The blockchain market in the USA is comprised of a number of different components, each with their own status and level of development. Overall, each of these components saw significant activity during the past 12 months.

The United States is home to many global, market-leading blockchain companies, including:

• cryptocurrency exchanges such as Kraken, Coinbase and Gemini;
• permissioned ledger developers such as Symbiont, R3 and the Hyperledger Foundation;
• custodians of digital assets such as Gemini, BitGo, Paxos and Anchorage;
• developers of Decentralised Finance (DeFi) protocols such as Aave, Compound and Uniswap; and
• non-fungible token (NFT) marketplaces such as OpenSea.

The USA has also been a centre of innovation with respect to integrating blockchain and digital assets into traditional financial services, with the development of JP Coin, the use of the Symbiont Assembly platform by Vanguard for both ABS issuances and the programmatic rebalancing of index funds – as well as the emergence of national banks such as Vast Bank N.A. and state-chartered banks such as Payward Financial, Inc and Avanti Bank that are focused on digital assets.

In addition, DeFi has exploded, and the use of blockchain technology to unlock, access and use dormant value in layered strategies composed of transactions involving multiple protocols and steps has captured the imagination of sophisticated digital asset market participants as well as traditional financial institutions. Interest in NFTs has also skyrocketed, as they allow data (whether media, art or collectible) to be easily retrieved and displayed, and each NFT is a unique asset.

Regulatory treatment with respect to blockchain and digital assets will continue to have a significant impact on the above-mentioned sectors over the next 12 months. In March of this year the President of the United States issued an Executive Order on Ensuring the Responsible Development of Digital Assets that recognised the growth in markets for digital assets, and directed or encouraged federal agencies to assess digital assets, related technology, policy issues and draft reports. The Executive Order was designed to promote responsible innovation and to co-ordinate across agencies to establish a whole-of-government approach to the digital assets space – including from a regulatory perspective. Significant regulatory activity is expected from the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency (OCC), the Financial Crimes Enforcement Network (FinCEN), the Consumer Financial Protection Bureau (CFPB) and other federal regulators with respect to digital assets.

US regulators are expected to focus on providing clarity to market participants regarding the classification of digital assets and the rules that apply. The SEC and the CFTC are exploring how they jointly oversee crypto platforms under their respective authorities. From an enforcement perspective, there is likely to be more focus on stablecoins, DeFi and NFTs as activity continues to grow. In addition, a number of judicial decisions are anticipated in the coming year that could have a significant impact on how digital assets are categorised for regulatory purposes.

US businesses are using blockchain technology in a wide variety of ways, including:

• digital asset exchange platforms;
• digital asset custody;
• securities issuance and record-keeping;
• securities clearing and settlement;
• gaming, collectibles and fan engagement platforms;
• protocol and software development;
• logistics and tracking goods; and
• self-sovereign identity.

The use of DeFi protocols in the United States has continued to explode in the past 12 months, with the total value locked (TVL) in DeFi protocols going from approximately USD65 billion to approximately USD114 billion. According to certain reports, prior to the implosion of the Terra Protocol, TVL in DeFi protocols peaked at close to USD256 billion. This explosion in value committed to DeFi is due to a variety of factors, including significant appreciation in the value of digital assets during the year as well as the implementation of token-based incentives for participation by many DeFi protocols. These incentives allow participants to earn a return from the protocol for participating in it, whether by providing liquidity to an automated market maker or by staking tokens to participate in governance decisions.

DeFi protocols being utilised by US residents run primarily on the Ethereum network and include platforms like “MakerDAO”, “Aave”, “Uniswap”, “0x” and “Compound”, as well as many other emerging protocols that are coming online rapidly. These protocols facilitate lending, borrowing, peer-to-peer exchange and combinations of these activities designed to create yield on non-interest-bearing digital assets.

DeFi platforms are open and immutable (to a large extent), and transparent protocols and regulators can theoretically observe platform activity in real time. In theory, regulatory compliance could be built in to DeFi protocols or the platforms running on those protocols. However, there are some clear challenges, given that DeFi platforms consist of open source code accessible to anyone anywhere with the technical capability to access and interact with that code, and developing a platform with built-in regulatory compliance in each jurisdiction in which it might be used would likely be exceedingly difficult.

The SEC has recently proposed amendments to Rule 3b-16 under the Securities Exchange Act of 1934, which would expand the definition of “exchange” to include systems that use “communication protocols” and systems that bring together “trading interest”. The proposed amendment, if adopted in its current form, would potentially require platforms facilitating transactions in securities utilising decentralised exchange protocols or automated market-making protocols to register as broker-dealers and exchanges, or to fall within an exemption from registration as an exchange.

The market for NFTs in the USA has continued to explode in popularity with attention drawn by celebrities and consumer brands. The level of activity with respect to NFTs is significant, and new NFT drops and projects are being announced almost daily on various smart contract platforms. It is reported that total NFT transaction volume reached approximately USD25 billion last year. The rise of NFT marketplaces, which allow NFTs to be created, stored and traded, has fuelled the popularity of NFTs. Key areas of interest include visual art, profile picture projects, collectibles and gaming. One NFT representing a digital artwork was sold for a record price of USD69 million, and another NFT representing the first tweet of the CEO of Twitter was sold for more than USD2.9 million. Meanwhile, as NFTs become more valuable, more focus on how these assets are stored and secured can be expected.

There are multiple regulatory regimes that may apply to the use of blockchain technology in the USA. Depending on the business model and the classification of associated digital assets, blockchain technology and associated digital assets may be regulated under multiple regulatory frameworks, including securities law, commodities law, money transmission law and consumer protection law. These are all existing regulatory regimes that have not been specifically tailored to blockchain technology or digital assets.

The USA has implemented international standards in several areas impacting blockchain. Most notably, the USA has been a proponent of applying a corollary to the Funds Travel Rule to entities known as virtual asset service providers (VASPs) that process transactions involving virtual assets, and significantly expanding the universe of entities that meet the definition of a VASP and would therefore be subject to the Funds Travel Rule. In 2018, the Financial Action Task Force (FATF), a multi-governmental organisation that sets global standards related to anti-money laundering, clarified how the FATF standards apply to activities or operations involving virtual assets and imposed a corollary to the Funds Travel Rule on VASPs that process virtual asset transfers.

