The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law.
As expected with Congress on break, the news the past two weeks was dominated by updates in major industry litigation efforts. While there was some action on the House’s stablecoin bill in the wake of the major announcement by PayPal that it released its own fully backed stablecoin, most of the focus has stayed on the Coinbase litigation against the SEC and the SEC’s decision to appeal the adverse rulings against the agency in Ripple.
These developments and a few other brief notes are discussed below.
PayPal Announces Launch of U.S. Dollar-Pegged Stablecoin, PYUSD: August 7, 2023
Background: As we noted in the Briefly Noted section of the last Bi-Weekly update, on August 7 PayPal announced it would be launching a fully-backed dollar-denominated stablecoin, PayPal USD (“PYUSD”). The planned token is an ERC-20 token, which means it can be transferred to self-custodial wallets, but similar to USDC and USDT, it does have freezing functionality and can be seized.
Summary: Due to the follow-up news from Washington D.C. on this hotly debated issue of regulated stablecoin issuers, the Blockchain+ team wanted to provide a more in-depth background on the payment processing giant PayPal entering the stablecoin issuer field. Republicans have used the PayPal announcement to make a renewed push to pass the Clarity for Payment Stablecoins Act in the House. Democrat Maxine Waters was reportedly “deeply concerned” about PayPal’s new stablecoin. This may just be the first of many private stablecoins to come, as the issuer of the PayPal stablecoin, Paxos, is reportedly working on other white label stablecoins as well.
Senator Lummis and Others File Amicus in Coinbase Litigation: August 11, 2023
Background: On August 11, there was an expected bevy of amicus filings in Coinbase’s litigation against the SEC, with filings in support of Coinbase coming from Senator Cynthia Lummis, the Blockchain Association, a16z/Paradigm, the Chamber of Digital Commerce, the DeFi Education Fund, and a group of securities law professors. The SEC has until October 3 to file its opposition.
Summary: Most of the focus was on Senator Lummis’ brief which argues that the SEC is overstepping its authority by treating all crypto assets as securities, which contradicts legislative efforts in Congress and requires proper legislation. Senator Lummis is the co-sponsor of currently pending digital asset legislation titled the Responsible Financial Innovation Act. The brief's importance lies in its representation of a congressional perspective that challenges the SEC's approach and urges the court to defer to the legislative branch for creating a holistic crypto regulatory framework. While all the briefs are well-written and worth a read, the group of securities law professors’ brief also provides a cogent argument supporting the idea that and “investment contract” requires both an “investment” and “contract” to fall under the Howey test for a scheme.
SEC Files Intent to File Interlocutory Appeal in Ripple and Ripple Responds: August 16, 2023
Background: On August 9, the SEC filed a letter request to file a motion for leave to file an interlocutory appeal of the Court’s July 13, 2023 Summary Judgment ruling. On August 16, Ripple responded with its own letter of intent to oppose the SEC’s request. The SEC was given until August 18 to actually file its motion for leave to appeal with all briefing on the subject to be completed by September 8. The SEC’s arguments largely followed its letter, claiming the Court erred in its ruling regarding programmatic sales and “other distributions” to employees and charitable organizations as securities offerings.
Summary: Seeking this interlocutory appeal is an aggressive move from the agency. Many thought the current leadership would be inclined to ride the issue out until trial, knowing that uncertainty would be better than a potential sped up major loss on appeal. For more background on the Ripple decision which the SEC seeks to appeal, read our breakdown on the BitBlog available here. As we noted at the time, the Court’s ruling as to “other distributions” was the most cursory of the decision, and there may be a factual record at play which was the reason for such a terse decision on a major aspect of the litigation.
Court Issues Summary Judgment in Favor of Treasury Department in Tornado Cash Matter: August 17, 2023
Background: In September of 2022, Coinbase funded a lawsuit brought by six individuals challenging the U.S. Treasury Department’s sanctions of digital wallets linked to the Tornado Cash smart contracts. On August 17, the Court hearing that matter ruled in favor of the Treasury Department and issued summary judgment against the six individuals. The ruling found that Tornado Cash – a protocol comprised of a set of smart contracts with no formal organizational structure – is a “person” for purposes of the International Emergency Economic Powers Act, and that an “association” can be comprised of any group of people with a common purpose. It further found that the smart contracts comprising the protocol are property in which that association has an interest even though nobody has ownership of the smart contracts, in part because of the fees generated by transactions on Tornado Cash. This was one of two major lawsuits challenging the sanctions, the other brought by CoinCenter and still pending in the Northern District of Florida.
