White House Outlines Key Action Items Based on EO Reports Addressing Digital Assets

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On Sept. 16, 2022, the White House released a Fact Sheet providing key findings and action items arising from the nine reports addressing digital assets that have been submitted to the president to date consistent with the EO. The Fact Sheet provides a list of various directives and initiatives that the Administration plans to take in addressing the EO’s six previously identified objectives.

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NFT Initiatives Launch; OFAC Adds Crypto Public Keys to SDN List; Treasury Dept. Publishes Crypto Reports; Crypto Enforcement and Hacks Continue

In this issue:

Non-Fungible Marketing: Brands Continue to Launch NFTs
OFAC Adds Crypto Public Keys to SDN List Related to Russian Group
US Department of the Treasury Publishes Digital Asset Reports and RFC
Republican Senator Criticizes SEC Approach to Crypto Markets
DOJ and SEC Target Crypto Fraud and Unregistered ‘Crypto Asset Securities’
Cryptocurrency Market Maker Suffers $160M DeFi Hack

Non-Fungible Marketing: Brands Continue to Launch NFTs

By Lauren Bass

A South Korean technology company has reportedly launched a weeklong promotion in the metaverse. According to reports, the virtual events occurred across multiple platforms and the company’s own website, and participants had the option to join a scavenger hunt, enter an NFT sweepstakes, and attend live-streamed presentations featuring new products.

To mark its 75th anniversary, an American jean manufacturer reportedly teamed with a Grammy-winning soul singer to create and sell a hybrid NFT collection consisting of a one-of-a-kind custom outfit and a tokenized digital replica that can be “worn” in the metaverse. According to reports, this hybrid NFT was born out of a partnership with platform LTD.INC, which creates “ultra-rare physical and digital NFT collections for artists, creators and brands.”

In a final piece of NFT news, golf’s premier professional tour organization has reportedly teamed with NFT marketplace Autograph to create a dedicated NFT platform. Similar to other sports organizations that have launched NFT marketplaces, the golf organization’s platform will reportedly offer digital content created from the organization’s archives of videos and player data. According to the organization, all revenue generated from the platform, which is set to launch in 2023, will go to the players.

For more information, please refer to the following links:

OFAC Adds Crypto Public Keys to SDN List Related to Russian Group

By Jordan R. Silversmith

Last week the U.S. Department of the Treasury’s (Treasury) Office of Foreign Assets Control (OFAC) sanctioned 22 individuals and two entities in connection with Russia’s invasion of Ukraine, adding the individuals and entities to OFAC’s Specially Designated Nationals (SDN) List. According to a press release, several of the sanctioned individuals are responsible for furthering the Russian Federation’s objectives in Ukraine, both prior to and during Russia’s latest invasion of Ukraine in 2022. Among the entities sanctioned is Task Force Rusich, a neo-Nazi paramilitary group that has participated in combat with Russia’s military in Ukraine; in addition to sanctioning the group, OFAC added five associated cryptocurrency addresses to OFAC’s SDN List. The Treasury announcement noted that the actions come as part of a united international front to isolate Russia’s financial systems and counter any Russian attempts to evade sanctions.

For more information, please refer to the following links:

US Department of the Treasury Publishes Digital Asset Reports and RFC

By Robert A. Musiala Jr.

Last week the U.S. Department of the Treasury (Treasury) published three reports pursuant to President Joe Biden’s Executive Order on Ensuring Responsible Development of Digital Assets. The reports address the future of money and payment systems, consumer and investor protection, and illicit finance risks. According to a statement by Secretary of the Treasury Janet L. Yellen, the reports “provide a strong foundation for policymakers as we work to realize the potential benefits of digital assets and to mitigate and minimize the risks.” The BakerHostetler Blockchain and Digital Assets team will publish alerts analyzing each of the three reports over the course of the coming weeks.

Also last week, pursuant to the same executive order, Treasury filed a Request for Comment (RFC) seeking “feedback from the American people on the illicit finance and national security risks posed by digital assets.” The RFC asks for input on issues related to digital assets in the areas of illicit finance risks, anti-money laundering (AML) and counter-terrorist financing (CFT) regulation and supervision, global implementation of AML/CFT standards, private sector engagement and AML/CFT solutions, and central bank digital currencies. The RFC will be open for comment through Nov. 3, 2022.

For more information, please refer to the following links:

Republican Senator Criticizes SEC Approach to Crypto Markets

By Robert A. Musiala Jr.