In October 2021, the FATF updated its guidance regarding virtual assets and VASPs. Notably, the recent FATF guidance broadly interprets the definition of a VASP to include “a central party with some measure of involvement” with a decentralised application. This broad interpretation would potentially bring a variety of parties within the definition of a VASP and subject them to compliance with anti-money laundering and counter-terrorism financing (AML/CFT) laws in jurisdictions that adopt this interpretation of the VASP definition.

It is not surprising that the US delegation to the FATF pushed for a global Funds Travel Rule corollary and the expansive interpretation of the entities that might be deemed VASPs. In doing so, the USA is attempting to promote compliance through global standard setting, which would make it easier for the USA to enforce the laws in place domestically in this area. Without a global standard, US-based money transmitters would have to determine whether or not they would process transmittal orders originating from outside the USA that may not include the information required by the Funds Travel Rule. If they were to process such orders, they would need to perform their own due diligence to obtain the information required to fill any gaps, which would require additional cost and time.

There are a number of regulatory bodies in the United States that are relevant to blockchain and digital assets.

The Securities and Exchange Commission

The SEC has broad regulatory authority over securities transactions and securities professionals and intermediaries in the United States. The threshold question that determines whether the SEC has authority with respect to blockchain or digital assets is whether a “security” is involved. The definition of the term “security” in both the Securities Act of 1933 and the Securities Exchange Act of 1934 includes the term “investment contract”. When commercial arrangements do not fall plainly within the other enumerated types of securities in the definitions of the term “security”, they may still be treated as securities if they are deemed to constitute investment contracts.

The test for whether a particular scheme is an investment contract was established in the Supreme Court’s Howey decision. The test looks to “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” In 2017, the SEC issued a Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: the DAO (DAO Report), applying the Howey test to an offering of cryptographic tokens for sale and concluding it was an offering of securities. The DAO Report noted that “[w]hether or not a particular transaction involves the offer and sale of a security – regardless of the terminology used – will depend on the facts and circumstances, including the economic realities of the transaction.” This continues to be the SEC’s position.

The Commodities Futures Trading Commission

The CFTC has broad regulatory authority over derivative markets for commodities, and general anti-fraud and anti-manipulation authority over the spot markets for commodities pursuant to the Commodities Exchange Act (the CEA). The CFTC has asserted jurisdiction over transactions in virtual currencies as “commodities”. Numerous courts have found that the CFTC’s jurisdiction extends to virtual currencies in this context. The CFTC has explicitly taken the position that bitcoin and ether are commodities subject to their jurisdiction under the CEA. Accordingly, it is widely accepted that bitcoin and ether are commodities subject to CFTC jurisdiction.

CFTC jurisdiction is primarily with respect to derivatives transactions. Derivatives transactions subject to CFTC jurisdiction include futures, options, swaps and leveraged retail commodities transactions under the CEA.

The Treasury Department and the Financial Crimes Enforcement Network

FinCEN is the arm of the Treasury Department that is responsible, in the first instance, for enforcing the US federal laws and regulations relating to crimes involving the transmission of money, frequently working in conjunction with other federal agencies and bureaus, including the Federal Bureau of Investigation and the National Security Agency. This includes enforcing the Bank Secrecy Act (BSA), which is a comprehensive AML/CFT statute. The BSA mandates that “financial institutions” must collect and retain information about their customers and share that information with FinCEN. “Money services business” are included within the definition of “financial institutions”, and “money transmitters” are money services businesses. FinCEN guidance from May 2019 examined a number of hypothetical business models involving digital assets to provide guidance with respect to the application of the BSA. Not surprisingly, many businesses engaging in activity involving convertible virtual currency, a subset of digital assets, have an obligation to comply with the BSA.

The Treasury Department and the Office of Foreign Assets Control

The Office of Foreign Assets Control (OFAC) is a division of the US Treasury Department, and administers and enforces economic and trade sanctions to promote national security and US foreign policy objectives. OFAC can take enforcement action against entities in the USA that violate sanctions programmes. OFAC has taken several such actions that involve digital asset transactions; one was with respect to BitGo and another was with respect to BitPay. Both of these actions were settled, and OFAC emphasised that US sanctions compliance obligations apply to all US persons, and encouraged companies that provide digital asset services to implement controls commensurate with their risk profile, as part of a risk-based approach to US sanctions compliance. Further, OFAC published Sanctions Compliance Guidance for the Virtual Currency Industry in October 2021 to assist members of the virtual currency industry in navigating and complying with OFAC sanctions.

The Consumer Financial Protection Bureau

The CFPB has authority pursuant to the Consumer Financial Protection Act (CFPA) to address unfair, deceptive or abusive acts and practices (UDAAP) with respect to financial products offered primarily for consumer use by certain “covered persons” as defined by the CFPA. To date, the CFPB has not pursued a case alleging a violation of the CFPA involving digital assets and thus far has declined to extend Regulation E – which governs electronic fund transfers involving consumers and financial institutions – to virtual currencies. However, the CFPB recently announced that it will begin examining non-bank financial companies that pose risks to consumers in reliance on previously little-used authority. The CFPB is expected to become much more active in the next several years, including with respect to addressing consumer financial issues relating to digital assets.

State Money Transmission Regulators

Historically, states rather than the federal government have been the primary regulators of “money transmitters”. Each state, other than the state of Montana, has independently passed a statute that defines the activities that constitute money transmission in that state. State laws generally define a money transmitter very broadly and typically include an entity that engages in “receiving money for transmission” or “transmitting money” or issuing or selling stored value. The scope of each state’s law, and its application to virtual currency, is dependent on how broadly the definitions of money and money transmission are interpreted by the applicable state regulator. As a result, exchanging virtual currency or facilitating payments in virtual currency may be subject to state-by-state regulation as money transmission.

