Category Archives — Regulation

US Department of Justice, CFTC Probe Crypto Market Manipulation: Report

The U.S Department of Justice has reportedly launched a criminal investigation into cryptocurrency traders who may have manipulated the market old-school illicit tactics.

According to a report by Bloomberg on Thursday citing anonymous sources familiar with the probe, the investigation is being conducted together with the Commodity and Futures Trading Commission (CFTC).

One area of the investigation targets so-called spoofing – a technique that has been used in traditional financial markets to affect price movements by making large volumes of fake orders – that possibly influenced trades of bitcoin and ethereum, according to the report.

In addition, DoJ is probing crypto traders who may have cheated the system by sending themselves large volumes of orders to create a mirage of increasing demand in order to tip other investors into making a move.

The news marks the latest effort by U.S. authorities to ensure a fair cryptocurrency market since the CFTC gave the green light to domestic exchanges to list bitcoin-backed futures and derivative products late last year.

Today’s report also comes just weeks after a commissioner from CFTC made comments on the agency’s growing scrutiny over cryptocurrency activities that may have violated the law.

As previously reported by CoinDesk, speaking at a conference in Washington, D.C., CFTC commissioner Brian Quintenz said the agency is particularly focusing on “fraud, market manipulation and disruptive trading involving virtual currency.”

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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CFTC Publishes New Advisory to Clarify Crypto Futures Trading

The Commodity Futures Trading Commission (CFTC) — the United States’ top-ranking derivatives regulator — has published an advisory providing further guidance to both clearinghouses and exchanges seeking to list cryptocurrencies on their platforms. The cryptocurrency space has been riddled with concerns about the vetting process for contracts, like bitcoin futures, and the CFTC is looking to clear the air.

Staff members have issued the following statement:

“Commodity Futures Trading Commission (“CFTC” or “Commission”) staff believes it is important to encourage innovation and growth in these products, but within an appropriate oversight framework that enables exchanges and clearinghouses to operate within the confines of the core principles. To this end, Commission staff continues to monitor developments in these products and discuss the risks and challenges they present with industry and market participants.”

The CFTC says it’s focusing on the latest “best practices” for launching cryptocurrency derivative contracts, saying that exchanges should be able to monitor “underlying cryptocurrency spot markets” and coordinate with federal regulators. They should also be allowed to contact market participants and request comments regarding pending contract launches.

Division of Clearing and Risk Director Brian Bussey mentioned, “CFTC staff is providing this information, in part, to aid market participants in their efforts to design risk management programs that address the new risks imposed by virtual currency products. In addition, the guidance is designed to help ensure that market participants follow appropriate governance processes with respect to the launch of these products.”

While the advisory is not considered a final “compliance checklist,” it does offer insight pertaining to current CFTC expectations and aims to assist both clearinghouses and exchanges in keeping up with changes in the crypto market. The guidance provided in the report includes enhanced market surveillance, large trader reporting, outreach to stakeholders and derivatives clearing organization (DCO) risk management.

Both CME Group and Cboe Global Markets were among the first trading platforms to launch bitcoin futures contracts in December 2017. At the time, both companies had consulted with the CFTC on a strictly limited basis. Bitcoin’s volatile nature and price swings caused many Wall Street players — including the Futures Industry Association — to request that the CFTC further examine virtual currency derivatives before allowing them to be traded.

Thus far, bitcoin futures have behaved as few new contracts have, and their liquidity continues to grow through limited means. However, a study conducted by the Federal Reserve Bank of San Francisco ultimately discovered that the release of bitcoin futures led to the steep drop in cryptocurrency prices last January by allowing “pessimists” to enter the game.

The CFTC has been in control of bitcoin activity since 2015 through the Commodity Exchange Act. The organization has worked extensively to rid the cryptocurrency space of unregistered futures exchanges and protect consumers from fraud, manipulation and illicit practices.

To read the full advisory, click here.

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Future of Cryptocurrency in India Uncertain, Fate to be Decided in Summer

India, one of the largest countries in the world with a population of 1.3 billion potential future users of cryptocurrencies, remains in a legal limbo as cryptocurrency exchanges await more clarity from the Reserve Bank of India (RBI) and the country’s supreme court. Operators have recently been barred by banks, under orders from the central bank, and petitioners are blocked from filing any case against the RBI on the subject of cryptocurrency in any of the other high courts.

