The United States is home to many global, market-leading blockchain companies, including cryptocurrency exchanges, permissioned ledger developers, custodians of digital assets, developers of Decentralised Finance (DeFi) protocols and non-fungible token (NFT) marketplaces. The USA has also been a centre of innovation with respect to integrating blockchain and digital assets into traditional financial services and real-world assets. Major US brands have also started exploring the use of NFTs.

The past twelve months witnessed the collapse of a few major crypto platforms, such as FTX, Voyager and Celsius, as well as other significant players, such as 3AC, and projects such as Terraform Labs. There are several bankruptcy proceedings ongoing in the US involving some of these platforms. As a result of these failures, the global cryptocurrency market tumbled, and DeFi and NFT activities declined.

Significant regulatory activities with respect to digital assets have been taken by various regulators in the past 12 months, including the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency (OCC), the Financial Crimes Enforcement Network (FinCEN) and many state agencies. These include enforcement actions, rulemaking proposals, and litigations. A number of judicial decisions are anticipated in the coming year that could have a significant impact on how digital assets are categorised for regulatory purposes.

In addition, legislative proposals focusing on digital assets have been introduced in Congress or released with the aim of providing clarity to market participants.  Regulatory developments in the next 12 months will be crucial to the future of web3 in the USA.

US businesses are using blockchain technology in a wide variety of ways, including:

• digital asset exchange platforms;
• digital asset custody;
• securities issuance and record-keeping;
• securities clearing and settlement;
• gaming;
• art, collectibles and fan engagement platforms;
• protocol and software development;
• real world assets;
• payment;
• logistics and tracking goods; and
• self-sovereign identity.

Following the implosion of the Terra Protocol and the collapse of a few major players in the crypto industry in 2022, the total value locked (TVL) in DeFi protocols declined significantly – according to certain reports, from its historical peak close to USD256 billion at the end of 2021 to approximately USD49 billion in early 2023. 

DeFi protocols being utilised by US residents run primarily on the Ethereum network and include platforms like “MakerDAO”, “Aave”, “Uniswap”, “0x” and “Compound”, as well as many other emerging protocols that are coming online rapidly. These protocols facilitate lending, borrowing, peer-to-peer exchange and combinations of these activities designed to create yield on non-interest-bearing digital assets. 

DeFi platforms are open and immutable (to a large extent), and transparent protocols and regulators can theoretically observe platform activity in real time. In theory, regulatory compliance could be built in to DeFi protocols or the platforms running on those protocols. However, there are some clear challenges, given that DeFi platforms consist of open-source code accessible to anyone anywhere with the technical capability to access and interact with that code, and developing a platform with built-in regulatory compliance in each jurisdiction in which it might be used would likely be exceedingly difficult.

One of those challenges relates to exploits of vulnerabilities in the code comprising DeFi protocols. Significant value continues to be lost as a result of such exploits.  For example, the Wormhole exploit caused significant losses to users of DeFi protocols.

Various regulators have taken actions or issued reports with respect to DeFi.  In August 2022, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) added a number of Ethereum addresses, including smart contract addresses, associated with Tornado Cash, an open-source privacy protocol that facilitates anonymous transactions by obscuring the origins of cryptocurrencies like Bitcoin and Ether, to the Specially Designated Nationals and Blocked Persons List (SDN List). As a result, all US persons or those within the US are prohibited from engaging in transactions with these blockchain addresses, and any violations will be a strict liability crime. 

In its 2023 DeFi Illicit Finance Risk Assessment report, the US Department of the Treasury explored how illicit actors abuse DeFi and discussed illicit finance vulnerabilities unique to DeFi. The report suggested that many existing DeFi services fail to comply with anti-money laundering and counter-terrorism financing (AML/CFT) obligations and signalled an enhanced focus of the US government on the ability of blockchain systems to be misused by illicit actors. 

Finally, the SEC previously proposed amendments to Rule 3b-16 under the Securities Exchange Act of 1934 (the Exchange Act), which would expand the definition of “exchange” to include systems that use “communication protocols” and systems that bring together “trading interest”. In April 2023, the SEC reopened the comment period for its proposed amendments and simultaneously issued a notice providing supplemental information and economic analysis focusing on the applicability of the proposed amendments to DeFi systems. The proposed amendments, if adopted in its current form, would require platforms facilitating transactions in securities utilising decentralised exchange protocols or automated market-making protocols to register as broker-dealers and exchanges, or to fall within an exemption from registration as an exchange.

The market for NFTs in the USA has cooled down in the past 12 months. However, new NFT marketplaces, which allow NFTs to be created, stored and traded, continued to emerge. Key areas of interest include visual art, profile picture projects, collectibles, gaming and real-world assets. Moreover, major consumer brands have started exploring the use of NFTs.  For example, Starbucks started its NFT-based loyalty programme, and Adidas created its NFT collection.

There are multiple regulatory regimes that may apply to the use of blockchain technology in the USA. Depending on the business model and the classification of associated digital assets, blockchain technology and associated digital assets may be regulated under multiple regulatory frameworks, including securities law, commodities law, money transmission law and consumer protection law. These are all existing regulatory regimes that have not been specifically tailored to blockchain technology or digital assets.

The USA has implemented international standards in several areas impacting blockchain. Most notably, the USA has been a proponent of applying a corollary to the Funds Travel Rule to entities known as virtual asset service providers (VASPs) that process transactions involving virtual assets, and significantly expanding the universe of entities that meet the definition of a VASP and would therefore be subject to the Funds Travel Rule. In 2018, the Financial Action Task Force (FATF), a multi-governmental organisation that sets global standards related to anti-money laundering, clarified how the FATF standards apply to activities or operations involving virtual assets and imposed a corollary to the Funds Travel Rule on VASPs that process virtual asset transfers.

In October 2021, the FATF updated its guidance regarding virtual assets and VASPs. Notably, the FATF guidance broadly interprets the definition of a VASP to include “a central party with some measure of involvement” with a decentralised application. This broad interpretation would potentially bring a variety of parties within the definition of a VASP and subject them to compliance with AML/CFT laws in jurisdictions that adopt this interpretation of the VASP definition.

It is not surprising that the US delegation to the FATF pushed for a global Funds Travel Rule corollary and the expansive interpretation of the entities that might be deemed VASPs. In doing so, the USA is attempting to promote compliance through global standard setting, which would make it easier for the USA to enforce the laws in place domestically in this area. Without a global standard, US-based money transmitters would have to determine whether or not they would process transmittal orders originating from outside the USA that may not include the information required by the Funds Travel Rule. If they were to process such orders, they would need to perform their own due diligence to obtain the information required to fill any gaps, which would require additional cost and time.

