John Taskinsoy (Universiti Malaysia Sarawak) has posted “The Great Silent Crash of the 21st Century” on SSRN. Here is the abstract:

A mysterious creator under the alias Satoshi Nakamoto (a pseudonym) launched the world’s first successful cryptocurrency in early January 2009 which, not only was a historic moment, but was one that cultivated a technology revolution and money’s evolution into a digital form. However, technical issues (inherent flaws) in the design of Bitcoin blockchain, non-technical issues (political backlash, regulatory hurdle, and environmental hazard), plus the opaqueness surrounding the launch of Bitcoin have opened the door for an endless debate, incessant criticism, spurious claims, heated arguments, plethora of articles, and media frenzy contemplating what Bitcoin really is (crypto-asset, commodity, or investment vehicle) or it is not (currency). On the technical side, blockchain that made Bitcoin a household name fails miserably; high latency (8 minutes or more), low transaction throughput (7 per second), low-scalability (mining, proof-of-work based validation using consensus and cryptography), and high energy cost make Bitcoin unfit to compete with new and fast-scalable cryptocurrencies such as Solana’s transaction speed (50,000 per second) or XML’s $0.00001 fee per transaction. Although technical problems are not without a solution, non-technical issues are not easy to resolve because their resolution depends on politicians, law makers, regulators, and various government agencies (central banks, the Fed and the ECB in particular) who choose to run headlong into backlash to Bitcoin and other cryptocurrencies. On Tuesday (October 8, 2022), prices of cryptocurrencies tanked, citing the industry-shaking collapse of FTX (second largest after Binance), some even dubbed the event as “Crypto’s Lehman moment”.

But erratic price movements is not something new in the crypto industry which has been on a roller-coaster since December of 2021, i.e. after Bitcoin price hit almost $68,000 and its market cap $1.24 trillion, jittery investors in a hurry began to cash out their hefty gains. The inability of FTX’s CEO Sam Bankman-Fried to handle his plan to sell his company (which was regarded as one of crypto’s “blue chip” companies) to the rival crypto exchange Binance set off a widespread selling panic, as a result, cryptocurrency market shed a mindboggling $236.7 billion ($81 billion by Bitcoin) in just two days (Tuesday and Wednesday), which by any standard was insanely bonkers.

Lawrence J. Trautman (Prairie View A&M University – College of Business; Texas A&M University School of Law (By Courtesy)) has posted “The FTX Crypto Debacle: Largest Fraud Since Madoff?” on SSRN. Here is the abstract:

In her letter to Treasury Secretary Janet Yellen dated September 15, 2022, U.S. Senator Elizabeth Warren requests “the Treasury Department’s (Treasury’s) comprehensive review of the risks and opportunities presented by the proliferation of the digital asset market, which ‘will highlight the economic danger of cryptocurrencies in several key areas, including the fraud risks they pose for investors.” Senator Warren warns, “It is crucial that Treasury “create the analytical basis for very strong oversight of this sector of finance because cryptocurrency poses grave risks to investors and to the economy as a whole.”

Just weeks later, during November 2022 reports emerge that “In less than a week, the cryptocurrency billionaire Sam Bankman-Fried went from industry leader to industry villain, lost most of his fortune, saw his $32 billion company plunge into bankruptcy and became the target of investigations by the Securities and Exchange Commission and the Justice Department.” The demise of FTX and its’ many related crypto entities created contagion and collateral damage for other participants and investors in the cryptocurrency community. The U.S. bankruptcy proceedings of many FTX related entities, scattered across many jurisdictions worldwide, will likely take years to sort out.

Shortly after the Chapter 11 filing, post-bankruptcy FTX new CEO John J. Ray III characterizes the collapse of FTX as the result of “the absolute of concentration of control in the hands of a very small group of grossly inexperienced and unsophisticated individuals who failed to implement virtually any of the systems or controls that are necessary for a company that is entrusted with other people’s money.”

In just a few years Bitcoin and other cryptocurrencies have had a major societal impact, proving to be unique payment systems challenge for law enforcement, policy makers, and financial regulatory authorities worldwide. Rapid introduction and diffusion of technological changes, such as Bitcoin’s crypto foundation the blockchain, thus far continue to exceed the ability of law and regulation to keep pace. The story of FTX and potential consequences for investors and the global financial system is the subject of this paper.

This paper proceeds in thirteen parts. First, is a discussion of the history and growth of crypto currencies. Second, crypto and national security risks is examined. Third, the failure of FTX is introduced. Fourth, bankruptcy. Fifth, the collateral damage thus far to the crypto ecosystem is described. Sixth, the FTX demise is examined in terms of threshold questions that may help to understand what has transpired and how productive policy may be crafted for the future. Seventh, the role of the SEC is explored. Eighth, the CFTC is discussed. Ninth, crypto and the federal Reserve is addressed. Tenth, features the role of Congressional inquiries. Eleventh, explores regulatory implications. Twelfth, focuses on the failure of corporate governance. Thirteenth discusses prosecution and litigation. And last, I conclude.

