THE INTERNATIONAL JOURNAL OF BLOCKCHAIN LAW - Volume 2 March 2022
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THE INTERNATIONAL JOURNAL
OF BLOCKCHAIN LAW
Volume 2
March 2022GLOBAL BLOCKCHAIN
BUSINESS COUNCIL
Geneva | London | New York | Washington, D.C.TABLE OF CONTENTS
Note from the Editor-in-Chief 2
About the Editors 3
A Round Table Discussion: Pressing Legal Issues in Decentralized Finance 4
Spotting And Managing Litigation Risk In Defi 14
If NFTs Ruled The World: A New Wave Of Ownership 19
Blockchain Vulnerabilities And Civil Remedies To Recover Stolen Assets 25
Can Code Be Law?: A Review Of Current Developments 36
Digitalizing Trade in Asia Needs Legislative Reform 43
The Emerging Legal And Regulatory Framework For DeFi Lending Platforms In Vietnam 48
1NOTE FROM THE EDITOR-IN-CHIEF
DR. MATTHIAS ARTZT
SENIOR LEGAL COUNSEL
DEUTSCHE BANK
Dr. Matthias Artzt is a certified lawyer and senior legal counsel
at Deutsche Bank AG since 1999. He has been practicing data
protection law for many years and was particularly involved in the
implementation of the GDPR within Deutsche Bank AG. He advises
internal clients globally regarding data protection issues as well
as complex international outsourcing agreements involving data
privacy related matters and regulations.
Welcome to the 2nd issue of the IJBL! Following the DeFi pieces,
Samir Patel explores the issue of
I am proud to present a great set of fractionalization of NFTs.
new articles covering various legal topics
surrounding blockchain technology from It is a matter of fact that blockchain/
around the globe and from different DLT based solutions continue to be
perspectives. prone to hacks, frauds and scams.
Barry Sookman (Mc Carthy/Tetrault
First things first: For this issue the Toronto) presents a case study and
editor’s board has decided to add a the pertaining remedies as well as
new feature to the Journal: a written challenges in recovering digital assets.
round table. My fellow editors, Andrea
Tinianow and Stephen Palley, took Michael Jünemann and Udo Milkau
the initiative to reach out to top US from Bird & Bird Frankfurt explore the
attorneys in the blockchain space to practical challenges of using smart
ask them about the most pressing legal contracts, in comparison to traditional
issues pertaining to DeFi. The result written contracts. This will be the first
is a comprehensive and insightful “episode” of a broader discussion
discussion on currently unresolved around smart contracts, as my fellow
legal topics around this issue from an co-editor Jake van der Laan is drafting
American legal perspective. This piece an article on the same topic for the
is deservedly the leading article of this 3rd issue of the IJBL focusing on the
issue. A special shout out to Andrea and more technical aspects of how smart
Stephen for making this happen. contracts currently function and the
limitations this creates in their utility in
DeFi is touted by many in the crypto the “contractual life cycle”.
space as having potential to significantly
disrupt the traditional financial industry Further, Raoul Renard, Carmen
over the next decade. With that in mind, María Ramírez Ortiz, Oswald Kuyler and
this issue continues with two more Steven Beck provide an overview of
appealing articles covering DeFi from the state of play on the adoption of the
different perspectives: Norton Rose Model Law on Electronic Transferable
Fulbright lawyers Robert A. Schwinger, Records (MLETR) in conjunction with
Harriet Jones-Fenleigh and Jonathan blockchain-based trade deals in the
Hawkins look at some of the disputes APAC region.
that may arise in the DeFi space and
set out the steps to be taken by users Finally, Prof. Tran Viet Dung and Le
of DeFi- or smart contract protocols to Tran Quoc Cong present an interesting
manage these potential risks. perspective of the legal and regulatory
aspects of DeFi Lending in Vietnam.
Happy reading!
2ABOUT THE CO-EDITORS
You can find the editor’s full bios here.
LOCKNIE HSU
PROFESSOR
SINGAPORE MANAGEMENT UNIVERSITY
Locknie Hsu received her legal training at the National University of Singapore and
Harvard University, and is a member of the Singapore Bar. Locknie specializes in
international trade and investment law, including areas such as paperless trade,
FTAs, digital commerce, and business applications of technology.
STEPHEN D. PALLEY
PARTNER
ANDERSON KILL
Stephen Palley is a partner in the Washington, D.C. office of Anderson Kill. He is the
founder and chair of Anderson Kill’s Technology, Media and Distributed Systems
Group, a cross-disciplinary team of lawyers, with experience across a wide range
of legal practice areas, who specialize in advising software, internet, and FinTech
companies.
THIAGO LUÍS SOMBRA
PARTNER
MATTOS FILHO
Thiago’s practice focuses on Technology, Compliance and Public Law, and in
particular on anti-corruption investigations handled by public authorities and
regulators, data protection, cybersecurity and digital platforms. He was awarded as
one of the world’s leading young lawyers in anti-corruption investigations by GIR 40
under 40 and technology by GDR 40 under 40.
ANDREA TINIANOW
CHIEF LEGAL OFFICER
IOV LABS
Andrea Tinianow, a Delaware attorney, is the chief legal officer for IOV Labs, the
brand behind the Rootstock and RIF protocols. In 2015, Andrea started the Delaware
Blockchain Initiative which gave rise to the “Blockchain Amendments” to Delaware’s
business entity statutes that authorize corporations (and other business entities) to
maintain their corporate records, including stock ledgers, on a blockchain.
JAKE VAN DER LAAN
CHIEF INFORMATION OFFICER & DIRECTOR
FINANCIAL AND CONSUMER SERVICES COMMISSION, NEW BRUNSWICK, CANADA (FCNB)
Jake van der Laan is the Director, Information Technology and Regulatory Informatics
and the Chief Information Officer with the New Brunswick Financial and Consumer
Services Commission (FCNB) in New Brunswick, Canada. He was previously its
Director of Enforcement, a position he held for 12½ years. Prior to joining FCNB he
was a trial lawyer for 12 years, acting primarily as plaintiff’s counsel.
GARY D. WEINGARDEN
ASSISTANT VICE PRESIDENT, DATA PROTECTION OFFICER
NOTARIZE, INC
Gary Weingarden is AVP and Data Protection Officer at Notarize, Inc. He is
responsible for their information security, privacy, IT, and fraud prevention programs.
