Regulation
Reviewing Blockchain Technology Regulation News Week of May 29, 2
The week of May 19-25 was the most promising for the regulation of blockchain technology in the United States in a very long time. Polsinelli’s Blockchain+ team delayed the publication of this Bi-Weekly update by a week to allow us to cover these exciting updates. These updates include the House of Representatives’ bipartisan approval of the Financial Innovation and Technology for the 21st Century Act (“FIT 21”), Uniswap decentralized finance (“DeFi”) developer responding to Wells notice from the U.S. Securities and Exchange Commission (the “SEC”), and the SEC apparently reversing course on its Ether spot ETF stance. Overnight, it seems like political tides may be turning, with a rising number of administrative and elected officials from across the political spectrum supporting various digital asset proposals.
These developments and a few other brief notes, including claw-back notices sent to many creditors of Voyager Networks, are discussed below.
House and Senate Vote to Overturn Senate Accounting Bulletin 121 (“SAB 121”): May 8-16, 2024
Background: The first crypto-specific bill to reach a full vote in either chamber of Congress passed both chambers with bipartisan support. On May 8th, the House passed Joint Resolution 109 to overturn SAB 121, the controversial guidance from the SEC requiring public companies that custody crypto-assets to treat those assets as liabilities on their balance sheet. With most U.S. banks being public companies required by other regulators to meet asset ratio tests based on their financial statements, this makes it impractical (if not impossible) for most depository banks to take custody of crypto-assets on behalf of customers. The bill was sponsored by Democrat Wiley Nickel (NC) and Republican Mike Flood (NE), with 21 House Democrats voting in favor of the bill despite a White House statement that it intends to veto the bill if it reaches the President’s desk. The bill passed in the Senate a week later, including the approval vote of Democratic Senate Majority Leader Chuck Schumer (NY). While the bill only needed a simple majority to pass, it ended up with a filibuster-proof 60 votes, but less than the two-thirds vote that would be needed to override a Presidential veto.
Analysis: Preventing the safest, most trusted custodial institutions in America from holding digital assets is a step back, rather than a step forward, in consumer protection. It also provides disparate treatment, as banks are not required to account for any other custodial asset as if the bank itself owns the asset. It remains to be seen whether President Biden will make good on his promise to veto or if the SEC will withdraw the rule as requested by Congressman Nickel. While the Presidential veto remains likely, this Congressional support, combined with FDIC Chairman Martin Gruenberg announcing his planned resignation, is a possible sign of the diminution of the influence of certain subsets in the Democratic Party that have been most vocal in their opposition to the digital asset industry.
Uniswap Responds to SEC Wells Notice: May 21, 2024
Background: Uniswap made the fairly unusual decision to publish its response to the SEC’s Wells notice. Wells notices and their responses are generally confidential and are used when the agency’s staff intends to recommend bringing formal charges of securities law violations against the entity under investigation. You can read Uniswap’s blog post announcing the decision to publish its response here. In the response, Uniswap advocates that “[t]he Commission should not take on these significant litigation risks and that bringing this case would encourage Americans to use harder-to-regulate foreign interfaces and trading protocols, while also discouraging future innovators from attempting to foster new ideas that bring much-needed competition and innovation to financial and commercial markets. Although there are legitimate questions about how best to protect customers and market integrity when traders transact on a peer-to-peer basis without an intermediary, those are policy questions that are primarily for Congress and are part of ongoing policy discussions that [Uniswap] Labs has helped lead.”
Analysis: While the Wells notice itself has not been made public, the response gives us a hint to its contents and prior communications between Uniswap and the agency. For instance, the blog post indicates that “[t]he SEC asserts that the Uniswap Protocol is an unregistered securities exchange controlled by Uniswap Labs, that the Uniswap interface is an unregistered securities broker-dealer, and that the UNI token is an investment contract.” While the response comes out swinging, it is unlikely to dissuade the agency from bringing any planned action against Uniswap. Their response, similar to others, appears mostly intended to sway the hearts and minds of legislators and the public rather than the agency officials that the response is addressed to.
House of Representatives Passes FIT 21 Comprehensive Crypto Law: May 22, 2024
Background: The House of Representatives voted overwhelmingly in favor of passing the Financial Innovation and Technology for the 21st Century Act (“FIT 21”). FIT 21 proposes a complete market structure of digital asset regulations, with authority split between the SEC and CFTC. While the bill has changed since we first wrote about it, the general structure has remained remarkably similar. The bill passed 279-136, with 71 Democrats crossing party lines to vote in favor of this Republican-sponsored bill. Notably, support included much of the Democratic House leadership, including the House Minority Whip, Democratic Caucus Chair and Vice Chair, Campaign Committee Chair, and Speaker Emerita Nancy Pelosi. Both the President and SEC Chair, Gary Gensler, denounced the bill, but no veto is presently threatened. Additionally, multiple Democrats, including Yadira Caravei (CO) and Josh Gottheimer (NJ), not only voted for FIT 21, but also argued in favor of it on the House floor debate.
Analysis: This bill’s passage is remarkable for the sheer of number votes and arguments in favor of it from both sides of the aisle. This demonstrates the depth of bipartisan support that the crypto industry is developing, even in this very partisan election year. It is interesting to note that, prior to the vote, House Democratic leaders said that they would not encourage voting against the bill after dozens of Democrats voted to repeal SAB 121, leaving Representative Waters and her allies to rally opposition on their own. The bill still faces a tough route to passage through the Senate.