Menesh S. Patel (University of California, Davis – School of Law) has posted “Fraud on the Crypto Market” (Harvard Journal of Law & Technology, Forthcoming (2023)) on SSRN. Here is the abstract:

Crypto asset trading markets are booming. Traders in the United States presently can buy and sell hundreds of crypto assets on dozens of crypto exchanges, and this trading is expected to further intensify in the coming years. While investors now increasingly turn to crypto asset trading for portfolio appreciation and diversification, the popularization of secondary crypto asset trading risks significant investor harm through increased incidents of fraud. False or misleading statements by crypto asset sponsors or third parties have the prospect of financially impairing traders in crypto asset trading markets, including everyday traders who are ill-equipped to sustain significant investment losses.

As traders seek judicial redress for their fraud-related injuries, courts will be asked to make doctrinal determinations that will be pivotal to injured traders’ ability to recover. A primary issue that courts will need to confront is whether crypto asset traders can avail themselves of fraud on the market in connection with fraud claims asserted under SEC Rule 10b-5 or CFTC Rule 180.1. This Article addresses that question and has as its intended audience not just academics, but also courts, practitioners, and market participants.

The Article shows that as a doctrinal matter fraud on the market is available in securities or commodities fraud cases involving crypto assets that trade on crypto exchanges, especially in light of the Supreme Court’s decision in Halliburton II, which resolved that fraud on the market is predicated on just a generalized notion of market efficiency, rather than a strict financial economic notion of efficiency. Drawing on how courts apply the doctrine to fraud cases involving stock transactions, the Article articulates a framework for how fraud on the market should be applied to the crypto asset context and explores methodological issues relevant to the framework’s application in a given crypto asset case.

Heng Wang (Singapore Management University – Yong Pung How School of Law; University of New South Wales (UNSW) – Faculty of Law & Justice) and Ross P. Buckley (University of New South Wales (UNSW) – Faculty of Law & Justice) on SSRN. Here is the abstract:

The only central bank money individuals and businesses have today is cash. Everything else they use as money is commercial bank promises. Central bank digital currencies (CBDC) will likely change all this by putting central bank money into everyone’s hands. China is a front runner in this revolution, and its CBDC, the e-CNY, may well in time profoundly affect the international economic order. This article analyses the major considerations around the e-CNY, its ramifications in particular for trade, and its possible challenges.

Shao Wei Tan (National University of Singapore) has posted “Transnational Transactions on Cryptoasset Exchanges: A Conflict of Laws Perspective” (Singapore Journal of Legal Studies, Sep 2022, pp 384-422) on SSRN. Here is the abstract:

Cryptoassets, now in the mainstream with significant retail and institutional ownership, can be purchased on cryptoasset exchanges online from around the world. Correspondingly, disputes involving transnational cryptoasset transactions—which have already begun to crop up in the US – are likely to become increasingly common in Singapore given its status as a global financial hub. The problem, however, is that there is no global consensus on how to determine the applicable law for transnational transactions on cryptoasset exchanges. This lack of consensus engenders unnecessary uncertainty as to the disputing parties’ rights and obligations, which in turn has significant implications for issuers, potential investors, regulators, and even the entire financial system. Building on the shortcomings of existing conflict of laws solutions in other jurisdictions, this article proposes a conflict of laws solution to this problem for the Singapore courts. The solution entails (1) recognising that the problem should be dealt with using a choice-of-law approach, (2) creating a new category of issues, ‘market issues’, as which issues may be collectively characterised, and (3) choosing only the lex mercatus for issues characterised as market issues.

Ioannis Revolidis (University of Malta, Centre for Distributed Ledger Technologies and Department of Media, Communications & Technology Law) has posted “On Arrogance and Drunkenness – A Primer on International Jurisdiction and the Blockchain” (Lex & Forum, 2 (2022)) on SSRN. Here is the abstract:

Blockchain applications are gradually approaching mainstream adoption. But with mainstream adoption come frictions and challenges, as larger digital communities are more complex and, therefore, more prone to developing disputes between transacting stakeholders. The problem of dispute resolution as regards blockchain transactions has mainly been discussed from the standpoint of blockchain-based alternative dispute resolution methods. A key narrative of this approach is that state courts shall generally stay away from blockchain dispute resolution because the characteristics of the technology make them ill-suited to meet the challenge. This paper takes a slightly different approach. While it does not question the value of blockchain-based ADR, it submits that state courts still have a role to play in the adjudication of blockchain-related disputes. To explore the challenges that state courts might face when dealing with blockchain-related disputes it focuses on the use case of Non-Fungible Tokens (NFTs). After critically exploring the characteristics of blockchain technologies and the deployment of NFT business models, it looks into the Brussels AI Regulation and investigates how far it can accommodate disputes that revolve around NFTs.

