Hi Insiders, This is the final issue of our Blockchain and the Law series. I hope that these newsletters have provided you with some insights into the legal and regulatory framework around the different applications of blockchain technology. If anyone has any questions on this topic, feel free to reach out on Twitter or LinkedIn. Also if you want to talk to me directly you can join our "Inside Cryptocurrency: Law and the Blockchain" event on Monday, where I will discuss these issues directly with you and answer whatever questions you may have. This newsletter should be a bit more fun than earlier issues, as we will go through cases instead of legislations and regulations. We will look at some of the lawsuits or criminal cases that are ongoing or concluded in the blockchain space to see how the regulations and laws we've been discussing are applied in practice. |
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Silk Road Trilogy The so-called "Silk Road Trilogy" of cases between 2013 and 2015 were the first three major legal cases dealing with blockchain technology. They established many precedences and covered a wide range of laws and all three resulted in criminal convictions. - USA vs Ulbricht — Ross Ulbricht was the founder and administrator of Silk Road, an online marketplace where contraband including drugs, guns, fake IDs, artworks, etc. could be sold. The site accepted payments only in Bitcoin and, at the time of his arrest, it was estimated that Ulbricht had earned ~$8M in commissions from sales through the site. He was convicted on numerous charges including engaging in a continuing criminal enterprise, distributing narcotics, and conspiracy to commit money laundering. He was sentenced to life in prison and ordered to pay $183M to the government.
- USA vs Faiella and Shrem — Robert Faiella owned a bitcoin exchange that was unlicensed and was used by Silk Road customers to anonymously acquire cryptocurrencies. His exchange would place orders through BitInstant, a company owned by Charlie Shrem, which was licensed. Faiella was charged with operating an unlicensed money transmitting business and conspiracy to commit money laundering while Shrem was charged with aiding and abetting those crimes. Faiella was sentenced to four years in prison and Shrem to two years.
- USA vs Bridges and Force — Shaun Bridges and Carl Mark Force were government agents working on the case against Silk Road. Force was sentenced to 6.5 years in jail for providing details of the criminal investigation to Ross Ulbricht (the founder of Silk Road) in exchange for Bitcoin. Bridges was sentenced to 7.5 years in jail for stealing 20,000 Bitcoin from Silk Road during the investigation and ~1,500 Bitcoin that had been seized by the U.S. government.
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NFT Copyright In January 2022, StockX, a reseller of high-end sneakers, launched NFTs that allowed the purchaser to later use those NFTs to redeem the sneakers in the image. Many of the images were of Nike shoes, although NFTs of other brands were also sold. In December, Nike acquired RTFKT, a digital art company, as part of efforts to launch its own NFTs in early 2022. In a lawsuit, Nike claims that the StockX NFTs, which have images of their shoes, are an infringement of their trademark. This ongoing case is capturing the attention of many analysts because companies have not historically claimed that drawings, paintings, or other artwork containing depictions of their products infringed their trademarks. There should be more clarity as the case develops but this case exemplifies the challenges of applying existing law to blockchain technology.
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USA vs Son Jong-woo This was one of the first major criminal cases dealing with issues related to the blockchain and its ability to distribute content and information in a decentralized manner. The case involved "Welcome To Video," a Darknet website launched in 2015 that became the largest child pornography website, with some 1.3 million members, including about 4,000 paying members. By the time the U.S. government seized the site's servers, it found 8 terabytes of child pornography videos. - "Welcome To Video" users paid in Bitcoin. To help users stay anonymous, a new public address was created for each user automatically when they joined the site.
- Ultimately, the government was able to trace the flow of funds on the blockchain to a wallet in South Korea, which allowed them to identify the administrator of the website.
- The U.S. government has been using the public ledger to identify the clients, which has led to some 400 arrests.
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USA vs Ripple Labs Earlier newsletters discussed some of the issues with attempting to start payments or banking businesses in this industry. Ripple Labs was one of the first major companies to be penalized for not following anti-money laundering laws and failing to comply with the strict regulations around financial services. The company developed its own cryptocurrency, XRP, which was sold to consumers for cash, and given to institutions to encourage them to use it for internal transactions. Ripple Labs was not upfront about the coins in reserve and how and why those would be distributed in the future, which triggered doubts and uncertainty in the community, and prompted critics to call XRP "a scam." The U.S. Department of Justice charged Ripple Labs with failing to register as a money services business and, in 2015, the company reached a settlement with the Financial Crimes Enforcement Network and agreed to pay a $700K fine for violating the Bank Secrecy Act.
