Crypto Research Published; USPTO Seeks NFT Input; SEC and FINRA Address Digital Assets; OFAC Settles with Exchange; DOJ Enforcement Continues

In this issue:

New Research and Surveys Address CBDCs, Institutional Crypto Investment
NFTs: Government Agencies Seek Comments on NFT IP; New Marketplaces Open
Crypto DEX and Wallet Providers Reveal User Data Collection Practices
SEC Commissioner Addresses Digital Assets and Investor Protection Concerns
SEC Institutes Proceedings Against DAO; FINRA Examines Crypto Advertising
New York State and Canadian Province Set Limits on Crypto Mining
OFAC Settles with US Crypto Exchange Related to Alleged Sanctions Violations
Multiple DOJ Enforcement Actions Target Crypto Fraud and Money Laundering

New Research and Surveys Address CBDCs, Institutional Crypto Investment

By Robert A. Musiala Jr.

Staff from the board of governors of the U.S. central bank recently published a research paper addressing central bank digital currencies (CBDCs). According to a press release, the paper “provides an overview of the literature examining how the introduction of a CBDC would affect the banking sector, financial stability, and the implementation and transmission of monetary policy in a developed economy such as the United States.” Among other things, the paper discusses the potential for a CBDC to “improve welfare by reducing financial frictions in deposit markets, by boosting financial inclusion, and by improving the transmission of monetary policy.” The paper also addresses “noteworthy risks, including the possibility of bank disintermediation and associated contraction in bank credit, as well as potential adverse effects on financial stability.”

The Bank for International Settlements (BIS) recently published two sets of materials addressing CBDCs. The first is an announcement of the launch of Project Tourbillon, a new project by the BIS Innovation Hub’s Swiss Centre that aims to explore “how to improve cyber resiliency, scalability and privacy in a prototype Central Bank Digital Currency (CBDC).” The second is a paper addressing CBDCs in Africa that is based on a survey to central banks and that “analyses the development, motivations and concerns of … [CBDCs] in Africa relative to other emerging and developing regions.”

A major U.S. cryptocurrency exchange recently published its 2022 Institutional Investor Digital Assets Outlook Survey. The survey sought “to understand how decision makers at US institutions view digital assets,” and “[a] total of 140 institutional investors in the US participated in the survey, representing assets under management of about $2.6 trillion.” Among other things, the survey results indicate that (1) institutional investors increased their allocations during the crypto winter; (2) investors’ top motivation for investing in crypto is differentiated performance, including innovative technology; (3) digital assets were seen as offering one of the most attractive opportunities to generate alpha; (4) regulatory compliance is a top criteria for selecting a crypto partner; and (5) regulatory clarity is an important catalyst for future growth.

For more information, please refer to the following links:

NFTs: Government Agencies Seek Comments on NFT IP; New Marketplaces Open

By Lauren Bass

In connection with a joint study on intellectual property (IP) issues and non-fungible tokens (NFTs), the United States Patent and Trademark Office (USPTO) and the United States Copyright Office (USCO) published a notice in the Federal Register last week seeking public comments on 13 separate questions – each related to a different aspect of IP use in NFTs. The comment period closes on Jan. 9, 2023. Additionally, in mid-January 2023, the USPTO and USCO will hold three public roundtables focused on IP issues in the NFT space. Registration for these events closes on Dec. 21, 2022.

In related news, an American toy manufacturing and entertainment company reportedly launched its own NFT marketplace. According to reports, the marketplace, built on the Flow blockchain, will allow users to purchase NFTs without the use of cryptocurrency and will support peer-to-peer trading. The first series of digital collectibles – based on one of the company’s most recognizable properties – is reportedly set to drop in mid-December.

In other marketplace news, OpenSea reportedly released an “on-chain enforcement tool” to help NFT creators enforce royalty payments on the secondary sales of their work. According to reports, the tool would allow NFT artists to “specify which addresses can make token transfers on their behalf.” This would effectively allow artists to halt resale of their work on sites that refused to honor royalty fees.

For more information, please refer to the following links:

Crypto DEX and Wallet Providers Reveal User Data Collection Practices

By Sydney Park

According to reports, in a recently released privacy policy, Uniswap Labs revealed that it collects on-chain data from its users for the purpose of making improvements to its products. The company stated that this data includes “public on-chain data and limited off-chain data like device type, browser version, etc.” but does not include personal data like names, street addresses, email addresses or IP addresses. In a blog post, Uniswap stated that it “does not share [] data with any third parties for marketing purposes” but uses data “to make data-driven decisions that improve user experiences.”

Three days after Uniswap revealed its data collection policies, the developer of the MetaMask Ethereum wallet reportedly updated its privacy policy to begin tracking users’ IP addresses and other data when they send a transaction. According to the updated privacy policy, the update applies to users who use Infura, an affiliate of ConsenSys, that functions as the default Remote Procedure Call (RPC) provider in all Metamask wallets. The privacy policy states that “when you use Infura as your default RPC provider in MetaMask, Infura will collect your IP address and your Ethereum wallet address when you send a transaction.” According to reports, social media users reacted with displeasure at the privacy policy update, stating generally that the update “invade[s] a user’s privacy – one of the core ethos of the crypto space.”

For more information, please refer to the following links:

SEC Commissioner Addresses Digital Assets and Investor Protection Concerns

By Teresa Goody Guillén

U.S. Securities and Exchange Commission (SEC) Commissioner Jaime Lizárraga recently delivered a speech focused on “putting investors first” with regard to digital assets. He cited recent surveys for the propositions that low-income communities underserved in the traditional financial markets are increasingly investing in digital assets and that a “greater share of unbanked and underbanked individuals may own digital assets than those who are fully banked.” He raised concerns of increased fraud in the digital asset market and the concentration of wealth such that “whales” who hold large positions can exert pressure and impact the market. He expressed his views that the ecosystem is predominantly centralized despite the “narrative” of decentralization; platforms that offer numerous services such as trading, custody, maintaining order books, market-making, and borrowing and lending may have conflicts of interest and may commingle customer assets with those of the platform, which poses risks to customers; the market lacks transparency and uniformity of disclosures; and digital assets are volatile and risky.