While federal law requires the mere registration of money transmitters, state law requires licensing. It is significant to note that money transmission regulations are extraterritorial; a person must have a licence in every state in which they have customers. What matters from a jurisdictional standpoint is the location of the customer, not the location of the transmitter.

States have taken different positions with respect to whether convertible virtual currency activities fall within the definition of money transmission.

State Securities Regulators

State securities regulators enforce and administer state-specific securities laws. These laws are often referred to as “blue sky” laws and are generally similar, but certain aspects vary significantly from state to state. Many state securities statutes are derived from either the 1956 or 2002 version of the Uniform Securities Act.

State securities regulators have been very active in regulating cryptocurrency-related investment products and the sale of digital asset securities.

Recently, state securities regulators were first to file enforcement actions with respect to centralised lending businesses offering consumers interest in cryptocurrency deposited to certain accounts. State securities regulators filed cases against BlockFi, Celsius, and Voyager Digital over the past year alleging that their interest account products constituted investment contracts under the Howey test that needed to be either registered or exempt from registration. The state actions against BlockFi were resolved, along with an SEC enforcement action, with the entry of a consent order.

Even more recently, the states of Texas, Alabama, New Jersey, Kentucky, and Wisconsin filed actions against the operator of a casino in the metaverse. The actions alleged that the casino operators fraudulently solicited the purchase of NFTs tied to ownership rights of a casino in the metaverse that provided the holders with a share of any profits.

There are no self-regulatory organisations in the USA specifically dedicated to blockchain or digital assets. There are a variety of trade groups, but none of them perform a formal regulatory or even quasi-regulatory function. Instead, these trade groups advocate on behalf of their members with respect to the adoption and regulation of blockchain technology and digital assets. There are, however, self-regulatory organisations associated with the securities and commodities industries that do have regulatory authority relevant to blockchain and digital assets, and these are discussed below.

The Financial Industry Regulatory Authority

The Financial Industry Regulatory Authority (FINRA) is a government-authorised organisation tasked with the oversight of US-registered securities broker-dealers to ensure they operate fairly and honestly. FINRA works under the supervision of the SEC and writes rules governing the activities of broker-dealers, examines broker-dealers for compliance with those rules, promotes market transparency to protect market integrity, and provides for investor education.

FINRA has taken a specific interest in activity involving digital assets. It joined the SEC in putting out a joint statement regarding broker-dealer custody of digital asset securities in July 2019. The release dealt with the application of the customer protection rule pursuant to the Securities Exchange Act of 1934, and the related rules, to digital asset securities. The joint statement provided guidance with respect to how digital asset securities may be custodied by broker-dealers, indicating several areas of concern. FINRA has also asked broker-dealers to notify it if they engage in activities related to digital assets, and has made digital assets an examination priority.

The National Futures Association

The National Futures Association (NFA) is an industry-wide self-regulatory organisation for the derivatives industry. It is a registered futures association designated by the CFTC, and registers a number of different participants in the commodities derivatives markets.

Several important judicial decisions have played a role in interpreting the laws applicable to blockchain technology and digital assets.

Telegram

In October 2019, the SEC filed a complaint against Telegram and related entities seeking a preliminary injunction to prevent Telegram from distributing the digital tokens native to the Telegram Open Network (TON) blockchain, known as GRAM tokens, and other relief. The SEC complaint alleged that the intended distribution of GRAMs was just one part of a larger scheme to engage in a public distribution of securities that should have been registered. The scheme started with the sale of purchase agreements to accredited investors, providing them with the right to receive GRAMs in the future, and included the representations, undertakings and understandings with respect to the GRAMs.

The court ultimately granted a preliminary injunction finding that the SEC had shown a substantial likelihood of success in proving that the resale of GRAMs into the secondary market would be an integral part of a scheme to publicly distribute securities that were not registered. On 12 May 2020, Telegram announced that it had cancelled the TON blockchain project as a result of the court’s decision; on 26 June 2020, the SEC announced a settlement with Telegram requiring it to return USD1.2 billion to investors and pay an USD18.5 million fine.

Ripple Labs

In December 2020, the SEC filed an enforcement action in the Southern District of New York alleging that Ripple Labs, Inc and certain executives had violated federal securities laws in connection with their failure to register the digital asset known as XRP as a security prior to selling XRP. The complaint alleges that XRP is a security and sets forth an analysis of XRP pursuant to the Howey test to support that assertion. Ripple has raised a variety of defences to the allegations in the complaint thus far, and the matter is pending.

Of note, several holders of XRP have attempted to intervene in this case as defendants. In responding to the request to intervene filed by these holders, the SEC addressed, briefly, its view with respect to secondary transactions in digital assets originally sold in an investment contract. The SEC argues that the security at issue is not XRP (the digital asset) itself, but rather all the facts and circumstances surrounding the digital asset and the manner in which it was initially offered and sold. They then indicate their view that XRP (the digital asset) “is the embodiment of those facts, circumstances, promises, and expectations and today represents that investment contract.” This characterisation is important where questions arise over whether or not secondary transactions in a digital asset are subject to the federal securities laws. It is not likely these questions will be answered in this case because the allegations concern only primary sales of XRP. The matter is still pending.

Bitconnect

In May 2021, the SEC filed an enforcement action against individual promoters of Bitconnect, an informal group of people selling interests in a bitcoin lending programme that would purportedly provide outsized returns to lenders through the use of a proprietary trading algorithm. The SEC alleges in the complaint that this scheme constituted an investment contract that was offered and sold to US persons without registration by the individual promoters. In addition, the individual promoters were charged with failure to register as broker-dealers in connection with their offers and sales of these alleged securities. This case is notable because the SEC is not pursuing an action against a formal entity but against the promoters of a product offered by an informal group of people. This case may be the first step in the SEC’s pursuit of promoters associated with other informal groups engaging in securities activities such as potentially certain DeFi protocols.

In September 2021, the SEC filed a second action against Bitconnect, its founder, its top US promoter and his affiliated company, alleging that they defrauded investors and engaged in an unregistered offering of securities. The SEC has obtained judgments against certain defendants in both cases. In addition, investors in Bitconnect have separately filed a class action against Bitconnect and its directors and promoters that is currently pending in the federal court.

