Last April, I wrote about Wyoming’s ongoing effort to roll out the red carpet for cryptocurrency firms by passing a number of bills favorable to the sector. Most notably, the state created an entirely new type of bank charter – the Special Purpose Depository Institution (SPDI) charter – to assist “blockchain innovators” in accessing “secure and reliable banking services.” While the state has approved four SPDI charters thus far, the SPDI business model only works if charter recipients are able to obtain a Federal Reserve master account. A master account would grant SPDIs access to the Federal Reserve’s payment systems and reduce the current frictions and fees associated with crypto to fiat conversion, and vice versa. Despite it being well over a year since the first SPDI charter was granted, the Kansas City Fed has yet to approve a master account application for any SDPI, and for good reason. Because SPDIs lack Federal Deposit Insurance Corporation insurance, they do not meet the definition of “bank” under the Bank Holding Company Act, and therefore would not be subject to consolidated Federal Reserve Supervision. This means that commercial entities, like crypto exchange Kraken, can own a SPDI without being subject to parent company supervision, which violates the long standing policy of keeping banking and commerce separate. In short, granting master accounts to Wyoming SPDIs would open the door for crypto to enter the banking system and expose interbank payments systems to the numerous operational risks crypto presents, with no government entity overseeing SPDIs besides the Wyoming Division of Banking. Federal Reserve chairman Jerome Powell recognizes these risks, which is why at his confirmation hearing last month he acknowledged the “hugely precedential” nature of the decision and noted that if “we start granting these, there will be a couple hundred of them pretty quickly and we have to think about the broader safety and soundness implications.”
Wyoming’s New Crypto Tax Bill
While Wyoming SPDIs await a decision on their master account application, the state legislature and their crypto backers have continued their push to make Wyoming the “Delaware of digital asset law.” Last month, state Rep. Ocean Andrew proposed a bill that would allow “for the payment of state and local sales and use taxes in virtual currency,” and the “filing of state and local sales and use tax returns through the operation of a smart contract.” Many crypto proponents have long sought the ability to pay taxes in crypto due to the belief that this would accelerate crypto’s use as a medium of exchange. The logic goes that because all citizens must pay taxes, and thus share a common creditor, anything the government accepts to discharge tax obligations will freely circulate as currency within the community. The problem with this argument is that we have options. As economist Barry Eichengreen points out, why would you trade “a perfectly liquid dollar, supported by the full faith and credit of the U.S. government, for a cryptocurrency with questionable backing that is awkward to use?” The reality is that cryptocurrency is far too volatile to be used as a medium of exchange; why would you spend something that goes up by 20% in a day, and conversely, why would you accept payment in something that goes down by 20% in a day. Ohio found this out the hard way in 2018, when they became the first U.S. state to accept bitcoin for tax payments (technically, the state contracted with a payment processor that converted bitcoin to dollars). Ohio ended their experiment within a year, after accepting less than ten tax payments from the payment processor.
Wyoming is destined for the same experience as Ohio if their crypto tax bill becomes law – especially considering the bill only permits virtual currency sales tax payments “so long as the same virtual currency was used for the sale that gave rise to the sales tax.” This is why I was so perplexed by some quotes in a recent Politico article that highlights the Wyoming bill and a similar effort in Arizona. The article notes that one of the groups backing the Wyoming proposal is American CryptoFed, and quotes one of the group’s founders, Zhou Xiomeng: “We are looking for alternative currencies to compete with the U.S. dollar.” The article goes on to note:
“If the Wyoming proposal succeeds, its real significance would be to help legitimize cryptocurrencies as alternatives to the greenback. ‘It’s the beginning of the end,’ for central banking and the U.S. dollar, Zhou declared.”
What I view as a publicity stunt, proponents consider the beginning of the end for the U.S. dollar. As my curiosity was piqued, I decided to dig into American CryptoFed and found a Securities and Exchange Commission (SEC) Order Instituting Proceedings (OIP) from last November.
The OIP reveals American CryptoFed to be a hot mess. The SEC alleges that American CryptoFed filed a Form 10 registration statement with the Commission, seeking to register two classes of digital assets, the Ducat token and the Locke token, as equity securities under Section 12(g) of the Exchange Act. After the SEC notified American CryptoFed that the Form 10 contained material deficiencies, American CryptoFed submitted an amended Form 10 that now claimed Ducat and Locke tokens were not securities. The OIP details numerous deficiencies in the amended Form 10, but two really stand out:
1.) “The Form 10 stated throughout that the Ducat and Locke tokens were not securities, which was inconsistent with the statement on the cover page identifying the Ducat and Locke tokens as ‘[s]ecurities to be registered pursuant to Section 12(g) of the [Exchange] Act’ and American CryptoFed’s use of the Form 10 to register the tokens as securities under Section 12(g) of the Exchange Act.”
