In this issue:

NY DFS Grants License to Bitcoin ATM Operator, Exchanges Make Announcements

Capital Markets Developments in Regulatory Guidance, Value of ICO Offerings and Banking

Blockchain Pilots for Voting and Supply Chain, Global Shipping Business Network Challenges TradeLens

Multiple Enforcement Actions in US and Abroad Seek to Quell Blockchain Industry Crimes

Tax Compliance Stakes Raised for Cryptocurrency Issues

NY DFS Grants License to Bitcoin ATM Operator, Exchanges Make Announcements

By: Joanna F. Wasick

The New York State Department of Financial Services (DFS) announced last week that it approved Coinsource, Inc.’s application for a virtual currency license. Coinsource presently operates 40 Bitcoin teller machine (BTM) kiosks in New York, allowing customers to buy and sell bitcoin for cash. DFS says its approval was based on stringent requirements related to various risk controls and consumer protections. Coinsource is the only company operating BTMs with this type of license; however, DFS previously approved more general licenses for other companies in the cryptocurrency marketplace. One licensee, Square, a payments company that recently integrated cryptocurrencies, announced on Thursday that it generated $43 million in bitcoin revenue this quarter (up $6 million).

In token news, Coinbase announced it will support BAT, tokens issued by Brave, which runs an internet browser that “pays” users in BAT to view ads. In addition, Stably, a Canadian startup, recently announced the early-access launch of StableUSD, a stablecoin issued with an equivalent unit of U.S. dollars held in escrow accounts. Tether, another stablecoin issuer (criticized by some for opacity), issued a letter earlier this month stating it had a $1.8 billion account with a Bahamas-based financial institution to back up its Tether coins. Days later, the bank issued a statement that the letter was legitimate. To help determine the best places to trade and store cryptocurrencies, the cybersecurity company Group-IB has announced its system of grading the security of various exchanges. Its methodology, which will be used to determine insurance premiums, tracks factors such as cyberattack losses, anti-money laundering (AML) policies and storage capabilities.

Outside the U.S., Binance Uganda reportedly signed up 40,000 users in the first week after it launched its cryptocurrency exchange. And Bithumb, a South Korean cryptocurrency exchange, announced a partnership with a major Asian e-commerce company that will enable customers to make purchases via the Bithumb Cache system, a password-protected payment service that allows Bithumb customers to convert their cryptocurrency funds for use as payments.

To read more about the information covered in this week’s post, see the following:

Capital Markets Developments in Regulatory Guidance, Value of ICO Offerings and Banking

By: Jonathan D. Blattmachr

There are (as usual these days) many interesting developments in the blockchain capital markets space this week. First up, Securities and Exchange Commission (SEC) director William Hinman announced the Commission intends to release “plain English” guidance for ICO issuers. This information may help those gearing up for an offering to determine whether the SEC will consider the token a security. Hinman is the same director who gave an interesting speech in June about what should be considered a security, which we wrote about here.

Also in regulatory news, the Swiss Financial Market Supervisory Authority (FINMA) has weighed in on capital adequacy requirements for crypto assets, recommending (but not requiring) that investors should be “assigned a flat risk weight of 800% to cover market and credit risks.” This would mean, for example, that for each bitcoin held, a bank should assume a value of eight times that amount in fiat currency when calculating the risk-weighted value of its assets. FINMA also recommends institutions limit their crypto trading activities to 4 percent of total capital, including long and short positions.

While everyone agrees the capital markets have raised a significant sum from initial coin offerings (ICOs) this year, what the total amount is depends on who’s asked. Estimates range anywhere from $11 billion to $22 billion; the divergence exists because while the issuers have self-reported how much they raised from their ICOs, market watchers can take those numbers at face value or adjust. That said, according to a recent report, Israel-based ICOs have raised $606 million during the third quarter this year. Israel has reportedly attracted $1.3 billion in blockchain investments so far, with the plurality of the money going into the fintech space.

