Regulating the Crypto Economy: Business Transformations and Financialisation 9781509935741, 9781509935772, 9781509935758

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REGULATING THE CRYPTO ECONOMY This book focuses on the building of a crypto economy as an alternative economic space and discusses how the crypto economy should be governed. The crypto economy is examined in its productive and financialised aspects, in order to distil the need for governance in this economic space. The author argues that it is imperative for regulatory policy to develop the economic governance of the blockchain-based business model, in order to facilitate economic mobilisation and wealth creation. The regulatory framework should cater for a new and unique enterprise organisational law and the fund-raising and financing of blockchain-based development projects. Such a regulatory framework is crucially ­ enabling in nature and consistent with the tenets of regulatory capitalism. Further, the book acknowledges the rising importance of private monetary orders in the crypto economy and native payment systems that do not rely on conventional institutions for value transfer. A regulatory blueprint is proposed for governing such monetary orders as ‘commons’ governance. The rise of Decentralised Finance and other financial innovations in the crypto economy are also discussed, and the book suggests a framework for regulatory consideration in this dynamic landscape in order to meet a balance of public interest objectives and private interests. By setting out a reform agenda in relation to economic and financial governance in the crypto economy, this forward-looking work argues for the extension of ‘regulatory capitalism’ to this perceived ‘wild west’ of an alternative economic space. It advances the message that an innovative regulatory agenda is needed to account for the e­ conomically disruptive and technologically transformative developments brought about by the crypto economy. Hart Studies in Commercial and Financial Law: Volume 6

Hart Studies in Commercial and Financial Law Series Editor: John Linarelli This series offers a venue for publishing works on commercial law as well as on the regulation of banking and finance and the law on insolvency and bankruptcy. It publishes works on the law on secured credit, the regulatory and transactional aspects of banking and finance, the transactional and regulatory institutions for financial markets, legal and policy aspects associated with access to commercial and consumer credit, new generation subjects having to do with the institutional architecture associated with innovation and the digital economy including works on blockchain technology, work on the relationship of law to economic growth, the harmonisation or unification of commercial law, transnational commercial law, and the global financial order. The series promotes interdisciplinary work. It publishes research on the law using the methods of empirical legal studies, behavioural economics, political economy, normative welfare economics, law and society inquiry, socio-legal studies, political theory, and historical methods. Its coverage includes international and comparative investigations of areas of law within its remit. Volume 1: The Financialisation of the Citizen: Social and Financial Inclusion through European Private Law Guido Comparato Volume 2: MiFID II and Private Law: Enforcing EU Conduct of Business Rules Federico Della Negra Volume 3: Reforming Corporate Retail Investor Protection: Regulating to Avert Mis-Selling Diane Bugeja Volume 4: The Future of Commercial Law: Ways Forward for Change and Reform Edited by Orkun Akseli and John Linarelli Volume 5: The Cape Town Convention: A Documentary History Anton Didenko Volume 6: Regulating the Crypto Economy: Business Transformations and Financialisation Iris H-Y Chiu

Regulating the Crypto Economy Business Transformations and Financialisation

Iris H-Y Chiu

HART PUBLISHING Bloomsbury Publishing Plc Kemp House, Chawley Park, Cumnor Hill, Oxford, OX2 9PH, UK 1385 Broadway, New York, NY 10018, USA 29 Earlsfort Terrace, Dublin 2, Ireland HART PUBLISHING, the Hart/Stag logo, BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc First published in Great Britain 2021 Copyright © Iris H-Y Chiu, 2021 Iris H-Y Chiu has asserted her right under the Copyright, Designs and Patents Act 1988 to be identified as Author of this work. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. While every care has been taken to ensure the accuracy of this work, no responsibility for loss or damage occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the authors, editors or publishers. All UK Government legislation and other public sector information used in the work is Crown Copyright ©. All House of Lords and House of Commons information used in the work is Parliamentary Copyright ©. This information is reused under the terms of the Open Government Licence v3.0 (http://www.nationalarchives.gov.uk/doc/ open-government-licence/version/3) except where otherwise stated. All Eur-lex material used in the work is © European Union, http://eur-lex.europa.eu/, 1998–2021. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication data Names: Chiu, Iris H.-Y., author. Title: Regulating the crypto economy : business transformations and financialisation / Iris H-Y Chiu. Description: Oxford ; New York : Hart, 2021.  |  Series: Hart studies in commercial and financial law ; volume 6  |  Includes bibliographical references and index. Identifiers: LCCN 2021032661  |  ISBN 9781509935741 (hardback)  |  ISBN 9781509954490 (paperback)  |  ISBN 9781509935758 (pdf)  |  ISBN 9781509935765 (Epub) Subjects: LCSH: Cryptocurrencies—Law and legislation. Classification: LCC K4433 .C45 2021  |  DDC 343/.032—dc23 LC record available at https://lccn.loc.gov/2021032661 ISBN: HB: 978-1-50993-574-1 ePDF: 978-1-50993-575-8 ePub: 978-1-50993-576-5 Typeset by Compuscript Ltd, Shannon To find out more about our authors and books visit www.hartpublishing.co.uk. Here you will find extracts, author information, details of forthcoming events and the option to sign up for our newsletters.

ACKNOWLEDGEMENTS This book was commissioned in early 2019 and it has been challenging to grapple with new phenomena and changes in the crypto economy and its financial universe, which occur at a heady pace, over the course of writing. The initial coin offerings in 2017–18 which inspired the book have given way to DeFi, which has been growing in popularity since late 2019. I thank Roberta Bassi at Hart for her support and giving me the opportunity to paper many of my thoughts on the crypto conomy. I have truly been fascinated by many blockchain project developments and hope that many of those that raised funds in 2017–18 and are still in development will be successful. I am thankful to the UCL Faculty of Laws for giving me a period of research leave to finalise the book, and the support of the Centre for Ethics and Law at which I am based. I also thank the Centre for Banking and Financial Law, National University of Singapore, which hosted me in February to April 2021 as I was finalising this book. Many colleagues commented on drafts, and I thank colleagues at the Systemic Risk Centre, LSE at whose conference I presented ideas on the book; Erik Vermeulen, Tilburg University, for inspiring me with the ‘creator economy’; and colleagues at the National University of Singapore Centre for Banking and Financial Law including Dora Neo, Sandra Booysen, Christian Hoffman, Jodi Gardner, Kenneth Khoo, Jack Nelson and Emma Leong for valuable comments and input. I do not hold any tokens in relation to any of the projects mentioned in the book and this book is not affected by conflicts of interest. This book was also completed before I could comment on the move made by El Salvador to make bitcoin legal tender. I dedicate this book and reserve my profuse thanks to Robert who speaks the languages of computers and coders, and has been extremely patient with my workaholic patterns while crafting this book. All errors and omissions are mine. Iris H-Y Chiu London, April 2021

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CONTENTS Acknowledgements�����������������������������������������������������������������������������������������������������������������v Table of Cases������������������������������������������������������������������������������������������������������������������������xi Table of Legislation������������������������������������������������������������������������������������������������������������� xiii 1. A Legal Mapping of the Crypto Economy and the Drivers for Institutional Change������������������������������������������������������������������������������������������������������������������������������� 1 I. Introduction to the Book��������������������������������������������������������������������������������������� 1 II. Bitcoin and the Beginnings of a Blockchain-based Economy�������������������������� 4 A. The Bitcoin Blockchain as a Payment System? Issues and Problems in the Light of the Institutions of Law and Regulation of Payments����������������������������������������������������������������������������������������������������� 5 B. Cryptocurrency and the Law and Regulation of Money������������������������� 16 III. Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy��������������������������������������������������������������������������������������������������� 21 A. Permissioned Blockchain and Business Networks����������������������������������� 22 B. Permissionless Blockchains������������������������������������������������������������������������� 25 C. Issues Particular to Off-chain Legs������������������������������������������������������������� 29 D. Dispute Resolution, Crisis Management and the Governance of a Commons����������������������������������������������������������������������������������������������� 29 E. The Decentralised Autonomous Organisation����������������������������������������� 33 IV. Tokenisation and Financing�������������������������������������������������������������������������������� 35 A. Fundraising by Blockchain-based Developers and Tokenisation���������� 37 B. ICOs and Challenges in Regulatory Classifications��������������������������������� 39 V. The Need for Law Reform������������������������������������������������������������������������������������ 44 2. Rise of the Productive Crypto Economy and the Need for Regulation��������������48 I. Regulatory Capitalism������������������������������������������������������������������������������������������ 48 II. The Productive Crypto Economy: Three New Forms of Commoditisation�������������������������������������������������������������������������������������������������� 52 A. New Virtual Goods and Services in the Productive Crypto Economy�������������������������������������������������������������������������������������������������������� 57 B. New Distributed Models of Peer-to-peer Services����������������������������������� 62 C. New Tokenisation of Existing Real Economy Assets������������������������������� 71 III. A Blueprint for a Regulatory Agenda����������������������������������������������������������������� 74 A. Why the Token Taxonomy is Not Sufficient��������������������������������������������� 75 B. The Need to Avoid Merely Focusing on Financial Regulation��������������� 79 IV. Co-regulation in Policy Development��������������������������������������������������������������� 83

