The Blockchain Monitor

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In this issue: • <a href="#Proof">Proof of Stake Alliance Publishes Analysis, Advocates for Industry Standards</a> • <a href="#BIS">BIS Analyzes Crypto Market Data, Digital Asset PoC and Consultation Announced</a> • <a href="#US">U.S. District Court Denies Motion to Dismiss Claims that NFTs Are Securities</a> • <a href="#SEC">SEC and CFTC Actions Pursue Crypto Misrepresentation and Fraud Actions</a> • <a href="#DOJ">DOJ and New York State Actions Target Crypto Fraud and Other Violations</a>

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Proof of Stake Alliance Publishes Analysis, Advocates for Industry Standards

By <a href="https://www.bakerlaw.com/AmosKim">Amos Kim</a>

This week the Proof of Stake Alliance (POSA), a nonprofit industry alliance focused on proof of stake (PoS) ecosystems, announced their newly developed industry principles for liquid staking. These principles are the product of two legal white papers developed by “POSA’s liquid staking working group of members from over 10 industry organizations” that includes representatives from the legal and software development industries, as well as Lido, a liquid staking solution for Ethereum and other PoS blockchains.&nbsp;

According to the announcement, POSA’s liquid staking working group “represent[s] the first collaborative industry effort to define and consider key legal questions around liquid staking and to call upon the industry to self-regulate.” POSA’s newly developed legal working papers “address regulatory and tax considerations for liquid staking in the U.S., representing the first legal research and conclusions on the regulatory and tax status of liquid staking receipt tokens, the lack of clarity around which has been cited as a primary barrier to liquid staking’s widespread adoption and development domestically in the United States and globally.” According to the Executive Director of POSA, “In the wake of recent SEC actions against staking-as-a-service providers, we believe that revisiting and updating our industry principles to reflect new innovations like liquid staking will help unite those who participate in staking ecosystems and strengthen all of our advocacy efforts.”&nbsp;

The announcement highlights the following “industry-driven standards” that are being advocated by the POSA for adoption by “those who are engaged in liquid staking and developing liquid staking protocols”: (1) Use appropriate terminology to describe liquid staking tokens (LSTs) and the nature of activities; (2) focus on increased liquidity, without sacrificing what is of utmost importance – security and participation; (3) develop tools to enable direct staking with access to liquidity, not staking-backed yield products; and (4) refrain from providing investment advice.

For more information, please refer to the following links:

<a href="https://www.proofofstakealliance.org/22123-posa-liquid-staking-legal-white-paper">Proof of Stake Alliance Offers First Legal Research and Analysis on Liquid Staking Tokens: Urges Industry to Self-Regulate</a>

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<a href="https://static1.squarespace.com/static/62f147feb8108a08e666aea5/t/63f3fd27f0b0fc45f7d906c2/1676934439845/U.S._Federal_Income_Tax_Analysis_of_Liquid_Staking.pdf">U.S. Federal Income Tax Analysis of Liquid Staking</a>

<a href="https://static1.squarespace.com/static/62f147feb8108a08e666aea5/t/63f41766f6095b07bec7d1e8/1676941158721/U.S.+Federal+Securities+and+Commodity+Law+Analysis+of+Liquid+Staking+Receipt+Tokens+%28Willkie+Draft+02.14.23%29.pdf">U.S. Federal Securities and Commodity Law Analysis of Liquid Staking Receipt Tokens</a>

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BIS Analyzes Crypto Market Data, Digital Asset PoC and Consultation Announced

By <a href="https://www.bakerlaw.com/ChristopherLamb">Christopher Lamb</a>

According to a recent bulletin published by the Bank for International Settlements (BIS), data collected and analyzed by BIS shows that “crypto trading activity increased markedly” in the wake of the recent collapses of major cryptocurrency exchanges and algorithmic stablecoins, with “large and sophisticated investors selling and small retail investors buying.” The bulletin reports that, in 2022, over $1.8 trillion of crypto value dissolved – with roughly $650 billion of these losses following the collapse of major algorithmic stablecoins and crypto exchanges. Data referenced in the bulletin also indicates that, over the period of August 2015 to December 2022, “a majority of investors probably lost money on their bitcoin investment.” However, the bulletin indicates that the broader financial system suffered limited impact from the collapse in valuation over the course of 2022, and that there is “at best a weak correlation between broader stress and crypto losses.” According to the bulletin, despite the weak correlation between the cryptocurrency market and the broader financial system, the patterns between retail trading and sophisticated investor selling indicate a need for further investor protection in the digital asset market.

In other news, a German multinational investment bank and financial services company recently completed a proof of concept known as Project DAMA (Digital Assets Management Access) to serve as a “one-stop digital fund investment servicing platform” and to address challenges associated with launching and accessing digital funds. According to a press release, Project DAMA was awarded the Monetary Authority of Singapore’s Financial Section Technology and Innovation (FSTI) Proof of Concept grant in August 2022.

