Current Developments in Digital Assets: April 28, 2021 | Practical Law

Current Developments in Digital Assets: April 28, 2021 | Practical Law

Practical Law Finance highlights current developments in digital assets, including the latest OCC cryptobank charter, a proposed "Britcoin" central bank digital currency (CBDC), expansion of China's experimental CBDC program, a prohibition on crypto payments by the Turkish central bank, Bitcoin "hard fork" advice from the IRS, an updated digital token safe harbor proposal from SEC Commissioner Hester Peirce, as well as Dogecoin, NFTs, and more.

Current Developments in Digital Assets: April 28, 2021

Practical Law Legal Update w-030-7479 (Approx. 9 pages)

Current Developments in Digital Assets: April 28, 2021

by Practical Law Finance
Published on 28 Apr 2021USA (National/Federal)
Practical Law Finance highlights current developments in digital assets, including the latest OCC cryptobank charter, a proposed "Britcoin" central bank digital currency (CBDC), expansion of China's experimental CBDC program, a prohibition on crypto payments by the Turkish central bank, Bitcoin "hard fork" advice from the IRS, an updated digital token safe harbor proposal from SEC Commissioner Hester Peirce, as well as Dogecoin, NFTs, and more.
Practical Law Finance highlights the following recent developments in digital assets.

OCC Approves National Bank Charter for Cryptobank Paxos Trust

On April 23, 2021, the Office of the Comptroller of the Currency (OCC) issued a letter granting preliminary conditional approval of the application to charter Paxos National Trust, New York (Paxos), subject to the conditions specified in the letter. Paxos is an uninsured national bank with operations limited to those of a trust company and related activities. The bank will provide a range of services associated with digital assets that are permissible for a national bank, including:
  • Custody services for digital assets.
  • Custody and management of USD stablecoin reserves.
  • Payment, exchange, and other agent services.
  • Other cryptocurrency services, such as trading services and enabling partners to buy and sell cryptocurrency.
  • Know-your-customer (KYC) services, which include customer identification, sanctions screening, enhanced due diligence, customer risk rating, and other related services.
The letter notes that these activities are currently being conducted by Paxos Trust Company, LLC, a New York-chartered limited liability trust company (Paxos Trust Company). Paxos and Paxos Trust Company are affiliates and direct, wholly owned subsidiaries of Kabompo Holdings Ltd., based in the Cayman Islands.
For information on other Paxos-related developments, see Legal Updates:

UK Treasury and Bank of England (BoE) Explores "Britcoin" CBDC

On April 19, 2021, Reuters reported that British finance minister Rishi Sunak instructed the Bank of England (BoE) to investigate the case for a new "Britcoin" central bank-backed digital currency (CBDC).
The BoE said that it and the government had not yet made a decision on whether to introduce a CBDC in the UK, and that it would engage widely with stakeholders on the benefits, risks, and practicalities of doing so. Any digital currency would be designed to exist alongside physical cash and existing bank deposits, rather than to replace them, the central bank said.

China Expands Central Bank Digital Currency (CBDC) Experiments

On April 18, 2021, Reuters reported that China will expand its digital yuan experiments to more cities, but there is no specific timetable for its official rollout. China is one of the frontrunners in the global race to launch CBDC, which promise to modernize financial systems and speed up domestic and international payments. Last year, the People's Bank of China (PBOC) launched testing in several cities including Suzhou, Shenzhen, Chengdu and Xiong'an. Testing has shown that the issuance and distribution mechanism of China's CBDC – the digital yuan/renminbi, referred to as e-CNY – are compatible with the existing financial system.
According to a release, the digital renminbi is designed for domestic retail payments. However, cross-border transactions are also contemplated. In the early stages of the rollout, the Digital Currency Research Institute of the PBOC and the Hong Kong Monetary Authority conducted technical tests on the cross-border use of digital renminbi in the Mainland and Hong Kong, with positive results. For now, the PBOC plans to continue the program in select locations for additional study. A broader rollout of the digital yuan/renminbi has yet to be announced.

