Digital Currency & Blockchain 2024 Year End Review

Key takeaway: Shifts in US Securities and Exchange Commission (SEC) leadership and an anticipated reevaluation of crypto policy under the new presidential administration likely will mean a regulatory sea change for the digital-assets industry in 2025 and beyond. The departure of SEC Chair Gary Gensler marks the end of a particularly combative period for crypto regulation in the US, with many in the digital-assets industry hopeful for a more balanced and constructive approach. Bipartisan legislation seems likely given the down-ballot success of Stand With Crypto-backed candidates and many legislators identifying as pro-crypto.

SEC Chair Gary Gensler announced that he will depart the agency on Inauguration Day, January 20, 2025. The crypto community welcomed this news. Gensler’s tenure as chair of the SEC has been marked by a combative relationship with the digital-assets industry. Appointed in April 2021, Gensler was a vocal critic of digital assets and markets, citing concerns about investor protection, regulatory oversight, and the potential for fraud and manipulation. He called for an aggressive and broad application of federal securities laws to digital assets, decentralized finance (DeFi) platforms, and stablecoins.

The SEC’s enforcement actions under Gensler’s leadership received significant criticism from the digital-assets community, who felt that the aggressive approach stifled innovation and hurt the United States’ position in the global crypto market. Critics accused Gensler of regulating through enforcement rather than fostering clear regulatory frameworks for the digital-assets industry. The industry has signaled that it will not forget the challenges imposed by the Gensler-led SEC. Coinbase CEO Brian Armstrong recently posted on X advising law firms against hiring former SEC staff who have been hostile to the crypto industry.

Many expect that the next chair will be friendlier to the digital-assets industry and more collaborative in general. For the digital-assets sector, this change in leadership could signal a recalibration of the SEC’s stance, offering an opportunity for constructive dialogue and a more balanced regulatory framework that will facilitate a move back to the United States for developing projects.

The industry is optimistic about the president-elect’s purported choice of Paul Atkins as the next SEC chair. Atkins is a veteran financial regulator who formerly was an SEC commissioner under President George W. Bush from 2002 to 2008. After his term as SEC commissioner ended, Atkins founded a financial services consulting firm that provides advisory services to banks and investment firms on regulatory and compliance matters, including on issues related to crypto and digital assets. In connection with the nomination, President-elect Trump wrote on Truth Social, “[Atkins] also recognizes that digital assets & other innovations are crucial to Making America Greater than Ever Before.” Atkins’s nomination has been favorably received by the industry.

Additional crypto-friendly appointments also seem to signal a new era in the US in which government will support, or at least not actively stand in the way of, the growth of blockchain technology and the crypto industry. The newly created Department of Government Efficiency (DOGE), headed by co-leads Elon Musk and Vivek Ramaswamy, and the appointment of David Sachs as “Crypto Czar,” also seem to demonstrate the new administration’s commitment to crypto and digital assets as an area for growth for the US economy.

Key takeaway: On November 26, 2024, the US Court of Appeals for the Fifth Circuit issued a watershed decision affecting sanctions enforcement in the digital-asset space by holding that the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) overstepped its congressionally defined authority under the International Emergency Economic Powers Act (IEEPA) by attempting to block immutable smart contracts as “property” when it designated cryptocurrency mixer Tornado Cash as a person on its Specially Designated Nationals and Blocked Persons (SDN) List.

The case, Van Loon et al. v. Department of the Treasury, stemmed from a district court’s decision that OFAC acted within its authority when it placed cryptocurrency mixer Tornado Cash on the SDN List and imposed an across-the-board prohibition on the transfer, withdraw, or dealing of any kind of property (known as “blocking”) in which Tornado Cash has an interest, which, per the court, included its immutable smart contracts. In making this determination, the district court concluded that: (1) Tornado Cash is an “entity” that may be designated as a “person” under IEEPA; (2) smart contracts constitute “property”; (3) and the Tornado Cash DAO has an “interest” in its smart contracts because it derives profits from its crypto mixing and relaying services that run on them.

The Fifth Circuit reversed the decision regarding the classification of Tornado Cash’s immutable smart contracts as “property.” The Court ruled that the district court erred in giving “heightened deference” to OFAC’s definition of “property” and erred in finding that the immutable smart contracts met that definition. Instead, relying upon the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo — requiring courts to exercise their independent judgment in deciding whether an agency has acted within its statutory authority — the court determined that the immutable smart contracts at issue cannot be “property” under the IEEPA (an undefined term under the IEEPA) because they are not capable of being owned. Here, the court noted that more than 1,100 users participated in a “trusted setup ceremony” in 2020 to make the smart contracts irreversibly immutable, at which point they became self-executing and could no longer be discarded, changed, disconnected, or controlled, thus taking away any hallmark of ownership.

The court also concluded that immutable smart contracts do not fall under OFAC’s longstanding regulatory definition of “property,” which includes “contracts” and “services” of any nature. First, the court rejected the government’s argument that immutable smart contracts are effectively a “code-enabled species of unilateral contracts” because they lacked two essential criteria: a party on the other side of a transaction to accept or make a counteroffer, and an ability to be revoked by an offeror before performance has been completed by an offeree. Second, while the court acknowledged that immutable smart contracts can be a tool used in performing a service, the court did not equate such code with being a service, which the court said must expend some form of human effort.