viii  Contents 3. Financial Regulators’ Approaches to the Crypto Economy����������������������������������85 I. Regulatory Divergences��������������������������������������������������������������������������������������� 85 II. Overview of Regulatory Approaches����������������������������������������������������������������� 86 III. Facilitative but Permissive Regimes������������������������������������������������������������������� 90 IV. Facilitative but Restrictive Regime – The US Regulatory Approach�������������� 93 V. Enabling Tailor-Made/Special Regimes������������������������������������������������������������� 99 A. Thailand�������������������������������������������������������������������������������������������������������100 B. Individual European Jurisdictions Prior to the European Commission Proposal 2020����������������������������������������������������������������������101 C. EU Regulatory Regime for Cryptoassets�������������������������������������������������103 VI. Critical Reflections on Global Regulators’ Approaches���������������������������������106 4. Facilitating the Crypto Economy: The Law of Business Organisations and Governance�����������������������������������������������������������������������������������������������������������111 I. Introduction to the Organisational Perspective of Blockchain-based Business����������������������������������������������������������������������������������������������������������������111 II. What Organisational Form for Blockchain-based Business?������������������������113 III. The Applicability of Existing Organisational Regimes in Law����������������������125 A. The Company����������������������������������������������������������������������������������������������125 B. Social Enterprise Forms�����������������������������������������������������������������������������130 C. The Cooperative������������������������������������������������������������������������������������������132 D. The Limited Liability Partnership������������������������������������������������������������134 E. Adapted Corporate Organisational Form�����������������������������������������������138 F. New Legal Organisational Form?�������������������������������������������������������������139 IV. Separate Legal Personality���������������������������������������������������������������������������������144 V. An Enabling Legal Framework and Conclusion���������������������������������������������147 5. The Financing of Blockchain-based Business Development and the Need for Regulation����������������������������������������������������������������������������������������������������151 I. Why a Tailor-made Regulatory Regime for Fundraising is Needed������������151 A. Why Distinguish ICOs from Securities and Crowdfunding Regulation����������������������������������������������������������������������������������������������������153 B. Similarities to and Differences from Initial Public Offers���������������������154 C. Similarities to and Differences from Equity Crowdfunding�����������������160 D. Should ICOs be Regulated by Product Governance Generally?����������162 II. A Blueprint for Regulating Token Financing��������������������������������������������������166 III. Mandatory Disclosure����������������������������������������������������������������������������������������170 A. Information Relating to the Development Team that Signals Integrity�������������������������������������������������������������������������������������������������������172 B. Information Relating to the Blockchain-based Nature of the Business Project������������������������������������������������������������������������������������������173 C. Information Relating to the Nature of the Pre-sold Tokens, their Anticipated Rights and Functionality, and their Pricing at the ICO����������������������������������������������������������������������������������������������������174

Contents  ix D. Information Relating to the Development Team’s Relationships with Third Parties���������������������������������������������������������������������������������������175 E. Other Information Relating to the Details Required for the Schedule of Commitment�������������������������������������������������������������������������176 IV. Ex Post Monitoring and Rights in a Schedule of Commitment�������������������176 A. Schedule of Commitment for Addressing Investors’ Investment Risk���������������������������������������������������������������������������������������������������������������177 B. Schedule of Commitment for Investors’ Agency Risk���������������������������183 C. Schedule of Commitment in Relation to Public Interest Concerns������������������������������������������������������������������������������������������������������187 D. How Mandatory Disclosure and the Schedule of Commitment Protect Investors – Consequences of Breach������������������������������������������189 E. Is Dual-class Financing an Issue?�������������������������������������������������������������191 V. Establishing a Unique Regulatory Regime for Pre-development Fundraising����������������������������������������������������������������������������������������������������������192 6. Regulating the Monetary Order of the Crypto Economy������������������������������������194 I. The Private Monetary Order in the Crypto Economy�����������������������������������194 A. Private Stablecoins��������������������������������������������������������������������������������������198 B. Interoperable Coins������������������������������������������������������������������������������������207 II. The Objectives for Regulating the Payment Systems in the Crypto Economy��������������������������������������������������������������������������������������������������������������209 III. The Regulation of the Payment and Mining Protocols in Terms of Payment Functionalities and Standards������������������������������������������������������215 A. Regulatory Oversight for Payment Functionalities��������������������������������216 B. Regulation of Miners?��������������������������������������������������������������������������������219 IV. Regulating Key Payment Service Providers – Wallets and Custodial Services Providers�����������������������������������������������������������������������������������������������220 A. Types of Wallets������������������������������������������������������������������������������������������220 B. Customer Protection����������������������������������������������������������������������������������223 C. Anti-money Laundering����������������������������������������������������������������������������227 D. Rise of Non-fungible Token Custody Providers?�����������������������������������229 V. Regulating Cryptocurrency Exchanges�����������������������������������������������������������230 A. Coherentist Extension of Securities Markets Regulation?��������������������231 B. New Regulatory Regimes for Cryptocurrency Exchanges��������������������233 C. Regulating Centralised and Decentralised Features of Exchanges������������������������������������������������������������������������������������������������235 D. Marketplaces for Non-fungible Tokens?�������������������������������������������������241 VI. Central Bank Digital Currencies and the Crypto Economy�������������������������242 A. The Development of Central Banks’ Thinking Regarding Digital Versions of Fiat Currencies����������������������������������������������������������243 B. CBDC for the Crypto Economy?��������������������������������������������������������������246 VII. Concluding Remarks������������������������������������������������������������������������������������������249

x  Contents 7. Regulating Crypto Finance����������������������������������������������������������������������������������������251 I. Productive and Hyper Forms of Financialisation������������������������������������������251 A. Policy Choice for Productive Financialisation���������������������������������������256 B. Policy Choices for Hyper-financialisation����������������������������������������������259 II. Trends in Regulating Crypto Finance��������������������������������������������������������������267 A. Crypto Hedge Funds, Derivatives and Exchange-traded Products�������������������������������������������������������������������������������������������������������268 B. Bank-based Platform Coins����������������������������������������������������������������������271 C. Coins with Dollar Parity����������������������������������������������������������������������������274 D. Cryptoasset Service Providers������������������������������������������������������������������275 E. Novelties for Regulatory Policy: Asset-referenced Stablecoins������������278 F. Novelties for Regulatory Policy: DeFi������������������������������������������������������282 III. A Framework for Developing the Regulatory Agendas for Crypto Finance�����������������������������������������������������������������������������������������������������������������286 A. The Development of Regulatory Ontologies and Need for Dynamism���������������������������������������������������������������������������������������������������288 B. Regulators Need to Approach Regulatory Design with an Open Mind���������������������������������������������������������������������������������������������291 C. Regulators Need to Consider Reframing or Reform of Regulatory Standards and Content������������������������������������������������������294 D. Regulators Need to Consider Agility in Regulatory Architecture to Respond to Crypto Finance Developments����������������������������������������296 8. Upcoming Trends and Concluding Remarks���������������������������������������������������������300 Bibliography������������������������������������������������������������������������������������������������������������������������302 Index�����������������������������������������������������������������������������������������������������������������������������������329

TABLE OF CASES United Kingdom AA v Persons Unknown and Bitfinex [2019] EWHC 3556�������������������������14–15, 188, 211 Asset Land Investment Plc v The Financial Conduct Authority [2016] UKSC 17 ��������������������������������������������������������������������������������������������������������42, 72 Ball v Banner 2000 WL 824097�������������������������������������������������������������������������������������������156 Barclays Bank v Quistclose Investments Ltd [1970] AC 567; applied in Twinsectra v Yardley Ltd [2002] 2 AC 164�����������������������������������������������������������������������������������������182 Bellis v Challinor [2015] EWCA Civ 59�����������������������������������������������������������������������������182 Bhullar v Bhullar [2003] EWCA Civ 424���������������������������������������������������������������������������137 Camarata Property v Credit Suisse [2011] EWHC 479.���������������������������������������������������227 CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704�������������������������������������������������������������137 F & C Alternative Investments Holdings Ltd vs Barthelemy and Culligan [2011] EWHC 1731 (Ch)����������������������������������������������������������������������������������������������135 FCA v Capital Alternatives Ltd and Ors [2014] EWHC 144 (Ch).����������������������������������� 72 Foss v Harbottle (1843) 67 ER 189.�������������������������������������������������������������������������������������128 Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200 ����������������������������������������137 Gilbert v Brett (1604) Davis 18��������������������������������������������������������������������������������������������209 Grant & Tickells (joint liquidators) v Ralls and Hailstones (2016) EWHC 243�������������170 Harbinger Capital Partners v Caldwell (As the Independent Valuer of Northern Rock Plc)& Anor (Rev 1) [2013] EWCA Civ 492����������������������������������������� 69 Hosking v Marathon Asset Management LLP [2016] EWHC 2418 (Ch)�����������������������135 Howard Smith v Ampol Petroleum [1974] AC 821 ����������������������������������������������������������137 ICDL Saudi Arabia v. European Computer Driving Licence Foundation Limited [2011] IEHC 343, [2012] IESC 55 ����������������������������������������������������������������������������������� 8 Island Export Finance Ltd v Umunna [1986] BCLC 704 ������������������������������������������������137 JKX Oil and Gas Plc v Eclairs Group Ltd [2015] UKSC 71����������������������������������������������137 JP Morgan Chase Bank (formerly known as The Chase Manhattan Bank) (a body corporate) and Others v Springwell Navigation Corporation (a body corporate) and by Counterclaim Springwell Navigation Corporation (a body corporate) v JP Morgan Chase Bank (formerly known as The Chase Manhattan Bank) (a body corporate) and Others [2008] EWHC 1186 (Comm)����������������������������������������������������������������������������������������������������227 Jugoslavenska Oceanska Plovidba v Castle Investment Co Inc [1974] QB 292��������������209 Mothew (T/A Stapley & Co) v Bristol and West Building Society [1996] EWCA Civ 533���������������������������������������������������������������������������������������������������������������219 Murphy v HSBC Bank plc [2004] All ER (D) 211 ������������������������������������������������������������227