In the world of banking, Bancor announced it will provide cross-blockchain token swaps between ether and EOS-based tokens, without exchanges. The company believes this will allow its users to “seamlessly interact with any blockchain which best suits their needs.” And a major Spanish bank announced it has completed a test program that placed a $150 million syndicated loan on the Ethereum blockchain. The pilot reportedly eliminated the need for banks to share information via fax, a slow and costly process.

To read more about the topics covered in this week’s post, see the following:

Blockchain Pilots for Voting and Supply Chain, Global Shipping Business Network Challenges TradeLens

By: Diana J. Stern

In this year’s midterm elections, West Virginia conducted a statewide pilot utilizing a private blockchain, smartphones and facial recognition so that Americans abroad could vote more easily. One election security expert advised this would likely be superior to submitting absentee ballots by email but far less secure than in-person voting.

In another recent pilot, hardware manufacturer Seagate and a large, global technology company will seek to stop counterfeiting in the computer hard-drive supply chain. Hard drives produced by Seagate for the other company’s servers will include a physical marker and corresponding electronic key, which will be stored on a blockchain platform, where it will be available for verification at any time.

In a digital supply chain use case, smart contract outfit OpenLaw created an end-to-end demonstration of how artists can utilize their smart contract tools to manage fragmented ownership interests and commercialization strategies for their intellectual property in a more automated way – from proving ownership and issuing licenses to receiving royalty payments. In the demo, the artist uploads art as a nonfungible token on the Ethereum blockchain, then creates licenses linked to that token and finally enters into a written contract with the counterparty through a partially automated process. By tying the smart contracts to the token, OpenLaw aims to have the payments mechanism follow the license each time it is transferred. In related news, a U.S.-based software company was awarded a patent for a blockchain-based platform that would seek to prevent spam email.

Following our previous coverage of TradeLens, reports state the platform may have hit tumultuous tides as competitors attempt to work together, and efforts to achieve a network effect have fallen short with respect to carriers. One contributing factor may be that carrier Maersk is essentially steering the ship. On the other hand, customs authorities, logistics companies and a total of 94 players have reportedly integrated with TradeLens, and this week, the Port of Authority of Valencia in Spain joined as well. Still, multiple carriers have sailed over to a competing consortium, the Global Shipping Business Network (GSBN), affiliated with the Ocean Alliance. The recently announced GSBN is composed of ocean carriers serving the trans-Pacific market that collectively represent approximately one-third of global container ship capacity.

A major global enterprise software firm recently announced its HANA blockchain, which leverages the company’s databases and cloud platform and is compatible with Hyperledger Fabric and MultiChain and soon will be compatible with Quorum. In addition, Hyperledger Fabric recently announced support for Ethereum Virtual Machine (EVM) bytecode smart contracts. Among other features, Fabric now integrates with Solidity, a popular programming language used to write smart contracts.

To read more about the topics covered in this week’s post, see the following:

Multiple Enforcement Actions in US and Abroad Seek to Quell Blockchain Industry Crimes

 By: Simone O. Otenaike

This week, the SEC announced that it has settled charges against the founder of EtherDelta for operating an unregistered national securities exchange. EtherDelta is a digital token trading platform for blockchain-based tokens commonly issued in ICOs. According to the SEC’s order, EtherDelta’s founder agreed to pay $300,000 in disgorgement plus $13,000 in prejudgment interest and a $75,000 penalty. This is the SEC’s first enforcement action against a digital token trading platform for operating as an unregistered national securities exchange. The SEC has previously brought enforcement actions relating to unregistered broker-dealers and ICOs, some of which were traded on EtherDelta. The SEC’s recently released annual enforcement report for the 2018 fiscal year cites three specific ICOs that defrauded investors of a combined $68 million.

In more SEC-related news, the crypto fund Blockvest LLC asked a federal court to require the SEC to submit admissible evidence before allowing the agency to block its ICO. Blockvest LLC argued that the SEC should be required to make more specific allegations and argued that evidence submitted in support of the SEC’s application for a temporary restraining order is based on hearsay and thus inadmissible. On the state level, this week the Texas State Securities Board filed an emergency cease and desist order against Automated Web Services Mining (AWS Mining), an Australia-based cloud mining company, for selling unregistered crypto mining power contracts. According to the order, AWS Mining, along with its officers and partners, failed to register as dealers or agents for securities offerings and failed to register its contracts as securities.