There are a number of regulatory bodies in the United States that are relevant to blockchain and digital assets.

The Securities and Exchange Commission

The SEC has broad regulatory authority over securities transactions and securities professionals and intermediaries in the United States. The threshold question that determines whether the SEC has authority with respect to blockchain or digital assets is whether a “security” is involved. The definition of the term “security” in both the Securities Act of 1933 and the Securities Exchange Act of 1934 includes the term “investment contract”. When commercial arrangements do not fall plainly within the other enumerated types of securities in the definitions of the term “security”, they may still be treated as securities if they are deemed to constitute investment contracts. The test for whether a particular scheme is an investment contract was established in the Supreme Court’s Howey decision. The test looks to “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” In 2017, the SEC issued a Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: the DAO (DAO Report), applying the Howey test to an offering of cryptographic tokens for sale and concluding it was an offering of securities. The DAO Report noted that “[w]hether or not a particular transaction involves the offer and sale of a security – regardless of the terminology used – will depend on the facts and circumstances, including the economic realities of the transaction.” The SEC continues to take the position that most digital assets themselves are securities. 

The Commodities Futures Trading Commission

The CFTC has broad regulatory authority over derivative markets for commodities, and general anti-fraud and anti-manipulation authority over the spot markets for commodities pursuant to the Commodities Exchange Act (the CEA). The CFTC has asserted jurisdiction over transactions in virtual currencies as “commodities”. Numerous courts have found that the CFTC’s jurisdiction extends to virtual currencies in this context. The CFTC has explicitly taken the position that bitcoin and ether are commodities subject to their jurisdiction under the CEA. Accordingly, it is widely accepted that bitcoin and ether are commodities subject to CFTC jurisdiction. CFTC jurisdiction is primarily with respect to derivatives transactions. Derivatives transactions subject to CFTC jurisdiction include futures, options, swaps and leveraged retail commodities transactions under the CEA.

The Treasury Department and the Financial Crimes Enforcement Network

FinCEN is the arm of the Treasury Department that is responsible, in the first instance, for enforcing the US federal laws and regulations relating to crimes involving the transmission of money, frequently working in conjunction with other federal agencies and bureaus, including the Federal Bureau of Investigation and the National Security Agency. This includes enforcing the Bank Secrecy Act (BSA), which is a comprehensive AML/CFT statute. The BSA mandates that “financial institutions” must collect and retain information about their customers and share that information with FinCEN. “Money services business” are included within the definition of “financial institutions”, and “money transmitters” are money services businesses. FinCEN guidance from May 2019 examined a number of hypothetical business models involving digital assets to provide guidance with respect to the application of the BSA. Not surprisingly, many businesses engaging in activity involving convertible virtual currency, a subset of digital assets, have an obligation to comply with the BSA.

The Treasury Department and the Office of Foreign Assets Control

The OFAC is a division of the US Treasury Department, and administers and enforces economic and trade sanctions to promote national security and US foreign policy objectives. OFAC can take enforcement action against entities in the USA that violate sanctions programmes. OFAC has taken several such actions that involve digital asset transactions – for example, BitGo, BitPay and most recently Poloniex (a subsidiary of Circle). Each of these actions was settled, and OFAC emphasised that US sanctions compliance obligations apply to all US persons, and encouraged companies that provide digital asset services to implement controls commensurate with their risk profile, as part of a risk-based approach to US sanctions compliance. Further, OFAC published Sanctions Compliance Guidance for the Virtual Currency Industry in October 2021 to assist members of the virtual currency industry in navigating and complying with OFAC sanctions.

The Consumer Financial Protection Bureau (CFPB)

The CFPB has authority pursuant to the Consumer Financial Protection Act (CFPA) to address unfair, deceptive or abusive acts and practices (UDAAP) with respect to financial products offered primarily for consumer use by certain “covered persons” as defined by the CFPA. To date, the CFPB has not pursued a case alleging a violation of the CFPA involving digital assets and thus far has declined to extend Regulation E – which governs electronic fund transfers involving consumers and financial institutions – to virtual currencies. The CFPB previously announced that it will begin examining non-bank financial companies that pose risks to consumers in reliance on previously little-used authority. The CFPB is expected to become much more active in the next several years, including with respect to addressing consumer financial issues relating to digital assets.

State Money Transmission Regulators

Historically, states rather than the federal government have been the primary regulators of “money transmitters”. Each state, other than the state of Montana, has independently passed a statute that defines the activities that constitute money transmission in that state. State laws generally define a money transmitter very broadly and typically include an entity that engages in “receiving money for transmission” or “transmitting money” or issuing or selling stored value. The scope of each state’s law, and its application to virtual currency, is dependent on how broadly the definitions of money and money transmission are interpreted by the applicable state regulator. As a result, exchanging virtual currency or facilitating payments in virtual currency may be subject to state-by-state regulation as money transmission.

While federal law requires the mere registration of money transmitters, state law requires licensing. It is significant to note that money transmission regulations are extraterritorial; a person must have a licence in every state in which it has customers. What matters from a jurisdictional standpoint is the location of the customer, not the location of the transmitter. States have taken different positions with respect to whether convertible virtual currency activities fall within the definition of money transmission.

State Securities Regulators

State securities regulators enforce and administer state-specific securities laws. These laws are often referred to as “blue sky” laws and are generally similar, but certain aspects vary significantly from state to state. Many state securities statutes are derived from either the 1956 or 2002 version of the Uniform Securities Act.

State securities regulators have been very active in regulating cryptocurrency-related investment products and the sale of digital asset securities. In the cryptocurrency space, state securities regulators were first to file enforcement actions with respect to centralised lending businesses offering consumers interest in cryptocurrency deposited to certain accounts. State securities regulators filed cases against BlockFi, Celsius, and Voyager prior to their collapses, alleging that their interest account products constituted investment contracts under the Howey test that needed to be either registered or exempt from registration.

There are no self-regulatory organisations in the USA specifically dedicated to blockchain or digital assets. There are a variety of trade groups, but none of them perform a formal regulatory or even quasi-regulatory function. Instead, these trade groups advocate on behalf of their members with respect to the adoption and regulation of blockchain technology and digital assets. There are, however, self-regulatory organisations associated with the securities and commodities industries that do have regulatory authority relevant to blockchain and digital assets, and these are discussed below.

