TABB Forum Who’s in Charge? Evaluating the Regulatory Landscape for Digital Assets By Herb Kozlov, Trevor Levine, and Christine Trent Parker, Reed Smith Regulatory oversight of cryptocurrencies has seen a dramatic increase in the United States. While federal agencies have clarified that certain virtual currency-related activities may be subject to existing regulations, state agencies have taken the lead in issuing new regulations targeting virtual currencies. To provide an overview of the difference between the two approaches, Reed Smith attorneys examine developments in two key states as well as how the SEC and CFTC have been using their traditional frameworks to regulate the digital asset markets. The recent dramatic increase in the use of virtual currencies such as bitcoin has led to a corresponding increase in regulatory oversight in the United States, particularly in the past two years. While various federal agencies have clarified through guidance that certain virtual currency­­-related activities may be subject to existing regulations (such as those governing money transmission), state agencies have been taking the lead in issuing new regulations specifically targeting virtual currencies. To provide an overview of the difference between the two approaches, we will first examine developments in two key states seeking to lead the way in crafting a responsive regulatory framework: New York and Wyoming. Next, we will examine how the Securities and Exchange Commission and Commodity Futures Trading Commission have been using their traditional frameworks to regulate the digital asset markets. State Regulatory Developments In 2019, both New York and Wyoming sought to add clarity to digital asset markets through both rulemaking and legislation. New York In December 2019, the New York Department of Financial Services proposed to update its regulations governing virtual currency licensees (i.e., those entities holding a BitLicense or trust charter) by adding: 1) a list of all coins permitted to be used in the virtual currency-related business activities of licensees without prior approval by DFS; and 2) a proposed model framework that licensees can utilize to create their own coin-listing policy, which could be used by licensees to self-certify the listing of new coins without DFS approval. If these rules are adopted, licensees will have more clarity about the legality of using specific currencies and a clear path forward to utilizing new virtual exchanges. Wyoming In February 2019, the Wyoming Legislature passed three laws adding clarity to the Wyoming digital asset regulatory landscape. SF0125 recognizes digital assets as property – paving the way for banks to custody digital assets – and defines them as “a representation of economic, proprietary or access rights that is stored in a computer readable format, and includes digital consumer assets, digital securities and virtual currency.” HB0185 permits corporations to issue tokenized stock certificates. And, finally, on Oct. 1, 2019, pursuant to HB0074, Wyoming began accepting applications from entities seeking to charter a special purpose depository institution, or SPDI. HB0074 was specifically enacted in response to the inability of blockchain innovators to access traditional banking services. Entities that become chartered SPDIs will be able to receive deposits, conduct asset management activities and provide custodial services. In order to keep pace with innovation, to attract new fintech companies to their states and to provide market participants with regulatory clarity, both Wyoming and New York have chosen to update their regulatory regimes through legislation and rulemaking. Federal Regulatory Developments In 2019, the SEC and CFTC took a slightly different approach to the digital asset regulatory landscape than their counterparts in New York and Wyoming. While both agencies remain highly active in the space, both have predominantly relied on enforcement and the release of nonbinding frameworks and statements to stake out their positions on key digital asset-related issues. Securities and Exchange Commission In April 2019, SEC FinHub published a framework aimed at providing clear guidelines for market participants to analyze whether a digital asset is an “investment contract” and therefore a security under the U.S. securities laws. While the framework included several factors to weigh when considering the proper classification of a particular digital asset, it did not add any concrete or binding principles. In October 2019, the SEC took a decisive enforcement action in initiating an action against Telegram Inc. in the U.S. District Court of the Southern District of New York. The SEC is seeking an injunction against the launch of Telegram’s new blockchain ecosystem and companion virtual currency. In the complaint, the SEC alleged that Telegram sought to circumvent registering its new virtual currency as a security. Telegram argues in its answer that the virtual currency is a currency or commodity, not a security, and therefore is outside the SEC’s jurisdiction. The parties will argue their sides at a hearing on the court’s order to show cause in February 2020. Digital asset market participants are following the matter closely, as the court’s decision could go a long way toward adding clarity to what constitutes a security in the world of digital assets. Commodity Futures Trading Commission The CFTC continued to pursue enforcement actions against virtual currency schemes charged with being fraudulent. While these actions are fundamental to the CFTC’s mandate to protect retail investors, they do not add much clarity to its regulatory approach to digital assets, as they are primarily traditional fraud cases. Looking ahead, there are signs that the CFTC will play a bigger role in the digital asset regulatory space. In 2019, the CFTC approved the applications of several entities to become designated contract markets and derivatives clearing organizations that offer and clear derivatives in virtual currencies. The CFTC’s ability to apply all of its regulatory authority in the digital assets markets will help bring greater clarity to and understanding of market participants, market fundamentals and new products. In addition to having increased visibility into virtual currency markets through regulatory authority over related derivatives markets, the CFTC is also expected to release its final rulemaking on what constitutes actual delivery of a digital asset with respect to retail commodity transactions in virtual currency, thereby providing added clarity to participants seeking to offer virtual currencies to retail customers on a leveraged or margined basis. Looking Forward These recently promulgated state regulatory regimes and statutes, along with the guidance provided by state and federal agencies regarding the application of existing regulations to virtual currency, have major implications for companies engaged in virtual currency activities from a licensing, supervision, compliance and cost perspective. Though many questions remain, the sustained growth of virtual currencies will no doubt continue to solicit attention from regulators and legislators, leading to additional regulation and greater clarity in the coming years to protect market participants. Herb Kozlov, Trevor Levine and Christine Trent Parker are attorneys in Reed Smith’s global Fintech practice. TabbFORUM is an open community that provides a platform for capital markets professionals to share their ideas and thought leadership with their peers. The views and opinions expressed are solely those of the author(s). 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