Opportunity for U.S. Backed Digital Currency

Cryptocurrency (“Crypto”) is an easily accessible digital asset used for financial transactions.[1] Crypto has become a source of payment on virtual platforms and utilizes blockchain technology.[2] While digital transactions eliminate the need for intermediaries such as banks, credit card companies, or third-party payment processors, it is an unregulated and volatile field.[3] The recent events with FTX highlight this issue.

The use of Crypto rose globally at an unprecedented rate during the COVID-19 pandemic.[4] Developing countries in particular accounted for 15 of the top 20 economies in 2021 using Crypto.[5] One of the most notable countries attempting to adopt Crypto is El Salvador. In 2021, El Salvador became the first country in the world to recognize Bitcoin as legal tender.[6] As such, El Salvador attempted to turn an impoverished area around the Conchagua volcano into a Bitcoin City.[7] The President of El Salvador, Nayib Bukele, hoped to create a futuristic metropolis from Crypto using the Conchagua volcano as a geothermal plant.[8] Unfortunately, President Bukele invested $100 million of government funds into Bitcoin when prices peaked, which led to a further debt crisis in El Salvador. One of the issues El Salvador and other developing countries have run into with the use of Crypto as legal tender is the volatility of the market. Since 2021, Bitcoin has dropped 61%, and El Salvador is likely to default on its debts in the next few years due to the dramatic drop in value.[9] The price of Crypto is open to fluctuation, fraud, and tax evasion due to the lack of regulation and backing by a central bank or government.[10]

One solution that has been proposed to bring stability to the Crypto market is a Central Bank Digital Currency (“CBDC”), which is a digital token, similar to Crypto, issued by a central bank. In the United States, the digital form of the token would be the equivalent of the U.S. dollar.[11] President Biden and the Federal Reserve are evaluating the creation of a U.S. CBDC and how it would work alongside the existing form of physical currency.[12]

The benefits of a U.S.-issued CBDC include privacy-protected digital currency, improvements to cross-border payments, and support to the U.S. dollar’s international role.[13] A U.S. CBDC would offer access to digital money that is free from credit and liquidity risks, unlike money held in a traditional bank.[14] Currently, Federal Reserve notes are the only central bank money available to the public. The use of a CBDC would provide a cheaper, faster form of transferring money and bring people who do not have bank accounts into the financial market.[15]

The dollar is the world’s most widely used currency for payments and investment.[16] A CBDC would expand the U.S. economy by creating a financial market with the global use of a CBDC.[17] Recently, China introduced its own CBDC, which may decrease the demand for the U.S. dollar abroad. The creation of a U.S. CBDC would allow competition on a global scale with China and other countries that have developed a digital currency backed by their central bank.[18]

Despite the benefits to the U.S. consumer and the global financial system, a U.S. CBDC has several issues. Many Americans actively use and prefer cash.[19] Additionally, there are privacy issues with digital currency. A Federal Reserve-backed CBDC system would allow the central bank to see every user transaction.[20] Additionally, banks have questioned the legal authority of the Federal Reserve to issue a digital currency without authorization from Congress.[21]

The White House, the Office of Science and Technology Policy, and the National Science Foundation continue to work on the National Digital Assets Research and Development Agenda.[22] The Executive Branch has placed a high priority on advancing research concerning Crypto and how it could provide financial inclusion and equity to Americans.[23]  While the benefits of a U.S. CBDC are plentiful, there are many moving parts to the initiation of a central bank backed digital currency in the United States. However, even with the lack of regulation and its volatile nature, Crypto is not going away. Crypto provides businesses and consumers with easily transferable, convenient, less expensive means of transferring money.[24] A U.S. backed stable coin may provide such stability. Clearly, the U.S. would not want the European Union or another Western power to issue such a coin and undermine the U.S. leadership in global currencies.

 

[1] Molly Mastantuono, Cryptocurrency 101: A Guide to Digital Dollars (Dec. 17, 2021), https://www.bentley.edu/news/cryptocurrency-101-guide-digital-dollars.

[2] Id.

[3] Id.

[4] UN trade body calls for halting cryptocurrency rise in developing countries, United Nations (Aug. 10, 2022), https://news.un.org/en/story/2022/08/1124362.