Last week, U.S. Senate Banking Committee Ranking Member Pat Toomey (R-Pa.) published his opening statement from a recent hearing with U.S. Securities and Exchange Commission (SEC) Chairman Gary Gensler in which the senator said that “the SEC has failed to provide consumers and innovators alike with much-needed regulatory clarity when it comes to digital assets, prompting the need for Congress to step in.” Among other things, Toomey criticized the SEC for failing to take action to prevent the recent bankruptcies of Celsius and Voyager, saying, “The SEC took enforcement action against BlockFi for similar activities last winter, yet somehow … Celsius and Voyager continued through this spring, when both companies blew up and found themselves in bankruptcy, with investors staring at billions in losses.” Toomey also criticized Gensler’s recent remarks suggesting that “many crypto intermediaries … are transacting in securities and have to register with the SEC.” According to Toomey, “Given the novel nature of these tokens, Congress ought to step in to provide clarity. In particular, we need to revisit the definition of ‘security’ as part of a larger effort to tailor a regulatory framework that is calibrated to the unique risks and activities of the crypto market.”

For more information, please refer to the following link:

DOJ and SEC Target Crypto Fraud and Unregistered ‘Crypto Asset Securities’

By Keith R. Murphy

A recent press release from the U.S. Department of Justice (DOJ) announced that a cryptocurrency fraudster was sentenced to 42 months in prison for devising a fraudulent investment scheme that took in more than $600,000 from 60 victims. According to the press release, the fraudster convinced victims to loan money to his organization, World Sports Alliance, based on a purported connection to the United Nations and for the promise of investment returns related to a digital currency called IGObit.

Another recent DOJ press release announced the guilty plea of an individual accused of laundering and transmitting the proceeds of Ponzi-type investment fraud schemes based out of Nigeria. According to the press release, the schemes involved the offer of trading and bitcoin investing services in a Ponzi-like fraud. The defendant reportedly laundered the fraud proceeds through a network of co-conspirators in the United States, and used his personal and business accounts in the United States and Nigeria.

Another Ponzi-type fraud was targeted by the U.S. Securities and Exchange Commission (SEC), which recently announced an action against an individual and his affiliated companies for fraudulently raising and misappropriating funds from investors. The defendant and his companies are alleged to have fraudulently offered and sold securities using false and misleading statements to raise approximately $4.3 million, telling investors that the funds would be invested in digital assets. According to the press release, only a fraction of those funds were invested in digital assets and the defendant made early repayments to investors in a Ponzi-like fashion to attract more investments. 

This week the SEC also issued a cease-and-desist order against Sparkster Ltd. and its chief executive officer for the alleged unregistered offer and sale of “crypto asset securities.” The SEC also charged a crypto influencer for failing to disclose compensation he received from the company for promoting the company’s SPRK tokens and for failing to file a registration statement with the SEC for tokens he resold. The order finds that the SPRK tokens, as offered and sold, were securities that were neither registered with the SEC nor exempt from registration. The company and its CEO settled and agreed to collectively pay in excess of $35 million into a fund for distribution to harmed investors, according to the press release. 

For more information, please refer to the following links:

Cryptocurrency Market Maker Suffers $160M DeFi Hack

By Joanna F. Wasick

Early this week, cryptocurrency market maker Wintermute suffered a $160M hack on the wallet the company uses for DeFi proprietary trading, tweeted the company’s founder and CEO, Evgeny Gaevoy. Gaevoy noted that the DeFi wallet was “completely separate and independent” from Wintermute’s CeFi and OTC operations. He also stated that Wintermute remains solvent, with “twice over” $160 million remaining in equity, and any disruption to services will be resolved within days. The Wintermute attack is just the latest in a number of high-profile hacks to crypto platforms this year. In August, for example, millions’ worth of crypto was stolen from Solana wallets; and Nomad, a crypto bridge company that allows users to transfer tokens between blockchains, suffered an attack in which $190M worth of crypto was reportedly drained.

For more information, please refer to the following links:

Ethereum Moves to PoS; Firms Launch Crypto, NFT Initiatives; EO Crypto Energy Impact Report Published; Crypto Addressed by OFAC, DOJ, SEC, U.S. Senators

In this issue:

Ethereum Network Completes Transition to Proof of Stake Consensus
Crypto Exchange, Bitcoin Futures ETF Launch; Crypto Adoption Data Published
Major Coffee and Scotch Brands Launch NFT Initiatives
OFAC Adds Crypto Public Keys to SDN List, Addresses Tornado Cash Sanctions
Major U.S. Exchange Backs Lawsuit Challenging OFAC Tornado Cash Sanctions
Office of Science and Technology Publishes EO Report on Crypto-Assets
SEC Adds New Crypto Office to Disclosure Review Program; Senators Target Crypto Scams
• DOJ and SEC Continue Crypto Enforcement; $30M in Hacked Crypto Recovered

Ethereum Network Completes Transition to Proof of Stake Consensus

By Joanna F. Wasick

After years of development and delays, Ethereum’s long-awaited “merge” occurred this week, changing the network’s consensus mechanism from proof-of-work (POW) to proof-of-stake (POS) (specifically, Ethereum’s newer POS-based “Beacon Chain,” unveiled in December, “merged” with the original Ethereum blockchain). The update ends the network’s reliance on the energy-intensive process of cryptocurrency mining to create blocks on the Ethereum blockchain. Instead, the Ethereum network will now rely on “validators” — people who “stake” or “lock” ETH by sending their ETH to an address on the Ethereum network where they cannot be bought or sold. The more ETH a validator stakes, the more likely it will be chosen by the network to validate/write the next “block” of transactions for Ethereum’s blockchain. The upgrade is expected to reduce Ethereum’s energy consumption (by more than 99 percent according to some estimates) and make the platform easier and less costly to use.

