Ask a CFIUS Expert: Is Crypto Spying on Us?

July 10, 2024

In this episode of the CryptoCounsel at Wiley, Josh talks with guest Nova Daly, a former U.S. national security official, to delve into the complexities of crypto regulation and international investment. They explore a groundbreaking Presidential divestment order blocking a Chinese-owned company’s operation of a cryptocurrency mining facility near a strategic missile base in Wyoming. Nova and Josh discuss how the divestment, which followed a review by the Committee on Foreign Investment in the United States (CFIUS), highlights broader concerns over potential espionage and national security risks from cryptocurrency operations.

Transcript

Josh

Welcome to the CryptoCounsel at Wiley. We are the podcast that decodes the most important crypto disputes in litigation and regulation. My name is Josh. I’m an international lawyer who does crypto and while I’m sad to miss out on my normal co-host Frank Scaduto today, I am delighted to be joined by our first guest on the CryptoCounsel, Nova Daly. How are you today Nova?

Nova

I’m doing great. Great to be here, Josh. I appreciate the opportunity to talk crypto.

Josh

I’m looking forward to it, particularly because you have the expertise on this critical national security issue we’ll be discussing – a fascinating and unprecedented divestment order by the president. But before we get to that, we typically start with three quick bits. These are some news items in the crypto field and I will share these and maybe have a few questions for you. Are you ready to go?  

Nova

Fire away. 

Josh

Just recently the Supreme court granted cert in a case involving Nvidia, it’s another cryptocurrency case, because the question is whether certain graphics processing units, or GPUs, designed by Nvidia. Whether the revenue from those GPU’s comes mostly from gaming or from cryptocurrency mining. So Nova, do you typically use your GPU’s for gaming or cryptocurrency mining?

Nova 

That’s a fantastic question Josh. One for which I don’t know the exact answer, but I do know this. I don’t do cryptocurrency mining myself. So the answer I think, is gaming and knowing the Nvidia team, great folks out there, I have to say it’s gaming for my side.

Josh

Okay. Second quick bit, the company Robinhood, which has been a bit in the crosshairs of the SEC lately. Recent news is that they are planning to acquire a Luxembourg-based crypto exchange called Bitstamp. So Nova, how would you feel about having a Luxembourg-based crypto exchange?

Nova

Well, I know a lot of things happen in Luxembourg in terms of the business side and corporate headquartering, so I think, you know, I guess I’d generally be comfortable with that, given its history and its business orientation. Yeah.

Josh

Comfortable with Luxembourg. Let’s turn to another part of the world then, final quick bit. The news today is that Nigeria has dropped tax charges against certain Binance executives, but money laundering charges continue to go forward. So, we’re going to be talking about the United States. We’ve mentioned a Luxembourg-based crypto exchange. Now we have some news out of Nigeria in the crypto world. If you were starting fresh with your own crypto operation, where would you put it Nova?

Nova

Well, you know, being a U.S. citizen and U.S. person, I’d probably put it here just so I can monitor it better. But if you’re talking about a mining operation that, that crypto mining operation, there’s a lot of electricity that is needed for that to be sustained. It’s 24 and seven. I might just locate it north of the border in Canada, they got a ton of hydro power. Cheaper, constant, so I might go there.

Josh

Okay. Nova Daly’s Canadian crypto platform. I’m looking forward to that day.

Nova

But it’d be close to the border, it wouldn’t be too far field.

Josh

Keep it in reach. That makes sense. Within reach. It’s not too far. Well, speaking of foreign investments in crypto. We are going to be talking today about a truly unprecedented and groundbreaking decision by the U.S. government. We’re going to drill into some details, but just so everyone knows  what kind of expert we have here. Nova has held senior leadership positions at the U.S. Senate and the Departments of Treasury and Commerce and at the White House. And as I think you’ll come to see all of that experience is relevant here because we’re going to be focusing on, the Committee on Foreign Investment in the United States. Known inside the beltway and to others involved in the foreign investment field as CFIUS. The news out of CFIUS is that a few weeks ago, this spring, President Joe Biden issued an executive order prohibiting the acquisition of certain real estate in Wyoming by a company called MineOne, which was ultimately majority-owned by Chinese nationals. Now there’s a lot to this and I want to take it a step at a time. So let’s start at the beginning. What is CFIUS?

