Research, ideas, and leadership for a more secure, peaceful world
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Helena Rong
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Sarah Hubbard
On December 1st, we hosted our third and last panel Policymaking in Web3 as part of our three-part Perspectives in Web3 Virtual Series. We were joined by legal scholars, lawyers and policy researchers who work at the forefront of this domain, including Primavera De Filippi, Research Director at the National Center of Scientific Research and Faculty Associate at Harvard’s Berkman-Klein Center for Internet & Society; Connor Spelliscy, Executive Director of the DAO Research Collective; Miles Jennings, General Counsel and Head of Decentralization of a16z Crypto; David Kerr, Principal of Cowrie LLC; and Lindsey Kelleher, Senior Policy Manager at Blockchain Association.
Here are some key takeaways from the event:
Web3 innovations such as cryptocurrency, decentralized finance (DeFi), and decentralized autonomous organizations (DAOs) face immense compliance challenges due to legal and regulatory uncertainties. Given the complexity of the technology stack and nascency of the industry, it took the last five to seven years for regulators to become educated about the technology and many more are still grappling with learning about the technology. As the field grows and expands, policymakers are increasingly aware of the urgent need to provide legal certainties for the field in order to ensure consumer and investor protection and market integrity. Our panelists walked us through several key pieces of legislation around the world concerning web3 regulation.
In the U.S., the Digital Commodities Consumer Protection Act (DCCPA) provides the Commodity Futures Trading Commission (CFTC) the authority to regulate “digital commodities” and “digital commodity platforms.” Under the DCCPA, crypto assets will be classified as commodities as opposed to securities which would grant the CFTC jurisdiction over crypto spot markets. Spellicy highlights some of the industry’s key concerns with DCCPA, including the de facto ban of De-Fi by applying the same rules to decentralized protocols/smart contracts and centralized intermediaries, and the lack of clear distinction between “digital commodity” and “digital security” and thus the unclear dividing line between responsibilities of the CFTC and those of the SEC.
In Europe, Markets in Crypto-Assets (MiCA) is a comprehensive bill proposed by the European Commission to streamline DLT and virtual asset regulation in the EU that is planned to take effect in April 2024. It is designed to address crypto-assets such as cryptocurrencies, security tokens and stablecoins that are not currently governed by any existing financial services legislation. A notable omission of MiCA is the topic of DeFi, whose complexity and legal ambiguities warrants a separate investigation that sits outside the current scope of MiCA. In regulating stablecoins, the MiCA legislation proposes to place a cap on the size of crypto assets that are linked to non-euro dominated stablecoins circulating in the EU to 1 million transactions and 200 million euros in transaction value in order to protect the use of euro-dominated stablecoins. Dr. De Filippi points out an important dichotomy that the bill currently does not sufficiently recognize: the difference between stablecoins issued by centralized entities and collateralized algorithmic stablecoins that do not have an entity that manages its token issuance. Lack of distinction between the two could cast enormous compliance challenges for the latter as it becomes impossible to ask for an authorization to operate in the EU. For web3 builders who work with collateralized algorithmic stablecoins, Spelliscy urges them to pay particular attention to MiCA as it would have drastic implications for whether algorithmic stablecoins are even allowed to exist once the bill is enacted.
Prompting regulators to pay attention to the nuances of the technology, Dr. De Filippi highlights the need for regulators to provide different ways to comply with the same regulatory objective. For policymakers, there needs to be recognition of to which extent there is risk with different systems, and to which extent specific technological guarantees may even lower the risk or at least increase the transparency and respond to regulatory requirements, and thus be recognized as regulatory equivalent to existing legal protections. This way, self-regulation can more easily interface with and complement governmental regulations to get the best of both worlds of the private sector and government, “by bringing practitioners in the blockchain space to engage with regulators so as to propose technical solutions that can be regarded as fulfilling the same policy objectives as existing regulatory frameworks.”