India’s Cryptocurrency Ecosystem to Have Fate Sealed in Summer

Cryptocurrency exchanges in the Republic of India have been facing a legal ordeal particularly since early this year. Finance minister Arun Jaitley said in his budget speech in February that the government would do everything in its power to discontinue the use of digital currencies for criminal uses.

“The government does not recognize cryptocurrency as legal tender or coin and will take all measures to eliminate the use of these crypto assets in financing illegitimate activities or as part of the payments system.”

It became unclear, however, whether government authorities and the central bank were in practice prohibiting the sale or purchase of cryptocurrencies. Various sources claimed India truly banned Bitcoin trading, but officially, the RBI decided to end the relationship between its own banks and any cryptocurrency exchange. Not an outright ban, but not crypto-friendly either.

The Reserve Bank of India has added a directive to wind down all existing accounts by the first week of July 2018, which aims to push any operator out of the country. Taking in account a Supreme Court order by chief justice Dipak Misra, the legal route of court appeals against the RBI order is also proving to be a treacherous road.

“The petitioners shall be at liberty to submit a representation to the competent authority of RBI within two weeks hence which shall be dealt with in accordance with law.”

Given that the next date for the hearing of the case in the apex court is July 20, which is two weeks after the RBI deadline to close down all crypto-related bank accounts, there is a growing wave of exasperation among the cryptocurrency community in India. Kunal Barchha, director at Kali Digital Eco-Systems, took the RBI to court and told Quartz how this is affecting the ecosystem.

“The understanding is that this means that the ban will continue, at least for the time being. Businesses are getting affected due to this uncertainty and this phase will continue for a while.”

Digital currency operators in India await the July deadline to act on it. While a number of exchanges have left the country and others plan to do so, there are a few platforms that are launching crypto-to-crypto trade, which is RBI-compliant.

Regarding lawsuits filed against the RBI on the subject of cryptocurrency, the supreme court has ruled that all filings will be merged and heard collectively.


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‘BitLicense Refugees’: ShapeShift, Kraken Talk Escape from New York

If you wanted to hear red-meat rhetoric about New York State’s regulatory approach, a fireside chat Tuesday between two of the cryptocurrency industry’s most outspoken leaders delivered.

For example, the audience at Consensus 2018 in New York City cheered when ShapeShift CEO Erik Voorhees invoked a local icon to make the case that the state’s BitLicense was a case of regulatory overreach.

Here we are two miles from the Statue of Liberty and you cannot sell CryptoKitties in the state without that license. That’s the absurdity of what’s happened here,” he said.

And Jesse Powell, the CEO of Kraken, got some laughs at the expense of former New York Attorney General Eric Schneiderman.

When Scheniderman’s office sent a request for information to Kraken (along with several other exchanges) earlier this year – three years after his company stopped doing business in New York – it felt like “a slap in the face,” Powell said.

But then “it turns out this asshole actually slapped people in the face,” he quipped, referring to the allegations of physical abuse that forced Schneiderman to resign shortly afterward.

Yet between these zingers and applause lines about the BitLicense – which both executives blame for driving their companies out of state – there were subtler points made. The conversation highlighted the challenges facing both the industry and regulators worldwide as governments come to terms with the ramifications of cryptocurrency.

Powell, for example, pointed out the tension between anti-money-laundering regulations and customer privacy protections. In the case of the BitLicense, he said, Kraken would have had to “disclose all the information about our entire global client base to the state of New York.”

That was not only distasteful, Powell said, but “potentially illegal” under the privacy laws of other countries.

“To service New York today, what we’d have to do is create a special purpose entity just to service New York and completely firewall off” all the exchange’s other users to protect their privacy, he said.

Alternative models

Widening the lens, Powell contended that the U.S. “has really failed” by leaving it up to local regulators to figure out how to deal with cryptocurrencies.

“In others parts of the world, it’s an issue that’s being taken seriously by heads of state – presidents, prime ministers. It’s not something that’s relegated to individual regulators at a state level,” he said. “It should be treated as a national economic and national security issue, maybe even an international issue.”

