Crypto and War | Decentralized Law
BanklessDAO Legal Newsletter
Dear Crypto-Legal Observers,
Over the past six months, Decentralized Law has spilled more than a little digital ink discussing crypto and uncertainty. Regulatory guidance for blockchain-based businesses and individuals is uncertain. The future of the crypto space is bright, but the particulars are unknown. Crypto-natives are used to operating in this uncertainty; in fact, many of us thrive in it. War footing analogies are not uncommon, but until recently, these analogies had nothing to do with literal war.
Crypto and war — these are words which have not been uttered together, at least not on a global scale and not in the context of actual armed conflict. And yet, with the war in Ukraine, the two terms are now paired regularly in mainstream media.
Much of the coverage has discussed whether Russia and its oligarchs are able to avoid sanctions by using cryptoassets. There have also been many stories about how crypto is being used in Ukraine, which has one of the highest crypto adoption rates in the world. The analyses have been fair: acknowledging the misconception that crypto is an effective sanction-avoiding tool, while also highlighting the positive role that crypto has played in helping those in Ukraine suffering through modern war.
Decentralized Law also seeks to present a balanced analysis of crypto during times of war. For this issue, we had the pleasure of interviewing our good fren Eagle, the coordinator of BanklessDAO’s Legal Guild and a regular contributor to this publication, who also happens to be a lawyer and law professor deeply involved in multiple DAOs and Web3 projects. From his perch, Eagle provides a learned perspective on crypto's place in times of global uncertainty.
Also in this issue of Decentralized Law, we explore the tokenization of disputes, analyze how crypto interplays with the war in Ukraine, provide an overview of the U.S. President Joe Biden’s new executive order on crypto, and summarize news and articles from across the cryptoverse.
Although this newsletter may help to familiarize readers with the legal implications arising out of blockchain technology, the contents of Decentralized Law are not legal advice. This newsletter is intended only as general information. Writers’ opinions are their own; therefore, nothing in this newsletter constitutes or should be considered legal advice. Contact a legal expert in your jurisdiction for legal advice.
Eagle Swoops in to Talk About Crypto in Times of Global Unrest
Please tell us about your background and how you came to specialize in crypto-legal issues.
I am an Italian law professor and attorney. I was born into a family of lawyers and, starting from high school, I used to spend lots of time at my father’s law firm. During the university years, I became really passionate about the law and after graduation I followed the academic path with an LL.M. and a Ph.D. I then became an attorney and law professor, and used to work as a litigator with a specific focus on contract law. In 2020, two former students asked me to help set up a crypto-fund. They came to me because I started to give classes on digital law. To be honest, back then I did not have practical knowledge about crypto-related issues, but I immediately understood the potential and the innovative nature of the industry.
Apart from the fantastic journey with the crypto-fund, the most important gift that my students gave me was introducing me to Bankless. I subscribed to the newsletter, which gave me privileged access to the BanklessDAO. There I have started to contribute at the Legal Guild and had the possibility to enter in contact with fantastic people with different legal backgrounds. Nowadays, I devote almost all my time to crypto-related projects and every day I become more enthusiastic about the technology and how the industry is growing.
How do you think that the crypto industry is positioning itself in these uncertain times?
This is a very difficult question. I think that the crypto industry and all of the people who are part of it are behaving in a way which is peculiar. Of course, everyone is against the war and everyone hates seeing humans suffer and die without a reason, but there are some peculiar elements that distinguish this industry from other sectors.
First of all, our industry is niche compared to others; a niche in which people have easy contact at a global level. During a crypto-working day, I easily come into contact with almost every continent. In the morning, mostly with Indians and Chinese; in the afternoon with Americans and in the late evening with Australians. And of course I speak with a lot of Europeans! Every person has their own background and a different sensibility. Nobody wants to create discomfort and I have the impression that mainstream narratives that one hears from the media do not affect so much the way in which we are behaving. It is very important to read and have knowledge of Vitalik’s tweets, to keep contact with (and try to help) Ukrainian friends, but the war is not on-chain. Decentralization and the related incentives lead to a peaceful environment where people tend to be aligned for common goals.
Second, our technology is absolutely “neutral” in nature. Public blockchains are permissionless and censorship resistant. This has a particular meaning when it comes to applying economic sanctions or restricting certain activities. Operations on the blockchain are unstoppable because no intermediaries are needed and nobody really has the control. Nevertheless, in the last two weeks, the “humanity” of blockchain emerged in a way which I would describe as twofold: some things were really bad, other things were simply amazing.