Because the court found the “property” question dispositive, it elected not to address other important elements of the case, including whether Tornado Cash qualifies as an “entity” or has an “interest” in property under the IEEPA. Because the decision narrowly pertains to immutable smart contracts, it does not appear to affect the SDN designation of Tornado Cash and blocking of its other property, including the tornado.cash website and Tornado Cash Ethereum addresses for mutable smart contracts. But nonetheless, barring the government’s successful appeal to the Supreme Court, this ruling will significantly restrict OFAC’s ability to use its blocking authority against DeFi targets with smart contracts. While the court acknowledged the “real-world downsides of certain uncontrollable technology falling outside of OFAC’s sanctioning authority” under the IEEPA, it left any updating of the IEEPA to account for this deficiency to the will of Congress, stressing that “[l]egislating is Congress’s job — and Congress’s alone.” We should also expect this case will be cited in a variety of future disputes relating to smart contracts.

Key takeaway: In a pair of decisions, a federal judge in the Northern District of Texas recently vacated the SEC’s February 2024 rulemaking that would have expanded the definition of “dealer” under federal securities laws to include large traders regularly providing liquidity to the securities markets and those who supply liquidity to crypto protocols. The related opinions mark yet another instance of a court finding that the SEC exceeded its statutory authority, as noted in other pending cases against the SEC discussed infra: Consensys, LEJILEX, and Beba.

In two separate decisions on November 21, 2024, a federal judge in the Northern District of Texas granted motions for summary judgment filed in cases brought against the SEC by the Managed Funds Association and other investment management industry trade groups, on the one hand, and the Blockchain Association and Crypto Freedom Alliance of Texas (Crypto Freedom), on the other, vacating the SEC’s February 2024 rulemaking that expanded the definition of “dealer” under federal securities laws. The expansion, which we covered in a recent client alert, would have applied to digital assets in addition to traditional securities and required high-frequency traders, private investment funds, decentralized exchanges, automated market makers, and even state pension plans to consider whether they would be required to register as a securities dealer with the SEC and with an SRO like FINRA. Specifically, this proposal would have had severe implications for decentralized exchanges and automated market makers that supply liquidity to crypto protocols, and even raised questions about potential distinctions between software coders, the software itself, and those who eventually use the software to provide liquidity or otherwise contribute to a pool of assets and whether any of these entities might be required to register as dealers.

In the court’s own words (with emphasis added) in the Crypto Freedom order:

“The Rule as it currently stands de facto removes the distinction between ‘trader’ and ‘dealer’ as they have commonly been defined for nearly 100 years. The Court refuses to allow such a broad expansion of the Exchange Act by way of this Rule. In addition to the reasons provided in the Related Case, the Court concludes that the Dealer Rule impermissibly exceeds the SEC’s statutory authority.”

The holdings in these cases are significant for several reasons. First, the ruling that the SEC exceeded its statutory authority may be a harbinger as it relates to several other recent SEC rules that have been challenged as an overreach of the agency’s authority. This is especially true in the wake of the Loper Bright decision that struck down the Chevron deference doctrine, which required courts to defer to agency interpretations of ambiguous statutes. Second, this may give the current SEC pause regarding the adoption of any pending rulemaking, particularly when considering the election outcome and lame duck period, and that any newly approved rule would be well within the lookback period of the Congressional Review Act. Finally, the act of vacating, rather than remanding the rule back to the SEC, is significant because it provides clarity that, short of an appeal, the rule is dead for now (whereas a remand would have sent the rule back to the SEC for further tinkering).

Because the court held that the SEC exceeded its statutory authority in making the rule, thus holding it invalid, it did not need to determine whether the rule was arbitrary and capricious under the Administrative Procedures Act (APA). The court’s holdings also focused on the interpretation that dealers have customers and provide services to those customers, whereas proprietary traders that would have been covered by the rule typically do not have customers.

The SEC has 60 days to appeal, which puts the appeal deadline right around the inauguration. It is possible that the current SEC files a notice of appeal merely to preserve the next administration’s ability to determine what steps to take, if any, though it seems likely that the SEC will simply let this ruling pass without a further fight.

Key takeaway: In its recent settlements with Rari Capital, Inc. and Mango DAO, the SEC made clear that it would look beyond labels to “economic realities” regarding decentralization and autonomy and hold individuals behind decentralized crypto products and platforms accountable for violations of federal securities laws. Importantly, the SEC permitted an authorized entity, rather than the DAO itself, to appear for and approve the settlement.

Notwithstanding the flurry of settlements at the end of the SEC’s fiscal year, predating the election, it seems unlikely that the industry will see more of these types of settlements under the new administration. The SEC instead is expected to focus on fraud and bad actors rather than relentless pursuit of crypto companies without identifying significant harm to participants.

On September 27, 2024, the SEC announced that it filed settled charges against Mango DAO, Mango Labs LLC, and Blockworks Foundation, with its complaint asserting that the MNGO token was an unregistered security and that the latter entities offered unregistered broker services. Also of note is the DAO’s appearance and execution of the settlement documents through a delegated Poland-based entity.

The SEC’s complaint, filed in US District Court for the Southern District of New York, charges Mango DAO and Blockworks Foundation with violations of the securities offering registration provisions of the Securities Act of 1933 (Securities Act) and charges Mango Labs and Blockworks Foundation with violations of the broker registration provisions of the Securities Exchange Act of 1934 (Exchange Act). The SEC’s complaint alleges that, beginning in August 2021, Mango DAO and the Blockworks Foundation raised more than $70 million through unregistered offerings and sales of MNGO tokens, the governance tokens for the Mango Markets platform. The SEC alleged that MNGO tokens were offered and sold as investment contracts and therefore were securities. The SEC further alleged that there were no registration statements filed or in effect for the offer and sale of the tokens and that there was no exemption from registration available for the tokens. These tokens were sold to hundreds of investors worldwide, including to US investors. Additionally, the SEC claims that, since at least August 2021, both Mango Labs and Blockworks Foundation had operated as unregistered brokers by actively soliciting and recruiting Mango Markets users to trade MNGO tokens, offering advice and valuations on investment merits and assisting in securities transactions by helping customers open accounts and regularly handling customer funds and MNGO tokens.

