Snapshot: Blockchain Technology Explored for Homeland Security DHS

Remember when we were excited about The Cloud? Today, internet storage space is an assumed amenity for many of us. Now it’s time to look toward Blockchain. It’s something you might have heard of, but you might not know much about it.

Who is interested in blockchain?

Blockchain technology represents an innovative leap forward that has many uses and applications across multiple sectors of the economy. Many people, organizations, companies and departments are increasingly excited about blockchain.

So, is it potentially relevant to the homeland security enterprise (HSE)? If so, what needs to be proven before its use and adoption by the federal government?

In its role as the science advisor to the Department of Homeland Security, the Science and Technology Directorate (S&T) is well-positioned to answer these questions. S&T is taking the lead with research and development projects in this area to determine viable uses for the technology.

What is blockchain?

In short, blockchain powers the engine that drives Bitcoin’s digital currency’s transaction confirmation process. The technology provides a level of independently verifiable tracking and transparency for every exchange of the digital monies involved. For each transaction, another “block” of transaction information is added to a public ledger on a shared database. So, if someone wanted to track the history of a particular unit of digital currency, they could. Gone are the concerns of “version control.” The blockchain process and database are touted as secure and tamper-proof and the technology is highly resistant to hacking and data modification.

How did blockchain begin?

In 2008, an obscure technical paper titled Bitcoin: A Peer-to-Peer Electronic Cash System proposed a revolutionary mechanism to solve a growing problem within the transfer of digital currencies—fraud. When using a peer-to-peer network, preventing double-spend became extremely complex. The lack of transparency within the system only added to the challenge.

Since transactions were through peer-to-peer networks, there was not a centralized bank to coordinate and monitor every transaction of the electronic monies. Nor was there a way to stop all illegal duplication of the digital monies, which could be spent multiple times. Not only was it hard to prevent, it was hard to find the digital paper-trail of wrongdoing.

The article was published by an anonymous individual or group—no one knows which—that goes by the name of Satoshi Nakomoto. The proposed mechanism combined something as old as recordkeeping—a ledger—with an innovative mechanism for reconciling the transactions in that ledger without using a trusted, centralized bookkeeper.

It did so by replacing that trusted bookkeeper with a set of crowd-sourced entities who were incentivized to reach consensus on the state and order of the transactions in the ledger. Their “incentive” was they got paid in Bitcoin for their work. This combination of a “distributed electronic ledger” and the associated incentive structure (which makes the Bitcoin digital currency possible) is called the blockchain.

What does blockchain do?

Blockchain transparently stores all the information about every transaction involving the Bitcoin cryptocurrency so the same Bitcoin cannot be spent more than once.

As of late, the term blockchain has taken on near mystical overtones. Some have called it the “second generation of the Internet,” with proponents claiming it will enable everything from letting users police the monetary system to providing unlimited communication channels. Some even assert it will replace lawyers via the use of smart contracts.

In fact, advocates say blockchain’s potential uses extend far beyond its original application and are nearly limitless. They contend its uses encompass almost any transaction involving money, goods and property, while reducing fraud because blockchain records all transactions on a public ledger, which can be viewed by anyone.

With interest growing, spending on further development of blockchain technology in the finance, business, government and public sectors rose dramatically in 2015. The financial services sector alone spent $75 million developing the technology for its uses, while angel investors and venture capitalists invested another $180 million in blockchain startups last year.

Blockchain and S&T?

Cutting through the sensationalism associated with such a product, S&T sees the reality of blockchain’s promise. The technology presents intriguing possibilities with associated far-reaching benefits that may be relevant to the HSE, such as:

No central authority needed to reconcile the ledger
Parties in the transaction do not have to trust each other
Immutability of records after reconciliation

The wide gap between the hype and the reality requires proving if security and privacy controls can be supported or enabled by blockchain and whether the benefits of adopting the technology outweigh the pain of incorporating it into a proven information technology environment.

If in fact the security and privacy claims of blockchain’s advocates can be proven to be valid, there are some interesting HSE use-cases that could be enabled by this technology, including:

Sharing of emergency responder credentials across federal, state, local, tribal and international borders by authoritative parties with no single point of failure
Creating immutable records and audit logs of data that cannot be spoofed and can be publicly verified without revealing personally identifiable information
Improving traveler experience in airports by reducing redundant checks
Reducing fraud in the transfer of goods across international boundaries that touch multiple entities who do not trust each other

With such potential, proving the security and privacy aspects is precisely where S&T currently is focusing its resources. It is doing so via Small Business Innovation Research projects to investigate the various capabilities of blockchain. This includes security and privacy characteristics as well as exploring its immutability, data integrity and anti-spoofing aspects via a Silicon Valley Innovation Program project.