For more information, please refer to the following links:

Crypto Exchange, Bitcoin Futures ETF Launch; Crypto Adoption Data Published

By Jordan R. Silversmith

This week, a consortium of major U.S. financial services firms, broker-dealers, market makers and venture capital firms announced the launch of a new digital asset exchange, EDX Markets (EDXM). According to a press release, “The new exchange will combine proven technology … with best practices from traditional financial markets and tighter spreads enabled by greater liquidity, to support secure, fast and efficient cryptocurrency trading for U.S. retail and institutional investors.”

In another recent press release, a cryptocurrency asset management company announced the launch of the first U.S.-based Bitcoin futures exchange-traded fund (ETF) to be registered and regulated exclusively under the Securities Act of 1933 (Securities Act). According to the press release, other existing Bitcoin futures ETFs are registered and regulated under the Investment Company Act of 1940 (Investment Company Act). And a third press release published this week announced that Securitize, a digital assets security firm, launched a new fund tokenizing a major health-care growth fund on the Avalanche blockchain.

Also this week, blockchain analytics firm Chainalysis released its 2022 Global Crypto Adoption Index. Rather than rank countries by raw cryptocurrency transaction volume, the index aims to measure grassroots adoption of cryptocurrencies by studying where individual, nonprofessional investors are embracing digital assets. The report found that emerging markets are leading grassroot adoptions of cryptocurrency, with Vietnam, the Philippines and Ukraine in the top three spots. India and the United States rounded out the top five, and China, despite its ban on all cryptocurrency trading, was ranked 10th in grassroots adoption, suggesting ineffective or loose enforcement of the ban.

For more information, please refer to the following links:

Major Coffee and Scotch Brands Launch NFT Initiatives

By Jordan R. Silversmith

This week a major American multinational chain of coffeehouses and roasters announced its plans to offer a non-fungible token (NFT)-based loyalty program. According to a press release, the company’s program will allow customers to buy and earn collectible NFT stamps that will offer access to benefits and immersive, coffee-related experiences. Among other things, the press release also notes that the program “will utilize a ‘proof-of-stake’ blockchain technology built by Polygon, which uses less energy than first generation ‘proof-of-work’ blockchains.” Customers of the coffee chain can join a waitlist now to gain access to the loyalty program, which will reportedly launch later this year.

In other NFT news, a famous scotch whisky company announced it would partner with the world’s first direct-to-consumer NFT marketplace for wine and spirits to release a limited set of digital NFT bottles. A limited-edition physical bottle will be available to buyers who “burn” – effectively remove the NFT from the blockchain – their NFT. According to reports, this will be the company’s third Web3 campaign of the year.

For more information, please refer to the following links:

OFAC Adds Crypto Public Keys to SDN List, Addresses Tornado Cash Sanctions

By Joanna F. Wasick

On Wednesday, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) sanctioned 10 individuals and two entities for their roles in conducting malicious cyber acts, including ransomware activity. OFAC added the individuals and entities to OFAC’s Specially Designated Nationals (SDN) List – including seven cryptocurrency public keys associated with certain individuals. The sanctioned individuals and entities are all affiliated with Iran’s Islamic Revolutionary Guard Corps, a group known to exploit software vulnerabilities in order to carry out their ransomware activities as well as engage in unauthorized computer access, data exfiltration and other malicious cyber activities.

Also this week, the U.S. Department of the Treasury issued guidance related to OFAC’s recent sanctioning of Tornado Cash, an open-source software project that uses smart contracts to allow users to send cryptocurrencies privately on the Ethereum network by obfuscating ownership history. The Department’s guidance states that a U.S. person who initiates or otherwise engages in a transaction with Tornado Cash violates U.S. sanctions prohibitions, unless exempt or specifically authorized by OFAC. Among other things, the guidance further states that persons with certain pending transactions with Tornado Cash (i.e., where the transaction was initiated before the OFAC sanctions were issued in August but where the transaction had not completed) may request a license from OFAC enabling the transaction’s completion. The guidance also addresses situations where persons receive unsolicited and nominal amounts of assets from Tornado Cash (a practice called “dusting”).