Let’s start from the bad ones. What did you not like?
This is more an external view that people have about blockchain that brought tremendous misconceptions. Many articles were written that blockchains and crypto are the perfect tool to escape economic sanctions. On the other side, somewhat paradoxically, others wrote that Western states are inflicting sanctions on digital assets.
I think that both claims are misleading and untrue. The one related to “escaping sanctions” is similar to the typical position that considers crypto the perfect tool for illicit activities: buying drugs, arms, executing cyber-crimes, etc. Well, I think that it is absurd to hold a technology at fault for something, as humans drive the transactions in the network. Moreover, our technology permits us to do lots of fantastic things; we are building the metaverse! But blockchains cannot enable everything. In situations where food or energy are not there, economic activities are blocked and personal freedom is endangered, holding Bitcoin or Ether becomes pretty useless. What I am saying is that external conditions count, and blockchains and crypto actually influence these to a very limited extent.
As to the crypto sanctions, in reality the measures mostly concerned crypto-exchange accounts where people are identified through KYC procedures. Again, blockchain technology is neutral and its permissionless nature holds true, no matter what happens in the off-chain world.
Ok, that’s enough! Tell us something beautiful now!
This one is quite easy. As in other occasions, the industry showed a great solidarity and myriad fantastic initiatives to support the Ukrainian people. What I want particularly to mention is the creation of digital organizations aimed at supporting people that are in need. This is an additional evolution of our beloved DAOs, which are becoming more and more social constructs that use technology only “as a tool” to fulfill certain missions.
On a more general note, in spite of the dramatic times, it was beautiful to see that cryptocurrency was universally accepted as a medium to help people. I think that this is an important milestone for our industry.
Lastly, I like the fact that crypto goes on as usual with memes, shitposts, terrific bets, and speculation. This is an inherent factor that apparently nothing can change. The industry is not able to take itself too seriously. I think that is a result of being part of a kind of parallel world, which eventually leads to leaving sad feelings in the “true” world.
Do you think that the war will influence the crypto industry in the long run?
Not much. In my opinion, this is demonstrated by discussions held in two of the major regions of the Western world within the last few days. While the worldwide geopolitical equilibrium was blowing up, Biden signed an executive order on “Ensuring Responsible Development of Digital Assets.” On the other hand, notwithstanding the menace of a nuclear war, the European Parliament found the time to discuss and (luckily for us) to dismiss an amendment of the crypto assets regulation proposal which would have led to a ban of proof-of-work blockchains.
Talking about these regulatory issues in this dramatic time is proof of insensibility, but it also demonstrates that blockchain technology is here to stay. No matter what.
What I think will affect the crypto industry — at least a bit — is a growing mistrust for traditional institutions. The fact that policy and diplomacy were not able to find a peaceful solution to the Ukrainian situation in 2022 may enhance the will of building a monetary system which is truly free from external constraints. Time will tell if this is a good thing…
Tokenized Arbitration Funding May Be the Future of Disputes Finance
Compared to litigation, arbitration is probably a more “decentralized” way to resolve disputes. Instead of resorting to a centralized judicial authority, parties can freely decide (i) who can adjudicate their disputes and (ii) how proceedings should run. Under the legal framework of the New York Convention, the decision made by the arbitral tribunal can also be largely free from the authorities’ interference. Arbitration is a peer-to-peer and censor-proof mechanism, and thus a viable option for the on-chain dispute resolution in future.
Third-party funding has been one of the most popular topics in the arbitration industry. A third-party funder is defined as “an entity that has no interest in the underlying merits of a dispute but provides funding or resources for the purpose of financing the legal costs and expenses of an international arbitration.” According to data compiled by Burford Capital, the period from 2019 to 2021 saw a 66% increase in funded arbitration, as reported by top law firms.
In the era of Web3, can third-party funding be tokenized? Does tokenized funding play well with on-chain dispute resolution?
Tokenization has happened in the litigation finance space. For example, the ABA Journal reported that an “initial litigation offering” (ILO) had been launched in relation to a Californian case (Apothio v Kern County). Investors funding the Apothio case receive crypto tokens on the Avalanche blockchain which could produce returns if Apothio’s counsel secures a recovery for its client in the litigation. One ILO token on Avalanche is the equivalent of one U.S. dollar, and returns will be paid out in USD-denominated stablecoins. The return can vary from zero to 350% depending on the case result.
