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Regulation

How Long Is the Arm of the Law? August 7-14

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Every Friday, Law Decoded delivers analysis on the week’s critical stories in the realms of policy, regulation and law. 

Editor’s note

DeFi has stolen the show lately. Spectacular rises and falls of unaudited tokens named after meme-able foods changing hands via ascendant liquidity pools have left many of us unimaginative observers mostly blinking.

In this area, I can offer no particularly hot takes beyond the line that keeps coming to me: “This does not end well.” Chalk it up to some midwestern assumption that money you make too quickly is never truly yours. But the situation with DeFi and yield farming resembles the ICO boom too closely for comfort. A fascinating technology very few understand attracts people who can earn a lot of money at the expense of other people wanting to earn a lot of money. 

With the ICO boom, the SEC took a long time to put together the tools to grapple with billions of dollars changing hands, but grabble they have. Similarly, a Calvinist sense of inevitability tells me that the law will come, because the law wants to get paid. In that cheery spirit, we’re looking at a series of recent upgrades to government capabilities to track and punish illicit crypto usage.

US sets new standard for tracking down terrorist-bound crypto 

In groundbreaking news for the future of illicit financing in crypto, the Justice Department announced the seizure of millions of dollars in crypto bound for Al-Qaeda, ISIS and the militant arm of Hamas.

It’s been obvious to anyone watching that federal agencies in the U.S. have been working hard to cope with crypto as a channel to fund terrorism for years. The association is often used as a means of dismissing crypto as a whole. However, it’s easy to see a number of philosophical parallels between modern terror and Bitcoin. 

Al-Qaeda, for example, has spent decades developing a network of decentralized cells made up of pseudonymous operators that has proved incredibly resilient to better-armed established nations. Does that not remind you of Bitcoin nodes? Not to mention that these days, organizations like ISIS depend on crypto-favorites like Telegram and Signal to recruit and communicate, rather than the traditional satellite phone in the mountains. 

A major moral distinction to interrupt such philosophizing is that Bitcoin doesn’t kill people, though, as with all money, plenty of people are prepared to kill to get Bitcoin. 

The recent announcement of the investigation was clearly meant as a bombshell. It takes the Department of Justice, the Department of Homeland Security, the IRS and the FBI a very long time to work together on anything. This is the product of years. Major media outlets like the New York Times and the Washington Post were tagged in to get the story amplified right out the door. The DoJ meant to broadcast the message as far as possible: Look out, the Feds are coming.

The Russian Bear Never Sleeps

In related news from the other side of the world, Rosinfomonitoring, Russia’s illicit financing watchdog, is building a new analytics system to track blockchain transactions. 

While recent developments around the world, especially from Chainalysis, Ciphertrace, and the younger Elliptic have done much to pull the veil off of the “anonymity” that governments so fear in networks like Bitcoin, Rosinfomonitoring’s plans apparently include tracking for privacy coins like Monero and Dash. 

Despite widespread and growing interest in the area and questions as to how private some of these so-called privacy coins are, some have proved quicker at adapting their tech than the people looking to track it. 

To public appearances, Russia is relatively late to the game. Nonetheless, despite not having the resources of the U.S. or China, the technological agility of Russian intelligence habitually exceeds expectations. 

While government agencies continue to onboard crypto capabilities, there’s a major barrier that resources don’t always make up for. In the more security-sensitive areas of tech generally and cryptocurrencies specifically, there’s deep hostility towards working with the government. If you take privacy tokens, a lot of the people who understand them best are people who would least like to work with the government. On the flip side, in the U.S. at least, the intelligence community has a hard time squaring their security clearance processes with the hackers and cypherpunks they’d need to hire to stay competitive.

Another ICO bites the dust

The SEC is busting up another ICO from the boom era, in news that has become familiar. 

The ICO in question — for Boon.Tech’s Boon Coins — netted only $5 million, and the enforcement action is not especially extreme. The SEC requires a return of those funds to investors, demands penalties of less than $1 million, and bars the project’s CEO from holding office at a publicly traded company ever. 

So what does it matter? The order is part of what seems to be a continuing trend of the SEC’s improving knowledge of crypto jargon and technology, even in cases small enough where they were probably not expending a ton of the commission’s resources. Typically, ICO pursuits of this scale have depended on obvious thefts of funds — lambos showing up in the driveways of homes recently purchased by token operators using funds they can’t account for. This case is interesting in that it shows a rise in casual technological savvy. 

Further reads

Kelman Law goes through the patchwork of money transmitter licenses required in each of the United States.

Jerry Brito, executive director of non-profit lobbying group Coin Center, argues for the language of “permissioned” and “permissionless” networks. 

Global payments processing system SWIFT evaluates what digitalization can do for know-your-customer identification requirements.



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Regulation

ICO issuer charged with fraud by SEC for selling unregistered security

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The United States Securities and Exchange Commission, or SEC, has charged a cryptocurrency issuer for “making materially false and misleading statements” in connection with an unregistered security offering conducted between August 2017 and January 2018, offering further evidence that regulators were still targeting initial coin offerings from the last major market mania. 

Loci Inc., the platform behind LOCIcoin, and CEO John Wise were formally charged on Tuesday. The SEC claims that Loci and Wise misled investors about the company’s revenues, employee numbers and user base during the $7.6 million crowdsale. The regulator also alleges that Wise misused $38,163 in investor proceeds for personal expenses.

“Loci and its CEO misled investors regarding critical aspects of Loci’s business,” said Kristina Littman, the head of the SEC Enforcement Division’s cyber unit, adding:

“Investors in digital asset securities are entitled to truthful information and fulsome disclosures so they can make informed investment decisions.”

The order also requires that Loci and Wise pay a $7.6 million civil penalty for their transgressions.

Handing out penalties to cryptocurrency businesses is nothing new for U.S. authorities. Regulators from the SEC, Commodity Futures Trading Commission and Financial Crimes Enforcement Network have imposed fines of more than $2.5 billion on cryptocurrency-related businesses since 2014, underscoring the murky regulatory climate surrounding digital assets.

Elliptic Enterprises, a blockchain analytics firm headquartered in the United Kingdom, reported Tuesday that the $2.5 billion in penalties covered a broad range of infractions, including fraud, the selling of unregistered securities and a failure to uphold Anti-Money Laundering regulations.

The SEC accounted for the lion’s share of the penalties at $1.69 billion. The CFTC imposed penalties of $624 million and FinCEN slapped crypto businesses with $183 million in fines. The Office of Foreign Asset Control handed out the smallest fines among the regulators at $606,000.

Cryptocurrencies have been described by many as the wild west of finance. Tens of thousands of crypto-centric projects have launched in the wake of Bitcoin’s genesis block in early 2009. Many of these companies got their start in 2017 during the height of the initial coin offering boom.

Related: With US regulators handing out $2.5B in fines since 2014, crypto is not the ‘wild west’ of finance

ICOs allowed crypto startups to raise millions of dollars without having to meet the stringent regulations of more traditional security offerings. ICO funding reached the tens of billions in 2017 and 2018 combined, attracting unwanted attention from securities regulators. The SEC successfully charged the founders of several crypto companies, which effectively put an end to the mania — in the United States, at least.