Nova

A good strong question and an important one. What is CFIUS? The Committee on Foreign Investment in the United States. It is not, you know, a disease. Some people thought CFIUS was a disease, but it’s not.  It’s a committee run by Treasury composed of about 15 to 16 different agencies. [00:05:00] Really only nine are voting and two others have non-voting rights, but effectively they review foreign investments, this group led by Treasury review foreign investments and ownership of U.S. businesses or real estate. And they have to decide in concurrence whether to approve it, whether to require, what’s called mitigation and those are steps that allow the committee to deal with national security issues. Or if it’s something that they don’t feel they can address through national security provisions of mitigation, they can recommend that the president block the transaction. So a lot of power and a lot of duties. And in terms of how Global M&A looks at it, CFIUS has become an important institution.

Josh

I might add as well, a lot of bureaucracy. Because we have a lot of agencies on this committee, but one that you mentioned is Treasury. You are a former deputy assistant secretary at the Treasury Department. What was your role with CFIUS?

Nova

So as the deputy assistant secretary for investment security and open investment, actually back then, my job was to effectively run the committee. To administer the process and get decisions out of all these member agencies on where to go with these transactions. I considered myself, a cat herder -- effectively trying to get all these agencies in line and on the right decision path. A lot of negotiation, it was not a job where Treasury had the heavy hand and decided where things went. It really was controlling agencies that make a decision, determine what the national security issues were, and address them or clear the transaction. And then during my time there, we had a new law that got passed as a result of a big investment, Dubai Ports World, which blew up. So we had a new law back then. My job was to implement that law in terms of regulations as well. So, had a lot of different hats.

Josh

And CFIUS covers a lot of different sectors. I’m going to go out on a limb and guess that you did not have any potential cryptocurrency investments in your tenure under your review. Is that right?

Nova

That is absolutely right. Back then during the Bush administration, the Bush II, the big issue there was actually cyber. It was a cutting issue because we really hadn’t delved into it. Most of the acquisitions were hard assets of mines or manufacturing, semiconductors, but really crypto was not something we were doing back then.

Josh

Now it is. And this recent order is one of the very few in history in which the president has prohibited a transaction. Were there any other examples that were similar to that during your tenure?

Nova

Sure sure. And that’s one of the interesting sides of CFIUS is that even though the president is able to take and make a decision on whether to block a transaction. During my time there, the vast majority of transactions died at the cutting table when CFIUS went to the companies and said, “I’m sorry, we are not going to allow this transaction or we’re going to recommend that the president block it.” So it’s your decision. If you want to have the president block it, or you just want to back away from the deal. And for the most part, the companies just backed away. But there’s a total of seven transactions that have been blocked by the president. So, and this is the latest.

Josh

And this one now is about cryptocurrency and that’s why we’re here. The CryptoCounsel. We want to unpack the crypto-specific angles of this to some extent. But CFIUS is not a crypto only committee. It looks like a lot of different dynamics, potential red flags. And here there seem to be a few. We had an investment ultimately owned by Chinese nationals, and it was within a mile of a strategic missile base in Wyoming. So how much of this decision was driven by those factors as compared to the actual use of the property, which was cryptocurrency mining?

Nova

Yeah, this one had to deal with location. You had a foreign investor that was Chinese-owned that had decided to build this facility next to the Francis E. Warren Air Force base in Wyoming. It’s one of three strategic missile bases for the United States, so we’re talking nuclear here. And you know, with crypto mining and cryptocurrency, I mean, you have very advanced technologies that go into being able to process the algorithms to get and mine the data for the cryptocurrencies. Most of that equipment is just processing and servers, but when you have a facility like that, you can put in other equipment, that has other purposes. And I think the U.S. government was concerned that there was equipment in there that was not going to be used for cryptocurrency mining, and it was going to be used for other purposes. And that’s why it decided to recommend that the president block this.

