Blockchain 101 for Lawyers and 2019 Year in Review

February 19, 2020

12:30 p.m. – 1:30 p.m.

CT Bar Association

New Britain, CT

CT Bar Institute, Inc.

CT: 1.0 CLE Credits (General) NY: 1.0 CLE Credits (AOP)

No representation or warranty is made as to the accuracy of these materials. Readers should check primary sources where appropriate and use the traditional legal research techniques to make sure that the information has not been affected or changed by recent developments.

Page 1 of 51 Lawyers’ Principles of Professionalism

As a lawyer I must strive to make our system of justice work fairly and Where consistent with my client's interests, I will communicate with efficiently. In order to carry out that responsibility, not only will I comply opposing counsel in an effort to avoid litigation and to resolve litigation with the letter and spirit of the disciplinary standards applicable to all that has actually commenced; lawyers, but I will also conduct myself in accordance with the following Principles of Professionalism when dealing with my client, opposing I will withdraw voluntarily claims or defense when it becomes apparent parties, their counsel, the courts and the general public. that they do not have merit or are superfluous;

Civility and courtesy are the hallmarks of professionalism and should not I will not file frivolous motions; be equated with weakness;

I will endeavor to be courteous and civil, both in oral and in written I will make every effort to agree with other counsel, as early as possible, on communications; a voluntary exchange of information and on a plan for discovery;

I will not knowingly make statements of fact or of law that are untrue; I will attempt to resolve, by agreement, my objections to matters contained in my opponent's pleadings and discovery requests; I will agree to reasonable requests for extensions of time or for waiver of procedural formalities when the legitimate interests of my client will not be In civil matters, I will stipulate to facts as to which there is no genuine adversely affected; dispute;

I will refrain from causing unreasonable delays; I will endeavor to be punctual in attending court hearings, conferences, meetings and depositions; I will endeavor to consult with opposing counsel before scheduling depositions and meetings and before rescheduling hearings, and I will I will at all times be candid with the court and its personnel; cooperate with opposing counsel when scheduling changes are requested; I will remember that, in addition to commitment to my client's cause, my When scheduled hearings or depositions have to be canceled, I will notify responsibilities as a lawyer include a devotion to the public good; opposing counsel, and if appropriate, the court (or other tribunal) as early as possible; I will endeavor to keep myself current in the areas in which I practice and when necessary, will associate with, or refer my client to, counsel Before dates for hearings or trials are set, or if that is not feasible, knowledgeable in another field of practice; immediately after such dates have been set, I will attempt to verify the availability of key participants and witnesses so that I can promptly notify I will be mindful of the fact that, as a member of a self-regulating the court (or other tribunal) and opposing counsel of any likely problem in profession, it is incumbent on me to report violations by fellow lawyers as that regard; required by the Rules of Professional Conduct;

I will refrain from utilizing litigation or any other course of conduct to I will be mindful of the need to protect the image of the legal profession in harass the opposing party; the eyes of the public and will be so guided when considering methods and content of advertising; I will refrain from engaging in excessive and abusive discovery, and I will comply with all reasonable discovery requests; I will be mindful that the law is a learned profession and that among its desirable goals are devotion to public service, improvement of In depositions and other proceedings, and in negotiations, I will conduct administration of justice, and the contribution of uncompensated time and myself with dignity, avoid making groundless objections and refrain from civic influence on behalf of those persons who cannot afford adequate legal engaging I acts of rudeness or disrespect; assistance;