For more information, please refer to the following links:

Major U.S. Exchange Backs Lawsuit Challenging OFAC Tornado Cash Sanctions

By Joanna F. Wasick

Last week Coinbase announced that it was funding a lawsuit brought by six people that challenges the recent action by the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) sanctioning the Tornado Cash smart contracts. The lawsuit asks the court to remove the Tornado Cash smart contract addresses from OFAC’s Specially Designated Nationals (SDN) List. The plaintiffs argue that OFAC exceeded its authority from Congress and the president in sanctioning open-source technology rather than sanctioning bad actors who used it and those actors’ property. They also allege that OFAC’s actions infringe on their constitutional rights “and threaten[] the ability of law-abiding Americans to engage freely and privately in financial transactions.”

Crypto investment firm Paradigm also responded to OFAC’s actions by publishing a detailed position paper, co-authored by the Crypto Council for Innovation, that addresses what monitoring and censoring obligations OFAC’s actions place on participants in crypto’s base layer. The paper goes on to criticize OFAC’s sanctioning of Tornado Cash and asserts that onerous regulation and targeted actions against players in the crypto space will eventually push blockchain innovators out of the United States, and make it more difficult – not less – to track crypto transactions that threaten national security.

For more information, please refer to the following links:

Office of Science and Technology Publishes EO Report on Crypto-Assets

By Robert A. Musiala Jr.

Last week, in accordance with President Joe Biden’s Executive Order on Ensuring Responsible Development of Digital Assets, an interagency group led by the White House Office of Science and Technology Policy published its report titled “Climate and Energy Implications of Crypto-Assets in the United States.” The 46-page report “explores the challenges and opportunities of crypto-assets for energy and climate change issues in the United States, and answers four main questions asked in Executive Order 14067.”

The first question addressed by the report is “How do digital assets affect energy usage, including grid management and reliability, energy efficiency incentives and standards, and sources of energy supply?” In response, the report notes that “[f]rom 2018 to 2022, annualized electricity from global crypto-assets grew rapidly, with estimates of electricity usage doubling to quadrupling.” According to the report, “[a]s of August 2022, published estimates of the total global electricity usage for crypto-assets are between 120 and 240 billion kilowatt-hours per year, a range that exceeds the total annual electricity usage of many individual countries, such as Argentina or Australia.” The report also notes that “[a]s of August 2022, Bitcoin is estimated to account for 60% to 77% of total global crypto-asset electricity usage, and Ethereum is estimated to account for 20% to 39%.”

The second question addressed by the report is “What is the scale of climate, energy, and environmental impacts of digital assets relative to other energy uses, and what innovations and policies are needed in the underlying data to enable robust comparisons?” Among other things, here the report notes that “[c]rypto-asset activity in the United States is estimated to result in approximately 25 to 50 Mt CO2/y, which is 0.4% to 0.8% of total U.S. GHG emissions, similar to emissions from diesel fuel used in railroads in the United States.”

The third question addressed by the report is “What are the potential uses of blockchain technology that could support climate monitoring or mitigating technologies?” The report answers this question, in part, by stating, “There is potential for blockchain technologies to play a role in environmental markets, and DLT could potentially enable distributed energy resource coordination, as well as broader supply chain management.”

The fourth and final question addressed by the report is “What key policy decisions, critical innovations, research and development, and assessment tools are needed to minimize or mitigate the climate, energy, and environmental implications of digital assets?” In summary, the report finds that “[t]o help the United States meet its climate objectives … crypto-asset policy during the transition to clean energy should be focused on several objectives: reduce GHG emissions, avoid operations that will increase the cost of electricity to consumers, avoid operations that reduce the reliability of electric grids, and avoid negative impacts to equity, communities, and the local environment.”

For more information, please refer to the following links:

SEC Adds New Crypto Office to Disclosure Review Program; Senators Target Crypto Scams

By Keith R. Murphy

The U.S. Securities and Exchange Commission (SEC) intends to grow the Division of Corporate Finance’s Disclosure Review Program (DRP) by adding an Office of Crypto Assets and an Office of Industrial Applications and Services to review company filings by issuers, according to a recent press release. The new offices, which are expected to be established later this fall, “will enable the DRP to enhance its focus in the areas of crypto assets, financial institutions, life sciences, and industrial applications and services and facilitate our ability to meet our mission,” according to a representative.

The SEC recently published remarks made by Commissioner Mark Uyeda at the SEC Speaks Conference. Commissioner Uyeda expressed his views on many issues and commented, “Today, one big, difficult, and complex issue that is conspicuously absent from the Commission’s published regulatory agenda is how to regulate crypto assets and related services.” According to Uyeda, “There is a widespread concern that the lack of predictability with regard to our regulation may encourage crypto firms to relocate to other jurisdictions.” Recognizing the benefit of comments from crypto investors and other market participants, the commissioner proposed that “[t]o the extent that crypto assets raise unique issues not otherwise addressed in the current rule book, the Commission should consider proposing rules or issuing interpretive releases.”