In the arbitration sector, however, there is limited data on whether any arbitration funding has been tokenized. This does not prevent us from analyzing and anticipating the opportunities and challenges in this area.
The Tokenization of Disputes
What can tokenization bring to disputes funding? First, tokenization can help the parties raise funds from a wider group of people, instead of relying on institutional funders. In this respect, tokenization is more analogous to crowdfunding. For example, AssangeDAO was launched to raise legal fees for the WikiLeaks founder and a governance token named JUSTICE was issued to the donors. Assuming there is an arrangement between Assange and the DAO in which they will share the return if Assange wins the case, and such return will be paid back to the token holders, this process will then amount to a tokenized disputes funding and the donation will amount to an investment.
Second, a tokenized disputes fund can be put in a secondary market which boosts the liquidity of this type of investment, enabling investors to buy and sell their units freely without having to wait until the case is decided. Third, tokenization can arguably (a) increase the transparency of the funding process — since the amount raised, the trade volume, and which address has participated can all be traced — and (b) attract more investors as they can make informed funding decisions by collecting more data from different cases.
These advantages may be offset by some of the challenges faced by arbitration funding. Most commercial arbitrations are private and confidential by default. Under those regimes which allow third-party funding, funders are expected to comply with the confidentiality obligation. The funding arrangement is often disclosed to the other party and the tribunal to avoid any conflict of interest. Thus, in a traditional arbitration, it is difficult for a party to directly raise funds through tokenization since it will necessarily disclose the existence of the arbitration, which can be a breach of the confidentiality obligation.
An alternative approach is that the party is funded by a particular institutional funder, while the institution tokenizes the fund units and offers the tokens to the public. This seems more feasible but leads to the next challenge: information asymmetry between the institutional funder and token holders. Due to professional privilege, a lawyer’s advice on legal position and strategy can only be communicated to the client, and sometimes to the institutional funder. It is almost impossible to disclose all these communications to a large group of investors. Unlike a court litigation where many filings are open to the public, token holders who invest in an arbitration will barely know anything about the case. They can do nothing but “trust” the institutional funder’s evaluation. This may again discourage investors from buying such tokens, since few investors like to buy sight unseen. The transparency advantage discussed above is no longer relevant in this situation.
Tokenizing On-Chain Arbitration
Beyond the traditional arbitration finance, will on-chain arbitration be more friendly to tokenized funding? The answer can be yes, but only if it is a small claim in the public domain. Taking Kleros as an example: at least for now, the disputes submitted to this platform are (a) open to the public and (b) mostly small claims. The public feature is compatible with fundraising from unknown investors. Further, although funding small claims may not be attractive from the traditional third-party funder’s perspective, a small-scale, peer-to-peer funding arrangement can play a role in this scenario. The party to an on-chain dispute may not have enough funds to pay the fees for adjudicators to commence or defend the action. On the other hand, someone who has a strong view on that dispute may be willing to fund the party to get a portion of the compensation. But this mechanism must be designed in a way to avoid any collusion between funders and adjudicators, given that on-chain participants are usually pseudo-anonymous.
Section 4.8.2 of the Kleros Yellow Paper also provides a model for the appellant to raise funds to pay appeal fees to tackle the issue of facing a wealthy party who exploits the appeal system. See also a recent discussion initiated by @jordanteague on Twitter.
Another reason it is more feasible to fund small claim arbitrations is the absence of lawyers. There is no privileged communication between parties and their legal advisors, and thus there is no information asymmetry.
Tokenization of disputes finance (especially for arbitration cases) is still in a proof-of-concept stage. A successful tokenized funding model must handle the following competing concepts well: (a) confidentiality of arbitration vs openness of tokenized fundraising; (b) privileged legal advice for the party vs information rights of token holders; and (c) clearance of conflict of interest vs pseudo-anonymity of on-chain identity.
Cryptoassets and the Russia-Ukraine Conflict
On February 26, 2022, the European Union, the United States, and other Western countries disconnected certain Russian banks from the SWIFT international financial system in the wake of Russia's invasion of Ukraine. The EU has imposed sanctions on Russia that will increase its borrowing cost, raise inflation, and may push its economy into recession. Amidst all the ongoing tension, the crypto markets have been impacted. Crypto markets fell more than 4% at the start of the war but defying expectations, Bitcoin's value rose again, reaching over 40,000 USD.