Without admitting or denying the allegations, Mango DAO¹, Mango Labs, and Blockworks Foundation agreed to settle the SEC’s charges, consenting to injunctions and orders to collectively pay almost $700,000 in civil penalties. They also agreed to destroy their MNGO tokens², request that these tokens be removed from trading platforms, and refrain from encouraging any platform to allow MNGO trading or sales. Of particular note is that the Mango DAO consent judgment provided that Mango DAO was waiving service of the summons and complaint and that Mango DAO was entering a general appearance (submitting to the court’s jurisdiction). The judgment was signed by a Mango DAO representative, “CyberByte sp. z.o.o.,” which was authorized by a DAO majority vote to appear on behalf of Mango DAO in the proceedings. Mango DAO’s attorney also signed the consent judgment and approved it as to form. This was a mutually agreed-upon resolution between Mango DAO and the SEC on how to enter a proper appearance in and “bind” the DAO to the settlement of the filed litigation.

The respective settlements are pending court approval.

In the SEC’s press release announcing the charges, Acting Chief of the Crypto Assets and Cyber Unit Jorge Tenreiro emphasized that any entity offering “securities-intermediary functions” must register, or otherwise be exempt from registration, with the SEC. His comments highlight the SEC’s focus on the “economic realities” surrounding crypto products and platforms; he noted that “[s]ince the inception of our crypto enforcement program, our view has been that the label ‘DAO’ does not change the reality of who is behind a project, what activities they engage in, or whether their activities need to be registered. Nor does engaging in intermediation of securities with the aid of automated or open-source software change the nature of such activities.”

^[1] Mango DAO members voted on the settlement proposal through a governance vote. The proposal was initially rejected; however, upon a second vote, it resoundingly passed, with more than 387 million votes for the proposal and 236 votes against the proposal. This outcome highlights that DAO-related litigation can be challenging and often fraught with unexpected hurdles.
^[2] Because Mango DAO members vote on proposals through the MNGO governance token, it remains unclear what the DAO’s future will look like without the token. There has been a recent governance proposal in which some DAO members sought to mint new MNGO tokens, but concern was raised as to whether this would violate the settlement agreement, again highlighting the complexities and challenges involved with DAOs and litigation.

On September 18, 2024, the SEC announced that it had settled charges against the decentralized finance protocol Rari Capital, Inc. and its three co-founders, Jai Bhavnani, Jack Lipstone, and David Lucid, for allegedly misleading investors and engaging in unregistered broker activity in connection with the operation of two blockchain-based investment platforms. Rari Capital also settled charges that it conducted unregistered offerings of three securities tied to those platforms. Separately, Rari Capital Infrastructure, which took over operations and development of one of the platforms, also settled charges that it engaged in unregistered securities offerings and unregistered broker activity.

According to the SEC’s complaint, Rari Capital, a Delaware corporation created by the three cofounders, offered two products: (i) Earn pools, which allowed users to deposit digital assets into lending pools managed by Rari; and (ii) Fuse pools, which allowed users to deposit digital assets into user-created borrowing and lending pools; at its peak, the Fuse platform held approximately $1 billion in assets in these pools.

As alleged by the SEC, investors in the Earn pools received ERC-20 tokens, such as Rari Fund Tokens, that could be traded on secondary digital asset trading platforms and that represented their pro rata share of the pool’s assets and through which they earned interest earned by the pool. Certain Earn pool investors also received a governance token, called the Rari Governance Token (RGT).

The SEC complaint alleges that investors in the Fuse pools received a token called the fToken representing their pro rata interests in those pools’ assets and through which they earned their pro rata interests in those pools’ earnings. A portion of that paid interest was also allocated to the Rari protocol as a performance fee, with the remainder going to investors on a pro rata basis.

According to the SEC, Rari Capital violated Sections 5(a) and 5(c) of the Securities Act because it offered and sold securities in the form of interests in the Earn pools, RGT, and interests in the Fuse pools represented by the fToken without registering any of those offers and sales and without qualifying for any exemptions from such registration requirements. The SEC complaint also alleged that Rari Capital, Bhavnani, Lipstone, and Lucid violated Section 15(a) of the Exchange Act by engaging in unregistered broker activity in connection with the Fuse pools.

In connection with the Earn pools, the SEC complaint further alleged that Rari Capital violated Section 17(a)(3) of the Securities Act, and its cofounders violated Section 17(a)(2) of the Securities Act, by making materially false and misleading representations about the Earn product to investors. The SEC alleges that Rari falsely told investors they would automatically and autonomously rebalance investors’ digital assets into the highest yield-generating opportunities though a smart-contract mechanism when in fact the rebalancing mechanism required manual input, which Rari sometimes failed to initiate. The SEC also alleges that Rari misleadingly touted a high annual percentage yield that investors would earn, without factoring in the impact of the fees collected by Rari Capital and other costs. Ultimately, a significant percentage of Earn pool investors lost money because blockchain transaction fees and other platform fees exceeded returns on their investments.

The SEC further alleged that Rari Capital engaged in unregistered broker activity through the operation of the Fuse platform, which engaged in transactions for the accounts of Fuse users involving certain digital assets offered and sold as securities. According to the SEC, the underlying smart contracts, which were developed and controlled by Rari and the cofounders through at least early 2022, received transaction instructions from users to move digital assets offered and sold as securities into and out of certain Fuse pools, and the smart contracts developed and controlled by the Rari and cofounders carried out those instructions. As stated in the complaint, Rari and the cofounders also created and administered several of the larger Fuse pools. The SEC alleged that Rari and the cofounders generated revenue for the Rari protocol by charging a performance-based fee of approximately 10 percent of the interest earned from depositing and borrowing activity in each pool.