[5] Id.

[6] Joe Hernandez, El Salvador Just Became The First Country To Accept Bitcoin As Legal Tender, NPR (Sept. 7, 2021), https://www.npr.org/2021/09/07/1034838909/bitcoin-el-salvador-legal-tender-official-currency-cryptocurrency.

[7] Zeke Faux, El Salvador’s $300 Million Bitcoin ‘Revolution’ Is Failing Miserably (Nov. 4, 2022), https://www.bloomberg.com/news/features/2022-11-04/el-salvador-s-bitcoin-revolution-is-failing-badly.

[8] Id.

[9] Id.

[10] UN trade body calls for halting cryptocurrency rise in developing countries, supra note 4.

[11] Dr. Alondra Nelson, Alexander Macgillivray, Nik Marda, Technical Possibilities for a U.S. Central Bank Digital Currency (Sept. 16, 2022), https://www.whitehouse.gov/ostp/news-updates/2022/09/16/technical-possibilities-for-a-u-s-central-bank-digital-currency/.

[12] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, Board of Governors of the Federal Reserve System (Jan. 2022), https://www.federalreserve.gov/publications/files/money-and-payments-20220120.pdf.

[13] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, supra note 12.

[14] Id.

[15] Andrew Ackerman, What is a Central Bank Digital Currency and Should the U.S. Issue it? (May 26, 2022), https://www.wsj.com/articles/should-the-u-s-issue-a-digital-dollar-which-could-compete-with-crypto-assets-11646921329.

[16] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, supra note 12.

[17] Id.

[18] Boucher, supra note 16.

[19] Andrew Ackerman, Fed Launches Review of Possible Central Bank Digital Currency (Jan. 20, 2022), https://www.wsj.com/articles/fed-launches-review-of-possible-central-bank-digital-currency-11642706158

[20] Id.

[21] Id.

[22] Money and Payments: The U.S. Dollar in the Age of Digital Transformation, supra note 12.

[23] Id.

[24] Shobhit Seth, What is a Central Bank Digital Currency (CBDC)?, Mar. 9, 2022, https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp.

Pastore’s Managing Partner Leads Discussion with Congressman Jim Himes

On September 23, the Connecticut Crypto Forum (the “Forum”) held an event at the University of Connecticut at Stamford. The Forum connects large and sophisticated capital pools with leading players and thinkers across the crypto, defi and Web 3.0 markets to strengthen investor knowledge, understanding and skill. Pastore LLC is proudly a Founder and Sponsor of the Connecticut Crypto Forum. The Forum’s September 23 event was an invite-only session.

In the first half of the event, a panel of speakers discussed the current maturity of the crypto and blockchain markets.  The panel addressed the current challenges facing the evolving asset class and concluded that crypto/blockchain assets are still “metaphorically” in their teenage years. The asset class still is characterized by volatility. Moreover, the panelists noted the time of hyper valuation of projects in the industry is over. What follows now is a time of acquisitions. Many companies and projects will likely fail, but the ones with worthwhile technology that lack sufficient cashflows to continue operation will likely be consolidated within larger players and ultimately be poised to make the industry more efficient. However, the panelists agreed that the industry’s best days are ahead of it.

During the second half of the event, Pastore LLC’s Managing Partner, Christopher Kelly, led a discussion with Congressman Jim Himes, an emerging leader in the crypto/blockchain industry on Capitol Hill. Congressman Himes noted the significant attention that crypto and blockchain assets have received in Congress. He noted that he is working with other members of Congress on legislation concerning the industry.

When a member of the crowd asked what should businesses do considering the lack of legal and regulatory clarity surrounding crypto assets, Mr. Kelly gave a poignant response: Don’t be afraid, be transparent and work with counsel to navigate the murky regulatory waters. Pastore, as a thought leader in the field, is positioned to help businesses and individuals plan a path forward despite the uncertainty.

