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It is one of the basic principles of capital and financial markets regulation that the same rules apply to the same business and the same risk. In the age of DeFi, this does not seem to be the case anymore. A second look shows, however, that nothing has changed but that the results have become far more difficult to predict.

To assess whether regulations apply, it is generally necessary to assess (1) whether the activities are regulated and (2) identify the entity/person engaging in such activities.

Until more recently, it has been relatively easy to identify both the regulated activities as well as the relevant actors. For DeFi protocols, the answer is not always that straight forward. In the absence of legal documents, it is often unclear how the services are structured (e.g. lending vs. investing). And even where it is possible to classify the respective activity, it is still necessary to analyze whether the activity is performed by a person (regulated) or a piece of software (unregulated).

This brings us to the question of when a project is sufficiently decentralized.

While there is no general answer to this question, there is a distinct set of factors that must be considered when answering the question. The most important factor is the degree of control the team retains over the project after it is launched. In many cases, the team retains admin rights to fix bugs or to upgrade the protocol. This alone may, however, not be enough to establish a sufficient link between the team and the regulated activity. In fact, a comparison with the traditional financial and capital markets shows that the regulations do not apply to the technology providers but those using the technology, in other words, banks, exchanges, and other financial intermediaries. Nasdaq, for example, is not only a registered exchange in the United States but also a software company providing its matching technology to more than 70 markets globally. This does, however, not make Nasdaq subject to regulations in all these markets. Instead, the regulated entities are those providing the marketplace.

If financial and capital markets regulations are meant to be interpreted technology-neutral as claimed by regulators around the globe, nothing different can apply to DeFi protocols. Just because the smart contracts are publicly available on the blockchain does not justify different results in the case of DeFi.

Something different applies, of course, if the team does not only develop and maintain the smart contract but also engages in the listing of tokens or provides the GUI for interacting with the protocol. In this case, there is a clear link between the regulated activity and the team, and registration becomes necessary.

If the GUI is provided by someone else, it is likely that this person becomes subject to regulation as this person opens the marketplace and facilitates trading, etc.

As can be seen from these examples, it is not always possible to draw a clear line. To avoid the risk of becoming subject to regulation, the best way is still full decentralization. In other words, the team must deploy smart contracts without admin rights or transfer the protocol’s governance to the community. While still untested, it is highly likely that this provides an effective shield against regulations.

The trade-off of this approach may, however, be a lack of institutional investment/usage. It is, therefore, necessary to consider the implications of a fully decentralized strategy holistically and not solely from a regulatory point of view. What works for one project might not necessarily be ideal for others.

We are proud to announce that So & Sato and Curvegrid are joining forces to deliver next-generation services at the intersection of finance, tech, and regulation.

With this first-of-its-kind partnership, we aim to address the key pain points that plague many businesses in the crypto industry and that have slowed down the development of the Japanese blockchain industry as a whole.

In many cases, these problems are of technical or legal nature. More often than not they are both. This adds further complexities to an already challenging environment which can neither be solved satisfactorily by law firms or tech companies on their own. Yet, many companies still follow this one-dimensional approach, which results in suboptimal solutions, delays, and wrong allocation of resources.

By combining the expertise of one of the leading law firms in the blockchain/crypto space with Curvegrid’s MultiBaas blockchain middleware and extensive technical knowhow, we are not only able to remove these inefficiencies but also to provide a one-stop solution for our clients, streamline communication with the regulators, assist with the launch of new products, and build solutions which are not only meeting the highest technical standards but which are also fully compliant.

Examples

Want to learn more? Feel free to contact us and arrange a meeting.

About Curvegrid

Curvegrid is a blockchain technology company based in Tokyo, Japan. Curvegrid’s MultiBaas blockchain middleware makes it fast, easy, and cost effective for companies to build on multiple blockchain platforms. Turnkey MultiBaas solutions are available for financial services, decentralized finance, online gaming, document management, logistics, and manufacturing that help companies get to market with blockchain faster than otherwise possible.

About So & Sato

So & Sato is a boutique law firm specializing in blockchain and crypto. Our partners are fully bilingual and have worked with leading law firms in the US, Singapore, and Japan for many years. Our firm has been at the forefront of Blockchain and Fintech ever since it was established in 2015. In 2020, our partner So Saito was ranked among the top 3 FinTech lawyers in Japan by Chambers and Best Lawyers. Combining years of experience in the field of capital markets and finance with an in-depth understanding of new technologies, So & Sato is uniquely positioned to develop innovative solutions for our clients in a highly complex and constantly changing legal and regulatory environment.

(1) SEC Chairman Jay ClaytonのICOレター (Dec. 11, 2017)
https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11
Statement on Cryptocurrencies and Initial Coin Offerings

(2) Dec. 11, 2017
Company Halts ICO After SEC Raises Registration Concerns
https://www.sec.gov/news/press-release/2017-227

Sample Questions for Investors Considering a Cryptocurrency or ICO Investment Opportunity

  1. Who exactly am I contracting with?
  2. Who is issuing and sponsoring the product, what are their backgrounds, and have they provided a full and complete description of the product? Do they have a clear written business plan that I understand?
  3. Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product? Have they been paid to promote the product?
  4. Where is the enterprise located?
  5. Where is my money going and what will be it be used for? Is my money going to be used to “cash out” others?
  6. What specific rights come with my investment?
  7. Are there financial statements? If so, are they audited, and by whom?
  8. Is there trading data? If so, is there some way to verify it?
  9. How, when, and at what cost can I sell my investment? For example, do I have a right to give the token or coin back to the company or to receive a refund? Can I resell the coin or token, and if so, are there any limitations on my ability to resell?
  10. If a digital wallet is involved, what happens if I lose the key? Will I still have access to my investment?
  11. If a blockchain is used, is the blockchain open and public? Has the code been published, and has there been an independent cybersecurity audit?
  12. Has the offering been structured to comply with the securities laws and, if not, what implications will that have for the stability of the enterprise and the value of my investment?
  13. What legal protections may or may not be available in the event of fraud, a hack, malware, or a downturn in business prospects? Who will be responsible for refunding my investment if something goes wrong?
  14. If I do have legal rights, can I effectively enforce them and will there be adequate funds to compensate me if my rights are violated?

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