Lawyers on Blockchain: AKA Value Technology
It was amazing to see the turnout for Consensus 2019. There were less marketers, according to Lewis Cohen, a layer from DlxLaw. CoinDesk hosted a live interview station outside the stages and spoke to various players in the space about various topics. Usually legal interviews are the least exciting and least paid attention to, however this interview with 2 lawyers, Mr. Cohen and Drew Hinkes, a layer from Athera was very germane to industry. It also happened to be an enjoyable presentation and angles were discussed that are often overlooked or conveniently avoided.
Disclaimer: this is not financial, nor legal, advice. No product(s) are endorsed, mentioned or not. This is merely an article highlighting the interview and bringing attention to the topic. Do your own research and consult legal and financial experts. If anything is miss quoted or misunderstood it is not on purpose, it is just that a miss quote or misunderstanding. The views written in this article are only the impression, opinions, and understanding of the author who watched the interview.The interview is found at https://www.youtube.com/watch?v=Q6fA6H_IAnk between o.35 and 39.30 minutes. Please do not use any information provided in this article as it is not definitive and the full interview is not covered by this article.
Store of Value
Mr. Cohen’s friend, Jason Brad (I hope I got this correct), came up with an excellent alternative to the label blockchain as reference to the technology cryptocurrency is built upon. Blockchain is a confusing term. He confirms that most people glaze over when the term blockchain is used. It is also confusing because not all “Blockchains” use blocks, for example, IOTA’s Tangle and COTI’s Cluster. They are both built on a Directed Acyclic Graph (DAG) as a base. Mr. Brad has hopefully coined the term that will be popularised, Value Technology, which is vis-a-vis information technology.
A Brief History of Entities
Mr. Hinkes very briefly gave an overview of the history of entities. First you had to ask the King permission. This was not an easy endeavor. Now it is fairly simple, you chose between a number of options and file a form. Each option has different rights and obligations and ways to conduct the business. It is rather easy according to Mr. Hinkes.
In a general discussion, it came out that we are now in a global society. Therefore different countries have different answers to what constitutes an enterprise and how to respond to and regulate Blockchain, cryptocurrencies, and decentralisation. Borderless systems are a real challenge to the status quo. We are now dealing with a truer global financial entity. Law between countries is difficult to navigate because some countries have clear, friendly regulations, others have clear, unfriendly regulation, others are friendly, but do not have clear regulations, and yet others do not even know about and/or understand cryptocurrencies at all.
Where are cryptocurrency businesses legally?
Where are cryptocurrency businesses legally? This is a very important and central question, especially in America. Not being a lawyer, it was fascinating to hear where the cryptospace has come in terms of law. We all waited with bated breath for the US SEC (Securities and Exchange Commission) to come out with guidelines. Hence forth referred to as the SEC. They sent out a number of actions against many ICOs who launched in the 1997/8 ICO bubble. However regulations and guidelines lagged and deadlines for releasing guidelines were extended over and over again. Finally we have some forward movement. Proof of the regulatory bodies coming forward is Fidelity, JP Morgan, and others coming out and starting to actually join the cryptomarket. The lawyers pointed out that the institutions need to catch up quickly because the entrepreneurs are usurping up the opportunities. Having said this, it is important to note the jury is still out on many critical issues.
What was interesting was that they said that the SEC has come out with consent orders as "guidelines" to other companies. While this is interesting, it is not clear if that is fair. Why should some companies get served consent orders in order to set out what the SEC expects. Surely it would be more logical to come out with guidelines and give companies a chance to comply and/or consent to and a waiver for those who tried and failed and have declared bankruptcy? On the other hand, it is important to set standards and enforce laws otherwise regulators lose credibility (not sure if they have any in the cryptospace, except companies have to comply LOL).