SEC Approves Ether Spot ETF 19b-4 Applications, Implicitly Acknowledging Ether is Not a Security: May 23, 2024
Background: The SEC has approved various applications for rule changes that, together, will allow exchanges to list spot Ether ETFs (exchange-traded funds that will track the current price of ETFs). While the S-1 applications of the issuing entities have not yet been made effective, and thus the ETFs are not yet actually approved and cannot yet trade, by approving the requested rule change, the SEC has made the determination that spot Ether ETFs can be obtained through Form S-1 applications. Entities whose assets are composed of 40% or more securities may not register through an S-1; rather, they are considered investment companies and must register on Form N-1A or N-2. Until very recently, few people expected these applications to be approved. It appears that something changed internally at the agency, possibly related to the SAB 121 vote, which led the agency to make these changes.
Analysis: It is unclear what made the SEC take an apparent change in stance on the pending spot Ether ETF applications. While not confirmed, it is possible that SEC Commissioner Jaime Lizárraga changed his stance after previously voting to reject the spot Bitcoin ETF and instead indicated that he would not vote to reject the pending Ether Spot ETF 19b-4 applications, leading to a flurry of activity to provide official approvals before the applications lapsed. It may not be coincidental that Commissioner Lizárraga was a top advisor to Congresswoman Nancy Pelosi, who voted in favor of FIT 21. This, combined with a bipartisan push from members of Congress, may have turned a likely rejection into an approval. It is worth noting that none of the applicable Form S-1s on file include Ether staking, meaning these funds will be income-negative as they will need to pay blockchain fees required for trading spot Ether without getting the potential benefit of offsetting staking rewards.
Briefly Noted:
Voyager Network Issues Preference Demands, Unlike FTX: The Unsecured Creditors Committee of Voyager Holdings, a bankruptcy crypto lender, has issued demand letters to many account holders who withdrew funds from their accounts within 90 days prior to their bankruptcy filing. This follows a similar action in the Celsius case. This contrasts with FTX, where preference claims are not applicable since the debtor intends to pay back claims at over 100 percent. Polsinelli is representing a number of claim holders in challenging these preference actions.
Court Rules Craig Wright is Not Inventor of Bitcoin: A U.K. court has ruled that Craig Wright lied “extensively and repeatedly” in both his written and oral evidence over his claims to be the pseudonymous inventor of Bitcoin, Satoshi Nakamoto. The written ruling further stated: “Dr. Wright presents himself as an extremely clever person. However, in my judgment, he is not nearly as clever as he thinks he is.”
Netherlands Court Sentences Privacy Protocol Developer: Tornado.cash developer Alexey Pertsev was sentenced to 64 months in prison for his contributions to the privacy protocol. He faces a long appeal route ahead, which he will need to litigate while imprisoned for writing software.
Individuals Connected to MEV Bot Indicted: Two individuals have been indicted in connection with a hack on an MEV bot. As a reminder, MEV bots essentially front-run transactions to increase the price others buy tokens at and then sell at the increased price. It appears this was an alleged case where the bot operators had others involved in the operation run off with the money. Considering the potential market manipulation implications of the bot itself, it will be interesting to see if the “victims” are also swept up in charges eventually.
SEC Responds in Various Coinbase Lawsuits: The SEC filed its opposition to Coinbase’s request for interlocutory appeal in the case against the exchange and its response to the Coinbase lawsuit over rejected rulemaking in the same week. Those agency attorneys are seemingly busy with even more litigation on the horizon.
SEC Approved Crypto Securities Dealer Soft Launches: Prometheum has soft-launched Ether custody services, treating Ether as a security. It is currently unclear who Prometheum will treat as the issuer and how they will comply with diligence and other obligations with respect to Ether as their offerings expand. This position also appears to be inconsistent with the spot Ether ETF approvals discussed above.
Anti-CBDC Bill Passes in House: The House also passed the CBDC Anti-Surveillance State Act, but this time by a narrow margin on partisan lines. The bill, if passed into law, would prohibit the Federal Reserve from issuing a Central Bank Digital Currency. This is a largely ceremonial bill that has almost no chance of being passed in the Senate and signed into law.
Presidential Candidates Campaign on Crypto Issues: While there is broadening bipartisan support for digital assets as listed above, that may not be as true for the current Presidential Candidates, as former President Trump announced his plan to accept digital asset campaign contributions while President Biden released a campaign advertisement denouncing “cryptocurrency executives and oil barons” as Trump supporters.
Jonathan Schmalfeld Speaks at DC Blockchain Summit: On May 15th, BitBlog author and Polsinelli attorney Jonathan Schmalfeld moderated and provided insight at the D.C. Blockchain Summit during the discussion on branding in the metaverse, including discussions on recent copyright and trademark cases and their implications for industry participants going forward.
Conclusion:
After years of United States regulators failing to work on a comprehensive regulatory scheme pertaining to digital assets and lawmakers making little progress on the kind of bipartisan, systematic legislation needed to allow the industry to prosper in the United States, prospects are looking up.
None of this means that a robust solution is expected in the immediate future, with the SEC still bringing broad enforcement actions against key industry players and without a clear path to get legislation through the Senate in a busy election year. It does, however, seem like a window of opportunity for responsible players within the blockchain industry to proffer legislative solutions that will help crypto and the digital asset industry proliferate in a way that both protects users and investors while allowing for innovation in the always evolving digital economy.