Australia and BIS Address CBDCs; OCC, PCAOB and U.S. Senators Address Crypto Risks; SEC, DOJ and USSS Continue Crypto Enforcement Actions | BakerHostetler

Reserve Bank of Australia and BIS Commence Efforts to Advance CBDCs

By Amos Kim

In a recent announcement, the Reserve Bank of Australia and the Digital Finance Cooperative Research Centre (DFCRC) released details on an ongoing research project exploring the benefits of a central bank digital currency (CBDC) in Australia, including the use case proposals and providers invited to participate in a live pilot. According to the announcement, the pilot will involve a “limited-scale pilot CBDC that is a real digital claim on the Reserve Bank” and pilot participants range “from smaller fintechs to large financial institutions.” A program director with the DFCRC said the pilot can cover a range of issues that could be addressed by the CBDC, “including some that involve the use of CBDC for atomic settlement of transactions in tokenized assets.”

In another recent announcement, the Bank for International Settlements (BIS) Innovation Hub published a report on the results of Project Icebreaker, a collaboration between the BIS Innovation Hub, the Bank of Israel, Norges Bank and Sveriges Riksbank that seeks to further the G20’s “priority to enhance cross-border payments.” According to the report, Project Icebreaker focuses on retail central bank digital currencies (rCBDCs) and “explores a specific way to interlink rCBDC systems with several additional features” to “promote simplicity and interoperability, reduce settlement risk, and foster competition and transparency for cross-border rCBDC payments.” Among other things, Project Icebreaker proposes an rCBDC model that seeks to eliminate time gaps between payment initiation and settlement “via an atomic payment-versus-payment (PvP) arrangement using Hash Time Locked Contracts (HTLC),” allow payers to “access competitive FX rates independently of the payment service provider,” and “mitigate risk of insufficient liquidity.” The report makes the following key recommendations for central banks seeking to implement an rCBDC for cross-border payments: (1) consider ways to incorporate conditional settlement, e.g., HTLC; (2) consider ways to ensure system availability and short response times 24/7/365 to maximize speed and minimize failed payments; (3) consider adopting current messaging and addressing standards and ensure flexibility in adopting future standards; (4) consider ways to provide instant rCBDC liquidity for FX providers 24/7/365; and (5) promote transparent and competitive incentives for FX providers.

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Acting Comptroller of the Currency and PCAOB Address Crypto Risks

By Robert A. Musiala Jr.

This week, Acting Comptroller of the Currency Michael J. Hsu delivered a speech titled “Trust and Global Banking: Lessons for Crypto.” In the speech, the Acting Comptroller drew parallels between the recent failure of the FTX exchange and the 1991 failure of the Bank of Credit and Commerce International (BCCI), “which failed in 1991 and led to significant changes in how global banks are supervised.” Among other things, the Acting Comptroller emphasized the importance of global coordination on banking matters and the role of the Basel Committee on Banking Supervision (BCBS) in establishing such standards as articulated in the first, second, and third Basel accords, and in the recently developed BCBS prudential standards for crypto-asset exposures.

Addressing the crypto markets, the Acting Comptroller said that while Satoshi Nakamoto’s bitcoin whitepaper is “elegant in its arguments,” in practice crypto “has proven to be extraordinarily messy and complex.” According to the Acting Comptroller, “Intermediaries are required for crypto to operate at any scale.” In drawing parallels between the failures of BCCI and FTX, the Acting Comptroller noted that both “faced fragmented supervision;” lacked a “lead or ‘home’ regulator with authority and responsibility for developing a consolidated and holistic view of the firms;” operated across jurisdictions that lacked informationsharing frameworks; and “used multiple auditors to ensure that no one could have a holistic view of their firms.” According to the Acting Comptroller, “[a]s a result, BCCI and FTX were able to carry out and obfuscate fraudulent activity and operate with a stunning lack of basic risk management and internal controls for an extended period of time.” In closing, among other things the Acting Comptroller highlighted the need for a “comprehensive global supervisory and regulatory framework for crypto participants.”