Powell cited Japan’s Virtual Currency Act as an example of “reasonable” regulation. Although the law is “not perfect,” he said, “we’re already seeing an explosion of business in Japan” as a result of the clarity it brought.

Voorhees, however, held up a different U.S. state as an example of how to do things right: Wyoming, which recently passed a package of five blockchain-related laws.

The two most important ones, in his view, were a law that excludes tokens from being automatically categorized as securities, and another that excludes digital asset companies from being automatically classified as money transmitters.

“That’s the model people should be looking at, they’ve done it the best,” Voorhees said.

And despite using the phrase “statist oppression” early in the conversation to describe his feelings about New York when the BitLicense was created, Voorhees later clarified that he thinks regulators generally have good intentions.

But their aims can be met today by means other than imposing bureaucratic, bank-style regulations on businesses that want to be nothing like traditional financial institutions, he argued.

“The crypto industry and regulators can find common ground in realizing that this incredible new technology can achieve many of the noble goals of the regulators such as protecting consumers,” Voorhees said.

Regulatory hopscotch

Ultimately, though, the two executives depicted cryptocurrency as a highly mobile activity that can easily relocate when any jurisdiction starts to appear heavy-handed.

Powell said Kraken’s main office is located in San Francisco only as a convenience because that’s where he lived when he started the company. Crypto businesses can basically pick up and move anywhere in the world they want to be, he said.

And users need not always move to another place, use a VPN to mask their IP address or even break the law to get around restrictions; Powell shared a tip for New York residents who feel deprived because of the way the BitLicense has limited their cryptocurrency trading options.

“If you’re here stuck in New York and you can’t trade how you want to trade, set up a Wyoming LLC and you can trade through that and have your business trade for you,” he said.

Further limiting regulators’ power, Powell said, the rise of decentralized exchanges will give users even more alternatives.

“If they can’t do what they want on Kraken they’re doing to do it on a decentralized exchange,” he said.

And Voorhees said “regulatory hopscotch” by exchanges and other businesses that move from one country to another is only a symptom of a broader phenomenon that won’t easily be resolved.

He concluded:

“Bitcoin basically broke down the borders of how value moves across humanity. There is no way that an invention like that doesn’t run straight into the jaws of regulations. And that conflict is going to be one of the great themes of my lifetime.”

Photo via Wolfie Zhao for CoinDesk. Left to right: CoinDesk research director Nolan Bauerle, Jesse Powell and Erik Voorhees. 

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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‘Belligerent’ Crypto Miners Prompt Power Utility to Beef Up Security

A public utility in one of the U.S. hot spots for bitcoin mining is adopting new security measures in light of harassment of some of its employees.

The steps are being taken by the Chelan County Public Utility District (PUD) in Washington County – as previously reported, the area has attracted a number of bitcoin miners because of its abundant access to hydropower sources. Yet “confrontations” between staffers and would-be mine operators, as first reported by The Wenatchee World, has sparked a drive to add new cameras, install security panels and institute other actions.

On Monday, Chelan County PUD director of corporate security Rich Hyatt briefed the district’s commissioners during a meeting, attributing the moves to “belligerent behavior by impatient cryptocurrency miners” who are reacting poorly following a moratorium imposed on new bitcoin mines.

Hyatt explained:

“Some of the things we’re doing internally, we’ve got a lot of business security measures, at [headquarters] we’ve [installed] a lot of security panels, we’ve increased the camera coverage. We’ve also designed and are going into the construction phase for a very small store front lobby that would give employees a lot more security without having personnel or customers being able to walk right into their work area. We’re monitoring those areas.”

He also described new measures being taken to dissuade unauthorized bitcoin miners from setting up facilities, saying his office was making agreements with the chief of police, the county sheriff and the county prosecutor to investigate and potentially prosecute repeat offenders.

“We … have an agreement with those agencies that we could use [them] as the mechanism that when we prepare a case and gather the evidence and establish probable cause, we can take that case through their detectives and that can help the county for prosecution considerations,” he said.

The agency has also trained its personnel on how to deal with potentially hostile people by installing panic buttons for front-line staff and adding security officers able to spot “negative body language,” he said.