Gary has over 15 years of experience in the mortgage industry having served as Chief 3
Privacy Officer and General Counsel at Birmingham Bancorp Mortgage Corp.ARTICLE I
A ROUND TABLE DISCUSSION
(IN FOUR PARTS):
PRESSING LEGAL ISSUES IN
DECENTRALIZED FINANCE
DAVID ADLERSTEIN OLTA ANDONI
COUNSEL DEPUTY GENERAL COUNSEL
WACHTELL, LIPTON AVA LABS
COLLINS BELTON LEWIS COHEN
MANAGING PARTNER CO-FOUNDER
BROOKWOOD P.C. DLX LAW
JASON GOTTLIEB CHRISTINE PARKER
PARTNER, CHAIR VICE PRESIDENT,
MORRISON COHEN LLP DEPUTY GENERAL COUNSEL
COINBASE
LEE SCHNEIDER ANDREA TINIANOW
GENERAL COUNSEL CHIEF LEGAL OFFICER
AVA LABS IOV LABS
STEPHEN D. PALLEY
PARTNER
ANDERSON KILL
4This roundtable discussion was curated leverage on long term contracts.
and edited by Andrea Tinianow and
Stephen Palley, Editors of the IJBL. See their Do such on-chain protocols constitute
bios and headshots on page 4. “exchanges” as that term is defined under
the Securities Exchange Act of 1934
(“1934 Act”)?
INTRODUCTION LEE SCHNEIDER: The answer to
With more than $USD 92 billion this question depends on a variety of
locked in decentralized finance (DeFi) factors, including how the protocol
protocols, DeFi is hot and it’s not is involved in effecting transactions.
showing any signs of cooling down The 1934 Act definition would seem
soon. We reached out to top attorneys to exclude from “exchange” a smart
in the blockchain space to ask them contract that has no single point of
about the most pressing legal issues failure, no single source of truth and
pertaining to DeFi. Here is what they no single authority capable of, or
had to say. responsible for, effecting transactions
and recording or altering data. In
A special shout out to attorney other words, if there is no operator
Gabe Shapiro for helping us to craft (or group constituting an operator),
these questions and to the attorneys then something is not an exchange.
who provided commentary. We Therefore, each protocol needs to be
appreciate their excellent contributions scrutinized to determine applicability
to this article as well as the crypto/ of the definition.
blockchain ecosystem overall. The
roundtable discussion assumes that JASON GOTTLIEB: I agree with
the reader has some basic information Lee. Definitionally, if the protocol is
about crypto and DeFi. allowing the trading of securities
tokens, it is more likely to be
PART ONE deemed an exchange; but if it allows
trading of only non-security tokens,
Certain on-chain protocols allow it cannot be (at least, under the 1934
transactions (trades, borrowing, etc.) Act).
relating to tokens, and it is likely that
some of these tokens are securities or, COLLINS BELTON: While I
some of the transactions are securities philosophically agree with Lee and
transactions under U.S. law.
Jason, there is at least some cause
to believe that historical precedent
CHRISTINE PARKER: The focus
may bias the Securities Exchange
on securities is important, but in the
Commission (“SEC”) towards a different
future, the vast amount of value
finding. In particular, some of the
will be transacted in the derivatives
earlier literature and procedural
market, based on the non-security
history discussing the creation
tokens, bitcoin and ether (“BTC and
and categorization of electronic
ETH”). There will be an increase in the
communication networks, which did
relative notional value of tokens that
ultimately largely fall into the category
are commodity-based, as opposed to
of an alternative trading system
security-based. In the future, there will
(“ATS”), seems to be at least in part
be large derivative exchanges for retail
applicable to protocols allowing for
investors. And, once there is robust
certain exchanges. Like Lee suggests,
trading in the derivatives markets in
specific factors will weigh heavily in the
the U.S., it will be much greater than
Exchange Act’s “functional” test, but I’m
the securities markets, with massive
not sure if the lack of a single point of
5failure alone will be dispositive (even broker are not regulated under the
though it largely should be). Commodity Exchange Act, unless the
tokens are offered with some form of
LEWIS COHEN: I tend to agree financing/leverage (e.g, a commodity
with Collins on this. The question derivative).
to me is less whether technically
the network of computers running Does the combination of such an on-
the relevant protocol code are chain protocol and such a website
operating an “exchange” (assuming constitute such an exchange and, if so,
that the protocol facilitates the bids/ does that depend on the website being
offers of “securities”). If that was operated by the same person or group of
persons which developed or deployed the
the function of the protocol code, protocol?
a judge would likely conclude that
the network was an exchange. But it LEE SCHNEIDER: Yes, it depends
does raise difficult questions around on who is operating both.
enforcement, though. For example,
which participants would a regulator COLLINS BELTON: I tend to agree
be able to go after? An Ethereum that the combination of providing
node operator whose node passively the service functionality and access
validates whatever code has been likely increases the risk of a site being
deployed? The developer who actually deemed an exchange, although the
deployed the relevant code? And what protocol may still retain colorable
if multiple people contributed to the arguments against that classification.
creation of the code, and the person That said, if the developer-operator is
who physically deployed the code one of many interfaces, and further,
was just an unknowing agent? What that single site is not the sole or
about transient holders of governance primary means by which persons
tokens for the protocol, or the person interact with the protocol or engage in
that runs a front end for accessing the activity, then the argument for treating
protocol (even if it is just one of many that particular combination as an
such front ends)? exchange is weaker (unless *all* other
combinations are similarly treated as
Does a website that offers access to these
types of on-chain protocols constitute an such).
“exchange,” as that term is defined under
the Securities Exchange Act of 1934? LEWIS COHEN: if you are an
identifiable person over whom a
LEE SCHNEIDER: It depends on relevant regulator or member of law
what “access” means. If it just means enforcement can get jurisdiction
that you can see what’s going on, that derives an economic
look at pricing information, etc., then benefit from providing services
probably not. If the website is the (even indirectly) that are not in
execution facility and is operated by compliance with relevant law/regs,
a single authority, then probably yes. you are at risk for an enforcement
If the website allows users to effect/ action. Another reason why we need
execute trades on the protocol but better laws. Soon.
does not operate the protocol, then
it is probably a broker. All of this Are there ways for non-banks (again,
assumes the tokens are securities. in the U.S.) to structure so-called
decentralized finance (DeFi) or centralized
finance (“CeFi”) “yield” protocols that
CHRISTINE PARKER: Same do not run afoul of the securities laws
outcome for commodity-based (including the registration requirements
tokens EXCEPT that the exchange and
6of the Securities Act of 1933 (the “1933 LEWIS COHEN: I agree with Lee
Act”), the Investment Company Act of that the central question here is
1940 and the Investment Advisers Act of whether the “facts and circumstances”
1940)? around the yield product implicates the
formation of an “investment contract.”