Rari and the cofounders neither admitted nor denied the SEC’s allegations, but each agreed to the entry of a final judgment ordering various forms of relief, including as to each cofounder:

• A five-year prohibition from acting as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act or that is required to file reports pursuant to Section 15(d) of the Exchange Act for each co-founder
• A five-year injunction on participation in the issuance, purchase, offer, or sale of any digital assets sold as securities (with a carve-out that the defendants can purchase or sell securities for their own personal accounts)
• Civil penalties pursuant to Section 21(d) of the Exchange Act ($55,000.00 for Bhavani, $40,000.00 for Lipstone, and $40,000.00 for Lucid)
• Disgorgement ($7,189.51 plus $1,378.00 prejudgment interest for Bhavani, $2,685.30 plus $514.68 for Lipstone, and $4,371.12 plus $837.80 prejudgment interest for Lucid)

The final judgments were approved by the Central District of California court.

In its press release announcing the settlement, the SEC said it would “not be deterred by someone labeling a product as decentralized and autonomous, but instead will look beyond the labels to the economic realities” and that it would “hold the individuals behind crypto products and platforms accountable when they harm investors and violate the federal securities laws.”

Regarding the SEC’s settlement with Rari Capital Infrastructure, the SEC noted that the firm’s efforts to stop trading activity following a major hack and the decision to wind down the Fuse platform in May 2022, including the voluntary return of performance-based fees, was an important factor in the SEC’s decision to forgo imposing a civil penalty. This settlement is an example of the SEC’s purported consideration of remedial efforts in the wake of harm when determining penalties.

Key takeaway: The SEC charged Flyfish LLC with conducting an unregistered securities offering for selling NFTs that would eventually provide access to an otherwise-exclusive forthcoming restaurant. SEC Commissioners Hester Peirce and Mark Uyeda disagreed with the enforcement action and penned a forceful statement asserting that this enforcement action was inappropriately lodged against a utility token and, on a broader scale, that the SEC’s actions discourage innovation in the digital-asset industry. This case highlights an internal disagreement at the SEC regarding the types of digital assets that should be subject to the SEC’s jurisdiction, and with Commissioners Uyeda and Peirce expected to have significant sway in the newly constituted commission, their more pragmatic positioning around digital assets could prevail before and after a new chair is confirmed.

On September 16, 2024, the SEC issued an order (Order) instituting cease-and-desist proceedings, among other things, against Flyfish LLC (Flyfish) for conducting an unregistered offering of digital asset securities in the form of NFTs in violation of Sections 5(a) and 5(c) of the Securities Act. In the Order, the SEC alleged that between August 2021 and May 2022, Flyfish sold NFTs that were to become the exclusive way to access a yet-to-be-built restaurant and bar opening in New York City. Flyfish had created approximately 3,000 NFTs, of which it sold slightly more than half. The 1,600 NFTs were sold at two price points: the Flyfish NFT was offered for 2.5 ETH (~$8,400), and the Omakase NFT was offered for 4.25 ETH (~$14,300). The Flyfish NFTs would allow the holders to eat in the main restaurant, and the Omakase NFTs provided additional access to a more exclusive dining room. Both Flyfish and Omakase NFT owners could lease or sell their NFTs (and thus their membership) to others. Through this sale, Flyfish generated gross proceeds of about $14.8 million. The NFTs were also sold on the secondary market. Flyfish Club received 10% royalties for many secondary sales, earning $2.7 million.

The SEC’s determination that the NFTs were investment contracts was based heavily on Flyfish’s touting of the managerial expertise of the Flyfish team, which consisted of well-known chefs and restaurateurs. The SEC also focused on Flyfish’s representations to investors that they could potentially profit from reselling their NFTs at appreciated prices in the secondary market. The SEC further emphasized that Flyfish described the purchase of the NFT as a “passive income strategy.”

In addition to the above, the SEC focused on the purchasers’ intent to profit from the NFT. The SEC found it significant that “[m]ore than half of purchasers stated that they were motivated at least in part by the chance to profit from the investment in the NFTs” when they responded to a Flyfish survey. The SEC also used purchasers’ behavior after the sale of the NFTs as evidence that the NFTs were an unregistered offering, noting that “75% of the NFTs sold to the public had been resold one or more times in the secondary market, suggesting that the original owners bought them with investment intent and not for consumption.”

To settle the matter, Flyfish agreed to pay civil penalties of $750,000 to the SEC; to destroy all Flyfish NFTs in its possession; to publish notice of the order on the Flyfish website and social media channels; to remove all links to digital asset trading platforms from the Flyfish website and social media channels; to not accept, and notify secondary market trading platforms that it would not accept, further royalties from the sale of Flyfish NFTs; to assist the commission staff in the administration of a distribution plan, including all efforts to distribute the monetary relief to affected investors; and to publish a notice of a claims process, among other things.

Commissioners Peirce and Uyeda felt that this enforcement was a bridge too far and penned a colorful statement rebuffing the Order (the Dissent). Playing on the theme of Flyfish as a sushi restaurant, the dissent stated, “Omakase dining requires a deep level of trust. Americans should be able to extend a similar trust to our regulators. Today’s settled enforcement action with Flyfish Club for its sale of [NFTs] is just the latest dish that undermines trust in Chef SEC.”

The Dissent opined that because these NFTs provided access to a social experience, they were actually utility tokens. It emphasized that the intent behind Flyfish’s utility-based NFT project was to “build a large business around this with multiple clubs, ancillary offerings, other social experiences, pop-up events, and build a whole world around Flyfish Club.” The Dissent argued that while one could make a profit off these NFTs, they had a concrete use. It also likened investment in NFTs to investment in art, noting that people resell art for a variety of reasons, but the intent of the seller should not matter.