2.) “American CryptoFed asserted that upon effectiveness of the Form 10, it will use Form S-8 – a Securities Act of 1933 (“Securities Act”) form for securities offered to employees through employee benefit plans – to distribute Locke tokens to more than 500 entities, such as municipalities, merchants, banks, and ‘crypto exchanges,’ and non-employee individual contributors. However, the Form 10 failed to disclose that Form S-8 is not legally available for such a distribution.”
American CryptoFed has filed several motions – listed on their website – which have been denied by the SEC and the case now awaits summary disposition.
The Legal Status of Decentralized Autonomous Organizations
American CryptoFed’s website provides more details on Ducat and Locke. Ducat is “an inflation and deflation protected Stablecoin with unlimited issuance, constrained by algorithms targeting zero inflation and zero deflation. Ducat is used for daily transactions without conversion to fiats and as a store of value.” And Locke is “a Governance token with a maximum authorized finite number of 10 trillion. Locke is used to stabilize Ducat and for holders to participate in network rule and decision making.” This dual-token system is common with many crypto projects; the structure is supposed to provide regulatory certainty by separating utility tokens from security tokens. However, in the case of Ducat and Locke, they more closely resemble MakerDAO’s use of MKR and DAI. Maker is one of the first decentralized autonomous organizations (DAOs) and uses MKR “as a governance token and price stability mechanism for the DAI stablecoin.” Neither MKR nor DAI are registered securities, which conflicts with American CryptoFed’s initial assumption that Ducat and Locke are securities.
The premise behind DAOs is that they replace traditional corporate governance with a set of automated rules embedded in computer code (smart contracts). For DAOs that are truly decentralized, there is no legal entity capable of registering with the SEC or complying with applicable laws and regulation. To help bridge the gap between decentralization and regulatory compliance, the Wyoming legislature passed a bill last year that grants legal company status to DAOs “that operate on a blockchain, provided they are organized as a Wyoming limited liability company.”
The Wyoming law provides for two types of DAOs, member-managed and algorithmically-managed, without defining the latter (the law states that algorithmically-managed DAOs may only form if the “underlying smart contracts are able to be updated, modified or otherwise upgraded.”) Despite offering an algorithmically-backed stablecoin (Ducat), American CryptoFed’s articles of organization state that it is a member-managed DAO:
“This Company is managed by members with the possible use of algorithmic and/or smart contract protocols as set forth in the applicable smart contracts, operating agreement, and other internal governance documents.”
On their website, American CryptoFed also note that “Ducat and Locke will be issued pursuant to the token definition in Token Safe Harbor Proposal 2.0 outlined by SEC Commissioner Hester Peirce.” This is puzzling because Commissioner Peirce’s proposal is just that, a proposal. It has not been approved by the full Commission and is therefore not legally binding. Had American CryptoFed gone ahead and issued Ducat and Locke pursuant to Peirce’s safe harbor proposal, it would have likely constituted a securities law violation.
After reviewing American CryptoFed’s website and related SEC materials, I have more questions than answers when it comes to the organization’s intentions and the structure of Locke and Ducat. What is perfectly clear, however, is that this is an organization that plays fast and loose with federal securities laws, and that they feel emboldened to do so by the favorable regulatory climate in Wyoming. As they state on their website: “The Wyoming Decentralized Autonomous Organization (DAO) Law enables American CryptoFed as a Monetary System of the people, by the people, for the people.”
The Merchant Advisory Group
The Politico article also notes that the Wyoming bill is supported by the Merchant Advisory Group (MAG), a payments-focused trade group for retailers with some big-name members (Amazon, Walmart, etc.). MAG’s support for the bill seems tepid at best, which likely explains why they declined to be interviewed for the story. In a January letter to the Wyoming Legislative Select Committee on Blockchain, MAG’s CEO, John Drechny, said that:
“MAG supports the bill which automates the sales and use tax submitting process, increases options for merchants and potentially increases revenue for the State. Together with American CryptoFed DAO, I had the opportunity to discuss this bill with Representative Ocean Andrew, Senator Chris Rothfuss and Brenda Henson, Director of Wyoming’s Department of Revenue. The MAG appreciates the pioneering efforts of Wyoming’s lawmakers to explore the frontier of cryptocurrencies and look forward to an ongoing dialogue with Wyoming’s legislators.”