xii  Table of Cases Official Receiver v Doshi [2001] 2 BCLC 235��������������������������������������������������������������������170 Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275, [1999] BCC 26������������������170 Re D’Jan of London of London [1994] 1 BCLC 561����������������������������������������������������������137 Re Produce Marketing Consortium (No 2) [1989] BCLC 520�����������������������������������������137 Re Smith & Fawcett Ltd [1942] Ch 304������������������������������������������������������������������������������137 Salomon v A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22������������������������������������125 Your Response Ltd v Datateam Business Media Ltd [2014] EWCA Civ 281�������������13, 45 European Union Asociación Profesional Elite Taxi v Uber Systems Spain SL, Case C-434/15 (December 2017)����������������������������������������������������������������������������������� 66 Högsta förvaltningsdomstolen, Case C-264/14������������������������������������������������������������14, 209 Request for a Preliminary Ruling under Art 267 TFEU from the tribunal de grande instance de Lille against Uber, Case C-320/16 (April 2018)���������������������� 66 Other Jurisdictions Singapore B2C2 Ltd v Quione Ltd [2019] SGHC(I) 03������������������������������������������������������������������������ 24 US CFTC v My Big Coin Pay Inc (26 September 2018), at https://www.cftc.gov/sites/ default/files/2018-10/enfmybigcoinpayincmemorandum092618.pdf���������������������� 97 In the Matter of Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan and the CFTC (17 September 2015), at https://www.cftc.gov/sites/default/ files/idc/groups/public/@lrenforcementactions/documents/legalpleading/ enfcoinfliprorder09172015.pdf��������������������������������������������������������������������������������������� 97 SEC v Howey (1946) 328 US 293, 294���������������������������������������������������������������������������������� 40

TABLE OF LEGISLATION United Kingdom Statutes Co-operative and Community Benefit Societies Act 2014���������������������������������������������132 Companies Act 2006���������������������������������������������������������������������������128, 137, 149, 160, 181 Companies (Audit, Investigations and Community Enterprise) Act 2004������������������130 Directors Disqualification Act 1986�����������������������������������������������������������������������������������136 Financial Services and Markets Act 2000���������������������72, 92, 146, 164, 190, 260, 262–63, 273, 288–89, 292, 297–98 Financial Services (Banking Reform) Act 2013���������������������������������������������������������������260 Gambling Act 2005��������������������������������������������������������������������������������������������������������������265 Insolvency Act 1985�������������������������������������������������������������������������������������������������������������170 Limited Liability Partnerships Act 2000��������������������������������������������������������������������111, 135 Partnership Act 1890�����������������������������������������������������������������������������������������������������������169 Proceeds of Crime Act 2002�����������������������������������������������������������������������������������������17, 228 SIs Community Interest Company Regulations 2005 (SI 2005/1788)�������������������������130, 132 Control of Poisons and Explosives Precursors Regulations 2015 (SI 2015/966)���������228 Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (SI 2005/1529)�������������������������������������������������������������������������������������93, 108 Limited Liability Partnerships Regulations 2001 (SI 2001/1090)��������������������������111, 135 European Union Directives Commission Delegated Directive (EU) 2017/593 of 7 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits������������������������������������������������������������������������������������������164, 264

xiv  Table of Legislation Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company����������������������������������������������������������203, 294 Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (recast)������������������������� 163, 203, 205–06, 258, 294 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010������������������������������� 178–79, 206, 258, 268, 294 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49�����������������������������260 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council�����������������������������������������������������223, 261 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61���������������������������164, 206, 260, 264, 292 Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC on the definition of ‘electronic money’����������������������������������� 7–8, 195, 211, 214, 216, 225, 244, 273, 289 Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement������������������������������������������������������������������������157 Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU��������������17–18, 92, 177, 228 Regulations Commission Delegated Regulation (EU) 2016/1675 of 14 July 2016 supplementing Directive (EU) 2015/849 of the European Parliament and of the Council by identifying high-risk third countries with strategic deficiencies�����������������������������227

Table of Legislation  xv Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories which mandated centrally cleared derivatives for most classes of trading instruments ����������������������������������������������������� 97, 163, 231, 258 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012����������������������260 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (MiFIR)��������������������������������������������233, 262 Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs)�����������������������������������������263, 294 Regulation (EU) 2015/751 of the European Parliament and of the Council of 29 April 2015 on interchange fees for card-based payment transactions����������196 Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012, Art 15������������������������258 Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on money market funds���������������������������������������279, 294 Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012��������������������������������������������������������������������������������������������������163 Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014; Directive (EU) 2019/2034 of the European Parliament and of the Council of 27 November 2019 on the prudential supervision of investment firms and amending Directives 2002/87/EC, 2009/65/EC, 2011/61/EU, 2013/36/EU, 2014/59/EU and 2014/65/EU on a microprudential regime for investment firms�������������������������������������������260, 294 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector������������������������������������������������������������������������������������������294 Other Jurisdictions Malta The Innovative Technology Arrangements and Services Act�����������������������������������������113 Virtual Financial Assets Act���������������������������������������������������������������� 101–03, 140, 165, 276

xvi  Table of Legislation US Jumpstart Our Business Startups Act, Public Law 112-106 [HR 3606]������������������������162 Model Benefit Corporation Legislation v2017�����������������������������������������������������������������131 NY Comp Code Rules & Regs tit 13, ch 1, pt 200 (2015), at www.dfs.ny.gov����������10, 94 Regulation of Virtual Currency Business Act, at www.uniformlaws.org/committees/ community-home?CommunityKey=e104aaa8-c10f-45a7-a34a-0423c2106778������10, 13 Securities Act 1933������������������������������������������������������������������������������������35, 39, 161–62, 257 Securities Exchange Act 1934, Reg D������������������������������������������������������� 35, 37, 76, 95, 290 SEC’s Regulation Crowdfunding Release Nos 33-9974; 34-76324; File No S7-09-13, at www.sec.gov/rules/final/2015/33-9974.pdf����������������������������161 Uniform Commercial Code, Art 9�������������������������������������������������������������������������������������270 US Commodity Exchange Act 7 USC § 2a(1)(A)–(C)������������������������������������������������������ 97

1 A Legal Mapping of the Crypto Economy and the Drivers for Institutional Change I.  Introduction to the Book Since the introduction of blockchain-enabled transfers of private digital currency in the form of Bitcoin,1 the imaginations of business, policy-makers and academics have been captured by this innovation. Permissionless blockchains that enable operations more complex than transfer of value have been developing in this new economic space.2 The development of automated protocols that offer more functionalities than the script that executes currency transfer in Bitcoin and their equivalents (known as alt coins),3 called smart contracts,4 offers new opportunities for organising business and commerce.5 Commentators now opine that tokenomics or the crypto economy may be regarded as a new economic paradigm,6 as the advent of smart contracts and tokens7 on a blockchainbased infrastructure brings about change of an institutional significance.8 Herian9 warns against the fetishisation of blockchains as an ideological revolution, as there are crucially neoliberal aspects of this innovation, although the economic, social and political visions of this innovation have often been hyped to be revolutionary and liberating. This book takes a narrower scope, ie focusing on the economic space fostered 1 S Nakamoto, ‘Bitcoin: A Peer to Peer Electronic Cash System’ (2008) at Bitcoin.org/Bitcoin.pdf. 2 M Swan, Blockchain: Blueprint for a New Economy (O’Reilly Media, 2015). 3 Alt coins are currency-like digital currencies developed on alternative blockchains from the Bitcoin blockchain, in competition with Bitcoin, such as Litecoin, Dogecoin, Dash, Monero and Ripple, see Bitcoinmagazine.com/guides/what-altcoin. 4 N Szabo, ‘Smart Contracts: Building Blocks for Digital Markets’, University of Amsterdam (1996), www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/ szabo.best.vwh.net/smart_contracts_2.html, and layman’s version at www.coindesk.com/information/ ethereum-smart-contracts-work. 5 This has been largely developed on the Ethereum blockchain as a native coin ether was developed to facilitate the execution of applications that are stacked upon the protocol layer. 6 S Au and T Power, Tokenomics: The Crypto Shift of Blockchains, ICOs, and Tokens (Packt Publishing, 2018). 7 Tokens are code that are able to execute functions, but they are conveniently called tokens as they are usually standardised. 8 S Davidson, P De Fillippi and J Potts, ‘Blockchain and the Economic Institutions of Capitalism’ (2018) 14 Journal of Institutional Economics 639; C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) ch 9. 9 R Herian, Regulating Blockchain: Critical Perspectives in Law and Technology (Routledge, 2019).