Security camera image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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The Crypto Community Must Use the Blockchain to Self-Police

Yaya J. Fanusie is the director of analysis at the Foundation for Defense of Democracies’ Center on Sanctions and Illicit Finance. He tweets at @signcurve.

Self-policing illicit activity on the blockchain may soon be a necessity for the cryptocurrency space.

The everyday cryptocurrency enthusiast in the future is likely to spend time identifying illicit wallets and transactions to avoid. The U.S. Treasury Department has made that inevitable.

A few weeks ago, Treasury quietly published additions to its FAQs section on the website for the Office of Foreign Assets Control (OFAC), the unit which oversees U.S. economic sanctions. The language shows that OFAC is planning to include “digital currency” addresses on its Specially Designated Nationals and Blocked Persons (SDN) list.

This would be a big deal.

Banks and all types of businesses are supposed to check the SDN list to ensure they do not provide financial services to people, organizations, and governments which the U.S. has designated as “blocked” due to involvement in terrorism, nuclear proliferation, kleptocracy, human rights violations, and other crimes.

Banks can be legally compelled to freeze any assets they have custody over that belong to those on OFAC’s list, and stop their transactions. The financial penalties for not doing so can be severe. And while most everyday cryptocurrency investors know little about the legalese-laden world of sanctions compliance, anyone running any sort of financial business knows that noncompliance can put you out of business-and potentially, in jail – quick.

Never before has a specific cryptocurrency address or wallet been listed by OFAC, although legal experts have understood for years that sending bitcoins or other cryptocurrencies to anyone on the SDN list is illegal for U.S. persons.

Still, there is a big difference between blocking funds in the fiat banking world and what can be done in the realm of crypto. Peer-to-peer cryptocurrency transactions cannot be blocked or reversed by third parties.

So an OFAC-designated crypto wallet is likely going to bring more scrutiny on the external addresses it transacts with rather than the designated wallet itself.

Some cryptocurrency industry compliance experts argue that digital currency wallet designations could usher in a new era; where tokens get categorized as either clean, tainted, or unknown with regard to their level of association with SDN addresses.

This might cause varying price levels for coins on the same blockchain, with clean tokens valued above those with tainted or unclear origins, and the end of the fungibility that cryptocurrencies have enjoyed since their existence.

One can also expect that blockchain forensics tools will become more valuable and more widely deployed as crypto exchanges aim to lessen the risk of transacting with users with tainted coins.

It’s on you

However, the more significant part of a new era arising from financial authorities scrutinizing cryptocurrency addresses is going to be what the cryptocurrency community itself will have to do: Work to prevent illicit transactions on the blockchain.

This is something many in the crypto space do not want to hear.

Cryptocurrency experts often point to “censorship resistance” as the technology’s most valuable feature, enabling anyone to store and send funds, unencumbered by any government authority. In theory, this is a strong enabler of freedom and democracy.

But in practice, this technical ability has never been a scalable reality given the reach of laws in most jurisdictions relating to financial crime. While evading the impositions of corrupt governments is a worthy goal, the crypto community should recognize that it is morally unacceptable to stay passive while evidence grows that criminals and terrorists are exploiting the community’s freedom.

In recent years, anti-money laundering (AML) compliance experts focusing on the blockchain industry have encouraged cryptocurrency firms to go beyond doing the “know your customer” (KYC) due diligence required of traditional financial institutions and do “know your transaction” (KYT) analysis by leveraging data on the blockchain.

There are multiple startups specializing in such blockchain forensics, serving crypto exchanges along with other enterprise customers like law enforcement agencies and large banks. These companies’ analytic tools are useful for fighting crime, but many voices in the crypto community criticize such tools–which deanonymize financial transactions on the blockchain–for undermining privacy. However, most information from blockchain forensics is not shared publicly. One usually needs to be a corporate or government client to access the data.

But OFAC listing cryptocurrency addresses would raise the stakes of KYT analysis.

It would make it more important for anyone involved in cryptocurrency transactions to verify the “licitness” of the addresses they touch.

And although it is likely that the number of designated addresses would be minimal to begin with (OFAC does not make designations lightly), even the small chance of a sanctions violation brings compliance risk mitigation into the picture for Joe Blow Token Buyer.

An inadvertent transaction with a banned address or an address that has transacted with a banned address would be viewable on the public blockchain ledger, possibly tainting that person’s cryptocurrency wallet as well.