The Commissioner stated that “not every issued digital token necessarily represents a securities offering, and not every digital asset intermediary is necessarily operating as an unregistered market participant,” but he noted his agreement with Chair Gary Gensler that most digital assets are likely securities. He rebutted that the SEC is engaged in regulation by enforcement and cited well-established laws and guidance comprised of the distributed autonomous organization report, the SEC Staff Framework for an Investment Contract, multiple no-action letters, and decades of legal precedent on investment contracts and notes.

For more information, please refer to the following links:

SEC Institutes Proceedings Against DAO; FINRA Examines Crypto Advertising

By Teresa Goody Guillén

The SEC recently instituted administrative proceedings against a Wyoming-based distributed autonomous organization (DAO) seeking to stop the registration of crypto asset offerings. The Order alleges that the Form S-1 registration statement failed to include required information and contained materially misleading statements and omissions in violation of the federal securities laws, including inconsistent statements as to the status of the tokens as securities. The Order further alleges that the company failed to cooperate with the SEC’s examination of the registration statement.  

This month, the Financial Industry Regulatory Authority (FINRA) announced that it is conducting a “targeted exam of firm practices regarding retail communications concerning [c]rypto [a]sset products and services.” This sweep is reportedly examining approximately 20 brokerage firms regarding potential advertising of crypto to retail investors without properly communicating the risks associated with the assets. Specifically, the request is for the period July 1, 2022, through Sept. 30, 2022, and seeks, among other things, retail communications, whether the communications were filed with FINRA, whether a registered principal of the firm approved the communications, the firm’s written supervisory procedures related to the approval and dissemination of the communications, and compliance materials relevant to the communications.

For more information, please refer to the following links:

New York State and Canadian Province Set Limits on Crypto Mining

By Joanna F. Wasick

Last week, New York Gov. Kathy Hochul signed a two-year moratorium on new and renewed permits for proof-of-work cryptocurrency mining operators that rely on carbon-based fuel to power their activities. The legislation makes New York the first state to enact a temporary ban on new fossil fuel-powered cryptocurrency mining operations. Issuance of permits for electric energy facilities that use alternatives to carbon-based fuel, such as hydropower, are still allowed. “I will ensure that New York continues to be the center of financial innovation, while also taking important steps to prioritize the protection of our environment,” Gov. Hochul said in a message after signing the legislation into law on Nov. 22.  

In similar news, Canada’s Manitoba province recently set an 18-month moratorium on new crypto mining operations, citing the possibility of the local grid being overwhelmed by new projects, according to local media reports. The government will stop new crypto mining operations from connecting to the grid during this time; the existing 37 mining facilities will not be affected.

For more information, please refer to the following links:

OFAC Settles with US Crypto Exchange Related to Alleged Sanctions Violations

By Amos Kim

This week the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced that it had reached a settlement with Kraken, a U.S.-based cryptocurrency exchange. The settlement is related to apparent violations of the Iranian Transactions and Sanctions Regulations. The settlement includes an agreement by Kraken “to invest an additional $100,000 in certain sanctions compliance controls.” According to an OFAC enforcement release, the apparent violations were “due to Kraken’s failure to timely implement appropriate geolocation tools,” which permitted “users who appeared to be in Iran [to engage] in virtual currency transactions on Kraken’s platform.” OFAC’s enforcement release provides further details on the apparent violations and OFAC’s considerations and analysis.

For more information, please refer to the following links:

Multiple DOJ Enforcement Actions Target Crypto Fraud and Money Laundering

By Christopher Lamb

According to a recent press release from the U.S. Department of Justice (DOJ), two Estonian citizens were arrested in Tallinn, Estonia, for their alleged involvement in a $575 million cryptocurrency fraud and money laundering scheme. The defendants allegedly defrauded hundreds of thousands of victims through a multifaceted scheme involving a fraudulent cryptocurrency mining operation and cryptocurrency bank.

According to another recent DOJ press release, an Ohio man was arrested on criminal charges related to his alleged involvement in a cryptocurrency fraud scheme that raised at least $10 million from investors. The Ohio man allegedly misled investors by fraudulently promoting himself as a cryptocurrency trader with a specialty in derivatives and promised to make lucrative returns.

A recent press release by the U.S. Attorney’s Office for the Eastern District of Texas reported that 21 individuals have been charged for their roles in transnational cryptocurrency money laundering networks, including laundering millions of dollars stolen from U.S. fraud victims through various scams. According to the press release, the cases stemmed from a multiyear operation initiated by the U.S. Attorney’s Office for the Eastern District of Texas called “Operation Crypto Runner” that has to date disrupted over $300 million in annual money laundering transactions.

For more information, please refer to the following links:

DOJ Seizes Over $3 Billion in Historic Crypto Dark Web Fraud Case

On November 7, 2022, the U.S. Department of Justice (DOJ) announced that it had seized more than $3.36 billion worth of bitcoin as part of a continuing investigation into a 10-year fraud involving the Silk Road dark web marketplace. This seizure signifies the DOJ’s second-largest cryptocurrency seizure and financial seizure in history, and it demonstrates the DOJ’s commitment to chase funds and prosecute those involved, despite the passage of years. On November 4, Defendant James Zhong pleaded guilty to one count of wire fraud before the U.S. District Court for the Southern District of New York in connection with his scheme.

Read the full alert.

Crypto Market Data Published; Settlement Pilot Announced; Reports Analyze Crypto Scams; Exchanges Seek to Prove Reserves as Users Withdraw Funds

In this issue:

New Crypto Market Data Published, Blockchain Settlement Pilot Announced

By Amos Kim

The Bank for International Settlements (BIS) recently published the results of a study “to investigate the drivers of crypto adoption” by assembling a database “on retail use of crypto exchange apps at daily frequency for 95 countries” over a period of seven years. According to BIS, the data shows that rising bitcoin prices are followed by the entry of new users, with about 40 percent of new users being men under 35, commonly identified as the most “risk-seeking” segment of the population. The data also indicates that roughly 75 percent of retail investors have likely lost money on their bitcoin investments.

