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European Crypto Regulation on the Verge of Enactment

The EU’s Markets in Crypto-Assets (MiCA) regulations are now all but final and may take effect this year. MiCA will provide new regulatory frameworks, including licensing and disclosure obligations, for participants in the cryptocurrency ecosystem, including token issuers, financial intermediaries (exchanges, brokers, etc.) and custodians.

What Happened

The Economic and Monetary Affairs Committee of the European Parliament gave its approval to MiCA on October 10, 2022, the latest step in a process that has lasted more than two years.

What’s Next

This paves the way for the larger European Parliament plenary to approve the regulations, a step that often is merely procedural. Once the plenary approves MiCA, it will become effective and mark the beginning of 18 months in which firms must become compliant, with the regulations coming into full effect in the second or third quarter of 2024.

While the text of MiCA helps provide regulatory certainty for crypto-asset businesses and consumers in the EU, additional practical guidelines for implementation will also be drafted to further elaborate MiCA.

MiCA’s Goals

MiCA’s main objective is to provide a level of regulatory and economic harmonization to crypto-asset businesses and consumers across Europe. Guiding principles of MiCA include:

  • Providing legal certainty through clear definitions of crypto assets and activities in relation to those crypto assets that are in scope;
  • Providing for consumer protection and market integrity alongside financial stability of crypto-asset businesses; and
  • Encouraging innovation and fair competition in the European crypto-assets markets and avoiding regulatory arbitrage between member states.

Businesses engaged in activities that are within the scope of MiCA will, at a minimum, be required to register with the competent regulatory authorities and produce a detailed white paper for their business, in a form and content specified by MiCA.

MiCA will not apply in the United Kingdom or Switzerland as they are not member states of the European Union. While similar principles of regulation may apply in these two jurisdictions, separate analysis is needed to understand what crypto-asset businesses must do to achieve compliance with local regulation.

What MiCA Missed

The final text of MiCA omits treatment of Non-Fungible Tokens, Decentralised Finance, Decentralized Autonomous Organizations and Proof of Work consensus mechanisms. European regulators are expected, however, to treat fractionalized NFTs as utility tokens governed by MiCA.

How Will MiCA Impact the U.S. Market?

MiCA reflects the EU’s acknowledgement that digital assets are a persistent part of a modern financial system. Whether the EU’s steps to define and regulate digital assets will influence U.S. regulators remains to be seen.

The Biden Administration’s March 2022 Executive Order on Ensuring Responsible Development of Digital Assets remains the most comprehensive U.S. policy statement on the topic. While there are numerous proposed legislative efforts in the U.S. Congress, the U.S. has yet to produce comprehensive legislation or regulatory guidance. Instead, regulators have relied on enforcement actions and individual agency guidance to inform market participants. We expect the U.S. regulatory regime to continue, at least in the short term, to take coordinated but separate action aligned with the Executive Order’s primary objectives of protecting consumers and investors.

The Orrick fintech team takes an international approach to digital asset markets. We will continue to monitor regulatory developments in both the U.S. and Europe to support our clients and innovation in crypto.

Digital Assets Executive Order Brings Regulation Closer Than Ever

President Biden issued a sweeping executive order in 2022 acknowledging the key role digital assets will play in the global financial system. It embraces crypto as the wave of the future – while setting the stage for increased oversight, regulation and enforcement.

What It Means

  • Businesses that have seen themselves in a legal gray area may find themselves subject to many of the same regulations as traditional financial service providers.
  • The order calls for an “unprecedented focus of coordinated action” to address the illicit use of digital assets. This will likely lead to increased criminal enforcement, including holding companies accountable for illegal activity perpetrated through their networks.
  • Numerous agencies are developing policies and regulatory frameworks to protect consumers, investors and businesses in the crypto sphere.
  • The order directs agencies to coordinate with international partners on approaching and responding to risks. That may involve cross-border investigations and prosecutions.

