I. Executive summary
The crypto industry is hamstrung by legal cost, confusion, and delay.
Crypto projects frequently misunderstand the critical legal risks to their companies and have limited tools to mitigate those risks. Founders often find themselves facing high legal fees and regulatory scrutiny, impeding development of their project while accruing substantial cost. Given the low supply of, and high demand for, lawyers with crypto expertise, even projects willing to pay for robust legal advice have difficulty obtaining it.
This failure can impair or destroy a project, and slows progress in the industry.
We encourage the community to support initiatives to research, compile, curate, and open-source information on the types and scale of legal risk in crypto, and present practical solutions and tools available to crypto companies. By collectively opening access to legal information, we can make high-quality legal information available to founders while dramatically reducing cost.
Access to legal information will help founders to better understand and assess the risk of the products they create at an earlier stage of development, and make them aware of relevant solutions or risk-mitigating opportunities.
We have compiled a list of the most pressing legal issues for crypto companies based on interviews we had with 35 leading crypto teams and lawyers.
Based on that list of issues, with assistance from advisors, we have formulated strategies for the community to start developing solutions. Key strategies include promoting the development of crypto legal cooperatives, which leverage group knowledge and buying power to collectively prioritize and purchase legal information at a small fraction of the normal cost, and risk-mitigating crypto products like OpenZeppelin’s Defender and Nexus Mutual Smart Contract Cover.
We encourage the crypto community to work together to create a better legal environment for crypto and to resolve the issues identified in this paper. If you want to contribute to the space, or you are thinking through related solutions, reach out to @c_spelliscy on Twitter.
II. Key observations and metrics
The observations listed below address the legal and regulatory issues crypto founders face and were compiled during our interviews with 35 crypto founders, operations executives, general counsel, and external counsel.
- Legal analysis in crypto is expensive, time-consuming, and speculative
Crypto founders do not understand key legal issues that impact their projects
The lack of legal clarity and qualified lawyers, paired with the high stakes of running afoul of the law, make for a very resource-intensive and nebulous legal environment.
Many founders were not aware of the need to consult a lawyer at an early stage of the development of their project or chose not to consult a lawyer because of the expense. Unsurprisingly, 100% of the founders we interviewed reported having altered the design of their product or business in response to legal information learned after they started development. These circumstances prove costly for startups, particularly those that delay consulting a lawyer until they are deep into the development of their project. Founders also frequently complained that legal advice varied significantly between lawyers.
Crypto-native lawyers are expensive and in very limited supply
Based on our interviews, teams find that lawyers often fall into one of two categories. The first category is composed of crypto-native lawyers who are familiar with crypto but have limited availability and are very expensive. Interviewees found that many crypto lawyers would not respond to their emails or would tell them that they had no capacity. The fees for crypto-native lawyers are high: rates in the US range between $300/hr on the low end for junior associates and $2,200/hr on the high end for senior partners. In the second category are lawyers who are not crypto-native but have availability and may have lower hourly rates. These lawyers will, however, generally take longer and provide less informed advice, while receiving a paid opportunity to educate themselves on crypto. This leads to a huge tradeoff in the quality and dependability of legal advice.
Interviewees reported that the number of qualified lawyers is dropping, as the few crypto-native lawyers available leave private practice and join crypto companies full-time. Since the lifestyle of working for the average crypto company is much better than a law firm and the pay can be comparable or even better, depending on rights to tokens and other upside, this is not too surprising.
Crypto requires novel, complex, and fact-specific legal analysis
Many of the key issues faced by crypto companies are without precedent, making a lawyer’s analysis even more difficult, expensive, and speculative. These issues are also often not pure legal issues that a lawyer can cleanly resolve in a memo. Instead, they are complex issues that involve an overlap of legal, technical, and tax advice. As such, lawyers have to work closely with many different members of a team and/or other service providers, which further drives cost. Given the quick pace of change in crypto, lawyers who are not exclusively focused on the industry will fall behind and provide advice that is not up to date.
Many of the crypto companies we interviewed had complex international structures, which they originally employed for tax or regulatory reasons. Those structures make it much more difficult for these companies to operate, and founders spend a significant amount of their time trying to navigate issues like establishing presence in particular jurisdictions, or finding tax-efficient ways of transferring assets between entities. Many founders believed that their service providers – lawyers, tax consultants, and accountants – recommended overly complex structures so they could bill more.
Some crypto projects also issue tokens and run their operations through foundations which, while potentially beneficial for purposes of a securities analysis, tax analysis, and overseeing ongoing development of a network, can result in a significantly higher administrative burden.
Lawyers generally provide poor guidance on the likelihood and quantum of a risk
Interviewees found that their lawyers often warned them of potential consequences of launching their products, like corporate and personal liability (including potential criminal charges), but rarely provided information on the likelihood and quantum of such risk. Without that information, teams had difficulty weighing risks and determining when to make changes to products, or mitigate risk through insurance or other tools.
Crypto companies are most interested in US law and securities issues
Projects identified the following categories of legal issues as important to them, in order of those identified most to least often: securities, corporate structuring, tax, KYC/AML, personal and corporate liability, licensing, intellectual property, treasury management, DAOs, and derivatives.
