NY PRIME CONFERENCE:
OCTOBER 17, 2019
Disruptions from the FinTech Sector:
What’s Coming and How Should We
Prepare: An Overview of the Regulation
Special Counsel and Chair,
Financial Markets and Regulatory
Katten Muchin Rosenman LLP
Distributed Ledger Technology and
Distributed ledger technology or DLT is an umbrella term used to
describe technologies which store, distribute and facilitate the
exchange of value between users, either privately or publicly
Distributed ledgers programmatically reach agreement on the
information stored on the ledger through a “consensus mechanism”
with respect to the status of, or changes to, certain shared data
Distributed ledgers enable peer-to-peer exchange without the need for
a trust third-party intermediary
A blockchain is one type of DLT where shared data is grouped
together and organized chronologically into blocks that are
interconnected to each other and secured by cryptography
Public vs Private Distributed Ledgers
Public (open sourced and not permissioned; anyone may participate
Permissioned blockchains (private)
• Consortium blockchains (operate under the leadership of a group)
Utility Settlement Coin
• Private (permissions are kept centralized to one organization)
• IBM Food Trust (connects participants across the food chain through a permissioned, permanent and shared record of food system
Walmart is requiring all vendors who supply leafy greens to the retailer to use IBM Food Trust to track their produce back to the
point of origin
• Carrefour (using IBM Blockchain platform)
Customers are able to scan QR barcodes on a product with their phone and obtain information such as its date of harvest, farm
location and owner, packing date, how long it was transported and tips on how to prepare it
• LVMH (in partnership with ConsenSys and Microsoft)
AURA, a blockchain for proving the authenticity of high-priced goods, launched in May 2019
Louis Vuitton and Dior are the first two brands using AURA
• Insurewave, a blockchain platform to support marine hull insurance, is a joint venture between Ernst & Young and Guardtime which
launched in 2018
• It will support more than half a million automated ledger transactions and help manage risk for more than 1,000 commercial vessels in
the first year
• Stablecoins, cryptocurrencies backed by assets or a basket of assets, allow transfers anywhere in the world in minutes instead of
days for very little cost
• Stablecoins backed by sovereign currencies are the most common; value pegged to one or more currencies in a fixed ratio
Consensus mechanisms are protocols to ensure all nodes on a blockchain are synchronized with each other
and agree on which transactions are valid/legitimate and are added to the blockchain
• Proof of Work (referred to as “mining)
Nodes are induced to compete for the right to publish a new block by solving computationally intensive puzzles; the first
to solve the puzzle creates a new block and is rewarded with a cryptocurrency
Requires a tremendous amount of energy
Low transaction volume as compared to legacy transaction processing systems
• Proof of Stake
The right to publish a new block is determined by the node’s current investment in the blockchain-participants stake
their cryptocurrency to partake in the validating process
The idea here is that if an owner puts up it’s own assets, it is now incentivized to validate the legitimate transactions
If a fraudulent transaction is validated, the node loses it stake
If the right transactions are validated, the owner receives transaction fees
Requires less energy than proof of work, but low transaction volume as compared to legacy transaction processing
• Generally use less complicated mechanisms due to the closed-off nature of those blockchains
Neither smart nor legal contracts
Self-executing computer programs which facilitates transaction
automation and eliminates the need for intermediaries
• If/when-then conditional statements
Enables peers on a distributed ledger network to exchange
value without counterparty risk
Blockchain based smart contracts are visible to all users of a
blockchain, which means the code is open to vulnerabilities
Types of Cryptocurrencies
There are three principal types of cryptocurrencies; they each serve different
functions. Although all are termed cryptocurrencies, they all are solely entries
on a decentralized distributed ledger.
• Some serve principally as a medium of exchange and store of value, like Bitcoin;
they operate as a virtual currency.
• Some reflect an interest in an enterprise and are likely securities, like DAO and
REcoin. They might be initially issued as part of initial coin offerings (ICOs); they
may be associated with pre-sales (SAFTs). They are often referred to as digital
• Others are structured as utility tokens, giving preferential rights to use the output of
a new project. These also may be deemed securities.
Cryptocurrencies may morph from one function to another during their lives,
like security futures (e.g., similar to how a broad-based stock index futures
contract may become a narrow-based stock index futures contract). They may
have multiple purposes throughout.
On July 25, 2017, the SEC Report of Investigation regarding DAO found that
digital tokens issued by an entity for the purpose of raising funds for projects
may be considered securities under federal law.
The SEC based its conclusion that DAO tokens were securities on the four-
part test articulated in SEC v. W.J. Howey.
• The elements of an investment contract are an (1) investment of money (2) in a
common enterprise (3) with a reasonable expectation of profits (4) to be derived
solely from the entrepreneurial or managerial efforts of others.
The SEC additionally raised the possibility that a virtual organization might be
required to register as an investment company and a securities exchange.
However, not all digital tokens are securities. on June 25, 2019, SEC
Chairman Jay Clayton confirmed that BTC does not meet the Howey test and
is therefore not a security, but he was reluctant to comment on the status of
the ETH and XRP.
