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The Reintroduction of the Lummis-Gillibrand Crypto Bill
What Happened?
On Wednesday, Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) reintroduced their landmark crypto bill, building upon the 2022 version to address emerging challenges and enhance regulatory oversight. The Lummis-Gillibrand bill specifically included the following:
(1) The bill targeted an expanded role for the Commodity Futures Trading Commission (CFTC). The bill grants the CFTC increased regulatory powers over cryptocurrency markets, including crypto trading, money laundering, and exchange interactions with decentralized finance protocols.
(2) The bill will require enhanced consumer protections such as mandatory requirement for proof of reserves for stable coin users, mandatory registration for U.S. crypto exchanges, and stablecoin issuance limited to banks or credit unions. The legislation likewise bans “rehypothecation” for crypto lending. In response to several firms declaring bankruptcy, the bill will ban crypto firms from using their customer’s assets to increase their line of credit.
(3) The bill aims to establish a sensible regulatory framework that promotes responsible innovation. In so doing, the bill cites the European Union’s Markets in Crypto Assets Regulation as a potential model.
(4) To combat illicit financial activities involving digital, the bill proposes to establish an interagency law enforcement working group on crypto assets and imposes stricter penalties for willful violations of the law.
(5) The bill requires crypto asset companies to provide detailed disclosures on the risks and opportunities associated with crypto assets, including advertising standards, plain language requirements for customer agreements, and guidelines for the treatment of forks and airdrops.
(6) The 2023 version introduces an explicit definition of decentralized finance. Generally, the bill defines a “Decentralized Crypto Asset Exchange as software that comprises predetermined and publicly disclosed code deployed in a public ledger that permits user(s) crypto transactions, where no one person or group of persons can unilaterally control or cause to control the software protocol.”
(7) Addressing taxation and appropriate, the bill covers topics such as wash sales, provides a de minimis exemption for small purchases, clarifies the definition of 'broker,' facilitates charitable donations, and offers guidance on the treatment of forks, airdrops, mining, and staking. Additionally, the bill allocates $1.3 billion over five years to Federal agencies for the implementation of sound policies related to crypto assets.
What does this mean?
The second round of the Lummis-Gillibrand crypto bill represents another significant step forward in establishing crypto regulation in the United States. We appreciate the senators' careful consideration of the crypto industry’s issues, and we look forward to providing our thoughts on how this legislation might be improved.
Coinbase Rebuts SEC
What happened?
In a high-stakes back-and-forth, the SEC and Coinbase previewed the fight to come over Coinbase’s motion for judgment on the pleadings. On July 7th, the SEC responded to Coinbase’s letter moving the court for permission to file their upcoming motion, arguing that Coinbase knowingly violated securities laws and intentionally overlooked potential infractions to foster its growth. Importantly, the SEC signaled to the court that if Coinbase moves forward with its motion, the SEC plans to respond and also file its own motion, asking the court to strike Coinbase’s defenses, including those related to the major questions doctrine and unclean hands. In response, on July 12th, Coinbase lawyers challenged in a letter, the SEC's attempt to strike out its defenses, noting for the court that this type of motion is typically "disfavored" and unlikely to succeed, and insisting that Coinbase’s defenses meet the standard to resist dismissal.
What does it mean?
A decision related to the "major questions doctrine” would be significant. The doctrine stands for a principle in U.S. administrative law that federal agencies lack authority to issue regulations on significant policy matters unless Congress explicitly delegates that power to them. Coinbase argues that the major questions defense should clearly be permitted to remain in the case because Congress has not given the SEC regulatory power over the crypto industry.
This tug of war between Coinbase and the SEC evidences that any decision in this dispute will hold profound implications for the wider cryptocurrency sector. We very much appreciate Coinbase's vigorous persistence in defending itself against the SEC’s accusations, and future victims of the SEC’s jurisdictional imperialism may want to replicate Coinbase’s approach.
DOJ Charges Individual for Defrauding a Decentralized Exchange
What Happened?
This week, the U.S. Department of Justice (Southern District of New York) brought charges against Shakeeb Ahmed, a former cybersecurity professional, for “defrauding” a decentralized cryptocurrency exchange. Ahmed, who was a senior security engineer at an international technology company, allegedly used his expertise to hack a decentralized exchange’s smart contracts and steal approximately $9 million in cryptocurrency.
According to the indictment, Ahmed exploited a vulnerability in the exchange's smart contracts and manipulated pricing data to generate inflated fees, which he then withdrew. He is also accused of laundering the stolen funds through a series of transactions, including swapping tokens and bridging the proceeds from the Solana blockchain to the Ethereum blockchain.
Ahmed allegedly reached out to the developers and offered to return some of the funds, but to keep for himself $1.5 million, on the condition that the exchange would not report the attack to law enforcement. However, this proposed deal did not prevent him from being prosecuted.
What Does This Mean?
This case represents one of the first criminal indictments brought pursuant to a “hack” of a decentralized exchange. It underscores the government’s view that individuals can engage in fraudulent activities through decentralized protocols even when the nature of the alleged conduct involved someone using the protocol in a way the code permitted it to be used. The case also raises questions about the legal implications of negotiations between a hacker (whether white hat or black) and a project subject to attack. As this case shows, even a “deal” to not report an attack will not necessarily stop the DOJ from pursuing alleged crime once they learn about it.
Ruling in SEC v. Ripple Labs
What happened?
On Thursday, Southern District of New York Judge Torres granted in part and denied in part both the SEC and Ripple Lab’s motions for summary judgment. Importantly, Judge Torres ruled that XRP (the token related to Ripple Labs) is not necessarily a security, even if it is offered in connection with an investment contract. Judge Torres also ruled that certain sales to “programmatic investors” who did not know they were purchasing tokens from Ripple would not be considered investments contracts, while choosing not to issue a larger holding about all secondary market sales.
While the ruling brought a wave of relief for Ripple and many in the digital asset industry, there are also parts of the holding that are favorable to the SEC. For example, the court found that Ripple's sale of XRP to institutional investors did amount to unlawful sales of securities and did not agree with Ripple’s due process and fair notice defenses. However, while the decision is a partial victory for Ripple and a partial victory for the SEC, it strikes an important blow in the SEC’s nearly unfettered regulation-by-enforcement strategy it has pursued up to this point.
What does this mean?
The ruling marks a significant milestone for the crypto industry. The court's ruling is one of a few cases that analyzes the Howey test as it relates to digital assets and actually rules on key components of the test. Given the fact that this decision was made in the Southern District of New York, it may also have an effect on the outcome of the SEC’s case against Coinbase, which is pending in the same district. While not binding precedent over Coinbase’s judge, it will serve as persuasive - and hopefully compelling - guidance when it comes to legal analysis of secondary market sales on Coinbase.