2  A Legal Mapping of the Crypto Economy by blockchains, and argues that the crypto economy presents novel and interesting aspects that can benefit from more development, and such development is crucially not disengaged from wider institutional implications and a regulatory agenda. For the purposes of this book, the crypto economy refers to economic activities that are carried out over permissionless, publicly accessible blockchains. These create a new architecture and space for the innovation of economic activities. We focus on this phenomenon as distinguished from the adoption of blockchain technology by corporations in the mainstream economy, mostly in the form of permissioned blockchains.10 There is also significant development in the adoption of blockchain technology by the mainstream economy, but that topic requires a different form of treatment to that taken in this book. This book focuses only on the new economic activities and developments that are taking place on permissionless, publicly accessible blockchains. The book argues that regulatory capitalism can be developed for this new economic space, as the governance of capitalist orders by appropriately designed regulation is important to support such a new capitalist order, and underpin its legitimacy and integration into the social fabric. Institutions can be thought of as formal and informal rules, norms, patterns, forms, systems, ceremonies or even rituals through which human interactions or relations are stabilised in terms of expectations and conduct.11 When we consider the import of technological change, what we are concerned with is how far technological change may affect ways of life, perhaps for good, and how such change destabilises and then re-establishes patterns, norms, systems, artefacts, etc (ie new institutions) that govern social relations and interaction. Law and regulation are key institutions through which technological innovations navigate, and against which they pose challenges. This book starts by providing an account of the development of the crypto economy in relation to the cumulative challenges that are posed to law and regulation. This account is first descriptive,12 and takes stock of the key debates in relation to the crypto economy’s fit with existing categories in law and regulation. For this purpose chapter one covers substantial ground, as it depicts not only the crypto economy developments from the innovation of Bitcoin, but also takes stock of the legal commentary and landscape of unresolved issues in terms of legal characterisation. The unresolved nature of the debates relating to how existing law and regulation fit with crypto economy developments compels us to consider whether endeavours should be employed in updating legal interpretation and/or legal and regulatory reform. The latter is underlined by choices in policy that are not merely questions of law, but the former is not necessarily immune from policy choices and neither conducted in an autopoietic paradigm.13 10 Such as corporate adoption of the Hyperledger fabric for coordinating actions and activities in a chain of cross-border logistics, or the adoption by financial institutions of the Ripple blockchain framework for international remittances. 11 DC North, Institutions, Institutional Change and Economic Performance (Cambridge University Press, 1990) ch 1. 12 J Bacon, JD Michels, C Millard and J Singh, ‘Blockchain Demystified: a Technical and Legal Introduction to Distributed and Centralized Ledgers’ (2018) 25 Richmond Journal of Law & Technology 1. 13 Autopoiesis is a general theory that posits that all systems such as sociology, law and political science and so on, are autonomous systems which are hermetically closed, but cognitively open to observe other systems. This means that these systems have normative paradigms of their own that determine rule-setting within the systems. The systems are also individually self-referential and self-contained in their legitimacy and competency. G Teubner, ‘After Legal Instrumentalism: Strategic Models of Post-Regulatory Law’ in G  ­Teubner, Dilemmas of Law in the Welfare State (Walter de Gruyter, 1986); G.Teubner (ed), Autopoietic Law: A New

Introduction to the Book  3 Brownsword describes two legal responses to technological disruption as ‘coherentism’ or ‘regulatory instrumentalism’.14 This chapter argues that an account of crypto economy developments through the lens of existing law and regulation shows the limitations of coherentism; that is, an approach excessively focused on fitting new technological artefacts within existing legal concepts. Such an approach may be well-intentioned and geared towards achieving legal certainty.15 However, legal interpretation can lead to patchworks of uneasy and temporary coherence within certain bodies of law that may not reconcile across different bodies of law. Regulatory concepts also do not map well onto the crypto economy as regulatory concepts are based on identifying regulated subjects from the existing industrialised and corporatised economy. This is illustrated shortly in sections II and III. Developments in the crypto economy potentially disrupt the way business, people and activities are organised in the industrialised and corporatised economy, whether locally or globally. Private law concepts may be extended to fit with crypto economy developments, but it is queried whether these would become too remedy-driven, and whether ideological coherence would really be preserved. The radical nature of crypto economy developments compels us to consider if institutional change would be brought about, and what drivers would contribute to such a trajectory. This chapter examines the contesting factors for legal and regulatory reform and argues that it is possible to chart a reform path. Such a reform path should be based on regulatory capitalism for the productive crypto economy. Chapter two explains the theoretical construct of regulatory capitalism and its fit for liberal market economies like the UK, as well as the book’s vision of the productive crypto economy. It discusses novel economic activities made possible in the crypto economy, and argues that the conduct of these activities benefit from regulatory capitalism in the crypto economy. The chapter explains that such a reform path is enabling and governing at the same time, reflecting the full ethos of regulatory capitalism. The crypto economy, in its productive development, is also entangled with rapid financialisation. Chapter three warns against focusing excessively on the financialised aspects of the crypto economy, as many jurisdictions seem to be pursuing, due to developments in initial coin offerings by blockchain business developers. Concerns for regulatory arbitrage in relation to many jurisdictions’ regimes for securities and investment regulation have drawn policy-makers’ attention almost exclusively to this financialised phenomenon. The chapter argues against relying only on financial regulation for the crypto economy and surveys a range of different jurisdictions’ approaches in order to explore their shortfalls. Chapter four then embarks on offering the blueprint for a regulatory agenda for the productive crypto economy, by focusing on an enabling legal framework for the business organisation and governance of blockchain-based businesses. This framework arguably allows their innovative difference to be commercially operationalised but Approach to Law and Society (Walter de Gruyter, 1988), a useful synopsis is found in AJ Jacobson, ‘Autopoietic Law: The New Science of Niklas Luhmann’ (1989) 87 Michigan Law Review 1647. A critique of autopoiesis is found in H Baxter, ‘Autopoiesis and the Relative Autonomy of Law’ (1998) 19 Cardozo Law Review 1987 where it is argued that the level of autonomy in autopoiesis is not clear and subject to doubt. 14 R Brownsword, Law, Technology and Society (Routledge, 2019) 191–96. 15 ibid, 154, 192.

4  A Legal Mapping of the Crypto Economy appropriately governed. We argue that such a regulatory agenda is necessary for legitimising and mainstreaming blockchain-based businesses while addressing its unique and radical aspects. Chapter five takes on the fundraising needs of blockchain-based businesses and argues that such fundraising, which is predevelopment fundraising, is in nature different from securities offers or equity crowdfunding. As such, a new regulatory agenda should be built upon the principles of investor protection and the objectives for which investment is made. By unpacking the essentials of the relational paradigms in initial coin offerings, we propose a new regulatory agenda for the relational paradigm of the developer–investor relationship. This provides a foundation for the book’s proposals for financial regulation that is needed for addressing the financialised phenomena in the crypto economy, discussed in chapter seven. Chapter six then turns to the monetary order of the crypto economy. The crypto economy is built upon private currency forming an essential protocol layer for business and commercial applications and achieves certain efficiencies. However, with the commoditisation of private currency, private currency has exhibited less stable and robust characteristics than fiat currencies to support the crypto economy. This chapter turns to various options in the monetary order of the crypto economy, such as private stablecoins, central bank digital currencies and competition in the monetary order, and argues that the monetary order of the crypto economy should be subject to a regulatory order that protects users. It may also be inevitable that central banks and regulators would have to be prepared for private currency competition. Chapter seven turns to the financialised aspects of the crypto economy. It argues that a form of hyper-financialisation is developing in order to meet both business and speculative needs in an unregulated sphere. In this respect regulatory agendas are being developed to combat regulatory arbitrage, such as by the EU, but the chapter argues that there is a need to develop a financial regulatory agenda in a holistic manner integrated with enterprise considerations. Financial regulation in its substantive and architectural aspects would necessarily be interrogated by the enterprisal and technological architecture of the crypto economy. The chapter provides a high-level framework for regulatory policy in the financialised aspects of the crypto economy and offers concluding remarks for the book.

II.  Bitcoin and the Beginnings of a Blockchain-based Economy The Bitcoin blockchain was introduced in 2008 by a pseudonymous Satoshi Nakamoto16 in order to allow private payments to be made securely and efficiently between individuals without needing to involve existing intermediaries in the banking and financial system. The global financial crisis of 2007–0917 loomed large in the context and this

16 Nakamoto (2008). 17 See Financial Services Authority, ‘The Turner Review: A Regulatory Response to the Global Banking Crisis’ (2009), at news.bbc.co.uk/1/shared/bsp/hi/pdfs/18_03_09_turner_review.pdf; H Davies, The Financial Crisis: Who is to Blame (Polity, 2010).

