Keyword: cryptoassets

Power of the Peirce: SEC Commissioner Spends Some of Her Influence on Trying to Help Crypto Network Developers

SEC Commissioner Hester Peirce continues to be one of the most vocal persons in leadership positions at federal regulators who are promoting innovation in digital currency and the blockchain. On February 6th, she unveiled Proposed Securities Act Rule 195 – Time-limited Exemption for Tokens, a rule proposal for a safe harbor that would provide regulatory relief under the federal securities laws for developers attempting to build functioning token networks. Her proposal is a step in the right direction to address one of the greatest challenges token network projects face.

As explained by the Commissioner, in the course of building a functioning network, developers must get tokens into the hands of other persons. These efforts run the risk of violating the U.S. securities laws regulating offers and sales, and the trading of, investment contract securities under the Howey test. Thus, she stated, the SEC has created a “regulatory Catch 22.” The Proposed Rule addresses this issue head-on by providing a three-year period during which an Initial Development Team can build their network and distribute tokens to persons who will use the network without concern that these efforts will be deemed by the SEC to violate the securities laws.

Of course, the Proposed Rule, as conceded by Commissioner Peirce and as discussed below, is a work in progress, and a great deal of work is necessary to address outstanding issues. One overarching issue is the degree to which the Proposed Rule should be prescriptive and thereby decrease the need for development teams to seek no-action relief. However, if overly prescriptive, the Proposed Rule would not be flexible enough to accommodate evolving technological developments and the complex facts that will arise in each case.

The Proposed Rule Would Provide Subjective and Prescriptive Requirements

The Proposed Rule provides Initial Development Teams with a three-year safe harbor from the application of the securities laws, with the exception of its anti-fraud provisions. In order to be covered by the safe harbor, five conditions would have to be met:

  1. The Initial Development Team must intend for the network to reach “Network Maturity,” defined as either decentralization or token functionality – within three years of the first offer and sale of tokens and undertake good faith and reasonable efforts to achieve that goal;
  2. Detailed disclosures pertaining to the token project and the Initial Development Team must be made to the public;
  3. The token must be offered or sold for the purpose of facilitating access to, participation on, or the development of the network;
  4. The Initial Development Team must intend to and undertake good faith and reasonable efforts to create liquidity for users; and
  5. The Initial Development Team must file a Notice of Reliance with the SEC.

The safe harbor conditions incorporate elements that are both subjective and prescriptive. The first and third conditions are principle-based and highly subjective, and without further regulatory guidance or authoritative precedent, it is unclear how the SEC would determine if they are being complied with. Additional guidance regarding the definition of “Network Maturity,” particularly in the form of hypotheticals and Q&A’s, would help provide clarity. Thus far, there are few concrete examples, beyond Bitcoin and Ethereum – which appear to have passed the SEC’s muster – to which developers can refer to understand the considerations relied upon by the SEC in determining whether a token is not deemed to be a security.

The second and fifth requirements are prescriptive. The disclosure requirements are intended to address information asymmetries between token issuers and purchasers. However, given that the anti-fraud provisions of the securities laws remain in place, it is not self-evident that an overlay of specific disclosure requirements is necessary.

As proposed, the notice requirement presents potential challenges to Initial Development Teams, particularly in the case of its applicability to tokens previously sold in compliance with the securities laws. It is uncertain as to the remedial actions that would be required, and what fines or penalties might be imposed, if the requirements of the Proposed Rule are not satisfied in whole or in part. Also, what would happen at the end of the three-year period if a network has not reached Network Maturity, e.g., the Proposed Rule does not provide a mechanism whereby the development team can request an extension of the safe harbor period and how such a request would be processed.

Until it is Enacted, the Rule Will Not Provide Industry Relief

Since the Proposed Rule is not binding on the Commission, SEC enforcement actions can and will continue to be prosecuted without regard to the Proposed Rule; attempted compliance with the Proposed Rule will not serve as a defense to an enforcement action. At the same time, the elements of the Proposed Rule can and should inform discussions between the Staff and development teams. In this regard, the specific disclosure requirements of the second condition may, in the short term, have the greatest impact, as they might serve as a ready checklist for statements by development teams and counterparties in connection with the development of their networks.