A leading web analytics platform, StatCounter, was breached late last week through an external JavaScript tag. The service is used by more than 2 million other websites, including several government-related websites, to gather statistics on website visitors. This breach was unique because the hackers compromised StatCounter’s external JavaScript tag, not StatCounter’s website. The hackers used an external resource that touches millions of other sites just to steal bitcoin from one cryptocurrency exchange website. The attack demonstrates that well-maintained and protected websites are still susceptible to flaws in external resources that are under the control of third parties.

On the international front, regulators continue to put pressure on hackers. Late last week, the Financial Markets Authority (FMA) of New Zealand blacklisted three new crypto-related websites – Crypto Gain, Russ Horn and Zend Trade. Meanwhile in Turkey, the Cybercrime Department of the Turkish National Police arrested 11 suspects for an alleged crypto hack that resulted in more than $80,000 in losses. In South Korea, intelligence officials have solved the first known case of cryptojacking in South Korea. Cryptojacking is a hacking method where the hacker secretly takes control of personal computers to mine cryptocurrency. While the four hackers collected only about $895 worth of virtual money, they will stand trial for infecting over 6,000 PCs during the course of their scheme.

On Monday, Cybersecurity experts at Japan Digital Design, a subsidiary of Mitsubishi UFJ Financial Group, announced the discovery of incriminating evidence against the hackers of Japanese crypto exchange Zaif. Back in September, Zaif lost roughly $60 million worth of crypto assets. The experts have provided all relevant information to the authorities. Also this week, Taiwan’s legislature bolstered current cryptocurrency regulations with the passage of amendments to its existing AML and counterterrorism financing laws. The amendments give Taiwan’s Financial Supervisory Commission (FSC) the power to prohibit anonymous crypto transactions and to allow banking organizations to reject anonymous transactions and report suspicious ones to the FSC. These changes promote AML compliance and allow Taiwan to better align with international AML standards.

To read more about the topics covered in this week’s post, see the following:

Tax Compliance Stakes Raised for Cryptocurrency Issues

By: Roger M. Brown and Heather K.P. Fincher

At the International Tax Symposium held in Houston on Nov. 8 and 9 by the State Bar of Texas Tax Section, Daniel N. Price of the IRS Office of Chief Counsel reportedly said the IRS is not contemplating a separate disclosure program related to offshore cryptocurrency reporting. The IRS recently closed a comparable program, the offshore voluntary disclosure program (OVDP), in which taxpayers with foreign accounts could voluntarily report transactions to the IRS and receive certain benefits, and Mr. Price’s comments were meant to dispel a rumor that the IRS would launch a similar program encouraging taxpayers to disclose virtual currency transactions.

Many taxpayers struggle with a myriad of tax issues that arise in the cryptocurrency context, including the following:

  • Whether taxable gain arises from the exchange of one cryptocurrency for another (including potential application of the pre-2018 like-kind exchange rules).
  • Tax treatment of hard and soft forks, air drops, and exchanges of tokens for goods, services or other items of value.
  • Valuation issues arising from a variety of transactions, including token grants, option grants and air drops.
  • FBAR reporting for cryptocurrency assets held offshore.
  • Ability of non-U.S. persons to trade in cryptocurrencies through U.S. agents without being subject to U.S. tax.
  • Tax treatment of ICOs.
  • Classification and potential tax treatment of non-U.S. entities that may be used in effecting ICOs.
  • Potential application of broker, barter exchange and other reporting rules.

The absence of an OVDP-type program means that taxpayers will not have the benefit of reduced penalties if their tax treatment and reporting of these and other issues are incorrect. Further, because no reference to guidance related to cryptocurrencies is made in the 2018-2019 Priority Guidance Plan, released yesterday by the IRS and Treasury, it is unclear whether the IRS will be providing any additional guidance for taxpayers anytime soon. Thus, traditional means of reducing penalties by taking positions based on a learned application of the tax law to a taxpayer’s facts will be needed to minimize tax-adverse consequences that may arise when dealing with cryptocurrencies.