The Dissent emphatically stated that the “securities laws are not needed here, and their application is harmful both in the present case and as future precedent. ... Experiments like Flyfish Club are not a threat to the American investor. Creative people should be able to experiment with NFTs without having to consult a high-priced tea-leaf reader—ahem, lawyer.” As a new more crypto-friendly administration prepares to take the helm of the SEC, such dissents may become much less frequent.

Key takeaway: A Texas federal district court dismissed a putative class action lawsuit against foreign-owned and -operated Bancor DAO and its affiliates, ruling that the court lacked personal jurisdiction over the foreign defendants and that US securities laws did not apply to their activities. This case emphasizes the limited applicability of domestic laws to decentralized, global crypto exchanges and the need for legislative action to address the regulatory gaps perceived by the court, and ways to minimize establishing personal jurisdiction in the US.

On September 6, 2024, Judge Robert Pitman of the US District Court for the Western District of Texas adopted in full the report and recommendation (R&R) of US Magistrate Judge Mark Lane to dismiss a putative class action lawsuit against Bancor DAO, along with its affiliated entities and cofounders (collectively, Bancor).

The plaintiffs filed a class-action lawsuit against Bancor DAO (which has not filed an appearance); two foreign affiliated corporations, LocalCoin and BProtocol Foundation (collectively, Entity Defendants); and the individuals who are alleged to have founded, operated, and/or controlled the Entity Defendants in various ways (Individual Defendants), and misled investors about the safety and functionality of its automated crypto-asset trading platform: the Bancor Protocol. Specifically, the plaintiffs claimed that Bancor’s “Version 3” product promised “impermanent loss protection” to safeguard against certain investment risks but failed to deliver, resulting in significant financial losses for investors.

The R&R addressed two main issues: whether the court had personal jurisdiction over Bancor where the Individual and Entity Defendants were all foreign defendants, and whether US securities laws applied to investments in Version 3.

First, the R&R found that personal jurisdiction over Bancor was not adequately alleged. The court considered whether the acts of Bancor should be attributed to each of the defendants. The court found that the plaintiffs sufficiently alleged that Bancor’s contacts with the US could be attributed to LocalCoin and to BProtocol Foundation but not to the Individual Defendants. Specifically, the complaint alleged that LocalCoin is the direct employer of all Bancor personnel, including certain nonparties who represented Bancor and Version 3 at conferences held in the US. Based on those allegations, the court found that the plaintiffs sufficiently alleged that these contacts with the US should be attributed to LocalCoin. The court also found that the plaintiffs sufficiently alleged that Bancor’s US activity could be attributed to BProtocol Foundation, focusing in particular on the facts that BProtocol Foundation publicly identified itself as “Bancor” and that it retained exclusive control over Bancor’s treasury.

However, the court found that the plaintiffs’ bare-bones allegation that the Individual Defendants “have effective day-to-day control over Bancor” was conclusory and insufficient as a matter of law to survive dismissal on jurisdictional grounds. The court noted that the plaintiffs did not allege that any individual defendant had direct contact with the US related to Version 3; instead, the plaintiffs alleged that each of the individual defendants founded Bancor and the BProtocol Foundation and that some individual defendants also founded and controlled LocalCoin. Relying on precedent that an individual’s status as a control person of a corporation that has jurisdictional contacts with the US, standing alone, is insufficient to establish personal jurisdiction, the court found jurisdiction over the Individual Defendants was not properly alleged. Finally, the court noted that the plaintiffs failed to allege that any individual defendant directed Bancor’s contacts in the US and that the plaintiffs’ allegations of control over the entity defendants were conclusory.

The R&R then explained that Bancor’s limited contacts with the US, such as hosting events at conferences and operating a globally accessible website—were insufficient to establish jurisdiction under the standards of due process.

The court also ruled that US securities laws did not apply to Bancor’s activities. It determined that the transactions at issue were not sufficiently domestic to invoke the protections of the Securities Act or the Exchange Act, relying on precedent case law that requires securities transactions to occur within the US or involve securities listed on domestic exchanges. The court distinguished this case from others in which server location or domestic contractual agreements established jurisdiction, emphasizing that Bancor’s decentralized, global nature posed unique challenges for applying US law.

The case was dismissed without prejudice, with the court stressing the need for legislative action to address the evolving complexities of decentralized, global crypto-asset exchanges. This case is important for the guidance it provides DAOs and their contributors on what actions can trigger US jurisdiction.

Key takeaway: In a suit against Coinbase and certain of its executives and board members, investors successfully alleged that they were harmed when Coinbase failed to disclose the risk that its customers could lose their assets if Coinbase filed for bankruptcy and the risk that the SEC would file an enforcement action against Coinbase for listing digital assets that were securities. The case highlights the growing legal scrutiny of the SEC filings made by publicly traded digital asset companies and digital asset issuers relating to whether digital assets are securities and the need to ensure that statements touting the advantages of those digital asset platforms or assets are accompanied by fulsome risk disclosures.

On September 5, 2024, Judge Brian R. Martinotti of the US District Court for the District of New Jersey allowed certain claims in an investor suit against publicly traded cryptocurrency exchange platform Coinbase Global, Inc. (Coinbase) and certain of its executives and board members to proceed. In his opinion, Judge Martinotti granted in part and denied in part Coinbase’s motion to dismiss the investors’ second amended complaint.