The only way to help everyday users of cryptocurrency navigate the maze of an SDN-laden blockchain platform would be having real-time AML/KYT insight into the funding flows of various wallet addresses. This is not possible under the current environment where blockchain analysis is done in siloes, available just to financial firms and law enforcement.

Crowdsourced AML

What’s needed is an open-source platform where illicit activity is flagged and derogatory information is vetted. Call it crowdsourced AML on the blockchain.

I understand this need. As a researcher at a nonprofit national security think tank, I’ve investigated cases of cryptocurrencies and illicit financing, such as bitcoin terrorist funding campaigns in the Middle East. Our team has used free public blockchain explorer websites to analyze donations to these campaigns.

These tools are not as robust as what the government and banks can access with costly specialized machine learning and algorithmic tools. And even  if I, through rigorous manual tracking and analysis of blockchain activity, flag addresses I see transacting with a terrorist funding wallet, there is no efficient way to share my findings on a platform so everyday cryptocurrency users could see my “flags,” evaluate their veracity, and stay clear of those addresses, as appropriate.

The industry can help.

Two years ago, I suggested that cryptocurrency experts should set up their own watchdog groups to look out for nefarious activity on the blockchain, similar to how “white hat” hackers flag viruses and other cyber threats. Treasury’s plans make it more important now for the crypto space to build self-policing initiatives.

And besides incorporating OFAC’s blacklist, a public crowdsourced blockchain AML tool could address an illicit finance threat that affects crypto users directly: crypto heists. It would allow victims of ransomware or exchange hacks to voluntarily list their extorted or stolen tokens. While that won’t bring funds back to their rightful owners, it could make moving or stealing coins more difficult and disincentivize cryptocurrency theft in the long term.

Of course, for a self-policing AML platform to work, there would have to be a way to vet listings so that inaccurate and false information is not published. Otherwise, such a tool could be misused to falsely malign addresses, and thus, undermine innocent people financially. But this is more a technical problem to solve rather than a reason to not pursue a better way of doing AML on the blockchain.

The breakthrough of the first blockchain protocol, bitcoin, was in designing a decentralized way to incentivize strangers to compete and confirm the veracity of a global public financial record.

Certainly, with all the attention, time, and money invested in new products and services built off of cryptocurrency tokens, those who are developing this technology should be able to design ways to incentivize keeping the blockchain clean.

Police car image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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ICO Tokens Should Be Regulated as Securities, Not Bitcoin

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The role of cryptocurrencies was thrust into the spotlight during a hearing between Congress and the US Securities and Exchange Commission.

The US House of Representatives Committee on Appropriations held a hearing with the Wall Street regulator on April 26, and they explored regulating cryptocurrencies in what they still seem to believe exist in a Wild West environment. SEC Chairman Jay Clayton was looked to as an authority on the topic of cryptocurrencies in what was his maiden testimony before this specific committee.

Congressman Chris Stewart (R-UT) told how his son invested $17 in a digital currency that he opted not to name but acknowledged that his son has a greater net worth than he does at the moment. But without proper regulation, “people don’t have the information they need to make good decisions,” he said, looking to Chairman Clayton for answers.

Bitcoin Not a Security, ICOs Are Not Transparent

Chairman Clayton described a “complicated area,” one in which he divides between bitcoin as a currency and ICOs. Bitcoin, Chairman Clayton said, has “been determined by most people to not be a security.”

Tokens used to finance projects, such as tokens that are issued in the fundraising process of an ICO, however, are different. “There are none that I’ve seen that aren’t securities,” said Clayton,” adding: “To the extent something is a security, we should regulate it as a security.”

It’s these new tokens that appear to be the focus for regulators at the moment, and the SEC is waiting for the issuing companies to step up. Chairman Clayton pointed out that “securities regulations are disclosure-based,” adding that “people should follow those and provide the information that [the agency] requires.” When asked by Rep. Stewart if issuing startups are transparent about how they present themselves, Chairman Clayton didn’t hold back, saying “no.”

Chairman Clayton recognized the “economic utility” and “great promise” that cryptocurrencies bring to bear. But policymakers are still torn on how the market should be regulated.