LEE SCHNEIDER: These are I would say that in many cases, the
very broad questions. Let’s focus answer will be “yes,” but it depends on
on the question of whether such the details of how the program is being
arrangements are investment run.
contracts or otherwise securities. Let’s
also consider similar arrangements DAVID ADLERSTEIN: I would
and ask why they have not been add that in addition to securities
treated as securities: payment for laws, these products involve bank-
order flow; maker-taker arrangements; like functions, so depending on the
credit card rebates. If the answer relies circumstances, other areas of law may
on “pooling” of funds and returns, that also be implicated. The ability for retail
seems a little thin because these 3 to place money with a counterparty in
examples rely on pooling as well. exchange for a yield and to withdraw
the money on demand resembles a
CHRISTINE PARKER: There is bank deposit. The legal considerations
likely a role that a futures commission around these products need to be
merchant (“FCM”) can have in offering considered case-by-case.
DeFi or CeFi yield protocols for BTC/
ETH products. This would be outside of
the scope of their regulated activity but
PART TWO
comports with the financing/lending Automated Market Makers (“AMMs”)
FCMs provide based on warehouse are the underlying protocol that enable
receipts.1 users to trade crypto on a decentralized
basis. Where do AMMs fit into the current
COLLINS BELTON: I agree with structure of U.S. securities laws, if at all?
Christine that the most likely non- How does MGM Studios Inc. v Grokster,
bank entity to embody a hybrid Ltd. impact your conclusion?
CeFi/DeFi model that doesn’t run
afoul of securities laws like the one JASON GOTTLIEB: Ultimately,
described above is a commodities most AMMs are just software, and
entity. We are already beginning to software that can be used for a host
see some examples of this model of completely legal purposes. The
being experimented with in DeFi and software developers cannot be
established commodities players. held responsible for misuse of the
That said, to the extent that assets platform, any more than Bill Gates
are treated as security-based swaps, could be held responsible if a drug
I’m not sure it would be accurate to gang used Microsoft Excel to keep
refer to these as being outside of the track of their drug deal profits.
securities law requirements, but the
offerings wouldn’t necessarily run afoul Some lawyers look to the file-
of them either. sharing cases for the Supreme
Court’s ultimate opinion in Grokster.
I have a different, more pragmatic
view. Ultimately, the courts could
1 To learn more, we refer you to the advisory
from The Division of Swap Dealer and Intermediary shut down Grokster (or Napster, or
Oversight (DSIO) of the Commodity Futures Trading Limewire, or or or…), but ultimately,
Commission which provides guidance to FCMs on how during the several years it took to
to hold and report certain deposited virtual currency
from customers in connection with physically-delivered
shut down a file-sharing service in the
futures contracts or swaps. courts, several others sprung up. DeFi
7protocols are easier: a team can “fork” and took no action to prevent it.
an open-source protocol in a half-hour, Further, given their control of certain
host it on a distributed website like access points, software distribution
IPFS, and walk away from it. Maybe mechanisms required to maintain
they’re liable under Groskster, maybe the service and other areas of central
not, but good luck suing a bunch of control, ascribing illicit activity to them
people who may be foreign, may be was more practical and reasonable.
anonymous, and may be unwilling to In contrast, here, AMMs have largely
comply with any US court orders. shown that they are totally neutral and,
in many jurisdictions, allow completely
Ultimately, what killed the permissible transactions. The fact that
Groksters wasn’t the courts. It was the U.S. and certain jurisdictions
Apple, and iTunes. Apple figured out have nebulous rules that have yet to
a way to make music file sharing easy, make broad determinations about
cheap, and 100% legal. The protocols assets should not be analogized
that do that will win, and settle the to enabling the illegal sharing of
argument. copyrighted materials (which was
already a well-known prohibition
COLLINS BELTON: I strongly agree prior to the development of basic
with Jason that a “truly decentralized” file sharing).
AMM, even with an unrelated treasury
or something else, should not and is AMM liquidity pools enable users to
not properly viewed as an exchange buy and sell crypto without the need for
or function that is covered under the centralized market makers. Liquidity is
1933 Act or 1934 is Act. However, provided by “liquidity providers” (“LPs”)
the term “truly decentralized” does and pooled, with each LP receiving a pro
rata share of the pool’s assets (including
much lifting here, and ironically, I accumulated trading fees) represented
would say the SEC’s action against by an “LP token”. In addition to receiving
something like EtherDelta, which a pro rata share of trading fees paid
was ostensibly a DeFi exchange that by people who trade assets through the
could be likened to an early AMM, AMM pool, LPs can often stake their LP
was the correct outcome. Similarly, tokens in third-party smart contract
for several AMM models where critical systems to receive governance tokens
components core to the protocol’s relating to those systems–a process
ongoing or future functionality are not known as “liquidity mining.” AMM
decentralized (e.g. backend servers systems sometimes also reward LPs with
or unilateral control of a governance governance tokens relating to that AMM
token allowing material operational system itself. Thus, LPs are potentially
triple-incentivized to provide liquidity to
changes by a single group or group AMM pools–by trading fees from the pool,
of affiliates), the risks attendant with by third-party governance tokens and
other entities and platforms that we by the AMM’s own governance tokens. Is
regulate under the securities laws liquidity-providing to an AMM pool an
often are resurgent, and in those investment contract under Howey?
cases, they fit squarely within the
existing framework of securities laws. LEE SCHNEIDER: No, it is an order
type that results in trades, with the
Grokster can be distinguished share of trading fees being equivalent
on the grounds that there, the court to maker-taker fees or payment for
focused much attention on the fact order flow.
that the arguable core functionality
and practical reality of the platform LEWIS COHEN: I agree - not
was illicit activity, and that the investment contracts. However, if
operators knew about such activity a court were to take the position
8(wrongly!) that the specific tokens altering data.
were “securities,” identifiable U.S.
persons in a liquidity pool would run PART THREE
a risk of being unregistered broker-
dealers. Should the developer of a website that
does no more than serve as a non-
Are LP tokens representing positions in exclusive interface to a blockchain DeFi
AMM pools investment contracts under protocol require anti-money laundering/
Howey? know your customer (“AML/KYC”)
compliance? What if the website cannot
LEE SCHNEIDER: No, they are interface with the protocol without being
claim-checks for the assets placed in paired on the user side with a third-party
wallet software under the user’s control?
the pool.