In a recent press release, the innovation center of the New York branch of the U.S. central bank announced that it will collaborate with a group of private sector organizations in a 12-week proof-of-concept project “to explore the feasibility of an interoperable network of central bank wholesale digital money and commercial bank digital money operating on a shared multi-entity distributed ledger.” According to the press release, the project “will test the technical feasibility, legal viability, and business applicability of distributed ledger technology to settle the liabilities of regulated financial institutions through the transfer of central bank liabilities.”

In a final notable item, a cryptocurrency trading firm recently published a report on current cryptocurrency market activity and the “general macro outlook” of the cryptocurrency sector. The report provides current data and analysis on various areas of the cryptocurrency markets, including lending, derivatives, altcoin volatility and DeFi activity.

For more information, please refer to the following links:

CFPB Publishes Report on Crypto Scams; Study Analyzes Scams on Uniswap

By Christopher Lamb

A recently published report from the Consumer Financial Protection Bureau (CFPB) highlights the vast number of complaints to the CFPB related to cryptocurrency assets. According to the report, “more than 8,300 complaints related to crypto-assets submitted to the CFPB from October 2018 to September 2022 have been submitted in the last two years with the greatest number of complaints coming from consumers in California.” The report notes that the most common issues were fraud and scams, followed by transaction issues and hacking. Included in these complaints are reports of frozen accounts, platform bankruptcies and consumer losses. The report claims that older consumers and service members are two special-interest populations affected by these issues because they can be disproportionately impacted by financial product and service issues. According to the CFPB, “analyses suggest that complaints related to crypto-assets may increase when the price of Bitcoin and other cryptoassets increase[s].”

According to a recent study carried out by academics from University of Barcelona, 26,957 of 27,588 tokens listed on the decentralized cryptocurrency exchange Uniswap were “rug pulls” or scams. The study found that only 631 of the tokens analyzed were determined to be non-malicious.

For more information, please refer to the following links:

Multiple Cryptocurrency Exchanges Intend to Publish ‘Proof of Reserves’

By Robert A. Musiala Jr.

According to reports, multiple cryptocurrency exchanges have recently indicated an intent to publish so-called proof of reserves in an attempt to alleviate market concerns. One major exchange recently released a list of its hot wallet and cold wallet cryptocurrency addresses, and several other major exchanges have committed to publishing proof of reserves, also known as Proof of Funds (PoF). According to reports, PoF involves an exchange engaging a third-party auditor to record all customer balances at the exchange and convert the balances into a cryptographic Merkle tree, which anonymizes the data. Customers of the exchange are then able to use the Merkle tree data to compare the total balances held by customers with the total assets held by the exchange, to gain assurance that the exchange holds sufficient cryptocurrency funds to meet customer withdrawal requests. According to reports, two separate cryptocurrency firms have recently announced solutions intended to assist exchanges in facilitating and demonstrating PoF audits. 

For more information, please refer to the following links:

Users Move Crypto Off of Exchanges, Tether Freezes $47M in USDT

By Keith R. Murphy

According to recent reports, nearly $3 billion in bitcoin was withdrawn from exchanges last week, with a huge spike on November 9, and more users appear to be moving their bitcoin to non-custodied wallets. As of November 12, withdrawing addresses aggregated more than 70,000 according to the report, which further suggested that the numbers tie in with what seems to be “rapidly-declining BTC reserves across multiple platforms.” While a true accounting may be difficult to ascertain, an on-chain analytics company indicated that data suggests exchange reserves are at their lowest since February 2018. One report noted that a major U.S. cryptocurrency exchange recently experienced $485 million in net withdrawals within a 24-hour period.

Tether, the issuer behind the widely used stablecoin USDT, has reportedly frozen $47 million in USDT on the Tron blockchain in response to a request from a law enforcement authority. A spokesperson reportedly acknowledged that the company has started receiving requests by law enforcement authorities to freeze assets temporarily while an investigation ensues.

For more information, please refer to the following links:

IRS Warns: Hundreds of Crypto Criminal Tax Cases Coming Soon; Hiring of 300 Special Agents Means More to Follow

The 2022 annual report from the IRS Criminal Investigations (CI) division (the Report) demonstrates an impressive year for enforcement, particularly with regard to cryptocurrency. Following the publication, CI Chief Jim Lee made clear that the division will continue to closely scrutinize crypto transactions. He warned: “Expect more outward-facing tax crypto cases here in the near future” – “outward-facing” referring to publicly brought charges. Lee also warned that criminal charges may result from “off-ramping transactions” (i.e., the process of converting digital assets into fiat currency). Bolstered by the prominent placement of reporting language on the front of Form 1040, law enforcement can be expected to bring more criminal tax cases against those who fail to disclose transactions involving digital assets. Given the division’s 90.6 percent conviction rate on cases accepted for prosecution in fiscal year (FY) 2022, companies and individuals should act now to work with counsel to ensure they are in compliance with all applicable laws and regulations.

Read more.

US District Court Finds LBRY Tokens Are Securities

In 2016, crypto startup LBRY launched the LBRY network and the LBRY protocol, described by LBRY as a decentralized content sharing and publishing protocol that supports the creation of community-run digital marketplaces. The same year, LBRY offered and sold native LBC tokens to the public for the purported purpose of allowing LBRY users to compensate content creators who publish content using the LBRY protocol and miners who process transactions on the LBRY network, a public, proof-of-work blockchain network.

Read full alert.

CBDC Report Published; Crypto and NFT Initiatives Launch; OFAC Redesignates Tornado Cash; SEC and CFTC Target Crypto Fraud; FTX Files for Bankruptcy

In this issue:

CBDC Report Published, Blockchain Settlement and Payment Initiatives Launch
NFT World Cup Initiative Launched, Market Actors Launch NFT Royalty Solutions
OFAC Redesignates Tornado Cash, Mixer Receives Hacked Crypto
SEC, CFTC Bring Enforcement Actions Involving Fraudulent Crypto Trading Bots
FTX Files Bankruptcy Amid Binance’s FTT Selloff and Incoming DOJ Probe

CBDC Report Published, Blockchain Settlement and Payment Initiatives Launch

By Robert A. Musiala Jr.