 

New York State Department of Financial Services Issues Consent Order Against Robinhood Crypto, LLC

As interest in cryptocurrencies (“crypto”) continues to rise, businesses and investors are left wondering what regulations they must follow. While a broad regulatory framework is still nonexistent for the crypto industry, the New York State Department of Financial Services (“DFS”) recently imposed a $30 million fine on Robinhood Crypto, LLC (“Robinhood”), a wholly-owned crypto trading unit of Robinhood Markets Incorporated, for failing to comply with New York anti-money laundering (“AML”) and cybersecurity regulations.[1] This is the first time DFS has taken enforcement action against a crypto company. In making the announcement, the Superintendent of DFS, Adrienne Harris, stated, “[a]ll virtual currency companies licensed in New York State are subject to the same anti-money laundering, consumer protection, and cybersecurity regulations as traditional financial services companies.”[2] Superintendent Harris made it clear that while this may be the first such action against a crypto company, it will not be the last.[3] DFS expects crypto companies to invest in compliance programs like traditional financial institutions.

In the DFS Consent Order, DFS took issue with several aspects of Robinhood’s compliance program[4] Specifically, Robinhood failed to devote sufficient funds and resources to its compliance program,[5] its Chief Compliance Officer lacked “commensurate experience to oversee a compliance program such as [Robinhood’s]” and did not participate adequately in the implementation of Robinhood’s automate software compliance program, [6] and Robinhood overly relied on the compliance program of its parent and affiliate despite those compliance programs were not compliant with New York State’s regulations.[7] Moreover, Robinhood failed to adequately evaluate “potentially suspicious transactions in order to determine whether a [Suspicious Activity Report] should be filed.”[8] DFS noted that as of October 26, 2020, Robinhood had a backlog of 4,378 potentially suspicious transaction alerts.[9]

While Robinhood may have had a compliance program on paper, DFS made it clear that it is focused on the execution of such programs. One thing is clear: the DFS Consent Order indicates that regulatory and enforcement agencies are starting to take action against the crypto industry. Common sense, sound legal advice, and diligence will help any business or investor navigate this market as state and federal agencies begin to enforce traditional financial services regulations on the industry.

[1] In the Matter of Robinhood Crypto, LLC, Dep’t of Fin. Servs. (Aug. 1, 2022), https://www.dfs.ny.gov/system/files/documents/2022/08/ea20220801_robinhood.pdf.

[2] DFS Superintendent Harris Announces $30 Million Penalty on Robinhood Crypto for Significant Anti-Money Laundering, Cybersecurity & Consumer Protection Violations, Dep’t of Fin. Servs., https://www.dfs.ny.gov/reports_and_publications/press_releases/pr202208021 (last visited Sept. 19, 2022).

[3] Id.

[4] Id.

[5] Id. at ¶¶ 36-41.

[6] Id. at ¶ 36.

[7] Id. at ¶ 6.

[8] Id. at ¶ 37.

[9] Id.

Is the SEC kicking Crypto when it is down?

Coinbase Global Inc. (“Coinbase”) is facing an SEC probe into whether it improperly allowed trading of digital assets that should have been registered as securities. Although there have been several court rulings and position statements by the SEC regarding digital assets, it has not halted the trading on crypto exchanges. While the SEC scrutiny of Coinbase has increased since the platform expanded the number of tokens, in which it offers trading, no meaningful regulatory action has occurred with respect to Coinbase.

The drumbeat in Washington for US regulators to do more to oversee crypto has grown louder as digital currencies have tumbled from all-time highs, erasing hundreds of billions of dollars in market value. SEC Chair Gary Gensler has homed in on trading platforms and argued that the SEC should do more to protect “retail investors”.

To determine if a digital asset is a security, the SEC applies a legal test from the 1946 U.S. Supreme Court decision. Generally, the SEC considers monies under its purview if the funding is made with the intention of profiting from the efforts of the issuer. The SEC Commissioner has suggested publically that “many” cryptocurrencies come under the definition. The SEC has not indicated which “coins” are “securities”, and instead has allowed exchanges to decide for themselves.

In the absence of clear guidance this regulatory approach, seems like a game of “gotcha”. Crypto is a young industry and it deserves clear and accurate rules so that its participants can navigate the path forward. The SEC should either test its approach in court, and perhaps it is with Coinbase, or stand down. Ultimately, the U.S. Supreme Court will likely decide the question of how to determine whether crypto coins or tokens are securities. Either way, crypto can thrive if its coins generate enough investor interest, but the rules for regulation and investor protection should be made clear at this point.