Summary: Coinbase Chief Legal Officer took to Twitter in the wake of the decision saying “[w]e’ve always known that Fifth Circuit review is required to resolve these issues, and we continue to support them on appeal.” The language from the ruling is fairly expansive and does not seem to be limited to smart contracts of a type that comprise the Tornado Cash protocol. That said, smart contract can memorialize legally binding promises, facilitate the performance of legally binding promises, or may just be executable code having nothing to do with promises (legally binding or otherwise). Not all smart contracts act or should be treated the same. The Court seems to have missed this nuance when claiming all smart contracts are like vending machines (which, to be fair, is an example used by blockchain innovator Nick Szabo in explaining one of the functions of smart contracts).
Briefly Noted:
Celsius Network Plan and Disclosure Statement Approved for Voting by Creditors: On August 17, the Bankruptcy Court approved the Celsius Network Plan of Reorganization for it to be voted on by eligible creditors. Please see our Bitblog post setting out the relevant timelines as well as our highlighting the terms of the Plan of Reorganization. With this approval “Earn” creditors are significantly closer to getting repaid at least some of their claims. Eligible creditors should expect to be getting ballets to vote on the plan in the very near future. It Is important for any eligible to vote as one’s recovery may be impacted on whether a creditor voted.
Federal Reserve Announced Program Directed Towards Blockchain: The Federal Reserve has announced a new program to “novel activities” for banks related to crypto-assets, distributed ledger technology, and complex, technology-driven partnerships with nonbanks. This level of advanced supervision for banking partners of the digital asset industry has been troubling to many and raises questions as to the legality of such practices.
Bittrex Settles with SEC: Bittrex settled with the SEC and agreed to pay a $25 million fine. The release points out the fact that Bittrex told token issuers to scrub statements regarding promises of future returns and such prior to listing the asset. Of note was the SEC’s focus on Bittrex advising token issuers to remove statements which may induce others to rely on the efforts of others and/or expect profits in their decisions to buy tokens. Creating a “once a security always a security” issue for token issuers who made early marketing foot faults.
Coinbase Gets CFTC Approval: Coinbase announced that it has received regulatory approval from the National Futures Association (the self-regulatory body governing the US commodities derivative industry) to operate a Futures Commission Merchant (FCM) to offer and sell crypto futures. While there are a number of approved FCMs that were born from traditional commodities businesses or broker-dealers, this is the first time a retail crypto exchange operator has received a US FCM license.
Prime Trust Files for Bankruptcy Protection: Nevada based cryptocurrency custodian Prime Trust filed for bankruptcy protection on August 15 in United States Bankruptcy Court for the District of Delaware. This filing comes as no surprise as Prime Trust has had a number of problems and setback over last the few months. These problems include Nevada's Financial Institutions Division attempting to take over the company in June by declaring them insolvent as well as a failed transaction where they were to be taken over by BitGo. Prime Trust stated in its filing that it has assets of between $50 and $100 million with liabilities of between $100 and $500 million with between 25,000 and 50,000 creditors.
SEC Brings First Charges for Violating new Marketing Rule: The SEC’s first crackdown regarding the relatively new “Marketing Rule” under the Investment Advisers Act relates to a crypto fund manager. Allegations include that the manager extrapolated three weeks of performance into a full year to get to 2700% hypothetical annualized return under a certain strategy, as well as inconsistent disclosure regarding custody of cryptoassets. A big part of the problem was that the manager allegedly buried disclaimers and assumptions used in calculating hypothetical performance behind embedded hyperlinks. Just as a friendly reminder, an attorney or compliance professional should review any performance information (including hypotheticals, case studies, projections and track record) included in investment adviser marketing materials, even if it’s a tool located on a website or within an app.
Conclusion:
Over the past two weeks, major developments in the digital asset industry's litigation landscape dominated the headlines. PayPal's announcement of its new fully-backed U.S. dollar-pegged stablecoin, PYUSD, further ignited the ongoing discussions about regulated stablecoin issuers in Washington D.C. Additionally, Coinbase's litigation against the SEC saw support pouring in from influential entities, challenging the SEC's broader approach towards crypto assets.
The SEC's decision to pursue an interlocutory appeal against Ripple and the summary judgment in favor of the Treasury Department regarding the Tornado Cash issue reflect the increasing complexity of the legal environment surrounding digital assets. With significant updates from Celsius Network, Federal Reserve, Bittrex, Coinbase, Prime Trust, and the SEC's enforcement actions, it's evident that the intersection of digital assets and regulatory frameworks is in a state of flux. These developments underscore the importance of attorneys for the digital asset industry to navigate and help shape the ever-evolving legal landscape.
