Web3 Law and Regulation

Jake Chervinsky
November 8, 2022
Berkeley, CS294-224/CS194-224

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About MePresently●

Head of Policy @ Blockchain Association●

Lawyer, but not yours●

Advisor @ Variant Fund / Board @ DeFi Education Fund

Formerly●

General Counsel @ Compound Labs, Inc.

●

Government Enforcement Defense @ Kobre & Kim LLP●

Compliance and Investigations @ Baker McKenzie LLP

Futurely●

Happy to hear from you — jake@variant.fund / @jchervinsky
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The Blockchain Association | 2Roadmap1)

Introduction2)Regulators and Frameworks

3)

Current Issues to Watch4)

Web3 Legal Strategy5)

Questions?

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Basics of Regulation
What are regulations?
● Rules that prohibit conduct or condition it on compliance with certain obligations● Violations are punishable by ﬁnes, restrictions, and imprisonment (for crimes)
Why do we have them?
● “The market cannot be left to its own devices”● To control market power, facilitate competition, promote stability, attract
investment, protect consumers, and achieve other governmental interests
Who makes and enforces them?
- US has regulations on both state and federal levels; we will focus on US federal- Legislature makes laws, executive enforces laws, judiciary interprets laws
How should you think about them?
- Learn the basics for issue-spotting; hire a lawyer before doing anything risky!

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Regulators and Frameworks

1)

Introduction

2)

Regulators and Frameworks

3)

Current Issues to Watch

4)

Web3 Legal Strategy

5)

Questions?
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Securities Laws
The Securities and Exchange Commission (“SEC”)● The SEC has a three-part mission: to protect investors, facilitate
capital formation, and maintain fair, orderly, and eﬃcient markets● The federal securities laws originated in the 1930s after the Great Depression,
which was thought to be caused by ﬁnancial abuse and information asymmetry● The SEC regulates “securities” and a broad range of securities market actors,
including issuers, exchanges, advisers, brokers, dealers, investment ﬁrms, etc.
Crypto x Securities Laws
● Securities must be registered with the SEC (an IPO) or exempt from registration● Registered securities are subject to onerous requirements that don’t work forcrypto: traded on SEC-regulated venues, held by SEC-approved custodians, etc.
● Because a securities designation is a death blow for most digital assets, thecrypto industry spends a lot of time and money avoiding SEC regulation
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Securities Laws
Investment Contracts and the Howey Test
● Many types of securities: stocks, bonds, notes, investment contracts, etc.
● SCOTUS deﬁned an “investment contract” in SEC v. W.J. Howey Co. (1948):(1) an investment of money(2) in a common enterprise(3) with a reasonable expectation of proﬁt(4) based on the eﬀorts of others
SEC Guidance● DAO Report, July 2017: DAO tokens are securities under the Howey test
● Bill Hinman, June 2018: bitcoin and ether are “suﬃciently decentralized”● SEC Framework, April 2019: dozens of factors relevant to the Howey test
● SEC Chair Gary Gensler, October 2022: “The law is clear. I believe based on thefacts and circumstances most of these tokens are securities.”
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Securities Laws
The Hinman Test
● “If the network on which the token or coin is to function is suﬃciently
decentralized – where purchasers would no longer reasonably expect a person
or group to carry out essential managerial or entrepreneurial eﬀorts – the assets
may not represent an investment contract. Moreover, when the eﬀorts of thethird party are no longer a key factor for determining the enterprise’s success,material information asymmetries recede. As a network becomes truly
decentralized, the ability to identify an issuer or promoter to make the requisite
disclosures becomes diﬃcult, and less meaningful. And so, when I look at
Bitcoin today, I do not see a central third party whose eﬀorts are a key
determining factor in the enterprise. . . .”theblockchainassociation.org