How are Security Tokens Regulated in
Security tokens are subject to federal and state securities regulation:
• A new security must either be registered with the SEC (and potentially states) or meet an exemption.
• In September 2018, a US federal court in Brooklyn, New York, declined to dismiss a criminal indictment against
Maksim Zaslavskiy charging him with securities fraud and related offenses in connection with two
cryptocurrency investment schemes and their related initial coin offerings. The court ruled that, at least for the
basis of the defendant’s motion to dismiss, the government had sufficiently alleged that the relevant digital
assets were securities and that the relevant law prohibiting fraud is not unconstitutionally vague as applied in
Offers and exchanges:
• Exchanges for digital tokens that are securities must be registered as a national securities exchange or be
exempt from such registration requirement (e.g., broker-dealers operating alternative trading systems).
• Under SEC and state law, participants should be aware of potential broker-dealer registration requirements.
• Participants in the business of giving advice about securities to clients are investment advisers and may be
required to register with the SEC.
• An investment company is a vehicle that issues securities and is predominantly involved in the business of
investing in securities. Under the Investment Company Act, investment companies must register with the SEC
or qualify for an exemption from registration.
Litigation – SEC/SEC Follow-up
In December 2017, Munchee Inc., a company offering digital tokens to raise capital for its
blockchain-based food review service halted its ICO after the SEC found that Munchee’s
conduct constituted unregistered securities offers and sales. The Munchee order made it
clear that a cryptocurrency will be deemed a security if its holders purchase the token with
the expectation that it will rise in value principally based on the managerial efforts of others.
In September 2018, William Hinman, the SEC Director of the Division of Corporation Finance,
said that the cryptoasset Ether is not a security. It may have once been a security, but not
today. As a result, transactions involving Ether are not securities transactions. Mr. Hinman
additionally indicated that he could envision that certain utility tokens might also not be
securities. He said that such a conclusion might be appropriate “where there is no longer any
central enterprise being invested in or where the digital asset is sold only to be used to
purchase a good or service available through the network on which it was created.”
In April 2019 the SEC’s Strategic Hub for Innovation and Financial Technology issued
specific guidance on what characteristics a cryptoasset might have that could make it more
likely to be deemed an investment contract, and thus a security, under US securities laws.
FinHub noted that these characteristics pertain not solely to the “form and terms” of the digital
asset itself, but also “the means in which it is offered, sold or resold (which includes
secondary market sales).”
Litigation – SEC/SEC Follow-up
Generally, FinHub wrote, purchasers would more likely be relying on the
efforts of others if, in connection with a cryptoasset, a promoter, sponsor or
other third party, or an affiliated group of third parties (each defined as an
“Active Participant” or “AP”) has a principal role in developing, operating or
promoting the cryptoasset, or the network or project with which it is
associated, or creates or supports a market or the price of the digital asset.
This would be particularly relevant, said FinHub, where a network is still in
development and not fully functional, and an AP “promises further
developmental efforts in order for the digital asset to attain or grow in value.”
Where cryptoasset purchasers would reasonably expect an AP for its own
benefit to undertake efforts to enhance the value of a digital asset, or the
network or project, the third prong of the Howey test is more likely satisfied,
Litigation – SEC/SEC Follow-up
The SEC views cryptoassets (1) issued in ICOs or pre-ICO offerings (2) to fund
non-developed projects (3) marketed as an opportunity to gain profits through
secondary market trading if the project was successful (4) relying on the
managerial or entrepreneurial efforts of the projects’ promoters, as securities that,
if sold to the general public, must be registered under applicable law.
The SEC has now brought and settled two enforcement actions following ICOs
where fraud was not alleged, but solely an unlicensed offering. Both respondents
were offered an opportunity to remediate:
• In an enforcement action against CarrierEQ Inc. d/b/a AirFox, the SEC alleged that the
company issued digital tokens on the Ethereum blockchain – termed “AirTokens” – to
raise funds to develop a “new, international business and ecosystem” that would permit
holders to transfer AirTokens to each other, engage in peer-to-peer lending, and to buy
and sell goods and services, as well as take advantage of existing company
• In its enforcement proceeding against Paragon Coin, Inc., the SEC claimed that the
company initiated an ICO to raise funds to bring blockchain technology to the cannabis
industry and promote the legalization of cannabis.
Litigation – SEC/SEC Follow-up
Both companies promoted their ICOs as an opportunity to profit through appreciation in
the price of their tokens, said the SEC. Neither AirFox’s nor Paragon’s
blockchain-based business models were up and running at the time of their ICOs,
which were marketed, noted the SEC, to the general public. Each company said they
would take steps to list their tokens on secondary markets.
To resolve these actions, each respondent agreed to pay a fine of US $250,000, file a
registration statement with the SEC, and pay back, upon request, any initial purchaser
of a digital token from the issuer. This pay back undertaking does not appear to apply to
any secondary market purchaser of a digital token.