In More Detail: The Executive Order’s Six Priorities

Citing the explosive growth in digital assets, the order makes the case for stronger oversight and increased regulation of cryptocurrencies. It announces six key priorities:

  1. Protecting Consumers, Investors and Businesses
    • The Treasury Department and others will develop recommendations to address the risks and opportunities of digital assets. The Attorney General will report on law enforcement’s role to detect, investigate and prosecute crypto crime and recommend regulatory or legislative action.
  2. Protecting U.S. and Global Financial Stability
    • The Financial Stability Oversight Council will identify economy-wide financial risks digital assets pose and develop proposals to address them and associated regulatory gaps.
  3. Mitigating Illicit Finance and National Security Risks
    • The order emphasizes the growing use of digital assets to facilitate cybercrime, money laundering, terrorist and proliferation financing, fraud, theft, and corruption. It asks agencies to evaluate how regulation can mitigate risk.
    • The plan addresses how investigators can increase compliance with laws against money laundering and financing terrorism, focusing on decentralized financial ecosystems, peer-to-peer payments and obscured blockchain ledgers.
  4. Reinforcing U.S. Leadership in the Global Financial System
    • The Commerce Department will work with other agencies on a framework to drive U.S. competitiveness and leadership in and use of digital asset technologies.
    • The Treasury Department will facilitate international engagement on issues like global compliance and standards.
  5. Promoting Access to Safe, Affordable Financial Services
    • The Treasury Department will report on the future of money and payment services.
  6. Supporting Responsible Innovation
    • Several agencies will support advances in the development, design and implementation of digital asset systems.
    • One goal: Ensuring such technologies emphasize privacy and security, defend against illicit exploitation and reduce negative climate impacts and environmental pollution from cryptocurrency mining.

On the horizon

  • The order puts the “highest urgency” on research and development of a U.S. Central Bank Digital Currency.[1] It says that may support efficient and low-cost transactions and greater access.

Signs of Increased Regulation

  • The Justice Department’s National Cryptocurrency Enforcement Team
    • Biden’s March 2022 executive order came months after the Justice Department announced a National Cryptocurrency Enforcement Team.
    • The team investigates and prosecutes crimes like money laundering, ransomware and extortion schemes, and trading on dark markets for drugs, weapons and hacking tools.[2]
    • The task force’s creation suggests the Justice Department has the resources and will to investigate allegations of crypto wrongdoing.
  • The SEC has eyed regulating crypto trading platforms
    • When asked in January if the SEC will start regulating crypto trading platforms in 2022, Chairman Gary Gensler said “…I sure hope so.”[3]
    • He also said: “To the extent that folks are operating outside the regulatory perimeter, but are supposed to be inside, we will bring enforcement actions.”[4]
    • Gensler has said he sees most cryptocurrencies as securities subject to SEC regulation.[5]
  • Other agencies are also marching toward regulation
    • The Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency have conducted interagency “policy sprints” focused on crypto assets.[6]
    • The goal was to analyze if and how existing regulations apply to crypto activities and to establish a road map for the future.
    • They promised to “provide greater clarity on whether certain activities related to crypto-assets conducted by banking organizations are legally permissible” and articulate expectations for compliance with existing laws.
    • Our 2021 Year-End Crypto Roundup details other regulatory initiatives.
  • Regulators are getting more tools – and power
    • Until now, regulators approached crypto misconduct with outdated laws that didn’t always fit. Now regulators are getting more tools and power.
    • Even without a coordinated strategy or crypto-specific regulatory framework, agencies have held companies and people accountable for misconduct.
    • The SEC has brought numerous enforcement actions for fraudulent and unregistered digital asset offerings,[7] and the DOJ recently arrested two people on charges they tried to launder $4.5 billion in stolen cryptocurrency.[8]
    • FinCEN and the Commodity Futures Trading Commission reached a $100 million settlement with cryptocurrency exchange BitMEX last year. The exchange’s founders pleaded guilty to charges stemming from the company’s failure to establish, implement, and maintain an anti-money laundering program.

 

 


[1] See Board of Governors of the Federal Reserve, Money and Payments; The U.S. Dollar in the Age of Digital Transformation (Jan. 2022).
[2] U.S. Dep’t of Justice, Press Release, Deputy Attorney General Lisa O. Monaco Announces National Cryptocurrency Enforcement Team (Oct. 6, 2021).
[3] Jennifer Schonberger, SEC’s Gensler wants crypto exchange regulation in 2022, warns on stablecoin, Yahoo Finance (Jan. 20, 2022).
[4] Id.
[5] Cheyenne Ligon, Gensler’s Crypto Testimony: 6 Key Takeaways, CoinDesk (Oct. 6, 2021).
[6] Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Joint Statement on Crypto-Asset Policy Sprint Initiative and Next Steps (Nov. 23, 2021).
[7] See U.S. Securities & Exchange Commission, Cyber Enforcement Actions.
[8] U.S. Dep’t of Justice, Press Release, Two Arrested for Alleged Conspiracy to Launder $4.5 Billion in Stolen Cryptocurrency (Feb. 8, 2022).

