Blockchain 2023

Blockchain 2023 – An Overview

DLx Law is delighted to once again present the Chambers guide to the realm of blockchain and cryptocurrency law and regulation. Over the past three years, this guide has served as a testament to the growth and advancement of this emerging field within the legal domain. It has prominently featured the efforts of lawyers from various jurisdictions that have worked towards establishing a regulatory framework in response to the emergence of the blockchain technology.

This year’s guide represents a significant step forward in the field. Over the past 12 months, the Web3 industry has faced challenging times, including a plunge in the prices of many digital assets and the insolvencies of several leading players in the sector, including:

• the decline of TerraUSD, which was once a prominent stablecoin;
• the disruption caused by the downfall of FTX, a major centralised exchange; and
• the repercussions felt by the failures of lending product providers like BlockFi and Celsius.

However, despite these setbacks, both individual and institutional interest in the digital asset sector remain resilient.

Furthermore, the adoption of blockchain technology continues to flourish across various industries on a global scale. From financial services, encompassing payments, asset management and real-world assets, to content-related businesses, such as art, music, videos and games, blockchain is being widely embraced. Its potential for transformation and innovation remains evident in these sectors.

In this year’s guide, experienced practitioners from around the globe reflect on the developments in a variety of major areas of rapid development, including the following.

Decentralised finance (DeFi)

It is reported that approximately USD46.76 billion in the form of digital assets are currently committed to automated financial arrangements made possible through the use of open blockchain-based platforms categorised as DeFi. Due to the nature of decentralisation, it has been difficult for regulators across jurisdictions to regulate truly decentralised products, except where they fall within existing regulatory frameworks. In the United States, the Treasury Department released the 2023 DeFi Illicit Finance Risk Assessment, a report focusing on illicit finance risks associated with DeFi, cautioning that illicit actors, including cybercriminals, sanctioned parties and scammers, are exploiting vulnerabilities in DeFi without implementing anti-money laundering and counter-terrorism financing.

Non-fungible tokens (NFTs)

In 2020–2021, NFTs gained widespread popularity, particularly in art and collectibles. Despite a subsequent bubble burst, NFTs continued to gain attraction with use cases beyond art and collectibles – eg, real estate, in-game items, event ticketing, cause marketing and reward programmes. NFTs have shown real staying power, with businesses around the globe finding creative ways to integrate these digital assets into their more traditional product offerings. Major brands like Starbucks are experimenting with NFTs as part of their rewards systems, enhancing marketing reach and building a community for Web3 users. Amazon will reportedly launch an NFT marketplace in 2023, which could encourage more mainstream brands to explore NFTs. Regulatory bodies and governmental entities have also started to focus on NFTs. In the United States, the Treasury Department and the Internal Revenue Service announced that they are soliciting feedback for upcoming guidance regarding the tax treatment of NFTs as collectibles under the US tax code.

Decentralised autonomous organisations (DAOs)

In nearly all jurisdictions, the framework for DAOs is still in the early stages. There are currently few specific laws in place that define DAOs as a new kind of legal entity, or attempt to address their legal status. In recent years, the foundation company structure in the Cayman Islands has gained popularity among projects seeking a flexible governance system to initiate a DAO. Meanwhile, in the United States, a class action lawsuit in California has passed the pleading stage such that the defendant – bZx DAO, which comprises all persons holding BZRX tokens – could be found to be a general partnership under California laws. As the field continues to evolve, more advancements in the formation and attributes of DAOs are anticipated, which may include potential legal protections for such organisations.

The many setbacks in the digital asset space over the past year inevitably triggered regulatory responses. From an enforcement standpoint, each of the areas mentioned above is expected to receive increased scrutiny across the globe as activities continue to expand. In the meantime, regulatory bodies in various jurisdictions introduced regulations to regulate transactions in digital assets and related services. There follows a brief overview of some of the major developments within the regulatory frameworks featured in this guide.

The Markets in Crypto-Assets Regulation (MiCAR)

MiCAR was approved by the European Parliament in April 2023 and is expected to enter into application toward the end of 2024. It is applicable to transactions in all crypto-assets that do not qualify as financial instruments, deposits or structured deposits under the EU financial services legislation.

