Highlights:
- The First Amendment of the US Constitution protects crypto software development, but if you do more than simply develop the software, laws and regulations may apply.
- Certain types of control, such as deploying a smart contract, can result in liability.
- Governance tokens also can raise questions of control under securities law.
- Check out the ACC Blockchain Collection
Coinbase expressed surprise when the U.S. Securities and Exchange Commission (SEC) served a Wells notice on the crypto currency company in September 2021. A Wells notice serves as a notification to a company that the SEC will be suing the company. Coinbase claimed it has been transparent with the SEC about its Lend program.
Ever since Bitcoin came to prominence a few years ago, blockchain companies have been operating without much government oversight. They claimed laws and regulations designed for the financial industry do not cover them due to their decentralized structure and lack of agents or custodians.
The issues below are mainly based on the ACC webcast “Emerging Legal Issues with Blockchain Technology” by Professor Aaron Wright, Cardozo Law School. Key blockchain-related definitions follow this list.
1. Financial laws and regulations apply to agent or custodians of financial products, but decentralized finance (DeFi) has a non-custodial structure which raises the issue of whether financial laws and regulations apply to DeFi.
2. The First Amendment of the US Constitution protects software development, which has been upheld in the courts, and developers have protection if their purpose is lawful. However, a court held against a developer that wrote software to effectuate gambling.
3. Activities that are adjacent to DeFi protocols, such as maintaining the sole interface with an underlying smart contract or maintaining centralized control of aspects of a smart contract, can result in liability.
4. People interacting with DeFi protocols may have secondary liability based on participating in or interacting with the protocols, for example liability for aiding and abetting.
5. There is the potential for liability under the US Commodity Exchange Act (7 U.S.C. § 13c(a)) if decentralized exchange aggregators, liquidity providers, governance token holders, or multi-signature holders aid and abet illegal activities.
6. The April 2019 SEC Token Framework leaves unanswered questions about how to characterize governance tokens (see definition below), because they have no right to profits and are not sold directly to investors.
7. The structure of decentralized autonomous organizations (DAOs), which are adjacent to DeFi protocols and allow token holders to manage digital assets with no central manager and tend to be unincorporated business entities, can result in unlimited liability, and raise questions about the possible taxation of tokens.
8. Vermont enacted a statute that authorizes the creation of blockchain-based limited liability companies (BBLLCs), but characterization questions remain.
9. There have been efforts to create limited liability autonomous organizations (LAOs) for DAOs to align LLCs and DAOs.
10. When dealing with blockchain, it is advisable to obtain insurance. For example, Nexis Mutual is an insurance product that is operated as a DAO, which provides insurance on smart contracts.
Key Blockchain Definitions
Any analysis of blockchain requires understanding certain terms such as:
DeFi – “decentralized finance” offers decentralized financial services that are non-custodial. The main platform for DeFi is Ethereum. DeFi relies on digital assets, and underlying DeFi are smart contracts which run the blockchain without requiring a custodian.
DEXs – are decentralized exchanges that are part of the DeFi system and rely on automated market makers (AMMs) smart contracts, which allows users to trade peer-to-peer assets without using an order book.
DEX aggregators – “decentralized exchange aggregators” allow traders that are looking to exchange tokens to do so through an aggregator that will look across all DEXs to find the best price. The most important points about DEX aggregators are that they combine token pricing; are non-custodial in nature; and simply sit on top of DEXs.
dApps - means “decentralized finance-related applications” that are based on pooled assets in a liquidity pool. When assets are deposited in liquidity pools the assets are locked and earn fees or digital assets in the form of governance tokens.
Liquidity mining – is the process of submitting assets to a DeFi protocol.
Decentralized lending protocols – are a category of DeFi protocols that allow users to deposit digital assets into a liquidity pool and borrow another token.
Governance tokens –are the result of when a protocol creator gives users of the software a token that provides them with the authority to set parameters or upgrade the protocol.
Learn More:
Learn more in the ACC webcast “Emerging Legal Issues with Blockchain Technology”
Read “Ten Things General Counsel Need to Know About Blockchain,” by Bertrand Alexis and Iohann Le Frapper, ACC Docket, 15 December 2020.
Read “Blockchain Technology is Here – Is It Compliant With GDPR?” by Elene Dighmelashvili, Legal Counsel for BitFury Group, Aleko Nanadze, Counsel for BitFury Group, Yuriy Kotliarov, Partner at Asters, and Sergiy Tsyba, Counsel at Asters, ACC Docket, 22 December 2020.
Read “Legal Considerations in the Use of Blockchain Technology and Smart Contracts for Multinational Business,” by Wendy Callaghan, Chief Innovation Legal Officer and Associate General Counsel at AIG, and Rajika Bhasin, Assistant General Counsel, Multinational at AIG, ACC Docket, 1 June 2018.
Check out the ACC Resource Library: www.acc.com/resource-library
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