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NY DFS Proposes Self-Certification Process for Licensed Cryptocurrency Firms to Transact in New Virtual Currencies – Lexology

The New York Department of Financial Services proposed a simplified process to allow licensed virtual currency firms (i.e., those holding BitLicenses or trust charters) to more easily transact in virtual currencies approved for other licensees or never before approved.

As proposed, DFS will maintain a list on its website of all virtual currencies approved for transactions by licensed firms. Any licensee may transact in these digital assets without the prior approval of DFS, provided such cryptocurrencies have not been subject to any modification, division or change after their posting on DFS’s website. Virtual currencies proposed for initial inclusion on DFS’s website are bitcoin, bitcoin cash, ether, ether classic, litecoin, ripple, Paxos Standard and Gemini dollar.

A licensee desiring to transact in new digital coins would first have to adopt a coin listing or adoption policy (“listing policy”) that outlines all steps the firm would take to review and approve potential new virtual currencies not listed on DFS’s website. After having its policy approved by DFS, the licensee would be able to self-certify any new virtual currency and upon prior notice to DFS, transact in such coins without the agency’s prior consent.

Licensees without an approved listing policy would be required to seek DFS’s prior approval to transaction in new digital currencies as is currently the case. All licensees would be required to advise DFS of all digital coins they transact in no less than on a quarterly basis.

Virtual currency listing policies should be designed in light of each firm’s specific business model, operations, customers, geographies of operations, service providers and the specific characteristics of each cryptocurrency being evaluated. In its listing policy, each licensee should address its governance around approval; risks associated with a new coin; and ongoing monitoring to ensure transacting in the digital asset by the firm, after approval, “remains prudent.”

DFS will accept comments on its proposal through January 27, 2020.

(Click here for background on NY BitLicense requirements in the article “New York BitLicense Regulations Virtually Certain to Significantly Impact Transactions in Virtual Currencies” in a July 8, 2015 Advisory by Katten Muchin Rosenman LLP. Click here for additional information on the 2018 augmentation of requirements for persons conducting a NY virtual currency business in the article “NYS Financial Services Regulator Ups the Obligations of State-Licensed Virtual Currency Entities” in the February 11, 2018 edition of Bridging the Week.)

In other legal and regulatory developments regarding cryptoassets:

  • International Central Banks Organization Calls for Harsh Capital Treatment for Banks Holding Cryptoassets Exposure: The Bank for International Settlements issued a discussion paper suggesting that it might be appropriate for banks with direct or indirect exposure to cryptoassets to take up to a full deduction from their capital for the value of their exposure. This is warranted, said BIS, because of “the high degree of uncertainty about the positive realizable value of cryptoassets in times of stress.” BIS also suggested that banks should manage risks associated with crypto holdings “in a conservative manner,” and inform their regulators of any actual or proposed crypto exposures or activities. Any prudential treatment of cryptoassets should be “simple and flexible in nature” and should preclude the use of complex internal models to calculate regulatory requirements. BIS will accept comments on its discussion paper through March 13, 2020.

  • SEC Charges Individual and His Company With Fraud in Connection With Purported Illegal ICO: The Securities and Exchange Commission charged Eran Eyal and his company, Uniteddata, Inc. d/b/a “Shopin” with committing fraud while conducting a purportedly illicit pre-sale and initial coin offering from August 2017 through April 2018. The two-stage offering allegedly raised at least US $42.5 million. According to the SEC, using the blockchain, Shopin was intended to create shopper profiles that would contain buying history across retailers and make recommendations for purchases based on the information. The SEC claimed that the presale and ICO of Shopin tokens was a securities offering that was neither registered nor lawfully exempt. Among other things, charged the SEC, defendants promoted their own efforts to generate ultimate profits for investors and did not take “reasonable steps” to ensure that purchasers in the pre-sale were accredited investors qualified to participate in an exempt offering. The SEC also said that defendants made multiple misrepresentations in connection with the offering, including describing a supposed successful test of Shopin’s application with a prior company, when in fact no such pilot ever occurred. The SEC also charged that Mr. Eyal used offering proceeds for personal purposes. The SEC seeks injunctive relief and penalties, among other sanctions.