The Howey Test
The famous, and now probably infamous, Howey test comes into the picture. It is a litmus test for enterprises to help them determine if they are a security or not. Mr. Cohen points out that the Howey test is germane to cryptocurrency ICOs, but it is tricky to apply this to cryptocurrency ICOs. Mr. Cohen points out that the Howey test specifies there must be an enterprise. Further 2 conditions need to be met. The first is that there must be a central person in a managerial position and the second is that people who invest are expecting to make money out the enterprise. Mr. Hinkes joked about an enterprise being, “short hand as dencentralization for a while".
The whole idea of blockchain, decentralisation, and cryptocurrency is that it disrupts and changes, either through replacing or adding to, the current financial structure that is in place today (at the time it was 2008, now it is 2019). Therefore I would argue that while it is important to comply to regulations and rules, there need to be new structures, rules, and regulations governing these systems that make sense to these systems.
Why is Any of this Relevant?
Mr. Cohen brought up a very good question: why does the topic regulation matter? Is it not just relevant to the lawyers? This is a very good question and here is Mr. Cohen’s response: "How do you create a decentralised system?". We have to be able to definite blockchain, cryptocurrency, and digital money. In addition we have to define tokens and coins and different types of tokens or coins, for example, utility tokens and security tokens. Probably the most central definition needed is the definition of “decentralised”. This is most relevant portion because it might determine whether something is an entity or not.
Mr. Hinkes said susinctly:
“"Where's the line between: I am selling you software and I am letting you buy into a business. That is the core question we are trying to balance here. Is Ethereum a software package or a loose affiliation of people conducting a business enterprise?”
He also provided a classic answer:
“No one knows the answer yet".
Further, Mr. Cohen asked:
"In a decentralised system where is the enterprise?"
And again the classic answer came from Mr. Hinkes:
“It depends”.
Mr. Cohen points out that:
"We took away the person responsible (management position) and replaced him with code” is not going to work as a defense. Personally, I think it should be a defense because that is the ultimate purpose of the cryptocurrency being created. If you can show that your “enterprise” is actually decentralised of course, then you should be able to claim that code is the owner of the “enterprise”. A discussion ensued with views differing from the author’s view just stated. If the person who manages the enterprise steps back, the person who is running the code might become responsible. Maybe the developers who contributed to the code are responsible. Are just the critical coders responsible or will it depend on how much code you contributed? Are marketers and moderators responsible? What if the staff changes frequently?
Satoshi Nakomoto
Mr. Cohen points out something I never considered before and might be the reason Mr. Nakomoto (possibly and co.) stepped away and remains/remained anonymous. This is a very interesting point. Bitcoin has decentralisation with no known creator of it. My initial guess was that it was a marketing ploy. It soon became apparent that this could not be logical when Mr. Nakomoto (possibly and co.) did not reveal him/herself/themselves when Bitcoin “proved itself”. “Proved itself” meaning that it still exists and probably will never go away (LOL).
“Back to” the Relevance
Mr. Cohen pointed out two scenarios where a person would be held responsible for the “decentralised” enterprise. One where you gain, or are going to gain, financially from the system. Then there is a good chance you are going to be held responsible, especially if you are maintaining an economic connection. And a second where you own some tokens (the portion might not be important even if it is not the majority) and step away from the project. No one knows the answer. These answers, like the author’s answer are merely speculatory. What about one more scenario: if you own tokens and use them to vote in governance, whether you were the original owner or not? Would that make you responsible?
Even though a blockchain is transparent and it is easily traceable to the original owner of the private key, it could be that the owner sold the key for cash to some unknown new owner without recording the transaction anywhere. So even if you traced back to the original owner you might not know who owned the private key. So who is responsible then. What if KYC (Know Your Customer) was not done by that particular ICO? How do you know who actually owned the wallet. What if the owner was a custodian for someone else? These are some interesting questions that need to answered in order to deal with who is responsible for the enterprise and enterprises complying with consent orders issued by the SEC to ICOs.
The point made about multiple trading of such tokens owned by “managerial’ positions was interesting. I would have thought that to trace them to the original owner would be fairly easy, given the transparency of the blockchain. However it seemed like Mr. Hinkes thought trading on multiple trading platforms would make it harder to identify the original owner.
