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.
The week leading up to Thanksgiving was a busy one in blockchain law, with the SEC instituting another lawsuit against a major U.S.-based cryptocurrency exchange, the DOJ and CFTC reaching a settlement in their cases against international exchange Binance and Tether cooperating with the DOJ to freeze almost a quart of a billion dollars in its stablecoin linked to illicit finance. This all came a week after the House of Representatives held a subcommittee hearing to discuss the links between digital assets and criminal operations.
These developments and a few other brief notes are discussed below.
House Financial Services Subcommittee on Digital Assets Debates Issues Surrounding Illicit Use of Cryptocurrencies: November 15, 2023
Background: The House Financial Services Subcommittee on Digital Assets met on November 15 to ask questions from industry experts on the scale and use of digital assets in terror and other illegal financing. This was largely due to a wave of false or misleading reporting which is described well in this Forbes article, How Misinformation On Hamas And Crypto Fooled Nearly 20% Of Congress. As stated by Senator Lummis, “Crypto is not the problem, bad actors that exist in every industry are.” This hearing followed a letter that was sent from a bipartisan group of lawmakers asking for an executive study on the use of digital assets in Hamas financing.
Summary: The testimony of Gregory Lisa and Jane Khodarkovsky are both worth reading, and by all accounts, this hearing was a fair and honest look at digital assets which didn’t overplay its use in terror financing or underplay the serious security threat it represents. At the end of the day, anything of value, be it art, land, fiat currency, gold, crypto or anything similar, is going to be used by people we do not support for purposes that we do not endorse. However, of all the forms of illicit finance, only the movement of digital assets on a public blockchain can be traced in real-time by anyone with access to the internet. There is no means of exchange that is more anonymous than cash, which truly leaves no footprint, and there is no blockchain for cash. We certainly need to do what we can to limit the use of any asset in terror financing, but we also need to do it in a way that doesn’t abridge the rights of Americans to privacy and financial inclusion.
SEC Files Lawsuit Against Cryptocurrency Exchange Kraken: November 20, 2023
Background: The SEC has filed a lawsuit accusing the second-largest cryptocurrency exchange in the US of violating federal securities laws. Payward Inc. and Payward Ventures Inc., which operate the cryptocurrency exchange known as Kraken, are the latest to be accused of “unlawfully facilitating the buying and selling of crypto asset securities.”
Summary: It was odd this wasn’t filed when the Coinbase/Binance lawsuits were filed. Many assumed that Kraken’s prior $30 million settlement got the exchange some level of approval from the SEC for its remaining operations. That was wrong. While the SEC alleges that Kraken co-mingled customer funds, this is something Kraken self-reported years ago as an accounting issue which happened when Kraken switched accounting systems and they resolved thereafter. Kraken’s founder has pointed out that its cooperation and settlement with the SEC did not help the exchange avoid further litigation, and encouraged others in the space to avoid the U.S. under its current regulatory regime. Many of the tokens named in the lawsuit are used daily as utility tokens and are up big on the year, creating the question of exactly who the SEC is protecting in these actions? Also, the timing of this is certainly suspicious with SEC Chair Gary Gensler potentially front-running the major Binance settlement news his agency wasn’t a part of.
Tether Freezes $225 Million in Cryptocurrency Linked to Pig Butchering Scams and Human Trafficking: November 20, 2023
Background: Tether, working in concert with the DOJ and Chainalysis, has frozen $225 million worth of its own stablecoin linked to an international human trafficking syndicate in Southeast Asia. The freeze occurred across 37 self-custodial wallets. The funds were primarily linked to pig butchering scams, where users are tricked into thinking they are sending funds to a cryptocurrency trading platform only to be robbed and refused the ability to cash out.
Summary: It appears that Tether is working closely with the DOJ based on this and other recent cooperative asset freezes. This coincides with the recent push, at the request of Senator Lummis and Representative French Hill, to crack down on major offshore players in the digital asset space. With the Binance settlement discussed below and the DOJ working with a cooperative Tether, that request for attention was seemingly abided by. This is good for the space and shows when there are lawful reasons and court orders to freeze funds, that an asset freeze can still be done without over-intrusive financial surveillance.
