New Initiatives Launch in Staking, DeFi, DAOs; IRS Issues NFT Guidance; White House Report Criticizes Crypto; SEC and DOJ Crypto Enforcement Continues | BakerHostetler

Staking Market Launches, ‘Defi Cover’ Data Published, DAO Buys Golf Course

By Christopher Lamb

According to a recent press release, MetaMask Institutional, “the web3 wallet for organizations,” has launched its “institutional staking marketplace” in partnership with three other blockchain companies. According to the press release, “[t]he first-of-its-kind platform is designed to simplify and provide unrivaled access to institutional staking” and will “reduce … complexity by streamlining access to top-tier staking providers.”

A recent report provides data on the emerging “DeFi cover” market, which provides “insurance alternatives” for DeFi market participants. According to the report, DeFi cover providers paid out $34.4 million in claims in 2022. The most notable payouts include “$22.5 million during the collapse of the Terra ecosystem in May 2022 and $4.7 million from the collapse of a major crypto exchange in November 2022.” The report notes the small percentage of DeFi funds that were insured by DeFi cover in 2022, with a mere $231 million worth of DeFi funds insured, “representing just 0.5% of the total value locked in the DeFi industry.” The report provides data on 23 DeFi cover providers that operate across the Ethereum, Polygon, Arbitrum, Optimism, BNB Smart Chain, Astar, and Avalanche blockchain networks.

According to reports, LinksDAO is about to become the first decentralized autonomous organization (DAO) to acquire a golf course, successfully winning a bid to buy the Spey Bay Golf Club in Scotland. The successful bid is reportedly the result of a DAO governance vote where 88.6 percent of LinksDAO token holders voted in favor of making an offer to purchase the golf course.

According to a press release, the Provenance Blockchain Foundation, “which catalyzes the adoption and development of the public and open-source Provenance Blockchain … announced the launch of a $50 million grant program for blockchain developers.” In a quote from the press release, the Head of Developer Ecosystem at Provenance Blockchain Foundation said, “This program is not simply a grant, the Provenance Blockchain Foundation will partner directly with developers.” Interested developers may apply at https://provenance.io/build/grants/grants-program.

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IRS Issues Guidance on Non-Fungible Tokens

By Nicholas C. Mowbray

The IRS issued guidance this week regarding the federal income tax treatment of NFTs. The guidance states that the IRS intends to issue future guidance stating that certain NFTs are collectibles for federal income tax purposes, and requests comments from taxpayers regarding the federal income tax treatment of NFTs. The guidance further states that future guidance addressing whether an NFT is a collectible will adopt a “look through” approach that analyzes the NFT’s underlying right or digital file, and whether it is a collectible.

In general, collectibles that qualify as capital assets are subject to a maximum 28 percent long-term capital gains rate, which is higher than the capital gains rates that apply to capital assets that are not collectibles. In addition, there are negative federal income tax consequences for an individual retirement account that holds a collectible.

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Economic Report of the President Criticizes Digital Assets

By Robert A. Musiala Jr.

This week, the White House released its Economic Report of the President. The 507-page report includes a 37-page chapter devoted to digital assets titled “Digital Assets: Relearning Economic Principles.” The chapter presents an overall skeptical view of “crypto assets,” although it acknowledges that “[t]he development of crypto assets and their underlying distributed ledger technology have the potential to transform industries and business models.” According to the chapter, despite certain perceived benefits, “[s]o far, crypto assets have brought none of these benefits.” The chapter is broken out into three sections titled “The Perceived Appeal of Crypto Assets,” “The Reality of Crypto Assets,” and “Investing in the Nation’s Digital Financial Infrastructure.”

The first section “reviews the potential benefits that crypto assets may offer, as often touted by their proponents.” The section describes “several possible benefits that proponents claim for [the] popularity of crypto assets.” These include use as investment vehicles; faster, “censorship resistant” payments; financial inclusion; and improved financial technology infrastructure.

The second section “evaluates what [crypto assets] have actually achieved.” The section asserts that as investments, crypto assets are “highly risky” and “many … do not have a fundamental value.” The section contrasts this with stocks, “which are claims on the future profits of firms”; debt, which “is a claim on interest and principal payments”; and commodities such as gold and silver, which “can be used in jewelry and for special manufacturing purposes.” In comparing crypto assets to sovereign money, the section asserts that cryptocurrencies are not as effective as the U.S. dollar in serving as a unit of account, medium of exchange, or store of value. The section also cites various risks of crypto assets including the environmental impact of cryptocurrency mining, “run risk” of stablecoins, fraud, lack of disclosures, conflicts of interest at crypto asset platforms that perform multiple functions, potential future systemic risks, illicit finance risks, and ransomware.