Is Cryptocurrency Regulation here yet?

Is Regulation here yet? The Evolving State of Case Law and the Appropriate Characterization of Crypto as a Security or Not.

For some investors, part of the appeal of tokenized assets is that the sector has been able to dodge regulations from institutions like the U.S. Securities and Exchange Commission (“SEC”), the U.S. Department of Treasury, and the Commodity Futures Trading Commission. Tokenized assets can be fungible or non-fungible. Fungible tokenized assets are both interchangeable and indistinguishable such as Bitcoin and other cryptocurrencies (“Crypto”). Non-fungible tokens (“NFTs”) are unique tokens that are non-divisible and cannot be replaced because each token has its own unique value.[1]

Investors and regulators alike have faced the recurring question of how to make sense of this decentralized digital space. However, more clarity on the guidelines surrounding Crypto and NFTS are forming. On March 9, 2022, President Biden signed an Executive Order on Ensuring Responsible Development of Digital Assets, calling for a closer look into the possible threats and benefits of Crypto.[2] The SEC has shouldered the weight of overseeing the majority of Crypto products and platforms. Regulatory efforts have been a challenge due in part to a major dilemma being weighed by regulators: whether cryptocurrencies should be processed as securities or commodities.

In 2021, a Connecticut federal case involving a securities class action suit against Stuart Fraser, GAW Miners, and ZenMiner began to provide a more definitive answer on how to classify cryptocurrencies; as the federal jury concluded that Paycoin and several other crypto-currency mining related assets were not securities.[3] However, as recently as June 3, 2022, U.S. District Judge Michael P. Shea has granted a motion for a new trial regarding Paycoin.[4]

Judge Shea justified the new trial by citing precedent in SEC v. Kik Interactive Inc., in which Kik Interactive Inc. (“Kik”) failed to register its digital tokens as a security.[5] The SEC was able to demonstrate that under the Howey Test, Kik met the criteria to be considered an “investment contract”. For an asset to be considered an investment contract, it must meet the three criteria of the Howey Test, which was developed and named after the Supreme Court case SEC v. W.J. Howey Co., 328 U.S. 293 (1946).[6]  The Howey Test requires that there be (i) an investment of money (ii) in a common enterprise (iii) that is subject to a reasonable expectation of profits to be derived from the efforts of others.[7] With Kik’s money being invested in a single integrated offering, the court granted the SEC summary judgement and Kik a $5 million dollar penalty.[8]

In addition to Kik, the SEC also brought a lawsuit against Ripple Labs Inc., claiming that over $1.3 billion had been raised as an unregistered digital asset security.[9] The lawsuit has made national news because XRP, the cryptocurrency developed by Ripple, is one of the most valuable in the world. Ripple has been arguing that XRP should not qualify as an investment contract because the company had never promised profits to any of its holders.[10] The case was formally served in December of 2020 and is still ongoing. However, on March 22, 2021, Judge Netburn declared that XRP has monetary value, separating it from bitcoin and Ether.[11]

A regulatory stance that aligns with the initial Paycoin decision would result in more lenient oversight over the Crypto space and likely promote further development in blockchain technology.[12] Conversely, a regulatory stance promoting SEC oversight over tokenized assets could force digital currencies, such XRP, to register as securities. Upcoming legal decisions, particularly the new trial regarding Paycoin, will be crucial in providing investors and legislators with a more concrete understanding of the legal space surrounding tokenized assets and blockchain technology.

 

[1] Tokenization: Opening Illiquid Assets to Investors, BNY Mellon (June 2019), https://www.bnymellon.com/emea/en/insights/all-insights/tokenization-opening-illiquid-assets-to-investors.html.

[2] Executive Order on Ensuring Responsible Development of Digital Assets, The White House (March 2022),

https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.

[3] Federal jury Concludes Cryptocurrency Products NOT Securities, The National Law Review (November 2021), https://www.natlawreview.com/article/federal-jury-concludes-cryptocurrency-products-not-securities.