Josh

Interesting. So it does seem that there’s some ambiguity in the president’s decision about what exactly the concern about the technology was. And I’m going to quote it and then ask you about the meaning. So the president referred to the cryptocurrency mining operation as using “equipment potentially capable of facilitating surveillance and espionage activities.” I think that’s DC talk for spying. And so is the president saying that cryptocurrency miners are spying on us?

Nova

That is a great question. And I don’t think the president is saying cryptocurrency miners are spying on us. I’m saying for this particular instance, for this particular investment, the president has said, based on the findings of the committee, that there was or could be equipment that was also in that facility that was also being used for nefarious purposes. And frankly, the tip that came from this, this wasn’t CFIUS finding this transaction all on its own, it was a tip from an outside source. According to The New York Times that was Microsoft that had a facility right next to this cryptocurrency miner. And Microsoft was doing stuff for the Department of Defense. So, Microsoft themselves let the committee know that this is a problem. But going back to address your question -- no, not all cryptocurrency mining is going to have equipment that can or would be used for the purpose of spying or espionage, but in this particular instance, that’s what this committee found.

Josh

And is it that because cryptocurrency mining equipment is big and sophisticated, we get that these are high powered computers. They’re going to be in a temperature controlled warehouse using a lot of energy. But the process of cryptocurrency mining -- and I’ve read that this really was a Bitcoin mine. It is essentially big computers guessing numbers. That’s what they’re trying to do. That’s the hash rate. There’s nothing nefarious about big computers trying to guess numbers. So, is the point, reading through the lines here that, because there were so many big, complicated computers, there could be things hidden within the system doing other activities? Is that the idea?

Nova

Yeah. And I don’t know, expressly the technology or if just all the servers that are located in that facility can themselves be utilized for other purposes, but in order to really, from what I recall in terms of the intelligence, to tap into the things that would be espionage, you have to be outside of the mining enterprise. It requires seeking to or tapping into other electronic information sources or facilities. So, the mining equipment itself isn’t going to do it, but if you have other specialized equipment, that could be the case.

Interesting parallel or a similar transaction to this one was a deal that was brought by President Obama in 2012. It had to deal with wind towers in Oregon - the Ralls transaction. That’s one in which the president, again, took action in blocking that transaction because on top of these wind towers, certain equipment could be placed - this particular facility that got blocked was near another U.S. military facility - but equipment could be placed on top of these wind towers to effectively monitor the kind of activities that the U.S. military is doing. So now moving it to this particular transaction, again, we have a facility that’s processing a lot of data, but other equipment could be placed in that facility that would be used to take other action or to tap in other electronic sources.

Josh

Is there a broader concern here, because I think I read as well that these Bitcoin miners here, and generally in the industry, Bitcoin miners are coming from China or certainly have components from China. Does that mean that we can expect cryptocurrency mining, particularly Bitcoin mining, where you have Chinese supply chain issues?  Is there going to be greater scrutiny going forward for all of this kind of mining?

Nova

Yeah, I do actually think that’s going to be the case. Again, hearkening back to the New York Times article. Apparently, per their finding there’s at least 12 other states quoting Arkansas, Ohio, Oklahoma, Tennessee, Texas, and Wyoming, where there are Chinese-owned or operated Bitcoin mines. And apparently together, these miners use as much energy as 1.5 million homes. So, not only do you have these facilities that could have other equipment electronic equipment used to do serendipitous spying operations, but also you have a critical infrastructure issue where you have a lot of energy that’s being drawn off that if these different mining operations act in tandem, they could certainly have issues that would put grids in jeopardy. Especially since the U.S. really has to improve its electric grids here in the United States.

Josh

That brings us, perhaps back to this question of proximity. Here, this, I think you know, you could draw lines pretty easily with one mile from one of the three most strategic lower 48 military bases for missiles. What’s the distance? How far out can they go? Should we expect a flood of cryptocurrency mining operations -- 5.6 miles from the base? What’s the plan going forward?