Across the Pacific, Singapore, Hong Kong, and India are at the forefront of crypto regulations. Kelleher introduced several key policy discussions in Asia. The Monetary Authority in Singapore (MAS) recently published two papers on regulating cryptocurrency payments and stablecoin-related activities. In addition, to support the development of De-Fi and understand its opportunities and risks areas, the MAS also recently launched Project Guardian, which is a pilot project between JP Morgan, DBS and SBI Digital Asset Holdings to experiment with cross-border transactions of tokenized currencies and government bonds. In Hong Kong, regulators are searching for ways to open up a mature crypto market to retail investors by authorizing crypto ETFs that would give investors access to mainstream crypto assets with the appropriate investor guardrails. India on the other hand, aims to develop standard operating procedures (SOPs) for cryptocurrencies during its G20 presidency this winter.
When asked to comment on which geography is ahead of the game in terms of regulation, our panelists agree that the EU is currently taking the spearhead lead, particularly in the realm of stablecoin regulations, albeit still lacking more nuanced differentiation of the different types of stablecoins. The omission of De-Fi in the current version of MiCA gives buffer space for policymakers to understand the technology and to provide the most appropriate regulatory frameworks for the technology. But until then, entrepreneurs are again facing uncertainty as they continue to build products in the space.
Given the domino effects that come from the downfalls of FTX and Terra/Luna in recent times, much regulatory scrutiny has focused on the urgency of providing consumer and investor protection. Sharing similar views as panelists from our Investing in Web3 event, our panelists contend that the collapse of FTX is a tale of corporate fraud rather than due to any defects of the technology itself. Jennings stresses that while it is beneficial to have regulatory oversight of crypto spot markets, it is crucial for regulators to tell the distinction between good-faith actors innovating in decentralized technologies within the ecosystem versus violators of securities laws that could well exist in any industry, the latter deserving much more attention and resources for investigation from the SEC to prevent similar financial fiascos from occurring in the future.
Adding a layer of jurisdictional complexity of crypto regulations, Kelleher notes that the solvency of FTX U.S. Derivative (formerly known as LedgerX) owes to the strict oversight of the CFTC, while the absence of regulatory oversight for the company’s operations abroad largely led to FTX’s ultimate downfall, underlining the benefits of having clear and transparent rules. However, the challenge remains that policymakers should provide a sensible regulatory environment that both encourages innovation and mitigates potential risks, rather than enforcing one-size-fits-all umbrella solutions that could stifle innovation and steer away entrepreneurs from innovating within their jurisdictional borders. Kerr raises the point that “web3 is not a zero-sum game between centralization and decentralization.” Although technology today has allowed for robust forms of decentralization to combat undesirable privatized control over technology platforms found in web2, this does not mean centralization has no role in a decentralized ecosystem. According to Kerr, “where the harm or the activity was effectively regulated in web2 should provide the map for web3 and it is only the areas where the technology fundamentally changes the existing operations or relationship between parties that would require new or different regulatory structures at all.”
In the past, regulation has often relied on informational reporting and compliance provided by intermediaries. However, Kerr argues that such an approach is ineffective and outdated for web3 applications that do not have intermediated transactions. To confront the new technological reality of the present, governments themselves should update their own toolbox and methodologies of investigation. To this end, our panelists emphasize the need for collaboration between practitioners and policymakers in this space to search for novel ways of cultivating and sustaining a healthy and safe Internet ecosystem.
Designing jurisdictional orders over a borderless Internet technology has practical challenges. Kerr shared with us his experience working in the realm of taxation and highlighted key jurisdictional challenges relating to taxes. International taxation on technologies has been affected by the concept of “base erosion,” which refers to corporate tax planning strategies adopted by multinational enterprises to exploit gaps and mismatches in tax rules in order to avoid paying tax. The utilization of borderless technology eliminates the idea of “physical nexus” and results in the need for “economic nexus,” which allows jurisdictions to collect sales taxes based on a set threshold of sales revenue rather than the physical presence of a business in the jurisdiction. Current discussions on crypto often revolve around the technology itself, but there are huge unsettled issues in the matter of international taxation in regards to fair apportionment of where taxes should be assessed, who should pay, what qualifies as a nexus requirement, and what should be shared between jurisdictions. These issues deserve attention from the international community to define a responsible tax position in a world where the type of technology at hand is innately adverse to a clear path towards taxation.