The chapter’s final section acknowledges that “[t]he growth of crypto assets has revealed a demand for a faster and more inclusive financial system with a real-time payment system and circulating digital money.” The section explores various potential methods of meeting this demand using alternatives to crypto assets, including central bank digital currencies (CBDCs) and the forthcoming FedNow Instant Payment System.

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SEC Charges Crypto Entrepreneur and Celebrities; DOJ Targets Crypto Fraudster

By Joanna F. Wasick

On Wednesday, the U.S. Securities and Exchange Commission issued a press release announcing charges against crypto asset entrepreneur Justin Sun and three of his wholly owned companies for the unregistered offer and sale of “crypto asset securities” Tronix (TRX) and BitTorrent (BTT). The SEC also charged Sun and his companies with fraudulently manipulating the secondary market for TRX through extensive wash trading, which involves the simultaneous or near-simultaneous purchase and sale of a security to make it appear actively traded without an actual change in beneficial ownership, and for orchestrating a scheme to pay celebrities to tout TRX and BTT without disclosing their compensation. Eight celebrities, including Lindsay Lohan and DeAndre Cortez Way (aka Soulja Boy), were also charged for illegally touting TRX and/or BTT without disclosing that they were compensated for doing so and the amount of their compensation.

Earlier this week, the U.S. Department of Justice (DOJ) announced the unsealing of charges against Irina Dilkinska in connection with her participation in “the massive OneCoin fraud scheme, which began operations in 2014 in Bulgaria, and marketed and sold a fraudulent cryptocurrency by the same name through a global multi-level-marketing network. According to a DOJ press release, as a result of misrepresentations made about OneCoin, victims invested over $4 billion worldwide in the fraudulent cryptocurrency. A U.S. Attorney stated, “Irina Dilkinska, the supposed Head of Legal and Compliance for the OneCoin cryptocurrency pyramid scheme, accomplished the exact opposite of her job title and allegedly enabled OneCoin to launder millions of dollars of illegal proceeds through shell companies. Dilkinska helped perpetuate a wide-ranging scheme with millions of victims and billions of dollars in losses, and she will now face justice for her alleged crimes.” Dilkinska was reportedly extradited from Bulgaria prior to the announcement.

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U.S. Crypto Exchange Receives SEC Wells Notice, Publishes Staking Analysis

By Keith R. Murphy

According to recent reports and a blog post by the company, a major U.S. cryptocurrency exchange has received a Wells notice issued by the U.S. Securities and Exchange Commission (SEC). According to the company, the notice relates to an unspecified portion of its listed digital assets, as well as its staking business, despite multiple efforts by the company to engage the SEC as to which assets are claimed to be securities and for guidance on how to potentially register some portion of its business with the SEC. In a blog post responding to the Wells notice, the company’s general counsel said, “We are confident in the legality of our assets and services, and if needed, we welcome a legal process to provide the clarity we have been advocating for and to demonstrate that the SEC simply has not been fair or reasonable when it comes to its engagement on digital assets.” The company’s blog post further notes the conflicting positions on these issues by multiple regulatory agencies, and calls for rulemaking, as opposed to enforcement actions, to assist with continued innovation.

Just days prior to receiving the Wells notice, the same cryptocurrency exchange issued a letter to the SEC providing further comment on the company’s petition for rulemaking on digital asset securities regulation previously submitted to the SEC in July 2022. The content of the letter focuses on the securities law treatment of services related to the validation of proof-of-stake protocols (staking). According to reports, the letter was in response to the SEC’s recent enforcement action against another U.S. cryptocurrency exchange’s staking program. In the letter, the company argues that staking is not a “monolith operation concept,” and that while some existing models could fall within the definition of investment contract offerings, others do not and do not meet the criteria of the “Howey test.” According to reports, the company’s chief executive officer indicated that the company is prepared to defend its position on its staking program.

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Moscow Money Mules and Hackers: Digital Asset Threats Continue

By Lauren Bass

According to a recent report by a global anticorruption NGO, Transparency International Russia, cryptocurrency exchanges and OTC desks located in Moscow International Business Center (aka Moscow-City) have been evading international sanctions and know-your-customer protocols to help Russian citizens move money out of Russia. The transactions reportedly happen via encrypted Telegram messages without any verification of identity or source of funds. According to the report, customers in Russia buy USDT, then use OTC desks to exchange the USDT for a foreign currency – often sterling – to be physically delivered by an on-demand courier service to a drop point (or person) in another country. The report suggests that since 2021, over $50 million has been processed through OTC desks as part of this scheme.

OpenZepplin, a leading technology security firm, recently released a report noting that a surge in blockchain-hacking techniques and exploits in 2022 has led to consumer losses exceeding $3.7 billion. The report outlines the top 10 hacks that blockchain proprietors should be mindful of – including software bugs and code vulnerabilities.

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