Current Developments in Digital Assets: October 1, 2020 | Practical Law

Current Developments in Digital Assets: October 1, 2020 | Practical Law

Practical Law Finance highlights recent noteworthy developments in digital asset regulation, including a wave of CFTC activity and state authorization for a Wyoming-based entity that is being called the world's first "cryptobank."

Current Developments in Digital Assets: October 1, 2020

Practical Law Legal Update w-027-6855 (Approx. 7 pages)

Current Developments in Digital Assets: October 1, 2020

by Practical Law Finance
Published on 01 Oct 2020USA (National/Federal)
Practical Law Finance highlights recent noteworthy developments in digital asset regulation, including a wave of CFTC activity and state authorization for a Wyoming-based entity that is being called the world's first "cryptobank."
Practical Law Finance highlights the following recent noteworthy developments in digital asset regulation.

State of Wyoming Approves Application for First Special Purpose Depository "Cryptobank"

According to an announcement by Kraken Financial, the State of Wyoming has approved its application to form the first special purpose depository institution (SPDI) under Wyoming state law. According to a company release, the Cheyenne, Wyoming-based firm is the first digital asset company in US history to receive a bank charter recognized under federal and state law and will be the first regulated US bank to provide comprehensive deposit-taking, custody, and fiduciary services for digital assets.
As explained in the release, the SPDI is a custody bank for digital assets like virtual currency (VC). In 2019, the Wyoming Legislature enacted HB 74, which authorized the chartering of SPDIs. Excluding incidental activities like fiduciary services, asset management and custody, SPDIs are prohibited from making loans with customer deposits of fiat currency and therefore are not required to obtain insurance from the Federal Deposit Insurance Corporation--though they may do so.
Under Wyoming law, Kraken is required to maintain 100% reserves of its deposits of fiat currency at all times. The Kraken release states that "if every client were to demand withdrawals of their fiat at the same moment, Kraken Financial would be able to fulfill each withdrawal immediately without regard to how many loans we had outstanding." This is an advantage of the SPDI charter, as the FDIC generally only insures deposits up to $250,000.

Other Noteworthy Sate-Law Developments

  • California DBO: cryptocurrency escrow services may be conducted without license under state Money Transmitter Act (MTA). In a redacted letter, the California Department of Business Oversight (DBO) notified an unidentified party that its custodial activities relating tri-party cryptocurrency repurchase (repo) and prime brokerage transactions would not require a money transmitter license in the State of California. DCO noted in the letter that, "Whether cryptocurrencies are a viable form of money or a speculative non-money asset is widely debated. Given this ongoing debate, the Department has not concluded whether cryptocurrencies are a form of money or whether they may trigger the application of the California Money Transmission Act." DBO noted that this position is subject to change, and the party may have its cryptocurrency activities restricted by DBO in the future.

