Crypto View - September 2023

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It's been a while since the last Crypto View - we took a bit of a break in July - but we're back with a vengeance with this instalment. It turns out two months, even over the summer, is a long time in crypto. The theme of the past two months has certainly been "consulting", with new consultations being published, submitting response, and generally a lot of reading. For this bumper 'back to school' edition, we look at some of the big developments over the summer, such as the US Securities and Exchange Commission (SEC) losing not once, but twice in important crypto cases, as well as discussing what the regulators were asking in all those consultations!

Woe is SEC

It has not been a good summer for the SEC - who have lost two landmark cases relating to cryptoassets. The first came on 13 July, when the Southern District of New York ruled that XRP was not a security - as it did not meet the definition under the Howey Test. There were a number of other decisions that came out - not all of them bad for the SEC, with the Court ruling that direct sales to institutional investors did meet the Howey Test, and so were securities contracts. The fact that the token itself was ruled not to be a security was though the big news, along with the decision that sales by Ripple through crypto exchanges were also not securities. The SEC has, however, filed a motion to appeal (this case could run and run). As the Coinbase case is to be heard in the same district, any ruling from the appeal would be binding on the court in the Coinbase case -- which could have huge ramifications.

The second loss for the SEC came last week when the U.S. District of Columbia Court of Appeals ruled that the SEC was wrong to reject an application from Grayscale Investments (a cryptoasset ETF provider) to list an exchange-traded fund that tracks the price of bitcoin. It follows the SEC denying Grayscale's application to convert Grayscale Bitcoin Trust into an ETF, despite it allowing bitcoin futures ETFS. The court ruled that its proposed spot bitcoin ETF is "materially similar" to the already approved bitcoin futures ETFs - the underlying assets are "closely correlated," and the surveillance sharing agreements with the Chicago Mercantile Exchange are "identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin." The price of BTC jumped 5% on the news.

Finally, while not an SEC loss this time, there was another ruling in the crypto sector last week when Uniswap Labs successfully defended a class actions claim against it. The lawsuit was filed by a group of investors who alleged that Uniswap, a DeFi exchange platform, had violated US Securities laws by failing to register as an exchange, and sought to hold Uniswap accountable for losses related to "scam" tokens purchased on the platform. However, the Judge ruled that the decentralized nature of the Uniswap Protocol made identifying scam token issuers "unknown and unknowable," which left no "identifiable defendant" in the case. This is potentially a very important development for the DeFi space.

Financial Promotions in the UK

You may have seen our FinProm Special in June which looked at the amendments to the Financial Promotion Order that will be coming into force, just a month away, on 08 October 2023. In that we mentioned an FCA consultation on Guidance on Cryptoasset Financial Promotions (GC23/1), which was due for submission last month. We assisted a number of clients in their response to this, and we hope that the FCA are able to publish final guidance as soon as possible so that firms are in a position to implement it prior to cryptoassets coming within scope of the financial promotion restriction. There remain a number of elements which are very unclear, and potentially unworkable in practice, and clarity is very much what the industry needs before October.

Shortly after GC23/1 came GC23/2 - a guidance consultation on financial promotions on social media. While not limited to promotions related to cryptoassets, it is certainly relevant for the industry. The key point the FCA is seeking to address is ensuring that firms manage to convey the risks of any product or service that they are marketing through social media, whether that be through appropriate risk warnings or linking out to more full disclosures elsewhere. What is interesting is that the FCA clearly see some media as being fundamentally unsuitable for certain products to be marketed on (the example given is debt counselling). So firms need to consider the platform as well as the content when considering whether marketing material is appropriate.

As mentioned, the financial promotion rules change to include cryptoassets from 08 October 2023 - the restriction is extremely broad and applies to any promotions capable of having effect in the UK, and the definition of financial promotions is broad - it does not just include marketing, but likely the provision of trading functionality via a website or app. We strongly encourage firms to review how these changes will impact them, and are happy to provide advice on the impact.

