United States:
A Blockbuster Week For DOJ Enforcement Against Cryptocurrency Exchanges
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This has been a blockbuster week for cryptocurrency enforcement
actions in the United States against cryptocurrency exchanges. To
cover just two of the major developments that occurred in the past
week, two co-founders of a cryptocurrency exchange, BitMEX, Arthur
Hayes and Benjamin Delo, pled guilty to violating the Bank Secrecy
Act (the BSA) by failing to implement and maintain an anti-money
laundering (AML) program. Shortly thereafter, the court overseeing
the BitMEX prosecution denied a motion to dismiss the indictment
against Samuel Reed, a third co-founder of BitMEX.
This alert breaks down the decision in detail below, but for the
busy reader, here are key takeaways from this decision:
- If a cryptocurrency exchange lists digital assets that require
registration with the U.S. Securities and Exchange Commission
(SEC), that does not preclude the possibility that the exchange may
also need to register with the Commodity Futures Trading Commission
(CFTC). - The registration categories of the Commodity Exchange Act are
not exclusive, and the fact that an exchange meets the
qualifications to register under one category does not relieve the
exchange of the obligation to register under all other applicable
categories as well. - The strictures of U.S. law cannot be safely avoided by
implementing a geoblock if an exchange allows U.S. users to evade
that geoblock by using a VPN or through other mechanisms known to
the exchange. - U.S. users known to exchange management must be actively and
regularly removed by an exchange that wishes to avoid having to
comply with U.S. laws and regulations. - Where an exchange knowingly allows at least some U.S. users to
access its platform, it should anticipate that it will be required
to comply with U.S. laws and regulations. - The failure to register with the CFTC and follow AML
requirements, where required, can result in up to five years
imprisonment, and the Department of Justice has signaled through
the BitMEX indictment its willingness to enforce such
penalties.
The indictment charges the three co-founders with violating the
BSA in connection with their operation of BitMEX. The indictment
alleged that BitMEX was required to register as a futures
commission merchant with the CFTC under the Commodity Exchange Act
(CEA), 7 U.S.C. § 1. As a required CEA registrant, the
indictment alleges that BitMEX was subject to the requirements of
the BSA, particularly the requirement to implement and maintain an
AML program. Such programs require, among other things, collecting
identifying know your customer information from every customer and
reporting suspicious transactions. According to the indictment,
BitMEX failed to comply with these AML obligations.
Reed had moved to dismiss the indictment, arguing that he lacked
fair notice that the failure to register with the CFTC was
unlawful. The defense argued that, among other things, he lacked
fair notice that any cryptocurrencies listed on BitMEX qualify as
commodities under the CEA. The court rejected that argument,
observing that BitMEX operated as a trading platform that solicited
and accepted orders for trades in futures contracts and other
derivatives products tied to the value of Bitcoin and other
cryptocurrencies. The court reasoned that the CEA defines
commodities broadly to include “all other goods and
articles” after listing a number of common examples, such as
corn and grains. The court further observed that cryptocurrencies
share a “core characteristic” with other commodities in
which derivatives are traded, “namely, that they are
‘exchanged in a market for a uniform quality and
value.'” The court also noted that several courts have
previously held that cryptocurrencies, including Bitcoin, qualify
as commodities. Finally, and of particular significance, the court
held that even those cryptocurrencies that qualify as
“investment contract” securities may also be regulated as
commodities under the CEA.
The court also rejected the argument that BitMEX did not have
fair notice that it had to register as a Futures Commission
Merchant (FCM) under the CEA because BitMEX offered features that
also could have triggered registration under other categories of
the CEA. It reasoned that the CEA registration categories are not
exclusive, such that an obligation to register under one category
does not prevent an entity from also having a duty to register
under other applicable categories.
The court further rejected Reed’s argument that BitMEX did
not have to comply with the BSA because it had withdrawn from the
U.S. market in 2015 and did not know it had U.S. customers
thereafter. Reed had argued that BitMEX had withdrawn from the U.S.
market in 2015 by implementing an internet protocol (IP) address
check designed to block U.S. customers (known as a geoblock). The
court rejected this argument, noting that the indictment alleged
that BitMEX knew that it served U.S. customers after 2015, and
specifically observed that the indictment alleged that the geoblock
only applied on one single occasion for each customer, such that
each customer could access the platform from the United States if
on a prior log-in attempt, they had shown a non-U.S. IP address.
The court also observed that according to the indictment, the
defendants and BitMEX allowed U.S. customers to circumvent the IP
check in other ways to access the platform, such as through VPNs or
logging in anonymously through the Tor network, and that the
defendants knew that this occurred.
Nor was the court persuaded by a lack of fair notice based on
the fact that there was no prior precedent precisely on point,
reasoning that the statutory definition of an FCM under the CEA and
the requirements of the BSA were sufficiently clear that Reed had
fair notice that his actions violated the law.
As a further notable aspect of this case, the indictment asserts
that “[a]s a result of its failure to implement AML and KYC
programs, BitMEX made itself available as a vehicle for money
laundering and sanctions violations.” In the wake of the most
recent U.S. sanctions imposed against Russian oligarchs and
entities, and the Treasury Department regulations published
yesterday banning U.S. persons from providing support to such
sanctioned individuals and entities, including through digital
assets, this decision takes on additional and immediate
importance.
The BitMEX decision is thus a significant one for all
cryptocurrency exchanges that operate in the United States. Most
importantly, it serves as a caution to all such exchanges that they
should engage in a careful evaluation of their registration
obligations under the CEA and U.S. securities laws, as well as
their potential obligations to comply with the BSA’s AML
requirements.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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