This week the New York branch of the U.S. central bank published a report on the Phase I results of Project Cedar, “a multiphase research effort to develop a technical framework for a theoretical wholesale central bank digital currency (wCBDC).” According to a press release, currently it takes two days for most foreign exchange (FX) spot trades to settle, which exposes payment senders and recipients to “settlement, counterparty, and credit risk which, among other things, can hinder an institution’s ability to readily convert its assets into cash.” In Project Cedar Phase I, “the experiment simulated a foreign exchange (FX) spot trade and introduced a wholesale central bank digital currency prototype to test whether using blockchain technology could improve speed, cost, and access to cross-border wholesale payments.” In this test environment, the experiment reportedly revealed three key findings:

  • Faster Payments: In the test environment, transactions on the blockchain-enabled system settled in under 15 seconds on average.
  • Atomic Settlement: The simulated ledger network enabled atomic settlement, meaning the two sides of the simulated transactions were settled either simultaneously or not at all, which reduces FX risks.
  • Safer and Accessible Transactions: The distributed ledger system design enabled payments on a 24/7/365 basis and supported objectives related to interoperability across financial institutions, including central and private sector banks.

Separately, this week a major global bank published a press release announcing “the world’s first digital bond that is publicly traded and settled on both blockchain-based and traditional exchanges.” According to the press release, “[t]he CHF 375 million bond is digital only, and will be issued on the blockchain-based platform of SIX Digital Exchange (SDX) while being dual listed and traded on SDX and SIX Swiss Exchange (SIX).”

In a final notable item, a major South African grocery chain has reportedly announced plans to begin allowing customers to pay for groceries with bitcoin at 39 stores in South Africa using any bitcoin lightning-enabled app. According to reports, customers will scan a QR code from the app and accept the conversion rate on their smartphone at the time of the transaction.

For more information, please refer to the following links:

NFT World Cup Initiative Launched, Market Actors Launch NFT Royalty Solutions

By Veronica Reynolds

According to a recent press release, a major U.S. financial services firm has partnered with a major cryptocurrency exchange to launch an NFT auction for fans of the FIFA World Cup Qatar 2022. The initiative will reportedly feature digital art designed using an algorithm and “inspired by iconic goals from five legendary footballers.” The experience will become immersive later this month, when fans will be able to create their own “digital art inspired by their own signature movements” and mint the art onto their own NFT.

This week, NFT marketplace OpenSea reportedly unveiled a new onchain tool that will facilitate enforcement of royalties. The tool, described in an OpenSea blog post as a “simple code snippet,” is intended to allow NFT creators to enforce fees onchain on an opt-in basis and block their NFTs from being listed on marketplaces that do not support creator fees. The tool is available only for new, not-yet-existing NFT collections, a decision that reportedly left some users feeling like there is “no plan and [there are] no clear answers [regarding] existing collection and artist’s royalties.”

Last week, Solana-based NFT marketplace Exchange.Art announced a “Royalties Protection Standard” that reportedly “will enforce creator royalties on secondary sales of NFTs that originally mint on its platform.” According to reports, the new standard is an opt-in program that the marketplace designed to allow NFT creators to choose which secondary NFT platforms may feature their NFTs and to prevent “creators’ work from being ‘force-listed’” on marketplaces that don’t enforce NFT royalties.

In a related development, an Ethereum layer 2 NFT platform recently announced the release of its “community-governed whitelist and blacklist for smart contracts that honor royalty fees.” The feature reportedly allows NFT creators to use the lists to control smart contracts that deploy their NFTs without the help of a third-party exchange, and may be used to limit the transferability of NFTs through the tool’s royalty-respecting smart contracts.

For more information, please refer to the following links:

OFAC Redesignates Tornado Cash, Mixer Receives Hacked Crypto

By Amos Kim

This week the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced that it has delisted and redesignated Tornado Cash to record further reasons for the designation, including its role in obfuscating “the movement of over $455 million stolen in March 2022 by the OFAC-designated, DPRK-controlled Lazarus Group in the largest known virtual currency heist to date.” OFAC also issued new guidance “to provide additional compliance guidance regarding the nature of the Tornado Cash entity, and updated three existing FAQs with additional guidance.” According to reports, earlier this week, based on data from Etherscan, the hacker responsible for the $28 million hack of Deribit, a major bitcoin and ether options exchange, transferred over 1,600 ether (~$2.5M) to Tornado Cash.

For more information, please refer to the following links:

SEC, CFTC Bring Enforcement Actions Involving Fraudulent Crypto Trading Bots

By Joanna F. Wasick

Last week, the U.S. Securities and Exchange Commission (SEC) announced charges against four individuals for their roles in Trade Coin Club (TCC), which the SEC describes as “a fraudulent crypto Ponzi scheme that raised more than 82,000 bitcoin, valued at $295 million at the time, from more than 100,000 investors worldwide.” According to the complaint, TCC was a multilevel marketing program that operated from 2016 through 2018 and promised profits from the trading activities of a purported crypto asset trading bot. Defendants told investors the bot made “millions of microtransactions” every second and that investors would receive a minimum return of 0.35 percent daily. However, according to the SEC, instead of investors’ funds being deployed for the purported bot, they went into the pockets of defendants and other TCC promoters.

In a similar action, last week, the Commodity Futures Trading Commission (CFTC) issued an order indicating that Jeremy Rounsville defrauded investors through his company, Arbitraging.co, which also purported to have a “highly advanced arbitrage bot” that executed the company’s complex digital asset trading strategies. However, according to the CFTC, the bot never executed any trades; customers were unable to make withdrawals and lost all of their funds. The order requires Rounsville to pay a $177,000 civil monetary penalty, permanently bans him from soliciting or trading in commodity interests and virtual currencies or registering with the CFTC in any capacity, and requires him to cease and desist from any further violations of the Commodity Exchange Act and CFTC regulations.

