<![CDATA[The LawVerse Substack: Crypto]]>https://www.thelawverse.com/s/cryptohttps://substackcdn.com/image/fetch/$s_!APjE!,w_256,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F61fb6cb9-f1b9-43e5-9443-f3fde3fe38ac_800x800.pngThe LawVerse Substack: Cryptohttps://www.thelawverse.com/s/cryptoSubstackSat, 02 May 2026 17:42:20 GMT<![CDATA[Read the Fine Print: Token Compensation ]]>https://www.thelawverse.com/p/read-the-fine-print-token-compensationhttps://www.thelawverse.com/p/read-the-fine-print-token-compensationFri, 16 Jan 2026 19:53:34 GMT[This article was originally published on Dragonfly’s Blog and is co-written with Brandon Ferrick. This is a follow up piece to a prior post on understanding stock options.]

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For employees, consultants, and advisors at crypto startups, understanding token compensation is just as critical as understanding equity. Tokens may look deceptively simple—digital units recorded on a blockchain—but in practice, they come with their own thicket of legal, tax, and liquidity issues. Unlike equity, which has decades of case law and established market norms behind it, token compensation sits in a fast-evolving, often ambiguous regulatory environment.

This article is designed to demystify how token packages are structured, when and how tokens are actually delivered, and the restrictions and risks that may come with them. Whether you’re reviewing a consulting agreement, joining as an early employee, or advising a project in exchange for tokens, it pays (literally) to know what you’re signing up for.

The article is written with a focus on U.S. audiences, so for non-U.S. service providers, make sure you consult local tax and legal professionals for jurisdiction specific matters. Either way, we are lawyers but not YOUR lawyer, and this isn’t legal advice.

Note, be sure to read the glossary at the bottom of the document for important definitions and concepts described here.

Roadmap
I. What Are Tokens?
  A. Software Is Not Equity
  B. Dual Track Compensation
  C. Paperwork
     Checklist of What to Ask / Watch Out For
II. Types of Token Incentive Compensation
  A. Restricted Tokens or Restricted Token Awards (RTAs)
  B. Restricted Token Units (RTUs)
III. Differences Between Token v. Equity Comp
  A. No 409A safe harbor
  B. It bears repeating: tokens are not equity
  C. Tokens are pseudonymous
  D. Tokens can be more liquid than stock options
  E. Tokens are taxed the same as stock (for the most part)
  F. You may be granted a token interest or a token
  G. Paperwork may be delayed
  H. Tokens are subject to lockups and vesting (different restrictions)
  I. Transfer restrictions enforced via smart contracts or custodians
  J. Typical timelines for lockups and vesting schedules
  K. Acceleration for tokens
  L. Withholding taxes / net settlement
  M. You may not be able to participate in governance until you vest
IV. Tips and Nuances
  A. How to Value What You Are Getting
  B. What Happens If You Leave the Company?
  C. What If I’m a Non-US Person?
V. Glossary of Key Terms
VI. Sources

I. What Are Tokens?

A. Software Is Not Equity

Tokens are units recorded on a blockchain that can enable access to or voting power of a protocol. Critically, tokens are (usually) not equity and usually do not resemble traditional securities.1 Because of that, they confer no shareholder rights—no dividends, no corporate voting2, no residual claim on company assets. In other words, you should never confuse token ownership with owning stock. That said, it’s important to read the rest of this article to understand where tokens function like stock and where they differ, so you can evaluate what receiving or selling tokens may mean for you and conduct appropriate due diligence before accepting tokens as compensation.

B. Dual Track Compensation

In Web3, companies may issue tokens to their service providers in addition to, or in lieu of, equity. This is because in Web3, value may accrue to a decentralized, token-governed system rather than to the equity in a development company (DevCo). For more information about market trends in offers, we recommend Dragonfly’s 2024/2025 Crypto Compensation Report.

That said, token-based awards often (but not always) track the structure of traditional stock awards made under equity compensation plans, as a company will adopt a token plan along with individual form agreements. This was born out of a combination of not wanting to reinvent the wheel on incentive compensation, as well as an effort for companies to comply with existing securities laws during periods of high regulatory uncertainty.

C. Paperwork

As mentioned above, just like many companies have equity incentive plans/stock incentive plans, crypto startups often create token incentive plans whereby they’ll award tokens to the company’s service providers, as a form of incentive compensation—the most common papered forms of token awards are papered are the following:

  • Restricted Token Awards (RTAs) and

  • Restricted Token Units (RTUs)

[Note: We won’t go into token options and Token Purchase Agreements (TPAs) in this primer. Token options are pretty rare. TPAs are effectively the same as RTAs except that TPAs are paid for with cash while RTAs can be paid in either cash or services.]

II. Types of Token Incentive Compensation

Now, let’s get into the nitty gritty of RTUs and RTAs.

A. Restricted Tokens or Restricted Token Awards (RTAs)

1. What is it?

These are actual tokens issued to service providers, subject to some vesting restrictions (e.g., if you stop providing services to the company before they vest). You own these tokens and generally pay taxes in the year you receive them. The company’s right to take back the tokens (usually repurchase them upon separation) lapses as they vest. Unvested tokens are typically also subject to restrictions on transfer (but can be adjusted for estate planning purposes).

2. When do you see an RTA used?

When the fair market value of the token is still very low, usually pre-TGE, before a funding round has attributed a market-driven valuation to the tokens (i.e., before any SAFTs, token subscriptions, or token purchase agreements are entered into). So, you tend to see this used for grants issued after tokens have been minted but prior to a token being publicly launched.

3. When does settlement happen?

Title transfer happens around the time of the award for these. You need to give the team member title to the tokens, subject to the repurchase right. This means either actually give the tokens to the employee, or transfer legal title to them via legal agreement and have the company or a custodian hold them on behalf of the team member until vesting. Delivery of the tokens themselves may take place over time as vesting occurs after the lockup and cliff expires, sometimes using a platform such as Liquifi or Magna. There’s a bit of a debate over whether a multisig / smart contract vesting schedule is sufficient for 83(b) purposes where the employee doesn’t have dominion and control over the asset.

4. How are they taxed?

Token compensation is taxed as ordinary income at the time of grant. As with equity, you would generally be granted an RTA for unvested tokens, to incentivize you to earn them over a period of time with your contributions. If so, taxes can work in one of two ways, depending on whether you file an 83(b) election:

  1. No 83(b) Election: If you don’t file, you are taxed when the tokens vest so you have to pay ordinary income on the value of the tokens at each vesting milestone. It can be costly if the token price appreciates. Since you likely can’t sell the tokens during the lockup, you could be stuck with a large tax bill and no liquidity to pay it!

  1. 83(b) Election: If you file one within 30 days of the transfer, you pay ordinary income at the time of grant on the fair market value of the entire grant, vested or unvested. The token hopefully is worth more over time, so it makes sense to pay taxes on the full grant value at the time of the grant, rather than taxes at each vesting event for the amount of tokens that vested. Once you go to sell the tokens, depending on how long you hold them, you can be taxed at the capital gains rate.

Note: Tokens need to be minted and issued to the employee or service provider, as 83(b) elections can only be made on property you receive. Some firms may take a different perspective on this, so make sure you consult with a tax professional before accepting any tokens and filing an 83(b) election.

For RTAs, you technically own all of the tokens at grant under reverse vesting. However, the company retains the contractual right to repurchase any unvested tokens for a nominal amount if you leave before they vest. This “substantial risk of forfeiture” is what drives the default tax rule—without an 83(b) election, the Internal Revenue Service (“IRS”) treats the taxable event as occurring at vesting, not grant. Filing an 83(b) lets you accelerate the tax recognition based on the grant date despite this forfeiture risk.

Let’s say you were granted an RTA for fully vested tokens, then no 83(b) would be necessary and you would have a tax consequence on all the tokens under the RTA upfront.

5. Are there transfer restrictions?

Yes, through vesting and lock-ups.

6. How do you pay for it?

RTAs can be either purchased or received as compensation for services.

B. Restricted Token Units (RTUs)

1. What is it?

An RTU is akin to a restricted stock unit (RSU) in that an RTU is not an actual token but rather a contractual obligation to transfer tokens to the service provider in the future. You are issued tokens at the point of vesting. One unit is equal to one token.

2. When do you see an RTU used?

If the fair market value of the tokens would result in a material tax burden (i.e., if it would be too expensive for the contributors to make an 83(b) election because you have to pay taxes on the full value upfront), then that’s when you use RTUs. RTUs are most often used after a token is launched and in circulation (recall, most U.S. employees, consultants and advisors take RTAs pre-launch).

3. When does settlement happen?

Once the tokens vest, they will be delivered to the service provider’s wallet, but there could still be a transfer restriction via the unlock if the dates for the unlock and the vesting don’t align.

4. How are they taxed?

Service providers are taxed at settlement (i.e., delivery ), not when the RTUs are granted. With RTUs, you do not own the tokens until they settle in your wallet. Hence, there’s no option for an 83(b) election as there’s no property to elect on. The taxable amount is based on the fair market value at settlement, which also becomes your cost basis for future sales. Tokens are often issued on a net basis, meaning the company will sell a portion of your tokens to satisfy the taxes for each settlement date. There may be an option to structure it as deferred compensation and defer tax recognition, so it’s worth asking if that’s an option.

5. Are there transfer restrictions?

Yes, through vesting and lock-ups.

6. How do you pay for it?

Not really, you just earn them from working, which is why you pay taxes when you receive them.

III. Differences between Token v. Equity Comp

A. No 409A safe harbor.

Like equity, a token is valued for tax purposes by an independent, third-party valuation (from companies like Redwood or Teknos). In the equity context, people often refer to an independent valuation as a “409A Valuation” after Section 409A of the Internal Revenue Code, but while 409A Valuations last for up to 1 year, token valuations may go stale after 1 to 6 months – depending on the specific valuation company’s methodology and life cycle of the underlying company or token ecosystem. Unlike equity compensation, tokens probably don’t qualify as “service recipient stock” under Section 409A (meaning they probably aren’t treated like common stock by the IRS).