OLTA ANDONI: Although we tend
LEWIS COHEN: I agree with Lee,
to lump AML/KYC together for DeFi
inasmuch as an “investment contract”
protocols, I would emphasize AML
necessarily involves a legal relationship
for DeFi protocols. If the developer
between two or more persons and
does no more than serve as a non-
an LP token does not create such a
exclusive interface to a blockchain,
relationship. This said, someone could
I would not impose AML/KYC
create an investment contract by
requirements. But a different scenario
marketing LP tokens as the object of
may be applicable when a protocol
the scheme (similar to ML’s marketing
operates via third-party wallet software
of certificates of deposit in Gary
under the user’s control.
Plastic).
Is there a credible argument that liquidity LEE SCHNEIDER: There are
pools are investment companies under several problems here, most
the Investment Company Act of 1940? prominently the problem that
many different asset types trade in
LEE SCHNEIDER: No, because DeFi protocols, and AML laws are
there is insufficient pooling of assets bleeding into general commerce
(my assets get traded when an order rather than their traditional purview
matches with them) and because there of financial instruments. This is no
is no investment adviser. small issue and reflects a major policy
shift that has not been justified or
LEWIS COHEN: Not sure I agree gained broad support other than at the
here. If a court found that the Financial Action Task Force (“FATF”). On
digital assets in a Liquidity Pool were the question of “should” the developer
“securities” then that pool could well be require AML/KYC compliance, that is
considered an “investment company” up to the developer. If the question
in the same way that a segregated is whether there is an existing
account could be an “investment requirement that they do so, that
company”. depends on the activities that can be
accomplished through the website
Is there a credible argument that LPs are and the compensation, if any, the
securities market-makers, brokers, dealers developer receives.
or underwriters under the securities laws?
COLLINS BELTON: Absent
LEE SCHNEIDER: It depends on additional activity, merely providing
whether there is a single point of a non-exclusive interface to an
failure, single source of truth and single existing protocol should not require
authority capable of, or responsible for, KYC under a consumer due diligence
effecting transactions and recording or (“CDD”), as such activity should not be
9treated as being engaged in a money pointed out (including Gabe Shapiro,
service business or otherwise trigger if I recall correctly), it is difficult to
the provisions of a Bank Secrecy envision imposing affirmative content
Act (“BSA”) by making such provider requirements on software developers,
a financial institution. On the side especially in the case of open-source
of sanctions/AML, imposing such software which could be replicated and
requirements is not aligned with the deployed from anywhere in the world.
intent or text of existing law, but unlike
the KYC/CDD arguments under the Nonetheless, for the policy reasons
BSA, I believe that Lee’s perspective noted, it stands to reason that an
is right, and that the reach of AML/ AML/KYC touchpoint be required
sanctions is now well beyond its somewhere along the line, and a
original intent or text. As such, while logical starting point might be to
I have a normative position on AML/ impose obligations on DeFi users at
sanctions, I believe many policymakers scale, requiring that they have their
in the U.S. and outside of the U.S. identity validated by a qualified
believe existing law does require such third party in order to participate
checks, and regulators operate under in DeFi transactions involving value
this guise many times. transfers exceeding a particular
threshold of value, and to prohibit
LEWIS COHEN: The answer may users of scale from transacting through
change if you are hosting a website protocols, or pools within protocols,
front-end to the protocol and profiting involving participation of non-validated
economically by doing so. participants. This need not entail fully
“permissioned” DeFi but rather could
DAVID ADLERSTEIN: Let’s entail portable proof of digital identity
just come out and state the (not unlike a digital vaccination card
fundamental policy issue at the associated with a wallet, perhaps
root of this question – specifically, even in the form of a non-fungible
currently operational DeFi protocols token (“NFT”)) or integration with
are enabling large transactions wallet software featuring a mandatory
between pseudonymous KYC integration, and could lead to
counterparties, which may include a situation where most users “vote
bad actors such as Office of Foreign with their feet” and transact through
Assets Control (“OFAC”)-sanctioned protocols that make allowance for this
persons and criminal organizations. type of functionality. Practically, this
More sophisticated bad actors can be would not prevent bad actors from
expected to circumvent the guarded transferring or receiving large amounts
routes of regulated finance where they of value using decentralized software,
can (although studies indicate that the but could facilitate enforcement by
prevalence of criminal activity involving driving them into more concentrated,
cryptoassets is significantly less than is darker corners.
generally believed).
PART FOUR
Fundamentally, then, the issue
is whether AML/KYC compliance— What are your predictions for legal/
acknowledging the prior points regulatory developments for DeFi in 2022
that there are distinctions between (and beyond)?
AML and KYC and policy questions
about when frameworks should LEE SCHNEIDER: For the U.S.,
appropriately apply—should be no developments from a rulemaking
achieved by imposing requirements perspective in 2022. Perhaps some
on website developers. As others have enforcement actions against low-
10hanging fruit (clear situations where a regulatory issues with DeFi protocols.
single authority has control and profits, At the end of the day, DeFi protocols
which isn’t really DeFi). function in a centralized system
which will not let go of transparency
JASON GOTTLIEB: I agree that requirements for its players.
we’re unlikely to see significant
rulemaking from the SEC, but LEE SCHNEIDER: This question
the Commodity Futures Trading presumes that securities laws are
Commission (“CFTC”) may consider the only relevant ones. The focus
some new guidance on certain on securities laws is too narrow
issues (the 28-day rule, DAO control). because all different asset types
I agree that we’re likely to see more trade on DeFi platforms, and since
enforcement actions and, like Lee, the nature of the asset typically
I think most of those will be against determines the applicable regulation
either low-hanging fruit, or settlements (in the U.S.), focus on securities laws is
with companies/developers who too narrow.
are happy to pay a relatively modest
settlement and walk away if they are Given the mix of asset types trading
allowed to continue their business. in DeFi and the fact that that mix will
The regulators are going to have great only become wider and more diverse,
difficulty figuring out how to enforce the focus should be on market
settlements (or even court orders) integrity principles, both for DeFi and
against truly decentralized platforms. CeFi. Such principles will be easier
to dictate for CeFi and pretend DeFi
CHRISTINE PARKER: Agreed. (i.e., DeFi in name only) but true defi
The bipartisan, bicameral letter (no single authority) will involve
from the leaders of the Agriculture lots of experimentation in market
Committee to the newly confirmed integrity, which is overall beneficial.