Non-U.S. Crypto and Other Money Services Businesses: Have Customers in the U.S.? Beware of AML and Sanctions Compliance Risk

Two recent guilty pleas involving a cryptocurrency exchange serve as a reminder to all money services businesses (“MSBs”)—including those ostensibly located outside the United States but that conduct business there—of the importance of implementing anti-money laundering (“AML”) programs and registering as MSBs with the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”). Last week, two founders and executives of BitMEX—a virtual currency derivatives exchange whose parent company was registered in the Seychelles but operated globally, including in the United States—pled guilty to criminal Bank Secrecy Act (“BSA”) violations stemming from the company’s willful failure to establish, implement, and maintain an AML program.[1]

The BitMEX enforcement action also highlights sanctions non-compliance risks. Without a Know Your Customer (“KYC”) program, BitMEX carried out transactions for customers based in Iran, a jurisdiction comprehensively sanctioned by the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”). As OFAC has made clear, sanctions compliance obligations remain the same regardless of whether transactions are denominated in virtual currency or fiat. A focus on sanctions compliance may become even more critical for cryptocurrency companies in the wake of the new far-reaching Russia-related sanctions imposed by the United States, the EU, and the UK, among other governments, in response to Russia’s invasion of Ukraine. OFAC and the New York State Department of Financial Services (“NYSDFS”) have warned that as sanctioned persons and jurisdictions “become more desperate for access to the U.S. financial system,” they are likely to turn to cryptocurrency to minimize the crippling effect of sanctions.

BitMEX Founders’ Guilty Pleas

The two BitMEX founders’ guilty pleas on February 24, 2022 follow the company’s settlement with U.S. regulators in August 2021, which was one of the largest-ever resolutions with a cryptocurrency exchange. While BitMEX was incorporated in the Seychelles, it had connections to the United States, including maintaining offices there and soliciting and accepting orders from U.S. customers. FinCEN and the Commodity Futures Trading Commission found that BitMEX was operating as an unregistered futures commission merchant under the BSA, and that it failed to comply with the BSA’s AML program requirements, including by failing to maintain an adequate customer identification program.  BitMEX resolved the allegations for $100 million, with a $20 million suspended penalty pending the company’s remediation and prevention measures, including ending all operations within the United States and no longer serving any U.S. customers.

The Department of Justice charged four of the company’s founders and executives in October 2020. In announcing that two of them, Arthur Hayes and Benjamin Delo, had pled guilty to willfully violating the BSA, the Department of Justice alleged that these two founders “closely” followed the U.S. regulatory developments and were aware of their BSA obligations due to U.S. customers’ trading on BitMEX. Yet, they allegedly took affirmative steps purportedly designed to exempt BitMEX from the application of U.S. laws like AML requirements and KYC requirements. For example, according to prosecutors, “the defendants caused BitMEX to formally incorporate in the Seychelles, a jurisdiction they believed had less stringent regulation, and from which they could still serve U.S. customers and operate within the United States without performing AML and KYC.” Without “even basic” AML policies in place, BitMEX became “in effect a money laundering platform” and a “vehicle for sanctions violations.”

Takeaways

This development illustrates the significant risks to which foreign-located MSBs expose themselves if they have U.S. customers but fail to comply with the BSA. Incorporating in a “friendlier” jurisdiction, like the Seychelles in the BitMEX case, does not protect an MSB from BSA liability if it operates in the United States. The BSA applies to MSBs “wherever located” if they conduct business “wholly or in substantial part within the United States.” Thus, all MSBs, including those transmitting cryptocurrency—with any U.S. nexus—should take note of the BSA requirements. Those include registering with FinCEN; implementing a written AML program with policies, procedures, and internal controls, including regarding customer identification and verification; and controls to detect and report suspicious activity. The AML programs must be commensurate with the risks posed by the location, size, nature and volume of the services provided by the MSB and be effective in preventing the MSB from being used to facilitate money laundering and the financing of terrorist activities.

An effective AML/KYC program will also help ensure compliance with sanctions regulations. As noted, cryptocurrency exchanges will likely face increased sanctions risks due to the sweeping sanctions recently imposed against Russian banks, entities, and individuals by the United States, EU, UK, and other governments, and additional measures that may be imposed in the coming days or weeks. As such, cryptocurrency exchanges may face, and must address, “unique risks.”