Robin Feldman (UC Hastings Law) and Kara Stein (Public Company Oversight Board) have posted “AI Governance in the Financial Industry” (Stanford Journal of Law, Business, and Finance, Vol. 27, No. 1, 2022) on SSRN. Here is the abstract:

Legal regimes in the United States generally conceptualize obligations as attaching along one of two pathways: through the entity or the individual. Although these dual conceptualizations made sense in an ordinary pre-modern world, they no longer capture the financial system landscape, now that artificial intelligence has entered the scene. Neither person nor entity, artificial intelligence is an activity or a capacity, something that mediates relations between individuals and entities. And whether we like it or not, artificial intelligence has already reshaped financial markets. From Robinhood, to the Flash Crash, to Twitter’s Hash Crash, to the Knight Capital incident, each of these episodes foreshadows the potential for puzzling conundra and serious disruptions.

Little space exists in current legal and regulatory regimes to properly manage the actions of artificial intelligence in the financial space. Artificial intelligence does not “have intent” and therefore cannot form the scienter required in many securities law contexts. It also defies the approach commonly used in financial regulation of focusing on size or sophistication. Moreover, the activity of artificial intelligence is too diffuse, distributed, and ephemeral to effectively govern by aiming regulatory firepower at the artificial intelligence itself or even at the entities and individuals currently targeted in securities law. Even when the law deviates from the classic focus on entities and individuals, as it meanders through areas that implicate artificial intelligence, we lack a unifying theory for what we are doing and why.

To begin filling this void, we propose conceptualizing artificial intelligence as a type of skill or capacity—a superpower, if you will. Just as the power of flight opens new avenues for superheroes, so, too, does the power of artificial intelligence open new avenues for mere mortals. With the capacity of flight as its animating imagery, the article proposes what we would call “touchpoint regulation.” Specifically, we set out three forms of scaffolding—touchpoints, types of evil, and types of players—that provide the essential structure for any body of law society will need for governing artificial intelligence in the financial industry.

Nizan Geslevich Packin (Baruch College, Zicklin School of Business; CUNY Department of Law) and Sean Stein Smith (CUNY) have posted “ESG, Crypto, And What Has The IRS Got To Do With It?” (Stanford Journal of Blockchain Law & Policy: Forthcoming) on SSRN. Here is the abstract:

Regulation almost always lags behind innovation, and this is also the situation with many FinTech-based products and services, and particularly those offered by crypto industry players. The crypto sector is a new and innovative one, which has proven to be not only based on highly technical concepts, but also by high levels of volatility and financial risk. In attempting to understand how to address many of the issues it raises in legal fields ranging from to financial regulation such as tax requirements to environmental law, and specifically matters that relate to climate change and energy wasting, regulators often find themselves trying to implement existing legal frameworks rather than creating new, clear rules. Much has been written about the SEC’s regime of regulation by enforcement of the crypto industry, and the impact of this type of rulemaking on businesses and persons. However, other financial regulators adopting a similar style of rulemaking—such as the IRS—have gotten much less attention for the impact of their regulatory actions. As noted within this Article, prominent industry associations continue to push back against applying existing tax law and protocols to specific crypto activities. One such notable example, which is relevant in the Environmental, Social and Governance (ESG) awareness era, relates to the unintended consequences of the IRS’ regulation by enforcement, given the impact that such new rules have on the transition to greener energy. This happens in the crypto industry in connection with proof-of-stake (PoS) consensus mechanisms—one of the two prominent transaction validation mechanisms. The PoS mechanism includes staking rewards – reward tokens that are earned/generated from securing a PoS blockchain – that validators, also known as stakers, get when they validate transactions. The IRS has asserted that cryptocurrencies are considered property for income taxation purposes, which means that every transaction results in a gain or loss equating to the difference between the price of the crypto asset at purchase and the price of the sale.
In the case of the PoS mechanism’s staking rewards, the debate behind deciding whether the rewards should be classified as taxable income when received versus when sold can also be framed as either applying existing tax code, word for word, to what many consider a new asset category, or eventually changing the code to reflect new economic models supported by some industry actors. This issue, which might seem minor, has recently become the subject of a lawsuit that one validator brought against the IRS, arguing that staking rewards should be taxed at the time they are sold, rather than created as the IRS has argued. Although just one specific court case with limited implications to other taxpayers, it is illustrative of the frustration felt by some market participants. In early October 2022, the case in question was dismissed by the court. Much like the Department of Justice several months earlier, the court found that Jerret presented no case or controversy, as it was moot. The reason for this is that the case had no issue that remained unsettled because the IRS had issued a full refund, including the interest, as was initially requested by the taxpayers. Ultimately this ongoing debate and conversation highlights the following: under strict application of existing tax rules, staking rewards are taxable when received, but should that be the case? Practically speaking, following the dismissal of the Jerret case, the immediate consequence is that taxpayers should assume that staking income is taxed as income at the time of receipt, unless explicitly excluded by the IRS in future tax guidance. That said, this Article argues that having legal clarity is important and that regulation by enforcement is less equitable. Additionally, this Article argues that proper lawmaking is especially needed in this PoS-based staking situation, given the importance of incentivizing persons to use PoS mechanisms due to environmental considerations, and the implications of financial regulation’s nudges on the behavior of persons and the promotion of ESG-based goals. Indeed, this clarity is needed because current legal ad hoc structures do not have the capacity to keep pace with the negative impact on the environment and the energy consumption issues that the crypto sector causes and also prompted the Ethereum merge. It is clear, therefore, that we need additional behavioral incentives for the law to rely on to support and facilitate the objectives of greener environment goals’ promotion.