For instance, ICOs have raised a whopping $6.3 billion in Q1 2018 alone, and Chairman Clayton says the growth has occurred “without the usual respect for the law that you would expect to see in the financial markets.” The SEC, he believes, should have jurisdiction over the newly issued tokens.

As for bitcoin, which is used as a payment method, that’s outside of the SEC’s purview.

“Our laws didn’t anticipate [cryptocurrencies.] Our laws anticipated sovereign-backed currencies. These currencies are not sovereign-backed. With a sovereign-backed currency, I would argue that the need for regulation to give people comfort is less than it is for something that is not sovereign-backed,” said SEC Chairman Clayton.

While Rep. Stewart appears to want greater oversight of the cryptocurrency market, he also wants to avoid a knee-jerk reaction. “Many times when we legislate in a moment of crisis, we overkill,” he said, pointing to Dodd Frank and the Patriot Act as examples.

“I would like us to lean into this rather than wait for something that gets someone’s attention and then draws upon Congress and others to respond to it when we’re really not prepared,” concluded Rep. Stewart.

Chairman Clayton agreed, and said “leaning in” is precisely what the SEC has been doing.

Featured image from Shutterstock.

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Australia’s Securities Watchdog Airs Concerns About Overseas ICOs

Australia’s securities watchdog has revealed plans to extend existing guidelines for initial coin offerings (ICOs).

In a speech at a fintech event in Sydney on Thursday, John Price, a commissioner of the Australian Securities and Investments Commission (ASIC), told the audience to expect updates that will focus overseas ICO fundraising projects targeting the country’s investors.

“We will highlight that Australian corporate and consumer law might apply – even if an ICO is created and offered from overseas. This is an important point given the international nature of this sector,” Price said during the event.

The remarks stem from concerns over the current perception that ICOs can bypass the regulator’s oversight by registering overseas.

“I cannot stress enough that if you are doing business here and selling something to Australians – including issuing securities or tokens to Australian consumers – our laws here can apply,” Price said.

ASIC first issued formal guidance for ICOs in September 2017, seeking to define the circumstances in which tokens should be treated as financial products and hence regulated by Australia’s Corporate Act 2001.

Price said, however, that the regulator still has concerns over the emerging space’s low threshold for immature businesses to enter, which drives a “certain level of opportunism.”

The commissioner stated:

“The stories that come out about these businesses are, and will continue to have, a negative impact on investor confidence over time.”

Australian dollar image via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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Regulatory Clarity Should Lead to More Capital Investment in Crypto: …

The Distributed Markets conference took place in Chicago on April 23, 2018, and featured an array of blockchain and financial experts working to shed light on opportunities and changes happening in the cryptocurrency space.

Among the main goals of the conference was to educate attendees on how they could integrate blockchain technology into their businesses, thereby increasing cost-effectiveness and overall efficiency. A Blockchain Academy workshop and a hackathon were also available to give developers and entrepreneurs a chance to study blockchain macro cases and showcase their skills.

In a panel moderated by Joseph Bradley, entitled “Crypto Regulation: Striking a Balance Between Compliance and Growth,” speakers Colleen Sullivan of CMT Digital; Illinois state regulator Sean T. O’Kelly; Haimera Workie, senior director of FINRA’s Office of Emerging Regulatory Issues; and Tennessee blockchain lawyer J. Gray Sasser of Frost Brown Todd addressed the topic of regulation.

Perhaps the biggest issues hitting the crypto arena are regulation, and how tokens and virtual assets should be classified. The Commodities Futures Trading Commission (CFTC), for example, has jurisdiction over commodities like bitcoin and lists bitcoin futures on regulated interest exchanges.

The Securities and Exchange Commission (SEC), however, which works to regulate securities and all derivatives of securities, is now seeking to label all tokens distributed through Initial Coin Offerings (ICOs) as such, which could subject them to strict regulatory tactics that could seriously decrease their values. The SEC has since issued several subpoenas to virtual asset enterprises to better understand how certain tokens have been issued and marketed.

Sullivan was quick to tackle this issue. “All securities have to be traded on registered securities exchanges in the United States,” she told the audience.

