States Dive Into Cryptocurrency Fray


From dealing with Ponzi schemes to financial windfalls, state leaders are weighing how to best handle the future of nationless money.

Amid a gold rush for “open source” currencies like Bitcoin, state leaders are attempting to establish their role in regulating or promoting the emerging world of cryptocurrencies.

With little precedent for nationless, blockchain-based money, regulators and legislators are deciding whether and how to protect citizens from speculation and hype, as well as fraud and Ponzi schemes that are popping up around cryptocurrencies at a rapid clip.

Over the past few months, a handful of states have focused on shutting down cryptocurrency-related financial organizations that don’t comply with state regulations, many of which were outright frauds.

In January, Texas and North Carolina both issued cease and desist orders against BitConnect for selling securities without state registration. According to the Texas State Securities Board order, the site was promising its investors “annualized returns of 100% or more.”

BitConnect did not respond to the North Carolina order; instead, the company shuttered the doors of its exchange.

“We think there may have been about $2 billion of nominal value in the scheme when it collapsed, with potentially a million investors worldwide,” Rich Godfrey, an investigator with the North Carolina Secretary of State’s Securities Division, told the National Association of Secretaries of State securities committee during its recent winter conference in the nation’s capital.

In his research, Godfrey said he has identified “several dozen” copycat schemes similar to BitConnect being promoted mostly over social media on platforms like YouTube, Reddit and Facebook.

That’s not surprising, as cryptocurrency-based businesses that promise fantastic riches are increasingly commonplace. And, for every legitimate story of unparalleled financial windfalls, there are countless scams that are reminiscent of the financial eras that brought us Ponzi schemes, “wildcat” banks, con men and grifters.

The traditional banking and finance industry left those days behind and became defined by large financial institutions and highly regulated markets. However, the decentralized nature of the blockchain technology that defines cryptocurrencies means the nascent new field is neither dominated nor regulated significantly by any single entity—which, in many ways, is the goal of a nationless digital currency.

And in recent months, as more of these speculative schemes pop up, state regulators have begun taking action. In addition to Texas’ Jan. 4 emergency cease and desist order filed against Bitconnect, the state has also filed orders against USI-Tech Limited, R2B Coin and DavorCoin in the last three months. Two weeks ago, New Jersey filed a cease and desist against Bitstrade.

“We want to make sure that investors tempted to cash in on the cryptocurrency rage aren’t being lured into sending funds to an anonymous internet entity without knowing where the funds are going or how they’ll be used,” said New Jersey Attorney General Gurbir S. Grewal in his statement announcing the action.

On Jan. 17, Massachusetts filed an administrative complaint, including a cease and desist, against Caviar, a Cayman Islands-based company planning to launch a cryptocurrency. Also cited in the Massachusetts complaint is Caviar’s owner: Kirill Bensonoff of Brookline, Massachusetts, who according to the complaint failed to follow proper state securities compliance.

In December, Massachusetts Secretary of the Commonwealth William Galvin warned his state’s residents about the speculation surrounding Bitcoin and related products.

“Bitcoin is just the latest in a history of speculative bubbles that most often burst, leaving the average investors with a worthless product,” Galvin said. “Going back to the 1600s with tulip mania to the present Bitcoin craze, chasing the next best thing will, more often than not, end in disaster for the average investor.”

While Secretary Galvin is clearly a skeptic, even those who are most invested in the future of cryptocurrency are urging investors act with caution. Vitalik Buterin, the founder of one of the leading cryptocurrencies, Ethereum, warned his followers on Twitter that “cryptocurrencies are still a new and hyper-volatile asset class, and could drop to near-zero at any time.”

“Don't put in more money than you can afford to lose,” he wrote. If you're trying to figure out where to store your life savings, traditional assets are still your safest bet.”

Buterin also has denounced online pro-cryptocurrency media as “complicit in making twitter (sic) scams look more legit,” and pointed out that these schemes are problematic to the future of decentralized cryptocurrencies.