Bitfinex

This matter, involving an investigation into whether the stablecoin known as Tether is backed by sufficient cash reserves, was settled in February 2021 with Bitfinex and Tether agreeing to pay USD18.5 million in penalties, cease further activity with New York residents and take steps to improve transparency through periodic reporting.

In October 2021, the CFTC announced its simultaneous filing and settling of charges against both Tether, for making untrue statements and omitting material facts in connection with its stablecoin, and Bitfinex, for engaging in illegal commodity transactions and operating as a futures commission merchant without required registration. The CFTC ordered Tether to pay USD41 million and Bitfinex to pay USD1.5 million in civil money penalties.

BitMEX

The founders and executives of BitMEX were criminally indicted by the US Department of Justice for violating the BSA in connection with their operation of an offshore derivatives exchange for digital assets. The indictment alleges that “BitMEX, which has long serviced and solicited business from US traders, was required to register with the [CFTC] and to establish and maintain an adequate AML program. AML programs ensure that financial institutions, such as BitMEX, are not used for illicit purposes, including money laundering.” Three of the founders and executives recently pled guilty to violating the BSA and agreed to pay a USD10 million criminal fine each.

In a companion case, the CFTC charged BitMEX with operating an unregistered futures commission merchant. BitMEX later entered into a consent order that requires it to pay a USD100 million civil monetary penalty.

These co-ordinated actions signal a collaborative approach by US regulators to address alleged US law violations by digital asset intermediaries. Co-ordinated actions of this nature are expected to continue as US regulatory agencies refine their approach to digital asset intermediaries.

Digital Asset Pump-and-Dump Scheme

In March 2021, the CFTC charged two individuals, John McAfee and Jimmy Gale Watson, for engaging in a digital asset “pump-and-dump” scheme, whereby the defendants accumulated positions in digital assets, deceptively promoted them through social media, then sold their holdings as prices rose sharply, and earned profits in excess of USD2 million. It was the first enforcement action brought by the CFTC for a manipulative scheme involving digital assets. Relatedly, the US Attorney’s Office indicted McAfee and Watson on charges including conspiracy to commit commodities and securities fraud. The SEC also brought a civil enforcement action against both defendants.

Coinbase

A class action was recently filed in the federal district court in New York by three Coinbase users against Coinbase and its CEO. The complaint alleged that 79 tokens that are sold on Coinbase qualify as securities under the Howey test, and that Coinbase is selling unregistered securities and fails to register as a securities exchange or a broker-dealer in violation of securities laws. The lengthy complaint may be one of the most fulsome attempts to argue that digital assets are securities. The plaintiffs seek to obtain both monetary relief and an injunction against Coinbase ensuring that it cannot operate without required registrations.

Uniswap

A user of Uniswap recently filed a class action against Uniswap, its founder and the venture capital investors of Uniswap in the federal district court of New York. The complaint alleged that Uniswap sells unregistered securities, fails to register as a securities exchange or a broker-dealer, and as a result fails to provide investors with disclosures relating to risks associated with the tokens. The complaint further alleged that the defendants are responsible for the fraudulent activities on the exchange, which has no barriers of entry or any “know-your-customer” process, and incentivises unlawful activities through its fee structure. Despite the decentralisation aspect of the DeFi protocol, the complaint suggested that the defendants, including the venture capital firms, have complete control over both the Uniswap protocol and the user interface of Uniswap.

Previously, in September 2021, the SEC launched its investigation into Uniswap, which is still ongoing. Both the class action outcome and the SEC investigation results will be significant in the regulation and compliance of DeFi projects.

NFT “Rug-Pull”

Two individuals, Ethan Nguyen and Andre Llacuna, were recently arrested and charged with conspiracy to commit wire fraud and money laundering by the US government in connection with an NFT “rug-pull” scheme. According to the criminal complaint, the individuals advertised an NFT project called “Frosties”, but later abruptly abandoned the project without providing the benefits advertised to investors and, after selling the Frosties NFTs, transferred millions of proceeds in payments.

It is reported that rug-pull scams associated with cryptocurrency may have taken in more than USD2.8 billion from victims in 2021. As indicated by the criminal indictment, given the increasing interest in and demand for investments in cryptocurrencies, government agencies have started to pay heightened attention to fraudulent activities associated with digital assets.

Since releasing the DAO Report, the SEC has resolved several investigations into the sale of digital assets by entering into consent orders with the subjects of those investigations. Many of these consent orders seem to communicate a distinct regulatory proposition to the blockchain community, and the SEC has been accused by many of regulation via enforcement with respect to digital assets.

The Munchee order stands for the proposition that the sale of a digital asset may be subject to compliance with the securities laws even when there is a purported consumptive use of the token.

The Tomahawk order stands for the proposition that the investment-of-money element of the Howey test may be satisfied even when a digital asset is airdropped to holders for free, so long as the blockchain network sponsor obtains a benefit by doing so.

The TokenLot order makes clear that engaging in buying or selling digital asset securities for the account of another requires registration as a broker-dealer.

The Zachary Coburn order, related to the Dex EtherDelta, stands for the proposition that a platform engaging in exchange activity with respect to digital asset securities must be registered as a national securities exchange or operate within an exemption from such registration.

The Airfox and Paragon orders required these token sellers to register their digital asset securities post-ICO, making clear that the SEC wants issuers of digital asset securities to provide the disclosure necessary for purchasers to make informed decisions.

And most recently, the BlockFi order clarifies that arrangements involving crypto interest accounts offered by crypto-lending platforms such as BlockFi, whereby investors deposit crypto-assets to the platform in exchange for a variable periodic interest payment, may be investment contracts that must be registered or qualify for an exemption from the registration. 

These are just a few examples of enforcement actions brought by the SEC that target a specific participant in the digital asset space in order to communicate a regulatory approach to the broader market.