Carol R. Goforth (U Arkansas Law) has posted “Critiquing the SEC’s On-Going Efforts to Regulate Crypto Exchanges” (14 William & Mary Business Law Review (Forthcoming 2022)) on SSRN. Here is the abstract:

Despite the so-called “Crypto Winter” in the spring of 2022, which saw a deep plunge in global crypto markets, interest in the appropriate way to develop, use, and regulate cryptoassets and crypto-based businesses continues to be high. In the U.S., a Presidential Executive Order and multiple bills that seek to tackle various issues of crypto regulation are regularly highlighted in the news, suggesting the appropriate treatment of crypto is a growing national priority. Despite these discussions, which tend to focus on finding a balanced way to regulate those within the industry without stifling the technology, the Securities and Exchange Commission (SEC) continues to seek to asset its jurisdiction unilaterally. A pending proposal from the SEC, misleadingly characterized as an attempt to regulate trading in government securities, would broaden the definition of “exchange” with potentially destructive consequences. This Article carefully considers the existing definition of “exchange” under the Securities Exchange Act of 1934 (the ’34 Act), and then examines a proposal from the Commission that would substantially broaden the current interpretation to reach a much larger group of persons involved in trading cryptoassets without adding clarity or a path to compliant operation for such persons. It then evaluates why the proposal creates problems, identifying a number of such issues, before concluding that a better approach would be to allow the legislative process to play out.

Hossein Nabilou (University of Amsterdam Law School; UNIDROIT) has posted “Probabilistic Settlement Finality in Proof-of-Work Blockchains: Legal Considerations” on SSRN. Here is the abstract:

The concept of settlement finality sits at the heart of any type of commercial transaction; whether the transaction is in physical or electronic form or is mediated by fiat currencies or cryptocurrencies.
Transaction finality refers to the exact moment in time when proprietary interests in the object or
medium of transaction pass from one party to his counterparty and the obligations of the parties to a transaction are discharged in an unconditional and irrevocable manner, i.e., in a way that cannot be reversed even by the subsequent legal defenses or actions against the counterparty. Given the benefits of finality in terms of legal certainty and its potential systemic implications, legal systems throughout the globe have devised mechanisms to determine the exact moment of the finality of a transaction and settlement of obligations conducted using fiat currencies as a medium of exchange. However, as the transactions involving cryptocurrencies fall beyond the scope of such rules, they introduce new challenges to determining the exact moment of finality in on-chain cryptocurrency transactions. This complexity arises because the finality of the transactions in the cryptocurrencies that rely on proof-of-work (PoW) consensus algorithms is probabilistic. The probabilistic finality makes the determination of the exact moment of operational finality nearly impossible.

After discussing the mechanisms of settlement of contractual obligations in the traditional sale of goods as well as payment and settlement systems – which rather than relying on the concept of operational finality, rely upon the concept of legal finality – the paper argues that even in the traditional payment and settlement systems the determination of operational settlement finality is nearly impossible. This is because no transaction, even a transaction involving a cash payment, cannot be operationally deemed irrevocable as it remains prone to hacks or unwinding by electronic means or mere brute force. The paper suggests that the concept of finality is inherently a legal concept and, as is the case in the conventional finance, the moment of finality in PoW blockchains should also rely on the conceptual separation of operational finality from legal finality. However, given the decentralized nature of cryptocurrencies, defining the moment of finality in PoW blockchains, which may require a minimum level of institutional infrastructures and centralization to support the credibility of the finality, may face insurmountable challenges.