Enforcement Actions by the Regulators in Cryptocurrency and Blockchainby Sacha Huber May 2, 2016
Due to the explosive growth of Bitcoin in recent years, as well as rapidly increasing interest in the cryptocurrency’s underlying ledger technology, the blockchain, regulators have been keen to keep pace with developments to ensure that existing laws are enforced to prevent illegal activity, such as money-laundering. New laws have also been enacted to address the changing FinTech landscape.
The State of California became the first state to legally approve the use of Bitcoin – The law AB 129
Nowhere has been more active in regulatory enforcement than the US over the past 2 years. In January 2015, the State of California became the first state to legally approve the use of Bitcoin (law AB 129). This law repeals part of the California Corporations Code, which prevented putting forms of money into circulation other than the lawful money of the United States. AB 129 was signed into law in June 2014, but took effect from January 2015.
US Law firm Latham & Watkins recently outlined several enforcement actions by US regulatory agencies, such as the Securities & Exchange Commission (SEC), the Department of Justice, the CFTC, the Federal Trade Commission and the Financial Crimes Enforcement Network. The actions under scrutiny include securities and wire fraud, securities violations, anti-money laundering and Bank Secrecy Act violations.
Enforcement Action 1: Failure to register the securities offerings on and in Bitcoin
For instance, bitcoin entrepreneur Erik Voorhees was charged in June 2014 for offering securities – and which was paid for by investors with bitcoins – without officially registering the offerings. This failure to register the securities offerings put Voorhees in breach of the Securities Act, which resulted in him having to pay a civil penalty and his agreement not to issue securities in unregistered transactions in exchange for digital currencies for 5 years.
A failure to register bitcoin-related securities offerings was similarly recorded in December 2014, when computer programmer Ethan Burnside was charged by the SEC for operating a ‘virtual stock exchange’ without registration, and for not registering his two online platforms – used to trade securities using digital currencies – as broker dealers. These offences put Burnside in violation of both the Exchange Act and Securities Act, resulting in a 2-year ban from the industry, and civil penalty and disgorgement payments.
June 2015 witnessed the SEC settle with Sand Hill, an online derivatives exchange that sold financial derivatives and accepted payment in Bitcoin. Using the digital currency, users could bet money on picking winning start-up companies before they went public. The offering of such derivatives was deemed illegal as it was in violation of the Dodd-Frank Act. Specifically, contracts were sold to parties who failed to meet Dodd-Frank’s requirements in being classed as ‘eligible contract participants’. The company also breached regulations because transactions were carried out on Sand Hill’s website, rather than through a national securities exchange. Consequently, Sand Hill agreed to cease such violations in the future and also paid the SEC a civil monetary penalty.
Bitcoin and other cryptocurrencies are also now defined as commodities, thanks to official acknowledgment by the US Commodity Futures Trading Commission in September. The action came on the back of a settlement of charges by the CFTC against Coinflip Inc. for operating its bitcoin facility ‘Derivabit’ for trading or processing commodity options without being registered as a swap execution facility or designated contract market.
This puts Coinflip in violation of the Commodity Exchange Act, and signalled the first enforcement action by the CFTC for bitcoin. The CFTC also concluded that options on cryptocurrencies must be regulated as ’swaps’, and that such instruments are subject to CFTC jurisdiction.
Enforcement Action 2: Money Laundering
As far as anti-money laundering is concerned, there have already been numerous cases involving cryptocurrencies. The most notorious thus far has been that of Ross William Ulbricht, founder of Silk Road, an online black market which facilitated a multitude of illegal activities such as the trade of narcotics, and which included a Bitcoin-based payment system that was used to facilitate illegal business activity on the site. Indeed, all transactions between buyers and sellers were reportedly conducted with bitcoins.
After Ulbricht was charged with money laundering, computer hacking and conspiracy to traffic narcotics, bitcoins worth $3.6 million were initially seized from Silk Road accounts by the FBI, and then $28.5 million worth of bitcoins belonging to Ulbricht in October 2013. The Southern District of New York ultimately sentenced Ulbricht to life imprisonment in February 2015.
Emerging Regulations: BitLicense
Indeed, New York State has been at the forefront of cryptocurrency regulatory enforcement. June 2015 marked the first time a US state issued a stringent set of rules for cryptocurrencies when the New York State Department of Financial Services (NYDFS) released ’BitLicense’, a document which outlines the regulatory framework for businesses using virtual currencies to operate within the state. Circle Internet Financial became the first company to obtain a BitLicense in September.
The effects of the NYDFS legislation have already been sizeable, with some Bitcoin companies having to suspend business in New York. For example, Bitcoin mining pool BTC Guild announced plans to close in June – while not being based in New York, the company conducted business with many of the state’s residents. Bitcoin exchanges such as Kraken and BitFinex also stated that they would exit New York because of BitLicense, while cryptocurrency cloud mining company Eobot said it would cease serving New York based customers.
October 2015 then saw NYDFS grant a charter to Gemini Trust Company, allowing it to conduct virtual currency business through a bitcoin exchange. Gemini is required to comply with BitLicense regulations, as well as those applicable to limited purpose trust companies.
EU regulations follow the US
Enforcement actions in cryptocurrency have not just been confined to the US. The EU has also been enacting regulation recently, with the European Court of Justice having decided in October that the business of exchanging Bitcoin for a traditional currency across a Bitcoin exchange is exempt from Value Added Tax (VAT), a consumer tax imposed across all EU member states. The decision resulted from the case of Skatteverket v David Hedqvist, when Hedqvist wished to set up a Bitcoin exchange and sought clarity regarding the VAT position of this business.
The ruling made clear that an exchange of Bitcoin for a ‘normal’ currency is considered as a supply of services, thus an exchange of Bitcoin falls under the exemption article of the VAT Directive, which excludes transactions ‘concerning currency, bank notes and coins used as legal tender’ from VAT. While only applying to Bitcoin at present, it is expected that the exemption will be applied to other cryptocurrencies in future.
The UK Treasury in March announced several initiatives to solve the regulatory and consumer protection issues raised by the growth of cryptocurrencies. Among the Treasury’s stated aims is to “foster a supportive environment for the development of legitimate businesses in the digital currency sector…while also creating a hostile environment for illegal activity”.
As a result, the government has stated that operators of digital currency trading platforms will be mandated to perform anti-money laundering checks. The measure was decided following a public call for input on cryptocurrency regulation, which returned 120 responses from a variety of parties, including digital currency developers, banks, consultants and government agencies.
As for Blockchain, specific regulatory enforcement has been scant thus far, especially given that interest in the technology has been more recent than with Bitcoin. Nevertheless, October welcomed the news that a collaboration between US law enforcement and a group of cryptocurrency companies was being formed in order to promote communication and education between the industry and government.
Called the Blockchain Alliance, the forum has been initiated by the Chamber of Commerce and Coin Center, a Bitcoin and Blockchain advocacy group. Government agencies already signed up to the alliance include the US Justice Department, the FBI, the Secret Service, the Department of Homeland Security, the US Marshals Service and the CFTC, with international bodies expected to join imminently. Coin Center executive director Jerry Brito has described the forum as a place where interested parties can “have conversations about law enforcement on the Bitcoin blockchain, to ask questions and to answer questions”. This implies that it will play a pivotal role in supporting enforcement of regulatory and legal action pertaining to Blockchain in the future.