If these research projects bear fruit, S&T will begin developing ways to implement blockchain technology to better safeguard the American people, our homeland and our values.

...

RESOURCES

NOTES 

Statement on Cryptocurrencies and Initial Coin Offerings SEC

SEC Chairman Jay Clayton

Dec. 11, 2017

The world’s social media platforms and financial markets are abuzz about cryptocurrencies and “initial coin offerings” (ICOs).  There are tales of fortunes made and dreamed to be made.  We are hearing the familiar refrain, “this time is different.”

The cryptocurrency and ICO markets have grown rapidly.  These markets are local, national and international and include an ever-broadening range of products and participants.  They also present investors and other market participants with many questions, some new and some old (but in a new form), including, to list just a few:

Is the product legal?  Is it subject to regulation, including rules designed to protect investors?  Does the product comply with those rules?
Is the offering legal?  Are those offering the product licensed to do so?
Are the trading markets fair?  Can prices on those markets be manipulated?  Can I sell when I want to?
Are there substantial risks of theft or loss, including from hacking?

The answers to these and other important questions often require an in-depth analysis, and the answers will differ depending on many factors.  This statement provides my general views on the cryptocurrency and ICO markets[1] and is directed principally to two groups:

“Main Street” investors, and
Market professionals – including, for example, broker-dealers, investment advisers, exchanges, lawyers and accountants – whose actions impact Main Street investors.

Considerations for Main Street Investors

A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.  

Investors should understand that to date no initial coin offerings have been registered with the SEC.  The SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies.[2]  If any person today tells you otherwise, be especially wary. 

We have issued investor alerts, bulletins and statements on initial coin offerings and cryptocurrency-related investments, including with respect to the marketing of certain offerings and investments by celebrities and others.[3]  Please take a moment to read them.  If you choose to invest in these products, please ask questions and demand clear answers.  A list of sample questions that may be helpful is attached.

As with any other type of potential investment, if a promoter guarantees returns, if an opportunity sounds too good to be true, or if you are pressured to act quickly, please exercise extreme caution and be aware of the risk that your investment may be lost.

Please also recognize that these markets span national borders and that significant trading may occur on systems and platforms outside the United States.  Your invested funds may quickly travel overseas without your knowledge.  As a result, risks can be amplified, including the risk that market regulators, such as the SEC, may not be able to effectively pursue bad actors or recover funds.

To learn more about these markets and their regulation, please read the “Additional Discussion of Cryptocurrencies, ICOs and Securities Regulation” section below.

Considerations for Market Professionals

I believe that initial coin offerings – whether they represent offerings of securities or not – can be effective ways for entrepreneurs and others to raise funding, including for innovative projects.  However, any such activity that involves an offering of securities must be accompanied by the important disclosures, processes and other investor protections that our securities laws require.  A change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed.[4]  Said another way, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance. 

I urge market professionals, including securities lawyers, accountants and consultants, to read closely the investigative report we released earlier this year (the “21(a) Report”)[5] and review our subsequent enforcement actions.[6]  In the 21(a) Report, the Commission applied longstanding securities law principles to demonstrate that a particular token constituted an investment contract and therefore was a security under our federal securities laws.  Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

Following the issuance of the 21(a) Report, certain market professionals have attempted to highlight utility characteristics of their proposed initial coin offerings in an effort to claim that their proposed tokens or coins are not securities.  Many of these assertions appear to elevate form over substance.  Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.  Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law.  On this and other points where the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities.  I urge you to be guided by the principal motivation for our registration, offering process and disclosure requirements:  investor protection and, in particular, the protection of our Main Street investors.

I also caution market participants against promoting or touting the offer and sale of coins without first determining whether the securities laws apply to those actions.  Selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of “scalping,” “pump and dump” and other manipulations and frauds.  Similarly, I also caution those who operate systems and platforms that effect or facilitate transactions in these products that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934.        

On cryptocurrencies, I want to emphasize two points.  First, while there are cryptocurrencies that do not appear to be securities, simply calling something a “currency” or a currency-based product does not mean that it is not a security.  Before launching a cryptocurrency or a product with its value tied to one or more cryptocurrencies, its promoters must either (1) be able to demonstrate that the currency or product is not a security or (2) comply with applicable registration and other requirements under our securities laws.  Second, brokers, dealers and other market participants that allow for payments in cryptocurrencies, allow customers to purchase cryptocurrencies on margin, or otherwise use cryptocurrencies to facilitate securities transactions should exercise particular caution, including ensuring that their cryptocurrency activities are not undermining their anti-money laundering and know-your-customer obligations.[7]  As I have stated previously, these market participants should treat payments and other transactions made in cryptocurrency as if cash were being handed from one party to the other.

