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House Financial Services “Decoding DeFi” Hearing
DEF’s Chief Legal Officer, Amanda Tuminelli, testified today before the House Financial Services Committee in Congress’ first ever DeFi-focused hearing “Decoding DeFi: Breaking Down the Future of Decentralized Finance.”
Oral Arguments in Van Loon v. Treasury
What happened?
Last Tuesday, oral arguments for Van Loon v. Department of the Treasury were held before a three-judge panel in the Fifth Circuit Court of Appeals. The case presents a challenge to the Treasury’s Office of Foreign Assets Control’s (OFAC) sanctions designations of the Tornado Cash protocol. Last year, a US district court in Texas upheld OFAC’s sanctions, provoking this appeal. Last November, DEF submitted an amicus brief in support of the plaintiff’s, arguing that OFAC should not criminalize privacy preserving tools like Tornado Cash by designating software nor does it have such authority.
In the oral arguments, Judge Edith Jones challenged the assertion that Tornado Cash smart contracts are a sanctionable entity and contended that the Treasury’s sanctions seemed to be “a solution in search of an entity.” She stated, “I disagree with [the Government] that ‘Tornado Cash’ runs something. It is a set of computer programs and the people who drafted those programs are like people who take in wounded animals, and they treat them and they nurse them and they put them back into health, and then they set them out into the wild. The deer or the eagle or the snake or the skunk that has been taken care of is no longer the property of the person who was its temporary custodian, correct?” Given this understanding, Judge Jones turned to the question of a third-party’s use of software and asked the Treasury, “Why don't you shut down your tax software because it can be used to commit fraud on the part of foreign entities?"
What does this mean?
We couldn’t have said it better than Judge Jones, appreciate the Court’s careful consideration of these fundamental issues for DeFi, and look forward to the Court’s decision in this case.
DEF and BA File Amicus Brief in Challenge Against SEC’s CAT Rule
What happened?
In late August, DeFi Education Fund (DEF) and Blockchain Association (BA) filed a joint amicus brief in Davidson v. SEC raising concerns about the serious threat to individual privacy posed to American crypto users by the Consolidated Audit Trail (CAT). The Securities and Exchange Commission’s (SEC) CAT requires every national securities exchange and broker-dealer to provide securities transaction information to a large government database. Reported data includes customer identification information, the date and time of the order, and the “material terms of the order” such as security symbol, price, size, etc. The CAT database became fully operational in May 2024, when the Financial Industry Regulatory Authority (FINRA) began requiring compliance with all reporting procedures.
While the CAT pertains to securities transactions, DEF and BA argue that if the SEC’s claims of broad authority over digital assets were correct, various digital asset market participants would be subject to CAT reporting. In the SEC’s view, various businesses in the digital asset industry are “exchanges,” “brokers,” and/or “dealers,” meaning that they will be required to report sensitive financial information in crypto-denominated transactions that will be accessible to a web of government agencies and private sector organizations.
DEF and BA explain that the CAT could link personally identifying information with wallet addresses that reveal blockchain-based user transactions of all kinds. The privacy concerns of CAT are heightened by the nature of public blockchains, in that all transaction information on the chain is linked and publicly accessible. With just a few details from any one transaction, any person can see all other transactions associated with a particular wallet address, meaning that unlocking one transaction unlocks them all.
Thus, anyone with access to CAT would be able to see not just a person’s purported securities transactions, but all of that person’s blockchain transactions in the past, present, and future. DEF and BA argue that this reporting represents a massive invasion into the personal privacy of millions of Americans, allowing the government to sift through the entirety of someone’s financial transactions without a warrant or probable cause, violating the Fourth Amendment. DEF and BA also warn of the CAT database’s significant vulnerabilities to data loss or hacking.
What does this mean?
The CAT poses a tremendous and unprecedented threat to the personal privacy of Americans in general and especially those who transact on public blockchains. As DEF’s Amanda Tuminelli and BA’s Marisa T. Coppel wrote in a recent op-ed, “One shouldn’t feel like their government is looking over their shoulder as they complete every personal financial transaction, especially when those transactions may include revealing sensitive information such as through donations to political causes or paying for medical procedures.”
Kraken Loses Motion to Dismiss in SEC Litigation
What happened?
Late last month, in SEC v. Kraken, the district court issued an order denying Kraken’s motion to dismiss in the SEC’s case alleging Kraken acts as an unregistered broker, dealer, exchange, and clearing agency for so-called “crypto asset securities.” The DeFi Education Fund (DEF) submitted an amicus brief in support of Kraken’s motion to dismiss in February.
The main question the court considered was whether the SEC plausibly alleged in its complaint that at least some of the cryptocurrency transactions facilitated by Kraken constitute “investment contracts” that are therefore subject to federal securities laws. Before going further, it is important to note that, at the motion to dismiss stage, the court must presume that all of the facts alleged in the SEC’s complaint are true and draw all reasonable inferences in the SEC’s favor.
Moving to the substance of the court’s order, the test for qualifying as an investment contract was laid out by the Supreme Court in 1946 when it decided SEC v. W.J. Howey Co. The “Howey” test as it has come to be known, requires four elements to qualify as an investment contract: (1) an investment of money; (2) in a common enterprise; (3) with an expectation of profits (4) produced by the efforts of others.