I will not serve motions and pleadings on the other party or counsel at such I will endeavor to ensure that all persons, regardless of race, age, gender, time or in such manner as will unfairly limit the other party’s opportunity disability, national origin, religion, sexual orientation, color, or creed to respond; receive fair and equal treatment under the law, and will always conduct myself in such a way as to promote equality and justice for all. In business transactions I will not quarrel over matters of form or style, but will concentrate on matters of substance and content; It is understood that nothing in these Principles shall be deemed to supersede, supplement or in any way amend the Rules of Professional Conduct, alter existing standards of conduct against which lawyer conduct I will be a vigorous and zealous advocate on behalf of my client, while might be judged or become a basis for the imposition of civil liability of recognizing, as an officer of the court, that excessive zeal may be any kind. detrimental to my client’s interests as well as to the proper functioning of our system of justice; --Adopted by the Connecticut Bar Association House of Delegates on June 6, 1994 While I must consider my client’s decision concerning the objectives of the representation, I nevertheless will counsel my client that a willingness to initiate or engage in settlement discussions is consistent with zealous and effective representation;

Page 2 of 51 Preston Byrne – Blockchain CLE 17 Feb 2020 – program Agenda + Schedule

ABOUT THE PROGRAM

This course will advise course participants what blockchains are, how blockchain databases are used, how to distinguish between cryptocurrency applications and enterprise applications of blockchain technology, and what to look out for in day to day practice.

YOU WILL LEARN

 What a blockchain is and how it works, in plain English  What a blockchain is not and what claims about blockchain should be regarded as suspect  Common issues encountered in cryptocurrency practice, including securities, anti- money-laundering and counter-terrorist financing, and cross-border issues  2019 year in review

WHO SHOULD ATTEND

Any attorney interested in learning about the basics of blockchain and cryptocurrency practice.

SPEAKER

Preston J. Byrne, Partner, Byrne & Storm, P.C. Founder and former-COO, Monax (Blockchain legal tech company and first-ever enterprise blockchain company)

PROGRAM AGENDA

TIME TOPIC 12:25-12:30 Speaker Introduction 12:30-12:45 Introduction to blockchains 12:45- 13:00 Cryptocurrrencies 13:10– 13:05 Non-cryptocurrency use cases (“enterprise blockchain”) 13:05-13:15 Brief rundown of commonly encountered issues in practice 13:15-13:30 Market structure and red flags 13:30-13:45 Question and answer

Page 3 of 51 Faculty Biography

Preston J. Byrne, Byrne & Storm PC Preston is a partner at Byrne & Storm, P.C. He advises cutting edge technology companies, including interactive computer services providers, decentralized cryptocurrency protocol developers and cryptocurrency miners, on complex, cross-border legal issues. He is admitted in England and Wales, Connecticut, and New York. Prior to joining Byrne & Storm Preston was a co-founder of Monax Industries, an early blockchain infrastructure company, and an associate with Berwin Leighton Paisner (now Bryan Cave Leighton Paisner) and Norton Rose Fulbright in London. He is also a Fellow of the Adam Smith Institute. He holds an M.A. from the University of St. Andrews in Scotland, LL.B. from the University of Law in London, and LL.M. from UConn Law School.

Page 4 of 51 Blockchain 101 for Attorneys (aka people who can’t do math) 12:30‐13:30 PM 19 Feb 2020

Page 5 of 51 Hello! I’m Preston Byrne.

• Admitted in England & Wales, New York, and Connecticut • Early career with BigLaw in London, UK • Founded Monax Industries in 2014 • Monax == first non‐cryptocurrency/”enterprise” blockchain application software stack, now a legal tech company • College of Law of England and Wales (LL.B., 2009) • UConn Law (LL.M., 2018) • Currently: Partner at Byrne & Storm, P.C. (est. 1991) • Represent a mix of telecommunications, cryptocurrency and blockchain tech firms

Page 6 of 51 Structure of the talk

1. What’s a blockchain? 2. What’s a cryptocurrency? 3. How does an “enterprise blockchain” differ from a cryptocurrency? 4. What are common practice issues faced in each area? 5. What’s the market structure like? 6. Red flags 7. Q&A

Page 7 of 51 1. What’s a blockchain?