At the federal Level, there are no regulatory sandbox programmes in the USA specifically geared towards blockchain projects. That said, both the SEC and the CFTC have other programmes in place that seek to engage with projects in the fintech space.

At the state level, there are several sandbox programmes relevant to blockchain.

Utah passed a law in 2019 providing for a regulatory sandbox programme overseen by the Department of Commerce that allows participants to test innovative financial products or services without otherwise obtaining a licence or authorisation to act under the laws of Utah. The Utah sandbox specifically contemplates the use of blockchain technology in innovative financial products or services.

Wyoming passed a law in 2019 providing for a financial technology sandbox for the testing of financial products and services. The sandbox is overseen by the Banking Commissioner or the Secretary of State, depending on the statutes or rules at issue with respect to a particular applicant. The Wyoming sandbox specifically contemplates the use of blockchain technology in innovative financial products or services.

Additionally, each of Arizona, Kentucky and Nevada has passed laws providing for regulatory sandbox programmes to promote innovation, though they address more generally the use of emerging technologies for innovation.

The Internal Revenue Service (IRS) issued guidance in October 2019 with respect to transactions involving virtual currency. Specifically, the guidance addresses the tax implications of a hard fork of a blockchain. When a hard fork results in a taxpayer receiving new units of cryptocurrency over which they have dominion and control, they will have gross income as a result. If they do not receive any new units of cryptocurrency over which they have dominion and control in connection with a hard fork, they will not have any gross income.

This guidance builds upon the previous IRS guidance with respect to virtual currency from 2014, in which the IRS determined that virtual currency is “property” for federal tax purposes and that general tax principles applicable to property transactions apply to transactions in which virtual currency is used.

A lawsuit was filed by private litigants against the IRS in 2021 with respect to the taxation of staking rewards. The plaintiffs sought a refund on taxes paid on staking rewards earned staking on Tezos. The IRS subsequently authorised a full tax refund on the claim, and moved to dismiss the action as moot. However, the private litigants objected and instead amended their complaint to plead for injunctive relief for treatment of staking rewards in the future, in addition to the monetary relief.

As described in 1.1 Evolution of the Blockchain Market, the President of the United States has issued a comprehensive executive order addressing digital assets with the goal of establishing a comprehensive approach to this space.

While there are not any definitive laws or court cases specifying how ownership of a digital asset is determined in the USA, most non-security digital assets are likely to be considered “bearer” instruments. Control over the asset equates to ownership, primarily through control of the private key necessary to effectuate an on-chain transaction involving the digital asset. There are many instances in which the owner of a digital asset transfers control to a third party, in which case the owner’s right to the asset is contractual, pursuant to the terms of their agreement with the third party.

The categorisation of a digital asset as a security, commodity or some other type of property is highly fact-dependent in the USA, and in many cases it is not easy for market participants to determine the correct characterisation in advance. Unfortunately, there is no efficient mechanism for market participants to make an advance determination with any degree of legal certainty in the current regulatory environment.

In order to obtain specific formal guidance that can be confidently relied upon, market participants have the option of pursuing a request for no-action from either the SEC or the CFTC. Such a request would set out in detail a business model utilising blockchain technology or involving a digital asset and then seek confirmation from the relevant regulator that, if the plan is followed as described, they will not recommend enforcement. The SEC has so far provided no-action relief with respect to four projects involving the use of blockchain technology:

• the first was for Turnkey Jet, Inc, in which the SEC provided no-action with respect to the sale of a digital token at a fixed price redeemable for air travel;
• the second was for Pocketful of Quarters, Inc, a gaming platform on the Ethereum blockchain, in which the SEC provided no action relief with respect to the sale of an ERC-20 token for gaming;
• the third was for Paxos, in which the SEC provided no-action relief with respect to a blockchain-based clearing and settlement platform for certain National Market System (NMS) securities; and
• the fourth was for IMVU, Inc, in which the SEC provided no action relief with respect to the sale of ERC-20 tokens for a virtual world with limited transferability outside the virtual world.

The CFTC has chosen to deal with these issues in a more generally applicable way by providing broad guidance. For example, the CFTC released final interpretive guidance with respect to the actual delivery in the context of retail commodity transactions involving virtual currency, an issue that was the subject of several requests for no-action or guidance.

The regulatory treatment of stablecoins in the USA is still unclear. The Presidents Working Group on Financial Markets released a report on stablecoins in November of 2021 that called for Congress to address the inconsistent and fragmented oversight of stablecoins. Stablecoins backed by deposits of fiat currency or other assets have not yet been treated as securities by the regulators, although there has been significant discussion on this point within the legal community. In particular, the initial proposed structure of the Libra token – proposed by Facebook as a stablecoin backed by a basket of currencies – prompted much speculation about whether that arrangement constituted a security. Similarly, no formal guidance has yet been issued by the regulators with respect to stablecoins generated algorithmically. That said, the recent failure of algorithmic stablecoin Luna to hold its peg to the US Dollar highlights regulatory concerns regarding these types of stablecoins, particularly where there may be a need to manage the peg with open market operations.

In the USA, generally speaking, cryptocurrencies may be used for payments if they are accepted by merchants. The use of cryptocurrencies or any other fiat substitute for payments may trigger the money transmission laws at the federal and state levels.

There are no regulations in the USA that are specific to NFTs, but existing laws will apply to activities involving NFTs. To the extent that the offer or sale of NFTs constitutes an investment contract under the Howey test, compliance with the securities laws would be required. Given their non-fungible nature, NFTs are unlikely to be considered “commodities”.

Additionally, the offer and sale of NFTs as consumer products would be subject to consumer protection laws and regulations. Both federal and state consumer protection laws generally prohibit unfair or deceptive acts and practices with respect to consumer goods and services. Those selling NFTs must keep sanctions compliance in mind and take steps to avoid engaging in transactions with sanctioned individuals or individuals residing in sanctioned jurisdictions. The continued popularity of NFTs will likely result in more scrutiny in the next year, particularly in light of reports of “rug-pulls” as illustrated by the Frosties criminal case described in 2.5 Judicial Decisions and Litigation.