[4] Federal Judge Orders new Securities Trial for Crypto-Product ‘Paycoins’, ConnecticutLawTribune (June 2022), https://www.law.com/ctlawtribune/2022/06/13/federal-judge-orders-new-securities-trial-for-crypto-product-paycoins/?kw=Federal%20Judge%20Orders%20New%20Securities%20Trial%20for%20Crypto-Product%20%27Paycoins%27&utm_source=email&utm_medium=enl&utm_campaign=dailybriefing&utm_content=20220614&utm_term=clt&slreturn=20220529104704.

[5] Id.

[6] Framework for ‘Investment Contract” Analysis of Digital Assets, The U.S. Securities and Exchange Commission, https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets (last visited June 29, 2022).

[7] SEC v. Kik Interactive Inc., 492 F.Supp.3d 169, 177 (S.D.N.Y. 2020).

[8] SEC Obtains Final Judgment Against Kik Interactive for Unregistered Offering, The U.S. Securities and Exchange Commission (October 2020), https://www.sec.gov/news/press-release/2020-262.

[9] XRP vs. SEC lawsuit update, Cryptopolitan (June 2022), https://www.cryptopolitan.com/xrp-vs-sec-lawsuit-update/.

[10] The ‘Ripple’ effect: a striking development on defending digital asset securities litigation, Reuters (April 2022), https://www.reuters.com/legal/legalindustry/ripple-effect-striking-development-defending-digital-asset-securities-litigation-2022-04-21/

[11] XRP vs. SEC lawsuit update, Cryptopolitan (June 2022), https://www.cryptopolitan.com/xrp-vs-sec-lawsuit-update/.

[12] SEC vs. Ripple: Case Explained, CNBC (April 2022), https://www.cnbctv18.com/cryptocurrency/sec-vs-ripple-case-explained-13054042.htm.

Pastore Sponsors Connecticut Crypto Forum

The Connecticut Crypto Forum has recently been created to advance education and knowledge in this new asset class. The forum will connect large and sophisticated capital pools with leading players and thinkers across the crypto, delfi, and Web 3.0 market to strengthen investor knowledge, understanding, and skill. The mission of the forum is to build a diverse, sophisticated, Connecticut-based community interested in crypto from many angles.

On May 13, 2022, the Connecticut Crypto Forum will be conducting an invite-only session for those interested in the forum to partake in. Pastore LLC is proudly a founder and sponsor of the Connecticut Crypto Forum.

Learn more about Pastore’s Crypto practice

 

 

 

Weighing the Carbon Footprint of Cryptocurrency

Cryptocurrency (“Crypto”) is a virtual form of currency that functions through a decentralized system to record transactions and uses encryption, rather than an entity such as a bank, to verify transactions.[1] Crypto’s first mark on the digital world was in 2009 through Bitcoin, which remains the best-known form of Crypto today.[2] Crypto is created through a process known as mining, which involves downloading a unique software that contains all transactions that have taken place through that specific network.[3]

Crypto has had a profound effect on the global economy and has altered our world’s view of currency and financial transactions in general. Any investor with access to the internet can purchase cryptocurrency.[4] Additionally, over 15,000 businesses worldwide now accept Crypto as a form of payment, which has altered the availability of transactions to interested purchasers.[5] A study conducted by Forester Consulting on Crypto using the Total Economic Impact methodology demonstrated that 40% of customers that used Crypto as their form of currency were new customers to the merchant, evidencing intriguing information that Crypto is affording access to new transactions to new demographic groups.[6]

Despite the numerous advantages that Crypto has offered globally, Crypto’s high demand comes at the cost of an impact on our environment, which is currently being addressed at a federal executive level. The process of mining all Crypto was initially designed to be capped at 21 million units; however, the number of units available to mine has caused an increase in computation power exerted in order to mint new units of Crypto.[7] The estimated carbon footprint stemming from a single crypto transaction is estimated to burn 2,292.5 kilowatt hours of electricity, which equates to the amount of power the average U.S. household uses over the course of 78 days.[8] No payment system is foolproof in completely abolishing its carbon footprint and CO2 emissions. However, compared   to VISA, which is another payment system, the average Crypto transaction requires 200,000 times more energy consumption.[9]