Contemporaneously with publication of its two settlement orders, the SEC issued a
“Statement of Digital Asset Securities Issuance and Trading” by the Divisions of
Corporation Finance, Investment Management and Trading and Markets that reviewed
recent SEC enforcement actions against initial offerors and brokers of cryptosecurities,
investment vehicles investing in cryptosecurities, and secondary market facilities for the
trading of cryptosecurities. Among other things, the Division indicated that
the AirFox and Paragon settlements provided a “path to compliance” for prior issuers of
unregistered or not lawfully exempt cryptosecurities.
In April 2019, the SEC Division of Corporate Finance, issued its
first No-Action letter pertaining to the issuance of a token that is
considered not to be a regulated security.
TurnKey Jet proposed a token program for membership in an
air charter service. The TKJ tokens would be tied to a single
US dollar and only redeemed for services by members in the
program. TKJ requested that these digital assets not be
deemed securities under the Exchange.
Although the SEC did not write it explicitly in the no action
letter, the TKJ token does not meet the Howey test mainly
because there was no expectation of profits by holders.
• TKJ will not use any funds from Token sales to develop the TKJ Platform,
Network, or App;
• the Tokens will be immediately usable for their intended functionality
(purchasing air charter services) at the time they are sold;
• TKJ will restrict transfers of Tokens to TKJ Wallets only;
• TKJ will sell Tokens at a price of one USD per Token and each Token will
represent a TKJ obligation to supply air charter services at a value of one
USD per Token;
• If TKJ offers to repurchase Tokens, it will only do so at a discount to the face
value of the Tokens (one USD per Token) that the holder seeks to resell to
• The Token is marketed in a manner that emphasizes the functionality of the
Token, and not the potential for the increase in the market value of the Token.
Pocketful of Quarters
On July 25, 2019, the SEC issued a no-action letter to
Pocketful of Quarters (“POQ”) saying a digital token
designed to facilitate access to a multitude of online video
games would not be required to be registered as a
It granted no action to POQ because the digital tokens
(“Quarters”) did not meet the definition of an investment
contract pursuant to the Howey test. The Quarters were
immediately useable, made available in unlimited
quantities and fixed prices, and were encumbered with
restrictions on their use and transferability.
Virtual currencies are a commodity.
• Commodities are generally defined as any goods, articles, services, rights and interests “in which contracts for
future delivery are presently or in the future dealt in.”
• The CFTC first found that Bitcoin and other virtual currencies were properly defined as commodities in 2015, when
it filed and settled charges against Coinflip, Inc. and Francisco Riordan for operating a trading facility for Bitcoin
options without it being registered as a SEF or a DCM.
• On October 10, 2019, CFTC Chairman Heath Tarbert said, at the Yahoo All Markets Summit in NYC that ether too
is a commodity “and it would fall under our jurisdiction.”
Sale to retail clients:
• If financing is involved, actual delivery must be within 28 days, or must be registered as an FCM. Futures
transactions must be executed on or subject to the rules of a DCM.
• The Ninth Circuit Federal Court of Appeals is considering a decision by a California district court having nothing to
do with virtual currencies that will bear on “actual delivery”: CFTC v. Monex. In early 2018, the district court held
that actual delivery of precious metals in financed transactions to retail persons falls outside the CFTC’s
jurisdiction when ownership of real metals is legally transferred to such persons within 28 days – the so-called
“Actual Delivery Exception”– even if the seller retains control over the commodities because of the financing
beyond 28 days.
Sale of options on virtual currencies:
• Defined as swaps.
• All trading facilities for commodity options on cryptocurrencies must be registered with the CFTC as an SEF or a
Additionally, anti-manipulation authority of the CFTC adopted as part
of Dodd-Frank prohibits the use of any manipulative device or
contrivance in connection with transactions involving commodities in
• The ancillary CFTC rule adopted under Dodd-Frank prohibits the
intentional or reckless employment or attempt to employ any manipulative
device, scheme or artifice to defraud, to make any untrue or misleading
statement of a material fact or to omit a material fact.
• Traditional CFTC anti-manipulation authority is also relevant.
Litigation – CFTC
In June 2016, BFXNA Inc., doing business as Bitfinex, which operated an online platform for
trading cryptocurrencies, agreed to settle charges brought by the CFTC that it allegedly
engaged in prohibited, off-exchange commodity transactions with retail clients and failed to
register as an FCM, as required.
Relying on its broad anti-manipulation authority enacted as part of Dodd-Frank, the CFTC
recently filed an enforcement action against Gelfman Blueprint, Inc., and Nicholas Gelfman,
its CEO and head trader, for purportedly running a Ponzi scheme related to Bitcoin. These
allegations related to Bitcoin alone, and not to derivatives on Bitcoin. The defendant’s answer
argues that the CFTC is not authorized to seek relief as virtual currencies are not
On March 6, a federal court in New York affirmed that the CFTC has the authority to bring an
enforcement action against a person that has engaged in fraud involving a virtual currency,
even if the transaction does not involve a futures contract or other derivatives contract. The
enforcement action was against CabbageTech, Corp. and Patrick McDonnell, its owner and
controller, for unlawfully soliciting customers to send money and virtual currencies for virtual
currency trading advice and for the discretionary trading of virtual currencies by Mr.