The Financial Industry Regulatory Authority (FINRA)

FINRA is a government-authorised organisation tasked with the oversight of US-registered securities broker-dealers to ensure they operate fairly and honestly. FINRA works under the supervision of the SEC and writes rules governing the activities of broker-dealers, examines broker-dealers for compliance with those rules, promotes market transparency to protect market integrity, and provides for investor education.

FINRA has taken a specific interest in activity involving digital assets. It joined the SEC in putting out a joint statement regarding broker-dealer custody of digital asset securities in July 2019. The release dealt with the application of the customer protection rule pursuant to the Securities Exchange Act of 1934, and the related rules, to digital asset securities. The joint statement provided guidance with respect to how digital asset securities may be custodied by broker-dealers, indicating several areas of concern. FINRA has also asked broker-dealers to notify it if they engage in activities related to digital assets, and has made digital assets an examination priority.

The National Futures Association

The National Futures Association (NFA) is an industry-wide self-regulatory organisation for the derivatives industry. It is a registered futures association designated by the CFTC, and registers a number of different participants in the commodities derivatives markets.

Judicial decisions have played an important role in interpreting the laws applicable to blockchain technology and digital assets.

The past several years have proven to be a monumental period for the development of crypto-asset jurisprudence. 

The Telegram Decision

Back in 2020, the most notable case in the crypto-asset sector was the Telegram decision, a case in which the SEC alleged that the intended distribution of the tokens native to the Telegram Open Network (TON) blockchain, known as GRAM tokens, was part of a scheme to engage in a public distribution of securities. The court granted a preliminary injunction finding that the SEC had shown a substantial likelihood of success in proving that the resale of GRAMs into the secondary market would be an integral part of a scheme to publicly distribute securities that were not registered. 

Ripple Labs

Shortly after Judge Castel granted the SEC’s motion for a preliminary injunction in Telegram, the SEC filed a complaint against Ripple Labs, Inc. and certain key executives. In Ripple Labs, the SEC alleged that Ripple Labs, along with certain executives, violated federal securities laws in connection with their failure to register the crypto-asset known as XRP.  The complaint alleges that XRP was sold as a security and sets forth an analysis of XRP pursuant to the Howey test to support that assertion.

Of note, several holders of XRP attempted to intervene in this case as defendants. In responding to the request to intervene filed by these holders, the SEC addressed, briefly, its view with respect to secondary transactions in digital assets originally sold in an investment contract. The SEC argued that the security at issue is not XRP (the digital asset) itself, but rather all the facts and circumstances surrounding the digital asset and the manner in which it was initially offered and sold. They then indicated their view that XRP (the digital asset) is “the embodiment of those facts, circumstances, promises, and expectations and today represents that investment contract.” This characterisation is important where questions arise over whether or not secondary transactions in a digital asset are subject to the federal securities laws. Nevertheless, it is not expected that the court will address this issue in its pending summary judgment opinion because the allegations in this case concern only primary sales of XRP.

SEC v LBRY, Inc. SEC v Wahi et al and other crypto-asset related matters

Recent notable cases touching upon the question of whether a crypto-asset is itself a security include the matters of SEC v LBRY, Inc. and SEC v Wahi et al.

In the case of LBRY, Inc., Judge Barbadoro of the United States District Court for the District of New Hampshire granted the SEC’s motion for summary judgment, finding that LBRY offered and sold LBC tokens as securities and violated Section 5 of the Securities Act. 

In the Wahi complaint, alleging that Ishan Wahi, Nikhil Wahi, and Sameer Ramani engaged in a scheme to trade crypto-assets based on non-public information known to Ishan Wahi due to his employment with Coinbase, the SEC identified nine specific crypto-assets that it alleged are securities. The SEC notably did not bring actions against the underlying crypto-asset project participants for selling unregistered securities, however. The defendants filed a motion to dismiss the complaint, arguing that the crypto-assets traded are not securities. Several amicus briefs making similar arguments were also filed. The Wahi matters were resolved with the entry of an agreed upon judgment before the court could rule on the Motion to Dismiss.

In a parallel action, the US Attorney’s Office for the Southern District of New York indicted all the Wahi brothers and Ramani for wire fraud over the same conduct, although the theory of liability did not require a showing that the crypto-assets in question are securities. Both Ishan and Nikhil Wahi pled guilty to certain crimes and were recently sentenced to prison time of two years and ten months, respectively. 

Other notable actions where the SEC alleged various crypto-assets are themselves securities include its actions against various crypto-asset trading platforms, such as Bittrex, Beaxy Digital, and most recently, Binance and Coinbase, in addition to various high-profile cases in the crypto space, such as those against Terraform Labs and executives of FTX. 

Ooki DAO

The CFTC, for its part, has actively been asserting its regulatory authority over crypto-asset projects as well. The CFTC filed a complaint against Ooki DAO alleging, among other things, that Ooki DAO was intentionally structured as a DAO in an attempt to avoid regulatory oversight thanks to the anonymity of its users. The CFTC alleged that Ooki DAO was an unincorporated association comprised of Ooki DAO governance token holders, illegally offering leveraged and margined retail commodity transactions in digital assets and engaging in activities that only CFTC-registered entities can perform.

Judge Orrick of the US District Court for the Northern District of California concluded that Ooki DAO could be sued because Ooki DAO was an unincorporated association and covered under the definition of “person” under the Commodity Exchange Act. Most recently, the court entered a default judgement order against Ooki DAO.

In an unrelated matter involving the predecessor to Ooki DAO, Judge Burns of the US District Court for the Southern District of California partially denied motions to dismiss a putative class action lawsuit brought by users of the bZx platform, who alleged that a general partnership existed among all persons holding the bZx DAO token BZRX, finding that the plaintiffs sufficiently plead facts to demonstrate that bZx DAO was a general partnership under California’s Corporation Code.

Dapper Labs, Inc.

Dapper Labs, Inc., the company behind the CryptoKitties sensation whose trading clogged the Ethereum blockchain over the holiday season of 2017-18, has been embroiled in a private class action alleging that the offer and sale of NBA Top Shots Moments (NFTs of digitised photos and video clips from memorable NBA events) were securities offerings because they fit within the four prongs of the Howey test. The plaintiffs also alleged that Dapper Labs had made hundreds of millions of dollars by propping up the market for Moments, and the value of the FLOW token, by preventing users from withdrawing money from their accounts. 