For more information, please refer to the following links:

FTX Files Bankruptcy Amid Binance’s FTT Selloff and Incoming DOJ Probe

By Christopher W. Lamb

On Nov. 11, 2022, the once-third-largest cryptocurrency exchange, FTX, announced that it filed for bankruptcy protection along with approximately 130 additional affiliated companies. According to reports, CEO and founder Sam Bankman-Fried has stepped down and will be replaced by John Ray III, a turnaround veteran who participated in the Enron bankruptcy.

This week, multiple reports have been released highlighting attempts by FTX to achieve a bailout of over $1 billion before receiving a nonbinding letter of intent from fellow cryptocurrency exchange Binance. Binance reportedly neglected to move forward after an initial review of FTX’s books and amid concerns that FTX was the subject of governmental investigations. One report explained that the problems began when Binance started to offload hundreds of millions of dollars of FTT, a token created by FTX, on Sunday. According to the report, FTX’s legal and compliance staff quit shortly thereafter. Another report indicated that FTX was already the subject of probes from state and federal regulators, and that the U.S. Department of Justice (DOJ) may have opened an investigation into FTX related to its recent liquidity issues.

For more information, please refer to the following links:

Crypto Products and DeFi Pilot Launch; Reports Address NFT Royalties, Ethereum PoS Efficiency; IRS, CFTC, Address Crypto; Exchange Hacked for $28M

Blockchain

In this issue:

New Crypto Products Launch; Singapore Completes DeFi Pilot with Major Banks
Report Provides New Data on NFT Royalties and Explores Related Issues
Ethereum Efficiency Data Published; Blockchain Infrastructure Projects Launch
IRS Updates Digital Asset Guidance, CFTC Commissioner Warns of Crypto Risk
Crypto Exchange Hacked for $28M; Reports Address Ransomware, Crypto Scams

New Crypto Products Launch; Singapore Completes DeFi Pilot with Major Banks

By Amos Kim

In a press release published this week, a major U.S. cross-border payments and money transfer company announced a new service in its existing mobile application, allowing customers to trade and hold three major cryptocurrencies: bitcoin (BTC), ether (ETH), and litecoin (LTC). The press release noted that the service was made possible through a partnership with a U.S. cryptocurrency exchange.

In another recent press release, the Monetary Authority of Singapore (MAS) announced “that the first industry pilot under MAS’ Project Guardian that explores potential decentralised finance (DeFi) applications in wholesale funding markets has completed its first live trades.” According to the press release, the DeFi pilot involved several major global banks that “conducted foreign exchange and government bond transactions against liquidity pools comprising of tokenised Singapore Government Securities Bonds, Japanese Government Bonds, Japanese Yen (JPY) and Singapore Dollar (SGD)” and included the successful completion of a “live cross-currency transaction involving tokenised JPY and SGD deposits.”

Several other notable developments were announced in Singapore this week during the Singapore Fintech Festival. In separate press releases, U.S. stablecoin issuers Paxos and Circle Internet Financial both announced that they had received approval from the MAS to offer digital payment token products and services in Singapore. In another press release, a major multinational bank announced its investment in Partior, a blockchain-based payment and settlement platform. According to the press release, the bank will “serve as the first Euro settlement bank for the Partior platform” and the investment will accelerate the bank’s “deployment of blockchain technology across its global wholesale payments and settlements network, scaling the utility of Partior’s technology in global capital markets.”

For more information, please refer to the following links:

Report Provides New Data on NFT Royalties and Explores Related Issues

By Robert A. Musiala Jr.

A recent report by Galaxy Digital provides new data on non-fungible token (NFT) royalty payments. Among other things, the report provides the following notable statistics:

  • Over $1.8 billion worth of royalties have been paid out to creators of Ethereum-based NFT collections.
  • The average royalty percentage paid out to creators on OpenSea, the platform that has paid out the most royalties to creators by far, has doubled from 3 percent to 6 percent over the past year.
  • Ten entities accounted for 27 percent of all NFT royalties earned to date.
  • 482 NFT collections accounted for 80 percent of all royalties earned to date.
  • Eight major brands have collectively earned almost $100 million in NFT royalty payments to date.

The report notes that NFT royalties “are not actually programmed at the token/smart-contract level,” and it provides an analysis of the technical and business reasons that make this difficult and impractical. Among other topics, the report also explores “two leading schools of thought” on NFT royalties, with those in favor of NFT royalties pointing “to the potential for creators to earn more money over time as their projects become more popular” and opponents claiming “that enforcement mechanisms are not possible on-chain without severe trade-offs that negate many of the advantages of permissionless blockchains in the first place.” The report closes by offering potential solutions to the problem of NFT royalty enforcement at the smart contract level.

For more information, please refer to the following links:

Ethereum Efficiency Data Published; Blockchain Infrastructure Projects Launch

By Joanna F. Wasick

New data is out regarding the amount of energy saved by Ethereum’s move from a Proof of Work to Proof of Stake consensus mechanism known as the “Merge,” which occurred on Sept. 15. Cointelepgraph reports that post-Merge, Ethereum’s network power consumption is down by over 99 percent, and the network’s carbon footprint now stands at 0.1 million tonnes of CO2 (MtCO2) per year, meaning that the electrical consumption for single Ethereum transactions “is equivalent to the energy used when watching two hours of YouTube.”

Earlier this week, Protocol Labs and Filecoin Foundation, together with other founding members, announced the launching of the Decentralized Storage Alliance (the Alliance), a first-of-its-kind, member-led industry organization to drive awareness and adoption of decentralized technologies such as Filecoin, IPFS and libp2p, and help Web2 participants make the transition to Web3 through education, advocacy and best practices. According to a press release, decentralized storage networks promise to enable more efficient, robust and secure storage at lower costs than traditional data storage. “With top-tier leaders across Web2 and Web3 coming together to explore the unrealized potential of decentralized technology, this Alliance has the power to transform the foundation of the internet,” said Stefaan Vervaet, Head of Network Growth, Protocol Labs. “Decentralized storage can provide assurances of data integrity, avoid data lock-in, meet data sovereignty requirements, and offers many significant advantages over traditional Web2 data solutions.”