The plaintiffs allege that Coinbase, along with certain of its executives and board members, made false or misleading statements with respect to critical risks related to the security of customer assets, the company’s regulatory compliance, and the company’s engagement in proprietary trading. According to the plaintiffs, these misrepresentations inflated Coinbase’s stock price, and investors suffered financial losses when the risks became apparent. Specifically, the plaintiffs challenge the following three categories of allegedly misleading statements:

1. Bankruptcy risk statements: The plaintiffs allege that Coinbase failed to disclose in its required filings with the SEC the potential risk for customers to lose their assets maintained on Coinbase’s platform if Coinbase filed for bankruptcy, rendering misleading Coinbase’s assurances that its customers’ assets were safe. The court agreed that this omission was material, in part relying on a subsequent Form 10-Q filed by Coinbase, in which Coinbase revealed that customers might view its custodial services as riskier had they known about the bankruptcy risk. The court noted that the sharp drop in Coinbase’s stock price following the disclosure provided further support for the materiality of the omission. Moreover, the court determined that by choosing to discuss the safety of customer assets, Coinbase had a duty to fully disclose all material risks to these assets, including the risk that customers might lose their assets if Coinbase filed for bankruptcy. The court also found that the plaintiffs had sufficiently alleged scienter (i.e., intent to defraud) because the defendants acknowledged the same potential risk in internal communications and provided protections to institutional clients to mitigate that risk. However, the court found that certain statements about customer trust and satisfaction were nonactionable puffery because they were too vague to be relied upon by investors.
2. Regulatory compliance statements: The plaintiffs allege that Coinbase misled investors by claiming it rigorously avoided listing securities. Internally, however, Coinbase allegedly listed digital assets it likely knew were securities, based on its own internal reviews. Additionally, by mid-2022, the SEC had reportedly informed Coinbase that most of the assets on its platform were securities, which would subject the company to regulatory enforcement actions. Despite this knowledge, Coinbase continued to assure investors that it did not list securities and emphasized its strong compliance processes. The court further found that the plaintiffs’ allegations that Coinbase’s leadership knowingly minimized the likelihood of SEC enforcement, despite the SEC’s clear indications to Coinbase of its view that most of the assets on Coinbase’s platform were securities, created a strong inference of scienter. The court ruled that once Coinbase chose to discuss its compliance and asset review process, it had a duty to disclose material facts, including contrary information indicating regulatory risks, necessary to make those statements not misleading. The court rejected Coinbase’s argument that these statements were nonactionable opinions and found that the statements did not align with the company’s alleged internal knowledge. Accordingly, the court allowed the claims based on statements regarding regulatory compliance to proceed.
3. Proprietary trading statements: The plaintiffs also allege that Coinbase engaged in proprietary trading, despite its public denials. To support their allegations, the plaintiffs pointed to a Wall Street Journal article that cited anonymous sources claiming Coinbase had a proprietary trading unit. The court dismissed these claims, finding that the allegations lacked sufficient corroboration or detail to meet the heightened pleading standards for securities fraud. Shortly after the court rendered its decision granting in part and denying in part the defendants’ motion to dismiss, the defendants moved for reconsideration on the portion of the court’s decision addressing the claims brought under the Securities Act of 1933 based on statements regarding Coinbase’s proprietary trading, requesting that the court dismiss those claims in their entirety; that motion is pending.

This case highlights that public companies operating in the digital-assets industry, like Coinbase, which are subject to the Securities Exchange Act of 1934, will be held to traditional securities law standards, particularly with respect to transparency and risk disclosure. It also highlights the risk to digital-asset companies (public and private) of minimizing the potential regulatory risks of the company’s digital-asset products and services or overstating compliance with existing laws and may signal a larger push from private litigants to bring cases based on misleading disclosures, whether as part of a public company’s SEC filings or arising from public statements and disclosures in general.

Key takeaway: The SEC announced settled charges against Galois Capital Management LLC for failing to ensure that certain digital assets held by its private fund were maintained with a qualified custodian, as required by the Investment Advisers Act “Custody Rule.” More specifically, the SEC found that Galois improperly custodied assets at FTX Trading Ltd. (FTX), which it deemed “not a qualified custodian.” This case may signal a broader intention by the SEC to take a stricter approach toward custody of digital assets, yet in light of the changing SEC management, it remains to be seen whether this type of regulation by enforcement will persist. The case also underscores the importance of equal treatment of investors in enforcing compliance with written redemption policies.

On September 3, 2024, the SEC announced settled charges against Galois Capital Management LLC (Galois). Galois, a now-defunct crypto-focused investment advisory firm, was charged with violating the Investment Advisers Act of 1940 (IA Act) by failing to ensure certain digital assets held by a private fund it advised, Galois Capital Alpha Fund LP (Fund), were maintained with a qualified custodian. The SEC’s order also found that Galois misled investors about the Fund’s redemption practices and failed to implement written compliance policies and procedures while registered with the SEC as an investment adviser.

The SEC found that from July 2022 through December 2022, the Fund held digital assets, including digital asset securities (without specifying which digital assets were securities), in online trading accounts on crypto trading platforms such as FTX and not with banks, registered broker-dealers, registered futures commission merchants, or other qualified custodians. This practice—according to the SEC—not only caused the Fund to lose approximately half of its assets as of the FTX collapse but it also violated the “Custody Rule” (IA Act Rule 206(4)-2), which requires registered investment advisers who have custody of client funds or securities to safeguard those assets and comply with certain requirements aimed at preventing loss, theft, misuse, or misappropriation of such assets, including the insolvency of an investment adviser. The SEC found that FTX was not a qualified custodian under the meaning of the IA Act.