Additional Discussion of Cryptocurrencies, ICOs and Securities Regulation   

Cryptocurrencies.  Speaking broadly, cryptocurrencies purport to be items of inherent value (similar, for instance, to cash or gold) that are designed to enable purchases, sales and other financial transactions.  They are intended to provide many of the same functions as long-established currencies such as the U.S. dollar, euro or Japanese yen but do not have the backing of a government or other body.  Although the design and maintenance of cryptocurrencies differ, proponents of cryptocurrencies highlight various potential benefits and features of them, including (1) the ability to make transfers without an intermediary and without geographic limitation, (2) finality of settlement, (3) lower transaction costs compared to other forms of payment and (4) the ability to publicly verify transactions.  Other often-touted features of cryptocurrencies include personal anonymity and the absence of government regulation or oversight.  Critics of cryptocurrencies note that these features may facilitate illicit trading and financial transactions, and that some of the purported beneficial features may not prove to be available in practice.

It has been asserted that cryptocurrencies are not securities and that the offer and sale of cryptocurrencies are beyond the SEC’s jurisdiction.  Whether that assertion proves correct with respect to any digital asset that is labeled as a cryptocurrency will depend on the characteristics and use of that particular asset.  In any event, it is clear that, just as the SEC has a sharp focus on how U.S. dollar, euro and Japanese yen transactions affect our securities markets, we have the same interests and responsibilities with respect to cryptocurrencies.  This extends, for example, to securities firms and other market participants that allow payments to be made in cryptocurrencies, set up structures to invest in or hold cryptocurrencies, or extend credit to customers to purchase or hold cryptocurrencies. 

Initial Coin Offerings.  Coinciding with the substantial growth in cryptocurrencies, companies and individuals increasingly have been using initial coin offerings to raise capital for their businesses and projects.  Typically these offerings involve the opportunity for individual investors to exchange currency such as U.S. dollars or cryptocurrencies in return for a digital asset labeled as a coin or token. 

These offerings can take many different forms, and the rights and interests a coin is purported to provide the holder can vary widely.  A key question for all ICO market participants: “Is the coin or token a security?”  As securities law practitioners know well, the answer depends on the facts.  For example, a token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders.  In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come.  It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens.  Prospective purchasers are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the efforts of others.  These are key hallmarks of a security and a securities offering.   

By and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.  Generally speaking, these laws provide that investors deserve to know what they are investing in and the relevant risks involved.  

I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws. 

Conclusion

We at the SEC are committed to promoting capital formation.  The technology on which cryptocurrencies and ICOs are based may prove to be disruptive, transformative and efficiency enhancing.  I am confident that developments in fintech will help facilitate capital formation and provide promising investment opportunities for institutional and Main Street investors alike. 

I encourage Main Street investors to be open to these opportunities, but to ask good questions, demand clear answers and apply good common sense when doing so.  When advising clients, designing products and engaging in transactions, market participants and their advisers should thoughtfully consider our laws, regulations and guidance, as well as our principles-based securities law framework, which has served us well in the face of new developments for more than 80 years.  I also encourage market participants and their advisers to engage with the SEC staff to aid in their analysis under the securities laws.  Staff providing assistance on these matters remain available at FinTech@sec.gov .

Sample Questions for Investors Considering a Cryptocurrency or ICO
Investment Opportunity[8]

Who exactly am I contracting with? 

Who is issuing and sponsoring the product, what are their backgrounds, and have they provided a full and complete description of the product?  Do they have a clear written business plan that I understand?
Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product?  Have they been paid to promote the product?
Where is the enterprise located?

Where is my money going and what will it be used for?  Is my money going to be used to “cash out” others?
What specific rights come with my investment?
Are there financial statements?  If so, are they audited, and by whom?
Is there trading data?  If so, is there some way to verify it? 
How, when, and at what cost can I sell my investment?  For example, do I have a right to give the token or coin back to the company or to receive a refund?  Can I resell the coin or token, and if so, are there any limitations on my ability to resell?
If a digital wallet is involved, what happens if I lose the key?  Will I still have access to my investment? 
If a blockchain is used, is the blockchain open and public?  Has the code been published, and has there been an independent cybersecurity audit?
Has the offering been structured to comply with the securities laws and, if not, what implications will that have for the stability of the enterprise and the value of my investment?
What legal protections may or may not be available in the event of fraud, a hack, malware, or a downturn in business prospects?  Who will be responsible for refunding my investment if something goes wrong?
If I do have legal rights, can I effectively enforce them and will there be adequate funds to compensate me if my rights are violated?