Projects identified the following jurisdictions as important to them, in order of those identified most to least often: United States, EU, Canada, UK, Switzerland, Germany, Cayman Islands, Singapore, Portugal, Estonia, Hong Kong, and Luxembourg.
- Key risks for crypto founders
Insufficient risk-management offerings expose crypto companies and their directors and officers to significant liability
Founders in crypto are subject to substantially more risk than founders in other industries, in large part because the tools and products available in other industries that allow for protection are not yet available in crypto, including insurance and security products.
For instance, crypto companies rarely have access to insurance products like Directors’ and Officers’ (D&O) insurance, which provides cover for directors and officers of a company in the event that they are personally sued for actual or alleged wrongdoing when managing a company (source). Common claims brought against directors and officers include poor corporate governance and failure to comply with laws and regulations – two claims that are particularly relevant in crypto, where the regulatory landscape is murky and corporate governance is in early stages.
Almost all of the founders we asked about D&O insurance wanted it, but only slightly more than 25% had it. That difference was largely due to the fact that D&O insurance for crypto companies is significantly more expensive than in other industries. To give you a sense of the scale of the difference, the average company with revenue of under $50M typically pays between $5,000 and $10,000 per year for $1M in D&O insurance (source), whereas the companies in crypto that we spoke to were offered policies that generally ranged between $50,000 and $150,000 per year. And those policies had exceptions that made them much less effective, like carve-outs for the US, SEC, or tokens.
Many of the companies we spoke with could not even find an underwriter to offer them policies. The lack of D&O and similar insurance inhibits innovation in the industry. Founders take fewer risks as they could be held personally liable for their work, and certain advisors refuse board positions for the same reason.
Though not directly a legal risk, projects often lack tooling to mitigate cybersecurity risk to their projects, an issue that might ultimately lead to legal enforcement including via class action. Limited cybersecurity tooling is a major problem in crypto, where hacks are common, and will become a greater problem as the total value locked in crypto networks continues to grow exponentially. Since 2019, crypto stakeholders have lost more than $364M to hacks and exploits.
Founders in a rush to fundraise often expose themselves and their team to unforeseen legal and tax liability
Founders excited by bull markets and investor furor often raise capital using methods that might result in unnecessary legal risk, including: (i) violating securities laws; (ii) increasing the likelihood that their tokens will be deemed securities; (iii) operating Money Services Businesses (MSBs) or exchanges without a license; and (iv) selling derivatives without a license.
Founders also make quick decisions that could result in recipients of tokens (contractors, miners, and other stakeholders) being subject to enormous tax liability, for instance, by distributing illiquid tokens after a priced round. Token recipients may not be able to pay tax bills if the token is not yet liquid or its price drops after a taxable event. Due to the lack of guidance from tax regulators around the world, conducting proper tax planning in advance comes at a high cost, which often is not a good use of funds before a project has found product-market fit or generated traction.
Crypto projects mimic the structural and procedural precedents set by their high-signal predecessors, without assessing whether that strategy optimizes for their specific projects
Founders often describe copying the legal strategy and structures of industry leaders for purposes of mitigating legal risk, despite the fact that these founders lacked the necessary information on the specifics of the decisions made by those industry leaders. For instance, projects seemed particularly interested in copying the decentralization and airdrop strategies employed by Uniswap, Compound, and The Graph. Founders justified doing this, in part, because it was easier to copy an existing precedent than to apply complex and vague regulations to their particular fact pattern.
One of the high-risk mistakes projects frequently make is marketing before consulting with a lawyer
Projects may make public promises or promises to their stakeholders that are illegal or heighten the risk of their tokens being considered securities. Project representatives may also disclose sensitive information without understanding the consequences. For instance, projects may discuss past hacks and security vulnerabilities without appreciating that they could be liable for the consequences of such security vulnerabilities.
Failure of consistent compliance hinders fair competition and industry growth
The lack of regulatory clarity in crypto results in companies taking varied approaches to compliance or ignoring it entirely. Companies that are less observant are able to employ strategies that can provide a competitive advantage over their counterparts in the short-term. In the long-term, legally-grey actions may be significantly penalized, but that is not always clear to companies taking those actions.
Those who ignore compliance may hurt the industry by generating unfavorable attention from regulators and media.
Crypto projects rely on advice from non-professionals
Interviewees described relying on legal advice from Twitter, Discord and Telegram groups, podcasts, blogs, newsletters, and advisors. Given the complex legal environment in crypto, relying on non-professionals can lead projects into dangerous territory.
III. Using limited resources to solve ecosystem problems
I propose the following strategies for reducing some of the legal burdens to which crypto founders are currently subject. Though these are not comprehensive solutions, by making crypto-specific legal advice available to founders at a lower cost, and by mitigating the risks of operating blockchain companies, these proposals aim to make it easier and safer for founders to build products in crypto, and to have a positive impact on the space as a whole.
Purchase and distribute legal information through cooperatives
Crypto companies working in related fields could set up cooperatives through which they collectively buy legal information on issues that impact them all. A cooperative is an autonomous association of persons/organizations (“members”) united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically controlled enterprise (source). Cooperatives can be incorporated in different jurisdictions or operated as unincorporated associations.