The substantial footprint of Crypto is acknowledged by the current administration, which has prioritized climate change mitigation. [10] In an Executive Order on “Ensuring Responsible Development of Digital Assets” which took place on March 9, 2022, United States President Joe Biden addresses the resulting environmental pollution from Crypto and Crypto mining and implements a plan alongside many federal agencies such as the Environmental Protection Agency.[11] The Executive Order recognizes the benefits of Crypto financial markets for consumers, investors, and businesses, however addresses the responsibility the United States has to mitigate contributions to climate change and pollution.[12]

To reach these goals and assure that Crypto’s harms to not outweigh its benefits, and to learn more about how to stray away from harms, the Executive Order calls on the Director of the Office of Science and Technology Policy to prepare a report to the President within 180 days, specifically addressing “the connections between distributed ledger technology and short-, medium-, and long-term economic and energy transitions; the potential for these technologies to impede or advance efforts to tackle climate change at home and abroad; and the impacts these technologies have on the environment…The report should also address the effect of cryptocurrencies’ consensus mechanisms on energy usage, including research into potential mitigating measures and alternative mechanisms of consensus and the design tradeoffs those may entail.[13]

The damages Crypto could potentially have large effects on climate change and the state of our environmental crisis. However, mitigating Crypto pollution is not an impossible feat. Government encouragement in developing sustainable technologies can have social and economic benefits to the Crypto market and remove the serious threat that Crypto can pose to the emission of greenhouse gases and its carbon footprint.[14]

[1]What is Cryptocurrency and How Does it Work?, Kaspersky, “https://www.kaspersky.com/resource-center/definitions/what-is-cryptocurrency”>https://www.kaspersky.com/resource-center/definitions/what-is-cryptocurrency (Last visited March 17, 2022)

[2]Id.

[3] Jake Frankenfield, Cryptocurrency, Investopedia (Jan. 11, 2022) https://www.investopedia.com/terms/c/cryptocurrency.asp#:~:text=Cryptocurrencies%20are%20generated%20by%20mining,have%20occurred%20in%20its%20network.

[4] Jim Probasco, What to Know About Investing in Crypto Exchanges, Investopedia (Nov. 30, 2021) https://www.investopedia.com/buying-and-selling-4689764

[5]Who Accepts Bitcoin and Ether Cryptocurrencies, Currency Exchange International (May 12, 2021) https://www.ceifx.com/news/who-accepts-bitcoin-and-ether-cryptocurrencies#:~:text=More%20than%2015%2C000%20businesses%20worldwide,Microsoft%2C%20AT%26T%2C%20and%20Wikipedia.

[6]Forrester Study Shows Accepting Crypto Attracts New Customers and Boosts AOV, Forrester (Aug. 6, 2020) https://bitpay.com/resources/forrester-report-says-bitpay-adds-new-sales-and-2x-aov/

[7] John Bogna, What is the Environmental Impact of Cryptocurrency? PCMag (Jan. 8, 2022) https://www.pcmag.com/how-to/what-is-the-environmental-impact-of-cryptocurrency#:~:text=The%20environmental%20concern%20comes%20from,household%20for%20over%2078%20days.

[8]Id.

[9]Bitcoin Energy Consumption Index, Digiconomist (2022) https://digiconomist.net/bitcoin-energy-consumption

[10] Executive Order on Ensuring Responsible Development of Digital Assets (Mar. 9, 2022), https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.

[11] Executive Order, § 5(b)(vi)

[12] Executive Order, § 1

[13] Executive Order, § 5(b)(vii)

[14] Jon Truby, Decarbonizing Bitcoin: Law and Policy Choices for Reducing the Energy Consumption of Blockchain Technologies and Digital Currencies, 44 Energy Rsch. Soc. Sci. 399 (2018) (Discussing the benefits of Crypto and how the harms can be avoided through commitment to positive government intervention choices).

Tokenized Assets: What are They and how are They Regulated?