[1] This statement is my own and does not reflect the views of any other Commissioner or the Commission.  This statement is not, and should not be taken as, a definitive discussion of applicable law, all the relevant risks with respect to these products, or a statement of my position on any particular product.  Additionally, this statement is not a comment on any particular submission, in the form of a proposed rule change or otherwise, pending before the Commission. 

[2] The CFTC has designated bitcoin as a commodity.  Fraud and manipulation involving bitcoin traded in interstate commerce are appropriately within the purview of the CFTC, as is the regulation of commodity futures tied directly to bitcoin.  That said, products linked to the value of underlying digital assets, including bitcoin and other cryptocurrencies, may be structured as securities products subject to registration under the Securities Act of 1933 or the Investment Company Act of 1940. 

[3] Statement on Potentially Unlawful Promotion of Initial Coin Offerings and Other Investments by Celebrities and Others (Nov. 1, 2017), available at https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos; Investor Alert:  Public Companies Making ICO-Related Claims (Aug. 28, 2017), available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ia_icorelatedclaims; Investor Bulletin:  Initial Coin Offerings (July 25, 2017), available athttps://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings; Investor Alert:  Bitcoin and Other Virtual Currency-Related Investments (May 7, 2014), available athttps://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-alert-bitcoin-other-virtual-currency; Investor Alert: Ponzi Schemes Using Virtual Currencies (July 23, 2013), available at https://www.sec.gov/investor/alerts/ia_virtualcurrencies.pdf.

[4] It is possible to conduct an ICO without triggering the SEC’s registration requirements.  For example, just as with a Regulation D exempt offering to raise capital for the manufacturing of a physical product, an initial coin offering that is a security can be structured so that it qualifies for an applicable exemption from the registration requirements.

[5] Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934:  The DAO (July 25, 2017), available at https://www.sec.gov/litigation/investreport/34-81207.pdf.

[6] Press Release, Company Halts ICO After SEC Raises Registration Concerns (Dec. 11, 2017), available at https://www.sec.gov/news/press-release/2017-227; Press Release, SEC Emergency Action Halts ICO Scam (Dec. 4, 2017), available at https://www.sec.gov/news/press-release/2017-219; Press Release, SEC Exposes Two Initial Coin Offerings Purportedly Backed by Real Estate and Diamonds (Sept. 29, 2017), available at https://www.sec.gov/news/press-release/2017-185-0.  

[7] I am particularly concerned about market participants who extend to customers credit in U.S. dollars – a relatively stable asset – to enable the purchase of cryptocurrencies, which, in recent experience, have proven to be a more volatile asset.

[8] This is not intended to represent an exhaustive list.  Please also see the SEC investor bulletins, alerts and statements referenced in note 3 of this statement.

...

​​​​PaulCedardall.US

One Minute in a Cryptocurrency's Life...

Know the risks before investing in cryptocurrencies FTC

By: Elizabeth Kwok | Feb 16, 2018 2:36PM


As a business person managing your personal portfolio, you do your best to keep up with the latest financial news. You’ve been hearing more about cryptocurrencies and asking yourself “Hmmm.” Of course, it’s not just bitcoin. There are now hundreds of cryptocurrencies, which are a type of digital currency, on the market. They’ve been publicized as a fast and inexpensive way to pay online, but many are now also being marketed as investment opportunities. But before you decide to purchase cryptocurrency as an investment, here are a few things to know:

Cryptocurrencies aren’t backed by a government or central bank. Unlike most traditional currencies, such as the dollar or yen, the value of a cryptocurrency is not tied to promises by a government or a central bank.
If you store your cryptocurrency online, you don’t have the same protections as a bank account.Holdings in online “wallets” are not insured by the government like U.S. bank deposits are.
A cryptocurrency’s value can change constantly and dramatically. An investment that may be worth thousands of dollars on Tuesday could be worth only hundreds on Wednesday. If the value goes down, there’s no guarantee it will rise again.
Nothing about cryptocurrencies makes them a foolproof investment. Just like with any investment opportunity, there are no guarantees.
No one can guarantee you’ll make money off your investment. Anyone who promises you a guaranteed return or profit is likely scamming you. Just because the cryptocurrency is well-known or has celebrities endorsing it doesn’t mean it’s a good investment.
Not all cryptocurrencies or the companies behind them are the same. Before you decide to invest in a cryptocurrency, look into the claims the company is making. Do an internet search with the name of the company and the cryptocurrency with words like review, scam, or complaint. Look through several pages of search results.

...