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Blockchain Bites: Binance pulls out of FTX acquisition, US Court finds ERC-20 tokens security, first Australian retail crypto fund likely to close, Binance donates $300,000 to University of WA – Fin Tech

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Michael Bacina, Steven Pettigrove, Luke Misthos,
Jake Huang and Lola Hickey of the Piper Alderman Blockchain Group
bring you the latest legal, regulatory and project updates in
Blockchain and Digital Law.

Binance pulls out of FTX acquisition, staff leave and
websites go dark

Binance has pulled out of a proposed deal to acquire beleaguered crypto
exchange FTX, announcing the move yesterday.

FTX has reportedly been scrambling to raise USD$2 – 3B in the
last 48 hours to address a run on the exchange, without success.
With news that the entire legal and compliance team of FTX resigned
on Tuesday
and the websites of Alameda Research and FTX
Ventures have gone down.

This is shaping up as a significant failure which will have
far-reaching consequences.

FTX to be acquired by Binance

On 9th November, a deal between FTX and Binance has
been announced by Sam Bankman-Fried and Changpeng Zhao, who wrote on Twitter that Binance has signed a
non-binding letter of intent to fully acquire FTX.com. CZ, the chief
executive of Binance, wrote that the deal will be subject to due
diligence stage in the coming days and noted that:

There is a lot to cover and will take some time. This is a
highly dynamic situation, and we are assessing the situation in
real time. Binance has the discretion to pull out from the deal at
any time. We expect FTT to be highly volatile in the coming days as
things develop.

The deal has also been confirmed by the chief executive and
founder of FTX, Sam Bankman-Fried, who wrote that FTX and Binance have reached an
agreement on a strategic transaction. SBF commented that one of the main reasons behind
the deal is to address a liquidity crunch which arose suddenly and
assist in clearing out a backlog of withdrawals. SBF wrote on Twitter that:

This is a user-centric development that benefits the entire
industry. CZ has done, and will continue to do, an incredible job
of building out the global crypto ecosystem, and creating a freer
economic world.

Bankman-Fried has addressed the rumours that FTX and Binance
have been in conflict noting that:

Binance has shown time and again that they are committed to a
more decentralized global economy while working to improve industry
relations with regulators. We are in the best of hands.

The news has sent shockwaves through the crypto industry and is
expected to continue to cause waves while further details emerge of
what this bailout deal looks like.

US Court finds ERC-20 tokens sold to the public are an
unlawful security

On 7 November, the United States District Court in New Hampshire
found that a cryptographic token named LBC was a security under US
law after the Securities and Exchange Commission
(SEC) brought proceedings against the issuer of
the token, LBRY, in May 2021. Barbadoro J gave a summary judgment in favour of the SEC against the
issuer. LBRY operates Odysee, a decentralised video-sharing platform,
which allows creators to acquire LBC and viewers the opportunity to
earn cryptocurrency for watching videos in a “watch to
earn” model.

Between 2016 and 2021, LBRY had sold LBC for over USD$11M in
cash and Bitcoin. The SEC alleged that the offer of LBC was an
“investment contract” and the offer had occurred without
registration and disclosures required under US law. LBRY responded
with two defences:

  1. that LBC tokens were not securities under US law; and

  2. if the LBC were securities, that the SEC had not given fair
    notice that the sale of LBC was regulated by securities laws and
    that the SEC was in violation of LBRY’s right to due
    process.

Barbadoro J ruled against LBRY finding:

No reasonable trier of fact could reject the SEC’s
contention that LBRY offered LBC as a security, and LBRY does not
have a triable defense that it lacked fair notice.

The decision examined the purposes and scope of the 1933
Securities Act and affirmed the decision of Reves v. Ernst
& Young, 494 U.S. 56, 61 (1990).
The principle established
in Reves was that when Congress adopted the Securities
Act:

“[Congress] enacted a definition of ‘security’
sufficiently broad to encompass virtually any instrument that might
be sold as an investment”.

This principle was used by Barbadoro J to expand the definition
of a security so that is able to cover a token and through using
the instrument of an investment contract. His Honour adapted the
broad definition of this instrument established in SEC v. W.J .
Howey Co 328 U.S 293 298-99 (1946)
to cover

a contract, transaction or scheme whereby a person invests his
money in a common enterprise and is led to expect profits solely
from the efforts of the promoter or a third party

Barbadoro J focused on the intention of Congress when adopting
the 1933 Securities Act and held that its scope is broad enough to
cover a token, noting that:

Consistent with the broad reach of the Securities Act, [t]his
definition ’embodies a flexible rather than a static principle,
one that is capable of adaptation to meet the countless and
variable schemes devised by those who seek the use of the money of
others on the promise of profits’.The focus of the inquiry is
on the objective economic realities of the transaction rather than
the form that the transaction takes.

The District Court rejected LBRY’s argument that because LBC
purchases were made with consumptive intent, the tokens are not a
security.

Barbadoro J held that:

Nothing in the case law suggests that a token with both
consumptive and speculative uses cannot be sold as an investment
contract.

This decision to characterise these tokens as a security will
have serious flow on effects in the US, where only a very small
number of tokens have been offered as securities to date, and the
SEC has been active in bringing actions against the sellers of
tokens. Many of those actions have resulted in “no
admissions” findings and fines, and the ongoing battle between
the SEC and Ripple in relation to one such claim continues with
summary judgment motions being filed in that case.

