The Blockchain Bi-Weekly presented by the Polsinelli Blockchain+ team is a rundown of some of the key stories in the Web3, blockchain and crypto ecosystems curated by our attorneys navigating the intersections of code, smart contracts, and US law.
As the new year is in full swing, digital asset legal developments have picked up as well. In a surprising turn of events, it was revealed that the theft of $400 million in assets as FTX was going through their change in leadership prior to bankruptcy was allegedly the result of a sim swap, with three American charged in the theft. The Department of Energy is also looking into the energy usage if cryptocurrency mining, and there appears to be bipartisan support to overrule the SEC’s proposed digital asset custody rule.
These developments and a few other brief notes are discussed below.
Alleged FTX Hackers Indicted Over $400 Million Hack: January 24, 2024
Background: Three Americans have been charged with a series of sim-swap hacks which included the hack of certain FTX accounts during the disorganized period around the time that control of the exchange was handed over to attorneys. While the victims are not listed in the indictment, media outlets are reporting that Victim Company-1 is FTX, and access was obtained through a sim swap of an FTX employee’s phone who had access to various FTX digital wallets.
Summary: In the days after FTX’s collapse, hundreds of millions of dollars in cryptocurrencies were moved out of FTX’s accounts. Many believed at the time this was an inside job, with a high-level employee moving those funds as a nest egg to preserve against government seizure. After not hearing many updates on this in the years following, it is interesting to find out it was three Americans behind the heist. SIM swapping is not an especially sophisticated form of hacking, so to hear these three allegedly got over $400 million through relatively unsophisticated forms of fraud shows how lax the security and compliance was at FTX around the time of its collapse.
Energy Department Issues “Emergency” Collection of Information Regarding Bitcoin Mining Energy Consumption: January 26, 2024
Background: The U.S. Energy Information Administration (“EIA”) “authorized the survey on January 26, 2024, as an emergency collection” for commercial cryptocurrency miners to respond to. The agency stated in a press release. “We will specifically focus on how the energy demand for cryptocurrency mining is evolving, identify geographic areas of high growth, and quantify the sources of electricity used to meet cryptocurrency mining demand.”
Summary: The science is fairly well established that Bitcoin and other cryptocurrency mining is a net positive for stabilizing electrical grids, especially for renewable energy sources which often have high outputs that need consumption because factories and other energy consumers (unlike mining) cannot be turned on and off when the wind is high/low or the sun is bright/covered. Despite these benefits, this is just the latest step taken by the current administration with the intent of curbing crypto mining activity, along with the proposed Digital Asset Mining Energy (DAME) 30% excess tax on crypto miners. That said, while this was an “emergency” order that sidestepped normal regulatory agency due process it still is little more than an information-gathering measure, albeit one the EIA intends to use to develop a new standard collection.
Bipartisan Joint Resolution Issued to Repeal SEC Crypto Custody Guidance: February 1, 2024
Background: Senator Lummis (R-WY) along with Congressman Nickel (D-NC) and Flood (R-NE) introduced S.J.Res.59 under the Congressional Review Act which authorizes Congress to rescind agency rules through joint resolutions. The Joint Resolution would repeal the SEC’s Staff Accounting Bulletin (“SAB”) 121 which requires listed companies that custody digital assets to list those assets as liabilities on balance sheets unlike cash and other assets custodied by those custodians. The Government Accountability Office has previously ruled that SAB 121 failed to abide by the Congressional Review Act.
Summary: Senator Lummis seems to believe she has the votes to pass this through the Senate because Joint Resolutions only require a simple majority and not the 60 votes required to end debate on other bills. This will almost certainly pass the House if it gets there. It is an accounting rule that makes no sense and results in there being fewer trusted fiduciaries who can protect customer’s digital assets from theft. It will be interesting to see if the President’s current digital asset stance is important enough to him to use his veto power on this Joint Resolution if it passes the House and Senate. The SEC’s passage of SAB 121 was always odd as the purpose of SEC staff bulletins is to establish internal policies on how to implement already existing rules (and inform the general public about those internal policies), while SAB 121 goes well beyond the usual purpose of a staff bulletin and establishes new policy rather than interpreting an existing rule. Even if SAB 121 is overturned, it would not affect the SEC’s proposed “Safeguarding Rule” which would overhaul the Investment Advisers Act Custody Rule and make non-security crypto assets subject to custody requirements that could be difficult, if not impossible, to fulfill for many digital assets.
Briefly Noted:
SEC Delays Decision on Spot ETH ETF: Well this is a shocker! Some analysts are predicting that a spot ETH ETF could be approved as early as May if the SEC doesn’t reject the rule change required to approve the ETF, but later seems more realistic. While the SEC was bench-slapped over its failure to approve a BTC ETF, Gary Gensler has telegraphed that the SEC will argue that the holding in that case only applies to BTC and that, with a significantly lower market cap and different blockchain validation mechanics, ETH could be significantly more prone to manipulation than BTC. After having approved an ETH futures ETF, it could be difficult for the SEC to stall for too long. That said, every objection made by Commissioner Crenshaw (who still voted against the ETF despite a court order to the contrary) to the BTC ETF would also be true for an ETH ETF (even though most of those objections are also true for nearly all single-asset ETFs).
Article on DeFi As Critical Infrastructure Released: Various legal practitioners in the space issued an academic paper proposing that DeFi be regulated as a critical infrastructure provider rather than as a financial intermediary assuming it meets certain technical thresholds. It is not a final proposal, but is an interesting starting point in thinking of DeFi as technology first.
SEC Commissioner Dissents to Rule Prohibiting Denial of Charges by Settling: SEC Commissioner Hester Peirce has issued a dissent to the Commission’s decision to reject a proposed rule change that would allow settling parties to continue to claim innocence after accepting a settlement. It raises the question if a government agency while acting in civil litigation, has the ability to restrict speech to such a degree.
FTX Expected to Pay Customers in Full/Will Not Restart Exchange: FTX issued an update to the bankruptcy court stating that it expected to be able to pay back all depositors in the exchange prior to its collapse, but will not be restarting the business following the bankruptcy proceedings. It is yet to be determined if depositors will be paid back in kind or, more likely, based on the price of the applicable cryptocurrency at the time of bankruptcy (which was near 2-year lows for many digital assets).
Industry Opposed FinCEN Rulemaking Proposal: Chamber of Digital Commerce, Coinbase, Paradigm, and others all submitted comments to FinCEN’s Notice of Proposed Rulemaking which would result in bulk data collection and reporting requirements for all transactions involving any crypto mixing even with no indication of suspicious activity.
Conclusion:
As the digital asset landscape continues to evolve, the first month of this year has brought to light significant legal, regulatory, and ethical challenges facing the industry. From the shocking revelation of the alleged FTX hack to the ongoing debates over energy consumption and regulatory oversight, each development underscores the complex interplay between innovation, security, and governance in the digital age.
The bipartisan effort to overrule the SEC’s digital asset custody rule highlights a growing recognition of the need for nuanced, balanced policies that safeguard both the industry’s potential and the public’s interest. As we navigate these turbulent waters, it’s clear that the path forward requires a collaborative approach, one that embraces the transformative possibilities of digital assets while addressing the vulnerabilities and ethical considerations they can also represent. The rest of the year promises to be a critical period for shaping the future of digital assets, as stakeholders across the spectrum strive to find common ground in building a resilient, equitable, and sustainable digital economy.