CryptoLaw Newsletter #3 - 25 May 2021

Will the crypto market crash trigger more regulatory scrutiny? And more...

May 25, 2021

Contents

Into
Digital assets - crypto warnings, looming regulation and crypto expert panels
CBDC
DLT
DeFi
Revolving door
Law Firm Briefing
Academic Corner
Also in the news
Opinion

Hello CryptoLawyers,

Another turbulent week for digital assets, with wild price swings across the board. While insiders pointed fingers to excessive leverage, the financial press and global news outlets focused on looming regulatory intervention to explain the crashing crypto prices.

What was the role of regulatory concern in the recent sell-off? Although regulatory intervention may not have explained the price crash, the mayhem certainly piqued the interest of regulators worldwide.

‘Regulatory concerns Bitcoin and related assets have also come under increased scrutiny from regulators around the world as they have grown into a bigger part of the financial markets. “We believe government crackdown on cryptocurrencies can trigger another ‘crypto winter’ and reduced trading activity. Harsher crackdown on crypto is possible in many developing countries which may view crypto as a threat to their fiat currencies and monetary system,” Bernstein’s Harshita Rawat said in a note on Tuesday.’ (CNBC)

Not everyone agrees that greater regulatory scrutiny may cause another crypto winter. Others think that a lack of legal certainty hinders the development of promising projects and gives free play to all sorts of scams and hypes that are an unwelcome distraction in the industry. Whatever your take, it is a matter of time before regulators respond.

Digital Assets

A host of regulatory warnings and signs of greater regulatory scrutiny:

China tightens crypto-restrictions on financial institutions (Coindesk). Huobi and OKEx limit services to Chinese customers as a result (Decrypt). Bitcoin miners also appear to be shifting activities abroad (Cointelegraph). Hong Kong announced it would restrict crypto exchanges to professional investors (Reuters).
The European Central Bank’s VP says bitcoin is not a ‘real’ investment (BNN Bloomberg). The comments came on the same day as the ECB published its Financial Stability Review.It didn’t hold back on crypto: “The surge in bitcoin prices has eclipsed previous financial bubbles like the “tulip mania” and the South Sea Bubble in the 1600s and 1700s.” It listed crypto’s ‘exorbitant carbon footprint’ and its ‘potential use for illicit purposes’ as grounds for concern. It concluded that crypto’s risk to financial stability is limited at present. (Two Fed policymakers echoed this view of lack of systemic risk, according to Reuters).
Lots of crypto regulatory updates from the US:
- The SEC’s Gary Gensler said we ‘should be ready’ to enforce crypto cases (Decrypt). Some wondered whether the recent crypto events will make the SEC even more reluctant to approve a bitcoin ETF. The SEC has approximately 11 bitcoin ETF applications pending and is waiting to learn from neighbouring Canada’s bitcoin ETF approval. Teucrium submitted an application for a bitcoin futures fund to the SEC on May 20.
- OCC reversal? Brian Brook’s crypto approach while at the helm of the US OCC is coming under increased scrutiny. Current OCC head Michael Hsu asked staff to review Brooks-era crypto rules. ‘My broader concern is that these initiatives were not done in full coordination with all stakeholders. Nor do they appear to have been part of a broader strategy related to the regulatory perimeter’, he said (Cointelegraph). Senator Brown sent a letter to Hsu expressing his concern over the OCCs’ decision to grant national trust charters to a number of crypto companies during Brooks’ tenure. Brooks is currently the CEO of crypto exchange Binance.US, as more crypto companies poach former officials to join their ranks.
- The US Treasury announced new measures to crack down on crypto tax dodging. It will require any transfer worth $10,000 or more to be reported to the IRS (CNBC).
- In what some see as a sign of looming enforcement activity, the NY State Department Of Financial Services appointed an enforcement attorney to the newly created position of Deputy Virtual Currency Chief (Forbes).
- The FDIC sent a RfI (request for information) to banks about crypto activities and plans.

The Central Bank of Kuwait issued a statement on crypto-risks and Uganda’s FIA asked the government to find ways to regulate crypto (Daily Monitor). The Bank of Canada called crypto highly risky despite institutional involvement (Cointelegraph).

However, not all legal news was about more regulatory intervention:

Building the regulatory knowledge base. India is considering an expert panel on crypto regulation (Economic Times India). In the US, the Fed, OCC ad FDIC are considering an interagency crypto-team (Cointelegraph).

Finding the balance in AML/KYC. A Dutch court ruled in favour of crypto exchange Bitonic on KYC rules. The Dutch Central Bank (De Nederlandsche Bank) consequently revoked its requirement for wallet verification under the Sanctions Act (Coindesk).