McDonnell. The CFTC alleged that the defendants did not provide the promised services and
misappropriated their customers’ funds.
FinCEN oversees the application of the Bank Secrecy Act and USA PATRIOT
Act to companies.
In May 2019, FinCEN published a comprehensive overview of its regulations
and previously published guidance related to how individuals and firms may
have to comply with obligations for money transmitters to the extent they
engage in businesses involving so-called “convertible virtual currencies”
A firm or individual engages in money transmission, says FinCEN, when it
receives one form of value (including CVC) from a person and transmits it in
the same or different form to another person or location by any means.
FinCEN concludes, for example, that, applying this definition, a business
operates as a money transmitter when it accepts fiat currency from a person
and transfers the CVC to the person’s CVC account with the business.
Generally FinCEN requires any person engaging in the business of
money transmission or the transfer of funds, including CVC, to
(1) maintain an “effective” written anti-money laundering program
reasonably designed to prevent the business from being employed to
help the financing of terrorist activities and money laundering and
(2) register as a money service business.
According to FinCEN, it is the business model of a person engaging in
activities regarding CVC that dictates obligations of money
transmitters, not the “label used by industry to designate a general
type of product or service.”
The Financial Action Task Force recently urged member countries to require that virtual asset service
providers and already regulated financial institutions initiating virtual asset transfers should obtain and
retain certain information regarding each sender and intended recipient and forward that information to the
recipient’s obliged entity.
A VASP includes any legal or natural person not otherwise covered by anti-money laundering or
prohibitions against terrorism financing requirements that, as a business for or on behalf of other persons:
(1) exchanges virtual assets for fiat currencies or other virtual assets; (2) transfers virtual assets;
(3) safekeeps and/or administers virtual assets enabling control over such assets; or (4) participates in and
provides financial services related to an offer and/or sale of a virtual asset. VASPs could include virtual
asset exchanges and transfer services, and virtual asset wallet providers that host wallets or maintain
custody or control over other persons’ virtual assets, wallets or private keys, among other legal entities or
FATF also recommended a host of other requirements that countries should require of VASPs, including to
develop risk-based programs to address the risks of their businesses and conduct due diligence of all their
customers. This customer due diligence should include identifying a customer and, where applicable, the
customer’s beneficial owner, and verifying the customer’s identify on a risk basis utilizing “reliable and
independent information, data, or documentation as consistent with existing requirements for obliged
Although FATF's recommendations are not binding on any national authority, FATF encouraged its member
countries to take “prompt action” to implement its recommendations and will conduct a review of
implementation in June 2020.
In March 2018, OFAC updated its FAQs to include that persons subject to its
jurisdiction are prohibited from doing business with persons named on the
Specially Designated Nationals (SDN) and Blocked Persons list, whether
utilizing fiat or virtual currency.
OFAC indicated that it may add digital currency addresses to its SDN list to
alert the public of specific digital currency identifiers associated with blocked
Persons that identify digital currency identifiers or addresses associated with
prohibited persons should take the steps to block the relevant digital currency
and file a report with OFAC.
In May 2018, NFA issued a notice reminding FCMs and introducing brokers to
comply with the recent OFAC guidance for virtual currency transactions.
Most states regard transactions in virtual currencies as part of a
business as being subject to money transmitter requirements.
All states other than Montana have a money transmitter statute.
Statutes vary but most define money transmission as one or more of:
• selling stored value,
• receiving money or monetary value for transmission,
• transmitting money, and/or
• selling payment instruments or checks.
Agents of Money Transmitters
There is no consensus among state regulators on how to interpret the
foregoing provisions (e.g., Georgia takes the position that virtual
wallets are payment instruments; Illinois has concluded that virtual
currencies are not “monetary value” or “instruments” subject to its
money transmitter law).
To date, Illinois, Kentucky, Pennsylvania, Tennessee, Texas and
Washington have issued specific guidance on cryptocurrency
In New York, such transactions are also subject to NY BitLicense
NYDFS has implemented BitLicense regulations with respect to
Bitcoin and other virtual currencies.
These regulations require the licensing of, and establish minimum
standards of conduct for, any person who engages in virtual currency
business activity involving New York or a New York resident.
Virtual currency business activity includes:
• Receiving virtual currency for transmission or transmitting it.
• Storing, holding or maintaining control of virtual currency on behalf of
• Buying and selling virtual currency as a customer business.
• Controlling, administering or issuing a virtual currency.
Any person engaged in the business of receiving money for transmission or
transmitting the same must be licensed as a money transmitter.
This likely includes, but is not limited to, e-wallets, exchanges, payment
processors, dealers, virtual currency ATMs and administrators.