Head of Binance Pleads Guilty to Bank Secrecy Act Charge and Steps Down: November 21, 2023
Background: On November 21, Binance and its CEO Changpeng Zhao (“CZ”) admitted to violations of anti-money laundering laws along with sanctions violations and operating as an unlicensed money transmitter. You can read the indictment here and the plea document here. As a part of the deal, CZ agreed to step down as CEO, have no involvement with Binance for 3 years, and Binance is required to appoint an independent compliance monitor for three years. Total fines and sanctions were just under $4 billion. CZ will plead guilty to a single count of failure to maintain an effective Anti-Money Laundering program under the Bank Secrecy Act, which carries a maximum sentence of five years. But due to various sentencing guidelines and downgrades, he is likely looking at a maximum of 18 months. CZ primarily lives in the United Arab Emirates, which is a non-extradition country with the U.S., making CZ’s agreement to appear in Seattle for sentencing all the more impactful.
Summary: There were rumors leading up to the eventual press conference regarding the charges and plea deal. The $4 billion is a massive fine but it looks like Binance was already getting ready to pay that for weeks now. CZ’s departure tweet is available here and the Binance official statement is here. Notably, the SEC was not a part of this settlement so its case against the exchange and CZ continues. It was well-known in the industry that Binance took some regulatory shortcuts in its rise to power, so this is not entirely surprising. This article provides a neat timeline of events leading up to this settlement. Hopefully the new CEO Richard Teng can continue on the path started by his predecessor of compliance with basic AML/KYC obligations. It is also interesting and likely smart that Binance tapped a former compliance officer and regulator to lead the new era of Binance instead of the other co-founder who is conspicuously absent from the settlement.
Coinbase Funded Challenged to Mixing Service Sanctions Decision Appealed: The decision in the Coinbase funded challenge to the Tornado.cash sanctions have been appealed. As you may recall, back in August the lower court hearing that matter ruled in favor of the Treasury Department and issued summary judgment. The Blockchain Association has filed a brief in support of the Tornado Cash request for appeal. This was a solid article breaking down the decision behind the filing and its implication on the larger industry.
Blackrock and Fidelity File Spot Ether ETF Applications: the Blackrock Spot Ether ETF application has officially been filed along with a matching filing from Fidelity. This comes at the same time as the SEC delays deciding on a variety of Bitcoin Spot ETF applications.
Lawmakers Send Letters to State Agencies on Digital Asset Issues: Patrick McHenry, Richie Torres, and a bipartisan group of other lawmakers sent multiple letters this the past two weeks including this letter expressing concerns with the proposed IRS digital asset broker reporting rules and this letter urging agencies not to enforce SAB 121 after the Government Accountability Office’s finding that the SAB violated the Administrative Procedures Act.
Domain Service Providers Fight over Patent Applications: The Ethereum Name Service (“ENS”) is in a fight with Unstoppable Domains over the aggressive patent application approach taken by the latter. ENS claims these patents are based on prior technology invented by ENS and others and intentionally put into the public domain for all to use.
The past two weeks have been a whirlwind of activity in blockchain law, illustrating the complex interplay between cryptocurrency, regulation, and enforcement. From the SEC's latest lawsuit against a major U.S. crypto exchange to Tether's proactive measures in freezing funds linked to criminal activities, these events highlight the evolving landscape of digital finance.
The House Financial Services Subcommittee's balanced discussion on the use of digital assets in illicit finance, along with significant legal developments involving major players like Kraken and Binance, underscores the ongoing challenge of ensuring security and compliance in a rapidly changing sector. As the industry continues to grapple with these issues, it becomes increasingly clear that the path forward requires a delicate balance between innovation, privacy rights, and the imperative to thwart financial crimes. The above events serve as a powerful reminder of the importance of vigilance, cooperation, and thoughtful regulation in shaping the future of digital currencies and their impact on global finance.