This is Part 1 in a series on legal implications of blockchain technology.
Blockchain technology and cryptocurrency represent a potential paradigm shift in the way we transact with each other. The number of potential uses is wide-ranging and open-ended — it’s a reality that could disrupt any industry that involves the movement of data or value. Most industries and business models will at least be exposed to blockchain technology.
Many commentators have claimed the technology could have a greater impact than the creation of the Internet; recent activity around blockchain suggests they may be correct. These new and innovative uses present interesting and novel legal challenges. Every company pursuing a blockchain-related initiative should be familiar with the applicable regulatory frameworks.
Legal Certainties — and Questions
Some laws enable blockchain. For example, companies registered in Delaware can issue and trade shares/securities on a blockchain. While the Delaware legislation is more of a clarification of existing laws than a complete overhaul, it provides certainty that leveraging blockchain in connection with the issuance and management of securities (which should enable efficiency and transparency benefits) is legitimate and legal.
On the other hand, there are far more laws that prohibit or restrict blockchain’s use for certain activities. Increasingly-popular “Token Sales” — commonly referred to as Initial Coin Offerings (ICOs) — run into several potential legal issues. ICOs can present innovative ways to raise capital, fund projects, and generate community involvement. However at the same time, some ICOs present a range of legal challenges, including those related to securities laws, financial services regulations and tax issues. We’ll take a closer look at the potential issues.
In the U.S., the primary test for whether something is a security (or investment contract) is called the Howey Test. It holds that the thing being assessed — in this case a token — is a security if there is:
(1) An investment of money,
(2) In a common enterprise, and
(3) An expectation of profits predominantly from the effort of others.
Whether each element is met often depends on specific facts and circumstances. So if the token being offered is a security, certain requirements must be met for it to be lawfully sold.
For a completely unrestricted issuance, the securities must be fully-registered — like the securities of publicly-traded companies — and there are ongoing disclosure and reporting requirements. Different types of exempt offerings may be available, which generally include restrictions on the types (such as accredited or international) and number of investors. Exempt offerings generally require fewer disclosures and ongoing reporting requirements.
Companies considering a token sale should consider the securities law implications. And due to the rapid growth of the industry, we can expect to see new regulations (and clarifying guidance on existing regulations) as lawmakers try to catch up with the disruptive change being brought about by blockchain technology.
In Part II, we’ll look at the legal challenges Blockchain presents related to the application of existing laws on money transmission, money services businesses, and tax.
Attorney Austin Mills leads the Blockchain and Cryptocurrency Group at Morris, Manning & Martin, LLP. The group is also holding a “Beyond Blockchain 101” event on Nov. 13 for those who want to learn more.