Before considering each element of Howey as they applied to the SEC allegations, the court discussed whether an investment contract requires post-sale obligations from the issuer.
The court found that the SEC’s view is consistent with Howey and supports allowing the SEC’s claims to advance to discovery. The court held that the totality of circumstances surrounding a given transaction, as opposed to looking for specific formalities that would indicate the existence of post-sale obligations from the issuer to the buyer, should be considered when determining the existence of an investment contract.
Next, the court considered Kraken’s argument that transactions occurring on a secondary market changes investment contract analysis.
Finding that the SEC has met the burden to survive Kraken’s motion, the court explained that evaluating whether an investment contract exists in a secondary market requires examination of the specific transaction. Courts are not required to ignore representations made in the primary market if a reasonable investor would still rely on them in the secondary market.
After addressing the parties’ arguments on the post-sale obligation and secondary market sales issues, the court applied the Howey elements to the allegations in the SEC’s complaint and held that the SEC plausibly alleged that the specific assets on Kraken were offered and sold as investment contracts during the relevant period.
Finally, the court addressed Kraken’s argument that the SEC’s action is barred by the major questions doctrine. The doctrine is grounded in the idea that Congress does not delegate extraordinary powers to an agency with respect to issues of major economic and political significance without making its intent to do so clear. The court ultimately rejected the doctrine’s application to Kraken and the crypto industry more broadly.
What does this mean?
Surviving a motion to dismiss means that the SEC has plausibly alleged its claims when the court is taking all of its alleged facts as true and drawing all inferences in the SEC’s favor. This decision allows the case to proceed, but it is not a final ruling on the merits. Kraken will now have the opportunity to challenge the SEC’s allegations during discovery and build its defense.
Additionally, while the court was required to be deferential to the SEC’s factual allegations, there are several aspects of the order that give cause for hope. The court criticized the SEC’s use of the term “crypto asset securities” as “unclear at best and confusing at worst.” This is consistent with the opinion in SEC v. Ripple, which affirmed that digital assets are not themselves inherently securities, but the circumstances surrounding their sale can be investment contracts.
SEC Issues Wells Notice to OpenSea
What happened?
OpenSea announced that the SEC sent it a Wells notice related to the NFTs traded on their platform. A Wells notice is a notification sent by the SEC to an individual or entity to put them on notice that the SEC’s staff is considering suggesting enforcement against the recipient. In this case, the Wells notice concerns the buying and selling of NFTs on OpenSea.
What does this mean?
This is a continuation of the SEC’s anti-crypto crusade and its expansion to NFTs in this case. As David Finzer, CEO of OpenSea, argued on X, the SEC’s approach will place thousands of artists at risk since they do not have the resources to defend themselves. Finzer added that “we should not regulate digital art in the same way we regulate collateralized debt obligations.”
CTFC Issues Settlement Order with Uniswap Labs
What happened?
Last week, the Commodity Futures Trading Commission (CFTC) issued an order filing and settling charges against Uniswap Labs, alleging that Uniswap illegally offered leveraged or margin retail commodity transactions in digital assets via its front end. The order requires that Uniswap Labs pay a $175,000 civil penalty and to cease and desist from violating the Commodity Exchange Act (CEA).
Two commissioners dissented to the order. In a dissenting statement from Commissioner Summer Mersinger, she states that “given that the [CEA] and CFTC rules were written for traditional, centralized market infrastructure providers and intermediaries, it was my hope that one day soon the Commission would consider rulemaking, or at the very least guidance, making clear how DeFi protocols could comply with them.” Commissioner Mersinger argued that this action amounted to regulation by enforcement dependent on novel legal theories. She warns against holding a DeFi protocol liable for the actions of third parties: “Through this settlement, the Commission appears to be taking the position that any DeFi platform could be liable for any and all conduct occurring on its protocol. The practical effect of this approach is to severely chill the launching of any DeFi protocol within the United States and to significantly increase the odds that all DeFi innovation and economic activity will occur elsewhere.” The Commissioner concludes her dissent by pushing for rulemaking rather than enforcement as a better path forward.
Commissioner Caroline Pham found that “there is no evidence in the administrative record that describes the specific terms and/or characteristics of the” assets at issue, rendering it impossible to “determine whether they are a CFTC-jurisdictional product, and, therefore, whether the CFTC has the authority to bring this enforcement action in the first place.” She wrote, “This DeFi case may very well be a regulatory allergic reaction to new technology. But this reaction is not realistic or sustainable…. Emerging technologies like the blockchain and decentralized protocols that enable the direct peer-to-peer connection that underpins the consumer-driven shifts already underway in sectors such as retail, entertainment, and financial services, have the potential to write a brand-new chapter in our Nation’s rich history of ingenuity and opportunity—the embodiment of the American Dream,” Commissioner Pham said.
What does this mean?
DEF will continue to push Congress to pass legislation that addresses these issues. DeFi developers and users deserve a clear legal environment in which to operate. The CFTC’s decision to enforce against Uniswap Labs in this instance is disappointing in that no harm was alleged, and there is no path to compliance under the CEA for similarly situated market participants beyond blocking the assets on their front end.
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