According to a recent press release, the Hong Kong Securities and Futures Commission (SFC) has launched a consultation on the proposed requirements for operators of virtual asset trading platforms. The press release notes that the proposed requirements are “comparable to those required by licensed securities brokers and automated trading venues.” The SFC is seeking input “particularly on whether to allow licensed platform operators to serve as retail investors, and if so, the measures to be implemented in addition to the proposed range of robust investor protection measures ….” Interested parties can submit their comments to the SFC on or before March 31, 2023.

<a href="https://www.bis.org/publ/bisbull69.pdf">BIS Bulletin No 69: Crypto shocks and retail losses</a>

<a href="https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=23PR5">Hong Kong Securities and Futures Commission (SFC): SFC consults on proposals to regulate virtual asset trading platforms</a>

<a href="https://corporates.db.com/publications/White-papers-guides/simplifying-digital-fund-management-and-investment-servicing">Deutsche Bank and Memento Blockchain have successfully completed a proof of concept</a>

<a href="https://corporates.db.com/files/documents/publications/DB-Project-DAMA.pdf">Project DAMA: Simplifying digital fund management and investment servicing</a>

U.S. District Court Denies Motion to Dismiss Claims that NFTs Are Securities

By <a href="https://www.bakerlaw.com/RobertAMusiala">Robert A. Musiala Jr.</a>

This week the U.S. District Court for the Southern District of New York (Court) issued a decision and order (Order) in an ongoing class action lawsuit denying the defendants’ motion to dismiss claims that certain popular basketball-focused nonfungible tokens (NFTs), referred to as “Moments,” were “investment contracts” and therefore securities under the standard set forth by the U.S. Supreme Court in SEC v. W.J. Howey Co. In Howey, the U.S. Supreme Court found that a contract, scheme or transaction is deemed an investment contract, and thus a security, if it involves (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) based on the entrepreneurial or managerial efforts of others. Here, the Court found that the plaintiffs’ allegations claiming the NFTs met the Howey test were “facially plausible” and therefore survived the defendants’ motion to dismiss the alleged violation of Sections 5 and 12 of the Securities Act.

According to the Order, the plaintiffs’ allegation that the Moments existed on the Flow blockchain, a private blockchain maintained and controlled by the defendants – unlike public blockchains like the Bitcoin Network – was “fundamental” to the Howey analysis because the plaintiffs’ control over the Flow blockchain network “significantly, if not entirely, dictates Moments’ use and value.” The Order further stated, “By privatizing the blockchain on which Moments’ value depends and restricting the trade of Moments to only the Flow Blockchain, purchasers must rely on [defendants’] expertise and managerial efforts, as well as its continued success and existence.”

The Order also found that the defendants marketed the Moments NFTs “as a means for purchasers to realize substantial profits through the low sale prices for packs and marketing of the substantial profits others had made through sale on [defendants’] proprietary Marketplace.” In conclusion, the Order found that without the defendants’ “essential efforts in maintaining the Flow Blockchain and Marketplace, Moments would be valueless.” The Court emphasized that its conclusion is “narrow” and that “[n]ot all NFTs offered or sold by any company will constitute a security, and each scheme must be assessed on a case-by-case basis.”

<a href="https://www.law360.com/fintech/articles/1578864?nl_pk=d839899d-0537-414a-b7cc-d6d00bb8e8ff&amp;utm_source=newsletter&amp;utm_medium=email&amp;utm_campaign=fintech&amp;utm_content=2023-02-23&amp;nlsidx=0&amp;nlaidx=0">NBA-Tied Crypto Co. Can't Dodge Unregistered Securities Suit</a>

SEC and CFTC Actions Pursue Crypto Misrepresentation and Fraud Actions

By <a href="https://www.bakerlaw.com/KeithRMurphy">Keith R. Murphy</a>

According to a recent press release, the U.S. Securities and Exchange Commission (SEC) has charged Singapore-based Terraform Labs PTE Ltd and Do Hyeong Kwon with operating a “multi-billion dollar crypto asset securities fraud” in connection with the Terra USD (UST), Luna and MIR tokens. According to the SEC press release, among other things the defendants marketed crypto asset securities to investors seeking to earn profits, repeatedly claimed that their tokens would increase in value, and misled investors about the stability of the UST token, which in May 2022 de-pegged from the U.S. dollar and saw its price decline to zero. In a quote from the SEC press release, Gurbir S. Grewal, the Director of the SEC’s Division of Enforcement, stated that the defendants’ "ecosystem was neither decentralized, nor finance. It was simply a fraud propped up by a so-called algorithmic ‘stablecoin’ – the price of which was controlled by the defendants, not any code."