In a recent letter to a major multinational social media and technology firm, Senator Bob Menendez along with five other senators questioned the firm regarding its efforts to combat cryptocurrency scams and hold bad actors accountable for cryptocurrency fraud on its platform. The senators pointed to data from the Federal Trade Commission indicating that high percentages of cryptocurrency fraud victims are victimized on a social media website, and the senators specifically referenced several of the firm’s social media platforms. The letter goes on to request information responsive to several questions, including what policies and practices the firm has to find and remove crypto scammers from the firm’s various platforms.

For more information, please refer to the following links:

DOJ and SEC Continue Crypto Enforcement; $30M in Hacked Crypto Recovered

By Keith R. Murphy

The U.S. Department of Justice (DOJ) recently published a press release announcing that the purported head trader of a cryptocurrency trading platform pleaded guilty to conspiracy to commit securities fraud in connection with an alleged cryptocurrency Ponzi scheme that took in $100 million from investors. According to the press release, the defendant admitted that he and others made numerous misrepresentations to investors, including about the existence of a proprietary trading bot and the promise of guaranteed returns. A sentencing date has not yet been scheduled.

This week, the U.S. Securities and Exchange Commission (SEC) announced an action against a cryptocurrency assets broker, Chicago Crypto Capital LLC, its owner and two salespeople, alleging violations of the securities laws. The allegations include that the company and individuals conducted an “unregistered offering of crypto asset securities” related to certain BXY tokens, and further made materially false and misleading statements in the offer, purchase and/or sale of the BXY tokens. The SEC seeks injunctive relief, disgorgement with prejudgment interest and civil penalties.

Finally, according to several recent reports, blockchain analytics firm Chainalysis has successfully assisted law enforcement agencies in recovering $30 million in funds stolen from the Ronin Bridge hack in March of this year by North Korea-linked Lazarus Group. Among other things, the reports note that while the Lazarus Group had been using the Tornado Cash mixer to launder the hacked proceeds, it subsequently switched to utilizing DeFi services to chain hop following the imposition of sanctions on Tornado Cash by the U.S. Department of the Treasury’s Office of Foreign Assets Control.

For more information, please refer to the following links:

SEC Chair Stands Firm: ‘Vast Majority’ of Cryptocurrency Tokens Are Securities

In prepared remarks delivered at the Practising Law Institute’s “SEC Speaks” program on Sept. 8, Chair Gensler emphasized and reiterated his long-standing position that the vast majority of cryptocurrency tokens are securities, and he noted that “only a small number of tokens, even though they may represent a significant portion of the crypto market’s aggregate value” may qualify as “crypto non-security tokens.” Gensler’s remarks are in line with the position he has historically promoted and are consistent with increased crypto-related enforcement actions by the Commission.

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NFT Initiatives Launch Across Markets; US Banking Regulators Address Crypto; DOJ and Congress Target Crypto Fraud; FBI Cites Risks as DeFi Hacks Continue

In this issue:

NFT Initiatives Launch in Ticket Sales, Social Media and College Football
US Banking Regulators Publish DeFi Analysis, Address Crypto in Speeches
DOJ Targets Crypto Fraud, House Subcommittee Addresses Consumer Risks
FBI Cites DeFi Hacking Threats as Hacks Continue; Reports Identify ISIS NFT

NFT Initiatives Launch in Ticket Sales, Social Media and College Football

By Christina O. Gotsis

According to a recent press release, a major ticket sales and distribution company announced that event organizers who sell tickets on its platform now can issue NFTs before, during and after live events. To date, the company has reportedly minted more than 5 million digital keepsakes on the Flow blockchain that can be activated to access additional engagement opportunities.

In a recent update to a May blog post, a major U.S. technology company announced that users of two of its social media platforms now can post NFTs by linking their digital wallets to their social media accounts. According to the blog post, “This will enable people to connect their digital wallets once to either app in order to share their digital collectibles across both.” The social media platforms support the posting and sharing of NFTs minted on the Flow blockchain or from wallets supporting Ethereum or Polygon.

In a final development, according to a press release, Fantastec SWAP, a technology firm focused on sports NFTs, recently launched limited-edition digital signature NFTs for two college football teams ahead of football season. Each athlete’s digital signature was reportedly recorded and authenticated on the Flow blockchain.