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Securities Laws
The Hinman Test
● “. . . And putting aside the fundraising that accompanied the creation of Ether,based on my understanding of the present state of Ether, the Ethereum network
and its decentralized structure, current oﬀers and sales of Ether are notsecurities transactions.”
Initial Coin Oﬀerings● SEC v. Telegram, March 2020
● SEC v. Kik Interactive, September 2020
● SEC v. LBRY, November 2022
Beyond Token Issuers● Crypto Asset Management, September 2018: fund manager● EtherDelta, November 2018: “decentralized” exchange● BlockFi, February 2022: lending platform
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Commodities Laws
The Commodity Futures Trading Commission (“CFTC”)● The CFTC's mission is to promote the integrity, resilience, and● vibrancy of US derivatives markets: futures, options, swaps, etc.
● The CFTC was created in 1974 when most futures trading occurred in agricultural
markets and is still overseen by the House and Senate Ag Committees● The CFTC’s role and responsibilities greatly expanded after the Global Financial
Crisis under the Dodd-Frank Act due to the impact of complex ﬁnancial derivatives
Crypto x Commodities Laws
● It is unlawful for a US person who is not an eligible contract participant (ECP) toenter into, or oﬀer, a derivatives transaction outside of a CFTC-regulated venue● CFTC v. Bitmex, August 2021
● CFTC v. Polymarket, January 2022
● CFTC v. bZx/Ooki DAO, September 2022
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Anti-Money Laundering Laws
The Financial Crimes Enforcement Network (“FinCEN”)● FinCEN enforces the US anti-money laundering (“AML”) laws underthe Bank Secrecy Act (“BSA”) and implementing regulations● The BSA requires regulated ﬁnancial institutions to have an AML complianceprogram that meets certain requirements, including customer due diligence(“KYC”), essentially deputizing ﬁnancial intermediaries to perform the task ofsurveilling transactions and reporting on them to the government
Crypto x AML Laws
● The BSA applies to crypto just like any other ﬁnancial instrument, so crypto
institutions like exchanges and custodians have to comply with AML laws
● How does the BSA work in a disintermediated ﬁnancial system like crypto?
● FinCEN Guidance, May 2019: explains the deﬁnition of “money transmitter” inthe context of speciﬁc crypto market participants
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FinCEN Guidance, May 2019
● Money transmitters are entities that accept funds from one person and transmit
those funds to another person or location by any means.
● FinCEN gives examples of when this deﬁnition applies and when it doesn’t○ For example, anonymizing service providers vs. software providers○ But, a confusing treatment of “DApps” and “DApp developers”
Simple Cases● In re Eric Powers, April 2019
● US v. Larry Dean Harmon, August 2021
● US v. Arthur Hayes et al., February 2022
Complex Cases● DeFi protocols with admin keys?
● Multisigs? DAOs with treasuries?
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Sanctions Laws
The Oﬃce of Foreign Assets Control (“OFAC”)● Sanctions are a foreign policy tool used to inﬂuence the behavior anddiminish the capabilities of foreign actors through economic penalties● OFAC administers US sanctions by designating targets on the Specially
Designated Nationals (“SDN”) List, who are then cut oﬀ from the US markets● It’s illegal for a US person to transact with, or facilitate transactions for, SDNs
● OFAC’s Sanctions Compliance Guidance, October 2021Crypto x Sanctions Laws
● Because sanctions laws are so broad, violations are strict liability oﬀenses,
and crypto is borderless by nature, sanctions compliance is paramount● BitGo, December 2020
● Bittrex, October 2022
● Industry standards: geofencing, blockchain forensics
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Tax Laws
Internal Revenue Service (“IRS”)● The IRS is responsible for collecting US federal taxes and administering theUS Tax Code, including how it applies to digital assets● There are many unanswered questions about how crypto should be taxed:○ Mining and staking?
○ Hard forks and airdrops?
○ DeFi transactions and interest income?
○ Transactions involving DAOs?
Infrastructure Bill● Last year, the Infrastructure Investment and Jobs Act (“IIJA”) amended theTax Code with ﬁve new provisions speciﬁc to crypto — all problematic○ KYC through the back door of the Tax Code○ We are awaiting guidance or rulemaking on implementation
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And on, and on, and on . . . .
Consumer Protection Laws
● Primarily focused at the state level on “deceptive and unfair tradepractices” statutes, which are very broad — accuracy is key
Banking Laws
● Primarily focused on “depository institutions” with heavy regulation
Unique State Regimes● Some are restrictive — New York BitLicense● Some are accommodative — Wyoming SPDI
Barely Scratching the Surface● There are many other important regulators at the US state andfederal level, as well as in other countries that are active in crypto● Regulations are also ﬂuid and ever changing, so it’s critical to stay
up to date as global crypto regulation develops and evolves
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Current Issues to Watch

1)

Introduction

2)

Regulators and Frameworks

3)

Current Issues to Watch

4)

Web3 Legal Strategy

5)

Questions?
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Current Issues to Watch
1)

2)

3)

4)
5)

Secondary Markets○ Congress is considering proposals to regulate secondary markets for
digital assets, most likely under a new framework under the CFTC
Stablecoins○ US policymakers concerned about stablecoins are considering ways toregulate centralized issuers and possibly restrict models like TerraUSDPrivacy○ Global AML regulators concerned about illicit activity in crypto arepushing to restrict peer-to-peer transactions and expand surveillance
DAOs○ Are DAOs merely unincorporated associations with unlimited liability?
Politics!
○ How will the US midterms change the outlook for crypto policy?
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Web3 Legal Strategy

1)

Introduction

2)

Regulators and Frameworks

3)

Current Issues to Watch

4)

Web3 Legal Strategy

5)

Questions?
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Web3 Legal StrategyDisclaimer● I’m not your lawyer! If you’re a Web3 entrepreneur, seek good legal advice
General Approach● Understand that regulatory risk and uncertainty are unavoidable in Web3
● Make, and demonstrate, a strong commitment to compliance on day one
Startup Speciﬁcs● Adopt and make sure everyone follows written policies for compliance● Involve legal counsel from the early stages of product development● Conduct a risk assessment to identify risks and how to mitigate them
● Spend the time (and money) to hire great lawyers, outside and in-houseResources● Guide: 5 Essential Elements of Corporate Compliance, May 2018
● Podcast: Navigating the Legal Landscape in Crypto, February 2022
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Questions?

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