Chair of the CFTC, which focused on And yield farming (liquidity mining
digital assets, suggests there will under the above definition) will add
be a renewed focus on the CFTC’s to the market integrity discussion and
role in regulating digital assets. The experimentation because it stitches
letter focused on a number of topics, together many platforms.
including DeFi, indicating that this will
be an area of focus for the CFTC in JASON GOTTLIEB: No, the
2022. We should expect to see some securities laws are woefully inadequate
proposed guidance or advanced notice to address crypto. To begin with, there
of proposed rulemaking addressing are vast pockets of crypto that do
certain DeFi principals. not implicate securities law at all. The
CFTC is relatively much smaller than
Are U.S. securities laws suited to address the SEC, and has jurisdiction only in
the risks that DeFi platforms create for matters involving futures, derivatives,
users or is a new/different regulatory etc. (except for fraud in spot trading
regime an inevitability? of commodities that have futures or
derivatives). So the CFTC’s jurisdiction
OLTA ANDONI: The current is limited as well. Financial Crimes
regulatory bodies are not ready Enforcement Network (“FinCEN”), the
to address and regulate DeFi. But Department of Justice (“DOJ”), states,
at the same time, the creators of even consumer protection agencies
DeFi protocols should address real - they all might have jurisdiction, in
regulatory risks. We cannot regulate certain circumstances, but their laws/
technology, but we can minimize regulations tend not to be designed
our appetite for risk. There are big for crypto either (except FinCEN, which
11has issued more specific guidance perfect regulatory balance, especially
than most of the other agencies). And for DeFi protocols.
even within the securities laws, there
are a host of “square peg, round hole” COLLINS BELTON: No, but there
problems that the current laws and are elements of other jurisdictions that
regulations do not address. the U.S. could adopt to dramatically
improve our balance. For instance,
CHRISTINE PARKER: This question a limited sandbox program with
seems oddly narrow in scope. It should responsive participants such as
be whether U.S. financial statutes Singapore’s could be helpful. But,
and regulations are currently suited more importantly, fostering deeper
to address the risks posed by DeFi engagement like what we’ve seen
platforms and even if they are suited, with FINMA (Swiss Financial Market
does it make sense to update the Supervisory Authority) or MAS
regulatory regime to accommodate (Monetary Authority of Singapore)
these new types of financial markets/ at various levels could drastically
products? cut down on misunderstandings of
technology and help them narrow
DAVID ADLERSTEIN: Today at their focus, as the current scattershot
least, your elderly relatives probably approach is not only ineffectual, but
aren’t using metamask to buy it is failing to capture real risks while
wrapped ETH through a decentralized largely preventing only good faith
exchange in order to liquidity mine actors from moving forward.
and yield farm. The technical UX (user
experience) hurdles could help explain Do DAO governance tokens in and of
why regulators haven’t acted here with themselves fall outside of SEC regulations
as much alacrity as in the case of some where token holders are required to
retail-oriented initial coin offerings participate? Is more needed?
(ICOs). But returning to first principles,
U.S. securities laws and other COLLINS BELTON: More is needed,
investment-related laws are predicated and the circumstances of the tokens’
on the idea of individual freedom to distribution and tokenomics is also
participate in markets, but with the material. For instance, to the extent
ability to obtain information about the a DAO is dominated by one party
merits and risks of an investment in or a group of affiliated parties,
order to make an informed investment the perfunctory participation of
decision. That policy imperative applies many other members is unlikely
here too, and as Jason alludes, the to abate regulators’ concerns that
key macro challenge is to protect the risks of conflicts of interest or
investors without fitting disclosure information asymmetries in favor of
and other regulatory requirements the majority will dominate. Similarly,
into a paradigm geared towards if the participation of the minority
traditional equity and debt holders is relegated to immaterial
investments offered by unitary, decisions, with the decision-making
centralized issuers. There is work to authority for decisions that materially
do here. impact future profit expectations being
relegated to a subgroup, the general
Are there jurisdictions that strike the right participation of the group might not
(regulatory) balance and could serve as a suffice to make such an arrangement
model for the U.S.? fail to appear similar to a traditional
GP-LP relationship, which would have
OLTA ANDONI: No, I do not think securities law implications. So, as a
there are jurisdictions that strike a general matter, mere participation by
12a broad number of people alone won’t
suffice to determine the applicability of
securities laws in most cases.
LEWIS COHEN: As I have noted
elsewhere, I agree that large groups
of people can act in a coordinated
way without being security holders.
The presence (or absence) of the
Williamson v. Tucker factors is critical in
determining whether “securities” have
been created.
JASON GOTTLIEB: The classic
lawyer’s answer: it depends. First, I’m
not sure there are protocols where
holders are required to participate.
But I’m not sure participation is the
key difference-maker. After all, most
retail holders of Apple stock don’t vote
their stock either, but there’s no doubt
Apple common stock is a security. We
go back to Howey: did people invest
money in a common enterprise with
the expectation of profits from the
efforts of others? If all you can do with
your governance token is vote, and if
the “others” that would take action are
just everyone else in the DAO, it’s hard
to see how governance tokens fit the
Howey test. (Nor do I think they fit the
Reves test, but that’s a separate issue.)
So, I don’t think DAO governance
tokens would automatically fall outside
SEC regulations, but in my view, the
governance tokens of the major
decentralized protocols very clearly
are not securities, and are outside the
securities law.