I would guess that hacks and scams would also make ownership proof harder to trace. This point was not even mentioned. However with exchanges being hacked and original owners being scammed out of their tokens, it would be hard to trace back. If it were to be traced back, who owns the tokens and would they get them back?
The other point I was thinking about is: did any of the “investors” in the ICO actually believe they were going to make a gain from their “investment” or did they merely buy token in order to be part of the cryptocurrency and utilize the tokens. Also with the hype, FOMO, and FUD did any “investor” actually believe he/she would make money from his/her “investment”?
Unfortunately none of my questions posed in this article were addressed because I did not see this live and could not Tweet them in. Secondly, while some came to mind as I was watching, I only thought of others while I was actually processing, planning, and writing this article.
SAFT Document
An adaptation of the SAFT document (saftproject.com) was put out by a prominent law firm. Originally it was used to help the tech startups in silicone valley. Its adaptation was supposed to help ICOs to raise capital. However the number one assumption of the SAFT document set out by the saftproject has one major and critical assumption, that the ICO is issuing utility tokens. Many other lawyers went on to create their own versions of this document with regards to cryptostartups. That is why I am mentioning the original adaptation.
It seems like this was Mr. Hinkes’es expertise because he spoke fluently, clearly, and with enthusiasm. He said that when you give me money and I promise to give it back, that is a loan. However when you convert it something else, it may be considered a securities transaction. That something else he was referring to in this context is a cryptocurrency token(s). He posed a critical question that needs pondering:
“What does the changing of a debt into a token mean?” Does the token change into a securities token or is it still a utility?
For SAFT to be valid, it seems that the token needs to be (and remain) a utility, not a security for the duration of the first owner’s ownership (sorry about the repeating repetition LOL). Mr. Hinkes qualified that the US government does not agree with that. It might be considered an SEC investments contract. Further if the US government did agree then it might be an improper forward contract according to the CFTC (US Commodity Futures Trading Commission) law. However Mr. Hinkes implied that using a SAFT was probably easier to clear up if legal issues did arise. So the SAFT is a significant player in the ICO legal space.
Summary
There are a lot of very important points in this article and there are very few conclusions. So to summaries it is vital to define what category a token or coin falls under. There are actually 3 categories that are largely accepted, utility, security, and payment tokens or coins. However the whole interview only dealt with the latter 2. It was not clear if either category would included payments depending on the usecase or not.
SEC and SAFT were the 2 major areas that defined the discussion. While the discussion focused mainly on America, it was pointed out that cryptocurrency is global and therefore the interaction between countries and their laws is also important. SAFT seems to be legally easier to navigate and “fix” legally.
With regards to the SEC, a major definition that is crucial is: what is an enterprise and further what is decentralisation. How to apply the Howey test was summed up by Mr. Hinkes’s question: “Where’s the line between: I am selling you software and I am letting you buy into a business. That is the core question we are trying to balance here. Is Ethereum a software package or a loose affiliation of people conducting a business enterprise? No one knows the answer yet”.
It seems that Mr. Nakomoto had a very good grasp of the legal implications of what he was doing. This might hold the key to the answer as to why he/she/they “disappeared” and remained/remains anonymous. He/she/they still hold a large sum of Bitcoin though, so what are the implications of this. Further an intriguing question is would the inheritors of these coins be held responsible for being the managerial position of Bitcoin “enterprise”?
Cryptocurrency has certainly disrupted many fields, for example technology and finance. However it has disrupted the legal field too, especially in the area of cryptostartups. Right now questions seem to be clearer than answers especially in America, but the SEC is (and other regulators, both in America and other countries are) slowly starting to address these and other issues. Regulations in America are starting to catch up as we see the entrance of institutional investments into the space and GAMFA experimenting with different types of blockchains and cryptocurrency models. We look forward, with hope, to coming back to the future developments in later articles (LOL).