In late February 2023, the motion to dismiss the action filed by Dapper Labs was denied. In denying the Dapper Labs motion to dismiss, the judge indicated that the allegations in the complaint, if proven true, were sufficient to find that the offer and sale of Moments were investment contract transactions. 

Other

Other significant industry players facing lawsuits brought by private parties range from CeFi entities such as Coinbase, to DeFi projects such as Compound and Uniswap, mostly for claims around selling unregistered securities in violation of the Securities Act.

Lastly, in early May 2023, Nathaniel Chastain, a former product manager at OpenSea, a marketplace for NTFs, was convicted of fraud and money laundering in connection with his purchase of various NFTs he had decided to feature on the front page of the OpenSea website, and selling them shortly thereafter at a large profit. Federal prosecutors described the conviction as the first insider trading case involving crypto assets. 

In 2022, the SEC brought a total of 30 enforcement actions against crypto-asset related companies and individuals. Notably, the BlockFi order clarifies that arrangements involving crypto interest accounts offered by crypto-lending platforms such as BlockFi, whereby investors deposit crypto-assets to the platform in exchange for a variable periodic interest payment, may be investment contracts that must be registered or qualify for an exemption from the registration. 

The SEC is not alone in enforcing its mandate; several other US regulatory agencies, including the CFTC, the US Treasury Department, and State regulatory agencies have brought enforcement actions against crypto-asset related companies of late.

The following are some of the most notable enforcement actions occurring over the course of 2022-23. These are just a few examples of enforcement actions that target a specific participant in the digital asset space in order to communicate a regulatory approach to the broader market.

Avraham (Avi) Eisenberg

In December 2022, Avraham (Avi) Eisenberg was arrested and charged in Puerto Rico on allegations of commodities fraud, commodities manipulation, and wire fraud in relation to his involvement in the manipulation of the Mango Markets decentralised crypto-asset exchange. The DOJ alleged in its complaint that Eisenberg was engaged in a scheme to fraudulently obtain crypto-assets worth approximately USD110 million from Mango Markets and its customers and achieved his objective by artificially manipulating the price of certain perpetual futures contracts. 

In late January 2023, the SEC also charged Eisenberg with engaging in a manipulative and deceptive scheme to artificially inflate the price of Mange Market’s MNGO token. The SEC’s complaint charges Eisenberg with violating the civil anti-fraud and market manipulation provisions of the Exchange Act, and seeks permanent injunctive relief, a conduct-based injunction, disgorgement with prejudgment interest, and civil penalties.

In all, these actions signal to industry participants the gravity of engaging in the types of activities allegedly performed by Eisenberg. It is expected that co-ordinated actions of this nature by regulators will continue as US regulatory agencies refine their approach to regulating activities involving crypto-assets. 

Hydrogen

In September 2022, the SEC filed a complaint against the Hydrogen Technology Corporation (“Hydrogen”) and its former CEO, along with the CEO of a self-described “market making” firm for their roles in effectuating the unregistered offers and sales of digital assets called “Hydro” tokens, which the SEC alleged were in fact investment contracts – a type of security under the Howey test. The SEC complaint outlined four different ways that Hydro tokens were allocated to US investors:

• an Airdrop;
• bounty programmes;
• employee compensation; and
• the creation of a secondary market to enable it to directly offer and sell Hydro to investors.

Notably however, the SEC did not directly allege that the Airdrop of Hydro tokens constituted investment contract transactions. Instead, the SEC alleged that the other three methods of distribution in the complaint constituted investment contract transactions. In particular, the SEC alleged that Hydrogen’s bounty programme, whereby airdrop recipients could receive additional Hydro in exchange for completing certain promotional tasks amounted to offers and sales of investment contracts (since the recipients in effect barter their time and skill in exchange for tokens). The ostensible consideration in the Hydrogen matter was the value of their “efforts to market, promote, and develop the Hydrogen platform” – tasks that had to be completed to receive Hydro tokens in the bounty programme. Tyler Ostern, one of the parties to the suit, quickly settled with the SEC for USD41,000. The company, along with its CEO, were later ordered to pay over USD2.5 million in fines and disgorgement fees.

Kraken

Payward Ventures, Inc. and Payward Trading Ltd, both commonly known as Kraken, settled charges alleging that they violated securities laws by failing to register the offer and sale of its crypto-asset staking-as-a-service programme. As proof of stake networks proliferate, staking-as-a-service programmes that allow holders of crypto-assets native to these networks to participate in transaction validation without operating their own node, are becoming more popular. The SEC’s complaint alleged that Kraken’s staking programme, which involved Kraken pooling and retaining control over the staked crypto-assets, meets the elements of an “investment contract”, and that the staking arrangement is therefore a security. This complaint is a reminder of the importance of keeping regulatory considerations at the forefront when undertaking product development. To settle the SEC’s charges, Kraken agreed to immediately cease offering its crypto-asset staking services and pay USD30 million in disgorgement, prejudgment interest, and civil penalties.

KuCoin

In March 2023, the New York Attorney General filed a lawsuit charging crypto trading platform KuCoin, alleging that the Seychelles-based crypto exchange violated the NY State securities laws by offering certain notable tokens that met the definition of a security. In establishing its charges, the NYAG alleged, most notably, that Ethereum’s ETH traded on the platform as a security. While the NYAG’s allegations have no force of law, its allegations are notable as it is the first time a US regulatory authority has clearly articulated such a position with respect to ETH.

At the federal level, there are no regulatory sandbox programmes in the USA specifically geared towards blockchain projects. At the state level, both Wyoming and Utah have regulatory sandbox programmes relevant to blockchain. Additionally, Arizona, Kentucky and Nevada have passed laws providing for regulatory sandbox programmes to promote innovation, though they address more generally the use of emerging technologies for innovation.

In 2014, the Internal Revenue Service (IRS) issued its first guidance with respect to virtual currency that virtual currency is “property” for federal tax purposes and that general tax principles applicable to property transactions apply to transactions in which virtual currency is used. In 2019, the IRS issued further guidance addressing the tax implications of a hard fork. When a hard fork results in a taxpayer receiving new units of cryptocurrency over which they have dominion and control, they will have gross income as a result. If they do not receive any new units of cryptocurrency over which they have dominion and control in connection with a hard fork, they will not have any gross income.