There are a variety of markets for digital assets available to US persons. These markets can be divided into several categories:

• markets for digital asset securities;
• centralised markets for digital assets that are not securities; and
• decentralised markets for digital assets that are not securities.

Digital Asset Securities Markets

Platforms that provide for the exchange of digital asset securities are highly regulated by the SEC. Any entity engaging in exchange activity with respect to securities, including digital asset securities, must register as a national securities exchange or operate within an exemption to such registration. There is an exemption from registration as a national securities exchange for alternative trading systems that comply with the SEC’s Regulation ATS, which requires the entity operating an alternative trading system (ATS) to register with FINRA as a broker-dealer and certain other prerequisites.

Centralised Markets for Non-security Digital Assets

Centralised platforms that allow users to exchange non-security digital assets are prevalent in the USA, and facilitate fiat-to-digital-asset or digital-asset-to-digital-asset transactions. These platforms may perform these services in a custodial manner, meaning the platform maintains custody of the assets trading on the platform in an omnibus account for the benefit of its customers and relies on its own internal record-keeping to credit and debit customer accounts as needed. In other words, exchanges of assets between customers of a custodial platform will not result in an auditable on-chain transaction, and the transaction will only be reflected in the internal ledger used by the platform to track customer balances.

These platforms may also perform these services in a non-custodial manner, in which transfers of digital assets facilitated by the platform occur on-chain and are directed to the self-custodied wallet addresses of the transaction participants. In either case, platforms that provide these services with respect to non-security digital assets are generally regulated as money transmitters at both the federal and state level and have the attendant know-your-customer (KYC)/anti-money laundering (AML) and BSA compliance obligations.

Decentralised Markets for Non-security Digital Assets

There are also a variety of decentralised exchanges available to US persons, which typically provide for a peer-to-peer exchange of digital assets by means of a technical protocol or one or more smart contracts. Exchanges facilitated in this way do not typically involve third-party custody of the digital assets being exchanged at any point in time during the transaction. The regulatory obligations with respect to decentralised exchanges will be highly fact-dependent, but it is likely they will be regulated as money transmitters at both the state and federal levels. As noted in 1.3 Decentralised Finance Environment, the SEC recently proposed a rule to expand the definition of exchange to include communication protocol systems. Such an expanded definition might have the effect of bringing smart-contract-based exchange and liquidity protocols, and/or tools used to access such protocols, within the definition of exchange to the extent that these protocols and tools are facilitating transactions in assets the SEC deems to be securities.

As discussed in 4.1 Types of Markets, there are a variety of US markets that facilitate the exchange of fiat currency for digital assets. Any market facilitating such an exchange is likely to be classed as a money transmitter at both the federal and state level and will likely have the attendant KYC/AML and BSA compliance obligations. The same is true for markets facilitating the exchange of one digital asset for another digital asset.

As discussed in 2.3 Regulatory Bodies, the BSA is the primary federal law addressing KYC/AML in the United States, and applies to any entity that is acting as a money services business, which includes money transmitters. Generally speaking, the BSA requires money transmitters to know their customers and implement and enforce policies and procedures reasonably designed to detect, report and deter suspected money laundering and other suspicious transaction activity.

Please refer to 2.3 Regulatory Bodies for a discussion of the relevant regulators with respect to digital assets in the USA.

There are no specific laws or regulations that deal with re-hypothecation of non-security digital assets.

Wallet providers were addressed in the May 2019 FinCEN guidance regarding convertible virtual currency. The guidance described the types of wallets that may be used to store digital asset value and the regulatory treatment with respect to each of them. That treatment depends on four criteria:

• who owns the value;
• where the value is stored;
• whether the owner interacts directly with the payment system where the convertible virtual currency (CVC) runs; and
• whether the person acting as intermediary has total independent control over the value.

Wallets in which user funds are controlled by third parties are referred to as “hosted wallets”, while wallets in which user funds remain in the control of the user are called “unhosted wallets”. Hosted wallet providers are money transmitters and have different obligations with respect to different types of wallet users. Unhosted wallets are software enabling a person to store and conduct transactions involving convertible virtual currency. A hosted wallet user does not need a third party in order to conduct transactions, and there is no third party acting as a money transmitter in this model. The user is also not acting as a money transmitter while using an unhosted wallet to engage in transactions on their own behalf.

The creator of unhosted multi-signature wallets that restricts its role to providing a second authorisation key to validate and complete transactions initiated by the wallet user is not a money transmitter according to the May 2019 FinCEN guidance. However, the provider of a hosted wallet with a multi-signature feature will be a money transmitter, as will any wallet provider that stands between a wallet user and the payment system or that exercises independent control of the value in a wallet.

Custody of digital assets is also a regulated activity in certain states, most notably New York State. The New York BitLicense regime requires entities located in New York State or doing business with New York State residents to obtain a licence when they engage in virtual currency business activity. There are five enumerated virtual currency business activities, one of which involves taking custody of virtual currency on behalf of customers, whether in a hot wallet or cold wallet solution. Accordingly, hosted wallet providers must obtain a BitLicense in New York before offering such services in New York or to New York residents.

Capital raising through the sale of a digital asset is almost always considered securities activity that is subject to compliance with federal and state securities laws in the USA, though courts and regulators conduct individual analysis to determine whether the sale of a digital asset that does not clearly fall within one of the enumerated instruments in the definition of a security constitutes an “investment contract” pursuant to the Howey test.

This test, as refined by subsequent interpretation, requires an investment of money in a common enterprise with an expectation of profit to be derived from the essential managerial efforts of others in order to find an investment contract. Two points are critical to this analysis:

• whether a reasonable purchaser of a digital asset would be expected to be purchasing with investment intent or consumptive intent – ie, whether a purchaser has a reasonable expectation of profit or not; and
• whether there is an active participant upon whose essential efforts a reasonable investor would rely in order to profit.

