Over the past year, we have seen an embarrassing dance-off of US government involvement in the cryptocurrency space. However, over the course of one hot week in July, we saw all three branches engage in important, and potentially transformative, ways that could have a lasting impact on the future of crypto policy-making in America.
The judicial branch is discovering that not all tokens are securities
First, on Thursday July 13, the judiciary entered the fray when the US District Court for the Southern District of New York issued a partial summary judgment in favor of Ripple, in its litigation with the Securities and Exchange Commission, holding that the company did not violate securities law by selling its XRPXRP token on public exchanges.
What does the decision mean for the future of cryptocurrency regulation in the US? Attorney Kayvan B. Sadeghi of Jenner & Block told me, “Ripple’s decision will have far-reaching implications for the SEC’s crypto enforcement agenda for the foreseeable future. Clearly, the court has rejected one of the core tenets of the SEC’s efforts to regulate secondary crypto markets. The SEC cannot treat tokens as securities.”
Whatever the partial nature of the win in which the court found XRP may be a safety when institutional investors are involved, the court’s decision likely started the process of unraveling a question that has plagued cryptocurrency in the United States for years — namely, how do we define particular digital assets and what financial regulator, if any, would have jurisdiction. For Sadeghi, an expert in legal issues in the cryptocurrency space, this decision could move matters to the legislature.
“We hope this decision helps everyone realize that the best way forward is responsible legislation tailored to this asset class,” added Mr. Sadeghi.
The legislative branch issues a new crypto surveillance bill
The courts weren’t the only branch exploring the question of who can regulate the crypto space last week. On Wednesday, July 12, Sens. Cynthia Loomis, R-Wyoming, and Kristen Gillibrand, D-NY, relaunched a cryptocurrency bill that would hand over primary oversight of digital assets to the CFTC.
Interestingly, the bill, like Ripple’s district court ruling, broadly states that assets that do not give an investor a clear financial interest in a business should not be considered securities even if they “benefit from entrepreneurial and administrative efforts that determine the value of the assets.” Therefore, the bill places oversight of most tokens under the CFTC’s purview.
While the bill calls for complete segregation of client assets, stablecoins to be issued only by regulated financial institutions, and for the first time, addresses decentralized finance, a hallmark of the bill is its attempt to separate the regulatory duties of the CFTC and the SEC.
In addition to the Lummis/Gillibrand bill, there also appears to be movement on stablecoin legislation from the House Financial Services Committee. As Ron Hammond, Director of Government Relations at the Blockchain Association, told me, “Nearly 6 years after the first bipartisan crypto law was introduced to Congress, the House Financial Services Committee appears set to introduce comprehensive legislation on stablecoins and market structure.” Highlighting the bipartisan nature of the work and noting the importance of moving things from the executive branch to the legislative branch, Mr. Hammond added, “Congress recognizes that regulation through enforcement and the body of court decisions is no substitute for a clear legislative framework.”
The executive branch is focused on criminal abuse of NFTs and DeFi
While the executive branch’s action in the crypto space is more closely related to a series of enforcement actions — including the SEC v. Ripple case — we’ve also seen law enforcement continue to pursue criminals seeking to use cryptocurrency to launder illicit proceeds. Last week, the United States Attorney’s Office for the Southern District of New York filed major cases against illegal actors who attacked and abused the cryptocurrency ecosystem.
First, on Monday, July 10, the US Attorney’s Office and the FBI announced the indictment of a Moroccan man for stealing more than $450,000 in cryptocurrency and NFT by spoofing the OpenSea NFT marketplace. According to the indictment, the deceptive website was intentionally designed to look like a legitimate OpenSea login page in order to trick unsuspecting victims into thinking they were interacting with the real OpenSea. However, when victims entered their login credentials or any other private information on the scammed site, their credentials were automatically sent to an email account controlled by the defendant allowing the defendant to steal crypto and NFTs. One victim from New York inadvertently provided the defendant with access to 39 NFTs including the “Bored Ape Yacht Club” NFT.
The next day, on Tuesday, July 11, the US Attorney’s Office, along with Homeland Security and IRS criminal investigations, announced the indictment and arrest of a trained security engineer in the first criminal case involving an attack on a smart contract operated by a decentralized exchange. A hacker exploited a vulnerability in an exchange’s smart contract to steal nearly $9 million.
The case is unique in a number of ways. First, it is the first criminal prosecution of a DeFi hack. Secondly, it is rare to make an arrest in this type of cyberattack since many cyber criminals reside in rogue countries like Russia or North Korea unlike New York City where the arrest was made in this case.
Finally, the case is characterized by the complexity of the attack, money laundering, and law enforcement response. The defendant allegedly exploited a smart contract linked to the exchange by providing false data to show that it provided a large amount of liquidity to the exchange, which it did not actually do. As a result, the defendant fraudulently received a large fee from the target. In addition, after learning how the exchange’s smart contract was exploited, the defendant allegedly used funds from “quick loans” to make a series of deposits to the exchange, generating additional fraudulent charges. The defendant then created another fraudulent account with the exchange and further manipulated the smart contract in order to quickly withdraw principal funds from the exchange. The defendant then laundered the money across chains, through mixers, coins and other obfuscation techniques.
However, law enforcement was able to use blockchain intelligence to track and trace funds accumulated for a court order as authorities were able to obtain off-chain information such as web searches – the defendant’s search “Can I cross borders with crypto”, “How to prevent the federal government from seizing assets”, and “Buy citizenship”; He visited a website called “16 Countries Where Your Investments Can Buy Citizenship…” – linking it to the crime.
While each of these cases would be significant in their own right, taken together, they are extraordinary. The cases involve emerging technologies – DeFi and NFTs – and show the commitment of US law enforcement to ensure that illicit actors do not profit from the cryptocurrency space. The cases also show a clear transition from BitcoinBTC to a more diverse and complex ecosystem of illicit actors attacking DeFi and moving money across blockchains.
Most importantly, perhaps these cases, and the ongoing efforts by law enforcement and regulators to go after the illicit part of the cryptocurrency ecosystem, showcase a future in which legislation – such as Lummis/Gillibrand and stablecoins – and court decisions such as ripple unite to build a legal framework as the Department of Justice, Treasury and others focus on the illicit actors seeking to undermine this new financial system.
While we are challenged for many years at ripple Seemingly endless status, debate, and debate about Lummis/Gillibrand, stablecoins, and beyond, there is no doubt that a hot week in July, as every branch of the US government delved into key questions about cryptocurrency, could have a lasting impact on an ever-evolving space.
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