Turkey's Central Bank Bans Crypto Payments

As reported by Reuters on April 16, 2021, Turkey’s central bank (TCB) has banned the use of cryptocurrencies and crypto assets for purchases citing possible "irreparable" damage and transaction risks. In legislation published in the Official Gazette, TCB stated that cryptocurrencies and other such digital assets based on distributed ledger technology could not be used, directly or indirectly, to pay for goods and services.
In a statement, the TCB asserted that crypto assets are not subject to regulation or supervision mechanisms nor a central regulatory authority, among other security risks. Earlier that week, Royal Motors, which distributes Rolls-Royce and Lotus cars in Turkey, became the first business in the country to accept payments in cryptocurrencies. The legislation goes into effect on April 30th.

CFTC Commissioner Stump Remarks on CFTC's Bitcoin Jurisdiction; XRP Litigation

On April 16, 2021, CFTC Commissioner Dawn Stump delivered remarks at the Texas A&M Bitcoin conference, in which she touched on a number of noteworthy matters. Among other important remarks, Commissioner Stump noted in her speech that:
  • Bitcoin is a commodity under the CEA. Treating Bitcoin as a commodity is no more surprising or unusual than treating corn, oil, or copper as a commodity, given the breadth of the definition of the term "commodity" under Commodity Exchange Act Section 1a(9) (7 U.S.C. § 1a(9)).
  • The CFTC regulates the futures contract but not the underlying commodity. The CFTC regulates derivatives associated with the underlying commodities, but not the underlying commodities themselves. In other words, the CFTC regulates futures on Bitcoin because Bitcoin is a commodity, but the CFTC does not regulate Bitcoin itself – much like the CFTC regulates cattle futures because cattle are commodities, but does not regulate the sale of cattle at auctions throughout the country.
  • But CFTC enforcement authority is broader. The CFTC’s regulatory authority is limited to derivatives products such as futures and swaps, as compared to the expanse of its enforcement authority, which is broader, and:
    • the CEA does not provide the CFTC with jurisdiction to regulate exchanges or other markets involving cash commodity transactions, whether for corn, oil, or digital assets;
    • while the CFTC does not regulate the underlying cash markets, it does have authority to investigate and prosecute civil enforcement actions in cases of fraud or manipulation in these cash commodity markets, including the Bitcoin cash market. Hence jurisdiction to bring recent CFTC Coinbase action, even though Coinbase does not offer derivatives products; and
    • the CFTC is involved in cash commodity markets only to the extent enforcement action is necessary to guard against fraudulent or manipulative conduct that may impact the proper functioning of the derivatives markets it regulates.
  • The question of whether XRP is a security will be crucial. XRP is similar to Bitcoin and other digital assets but also different in key respects, which prompted the SEC’s investigation: Bitcoin was an open software project launched by a pseudonymous creator calling himself Satoshi Nakamoto, whereas XRP was created, sold initially, and backed by the company known as Ripple. This case will help to establish the scope of the SEC’s authority in the digital assets space.
The commissioner also drew attention to and praised SEC Commissioner Peirce's proposed safe harbor for digital assets (see SEC Commissioner Peirce Updates Proposed Safe Harbor for Digital Token Sales, below).

SEC Commissioner Peirce Updates Proposed Safe Harbor for Digital Token Sales

On April 13, 2021, SEC Commissioner Hester Peirce issued a statement announcing updates to her proposal for a digital token safe harbor (see Practice Note, SEC Regulation of Digital Assets: Peirce Proposed Safe Harbor for Digital Token Sales). The safe harbor would provide digital network developers with a three-year grace period to facilitate participation in and develop the platform with a registration exemption from federal securities laws.
The proposal is solely Commissioner Peirce's own and not a formal SEC proposal, but Peirce hopes the SEC will consider how its rules can be modified to accommodate new technology in a responsible manner. For further information on the proposed safe harbor, see Legal Update, SEC Commissioner Peirce Updates Proposed Safe Harbor for Digital Token Sales.