It is more than a little odd for a trade group representing “over 150 U.S. merchants which account for over $4.8 Trillion in annual sales” to endorse an esoteric crypto tax bill, when it is widely known that crypto has completely failed to gain traction as a medium of exchange. Perhaps an explanation can be found on MAG’s website, where American CryptoFed is listed, alongside J.P Morgan, American Express, and other companies, as a sponsor of MAG’s 2021 annual conference. American CryptoFed’s website contains an embedded YouTube video of the conferences welcoming remarks, where Mr. Drechny thanks American CryptoFed for sponsoring the opening night reception with free drinks. Mr. Drechny than turns the microphone over to then-American CryptoFed CEO, and former Cheyenne mayor, Marian Orr (Ms. Orr left American CryptoFed in January 2022). In her remarks, Ms. Orr notes that mayors across the country are looking at how they can accept crypto for property taxes and use crypto as a way to raise revenue without increasing taxes. Ms. Orr then tells attendees that if mayors want crypto, then merchants “better come on board really quickly to accept crypto.” She then erroneously claimed that American CryptoFed just registered with the SEC, which was “pretty historical.”
Ducat Economic Zone
If you are still unsure about what American CryptoFed is and what they are trying to accomplish, welcome to the club. I was further confused when I stumbled across a letter from Ms. Orr on American CryptoFed’s website inviting MAG members to join her at the MAG annual conference networking reception. In the same letter, Ms. Orr also invites MAG members to join the Ducat Economic Zone. The letter notes that the Ducat Economic Zone will be launched in Wyoming and Miami, and that these municipalities “will accept our inflation protected stable token Ducat in its native form and receive additional tax donation from CryptoFed.” The economics of the Ducat Economic Zone sound too good to be true (probably because they are not true):
“Merchants not only pay zero transaction fees to accept Ducat as payment for goods and services, but also receive 1%-4% rewards for every purchase transaction made in Ducat, while consumers receive 5.5% – 12% rewards. All rewards are paid by CryptoFed as a method (fiscal policy) to put Ducat into circulation (not as costs), to directly drive effective demand for generating maximum employment.”
The invitation letter entices MAG members to join the Ducat Economic Zone by noting that “[m]erchant attendees are eligible to receive a grant of 10 million Locke Governance tokens per person. Locke grants are restricted and untradeable until the SEC declares CryptoFeds Form S-1 filing effective, and the price of Locke is sustained above $0.10 USD on compliant exchanges.” Again, American CryptoFed’s ignorance of securities laws is on display here, as Form S-1 is the initial registration that must be filed before companies can go public, and as already discussed, American CryptoFed is a Wyoming-registered DAO.
The invitation letter is the type of technobabble that is all too common in the crypto industry, and anyone of sound mind who reads it would spot a number of red flags. This is why I was surprised to find another letter to MAG members sent after the annual conference highlighting how “payment executives (as individuals, not companies)” from 24 merchants “expressed interest in joining a due diligence
workgroup to explore the feasibility of accepting our Ducat inflation protected stable token.” The letter notes that a “payment executive for Delta Airlines Treasury Department will lead this workgroup” and goes on to list the 24 merchants, which include such blue-chip companies as Best Buy, ExxonMobil, and Verizon Wireless. I wonder if these executives, and their employers, are aware that they are contributing to the “beginning of the end for central banking and the U.S. dollar.”
It would be easy to laugh at the juvenile antics of American CryptoFed if not for the fact that they appear to have the ear of one of the largest merchant trade groups in the country and the Wyoming state legislature. This influence did not arise from the power of their ideas, but from good old-fashioned dollars – and free drinks. But this begs the question, who is fronting American CryptoFed, and what is their motive? Details are hard to come by, but American CryptoFed’s website notes that they were established by mShift, a Silicon Valley-based mobile payments platform founded in 1999 by Scott Moeller (according to LinkedIn, Mr. Moeller is now CEO of American CryptoFed).
As I wrote last April, “Wyoming may seem like an odd choice to lead the crypto charge.” But upon further refection, it is actually not that odd. A small conservative state looking to grow their tax base is the perfect vehicle for coastal crypto enthusiasts to push their self-serving vision of a financial system free of rent-seeking intermediaries thanks to the magical powers of blockchain and cryptocurrency. Unfortunately, Wyoming’s legislative process has been hijacked by a select group of self-interested individuals whose sole mission is to leverage the state government’s imprimatur in an effort to attract greater fools to offload their useless tokens on.
If what happened in Wyoming stayed in Wyoming, there would be little cause for concern. But the U.S. dual banking system and fragmented financial regulatory structure, coupled with states competing for jobs and tax revenue, means that Wyoming’s actions will further integrate crypto into the traditional financial system, and may trigger a regulatory race to the bottom by the states. It is time we all start paying attention to what is going on in Wyoming.
Lee Reiners is the executive director of the Global Financial Markets Center at Duke Law
The views expressed in this post are those of the author and do not represent the views of the Global Financial Markets Center or Duke Law.