B. It bears repeating: tokens are not equity.

We may be wading into political territory here now, but objectively worth the risk. Here are a few reasons why:

  • Stock represents ownership of a company, and ownership means you have rights under the law as a shareholder (like the right to inspect the books, claim to the company’s assets, receive dividends, vote for major company decisions, etc.). Companies often have a board of directors who have a fiduciary duty to maximize shareholder value.

  • Tokens aren’t meant to bestow ownership of the company itself, so you aren’t entitled to any of those shareholder rights mentioned above. Rather, tokens are meant to support the development of and participation in a decentralized protocol (which is autonomous software, not a company). Protocols don’t have boards of managers who are obligated by law to maximize token value. In fact, public pronouncements by companies that they will dedicate themselves to maximizing token values may inadvertently trigger securities laws in certain jurisdictions. There are different types of tokens (utility, governance, security, etc.) and each token may offer some but not all of the following functions: access to services on the protocol, voting rights toward design of the protocol, etc. These are functions determined by innate, programmatic features of the underlying protocol, not legal prescriptions. Additionally, tokens can often be sold on public exchanges sooner than stock options, giving them an advantage in liquidity once restrictions are lifted.

C. Tokens are pseudonymous.

While stock ledgers track the name of a person or entity, token transactions on blockchain networks are typically linked to cryptographic addresses rather than real-world identities. This means that, unless specifically associated with an individual through Know Your Customer (KYC) processes or other off-chain methods, the identity of a token holder remains hidden.

D. Tokens can be more liquid than stock options.

The vast majority of startups fail, with over 95% failing in the 90’s and closer to 80% failing these days. So, unless there is an IPO, M&A deal or a company buy-back/tender offer, your options to purchase stock may be worth nothing at the end of the day, and due to transfer restrictions and limited ways to find a buyer, you may never have the opportunity to sell your shares and make money. Tokens, on the other hand, can be sold on public exchanges (decentralized or centralized) once they launch and any applicable restrictions are lifted.

E. Tokens are taxed the same as stock (for the most part).

Whether you get a bonus in stock or a bonus in tokens, both will be taxed (in the U.S.) as ordinary income upon receipt—the IRS treats the bonus as a receipt of property. After that point the token is generally viewed as a capital asset in the hands of the taxpayer (so capital gains treatment on disposition if you hold it for over a year). Similarly, whenever you get around to selling your shares (or tokens) you will be taxed based on the prevailing capital gains rate, as both are considered (usually) to be capital assets in your hands. That said, tokens are not eligible for qualified small business stock (QSBS) preferred tax treatment, so make sure you speak with a professional accounting advisor to understand your potential tax liability.

F. You may be granted a token interest or a token.

You may be granted either tokens outright or a right to receive tokens in the future. If you are issued tokens immediately, this functions much like a stock grant, and you may have the option to file an 83(b) election to accelerate taxation to the grant date. If you are instead only receiving a right to tokens later—typically tied to vesting or a network launch—you do not yet own tokens. In that case, the arrangement is more like an RSU: a contractual right that settles into actual tokens once the vesting or release conditions are met. If you are granted a token interest for unvested tokens, check with your tax advisor to see when it makes sense for you to file an 83(b).

G. Paperwork may be delayed.

Don’t be surprised, however, if your company doesn’t have a formalized token incentive plan: many companies believe that since their tokens are not regulated as securities, they can take the least operationally-intensive path forward, and give tokens directly to their team without robust token plan documentation. The existence or lack of an incentive plan shouldn’t be viewed negatively when you’re evaluating whether to accept a company’s tokens as part of your compensation, but you should inquire why the team chose one direction over another.

In many cases, a company will start solely by issuing equity to the team and later, once the company’s product is developed, they’ll create a token and issue some of it to their service providers. So, it’s possible you may start a gig at a company and not get any tokens until a point in the distant future, but your offer letter or service agreement may make an explicit promise of tokens if, and only if, tokens are ever created. Although, there is often no agreement nor specific promise, but rather just a handshake. What’s important to understand is that you are unlikely to ever see any sort of value associated with any token promises, as promising tokens with any kind of value pre-launch will likely cause tax risks (not tax advice).

Because token launches are complex and take many forms, you may not see any formal agreements until after the tokens are minted.3 That’s why the offer letter is very important as it may be the only document that serves as proof of a right to the token. It’s important to have an offer letter that outlines the comp structure and conditions.

H. Tokens are subject to lockups and vesting, which are 2 different types of transfer restrictions.

People often confuse lockups with vesting or use these terms interchangeably. Lockups refer to restrictions on transferability whereas vesting refers to whether or not the service provider has shed the risk of forfeiting or losing the tokens by satisfying the conditions imposed at the time of the token award. Both prevent you from being able to own the tokens “free4 and clear” of any restrictions.

Lockup refers to the period of time during which tokens cannot be sold or transferred. In many cases, the company maintains administrative custody of the tokens until they unlock.

Vesting refers to either the removal or lapsing of the company’s right to take back your tokens or the accrual of your rights to receive them. Unvested tokens, like unvested stock, are usually forfeited or repurchased upon termination of the individual’s service relationship with the company.

Once the token unlocks and is fully vested, the service provider has full control and ownership of the tokens underlying the token award in question and may hold or transfer/dispose of the tokens as they see fit. (But keep in mind you may have to pay taxes when you sell the tokens based on the difference between your basis in the tokens and fair market value when you sell them!)]

I. Transfer restrictions are enforced via smart contracts or custodians.

Transfer restrictions for tokens can refer to both the vesting and lockup (usually by mistake, when people are just speaking in shorthand). Typically, token agreements specify that tokens cannot be transferred until the later of when the vesting or lockup period is complete, partly because there could be a liquidity mismatch in non-83(b) scenarios. What do we mean by this? Since taxable income generally arises upon vesting, recipients without an 83(b) election may owe tax before they’re able to liquidate tokens. If a lockup is still in effect at vesting, this creates a liquidity mismatch that precludes sell-to-cover strategies (i.e., selling some tokens to cover your taxes). Once both conditions are met, the contributor can transfer their tokens to personal wallets or directly from company-controlled wallets. While your tokens remain subject to transfer restrictions, typically a third-party service provider (ex: Coinbase) will prevent you from transferring your tokens until the transfer restrictions lapse.

J. Typical timelines for lockups and vesting schedules.

The unlock / vesting schedules commonly do not track identically. Employee tokens are typically subject to a 4-year vesting period (but we have seen three years with some increase in popularity in recent years). The vesting schedule usually starts from your first day as an employee. If you receive tokens a few years after you join a company, the company will commonly give you vesting credit for your service to date. Often there’s a 1-year cliff (i.e., you have to wait 1 year to get a large chunk (25%) of the tokens), and the remaining will vest monthly over the remaining 3 years. Lockups tend to vary from 1 (in the case of liquidity providers, or other non-personnel ecosystem participants) to 4 years (for everyone else) in total, with the first tokens unlocking 1 year after the issuance of tokens or token launch.

Employees are typically subject to the same unlock schedule as all insiders (i.e. founders and investors). The 1-year cliff for lockup is done for securities law purposes (sometimes you’ll see 6 months for employees outside the US); in case tokens are deemed securities, then you need to have a holding period before the tokens could be sold to comply with securities laws. It can also be used to build confidence among a community of token holders: if employees/founders are able to sell quickly, the community may not have confidence that they’ll actually execute and just see it as a money grab. Lockups usually commence as of the TGE date, so depending on whether the token is live, the lockup and vesting start dates may not be the same. If the token launch has occurred, then the lockup probably begins when granted, and if prior to the token launch, it will begin at the token launch.

For consultants and advisors, you can expect a similar vesting and lockup duration. The only exception would be where you anticipate your relationship with the company to be shorter than 3 or 4 years, in which case vesting might be on an accelerated timeline (e.g., 1 year) but lockups would likely stay the same length as everyone else’s (particularly for a pre-launched token). If you’re only providing services for a few months or a year and are being offered tokens, be sure to ask for a vesting schedule that is commensurate to the amount of time you’ll be supporting the company.

K. Acceleration for tokens.

Recall that acceleration refers to the early vesting of equity upon certain events—usually a sale of the company or termination of employment. Double-trigger acceleration (DTA) (sale and termination) is more common and palatable to investors, while single-trigger acceleration (STA) (just the sale) is harder to get and often resisted; still, it’s worth asking for, especially if you are a key employee.

In the token space, DTA or STA are uncommon because there’s generally no change of control event that would interfere with token accrual rights; however, token accelerations upon termination do sometimes occur, though they’re typically not offered upfront and are instead provided as consideration for signing a separation agreement.

L. Withholding taxes are also a thing.

Tokens paid as compensation (as part of base compensation or bonuses) are subject to federal and state withholding taxes (employers can be secondarily liable for such taxes and face penalties if not paid). For RTUs, the project can either use net settlement, where tokens are withheld to cover taxes, or cash settlement, where the service provider receives all tokens and is responsible for paying the tax liability in cash by remitting cash back to the company equal to their tax obligation. Technically, the prior sentence could work for RTAs too, although in practice contributors almost always make 83(b) filings for RTAs and pay taxes upon issuance.

M. You may not be able to participate in governance until you vest.

As a stockholder, you can vote your shares whether vested or unvested (though not options or RSUs). Whether you can vote your unvested tokens depends on who possesses them. You may not be able to participate in governance with unvested tokens unless the tokens are in a wallet you control, or the company facilitates it. If you receive tokens under an RTA but the company continues to possess them pending vesting, you likely won’t be able to use those tokens to vote in governance.

