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Web3Blast #4 | SEC continues its crypto crusade, new regulatory developments, token warrant template and DAO governance
Welcome to Web3Blast edition #4
In this edition, we cover:
- Legal cases around the world (SEC vs Kraken settlement, Wells notice to Praxos for BUSD issuance)
- Regulatory updates (UK published crypto framework paper, many countries ramp up regulatory actions)
- New template from Legal Nodes’ Web3 Docs: token warrant
- DAO governance (going through interesting cases of DAO governance being imperfect and recalling the 101 of DAO governance set up)
A polite reminder – everything in the Web3Blast is for informational purposes only and is not to be construed as legal advice or legal opinion.
Legal cases around the world
The SEC continues its crypto crusade and settles with Kraken over its staking program
What happened?
Kraken has agreed to shut down its crypto staking operations in the US to settle SEC charges and pay a $30 million fine.
February 11th 2023
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Why it’s important
It’s the first-ever case of an enforcement action against a crypto staking program for violation of securities legislation.
AND not everyone agrees that the SEC is doing the right thing: SEC Commissioner Hester Pierce has made dissenting comments with regards to the current enforcement action:
“A paternalistic and lazy regulator settles on a solution like the one in this settlement: do not initiate a public process to develop a workable registration process that provides valuable information to investors, just shut it down.” Wow.
What should Web3 projects expect?
Practically, this case sets up a precedent where any centrally-managed staking program in the US will fall under the securities scope. Web3 businesses should think carefully about their future plans!
Read more on this story:
- Coinbase’s stance on why their staking program isn’t a security
- Matt Levine’s opinion piece on Bloomberg “SEC cracks down on crypto”
- Last week, the SEC also proposed more strict rules for crypto custodians
- Jason Gottlieb’s thread on why registration with the SEC doesn’t work for most of crypto projects:
February 12th 2023
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The SEC reportedly issues a ‘Wells notice’ to Praxos over BUSD: stablecoins might also be deemed securities
In a recent development, stablecoin issuer Praxos reportedly received a Wells notice from the SEC. A Wells notice is a kind of advance warning to companies, stating that they may be subject to enforcement action from the SEC. The company has already stated it plans to stop minting new BUSD coins (reportedly, after receiving a cease order from New York Department of Financial Services) and said it’s “prepared to vigorously litigate if necessary.”
Can stablecoins be deemed securities?
Yes, theoretically they can and it seems that the SEC is trying to make this the case in practice.
February 13th 2023
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What does this mean for stablecoins issuers?
It’s a clear sign that more cases may follow in the future. Stablecoin issuers who are registered in the US might look to move to a jurisdiction with clearer guidelines to stablecoin issuance. The MiCA (Markets in Crypto-Assets) Act adoption in 2024 will make EU countries a more favorable option, while currently Switzerland, the Bahamas, and Singapore have legal frameworks for different kinds of stablecoins.
Did someone say algorithmic stablecoins?
On that note, the SEC has also charged the notorious Do Kwon, founder and CEO of Terraform Labs, the company behind the collapsed Terra (LUNA) stablecoin, with defrauding investors in crypto schemes.
Other notable news:
- The CFTC has charged Avraham Eisenberg with manipulatively appropriating over $110 million from Mango markets decentralized exchange. Although it’s a case with an individual and not a legal entity, it’s interesting to note that it’s the first enforcement action involving “oracle manipulation”.
- Coinbase gets a lawsuit against them dismissed. The suit claimed Coinbase had sold unregistered securities.
February 1st 2023
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- The judge in the LBRY vs. SEC case clarifies that his original order against LBRY didn’t consider whether secondary sales of LBRY were an unregistered securities offering.
Regulatory updates
UK government publishes crypto framework paper: consultation and call for evidence started
The UK is taking big steps forward in transforming the country into an attractive location for crypto businesses.
What you need to know
- One of the key differences of UK crypto legislation from MiCA, for example, is that the UK’s proposals will bring crypto assets within the scope of existing financial regulation. MiCA is a separate crypto regulation created specifically for crypto matters.
- The UK is hosting a consultation and call for evidence until April 30. After that date, we’ll get a much clearer idea as to what changes will be included in the final legislation.
- Additionally, in the coming months new crypto marketing rules will come into effect in the UK, which means that firms that want to promote crypto products to UK consumers will need to comply with fresh rules.
What does this mean for crypto projects?
- It’s too early to make bold statements, but what’s already clear is that the proposals will make existing market players re-register after the legislation is adopted, to ensure that they comply with the extended rules.