Nova

Sure, sure. So it depends on the base. CFIUS has pretty clear guidelines on what facilities are sensitive, and it’s in the appendix to the CFIUS regulations where they list all the facilities. Where real estate holdings carry certain sensitivities and a filing, well the actual ownership creates a covered transaction for CFIUS purposes. For some facilities, you know, it has to be within a mile. If you’re outside a mile then it’s not a covered transaction for CFIUS purposes. For other facilities, if you’re a hundred miles away or even 50 miles away, it’s enough to bring it under CFIUS regular covered transaction rules, and CFIUS jurisdiction. Now if the facility is in an urban area, then it’s outside of CFIUS jurisdiction, but if it’s within an airport, jurisdiction, or an actual port, a shipping port, then that’s going to be a covered transaction.

So the rules are pretty clear. There’s not a lot of wiggle room to them, which means that CFIUS has to really think about what could fall outside of its jurisdiction, but still be a national security issue. And one of the interesting ones was the facility, the Fufeng transaction up in North Dakota, where the facility that was being constructed, a corn mill plant, was outside of CFIUS jurisdiction. But nonetheless presented a national security issue to the base, which, at that time wasn’t listed as a sensitive facility. So, there’s a lot to consider there in terms of CFIUS’ jurisdiction. Nonetheless, for the crypto miners themselves, need to be aware of where you’re located and its sensitivity.

Josh

You probably also need to be aware of reporting issues. You mentioned that this was a public tip. If say an innocuous, Luxembourg-based crypto miner wants to invest in a crypto mine within one of these sensitive areas. Should they just go for it and see what happens -- what’s the alternative?

Nova

Well I think, you know, if they want to ensure -- this is one of the things about CFIUS is that, prior to the new CFIUS law, it was a voluntary process. Meaning companies could choose to file or not choose. And the only repercussion for choosing not to file was that if CFIUS discovered it, they could go back and force a review and mitigate or block it. So there’s always a “sword of Damocles” hanging over the heads of the investors.

With the new rules, there are certain transactions that are mandatory. Those dealing with critical technologies, but looking at the real estate world, it’s not a mandatory filing, but nonetheless, given the sensitivities attached, especially the focus that was done on this particular transaction, I’d strongly suggest that any company choosing to do any crypto mining operation in the United States, be aware of the CFIUS rules in terms of location. And if you’re not, if you can’t follow the rules expressly because sometimes it can be very complicated and sometimes it’s not just the rules that puts you under CFIUS consideration. Sometimes you need a little bit more understanding and counsel, that’s where counsel comes in.

Josh

You mentioned the new law in this space, which is called the Foreign Investment Risk Review Modernization Act. How does that acronym go?

Nova

It goes FIRRMA.

Josh

FIRRMA. It’s a great one. FIRRMA for CFIUS. And it does seem to be hearkening more scrutiny in this space. This is the first acquisition of real estate, where there was a divestment order. Do you think this is a precedent that’s going to be followed in more cases going forward?

Nova

Yeah, absolutely. CFIUS, especially recently, has bolstered its enforcement guidelines and directives effectively telling the public -- look if you have a covered transaction, especially if it’s mandatory and you don’t file it, we can issue penalties, civil penalties that can be $250,000 per violation or up to the value of the transaction. And now, even higher. So, in instances where parties decide not to file or they do, and they’re under mitigation and they violate it, the penalties are significant. And now, you know, there’s a focus on this transaction. I feel as though the committee is definitely looking at the real estate holdings. There’s heightened sensitivity on the hill. I testified before the Agricultural Committee about landholdings, farm and agricultural land holdings by foreign entities. So not only is Congress sort of taking action to address this because they see holes in the application of U.S. national security, but also states themselves are putting up laws and restrictions on foreign ownership of land holdings, not just agriculture.

So it’s really got to know the playing field out there. It’s dynamic, it’s changing and it’s at the forefront of where Congress and the Administration and states themselves are.

Josh

We talked in the beginning about where companies might want to put their cryptocurrency mining operations. Power concerns are a big part of that. Regulatory certainty is a big part of that. We’ve advocated here in an amicus brief on this podcast for greater clarity for these regulations. But a lot of this investment involves foreign investment. This is not just U.S. entities, building cryptocurrency mines in the U.S., crypto is inherently cross-border. What should foreign investors who want to take advantage of some of the benefits of the U.S. market -- what should they do to best protect themselves?

