Web3 Regulation Talks with ICON.PARTNERS: Vision, Challenges, and Legal Guidance

As a forward-thinking Web3 development company, Dexola consistently improves expertise and stays up-to-date with technological advancements. We also recognize the critical importance of aligning innovation with legal compliance.

That’s why we maintain close professional contact with ICON.PARTNERS, a leading law firm specializing in legal assistance for Web3 businesses in 40+ countries. This collaboration ensures that our clients are not only technically groundbreaking but also legally impeccable.

To highlight the legal complexities and pitfalls of the industry, we’ve conducted an extensive interview with top experts from ICON.PARTNERS:

• Viacheslav Ustimenko, CEO and co-founder;
• Vladyslav Udianskyi, a senior lawyer specializing in blockchain and fintech;
• Oleksii Los, a senior lawyer focused on Web3 & AI technologies.

Piece by piece, we’re planning to publish the whole interview under the general title “Web3 Regulation Talks with ICON.PARTNERS.”

In part 1, Alex Stupakov, Dexola’s delivery director discusses with the experienced lawyers the key principles of Web3, the range of legal challenges startups commonly face, the pitfalls of tokenomics, and the risks of wine tokenization. Enjoy the reading!

Disclaimer: This interview does not provide legal or financial advice. The information presented is for general informational purposes only. We are not responsible for any actions taken based on the content of this interview. Readers should consult with a professional before making any decisions.

Alex: To get started, could you share your perspectives on what Web3 means to you?

Vlad: Web3 is a reaction to the centralization and monopolies of big corporations in Web2. Imagine a distributed network where each user controls their data and interactions within the network. In Web3, the emphasis shifts from large players to individual control. It has a great impact on the development of the Internet, and how we interact with it.

Oleksii: Still, Web3 isn’t fully realized yet; it’s more of an ongoing process. The idea of transferring power to each user and maintaining decentralization is what we canonically understand as Web3. However, It’s hard to break in because you need specific skills, knowledge, and mindset. Mass adoption is one of the main challenges for Web3.

Slava: But we believe in the potential of Web3. We think that it’s possible to transform the current version of the internet into a decentralized infrastructure based on blockchain. Distributed networks give users greater control over their privacy and digital assets, including their personal data.

Alex: Explain what decentralization is and how it makes Web3 different from Web2?

Slava: In Web2, we have large platforms like Google, Facebook, and Amazon. Basically, they control vast amounts of user data and set the rules of the online world. Web3 aims to change that by distributing control across the network of users and nodes.

Decentralization is possible due to blockchain technology that provides a transparent and unchangeable record of transactions and data. With smart contracts, there’s no need for intermediaries.

Oleksii: For example, in DeFi, smart contracts handle lending, borrowing, and trading automatically. Self-executing agreements written in code tend to cut out traditional financial institutions. This logic can be applied across the entire internet.

Alex: How does Web3 change how we use the internet and digital services?

Vlad: Web3 represents the idea of an independent internet that doesn’t rely on trust in large corporations. It’s fundamentally unified. With your unique universal credentials — whatever you choose to call them — you can access the entire internet.

For example, you no longer require separate accounts for Google, Facebook, Instagram, and others. Even major companies like Google typically restrict your account usage to their ecosystem or their partners. In contrast, Web3 proposes using a MetaMask wallet or similar solutions to interact with a wide array of unrelated systems and applications.

Alex: Understood! Now, let’s shift to your clients. Who are they?

Oleksii: ICON.PARTNERS works with various Web3 startups, including wallet creators, tokenization project developers, token and NFT issuers, DAO organizers, creators of blockchain-based data storage and email services. Our clients range from small startups with innovative ideas to large companies integrating blockchain into their infrastructure.

Alex: What challenges do they often run into?

Slava: The problems vary based on the project’s nature and stage. Early-stage startups often need help with forming their company, understanding regulations, and handling token issuance. More established projects might need support with compliance, protecting intellectual property, or resolving disputes.

We also guide clients on the legal aspects of smart contracts and how to ensure they’re valid. A common challenge is the unclear regulatory frameworks for Web3, which can lead to uncertainty and legal risks for businesses in this field.

Oleksii: During the project analysis, our team often detects many hidden issues. This is because startup founders frequently don’t see the full picture of the evolving legislative environment and the requirements in different jurisdictions. Just using the Howey test to decide if a token is a security or not for all jurisdictions, including Europe, is a bad approach and can cause serious problems.

Alex: So, what kind of assistance do you offer to your clients?

Vlad: Clients often come to us with issues like starting a company and getting support for issuing tokens. This includes auditing the company’s tokenomics and providing advice on the obligations for token issuers and the requirements they must meet.

In this case, we offer consultations and support throughout the entire token issuance process. Sometimes, we limit our assistance to consultations based on the client’s needs, but we can also handle registration and negotiate with regulators.

Oleksii: For instance, we had a client who needed to establish a decentralized autonomous organization (DAO). We researched various jurisdictions to find the most favorable one from different perspectives, such as company management and tax implications.

We provided consultations and, based on the business model the client described, offered solutions on the best location for setting up the company. This process involves communication with regulators, business registration, and ongoing support, including token issuance and compliance with personal data protection requirements.