In another recent press release, the SEC published an order and announced that it has settled charges against a former professional basketball player for making false and misleading statements on social media regarding “crypto asset securities” and for failing to disclose that he received payment for his endorsements. The SEC’s order found violations of the anti-touting and anti-fraud provisions of the federal securities laws. The former professional basketball player settled the matter for $1.409 million without admitting or denying the SEC’s findings, according to the press release. In a quote from the SEC press release, Gurbir S. Grewal, the Director of the SEC’s Division of Enforcement, stated that “the federal securities laws are clear that any celebrity or other individual who promotes a crypto asset security must disclose the nature, source, and amount of compensation they received in exchange for the promotion.”

A recent press release by the U.S. Commodity Futures Trading Commission (CFTC) announced charges against a California technology company and its chief executive officer, alleging fraudulent solicitation and misappropriation of customers’ bitcoin and ether “digital asset commodities” through a “Ponzi-like scheme.” According to the press release, the defendants falsely advertised to customers that the company would trade their digital assets and obtain significant returns, and that investors’ assets would be traded using “Robot Traders,” despite no such program existing. Through the litigation, the CFTC seeks restitution, disgorgement, various bans and civil monetary penalties.&nbsp;

<a href="https://www.sec.gov/news/press-release/2023-32">SEC Charges Terraform and CEO Do Kwon with Defrauding Investors in Crypto Schemes</a>

<a href="https://www.sec.gov/news/press-release/2023-34">SEC Charges NBA Hall of Famer Paul Pierce for Unlawfully Touting and Making Misleading Statements about Crypto Security</a>

<a href="https://www.cftc.gov/PressRoom/PressReleases/8660-23">CFTC Charges California-based Company and Its CEO with Fraudulent Solicitation and Misappropriation of Digital Asset Commodities</a>

DOJ and New York State Actions Target Crypto Fraud and Other Violations

By <a href="https://www.bakerlaw.com/JoannaFWasick">Joanna F. Wasick</a>

On Wednesday, the U.S. Department of Justice (DOJ) announced that a federal grand jury charged four Russian national founders of Forsage, a purported DeFi cryptocurrency investment platform, for their roles in a global Ponzi and pyramid scheme that took in $340 million from victim-investors. According to a DOJ press release, the defendants coded and deployed smart contracts that systematized a combined Ponzi-pyramid scheme on the Ethereum, Binance Smart Chain and Tron blockchains. As soon as an investor invested in Forsage by purchasing a “slot” in a Forsage smart contract, the smart contract automatically diverted the investor’s funds to other Forsage investors, such that earlier investors were paid with funds from later investors. The DOJ’s case follows a related action brought by the U.S. Securities and Exchange Commission (SEC) in August against 11 people tied to Forsage.

Also this week, the New York Attorney General (AG) sued the cryptocurrency platform CoinEx for failing to register as a securities and commodities broker-dealer and for falsely representing itself as a crypto exchange. <a>According to a press release</a>, New Yorkers were able to buy and sell cryptocurrencies on CoinEx even though the company is not registered in the state, in violation of New York law. In addition, according to the press release, CoinEx claimed to be an exchange but is not registered with the SEC as a national securities exchange or appropriately designated by the Commodity Futures Trading Commission (CFTC), as is required under New York law. The AG also alleged that CoinEx failed to comply with a subpoena issued to provide more information about its digital asset trading activities in the state. Through this enforcement action, the AG seeks to permanently stop CoinEx from operating in New York through its website and mobile apps.

Last week, the Manhattan District Attorney announced the indictment of Nan Wu and his four accomplices, including a U.S. Postal Service employee, for operating a dark web marketplace from New York and California that shipped more than 10,000 packages of cocaine, MDMA, ketamine and other substances to customers throughout the United States. As alleged, the defendants operated the dark web vendor “FireBunnyUSA” and laundered $7.2 million, including over $3.1 million in proceeds, through domestic and foreign cryptocurrency exchanges.

<a href="https://www.justice.gov/opa/pr/forsage-founders-indicted-340m-defi-crypto-scheme">Forsage Founders Indicted in $340M DeFi Crypto Scheme</a>

<a href="https://www.manhattanda.org/d-a-bragg-announces-takedown-of-dark-web-cryptocurrency-drug-trafficking-ring-that-laundered-7-2-million/">D.A. Bragg Announces Takedown of Dark Web Cryptocurrency Drug Trafficking Ring That Laundered $7.2 Million</a>

<a href="https://ag.ny.gov/press-release/2023/attorney-general-james-sues-cryptocurrency-platform-failing-register-new-york">Attorney General James Sues Cryptocurrency Platform for Failing to Register in New York</a>

PoS Principles Published; Crypto Market Analysis and POC Announced; Court Interprets NFTs Under Howey; SEC, CFTC and DOJ Continue Crypto Enforcement