For instance, a group of NFT exchanges, games, and issuers could come together to purchase legal opinions on how to mitigate the risk that NFTs could be deemed securities or that the use of NFTs could be considered gambling. While each company would require its own firm to tailor advice to its product and when handling confidential content, the collective purchase could be the foundation of their legal analysis. Just 10 projects in a cooperative would lead to a reduction in cost of 90% and, by the time you reach 50 members, a 98% reduction. The cooperative could choose to distribute collectively purchased legal information solely to its members, or it could also open source that legal information, or portions of it, for the benefit of the broader crypto community.
Cooperative members would also benefit from collective participation in identifying and prioritizing legal issues. Members could upvote issues they believe to be top priorities, and each member would benefit from the group’s collective issue-spotting. In addition to the legal advice purchased through cooperatives, crypto companies could also share portions of memos they have already received from counsel (which are not privileged or confidential).
These cooperatives could also share a portion or all of the legal information they purchase outside of the cooperative, helping the entire crypto community to better understand legal issues at a lower price. A great example of an impactful initiative is the memo Gabriel Shapiro, a prominent crypto lawyer, published arguing that YFI are not investment contracts. Gabriel also drafted a list of his motivations for publishing the memo, including that “many people involved in cryptocurrencies have never seen a securities law memo analyzing whether a token is a security because lawyers typically write them for clients and keep them secret—by publishing one, [they] can educate people, which might increase everyone’s understanding of the issues and help create better solutions.”
Our work: We are currently working on forming the first research cooperative for DAOs and, if we’re successful, we can develop a guide of best practices which can act as a precedent for other crypto stakeholders intent on building their own cooperatives.
Increase the supply of qualified lawyers by educating them on crypto
As described above, despite the crypto industry growing exponentially in recent years, lawyers have been slow to enter the space. Low supply paired with high demand makes for a limited number of expensive lawyers in the space.
Our work: We are currently working alongside a number of in-house crypto lawyers to start a program which would educate lawyers in private practice on how to provide crypto-tailored legal advice to clients. Our intent is to prepare a program taught by general counsel to help demystify some key concepts and put external counsel on the right path to developing crypto-friendly legal practices. Ideally, in return for our work in helping to educate these lawyers, we can convince them to volunteer some of their time to research and write on crypto concepts relevant to the community.
Support crypto industry associations and nonprofits
Organizations like the Blockchain Association, Coin Center, the Proof of Stake Alliance, and many others play key roles in building the industry by helping regulators and policymakers understand the value of crypto and why it should be properly regulated. Their participation often goes unnoticed by the community but, without their advocacy, the industry would be substantially set back by misguided regulation.
A good example of this is the campaigning done by Coin Center and the Blockchain Association against FinCEN’s self-hosted wallet regulation. This regulation would have required crypto exchanges to collect information from individuals transferring crypto from exchanges into their personal wallets, and could have had a major chilling effect on the industry. Without the leadership of industry associations providing government with trusted counterparties in crypto, the industry would have a much weaker, disorganized response to harmful regulation
De-risk the industry with innovative products and tools
Crypto companies generally do not have access to basic tools and products for risk mitigation.
Crypto companies also face risks associated with the lack of enterprise-quality security products in the industry. Demand is higher than ever for services and tools that mitigate risk, including security audits and protocol insurance. Innovative crypto companies, like OpenZeppelin and Nexus Mutual, have started to launch products that help mitigate some of this risk. OpenZeppelin’s Defender acts as a security hub for crypto networks that allows them to continuously scan on-chain activity for potential threats, and enables them to take action before exploits occur. Nexus Mutual is a decentralized insurance alternative that offers smart contract and centralized exchange coverage, and has other forms of coverage on its roadmap. More tools like these need to be developed to mitigate risk to crypto stakeholders.
Provide the community with a list of key legal issues inhibiting growth
We are optimistic that crypto lawyers will solve some of the key issues we have identified above, and be inspired to research and write on the subject, either motivated by profit or by a desire to focus on the biggest issues for the community.
We encourage the community to think creatively about these issues, and consider whether some of the tooling they are building may contribute to legal solutions. For instance, tools to facilitate the formation of cooperatives, or to allow crypto companies to stay compliant with the Travel Rule. If you want to contribute to the space, or you are thinking through related solutions, reach out to @c_spelliscy on Twitter.
Connor Spelliscy is currently working with blockchain organizations including OpenZeppelin, Cosmos, and the Ethereum Foundation on initiatives designed to improve the ecosystem with a particular focus on access to legal information or improving government policy. He co-founded and remains a Board Observer at the Blockchain Association, a lobbying group representing blockchain entrepreneurs and investors.
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services.
Thanks to Arianne Flemming, Jonathan Dotan, and Onur Akpolat for advising me on this paper; to Jelena Djuric, John Neufeld, Josh Hurwitz, Marc Boiron, Marta Belcher, Sam Vance-Law, Sina Habibian, Josh Stark, and Sarah Brooks for reviewing/editing; and to the Interchain Foundation for supporting my research!