Bitcoin and the Beginnings of a Blockchain-based Economy  5 development could be seen not only as a technological innovation but as a statement of distrust of the prevailing financial institutions at that time.18 In charting the development of the crypto economy, this section first accounts for the payment and currency functions of the Bitcoin blockchain. It argues that both these functions, although fundamental to the crypto economy, are riddled with deficits and sub-optimalities in their self-regulatory architecture. Hence the payment system of the Bitcoin blockchain is allowed to exist as a fringe phenomenon, a parallel system outside of conventional institutions. The legal and regulatory treatment of the Bitcoin blockchain can be characterised as largely instrumental and piecemeal in nature. The approach is to fit aspects of the Bitcoin blockchain into conventional policies, legal and regulatory ontologies. This approach is also due to the perception, on the part of the European Central Bank19 and Financial Stability Board that cryptocurrencies do not (yet) pose a threat to systemic stability20 to mainstream finance and the conventional economy. We take stock of the challenges in legal and regulatory treatment of the Bitcoin blockchain innovation and subsequent developments in the crypto economy. The development of the crypto economy is explored through the lens of legal coherentism in the law’s interaction with crypto economy phenomena. First we chart the development of the Bitcoin blockchain and the challenges to existing law and regulation in relation to the payment and money characteristics offered by this innovation. Next, we explore how the Ethereum blockchain has further developed the peer-to-peer crypto economy, giving rise to novel commercial and legal issues. We then explore the financialisation of the commercial potential revealed in the Ethereum blockchain and the new challenges for fit with legal and regulatory categories. This account is necessary to highlight the limits of a legal coherentist approach to the developments in the crypto economy.

A.  The Bitcoin Blockchain as a Payment System? Issues and Problems in the Light of the Institutions of Law and Regulation of Payments Purporting to be a private currency, Bitcoin is most famously depicted in an exchange context. Alice can send Bob bitcoins over a private network in order to discharge a payment obligation or to transfer value to Bob. How this is achieved is that Alice initiates a transfer of bitcoin which she owns, manifested by the bitcoin’s public key, which is a string of digital data representing the address of the coins, by using a private key to which she is authorised (and which is mathematically related to the public key). This transaction is directed to Bob’s address on the private network (Bob’s public key), which

18 D Bousfield, ‘Crypto-coin Hierarchies: Social Contestation in Blockchain Networks’ (2019) 19 Global Networks 291; M Hütten and M Thiemann, ‘Moneys at the Margins: From Political Experiment to Cashless Societies’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 2. 19 ECB Crypto-assets Task Force, ‘Crypto-Assets: Implications for Financial Stability, Monetary Policy, and Payments and Market Infrastructures’ (May 2019). 20 Mark Carney, in a letter as Chair of the Financial Stability Board to the G20 Finance ministers and central bankers (13 March 2018), at www.fsb.org/wp-content/uploads/P180318.pdf.

6  A Legal Mapping of the Crypto Economy can only be accessed via Bob’s private key. The public–private key pair technology was developed long before Bitcoin and underlies the secure protocols for transfers over the internet. The Bitcoin blockchain has gone one step further by adopting this technology in a private network while providing for the self-maintaining ability of the private network. To achieve the self-maintaining ability of the private network, automated protocols need to be programmed so that network participants maintain the integrity and efficacy of the network. On integrity of the network, we need to prevent the double spend problem, ie that the network prevents Alice from being able to send the same coins to someone else again. On efficacy, we need to ensure that the network is incentivised to validate that there is no double spending in as efficient a manner as possible. As the private network is decentralised, the maintenance of the network falls on the community within the network, known individually as nodes, whose computers are connected to and have joined the Bitcoin network. From the early days of Bitcoin, anyone can be a node, and membership of the Bitcoin blockchain is purportedly highly democratised. Automated protocols incentivise nodes to compete to validate transactions on the Bitcoin blockchain, as validation is rewarded by earning new Bitcoins released into the system. Validated transactions require the consensus of nodes, and each validated block of transactions is then added to the network’s ledger, known as the blockchain. Every node would have an identical copy of the ledger which is distributed and not centralised. The distributed ledger is thus tamper-proof and fail-safe at the same time as it is highly challenging for nodes to alter the ledger unilaterally across all identical copies and there is no single point of failure for the ledger. When Alice and Bob complete their transfer and this transaction is broadcast/ ‘proposed’ to the nodes on the Bitcoin blockchain, the transaction is broadcast with the public key relating to the bitcoin sent and a digital signature. Nodes do not know Alice’s private key, but need to verify if the digital signature is mathematically coherent with the public key, which is Alice’s Bitcoin address. Nodes compete to verify in a decentralised manner, and generally, several confirmations for one transaction would increase the chances of its validity. The validation of transactions is carried out by nodes mining for blocks, which are clusters of transactional data grouped together in order to constitute a valid and immutable section of ledger data that would be accepted by all. Miners compete to gather confirmed transactions within a time period – say 10 minutes – and verify them by running seed inputs to see if mathematical coherence is achieved for all the transactions in the block. Miners validate transactions to show that there is no double spend according to previous validated records in blocks. A new, approved block is then hashed together with a block header that comprises the block’s identification hash and the previous block’s hash, and is timestamped in order to be added to the previous block. This mining protocol is known as ‘proof of work’, which is derived from established cryptographic methodology. The successful miner receives a reward for mining, which started at 25 bitcoins per block and is gradually decreasing in an algorithmically determined manner. Decentralised competition provides the incentive-based mechanism for maintaining the distributed ledger in an efficient manner. However, the competitive process for mining can result in waste of ‘work’ by other miners as well as perverse incentives in the competitive process, such as attacks on other miners or hijacking of others’ computational power.21 21 Y Wang, C Tang, F Lin, Z Zheng and Z Chen, ‘Pool Strategies Selection in PoW-Based Blockchain Networks: Game-Theoretic Analysis’ (2019) 7 IEEE Access 8427.

Bitcoin and the Beginnings of a Blockchain-based Economy  7 The Bitcoin blockchain can be regarded as a relatively efficient payment mechanism as miners take on average 10 minutes to verify a transaction, compared to days taken for international remittances through banks. It may also be regarded as an alternative payment or remittance system for unbanked peoples.22 However, the cost-effective access to unbanked peoples potentially obscures a problem in relation to the cost of maintaining the network. Where payment systems are managed by centralised intermediaries, intermediaries bear the cost of maintenance by charging fees to users, but users get the benefit of institutional protections regarding mistakes and failures.23 In a distributed payment network, the cost of maintaining the network is theoretically distributed across all nodes. However, users are spared from bearing the cost as miners are incentivised to undertake maintenance. Nevertheless, in order to ensure that the blockchain is maintained at an optimal level, the cost of validation cannot be too low, and this is evidenced by significant amounts of energy spent24 by miners’ computers solving the mathematic hash puzzles in order to identify valid transactions. The carbon footprint of such maintenance is arguably sub-optimal, and also results in the undermining of democratisation in the blockchain as mining pools or clusters become oligopolistic and powerful.25 This rise of an alternative payment mechanism that has the potential to span the globe is however only marginally recognised in the laws and regulations relating to payment services. Regulatory regimes for payment systems are not necessarily extended to the private Bitcoin blockchain network. Moreover, anti-money laundering regulation is generally applied to certain points of cryptocurrency transactions.26 The approach of law and regulation is not one of regularising or legitimating the private Bitcoin blockchain in the conventional economy, but focused on averting social harms such as money laundering. European policy-makers do not regard cryptocurrency as falling within the European Payment Services Directive nor the Electronic Money Regulations.27 This is because the legislations make certain assumptions that cannot apply to cryptocurrencies. Electronic money is assumed to be provided by commercial providers who are able to issue, redeem and safeguard electronic units of money for customers. These providers include banking and non-banking credit card issuers, and online money remitters. Such electronic units of money can theoretically cover private cryptocurrencies, as argued by Didenko and Buckley,28 but it must be assumed that e-money only covers currencies with a legally recognised status, ie fiat currencies accepted in the EU, as the stability of 22 I Mas and DKC Lee, ‘Bitcoin-Like Protocols and Innovations’ in DKC Lee (ed), Handbook of Digital Currency (Elsevier, 2015) ch 21. 23 See IH-Y Chiu, ‘A New Era in Fintech Payment Innovations? A Perspective from the Institutions and Regulation of Payment Systems’ (2017) 9 Law, Innovation and Technology 190. 24 Bacon et al (2018) above documenting that about 200kW of energy is consumed to validate each transaction. 25 F Musiani, A Mallard, and C Méadel, ‘Governing What Wasn’t Meant to Be Governed: A ControversyBased Approach to the Study of Bitcoin Governance’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 7; M Campbell-Verduyn and M Goguen, ‘Blockchains, Trust And Action Nets: Extending the Pathologies of Financial Globalization’ (2019) 19 Global Networks 308. 26 This is discussed below. 27 ECB Crypto-assets Task Force (2019). 28 AN Didenko and RP Buckley, ‘The Evolution of Currency: Cash to Cryptos to Sovereign Digital Currencies’ (2019) 42 Fordham International Law Journal 1041.