For more information, please refer to the following links:

US Banking Regulators Publish DeFi Analysis, Address Crypto in Speeches

By Joanna F. Wasick

Earlier this month, the U.S. central bank board published a paper that provides a broad overview of the DeFi ecosystem and analyzes the potential benefits and risks of DeFi adoption. The paper cautions that while DeFi “has not yet reached the point of becoming systemically important,” policymakers should assess DeFi’s impact on “financial stability” in the event DeFi increases in popularity and usage. That increase may occur, the paper finds, if cryptocurrency prices stabilize, if blockchain services gain greater interoperability with the existing payments and financial systems, or if crypto assets become a separate, parallel financial system that provides real economy services. The paper also examines how DApps, smart contracts, and other DeFi products and services operate in the DeFi ecosystem, and it emphasizes the need for greater regulatory oversight in the space overall. Following the paper’s publication, Michael Barr, the recently appointed vice chair of the U.S. central bank board, gave his first official speech, echoing some of the paper’s call for greater oversight in crypto. Specifically, Barr stated that greater transparency overall was needed and that banks engaged in crypto-related activities need to have appropriate measures in place to manage novel risks associated with those activities and to ensure compliance with all relevant laws, including those related to money laundering.

Earlier this week, Michael Hsu, acting chief of the Office of the Comptroller of the Currency (OCC), also spoke out on the crypto industry. He remarked that under his direction, the OCC had adopted a cautious approach to permitting national banks and federal savings associations to engage in certain crypto activities. He lauded that approach, given the fragility in the crypto ecosystem, as evidenced by the Terra stablecoin collapse in May and its aftermath, in which billions of dollars in investor value were wiped out. Hsu stated that the OCC is building on the work it has accomplished over the past five years in the fintech/crypto space with regard to policy and service providers and related to IT and operational resilience supervision. He said that the OCC is also working closely with fellow agencies to help ensure benefits from shared intelligence and understanding. However, he cautioned, “Much more work remains to be done.”

For more information, please refer to the following links:

DOJ Targets Crypto Fraud, House Subcommittee Addresses Consumer Risks

By Robert A. Musiala Jr.

In a recent press release, the U.S. Department of Justice announced the extradition of a Latvian man in relation to “a six-count indictment charging him with wire fraud, securities fraud, and conspiracies to commit wire fraud and securities fraud in connection with the operation of eight companies that purported to offer, invest in or mine digital assets.” According to the press release, the defendant operated a series of entities “that advertised through email campaigns, social media and websites dedicated to cryptocurrencies” and made false representations to solicit investments related to initial coin offerings, cryptocurrency investment platforms and cryptocurrency mining operations, resulting in losses of at least $7 million from victims in the U.S. and elsewhere.

Another recent press release announced that a U.S. representative, the chair of the Subcommittee on Economic and Consumer Policy, has sent letters to the U.S. Department of the Treasury, the U.S. Securities and Exchange Commission (SEC), the U.S. Commodity Futures Trading Commission, and the U.S. Federal Trade Commission, as well as to five major U.S. cryptocurrency exchanges, “requesting information about the steps they are taking to combat cryptocurrency-related fraud and scams and additional actions that are needed to protect Americans.” According to the press release, “[T]he federal government has been slow to curb cryptocurrency scams and fraud, and existing federal regulations do not comprehensively or clearly cover digital assets under all circumstances.”

According to reports last month, a major U.S. cryptocurrency investment firm recently disclosed in public filings that it has been responding to SEC staff regarding the securities law analysis related to the native cryptocurrencies of the Stellar (XLM), Zcash (ZEC) and Horizen (ZEN) blockchains. Among other things, the disclosures reportedly diverge from prior filings by acknowledging that ZEC, ZEN and XLM each “may currently be a security, based on the facts as they exist today.”

For more information, please refer to the following links:

FBI Cites DeFi Hacking Threats as Hacks Continue; Reports Identify ISIS NFT

By Jordan R. Silversmith

The U.S. Federal Bureau of Investigation (FBI) recently released a warning to investors that cybercriminals are increasingly exploiting vulnerabilities in decentralized finance (DeFi) platforms to steal cryptocurrency from investors. Finding that almost 97 percent of the $1.3 billion stolen in cryptocurrencies between January and March 2022 was from DeFi platforms, the FBI noted that this represents an increase from 72 percent in 2021.The warning also noted that the FBI has observed cybercriminals exploiting vulnerabilities in smart contracts governing DeFi platforms. The warning urges investors to research any DeFi platforms they use and to ensure that the DeFi platforms are secure.

An Avalanche-based lending protocol was recently the victim of such a hack. A blockchain cybersecurity firm reported that a hacker stole $371,000 worth of USD Coin using a smart contract exploit. The protocol later released a detailed statement about the incident, explaining that an “exploiter” deployed a custom smart contract that utilized a $51 million flash loan from Avalanche to artificially manipulate the pool price for a single block. After consulting security experts, the protocol developed a mitigation plan, notified law enforcement and paused the exploited market.