As positive a development as is the Proposed Rule Proposal, it is only the preliminary proposal of one Commissioner and the adoption of a proposal such as this one is subject to a rigorous vetting process by the SEC. Therefore, its future is uncertain.

English High Court Recognizes Cryptoassets to be a Form of Property: Considerations Following AA v Persons Unknown

On January 17, In AA v Persons Unknown [2019] EWHC 2556 (Comm), the Commercial Court held that a cryptoasset such as Bitcoin is a form of property capable of being the subject of a proprietary injunction. Although this is not the first case before the English courts that considers whether cryptoassets might be property, it is the most detailed and effectively confirms the position set out in the Legal Statement of the UK Jurisdictional Taskforce (UKJT) on cryptoassets and smart contracts from November 2019. The decision is likely to be a matter of importance in a variety of commercial contexts from taxation and sale of goods legislation to the taking of security and insolvency scenarios.

Cryptoassets as Property

In a co-authored piece published in Thomson Reuters’ Practical Law, Orrick’s Jacqui Hatfield and Rebecca Kellner recently considered whether cryptoassets can constitute property by analyzing the issue through the lens of taking security over cryptoassets. In it, the pair note that “security may only be taken over property, and the type of security that can be taken over a particular cryptoasset, and the process for doing so, will depend on the type of property that cryptoasset amounts to or represents. Therefore, in order to establish whether security may be taken over a cryptoasset, the type of property (if any) which that cryptoasset represents will need to be considered.”

To work out what type of property a cryptoasset represents, they suggest this would be looked at by the courts in the same manner with which the Financial Conduct Authority analyzes cryptoassets – by looking through the “crypto” label to consider what the token represents underneath. The court would effectively consider the underlying function of that token and the rights it confers on its owner.

The authors then set out the law as it stands as it applied to classifying cryptoassets as property:

“under English law, only (i) real property (land) and (ii) personal property (choses in possession (property that is possessed, i.e. goods or equipment) and choses in action (rights enforceable against a third party, e.g. money in a bank account or shares in a company)) are considered property.

“Cryptoassets are not real property, nor may they be physically possessed. Therefore, they can only be considered property to the extent they are choses in action. Cryptoassets that represent a right that may be enforced against a third party may be treated as choses in action and therefore, fall within the definition of property. Examples of such cryptoassets include the following:

  • Security tokens that represent shares or debentures.
  • Asset backed tokens that represent property.
  • Tokens that have been issued under terms which are enforceable against a third party.

“If a cryptoasset does not give the person holding those tokens any rights against a third party, it cannot be treated as falling within the definition of a chose in action. It would also not fall within the definition of real property, nor could it be possessed, so in this scenario, it is difficult to see how such a cryptoasset would amount to property under this strict definition of property, which enables security to be taken over it. Examples of these types of cryptoassets include the following:

  • Bitcoin, Ether and other cryptoassets that are fully decentralized and not issued by a central issuing authority. These give no rights to the holder which are enforceable against a third party.
  • Certain tokens issued by a central party for fundraising purposes (as in the case of initial coin offerings) that do not attach any claim against the issuer.” (emphasis added)

Despite the speed with which cryptoassets have infiltrated the financial system, the fact is that in England and Wales, what a cryptocurrency is in legal terms (a right, property or otherwise), owing largely to this somewhat anachronistic categorization of what constitutes property, remains unclear and unresolved.

In noting that there are already futures and exchange-traded notes in Bitcoin, Marc Jones of Stewarts Law LLP draws a comparison with conventional securities to highlight how the legal framework regarding what constitutes property in England and Wales is behind the curve when it comes to cryptoassets: “imagine a scenario where shares in a public company are regulated by a legal system in terms of how they can be promoted to the public; what information must be provided; to whom they can be promoted; in which jurisdictions, and so on. But the same legal system provides no answer as to how legal title in a share passes; whether and how security can be given over a share; what happens to a share in the event its owner becomes insolvent; whether a share can be trust property; and whether a share can be subject to a proprietary freezing order in the hands of an alleged fraudster.”

