CryptoLaw Newsletter #24

Nigeria launches CBDC, Australian Senate proposes DAO legal entity, DeFi protocol founder sues SEC, CFTC investigates DeFi prediction market, WorldCoin and Facebook-backed Novi raise eyebrows.

Hello CryptoLawyers,

My favourite story of the week: an NFT album confiscated by US authorities from disgraced and imprisoned pharma fraudster Martin Shkreli was sold to… a DAO. PleasrDAO bought the unique album-NFT from Wu-Tang Clan for $4 million.

Digital assets

  • US – The first bitcoin ETF launched in the US last week and drew in a record US$ 1 billion of investor funds. Crypto-asset prices have rallied in tandem with the news. However, it is only a futures ETF: the ETF only buys bitcoin futures on a regulated market, not actual bitcoin. That’s one reason why the SEC was willing to cave in and approve this type of ETF, said SEC Chairman Gary Gensler: at least the futures trade on a regulated market, subject to US commodities rules. The regulator still has not approved an ETF that actually buys bitcoin itself. Investing in futures comes with greater costs than investing in bitcoin directly, for example the cost of rolling over subsequent futures contracts. (Reuters) However, that has not dampened its popularity, especially among institutional investors, responsible for the bulk of the trading on the ProShares bitcoin futures ETF. Only 12-15% of net buying in the ProShares ETF came from retail investors, according to the Financial Times.

  • US  - A team of US bank regulators is “trying to provide a roadmap for banks to engage with crypto assets”, according to Jelena McWilliams, chair of the Federal Deposit Insurance Corporation (FDIC). (Reuters) Banks are eager to receive more guidance and, if banks become more willing to engage with crypto-assets, this reduces risks of de-banking for crypto companies. De-banking (banks refusing to do business with crypto companies due to compliance risks) was flagged as an area of concern in an Australian Senate committee report on crypto (see our post here).

  • UK – The Financial Conduct Authority is using TikTok and YouTube to warn young people about the risks of crypto. (Decrypt)

  • US – Oh no… anyone but Facebook! That was probably the best summary of crypto twitter’s reaction to the announcement that Facebook & partners are launching a digital wallet called Novi. Some politicians gave the announcement the same cold shoulder welcome.

  • US  - Then came the Woldcoin announcement. The Silicon Valley backed project promises free Worldcoins to anyone willing to scan their eyeballs. Their PR team did a great job in getting attention… but perhaps not in the way they expected. Plenty of meme material thanks to the Worldcoin “Orb” device used to scan eyeballs. Worldcoin is supposed to be a “new, collectively owned global currency that will be distributed fairly to as many people as possible.” Its backers maintain that the iris scans merely serve the purpose of ensuring only humans sign up (not bots), and that every person can only sign up once. Yet there was a lot of scepticism, to say the least, about th idea of another Silicon Valley -backed tech company collecting biometrics in return for ‘free’ money in the name of financial inclusion.

  • Hong Kong – Large crypto companies such as FTX and crypto.com started in Hong Kong, which also has plenty of brick & mortar crypto shops. Some expect tourists from mainland China to buy crypto over the counter in Hong Kong, although there is concern over proposed crypto rules in Hong Kong. One key question is whether the jurisdiction will allow institutional investors to get involved in crypto. Cointelegraph  reports.

  • US – “Our view is that the vast majority of digital assets are being used for legitimate purposes, but for those that are primarily in the business of furthering criminal enterprises, we plan to use our tools to go after them,” said Wally Adeyemo, Deputy Secretary of the Treasury. (Cointelegraph)

  • Pakistan – The High Court of Sindh ordered the government to regulate cryptoassets in three months. The Court instructed the Securities and Exchange Commission, the central bank and other public bodies to develop cryptoregulations during a court case brought against the country’s crypto ban, imposed in 2018. (Cointelegraph)

  • UK – The Financial Conduct Authority registered Crypterium for “certain cryptoasset activities”. The FCA’s website shows the company is registered for AML purposes and is “regulated”, although its customers cannot go to the Financial Ombudsman Service for complaints nor make claims against the Financial Services Compensation Scheme should Crypterium go bankrupt. (Cointelegraph and FCA)

  • Dubai – The Dubai Financial Services Authority (DFSA) launched its regulatory framework for Investment Tokens. The framework reflects the proposals outlined in Consultation Paper 138 issued in March 2021 and forms the first phase of the DFSA’s Digital Assets regime, according to a press release. DFSA reportedly plans to launch another public consultation later this year, preparing a legal framework for tokens that are not investment tokens, such as stablecoins or utility tokens. (Cointelegraph)

  • US – Was Coinbase Lend really a security? Yes, argues Nathan Tankus. It is “very clear how easy it is to characterize this debt product as a security,” he wrote in Decrypt article.


Stablecoins

  • US – Will stablecoin supervision be allocated to the SEC? According  to a Bloomberg report, the President’s Working Group on Financial Markets will suggest just that in its long-awaited report.  

  • Tether – Tether’s woes are far from over. After a scathing Bloomberg article and another fine (this time by the US CFTC), the stablecoin issuer is now also the target of a short-selling digging for dirt on Tether reserves. (Decrypt)


DAOs

  • Australia – Company law should be amended to recognizes Decentralised Autonomous Organisations (DAOs) as legal entities, according to a Senate committee. The committee’s final report made a number of recommendations for a clearer legal framework on cryptoassets and DAOs, including suggestions on tax law, discounts for miners using renewable energy and making DAOs a type of new limited company (similar to what Wyoming has done). See our blog post here for an overview.