• Extended and burdensome application process – NYDFS has ninety days to
approve or deny a license application from the filing of an application NYDFS
determines to be complete.
• Anecdotally, process may take 6-8 months. NYDFS conducts extended due
diligence of applicant.
Approximately 20 BitLicenses and trust charters with virtual currency
authorization issued to date
FinCEN, State Regulation: No Apparent
General Exemptions or Exclusions
• “Money services business” does not include a “person registered with,
and functionally regulated or examined by, the SEC or the CFTC, or a
foreign financial agency that engages in financial activities that, if
conducted in the United States, would require the foreign financial agency
to be registered with the SEC or CFTC.”
• National Futures Association required disclosure for CFTC
registrants/NFA members: [NAME OF NFA MEMBER] is a member of
NFA and is subject to NFA's regulatory oversight and examinations.
However, you should be aware that NFA does not have regulatory
oversight authority over underlying or spot virtual currency products or
transactions or virtual currency exchanges, custodians or markets.
FinCEN, State Regulation: No Apparent
General Exemptions or Exclusions
• A registered futures commission merchant under the federal
commodities laws or a person registered as a securities
broker-dealer or investment advisor under federal or state
securities laws to the extent of its operation as such.
Access: Centralized Exchanges
Off blockchain entities that facilitate conversions of fiat currency to
cryptocurrencies, cryptocurrencies to cryptocurrencies or cryptocurrencies to
Some centralized exchanges, such as Bittrex, also allow for the trading of
May solely offer exchanging services or order books.
May offer custody services or provide wallet services to customers.
Transactions on an exchange are not on the blockchain; they are on the
exchanges’ private ledger.
Typically require KYC compliance and identity document submission.
May be faced with downtime or hacking attempts.
Examples: Binance, Bittrex, Gemini
Centralized Exchanges: Issues
There have been well publicized losses of digital assets by centralized exchanges:
• Mt. Gox
Legal and compliance staff supporting a firms trading or facilitation of trading by third
parties on a centralized exchange should consider:
• Ownership and control
• Basic operation and fees
• Trading policies and procedures
• Outages and other suspensions of trading
• Internal controls
• Cybersecurity and business continuity
• Privacy and money laundering
Access: Decentralized Exchanges
A new technology that facilitates cryptocurrency trading on a
Order solicitation and preliminary coupling with a counterparty may
occur off exchange.
Does not rely on a third-party service to hold the customer’s funds.
Trades are peer-to-peer through an automated process.
Examples: Bitsquare, 0X, EtherDelta
In November 2018 the SEC brought and settled charges against Zachary
Coburn for enabling EtherDelta, an online platform that allows persons to buy
and sell crypto-assets, many of which have the attributes of securities, to
operate as an exchange without registering as a national securities exchange
or operating pursuant to a lawful exemption, as required, from July 12, 2016,
through December 15, 2017.
EtherDelta uses smart contracts to effectuate executions between parties.
The SEC charged that, during the relevant time, Mr. Coburn wrote and
deployed the EtherDelta smart contract, and “exercised complete and sole
control over EtherDelta’s operations.” He also apparently approved which
digital tokens could be traded on the trading facility. As a result, he should
have known that his actions would cause EtherDelta to operate in violation of
requirements to register as a national securities exchange or to be lawfully
Access: National Securities
Exchanges and ATSs
In March 2018, the SEC stated that entities aiming to operate as an
ATS are subject to regulatory requirements and should register with
the SEC as a broker-dealer and become a member of an SRO.
• Liquid M Capital LLC / Templum
• Coinbase has reportedly entered into discussions with the SEC about
becoming an ATS.
There are no national securities exchanges that trade digital tokens.
On July 8, 2019, the SEC’s Division of Trading and Markets and FINRA issued a Joint
Staff Statement on Broker-Dealer Custody of Digital Asset Securities.
Considerations for Broker-Dealers that Take Custody of Digital Asset Securities
• For non-digital assets, compliance with the Customer Protection Rule for securities is generally
satisfied through third parties, such as the Depository Trust Company or a clearing bank, a
process that also allows for reversing or cancelling erroneous transactions.
• Regarding digital securities, the Staffs asserted that the mechanics and risk associated with
custody are different and may create greater risk of fraud or theft, including:
A broker-dealer could lose the “private keys” necessary to transfer a client’s digital asset securities or
could transfer a client’s digital asset securities to an unintended address without the ability to invalidate
fraudulent transactions or correct errors.
Uncertainty as to whether maintaining “private keys” is sufficient to establish the exclusive control of
digital asset securities required by the Customer Protection Rule.
• Good Control Locations
The joint statement suggested that depending on the type of securities, third-party custodians (such as
the Depositary Trust Company or an issuer’s transfer agent) may serve as good “control locations”
because these methods could protect clients from broker-dealer misappropriation and failure and allow
the ability to reserve or cancel mistaken or unauthorized transactions.
Non-Custodial Broker-Dealers Arrangements
• Some applicants seeking FINRA approval propose to engage in activities
that do not involve taking custody of digital asset securities.