13ARTICLE II
SPOTTING AND MANAGING
LITIGATION RISK IN DEFI
ROBERT SCHWINGER HARRIET JONES-FENLEIGH
PARTNER PARTNER
NORTON ROSE FULBRIGHT NORTON ROSE FULBRIGHT
JONATHAN HAWKINS
DISPUTES ASSOCIATE
NORTON ROSE FULBRIGHT
By the end of 2021, USD 88 billion
of crypto assets alone were held in DeFi
characteristics that
protocols. This figure is startling given allow DeFi protocols to
the real uncertainty regarding the legal solve certain problems
rights and obligations of those using DeFi
and smart contract protocols and the
– decentralised
ability to enforce them when disputes networks, automaticity,
arise. The resolution by courts and and pseudonymous
tribunals of disputes in the context of
DeFi and smart contract protocols is still participation – also create
largely uncharted territory. In this article, significant legal uncertainty.
we look at some of the issues that may
give rise to disputes in the DeFi context WHAT UNCERTAINTIES DO
and the importance for developers and
users of DeFi protocols of incorporating
THESE CHARACTERISTICS
mechanisms for the orderly resolution of
CREATE?
any disputes that do arise. The major disputes risks arising from
DeFi and related technologies stem from
THE CAUSES OF the following issues:
UNCERTAINTY 1. What is the nature of the legal
relationship between participants in
DeFi protocols and applications are DeFi transactions?
designed to provide certainty, and in 2. Will agreements entered into via
many respects the decentralised and DeFi protocols satisfy the necessary
autonomous nature of DeFi products can formalities to be considered binding
offer significantly more robust systems. legal contracts?
They create indelible records and 3. When disputes arise as to the terms
remove certain single points of failure of an agreement entered into via DeFi
that can exist in classical centralised protocols, how will a court interpret
financial transactions. the agreement?
However, the very 4. What remedies will be available to the
14parties to enforce their legal rights? are found to be in partnership because
5. How will the successful party/ies of the potential for unlimited liability,
enforce a court’s decision but there are many more potential
areas of uncertainty arising from the
relationships between the participants
RELATIONSHIP BETWEEN themselves. Will they be deemed to
PARTICIPANTS owe duties to one another that could
give rise to tort claims if those duties
Most of the time courts and arbitral were deemed to be breached? There
tribunals resolve commercial disputes is a web of potential tort-like duties
arising out of relationships that have between such participants as the
been around for hundreds of years, platform, the developers, the cloud
such as purchaser and seller, lender service providers, individual users,
and borrower, or landlord and tenant. and perhaps an outside oracle. While
The law has had a long time to adapt the law provides certain tests and
to the nature and nuances of those guidance regarding when and where
relationships. However, DeFi and it is appropriate to infer such tort-like
related technologies are still relatively duties among participants in a situation
novel. Our legal systems have had very where their relationship is not governed
limited time to get to grips with them by a contract, there is still considerable
and often there is no legal consensus scope for argument as to the
yet as to who owes what duties to application of those tests, especially in
whom, and in what situations. the novel landscape of DeFi protocols.
Partnerships User agreements
One legal risk that may arise,
particularly in the context of User agreements, which
sophisticated DeFi protocols, is whether define contractual
all of the participants involved might be
found to have formed a partnership.
relationships upon entry
Under New York law, this might be an into the relevant DeFi
actual or de facto partnership, while system, help significantly
under English law it might be a general
partnership. In either case participants
to minimise the risk
might be held to have unlimited liability that a court imposes
for the acts of other participants. The a relationship that the
law has not begun to grapple with
the application of partnership law to participants did not
DeFi transactions, and it is conceivable foresee.
that various classes of users, such as
investors, tokenholders, promoters, However, they do not prevent claims
miners and node operators, may be from those who are not themselves
found to either comprise a single parties to the user agreements. In the
partnership, or for each class to form US, third parties have based claims on
separate partnerships. grounds as varied as negligence, fraud,
conversion, trespass to chattels, unfair
Do these relationships create legal trade practices, and racketeering. As
duties? legal systems grapple with DeFi, we
expect to see creative claims being
We have highlighted the specific issued, as parties test the limits of the
relationship risk that the participants law and platforms’ user agreements.
15capacity their jurisdiction requires).
FORMALITIES Under New York and English law, a
contract with a minor is voidable at
Each jurisdiction has its own the minor’s discretion. However, DeFi
formalities for entering into a protocols are often pseudonymous,
contract. However, agreements meaning that participants do not
struck across DeFi platforms have automatically know their counterparties’
certain fundamental differences when real-world identities and consequently
compared to classical contracts. These whether or not they have capacity to
differences will only become starker contract.
with the rise of smart legal contracts.
It is not yet clear how the law will apply Multiple participants
these formalities in the context of DeFi
protocols or whether they will recognise Further uncertainties as to legal
all such agreements as being akin to relationships arise when there are
classical contracts. multiple participants involved in a
transaction on a DeFi platform. Are
Execution formalities there two transactional parties in a
single contract with each other? Or
The requirements for the formal is each of them in an independent
recognition of a contract in each contract with the platform, which is
jurisdiction are idiosyncratic. While the essentially operating as a middleman?
requirements of some jurisdictions Or is there one three-party relationship,
raise obvious issues – such as the for example if the platform is taking
requirement for ‘wet ink’ signatures by a commission of some kind on a sale
certain Middle Eastern jurisdictions – transaction between the other two?
even more flexible jurisdictions such as
New York and England have their own INTERPRETATION
areas of uncertainty.
The DeFi market is still in its nascent
For example, the UK Law stages, and participants do not typically
Commission has recently concluded use the long formal contractual
its investigation into how the current documents like those that govern
law of contract is able to apply to many traditional finance transactions.
smart legal contracts, and flagged the When people talk informally about
requirement that certain contracts, their affairs, they often speak in broad
such as guarantees, must be made in generalizations and overstatements and
writing. Whether a smart legal contract, sometimes use imperfect metaphors or
written only in code (i.e., no natural analogies. This can lead to unwelcome
language such as English) can satisfy surprises when they are found to owe
this requirement is uncertain. legal obligations that do not reflect their
understanding of arrangements. The
Legal capacity interpretation of smart legal contracts
is particularly complex, and there are
A contract entered with a party different schools of thought as to how
who lacks the capacity to contract is disputes over interpretation should be
unenforceable. In order to determine resolved.
the capacity of a party, it is necessary
to know the identity of the party. For Code is law
example, a mortgage lender may
require a passport, to allow it to One school of thought argues
determine that a borrower has reached that “code is law”, i.e. the contract is
18 years old (or whatever the age of whatever the system is programmed
16to do, so that if the outcome of the
programming does not reflect what
terms and supporting
participants expected, they have to commentary will emerge
live with it. “Code is law” may sound
appealing to some technologists or just as parties in the derivatives and
others who want to be able to operate loan markets have adopted ISDA, LSTA
without the risk of interference from and LMA standard documentation.