Earlier in 2023, the Treasury Department and the IRS announced that they were soliciting feedback for upcoming guidance regarding the tax treatment of NFT as a collectible under the tax code. Until further guidance is issued, the IRS intended to determine when an NFT is treated as a collectible by using a look-through analysis, under which NFT is treated as a collectible if the NFT’s associated right or asset falls under the definition of collectible in the relevant section of the tax code.

A lawsuit was filed by private litigants against the IRS in 2021 with respect to the taxation of staking rewards. The plaintiffs sought a refund on taxes paid on staking rewards earned on Tezos. The IRS subsequently authorised a full tax refund on the claim. The federal judge dismissed the case as the action was moot after a tax refund was issued. The plaintiffs are currently in the process of appealing their case’s dismissal. 

In March 2022, the President of the United States issued a comprehensive executive order addressing digital assets with the goal of establishing a comprehensive approach to this space. The executive order identified six key priorities: consumer and investor protection; promoting financial stability; countering illicit finance; US leadership in the global financial system and economic competitiveness; financial inclusion; and responsible innovation. Reports submitted call for responsible digital asset development, which includes increased enforcement of existing laws for mitigation of downside risks. 

While there are not any definitive laws or court cases specifying how ownership of a digital asset is determined in the USA, most non-security digital assets are likely to be considered “bearer” instruments. Control over the asset equates to ownership, primarily through control of the private key necessary to effectuate an on-chain transaction involving the digital asset. There are many instances in which the owner of a digital asset transfers control to a third party, in which case the owner’s right to the asset is contractual, pursuant to the terms of their agreement with the third party.

The categorisation of a digital asset as a security, commodity or some other type of property is highly fact-dependent in the USA, and in many cases, it is not easy for market participants to determine the correct characterisation in advance. Unfortunately, there is no efficient mechanism for market participants to make an advance determination with any degree of legal certainty in the current regulatory environment.

Notably, the SEC and the CFTC have expressed conflicting views regarding the status of specific cryptocurrencies with each other over time. For example, in recent public statements, the current SEC Chair indicated his view that every cryptocurrency other than Bitcoin is a security, while the CFTC took the position that many crypto-assets (including Ether and various stablecoins) are commodities.

In order to obtain specific formal guidance that can be confidently relied upon, market participants have the option of pursuing a request for no-action from either the SEC or the CFTC. Such a request would set out in detail a business model utilising blockchain technology or involving a digital asset and then seek confirmation from the relevant regulator that, if the plan is followed as described, they will not recommend enforcement. The SEC has so far provided no-action relief with respect to four projects involving the use of blockchain technology:

• The first was for Turnkey Jet, Inc, in which the SEC provided no-action with respect to the sale of a digital token at a fixed price redeemable for air travel.
• The second was for Pocketful of Quarters, Inc, a gaming platform on the Ethereum blockchain, in which the SEC provided no-action relief with respect to the sale of an ERC-20 token for gaming.
• The third was for Paxos, in which the SEC provided no-action relief with respect to a blockchain-based clearing and settlement platform for certain National Market System (NMS) securities.
• The fourth was for IMVU, Inc, in which the SEC provided no-action relief with respect to the sale of ERC-20 tokens for a virtual world with limited transferability outside the virtual world.

The CFTC has chosen to deal with these issues in a more generally applicable way by providing broad guidance. For example, the CFTC released final interpretive guidance with respect to the actual delivery in the context of retail commodity transactions involving virtual currency, an issue that was the subject of several requests for no-action or guidance.

The regulatory treatment of stablecoins in the USA is still unclear. The SEC has treated stablecoins as securities in its recent Wells notice to BUSD’s issuer, Paxos, asserting that this stablecoin is an unregistered security. In the SEC’s lawsuit against Terraform Labs, the SEC also alleged that algorithmic stablecoins USTs were sold as securities.

In November 2021, the President’s Working Group on Financial Markets released a report on stablecoins calling for Congress to address the inconsistent and fragmented oversight of stablecoins. In April 2023, the House Financial Services Committee released a draft version of a potential stablecoin bill, including a potential moratorium on stablecoins backed by other cryptocurrencies (such as UST) and a request to study a central bank digital currency.

In the USA, generally speaking, cryptocurrencies may be used for payments if they are accepted by merchants. The use of cryptocurrencies or any other fiat substitute for payments may trigger the money transmission laws at the federal and state levels.

There are no regulations in the USA that are specific to NFTs, but existing laws will apply to activities involving NFTs.  Given their non-fungible nature, NFTs are unlikely to be considered “commodities”. To the extent that the offer or sale of NFTs constitutes an investment contract under the Howey test, compliance with the securities laws would be required. As mentioned in 2.5 Judicial Decisions and Litigations, Dapper Labs was sued in one of the first private plaintiff actions alleging securities violations associated with NFT sales. In denying Dapper Labs’ motion to dismiss, the judge signalled that the offer and sale of Moment NFTs may satisfy the Howey test, considering that the value of Moment NFTs is dependent almost entirely on Dapper Labs’ control over the private blockchain upon which the NFTs are created and traded. 

Additionally, the offer and sale of NFTs as consumer products would be subject to consumer protection laws and regulations. Both federal and state consumer protection laws generally prohibit unfair or deceptive acts and practices with respect to consumer goods and services. Those selling NFTs must keep sanctions compliance in mind and take steps to avoid engaging in transactions with sanctioned individuals or individuals residing in sanctioned jurisdictions.

In a recent “rug-pull” scheme associated with an NFT project called “Frosties”, two individuals advertised the project but later abruptly abandoned it without providing the benefits advertised to investors and, after selling the Frosties NFTs, transferred millions of proceeds in payments. Both were recently arrested and charged with conspiracy to commit wire fraud and money laundering by the US government. 

Lastly, as mentioned in 2.8 Tax Regime, the IRS is soliciting feedback for upcoming guidance regarding the tax treatment of NFT as a collectible under the tax code.

There are a variety of markets for digital assets available to US persons.

Digital Asset Securities Markets

Platforms that provide for the exchange of digital asset securities are highly regulated by the SEC. Any entity engaging in exchange activity with respect to securities, including digital asset securities, must register as a national securities exchange or operate within an exemption to such registration. There is an exemption from registration as a national securities exchange for alternative trading systems that comply with the SEC’s Regulation ATS, which requires the entity operating an alternative trading system (ATS) to register with FINRA as a broker-dealer and certain other prerequisites.

Notably, in its recent Wells notice to Coinbase, the SEC contends that some of the digital assets listed on the Coinbase platform meet the definition of a security, and thus Coinbase is operating as an unregistered exchange, clearing agency, and broker, and additionally, its self-custody wallet software is operating as an unregistered broker. The SEC has not yet formally brought enforcement action against Coinbase.