As the decentralized world of blockchain continues to grow, tokenized assets have caught the eye of investors and regulators alike. Tokenized assets may be fungible or non-fungible. Fungible tokenized assets are interchangeable and indistinguishable such as Bitcoin and other cryptocurrencies (“Crypto”). Non-fungible tokens (“NFTs”) are unique tokens that are non-divisible and cannot be replaced because each token has a unique value.[1] Tokenized assets result from taking a tangible asset (such as real estate, paintings, and precious metals) or an intangible asset (such as a digital picture or a YouTube video) and converting the asset ownership into a digital token on a blockchain.[2] This process is known as tokenization.[3] By taking a real-world asset and making a digital representation, it creates a broader investor base, geographic reach, and a reduction in transaction times.[4] Moreover, placing the digital token on a blockchain ensures no single authority can erase your ownership in the tokenized asset.[5]

While tokenized assets can allow for a broader base of investors, like the Crypto market, the NFT market lacks clear regulations from the regulatory agencies such as the U.S. Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”).[6] Moreover, state regulatory bodies have yet to issue guidance on the tokenized asset market.[7]

The current legal framework was not designed to regulate and guide the creation and trade of digital assets.[8] Moreover, the question of what category an NFT falls into depends on the particular asset that was tokenized.[9] For example, the CFTC has stated that renewable energy credits and emission allowances are commodities as defined by the Commodity Exchange Act.[10] However, the SEC has stated that depending on the facts and circumstances of a given NFT, it might be considered an investment contract under the Howey test, which would cause the NFT to be regulated under the Securities Act of 1933 and Securities Exchange Act of 1934.[11] The legal uncertainty within the NFT market led SEC Commissioner Hester Peirce to recently state that guidelines would help provide the public with an understanding of how the SEC is approaching these issues.[12] The lack of a clear regulatory framework has made investors susceptible to fraud, and it allows for bad actors to avoid domestic and international anti-money laundering laws.[13]

Additionally, there is no standardized set of rights that accompanies an NFT since the seller determines what rights follow the NFT.[14] Therefore, sellers and buyers alike should understand the limitations that a transfer, assignment, or license may have on the NFT.

While tokenized assets allow for quick cross-border investment and increased liquidity of real-world assets, investors are left without a clear regulatory framework and, at times, not knowing what rights follow the purchase of an NFT. As the decentralized world of blockchain continues to grow, it is imperative that investors and businesses use common sense, sound legal advice, and diligence to navigate this market. Given the lack of legal certainty, attorney legal opinions on these assets will likely immunize any reasonable use.

[1] Tokenization: Opening Illiquid Assets to Investors, BNY Mellon (June 2019), https://www.bnymellon.com/us/en/insights/all-insights/tokenization-opening-illiquid-assets-to-investors.html.

[2]Id.

[3]Id.

[4]Id.

[5] What is asset tokenization?, Hedera, https://hedera.com/learning/what-is-asset-tokenization#:~:text=Asset%20tokenization%20is%20the%20process,either%20digital%20or%20physical%20assets.&text=Asset%20tokenization%20could%20convert%20ownership,0.0002%25)%20of%20the%20property (last visited Feb. 3, 2022).

[6] William de Sierra-Pambley, Tokenization: Opportunity and Regulation, Finding a Balance, Sheppard Mullin (Oct. 18, 2021), https://www.jdsupra.com/legalnews/tokenization-opportunity-and-regulation-5158893/.

[7]Id.

[8]NFTs: Key U.S. Legal Considerations for an Emerging Asset Class, Jones Day (April 2021), https://www.jonesday.com/en/insights/2021/04/nfts-key-us-legal-considerations-for-an-emerging-asset-class.

[9]Id.

[10]Id.

[11]Id.

[12] Sarah Wynn, SEC’s Peirce says agency guidance on nonfungible tokens needed, Roll Call (Jan. 25, 2022), https://rollcall.com/2022/01/25/secs-peirce-says-agency-guidance-on-nonfungible-tokens-needed/.

[13]NFTs: Key U.S. Legal Considerations for an Emerging Asset Class, supra note 11.

[14]Id.