Ripple’s lawyers are, however, advancing quite different and more comprehensive
arguments
than LBRY did in this decision, offering the
potential of a different outcome which will be closely watched by
the industry.

First Australian retail crypto funds likely to close
after ASIC “no warning” stop orders

Holon Capital, which was granted an Australian Financial
Services Licence in May of this year and launched three crypto
focused funds (Bitcoin, Ethereum and Filecoin) in June was recently the subject of a “no-warning”
stop order from the Australian Securities and Investments
Commission
(ASIC) with ASIC using new design
and distribution obligation powers granted to it following the
Hayne Royal Commission. Further interim stop orders have since been
made freezing distribution of those funds indefinitely.

ASIC’s objections were raised in relation to the Target
Market Determinations (TMD) required to be
published by Holon as part of offering financial products to retail
investors under 944B of the Corporations Act which
requires that:

A target market determination.must be such that it would be
reasonable to conclude that, if the product were to be issued, or
sold in a regulated sale. to a retail client in the target
market-it would likely be consistent with the likely objectives,
financial situation and needs of the retail client.

If a product issuer permits investors who are outside the target
market to be issued with their products, then serious consequences
can follow.

Typically “no-warning” enforcement is a rarely used
tool in a regulator’s toolbox, as regulators wish to engage
fairly with those they regulate and have obligations to provide
procedural fairness in the exercise of their function.

It is more typical to see a “no-warning” stop order
where there is a critical time sensitivity or pressing concern over
a product. The use of a “no-warning” approach to Holon
invites an inference in relation to ASIC’s view towards
crypto-assets. ASIC has been suggesting for years that
crypto-businesses consider obtaining financial services licensing
where those products involve financial products.

Holon have published the stop orders and their
other correspondence with ASIC, showing that since 10 October 2022,
Holon’s three retail funds have been barred from dealing with
retail investors. ASIC’s statement of concerns states, in
relation to “medium” and “high” risk
investors:

it cannot reasonably be concluded that, if the product were to
be issued or sold in a regulated sale to a retail client in the
target market, it would likely be consistent with the likely
objectives, financial situation and needs of the retail client.

ASIC continues, asserting that the fund is not appropriate for
“very high” risk investors either:

There are investors included in the target market for the Fund
that may fall within Holon’s limited definition of a “Very
High” risk and return profile, but because of the significant
volatility and deep negative returns in a given year, the Fund
would not be suitable for them.

Similar positions are put in relation to Ethereum and Filecoin.
Holon’s response highlighted the manner in which they had
followed TMD guidance and templates for determining a target market
for the fund, based on well understood investment principles. Those
approaches appear to have been rejected by ASIC with further stop
orders being made.

Luke Benhcke of Holon said to the Australian Financial Review:

ASIC has formulated a carte blanche view on crypto assets and
don’t seem to be acknowledging standard investment principles
for these types of financial products.

This kind of approach is likely to be viewed as “regulation
by enforcement” and sends a chilling message to those who have
been seeking to offer crypto-asset financial products under licence
in Australia.

Of even greater concern, if the CASSPr licensing currently
underway with Treasury ultimately results in a markets licence
which falls under design & delivery obligations requiring a TMD
for the offer of crypto-assets, the approach adopted by ASIC in
relation to Holon could lead to a de facto ban over crypto-assets
being offered by any Australia CASSPr licence holders.

The perverse outcome, noted by Holon in their submissions, is
that with increasing numbers of Australians owning crypto-assets
directly, an insured and licensed fund offering would provide
additional options for those who do not wish to be exposed to the
risk of losing passwords or facing counterparty risk with digital
currency exchanges. By shutting these funds, the protections to
investors offered by those funds are denied to investors.
ASIC’s submissions unfortunately do not suggest a path to the
funds being offered in a compliant way.

At a minimum, the reputation of Australia as a jurisdiction
which is welcoming to crypto-asset businesses, investment and jobs
is tarnished by this approach, with more businesses likely to leave
our shores for jurisdictions that offer greater certainty and
technology enabling regulation.

Binance donates $300,000 to University of Western
Australia

International cryptocurrency exchange, Binance, has donated US
$300,000 in cryptocurrency to the University of Western Australia
(UWA) to promote blockchain education. The
donation was made in BUSD, a 1:1 USD-backed stablecoin, which has
been approved and is regulated by the New York State Department of
Financial Services.

The donation was made through the Binance Charity, a
blockchain-enabled donation platform that uses blockchain
technology to support, among other initiatives, the United Nations
Sustainable Development Goals.

The donation has been given to assist in funding of the
University’s existing blockchain work, including to build a
master’s program and develop a metaverse lab researched and
built by students.

Binance and the University of Western Australia believe
blockchain will be a growing job sector as calls for regulation are increasing, and the
industry enters into a new stage of adoption both internationally and
in Australia.

Government-led regulation in Australia will require a range of
stakeholders across various industries all with intimate knowledge
of the regulations and industry generally. Blockchain courses are
increasingly being offered at universities around Australia.

The donation follows a raft of education-based moves in the
digital asset industry, from blockchain-based school solutions in India, to
a pairing between the Australian National University
and Ripple Labs
to provide a blockchain law course.

Blockchain fundamentals are becoming increasingly more common in
financial services industry, as well as various other business
sectors, and it is likely more universities will offer similar
courses to UWA in future.

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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