- Algorithmic stablecoins won’t likely be banned, but instead classified as “unbacked crypto assets”, which is good news for stablecoin issuers and investors.
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Image source: Midjourney
Biden administration releases “The Administration’s Roadmap to Mitigate Cryptocurrencies’ Risks”
The administration’s roadmap was published in the form of a blog post at the end of January, and acknowledges that 2022 was a tough year for cryptocurrencies.
The message in the blog is quite clear: the government intends to focus on mitigating the risks in the crypto industry by ramping up enforcement to fight fraud and ensure that new regulatory frameworks are being respected and adhered to. In addition, the document briefly recognises that “issuing new guidance where needed” is also important.
The sentiment echoes what we’ve already seen; plenty of enforcement, but not a big focus on creating clear and all-encompassing frameworks, which the industry could very much benefit from.
Regulators all over the world strengthen their position by broadening their reach, and issuing new guidance
- Panama’s Supreme Court will rule on cryptocurrency legislation. They will either decide that the regulation is unenforceable or will approve a modified version of it. Their decision will be a relief, after a prolonged saga of court reviews that this legislation has endured.
- Hong Kong will not tolerate algorithmic stablecoins as per their new regulation. We’re seeing a backlash by various governments towards algo stablecoins.
- The CFTC urges Congress to expand the commission’s regulatory oversight. Fears that existing regulation has multiple gaps have prompted the CFTC to suggest new measures that would enable them to perform effective due diligence checks on organizations (crypto and otherwise) wanting to acquire CFTC-regulated entities.
- South Korea is to deploy a cryptocurrency tracking system in 2023 and has issued guidance on the regulation of security tokens. Cryptocurrencies that fit the description of securities will be required to comply with the country’s Capital Markets Law.
- Philippines’ securities regulator seeks more authority to oversee the crypto industry. Another example of regulators seeking more powers. The proposal expands the definition of securities and gives more enforcement power to the Philippines SEC.
- The British Virgin Islands enacted a new Virtual Asset Service Providers Act on 1 Feb, 2023. The new regulation provides clear guidelines on crypto custody and exchanges, but doesn’t cover crypto and token issuance.
- Indonesia has transferred the regulatory power in crypto from a commodities watchdog to a securities regulator. Another country acknowledging the need for a more thorough regulatory approach.
- Wyoming lawmakers pass a bill that prohibits forced disclosure of private keys. The bill is set to take effect in July this year and “applies to all cases except in instances where information relevant to a case is unavailable through alternative means”.
New Web3 fundraising template
Token warrant from Legal Nodes
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Image source: Midjourney
Our team continues putting the best practices we have developed working with dozens of Web3 projects to practice: this time we’re releasing a free template of token warrant agreement.
Also known as a “token purchase right”, this document is quite often used by Web3 projects to attract early-stage investments. It gives investors the right to purchase a portion of tokens during the initial token sale, as well as fixes the price of the tokens.
We’re sharing the token warrant template that we’ve developed so that the Web3 community and industry can use it, completely free! Our template takes into account all the industry best practices and is designed to be easy to use.
Download it for free below, and be sure to check our guide on token warrants and how to use it.
| Download the token warrant template |
Please note that this template is built for informational purposes only and isn't legal advice.
The template is country-agnostic and it doesn't take into account the specific details of the project and should be customized by a qualified legal professional in order to be used effectively.
If you have any feedback on this template, let us know on twitter or by email.
Let’s talk about DAO governance
DAO governance, just like any governance model, isn’t perfect. Its application is still relatively new, so needs some fine-tuning. Currently, many DAOs develop their projects via collective governance and so the projects are figuring it out on-the-go. Most projects share with the industry their knowledge of what works and what doesn’t.
So, how could DAOs be improved? One way of answering that question is by looking at the intersection of lawl and DAO governance.
So far, we’ve seen at least two cases in the last 6 months that provide insights on how DAO governance models could be improved from a legal perspective. The first case involved a DAO canceling their investor’s SAFT and refunding the investor. The second involved a conflict of interests of DAO members which threatened to harm the DAOs future.
Case #1: The DAO that “refunded” one of its early investors
In May 2022, Merit Circle DAO voted on a proposal to “refund” one of its early investors, YGG, because they felt that YGG didn’t provide enough value. Examples of value included: “marketing, content creation, assisting seed purchases, DAO contributions, deal flow” and more. Merit Circle Ltd, which signed the SAFT with investors, wrote that “As an ltd we would like to honor all agreements, however we have to balance that with the power of the DAO” before concluding “The DAO holds the ultimate power here.”