In November last year, the UKJT published its analysis of the status of cryptoassets and smart contracts under the law of England and Wales and concluded that cryptoassets are capable of being a form of property in law. It also determined that the novel features of cryptoassets (i.e. intangibility, distributed transaction ledger use, and decentralization) did not disqualify them from being property.

With regard to ownership, the legal statement declared that a person can acquire knowledge and control of a private key, and therefore become owner of the associated cryptoasset. This is considered to be the same as a person lawfully being in possession of a tangible asset and therefore being presumed to be the owner. In much the same way, a person can hold the key on behalf of another (e.g. an employer or client or on trust); and ownership can be shared through multiple keys. A person who unlawfully acquires a key through hacking is not the lawful owner, in the same way as someone who steals property is not the legal owner of that property.

The Legal Statement emphasized the ability of the English common law to adapt to new technologies and to rise to the challenge of applying existing law to new and unexpected situations. However, the Legal Statement is not legal advice, nor is it law. It is not a considered ruling from judges by way of case law, nor is it a legislative change. Therefore, while it provides (i) a potentially valuable analytical framework against which to understand the application of existing law and regulation and (ii) clarity in relation to the availability of existing legal remedies, the conclusions in the Legal Statement are not definitive and are subject to challenge.

AA v Persons Unknown

The case of AA v Persons Unknown concerned a private application for an injunction by a UK insurer. The UK insurer had insured on of its clients, itself an insurance company (albeit a Canadian one), against cyber crime attacks.

The client was the subject of an attack, where a hacker managed to encrypt all of the client’s computer systems and then subsequently sent a ransom request for payment in Bitcoin in exchange for the decryption tool. The insurer agreed to pay the ransom on behalf of the client. The insurer then hired a company to track the Bitcoin, which were placed on an account held by an exchange, Bitfinex. The insurer was seeking, among other things, a proprietary injunction in respect of Bitcoin held with Bitfinex.

Bryan J in AA v Persons Unknown noted that cryptoassets meet the four criteria set out in Lord Wilberforce’s classic definition of property in National Provincial Bank v Ainsworth [1965] 1 AC 1175 as being definable, identifiable by third parties, capable in their nature of assumption by third parties and having some degree of permanence.

The judge identified that traditionally, English law views property as being of only two kinds: choses in possession and choses in action, and that cryptoassets do not sit neatly within either category.

However, the judge considered that on a detailed analysis, it is “fallacious” to proceed on the basis that English property law does not recognize other forms of property. A cryptoasset might not be a chose in action on a narrow definition of the term, but that does not mean it cannot be treated as property. As a result, the Bitcoin (and by implication, other cryptoassets) were considered to be property and thus could be the subject of a proprietary injunction. Further, the judge noted his view that the Legal Statement was an accurate statement as to the position under English law.

Bryan J also noted that there are two English authorities where crypto currencies have been treated as property, albeit that those authorities do not consider the issue in depth. These are:

  • Vorotyntseva v Money-4 Ltd (T/A and others [2018] EWHC 2596 (Ch), where there was no suggestion that crypto currency could not be a form of property, or that a party amenable to the court’s jurisdiction could not be enjoined from dealing in or disposing of it, and the High Court granted a freezing order against a company (and its directors) in respect of an amount of crypto currency which the claimant had given to the defendants. On the evidence before the court, there was a real risk of dissipation.
  • Robertson v Persons Unknown (unreported), 16 July 2019, (Commercial Court), where, following a theft of a number of Bitcoins, the judge accepted the argument that the Claimant had a proprietary claim over the Bitcoin and proceeded on the basis that Bitcoin could be personal property before making an asset preservation order in relation to Bitcoins which were stolen. By granting this order, the High Court treated the Bitcoin as property, which would allow for security to be taken over it. The Court also considered the UKJT analysis as ‘compelling’ in granting the order.