The SEC provided clarification with respect to factors relevant to these critical points in April 2019 in guidance entitled the Framework for Investment Contract Analysis of Digital Assets (the Framework). The Framework set forth 38 different factors, some with sub-factors, that the SEC considers relevant to the analysis. The Framework factors provide additional guidance with respect to conducting a Howey analysis, but it should be noted that a Howey analysis is very dependent on specific facts and circumstances, and some factors may be more or less relevant. In addition, the Framework does not assign a weight to any of the relevant factors, likely because each analysis must be done independently and it would be difficult to assign a weight that would apply equally to every project conducting an analysis using the Framework factors, which makes any analysis using the Framework factors highly subjective and of limited utility.

The use of an exchange to conduct an initial sale of digital assets for capital-raising purposes does not change the analysis set forth in 5.1 Initial Coin Offerings, and such sales are also likely to be treated as securities transactions subject to compliance with the securities laws in the USA. In particular, depending on how a particular initial exchange offering is structured, if an exchange is acting as an underwriter or an unregistered broker-dealer with respect to the distribution of digital asset securities, they may incur significant legal liability.

Distribution of tokens via an airdrop or other mechanisms that may not involve an obvious investment of money will still be subject to the Howey test to determine whether the arrangement constitutes an investment contract subject to the securities laws. As mentioned in 2.6 Enforcement Actions, the Tomahawk order highlights that the investment-of-money element of the Howey test may be satisfied even when a digital asset is airdropped to holders, so long as the blockchain network sponsor obtains a benefit by doing so.

In the Tomahawk matter, Tomahawk distributed “Tomahawkcoins” (TOMs) in exchange for promotional efforts by the recipients, such as marketing TOMs, promoting TOMs on social media, and making requests to list TOMs on trading platforms. The SEC concluded that the distribution of TOMs in exchange for provision of services constitutes an offer and sale. Therefore, despite the lack of monetary consideration, the investment-of-money element of the Howey test was satisfied, and the airdrop of TOMs was treated as an investment contract.

Digital asset investment funds are subject to the same regulatory requirements as traditional investment funds. A variety of fund structure options are available to funds holding digital assets under the Investment Company Act of 1940 (the ICA), which generally requires investment companies to register or fall within an enumerated exemption from registration. Any company with more than 40% of its assets in investment securities constitutes an investment company. Accordingly, the categorisation of digital assets as securities, commodities or something else is critical in determining whether a fund has a registration obligation pursuant to the ICA.

The most commonly relied upon exemptions from registration under the ICA are Sections 3(c)(1) and 3(c)(7). The Section 3(c)(1) exemption is for funds that have fewer than 100 holders that are all accredited investors, while the Section 3(c)(7) exemption permits an unlimited number of holders who must be qualified purchasers. Accredited investors are generally natural persons with an income of more than USD200,000 in each of the two most recent years (USD300,000 if joint with a spouse) or having a net worth that exceeds USD1 million (either individually or together with a spouse), as well as a variety of entities that meet certain other qualifications. Qualified purchasers are generally individuals and entities that own not less than USD5 million in investments.

Finally, private funds that hold assets other than securities, such as non-security digital assets, are not investment companies and can simply offer interests in their funds in private placements pursuant to Regulation D.

There are no special regulations pertaining to broker-dealers or financial intermediaries dealing in digital assets. Rather, legacy laws and regulations applicable to broker-dealers and financial intermediaries have been adapted to cover activities involving blockchain and digital assets. The SEC recently released guidance for broker-dealers with respect to taking custody of digital asset securities in the form of a five-year safe harbour for that activity so long as certain conditions are met. The conditions include that the broker-dealer limits its business to digital asset securities, establishes and implements policies and procedures reasonably designed to mitigate the risks associated with conducting a business in digital asset securities, and provides customers with certain disclosures regarding the risks of engaging in transactions involving digital asset securities. Broker-dealers meeting the conditions will not be subject to an SEC enforcement action.

The general view in the US legal community is that private contractual arrangements that are executable, in whole or in part, using blockchain or distributed ledger technology are valid and enforceable, assuming the elements necessary to form a contract are present – offer, acceptance, the intention to be legally bound, and consideration. Whether a smart contract is coded to reflect the intentions of the parties is a separate question and one that has prompted significant debate with respect to how such a situation would be handled and resolved.

It is not likely that developers of decentralised blockchain-based networks or the code that runs these networks would be considered fiduciaries who have a duty to the users of the network or the code. There have been no cases in the USA in which developers have been held responsible for a breach of a fiduciary duty in connection with losses sustained by the user of software they have developed for use on a decentralised blockchain network.

DeFi platforms are prevalent and gaining in popularity in the USA. These platforms operate in an emerging area and there have been few regulatory actions with respect to DeFi platforms in the USA to date. However, many of these DeFi platforms are operating in areas that might traditionally be subject to regulation. For instance, escrowing digital assets in a smart contract with the expectation of earning a profit in the form of interest paid by another user that borrows and uses those digital assets is very similar to peer-to-peer lending products, such as those offered by Lending Club and Prosper, that were adjudged by a variety of US securities regulators to be securities. In addition, it is worth noting that DeFi platforms often involve the use of stablecoins in order to provide a digital on-ramp to the relevant service. As increased regulatory scrutiny with respect to stablecoins is expected, so too is an increase in regulatory attention with respect to DeFi.

There is no proven method of perfecting a security interest in a digital asset in the USA. That said, a digital asset lender may attempt to take a security interest in a digital asset pledged as collateral for a loan pursuant to the applicable provisions of the Uniform Commercial Code (UCC). This is an emerging area of law that is untested, and there is some question as to which provisions of the UCC apply to any given arrangement. One strategy that has been used in the USA is to treat the digital asset pledged as collateral for a loan as a “financial asset”, treat the borrower’s account with the lender as a “securities account”, treat the borrower as an “entitlement holder”, and have the borrower acknowledge that the lender is a “securities intermediary”, as all of these terms are defined under the UCC. This should create a “security entitlement” under the UCC that will allow for perfection of a security interest in the collateral by the lender.

There are specific laws and rules that apply to how certain regulated participants in the securities markets in the USA hold assets in custody for the benefit of others. These laws and rules are all in place to protect customer assets. The custody laws and rules outlined below apply to securities, including digital asset securities, and funds, which may include non-security digital assets.