Last week, a major U.S. technology company announced its Blockchain Node Engine, a fully managed node-hosting service that can minimize the need for node operations, allowing developers to spend more time building product and less time managing their nodes, which may help strengthen blockchain infrastructures. According to an announcement by the company, the new Blockchain Node Engine boasts low-latency networking that can scale seamlessly as developers need it, proprietary digital asset security, and simplified node deployment with real-time data and insights from the company’s cloud service. Ethereum will be the first blockchain supported by the Blockchain Node Engine.

For more information, please refer to the following links:

IRS Updates Digital Asset Guidance, CFTC Commissioner Warns of Crypto Risk

By Teresa Goody Guillén

The U.S. Internal Revenue Service (IRS) reportedly released guidelines that state that digital assets, which now explicitly include stablecoins, NFTs and cryptocurrencies, are taxed pursuant to the same rules. This is a change from last year’s guidance, which included a virtual currency section defining a digital token as “a unit of account, a store of value, or a medium of exchange.” According to reports, taxpayers who have “disposed of any digital asset in 2022” – whether as a sale, exchange, gift or other transfer – are required to report this income and pay capital gains tax. Notably, capital gains are taxed at a lower rate than the tax rate applied to the disposition of collectibles such as collectible art, antiques or gems.

The Office of the Comptroller of the Currency (OCC) recently announced that it will establish an Office of Financial Technology, which will build on and include the Office of Innovation. According to an OCC press release, the Office will be created in early 2023 to “provide strategic leadership, vision, and perspective for the OCC’s financial technology activities and related supervision.”

Commodity Futures Trading Commission (CFTC) Commissioner Christy Goldsmith Romero recently gave a speech in which she stated that “crypto presents many similar financial stability risks as the traditional financial system, with parallel themes to 2008, and the potential for that risk to become systemic.” She stated that the 2008 financial crisis was so severe because of “unchecked risk-taking by financial institutions that were highly interconnected to each other,” and that interconnectedness caused contagion risk and run risk. Commissioner Romero ran through a series of events that she posits have caused larger financial distress in the crypto market overall due to these risks, such as stablecoins breaking the buck and triggering redemptions to mass liquidation of bitcoin causing a general crypto sell-off and to companies defaulting on loans and causing other companies to file for bankruptcy or go into financial distress. She contended that similar “[o]paque, complex, leveraged, and unregulated products” that led to “underappreciated risk” in the 2008 financial crisis are present in the crypto market. Commissioner Romero advocated for a “same risk, same regulatory outcome” approach, which begins with an assessment of risk, particularly financial stability risk. The Commissioner stated her belief that the crypto markets need regulation that will limit vulnerabilities to contagion risk and run risk.

For more information, please refer to the following links:

Crypto Exchange Hacked for $28M; Reports Address Ransomware, Crypto Scams

By Sydney Park

According to recent reports, cryptocurrency exchange Deribit has been hacked, with hackers draining $28 million from the company’s hot wallet. In a tweet, the company reportedly stated that “client funds are safe, and loss is covered by company reserves.”

This week, the Financial Crimes Enforcement Network (FinCEN) issued its most recent Financial Trend Analysis of ransomware-related Bank Secrecy Act (BSA) filings for 2021. According to a FinCEN press release, the report indicates that ransomware continues to pose a significant threat to U.S. critical infrastructure sectors, businesses and the public. Among its notable findings, the report found that (1) ransomware-related incidents have substantially increased from 2020, (2) ransomware-related BSA filings in 2021 approached $2.1 billion and (3) roughly 75 percent of the ransomware-related incidents reported to FinCEN during the second half of 2021 pertained to Russia-related ransomware variants.

According to a recent report by Chainanalyis, following Ethereum’s switch from proof of work to proof of stake (the Merge), Merge-related scams took $1.2 million worth of cryptocurrency before, during and after the Merge. The report found that the day of the Merge saw a massive spike in scam revenue, with scamming activity collecting over $905,000 worth of cryptocurrency, compared with just under $74,000 for other scams. Based on data collected and analyzed by Chainanalysis, scammers were able to take advantage of consumers’ lack of understanding of the Merge “to fleece unsuspecting users.”

For more information, please refer to the following links:

New Crypto Products Launch; US Official Addresses Crypto Regulation; State Securities Regulators Target Metaverse Casino NFTs; DOJ Targets Crypto Crimes

In this issue:

Crypto Products Launch in Debit Cards, Payment Gateways, Trading Platforms
EU Blockchain Observatory Publishes Report on Blockchain for Supply Chains
US Banking Official Addresses Approach to Regulating Crypto-Assets
BIS Publishes Report on Progress of Multi-CBDC Platform Pilot
Securities Regulators Bring Action Against NFTs Tied to Metaverse Gambling
DOJ Charges Detail Bitcoin Bribes and Crypto Paid for ‘Malware as a Service’

Crypto Products Launch in Debit Cards, Payment Gateways, Trading Platforms

By Joanna F. Wasick

This week, two cryptocurrency financial services and trading platforms announced partnerships with traditional financial services companies to offer new crypto debit cards. Blockchain.com’s card, initially available only to U.S. residents, will be linked to a verified Blockchain.com account and will enable users to spend cryptocurrencies in transactions that settle in fiat for the merchant. BitOasis, a leading crypto platform for the Middle East and North Africa, announced a similar crypto debit card linked to users’ crypto wallets to enable fiat-settled payments across 90 million global locations. Ola Doudin, BitOasis’ CEO and co-founder, said, “We continue to witness sustained demand amongst our customers for crypto to be integrated into, and relevant for, their daily lives. Research tells us that 47% of the Middle East population now believes crypto is the future of money.”

Anchorage Digital, a digital asset platform, infrastructure provider and federally chartered digital asset bank, recently launched “Build With Anchorage,” a full-stack infrastructure offering that facilitates crypto payment gateways, financial products and market participation. According to a press release, Build With Anchorage can enhance partner product and service development “through a combination of flexible Anchorage APIs – which partners can connect to programmatically [and] include[e] trading, settlement, staking, and custody APIs – and a dedicated team of industry-leading solution architects, integration engineers, and deployment strategists.”