In order to incentivize entrepreneurship and innovation, we must give entrepreneurs the tools they need to succeed. DAO legal entity structures is one of the critical tools and protections that web3 entrepreneurs currently lack. Through their work at a16z crypto, Kerr and Jennings have been exploring legal frameworks and entities for DAOs in a series of US-focused legal research and frameworks for DAOs. This exploration into legal frameworks had found that the unincorporated nonprofit association (UNA) entity was the current ideal strategy for domestic filing. “The UNA is a compelling alternative that provides legal existence to unincorporated organizational forms, which is analogous to what most DAOs represent…. The structure is operationally flexible, adheres to the tenets of decentralization (governance by token holders, anonymity, etc.) and despite the name, is not prohibited from earning profits,” Kerr and Jennings state in their piece How to pick a DAO legal entity.
In the U.S., several states have begun to introduce DAO LLC laws, such as Wyoming, Tennessee and Vermont. Overall, the panelists agreed that this was a great step forward on the part of legislators to be willing to learn, listen, and create a solution. However, the issue with these current laws is that they still have many LLC requirements that do not quite align with the nature of DAOs. For example, DAOs with anonymous membership will have a very difficult time proving the breakdown of ownership typically required in an LLC. These bills were also lacking annotations that help explain the applications in practice or what had to be included to stay consistent with existing legal principles. Overall, the bills as they stand today are not too unique or helpful for DAOs over a traditional LLC. But the states’ desire and willingness to iterate and experiment is ultimately conducive for advancing the field from a legal perspective. In the short-term, states have a role to play in developing these legal entity forms, but in the long-term they will need to collaborate at the federal level on tax policy.
An alternative approach with an international lens that Dr. De Filippi described is the DAO Model Law proposed by COALA. Given that DAOs are operating at such a transnational level, this approach explores specific ways that policy objectives can be accomplished with technological guarantees. For example, certain DAOs could potentially qualify for legal personality or some partial legal liability if their technical design meets some conditions. Instead of taking the “stick” approach of using regulation to punish, DAOs could be incentivized with the “carrot” (activities they seek to do such as hiring, entering contracts, property) by implementing technological guarantees that are equivalent to traditional regulatory compliance.
As we seek to ensure the responsible development of web3 technologies, questions of national competitiveness, national security, consumer protection, extremism, and free speech came to the fore. Kerr pointed out there are several difficult, thorny issues coming to a head in society we will need to address with or without “web3”.
Exploring the angle of national security and competitiveness, Jennings noted that the technological development of web3 is already happening, and whether or not particular geographies emerge as leaders in shaping the future of value transfer around the world hinges on the regulatory frameworks that are created for entrepreneurs, and whether there are sufficient support and incentives provided for them to build in this space. In addition, given the intricate relationship between the physical nature of regulatory jurisdictions and the borderless network created by the technology, there are inevitable geopolitical tensions at play when examining the technology from a global perspective, adding additional layers of challenges through which both policymakers and entrepreneurs need to navigate.
While a difficult balance to strike, the panelists think that there should not have to be a compromise between technical innovation and consumer protection. Protecting consumers does not necessarily have to come at the cost of constraining the potential of the technology. This is where collaboration will be critical between policymakers and practitioners to develop solutions going forward.
For those who are interested in learning more about the intersection of web3 and public policy, the panelists pointed to a handful of organizations that actively publish educational resources such as the Blockchain Association, Coincenter, European Crypto Initiative, and COALA as helpful starting points. Other advocacy groups such as the Electronic Frontier Foundation and Fight for the Future, while not web3 focused, are also interesting organizations with similar values.
The panelists suggested that the best way to learn was to dive-in to understanding the technology, talk with technologists in this space, and to do some writing yourself as a critical thought exercise. Given the complexity and rapid development in web3, we must bridge together builders, investors, and policymakers to create thoughtful technology policy for the future.
Thank you for following along with our Perspectives in Web3 series– for previous sessions, see the Investing in web3 recap and Building in web3 recap posts. Please feel free to reach out to Sarah Hubbard (sarah_hubbard@hks.harvard.edu) and Helena Rong (helena_rong@hks.harvard.edu) if you have further questions or are interested in future collaborations.
Rong , Helena and Sarah Hubbard. “Event Recap: Policymaking in Web3.” December 16, 2022