In a related development, this week the Public Company Accounting and Oversight Board (PCAOB) issued an Investor Advisory addressing so called “proof of reserve reports” (PoR Reports). According to the Investor Advisory, “Crypto entities may engage a service provider to issue a PoR Report in an attempt to reassure customers in response to widespread concerns about, for example, the type of reserve holdings, or, the safety and availability of customers’ digital assets in the event that some or all of the customers decide to withdraw their assets (e.g., if there is a run on a crypto exchange or stablecoin issuer).” Among other things, the Investor Advisory cautioned that PoR engagements are “not subject to PCAOB auditing standards” and “are not subject to PCAOB inspection,” and PoR Reports “do not provide assurance that such reserves will be adequate as of the date of the PoR Report, in the future, or that customer assets will be protected.”

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Binance and Binance.US Face Inquiry from U.S. Senators

By Keith R. Murphy

According to recent reports and a letter published by the office of U.S. Senator Elizabeth Warren, cryptocurrency exchange Binance and its U.S. arm Binance.US are the subjects of a broad request by U.S. Senators Elizabeth Warren, Chris Van Hollen, and Roger Marshall, M.D., to turn over documents and provide answers regarding the companies’ balance sheets, users, and policies and procedures, including with respect to the relationship between Binance and Binance.US. According to the letter, a related press release and related news reports, the request is based on growing concerns over the finances, risk management and regulatory compliance of the two companies and other related entities. As stated in the letter, the Senators assert that the “companies’ apparent attempts at evading the enforcement of anti-money laundering laws, securities laws, information reporting requirements, and other financial regulations cast serious doubt on the stability and legitimacy of Binance and its related entities, and on your commitment to your customers.”

The letter notes that Binance faces investigations on multiple fronts, including criminal sanctions evasion, money laundering conspiracy, unlicensed money transmission, questions about the company’s financial health, and rising scrutiny over an opaque corporate structure, and states that “Binance and its related entities have purposefully evaded regulators, moved assets to criminals and sanctions evaders, and hidden basic financial information from its customers and the public.” One of the allegations raised in the letter is that “Binance has intentionally allowed U.S.-based users to illegally access and trade unregulated products on the main exchange,” which is not licensed to operate in the U.S. The Senators further raise concern in the letter about the safety of customer assets and the potential impact of the companies’ activities on the stability of the cryptocurrency market and broader financial market. According to a report, Binance responded that there are significant misconceptions about its regulatory dealings, and that the companies will be responding to the information requests. The letter seeks a response by March 16, 2023.

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SEC and DOJ Continue Enforcement Actions Targeting Crypto Fraud Schemes

By Joanna F. Wasick

On Monday, the U.S. Securities and Exchange Commission (SEC) announced it had filed an emergency action and successfully obtained an asset freeze, appointment of a receiver and other emergency relief against Miami-based investment adviser BK Coin Management LLC (BKCoin) and one of its principals, Kevin Kang, in connection with a four-year-long crypto asset fraud scheme, through which BKCoin collected approximately $100 million from at least 55 investors. According to the SEC’s complaint, BKCoin and Kang told investors that their money would be used to trade crypto assets and represented that BKCoin would generate returns for investors through separately managed accounts and private funds. Instead, the SEC asserts, the defendants disregarded fund structure, commingled investor assets and used more than $3.6 million to make Ponzi-like payments. The complaint further alleges that Kang misappropriated at least $371,000 of investor money for his personal use.

On Wednesday, the U.S. Department of Justice announced the guilty pleas of six individuals for their roles in an internationally coordinated fraud and money laundering ring that deceived individuals into investing in AirBit Club, a purported cryptocurrency mining and trading company. As part of their guilty pleas, the defendants collectively have been ordered to forfeit their fraudulent proceeds consisting of U.S. fiat currency, bitcoin and real estate valued at $100 million. A U.S. Attorney stated, “The defendants took advantage of the growing hype around cryptocurrency to con unsuspecting victims around the world out of millions of dollars with false promises that their money was being invested in cryptocurrency trading and mining.”

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Bitcoin ATM Operators Arrested, Charged with Criminal Violations

By Lauren Bass

According to a press release by the U.S. Secret Service (USSS), three individuals were recently arrested for illegally owning and operating bitcoin kiosks (ATMs) across Ohio without a money transmission license. The individuals, along with their business entity, were reportedly indicted on charges including conspiracy, money laundering, receipt of stolen property and engaging in a pattern of corrupt activity. Reports indicate that in connection with these arrests, the USSS’ Cyber Fraud and Money Laundering Task Force seized over 50 bitcoin ATMs across Ohio.

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