S.D.N.Y. Grants Pastore’s Motion for Alternative Service Against International Cryptocurrency Corporation

Pastore LLC represents a financial services company in a cryptocurrency contract dispute with a Uruguay joint-stock company with its principal place of business in Sao Paulo, Brazil. In an effort to effectuate service of process against the Uruguayan company, Pastore LLC filed a Motion for Alternative Service with the United States District Court for the Southern District of New York (the “S.D.N.Y.”). In an order that recognized the steps Pastore LLC had taken to comply with the standards of service of process on an international corporation, the S.D.N.Y. granted the Motion for Alternative Service and has allowed Pastore LLC to effectuate service of process via e-mail. The matter involves the trading of a carbon credit crypto coin on the Gemini exchange, as a result of Pastore’s client’s relationship with the well-known founders of the exchange. A recent article regarding this matter can be found here.

Stablecoins: What are They?

A little-known area of the growing cryptocurrency market is stablecoins. Stablecoins, a type of cryptocurrency, are not mined through an open network like Bitcoin and Ethereum.[1] Instead, stablecoins derive their value from another asset.[2] Most stablecoins are pegged to a national currency.[3] For example, the USD Coin is a stablecoin that is pegged to the U.S. dollar.[4] Therefore, one USD Coin is always worth one U.S. dollar.[5] By deriving their value from a national currency, stablecoins avoid the volatility that is usually associated with cryptocurrencies.[6] Like other cryptocurrencies, stablecoins are stored in digital wallets.[7]

While Treasury Secretary Janet Yellen has recognized the potential benefits of stablecoins such as “supporting beneficial payment options,” there are no regulations in place to monitor stablecoin reserves. [8] Government regulators are concerned about the implications of a relatively stable cryptocurrency that allows investors to avoid anti-money laundering (“AML”) regulations. [9] Recently, the President’s Working Group on Financial Markets (“PWG”), consisting of Treasury Secretary Janet Yellen, the chairpersons of the Board of Governors of the Federal Reserve, Securities and Exchange Commission, and Commodity Futures Trading Commission, issued a report recommending Congress to pass legislation to regulate the stablecoin market.[10]

The legislation recommended by the PWG report would limit the issuance of stablecoins to insured depository institutions and establish a federal framework to regulate other parties in stablecoin arrangements, such as the party that facilitates the transfer of stablecoins between individuals and the entity that stores the stablecoins.[11] While the PWG believes the proposed legislation should be passed urgently, it recommends in the meantime that agencies use their current authority to address the risks posed by the unregulated stablecoin market.[12] Moreover, the PWG recommends that international AML standards should be implemented to prevent the use of stablecoins by illicit actors.[13]

While stablecoins are still operating in an unregulated environment, one thing is clear: the market is only continuing to grow, and the SEC and other government agencies are taking notice of the unregulated area. Common sense, sound legal advice, and diligence will help any business or investor navigate this market despite the uncertainty surrounding stablecoins.

[1] Julian Dossett, Stablecoins: What they are, how they work and how to buy them, CNET (Dec. 6, 2021), https://www.cnet.com/personal-finance/crypto/stablecoins-what-they-are-how-they-work-and-how-to-buy-them/.

[2]Id.

[3] Kathryn G. Wellman; Neil T. Bloomfield, President’s working group report calls for stablecoin regulation, Reuters (Dec. 2, 2021), https://www.reuters.com/legal/transactional/presidents-working-group-report-calls-stablecoin-regulation-2021-12-02/.

[4] What is USD Coin? Coinbase, https://www.coinbase.com/usdc (last visited Dec. 28, 2021).

[5]Id.

[6] Wellman; Bloomfield, note 3.

[7] Dossett, note 1.

[8] Felicia Hou, Stablecoins are taking over the crypto world hot topic for Congress—here’s what they are and the fastest-rising ones to keep an eye on, Fortune (Dec. 8, 2021), https://fortune.com/2021/12/08/stablecoins-cryptocurrency-congress/ (quoting Janet Yellen.

[9] Wellman & Bloomfield, note 3.

[10] Id.

[11] President’s Working Grp. on Fin. Mkts., the Fed. Deposit Ins. Corp., & the Off. of the Comptroller of the Currency, Report on Stablecoins (Nov. 2021).

[12] Id.

[13] Id.