According to recent reports, blockchain analysts and intelligence officials have noticed that the Islamic State of Iraq and Syria (ISIS) has begun to use non-fungible tokens (NFTs) for recruiting and funding. The report describes an NFT “visible on at least one NFT trading website” that bears the ISIS emblem and is titled “IS-NEWS #01.” According to the report, although the ISIS-themed NFT does not appear to have been traded, its existence on the blockchain makes it nearly impossible to remove or to censor, unlike other online recruiting and messaging tools.

For more information, please refer to the following links:

Combatting Fraud and Corruption in the NFT Market

On Oct. 6, 2021, the U.S. Department of Justice (DOJ) announced the creation of a National Cryptocurrency Enforcement Team to tackle investigations and prosecutions of criminal misuses of cryptocurrency. As the non-fungible token (NFT) market continues to expand, DOJ’s heightened focus on cryptocurrency has begun to encompass NFTs. Just as with any other market, a particular focus of DOJ’s efforts will be to identify and prosecute fraud. At the same time, fraudulent activity is becoming increasingly common in the NFT market. This paper provides an overview of common fraud typologies in the NFT market and steps NFT market actors can take to protect themselves from becoming victims of fraud or unwittingly facilitating fraud.

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Top 5 Digital Asset Litigation and Investigation Trends of 2022

  • Digital assets have pushed courts to adapt traditional litigation procedures to provide relief to defrauded plaintiffs. 
  • Government agencies have also ramped up enforcement efforts while increasing agency coordination, broadening investigative scopes and using special tools to root out digital asset fraud. 

Cryptocurrency and digital assets have kept the courts and regulators busy as digital assets continue to pose new questions and challenges for anyone involved in their sale, trade or development. The following trends have emerged this year as a likely indicator of what’s on the horizon. 

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NFT Market Research Published; Crypto Issues Addressed by FDIC, US Representatives and Foreign Regulators; DOJ Targets Crypto Fraud Scheme

In this issue:

Fashion Brands Score with NFTs, but Market Trends Show Threats Abound
FDIC and Congress Members Address Crypto Representations, Sanctions, Mining
Foreign Regulators Issue Crypto Guidance, Act Against Unregistered VASPs
DOJ Targets Cryptocurrency Fraud, Report Cites Recent Crypto Crime Trends

Fashion Brands Score with NFTs, but Market Trends Show Threats Abound

By Lauren Bass and Lynn Tang

According to a recent report, iconic fashion brands from ready-to-wear sportswear to haute couture have been reaping the financial rewards of their bespoke NFT (non-fungible token) collections. Reportedly, the top fashion NFT drops have collectively generated $260 million in sales since December 2021, with the top drops generating more than $185 million in revenue alone.

With millions of dollars in sales, the NFT market is a prime target for financial crimes, including money laundering, terrorist financing and scams, according to a recent report by blockchain analytics provider Elliptic. Key takeaways from their report’s findings: (i) Over $50.6 million worth of NFTs have been publicly reported stolen in the past year; (ii) sanctioned entities pose a growing threat; and (iii) since 2017, NFT-based platforms have reportedly facilitated the laundering of over $8 million in illicit funds. Despite these startling statistics, Elliptic concluded that “the perceived chances of NFT-based crime occurring is higher than it actually is” and “the true instances of these crimes account for a small proportion of NFT-related trade.”

For more information, please refer to the following links:

FDIC and Congress Members Address Crypto Representations, Sanctions, Mining

By Alexandra Karambelas

Last week the Federal Deposit Insurance Corporation (FDIC) announced that it had issued cease and desist letters to five blockchain-related companies, demanding that the companies “cease and desist from making false and misleading statements about FDIC deposit insurance” and instructing the companies to “take immediate corrective action.” The FDIC alleged that each company made false and misleading statements indicating that certain cryptocurrency products or accounts were FDIC insured, with one company alleged to have registered a domain name suggesting affiliation with the FDIC.

This week, U.S. Rep. Tom Emmer published a letter to Treasury Secretary Janet Yellen asking for clarification on the Office of Foreign Assets Control’s (OFAC) recent sanctions against the cryptocurrency mixing service Tornado Cash. Emmer described the sanctions as the “first of their kind” in that OFAC sanctioned the protocol’s smart contracts rather than a natural person or entity. In his letter, Emmer raised due process and privacy concerns, writing that “the sanctioning of neutral, open-source, decentralized technology presents a series of new questions, which impact not only our national security but the right to privacy of every American citizen.” This letter comes just weeks after the arrest in the Netherlands of a tech developer allegedly involved with Tornado Cash.

In a press release published last week, leaders of the House Energy and Commerce Committee announced that they had sent letters to four U.S.-based cryptocurrency mining companies, seeking further information on the environmental impact and energy consumption of proof-of-work (PoW) mining. The letter raises concerns regarding the effect of mining operations on both climate change and local power grids. According to the letter, “[w]hile blockchain technology is emerging as a potentially important tool in fighting climate change, increasing demand on the grid and burning more fossil fuels to power PoW cryptomining facilities only serves to undermine the potential climate benefits of blockchain technology and hold us back from achieving our climate pollution reduction goals.” The companies have until Sept. 17 to respond to the committee’s requests for information.

