Lawmakers and Regulators Recognize Crypto and Blockchain Present Unique Problems for Traditional Enforcement Mechanisms

Congressional Democrats Seek Increased Oversight Into Crypto Matters Following Ransomware Attacks

A group of Democratic senators and congressmen are calling on the Department of Justice, the State Department, the Department of the Treasury, and Homeland Security to beef up efforts to protect against the recent wave of ransomware attacks. The group, comprised of senators Edward Markey and Sheldon Whitehouse, as well as congressmen Ted Lieu and James Langevin, sent a letter on October 8, 2021 to the four secretaries in charge of these deparments urging coordination amongst their agencies to end ransomware attacks.

Citing the recent proliferation of cryptocurrencies as rationale for why ransomware attacks swelled by 225% since 2019, the October 8, 2021 letter states that increased enforcement of the existing money laundering and financial crimes statutes will play an important role in deterring bad actors from using cryptocurrency in conjunction with their ransomware attacks. At the same time, the authors also ask the named departments to provide more information on what efforts have been taken to track and stop ransomware attacks and where Congress might be able to provide assistance to further advance enforcement actions. The October 8, 2021 letter also focuses on working with international partners, as ransomware attacks most often originate outside of the United States.

Ransomware attacks involve encrypting an organization’s data and holding it for ransom. Perpetrators of  ransomware attacks often demand to be paid in cryptocurrencies. While the blockchain is designed to make every initiated transaction publicly visible, sophisticated hackers will often dilute and disperse cryptocurrency payments across a multitude of different wallets and exchanges, making transaction tracing increasingly difficult and time consuming.

The October 8, 2021 letter focuses on cryptocurrency exchanges, where cryptocurrencies are exchanged for a fiat currency. In the United States, these exchanges are subject to Anti-Money Laundering (AML) and Know Your Customer (KYC) laws and regulations, which are in place to help track illicit activity at financial institutions. Many crypto users are vehemently opposed to any sort of breach in the anonymity that has long been a hallmark of the community. The explosive growth in the industry, however, will likely continue to see increased regulatory oversight, as billions in dollars of cryptocurrency are exchanged every day.

Businesses in the crypto industry need to be familiar and compliant with AML and KYC laws and regulations. If your company is doing business with a cryptocurrency exchange, assessing that exchange’s compliance with these laws and regulations will be crucial.

Commodity Futures Trading Commision (CFTC) Commissioner Dawn Stump Speaks Out On The Commission’s Enforcement Actions Involving Digital Assets

In a recent intereview, CFTC Commisioner Dawn Stump discussed the CFTC’s enforcement actions against those in the crypto and blockchain industry. Commissioner Stump stated the CFTC’s role in enforcement actions against digital assets was to regulate derivatives regardless of asset class. Commissioner Stump also brought up some of the challenges related to a recent CFTC enforcement action against the cryptocurrency exchange Kraken, in which she issued a concurring statement urging the CFTC to recognize that digital assets present new and unique problems not found in traditional markets.

On September 28, 2021, Kraken entered into a settlement with the CFTC wherein it was fined $1.25M and accepted other sanctions for “entering into, executing, and/or confirming the execution of off-exchange retail commodity transactions with U.S. customers who were not eligible contract participants or eligible commercial entities.” The CFTC fined Kraken for not registering as a designated contract market (“DCM”). The major point of contention, noted in Commissioner Stump’s concurrence, was that Kraken was also penalized for “operat[ing] as an unregistered futures commission merchant (“FCM”) in violation of Section 4d(a)(1) of the Act, 7 U.S.C. § 6d(a)(1) (2018)”. In her concurring statement, Commissioner Stump stated:

[The CFTC] also finds that Kraken operated as an unregistered FCM with respect to those transactions, which begs the question: If Kraken had sought to register with the Commission as an FCM, how would it have been expected to operate? Absent these transactions occurring on a DCM, they would continue to be illegal even if Kraken had an FCM registration. Furthermore, how Kraken would be regulated as an FCM is not entirely clear, because many of the Commission’s rules governing its regulation of traditional FCMs do not fit Kraken’s role as an exchange. It also would be unprecedented for an entity to register as both a DCM and an FCM.

The Kraken enforcement was one of the first applications of the CFTC’s March 2020 “Final Interprative Guidance” concerning certain digital assets.

In the interview, Commissioner Stump discussed the following two points, which she also made in her concurring statement:

1) the March 2020 Final Interprative Guidance is non-binding and should be interpreted as the CFTC communicating its views on novel issues. That said, the CFTC needs to issue clear and enforceable rules so that all market participants understand those rules. Kraken was quick to work with the CFTC to find a solution and in the end, that’s why its settlement amount was relatively low.

2) Kraken is a unique market participant, offering both DCM and FCM services. Commissioner Stump stated “How do we, on one hand, tell an entity that they must register as an FCM to offer a product? And on the other hand, tell them there may be no real means of obtaining such a registration? They don’t today fit our rules for an FCM, and so I’m assuming that they could not comply with a vast majority of restrictions and requirements of being an FCM.”

The Takeaway

Commisioner Stump’s concurring statement is representative of the challenge for both regulators and market particpants in applying the traditional regulatory scheme to the emerging crypto industry. It is becoming increasingly evident that the U.S. Government is willing to use current and available enforcement mechanisms to regulate the crypto industry. At the same time, there is recognition that those enforcement mechanisms might not adequately address the unique issues posed by this nascent industry. As such, it is likely that the regulatory scheme will see further development in the near future.

We have been following the U.S. Government’s guidance on blockchain and cryptocurrency for some time. If you are in this industry, or will be integrating these technologies into your operations, and you work with the Federal Government, please contact us. We will help you navigate the developing federal regulations in this field to keep you on the right side of the law.