the courts. However, businesspeople Those standard terms are likely to be
want predictable and commercially built on early smart legal contracts
reasonable results when they enter which have been subjected to the
into commercial transactions. The crucible of litigation and judicial
majority will not be willing to execute consideration.
and perform commercial transactions
involving the transfer of millions of REMEDIES
dollars’ worth of value via DeFi protocols
if that in practice necessitates a side Courts historically have been willing
bet on whether the programmer got to intervene where enforcement of a
everything right. contract would produce commercially
unreasonable or outrageous results,
Interpreting code such as where there has been a fraud,
a commercial misunderstanding, or a
Assuming that the market or our misrepresentation. It seems reasonable
legal systems are unwilling to adopt to expect that courts may look to
code as law, then our courts will intervene in smart legal contracts in
soon be faced with the challenge of similar circumstances. What is uncertain
interpreting the parties’ intentions. is how courts will use their traditional
Not only may these parties never have remedies in a DeFi context.
met, but they may never have engaged
even in a single natural language Immutability of the distributed ledger
communication. Just as transactional
lawyers today may exchange mark- A fundamental characteristic of a
ups of contracts with little or no distributed ledger is that transactions
commentary as to the changes, or two cannot be erased. If a court determines
businesses may engage in a battle of that a smart legal contract does not
the forms, code-only contracts and represent what the parties agreed and
amendments may be exchanged should be rectified, or that it is void for
between participants in a DeFi platform. frustration or illegality, the record of
Just how the court will interpret the that initial transaction is going to remain
intentions of each party as against the on the ledger. A likely solution is an
effect of their code is uncertain. One offsetting transaction (often referred to
approach that has been suggested is as an ‘equal and opposition transaction’)
for the court to adopt the interpretation cancelling out the initial transaction.
that a ‘reasonable coder’ would give to However, it remains uncertain how
the relevant code, but this comes with aspects of this process will work in the
its own complications and uncertainties. real world. What happens if only part of
the transaction is voided or rectified?
Market standards What happens if assets involved in
the transaction have already been
transferred to an innocent third party?
As the DeFi market How will a party subsequently prove
develops we expect ownership for the period in between
that industry-standard the two transactions? The latter may be
especially complicated in the context of
17tax liabilities. governing law and jurisdiction in their
smart legal contracts.
ENFORCEMENT
How will the counterparty know
Even if the uncertainties highlighted there’s a dispute?
above regarding parties’ rights and
obligations are resolved, they are not Even if a court in New York or
worth much unless there is a practical London, or an arbitral tribunal, is willing
mechanism by which to enforce a to hear a dispute, how will a claimant
judgment or award. A recent bug in make a potential defendant aware of
Compound’s code (a money market the proceedings? The pseudonymous
run on Ethereum) involved a single nature of certain protocols further
character error that led to the mistaken complicates the process of identifying
disbursement of an estimated USD 80 the defendant.
million of funds to incorrect parties. The
self-executing nature of the protocol Dispute resolution mechanisms
meant that there was no one person in
charge, and therefore no administrator We expect that the DeFi market
controls to disable at mistaken will coalesce around standard dispute
distribution. resolution clauses and mechanisms as
it matures. Until then, parties entering
Parties should foresee that they into DeFi transactions should ensure
may need to amend their transactions. that their arrangements include
Even ‘fire and forget’ contracts a dispute resolution mechanism
or decentralised autonomous making clear who is to resolve any
organisations (DAOs) will need dispute, under what law, and how the
a method by which to receive dispute will be run and the decision
instructions from the outside world. implemented.
DeFi transactions that do not provide
a mechanism for resolving disputes KEY TAKEAWAYS
generate a significant amount of
uncertainty that is likely to slow the As the DeFi market grows and
adoption of such technology by increasingly complicated and high-
sophisticated parties. value transactions are entered into
and performed via DeFi protocols, it is
Jurisdiction and governing law inevitable that disputes will sometimes
arise, especially given the uncertainties
Identifying which court has caused by unsettled issues of law in
jurisdiction to decide a dispute arising this area. Parties entering into DeFi
out of a DeFi transaction and what transactions should approach smart
law should be applied to do so are legal contracts with the same critical
fundamental issues for smart legal eye as they would a classical contract
contracts. Traditional tests used and take legal advice to ensure that
to answer these questions, such their transactions are documented
as the physical location where the in a way that clearly defines the legal
contract was entered into, will often relationships between the parties and
be unworkable in the context of a provides a mechanism for resolving
decentralised system. It will take disputes and implementing the
time for a body of case law to evolve, decision.
and different jurisdictions may take
opposing views, creating unforeseen
complications. It is therefore especially
important that parties specify the
18ARTICLE III
IF NFTS RULED THE WORLD:
A NEW WAVE OF OWNERSHIP
SAMIR PATEL
ASSOCIATE
HOLLAND & KNIGHT LLP
In 1997, avant-garde artist David WHAT IS AN NFT?
Bowie, with incredible accuracy,
prophesized how the internet will An NFT is a unique digital asset that
disrupt music distribution systems, utilizes blockchain technology to record
erode copyright laws and revolutionize ownership of an asset and evidence
fandom consumption. He hedged authenticity. Fungible tokens can be
his bets by selling Bowie Bonds that substituted without losing value and
securitized the royalty rights to his have properties that make them exactly
songs for $55 million. It was the first the same in type. Unlike fungible tokens
ever securitization of music recordings, such as Bitcoin or Ether, NFTs cannot
publishing rights and privately held be traded for another identical token.
intellectual property rights.1 An NFT is not a content file—it does not
contain digital art or a video clip, only a
Fast forward 25 years later, uniform record locator to the content,
legendary hip-hop artist Nas sold a which itself has intrinsic value. Rather,
non-fungible token (“NFT”) entitling the NFT is a unique cryptographic key
the holder of the NFT to a percentage contained within a digital token that
of a song’s streaming royalties. In a verifies the corresponding content file
matter of minutes, Nas sold 1,870 NFTs as genuine and establishes a record
grossing over $560,000 in revenue. of ownership as it is transferred on
Unlike the Bowie Bond, no publishing a blockchain, which allows it to be
nor intellectual property rights were transferred without risk of fraud. While
transferred with Nas’ NFT. Consistent others may have copies of the same
with blockchains’ disruptive and content, only one person can own the
rebellious hubris, the NFT was sold specific token authenticating ownership
not as an investment contract, but as of the content.
a collectible or music memorabilia,
whereas the Bowie Bond was sold Collectors of many items (antiques,
pursuant to US securities laws. Just as baseball cards, art) purchase NFTs
how the internet and securitization as a way to support their favorite
provided a new revenue model for artists, actors, musicians, and athletes.
artists, blockchain technology and NFTs Certainly, there are others that
may have forged a new way for artists to purchase NFTs as speculative assets
disrupt the music industry. hoping they will increase in value and be
a good investment.