New ground broken by the English Court (again): recovery of cryptoassets

Two recent cases have continued the trend of the English Court applying existing legal remedies to crypto assets so as to secure their recovery, increasing the options open to law enforcement bodies and civil claimants:

• In a law enforcement context, the Crown Prosecution Service secured c.£750,000 in crypto assets by seizing recovery seeds (i.e. hard copy paper records containing recovery phrases) during a search of a convicted hacker's home. Possession of the recovery seeds enabled the CPS to recover the wallets containing the assets which had been obtained by the hacker in connection with the original hacking offences. While the background is very much criminal, the CPS secured a civil recovery order from the High Court using powers under the Proceeds of Crime Act 2002 (POCA) which enabled the seizure of the assets themselves, depriving the hacker of the proceeds of crime. The civil recovery powers under POCA make it easier for the authorities to recover assets as there is no need for a conviction and the civil standard of proof - the balance of probabilities - applies rather than the higher criminal standard of beyond reasonable doubt.
• In a civil context, the English High Court has ordered an exchange to transfer into England and Wales crypto assets held outside the jurisdiction. The background to the case is fairly unexceptional: a victim of fraud had obtained a worldwide freezing injunction against persons unknown (i.e. the fraudsters) in relation to crypto assets contained in wallets maintained by an offshore crypto exchange. The victim had already obtained judgment in default against the fraudsters and, exceptionally, sought an order transferring the assets in the fraudsters' wallets into England and Wales. The purpose of this order was to facilitate enforcement of the judgment in default against the assets by bringing them within the jurisdiction of the English Court. The exchange neither consented to nor opposed the order, and was cooperating with the victim to prevent the fraudsters accessing the wallets. Nevertheless, the Court held that exceptional circumstances warranted the order, on the basis that the situation could change to the victim's detriment and the Court would have no control over the exchange as it was based offshore. The Court also required the cryptocurrency to be converted into fiat currency before being transferred to the Court Funds Office. Once held by the Court Funds Office, the victim could apply for a further order that the funds be paid to him to satisfy the judgment debt. This conversion of the crypto into fiat gives rise to the possibility that, if the victim could not secure the order for payment of the fiat to himself, it might have to be used to repurchase crypto and return it to the exchange. This exposes the victim to fluctuations in the price of the crypto, as well as the conversion costs. (Joseph Keen Shing Law v Persons Unknown & Huobi Global Limited)  

Stablecoins in Singapore

In August, the Monetary Authority of Singapore (MAS) announced the features of a new regulatory framework to govern Single Currency Stablecoins (SCS). For the purposes of this new regime, SCS are digital payment tokens designed to maintain a constant value against the Singapore dollar or a G10 currency (Australian dollar (AUD), Canadian dollar (CAD), The Euro (EUR), Japanese yen (JPY), New Zealand dollar (NZD), Norwegian krone (NOK), Pound sterling (GBP), Swedish krona (SEK), Swiss franc (CHF) and United States dollar (USD)). This restriction on currencies is due to the availability of high-quality liquid assets in those currencies that would be fundamental to providing a strong reserve backing for SCS. Other types of stablecoins will not be prohibited from being issued, used or circulated within Singapore, but will continue to be subject to the existing DPT regulatory regime.

The framework is quite onerous - and certainly more so than Singapore's e-money regime - likely due to the fact that the SCS can be traded and potentially fluctuate in value. The key difference is the safeguarding requirements for issuers. While for e-money a 'major payment institution' must generally safeguard customer monies, either via an undertaking or guarantee from a safeguarding institution, or by actually depositing the relevant money in a trust account with the safeguarding institution, reserve assets valued on a marked-to-market basis, and be equivalent to at least 100% of the par value of the outstanding SCS in circulation (including those held by the issuer) at all times. Further, reserve assets can only be held in the form of cash, cash equivalents, or short-term debt securities issued by the central bank of the pegged currency, or organisations that are of both a governmental and international character with a credit rating of at least "AA-". All reserve assets must be denominated in the same currency as the pegged currency, and SCS issuers must obtain independent attestation (e.g. by external audit firms) that the reserve assets meet the above requirements on a monthly basis, with these attestations being published on the issuer's website.