Slava: To sum up, we offer comprehensive legal services to our clients, from company formation and token issuance to compliance and ongoing support. When it comes to the legal framework, Web3 is essentially an extension of Web2. So, we have to consider all legal practices related to Web2 as well. This confirms that our clients are fully compliant and protected.

Alex: Wow, that’s really thorough work! But tell me more about DAOs. How often do you get requests to create and support them?

Vlad: The frequency of DAO requests varies since not all Web3 companies need them. In my experience, I’ve worked on three DAO projects. One was related to sports and aimed to engage fans with teams. DAOs are gaining popularity for organizing and governing decentralized projects, but they also come with unique legal challenges. For instance, the absence of a clear legal framework for DAOs can complicate liability and dispute resolution. We assist clients to navigate these challenges and design DAOs that comply with relevant regulations.

Alex: What legal hassles come with DAOs?

Vlad: We need to determine if the client wants a security token, as this affects their control over the company’s direction. Ideally, token holders in DAOs should manage and vote on company decisions to reach decentralization, but this is challenging with the lack of e-shares recognition and relevant corporate legal frameworks.

Due to this, there are two DAO models: with or without a legal entity. Without a legal entity DAO is created de facto, however, token holders might be viewed as partners with the respective full liabilities. With a recognized DAO legal entity, the company assumes responsibility, which is preferable. However, not all jurisdictions support DAOs, and it’s tough to adapt laws to these innovations, especially in the European Union.

Oleksii: Web3 projects usually start centralized and aim to decentralize later. However, founders often struggle with decentralization despite token issuance. Distribution often doesn’t solve the problem. When we see distributions like 20% for the team, 20% for investors, and another 15% for the founders, we know there won’t be any decentralization.

Additionally, some DAOs may face problems with their tokens. DAOs that allow their token-holders to make non-essential decisions, like community rules, ordinarily, face no legal troubles. But when token holders influence critical decisions like fund allocation, it can attract regulatory attention, as seen in the recent Uniswap case where the SEC raised questions about their decision on swap fees.

Alex: You’re pointing out some really unexpected problems in tokenomics. And since you’ve touched on the topic, could you also share your legal perspective on the RWA tokenization trend?

Vlad: Generally, tokenization of real-world assets is the process of representing ownership of physical assets, like real estate, art, or commodities, objects of luxury, with a digital token on a blockchain. In theory, it can make these assets more liquid, divisible, and accessible to a wider range of investors. However, the legal aspects of tokenization can be complex, as they often involve securities regulations and other legal considerations.

Slava: Regulation of Real World Assets (RWAs) varies between legal systems, primarily common law in the USA and civil law in the European Union. In the USA, the Howey Test from the Securities Act of 1936 determines if an asset is a security. This test, based on precedents, applies to new assets like cryptocurrencies and RWAs without requiring new regulations.

The status of tokenized RWAs, for example, real estate, depends on how the property was tokenized. At the moment, the direct tokenization of the title in terms of legal framework is really problematic, as general civil law rules govern such relationships and a title transfer requires much more stringent procedures than the transfer of token. Meanwhile, in some practical cases where it’s done through the tokenization of shares of a company that owns the property, then the shares are definitely securities, and the token will be considered as such.

Oleksii: In the European Union, the MiCA (Markets in Crypto-Assets) framework follows the principle of “same activities, same risks, same rules.” This means that tokenized assets retain their traditional legal classification. For instance, tokenized stocks remain stocks, and tokenized debt remains debt.

In general, under the MiCA regulation, tokenized RWAs can potentially be classified as ART or e-money. Moreover, they can be considered securities under MiFID II (Second Markets in Financial Instruments Directive).

Alex: At Dexola, we’ve noticed that the idea of real estate tokenization comes up quite frequently. However, from our point of view, it is also the most problematic area. Could you highlight the additional challenges of this process?

Oleksii: Tokenization of real estate is tricky. The goal is to make hard-to-sell assets like real estate easier to trade, but there are legal headaches, like figuring out ownership shares and managing rental income. Token holders should get rental payments if the property is rented out, but there are lots of legal and practical questions to sort out.

So, without extra legal structures, real estate tokenization stays pretty complicated. Moreover, without changes to laws like the civil codes, tokenization of titles through token holding is highly questionable.

Alex: Sounds really painful. We do need relief! What about wine tokenization?

Vlad: Depends on the jurisdiction. In the US, the regulation of tokenized assets is determined by their nature and structure. The Howey Test determines if a transaction is an “investment contract” and needs to follow securities rules. If investors expect profits mainly from someone else’s work, the asset is likely considered a security.

However, if the tokenized asset represents direct ownership of something real, like a piece of art or a bottle of wine, and doesn’t rely on others’ efforts for profit, it might not be a security. This distinction is important because securities face stricter regulations than other assets. In the context of wine, tokenization is typically employed to validate a bottle’s authenticity or establish ownership.

Oleksii: So, buying an asset reference token for a bottle of wine and holding it as proof of ownership is unlikely to be considered a security. However, this isn’t legal advice and should be looked at on a case-by-case basis.

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This is the end of the first part of the interview with ICON.PARTNERS. The next part is coming soon. Follow us on LinkedIn for updates.