Page 8 of 51 Drinks party cheat sheet

• It’s a distributed application, i.e., it is a bit of software that runs simultaneously on many computers in many different places at once • It reaches consensus on the state of the data in a distributed or decentralized manner • Data integrity is ensured through the use of cryptographic hashes • Transactions are digitally signed through the use of public‐private key cryptography • Blockchains use cryptography but are (usually) NOT ENCRYPTED.

Page 9 of 51 “It’s a distributed application/database.”

Page 10 of 51 How the Internet is currently designed

Page 11 of 51 How blockchain networks are designed

Page 12 of 51 Blockchains agree on common rules just like lawyers do…

1) Distributed rulebooks

2) Which track changes made to them

3) Where changes will not occur unless someone with the requisite authority authorizes them

4) With the result that we can be fairly certain that if we find something on a blockchain, it belongs there

Page 13 of 51 …and all blockchains will have three core rules 1. Tell ‘em what you’re gonna say 2. Say it 3. Tell ‘em what you said

1. Transaction/Signature Rules: who has the ability to write particular messages to the database? • Elliptic curve digital signature algorithm (ECDSA) or Ed25519 if you’re really interested 2. Network Rules: how will we communicate the messages to one another? • Various peer to peer networking protocols over TCP‐IP 3. Consensus Rules: how do we decide on transaction ordering and the approved transaction history? • Proof‐of‐work (mining), proof‐of‐stake (voting), Delegated proof‐of‐stake (proxy voting)

Page 14 of 51 2. What’s a cryptocurrency?

Page 15 of 51 Applying the analytical framework…

1. Transaction/Signature Rules: 1. Varies by system 2. Bitcoin and Ethereum, e.g., use ECDSA 3. Bitcoin allows writes if you have an “unspent transaction output” (UTXO) plus the key which allows you to spend the unspent transaction output 4. UTXO (transaction permission) + private key (signature permission) = you can spend the corresponding Bitcoin 2. Network Rules: how will we communicate the messages to one another? • Various peer to peer networking protocols over TCP‐IP • Bitcoin uses handshaking; IPFS, Ethereum use libp2p • Lawyers don’t really need to know about this

Page 16 of 51 3. Consensus rules

• Subject of much wailing and gnashing of teeth • “Decentralization” is the key question • …but the term has no definite meaning and industry experts have no clear answers as to what it might mean • “Mining” == uses electricity expenditure to ensure decentralization • “Staking” = uses governance/buy‐in of stakes in the system to ensure decentralization • Neither is perfect and both can be (and have been) gamed with sufficient majorities of mining or staking power • Objective is to prevent hostile chain re‐organizations or “double‐spending” • These discussions are really the domain of mathematicians, security professionals and engineers

Page 17 of 51 3. What’s an enterprise blockchain?

Page 18 of 51 Applying the analytical framework…

1. Transaction/Signature Rules: 1. Transaction types highly variable, can really be anything that is expressible in code 2. Signature algorithms usually ECDSA (Bitcoin or Ethereum forks, Hyperledger Fabric) or Ed25519 (Hyperledger Burrow, Sawtooth‐Ethereum (“Seth”))

2. Network Rules: how will we communicate the messages to one another? • Again, not really legal turf; the only relevance is in determining when a message has been logged for the purpose of settlement finality/determining when an asset has moved out of a bankrupt’s estate, which is unlikely to be an issue except in very rare edge cases

Page 19 of 51 3. Consensus rules

• Whatever the application requires • Objective of these systems is to create a high‐security, highly automated transaction execution engine with a cryptographically verifiable, tamper‐resistant record of events • Can dole out particular permissions to particular validators and set requisite majorities for approving transactions (3‐of‐5 nodes, 7‐of‐10, 3 of 5 transaction participants plus a trustee, or whatever variation is agreed) • Looks like any other web application, except that the backend is blockchain based • Lawyers can be fairly useful in these discussions

Page 20 of 51 “This is real hacker stuff. How can a lawyer be useful in these discussions?” • Settlement finality • Staking/slashing vs requirements of contract law • Interactive Computer Services Provider vs. Money Transmitter • Negotiating leases for facilities that house mining equipment • Procedures to resolve consensus failures in permissioned systems • Finding legal alternatives to mainstream payment processors

Page 21 of 51 4. What are some key issues I should be aware of in practice?