  • Bitfinex Entities and NYS AG Express Different Views Regarding Legitimacy of AG’s Tether Investigation: The Attorney General of New York opposed efforts by companies associated with the management of Bitfinex, a cryptoasset exchange, and its associated stablecoin, tether, to have all legal proceedings against them by the AG dismissed. Defendants claimed such action was warranted because of improper service of court papers initiating the legal action; because the dispute does not emanate from activity in New York; and because tether is not covered by the reach of the relevant law – the Martin Act – because the stablecoin is neither a commodity nor a security. (Click here to access the most relevant provision of the Martin Act.)

In papers filed last week, the NY AG disputed defendants’ arguments and claimed their opposition was solely “an extraordinary effort to halt an ongoing investigation … into potential securities and commodities fraud.” The New York AG claimed that defendants’ arguments rest on a “fundamental misconception” that they can halt a pending investigation based on their objections “to what they think [the AG] will claim in a future lawsuit.” However, said the AG, the purpose of the relevant provision of the Martin Act is to enable the AG to uncover facts to support a later claim.

In April 2019, the NY AG obtained an ex parte order from a New York State court prohibiting defendants from accessing, loaning or encumbering in any way US dollar reserves supporting tether digital coins. The NY AG applied for such order without giving respondents notice or an opportunity to object, claiming such emergency action was necessary because of the potential danger of respondents compromising tether’s supporting balances to help fund Bitfinex’s operations. (Click here for background in the article “NY Attorney General Sues Stablecoin Issuer and Related Companies for Purportedly Misusing Tethered Fiat Currency Without Customer Disclosure” in the April 28, 2019 edition of Bridging the Week.)

My View and Legal Weeds: Generally, the DFS’s proposed process for licensed virtual currency firms to list new digital tokens will enable such entities to meet customer demand to transact in such cryptocurrencies more expeditiously subject to robust protections. This is a good development and will put the burden on each licensee to develop a robust framework to analyze new coins, as opposed to making the DFS the arbiter of digital coins’ features. Hopefully, in order to help DFS make a good proposal better, commentators will encourage the agency to flush out more precise details of its proposal, including how much time in advance a licensee must file a notice of intent to transact in a new virtual currency; what is the distinction between a self-certification filing and prior notice; and what authority, if any, might DFS have to preclude transacting in a new coin even after any notice is filed.

That being said, DFS’s proposal echoes the long-standing authority of Commodity Futures Trading Commission designated contract markets to list new products solely by filing a self-certification with the Commission. Typically, a DCM seeking to list a new product must file by no later than the close of the business day prior to the first business day of the proposed initial trading a submission with certain enumerated elements, including a certification that the product complies with applicable law and CFTC regulations; among other things, the product must not be readily susceptible to manipulation. (Click here to access CFTC Rule 40.2 (regarding filing) and here for CFTC rule 38.200 (regarding manipulation); click here to access general background regarding the CFTC’s DCM self-certification process.) Under the CFTC regime, swap execution facilities are also authorized to self-certify new products on one-day prior notice (see CFTC Rule 40.2, above).

On December 1, 2017, three DCMs – the Chicago Mercantile Exchange, the CBOE Futures Exchange and the Cantor Exchange – self-certified with the CFTC cash-settled derivatives contracts based on Bitcoin.

Contemporaneously with the three exchanges’ self-certifications, the CFTC issued a press release noting that it had “extensive discussions” with each of the DCMs regarding their proposed new contracts. Then CFTC Chairman J. Christopher Giancarlo said each of the facilities “agreed to significant enhancements to protect customers and maintain orderly markets.” The CFTC separately noted in a “Backgrounder” also issued on December 1 that its staff had considered the potential risk of default of the three exchanges’ derivatives contracts on the regulated clearinghouses clearing the products. However, said the CFTC, “[b]ased on analysis of different stress scenarios, staff estimates that any potential impact will not be significant to a DCO.” The CFTC also said that CME had modified its proposed margining in response to discussions with Commission staff.

(Click here for further background on the December 1, 2017 self-certification of three bitcoin derivatives contracts in the article “Three CFTC-Regulated Exchanges Self-Certify Bitcoin Derivatives Contracts” in the December 3, 2017 edition of Bridging the Week.)



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