IV. Tips and Nuances?

A. How to value what you are getting

With equity compensation, a company might promise you 0.3% of the fully diluted shares of the company. Similarly, token allocations are sometimes tied to your equity ownership percentage in the company given that it’s difficult to promise an exact number of tokens since companies often don’t know the total size of their token network at the time of grant. Sometimes, you may be allocated a fixed number of tokens pre-TGE, but that would usually be the case after the company knows the total supply and can vary depending on how close the company is to its token launch. Often, your ownership percentage of the token network will be based on a percentage of the company reserve (portion of the network reserved for insiders), rather than a percentage of the entire token network. Recently, we’ve been seeing a lot of companies use fair market value calculations when giving grants, calculated based on time- or volume-weighted averages.

Whether offered a hard number or percentage, that offer will likely look something like this:

  • Subject to Board approval and the creation of the anticipated cryptocurrency network, the company anticipates granting to you an award of tokens with the right to receive:

    • [your pro-rata share of the company’s token reserve native to such cryptocurrency network (based on your fully-diluted equity holdings in the company at the time of the Network Generation)] OR

    • [[_____] tokens native to such cryptocurrency network]

If you are receiving a hard number, you might want to ask what percentage of the fully diluted equity it represents so you have context. If the token is minted, but not publicly launched (i.e. you can’t see what it’s trading at), it’s fair to ask what the valuation is at the time you’ll be granted it.

If the token hasn’t been minted yet, consider looking at comparable protocols or networks to see how their value has grown or shrunk over time.

B. What happens if you leave the company?

If you leave or stop providing services to a company prior to the token launch, there is a risk that because there is no contractual obligation to issue your tokens, the company may not do so once the token is minted. Also, even if the company is willing to still issue your tokens, you may need to qualify for another securities law exemption that differs from what active service providers can rely on. Good to have a conversation with your company if you plan to leave about how they will do right by you, and get that in writing!

If you leave the company and your tokens are only partially vested and partially unlocked, the company has a right to repurchase any RTAs that are unvested usually for a nominal value. For RTAs, if an 83(b) election is made and unvested tokens are forfeited, the taxes paid upfront are generally non-refundable. For RTUs, the unvested portion simply wouldn’t settle to your wallet.

C. What if I’m a non-U.S. person?

RTAs and TPAs are primarily for U.S. service providers due to specific tax elections available in the U.S. and UK, like the 83(b) election, which allows tax payments at the time of award rather than vesting. Outside the U.S. and U.K., RTAs and TPAs don’t offer the same tax advantages. Service providers in other regions generally use RTUs, which don’t allow the same tax optimizations as RTAs and TPAs. If you are a non-U.S. person who plans to become a U.S. tax-resident during the vesting period, you may want to file an 83(b) anyway.

For non-U.S. persons, token grants can be taxed very differently depending on jurisdiction — potentially at receipt, vesting, or sale, and sometimes regardless of liquidity. In some countries, employer withholding rules may apply or treaty relief may be available. Generally, tokens paid to non-employee service providers don’t require a company to withhold tax (there’s no withholding on consultants or advisors). Recipients should confirm local tax treatment before accepting tokens, especially if they are mobile employees or may relocate during the vesting period.

V. Glossary of Key Terms

  • 83(b) Election: Under the Internal Revenue Code, recipients of property can elect to be taxed at the time they receive the property—on the spread between fair market value and purchase price—rather than at vesting. For token grants, eligibility for an 83(b) election (or equivalent in other jurisdictions) may determine the form of award issued, due to differing tax treatment.

  • Acceleration: Acceleration means your vesting happens faster than originally planned. This can occur under certain conditions, such as the sale of the company (a “change of control”) or if you’re terminated without cause. For example, “double-trigger acceleration” requires both a sale and termination to accelerate vesting, while “single-trigger acceleration” requires only one of those events.

  • Capital Gains vs. Ordinary Income: When you first receive or vest in tokens, their value is generally taxed as ordinary income—like a paycheck. Later, when you sell those tokens, any increase (or decrease) in value is treated as a capital gain (or loss). The rate you pay depends on how long you held the tokens: gains on tokens held more than a year usually qualify for lower, long-term capital gains tax rates.

  • Cliff: The cliff is the initial period before any of your tokens start to vest. For example, if you have a one-year cliff on a four-year vesting schedule, none of your tokens vest until you’ve completed one full year of service—at which point a chunk (often 25%) vests all at once. After that, vesting typically continues monthly or quarterly.

  • Custodians: It’s become more common for companies to use custodians instead of smart contracts for token compensation. A company will set up a qualified custodian/wallet for each contributor and use services like Coinbase Institutional, Copper Custody, LiquiFi, Magna, or Toku to manage vesting and lockup.

  • DevCo (Development Company): The Development Company or DevCo is the traditional legal entity—often a corporation or limited company—that builds and maintains the decentralized project or protocol. It’s separate from the decentralized network itself, which may be governed by token holders or a DAO.

  • Governance Rights: Governance rights to tokens enable holders to participate in decision-making processes on the blockchain, such as voting on protocol updates or network changes. These rights may be restricted until tokens vest or lock-ups expire. Companies may build in restrictions on service provider governance rights into the token comp paperwork and the smart contract.

  • Lockup: A lockup is a set period of time when you’re not allowed to sell or transfer your tokens. During this period, the company often holds the tokens programmatically for you until they “unlock.”

  • Minting: This is the process of creating new tokens and first circulating them on a blockchain.

  • Smart Contract: Think of a smart contract as software code that automatically executes whenever certain conditions exist. Like a vending machine, if you put a dollar into it and select a beverage, the machine knows to release that specific drink. Using the word “contract” is a bit of a misnomer. It’s not a legal contract per se, but the idea is that it enforces the terms written into the code without needing intermediaries.

    • In the context of token compensation, companies may use smart contracts to automate the vesting and unlock of tokens. The smart contract in this example will hold the tokens in escrow until they are released once vesting/unlock milestones occur.

  • Settlement: This refers to when tokens are delivered to the participant upon meeting certain conditions. Some companies bifurcate vesting and settlement events for administrative ease. E.g., you may vest on May 12th, but the company may do monthly token deliveries on the last day of each month or quarter.

  • Token Generation Event (TGE): The event in which tokens are created or “minted” by the company. For tokens that are not yet live, service providers generally receive tokens shortly after the TGE, which can be subject to vesting and lock-up periods.

  • Token Launch: This is the date when tokens are first sold to non-insiders (i.e., service providers and existing company investors). Service provider lockups are commonly measured from the Token Launch rather than from the date of issuance.

  • Vesting: Vesting is about earning the right to fully own your tokens. It means the company can no longer take them back once you’ve met certain conditions—like staying with the company for a set time or achieving specific milestones. Unvested tokens, like unvested stock, are usually forfeited or repurchased if you leave before they vest.

  • Withholding / Net Settlement: When tokens are treated as taxable compensation, the company may need to withhold taxes. In a net settlement, the company keeps or sells a portion of your tokens to cover the tax amount before transferring the rest to you. Alternatively, you might be required to pay the taxes in cash.

* * *

Token comp is still pretty new so the landscape is constantly evolving so make sure to seek out advice from a competent lawyer and/or tax professional.

Good luck!

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Special thanks to the following people who reviewed this article in their individual capacities: Chris Ahsing, Jordan Blum, Bryan Edelman, Jonathan Edwards, Benjamin Helfman, Lindsay Lin, Nima Maleki, David Safren, Lee Schneider, Darin See, Zack Skelly, Demetrios Stellatos and Connor Tweardy

VI. Sources:

Disclaimer: This post is for general information purposes only. It does not constitute legal or tax advice. This post reflects the current opinions of the author(s) and are for educational purposes only. The opinions reflected herein are subject to change without notice.

Images: All original images are AI-generated with using a combination of Dall-E, Firefly, DreamStudio and Pixlr.

1

There are obvious exceptions, including, for example, tokenized stock, which is literally just shares that have been digitized and can be transferred on a blockchain rather than through a brokerage.

2

Governance tokens allow holders to vote on protocol upgrades or treasury use, but they don’t have enforceable ownership or profit-sharing claims under corporate law the way stock does. They also do not result in unilateral control: tokenholders can only influence the parameters that were hard-coded into the project’s governance framework at inception. Voting stock, on the other hand, is a legal equity interest: it carries statutory rights, fiduciary protections, and economic entitlements.

3

Some law firms will create token documentation before a token is minted, but those may be structured as future token interests. Other firms may take the position that you can't file an 83(b) until you have dominion and control over the token itself.

4

Note: taxpayer may still have tax ownership of the property even if subject to certain restrictions, which may impact timing of taxability upon receipt and holding period.

]]><![CDATA[Building a “Sustainable Sandbox” for Crypto ]]>https://www.thelawverse.com/p/the-mad-science-of-regulatory-innovationhttps://www.thelawverse.com/p/the-mad-science-of-regulatory-innovationTue, 21 Jan 2025 01:50:56 GMT

As happens with every election cycle, some are left cheering, some left crying, and some not really caring either way. Well, look on the bright side. As the great pop rock group Semisonic once said, “Every new beginning comes from some other beginning’s end, yeah.”

The new Trump administration is expected to trigger a legal reset and systemic shift in policy around innovative industries. However, regulating sectors such as blockchain and AI is hard. How does one even begin to write laws for new industries without stifling their growth while at the same protecting consumers?

Enter: regulatory innovation!

Now, you may say, “I thought the law was designed to be slow-moving and therefore, is inherently antiquated?” That presumption is wrong. In fact, we have a legal tradition of innovation through many different devices, such as regulatory sandboxes (aka sandboxes), no action letters, and safe harbors. These tools create flexibility in old laws and regulations so the law can adapt to new products and services.

