Intro/Disclaimer: Since late 2022, I’ve prepared weekly updates for attorneys at my firm to stay abreast of the latest Web3 legal developments. The biggest stories are included in Bi-Weekly posts on the firm’s BitBlog, where we provide concise tl;dr overviews and insights into how these developments might ripple through the industry. In pursuit of a more thorough and personal discourse, I also share expanded versions of these updates on my personal blog every Tuesday. Here, you’ll find my unvarnished perspectives, offering a deeper dive into the nuances of these legal narratives. Please note, the views and opinions I express, both on BitBlog and my personal blog, are solely my own. They do not reflect the official stance or endorsement of my firm.
This week was huge in Web3 law. Coinbase (predictably) lost on most of its early dismissal attempts but did get a big win for DeFi/frontend providers with a win on the Coinbase wallet application. There seems to be a wave of declaratory judgment actions against the SEC to force the agency’s hand in defining what is and is not permitted for digital assets. KuCoin was hit with charges for violation of AML/KYC laws (similar to Binance), and SBF was sentenced to 25 years in prison for his role in the FTC collapse. Oh, and we are just a few weeks away from the next Bitcoin halving.
Also, I’ll be speaking at NFT/NYC on Wednesday this week and in New York from Wednesday-Friday, so if you are in town and want to meet up let me know. Conference season starts now.
Here’s everything that happened last week in Web3 law:
Coinbase (mostly) Fails to Obtain Dismissal at Judgment on the Pleadings Stage
The Court overseeing the SEC v. Coinbase lawsuit ruled against Coinbase on two of the three categories of alleged violations. The Court found that the SEC sufficiently pled there is a cryptocurrency “ecosystem” as to support horizontal commonality for the Investment Contract analysis for at least some of the 12 digital assets at issue. The Court also held that the risk of loss in the staking program and the consideration in the form of the crypto asset to be staked was sufficiently alleged to survive at this stage in litigation. Finally, while ruling digital assets were not of such importance as to invoke the Major Questions Doctrine, the Court did rule that Coinbase providing a front end to DeFi platforms through the Coinbase Wallet was not sufficient to fall afoul of securities laws and the Court dismissed that claim.
Tl;dr: From the questions by Judge Failla at oral arguments, I raised by prediction of Coinbase winning on the pleadings stage from zero to 10% (Coinbase’s own head of legal didn’t expect an outright win) so this was as expected. But still, the decision seemed to take liberties with the facts such as stating that token issuers “maintain” those tokens, that every blockchain has a native token (which all the blockchains at issue in this litigation do, but isn’t always the case), and defining “ecosystem” as everybody but the users of digital assets (who are arguably the most important parties in determining a digital asset’s value). Still, the wallet ruling is pretty great for people working in DeFi or on front-end applicable to those DeFi platforms. Biggest take-away? The foundations/labs behind the 12 tokens named for the non-wallet claims better be ready for an avalanche of third-party discovery. Pacer docket is about to have 30 firms added once discovery gets into the swing of things. And if staking is a security, so is Turo, Air B&B, and countless other applications which make the technically complex process of earning money on assets easier for consumers.
SEC Hit with Another Declaratory Action Case, This Time Regarding Airdropped Tokens
Beba LLC and the DeFi Education Fund have sued the SEC for a declaratory judgment regarding Beba’s planned token airdrop for use in obtaining discounts on certain handmade goods. You can read the lawsuit here. You can also read the thread by the DeFi Education Fund breaking down the lawsuit here. “Together with Beba, DEF seeks a declaration from the Court that the SEC violated the Administrative Procedure Act when they adopted their policy that nearly all digital assets themselves are investment contracts and nearly all digital asset transactions are securities transactions.”
Tl;dr: A few weeks ago it was exchange platform LEJILEX who sued the SEC for a declaratory judgment. Now it is Beba with the support of the DeFi Education Fund. There will likely be more to follow, especially if these cases can be shown to make it past jurisdictional defenses on a Motion to Dismiss. After years of the SEC bringing cases against tiny projects with limited funding (like LBRY) or other arbitrary enforcements, it is nice to see projects without the baggage (pun intended in the case of Beba) of bad facts that can argue simply on the basis of law.
Sam Bankman-Fried Sentenced to 25 Years in Prison
FTX founder Sam Bankman-Fried (“SBF”) was sentenced to twenty-five years is prison after previously being convicted for seven counts of fraud and conspiracy related to his actions which led to FTX’s collapse. Judge Kaplan recommended that Bankman-Fried serve his time in a minimal or medium-security facility, ideally close to San Francisco, CA, so he can be near his family.
Tl;dr– There will be appeals and all the co-conspirators who testified against SBF will also need to be sentenced, but this brings and end to one of the darkest stories in crypto. Instead of looking into FTX, the SEC was busy going after LBRY or other projects which caused no consumer harm. But glad that stoping crypto-youtube was more important than a multi-billion-dollar fraud. It is worth noting, that SBF’s crimes were possible because many of the exchange’s activities were off-chain, differentiating from DeFi where liquidity is always known. While there were some interesting exchanges during the sentencing hearing, I am just looking forward to putting this whole ordeal in the rearview mirror.
