U.S. Regulatory Issues for Consideration By Zcash Shielded Assets Issuers (White Paper)
This report is funded by Zcash Community Grants (ZCG)
- Disclaimer and Executive Summary Below (footnotes not included)
- Full White Paper
- Audio Version of White Paper
This white paper is intended to provide Zcash Shielded Asset (“ZSA”) issuers with an understanding of certain United States (“U.S.”) regulatory issues that may arise in connection with issuing ZSAs. Specifically, this white paper addresses relevant issues under the federal money transmitter laws, state money transmitter laws, Office of Foreign Assets Control (“OFAC”) sanctions, and federal and state securities laws.
This white paper is funded by the Zcash Community Grants committee and is provided with support from the Zcash Foundation and the law firm Steptoe LLP. This white paper, published September 9, 2024, is intended for informational purposes only to assist ZSA issuers in gaining a general understanding of certain of the legal regimes they should consider before launching a ZSA. The effectiveness of potential risk mitigation efforts identified herein will depend on the particular facts and circumstances of each ZSA issuance and on the extent to which federal and state regulators understanding and interpretation of blockchain technology continues to evolve. No specific risk mitigation effort or combination of mitigations described herein is assured to address any particular regulator’s concerns. Nothing in this white paper should be construed as legal advice or opinion with respect thereto. Nothing in this white paper establishes an attorney client relationship between you and Steptoe LLP. You should consult your own attorney and, with counsel, conduct your own assessment of the facts and the relevant authorities rather than relying on this white paper for your own compliance determinations or for any other purpose. Steptoe LLP has no obligation to update this document or notify you of any changes in law, or if any matters come to our attention that might affect the continuing validity of any statements or conclusions contained in this white paper.
This white paper addresses only the issuance of ZSAs and does not address other activities involving ZSAs, which may have different or additional legal considerations.
- Executive Summary
The United States has not adopted a comprehensive regulatory framework for digital assets. Issuers of tokens, including issuers of ZSAs, should therefore consider a number of U.S. regulatory regimes that could be applicable depending on the specific facts and circumstances. Among other potentially applicable regimes, these include regulations regarding anti-money laundering (“AML”), economic sanctions, and securities.
With respect to AML rules, the Financial Crimes Enforcement Network (“FinCEN”) within the U.S. Department of the Treasury has issued guidance indicating that certain token issuers may be considered money transmitters, a category of money services businesses (“MSBs”). MSBs are required to register with FinCEN and to comply with FinCEN’s AML requirements. Whether a given token issuer is considered an MSB will depend on a number of factors including the specific asset being issued, the manner of the issuance, and the location of the relevant activity, among others. The privacy-enhanced nature of the Zcash blockchain could present a number of unique considerations for issuers seeking to comply with FinCEN rules, given the more limited information available as compared to public blockchains. MSB issuers of ZSAs will want to consider how they can account for the privacy-enhanced nature of the Zcash blockchain as part of their compliance policies and procedures.
In addition to the federal rules promulgated by FinCEN, almost every U.S. state maintains its own state money transmitter law, requiring money transmitters (as defined in the applicable state statute) to obtain a license before operating in the state, including selling tokens to persons in the state, and to comply with various ongoing regulatory requirements. The states vary considerably in how their statutes are written and interpreted. For example, some state statutes do not apply to activity occurring entirely in digital assets and only regulate conduct involving fiat currency. On the other hand, some states explicitly require a license to issue digital assets. While many states have a single money transmitter statute, several states have adopted digital asset-specific statutes – for example, New York’s BitLicense. Whether a license is required will turn on many factors including the nature of the digital asset, the nature of the issuance, and the state’s statute, among others. The privacy-enhanced nature of the Zcash blockchain could lead to additional questions from regulators during the licensing process and may require different or additional compliance measures as compared to issuers using public blockchains.
Digital asset issuers should also be cognizant of U.S. economic sanctions, which apply to all U.S. persons and persons acting within the United States, regardless of whether that person is an MSB or holds any state money transmitter licenses. As detailed below, U.S. economic sanctions can also apply to persons acting outside of the United States in a number of situations. Therefore, all issuers should consider the economic sanctions risks posed by their contemplated activity and consider the appropriate measures to mitigate that risk. The privacy enhanced-nature of the Zcash blockchain may warrant different or additional compliance measures as compared to public blockchains.
The federal and state securities laws are triggered when a digital asset is sold pursuant to a securities transaction. Typically the analysis focuses on whether the digital asset is sold pursuant to an investment contract, which courts define as a (1) a contract, transaction, or scheme, (2) whereby a person invests money, (3) in a common enterprise, (4) with a reasonable expectation of profits to be derived from the efforts of others. This test requires an analysis of the economic reality of the relevant transaction and may result in a digital asset being sold pursuant to an investment contract in one context, but not in another context. Determining whether an investment contract exists, or continues to exist, requires a difficult and complex analysis of the particular facts and circumstances of each transaction or series of transactions. ZSA issuers should consider a number of factors detailed below, including the manner in which the ZSA will be distributed, the communications to ZSA holders and the public, and any economic attributes associated with the ZSA.
This white paper uses the terms “ZSA Issuer” to refer to a person that mints and transfers ownership of a ZSA. The term is not meant to suggest the applicability of the U.S. securities laws, or any other U.S. regulatory scheme, to a particular ZSA distribution. As discussed throughout this memo, the applicability of a U.S. regulatory scheme will depend on the particular facts and circumstances of the transaction.
Other U.S. and non-U.S. laws may apply to the activities of ZSA issuers. Issuers should work with counsel to identify those additional legal regimes, which may vary depending on the facts of a given ZSA issuance.