Centralised Markets for Non-security Digital Assets

Centralised platforms that allow users to exchange non-security digital assets are prevalent in the USA, and facilitate fiat-to-digital-asset or digital-asset-to-digital-asset transactions. These platforms may perform these services in a custodial manner, meaning the platform maintains custody of the assets trading on the platform in an omnibus account for the benefit of its customers and relies on its own internal record-keeping to credit and debit customer accounts as needed. In other words, exchanges of assets between customers of a custodial platform will not result in an auditable on-chain transaction, and the transaction will only be reflected in the internal ledger used by the platform to track customer balances.

These platforms may also perform these services in a non-custodial manner, in which transfers of digital assets facilitated by the platform occur on-chain and are directed to the self-custodied wallet addresses of the transaction participants. In either case, platforms that provide these services with respect to non-security digital assets are generally regulated as money transmitters at both the federal and state level and have the attendant KYC/AML and BSA compliance obligations.

Decentralised Markets for Non-security Digital Assets

There are also a variety of decentralised exchanges available to US persons, which typically provide for a peer-to-peer exchange of digital assets by means of a technical protocol or one or more smart contracts. Exchanges facilitated in this way do not typically involve third-party custody of the digital assets being exchanged at any point in time during the transaction. The regulatory obligations with respect to decentralised exchanges will be highly fact-dependent, but it is likely they will be regulated as money transmitters at both the state and federal levels. As noted in 1.3 Decentralised Finance Environment, the SEC recently proposed a rule to expand the definition of exchange to include communication protocol systems. Such an expanded definition, once adopted, will have the effect of bringing smart-contract-based exchange and liquidity protocols, and/or tools used to access such protocols, within the definition of exchange to the extent that these protocols and tools are facilitating transactions in digital assets the SEC deems to be securities.

As discussed in 4.1 Types of Markets, there are a variety of US markets that facilitate the exchange of fiat currency for digital assets. Any market facilitating such an exchange is likely to be classed as a money transmitter at both the federal and state level and will likely have the attendant KYC/AML and BSA compliance obligations. The same is true for markets facilitating the exchange of one digital asset for another digital asset.

As discussed in 2.3 Regulatory Bodies, the BSA is the primary federal law addressing KYC/AML in the United States, and applies to any entity that is acting as a money services business, which includes money transmitters. Generally speaking, the BSA requires money transmitters to know their customers and implement and enforce policies and procedures reasonably designed to detect, report and deter suspected money laundering and other suspicious transaction activity.

As mentioned in 1.3 Decentralised Finance Market, OFAC added a number of blockchain addresses associated with Tornado Cash, to the SDN List, thereby prohibiting all US persons from engaging in transactions with these addresses. The Treasury Department further made clear that any DeFi service that functions as a financial institution as defined by the BSA, regardless of whether the service is centralised or decentralised, will be required to comply with BSA obligations, including AML/CFT obligations. 

Please refer to 2.3 Regulatory Bodies for a discussion of the relevant regulators with respect to digital assets in the USA.

There are no specific laws or regulations that deal with re-hypothecation of non-security digital assets.

Wallet providers were addressed in the May 2019 FinCEN guidance regarding convertible virtual currency. The guidance described the types of wallets that may be used to store digital asset value and the regulatory treatment with respect to each of them. That treatment depends on four criteria:

• who owns the value;
• where the value is stored;
• whether the owner interacts directly with the payment system where the convertible virtual currency (CVC) runs; and
• whether the person acting as intermediary has total independent control over the value.

Wallets in which user funds are controlled by third parties are referred to as “hosted wallets”, while wallets in which user funds remain in the control of the user are called “unhosted wallets”. Hosted wallet providers are money transmitters and have different obligations with respect to different types of wallet users. Unhosted wallets are software enabling a person to store and conduct transactions involving convertible virtual currency. The user is also not acting as a money transmitter while using an unhosted wallet to engage in transactions on their own behalf.

The creator of unhosted multi-signature wallets that restricts its role to providing a second authorisation key to validate and complete transactions initiated by the wallet user is not a money transmitter according to the May 2019 FinCEN guidance. However, the provider of a hosted wallet with a multi-signature feature will be a money transmitter, as will any wallet provider that stands between a wallet user and the payment system or that exercises independent control of the value in a wallet.

Custody of digital assets is also a regulated activity in certain states, most notably New York State. The New York BitLicense regime requires entities located in New York State or doing business with New York State residents to obtain a licence when they engage in virtual currency business activity. There are five enumerated virtual currency business activities, one of which involves taking custody of virtual currency on behalf of customers, whether in a hot wallet or cold wallet solution. Accordingly, hosted wallet providers must obtain a BitLicense in New York before offering such services in New York or to New York residents.

Capital raising through the sale of a digital asset is almost always considered securities activity that is subject to compliance with federal and state securities laws in the USA, though courts and regulators conduct individual analysis to determine whether the sale of a digital asset that does not clearly fall within one of the enumerated instruments in the definition of a security constitutes an “investment contract” pursuant to the Howey test.

This test, as refined by subsequent interpretation, requires an investment of money in a common enterprise with an expectation of profit to be derived from the essential managerial efforts of others in order to find an investment contract. Two points are critical to this analysis:

• whether a reasonable purchaser of a digital asset would be expected to be purchasing with investment intent or consumptive intent – ie, whether a purchaser has a reasonable expectation of profit or not; and
• whether there is an active participant upon whose essential efforts a reasonable investor would rely in order to profit.

The SEC provided clarification with respect to factors relevant to these critical points in April 2019 in guidance titled the “Framework for Investment Contract Analysis of Digital Assets”, which sets forth 38 different factors, some with sub-factors, that the SEC considers relevant to the analysis of the security status of a digital assets.

Nevertheless, more recently, the current SEC Chair repeatedly indicated in public statements that almost all digital assets are themselves securities. If a digital asset is a security, then public offering of a security must be registered with the SEC under Section 5 of the Securities Act unless it falls within an exemption from registration, despite the fact that the disclosure regime designed for traditional securities issued by centralised companies is ill-suited for digital assets.

The use of an exchange to conduct an initial sale of digital assets for capital-raising purposes does not change the analysis set forth in 5.1 Initial Coin Offerings, and such sales are also likely to be treated as securities transactions subject to compliance with the securities laws in the USA. In particular, depending on how a particular initial exchange offering is structured, if an exchange is acting as an underwriter or an unregistered broker-dealer with respect to the distribution of digital asset securities, they may incur significant legal liability.