Such legal innovation serves as a crucial bridge, offering a dynamic way to allow regulations to keep up with technological advances. This is particularly pertinent in areas like digital assets. Regulatory innovation offers flexibility allowing laws and rules to evolve alongside technological progress. This gives emerging industries clear and actionable guidelines, thereby minimizing the risks of stifling innovation while simultaneously protecting consumers. By embracing regulatory innovation, we can address the inherent challenges of regulating new and fast-changing industries effectively.

One powerful tool is the regulatory sandbox—a policy framework for implementing regulatory innovation while maintaining oversight. However, current regulatory sandboxes are far from perfect for innovative technologies. The ideal regulatory sandbox should take aspects from other similar policy tools like safe harbors and no action letters to offer a more comprehensive approach.

In this article, we’ll explore how regulatory innovation tools like regulatory sandboxes, no action letters, and safe harbors can effectively regulate innovative industries such as blockchain and AI by offering a dynamic framework that adapts to technological advances while balancing growth and consumer protection.

As crypto technologies revolutionize financial systems through decentralized networks and digital assets, traditional regulatory frameworks often fall short. Policymakers can address this by reforming laws and regulations to incorporate the flexibility of regulatory sandboxes, the broad applicability of safe harbors, and the tailored clarity of no action letters. This integrated framework would support sustainable innovation, ensure regulatory clarity, and position the US as a global leader in the crypto and AI sectors. Finally, we’ll propose a blueprint “Sustainable Sandbox” for the crypto industry.

Roadmap:

I. What Are Regulations? How Are They Different from Laws?
     a. Regulatory Sandboxes
     b. No Action Letters
     c. Safe Harbors

II. Regulatory Sandboxes in Practice
     a. Common Issues with Regulatory Sandboxes

III. Designing the Ideal Sandbox
     a. Our Recommendation for Redesigning the Sandbox for Digital Assets: The Sustainable Sandbox
     b. How Our Sustainable Sandbox Would Align With “FIT 21”
     c. Why There Is a Need for a Sustainable Sandbox Program Now

IV. Final Thoughts

V. Resources

I. What Are Regulations? How Are They Different from Laws?

Let’s begin with understanding what regulations really are.

Congress passes a law and delegates authority to an agency to carry out that law, including by promulgating new rules (the regulations). Think of it as your boss who gives you a task but doesn’t tell you how to get it done—you have to figure it out. Same thing here. In general, the government uses three different approaches to regulate industries:

  1. A command and control regulation is when the government dictates a specific policy goal and controls the way to achieve it (like a micromanager). For instance, in the context of vehicle safety standards, the government may dictate the exact dimensions of a testing dummy required to meet car testing safety requirements.

  2. Performance-based regulation, on the other hand, is when the government sets a standard but allows flexibility in how to meet its standard. As an illustration, a regulation could set a car emission threshold for reducing CO2 emissions but not dictate the emission-reducing technology used to achieve that goal.

  3. A management-based regulation is when the government sets a broad policy goal but allows the regulated entity to set its own standards and means to achieve that goal. For example, a regulation may require offshore drilling companies to develop a program designed to reduce environmental hazards like oil spills.

Despite what one may think, many legitimate (and particularly large) businesses generally like regulations because they reduce competition from new entrants. Indeed, becoming regulated is one of the oldest tricks in the book. By building a regulatory “moat” around a business model, regulated incumbents raise the cost of entry to their respective industries. While the main purposes of regulations are to create fair markets and protect the public, a key outcome is that not all businesses and activities are created equally, and you don’t want to regulate our startups and emerging companies and projects out of business.

Regulations make great moats!

Now, let’s explore the various tools the law has for regulatory innovation.

a. Regulatory Sandboxes

Commissioner Hester Peirce has a been a proponent of regulatory experimentation like safe harbors and regulatory sandboxes.

A regulatory sandbox is a framework set up by a regulatory authority that allows startups and other businesses to conduct live experiments in a controlled environment under the regulator’s supervision. Businesses apply to the sandbox to seek waivers for certain laws that, while technically applicable, may not align with their innovative activities. The goal is to enable experimentation with new products and services outside the strict confines of traditional regulations—without eliminating oversight..

Instead, the regulatory sandbox provides a controlled environment where businesses can collaborate with regulators to test their ideas, while still adhering to certain baseline standards to ensure consumer protection and financial stability. This collaboration allows both parties to identify which regulations may need to be adapted or clarified, balancing innovation with accountability.

A regulatory sandbox serves as a tool for identifying outdated regulations and accelerating innovation. By allowing businesses to test their ideas under controlled conditions, it ensures oversight remains in place to protect consumers. Entrepreneurs benefit from a regulatory waiver lasting two to three years, enabling them to innovate freely. In return, the sandbox generates critical data to assess whether the waived regulations should be reformed or repealed. Without such a mechanism, unnecessary or impractical regulations would remain in force, stifling progress and innovation.

The UK, along with several US states, have adopted financial technology sandboxes. The UK’s Financial Conduct Authority’s Regulatory Sandbox has seen greater success, not just in participation but also in fostering innovation and collaboration, attracting a diverse range of entities, from large law firms to cryptocurrency projects, and enabling them to test new ideas within a structured regulatory framework.

b. No Action Letters

A no action letter is a written communication from a regulator to a company or individual who has asked the regulator whether a specific product or service implicates any regulations. If a company receives a no action letter, it’s an indication that the agency will not take enforcement action against the requester based on the facts described in a specific request. The letters are tailored to a very specific activity and may come with conditions.

While no action letters do not have the force of law and are not binding on the regulatory body, they can provide valuable guidance on regulatory compliance and are often used in areas of emerging business practices or where regulations may be ambiguous. However, they are also revocable at the discretion of the agency, which can leave a business scrambling to comply with an agency’s new regulatory stance. As an example, the state of California issued several no action letters concerning the registration requirements of cryptocurrency businesses that could have arguably qualified as money transmitters and thus been required to comply with burdensome regulatory requirements.

Department of Business Oversight No Action Letter re money transmission licenses for crypto project.

One recent letter described how a virtual currency exchange that purchases and sells virtual currencies directly with customers is not engaging in money transmission. With that no action letter in hand, the business could operate with a clearer understanding of its legal obligations and reduced risk of regulatory action. These letters, however, are very fact-specific, analyzing each discrete business model.

c. Safe Harbors

Lastly, a safe harbor is a law or regulation that states that if you perform certain actions, you are guaranteed not to be breaking the law. This is particularly useful in complex regulatory areas where the risk of non-compliance can be high and the rules may be open to interpretation. Unlike regulatory sandboxes, safe harbors are automatic (not needing an application and approval). Unlike no action letters, safe harbors have pre-defined criteria that must be met to qualify for the safe harbor.

One prominent safe harbor is Regulation D (“Reg D”), which establishes various requirements under which securities issuers can offer and sell securities without needing to register them with the Securities and Exchange Commission (“SEC”).

Reg D safe harbor language

By adhering to these guidelines, issuers can ensure that they are in compliance with SEC regulations governing securities registration, protecting them from potential enforcement actions due to non-compliance. This safe harbor is especially important in the securities market because it provides a clear way for issuers to meet complex legal and regulatory expectations and reduce the significant risks of non-compliance.

It’s important to note that these definitions can be fluid, and one tool for regulatory innovation can resemble another. Ultimately, the effectiveness of the design is more important than the terminology used to describe it. Rather, to design the ideal regulatory sandbox, one must take the best parts from these other policy tools.

II. Regulatory Sandboxes in Practice

While current regulatory sandboxes are specifically designed for regulatory innovation, they still lag behind no action letters and safe harbors in terms of efficacy and prevalence.

a. Common Issues with Regulatory Sandboxes

Several factors hinder the effective use of regulatory sandboxes, including a (1) narrow scope, (2) limited duration, and (3) high regulatory costs. However, these issues could actually be mitigated by incorporating elements from the safe harbors and no action letters.

(1) Scope: Regulatory sandboxes apply only to entities that meet strict conditions and are approved, unlike safe harbors, which automatically exempt all compliant entities. Adopting a more permissive model that would allow for more participants to enter the program, similar to safe harbors, could eliminate burdensome application processes and broaden accessibility.

(2) Duration: Regulatory sandboxes often have limited or uncertain timelines, requiring recertification. In contrast, safe harbors remain effective until enabling laws are amended. Regulatory sandboxes should offer longer or indefinite durations to provide businesses with greater stability and certainty.

(3) Cost: Regulatory sandboxes are resource-intensive for regulators, while safe harbors are cost-efficient, applying automatically without ongoing oversight. A streamlined, safe-harbor-like approach could significantly reduce costs.

In essence, the “ideal” regulatory sandbox should functionally resemble a more engaged safe harbor!

This table illustrates, at a high level, how each policy tool generally fares in each goal

III. Designing the Ideal Regulatory Sandbox

Regulatory sandboxes are not common in the US. Admittedly, no federal regulator currently has a viable regulatory sandbox program for innovative industries, and the few state sandboxes are still not fit for sustainable regulatory innovation, especially in the digital assets industry.

We propose a new “Sustainable Sandbox” for the crypto industry that fast-tracks supervised innovation of digital assets.

a. Our Recommendation for Redesigning the Sandbox for Digital Assets: The “Sustainable Sandbox”

Let’s roll up our sleeves and dive into the practical work of designing the ideal regulatory sandbox. This enhanced regulatory sandbox, a “Sustainable Sandbox,” should integrate the best features of existing frameworks while significantly adapting to the dynamic nature of the cryptocurrency sector.

Phase 1: Sandbox Enrollment

  • Simplified Automatic Enrollment: Registration for sandbox participation should be streamlined to a simplified checkbox form. The focus should be on fulfilling the basic requirements in the form and basic compliance (e.g., appointment of a chief compliance officer) rather than substantive evaluation of the underlying business model or technology.