8  A Legal Mapping of the Crypto Economy exchange and store of value, as well as consistency in the unit of account, are assumed in the rubric of the legislation. Cryptocurrencies have not maintained these qualities robustly.29 E-money is also distinguished from bank account or deposit money as it cannot be created based on credit. Cryptocurrency payment systems are not regarded as payment services under the Payment Services Directive. They are not subject to the institutional provisions for user protection. They are also not recognised entities to which the Directive’s obligations can be attached. The regulation of payment services providers covers a wide scope30 of account servicing providers such as: banks; payment initiation services that may be separate but plugged into bank or credit card accounts to initiate payments, such as PayPal or Apple Pay;31 and money organising services such as Money Dashboard.32 These are identifiable as business entities offering particular service models to consumers. These service models are captured by the regulatory framework, which allocates responsibilities to users and payment services providers, taking into account the needs of consumer protection. Consumers need to provide a clear payment mandate, by utilising personalised security features. Payment providers are responsible to ensure that strong customer authentication and secure communications can be achieved.33 Consumers are obliged to notify the provider in the event of unauthorised use of payment instruments, but in the absence of fraud or gross negligence, would only be responsible for up to £35.34 Further, credit card providers are jointly and severally liable with the supplier of goods or services paid for with the credit card, in the event of the supplier’s breach for transactions exceeding £100 but below £30,000.35 The regulatory framework for risk and responsibility allocation in payment services is generally appraised to be adequately protective of consumers, although it remains open what ‘gross negligence’36 amounts to in using payment instruments.37 The allocation of risk and responsibility is a governance order that is unlikely to be provided by market forces in an optimal manner consistent with consumer protection, and may be regarded as a public good. This position is also reflected in payment legislation at the US federal level as well as in Article 4A of the Uniform Commercial Code.38 In sum, the regulatory institution for regulated intermediaries providing payment systems achieves 29 E Avgouleas and W Blair, ‘The Concept of Money in the 4th Industrial Revolution – a Legal and Economic Analysis’ (2020) at papers.ssrn.com/sol3/papers.cfm?abstract_id=3534701. 30 Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015. 31 Chiu (2017a). 32 www.moneydashboard.com. 33 Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC (Payment Services Directive 2 (2015)), Arts 69, 70. 34 Payment Services Regulations 2017implementing the Payment Services Directive 2 (2015), Regs 74–80 (Art 74). 35 Consumer Credit Act 1974, s 75, amended by regulations in 1983. 36 The case of ICDL Saudi Arabia v. European Computer Driving Licence Foundation Limited [2011] IEHC 343, [2012] IESC 55 refers to a significant degree of carelessness, or that one falls short of the standard of care by a significant margin. 37 SM Seyad, ‘A Critical Assessment of the Payment Services Directive’ (2008) 23 Journal of International Banking Law and Regulation 218. 38 Regulation E, Electronic Funds Transfer Act and other legislation dealing with checks, cards and interchange fees, see www.federalreserve.gov/paymentsystems/other-regulations.htm.

Bitcoin and the Beginnings of a Blockchain-based Economy  9 certain public goods that are unlikely to be matched by self-governing market-based services in the cryptocurrency payment ecosystem. Can it however be argued that the technological capabilities of the Bitcoin blockchain or other alternative currency chains provide a self-regulatory order that meets the functionally equivalent needs provided under the regulatory orders discussed above?

i.  Currency Blockchains as Self-governing Orders? The distributed payment system offered by the Bitcoin blockchain is not necessarily more efficient nor superior to regulated payment services systems. First, the distributed system of validation is overall costly in terms of energy consumption and data storage as whole copies of the same ledger need to be downloaded onto each node’s computer. Second, distributed systems of validation may not provide sufficient confidence for important transfers such as large value transfers carried out by corporations. In order to support the importance of risk minimisation to these transfers, central-bank dominated/supervised systems of real-time gross settlement39 are the architecture used for such transfers. The role of central banks behind large-value transfer payment architecture highlights the need for a trusted centralised institution to maintain confidence and minimise risk. Although the Bank of England explored with the blockchain start-up Ripple whether the distributed ledger could improve settlement efficiencies,40 Ripple’s innovations would likely add to and not replace the central bank-based settlement systems for large-value transfers. Ripple is itself acting as a centralised intermediary exploring new efficiencies, and not offering a distributed permissionless ledger for such transfers. Third, it is not necessarily efficient that the ledger for recording transfer transactions is immutable and transactions are irreversible. Users may prefer to have the legal protection of reversal if there are mistakes, such as where Charlie masquerades as Bob in order to deceive Alice into sending the bitcoins. Such a situation can be remedied under the regulatory governance for payments systems, although the regulatory response to push payment fraud is only developing.41 However, individuals seeking remedies in an alternative currency blockchain may find their needs unredressed unless a sufficient number in the community is willing to effect a fork in the blockchain ie to construct a separate blockchain in order to exclude a particular disputed entry.

ii.  Emerging Regulatory Initiatives for Currency Blockchains and Continuing Gaps Many jurisdictions have not addressed integrating cryptocurrency and its payment universe into conventional regulation. However, as will be discussed shortly, the evolution of cryptocurrency into more complex cryptoassets, including stablecoins, has 39 Chiu (2017a). 40 Bank of England, ‘FinTech Accelerator Proof of Concept Ripple – Exploring the synchronised settlement of payments using the Interledger Protocol’ (2017), at www.bankofengland.co.uk/-/media/boe/files/fintech/ ripple. 41 JL Taylor and T Galica, ‘A New Code to Protect Victims in the UK from Authorised Push Payments Fraud’ (2017) 35 Banking and Finance Law Review 325.

10  A Legal Mapping of the Crypto Economy triggered financial regulators’ responses.42 In relation to private cryptocurrencies that are intended to fulfil payment or transfer purposes, the earliest regime of enabling regulation is found in New York’s BitLicense scheme43 that licenses money service businesses servicing the crypto community. The Uniform Law Commission has also recommended enabling legislation to recognise and regulate cryptocurrency exchange and remittance services.44 This regime is however only an incremental approach as it applies to certain commercial providers in the crypto payment landscape, but does not govern the payment architecture, standards, protocols and conduct amongst noncommercial user-entities. The BitLicense scheme requires businesses engaged in cryptocurrency exchange, custody, transmission, etc to apply for a specific licence to carry out their activities. However, this regime has been criticised to be onerous for compliance, and to date only three large businesses have been licensed.45 The Uniform Law Commission’s Regulation of Virtual Currency Business Act46 provides a registration regime for businesses that engage in virtual currency business. Virtual currency business includes the control, exchange and storage of virtual currencies, defined as a ‘digital representation of value’ that mimics characteristics of money, but not necessarily legal tender. This definition excludes electronic money that is legal tender and that which is defined as a ‘security’ or ‘commodity’ under the relevant federal legislation. Virtual currency businesses handling a total volume of over US $35,000 must be registered and those handling under US $5,000 are exempt. Businesses handling volumes under US $35,000 may opt to be registered or at least file a notice with the state authority, and are subject to certain compliance obligations. Registered businesses are subject to obligations in relation to keeping prescribed records of transactions and the possibility of annual examinations by the authority. To date there has only been one formal adoption of the Uniform Law Commission’s Act, in Rhode Island. Another approach is to bring cryptocurrency service providers within the fold of mainstream payment services regulation, but policy-makers may be concerned about the implications of legitimating these services in the mainstream economy. Singapore now recognises and subjects digital token payment providers, defined as centralised exchange services, to the same regulatory regime for payment services providers generally,47 including authorisation upon the meeting of prudential conditions and the approval of the fitness of responsible persons managing the service. Although the New York and Singapore regimes are beginning to recognise new commercial service providers in the crypto economy such as cryptocurrency service businesses, it is queried if such regulations, which tend to mimic the conventional framework for payment services, would be too derivative and fail to cater for novelties. 42 This chapter, and chs 3 and 6. 43 NY Comp Code Rules & Regs. tit 13, ch 1, pt 200 (2015), available at www.dfs.ny.gov/legal/regulations/ adoptions/dfsp200t.pdf. 44 Regulation of Virtual Currency Business Act, at www.uniformlaws.org/committees/community-home? CommunityKey=e104aaa8-c10f-45a7-a34a-0423c2106778. 45 Coinbase, Circle and Ripple. 46 Regulation of Virtual Currency Business Act, at www.uniformlaws.org/committees/community-home? CommunityKey=e104aaa8-c10f-45a7-a34a-0423c2106778. 47 Payment Services Act 2019, Sch 1, Pt 3, s 5.