• The joint statement appears to indicate that seeking approval for such
business activities may be easier as compared to businesses with
custodial activities because such activities do not raise the same level of
concern among the Staffs.
• Certain examples highlighted by the joint statement include execution-
only arrangements where the parties settle away from the broker-dealer:
Broker-dealers that resemble a private placement agent
Broker-dealer is an over-the-counter (OTC) market facilitator for digital assets
Broker-dealer that operates an alternative trading system (ATS) for digital
On December 1, 2017 three exchanges regulated by the CFTC self-certified
cash-settled derivatives contracts based on Bitcoin.
• Chicago Mercantile Exchange and the CBOE Futures Exchange proposed to offer
margined futures contracts related to the price of Bitcoin.
CBOE Futures has determined to cease listing additional Bitcoin futures contracts; the last
CBOE Futures contract expires this month.
In contrast, open interest for CME’s Bitcoin futures contract recently hit record highs.
• Cantor Exchange self-certified a fully collateralized binary options based on the
price of the same virtual currency, but ultimately determined not to list the options.
• On December 18, 2017, the non-intermediated exchange began offering trading in
Nadex Bitcoin Spreads. Nadex subsequently delisted the product.
TeraExchange, LLC, a CFTC-regulated SEF, listed uncleared, non-deliverable Bitcoin
swaps in 2014.
In July 2019, the CFTC approved Eris Clearing, LLC to clear fully collateralized virtual
currency futures contracts potentially deliverable into spot cryptocurrencies. In 2011,
the CFTC had approved Eris Exchange, LLC as a designated contract market. Branded
together as “ErisX,” Eris Clearing anticipated offering the clearing of digital asset futures
contracts traded on Eris Exchange.
In approving ErisX’s order, the CFTC provided a path forward for CFTC registrants
wanting to handle cryptocurrencies processed in connection with exchange-traded
derivatives contracts to comply with its equivalent of the SEC’s customer protection
• It appears the CFTC has reasonable confidence that private keys can be protected through
robust policies and procedures that guard against both external and internal fraud, and that at
least certain cryptoassets can be seen and verified on their host blockchains. Private
insurance, disclosure and third-party validation also have an important role in the CFTC’s view
of a robust customer protection scheme involving digital assets.
In July 2017, LedgerX was approved by the CFTC as a DCO to clear fully collateralized digital
currency swaps, after the SEC approved it as a SEF. To gain registration as a SEF and DCO,
LedgerX had to demonstrate how it proposed to comply with core principles applicable to such
entities as required by law. However, in connection with its DCO approval, LedgerX was granted
exemption from complying with a few specific CFTC requirements because of its fully collateralized
• In June 2019, LedgerX was approved as a designated contract market. LedgerX’s swaps may result in the
making or taking of delivery of actual bitcoin. Under its DCM relief, LedgerX may now allow non-ECP persons
to execute and clear its approved swaps, except for futures commission merchants clearing on behalf of third
parties. According to the CFTC, an amendment to LedgerX’s DCO status is pending to allow it to clear futures
listed on the DCM.
In August 2019, “Intercontinental Exchange Inc., the parent of NYSE, gained approval that cleared
the way for its Bakkt unit to allow investors to buy derivatives that pay out with Bitcoins for the first
time. The New York State Department of Financial Services … granted a charter to Bakkt Trust Co.
to hold custody of customers’ tokens. The futures had already gotten a green light from the U.S.
Commodity Futures Trading Commission under a self-certification process.”
• Customer’s BTC is stored in the Bakkt Warehouse, a qualified custodian regulated by the NYDFS.
• Trading began on September 22, 2019.
What Does This Mean for Funds?
Any offer to sell securities must either be registered with the SEC or meet an
Regulation D contains exemptions from this registration requirement.
In general, securities acquired in a private placement are “restricted” and cannot be
resold without registration or an applicable exemption.
The JOBS Act includes a number of measures to facilitate capital formation, including:
• An IPO on-ramp for a new category of issuer, “emerging growth companies.”
• Removal of the prohibition against general solicitation and general advertising in certain private
• A new exemption under the Securities Act of 1933, as amended (Securities Act), for
• An amendment to the Securities Act (informally referred to as Regulation A+) permitting
companies to conduct offerings to raise up to $50 million through a “mini-registration” process
similar to Regulation A.
• Higher triggering thresholds for SEC reporting obligations under the Securities Exchange Act of
1934, as amended (Exchange Act).
The SEC has repeatedly failed to approve any exchange-traded fund based on bitcoin.
Most recently the SEC determined not to approve proposed rule changes by NYSE
Arca, Inc. to list and trade shares of the Bitwise Bitcoin ETF Trust. NYSE Arca filed its
initial request for a rule change in February 2019; the SEC first delayed its decision in
March 2019 and again in May 2019. The objective of the Trust was to mimic
performance of the Bitwise Bitcoin Total Return Index which was designed to measure
the performance of bitcoin as traded on 10 cryptocurrency exchanges located in the
United States, Europe and Asia. The Trust intended to store bitcoin in custody at a
regulated third-party custodian.