MiCAR covers the offerings and marketing of different categories of crypto-assets:

• “asset-referenced tokens” – a type of crypto-asset that is not an electronic money token and that purports to maintain a stable value by referencing to any other value or right or a combination thereof;
• “e-money tokens” – a type of crypto-asset that purports to maintain a stable value by referencing to the value of an official currency of a country; and
• “utility tokens” – a type of crypto-asset that is only intended to provide access to a good or a service supplied by the issuer of that token.

MiCAR sets rules for the offering of tokens (depending on their categorisation), including:

• the requirement of creating and publishing a whitepaper;
• the licensing requirements for issuers of certain crypto-assets and providers of crypto-asset-related services, as well as related business organisation requirements; and
• the rules of conduct for crypto-asset issuers and crypto-asset service providers.

The regulation also includes provisions to prevent market abuse or market manipulation. Crypto-asset “issuers” are required to disclose insider information, avoid insider trading and refrain from market manipulation.

Transfer of Funds Regulation

The European Parliament approved a recast of the Transfer of Funds Regulation, which will include transfers of crypto-assets in its scope of application. The text aims to ensure that crypto transfers can be traced and suspicious transactions can be blocked, as is the case with any other financial operation. The so-called “travel rule”, already used in traditional finance, will cover transfers of crypto-assets.

Virtual Asset (Service Providers) Act (VASP Act)

In the Cayman Islands, the Virtual Asset (Service Providers) Act (VASP Act) has been in effect since October 2020, promoting the use of new technology and innovative enterprise in the Cayman Islands while complying with the FATF standards. In the British Virgin Islands, the VASP Act went into effect in February 2023.

Legal challenges in the US

In the United States, the emerging technology continues to present legal challenges that all three branches of the federal government are actively wrestling with.

• On the legislative front, a number of important legislative initiatives were introduced in Congress in the past year, including the Lummis-Gillibrand Responsible Financial Innovation Act, the Digital Commodities Consumer Protection Act and the Digital Commodity Exchange Act, each of which seeks to provide the Securities and Exchange Commission (SEC) and/or the Commodity Futures Trading Commission (CFTC) with jurisdiction and new authority over digital asset activities to different extents. Most recently, the US House Financial Services Committee published a draft version of a potential landmark stablecoin bill, and together with the House Committee on Agriculture, released a discussion draft of the digital asset market structure legislation that would divide responsibilities between the SEC and the CFTC over digital assets.

• In terms of enforcement, the SEC would likely take the view that almost any fungible blockchain-based crypto-asset is a security, or would treat most or all transactions involving such assets as securities transactions, based on ongoing statements and actions from the SEC and its Chair. The SEC has brought actions against various types of players in the industry, including:

1. various crypto-asset trading platforms, including Coinbase, for operating an unregistered securities exchange, broker and clearing agency;
2. LBRY, Inc., for offering and selling LBC as a security in violation of the registration provisions of the federal securities laws;
3. Ishan Wahi, a former employee of Coinbase for committing insider trading of cryptocurrencies; and
4. a number of celebrities for violating securities laws in touting cryptocurrencies.

However, there continues to be disagreement between the SEC and the CFTC regarding the status of Ether and various stablecoins as either securities or commodities. Consequently, the lack of clarity persists.

• Lastly, a number of important cases have been brought in federal courts, including the SEC’s suit against Ripple Labs for unregistered securities offering of XRP; the CFTC’s suit against Ooki DAO for illegally offering leveraged and margined retail commodity transactions; and a private class action against Dapper Labs for offering and selling NFTs as security in violation of securities laws, in addition to high-profile cases such as those against Binance, Terraform Labs and executives of FTX.

Conclusion

In conclusion, the past year has been challenging for many players in the crypto-asset space. The introduction of MiCAR in the EU and ongoing regulatory actions in the US represent increased regulatory oversight within the rapidly evolving crypto-asset and blockchain industry. With defined regulations forthcoming, start-ups and other businesses within the space would hopefully find it easier to navigate the landscape. It is hoped that new legislation would usher in a new era of growth and innovation in the crypto-asset and blockchain industry. We look forward to witnessing the future development in this space in the coming year!