By implementing a KYC program, which includes sanctions screening, cryptocurrency companies can help ensure they do not engage, directly or indirectly, in transactions prohibited by sanctions, such as dealings with blocked persons or property, or engaging in prohibited trade- or investment-related transactions. To ensure compliance, cryptocurrency exchanges should also employ geolocation and IP-address blocking to prohibit access by parties from sanctioned jurisdictions, perform transaction monitoring to detect suspicious activity, and file required reports with FinCEN and OFAC. Exchanges operating outside the United States that do not yet have but want to attract U.S. users should also consider implementing such measures.

[1] Also last week, on February 25, 2022, BitConnect founder Satish Kumbhani was indicted in a cryptocurrency Ponzi scheme, which the government alleges deprived investors worldwide, including in the United States, of over $2 billion. According to the indictment, to avoid regulatory scrutiny and conceal BitConnect’s fraudulent scheme, Kumbhani evaded and circumvented U.S. regulations, including those enforced by the FinCEN. Among other things, BitConnect never registered with FinCEN, as required under the BSA.

At Your Service: First-Ever On the Chain Survey Reflects a Steady Rise in Blockchain Awareness, Acceptance and Adoption

The results are in! Responses to Orrick’s first survey of the dedicated followers of On the Chain, our blockchain blog, revealed at least two things: (1) that blockchain technology is continuing to gain acceptance in and figure into plans of businesses across numerous industries, and (2) that during the holiday season people will take the time to respond to a survey if there is a prospect of receiving an Amazon gift card. Message received.

The 60+ survey responses came largely from senior personnel in a broad range of industries and regions, mostly working in technology, media, telecommunications, professional services, fintech and financial services, and mostly located in North America, Asia and Europe. Overall, almost all responders considered themselves moderately or very familiar with blockchain technology, which is not surprising given the nature of the blog’s steadily increasing readership. It is also not surprising, since one-third of the responders stated they work for companies that currently employ blockchain technology, including smart contracts. These uses include: payment processing and investments; buying, selling and exchanging digital currencies; data management and storage; maintaining data privacy; and gaming. For those companies not currently employing blockchain technology, about a third view it as a high priority or important to the organization; and about one-half of those view it as relevant to the company’s strategy but not a priority.

The overwhelming majority of responders believe that blockchain will achieve mainstream adoption in the next five years. This matches the observation of Orrick’s Blockchain Group, whose members from week to week seem to be working on or learning about a new or expanded application of blockchain technology in an existing industry. The greatest advantage to the adoption of blockchain technology, according to responders, is improved business efficiencies, while reduction of costs is viewed as a lesser benefit. The most significant barriers to mainstream adoption of blockchain technology are considered to be technological challenges to implementation, regulatory issues and the uncertain financial return on the investment. We received fewer responses that security threats, failure of companies to treat it as a priority, and unproven technology are barriers to adoption.

In sum, the survey results provide a snapshot – albeit unscientific – of how companies view blockchain technology at this point in time, and where they think it is going. The results help Orrick to focus its blockchain practice on the sectors where our advice and representation will most likely be useful. And, lastly, the results help us deliver our observations and analyses about “the state of blockchain” to our clients and other members of our audience. Survey responders expressed a preference for hearing from us through our electronic newsletter and our On the Chain blog, and we will continue to deliver content in those forms. Many responders also indicated that they would appreciate reading posts regarding success stories and practical uses of blockchain technology. We intend to start publishing regular pieces, so stay tuned for that. And many responders also sought human interaction with the charming and knowledgeable members of Orrick’s Blockchain Group – seminars and networking receptions – and we hope to announce such opportunities in the near future. Finally, we are grateful to those responders who provided ideas about the content for future blog posts (and those who appreciate the topics we have already offered). Look for content that is responsive to those requests.

Thanks again to all our survey respondents for taking the time to provide such useful information, and congratulations to our lucky prizewinner!

The NFA Enhances Reporting Requirements for Intermediaries Who Trade Virtual Currencies and Related Derivatives

Derivatives regulations have continued to evolve with the explosive growth of cryptocurrency in recent years. One of these earlier shifts transpired in late 2017, when the National Futures Association (NFA) issued three Notices to Members expanding the notifications and reporting requirements for financial derivatives intermediaries, citing similar actions by the CFTC along with the volatility in the underlying virtual currency markets.

Learn more about these regulatory shifts as well as perspectives on other derivatives regulators in this overview by our Securities Litigation team.