Long story short, YGG and Merit Circle decided not to engage in a legal battle that would cost both a lot of resources, and they agreed that Merit Circle would return 10 times the value of their initial token investment.
June 14th 2022
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Although they’ve resolved the matter quite well, this case set up a precedent that both investors and DAO founders should be aware of: the DAO holds the power.
Are there any legal safeguards to prevent these situations and protect investors?
There’s no easy answer to this one. Now that this precedent has been set, DAOs may choose to incorporate terms into their Constitutional documents that will prohibit posting and execution of proposals that violate the off-chain laws and obligations of the DAO companies (be it the DAO company or the Token SPV, which usually signs documents like SAFTs). Investors may also start to more proactively negotiate clauses into agreements that can protect them from scenarios like this.
It’s also worth noting that much of this information is based on tweets; we haven’t seen the original SAFT signed by YGG and Merit Circle. Instead, it’s understood that under the terms of the SAFT all “authority over tokens and token emissions was transferred to the DAO.”
June 14th 2022
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Case #2: The DAO member voting against a proposal with conflict of interest
Uniswap DAO members have launched a proposal to deploy v3 of the platform on BNB Chain (a community-driven, open-sourced, decentralized ecosystem). One of the main reasons for the proposal is that Uniswap’s business license expires on April 1, 2023, and without deploying to a new chain, other projects could start copying Uniswap v3 code to create clones.
The current proposal includes the fact that Uniswap will use Wormhole as a cross-chain bridge. This was opposed by Uniswap’s largest investor, a16z, as they raised questions about Wormhole’s security and generally about the due diligence process used for the selection of the cross-chain bridge solution. It’s worth noting that a16z is an investor in Wormhole’s closest competitor, LayerZero, which has also been evaluated by Uniswap in the past.
Is this some kind of conflict of interest? Maybe, but these crossovers of interest happen quite often in the industry. Also, conflicts of interest are easier to identify in employee-employer relationships or in cases concerning elected official business. With investors in a project who are DAO members, the line is a little more blurry.
What is interesting about this one is the scale: a16z is one of the biggest tokenholders and investors in the project, and the consequences looming under time pressure: failing to implement v3 of the platform on BNB Chain before the license expires (regardless of what the cross-chain bridge solution ends up being) could cause great harm to the project.
Eventually, a16z voted against the proposal for deploying on BNB Chain in the current proposed version (using Wormhole as cross-chain bridge), and was the biggest dissenter holding a whopping 15M of 28.47M of the votes against the proposal. In the end, the majority of votes (65.89%) were in favor of deploying v3 on the BNB Chain.
Narrator: They went that far pic.twitter.com/bAwCXVXKPY
"If a16z goes against community vote and tries to tank it, I'd be shocked. That would be truly abhorrent, and I don't think they would go that far." twitter.com/TheBlock__/sta…
February 5th 2023
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Are there any ways to limit the conflicts of interest in DAO governance?
We’re afraid there’s no easy answer here either. Conflicts of interest happen very often and it’s really hard to track and prove them, let alone create systems that will help prevent these conflicts from happening in an industry driven by VC investments.
Web3 legal 101
What are current best practices to implement DAO governance in a legal way?
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Image source: Midjourney
Another way of thinking about this is asking “when does it make sense to implement the decentralized governance of a Web3 project?”
Usually, it is when the product has already been tested and working, the tokenomics has been finalized, smart contracts have been deployed and the main token has been issued.
After this has been done, founders start developing the decentralized governance system. This usually includes taking these steps:
- Identifying the categories of participants of the Web3 ecosystem to whom governance rights will be vested, which requires defining the selection criteria for DAO members;
- Determining the method for issuing voting rights to DAO members;
- Deciding on the list of decisions that the DAO will make;
- Structuring the procedure for putting forward proposals, voting for them, and implementing the adopted decisions;
- Determining the structure of the DAO’s management bodies, as well as the powers and responsibilities of each of them; and
- Putting all of the above into a DAO Constitution.
The last point on preparing a DAO Constitution is an important one, because this is where you transform all these rules into a “social contract” that all DAO members agree with and should act upon accordingly.
It is also important in order to combine on-chain governance with the off-chain world and make the governance rules legally binding to ensure that a portion of the DAO Constitution is reflected in the statutory documents of the DAO legal entity (i.e. the DAO’s legal wrapper). Another reason why it’s important is that it provides more legal protection for DAO members.
Read more: Designing a Governance System for DAO: a Checklist for Web3 Founders
And so concludes this publication of the Web3Blast. We hope you've enjoyed it and found it useful. If you have any feedback you’d like to share, you can let us know by choosing a response below.
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The Legal Nodes Team
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