This is the first reported judicial consideration of the UKJT’s analysis of cryptoassets (otherwise a non-binding statement) and provides some further legal certainty over the classification of cryptoassets. Classifying cryptoassets as property has far-reaching implications that can have a real impact on how the asset can be dealt with. It enables (i) the law to recognize the legal rights of crypto currency investors, (ii) cryptoassets to sit more comfortably within the existing legal framework on property, which governs how they can be owned, used and transferred, as well as whether they can be charged and whether they would form part of insolvency/bankruptcy procedures, and (iii) courts to impose freezing and proprietary injunctions over them in cases of cyber attacks and theft.

It should be noted that the case considers the question of whether cryptoassets could be property only in the context of proprietary injunctions and therefore it is possible that alternative views could be reached in the context of other areas (e.g. corporate insolvency). Although this judgment is a helpful indication of how the law could apply in those circumstances, it would not be a binding precedent in matters beyond the context of proprietary injunctions. Nevertheless, the analysis relating to the definition of “property” did not solely rely on the definition of “property” in the context of injunctions but was drawn from broader sources, which may prove instructive for the application of this analysis in other contexts. Further, the alternative interpretation (i.e., that cryptoassets can never be property) could lead to unfair and unexpected results.

With the crypto currency market continuing to grow exponentially, this increased legal certainty will likely serve to shore up market confidence. However, while the judgment is a helpful confirmation that cryptoassets could be considered property, it remains to be seen whether the other conclusions of the Legal Statement of the UKJT will be confirmed in the English courts – e.g., the recognition of a valid granting of security over cryptoassets. In fact, the City of London Law Society’s submission to the UKJT suggests it prefers to wait for a dispute to work its way to the Supreme Court before the fundamental legal status of cryptoassets is clarified – an obviously unsatisfactory result for interested parties such as investors, insolvency practitioners and trustees.

As Sir Geoffrey Vos, Chancellor of the High Court, remarked in a speech at the University of Liverpool in May 2019, when considering why smart contracts had not become ubiquitous yet: “mainstream investors are unwilling to part with real money without the assurance that there is a legal foundation for their engagement. Thus far, the legal uncertainty that pervades the use of so-called crypto currencies and cryptoassets for financial transactions has meant that the starting line has not been crossed. It will be crossed at some stage soon.”

While the relative legal certainty offered by Bryan J in AA v Persons Unknown does not represent a crossing of the proverbial starting line for smart contracts and cryptoassets to become more mainstream in financial transactions envisaged by Sir Geoffrey, it does bring this moment one step closer.

SEC Division of Enforcement 2019 Annual Report Shows Cryptocurrency Is Still Under the Microscope

The SEC Division of Enforcement’s 2019 Annual Report, released earlier this month, shows a continuing focus on activities involving blockchain and cryptocurrency, and its website shows an increase in cases since last fiscal year. The Annual Report provides an overview of the SEC’s enforcement activities during FY 2019, highlighting enforcement priorities and trends, noteworthy actions, and enforcement challenges. The SEC’s attention to enforcing the securities laws in the blockchain and cryptocurrency space features prominently in the Annual Report, securing special attention both in the introductory message from Division Co-Directors Stephanie Avakian and Steven Peikin, and as one of two “initiatives and areas of focus in Fiscal Year 2019” (alongside the SEC’s traditional focus on protecting retail investors).

But while Co-Directors Avakian and Peikin state that the Division’s “activities in the digital asset space matured and expanded” in 2019, the nature of its enforcement priorities as detailed in the 2019 Annual Report is not markedly different from the previous year. To be sure, the 2019 Annual Report highlights some of the more high-profile enforcement actions in the industry, such as the SEC’s ongoing case against Kik Interactive for allegedly conducted an illegal $100 million securities offering in 2017. And, as reported on the SEC website, the number of enforcement actions the SEC designates as relating to “Digital Assets/Initial Coin Offerings” has seen an uptick since last year (with 13 filed in FY 2018, and 21 in FY 2019).