“With decentralization … barriers that keep many of those valuable ideas, and entrepreneurs and individuals (particularly from a diversity point of view) out, also allow a lot of bad actors in—that’s the other side of that coin,” Lewis Cohen, a partner with the law firm Hogan Lovells, that advises clients on a range of blockchain and cryptocurrency concerns, told Route Fifty. “There was a huge amount of money to be made and fraudsters and scammers of all shapes and sizes waded in.”

Mississippi Secretary of State Delbert Hosemann, who participated in a roundtable discussion at the conference, expressed his concern with how rapidly the schemes surrounding cryptocurrency were moving, saying that they “go out of existence really before we ever catch them.”

States seem to be forming a network of investigators to fight back, though.

“There’s emerging a group of people that have begun to work on these types of cases … people like me in other states, and we’re beginning to find each other,” Godfrey said.  

He pointed out that moving forward the network will need to “do a better job of formalizing those arrangements and sharing information, because … it’s happening so quickly it’s mind-boggling how quickly these platforms have arisen.”

Cohen believes the state’s work is absolutely necessary to identify fraudsters and ensure their citizens in their respective states are being protected.

“It is exceedingly difficult for the SEC, with a limited budget and really unprepared to handle all of the bad actors that are out there,” he explained.

He did, however, temper that statement by pointing out there needs to be more and better guidance for those who are seeking to be responsible in the marketplace and are surrounded by legal uncertainty.

“I think that’s where states need to be more cautious—where there’s no evidence of fraud, as such, but you have valid actors trying to do business in their state having trouble determining with certainty whether or not the activity is a regulated one or is not,” Cohen said.

‘The Next Great Thing Since the Internet’

From New Hampshire to Arizona, there are state legislators and regulators who see Bitcoin and other cryptocurrencies as an economic opportunity, and they want to ensure those “valid actors” feel welcome in their state.

For instance, the Wyoming legislature is currently reviewing a package of five bills. It includes language exempting certain cryptocurrency investments from securities laws.

In an op-ed co-bylined with a member of the Wyoming Blockchain Coalition, Wyoming State Rep. Tyler Lindholm, who serves as the sponsor for several of the bills, explained that the goal of the package is to “build on two characteristics of Wyoming that make it particularly attractive to the blockchain industry: zero corporate income or franchise taxes, and strict privacy laws governing LLCs formed in the state.”

“Companies don't need to move to Wyoming physically to take advantage, just as most Delaware corporations aren't located in Delaware,” Lindholm wrote. “But but there are real reasons why businesses might want to move there. Cheyenne, the state capital, has tremendous fiber-optic bandwidth and cheap power that is already attracting major data centers to locate there, for example.”

With Wyoming’s legislature constitutionally limited to a 20-day session, the bills are moving quickly, with two having passed the House unanimously and more scheduled for action.

However, not everyone in the state is certain that the changes to the laws have been fully thought through. Joe Chenchar, a representative from the Wyoming Secretary of State’s office that participated in a roundtable discussion, told the group that their office “would prefer to see more interim study on this topic” before it is taken up. “This hasn’t been vetted by our office too much and it’s moving really quick,” he told the group.

Scott Anderson, chief deputy to the Nevada Secretary of State, told the roundtable there was “lots of buzz” from state legislative leaders around cryptocurrencies in the Silver State, as well.

“They seem to think this is the next great thing since the internet,” Anderson said.

Hosemann seemed skeptical of the economic benefits, pointing out that typically when a state relaxes regulations to entice a corporation or industry, it comes with the promise of hundreds or thousands of jobs.

“They’re not going to build any infrastructure or any new buildings. Everything is done on something as small as this,” he said, pointing to his cell phone.

“It’s not like a business development opportunity. To me, it’s more of a fraud opportunity,” Hosemann quipped.

Cryptocurrency investors will still face applicable securities rules from other states no matter where they are headquartered. But, from Cohen’s legal perspective, states that do exempt these businesses will still have other avenues to go after bad actors.

“Law enforcement does not lack in the means of enforcing against fraud. They have all kinds of fraud, and they have all kinds of tools at their disposal,” he said. “They’re really trying to set a standard for other states and then to send a clear signal to blockchain-based businesses that ‘hey, this is a good place to be headquartered.’"