Bitcoin and the Beginnings of a Blockchain-based Economy  11 First, cryptocurrency are intangible data represented by their wallet addresses, ie the online or offline locations of their safekeeping. There are various types of services for coin custody, such as software that one can purchase and download onto one’s computer as a private wallet, or custodial services offered by wallet providers or cryptocurrency exchanges. It is queried if these new commercial providers that should be uniquely addressed in regulation.48 Next, regulation that is aimed at attaching duties and responsibilities to identified commercial outfits does not address the ill fit with decentralised architecture and peer level miners. Users of crypto currency may be disadvantaged for opting not to deal with intermediaries, which is ironic, given that the blockchain architecture is intended to empower decentralised coordination. Further, consumer protection is inadequately addressed in the emerging regulatory frameworks for cryptocurrency discussed above. A particular issue lies in customers’ positions in the event of the insolvency of a commercial outfit that has custody of customers’ cryptocurrency. For example, when the exchange Mt Gox became insolvent on 28 February 2014, customers were uncertain what their rights were in relation to the coins held by the exchange on their behalf. Customers’ revendication claims against Mt Gox were rejected by the Japanese court as the contractual arrangement between Mt Gox and customers did not preclude the exchange from having rights to use customers’ stored cryptocurrency such as for internal settlement of transactions.49 The court refused to recognise the rights as proprietary, and stranded customers became unsecured creditors, many of them never recovering from Mt Gox’s insolvency.50 A different position was taken in a recent New Zealand case.51 There is the question of whether cryptocurrency could be treated differently and in a more proprietary manner, a point we return to shortly. It may be argued that the Mt Gox creditors’ claims are not dissimilar to a depositor’s claim against an insolvent bank or financial institution, as deposits are not held on trust.52 However, depositors are protected institutionally by a guarantee scheme which is a public good underlying confidence in the banking system.53 In financial institutions where customers entrust monies in order to purchase or trade financial assets, these are even characterised as proprietary under regulatory law54 and customers would have priority in insolvency proceedings. In the absence of regulatory standardisation, researchers55 found that different commercial outfits, left to self-regulation, offer their cryptocurrency customers different types of characterisation as to their storage arrangements of cryptocurrency. Some may offer a contractual scheme which spells clearly that 48 D Chu, ‘Broker-Dealers for Virtual Currency: Regulating Cryptocurrency Wallets and Exchanges’ (2018) 118 Columbia Law Review 2323. 49 Discussed in M Haentjens, T de Graaf and I Kokorin, ‘The Failed Hopes of Disintermediation: Cryptocustodian Insolvency, Legal Risks and How to Avoid Them’ (2020), at ssrn.com/abstract=3589381. 50 Discussed in Allen (2019). 51 Ruscoe & Moore and Ors v Cryptopia (in liquidation) [2020] NZHC 728. 52 Foley v Hill (1848) 2 HLC 28, 9 ER 1002. 53 The Financial Services Compensation Scheme which pays out up to £85,000 per institution the customer has accounts with. 54 EU Markets in Financial Instruments Directive 2014, Art 16(8); MiFID Commission Delegated Directive 2017/563, Arts 2–6; Financial Conduct Authority Handbook CASS 6; Lehman Brothers International (Europe) (in administration) v CRC Credit Fund Ltd and others [2010] EWCA Civ 917, [2010] WLR (D) 227. 55 Haentjens et al (2020).

12  A Legal Mapping of the Crypto Economy the exchange controls users’ private keys and are able to access users’ cryptocurrency for internal settlement purposes. This would unlikely help customers in establishing a proprietary characterisation of their claim. Others like Gemini offer an explicit custodial arrangement to spell out; they hold their customers’ cryptocurrency as bailees or trustees, and customers may benefit from segregated accounts.56 These differences matter significantly for customers’ rights in the event of insolvency, and may be an issue for regulatory standardisation.57 Another episode in relation to lost coins occurred in relation to Quadriga CX, an exchange and wallet provider whose founder and chief executive Gerald Cotten died without making any provision for contingency access to the list of customers’ private keys kept in the exchange’s wallet, stored in his personal encrypted computer.58 This resulted in customers not being able to access their private keys and unable to assert any rights in order to recover their coins. Regulatory standardisation in terms of governing the internal control and governance of custodial services could mitigate the risks suffered by customers of Quadriga CX. In addressing the gaps highlighted above, private law is likely too fragmented to give rise to cross-border certainty. Customers first need to discern which jurisdictions’ contractual or proprietary laws apply to them, where transnational services are concerned.59 Further, in terms of regulatory protection, general bodies of regulation such as the consumer protection in the UK Consumer Rights Act 2015 may be too imprecise and limited. Can customers claim that their exchange or wallet service providers are traders providing a contract for service and should be placed under a duty of reasonable care and skill in discharging these services?60 Moreover, it is uncertain what may be regarded as negligent in the provision of services constantly subject to innovation. In the case of Quadriga CX it may be argued that storing users’ private keys in the CEO’s encrypted computer is a means of risk management so that important information is stored off-site from business servers. Is it negligent risk management on the part of Quadriga CX not to have considered the possible early and sudden death of its founder and CEO? At what level of risk management, cybersecurity provision and maintenance would a provider be negligent for rare errors, inaccessibility or outages? The minimal architecture in the Bitcoin blockchain for dealing with unexpected and ex post issues in payment disputes is inherently unable to cope with user protection. There are also no incentives for the distributed network of miners to govern this space. Further, the digital currency community, consisting of Bitcoins and altcoins, have coped with challenging issues such as cyberhacking and code exploitation by forking, which is the separation of a community of coders, miners and users from the main ledger, in order to exclude an irregular event and distinguish themselves as a separate system that would continue independently.61 Forking achieves the effect of overwriting 56 www.gemini.com/legal/custody-agreement#section-custodian-appointment. 57 ibid. 58 ‘Crypto CEO Dies Holding Only Passwords That Can Unlock Millions in Customer Coins’ (Bloomberg, 4 February 2019). 59 Haentjens et al (2020). 60 Consumer Rights Act 2015, s 49. 61 There are mixed views as to the pros and cons of forking. On the one hand, forking provides competition but on the other hand its users may lack a sense of certainty, see J Abadi and M Brunnermeier, ‘Blockchain

Bitcoin and the Beginnings of a Blockchain-based Economy  13 the error or breach that could not be reconciled in the blockchain community. Bitcoin, for example, has forked over 100 times, and this can cause uncertainty for users in relation to the currency they are holding, their values, and what rules may change from the main ledger.62 It may be argued that Rhode Island’s Regulation of Virtual Currency Business Act goes some way towards addressing ex post problems as it provides for the compulsory institution of anti-fraud, money laundering and terrorist attack programmes as well as disaster recovery, business continuity and operational security programmes for users.63 If a cryptocurrency business is compromised in any of these respects, a regulatory breach would occur, but this is cold comfort for users if their civil rights remain uncertain. The Act also envisages that cryptocurrency businesses should hold full reserves of cryptocurrency that their users are entitled to,64 and should also be adequately capitalised and insured against potential liability and claims.65 This still means that aggrieved users need to pursue civil actions, and it remains for private law jurisprudence to articulate if the rights are proprietary or unsecured, and how they can be enforced.

iii.  Limited Private Remedies Relating to Private Currency Blockchains As a matter of default, it may be argued that in the Bitcoin blockchain where selfregulatory or limited regulatory governance falls short of meeting users’ needs, private law remedies could still help claimants in certain situations. Commentators have argued that Bitcoin, or other virtual currencies of the same nature, can amount to property, so that the proprietary holder of lost or stolen coins can mount proprietary claims, and proprietary orders can attach to coins that are ill-gotten. For example, where a victim is able to locate the address to which stolen coins have been moved, a proprietary claim can be mounted against the holder of the address (sometimes a cryptocurrency exchange) in order to freeze and deliver up the coins. Fox66 and Allen67 acknowledge the difficulties with regard to a property characterisation of Bitcoin, as data cannot be the subject of property.68 Further, Bitcoin is not personal property that can be possessed or characterised as a chose in action (which has developed for the purposes of commodifying financial rights, and is assignable as a claim that can be exercised against third parties).69 Moreover, Savelyev asks whether Bitcoin can be regarded as conferring property rights which are erga omnes in nature when validation by miners present a condition for such rights to become ‘choate’.70 Economics’ (2018), at www.nber.org/papers/w25407; C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) ch 3. 62 See ‘The Beginner’s Guide to Bitcoin Forks’ (2019), at 99Bitcoins.com/Bitcoin-forks. 63 Regulation of Virtual Currency Business Act, s 601. 64 s 502. 65 s 204. 66 D Fox, ‘Cryptocurrencies in the Common Law of Property’ in D Fox and S Green (eds), The Law of ­Cryptocurrencies (OUP, 2019) ch 6. 67 JG Allen, ‘Property in Digital Coins’ (2019) 8 European Private Law Journal 64. 68 Your Response Ltd v Datateam Business Media Ltd [2014] EWCA Civ 281. 69 Fox (2019). 70 A Savelyev, ‘Some Risks of Tokenization and Blockchainizaition of Private Law’ (2018) 34 Computer Law and Security Review 863.