She explained that the SEC first weighed in on cryptocurrencies in July of 2017, when it released an investigative report on the DAO, stating that certain tokens fell under the “securities” category per specific regulations. Presently, there are over 1,500 separate virtual tokens, and none are traded through securities exchanges the way they should be, as suggested by SEC standards.

Sasser also offered his insight, suggesting that if a token is pre-sold or offered through an ICO, it should technically qualify as a security unless it meets a certain level of functionality.

One of the primary arguments among those who stand against tokens classifying as securities is that they are used as payment methods by those investing in new coins, and, therefore, qualify as “utility tokens” due to their practical nature. Thus far, the SEC has been hesitant to accept this viewpoint.

Sasser said the issue and the industry itself is clouded with uncertainty.

“I’ve been doing these panels for a long time, and usually, my first answer to a lot of these kinds of questions is ‘I don’t know,’” he joked.

For the most part, Sasser believes the SEC has been clear in stating where tokens should fall, though they’ve failed to guide distributors along the way.

Sullivan further mentioned that states follow separate rules when it comes to governing cryptocurrency activity. Illinois, for example, has long refused to recognize cryptocurrencies as valid means of money transmission, but, according to fellow speaker O’Kelly, state regulators are beginning to reverse their overall views and are now attempting to attract blockchain startups and build Illinois as a possible tech hub.

Discussing “regulatory gaps” in the crypto arena, Sullivan explained that CFTC Commissioner Brian B. Quintenz is calling for the industry to “self-regulate,” as Congress has not yet taken the reins. She said that Quintenz is asking that blockchain and cryptocurrency leaders impose a self-regulatory organization that can enforce strict standards for other industry members to follow.

Sullivan mentioned that steps toward such an association have already begun, with a recent example coming from Tyler and Cameron Winklevoss of New York’s Gemini Exchange. They have proposed a Virtual Commodities Association, an industry-sponsored, self-regulatory organization for the U.S. virtual currency industry, which will set forth practical standards regarding how an exchange should be officiated, among other goals.

Sullivan believes Congress will eventually get involved, but suggested that maneuvers like these could cover the main ground until then.

In the meantime, the blockchain is presenting several new opportunities for recording data. O’Kelly, who says the government will always be indirectly involved in the verification process of blockchain transactions, says state representatives were recently approached by an organization that wanted to track the entire life of a car on the blockchain, including the change of owners along the way. That change of title would entail government-based authorization.

Sullivan concluded the discussion by explaining that, while the crypto market lacks solid regulation, the influx of institutional capital entering the space should eventually lead to a prime broker’s presence, thus paving the way to further stability and efficiency.

“I think as the regulatory environment becomes more clear in the next 12 months, we’re going to see a lot more capital,” she explained. “Right now, most changes in the industry have applied to retail.”

Note: Distributed Markets is an event held by BTC Inc, the parent company of BTC Media and Bitcoin Magazine.

Photo credit: Allison Landy

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Fear and HODLing at MIT: Blockchain Experts Weigh Impact of SEC Crackdown

Regulation: It’s good for you, but it’s going to hurt.

That seemed to be the main takeaway for the cryptocurrency industry from Monday’s Business of Blockchain conference at the Massachusetts Institute of Technology (MIT).

On the one hand, the event was clouded by speculation that the U.S. Securities and Exchange Commission (SEC) may go as far as to classify two of the top three coins by market cap, ethereum and Ripple’s XRP, as securitiesSuch a determination could subject a wide swath of industry members to legal penalties – far beyond the promoters of recent initial coin offerings (ICOs) who were already on alert the last few months.

Those fears were reinforced late in the day when Gary Gensler, an old lion of financial services regulation, confirmed for the crowd that in his view, bitcoin’s two largest rivals may fit the description of securities in U.S. law.

“Ripple Labs sure seems like a common enterprise, or the Ethereum Foundation in 2014,” said Gensler, a former chairman of the Commodity Futures Trading Commission. “Ripple is doing a lot to advance the value of XRP.”

(The so-called Howey test says something is a security under U.S. law if it is an investment in a “common enterprise” offering an expectation of profits from the efforts of others.)

Yet, on the other hand, the general sentiment at the event was optimistic about regulators’ growing involvement in the space.