Russia and Ukraine have been at odds for some time now, with Ukraine living in fear of war with Russia since the invasion of Crimea in 2014. Tensions began to escalate in early 2021, after Ukraine’s President hinted that the nation would be allowed to join NATO, which infuriated Russia. Soon after, Russia deployed soldiers near the Ukrainian border, calling it a “training exercise.” The U.S. threatened Russia with heavy sanctions if Russia attacked Ukraine.
Russia has built a solid economy, with a GDP to debt ratio six times less than that of the U.S. Its growing relationship with China and increased adoption of cryptocurrencies indicates that Russia hopes it can resolve any adverse economic impacts in its favor. Various governments are preparing lists of Russian people and businesses who may have their economic transactions and assets restricted. However, the Russians are turning to crypto to move their assets around. It will be challenging for the authorities to track such transactions, however, as digital assets can largely be stored anonymously. Iran and North Korea are among countries that have used digital currencies to mitigate the effects of Western sanctions in the past.
Crypto and Sanctions
The bitcoin revolution may weaken the power of Western sanction programs if there is a prolonged use of this technology and the sanctioned governments from such countries choose to officially embrace cryptoassets. In order to monitor cryptoasset-based transactions, the United States is drafting laws that will create obligations for central cryptoasset exchanges with respect to restricting and reporting transactions. The U.S. is also urging the cryptocurrency industry to put checks and internal controls into place.
While cryptoassets were created to maintain wealth outside of a state’s purview and its banking system, the centralized cryptoasset exchanges are acting exactly same as regulated banks with regards to implementing sanctions. A major cryptoasset exchange, Binance, has blocked the accounts of clients targeted by the sanctions list, acting on the government’s request. Additionally, blockchain analysis tools offer a “know your transaction” tool that alerts companies when blacklisted entities use their services. Such tools are helpful if entities or individuals want to restrict their transactions with the sanctioned individuals, but savvy cryptocurrency users can find ways around the blacklist.
Crypto Can Help the Aggrieved
In this crisis, even Ukraine is using blockchain-based technology to strengthen its position against Russia. The equivalent of millions of USD in crypto has flowed in to support Ukraine’s army and hacktivist groups. Even the Ukrainian government is now soliciting donations in crypto and has already raised more than 15 million USD. As a matter of fact, Ukraine is one of the largest cryptocurrency adopters in the world, with Ukrainian leaders making concerted efforts to turn the country into a new crypto haven.
DAOs are playing an important role as well. UkraineDAO partnered with Come Back Alive to gather support for the Ukrainian army through crypto donations that will provide the military with necessary supplies, equipment, and medical kits. NFTs have also played an important role in fundraising. The country received 1.86 million USD — a portion of the mint sale of 'Censored NFT.' The NFT collection was created by digital artist ‘Pak’ in collaboration with Julian Assange. A CryptoPunk NFT worth over 200,000 USD has also been donated to Ukraine.
The Blockchain is Agnostic
Blockchain technology is changing and challenging the world. Cryptoassets have helped both Russia and Ukraine in this conflict. Russia also has multiple cryptocurrency-related tools at its disposal, and will eventually find ways to trade with various business entities in digital currency.
Ukraine is one of the first nations to benefit from the use of cryptoassets in times of external aggression. Regardless, it seems cryptoassets are now an essential part of public warcraft. Going forward, we will likely see countries focusing on regulating crypto more broadly given the use of this technology in times of conflict.
Not as Bad as We Feared: President Biden's Crypto Executive Order
U.S. President Joe Biden signed an executive order (EO) on March 9, 2022, directing federal agencies to develop comprehensive strategies for managing systemic risks and regulatory gaps posed by crypto while promoting "responsible innovation." Among the areas the agencies must consider are consumer, investor, and business protections; data privacy and security; global financial stability and systemic risk; illicit finance and national security risks; and energy demand, pollution, and climate change.
The EO does not just focus on risks and negative externalities; it also directs the agencies to support crypto innovation so that the U.S. can maintain technological leadership and competitiveness in crypto, payment innovation, and blockchain technology, which could lead to more federal investment in research and development. The emphasis on U.S. leadership in this space may also lead to the creation of a central bank digital currency. The EO does not say so explicitly, but it implies that a U.S. CBDC is a necessary step to maintaining the U.S. dollar as the world’s reserve currency. Other positive takeaways from the EO are its acknowledgment that privacy, access to safe and affordable financial services, and the ability to exercise human rights are legitimate and desirable goals of a crypto regulatory framework.