Page 22 of 51 Hitting the high notes

1. Securities law 2. Money transmission 3. Typical startup issues 4. NY BitLicense 5. GDPR 6. Subpoena/search warrant compliance

Page 23 of 51 Securities law • Regulatory non‐compliance is NOT “just like Uber” • Prospective clients may ask lawyers to write legal opinions that claim securities laws do not apply to their transaction • Assume at point of issuance that all token sales must be registered or benefit from a specific exemption or issuance pathway (Reg S, Reg D/Rule 506(c), Reg A) • Commodities regulation may be relevant but will not be at the point of issuance • Pre‐sales or pre‐mines likely to trigger U.S. securities rules • Criminal prosecutions for securities law violations are underway • Required reading: • The DAO Report of Investigation • Paragon/AirFox orders (non‐registration of securities by issuer) • EtherDelta order (non‐registration as national securities exchange) • Crypto Asset Management, LP order (non‐registration as investment adviser) • U.S. v. Ruja Ignatova indictment

Page 24 of 51 Money transmission: the good, the bad, and the ugly • Easy to fall foul of money transmission rules • Small‐time Bitcoin exchangers have been charged with operating unlicensed money transmission businesses under 18 U.S.C. § 1960 • Note FinCEN 2013 guidance distinguishing “users,” “administrators” and “exchangers” • Lightning Network/“Layer 2” scaling solutions • Status not known, but current view is that use of a payment channel to buy or sell goods is a low risk of constituting money transmission, but that funding one for fees is a higher risk despite • Enforcement will be difficult given the decentralized nature of these programs, but legitimate businesses will seek to comply

Page 25 of 51 Stablecoins

• Cryptocurrencies designed to hold their value against a third reference asset, such as 1 USD • Practitioners should be able to distinguish between • Algorithmic (Basecoin) • Collateralized (Dai, BitUSD) • Convertible (CBDC) • Quasi‐ETFs (Libra) • Most stablecoins that are not convertible at par, i.e. backed 1:1 in liquid currency or currency equivalents, given enough time, have failed

Page 26 of 51 Reserve‐backed coins

• Convertibility = Parity • Coins that audit (for avoidance of doubt, not a red flag): CircleUSD, Paxos, Gemini Dollar, TrustToken • Banks: JP Morgan Chase (proposed) • Tech companies: Facebookcoin (proposed) • Public queries about coins that have not undergone audits but account for substantial portions (over 80% by some estimates) of Bitcoin’s trading volume

Page 27 of 51 Advising young “serial entrepreneur” types

• Founders (usually) aren’t lawyers • Incorporation formalities frequently missing or deficient • Early blockchain companies need generalists – compliance, IP, tax, data protection, corporate and venture financing • Ability to provide legal input into system/software design is a bonus, seeing as most blockchain systems seek to automate obligations of some kind

Page 28 of 51 New York Bitlicense

• Any New York nexus requires New York advice • Required before one can operate a “virtual currency business” in New York State • Only 14 issued to date • Most companies block New York residents from using their services rather than seeking licensure • Some companies elect to operate as a trust company or bank instead (see e.g. Paxos) • Required for (per 23 NYCRR 200.3(a)) • Receiving crypto for transmission unless for non‐financial purposes and for a nominal amount • Storing, holding, maintaining custody of crypto • Buying and selling crypto as a customer business • Performing exchange services as a customer business • Controlling, administering or issuing (!) crypto