  • Management-Based Approach to Design: For businesses that don’t fit the traditional compliance structures in the checkbox form—such as decentralized exchanges or decentralized autonomous organizations (DAOs)—an alternative management-based approach would allow participants to develop their own compliance frameworks. Regulators should set broad policy goals, such as transparency or fraud prevention, and participants can then propose their own standards and methods to meet those goals, subject to regulatory approval. This flexibility accommodates innovative and decentralized models while ensuring oversight. By focusing on outcomes and collaborating with industry stakeholders, regulators can address technological knowledge gaps while promoting effective compliance.

Phase 2: Sandbox Oversight

  • Exemption During the Sandbox Period: To encourage participation and avoid deterring projects, participants should operate under a presumption of exemption from certain regulations, allowing them to innovate without the burden of potentially inapplicable laws. Clear guidelines upfront can alleviate concerns, though this exemption should not preclude enforcement of fraud or UDAP/UDAAP claims (i.e. unfair, deceptive or abusive business practices that harm consumers), ensuring protections against deceptive practices remain intact.

  • Annual Reporting for Ongoing Oversight: Participants should be required to submit annual reports detailing specific operational aspects, such as cybersecurity incidents. This will ensure ongoing oversight and responsiveness to emerging risks without stifling innovation. It also allows for the collection of metrics to measure the effectiveness of the sandbox.

Phase 3: Sandbox Exit

  • Transition to a Safe Harbor: The regulator in charge of the sandbox should, if it is able to, use the information the sandbox provides to create a tailored, sensible safe harbor once the sandbox ends. This would provide a stable, long-term framework for continued operations while ensuring compliance with the newly established rules.

  • Issuance of No-Action Letters as a Contingency: If the regulatory framework remains uncertain at the end of the sandbox, participants should alternatively be issued no-action letters. These letters would provide assurance that the regulator will not pursue enforcement actions against entities that continue operations under the terms established during the sandbox. This approach offers a more permanent and predictable pathway for participants, making the initial investment in the sandbox worthwhile.

By adopting these parameters, the next US crypto regulatory sandbox could serve as a powerful tool for fostering innovation and growth in the cryptocurrency sector. This approach would align regulatory frameworks with the rapid pace of technological advancements, ensuring that the US remains at the forefront of the crypto industry while maintaining robust consumer and market protections.

b. How Our Sustainable Sandbox Would Align With “FIT 21”

The Sustainable Sandbox offers a pathway to address one of the most contentious debates in blockchain regulation: defining and measuring decentralization. Decentralization, a cornerstone of blockchain technology, promises enhanced security and privacy through distributed networks, but its regulation has proven divisive. The decentralization test outlined in the current draft of the Financial Industry Transparency for the 21st Century Act (“FIT 21”)–the leading legislative proposal aiming to regulate much of the crypto industry–has sparked widespread debate within the sector over what truly constitutes decentralization and how it should be regulated. This discord among industry players poses a significant challenge: if the crypto industry itself struggles to reach a consensus, how can lawmakers be expected to create effective regulations? That’s where the “Sustainable Sandbox” comes into play.

The Sustainable Sandbox would act as a bridge between innovation and regulation, offering a structured environment to address the decentralization debate while fostering experimentation and data-driven policymaking. Participants in the regulatory sandbox would be able to test their models of decentralization under real-world conditions without the fear of immediate regulatory enforcement. This would allow both the industry and regulators to collaboratively identify practical frameworks that balance innovation with compliance. Participants would gain the opportunity to refine their decentralized technologies while providing regulators with data-driven insights.

The Sustainable Sandbox would use a management-based approach to ensure flexibility and inclusivity for a wide range of participants. While a standard check-box filing system might suit many businesses, the management-based model would accommodate more innovative or decentralized entities that fall outside traditional regulatory frameworks. For example, a decentralized exchange without a conventional corporate structure—such as a c-suite or chief compliance officer—would not align well with standard regulatory processes. Instead, the management-based approach would allow the regulatory sandbox regulator to set high-level policy goals, like promoting transparency, mitigating risks, and ensuring consumer protections, while participants design their own standards and methods to achieve these objectives, subject to regulatory review and approval.

This approach ensures that the regulatory sandbox supports diverse business models, particularly those leveraging decentralized technologies, while maintaining oversight aligned with broader policy objectives. The Sustainable Sandbox would serve as an experimental platform to:

  1. Define and Measure Decentralization: Develop clear, industry-supported metrics that define what decentralization means in various contexts within the crypto space. This includes tailoring distinct tests to assess decentralization across different market participants, ensuring that the criteria are relevant and appropriately stringent for each sector, whether they be layer 1s, applications, or DAOs.

  2. Assess Regulatory Fit: Evaluate how different levels of decentralization interact with existing legal frameworks to determine if adjustments are necessary.

  3. Influence Policy Development: Provide lawmakers with concrete data and insights into how decentralized technologies operate, supporting more informed legislation and regulation.

By adopting this management-based approach, the Sustainable Sandbox creates a thoughtful and iterative pathway to regulation, avoiding rushed or premature decentralization frameworks that could harm innovation or market stability. It ensures that both regulators and the industry are equipped to address the evolving challenges of decentralization and digital asset innovation.

In the dynamic landscape of blockchain and cryptocurrency, the importance of regulatory timing cannot be overstated. As we face the prospect of new administrations potentially reshaping the regulatory environment, there is a significant opportunity to influence the trajectory of policy development. However, this window should not compel us to rush into premature regulatory frameworks that could have long-term negative impacts on innovation and market stability.

c. Why There Is a Need for a Sustainable Sandbox Program Now

The need for regulatory innovation stems from two incentives: a “carrot” for businesses and a “stick” for regulators.

Innovative industries like blockchain and AI struggle with outdated legal frameworks that fail to address novel challenges. These industries seek regulatory certainty—a “carrot” that fosters innovation and compliance by providing clear rules. Tools like the Sustainable Sandbox allow companies to grow within legal boundaries while building accountability and trust. At the state level, stringent agreements with regulators show how structured frameworks can balance innovation and oversight.

Meanwhile, regulators face a “stick” from the Supreme Court’s decision in Loper Bright Enterprises v. Raimondo (2024) (see prior article), which limits courts' deference to agencies’ interpretations of their own authority. This decision shifts power toward highly regulated industries, granting them greater influence over how they are governed. Courts now independently assess an agency’s authority, reducing reliance on agency interpretations.

The power shift between agencies and industry requires agencies to adjust their practices and creates opportunities for more collaborative governance between agencies and industries. The Sustainable Sandbox is ideal for this task. Now is the time to implement the Sustainable Sandbox collaboratively, adapting to the new regulatory landscape.

IV. Final Thoughts

As technology advances, regulations must evolve to keep pace. Sandboxed environments provide controlled spaces for regulators to test ideas, gather data, and refine governance strategies for new technologies. Our Sustainable Sandbox proposal a forward-thinking framework, resilient to rapid innovation and designed to adapt alongside technological progress.

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[Special thanks to Bryan Edelman, Jane Perov, Sam Reynolds, and Sam Silverberg.]

V. Resources

]]><![CDATA[LawBurst: U.S. Uniform Commercial Code Gets an Upgrade for Digital Assets]]>https://www.thelawverse.com/p/lawburst-us-uniform-commercial-codehttps://www.thelawverse.com/p/lawburst-us-uniform-commercial-codeThu, 29 Feb 2024 18:46:23 GMT

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[What is a LawBurst?   A short, information-packed legal article that’s a roughly written breakdown of something interesting. 

I found myself re-reading and re-listening to some great legal minds out there about Article 12 of the Uniform Commercial Code (shout out to Drew Hinkes, Carla Reyes and Andrea Tosato).  Forget the steam engine, the printing press or the iPhone -- legal innovation is super cool.  Enjoy!]

[Created by Benjamin Franklin in 1754, the “Join or Die” Flag urged colonial unity and warned of the dangers of disunity during the French and Indian War.  During the American Revolutionary War, it became a symbol for resistance to British rule. We’ll see why apropos for how the Uniform Commercial Code works.]

Background:  How Commercial Law Works in the US

In contrast to many other countries, the United States does not operate under a centralized system of federal commercial laws. To address this and foster consistency throughout the country, the Uniform Commercial Code (UCC) was introduced in 1952. This groundbreaking initiative, undertaken collaboratively by the Uniform Law Commission (ULC) and the American Law Institute (ALI), established a standard set of commercial law that could be applied anywhere in the US enhancing the predictability and efficiency of commercial transactions.

How does it work?  The UCC is proposed, model legal language on which each US state can base its commercial laws (i.e. it’s suggested text for legislators to adopt and implement in their respective states).  Unless a state decides to copy and paste the UCC text into its laws, it will have no legal effect.  The state legislature must pass it into law.  Often, states will adopt pretty much word for word the model language, but that’s not always the case.  In practice, every state and most independent jurisdictions within the U.S. have adopted most, if not all, of the UCC.

Who writes it?  Legal experts (judges, legislators and law professors) in collaboration with the American Law Institute draft the UCC text, and over the years, they’ll come up with new language (either as an update to prior text or as a whole new subject matter) so that the law evolves with the times.

What does it cover?  Over the years the UCC has come to address various topics in commercial law, including sales and leases, negotiable instruments, bank deposits and collections, letters of credit, bulk sales, documents of title, investment securities, and secured transactions.  From time to time, the UCC model language is amended or augmented.  In 2022, the latest amendments introduced coverage for secured transactions of digital assets.  Let’s double click on this topic.

What Is a Secured Transaction?

A secured transaction is a loan in which the borrower gives an asset (collateral), which the lender can take in case the borrower can’t pay back the loan (defaults on the loan).  The collateral is a security interest that gives the lender a Plan B (seize the collateral) in case the borrower defaults.