Broker-dealers are subject to the customer protection rule under the Securities Exchange Act, which requires them to hold securities in custody over which they have exclusive possession and control in a “good control location.” Several different types of third-party custodians can serve as good control locations, including banks, other broker-dealers and clearing agencies. Please refer to 5.5 Broker-Dealers and Other Financial Intermediaries for further information.

Investment advisers are subject to the “custody rule” under the Investment Advisers Act of 1940, which generally requires them to hold customer funds and securities with a qualified custodian. Qualified custodians include banks, registered broker-dealers and futures commission merchants. Whether a particular state-chartered bank is a qualified custodian was addressed in a no-action letter issued by the Wyoming Division of Banking and responded to by the SEC. The Wyoming Division of Banking letter indicated that Two Ocean Trust, a Wyoming chartered public trust company, met the definition of qualified custodian under the Investment Advisers Act of 1940 by virtue of the primarily fiduciary nature of the services it offers, which are similar to the services offered by national banks. The SEC responded to the letter by thanking the Wyoming Division of Banking for the analysis of the issue and essentially preserving its right to independently review the custody arrangements entered into by investment advisers it regulates to determine whether the custodians are qualified as required. The SEC continues to solicit comments from industry participants with respect to the practices regarding qualified custodians for digital assets.

Registered investment companies are required by the ICA to maintain their securities and similar investments with a bank, a member of a national securities exchange or a central securities depository.

The SEC recently published Staff Accounting Bulletin No 121, an interpretation of Generally Accepted Accounting Principles that requires reporting companies, or soon-to-be reporting companies, that custody digital assets on behalf of clients, to book a liability equal to the value of the digital assets under custody and an off-setting asset on their balance sheet. Notably, the staff highlighted its consideration of the technological, legal and regulatory risks and uncertainties unique to the safeguarding of crypto-assets.

Data privacy laws are enacted at the state level in the USA. The absence of a federal data privacy law means that there are differing obligations in each state with respect to data privacy. Practically speaking, this means that national companies will seek to comply with the most robust state-level data privacy law. The California Consumer Privacy Act (CCPA) is the most robust state data privacy law, and became effective in January 2020. The California Attorney General adopted regulations on 1 July 2020, and has since sent thousands of “Notices to Cure” directing companies doing business in California that it determined are not in compliance with the CCPA to come into compliance within 30 days.

In addition, new regulations were published on 15 March 2021 that further clarify the manner in which businesses covered by the CCPA may communicate with respect to privacy options. Among other things, the CCPA provides consumers with the following:

• the right to access data collected about them by covered businesses;
• the right to delete that data; and
• the right to opt out of data collection altogether.

Covered businesses also need to provide consumers with a privacy notice, with two or more methods to opt out of the sale of personal information, and are prohibited from using opt-out mechanisms that make it difficult for a consumer to execute and have the effect of subverting the consumer’s choice to opt out. The CCPA does not directly implicate blockchain, but any covered business using blockchain to gather, store or refer to customer information should have compliance with the CCPA in mind.

Data protection laws are also enacted at the state level in the USA. The CCPA has a data protection component requiring covered businesses to implement and maintain reasonable security procedures. Similar data protection laws have been passed in other states, as have data breach reporting statutes. These laws do not specifically apply to the use of blockchain-based products or services.

Mining cryptocurrencies on blockchain networks running proof-of-work algorithms is allowed in the USA. There are no specific regulations in place with respect to this activity, but it may be subject to money transmission regulations in certain circumstances but not in others. The May 2019 FinCEN guidance reiterates previous guidance indicating that miners who are users of the virtual currency they mine are not money transmitters. On the other hand, the administrator of a mining pool that combines mining services with hosted wallets on behalf of pool members will be a money transmitter.

Staking assets to secure blockchain networks using proof-of-stake consensus protocols is allowed in the USA and there are no laws or regulations specific to staking. Staking as a service (StaaS) businesses do exist in the USA, but there are no laws or regulations specific to StaaS providers.

DAOs are exploding in popularity in the USA. Groups are seeking alternative forms of organisation to facilitate collective action. DAOs have emerged as a model that can incentivise contributions to a common cause and foster organic growth. Without a formal legal entity structure associated with a DAO, it is likely that DAOs with a significant US presence would default to treatment as general partnerships. This can have significant consequences for participants from a liability and tax perspective. For this reason, there has been much discussion about “wrapping” DAOs in a legal entity structure. Participation in a DAO is usually signified by holding governance tokens issued by the DAO. These tokens may be earned for contributing to the DAO and in other ways as determined by DAO members. These tokens typically provide the holder with the right to participate in the DAO governance process by voting on proposals or making proposals.

See 10.1 General regarding DAO tokens. Some tokens may also provide the holder with other benefits as well. Some DAO governance occurs completely on-chain by use of a governance smart contract that links on-chain voting to a DAO treasury such that an approved proposal to disburse funds from the treasury results in programmatic implementation of the approved action. Other DAO governance structures may have off-chain elements. The degree to which governance occurs on-chain or off-chain correlates to the degree to which the community is willing to rely on human action in order to implement approved proposals. 

Different DAOs have used different legal structures in the USA. Certain investment club DAOs have used Delaware limited liability companies, and membership units are held by the members of the investment club DAOs. Wyoming has passed a specific DAO LLC law that provides for an interesting legal entity structuring option. Vermont has a blockchain LLC entity option as well.

Membership interests in LLCs may constitute securities in the USA, and usually they are assessed under the Howey test for investment contracts. Accordingly, if the holder of an LLC membership interest is relying on the essential managerial efforts of another to expect a profit, there is a risk that the LLC membership interest may be treated as a security.

In addition, the ethos of many DAOs is to facilitate anonymous participation. The Corporate Transparency Act will soon require entities formed in the USA by filing papers with a secretary of state’s office to report on beneficial ownership, which will not allow for anonymous owners. For these reasons, many DAOs have also looked to more flexible entity structure options outside of the USA.