Distribution of tokens via an airdrop or other mechanisms that may not involve an obvious investment of money will still be subject to the Howey test to determine whether the arrangement constitutes an investment contract subject to the securities laws.

In the Tomahawk matter, Tomahawk distributed “Tomahawkcoins” (TOMs) in exchange for promotional efforts by the recipients, such as marketing TOMs, promoting TOMs on social media, and making requests to list TOMs on trading platforms. Despite the lack of monetary consideration, the SEC concluded that the investment-of-money element of the Howey test was satisfied, and the airdrop of TOMs was treated as an investment contract, the distribution of which constituted an offer and sale.

Similarly, as mentioned in 2.6 Enforcement Actions, in the Hydrogen matter, the SEC alleged that Hydrogen’s bounty programme, whereby airdrop recipients could receive additional Hydro tokens in exchange for completing certain promotional tasks, amounted to offers and sales of investment contracts. The SEC took the view that the ostensible consideration was the value of the participants’ efforts to market, promote, and develop the Hydrogen platform – tasks that had to be completed to receive Hydro tokens in the bounty programme.

Digital asset investment funds are subject to the same regulatory requirements as traditional investment funds. A variety of fund structure options are available to funds holding digital assets under the Investment Company Act of 1940 (the ICA), which generally requires investment companies to register or fall within an enumerated exemption from registration. Any company with more than 40% of its assets in investment securities constitutes an investment company. Accordingly, the categorisation of digital assets as securities, commodities or something else is critical in determining whether a fund has a registration obligation pursuant to the ICA. As mentioned in 2.6 Enforcement Actions, in the BlockFi order, the SEC concluded that BlockFi was an issuer of securities engaged in the business of investing, owning, holding or trading in securities with a value exceeding 40% of its total assets, and thus BlockFi was operating as an unregistered investment company in violation of the ICA.

The most commonly relied upon exemptions from registration under the ICA are Sections 3(c)(1) and 3(c)(7). The Section 3(c)(1) exemption is for funds that have fewer than 100 holders that are all “accredited investors”, while the Section 3(c)(7) exemption permits an unlimited number of holders who must be “qualified purchasers”. 

Finally, private funds that hold assets other than securities, such as non-security digital assets, are not investment companies and can simply offer interests in their funds in private placements pursuant to Regulation D under the Securities Act.

There are no special regulations pertaining to broker-dealers or financial intermediaries dealing in digital assets. Rather, legacy laws and regulations applicable to broker-dealers and financial intermediaries have been adapted to cover activities involving blockchain and digital assets. In 2020, the SEC released guidance for so-called “special purpose” broker-dealers with respect to taking custody of digital asset securities in the form of a five-year safe harbour for that activity so long as certain conditions are met. The conditions include that the broker-dealer limits its business to digital asset securities, establishes and implements policies and procedures reasonably designed to mitigate the risks associated with conducting a business in digital asset securities, and provides customers with certain disclosures regarding the risks of engaging in transactions involving digital asset securities. Broker-dealers meeting such conditions will not be subject to an SEC enforcement action. So far, no firm has been authorised to act as a special purpose broker-dealer.

The general view in the US legal community is that private contractual arrangements that are executable, in whole or in part, using blockchain or distributed ledger technology are valid and enforceable, assuming the elements necessary to form a contract are present – offer, acceptance, the intention to be legally bound, and consideration. Whether a smart contract is coded to reflect the intentions of the parties is a separate question and one that has prompted significant debate with respect to how such a situation would be handled and resolved.

As mentioned in 1.3 Decentralised Finance Environment, OFAC added Tornado Cash, along with its associated blockchain addresses, onto the SDN List, following which Dutch authorities arrested one of the core developers of Tornado Cash for concealing criminal financial flows and facilitating money laundering through the mixing of cryptocurrencies.  The case is pending trial in the Netherlands. 

Nevertheless, it is not likely that developers of decentralised blockchain-based networks or the code that runs these networks would be considered fiduciaries who have a duty to the users of the network or the code in the USA. So far there have been no cases in the USA in which developers have been held responsible for a breach of a fiduciary duty in connection with losses sustained by the user of software they have developed for use on a decentralised blockchain network.

DeFi platforms are prevalent and gaining in popularity in the USA. These platforms operate in an emerging area, though many of these DeFi platforms are operating in areas that might traditionally be subject to regulation. For instance, escrowing digital assets in a smart contract with the expectation of earning a profit in the form of interest paid by another user that borrows and uses those digital assets is very similar to peer-to-peer lending products, such as those offered by Lending Club and Prosper, that were adjudged by a variety of US securities regulators to be securities.

Various regulators have issued reports with respect to activities that have taken place on DeFi platforms. For example, as mentioned in 1.3 Decentralised Finance Environment, the US Treasury issued its 2023 DeFi Illicit Finance Risk Assessment report exploring illicit finance vulnerabilities unique to DeFi. 

In addition, it is worth noting that DeFi platforms often involve the use of stablecoins in order to provide a digital on-ramp to the relevant service. Accordingly, the increased regulatory scrutiny with respect to stablecoins will also increase regulatory attention with respect to DeFi.

Digital asset lenders may attempt to take a security interest in a digital asset pledged as collateral for a loan pursuant to the applicable provisions of the Uniform Commercial Code (UCC), a body of laws relating to commercial transactions that are adopted at the state level. Currently, many treat the digital asset pledged as collateral for a loan as a “financial asset”, treat the borrower’s account with the lender as a “securities account”, treat the borrower as an “entitlement holder”, and have the borrower acknowledge that the lender is a “securities intermediary”, as all of these terms are defined under the UCC. This should create a “security entitlement” under the UCC that will allow for perfection of a security interest in the collateral by the lender.

In July 2022, amendments to the UCC have been approved, pending adoption by each state, which would create a new Article 12 that governs the transfer of property rights in a “controllable electronic record” (CER), and amend the existing Article 9 to allow perfection of a security interest in a CER by obtaining control of the CER. Once the amendments are in effect in a particular state, the parties to a digital asset transaction can benefit from the rules provided under the UCC.

There are specific laws and rules that apply to how certain regulated participants in the securities markets in the USA hold assets in custody for the benefit of others, with the goal of protecting customer assets. 