Article 9 of the UCC governs secured transactions and lays out the mechanics for how a secured transaction properly works.  In order to have a 100%, no take backs security interest in the collateral for a loan, a security interest must both (1) attach and (2) be perfected.  You can think about attachment and perfection as the legal shield against (i) the borrower and (ii) the world, respectively.

Attachment:  For a security interest to attach, the lender needs 3 things to happen:  (i) the lender must give something of value for that security interest (like money), (ii) the borrower needs to have rights to the collateral or the power to transfer it to another party and (iii) the borrower must sign a written, security agreement.  That secures your rights to collateral -- at the borrower level.

  • Perfection:  The proper method of perfecting a security interest depends on the type of asset being used as collateral.  Potential methods include (i) filing a financing statement (known as a UCC-1 form) with a filing office, (ii) possessing the collateral, (iii) having control of the collateral, or (iv) happening automatically.  As an example, cash can only be perfected by possession, and goods can be perfected either by possession or filing a financing statement.  Perfecting an asset correctly, secures priority over an asset ensuring the lender’s claim supersedes all others.  Here’s an example of a financing statement for Texas.

What type of asset was a cryptocurrency?  There was a catchall category of assets known as “general intangibles” under UCC Article 9, which was meant to include an asset that couldn’t be physically controlled or possessed (ex. accounts receivable, proceeds, patents, trademarks, goodwill, etc.).  Security interests in which intangibles were used as collateral could only be perfected by filing a financing statement with the filing office. Because cryptocurrencies were deemed “general intangibles,” filing was the only way to perfect the security interest in a token.  However, the preferred method for perfecting security interests with crypto as collateral changed with the 2022 updates to the UCC, which revised the existing Article 9 and introduced a new Article 12.

UCC Article 12 (Controllable Electronic Records)

Article 12 of the UCC provides a legal regime for digital assets by introducing a new category of assets known as controllable electronic records (CER), which is a “record stored in an electronic medium that can be subjected to control under [the article].”  To be clear, these model rules have nothing to do with whether crypto is a security or a commodity, tax rules, sanctions laws, or anything else like that.  Its purpose is to provide standardization of commercial transactions of digital assets across the country.  Most cryptocurrencies, tokens, stablecoins, and NFTs would likely be classified as CERs. 

How do the 2022 updates to the UCC fix the perfection issue with crypto?  Instead of having to file a UCC-1 statement, control is the preferred method of perfecting a secured interest in a CER.  Control exists when a holder:

  1. can access and enjoy nearly all of the benefits derived from the CER;

  2. possesses the “exclusive power” to prevent others from enjoying “substantially all the benefit” of the CER; and

  3. holds the sole right to transfer control over the CER. It is important to note that control is not revoked when shared consensually or facilitated by technology, such as by using a multi-sig transaction. 

So now, under the new UCC model rules, you can perfect a secured interest through control.  You also have the option to identify yourself as the person having control either by name, cryptographic key or account number. 

What else does Article 12 do?  Great question!  Under Article 12, CERs can have many of the attributes of negotiable instruments.  Negotiability refers to a feature of financial instruments that allows them to be transferred without any competing claims.  Before the updates, anyone who acquired a token from another person (known as an onward transferee) could never truly be sure they owned said token free and clear unless they checked for a filed financing statement.  But with the new amendments, CERs have increased transferability.  Let’s give two common property law examples:  the “shelter rule” and the “take free rule.”

  • Under the shelter rule, purchasers of a CER obtain whatever rights to the property the original transferor had or had the power to transfer. 

  • Under the take free rule, a purchaser who takes control of a CER for value, in good faith, and without notice of a prior claim to the property (a qualifying purchaser) obtains the interest in the CER free of any restrictions of ownership (encumbrances).

The design of cryptocurrencies and the expectation of its users is for crypto to trade freely, and the default rules for intangibles just didn’t work in practice.  Ingeniously, the UCC amendments uphold the decentralized ethos of cryptocurrencies, ensure secured lenders can legally operate as the rest of the industry, and safeguard the unencumbered transferability of crypto. In other words, the UCC has caught up to the technology.

Why doesn’t filing a financing statement work for crypto?  People treat cryptocurrencies as bearer-like assets that free flow between parties.  A bearer asset is one that can be freely traded and whomever is in possession owns the asset (like gold or cash).  In other words, you don’t need to record ownership or have paperwork to prove ownership; possession indicates ownership.  In practice, people in crypto extending loans with tokens as collateral don’t tend to perfect their security interest by submitting a financing statement.  Web3 degens like to say that “code is law” meaning that you can rely on the code to automatically carry out the rules of the system.  Digital ecosystems have designed their own practices and sets of rules to define the distribution of powers within a system without needing to rely on contractual enforcement.

Why is it so important to properly perfect a security interest in crypto collateral?  Although there may be a desire for crypto systems to operate independently from the boring, grown-up world, failing to update laws to accommodate new technologies risks adverse outcomes.

One example, crypto secured lenders run the risk of being unperfected secured lenders if they don’t properly perfect collateral and the borrower were to default on a loan.  If a second lender took a security interest in the same collateral as the first lender and s/he properly perfected it, the second lender could have a first priority right to the same collateral. For the lender who holds a token but hasn't filed a financing statement (trying to rely on possession as the method of perfection), s/he would be considered an unperfected secured lender.  That means you lose the collateral to the party who properly perfected, or if the borrower went bankrupt, you’d have to deal with the bankruptcy process.

Second example, improperly perfected tokens would lead to an onward transferee receiving encumbered or partial property rights without the take free rule and shelter rule described above.  As a result, tokens would be less transferable and ownership or rights to the tokens could be fragmented.

Conclusion:  Let’s Put the Uniform in “Uniformity”

[From the UCC:  As of February 2024, above shows the states that introduced or enacted the UCC amendments (including Article 12  amendments.]

As of February 2024, the 2022 UCC amendments have been adopted by 12 states and introduced in 15 others. However, some states like Florida and South Dakota have opted out because they also address central bank digital currencies (CBDCs).  Under the model rules, CBDCs are not CERs but have been classified as “electric money,” which is defined as a “medium of exchange that is currently authorized or adopted by a domestic or foreign government.” 

According to law professors Carla Reyes and Andrea Tosato, such actions are politicizations of what should normally be non-controversial updates to the commercial code and indicate a fundamental misunderstanding of commercial law.  Not providing clear rules around digital assets just hurts crypto users in those states.  Please read more about that here and here.

[Spread the word to your local governments!]

Just as vaccines are most effective when administered widely to establish herd immunity, the efficacy of the UCC’s model rules is maximized when adopted by all 50 states, creating a harmonized framework of commercial law throughout the nation. It streamlines transactions, reduces costs, eases dealings, simplifies paperwork, reduces uncertainty, and brings order to a previously chaotic system.  Until the 2022 amendments pass across the country, we’ll have to deal with a patchwork of differing rules.

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Disclaimer:  This post is for general information purposes only. It does not constitute legal advice.  This post reflects the current opinions of the author(s).  The opinions reflected herein are subject to change without being updated.

]]><![CDATA[How Could SVB File For Bankruptcy And Be Under Receivership? Implications for Crypto]]>https://www.thelawverse.com/p/how-could-svb-file-for-bankruptcyhttps://www.thelawverse.com/p/how-could-svb-file-for-bankruptcyThu, 13 Apr 2023 16:55:30 GMT

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In the words of the poet Robert Frost, “Nothing gold can stay.”  The collapse of Silicon Valley Bank (SVB) left many of us in the tech world shell shocked.  SVB was a key player in the startup ecosystem for decades so it’s sad to see the end of an era.  With the Federal Deposit Insurance Corporation (FDIC) agreeing to backstop all deposits and later brokering a deal to sell SVB to First Citizens, we can all take a collective breath, switch off our panic buttons, and find a teachable moment. 

The news coverage during the weeks that SVB collapsed did not explain very clearly how SVB could both be under receivership with the FDIC and file for bankruptcy at the same time.  How exactly does that work?  Without further ado, let’s double click to understand what it means to file for bankruptcy vs. being put into receivership, the impact of each path, and why it matters, particularly for consumers and crypto. 

Difference between Bankruptcy and Receivership

Bankruptcy

Most companies that need to go through an insolvency process file for bankruptcy under the US federal bankruptcy code.  Filing for bankruptcy allows a company to seek relief for debt obligations it’s unable to honor by coming up with a plan to (i) repay debt and (ii) either stay in business or dissolve completely.  To clarify some definitions, a debtor is the party that files for bankruptcy, and a creditor is the party to whom a debtor owes money. 

Failing companies (debtors) can choose to file for bankruptcy themselves or they can be forced into bankruptcy by their creditors.  Bankruptcy cases are governed by federal law and thus processed through federal courts where a judge ultimately determines whether a debtor may file for bankruptcy and, if so, whether the debts can be forgiven.  Often times, the case will be handled by a bankruptcy trustee who is appointed by the Department of Justice’s US Trustee Program.  Trustees are in charge of collecting as much money from the bankrupt company’s estate (all the property of the debtor, which includes what it owns and what it controls) and dispersing it to creditors.  Sometimes, instead of a trustee, a Chapter 11 debtor will keep the business running itself on behalf of creditors (called a debtor in possession (“DIP”)), and a group of creditors (called a creditors committee) will monitor the activities of the DIP.  This is what’s happening with the FTX bankruptcy.

FDIC: Federal Deposit Insurance Corporation

Receivership

Per the US bankruptcy code (11 U.S.C. § 109(b) and (d)), certain persons may not file for bankruptcy under Chapter 7 (liquidation) or Chapter 11 (reorganization), including:  “domestic insurance company, bank, savings bank, cooperative bank, savings and loan association…credit union, or industrial bank or similar institution which is an insured bank.”  For those listed exceptions, there are other statutory regimes that would apply to each of them; specifically, in the case of banks, they are subject to the Federal Deposit Insurance Act (“FDIA”).  

