The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law.
In a blistering dissent against SEC overreach in digital asset enforcement actions, SEC Commissioner Hester Peirce stated “[the LBRY] case illustrates the arbitrariness and real-life consequences of the Commission’s misguided enforcement-driven approach to crypto.” Polsinelli previously covered the LBRY decision, and Polsinelli attorney Jonathan Schmalfeld is quoted in the dissent, noting the LBRY avoided the questionable fundraising pitfalls of many in the cryptocurrency space at the time and still felt the wrath of the SEC levied against it.
However, despite the statements of Commissioner Pierce, the agency has continued in its enforcement agenda the past two weeks. The agency continues to pursue litigation against cryptocurrency exchange Coinbase, and dismissed certain aspects of the ongoing litigation in Ripple to seemingly gain quicker access to appellate review of earlier decisions in that case. There were also important developments in civil cases such as the trademark infringement case brought by Yuga Labs, and an action brought against the owners of the MetaMask wallet technology by certain alleged early developers. The criminal case against FTX founder Sam Bankman-Fried (“SBF”) also continued the past two weeks, with SBF taking the stand in his own defense.
These developments and a few other brief notes are discussed below.
SEC Dismissing Remaining Claims Against Executives in the Ripple Case: October 19, 2023
Background: The SEC has agreed to dismiss the remaining claims in the agency’s litigation against Ripple regarding the alleged aiding and abetting of securities law violations by Ripple executives Christian Larsen and Brad Garlinghouse. This means the only remaining issues for the underlying case would be measures of damages related to the SEC’s summary judgment win against the company for certain non-programmatic sales.
Summary: While Ripple is calling this a win (which it certainly is), the case against the executives was always weak, so it seems like this is just a strategic move by the SEC to allow them to appeal after their request for interlocutory appeal was denied. So when we previously wrote there was “no chance of appellate review prior to 2024 as the SEC hoped for,” that was under the mistaken belief that the SEC would continue to vigorously pursue its case against the executives. In the absence of Congressional action in the near future, which seems unlikely given the House’s current struggles, an appeal of this case seems like the fastest path to anything resembling regulatory clarity. It also shows how motivated the agency is to remove the programmatic sales ruling from the ether.
ConsenSys Sued by Former Employees Regarding Transfers of Assets which Devalued Employees’ Equity: October 19, 2023
Background: Joseph Lubin, one of the founders of the Ethereum Blockchain, formed a company in 2014 to develop tools for that network. These tools included the hugely popular MetaMask wallet. As many start-ups do, early contributors were granted equity in the original companies (which were a Delaware entity, and a Swiss “hub” entity”). However, in 2020 The Swiss entity transferred a vast majority of its assets to a new Delaware entity (CSI) in a $46.6 million sale. Even at the time, this was a controversial sale. The employees of the first two entities are now suing, saying this deal was a way to rob them of their equity.
Summary: Back in August a similar lawsuit was filed by a former employee, and Joel Dietz also filed a lawsuit in August claiming invention of the MetaMask wallet, so this is another round of expected litigation over a highly successful start-up. Considering CSI raised in a Series D at $7B valuation last year, it is unclear if these are rightfully upset early developers or vultures circling, but time will tell. Either way, the earlier Swiss litigation is going to raise some early jurisdictional challenges for the employees to overcome.
Coinbase Files Final Reply in Motion for Judgment vs. SEC: October 24, 2023
Background: Coinbase filed their Reply Memorandum in response to the SEC in what should be the final substantive briefing on the Coinbase Motion for Judgment on the Pleadings. While there may be requests from the parties to supplement their briefings, such as if there is a development in other cases to alert the Court to, this sets the stage for Coinbase’s attempt to gain an early dismissal of some or all of the SEC’s case against them. Oral arguments on Coinbase’s Motion are scheduled for January 17, 2024.
Summary: The Coinbase filing is well-written, but the exchange still faces an uphill battle to get the entire case dismissed at this stage. The briefing does a good job of pointing towards the SEC’s changed stance as to what the word “investment contract” means. However, the SEC names a litany of assets as being “crypto asset securities” and Coinbase concedes that some assets (such as the DAO Report tokens) would be securities which could not be traded on the platform. This means all the SEC had to do was name a single asset which, as plead, could plausibly be an unregistered security listing to survive this Motion for Judgment. Either way, even if Coinbase does not get a complete win on its Motion, even a partial win or a loss which educates the Court on these issues is a step in the right direction for the exchange.
Yuga Labs Wins $1.6 Million in Trademark Infringement Lawsuit: October 26, 2023
Yuga Labs, the company behind Bored Ape Yacht Club and owners of the Crypto Punk intellectual property had damages decided in their trademark infringement case against Ryder Ripps and Jeremy “Pauly” Cahen. Yuga had previously won on all its claims at summary judgment, and a trial was held to determine measures of damages. Yuga was awarded $1,575,362.92 in damages and its attorneys’ fees and costs in an amount still to be determined. Yuag was also granted an injunction over the defendants, which required all the associated domain names, social media accounts, and smart contract controls be handed over to Yuga and to permanently cease infringing on the Yuga trademarks.