One thing that the 2019 Annual Report more clearly highlights about the SEC’s activities this year is the Division of Enforcement’s attention to non-fraud violations related to cryptocurrencies. For example, the SEC charged the founder of a digital asset trading platform for operating as an unregistered national securities exchange, and charged an “ICO Incubator” and its founder for acting as an unregistered broker-dealer and selling unregistered digital asset securities. And for the first time, the SEC filed charges for the unlawful promotion of ICOs (against boxer Floyd Mayweather Jr. and music producer DJ Khaled).

With cryptocurrencies being one of the SEC’s “initiatives and areas of focus” and the fact that the Division’s Cyber Unit only became fully operational in Fiscal Year 2018, the volume of enforcement actions in this space may well continue to increase in FY 2020. Even if not, participants in the industry should be mindful that the SEC is still scrutinizing cryptocurrency activities and is able and willing to penalize non-fraud violations of the securities laws. As Co-Directors Avakian and Peikin noted in the Report: “Collectively, these actions send the clear message that, if a product is a security, regardless of the label attached to it, those who issue, promote, or provide a platform for buying and selling that security must comply with the investor protection requirements of the federal securities laws.”

HMRC’s New Approach to Cryptoassets – Tax First, Define Later

The UK tax authority, Her Majesty’s Revenue & Customs (HMRC), has taken a further step towards tackling perceived tax avoidance in transactions involving cryptoassets. Specifically, according to press reports, exchanges such as eToro, Coinbase and CEX.IO have received letters from HMRC requesting customer and transaction data.

The move follows HMRC’s most recent policy paper, “Cryptoassets for Individuals,” published in December 2018, which in turn built on the brief general guidance published by HMRC four years earlier in 2014. The 2018 policy contains the statement that HMRC will apply the relevant income or capital gains tax provisions by looking at the factual details of each circumstance rather than by reference to terminology.

While the policy paper does distinguish between exchange tokens, utility tokens and security tokens, in practice we expect HMRC to focus on a transaction’s factual elements, rather than the description of the cryptoassets.

In contrast to HMRC’s approach, the UK financial regulator, the FCA, has recently revamped its classification of cryptoassets, clearly defining which ones among them would not fall within the scope of its regulatory regime, the Financial Services and Markets Act 2000. HMRC is yet to comment publicly on this development, but it is hoped that HMRC will follow suit and provide taxpayers with more certainty in determining their tax obligations in relation to cryptoassets.

Interestingly, on the other side of the Atlantic, the U.S. Internal Revenue Service (IRS) was also reported to have sent compliance letters to holders of cryptocurrency, warning them of the consequences of their potential non-compliance with relevant tax obligations. It is not clear whether the letters are limited to those taxpayers identified in the Coinbase Summons in 2016. The IRS believes that in 2017 up to $90 billon in cryptocurrency gains went unreported. On the Chain authors have written on the topic previously here, here and here.

While the IRS confirmed in 2014 that virtual currency ought to be treated as property for tax purposes, HMRC has, so far, used the word “property” only to describe cryptoassets for inheritance tax (IHT) purposes. Whether a similar approach will be taken for other UK taxes is yet to be confirmed and cannot be assumed.

The Financial Committee of the City of London Law Society published a paper that provided a potential framework for legal classification of cryptoassets. According to the Committee, exchange tokens could constitute a new category of personal property that is neither a “chose in possession” nor a “chose in action,” subject to the Supreme Court extending the notion of personal property to such assets.

In order to tap into the value generated by cryptoassets, HMRC’s approach has been to treat cryptoassets as property in relation to IHT and as “assets” in relation to other taxes. This approach is potentially quite unclear for taxpayers if we consider that, at the time of writing, there is no legislative basis (judicial or statutory) for the classification of cryptoassets as property. The fact that HMRC has recognized cryptoassets as property only in relation to IHT, and not for other UK taxes, adds to the uncertainty.

This uncertainty, coupled with the fact that most taxing legislation was drafted before digital assets even existed, means there is an urgent need for clarification on their legal status.

This is relevant to all value-generating actions involving cryptocurrencies, including the UK tax treatment of:

  1. options on tokens – will this mirror the taxation of options over shares?
  2. ICOs – will these be taxed in the same way as IPOs? and
  3. the transfer of tokenized shares – will these fall within the scope of stamp duty?