1 Bowie Ch-Ch-Changes the Market, CFO: the
Magazine for Senior Financial Executives, Apr. 1, 1997,
1997 WL 8300101.
19The legal and regulatory holders to receive royalties every
time the song is streamed across
analysis of an NFT will be streaming platforms or played on
heavily influenced by how the radio, TV, movie, or video game
(“Mona Lisa NFTs”). Opulous partnered
it is intended to be used with investment platform Republic,
and how it is marketed. a Securities Exchange Commission
(“SEC”) registered crowdfunding
MUSIC NFTS portal, to sell these securities to main
street investors. A Delaware LLC was
The single-edition NFT is the most created and given 50% of the master
commonly used form of NFT in the and publishing rights to the song.5
music industry. One NFT is associated The LLC then conducted a Reg CF
with one song. Much like its digital offering, which provides an exemption
image kin, music NFTs do not convey from the registration requirements
economic nor intellectual property for securities-based crowdfunding,
rights to the NFT holder, unless allowing companies to offer and sell up
specified. Under U.S. copyright law, the to $5 million of their securities without
artist, by default, owns the copyright to having to register the offering with the
their work. All the NFT does is simply SEC.
point to a file’s, video’s or image’s
web location. Catalog is the primary BOWIE BONDS
market-place for single edition music
NFTs. Artists using Catalog earn seven Applying the basic securitization
times more from NFT sales than one structure to Bowie Bonds, David
year’s worth of streams on Spotify.2 Bowie’s assets are a twenty-five-album
One artist made $226,800 using catalogue—roughly 300 songs—
Catalog compared to $178 on Spotify.3 of Bowie’s recordings and song
On the Catalog FAQ page, under “What copyrights. The two main sources
do I receive when I buy a record?” it of revenue were recording royalties
reads “[b]esides being a priceless piece and publishing revenues. Since David
of art, buying a record on Catalog is Bowie actually owns his own record
the biggest cosign another artist can masters, all record royalties go to
give, the most immediate patronage a him. As for publishing revenues, there
fan can offer, and a key to anything the are mechanical royalties, synchronic
creator (or anyone else) might provide usage (e.g. films, commercials), sheet
for its holder. No rights are included music, air play, Muzak, voice mail, live
with Catalog records unless otherwise performances and tours by Bowie. EMI
specified.”4 Music entered into a 15-year licensing
deal for Bowie’s songs. The licensing
In contrast, Opulous is a deal was the collateral put up for the
marketplace that sells music NFTs investor, Prudential Insurance.
that are securities and sold pursuant
to Regulation Crowdfunding (“Reg NAS NFT
CF”) of the Securities Act of 1933
(“Securities Act”). Unlike NFTs on Royal.io, is a platform that allows
Catalog, Opulous sold NFTs entitling music fans to purchase the right to
earn royalties from their favorite songs.
2 https://twitter.com/Cooopahtroopa/ In November 2021, Royal announced
status/1489327698430234625
3 Id
5 Mona Lisa LLC – cite to EDGAR https://
4 https://www.notion.so/Catalog-FAQ-98ee8509 musically.com/2021/11/05/lil-pump-soulja-boy-music-
2bad441daa1ee9426daa4be8 nft-populous/
20Tier Royalty Amount Purchase Price
Diamond 1.5789% $9,999
Platinum 0.0658% $499
Gold 0.0113% $99
a $55M Series A round that included chooses to play a specific song on a
Nas as an investor. In January of 2022, streaming service, thus reproducing
using NFTs, Nas sold 50% of his royalty (or rebroadcasting) the composition.
rights to Rare (“Rares”) — a single Public performance royalties
song from his 2022 Grammy Award- compensate masters owners when
nominated album, King’s Disease II. the song is performed or displayed
The royalty rights were limited to only publicly. Every time a composition
streaming royalties derived from digital is publicly performed, the rights
service providers, as such term is owners get paid — whether it’s a radio
commonly used in the music industry broadcast, performed live at a concert
(ex. Spotify, Apple, Music, Youtube or a digital stream. Synchronization
Music). The royalties are divided into license fees are generated when
three tiers with each tier having a a derivative work based on the
different royalty amount and purchase composition is created. In essence,
price. every time someone wants to use the
composition as a part of any other type
Unlike NFTs on Opulous, Rares of content, whether it’s a TV show, a
convey no publishing rights nor movie, an ad or a radio show, masters
royalties when the song is played on owners are financially compensated.
the radio, TV, movie, or video game. That process is generally known as
sync licensing and is more a bespoke
UNDERSTANDING MUSIC contractual arrangement than the first
ROYALTIES two royalty streams.
A master recording is the official MUSIC NFTS ARE
original recording of a song, sound SECURITIES?
or performance. Also referred to as
“masters”, it is the source from which The Howey Test is the standard
all the later copies are made. As an to determine whether a financial
artist, owning the master recording instrument is an investment contract,
gives them the legal rights to freely and is therefore subject to SEC
appropriate and maximize their regulation. This is a three-part test in
money-making opportunities. If the which the Supreme Court determined
master recording belongs to a record that an investment contract exists
label, then they have the right to when there is (1) an investment of
license out the recording (and collect money; (2) in a common enterprise;
the royalties). (3) with a reasonable expectation of
profit derived from the entrepreneurial
Mechanical royalties compensate or managerial efforts of others. If an
the masters owner for the asset does not meet all three prongs,
reproduction of the composition, it is not an investment contract, and
paid by third-parties that want to not a security. Importantly, the SEC
record, manufacture, and distribute has stated that neither bitcoin nor
the musical work. With digital service ether are securities under the Howey
providers, mechanicals are primarily test, but also specified that whether
generated whenever the user a digital asset is an investment
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