Blockchain+ Bi-Weekly December 14, 2023

The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law.

Amidst the recent excitement surrounding bitcoin’s price rally, the past two weeks have been unusually quiet for industry legal updates. Which is a welcome relief, after a very busy few weeks leading up to Thanksgiving. But there were still developments in multiple criminal cases in the space, Congress was busy despite the growing consensus that digital asset regulation won’t get past the House until 2024, and the SEC has asked for a ruling as a matter of law regarding the assets in the Terraform Labs case.

These developments and a few other brief notes are discussed below.

Finance Founder Ordered to Remain in U.S. Pending Sentencing: November 27, 2023

Background: Binance’s former CEO Changpeng Zhao (“CZ”) was ordered to remain in the U.S. while he awaits sentencing on his guilty plea to one count of violation of the Bank Secrecy Act. The Order was temporarily entered by the magistrate judge overseeing his criminal case and associated plea agreement before being affirmed as the correct determination by District Court Judge Richard Anthony Jones. CZ’s sentencing is set for February 23.

Summary: It seemed odd that the DOJ would enter the plea agreement with CZ if they did not trust him to return for his sentencing. But the fact that CZ’s domicile country the United Arab Emirates does not have an extradition treaty with the United States and his large amount of resources weighed in favor of keeping him in the United States until sentencing. We covered the CZ plea agreement and its associated impact on the industry in our previous BitBlog Bi-Weekly post available here.

SEC Ask Judge to Rule Assets are Securities as a Matter of Law in Terraform Labs Case: December 4, 2023

Background: The SEC has filed a letter with the Court in the SEC v. Terraform Labs case pending in the Southern District of New York that asks the judge determine that the digital assets in question are investment contracts as a matter of law. If successful, this would remove that determination from consideration by a jury. The SEC’s letter argues that the legal nature of digital assets at issue, particularly in the context of the Howey test, is not a matter which should be presented for jury determination in any trial on this issue.

Summary: The SEC has hedged its position, stating the assets at issue are securities as a matter of law or, in the alternative, there is no genuine issue of fact precluding the Court from ruling on the issue prior to trial. Smart considering Judge Rakoff’s previous Order on the Motion to Dismiss indicated he views the issue of efforts of others to hinge on a reasonable investor standard which would be an issue for the jury. Meanwhile, Terraform Labs founder Do Kwon is facing extradition for DOJ charges related to the Terra/Luna collapse in the Spring of 2022, although he may be extradited to Korea instead.

House Financial Services Subcommittee on Digital Assets Holds Hearing on Fostering Innovation: December 5, 2023

Background: The House Financial Services Subcommittee on Digital Assets held a hearing titled “Fostering Financial Innovation: How Agencies Can Leverage Technology to Shape the Future of Financial Services.” The focus of the hearing was the government’s approach to new and emerging technologies like digital assets, distributed ledgers, quantum computing, and greater use of artificial intelligence. Witnesses included representatives from the SEC, FDIC, the Federal Reserve, and other administrative agencies.

Summary: The biggest takeaway was Representative Emmer’s questioning of the SEC representative witness, who also was a commentator on the now-infamous Hinman speech (those comments were publicly released on June 13). There was also a call from Representative Waters for a smaller session specific to the operation of digital asset companies. Despite attempts by Representative McHenry to include digital asset bills which had passed through committee in the omnibus defense authorization bill, those attempts failed to be attached to larger spending measures, making it unlikely for any substantive digital asset regulations to pass in 2024. Notably, Representative McHenry also recently announced that he will not run for re-election at the end of this term. 

Briefly Noted:

House Committee Unanimously Passes Digital Asset Bill: the Deploying American Blockchains Act was unanimously voted through the House Committee on Energy and Commerce. The bill’s substantive provisions are not expected to have a large impact on the industry, but it shows a growing consensus that these assets are something the government needs to gain a better understanding of.

Report on Web3 Gaming Released: Colleen Sullivan of Brevan Howard Digital has released an over 150-page essay on the impact of Web3 digital ownership principles on the rising gaming economy. Well worth the read for anybody wishing to gain better insight into this growing industry sector.

Bitzlato Founder Plead Guilty: The Founder of Bitzlato has pled guilty and agreed to not participate in any digital asset exchange venture as a part of the deal. The DOJ brought charges against the founder in January, and despite only having an all-time peak of $6 million held on the exchange at any given time, it was accused of being used in laundering over $700 million over its business lifetime.

Department of Treasury Seeks Expanded Powers from Congress: The Department of Treasury sent a letter in response to the Senate’s request for information regarding Treasury’s existing powers and what powers the agency needed to fight illicit use of digital assets. Interestingly, the original draft in which the agency stated it did not have the power to designate smart contracts or protocols under existing powers was replaced with a less comprehensive letter which was released to the public.

Federal Reserve Manuel Includes Section on Crypto Activities: The Federal Reserve’s recently released updated bank examination manual includes a new section (Section 5330) focused on crypto-related activities. The section also highlights key Federal Reserve guidance on crypto-asset related risks to banking organizations and supervisory considerations in assessing banks engaged in crypto-asset-related activities.

Conclusion:

In wrapping up this edition of the Blockchain+ Bi-Weekly, even in a relatively calm period for legal developments it’s clear that the blockchain and crypto landscapes are rapidly evolving under the watchful eye of U.S. regulators and lawmakers. From the courtroom drama involving Binance’s ex-CEO to the SEC’s strategic moves in the Terraform Labs case, these developments paint a vivid picture of the intricate dance between legal structures and the ever-advancing world of digital assets. As we observe the unanimous support for the Deploying American Blockchains Act and other regulatory strides, it’s evident that the journey towards a more regulated and understood digital asset sphere is well underway. Stay tuned for more insights as we continue to navigate these exciting and uncharted waters of blockchain and crypto regulation.

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