Broker-dealers are subject to the customer protection rule under the Securities Exchange Act, which requires them to hold securities in custody over which they have exclusive possession and control in a “good control location.” Several different types of third-party custodians can serve as good control locations, including banks, other broker-dealers and clearing agencies. Please refer to 5.5 Broker-Dealers and Other Financial Intermediaries for further information.

Registered investment companies are required by the ICA to maintain their securities and similar investments with a bank, a member of a national securities exchange or a central securities depository.

Registered investment advisers are subject to the “custody rule” under the Investment Advisers Act of 1940, which generally requires them to hold customer funds and securities with a qualified custodian. Qualified custodians include banks, registered broker-dealers, futures commission merchants and foreign financial institutions. In February 2023, the SEC announced a proposal involving significant changes to the custody rule, which would significantly expand the overall scope of client assets subject to the custody rule to include all crypto-assets, create practical challenges as to which entities providing safeguarding services are permitted to act as qualified custodians, and mandate new contractual terms between investment advisers and qualified custodians, among other things. By emphasising the proposal’s coverage of crypto-assets, the SEC appears to be continuing to narrow the ability of financial intermediaries to viably participate in crypto-asset-related activities. 

The use by investment advisers of banks and other entities that are directly or indirectly owned by publicly traded companies as qualified custodians with respect to crypto-assets of clients was impacted by Staff Accounting Bulletin 121 (“SAB 121”), which was issued by the staff of the SEC’s Office of the Chief Accountant in March 2022. SAB 121 set new accounting standards for companies providing custodial services with respect to crypto-assets for customers. Ostensibly due to the unique risks of custodying crypto-assets, SAB 121 requires that, among other things, companies subject to the bulletin record a liability (and corresponding “indemnification asset”) on their balance sheets at fair value for all crypto-assets held for third parties. This change caused any entities subject to the bulletin and acting as a custodian to have to record additional theoretical assets equal to the amount of crypto they held for clients. 

Data privacy laws are enacted at the state level in the USA. The absence of a federal data privacy law means that there are differing obligations in each state with respect to data privacy. Practically speaking, this means that national companies will seek to comply with the most robust state-level data privacy law. The California Consumer Privacy Act (CCPA) is the most robust state data privacy law, and became effective in 2020. Among other things, the CCPA provides consumers with the following:

• the right to access data collected about them by covered businesses;
• the right to delete that data; and
• the right to opt out of data collection altogether.

Covered businesses also need to provide consumers with a privacy notice, with two or more methods to opt out of the sale of personal information, and are prohibited from using opt-out mechanisms that make it difficult for a consumer to execute and have the effect of subverting the consumer’s choice to opt out. The CCPA does not directly implicate blockchain, but any covered business using blockchain to gather, store or refer to customer information should have compliance with the CCPA in mind.

Data protection laws are also enacted at the state level in the USA. The CCPA has a data protection component requiring covered businesses to implement and maintain reasonable security procedures. Similar data protection laws have been passed in other states, as have data breach reporting statutes. These laws do not specifically apply to the use of blockchain-based products or services.

Mining cryptocurrencies on blockchain networks running proof-of-work algorithms is generally allowed in the USA. Other than New York state’s two-year moratorium on new fossil fuel-powered cryptocurrency mining projects, generally there are no specific regulations in place with respect to mining activity.

However, such activity may be subject to money transmission regulations in certain circumstances. The May 2019 FinCEN guidance reiterates previous guidance indicating that miners who are users of the virtual currency they mine are not money transmitters. On the other hand, the administrator of a mining pool that combines mining services with hosted wallets on behalf of pool members will be a money transmitter.

Staking assets to secure blockchain networks using proof-of-stake consensus protocols is allowed in the USA and currently, there are no laws or regulations specific to staking as a method of validating blockchain transactions. However, staking as a service (StaaS) products may satisfy the Howey test and thus the offering of StaaS products may constitute securities offerings. For example, as mentioned in 2.6 Enforcement Actions, in its enforcement action against Kraken, the SEC claimed that Kraken offered a programme that pooled customer assets to stake and advertised high return, offering and selling investment contracts without registering the offers or sales with the SEC. The SEC also similarly indicated its view that the Coinbase staking service constitutes securities.

DAOs are exploding in popularity in the USA. Groups are seeking alternative forms of organisation to facilitate collective action. DAOs have emerged as a model that can incentivise contributions to a common cause and foster organic growth. Without a formal legal entity structure associated with a DAO, it is likely that DAOs with a significant US presence would default to treatment as general partnerships. This can have significant consequences for participants from a liability and tax perspective. For example, as mentioned in 2.5 Judicial Decisions and Litigations, in the CFTC’s lawsuit against Ooki DAO, the CFTC alleged that Ooki DAO’s voting token holders comprised an unincorporated association and were liable for violations of the CEA.

For such reasons, there has been much discussion about “wrapping” DAOs in a legal entity structure. Participation in a DAO is usually signified by holding governance tokens issued by the DAO. These tokens may be earned for contributing to the DAO and in other ways as determined by DAO members. These tokens typically provide the holder with the right to participate in the DAO governance process by voting on proposals or making proposals.

See 10.1 General regarding DAO tokens. Some tokens may also provide the holder with other benefits as well. Some DAO governance occurs completely on-chain by use of a governance smart contract that links on-chain voting to a DAO treasury such that an approved proposal to disburse funds from the treasury results in programmatic implementation of the approved action. Other DAO governance structures may have off-chain elements. The degree to which governance occurs on-chain or off-chain correlates to the degree to which the community is willing to rely on human action in order to implement approved proposals. 

Different DAOs have used different legal structures in the USA. Certain investment club DAOs have used Delaware limited liability companies, and membership units are held by the members of the investment club DAOs. Wyoming has passed a specific DAO LLC law that provides for an interesting legal entity structuring option. Both Utah and Vermont have also created entity options for DAOs. A few other states (for example, California) currently have pending legislation around DAOs.

Membership interests in LLCs may constitute securities in the USA, and usually they are assessed under the Howey test for investment contracts. Accordingly, if the holder of an LLC membership interest is relying on the essential managerial efforts of another to expect a profit, there is a risk that the LLC membership interest may be treated as a security.

In addition, the ethos of many DAOs is to facilitate anonymous participation. The Corporate Transparency Act will soon require entities formed in the USA by filing papers with a secretary of state’s office to report on beneficial ownership, which will not allow for anonymous owners. For these reasons, many DAOs have also looked to more flexible entity structure options outside of the USA.