Page 29 of 51 GDPR

1. European data privacy law is *crazy* 2. Applies to anyone who is in the EU at the time that the data is processed by the data processor 3. If the application is public/consumer facing a GDPR analysis should be undertaken by EU counsel, particularly if the client is planning to have substantial European operations 4. There is a stronger coin‐based blockchain ecosystem in Europe than the States due to favorable regulatory environment (chiefly, ICO tokens are not securities under the Prospectus Regulation)

Page 30 of 51 Subpoenas and search warrants • U.S. law enforcement can ask private companies for a range of user data under several different statutory authorities • Not all subpoenas are alike: SEC subpoenas are (usually) onerous, grand jury subpoenas are (usually) not • Know the limits of what law enforcement can ask for under the Stored Communications Act • Compliance is expensive and risky (as it involves pulling customer data); ensure your clients understand their nondisclosure obligations, keep disclosure on a need to know basis and implement adequate back‐office procedures before they are actually served to reduce overhead involved in responding

Page 31 of 51 5. 2019 year in review: market structure, major developments, and looking forward

Page 32 of 51 “Crypto Winter” Continues

Page 33 of 51 Trust nothing – bogus data is everywhere

Page 34 of 51 And everyone is aware of it

Page 35 of 51 Consensus: Libra was the biggest event of the year last year • Led by Facebook • Intended to be standalone currency backed by basket of assets • Swiss‐incorporated Stiftung, includes many major U.S. tech companies • Evidence that Big Tech can’t grow wider, needs to grow deeper • Nate Whittemore: “Significantly increased the seriousness with which the existing political and economic establishment is engaging with the space.” • Triggered development of CBDCs; IMF begins to examine stablecoins • Antitrust issues?

Page 36 of 51 U.S./Asia divergence

• US funds continue to lead investment, drive the narrative • Differing regulatory regimes have led to different theses and market leaders • Emerging themes in U.S. include censorship resistance, reducing friction for products that are definitively in the “cryptocurrency” camp and developing better fiat on/offramps • Asia: IEOs (ICOs on an exchange) through Binance Launchpad, Bittrex International dominated “altcoin” investment offerings • Investor appetite for IEOs limited, offerings considerably smaller than the largest coins in the ICO boom; regulatory picture in the U.S. is identical • Open question as to why the U.S. has not pursued onshore altcoin exchanges

Page 37 of 51 U.S. Regulatory Update (Part 1)

• DOJ significantly increases operational tempo for criminal enforcement; FBI makes Crypto Capital Corp arrests; wide net of industry players possibly implicated in vast alleged money laundering scheme • SEC: divergent approaches to different issuers • Block.One/EOS ($4BN), Ripple ($hundreds of millions), and Ethereum ($20 million) apparently get free passes • Telegram ($1bn+), Kik ($100mm): not so lucky • So‐called “Hinman Test” alive but on life support and not reliable • SEC: divergent approaches to different issuers • FinCEN: Stablecoin issuers are money transmitters, period

Page 38 of 51 U.S. Regulatory Update (Part 2) • CFTC: Ethereum is a Commodity, but could become a security again in version 2.0 • Tl;dr – one rule for Ethereum, one rule for everyone else • Wyoming launches the Special Purpose Depository Institution or SPDI • $5mm minimum capitalization; “New type of Wyoming financial institution with expertise with customer ID, AML and beneficial ownership requirements… [noting that] most financial institutions today do not have familiarity with the challenges facing blockchain innovators which is required to provide secure and reliable banking services to them” • Congress: • HR 5197, “Managed Stablecoins Are Securities Act of 2019”; HR 2194, ”Digital Taxonomy Act of 2019” (FTC appropriations); S. 1025, “VERDAD Act of 2019” (Venezuela sanctions); HR4813, “Keep Big Tech out of Finance Act”

Page 39 of 51 Overseas regulatory update

• GDPR • AMLD5 drives exchange businesses offshore… again • UK Jurisdiction Task Force report on the legal nature of cryptocurrency • Oxford v. Moss apparently resolved?