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Money Laundering Given the war in Ukraine and the significant uptick in cryptocurrency activity in Eastern Europe, it seems fitting to discuss a past case that also included Russia's use of cryptocurrencies to act against U.S. interests. "USA vs Victor Borisovich Netyksho" was a case that evolved from the investigations into Russian interference in the 2016 U.S. presidential election. - During the campaign, there is evidence that the Democratic National Committee, Democratic Congressional Campaign Committee, and both candidates were hacked by Russian intelligence agents.
- Ads were also purchased on social media sites to target U.S. citizens with false information to influence their votes.
- Evidence showed that those who set up this infrastructure to influence the election had a global operation paid for with cryptocurrencies.
- Cryptocurrencies were used for everything from purchasing servers to registering domains and paying hackers.
- Viktor Borisovich Netyksho was one of the few suspects charged by the U.S. government in connection with Russian attempts to interfere in the 2016 Presidential election. He was specifically charged with conspiracy to launder money.
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Securities Law (1/2) We discussed these three cases in the first newsletter but here is a quick refresher because these cases are fundamental to our understanding of how securities law applies to the blockchain space. - Telegram — In October 2019, the SEC filed an emergency action to prevent an allegedly illegal offering of $1.7B worth of securities by Telegram. In 2018, Telegram had sold 2.9 Billion tokens, called grams, with the funds earmarked for the upgrade of its messaging system and the launch of a blockchain network. In 2020, a court issued an injunction to prevent the sharing of the Grams and, later that year, Telegram settled with the SEC, agreeing to return $1.2B plus interest to investors (the other $500M was purported to have already been returned to investors) and to pay an $18.5M fine. The company was banned from dealing with digital tokens for three years without the express approval of the SEC.
- Kik Interactive Inc — In June 2019, the SEC filed a complaint against Kik for selling 1 Trillion Kin tokens, raising $100M, to grow its messaging service. A court found that this was an illegal sale of a security contract and Kik had to pay a $5M penalty.
- Plexcoin — Plexcoin was a project that advertised itself as the next cryptocurrency. It was meant to be a more liquid version of Bitcoin, with backers getting a credit card and being able to spend the tokens on the Visa network. (At least these were the claims of the company.) Plexcoin also claimed, using Bitcoin as a reference, that investors could see returns of 1,300% in a month. After raising $15M through an ICO, AMF, the Quebec financial watchdog, issued orders to seize the funds, and shut down the website and social media of the company. Plexcoin founders were charged and sentenced to two months in jail and a $100K fine. The SEC also pursued the case and successfully froze all assets associated with the ICO.
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Securities Law (2/2) We previously discussed the DAO case in our Capital Markets newsletter but this case still forms the basis of an entire industry that continues to grow exponentially. From April 30 to May 28, 2016, The DAO sold 1.15 Billion DAO Tokens for 12 Million Ether in a transaction valued at approximately $150M. The DAO was supposed to allow for a new form of investing whereby those who held tokens could vote on how to invest the $150M. The DAO would invest on behalf of its “stakeholders,” then split the profits relative to the token holdings. Its plan was to provide an alternative to corporate finance. A flaw in The DAO’s code led to $50M being stolen, making the project a quick target for the SEC, which released a report analyzing the legality of the project in 2017. - The SEC determined that The DAO was an unincorporated organization illegally selling securities (DAO Tokens) without registering the sale with the SEC.
- The SEC found that The DAO co-founders, who controlled which projects would be voted on, and who initiated the unregistered offering, were legally liable for the actions of The DAO.
- The SEC determined that any platform that allowed for the sale of DAO tokens, which were considered a security, was therefore an exchange that needed to be registered with the SEC.
- The SEC interestingly did not comment on whether the attack, which exploited a vulnerability in the smart contract, was a crime. Instead, SEC officials said that they viewed the attack as someone taking advantage of poor contractual terms, with the contract being in the form of computer code.
The idea that DAOs can be fully decentralized, with nobody taking responsibility for the actions of The DAO appears to be something regulators will not allow. Fundamentally, the position of the SEC appears to be that it will allow DAOs, or any other investment vehicle, so long as there is someone they can hold accountable — similar to how they need someone who is in charge of a Bank, Hedge Fund, Venture Capital Fund or any other financial institution.
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 |  | Liam Gill is a founder, lawyer and investor.
He previously founded Fumarii Technologies, which became a top 20 ranked cloud computing service (Yahoo Finance! 2019) valued at over $30M. He holds an LLB Laws (UK), MSc Management and Master of Laws and currently practices law at Zargar Lawyers + Business Strategists in Vancouver, Canada.
|   | | Editor | Eduardo Garcia is a writer and editor based in New York. He is writing an illustrated book about climate change that will be published by Ten Speed Press, an imprint of Penguin Random House. Bylines in The New York Times, The Guardian, Slate, Scientific American, and others. In one of his previous lives, Eduardo worked as a Reuters correspondent in Latin America for nearly a decade. | |
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