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For Policymakers

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What are State Governments doing about Bad Actors in Crypto?

States have now begun to scrutinize crypto lending platform providers for violations of securities and money transmission laws. But these actions only begin to scratch the surface and for the most part only amount to a failure to register with the appropriate regulator. Meanwhile, bad actors like Nexo have largely escaped scrutiny for allegations of consumer protection violations, costing customers across the country upwards of tens of millions of dollars.

NY Attorney General Tish James

Consumer Protections

States typically have consumer protection laws that protect consumers and businesses from bad actors who engage in unfair methods of competition, or unconscionable, deceptive, or unfair acts or practices in their conduct of business. What is considered deceptive will ultimately depend state by state but commonly covers a representation, omission, or practice that is likely to mislead the consumer acting reasonably in the circumstances, to the consumer’s detriment. An unfair business practice is one that rises to the level of immoral, unethical, oppressive, unscrupulous or substantially harmful to consumers. Unlawful unfair acts and practices in crypto lending can include imposing unconscionable contractual provisions.

Consumer protection laws may allow an attorney general or regulator to seek an injunction or initiate a lawsuit for actual damages or restitution. For important public policy reasons such as protecting consumers and businesses that follow the rules, consumer protection laws generally allow states to quickly obtain injunctive and other equitable relief without pleading actual damages.

Person reviewing volatile cryptocurrency market

Securities: Registration Requirements

Offering interest-earning depository accounts: Crypto lending platform providers sell investors cryptocurrency interest-earning accounts, i.e., investors purchase these accounts by depositing certain eligible cryptocurrencies into accounts at the crypto lending platform provider in exchange for the promise of a lucrative monthly interest rate in cryptocurrency. The lending platform provider then pools these cryptocurrencies together to engage in lending or investment activity for profit. Depending on state law, this might amount to a security and therefore must be registered unless meeting an exemption in the law. Alabama, Kentucky, New Jersey, Texas and Vermont have issued a cease-and-desist order for a lending platform’s failure to register and offering such a product.

Broker, Dealer, and/or Broker-Dealer of Securities (and Commodities): Depending on state law, a person, firm, association or corporation engaged in the business of buying and selling securities from or to the public, or engaged in the business of effecting transactions in securities for the account of others, may need to register as a securities broker or dealer. Similarly, state law may require a person engaged in the business of selling, or offering to sell, commodity contracts to the public within or from the state to register as a commodity broker-dealer. Virtual currencies are generally either securities or commodities, and therefore are no exception to these registration requirements. States like New York have concluded as much and failure of broker or dealers in cryptocurrency to register exposes the violator to both civil and criminal liability.

Money Transmission: License Requirements

Certain states require a person who engages in the “money service” business to obtain a license unless meeting a certain exemption. An individual or business entity engaged in the “money service” business is typically a payment instrument seller, foreign currency exchanger, check casher, or money transmitter. This typically covers crypto lending platform providers because crypto lending platform providers exchange not only stablecoins but also fiat (i.e., the U.S. dollar) for cryptoassets, like bitcoin and sell cryptocurrency to customers for fiat currency.