Page 40 of 51 Notable cases

• Leibowitz et al. v. iFinex et al. • Attorney General of the State of New York v. iFinex Inc. et al. • U.S. v. Reginald Fowler and Ravid Yosef • U.S. v. Hugh Brian Haney • SEC v. Telegram Group, Inc. and Ton Issuer Inc. • SEC v. Kik Interactive, Inc. • The several Craig Wright lawsuits

Page 41 of 51 Biggest settlements

• Eos settles $4 billion unregistered ICO for $24 million fine • Most other big ICO schemes silent on the matter… so far • On the horizon: Filecoin, Cosmos, Tezos?

Page 42 of 51 7. Red flags

Page 43 of 51 Red flags

1. Stablecoin red flags 2. Unaudited reserve‐backed coins 3. ICOs that re‐brand as IEOs without doing the securities compliance legwork 4. Requests for quick and dirty legal opinions 5. Retainers in Bitcoin 6. Investment schemes that promise fixed rates of return 7. Any claim that U.S. law is not sufficiently advanced to encompass the transactions mediated by the invention / “it’s a new paradigm”

Page 44 of 51 “Stablecoins” • If your client is the stablecoin provider: • Is the client operating a Ponzi scheme? • Is the client a money transmitter? • Does the client have appropriate KYC/AML controls in place?

• If the client is a stablecoin user: • What is your client’s exposure to the stablecoin scheme? • How can that exposure be hedged or limited? • Is your client inadvertently performing a function that would make it an issuer, administrator or

Page 45 of 51 Un‐audited reserve backed coins • IF the client is the reserve‐backed coin provider: • The client is very probably a money transmitter • The client needs top‐notch KYC/AML controls in place • If the client is a user of a reserve‐backed coin provider: • Understand why the client is using it (often, to get access to high‐rate‐of‐ interest margin lending markets that use these currencies) • Ensure the client has a contingency plan to deal with the sudden collapse of that provider • Inquire as to client’s hedging arrangements • It’s not your job to learn how to hedge, but it is your job to perform “CYA”

Page 46 of 51 Investment schemes promising consistent above‐market rates of return • A Ponzi scheme dressed up in technobabble is still a Ponzi scheme • Trendon Shavers (pirateat40) – “Bitcoin Savings & Trust” (Scheme operated 2011‐12, sentenced 2016) • Joshua Homero Garza – “Hashlet” Bitcoin mining contracts, Paycoin stablecoin (scheme operated 2014‐15, sentenced 2018) • U.S. v. Konstantin Ignatov, Ruja Ignatova – OneCoin MLM (ongoing) • Federal prosecutors have an array of statutory tools at their disposal – securities fraud, money laundering, wire fraud, and conspiracy feature heavily • Clients looking for exposure to the sector should be steered to institutional players with robust diligence and security apparatuses, e.g. Fidelity Digital Assets and Bakkt

Page 47 of 51 “I don’t need the analysis, I just need your opinion” • Unscrupulous entrepreneurs will ask you for this • Your answer should always be “no”

Page 48 of 51 Client paying a retainer in Bitcoin

• Nothing wrong with this/this is not suspicious per se; accepting Bitcoin in exchange for legal services is normal and plenty of lawyers I know will accept it • Possible problems with client accounts rules and BTC as there are no “Bitcoin banks” where one can set up Bitcoin‐denominated trust accounts • As a general rule I will not accept retainers or hold funds on account in Bitcoin, but I will accept payment in Bitcoin/cryptocurrency for services that have already been provided • It is probably cleaner from an accounting standpoint to use an invoicing service like BitPay than to accept payments at a custodial wallet service like Coinbase

Page 49 of 51 “It’s a new paradigm, you just aren’t smart enough to understand it” • Yes you are. • If a blockchain software concept can’t be explained in terms that a Golden Retriever could understand, this is a red flag • At the end of the day this stuff is just software

Page 50 of 51 Q&A Thanks for your time! Ask anything you like.

Page 51 of 51