In last week’s blog post, I covered the technologies underlying Bitcoin (blockchain and distributed ledger technology—DLT) as well as tokenization and cryptocurrency wallets. Investors buy new cryptocurrencies and DLTs by exchanging fiat currency or existing cryptocurrencies in an Initial Coin Offering (“ICO”). Anyone with access to the Internet and a cryptocurrency wallet can buy tokens, presenting a unique spectrum of problems for regulators to tackle. We’re going to cover a few major points of interest today.
Federal Jurisdiction – Securities & Commodities Regulation
According to a 2017 report from the Securities and Exchange Commission (“SEC”), all securities offered and sold in the U.S. must be registered with the SEC or must qualify for an exemption. This includes entities operating securities exchanges and their investment companies. The SEC has succeeded or settled with several notable cryptocurrency exchange operators. Last summer, SEC Chairman Gary Gensler said that crypto is “rife with fraud, scams, and abuse.” He promised that the SEC would take its authorities “as far as they go” and indicated that stablecoins may be securities subject to regulation as well.
The Commodity Exchange Act (“CEA”) grants The Commodity Futures Trading Commission (the “CFTC”) rulemaking authority over a range of derivative and off-exchange transactions. The CEA definition of “commodity” is broad and often includes digital currencies and other virtual assets. However, the SEC has traditionally held exclusive authority over securities and most related products. It will be interesting to see how this potential “turf battle” plays out.
State Licensing – Various Approaches
State regulators have brought enforcement actions against cryptocurrency investors, brokers, advisors, and offerors for alleged Ponzi schemes and dealing in unregistered securities. Many states have issued guidance as to whether the state’s existing money transmission laws (originally intended to protect individuals sending money to each other) apply to cryptocurrency transactions. Others have amended their money transmission laws to explicitly include virtual currencies or plan to do so. Wyoming enacted laws aimed at attracting cryptocurrency businesses to their state. Conversely, New York enacted regulations requiring entities engaging in “virtual currency business activities” to obtain a license from the state’s Department of Financial Services.
FinCEN & Banking Regulation
The Financial Crimes Enforcement Network (“FinCEN”) is a bureau of the United States Department of the Treasury that combats money laundering and other financial crimes. FinCEN has regulatory authority over money services businesses (“MSBs”), defined as a person who functions as, among other things, a “money transmitter.” A “money transmitter” provides “money transmission services,” including the acceptance and transmission of currency, funds, or other value. Alone, or together with the Department of Justice and the CFTC, FinCen has brought enforcement actions against well-known cryptocurrency platforms such as Ripple Labs, BitMEX, and BTC-e.
The role of banks as deposit and payment service providers for cryptocurrency-related businesses has been complicated by anti-money laundering provisions and “know your customer” regulations. Regulators cite operational risks and other concerns. Banks have become hesitant to provide services to crypto business, or even to use DLT to conduct traditional bank businesses, limiting the development of certain digital products—and arguably driving more activities under regulatory purview.