Last Friday I spoke at the inaugral professional development event of the new Metaverse Bar Association. Below are my remarks adapted from that event, aimed at lawyers trying to become advisors to token projects.
1. Creating vs. Dealing vs. Using
The way a token is used dictates what laws are implicated. The laws regarding creating tokens, using tokens, and dealing in tokens are very different in Canada (and most other jurisdictions). The type of use of a token within a specific business makes the difference between whether registration may be required with anti-money laundering authorities, whether there might be securities law implications, or other issues. The token is important, but what is being done with that token is sometimes even more important.
2. Is The Token Useful Right Now?
Tokens are at the heart of the emerging digital asset industry. If a new token is being made by a startup, DAO, or any other creator, a key question to ask is: is it useful at the time it’s sold? This may have important securities law considerations, and a token that’s not useful now may be at higher risk for litigation from aggrieved purchasers than one that has a clear use case.
3. Is The Token Pitched Like An
Investment Would Be?
The analysis of whether a particular token is a “security” or not is challenging, and different lawyers may give different opinions, but the lawyers at the front lines should always keep their eyes out for investment-like pitches. If it’s pitched like an investment then that’s a warning sign that may necessitate bringing more specialized counsel in. This is not to say that anything described as an
investment will be offside, in part because that word is very often used outside of what qualifies as an investment under securities laws. Many people describe important purchases they make or goods they really enjoy as
investments but it is not that colloquial sense that is the problem (although it is probably better to avoid the term).
4. Does It Have An Income Stream Attached?
Digital assets generally don’t have an income stream that is a property of the asset and an obligation of an issuer (e.g. a dividend). They typically have a use, such as a plot land in a metaverse that can be used within the virtual environment. The question isn’t whether something can be profitable or make money for the owner (which is true of almost anything that can be owned and sold), but whether there’s an income stream built into the asset. This may indicate an investment, which means asking questions about securities laws.
5. Who’s Involved?
It may be difficult to judge the lawfulness of any digital asset, especially in countries that have a high degree of uncertainty, but you can judge the team. Do they have a history of doing the wrong thing (e.g. suspicious bankruptcies or negative court cases) or a history of building great technology products? A token with a great founding team is more likely to be a smoother legal engagement than one without history or a checkered past. A lawyer’s due diligence can pay off in this space more than in most areas of legal work. Go beyond the regulatory minimum to avoid trouble.
6. Is There Exchanging Of Tokens?
If tokens are being exchanged for digital assets or money then there may be anti-money laundering laws or other applicable rules. Is the exchange peer-to-peer at the protocol level or is there an intermediate business? Ask detailed questions about how the exchange process works, because some clients may not even recognize an exchange is happening due to how easy it is technologically. Always be on the lookout for exchanging/dealing because this may indicate an area of legal risk.
7. How Is The Token Marketed?
Bad marketing has doomed many token-based projects. Lawyers sometimes see marketing as beneath them, or the clients may not realize that lawyers can add significant value by nixing bad content. Marketers may be aggressively presenting a product in a way that doesn’t comply with the carefully crafted legal strategy. Marketers aren’t your enemy! Marketers are usually very open to hearing guidelines or constructive feedback that helps make marketing materials more honest and accurate. Marketing is an essential part of any business and this function should be supported, rather than obstructed, by legal.
8. Is The Team Serious About Creating A Technological Product?
Is there a sensible, technologically-grounded business that the token relates to? Or is the token the sole business with no other steps? There’s been a lot of bad token projects, or even outright frauds, and a lack of interest in the technology is one of the hallmarks of people looking to make a quick buck. These sorts of engagements might seem attractive to a new lawyer but it’s far better to focus on the teams building long-term value for stakeholders. The world needs more serious technology products with teams backing them that are dedicated to long-term success. These are also be the most interesting files for lawyers.
9. Are Profits Promised?
Brand new technology sometimes doesn’t work. No one can really know which protocols or software will catch on, and some of this comes down to outright luck. If guaranteed profits are promised with respect to a token then that might indicate a lack of sophistication, and could indicate that a token is a part of a prohibited securities transaction. The aspiring blockchain lawyer should be constantly on guard for investments, since these are typically not permitted on platforms and/or require special licenses (which are different by jurisdiction). Securities law is generally an area to be avoided by most businesses, due to the complex registration processes and expensive procedures. For most companies, they should stick to technology rather than investments.
10. Is A Securities Lawyer Opinion Necessary?
Writing securities law opinions should, like most types of specialty law, only be done by qualified counsel in the relevant jurisdiction. But that doesn’t mean there isn’t a role to play for the lawyer who knows the technical details. Outside counsel find it exceedingly helpful to receive a memo that accurately describes the business model in terms that lawyers can understand. This can often get much better results than having outside expert counsel try to engage with the engineers or founders. Complex law is usually a cooperative effort between lawyers with many specializations and degrees of technical knowledge - everyone has a role to play.