At the moment, there is no clear answer.

One thing does seem certain, however – blockchain is a harbinger of a new way of generating value and its potential will be fully leveraged only when the tax and legal frameworks around it have reached a serviceable level of cohesion. How and when this will be achieved is difficult to say.

The FCA Reclassifies Cryptoassets, But Is It Moving Away From Its Technology Neutral Approach?

The Financial Conduct Authority (FCA) has released final guidance on cryptoassets in a policy statement that includes feedback from their January consultation paper. It is important to note that the policy statement is of a limited scope and focuses on whether different types of cryptoassets fall within the regulatory perimeter of the Financial Services and Markets Act 2000 (FSMA) and Electronic Money Regulations 2011 (EMRs). While the policy statement does touch upon the use of cryptoassets for payment services, prospectus requirements and anti-money laundering issues, it does not provide much new guidance on these areas.

In terms of whether cryptoassets fall within the regulatory perimeter, there is not much new or groundbreaking in the FCA’s approach – which is a good thing. The guidance closely follows the FCA’s views that it had set out in the consultation paper, and the FCA is aware that regulation outside its purview would require legislative changes. This being said, the guidance is useful in assisting token issuers and market players to classify whether the cryptoassets they deal with are subject to, or could potentially be subject to, the regulatory regime.

The guidance confirms that cryptoassets will fall within the regulatory regime, if they meet the definition of specified investments, under the FSMA (Regulated Activities) Order 2001 (RAO), the definition of transferable securities under the Markets in Financial Instruments Directive (MiFID) or the definition of e-money in the EMRs. The guidance notes that the most relevant specified investments for cryptoassets are:

  • Shares
  • Debt instruments
  • Warrants
  • Certificates representing certain securities
  • Rights and interests in investments

The guidance deviates from the consultation paper in classifying the different types of cryptoassets. The previous categories had been security tokens, which were regulated, and exchange tokens and utility tokens, which were unregulated unless they met the definition of e-money under the EMRs. The new categories are:

  • Security tokens
  • E-money tokens
  • Unregulated tokens

The definition of security tokens remains the same, that is, those tokens that meet the definition of specified investments under the RAO and fall within the regulatory perimeter. The previous categories of utility tokens and exchange tokens have been reclassified as e-money tokens, which are those tokens (either utility or exchange tokens) that meet the definition of e-money, and unregulated tokens which, as the name suggests, fall outside the regulatory sphere. This new approach is far clearer from a regulatory standpoint and acknowledges that utility and exchange tokens did not need to be classified separately when considering whether they were regulated.

Less obvious, and potentially more interesting, the policy statement also indicates a change from the FCA’s previous technology-neutral approach. This is not spelled out, and we suspect the FCA would still claim to be technology-neutral; however, the guidance notes that the use of particular technology may raise operational issues unique to that technology and the FCA will consider this as part of its ongoing regulation.

The policy statement also notes the transposition of the 5th Anti-Money Laundering Directive (5AMLD) into UK law by January 2020, although separate guidance on this will be issued. The policy statement confirms that the UK’s approach goes beyond that required by the 5AMLD with regards to cryptoassets, and the Government proposes to extend the Anti-Money Laundering regulations to all cryptoasset exchanges, cryptoasset transfers on behalf of another person and issuance of new cryptoassets, for example an ICO.

This shift towards a less technology-neutral approach is also shown in the FCA’s recent consultation on banning contracts for difference (CFDs) and CFD-like products that reference cryptoassets to retail investors. This consultation comes on the heels of the FCA imposing restrictions on the sale of all CFDs and CFD-like products to retail investors. We would argue, and suspect a technology-neutral approach to support, that CFDs and CFD-like products that reference cryptoassets should be treated in the same way as CFDs and CFD-like products that reference other assets. Given that the ban which is being consulted on only targets those products that reference cryptoassets, is it possible that the FCA is moving away from its technology-neutral approach and towards specific cryptoasset regulation?