A number of crypto statements from Australia: Senator Bragg said there ‘may be a case’ for crypto regulation to ensure Australia ‘stays ahead of the game’ (Sky News). Bragg is chairing senate inquiry on crypto policy and compare Australia’s approach to that of Canada, Singapore, the EU and the UK (The Sydney Morning Herald). Senator and Minister Jane Hume said: ‘We take no issue with consumers investing in cryptocurrencies’ and that they are ‘an asset class that will grow in importance.’ (Coindesk)
Russian officials considering partial reversal of ban on crypto-payments, by amending Civil Code contract law rules (Cointelegraph).
US state Nebraska approved a framework for digital asset banks (Coindesk). If Gov. Pete Ricketts signs Bill 649, Nebraska would offer a state bank charter to crypto depository institutions, following in the footsteps of Wyoming.
Dubai Airport Free Zone Authority will allow crypto trading after signing a new agreement with the UAE Securities and Commodities Authority (Cointelegraph).

CBDC

Several new updates on CBDCs again: the central banks of South Korea, Indonesia and South Africa announced they are exploring CBDCs.
The US Federal Reserve will publish a CBDC discussion paper this summer.
Around 80% of central banks across the globe have begun to explore CBDCs, with 40% already testing proofs–of–concept, according to a report by Bisoin Trails. Further reporting by Forbes.

DLT

The EU published a call for evidence on digital finance. It’s not DLT-specific, but the feedback to this call may shed light on financial use cases for DLT. ESMA is asking for evidence, among other things, about changes in financial value chains, opportunities, risks (incl. AML, data privacy, market manipulation and competition) any proposed changes to the EU’s regulatory framework. The call reserves a separate section for questions on BigTech’s role in digital finance.
Bank of America is testing blockchain-based securities clearing on the Paxos network, following in the footsteps of Credit Suisse and Nomura Holdings (Bloomberg Quint).

DeFi

We already mentioned Wharton’s DeFi Beyond the Hype report. It lists a number of opportunities (such as reduced transaction costs, increased auditability, greater stakeholder control, faster settlement, improved market access and permissionless innovation, which can increase competition) and challenges (such as challenges in scalability and transaction fees, limited interoperability, privacy concerns, immature governance, hidden centralization and extreme short-term returns). It explains different DeFi ‘service categories’ such as exchanges, stablecoins, ‘credit’, derivatives, insurance and asset management, explaining how decentralised types differ from their centralised counterparts.
‘DeFi has the potential to transform global finance, but activity to date has concentrated on speculation, leverage, and yield generation among the existing community of digital asset holders. In addition, the very flexibility, programmability, and composability that make DeFi services so novel also expose new risks, from hacks to unexpected feedback loops among protocols. Retail investors, professional traders, institutional actors, regulators, and policy-makers will need to temper enthusiasm for the innovative potential of DeFi with a clear understanding of its challenges.’

Prof. Chiu discusses regulatory challenges of DeFi: see below in the Academic Corner.

Revolving door

Crypto companies continue to hire government officials to join their ranks. Binance tapped former OCC Brian Brooks as CEO of Binance.us. Now crypto-custodian BitGo hired former NY BitLicense Deputy as Chief Operating Officer (Coindesk). Forbes’ Hailey Lennon summarized crypto crossovers with former senior regulators being hired by crypto companies.

Law Firm Briefing

Skadden Arps published an update about US legal developments, including the summary judgment by the Delaware Chancery Court in the Ripple case and an analysis on whether NFTs are subject to US AML rules

Academic corner

Regulating Crypto-finance: A Policy Blueprint, by Iris H-Y Chiu, Oxford Business Law Blog
- Prof. Iris Chiu published a draft chapter of her upcoming book Regulating the Crypto-economy to be published by Hart Publishing later this year. The paper offers a ‘discussion on the policy issues that should be considered in relation to novel developments in crypto-finance and decentralised finance, and provides a blueprint for financial regulators.’ First we need to understand why we need to regulate cryptofinance before we can discuss how to regulate it, she states. Prof. Chiu argues that the regulatory policy for productive forms of financialisation should be different from that for hyper forms of financialisation. Although much of the paper is about crypto in general, it also zooms in on DeFi specifically. One of the key concerns in DeFi, prof. Chiu argues, is that it encourages speculative forms of hyper financialisation, which ‘may be damaging to the productive aspects of the crypto-economy.’ Yield farming can rely on extremely short-term strategies speedily executed with the help of automated smart contract protocols. Participants in liquidity yield farming atomise the risk of lending and, she argues, this ‘atomisation of risk is a radically different model from a bank engaging in full intermediation that centralises credit risk on its own books.’ Moreover, conflicting interests may arise between governance token holders and other participants in DeFi projects. As a result, she queries whether regulators should ‘focus on the principal-agent risk between governance holders on DeFi platforms and non-governance participants?’

Delaware’s Dominance, Wyoming’s Dare—Blockchain Companies and the Market for Corporate Charters, prof. Pierluigi Matera, Oxford Business Law Blog
- Is Wyoming challenging Delaware’s incorporation dominance? A closer look at Wyoming’s ‘special purpose depository institutions’ and other blockchain- and crypto-initiatives in the state by prof. Matera. ‘I contend that a mounting challenge to Delaware’s dominance is mostly going off the radar. Wyoming is targeting a new segment of the market for corporate charters: i.e., cryptocurrency businesses’, he writes. Also mentions New York State’s BitLicense, Delaware’s blockchain-focused amendments to the DGCL and Vermont’s blockchain-based limited liability companies.