The Crypto Weekly - August 2022 Issue #2

Kelley Drye & Warren LLP
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The below articles and industry developments have been identified by Kelley Drye and Warren’s Blockchain and Cryptocurrency practice group as relevant during the week of August 24 – August 30. We hope you find this useful. Access may require subscription.

Regulatory Update

Grayscale, Disclosing SEC Queries, Says Cryptos XLM, ZEC, ZEN May be Securities

CoinDesk, August 27, 2022

Grayscale Investments LLC has been fielding questions from the U.S. Securities and Exchange Commission (SEC) over the firm’s “securities law analysis” of tokens in some of its less-popular crypto trusts.

The inquiry, which Grayscale disclosed in little-noticed filings made in June and mid-August, casts a shadow over the trusts’ viability at a time when the world’s largest digital asset manager is already dealing with a precipitous decline in its assets’ value due to the ongoing crypto winter.

The SEC’s questions highlight uncertainty for Grayscale’s lineup of brokerage account-friendly crypto trusts. It also speaks to an ever-more aggressive regulator determined to crack down on tokens it believes should be subject to U.S. securities law.

Read more here.

Virtual Currency Question Needs Clarification, CPA Group Says

Bloomberg Law, August 26, 2022

The IRS should clarify the meaning of virtual currency on the Form 1040, the American Institute of CPAs said in a comment letter released Friday.

AICPA urged the IRS to modify virtual currency question for “simplicity and clarity.”

  • The agency also should not ask about “digital assets” until it has been defined under tax code Section 6045, the letter said.
  • AICPA said the IRS should include elements such as providing examples of taxable and nontaxable events for the virtual currency question in the Form 1040 instructions.
  • The CPA group recommended the agency specify that a taxpayer is not required to answer “yes” on the form “if a dependent had a virtual currency event but does not have a filing requirement.”

Read more here.

The Crypto World Can’t Wait for ‘the Merge’

New York Times, August 26, 2022

The cryptocurrency industry has endured a terrible year. A devastating crash wiped nearly $1 trillion from the market, draining the savings of thousands of people. Several companies filed for bankruptcy.

Now the industry is fixated on a potential saving grace: a long-awaited software upgrade to the most popular cryptocurrency platform, Ethereum, which provides the technological backbone for thousands of crypto projects. The upgrade — known as the Merge — has gained near-mythical status after years of delays that left some insiders questioning whether it would ever happen.

But if all goes according to plan, the Merge will take place around Sept. 15, more than eight years after it was initially discussed. The change would shift Ethereum to a more energy-efficient infrastructure, addressing the widespread criticism that crypto’s climate impact outweighs its possible benefits. And it would lay the foundation for future upgrades to reduce the hefty fees required to conduct transactions in Ether, the platform’s signature currency and the second-most valuable digital asset after Bitcoin.

“This transition is essentially laying a road map to a future which is far more scalable, far more energy efficient and a lot more usable to the normal person,” said Joseph Ayoub, an analyst at Citi who has studied the Merge. “It’s laying the groundwork for adoption.” But the risks are profound. Even by crypto standards, the process is almost ludicrously complicated.

Read more here.

The Merge May Negatively Impact DeFi Protocols, Stablecoins: Report

CoinDesk, August 26, 2022

Ethereum’s upcoming Merge could significantly impact the way DeFi protocols operate atop crypto’s most popular decentralized finance chain, according to a new DappRadar report published Friday.

The study focuses on delays that could arise during Ethereum’s transition to a proof-of-stake consensus mechanism, better known as the Merge. The long-awaited (and often delayed) tech upgrade may slow transaction times or create service disruptions across DeFi lending protocols, creating headaches for the platforms, the report said. In turn, this could plunge stablecoin values and shrink DeFi lending pools.

Ethereum is host to an ecosystem of decentralized token trading, lending and yield-farming projects that together process billions of dollars in crypto value daily. Those DeFi protocols rely on Ethereum’s consensus mechanism to function properly for their own services to work.

Read more here.

Crypto ATM Firm Bitcoin Depot Strikes $885 Million SPAC Deal to Go Public

WSJ, August 25, 2022

Bitcoin Depot has reached a deal with a special-purpose acquisition company that values the cryptocurrency ATM firm at roughly $885 million and would take it public, company officials said.

The merger comes during market downturns for cryptocurrencies and SPACs and is expected to test investor appetite for bitcoin ATMs, which some skeptics associate with crimes and high fees.

Atlanta-based Bitcoin Depot is combining with the SPAC GSR II Meteora Acquisition Corp. in a deal that was announced Thursday. The Wall Street Journal had reported earlier that the deal had been struck.

Skeptics worry that the ATMs are easy to abuse for crimes such as money laundering. High transaction fees add to worries that they can be used to prey on poor people. Singapore—once one of the friendliest financial hubs to the cryptocurrency industry—banned bitcoin ATMs early this year. The Federal Bureau of Investigation late last year warned of a rise in bitcoin ATM scams.

Bitcoin ATMs in the U.S. have to comply with the anti-money-laundering Bank Secrecy Act and work with the Treasury Department’s Financial Crimes Enforcement Network, though the U.S. Government Accountability Office has found lax oversight at some locations.

Read more here.

Most Crypto Companies Want Regulations to follow, Says Tether Co-Founder

CNBC (Video), August 25, 2022

Tether co-founder Reeve Collins discusses Tornado Cash sanctions, and Crypto World explores new rules around crypto donations to political candidates in California.

Read more here.

News Articles

The news articles cover relevant content from August 24 through August 30. Access may require subscription.

Ether, Bitcoin Could See Turbulence as Open Interest Leverage Ratio Soars to Record High

CoinDesk, August 30, 2022

Traders love volatility, and Ethereum's ether (ETH) and bitcoin (BTC) could soon offer plenty of it. That's the message from observers tracking the so-called open interest leverage ratio.

The metric is calculated by dividing the amount of dollars locked in open perpetual futures contracts by the market capitalization of the underlying cryptocurrency. The ratio represents the degree of leverage relative to the market size or sensitivity of the spot price to the derivative market activity.

Both ether and bitcoin's perpetual futures open interest ratios stood at lifetime highs above 0.03 and 0.02 at press time, according to data sourced from Decentral Park Capital and blockchain analytics firm Glassnode.

"The rising ratio indicates open interest is outpacing market size and increases the risk of volatility due to future [long/short] squeezes," Decentral researcher Lewis Harland said.

Read more here.

FBI Asks DeFi Platforms to Increase Security Measures, Warns Crypto Investors Against Vulnerabilities

CoinDesk, August 30, 2022

The Federal Bureau of Investigation (FBI) has asked decentralized finance (DeFi) platforms to beef up security measures and warned investors against the vulnerabilities in those platforms.

The FBI's warning comes as DeFi platforms, which do not use third parties to carry out financial transactions on the blockchain, have suffered several major attacks this year, which includes the massive near $650 million Ronin bridge exploit earlier this year.

Between January and March 2022, cyber criminals stole $1.3 billion in cryptocurrencies, almost 97% of which was stolen from DeFi platforms, the FBI said citing a report from blockchain analysis firm Chainalysis.

Read more here.

Crypto Coin AVAX Drops 11% After Self-Described Whistleblower Says Avalanche Weaponized Litigation Against Rivals

CoinDesk, August 29, 2022

The AVAX token dropped to its lowest price since July 13 on Monday after a self-described "whistleblower" website accused that Ava Labs, the company behind the Avalanche blockchain, paid lawyers to hurt competitors and keep regulators at bay.

On Friday, Crypto Leaks, a self-proclaimed whistleblower, published a report saying that some years ago New York-based Ava Labs focused on developing Avalanche's ecosystem, and law firm Roche Freedman made a deal under which Freedman would collect confidential information of rival companies and trap them under class-action lawsuits in return for massive amounts of AVAX tokens and Ava Labs corporate stock.

Read more here.

Roche Freedman Founder Denies Secret Pact With Crypto Co.

Law360, August 29, 2022

Roche Freedman LLP founding partner Kyle Roche on Monday denied allegations he formed a secret pact with a blockchain platform to sue competitors in the cryptocurrency space, saying a recently published report from the website Crypto Leaks includes false statements and uses secretly recorded interviews with him out of context.

Roche said in a post on the online publishing site Medium that allegations published Friday on Crypto Leaks' website contain "numerous unsourced false statements and illegally obtained, highly edited video clips that are not presented with accurate context."

Read more here.

Limited Partners Seek Assurances From Crypto Venture Funds

WSJ, August 29, 2022

Pensions, endowments and other venture-capital investors are imposing tighter compliance and security standards for venture funds backing crypto startups to protect the growing amount of capital going to them.

Even amid hard times for the crypto market, where prices for publicly traded digital tokens such as bitcoin have dropped more than 50% this year, venture funds are investing in a range of startups under the crypto umbrella, such as ones focused on finance, digital goods and software infrastructure.

Globally, more than 150 crypto funds, including ones with hedge-fund and venture-fund strategies, raised $35.9 billion in the first half of this year, compared with $18 billion raised in all of last year, according to data provider Dove Metrics, a unit of market-research firm Messari Inc.

Read more here.

The End of the Texas Bitcoin Mining Gold Rush

CoinDesk, August 29, 2022

Texas was once a promised land for bitcoin miners, a business-friendly state with stable regulations and a seemingly endless energy supply. But the tide has turned.

The state’s grid operator, the Electric Reliability Council of Texas, or Ercot, has slowed issuance of new permits for miners to connect to the grid, said Steve Kinard, director of bitcoin mining analytics at the Texas Blockchain Council (TBC), an industry association. Ercot is trying to balance the state’s demand and supply of electricity.

Meanwhile, the pipeline of readily available electricity in Texas has run dry, and bitcoin miners increasingly have to build out energy infrastructure such as generators and power lines for their machines to be plugged into. That buildout will take a while.

Read more here.

Bitcoin Options Signal Risk of Another Drop in Largest Token (1)

Bloomberg Tax, August 25, 2022

Bitcoin may be poised for another downward move if a slew of technical insights are on the mark.

The largest cryptocurrency by market value has retreated more than 50% this year and recently has been sitting in a range of about $19,000 to $25,000, contained by tightening monetary settings. It was little changed at about $21,566 as of 6:51 a.m. in London on Thursday.

Options data show some investors are paying a premium for protection against a possible fall below the lower bound of the trading range. Seasonal patterns, meanwhile, peg September as a testing month for the digital token.

Read more here.

Crypto Biz Owner Can't Undo $6M Fraud Conviction

Law360, August 25, 2022

The owner of a defunct cryptocurrency business fell short in his bids for an acquittal and retrial on Thursday after a jury had found him guilty last month of defrauding investors and customers of more than $6 million, according to a docket entry in Boston federal court.

In a brief ruling without explanation, U.S. District Judge Denise J. Casper denied the motion by Randall Crater, the owner of the allegedly fraudulent business, My Big Coin, to reverse the July 21 conviction.

Read more here.

Crypto VC Electric Capital Names Ex-SEC Chair Clayton as Adviser

Bloomberg Tax, August 24, 2022

Former Securities and Exchange Commission Chairman Jay Clayton has joined venture firm Electric Capital as an advisor, part of a growing wave of ex-regulators flocking to the crypto space as the industry faces increasing scrutiny.

Kevin Warsh, a former member of the Federal Reserve Board of Governors, and Pratiti Raychoudhury, vice president and head of research at Meta Platforms Inc., were also named as advisors, Electric Capital said Wednesday.

Read more here.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Attorney Advertising.

© Kelley Drye & Warren LLP

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