The SEC further found that Galois misled certain investors about its redemption process. The formalized redemption process, as outlined in the Fund’s Limited Partnership Agreement (LPA), allowed a partner to redeem from the Fund on the last day of any calendar month upon 30 days’ notice to the general partner. Galois also had an informal redemption process of allowing redemptions earlier than after 30 days’ notice as long as investors provided at least a five business days’ notice prior to month end, which was communicated to certain investors. Despite its representations about the informal redemption process, however, Galois approved redemption requests from other investors, including affiliated investors with less than five business days’ notice. The SEC found Galois’s practice of allowing certain investors to redeem with less than five business days’ notice while disclosing a different policy to other investors to be misleading.

Finally, the SEC found that Galois’s failure to adopt and implement a written compliance program to prevent violations of the IA Act while it was registered with the SEC as an investment adviser amounted to a separate violation of the IA Act.

Galois did not admit or deny the SEC’s findings, but it consented to the entry of the order requiring it to cease and desist from further violations of the act, censuring it, and requiring it to pay a $225,000 fine to its harmed investors.

This was the first enforcement action brought by the SEC alleging Custody Rule violations with respect to digital assets. While the SEC’s finding that FTX was not a “qualified custodian” under the act was not itself surprising, given the context of FTX’s collapse, the SEC’s decision to charge Galois with violations of the Custody Rule nevertheless may indicate a broader position that the SEC will apply, and charge violations of, the existing Custody Rule with respect to digital assets that the SEC believes are securities, notwithstanding the fact that the proposed amendments to the Custody Rule expressly covering digital assets have not yet been finalized. Moreover, there currently is both a limited market of custodians that hold themselves out as “qualified custodians” for digital assets and a degree of ambiguity about whether many such custodians actually qualify as such for purposes of the Custody Rule, making it challenging for investment advisers to determine whether they are complying with the Custody Rule’s requirements with respect to digital assets. This may be another area in which the SEC may back away from proposed amendments that would negatively affect the digital-asset industry and may choose instead to provide clarity on the meaning of qualified custodian through a notice-and-comment rulemaking process and industry engagement.

In addition, the SEC’s findings regarding Galois’s redemption policies and related disclosures should serve as a reminder for private fund advisers to review their redemption practices, especially to the extent that there are (a) potential inconsistencies between such policies in practice and how they are disclosed to investors or (b) potential undisclosed preferences granted to affiliates.

Key takeaway: In a previous publication, we explored the US District Court for the District of Columbia’s decision ruling that stablecoins fully backed with reserves and redeemable on a 1:1 basis with a fiat currency are not in and of themselves “investment contracts” and are thus not likely to be subject to the regulatory authority of the SEC. Since that decision, defendants in similarly situated cases have made similar motions. We include here a digest of the latest updates in the SEC’s case against Binance.

The SEC’s case against the digital-asset-trading platform Binance Holdings Ltd. (Binance Holdings); its founder and former CEO, Changpeng Zhao (Zhao); and two related US entities, BAM Trading Services Inc. and BAM Management US Holdings Inc. (collectively, BAM, and together with Binance Holdings and Zhao, Binance), remains one to watch as the SEC attempts to exercise jurisdiction over stablecoins. On June 28, 2024, the US District Court for the District of Columbia granted defendants’ motion to dismiss the SEC’s claim that Binance’s stablecoin BUSD was a security. Since that decision, the case’s docket has been active—from the SEC’s motion for leave to amend the complaint (which was granted) and its amended complaint to the Binance defendants’ latest motions to dismiss.

In June 2023, the SEC brought suit against Binance, asserting that the platform (1) offered and sold digital assets and related programs, including its stablecoin BUSD, without a registration statement; (2) operated cryptocurrency trading platforms without registering as an exchange, broker-dealer, broker, or clearing agency; and (3) made false statements to investors and engaged in acts and practices that operated as fraud upon purchasers. Binance filed a motion to dismiss, which the court granted in part, including as to Binance’s stablecoin token BUSD.

On June 28, 2024, the US District Court for the District of Columbia granted the defendants’ motion to dismiss the SEC’s claim that Binance’s stablecoin BUSD was a security, and also the claims relating to Binance’s Simple Earn program, but denied the remainder of defendants’ motions to dismiss. (That decision was explored in-depth in our last quarterly publication.)

On October 16, 2024, the SEC was permitted to amend its original complaint after seeking leave from the court. The amended complaint boasts 60 new pages of allegations, and the SEC’s accompanying motion for leave to amend outlined several specific pleading deficiencies it argues are cured by the amended complaint, including but not limited to the following:

1. Secondary-market sales of BNB: The court dismissed the SEC’s original claim about secondary market sales of Binance coin (BNB) because the SEC failed to establish that the resales constituted securities transactions under the Howey test. The SEC’s amendment introduces allegations that these secondary sales were not mere commodity transactions but rather were part of an investment scheme in which the value of the assets depended on Binance’s efforts to promote and develop its ecosystem. The SEC argues that the promotional activities were designed to maintain investor expectations of profits in BNB.
2. “Simple Earn” program: Claims related to Binance’s “Simple Earn” program were initially dismissed for insufficient factual details. The SEC’s amended complaint describes the structure and operation of the program in greater detail and includes allegations to show that the program offered returns tied to Binance’s efforts, framing it as an investment contract.
3. Employee compensation in digital assets: In the previous motion-to-dismiss decision, the court concluded that compensating employees with digital assets such as BNB does not typically constitute the offer or sale of securities under the Securities Act, because it resembles payment for services rather than an investment contract under the Howey test. In the amended complaint, the SEC expands on its claims that Binance’s use of BNB to compensate employees constituted securities violations, framing it as an investment opportunity tied to the company’s success. The SEC argued that employees effectively “invested” by accepting BNB instead of cash, with Binance promoting BNB’s potential for value growth akin to stock options.
4. Investment contracts: The amended complaint alleges that these BNB transactions should be considered investment contracts because the recipients’ benefits were linked to Binance’s performance and the success of its ecosystem, thereby satisfying Howey’s criteria.
5. Third-party token sales: The SEC seeks to bolster the surviving claims regarding the sale of 10 digital assets named in the original complaint by adding evidence of promotional efforts by issuers and Binance to create profit expectations. These allegations attempt to tie the promotions directly to a common enterprise and investor reliance on managerial efforts.
6. Intermediary services on Binance platforms: In an effort to address the court’s previous criticisms that it failed to adequately plead how Binance’s intermediary services violated securities laws, the amended complaint includes more specific examples of how Binance facilitated transactions in unregistered securities, arguing this constituted the operation of unregistered exchanges, broker-dealers, and clearing agencies.

