Crypto-Assets: What Are They and Why Do We Care? 70 BANKING PERSPECTIVES QUARTER 4 2018 the CEA, is extremely broad, covering everything from physical commodities to “services, rights, and interests.” Because cryptocurrencies are deemed to be commodities, it means that the CFTC has jurisdiction over margined or leveraged transactions in cryptocurrencies that involve “retail” investors (called noneligible contract participants). Perhaps more importantly, however, by virtue of being deemed a commodity, cryptocurrency transactions imbue the CFTC with anti-fraud and anti-manipulation authority. As a result, even when securities law anti-fraud and anti-manipulation authority does not reach a particular transaction, commodities law authority now does. CONSIDERATIONS FOR FINANCIAL INSTITUTIONS AND OTHER SERVICES Financial institutions and other service providers that are considering providing cryptocurrency-related services – such as custody, valuation, and lending, among others – will need to consider not only the variety of cryptocurrencies, as discussed above, but also the relevant regulatory treatment of each variety. For example, a bank that is considering providing custodial services with respect to ICO tokens would want to understand whether the tokens in question are securities, and, if so, what securities regulatory requirements apply to their safekeeping. Similarly, if a bank that is considering financing a customer with significant cryptocurrency assets, such as bitcoin and Ether, would want to understand both how they are treated for regulatory purposes (such as margin lending) as well as how they are treated for commercial law purposes (including transfer and security interests). Ultimately, a decision to provide cryptocurrency-related services must consider the relative risk of the type of cryptocurrency involved, the regulatory treatment of that cryptocurrency, relevant commercial law, and whether the regulatory treatment and relevant commercial law increases or decreases the relative risk a financial institution takes on in providing the requested services. Because the array of new electronic assets, whether they come under the rubric of cryptocurrencies or some other characterizations, will only expand, legal and valuation questions associated with them will continue to evolve for some time to come. For the foreseeable future, analysis of the commercial and legal issues associated with these assets will need to proceed on a case-by-case basis. In the meantime, it will be necessary to understand the structures and technologies that underlie these assets to understand how they will affect traditional as well as new banking services. n ENDNOTES 1 This dynamic is similar to that used by securities market makers, with the notable difference that market makers are intermediaries that make a market in an instrument issued by a third party. In contrast, in the case of an algorithmic stablecoin, the stablecoin algorithm itself is responsible for expanding and contracting the supply of the stablecoin. 2 See, e.g., Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, SEC Release No. 81207 (July 25, 2017) (“The DAO Report”). 3 Director of the Division of Corporation Finance William Hinman, “Digital Asset Transactions: When Howey Met Gary (Plastic),” SEC Speech, Remarks at the Yahoo Finance All Markets Summit: Crypto in San Francisco, Calif., June 14, 2018. 4 This concept of mutability has been expressed in the reverse (for example, a loan may start its life cycle as a commercial instrument but end its life cycle as a security), but until now, mutability has not been expressed so as to turn a security into a non-security. 5 Because they are New York limited-purpose trust companies, NYDFS reviews and approves all of Gemini’s and Paxos’ virtual currency activities. As New York limited-purpose trust companies, Gemini and Paxos are subject to regulation similar to that required under the New York Virtual Currency Law – the “Bitlicense” – but are not directly regulated under the Bitlicense. 6 In the case of Gemini, this condition appears to be addressed as follows: (1) U.S. dollars that correspond to the Gemini dollars issued and in circulation are held at State Street Bank and Trust Company; (2) the U.S. dollar deposit balance is examined monthly by BPM, LLP, a registered public accounting firm, in order to verify the 1:1 peg and audits are publicly available; and (3) the code of the Gemini dollar smart contracts has been audited by Trail of Bits, Inc., an information security research and development firm, whose report is publicly available. In the case of Paxos, this condition appears to be addressed as follows: (1) the entire supply of the Paxos Standard (PAX) is collateralized by USD in dedicated omnibus cash accounts at FDIC-insured U.S. banks; and (2) auditing firm Withum performs attestation procedures (established by the AICPA) on FDIC-insured accounts and the PAX tokens on a month-end basis. 7 This position was recently upheld by the District Court of Massachusetts. See CFTC v. My Big Coin Pay, Inc., Case No. 1:18- cv-10077 (D. Mass. Sept. 26, 2018) (Memorandum of Decision).