In February 2019, Cboe BZX Exchange, Inc. filed with the Securities and Exchange
Commission a proposed rule change to enable trading of shares of SolidX bitcoin
shares issued by the VanEck SolidX Bitcoin Trust. As proposed, each share in the trust
would represent a fractional interest in bitcoin holdings by the Trust. Cboe BZX initially
filed its rule change in connection with the VanEck SolidX Bitcoin Trust ETF in June
2018 and withdrew it in January 2019.
SEC Chairman Jay Clayton acknowledged in an interview on CNBC on September 9,
2019, that while the BTC market has taken steps to mature, there is still “work to be
done” before a BTC ETF can be approved, citing concerns about price manipulation
Broker-Dealer Considerations: SEC/FINRA Joint
SEC/FINRA Joint Statement on Custody of Digital Assets
• On July 8, 2019, the staffs of the Division of Trading and Markets of the
SEC and FINRA (“the Staffs”) published a joint statement articulating
concerns that appear to be delaying their approval for broker-dealers
facilitating digital asset security transactions for customers.
• The joint statement highlighted the importance of the Customer Protection
Rule, which is designed to safeguard customer securities and funds held
by broker-dealers to reduce the risk of loss in the event of a broker-
• The joint statement raised considerations with respect to broker-dealers
that (1) take custody of, or carry customers’ funds and securities, and (2)
• However, the statement largely failed to indicate what measures might be
taken to satisfy their concerns.
FinCEN, States: Doors to the Future –
Office of the Comptroller of the Currency (OCC)
• On May 6, 2019, SDNY determined that the NYDFS could proceed with its lawsuit
challenging plans of the OCC to accept and consider applications for
special-purpose national bank charters from financial technology companies that
have no intent to accept deposits.
Multi-state Licensing Program
• 23 participating states: CA, CT, GA, ID, IL, IA, KS, KY, LA, MA, MS, NE, NC, ND,
OH, RI, SD, TN, TX, UT, VT, WA and WY.
• Administered through Nationwide Mortgage Licensing System – online application
portal to submit common information and documents more efficiently. “Phase 1”
review state signs off on certain basic application materials. Specific “Phase 2”
state requirements. Process remains state-by-state.
SEC/FINRA Regulatory Initiatives
Both the SEC and FINRA will continue to monitor firms’ involvement in digital assets in
their examination priorities. Both the SEC and FINRA published investor alerts on
For firms actively engaged in the digital asset market, the SEC will conduct
examinations focused on custody, portfolio management of digital assets, trading,
safety of client funds and assets, pricing of client portfolios, compliance, and internal
FINRA will consider how firms determine whether a particular digital asset is a security
and whether firms have implemented adequate controls and supervision over
compliance with rules related to the marketing, sale, execution, control, clearance,
recordkeeping and valuation of digital assets, as well as AML/Bank Secrecy Act rules
FINRA was recently criticized for not taking action on about 40 firm applications to
engage in digital /crypto asset business, with some applications in the queue for over a
• In February 2018, the Swiss Financial Market Supervisory Authority (FINMA) endeavored to provide
some clarity regarding the different types of digital tokens – which it named "payment tokens," "utility
tokens" and "asset tokens.”
• According to FINMA, payment tokens are intended to be used as a means to acquire goods or
services, or as a means of money or value transfer. Because such tokens are meant to act as a
means of payment “and are not analogous in their function to traditional securities,” FINMA indicated
that, going forward, it would not treat payment tokens as securities.
• FINMA said that asset tokens represented assets such as a debt or equity claim on an issuer, or which
enabled assets to be traded on a blockchain. These tokens would be treated as securities. Also, pre-
financing and pre-sale phases of ICOs that grant rights to acquire tokens in the future, would also be
regarded as securities.
• FINMA defined utility tokens as tokens “intended to provide access digitally to an application or service
by means of a blockchain-based infrastructure.” The regulator indicated it would not consider utility
tokens as securities if the tokens’ “sole purpose” was to confer digital access rights at the time of
issue. However, if a utility token could additionally or only have an investment purpose at the time of
issue, it would be treated as an asset token too.
• Switzerland has now also issued guidance on stablecoins.
• In July 2019, the UK Financial Conduct Authority issued final guidance regarding how different
types of cryptoassets likely fall within its regulatory perimeter. Generally, the FCA concluded
that cryptoassets that do not provide rights or obligations typically associated with shares, debt
instruments or electronic money are not within its regulatory reach.
• Stablecoins are likely to be either regulated or unregulated depending on what rights or
obligations a holder may have associated with ownership of such tokens.
• The FCA said that cryptoassets akin to shares or debt instruments are likely within its
regulatory perimeter, while digital tokens that are effectively “electronically stored monetary
value” are likely subject to the UK’s e-money regime.
Additionally, over 130 countries and regional organizations have
issued laws/policies on cryptoassets.