DeFi

  • US – Polymarket, the largest DeFi prediction/betting market, reportedly is under investigation from the CFTC. The CFTC wants to know whether Polymarket should have registered and whether it is allowing users to trade swaps or binary options “improperly”. Although it has not been accused of wrongdoing, Polymarket has retained expert legal counsel: it hired the former head of the CFTC’s enforcement division, according to the report. (Bloomberg)

  • US – The founder of a DeFi protocol is suing the Securities and Exchange Commission. The SEC served a subpoena to the CEO of Terraform Labs, the company building a DeFi platform, at a popular crypto conference earlier this year.  The CEO and Terraform Labs, in return, filed a  lawsuit against the SEC in the Southern District of New York, claiming violation of due process rules. The lawsuit states the SEC had no jurisdiction over CEO Do Kwon, a Korean citizen. Serving him with a subpoena during a large crypto conference he was about the speak at also violated the SEC’s obligation to keep its investigation confidential, according to the court filing.

“Hiring a “Cavalier” process server to approach Mr. Kwon in public, and announce the purpose of his approach, at a summit attended by more than 2,000 people was, at worst, an intentionally brazen display meant to publicly intimidate and embarrass, and at best reckless, creating social media and  press speculation about the incident within minutes of the attempted service of process”.

  • It sure did! The SEC had previously asked Mr. Kwon for voluntary cooperation, leading to a 5 hour long interview. Mr. Kwon retained Dentons as legal counsel. The  SEC wanted to know more about the Mirror platform, built by Terra, which offers tokens that track (mirror) the price of US stocks. A number of securities regulators warned that such tracker-tokens might be financial instruments. The lawsuit filed by Mr Kwon and Terralabs, however, says that  the Mirror Protocol is a decentralised protocol, governed by the Terra community rather than Terraform Labs or its CEO. The case might be decided on the due process claims only, but it would get really interesting if the court would actually render a judgment on whether the Mirror Protocol is indeed decentralised, if that can help clarify what ‘decentralised’ means.  (Coindesk)

  • US  - SEC Commissioner Peirce once again criticized her colleagues for their regulatory approach to DeFi. In a speech, she asked: “Are We Going to Pretend Everything is Centralized So We Can Regulate It?”

    • “The crypto frontier, like the Wild West, appears pretty wild at first glance:  home to lots of codeslingers and speculators and some hucksters too, this new West also has its inter- and intra-protocol fights, friendships forged through shared difficulties and successes, colorful personalities, passions, dreams, hardships, spectacular failures, and remarkable victories.  But as in the West of the past, there is order and discipline in all of that rough and tumble.  Because crypto is built on code, the code itself serves as a governor of conduct.  But crypto is built on people too, and these people hold each other accountable not only through unbridled public discourse, but through using or not using a protocol.  Protocol users, competitors, bug bounty hunters, and sophisticated skeptics monitor protocols for hints of centralization, administrator keys vulnerable to compromise, slow speed, high costs, lax security, and so forth. A system outage, rugpull, insider trading incident, or exposed flaw in the code gives rise to an inevitable firestorm.  Decentralized communities collectively figure out how to deal with unanticipated problems.  These cooperative and competitive disciplining mechanisms have helped to clean up the crypto frontier though there is more work to be done.  The persistence of both self-regulation and calls by the crypto community for clarity from government regulators suggest that lawlessness is not the prevailing culture of the crypto frontier.”

  • Global – What exactly does ‘code is law’ mean? Often not what many think it means. In DeFi, after every exploit raises the question: will hackers give in to peer pressure and return stolen funds, even if they may never be legally forced to do so? As Vitalik Buterin wrote, this tool of social pressure has worked relatively well so far, but that may change as DeFi moves away from a tightly-knit community with basic shared values. With every DeFi  hack or exploit, community members face the question whether they try gentle persuasion or bring the case to law enforcement authorities. In a recent exploit, community members decided to do just that: collect evidence about a coding exploit and turn it over to authorities. Although this may seem to go against the DeFi ethos, many believe that exploiting DeFi code to take other people’s assets is just theft. In this case, the Indexed protocol was drained of $16 million by… a teenager. Community members tried to convince him to return the funds, but after he refused, the decision was taken to hand the evidence over to law enforcement. Very unlikely the court will be impressed by the misinterpreted “code is law” mantra. (Coindesk)


CBDCs

  • Nigeria – The eNaira was officially launched today.  Users can download a eNaira speed wallet or the eNaira merchant wallet from the Apple and Google app stores. Roughly 500 million eNaira ($1.21 million) has been minted so far. Notwithstanding the country’s ban on banks to facilitate crypto-transactions, cryptoassets have boomed. It’s unlikely the country’s CBDC will replace domestic interest in the crypoassets it tries to replace. (Coindesk)


Academic corner

  • Blockchain and antritrust- Antitrust and blockchain are complementary, writes Thibault Schrepel in his book Blockchain + Antitrust (free online version available). One the one hand, antitrust law protects the competitive process by eliminating forms of coercive control. On the other hand, blockchain seeks to eliminate centralized and vertical forms of control (and disrupt such existing structures). In a sense, antitrust law aims to constrain the exercise of power through the rule of law; while blockchain seeks to do so through technical means. And while some entities running on blockchain ecosystems are profit driven, the technology architecture (tends to) align their goals with antitrust la. Bot end up taking part in the decentralization of transactional power. They do not speak the same language, but they share the same ambition.” If you’re interested in hearing more: join our panel discussion with Thibault tomorrow, 27 Oct. at 5.30pm London time. Register here.

  • Carla Reyes proposes a “unified theory of code-connected contracts”, offering an analytical tool for anticipating legal and business risk when using computational contracts. You can read her article on SSRN.

  • Interested in smart legal contracts? Oxford University Press announced an edited volume on the topic, edited by Jason Grant Allen and Peter Hunn. The book will be published in March 2022.

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