Earlier this week, Prometheum Ember ATS, a broker-dealer and alternative trading system (ATS) regulated by FINRA and the U.S. Securities and Exchange Commission, announced the launch of its new ATS enabling institutions to trade digital asset securities compliant with federal securities laws. According to a press release, Prometheum ATS is built to integrate with legacy securities trading systems by connecting directly with qualified custodians to facilitate quick, efficient and compliant digital asset security trades. The underlying blockchain technology reportedly eliminates intermediaries and provides same-day settlement. “For too long, digital asset trading has been conducted on unregulated platforms instead of on a platform which works within the current SEC framework for digital asset securities,” stated Prometheum Founder and Co-CEO Aaron Kaplan. “Prometheum sets itself apart by maintaining the ability to be sustainably compliant under current securities laws, ensuring the multilayer protections and standards required on Wall Street.”

For more information, please refer to the following links:

EU Blockchain Observatory Publishes Report on Blockchain for Supply Chains

By Robert A. Musiala Jr.

A recently published report by the EU Blockchain Observatory and Forum addresses issues and use cases related to the use of blockchain to enable transparency in supply chains. Among other things, the report addresses problems in supply chain transparency; ongoing changes in supply chain management and ethics, including working conditions, environmental issues and extended supply chains; specific use cases where blockchain can be implemented to achieve supply chain transparency, including in the carbon markets; the impact of certain technical concepts, including public vs. private blockchain networks, layer-2 solutions, zero-trust technologies, and interoperability between blockchains and with other technologies such as IoT networks; and an overview of existing blockchain solutions currently being used in different supply chain contexts.

For more information, please refer to the following links:

US Banking Official Addresses Approach to Regulating Crypto-Assets

By Robert A. Musiala Jr.

The acting Chairman of a US federal agency that supplies deposit insurance to U.S. depository institutions recently gave a speech addressing the regulation of crypto-assets. Among other things, the Chairman noted that federal banking regulators are taking “a cautious and deliberate approach … to bank participation in crypto-asset-related activity … for several reasons: (a) the risk of these activities to safety and soundness, consumer protection, and financial stability; (b) the lack of history and familiarity with these assets both in the marketplace and within regulated financial institutions; and (c) the dynamic nature of these assets.” According to the Chairman, “before banks engage in crypto-asset-related activities, it is important to ensure that: (a) the specific activity is permissible under applicable law and regulation; (b) the activity can be engaged in [in] a safe and sound manner; (c) the bank has put in place appropriate measures and controls to identify and manage the novel risks associated with those activities; and (d) the bank can ensure compliance with all relevant laws, including those related to anti-money laundering/countering the financing of terrorism and consumer protection.”

Addressing stablecoins, among other things the Chairman said, “Thus far … stablecoins have predominantly been used as a vehicle to buy and sell crypto-assets for investment and trading purposes – there has been no demonstration so far of their value in terms of the broader payments system.” However, the Chairman noted, “there may be merit in continuing to examine the potential benefits associated with payment stablecoins … designed specifically as an instrument to satisfy the consumer and business need for safe, efficient, cost-effective, real-time payments.”

The Chairman cited “three important features that could make payment stablecoins significantly safer than the stablecoins currently in the marketplace”: (1) ensuring prudential regulation and separation from deposit taking by issuance of a payment stablecoin through a bank subsidiary; (2) requiring payment stablecoins to be backed dollar for dollar by high-quality, short-dated U.S. Treasury assets; and (3) transacting payment stablecoins on permissioned ledger systems with robust governance and compliance mechanisms. The Chairman also noted that to the extent a payment stablecoin system is developed, it should complement the forthcoming FedNow system and the potential future development of a U.S. central bank digital currency.

For more information, please refer to the following link:

BIS Publishes Report on Progress of Multi-CBDC Platform Pilot

By Robert A. Musiala Jr.

The Bank for International Settlements (BIS) recently published a joint report with the BIS Innovation Hub Hong Kong Centre, the Hong Kong Monetary Authority, the Bank of Thailand, the Digital Currency Institute of the People’s Bank of China and the Central Bank of the United Arab Emirates to provide findings from Project mBridge, a pilot that “experiments with cross-border payments using a common platform based on distributed ledger technology (DLT) upon which multiple central banks can issue and exchange their respective central bank digital currencies (multi-CBDCs).” According to a press release, “Over the course of six weeks in 2022, the mBridge platform was put to the test through a pilot involving real-value transactions among 20 commercial banks from four different jurisdictions … facilitating over 160 payment and FX PvP transactions totaling more than US$22 million in value.” According to the BIS report, “the mBridge pilot and accompanying analysis confirmed that a common multi-CBDC platform can improve cross-border payment speed and efficiency, reduce settlement risks and support the use of local currencies in international payments.” The mBridge pilot will continue in 2023 and 2024 “in an effort to move from the current pilot phase towards MVP and eventually a production-ready system.”

For more information, please refer to the following links:

Securities Regulators Bring Action Against NFTs Tied to Metaverse Gambling

By Keith R. Murphy

According to a press release from the Texas State Securities Board and related reports, the state securities regulators of New Jersey, Kentucky, Alabama and Texas have commenced coordinated enforcement actions against Slotie, a company based in the country of Georgia. According to the press release, “The actions accuse Slotie NFT (“Slotie”) of illegally and fraudulently selling nonfungible tokens, often referred to as NFTs, to raise capital for online and metaverse casinos.”

The company is alleged to be soliciting investors online to purchase Slotie NFTs that purportedly provide the investors with ownership interests in online and metaverse casinos and the right to share passively in the income of the casinos. Slotie also is alleged to be illegally offering and selling WATTS, which according to the press release is another type of NFT that “plays a key role in the illegal scheme” by purportedly enabling investors to double profits, along with granting ownership of a plot of land in the metaverse.

The Texas State Securities Board characterized the NFTs as an “unregistered DeFi [g]ambling investment.” According to the press release, Slotie is “illegally and fraudulently dealing in Slotie NFTs” by “concealing its assets and liabilities, its anticipated use of capital, the identity of partnering casinos, and key risks tied to the metaverse casinos.” Cease and desist orders entered against the company by the various states provide further information concerning the purported violations.