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Foreign Regulators Issue Crypto Guidance, Act Against Unregistered VASPs

By Robert A. Musiala Jr.

Last week, the European Central Bank (ECB) published a press release addressing “crypto-asset activities and services” in the European Union. According to the press release, “the finalisation of several regulatory initiatives at European and international level[s] … will lay down the broader regulatory framework under which crypto activities are allowed, and how banks should manage the risks they pose.” Among other things, the press release notes that in evaluating bank activities involving cryptocurrencies, the ECB will focus on risks related to cybersecurity, the use of third-party providers, and anti-money-laundering efforts/combating the financing of terrorism. According to the press release, the ECB is assessing “banks’ digital transformation, including the role of crypto technologies, that will result in horizontal analysis by the end of 2022.”

The South African Reserve Bank recently published guidance “to inform banks and controlling companies of practices related to the effective implementation of adequate anti-money-laundering and counter-financing of terrorism (AML/CFT) controls in relation to crypto assets (CAs) and crypto asset service providers (CASPs).” The guidance seeks to further implement recommendations from the Financial Action Task Force. Among other things, the guidance defines “crypto asset” and “crypto asset service provider,” addresses a risk-based approach to identifying and assessing CA and CASP risks, and underscores the importance for banks to monitor client transactional activity.

Last week, the South Korean Financial Intelligence Unit (KoFIU) published a press release warning that 16 virtual asset service providers (VASPs) are targeting South Korean consumers without proper registration. According to the press release, the KoFIU has informed the relevant financial regulators in their respective countries about the violations and has taken steps to block South Korean consumer access to the unregistered VASPs, including steps to block transfers of virtual assets to and from the unregistered entities.

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DOJ Targets Cryptocurrency Fraud, Report Cites Recent Crypto Crime Trends

By Jordan R. Silversmith

According to a press release published this week by the U.S. Department of Justice (DOJ), three individuals from Miami have been arrested for their involvement in a scheme that used cryptocurrency to defraud U.S. banks. According to the indictment, the three defendants used stolen identities to buy more than $4 million in cryptocurrency and then falsely claimed that the cryptocurrency transactions were unauthorized. This deceived U.S. banks and a leading cryptocurrency exchange into reversing those transactions and depositing the ill-gotten funds into the defendants’ bank accounts. According to the press release, the defendants’ scheme resulted in U.S. banks processing more than $4 million in fraudulent transaction reversals and the cryptocurrency exchange losing more than $3.5 million in cryptocurrency. The defendants face multiple charges of fraud and conspiracy to commit fraud, and face over 30 years in prison.

A leading blockchain analytics firm recently released its midyear cryptocurrency crime update. The report finds that despite this year’s downturn in cryptocurrency prices, illicit activity in the area is resilient. Among other things, the study found that illicit trading volumes are down 15 percent year over year, compared with a 36 percent decline for legitimate volumes. While scams and darknet activity are down as compared to 2021, hacks of exchanges and stolen funds buck the declining trend, with $1.9 billion of cryptocurrency stolen in hacks of services through July 2022, compared to just under $1.2 billion at the same time in July 2021.

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Developer Arrested Following OFAC Sanctions of the Tornado Cash Protocol

On Aug. 10, 2022, just days after OFAC issued sanctions against virtual currency mixer Tornado Cash, Dutch authorities arrested the protocol’s alleged developer. In a press release, the Treasury Department alleged that since 2019, Tornado Cash had been used to launder more than $7 billion in cryptocurrency, including more than $455 million stolen in the largest decentralized finance (DeFi) hack to date, on the Ronin Network, carried out by the North Korean-backed cybercrime syndicate the Lazarus Group. Dutch authorities have not released the identity of the developer and have not ruled out the possibility of further arrests related to Tornado Cash.

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The Tax Man Is Back: IRS Issues First John Doe Summons in 2022 to Major Crypto Platform, Seeking Treasure Trove of Information on Tax Noncompliance

Close-up Of Businessperson Hands Checking Invoice With Magnifying Glass At Desk

After going for more than a year without using one of its most powerful weapons, a John Doe summons, the Internal Revenue Service (IRS) has reverted to the use of this tool in its much-publicized efforts to investigate, find, and prosecute those who fail to report virtual currency transactions and those who facilitate not reporting. This latest filing demonstrates that Operation Hidden Treasure, announced in May 2021 to identify tax evasion among cryptocurrency users, is still going strong. Recent announcements also have made clear that the IRS, along with the Department of Justice (DOJ), is working with other agencies such as the Joint Chiefs of Global Tax Enforcement and other state and federal agencies to curb the abuse of laws using cryptocurrency transactions.

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