In its motion for leave to amend the complaint, the SEC stated it would no longer use the phrase “crypto asset securities,” explaining in a footnote that the agency “is not referring to the crypto asset itself as the security” and expressing regret for “any confusion it may have invited.” Instead, the SEC clarified that it uses the term to describe “the full set of contracts, expectations, and understandings centered on the sales and distributions” of the digital assets in question. The SEC emphasized that the digital asset is merely the subject of the investment contract, and its allegations focus on the unchanged promotional efforts and economic realities that make these assets investment contracts under Howey. Reflecting this shift, the SEC revised its language in the amended complaint to refer to “crypto assets that were offered and sold as securities” instead of “crypto asset securities.”

On November 4, 2024, Binance Holdings and Zhao filed their second motion to dismiss, challenging the claims in the SEC’s amended complaint that virtually all crypto transactions—especially secondary-market trades—constitute securities transactions. As to the allegations concerning BNB, Binance Holdings and Zhao argue that BNB sales, including blind transactions on Binance platforms, do not constitute “investment contracts” because buyers had no reasonable expectation that their money was being used in a common enterprise to generate profits on their behalf, especially in blind transactions in which buyers did not know the seller’s identity; any alleged promotional activities by Binance related to BNB are claimed to reflect consumptive, not investment, purposes; and employee compensation using BNB is framed as a currency-like use, not an investment. As to the allegations concerning Simple Earn, Binance Holdings and Zhao contend that the program lacks the entrepreneurial or managerial efforts by Binance necessary to satisfy Howey and that it resembles a deposit service with interest, rather than an investment into a common enterprise in which profits depend on Binance’s efforts. Binance Holdings and Zhao also accuse the SEC of arbitrarily determining which assets and transactions are deemed securities, further eroding market confidence.

On November 4, 2024, BAM filed its own motion to dismiss, arguing that the SEC’s amended complaint fails to sufficiently demonstrate that secondary sales of the implicated digital assets being sold on its platform constitute securities transactions under the Howey test. BAM contends that secondary buyers had no connection to the alleged “common enterprise,” nor any reasonable expectation of profit tied directly to the managerial efforts of Binance. BAM also criticizes the SEC’s attempt to extend the securities framework in a way that conflicts with established precedent and the jurisdiction of the Commodities Futures Trading Commission. BAM asserts that these digital assets are commodities, not securities, and that the SEC’s inconsistent application of securities laws undermines the industry’s regulatory clarity.

The SEC’s opposition was filed on December 4, 2024, with defendants’ replies expected to be filed on December 26, 2024. While they await a decision, the parties will be engaged in discovery, with fact discovery scheduled to close in November 2025 and expert discovery scheduled to close in March 2026.

Key takeaway: In our previous publications (Q1 2024 and Q2 2024), we provided an overview of a series of federal lawsuits in Texas challenging the SEC’s authority to regulate digital assets. We provide a brief update on the Consensys case here and continue to monitor the LEJILEX and Beba cases for updates.

As noted in our prior editions, Consensys filed a pre-enforcement challenge in the Northern District of Texas, Fort Worth division, seeking a declaratory judgment that the SEC lacks jurisdiction over ETH because ETH is not a “security” — specifically, an “investment contract.” Consensys Software Inc. v. Gensler, No. 24-cv-369 (N.D. Tex. filed April 25, 2024).

Consensys’s complaint sought both declaratory and injunctive relief that prevents “the SEC from continuing any investigation or commencing an enforcement action against Consensys based on the premise that Consensys’ transactions in ETH are securities transactions.” It also asked the court to hold that the SEC violated the Administrative Procedure Act by characterizing ETH as a security, despite its prior position that ETH is a commodity. Finally, Consensys asked the court to conclude that the SEC has no statutory authority to investigate or bring an enforcement action against Consensys regarding the Swaps or Staking features of its MetaMask software.

The SEC moved to dismiss, raising, among other arguments, a ripeness challenge.³ The court dismissed all claims brought by Consensys without prejudice. It found that claims related to Ethereum and ETH were moot because the SEC had concluded its investigation into ETH without recommending enforcement action. Regarding MetaMask, the court ruled that Consensys’s claims were unripe because there was no final agency action to adjudicate. The court specifically found that the SEC’s issuance of a Wells Notice, which merely signals a potential enforcement recommendation, did not meet the legal threshold of finality. The court emphasized that federal jurisdiction requires a concrete and ripe controversy, which was not present here.

This decision highlights the judiciary’s hesitance to intervene in pre-enforcement regulatory matters until and unless a definitive agency decision creates an immediate legal conflict.

The SEC has also moved to dismiss in both the LEJILEX and Beba cases, raising similar arguments as it did in the Consensys case. The LEJILEX motion was fully briefed as of October 2, 2024, and the Beba motion was fully briefed as November 20, 2024; we expect decisions on the motions sometime next year.

^[3] PE sponsors should pay close attention to how they define “disability,” given the term can be interpreted in many ways. A common approach is to define “disability” as the inability to provide services for 90 to 180 days in any 12-month period.