For more information on the regime, please reach out to my Singapore colleagues Ashleigh Low, Yingyu Wang, or Sonia Lim.

Digital Securities Sandbox

The deadline for responding to HMT's Digital Securities Sandbox (DSS) consultation was on 22 August, and we were really pleased to have 'held the pen' for UK Finance's response. The DSS will allow participating firms to test new technologies when operating certain financial markets infrastructures. Regulators will be empowered to disapply or modify legislation to facilitate that testing, subject to ongoing supervision and controls. Legislative changes may also be made permanent through the DSS. The DSS will be the UK's first flagship sandbox created under the powers granted to the regulators under the amendments to FSMA via the Financial Services and Markets Act 2023, and will be a useful mechanism to identify and implement regulatory change. The DSS is the centrepiece of the UK Government's plans to digitalise the issuance and trading of securities, and to become the 'go to' destination for innovation in the financial markets. If designed correctly, the DSS could potentially be the catalyst that's needed for distributed ledger technology and digital securities to flourish. We look forward to seeing the final proposals.

For more information on the DSS Consultation, or on tokenisation of assets more broadly, please get in touch with my colleague Oliver Ward.

The Travel Rule

On 01 September the Travel Rule entered into force in the UK via an amendment to the Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) (note that the government website hasn't updated yet). This requires cryptoasset firms registered in the UK to collect, verify and share information about where funds come from and who the beneficiaries are. There has been concern in the market that as the UK is further ahead in the implementation of this AML requirement than other jurisdictions that it would be practically difficult (if not impossible) to follow all requirements when transferring cryptoassets between wallets across borders. Helpfully, the FCA published its expectations for UK businesses complying with the Travel Rule on 17 August which confirms that the FCA expects VASPs to take all reasonable steps and exercise all due diligence to comply with the Travel Rule, and to fully comply with the Travel Rule when sending or receiving a cryptoasset transfer to a firm that is in the UK, or any jurisdiction that has implemented the Travel Rule. Firms should regularly review the implementation status of the Travel Rule in other jurisdictions and adapt business processes as appropriate. Please get in touch if you have any questions on how the Travel Rule impacts you.

This Month in MiCA

Over the summer ESMA published its first Consultation Package for MiCA - with another coming in October, and a final one expected in Q1 2024.  The first round focussed on a number of areas, some quite administrative, including forms for notification of cryptoasset business by authorised firms, conflicts of interest, information requirements for MiCA applications, and complaints handling processes.  Notably the conflicts of interest requirements have been well received, following some nervousness within the industry that ESMA might require firms to separate their operations to manage conflicts. The period for responses closes on 20 September 2023. 

The Irish government also published a consultation on four national discretions under MiCA. These are provisions within MiCA which will not be subject to full harmonisation, and which the Member States therefore have discretion in applying, including public disclosure of inside information, administrative penalties, the transition period and any simplified authorisation procedure. We expect many states to begin consulting, or indeed making decisions, on these areas of MiCA over the coming months - with the transition period and simplified authorisation procedure being key. For the former, MiCA sets out a transition period for VASPs that are already providing services in accordance with national law prior to the application of MiCA on 29 December 2024, which will allow them to continue to provide services for up to 18 months (i.e. June 2026), or until they are granted or refused an authorisation. Member States can either not apply the transition period at all, or reduce its duration in circumstances where they consider that their national regulatory framework is less strict than that set out in MiCA. For the authorisation procedure, Member States are permitted apply a simplified process for applications submitted between 30 December 2024 and 1 July 2026 by entities already authorised under national law to provide cryptoasset services, allowing the competent authority to use information already gathered under the national regime. It is important to note that under the simplified procedure, the competent authority will still have to confirm that all relevant aspects of MiCA are being complied with. For further information on this, please contact my colleague Derek Lawlor.

Decisions on these points will likely inform a number of firms' decision as to where to set up ahead of MiCA applying.