While the EO starts the process of creating regulations for crypto, it is not the crackdown that some had feared. Jerry Brito, executive director of Coin Center, said in a tweet that the EO signals that the U.S. government now sees cryptocurrency as "a legitimate, serious, and important part of the economy and society," which should encourage more involvement in the sector.
The EO is simply a call for further study and deliberate planning, and not a reactive rush to regulate crypto out of existence. It's too soon to say exactly what sort of regulations may come from the agencies. Still, providing a path to more regulatory clarity, coupled with a commitment to support innovation, is without a doubt a positive development for the industry.
🌐 News and Selected Articles
Author: Jialiang David Pan
In an annual meeting convened by the People’s Bank of China, it was reiterated that China would continue its crackdown on crypto speculation. The meeting, attended by heads of local banks, National Internet Finance Association of China, foreign currency settlement and clearing services providers, discussed regulatory priorities for the country’s financial market in the coming year.
The central bank said in a separate statement that China has resolved various financial risks, and has “effectively curbed the speculation of domestic virtual currency transactions, and the bitcoin transactions in China have rapidly dropped from more than 90% to 10% of the total in the world.”
Author: David Attlee
On Monday, March 14, 2022 the European Parliament’s Committee on Economic and Monetary Affairs (ECON) voted against a version of the Markets in Crypto Assets (MiCA) bill that could have banned proof-of-work mining within the EU.
Patrick Hansen, Head of Strategy at Unstoppable Finance, reported that 32 members of ECON voted against the bill, and 24 in favor. The moderated version of MiCA, which excludes any direct or implied banning of proof-of-work mining, will now continue on along the path to becoming law.
As part of the majority vote against a ban on proof-of-work mining, the European Commission was directed to present, by January 1, 2025, an alternative legislative proposal “with a view to including in the EU sustainable finance taxonomy any cryptoasset mining activities that contribute substantially to climate change mitigation and adaptation.”
Author: Hanna Lang
Centralized digital asset companies in the U.S. and abroad have agreed to comply with sanctions orders following Russia’s invasion of Ukraine. However, unlike many TradFi entities, companies such as Kraken, Gemini, Coinbase, and FTX have rejected calls to blanket-ban Russian users.
This position sparked concerns among U.S. and European officials that digital assets could be used to circumvent sanctions, and that digital asset companies are not up to the task of complying with sanctions imposed on Russia.
Executives at implicated companies appear increasingly frustrated that existing compliance regimes are being called into question; the increased scrutiny could prove to be a pivotal moment for the sector to demonstrate that it is not the “wild west” of finance portrayed by regulators.
Coinbase, for example, has subsequently issued a lengthy blog detailing its controls and noting that it has blocked more than 25,000 addresses connected with Russian individuals or entities believed to be engaging in illegal activity.
Since the sanctions were implemented, the U.S. Treasury Department has been in contact with digital asset companies and trade associations to explain its expectations for compliance and to establish a direct line of communication.
Author: Jamie Crawley
The UK’s Financial Conduct Authority (FCA) warned on Friday, March 11, 2022 that every crypto ATM in the UK is currently operating illegally, something consumers should take into account.
Crypto ATMs in the UK should be registered under the FCA and comply with the Money Laundering Regulations. To date, no ATMs have been approved by the FCA to exchange fiat money for cryptocurrencies.
This doesn’t mean that crypto ATMs are illegal in the UK, but that they must take the necessary steps to comply with the regulations.
Author: Danny Park
South Koreans have elected a new president, Yoon Suk-yeol of the conservative People Power Party, following a contentious election with a fair amount of mudslinging from both sides.
President-elect Suk-yeol has been viewed as a “crypto friendly” politician who believes in a proactive pro-crypto policy when it comes to regulation of the crypto markets in South Korea.
To address a beleaguered economy, President-elect Suk-yeol has campaigned on the promise of deregulation of the cryptocurrency markets and an easing of rules around capital gains taxation of cryptocurrency profits (raising the threshold for the 20% capital gains tax from approximately 2,100 USD to 41,000 USD).
A pro-crypto approach for South Korea would be quite a turnaround. South Korea has previously imposed draconian laws on the country’s crypto exchanges, effectively forcing 90%+ of them to shut down following very stringent regulatory requirements put into place in September 2021.
President-elect Suk-yeol is quoted as saying, “To realize the unlimited potential of the virtual asset market, we must overhaul regulations that are far from reality and unreasonable.”
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