111 Congress Avenue
Austin, TX 78701-4073
Comerica Bank Tower
1717 Main Street
Dallas, TX 75201-7301
LOS ANGELES –
2029 Century Park East
Los Angeles, CA 90067-3012
100 Spectrum Center Drive
Irvine, CA 92618-4960
2900 K Street NW
North Tower - Suite 200
Washington, DC 20007-5118
550 South Tryon Street
Charlotte, NC 28202-4213
1301 McKinney Street
Houston, TX 77010-3033
LOS ANGELES –
515 South Flower Street
Los Angeles, CA 90071-2212
1999 Harrison Street
Oakland, CA 94612-4704
525 West Monroe Street
Chicago, IL 60661-3693
65 St Paul’s Churchyard
London EC4M 8AB
575 Madison Avenue
New York, NY 10022-2585
Suite 4906 Wheelock Square
1717 Nanjing Road West
Katten refers to Katten Muchin Rosenman LLP and the affiliated partnership as explained at kattenlaw.com/disclaimer.
Attorney advertising. Published as a source of information only. The material contained herein is not to be construed as legal advice or opinion. www.kattenlaw.com
Notas del editor
Investopedia, SEC Chair Says Bitcoin is Not a Security (June 25, 2019) (https://www.investopedia.com/news/sec-chair-says-bitcoin-not-security/).
See “SEC Corp Fin Says Gaming Digital Token Not Marketed as an Investment Is Not a Security” in the July 28, 2019 edition of Bridging the Week (https://www.bridgingtheweek.com/Commentary/PostDetails/2569); see also SEC, Response of the Division of Corporation Finance Re: Pocketful of Quarters, Inc. (July 25, 2019) (https://www.sec.gov/corpfin/pocketful-quarters-inc-072519-2a1).
7 U.S.C. § 6d.
SEC, LedgerX Order of Registration (July 24, 2017) (https://www.cftc.gov/sites/default/files/idc/groups/public/@otherif/documents/ifdocs/ledgerxdcoregorder72417.pdf); see also “LedgerX Approved by CFTC as First Derivatives Clearing Organization for Fully Collateralized Swap Contracts Potentially Settling in Bitcoin” in the July 30, 2017 edition of Bridging the Week (https://www.bridgingtheweek.com/Commentary/PostDetails/2470#.XY5i4kZKiUk).
See “LedgerX Approved by CFTC as First Derivatives Clearing Organization for Fully Collateralized Swap Contracts Potentially Settling in Bitcoin” in the July 30, 2017 edition of Bridging the Week (https://www.bridgingtheweek.com/Commentary/PostDetails/2470#.XYjsPEZKiUl); see also CFTC, CFTC Grants DCO Registration to LedgerX LLC (July 24, 2017) (https://www.cftc.gov/PressRoom/PressReleases/pr7592-17).
See “LedgerX Authorized to Offer Physically Settled Bitcoin Swaps to Retail Persons by CFTC Order” in the June 30, 2019 edition of Bridging the Week (https://www.bridgingtheweek.com/Commentary/PostDetails/2565#.XZUOM0ZKiUm); see also CFTC, CFTC Approves LedgerX LLC as a Designated Contract Market (June 25, 2019) (https://www.cftc.gov/PressRoom/PressReleases/7945-19).
Bloomberg, NYSE Owner to Offer Futures Paying Out in Bitcoin Next Month (Aug. 16, 2019) (https://www.bloomberg.com/news/articles/2019-08-16/nyse-owner-to-offer-futures-that-pay-out-with-bitcoin-next-month).
Bakkt, Regulated Infrastructure for Bitcoin Markets and Custody (Bakkt.com/markets).
CNBC, New York Stock Exchange Owner Launches Futures Contracts that Pay Out in Bitcoin (Sept. 23, 2019) (https://www.cnbc.com/2019/09/23/nyse-owner-ice-launches-deliverable-bitcoin-futures-contracts.html).
CNBC Transcript: SEC Chairman Jay Clayton Speaks with CNBC's Bob Pisani Today (Sept. 9, 2019) (https://www.nbcumv.com/news/cnbc-exclusive-cnbc-transcript-sec-chairman-jay-clayton-speaks-cnbc%E2%80%99s-bob-pisani-today).
SEC, Joint Staff Statement on Broker-Dealer Custody of Digital Asset Securities (July 8, 2019) (https://www.sec.gov/news/public-statement/joint-staff-statement-broker-dealer-custody-digital-asset-securities).
17 C.F.R. § 240.15c3-3; see also SEC, Customer Protection Rule Initiative (June 23, 2016) (https://www.sec.gov/divisions/enforce/customer-protection-rule-initiative.shtml).
See “Customer Protection ABC, How Does It Translate to Cryptosecurity Custody? – SEC and FINRA Provide Considerations for Broker-Dealers” in the July 14, 2019 edition of Bridging the Week (https://www.bridgingtheweek.com/Commentary/PostDetails/2567#.XYTZ62lKiUl).
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