Federal Regulation of Digital Assets

  • CFTC charges foreign trading platform with offering illegal leveraged transactions in ether, litecoin, and bitcoin. On September 29, 2020, the CFTC announced that it filed a civil enforcement action in the US District Court for the Southern District of Texas against Laino Group Limited d/b/a PaxForex, a company registered in St. Vincent and the Grenadines. The CFTC's complaint charges the defendant with failing to register as a futures commission merchant (FCM) and offering or engaging in unlawful retail commodity transactions in ether, litecoin, bitcoin, gold, and silver. It is noteworthy that, while the CFTC pulls back from its role as self-appointed global regulator in other markets, such as swaps and derivatives, the agency remains committed to cross-border enforcement on digital assets accessed by US customers.
  • CFTC issues no-action relief from SEF reinstatement requirements under CFTC Regulation 37.3(d) permitting listing of bitcoin swap. On September 15, 2020, the CFTC issued temporary no-action relief to a dormant CFTC-registered swap execution facility (SEF) from SEF reinstatement requirements under CFTC Regulation 37.3(d). The no-action relief allows Tassat Derivatives, LLC to list a physically deliverable bitcoin swap contract for trading. For further details, see Legal Update, CFTC Issues No-Action Relief from SEF Reinstatement Requirements Under CFTC Regulation 37.3(d) Permitting Listing of Bitcoin Swap.
  • CFTC approves LedgerX to clear bitcoin futures. On September 2, 2020, the CFTC announced approval of an amended order of registration authorizing LedgerX, LLC, as a derivatives clearing organization (DCO) under the Commodity Exchange Act (CEA), to provide clearing services for fully-collateralized futures contracts and options on futures in addition to previously authorized VC swaps. The amended order permits LedgerX to clear bitcoin futures and other VC derivatives. LedgerX is also a CFTC-registered SEF and designated contract market (DCM). For more information on LedgerX, see Legal Update, CFTC Registers Digital Currency Trading Platform as Derivatives Clearinghouse.
  • SEC issues no-action relief to facilitate broker-dealer transactions in digital asset securities. On September 25, 2020, the SEC's Division of Trading and Markets issued a no-action letter to FINRA to facilitate broker-dealer trades of digital asset securities without violating Exchange Act Rule 15c3-3 (the Customer Protection Rule). The Division states in the letter that it would not recommend enforcement action to the SEC if a broker-dealer operating an ATS that trades digital asset securities uses a simplified three-step process detailed in the letter for settling digital asset securities transactions, subject to certain conditions. For more information, see Legal Update, SEC Issues No-Action Letter on Role of Alternative Trading Systems (ATSs) in Settling Digital Asset Security Trades.
  • SEC settles with Unikrn Inc. for unregistered ICO. On September 15, 2020, the SEC settled charges against Unikrn Inc., an operator of an online eSports gaming and gambling platform, for conducting an unregistered initial coin offering (ICO) of digital asset securities in violation of Sections 5(a) and (c) of the Securities Act. According to the SEC, Unikrn raised approximately $31 million through its offering of the UnikoinGold token (UKG), planned to use the proceeds to develop the platform, and promised investors that it would facilitate a secondary trading market for the tokens, which would increase the value of the tokens. Additionally, Unikrn offered and sold UKG as investment contracts, which constituted securities, without registering the offering or qualifying for an exemption from registration with the SEC.
  • OCC issues interpretive letter clarifying authority of banks to hold stablecoin reserves. On September 21, 2020, the Office of the Comptroller of the Currency (OCC) issued an interpretive letter clarifying the authority of national banks and federal savings associations (FSAs) to hold reserves on behalf of customers that issue stablecoins. The interpretive letter concludes that a national bank may hold reserves of assets backing stablecoins in situations where there is a hosted wallet and stablecoins backed on a 1:1 basis by a single fiat currency where the bank verifies at least daily that reserve account balances are always equal to or greater than the number of the issuer's outstanding stablecoins. For further information, see Legal Update, OCC Issues Interpretive Letter Clarifying Authority of Banks to Hold Stablecoin Reserves.
  • FinCEN issues new minimum anti-money laundering (AML) standards and other rules for banks with no federal prudential regulator. On September 14, 2020, the Financial Crimes Enforcement Network (FinCEN) issued a final rule that subjects banks lacking a federal prudential regulator to obligations under the Bank Secrecy Act (BSA) in addition to their current BSA obligations (such as filing suspicious activity and currency transaction reports). The additional obligations are minimum AML program standards, customer identification programs (CIPs), and beneficial ownership requirements. Banks affected by the final rule include private banks, non-federally insured credit unions, and certain trust companies. For additional detail, see Legal Update, FinCEN Expands AML Requirements for Banks Lacking a Federal Functional Regulator.

Global Regulation of Digital Assets

  • FATF identifies red flag indicators of money laundering and terrorist financing associated with virtual assets. On September 14, 2020, the Financial Action Task Force (FATF) published a report on virtual assets (VAs): red flag indicators of money laundering and terrorist financing. It states that the presence of certain key indicators should encourage further monitoring, examination, and reporting, where appropriate. These include transaction patters, transaction sizes, sender or recipient profiles, and source of funds. For additional detail, see Legal Update, FATF identifies red flag indicators of money laundering and terrorist financing associated with virtual assets.

Further Information on Digital Asset Regulation

For information on regulation of digital assets, see Practice Notes: