Biz Builder Mike

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Politics, Legal & Regulation

Bancor Lawsuit Tossed: “New York is not a reasonable and convenient place to conduct this litigation”

A New York judge has tossed a lawsuit filed against Bancor, or BProtocol Foundation, that claimed the sale of unregistered securities, according to an Order Granting Motion to Dismiss received by CI. Judge Alvin Hellerstein dismissed the case and the Plaintiff’s offer to re-plead was denied.

BProtocol Foundation (Bancor) is organized under the law of Switzerland, with offices in Zug, Switzerland, and Tel Aviv, Israel. In 2017, Bancor raised about $153 million in a token offering.

According to company representatives, the ruling is decisive as Judge Hellerstein canceled an oral argument that had been scheduled. The ruling may impact other cases that seek to apply US securities law to digital offerings that sold outside the US.

According to the document, the case was filed on behalf of Timothy C. Holsworth. Holsworth, who replaced the initial plaintiff William Zhang, alleged that he purchased 587 BNT digital coins on September 4, 2019, from Wisconsin, on COSS, a digital exchange in Singapore, for an aggregate cost of $212.50.

The lawsuit alleged that Bancor “made numerous false statements and omissions that led reasonable investors to conclude that the BNT tokens were not securities.” The Plaintiff argued that BNT is a security and thus falls under US securities law.

Filed yesterday, the Order said the Plaintiff has not shown that he was directly contacted by Defendants or that he purchased securities as a result of any active solicitations by Defendants. The Order adds:

“Wherever the current business location of Bancor, New York is not a reasonable and convenient place to conduct this litigation.”

Thus the motion to dismiss was granted in favor of the Defendants.

Bancor was represented by Alex Spiro of Quinn Emanuel, a law firm that specializes in litigation and is active in multiple high-profile crypto and Fintech cases.

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Nigerian Senate Admits they Can’t Ban or Control Pseudonymous Bitcoin (BTC) Transactions

A Nigerian crypto trader is claiming that they sold off all their coins (crypto-assets) following the government’s directives regarding cryptocurrencies. The trader also noted that they’ve now withdrawn all their proceeds, but they haven’t “seen a dime” in their bank account and it’s been more than two days after Luno, an app for purchasing virtual currencies like BTC and Ethereum (ETH), sent them an attached mail.

They also mentioned via Twitter that now Bitcoin is worth Naira 20M+ (over $47,000 at time of writing), they are unable to purchase or withdraw funds. While expressing their frustration, the trader said that “nobody should talk about Nigeria with me. Am done.”

It’s worth noting that what people post or share on social media is not always completely accurate. There are numerous crypto (and other) scams being carried out via Twitter and other major social networks such as Facebook, Reddit, and even LinkedIn.

However, the Nigerian Senate recently admitted “cryptocurrency has become a worldwide transaction of which you cannot even identify who owns what.” Nigerian Senator Sani Musa acknowledged that the technology is “so strong that I don’t see the kind of regulation that we can do.” The Senator notably stated that Bitcoin has made the Naira “almost useless or valueless.”

Senator Musa further noted:

“If we have an economy that is very weak and we cannot regulate cryptocurrency in Nigeria, then I don’t know how our economy would be in the next seven years. We didn’t create Cryptocurrency and so we cannot kill it and cannot also refuse to ensure it works for us. These children are doing great business with it and they are getting result and Nigeria cannot immune itself from this sort of business.”

Senator Biodun Olujimi noted:

“What we can do is ensure bad people must not use it. This motion is most important to us. The time has come for us to harmonize all the issues concerning cryptocurrency.” 

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Justin Mart, Ryan Yi from Coinbase take a Closer Look at Ethereum, DeFi Growth, Also Review OCC, FinCEN Developments

Digital asset exchange Coinbase recently published its Around the Block #11: “A snapshot of decentralized finance (DeFi) and two sides of the crypto regulatory spectrum” (report), which aims to cover important issues in the crypto and blockchain industry.

In this latest edition, released on February 3, 2021, Justin Mart and Ryan Yi take a close look at the current state of DeFi and the evolving digital currency regulatory space.

During the current crypto bull market, DeFi has “continued its strong rise,” the report confirmed. It pointed out that starting in the summer of last year, DeFi initiatives experienced dramatic growth in Total Value Locked or TVL (as tracked by DeFi Pulse and many other sites).

Coinbase’s report noted that DeFi’s meteoric rise is still “spurred” by the yield farming phenomenon. According to the US-based exchange, this includes “a virtuous cycle: Yield farming mechanics induce participants to add capital → which increases TVL → which drives governance token valuations → which increases yield farming subsidies → which continues the cycle.”

As stated in the report:

“Nevertheless, true zero-to-one innovations in DeFi cannot be discounted as part of the growth story. These are things like synthetic assets (e.g. Synthetix, UMA, and Mirror), increased capital efficiency in financial products (e.g. Aave, Compound), open financial access (including flash loans and emerging remittance use cases), and composable protocols that layer DeFi projects together like Yearn.”

Total Value Locked in DeFi protocols (TVL) currently stands at over $32B at the time of writing, a remarkable 2700% growth year-over-year. Meanwhile, the number of DeFi users has grown to exceed 1.2M, as “defined by the number of unique addresses accessing DeFi services,” the report revealed. It also noted that mainstream protocols such as Uniswap and Compound now claim around 200–500K users, with “most other DeFi apps between 25–50K users.”

DEX (or decentralized / non-custodial crypto exchange) volume has also maintained its steady growth since July 2020. Total DEX volume has “surpassed most centralized exchanges, topping $10B per day in January 2021,” the report confirmed. It also mentioned that volume has been “driven by growth in DeFi, but also tailwinds from broader crypto bull markets and sustained traction in categories where DEXs enjoy competitive advantages.” These include “access to the long-tail of novel DeFi tokens; and efficient swaps between highly correlated assets (e.g. stablecoins),” the report added.

But DEXs today settle trades on the Ethereum mainnet, and are subject to “oppressive” gas prices during periods of increased activity. This “drives continued interest in scaling solutions, with a notable milestone as Synthetix has launched on Optimism (a rollup-based scaling solution),” the report added.

The report further noted:

“DeFi is moving too quickly for any single person to keep track.”

But some major themes include:

  • DeFi projects are embracing composability: New DeFi projects “either introduce new primitives, or bundle existing primitives to create net new products.” Think of these primitives “as lego bricks, 6 months ago we were designing and building single bricks.” Today we are “combining these bricks into cars, planes, and castles.”
  • Composability is “extending into DeFi versions of partnerships: DeFi projects are wrestling with key questions around moats, defensibility, and top-line growth.” Most projects seem to “embrace open community collaboration, believing communities create moats (you cannot fork a community).” This exact vision “initially led to the governance token and yield farming phenomenon, and today is evolving into creative partnerships and collaborations, most notable in Sushiswap’s 2021 roadmap.”
  • Scalability is “becoming a bottleneck, but solutions are coming: As the base Ethereum chain struggles under scale, several protocols are openly exploring integrations with Layer-2 networks or other blockchains.” Look for “significant progress in 2021, especially in Ethereum rollups.”
  • Regulatory uncertainty impacts development: “In tandem, the SEC lawsuit against Ripple and CFTC lawsuit against BitMEX demonstrate that regulatory bodies are paying close attention to crypto, and not afraid to charge the largest players in the space.” It’s reasonable to “expect increased attention on DeFi based projects, and this uncertainty continues to impact feature development in regulated jurisdictions.”

During the last quarter, FinCEN and the OCC have introduced several crypto regulatory policies, the report from Coinbase noted. While both are under the purview of the US Treasury Department, the guidance appears to be on “the opposite ends of the spectrum toward crypto friendliness,” Coinbase claims.

They explained that FinCEN is responsible for ensuring that companies follow applicable KYC/AML regulations, which are really important for digital currency exchanges (or VASPs — virtual asset service providers) such as Gemini, Kraken, Coinbase, among others. Digital asset exchanges must verify their users’ identities (KYC) and use blockchain or DLT forensic tools to examine digital currency transactions to ensure deposits don’t come from illicit sources.

FinCEN has proposed an amendment to the Bank Secrecy Act’s FBAR regulations, which is specific to cryptocurrencies or VASPs. The new amendment will require US residents to report their cryptoc-asset holdings and transfers valued at more than $10,000 regardless of where these assets are being held.

The amendment could require US citizens to report crypto holdings in excess of $10,000 that are maintained in overseas accounts, and also require exchanges or digital wallets to store client details related to any transfer valued at more than $3,000, and also report these details to FinCEN for any transfers valued at over $10,000.

The public notice only had a 15-day comment period over the recent US holiday break, which made it quite challenging for VASPs to respond properly.

Many crypto firms (Coinbase, Fidelity, Square, CoinCenter, ErisX, among others) have issued strong responses which have noted that the suggested rules may create issues. These companies or organizations have also criticized the rushed nature of the proposal. Since then, the US Treasury decided to extend the comment period, but the future still “remains unclear given the new administration,” Coinbase claims.

The Office of the Comptroller of the Currency (OCC), an independent bureau in the Treasury which is responsible for assisting with the “charter, regulation, and supervising banks,”  appears to have “come out on the other end of the spectrum with recent guidance,” Coinbase stated in its report.

  • Federal Banks are allowed to operate public blockchain infrastructure (January 2021]
  • Federal Banks are permitted to engage in stablecoins (September 2020)
  • Federal Banks are allowed to custody crypto-assets (July 2020)

Coinbase added:

“It’s clear that national banks may now participate in the crypto economy through custody and settlement. Notably, Jan 2021 guidance which legitimizes public blockchains as settlement infrastructure, placing blockchains on par with ACH or SWIFT. … federal banks can serve as large validators on blockchains (e.g. miners), or more practically, banks may ultimately settle transactions on Bitcoin, Ethereum, or through stablecoins.”

The exchange further noted:

“This is the first step in regulatory action required to bridge the crypto economy into traditional financial infrastructure. … while the OCC is the federal regulator, it is not the only regulator. There will be an interplay between the interpretation of this guidance from the state vs federal level.”

The report concluded:

“Separately, adoption will take time — blockchains are still relatively new and lack some core features (e.g. privacy, scalability), but this is a promising development. To their credit the Treasury has since extended the comment period, and the proposal potentially hangs in limbo with the incoming Biden administration.”

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How Tax Authorities Should Treat Cryptocurrency Staking Rewards

Let me start with a confession: I am not smart enough to be a tax lawyer, certainly not a US tax lawyer.  The intricacies of the US tax code defy my brain’s attempts to systematize a coherent taxonomy.  The tax code is too complex and varied for me, even though I have spent my nearly 30-year career untangling the complicated schemes of the federal securities laws and financial services regulatory regimes.  And on top of the rules themselves, there are interpretations and lore that compound the difficulty.

Fortunately, there are people like Abe Sutherland, the author of numerous articles on one very particular area of US tax law: the treatment of cryptocurrency staking rewards created on public, permissionless blockchain platforms that use a proof of stake consensus mechanism (described in more detail below).  Most recently, he put together a primer on the question as a way to introduce more people to the correct analysis.  

Abe thinks this issue is easy because the cryptocurrency tokens created through staking, what he calls “reward tokens”, are new property deserving the same treatment as crops grown from seeds, livestock born on the farm, newly mined precious metals, novels, or songs newly written, newly manufactured items, and the idea for a new financial instrument.  As the primer notes:

“New property . . . is never immediate income to its first owner.”  Rather, “[n]ew property gives rise to taxable income when it is sold, not when it is created.”

I quickly grasped this concept because it made sense with my understanding of how proof of stake consensus works on these blockchain platforms.  An alternative to proof of work consensus used in the original Bitcoin blockchain, proof of stake is the means by which the system and certain of its participants agree on updates to the blockchain.  Put another way, it is how the database gets updated with new information.  

IRS Internal Revenue Service

IRS Internal Revenue ServiceAt its core, proof of stake requires numerous tokenholders to “lock” the native system tokens they hold into the platform for the ability to take turns adding the blocks of data that build the blockchain and update its database.  The tokens are “locked” by posting them into the platform’s staking application (part of its programming) that freezes the tokens so they cannot be transferred until removed from the application. The locked tokens form the tokenholder’s “stake,” which the staking application then evaluates in accordance with its programming to determine when the particular tokenholder takes their turn at validating a block (that is, adding the information to the blockchain database).  

The exact methodology used to pick how stakers take turns doing validation is not significant to the tax analysis because for the new property tax analysis it must be true that the validator’s act of forming the latest block simultaneously creates one or more new native system tokens.  These new tokens indicate to everyone that the block has been added to the blockchain and incentivize tokenholders to conduct the important activities of staking tokens and forming blocks in order to secure the network.  That security is achieved by adding new blocks that make the chain too long for an attacker to duplicate with incorrect or manipulated data.  Having lots of staking tokenholders also results in the distribution and decentralization of the network that are required for security and immutability.  The stakers’ job is critical to the survival and integrity of the platform, which in turn is why the forming of a new block results in the creation of new native system tokens.

In addition to the intuitive “new property” analysis, Abe’s primer discusses several other reasons for taxing staking rewards upon sale rather than upon acquisition. 

“To simplify, . . . [t]he practical problems involve the administration of the income tax and the costs of compliance [and t]he economic problem arises from the overstatement of gain – and resulting overtaxation . . ..”  

The primer then explains the practical problems by laying out in detail how difficult or impossible it would be to know when a reward token was created by a staker for purposes of establishing the time at which it would have to be valued under a tax scheme that treated reward tokens as compensation.  Even without the timing question, there are questions about what data source(s) would establish the value.  The primer provides examples of these points utilizing the Tezos, Cosmos and Ethereum 2.0 blockchains.  Both of these problems are solved by taxing reward tokens at the time of sale, when both the correct moment and valuation are easily ascertainable.

The economic problem of overstatement of economic gain stems from the fact that reward tokens do not represent a commensurate increase in the staker’s percentage of all outstanding tokens.  Reward tokens increase the overall token supply and are typically distributed pro rata to all stakers. They, therefore, are not the equivalent of an outsized benefit to the staker who created any particular reward, as one would expect from “compensation.”  As such, the economic benefit to the creating staker is not a payment or income but just a prorated portion of the overall system inflation.

With the analytical framework, practicalities and economic realities supporting his conclusion, Abe continues his quest to make sure everyone understands these issues and sees the proper tax treatment.  With his pleasant demeanor, simple explanation, and dogged determination, the Proof of Stake Alliance (“POSA”), which sponsors his work, has an effective advocate. 

Abe certainly took this scared taxpayer and made me understand.  Perhaps 2021 will be the year that tax authorities agree with him.

Disclosure:  POSA is the leading policy and advocacy organization for proof of stake blockchain networks.  I joined POSA’s Board of Directors effective January 1, 2021, but Abe and I have been discussing his analysis for a good part of 2020.

Lee A. Schneider is General Counsel at Block.one, one of the world’s largest blockchain companies and creator of the EOSIO blockchain protocol.  In that role, Schneider is responsible for various aspects of the legal function as well as the company’s government affairs initiatives. He joined Block.one after leading the blockchain, Fintech, and broker-dealer practices at two major international firms.  Lee has been recognized as one of the leading voices in blockchain-related regulation and compliance and has played a role in structuring several of the largest and most successful blockchain-related projects. Schneider co-hosts the Appetite for Disruption podcast with Troy Paredes and is the contributing editor for the Chambers and Partners Fintech Practice Guide. He is the contributing editor of the Chambers and Partners 2019 Fintech Practice Guide. All views expressed are in his personal capacity and reflect only his personal views and not those of Troy, Chambers, or block.one or its directors, officers or employees. His views do not constitute legal, investment or any other type of advice.

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US House Committee on Financial Services Schedules Hearing on Gamestop Trading, Market Volatility

Representative Maxine Waters, Chairwoman of the House Committee on Financial Services, has scheduled a hearing to address the trading in Gamestop shares as well as the broader issue of market volatility. The hearing, entitled “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide” will take place on February 18, 2020, beginning at 12 noon.

While it is anticipated that the CEO of Robinhood, Vlad Tenev, will testify the list of participants in the hearing has not yet been posted.

Representative Waters stated last week:

“Hedge funds have a long history of predatory conduct and that conduct is entirely indefensible. Private funds preying on the pension funds of hard working Americans must be stopped. Private funds engaging in predatory short selling to the detriment of other investors must be stopped. Private funds engaging in vulture strategies that hurt workers must be stopped.

“Addressing that predatory and manipulative conduct is the responsibility of lawmakers and securities regulators who are charged with protecting investors and ensuring that our capital markets are fair, orderly, and efficient. As a first step in reining in these abusive practices, I will convene a hearing to examine the recent activity around GameStop (GME) stock and other impacted stocks with a focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors.

“We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price.”

The hearing will be live-streamed on the House Committee’s website.

Expectations are for the US Senate to hold a hearing as well.

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