UPDATE (10th February, 2015 19:25pm GMT): The complete report has been added below.
The legal questions surrounding the use of the bitcoin blockchain and similar decentralized ledgers for non-financial purposes took a step toward clarity today with the release of a 30-page working paper.
The publication is the result of a workshop held 15th to 18th January at which decentralised crowdfunding startup Swarm, DATA’s Constance Choi and Harvard Berkman Center research fellow Primavera de Fillippi assembled thought leaders in the bitcoin legal space to address challenges facing the part of the industry referred to as the crypto 2.0 sector.
Attendees included Andy Beal, Elizabeth Stark and John Clippinger, and members of policy group Coin Center, law firm Perkins Coie and Harvard and MIT.
The representation at the event is indicative of what participants described as the potential of the bitcoin blockchain to spur innovations, as well as the current unclear regulatory environment in which such startups now operate in the US.
De Filippi, a research fellow at , told CoinDesk:
“Distributed networks can be used to promote the public good and encourage cooperation amongst peers. That’s why I’m excited about the pioneering legal work we’ve been doing. It is opening the door for new opportunities that the current regulatory framework is currently having a hard time to cope with.”
The full report analyzes a number of pressing questions facing the space, including under which circumstances tokens issued by decentralised projects meet the traditional definitions of a security. The hot-button issue first surfaced in October, when rumors that the US Securities and Exchange Commission was looking into the industry emerged.
Notably, the report finds that under certain conditions, cryptographic tokens are likely to meet such definition and potentially trigger regulatory scrutiny.
“Somewhat more controversially, these tokens can also be pre-sold or exchanged for other tokens in order to fund the development of the project. This type of sale raises significant concerns with respect to securities guidelines,” the report reads.
However, it stresses that due to the wide variety of use cases for the technology, some tokens may qualify as private property, while others are likely to be viewed as securities.
The full paper examines this issue, as well as the broader implications decentralised ledger technologies to enable Internet users new levels of ownership and control.
Crowdsales and securities law
Long a contentious topic in the digital currency community, crowdsales have emerged as a popular way for crypto 2.0 startups to raise awareness and capital, while inspiring a dedicated user base to help them reach lofty goals in a short amount of time.
Despite objections from some community members, notable projects in the space have argued that tokens sold during these events provide access to the technology, not ownership as in a traditional stock purchase. Further, their terms and conditions often seek to denote that the token is not intended to be a security.
The working group found that tokens are less likely to be viewed as a security under two conditions – the software is already available at the time of sale, and the token is not transferable to another party.
“Generally speaking a software access token which is expected to appreciate in value and is largely obtained for profit is likely to be considered a security. This is particularly the case if the token represents a good which is not available at the time of purchase and which depends on the effort of others in order to deliver,” the report reads.
Key distinctions
In reaching this conclusion, the report also highlights a variety of relevant case law while illustrating the specific variables that are likely to shape the definition of a given token.
Conditions that are likely to influence this categorization include whether the project is already built at the time of the token sale; the specific rights associated with the token; and whether tokens are transferable and divisible on the open market.
Tokens that are “exhaustable”, meaning they are only built for one-time use, the report suggests, are likely to fall under different case law than tokens that are meant to trade.
”Redeemable product tokens serve a similar function as a coupon for a good and generally fall into the same regulatory guidelines that apply to Kickstarter or other perks-based models,” the report says, adding that depending on the rights associated with the token, they may fall under the definition of securities.
Most important may be the basis of the token’s underlying value. The paper puts forth the opinion that whether the token is likely to appreciate with the effort of others, is sold with the expectation of profit or is dependant on a collaborative process for value is likely to shape its definition under US law.
Copyright law and proof of purchase
Yet another application of crypto 2.0 technology is in the form of copyright law, as projects have emerged that seek to use blockchains as a way to create records that a particular work was made at a certain time.
The paper suggests that cryptographic tokens provide a solution to these problems, enabling the ability to prove that a digital good is being purchased for the first time or whether it is being resold.
“By linking the distribution of a work to the transmittal of a scarce token with associated rights, one can ensure that a used good retailer has verifiably relinquished legal control of the copy to the used good purchaser. Subsequent purchasers and sellers are no longer violating the right to distribute because that right has been extinguished by the first sale doctrine,” the report states.
It goes on to provide an example of how this type of token meets the condition of a security, arguing it is “not a security by any usual definitions”, but that it could be depending on whether the user has an expectation of profit or some financial interest.
DAOs get greenlight
Another use case that the authors view as less problematic through the lens of US law is the use of tokens to create distributed collaborative organisations (DAOs).
In this instance, tokens are used to denote membership in an organisation, with the user retaining the expectation that he or she may benefit financial from the ownership.
The report suggests that, in this case, token owners may have some control over fund utilization, “making them effectively managers and/or partners in the success of the entity”, a factor that makes them less likely to be viewed as securities.
”Depending on the nature of the organization and the actual control held by people who have committed capital, ‘shares’ organizations which are structured on the blockchain are likely not to be considered as securities,” the paper suggests.
Smart contracts don’t meet standard definitions
One of the most often discussed abilities of blockchain ledgers is their ability to help execute smart contracts, digital contracts between two parties that are automatically enforced when certain conditions are met.
The paper notes that such contracts are applicable to a wide variety of fields, including derivatives, escrow services, swaps and voting mechanisms.
Notably, the working group found that smart contracts aren’t likely to meet the legal definition of a contract in their current form, but that they could be made to better fit this definition.
“There may be an implied legal contract depending on the nature of the contextual language used, which implies a certain set of outcomes from the computer code,” the report reads.
The findings comes at a time when the crypto 2.0 industry is seeing increased development and interest and are likely to add clarity to the discussion surrounding these projects.
The full version of the report can be found below:
SWARM Working Paper, Distributed Networks and the Law
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