain needs layer 2 systems to help deal with its "shortcomings on cost and throughput," though those same scaling products could leech revenue from the network as they become "competitive rather than complementary," crypto exchange Coinbase (COIN) said in a research report Monday.

"It's feasible that layer 2s could become the application layers hosting the bulk of economic activity while Ethereum exists exclusively to store transaction data," David Duong, head of institutional research at Coinbase, wrote in the report.

A layer 1 network is the base layer, or the underlying infrastructure of a blockchain. Layer 2 refers to a set of off-chain systems or separate blockchains built on top of layer 1s. A decentralized application (dapp) is a digital app that uses blockchain technology to keep users' data out of the hands of the organizations behind it.

The future of layer 2s could be a "zero-sum game" because the layer 2 that houses the majority of dapps could "power the entirety of the Ethereum ecosystem," the report said. There is about $68.9 billion in total value locked on Ethereum, compared with $5.2 billion across layer 2s, the report said.

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Crypto Market Turmoil Highlights Personal Risks for Compliance Chiefs

WSJ, August 8, 2022

The recent crash in the price of some cryptocurrencies, along with a series of hacks and bankruptcies as well as potential new regulatory regimes, underscores the importance of compliance programs in helping protect crypto firms from running afoul of the law.

But the increased pressure and attention placed on the industry has stoked the anxiety of individual crypto compliance officers and other legal professionals, who see regulators more willing to hold them personally accountable for the problems at their firms, according to industry experts.

Regulators can potentially charge compliance chiefs working in all sectors, including traditional finance, for conduct relating to their job-related duties. However, for those individuals working in the nascent crypto sector, where the rules are still evolving, the personal liability risks can be higher. Legal and compliance professionals at crypto firms are often asked to turn on a dime to make judgment calls and might not have the staff and resources that are available to a larger financial services business.

Read more here.

Top BitMEX Employee Pleads Guilty to U.S. Charge

WSJ, August 8, 2022

A top employee at BitMEX has pleaded guilty in New York to failing to put in place an anti-money-laundering program at the cryptocurrency derivatives exchange, joining three co-founders who previously admitted to violations of U.S. law.

Gregory Dwyer entered a guilty plea Monday in New York federal court, admitting to one count of violating the Bank Secrecy Act.

Prosecutors said Mr. Dwyer, one of the first employees of BitMEX and its onetime head of business development, was involved in BitMEX's flouting of U.S. anti-money-laundering rules.

Read more here.

What Will Cryptocurrency Market Look Like in 2027? Here Are 5 Predictions

Cointelegraph, August 6, 2022

The year is 2027. It's a time of great innovation and technological advancement, but also a time of chaos. What will the crypto market look like in 2027? (For those unfamiliar, that's a line from the 2011 video game, Deus Ex.)

Long-term predictions are notoriously difficult to make, but they are good thought experiments. One year is too short a period for fundamental changes, but five years is just enough for everything to change.

Here are the most unexpected and outrageous events that could happen over the next five years.

1. The crypto market will fragment along geographic lines

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Investors Claim Coinbase Hid Problems Before IPO

Law360, August 5, 2022

Investors have accused cryptocurrency exchange Coinbase Inc. and its top brass of misleading them about the strength of the exchange's platform and its compliance with federal securities laws before its initial public offering, in a derivative suit and separate proposed class action.

The derivative suit, filed in Delaware federal court Thursday by shareholder Donald Kocher, alleges Coinbase misrepresented cornerstone pillars of its business, such as its trusted platform and "flywheel" growth strategy, in its registration statement with the U.S. Securities and Exchange Commission before going public in April 2021.

A proposed class action in New Jersey federal court filed the same day, led by plaintiff Vijay Patel, accuses Coinbase of failing to disclose that it held crypto assets that could be subject to bankruptcy proceedings and that Coinbase customers would be treated as unsecured creditors of the company in that event.

Read more here.

Texas Regulators Call Celsius' Plans For Its Crypto Too Risky

Law360, August 5, 2022

Texas securities regulators asked a New York bankruptcy judge to reject cryptocurrency platform Celsius Network's request for permission to monetize the bitcoin it mines, saying Friday that Celsius should not get "carte blanche" to dispose of its cryptocurrency as it sees fit.

In its motion, the Texas State Securities Board said it was not opposed to allowing Celsius to sell the bitcoins, but the proposed order would allow the company to engage in the same transactions that landed it in Chapter 11 in the first place. The request also fails to specify how the proceeds would be used to pay creditors, the board said.

Read more here.

Voyager Digital Is Cleared to Return $270 Million to Customers

WSJ, August 5, 2022

Cryptocurrency brokerage firm Voyager Digital Holdings Inc. secured approval to return $270 million in customer cash, which accounts for a small portion of investor assets that have been locked up since its bankruptcy filing last month.

Judge Michael Wiles of the U.S. Bankruptcy Court in New York, who is overseeing Voyager's bankruptcy, ruled on Thursday that the company provided "sufficient basis" to support its contention that customers should be allowed access to the custodial account held at New York-based Metropolitan Commercial Bank.

Read more here.

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