Nova

Yeah, I think the best protection is if you want to get into the space, you know, hire a firm that understands the rules. Not only the rules in terms of crypto regulation broadly, but also the rules in terms of how the U.S. is addressing these things on national security. It’s just smart play and yes, of course, we’re here at the law firm and, you know, we see things in our perspective, but just from a precautionary standpoint. I have had so many clients themselves that, if you just took that modicum of caution and addressed due diligence on the forefront. You know, an ounce of caution saves a pound of . . . you finish the phrase. But the point is that when you address those national security issues upfront, you get counsel in terms of where the rules are and guidelines. Then it secures your investment for the future and you don’t have these issues that can cause substantial costs and substantial penalties if you don’t get it right.

Josh

And this one was really a worst-case scenario because you have no voluntary reporting. You have a public tip. And then a complete divestment order. So it completely rips the rug out of a foreign investment. Rightly or wrongly, that’s what happens here. What’s the opposite -- what’s the greenlight look like? Let’s assume a company does get the right advice and they get this approval. What are the benefits of that -- what’s that going to look like?

Nova

Yeah. So the benefit, I mean, there’s two safe roads to go down. You get advice on where to put something or a facility that’s not going to be in the jurisdiction of CFIUS or create a national security concern. The facility goes up, you run it straight, you know, you’re safe and you’re on safe grounds. The only thing you have to keep your eyes on are where the SEC or other regulatory bodies are going with a regulation broadly.

The other lane is, it has to go on a site or at a facility that’s going to be in proximity to a sensitive site. And, you know, if you’re an investor of good standing internationally. You know, you can go through the CFIUS process, file it. Once you’re done, you’re clear and you’re a known entity with CFIUS and you can grow your business here in the United States, knowing that you’re a known entity and trusted and cleared entity in the United States.

Josh

A cryptocurrency mining business?

Nova

Even a cryptocurrency mining business. Even though, let’s say you know even if it’s a Chinese entity -- obviously, there’s a lot of issues there but you know, and this is what I used to tell my Chinese counterparts in the Chinese government when we’d have discussions is look, go there out front and, if it is a covered transaction, meet with CFIUS and show that there can be a trust developed there. And that’s a big part of it. Governance is trust. A big part of governance is trust, especially in the national security realm.

Josh

I think one of the ironies of this is that what you and what CFIUS and what we are advocating for is a level of transparency, clarity upfront, which is, in a way, exactly what the blockchain technology is trying to do as well. And there’s the irony that here you have a cryptocurrency mining operation designed to be transparent that is so big and complicated, nevertheless, that you could be hiding something in it.

Nova

Ah, that’s right. That’s right. When you have a big facility, you can put a lot of different equipment in there. So it’s best to be a trusted entity and a known entity through that process. And get good counsel, but before getting there and putting the shovel in the ground.

Josh

We’ve talked about CFIUS, FIRRMA, good acronyms, good national security guidance. What’s your final word on cryptocurrency Nova?

Nova

My final word on cryptocurrency is that, you know, it’s gone – I mean look, I’m a neophyte compared to you Josh in terms of knowing this world. But I’ve seen it from sort of the outside. You know, I don’t think it’s going away.

I think it’s going to continue to grow, especially with blockchain and the ability to have a trusted platform where there is value to the currencies that are available. It’s going to continue to grow. And I think people have to keep, especially with any new growth area in the world of finance you have to keep close tabs because, not only the U.S. government, but also foreign governments are deciding how they’re going to address and deal with this new valued system. And so regulations are going to change. So the more you’re engaged, the more you get good counsel and then also advocate for the good policies for it. I know Coinbase and other operators out there do this. They engage the U.S. government, whether it’s the Administration or Congress, to educate them in terms of the platform and its applications. But also to help steer the right rules for the platforms themselves. So, the point is -- be engaged, get good counsel, and help yourself by helping the policy and decision-makers build the right rules, right platform.

Josh

It’s going to continue to grow, it’s going to continue to thrive, just maybe not within a mile of a strategic missile base.

Nova

Let’s not put it there!

Josh

Well thank you so much Nova for joining us. It’s been such a pleasure hearing your insights and thank everyone for listening to the CryptoCounsel.

Nova

Josh, thank you so much. Great to be here.