Per the FDIA, an insured bank that collapses is put under receivership by the FDIC, which in turn, tries to locate a buyer to assume the failed bank’s assets and liabilities.  If the FDIC is unable to find a buyer, it will sell all of the failed bank’s assets and distribute the proceeds to the creditors based on the priority of the claims.  In general, up to $250,000 per depositor per FDIC-insured bank per ownership category is insured (though there are exceptions to this general rule) – or to put it simply, if you have money in a bank that goes under, you can get up to $250,000 back.  The FDIC is required to find the most efficient, cost-sensitive resolution, and it has expansive statutory authority to ensure and expedite the receivership process. 

A Centralized v. Decentralized Process

Bankruptcy is like any other court proceeding in which all the players involved (the judge, debtor, creditor, and trustee) function independently and represent their own interests.  It’s a decentralized process in which the judge applies the laws passed by Congress, and the creditors, debtors, and trustee advocate their respective views and positions before the court.  It involves lots of discussion and debate between the parties to come to a resolution. 

On the other hand, the receivership approach is quite different and centralizes some of those comparable roles and responsibilities you see in a bankruptcy proceeding into one party, the FDIC, which functions as a judge, trustee, debtor, and legislator.  The FDIC has congressional powers to step in as a receiver for a failed bank, to administer the bank’s assets without judicial scrutiny, and to make the rules without any (or rarely any) judicial supervision. Hence, receivership is not a collaborative process as the intent is for the FDIC to move quickly to resolve a banking crisis.

Priority of Claims

Under both bankruptcy and receivership processes, there is an order in which obligations, or claims, are paid back to creditors.

For a bank under receivership, the priority of claims goes like this:  (i) FDIC administrative expenses (this may be for loans that the FDIC has to make to keep an institution running or afloat), (ii) insured deposits (meaning those backed by FDIC insurance, usually $250,000), (iii) uninsured deposits (those not backed by FDIC insurance), and (iv) general creditors and shareholders (usually, there’s little or no recovery for these claimants).

For a company under bankruptcy, here’s the priority hierarchy:  (i) secured creditors (debt backed by collateral), (ii) unsecured creditors (generally debt not backed by an asset but can include tax and payroll obligations, among others), and (iii) equity holders or shareholders.

How Does this Apply to SVB?

Looking at the corporate entities that made up SVB, at the top of the structure sat the parent company, SVB Financial Group (the “Holdco”), and underneath the Holdco were subsidiaries, including Silicon Valley Bank (the “Bank”), SVB Capital (the venture capital and credit investment arm), and SVB Securities LLC (the investment bank arm).

The California Department of Financial Protection and Innovation shuttered the Bank on March 10, 2023, and because it was an FDIC-insured bank, the FDIC was appointed as receiver.  When a bank fails, the FDIC will temporarily create a deposit insurance national bank (in this case called the Deposit Insurance National Bank of Santa Clara (“DINB”)) to assume the deposits of the failed bank and continue banking services for customers if no other bank is willing to step in.  When the Treasury Department decided to cover all the uninsured deposits, the DINB was replaced with a bridge bank called Silicon Valley Bridge Bank, National Association (the “Bridge Bank”).  All deposits and substantially all of the remaining  assets of the Bank were transferred to the Bridge Bank; such legal engineering is captured in the Transfer Agreement.  As a result of this forced restructuring, the Holdco was neither the parent of the Bridge Bank nor affiliated with it.

Forcing the Bank to close and be put into receivership compelled the Holdco to file for Chapter 11 bankruptcy in New York on March 17, 2023 as it triggered debt defaults and cut off the Holdco from its main revenue generating business line (i.e. the Bank).  As subsidiaries of the Holdco, SVB Capital and SVB Securities LLC were also included in the bankruptcy filing. The Bank, being under receivership, was not included in the bankruptcy filing.

Applying the Lessons of SVB for Custodied Assets in Crypto

As evident with SVB, a company going through a receivership vs. a bankruptcy process leads to a different outcome for all stakeholders involved. Let’s examine how this has played out during crypto winter in terms of what happens to consumer assets held in custody with a company that then becomes insolvent. 

As background, the types of entities that tend to hold customers’ crypto assets are state chartered trust companies, exchanges, and special purpose depository institutions, which are not banks and upon insolvency, would fall under a bankruptcy regime.  For simplicity, I’ll refer to these types of entities as a “Non-Bank Financial Company” (“NBFC”). 

Unlike with FDIC-insured banks, customer assets held in a NBFC won’t automatically be segregated from the bankruptcy estate unless the court decides that the relationship between the customer and the NBFC is a custodial relationship (i.e. not a debtor-creditor relationship). Recall, the FDIC has to guarantee up to $250,000 of customer deposits and must separate those deposits from the rest of the bank’s holdings.  In a bankruptcy proceeding, the court controls all property and contracts of the debtor, and therefore it may decide to assume, reject or terminate a contract with a customer (or in other words, the court can decide to segregate or not segregate customer assets).  If a crypto asset is considered part of the bankruptcy estate, the consumer is considered an unsecured creditor and waits in line to hopefully get some of her money back. However, a customer’s crypto assets held in custody would likely be deemed separate from the bankruptcy estate and returned to the customer. 

Bankruptcy courts will scrutinize the agreement between parties to determine whether that agreement created a debtor-creditor relationship or a custodial relationship.  Under such fact specific analysis, the court may consider questions such as (i) were customer assets commingled with the debtor’s assets, (ii) could the debtor choose how to use the customer’s property at its own discretion or were there controls in place on how such assets could be used, (iii) was the debtor acting as an agent of the customer by following customer instructions, and (iv) was beneficial title transferred to the debtor? In summary, if the failed institution is not a bank, it falls under bankruptcy purview, which puts it down the road of a judicial determination, which has a less certain outcome.

Celsius

An illustrative example is the bankruptcy proceeding of Celsius Network LLC (“Celsius”).  When Celsius filed for Chapter 11 bankruptcy protection, one issue that came before the court was whether to treat customer deposits as assets in custody, or belonging to the bankrupt company’s estate.  Celsius had offered various products, one of which was the Earn Program, in which a user deposited their digital assets in return for a high interest rate, but it also offered a Custody Program that earned no interest.  The judge had to conduct a contractual analysis to determine whether a custodial relationship with customers existed by reviewing Celsius’s customer contracts.  According to Celsius’s terms of use dated as of April 14, 2022 (the “Celsius Terms”), the following language relates to the Earn Program:

“In consideration for the Rewards payable to you on the Eligible Digital Assets using the Earn Service . . . and the use of our Services, you grant Celsius . . . all right and title to such Eligible Digital Assets, including ownership rights, and the right, without further notice to you, to hold such Digital Assets in Celsius’ own Virtual Wallet or elsewhere, and to pledge, re-pledge, hypothecate, rehypothecate, sell, lend, or otherwise transfer or use any amount of such Digital Assets, separately or together with other property, with all attendant rights of ownership, and for any period of time, and without retaining in Celsius’ possession and/or control a like amount of Digital Assets or any other monies or assets, and to use or invest such Digital Assets in Celsius’ full discretion. You acknowledge that with respect to Digital Assets used by Celsius pursuant to this paragraph:

1. You will not be able to exercise rights of ownership;

2. Celsius may receive compensation in connection with lending or otherwise using Digital Assets in its business to which you have no claim or entitlement; and

3. In the event that Celsius becomes bankrupt, enters liquidation or is otherwise unable to repay its obligations, any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable, and you may not have any legal remedies or rights in connection with Celsius’ obligations to you other than your rights as a creditor of Celsius under any applicable laws.”

In the court’s view, the language clearly transferred title and ownership from the Earn account holders to Celsius and therefore became the property of the Celsius bankruptcy estate.  The Celsius Terms allowed Celsius to have the right to move assets at its discretion and was clear that it had “all right and title to such Eligible Digital Assets.” This meant those Earn Account customers had to wait in line with the other unsecured creditors in the hopes of getting some of their assets back.  However, the Celsius judge viewed the Custody Program differently.  Per the Celsius Terms regarding the Custody Program:

“Title to any [each customer’s] Eligible Digital Assets in a Custody Wallet shall at all times remain with [the customer] and not transfer to Celsius. Celsius will not transfer, sell, loan or otherwise rehypothecate Eligible Digital Assets held in a Custody Wallet.”

Given (i) the above language intended for customers to retain ownership of their assets in the Custody Program, (ii) such assets weren’t commingled with Celsius funds and (iii) customers weren’t earning interest, the judge held that these digital assets were custodial assets that were not the property of the bankruptcy estate and were therefore to be returned to customers upfront.

FTX

Time will tell what the bankruptcy court does in the FTX case.  However, we know that FTX violated their Terms of Use by commingling assets.  [For further details on Celsius and FTX cases vis-à-vis bankruptcy, check out LawVerse’s prior article.]

The Lesson for Consumers

It’s important to understand as a consumer (i) what type of entity is holding your assets, (ii) whether your assets are insured and segregated if a company collapses, and (iii) how to mitigate those risks.  If using a traditional bank, remember the FDIC normally insures you up to $250,000.  If using a NBFC, know you don’t get FDIC insurance, and your asset may not be so easily returned to you.

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Disclaimer:  This post is for general information purposes only. It does not constitute legal advice.  This post reflects the current opinions of the author(s).  The opinions reflected herein are subject to change without being updated.