For more information, please refer to the following links:

DOJ Charges Detail Bitcoin Bribes and Crypto Paid for ‘Malware as a Service’

By Shade Quailey

This week, the U.S. Department of Justice (DOJ) issued a press release announcing the unsealing of a criminal complaint in which intelligence officers from the People’s Republic of China (“PRC”) were charged with attempting to obstruct a criminal prosecution in the Eastern District of New York. According to the press release, Guochun He and Zheng Wang are alleged to have orchestrated a scheme to steal files and information from the U.S. Attorney’s Office for the Eastern District of New York that are related to an ongoing federal criminal investigation and prosecution of a PRC-based global telecommunications company. In furtherance of this scheme, Guochun He and Zheng Wang, among other things, allegedly paid approximately $61,000 in bitcoin as a bribe to a U.S. government employee who worked as a double agent for the FBI and the PRC.

Another recent DOJ press release announced an indictment charging a defendant for his alleged involvement with Raccoon Infostealer, an international cybercrime operation that used malware to infect millions of computers globally. According to the press release, the defendant conspired to use Raccoon Infostealer as malware as a service or MaaS that enabled users to steal data from their victims for approximately $200 per month in cryptocurrency. The DOJ press release noted that the FBI has created a website, raccoon.ic3.gov, “where anyone can input their email address to determine whether it is contained within the U.S. government’s repository of Raccoon Infostealer stolen data.”

For more information, please refer to the following links:

Major U.S. Crypto Exchange Consents to $29 Million Penalty for Historic BSA and OFAC Violations Body

On October 11, 2022, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) and Office of Foreign Assets Control (OFAC) announced a $29 million civil monetary penalty against Bittrex, a major U.S. cryptocurrency exchange, as part of a global settlement with FinCEN and OFAC related to Bittrex’s alleged historic violations of the Bank Secrecy Act (BSA), FinCEN anti-money laundering (AML) regulations, and “apparent violations of multiple sanctions programs.” Simultaneous with the announcement, FinCEN published a Consent Order and OFAC published an Enforcement Release describing the alleged violations and terms of the settlements.

Read full alert.

New Crypto Services Launch for Banks, Fintechs and Staking; DOJ Targets Major Cryptocurrency Money-Laundering Scheme; Japan Warns of Crypto Hacks

In this issue:

Crypto Developments Emerge in Payments, Trading, Staking and Accounting
DOJ Targets Crypto Money Laundering and Fraud; Japan Issues Crypto Warning

Crypto Developments Emerge in Payments, Trading, Staking and Accounting

By Lauren Bass

This week, a global financial services and payment technology firm announced that it has partnered with a major U.S. cryptocurrency custody and blockchain infrastructure firm to launch “a comprehensive suite of buy, hold and sell services for select crypto assets, augmented with proven identity, cyber, security and advisory services … for banks and fintechs.” According to a press release, the new program will “enable financial institutions to bring secure crypto trading capabilities and services to their customers.” The new “Crypto Source” program reportedly will operate with the cryptocurrency custody firm providing “crypto-asset trading and custody services on behalf of the banks” and the financial services firm providing “technology to integrate those capabilities into banks’ interfaces, resulting in a seamless experience for the consumer.”

In related news, Anchorage Digital and Provenance Blockchain recently announced the launch of a digital asset staking program for the HASH cryptocurrency. According to a joint announcement, “Anchorage clients will now be able to stake HASH and collect associated rewards for securing the network.”

In a final notable item, following a review of crypto accounting rules, the U.S. Financial Accounting Standards Board (FASB) recently voted in a “tentative Board decision” to make “fair value” the primary accounting method for measuring crypto assets. Per FASB, the decision is “tentative and may be changed at future Board meetings.” According to reports, this marks a major shift away from the current practice of labeling digital assets “intangible assets” and valuing them at their lowest price during any reporting period – a practice that has resulted in substantial impairment losses on balance sheets. Final adoption of the standard will likely not occur until early 2023.

For more information, please refer to the following links:

DOJ Targets Crypto Money Laundering and Fraud; Japan Issues Crypto Warning

By Joanna F. Wasick

On Wednesday, the U.S. Department of Justice (DOJ) issued a press release announcing the unsealing of a 12-count indictment in a New York federal court, which charged five Russian nationals with various criminal counts related to a global smuggling and crypto money-laundering network. Those five defendants are being charged with attempting to evade sanctions against Venezuelan oil producers and obtaining technology used in the U.S. F-22, an air superiority fighter. Also charged were two individuals who brokered illicit oil deals for a Venezuelan state-owned oil company as part of the scheme. As alleged, the defendants were criminal enablers for oligarchs who were “orchestrating a complex scheme to unlawfully obtain U.S. military technology and Venezuelan sanctioned oil through a myriad of transactions involving shell companies and cryptocurrency.” 

Also on Wednesday, the DOJ announced that two Massachusetts men were sentenced for an extensive scheme to take over victims’ social media accounts and steal their cryptocurrency through various means, including computer hacking and SIM swapping. According to court documents, the defendants targeted executives of cryptocurrency companies and others who likely had large amounts of cryptocurrency and “had high value or ‘OG’ (slang for Original Gangster) social media account names.” Members of the conspiracy allegedly stole approximately $330,000 in cryptocurrency from at least 10 victims. The defendants were sentenced to slightly more than two years in prison.

Late last week, Japan’s National Police Agency and Financial Services Agency issued a statement warning Japanese crypto-asset businesses to stay vigilant for phishing attacks by the North Korean hacking group, Lazarus. The statement noted that the hacking group uses social engineering and impersonates executives of a target company to bait employees into clicking malicious links or attachments in order to gain access to the victim’s network. The statement also suggested that digital asset holders install security software, strengthen identity authentication mechanisms by implementing multifactor authentication, and not use the same password for multiple devices or services. Finally, the statement confirmed that several phishing attacks had been successfully carried out against Japanese-based digital asset firms, although no names or other such details were disclosed.

For more information, please refer to the following links:

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