KuCoin Charged With Violating BSA and Commodity Exchange Act
The CFTC and Department of Justice filed parallel civil and criminal actions against the companies operating the KuCoin exchange. In the civil complaint, the CFTC alleges that KuCoin illegally dealt in off-exchange commodity futures transactions and leveraged, margined, or financed retail commodity transactions, operating in the US without registering as a futures commission merchant, swap execution facility, or designated contract market. The criminal complaint reportedly is charging them with violating the Bank Secrecy Act, operating an unlicensed money transmitter business, and conspiracy to violate the Bank Secrecy Act and operate as an unlicensed money transmitter business.
Tl;dr: This isn’t the first time KuCoin has landed in hot water, as it was recently barred from operating in New York and was effectively kicked out of Canada. I thought KuCoin was going to no-show and take the default judgment as they have a history of doing in the New York AG lawsuit they settled, so it will be interesting to see how they respond to federal charges. It shouldn’t be a huge surprise that an exchange offering otherwise regulated products without either geofencing US IP addresses or requiring basic KYC verification would get in trouble. Interestingly, the CFTC press release provides that they “failed to impose any IP address restrictions during the relevant period to prevent U.S. customers from trading commodity interests or account for commonly used technology such as virtual private networks (VPNs) that could potentially circumvent IP address restrictions.” It is unclear how one would prevent VPN users from accessing the exchange short of blocking all VPNs (which is untenable for many reasons, not the least of which is that about 30% of all internet users are using a VPN, usually for completely legitimate reasons), or why someone would need to block VPNs when they’re not geofencing to begin with. But at least they restated that ETH is a commodity.
Other Stories
The SEC is asking for $2 billion in damages for the XRP case. A case which SEC lost half of, and which won on technical failure to register grounds opposed to any fraud or other charges. And again, a case where there is no alleged consumer harm. But the SEC’s mandate is to bankrupt companies for registration foot faults, right? Wait, it isn’t?!
House Republicans sent a sternly worded letter to Gary Gensler asking for clarification on the SEC’s position as to the regulatory classification of ETH, and the SEC’s position regarding Prometheum’s announcement that it intends to custody ETH (as a security) on behalf of customers. Turns out, letting a company with no business be your poster child of compliance has consequences!
New Vitalik dropped, this time discussing “blobs” on Ethereum. ETH’s problem is dealing with ever expanding transaction fees due to needing to store an increasing complex ledger. So love to see solutions to that issue being suggested, previously in the Dencun upgrade for L2’s and now Blobs.
All is well that ends well, as the Layer-2 Blast was able to negotiate the return of funds, but this $62 million exploit (which was seemingly done by North Koreans inadvertently hired by the protocol) show the real risk in trusting funds on an untested applicable running on an untested Layer-2. Or as @CirrusNFT put it: “In hindsight maybe depositing a reasonably sized home into an app called “Munchables” to earn “Schnibbles” so that I could feed these things so that they can level up and earn more “blast points” was a bad idea.” At least nobody can steal the off-chain points.
Apple had a previously dismissed class action against it regarding the permission of a fake digital currency wallet to be available in the app store revived by the 9th Circuit Court of Appeals. It turns out, you can’t take a 30% cut claiming vigorous app store protections while letting apps steal millions from your users. Who knew?
Franklin Templeton went to social media to announce their new managed BTC/ETH account. Big fan of people with a lot of money coming to buy my bags. Can I interest you in a reasonably priced .jpg?
Somebody mentioned to me in passing how DAOs are going to structure governance for merger advantages like the invention of the Poison Pill in corporate defenses and I can’t stop thinking about that.
Crypto funding in early stage start-ups is back, baby.
Based. Honestly, seeing what is being built on Base (the Coinbase sponsored Layer-2) is a case study in how you don’t need a native token if you just make your L2 insanely easy to build on. Let others build and make money on that, you make money on the tiny fees that add up over time. Just smart. Blockchain picks and shovels.
Custodia (mostly) lost their fight with the Fed to get a master account. It’s honestly v dumb that the business model of “we will keep 100% reserves and just charge a small fee rather than loaning out your money and keeping partial reserves” is not an acceptable way to run a bank.
If I didn’t have big Illuvium bags would I be posted this story in my update? No way to know. But I do know that one of these Web3 games which have been in development for years is going to reach mainstream adoption, and I don’t think Illuvium is in a bad position to be that game that breaks through.
I need to read this Motion to Dismiss the charges against Tornado.cash developer Roman Storm, but I was disappointed in my word search the “Fourth Amendment” does not appear to be a basis for dismissal.
I didn’t get an email beta invite to the Cobie angel investor platform. Which is cool. I am not upset or anything.
This Consensys public comment letter in support of the spot Ether ETFs was a great read. It is also an important addition to the public record in case the SEC rejects those applications, and something for the Court of Appeals to consider in case of such a rejection.
The Prisma hacker moved funds to Tornado Cash raising interesting questions on reporting obligations if those funds are returned.
Conclusion
If you have any questions or would like me to write about anything else, let me know on either of my Twitter (X?) pages! As always, I am an attorney, I am not your attorney. For legal advice, you should always consult (and pay for) an attorney.
The NFTtorney 