]]><![CDATA[Pending Litigation Could Impact Crypto in 2023 and Beyond]]>https://www.thelawverse.com/p/pending-litigation-could-impact-cryptohttps://www.thelawverse.com/p/pending-litigation-could-impact-cryptoMon, 13 Feb 2023 19:20:24 GMTSubscribe now

Given the headlines from 2022 (Celsius, 3AC, Terra/Luna, FTX, etc.), this year could be a turning point for crypto regulation and legislation. While the U.S. government has yet to put their heads together and come to an agreement on top down legislation, there are some core legal issues that courts are likely to rule on this year or over the next few years. Let’s dive right in:

Bankruptcy

In re FTX, Debtors - Who owns your deposit in a bankruptcy?

Once hailed as the JP Morgan of our times, Sam Bankman-Fried (SBF), among others, allegedly perpetrated an $8 billion Ponzi scheme, which involved taking and diverting customer funds. This violated FTX’s terms of service, which stated that customers retained control and title to their digital assets and that title would not be transferred to FTX. 

  • Why this is important: The important question is will FTX customers be deemed unsecured creditors, or will they be treated as custodial deposits? This means a world of difference in how they are treated in a bankruptcy. If treated as an unsecured claim, the customers would have to get in line with the other unsecured creditors instead of having priority and getting paid back first.

  • In the Celsius bankruptcy case, the judge ruled that the Earn Accounts were part of the bankruptcy estate, and those holders would have to wait in line with the other unsecured creditors. Why? The judge found Celsius’s terms of use to be a valid contract, and per its language, the terms clearly transferred title and ownership from the account holder to Celsius and thereby, was property of the Celsius bankruptcy estate. 

  • However, the Celsius judge also ruled that certain custody customers could get their money back first – those whose digital assets weren’t commingled, weren’t bearing interest, and were small amounts to not be worth the expense of the courts to claw it back (it was only $50M in aggregate). It’ll be interesting to see if the FTX judge will also lean heavily on FTX’s terms of service to decide where in line customer accounts will wait. 

  • One other topic of concern for many is whether any pre-bankruptcy withdrawals will be clawed back. When a company files for bankruptcy, an automatic stay goes into place, which basically prevents anyone from extracting payment from a bankrupt party (the debtor). The bankrupt company or bankruptcy trustee can demand the return of payments made within the 90 day period prior to filing for bankruptcy – called a preference demand. The rationale is that it would be unfair to “prefer” one creditor over another and would be more equitable to bring the money back into the bankruptcy estate to be evenly distributed to everyone. Clawing back funds is an expensive and laborious undertaking for a debtor, so oftentimes parties will reach a deal to return part of the money rather than going through the full claw back process. Complaint

Criminal

US v. Samuel Bankman-Fried – Will there be some IRL criminal implications for crypto’s poster child?

This is THE fraud of the industry (so far, but fingers crossed). What is interesting about the criminal case brought against SBF is that he has been positioning himself publicly to say he had no intent to do wrong, that he made a mistake, and that it’s no crime to be a bad businessman. All signs (and plea deals from Caroline Ellison and Gary Wang) indicate that he was well aware of what was going on between FTX and Alameda and perpetuated an ongoing fraud.

  • Why this is important: If SBF is able to overcome such criminal charges, it sends a bad message to the industry and society as a whole that crypto is dangerous because consequences can be evaded. Even someone from MIT couldn’t control it! There needs to be some personal accountability for a bad actor; if not, then we fear there will be a push for regulation that would overreach and stunt the industry. Complaint

US v. Chastain - Is it still insider trading if it’s on the blockchain?

This is the first insider trading case brought by the Department of Justice (DOJ) involving NFTs. Chastain was a product manager at the NFT marketplace OpenSea and was charged with wire fraud and money laundering for allegedly using the top secret info he had on NFTs that were to be featured on the OpenSea website. Note, the DOJ doesn’t need securities to be involved to bring a case for fraud and money laundering. In response to the charges, Chastain asserted that the information he had was not confidential business information, and since he conducted his trades on the Ethereum blockchain in public view, his actions were not designed to be concealed and therefore were not money laundering. The court dismissed Chastain’s motion to dismiss arguing that his points were better left for a jury or judge to decide. 

  • Why this is important: The Southern District of New York (SDNY) has prioritized crypto-related criminal cases as the SDNY has brought criminal charges in the SBF/FTX related cases and Wahi (see below). If a court ultimately holds that moving digital assets on a public blockchain (i.e. not done in secret) could be used as a means to conduct money laundering or fraudulent activity, then such a decision could encourage further actions to be brought regarding such activity. Moreover, it could invite DeFi-level scrutiny to NFTs. Indictment

NFTs

Jeeun Friel v. Dapper Labs, et. al. - Can NFTs be securities?

What we hope won’t be a slam dunk case, Jeeun Friel has sued Dapper Labs for selling unregistered securities (its “NBA Top Shot Moments”) in violation of securities laws claiming the NFTs were “investment contracts” under the Howey Test. Friel had purchased Top Shots Moments and filed the class action lawsuit to represent other Top Shot Moments purchasers. Dapper Labs pushed back arguing that NFT purchasers do not share horizontal or vertical commonality (no common enterprise) and that the purchasers do not have a reasonable expectation of profits arguing NFTs are “objects of play and not for investment or speculative purposes” akin to baseball cards. In August 2022, the defendants filed motions to dismiss the case. 

  • Why is this important: If the case is allowed to proceed and ultimately ruled in favor of the plaintiff, it could establish legal precedent that an NFT creator issues a security when it sells its NFTs. Doubtful that any apes, birds, or punks want to knock on the SEC’s door. Complaint

Yuga Labs, Inc. v. Ryder Ripps, et. al. –  Do NFTs come with normie IP rights?

Bored Ape Yacht Club (BAYC) accused a group of defendants of scamming consumers into purchasing fake Bored Ape NFTs by copying the original images and calling them “RR/BAYC” NFTs. BAYC brought a case for trademark infringement, false designation of origin, false advertising, cybersquatting, conversion, unjust enrichment, etc.  Defendants fought back saying the case was a violation of their free speech under Rogers v. Grimaldi, which held that the use of a trademark in an expressive work was protected under the First Amendment for artistic relevance.  The judge in December 2022 disagreed and ruled that the case can move forward to be tried as the judge reasoned that the defendant’s NFTs were pointing to the same digital assets. 

  • Why is this important:  If BAYC wins the case, it will solidify the ability of NFT creators and owners to protect and monetize their intellectual property rights. Complaint

Regulatory

SEC v. Wahi - Can the SEC unilaterally determine that a token is a security?

Get your popcorn - this is the first insider trading case brought involving cryptocurrencies (the DOJ brought a criminal case, and the SEC brought a civil case). Ishan Wahi was a product manager at Coinbase and is accused of using confidential information about which cryptocurrencies were going to be listed on the Coinbase exchange. Wahi took that information and shared it with his brother and friend who used that information to make a series of trades resulting in $1.5 million in profits. To conceal their tracks, the brother and friend used accounts in the names of other people and transferred funds through multiple wallets. The brother pleaded guilty to the DOJ’s complaint in September 2022, and Wahi has subsequently pleaded guilty to his DOJ charges in February 2023. He has since filed a motion to dismiss the SEC’s civil charges, but it remains to be seen whether the dismissal will be granted.  

  • Why is this important: What was unusual about the complaint brought by the SEC was that in addition to addressing the matter of insider trading, it also drew the conclusion that nine crypto assets were “crypto asset securities.” If the SEC were to win, it could be encouraged to continue regulation by enforcement. You’d likely see further actions against exchanges that don’t delist the digital asset as well as a slew of class action lawsuits against exchanges and other companies. It would create a can of worms – new NFT collection idea? Complaint

CFTC v. Ooki DAO - Can DAO members incur personal liability?

How do you sue an unincorporated DAO? Well, that’s being answered by the Commodity Futures Trading Commission (CFTC) who has sued the Ooki DAO for allegedly offering leveraged and margin trading products without registering as a futures commission merchant with the CFTC.

  • Why is this important:  The Ooki DAO case concerns the fundamental issues of (i) whether the CFTC satisfied notice requirements and properly served the defendant, Ooki DAO, by posting summons documents in Ooki DAO’s online discussion forum and its help chat box, and (ii) whether a DAO qualifies as an unincorporated association thus allowing courts to impose personal liability on individual token holders for the actions of a DAO. The CA U.S. District court has already ruled on the first matter affirming that the CFTC did in fact satisfy the notice requirements, and in its ruling, also noted that Ooki DAO qualified as an unincorporated association in CA and could be sued as a collective. The court cautioned however that it was not ruling on the merits of the CFTC’s charges and only that the CFTC sufficiently alleged, for the purposes of their service motion, that Ooki DAO is an unincorporated association. While there are currently dismissal motions pending, this is a case worth paying attention to as a final ruling could have broad implications on unincorporated DAOs. Complaint

SEC v. Ripple Labs – Will an ICO be ruled a securities offering?

This is the OG case concerning the issuance of unregistered securities in which the SEC alleges that Ripple failed to register its token XRP in its $1.3 billion offering (i.e. arguing that XRP is a security). Back in September 2022, both Ripple and the SEC filed for summary judgment to require the judge to rule on whether or not XRP was a security.

  • Why is this important: If the judge were to rule that XRP is a security, the SEC would likely win its case. Given the lack of clarity in the US on regulating crypto, agencies will continue to step in and carve out some territory for themselves. In this case, if XRP is deemed a security, it could mean that other digital assets will be considered a security and cement the SEC’s talons in regulating this space. Complaint

Why is any of this important?? Remember that law is created by both the legislative branch (code) and the judicial branch (case law). Until Congress comes together on comprehensive legislation, the crypto legal landscape will continue to be shaped by regulatory and legal actions (like the ones mentioned above). How the courts rule here could have a more immediate impact on the endogenous growth of crypto. Keep an eye on what’s happening in DC, and you can always phone your congressman!

Disclaimer:  This post is for general information purposes only. It does not constitute legal advice.  This post reflects the current opinions of the authors.  The opinions reflected herein are subject to change without being updated.

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