Tl;dr: Bad day to be an internet troll. The Court through the book at defendants here, in large part due to their conduct throughout the proceeding, stating “Defendants unnecessarily and inappropriately made disgraceful and slanderous statements about Yuga, its founders, and its counsel during litigation, including calling Yuga’s counsel criminals who support racism, antisemitism, beastiality (sic), pedophilia and accusing them of using cartoons to market drugs to young children. These statements were egregious and far exceed the bounds of acceptable conduct.” (internal quotes omitted). The pending appeal for the Rogers test issues which was pursued concurrently with the damages issues being decided in this case was also heard recently, with the judges appearing skeptical of defendants’ claims before ruling in Yuga’s favor.
SBF Takes the Stand in Criminal Case Against Him: October 26, 2023
Background: SBF has taken the stand in his defense of the DOJ charges against him. His first day of testimony largely occurred outside the presence of the jury, with the Court hearing testimony to determine certain pre-trial admissibility motions including details surrounding his proposed advice of counsel reliance testimony. The second day, the jury got to hear SBF’s side of the story on direct exam. As of writing this, the cross examination of SBF has just begun, and we will cover that along with the expected conclusion of the case on the next BitBlog Bi-Weekly to be published on November 16, 2023.
Summary: Most criminal defendants do not take the stand in their own criminal trials for good reason. The Fifth Amendment protects citizens from being compelled into giving self-incriminating testimony. Testifying waives that right, create potential additional charges for perjury, and that testimony can be pointed to by a judge during sentencing if convicted. Here, SBF apparently decided the risk of digging a deeper hole through his testimony was worth the chance he could convince the jury that his mistakes were not made knowingly (i.e., they lacked the requisite level of mens rea for conviction). Time will tell if this strategic decision works out for the founder of the now-defunct cryptocurrency exchange FTX.
Briefly Noted:
Treasury Extends Comment Period on Proposed Crypto Reporting Rules: The IRS has extended its crypto tax rule comment period. Industry participants have criticized the proposed rules as unreasonably burdensome and unworkable. Industry group LeXpunK has also developed an AI-enabled tool to facilitate the drafting of comment letters in opposition to certain aspects of the proposed Treasury Regulations.
FinCEN Proposed Mixer Designations Released: The United States Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) have published an 80-page proposal arguing that US financial institutions should “implement certain recordkeeping and reporting requirements” on transactions linked to convertible virtual currency mixing.
Disproven Narrative on Crypto’s Use in Terrorism Financing Persists: The Wall Street Journal published an article on October 10 titled Hamas Militants Behind Israel Attack Raised Millions in Crypto. Elliptic has said its data was misinterpreted by the Wall Street Journal article, and Chainalysis also released data correcting the record on this issue (Hamas has requested its supporters not donate through digital assets, due to the ease and public traceability of digital asset transfers). Still, the Wall Street Journal article has been cited in multiple letters from legislators recently.
dYdX Converts to Public Benefit Corporation: dYdX Trading Inc. has converted its corporate form to a public benefit corporation such that, under its new charter, it will not generate trading fee revenue under v4 of its DeFi trading platform. As one of the few DeFi platforms that is reportedly incorporated in the United States, we wonder whether this may be an initial step towards being able to utilize any number of exemptions under securities and commodities laws that are available to persons organized exclusively for “religious, educational, benevolent, fraternal, charitable, or reformatory purposes and not for pecuniary profit, and no part of the net earnings of which inures to the benefit of any person, private stockholder, or individual.” If so, is it possible that dYdX (which currently does not allow users located in the U.S.) is looking for an alternative path to open its offering to U.S. persons without registration under SEC and CFTC regulations?
SEC Enforcement Direct Gives Remarks: the SEC Director of Enforcement gave some remarks at the New York City Bar Associations’ Compliance Institute focusing on how companies can create a culture of compliance through education, engagement and execution. Firms in regulated industries should ensure they become aware of legal developments, make applicable employees aware of the rules that might be applicable to them, and proactively executing policies necessary to maintain compliance with the law. In a lot of areas, the path to compliance is clear; in many others, this is easier said than done in the absence of clear guidance that is supported by the law.
Conclusion:
The regulatory and legal landscape in the cryptocurrency sector remains both convoluted and volatile. Hester Peirce’s outspoken dissent encapsulates a broader sentiment of skepticism towards the SEC’s aggressive enforcement strategy, a stance clearly not hindering the agency’s ongoing litigation efforts. Civil cases, too, are adding layers of complexity, underscoring the myriad challenges that innovators in the space face. The various unfolding legal sagas—be they criminal cases like that against FTX founder Sam Bankman-Fried or regulatory entanglements involving asset transfers—are emblematic of a sector still grappling with its place in the legal framework.