Neha Narula, director of the Digital Currency Initiative at MIT Media Lab, for example, told CoinDesk insufficient regulation can actually stifle innovation by deterring honest players because rampant scammers undermine market integrity.

And aligning with Gensler, Narula said, there need to be more honest conversations about the fact that many emerging cryptocurrencies are actually securities.

However, there may not be a bright line separating the two.

As Narula said:  

“We’re realizing money versus equity isn’t a binary choice. It’s a spectrum.”

Coming pain

And that realization could have a serious impact on the cryptocurrency industry.

Patrick Murck, counsel at Cooley LLP and fellow at Harvard’s Berkman Klein Center for Internet & Society, told CoinDesk the token economy could be on the verge of a dramatic shift if the SEC agrees with Gensler.

If ether and XRP are deemed securities, cryptocurrency exchanges and general industry promoters or foundations, or anyone who sold or evangelized projects like ethereum to the general public, could be subject to legal penalties.

“It would be like shooting fish in a barrel,” Murck said, adding:

“There’s nothing magical about the blockchain that absolves you from investor protection regulations if investors have to trust you to deliver something.”

Driving that point home, Gensler in his talk cited several reasons that the way ethereum and XRP were issued and traded seemed to meet the definition of securities.

For example, the 2014 ethereum crowdsale would have created an expectation of profit for the people who purchased tokens before the network went live.

“The Ethereum Foundation offering had a 50 percent appreciation right in the first 42 days written into the offering,” Gensler said on stage. (The industry think tank Coin Center in Washington, D.C. promptly issued a statement that “ether is not a security,” rebutting Gensler’s argument.)

Meanwhile, for issuers of new tokens, it’s almost impossible to walk the line, even with more feedback from regulators and lawyers.

For example, so-called airdrops, once viewed as a way to avoid breaking securities laws by simply sending free tokens to people who already have some type of cryptocurrency wallet, are instead creating a damned-if-you-do, damned-if-you-don’t situation.

If issuers fail to collect information about recipients of airdrops, they may inadvertently violate international sanctions (what if that wallet belongs to someone in Iran?). On the other hand, if they do collect such information, the airdrop may start to look like an investment in regulators’ eyes, according to Murck.

“The SEC has interpreted the first prong of the Howey Test broadly,” Murck told CoinDesk. “The collection of information may be enough to fit the first prong” – pegging an airdrop as “an investment of money.”

Long-term gain?

Even so, Murck joined others at the conference in welcoming regulators’ participation in the space.

“They’re becoming a part of our blockchain community and that’s a valuable thing,” Murck said.

Part of the value is clearing up uncertainty.

The shortage of such clarity was illustrated during a talk by Kathleen Breitman, a co-founder of the Tezos project.

When asked whether securities regulations apply to her project’s tokens, Tezzies, she responded:

“I don’t know. I don’t mean to play coy, I’m not just an attorney…I would recommend token holders comply with relevant laws.”

But Gensler said legal clarity is slowly emerging in this red-hot market.

“If you do an issuance now, in April 2018, do it under U.S. securities laws,” said Gensler, who is now a senior lecturer at the MIT Sloan School of Management, “It’s better to bring it into a public policy framework, even if there’s a little bit of a chill.”

And perhaps some cooling off would be healthy. MIT’s Narula said she is deeply concerned about the lack of due diligence completed for many, if not most, cryptocurrency projects. Just because the code is open source doesn’t mean that knowledgeable people have evaluated it.  

“A lot of investors don’t know that. They go by signaling,” Narula said. “A lot of projects have had some pretty fundamental flaws that were exposed only after a project launched.”

If nothing else, the excited chatter in the halls of MIT suggested that regulatory encroachment has yet to put a damper on the energy being channeled into blockchain tech.

Amber Baldet, the former JPMorgan Chase blockchain expert, said what makes her optimistic about the space, writ large, isn’t skyrocketing coin prices or even regulatory clarity on the horizon. It’s the explosive growth of this community in the wake of the 2017 boom.

“In order to have an internet of value, people are going to have to interact with each other,” Baldet said, speaking to the need for an ecosystem that includes everyone from enterprises like her former employer to accredited investors to retail investors.

She concluded:

“You meet thousands of people tackling these challenges in unique ways.”

Image via Annaliese Milano for CoinDesk.

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

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