Internal Revenue Service (IRS) Issues Advice Memorandum on 2017 Bitcoin Hard Fork

On April 9, 2021, the office of the chief counsel of the Internal Revenue Service (IRS) released advice memorandum number 202114020 to a request for advice regarding the tax consequences for an individual who received Bitcoin Cash as a result of the Bitcoin hard fork on August 1, 2017 (hard fork). The memo addresses whether a taxpayer who received Bitcoin Cash as a result of the hard fork has gross income under section 61 of the Internal Revenue Code (Code).
The short answer is, yes. According to the memo, gross income is realized because the taxpayer had an accession to wealth under section 61 of the Code. Revenue Ruling 2019-24 applies the general principles of § 61 to conclude that the receipt of a new cryptocurrency following a hard fork results in income. The date of receipt and fair market value to be included in income will be dependent on when the taxpayer obtained dominion and control over the Bitcoin Cash.
According to the memo, Bitcoin underwent a hard fork on August 1, 2017, which resulted in the creation of a new cryptocurrency, Bitcoin Cash. The developers of Bitcoin Cash designed the Bitcoin Cash protocol in such a way that holders of Bitcoin received Bitcoin Cash in a 1:1 ratio based on the transaction history recorded in the shared portion of the Bitcoin/Bitcoin Cash distributed ledger (blocks 1 through 478,558.6). Therefore, at the time the new Bitcoin Cash protocols went into effect, Bitcoin Cash was effectively distributed to all distributed ledger addresses that held Bitcoin as of block 478,558.

Anticipated Dogecoin "Doge Day" Spike Fails to Materialize

An anticipated surge in the value of the cryptocurrency Dogecoin on April 20, 2021, failed to materialize, as the currency lost value on the day. Dogecoin (pronounced "doje-coin") was the subject of a coordinated social-media drive that encouraged market participants to undertake a massive buy of the cryptocurrency on the popular 4/20 cannabis date in an attempt to spike the price and replicate the recent GameStop phenomenon in the crypto markets.
Dogecoin has emerged as the latest "it" coin – widely viewed as the most exciting development in cryptocurrency since Bitcoin – due in part to its facetious inception on social media platform Reddit, where it first became popular with the platform's dog-loving community as a "like" mechanism. Despite the momentum and the coordinated online push, the coin plateaued for most of the day, dropping as low as $0.29 toward the end of the New York business day. A mild recovery pushed it back over $0.30 after hours, but it never approached its all-time high of just under $0.41, established last week.

The Notorious NFT: Non-Fungible Tokens Raise Consumer Protection Issues

Non-Fungible Tokens (NFTs) seem to be everywhere these days. But what are they, exactly? NFTs are digital assets that utilize blockchain technology to record ownership and evidence authenticity of a unique good or asset. Using NFTs to record ownership and authenticity enables the owner of such a good or asset to transfer ownership to a buyer, while maintaining a record of the transfer on the blockchain. Unlike fungible tokens such as Bitcoin, NFTs are unique and therefore cannot be traded for another identical token. Currently, the most common NFTs authenticate digital art, collectibles such as digital trading cards, and content (primarily video clips), which appear visually in gif, jpeg, or other common media formats.
However, the buying and selling of NFTs is rapidly entering the mainstream without the safeguards that accompany regulated financial instruments. This is because NFTs do not fit squarely within the parameters of traditional financial instruments. Rather, NFTs implicate a range of existing regulatory and legal frameworks. Depending on facts and circumstances, NFT marketplaces could be subject to anti-money laundering/Bank Secrecy Act (AML/BSA) obligations and securities laws obligations. NFT marketplaces, creators, and market participants also need to consider how intellectual property, tax, and data privacy laws may apply to their businesses. One regulatory regime that has received little attention to date in the NFT space is consumer protection. Because NFTs are often sold to retail buyers, NFT marketplaces and market participants should be aware that consumer protection regulations may apply to such sales.

Other Noteworthy Developments in Digital Assets

House approves SEC-CFTC digital assets working group. On April 20, 2021, the US House of Representatives passed H.R. 1602, introduced by Congressman Patrick McHenry, the Republican leader of the House Financial Services Committee. The Eliminate Barriers to Innovation Act would establish a digital asset working group to ensure collaboration between regulators and the private sector to foster innovation. The bill would require the SEC and the CFTC to establish a working group focused on digital assets.
Coinbase valued at $83 billion in first crypto-exchange IPO. As reported by Reuters, on April 14, 2021, cryptocurrency exchange Coinbase conducted its long-anticipated initial public offering (IPO) through a direct listing in which no shares were sold ahead of the opening. Concerns remain in the market that the value of the stock will fluctuate in lockstep with the value of Bitcoin. The IPO is a major milestone for the legitimacy of the cryptocurrency markets, particularly in the US.

Further Information on Digital Asset Regulation

For information on regulation of digital assets, see Practice Notes:
See also Practical Law's Blockchain Toolkit and Update Tracker.