14  A Legal Mapping of the Crypto Economy However, Bitcoin and other virtual currencies are uniquely identifiable with private keys that allocate ownership rights;71 they are not comingled; and every transaction is identifiable as precise outputs, making them capable of being traced.72 They are capable of being chattelised by documentation (or virtually in a ledger),73 and are rivalrous and excludable.74 Indeed, the UK Jurisdiction Taskforce agrees that cryptoassets are capable of being property and the general ruling against information being property does not squarely apply to crypto assets.75 The Taskforce is of the view that cryptoassets are closest to choses in action, but opines that cryptoassets cannot be subject to bailment or be regarded as goods, although they can be collateralised, assigned or treated with the requisite priority in insolvency. A UK court has also ruled that Bitcoins are proprietary in nature and that proprietary injunctions can attach to them, confirming its agreement with the Taskforce’s opinion.76 Allen further suggests that for the sake of clarity, new legal ontologies should be developed, such as recognising a category of intangible personal property.77 It can also be argued that tax treatment of capital gains from virtual currencies trading can support the characterisation of virtual currency as property. In the UK, HMRC explicitly states that capital gains made from crypto assets trading would be liable for capital gains tax just like gains made from trading in securities and other assets.78 However, at the same time, HMRC also levies income tax from cryptocurrency earned through mining and other forms of coin distribution, such as airdrops.79 This potentially creates inconsistent characterisation as earnings are more similar to contractual rather than proprietary claims. The CJEU case of Skatteverket v David Hedqvist had to deal with the question whether VAT was payable on transfers of cryptocurrency into fiat currency and vice versa, or whether such transfers fell within the exemption for transfers of currency.80 The Court did not treat as exempt only transfers between currencies that are legal tender and treated cryptocurrency as currency in the fiat-to-crypto transactions concerned. This is because the cryptocurrency is intended to be treated as currency and not goods. This treatment arguably contradicts the capital gains treatment undertaken by the UK, although it could cohere with the income tax treatment adopted. Tax policy may however be arguably too instrumental in nature to form the basis for the property law characterisation of cryptocurrencies to facilitate civil enforcement. The proprietary classification can provide private law remedies to an extent, but not in full. In the case before the UK courts mentioned above, a proprietary injunction claim was mounted by an insurer of a company that had suffered a cyberhack and was 71 Fox (2019). 72 Haentjens et al (2020). 73 ibid, and Allen (2019). 74 C Zellweger-Gutknecht, ‘Developing the Right Regulatory Regime for the Cryptocurrencies and Other Value Data’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 4. 75 UK Jurisdiction Taskforce, ‘Legal Statement On Cryptoassets And Smart Contracts’ (November 2019), at 35z8e83m1ih83drye280o9d1-wpengine.netdna-ssl.com/wp-content/uploads/2019/11/6.6056_JO_Crypto currencies_Statement_FINAL_WEB_111119-1.pdf. 76 AA v Persons Unknown and Bitfinex [2019] EWHC 3556. 77 Allen (2019). 78 HMRC, ‘Cryptoassets for Individuals’ (19 December 2018), at www.gov.uk/government/publications/ tax-on-cryptoassets/cryptoassets-for-individuals. 79 Referring to the gratuitous distribution of cryptocurrency, especially new currencies that seek to scale up their use. 80 Request for a preliminary ruling from the Högsta förvaltningsdomstolen, Case C-264/14.

Bitcoin and the Beginnings of a Blockchain-based Economy  15 forced to pay its ransom in bitcoin. The trail of the bitcoins could be traced, thanks to the distributed and publicly accessible ledger, but although 96 bitcoins were tracked to an exchange wallet account with Bitfinex, the identity of the hackers could not be uncovered beyond that.81 Stolen coins may be uniquely identified by their public keys, but if no activity occurs, such as in relation to the stolen ether in 201682 by a code exploitation on the Ethereum blockchain, then it is impossible to track down the thief. Public keys are only pseudonymous in nature. Further, even if a pseudonymous theft can be tracked down, private law enforcement can be challenged by barriers in cross-border enforcement.83 The cost and inconvenience of private law remedies remain significant. Ultimately, it also appears to be highly incompatible how ‘stolen money’ from an intermediary institution is treated vis-a-vis stolen cryptocurrency. For conventional regulated payment services providers, the institutionalisation of consumer protection norms has provided a balance of certainty and convenience for the end-user, in relation to how harm can be reversed and when loss is borne. Private law remedies based on property are more contorted in nature and likely to be subject to arguments with regard to ontological classification. Further, property law remedies cannot deal with issues of conduct and allocation of responsibility. In the absence of strict legislated liability, when should custodians be regarded as negligent and responsible if coins should be lost under their watch? What is the standard of care for custodians’ cyber-defences and risk management? The alternative payment mechanism offered by the Bitcoin blockchain is unlikely seen to be an institutional threat to the systems and business of wholesale and retail payments backed by institutional and regulatory architecture today.84 There is still a need to clarify whether there are institutions of governance that serve equivalent functions for social trust and protection in the cryptocurrency payment universe.85 Even in regulatory regimes where virtual currency has been given recognition and regulation is extended over commercial providers, the regulatory regimes are not without gaps. Moreover, it may be argued that institutional development and certainty only arise in the conventional economy because of the monetary underpinning of the conventional payment systems. The lack of moneyness of cryptocurrency inevitably affects the characterisation of private remedies such as debt or damages86 so private remedies do not work to the same extent of effectiveness in the crypto economy. Retailers who voluntarily accept cryptocurrency as payment remain a minority, and may be concentrated in markets where consumers are young and technology-savvy.87 81 AA v Persons Unknown and Bitfinex [2019] EWHC 3556. 82 ‘Understanding the DAO Hack’ (25 June 2016), at www.coindesk.com/understanding-dao-hack-journalists. 83 eg see F Guillaume, ‘Aspects of Private International Law Relating to Blockchain Transactions’ in D Kraus, T Obrist and O Hari (eds), Blockchains, Smart Contracts, Decentralised Autonomous Organisations and the Law (Edward Elgar, 2019) ch 3. 84 A Janczuk-Gorywoda, ‘Blockchain and Payment Systems: A Tale about Re-Intermediation’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 14. 85 G Papadopoulos, ‘Blockchain and Digital Payments: An Institutionalist Analysis of Cryptocurrencies’ in DKC Lee (ed), Handbook of Digital Currency (Elsevier, 2015) ch 7; also see the preferred enabling view proposed by G Dimitropoulos, ‘Global Currencies and Domestic Regulation Embedding through Enabling?’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 6. 86 S Gleeson, The Legal Concept of Money (OUP, 2019) 7.6.6–7.7.4, 9.9. 87 N Jonker, ‘What Drives the Adoption of Crypto-Payments by Online Retailers?’ (2019) 35 Electronic Commerce Research and Applications 100848.

16  A Legal Mapping of the Crypto Economy

B.  Cryptocurrency and the Law and Regulation of Money The Bitcoin blockchain is arguably more than just a peer-to-peer payment system as it also purports to offer a scalable private currency. Potentially, it could compete with fiat currencies,88 in relation to being a unit of account, store of value or means of payment. The previous section provided an account of the Bitcoin blockchain as an alternative payment system and the debates in relation to legal and regulatory characterisation. We now turn to the monetary aspects of cryptocurrency and its fit with existing institutions. Policy-makers are highly sceptical that cryptocurrency performs the functions of unit of account or store of value, largely based on empirical observation.89 There is minority uptake by markets in denoting goods and services in Bitcoin accounting units. Cryptocurrency also suffers from volatility in value to act comfortably as store of value. As a monetary system, Bitcoin adopts a standard functionally similar to the gold standard, and its monetary supply is based on productivity in its system. The supply of bitcoin is coded to be limited to 21 million coins and the finite supply reflects the pre-fiat theory of money where money had to be backed by gold reserves held by central banks. Although these reserves arguably provided the basis for the value of money, monetary policy was deeply constrained. The gold standard has been abandoned worldwide now, and most states adopt fiat money which is money backed by the sovereign as such.90 The value of money in any one jurisdiction therefore now reflects market confidence in the sovereign and the economy of the jurisdiction concerned, priced in free-floating exchange rates91 and domestic interest rates.92 Further, the Bitcoin blockchain is coded to ensure that the supply of money is generated according to mining productivity. This ensures that money supply is generated for productive work in maintaining the peer-to-peer payment system, arguably challenging the disengagement between monetary policy in many states today from their real economies. Monetary policy such as maintained by the US93 has been argued to be a cause for asset price inflations and indulgence in excessive credit without support from real economic growth or development, a recipe that ultimately culminated in the global financial crisis of 2007–09.94 Private cryptocurrencies also arguably suffer less from policy manipulation and rigged markets such as the recent scandals involving global forex markets.95 88 T Owen, ‘New Money’ in T Owen, Disruptive Power: The Crisis of the State in the Digital Age (OUP, 2015). 89 B Eichengreen, ‘From Commodity to Fiat and Now to Crypto: What Does History Tell Us?’ (2019) at www.nber.org/papers/w25426; J Chapman and CA Wilkins, ‘Crypto “Money”: Perspective of a Couple of Canadian Central Bankers’ (Bank of Canada Discussion Paper, 2019). 90 C Desan, Making Money: Coin, Currency, and the Coming of Capitalism (OUP, 2014) on the dominant token theory of money as opposed to intrinsic or metallist theories of money. 91 Free-floating exchange rates came about after the experiment to fix exchange rates for international trade stability, the Bretton Woods System, broke down after the US unilaterally abandoned it. 92 Domestic interest rates are set by central banks in order to set the ‘price’ of money in order to incentivise economic behaviour that is optimal for the economy, such as for the purposes of expanding credit, controlling inflation or unemployment. 93 S Gerlach and L Moretti, ‘Monetary Policy and TIPS Yields before the Crisis’, CEPR Discussion Paper (2011). 94 See M Wolf, ‘From Crises to Imbalances’ in M Wolf, Fixing Global Finance (Yale University Press, 2009) ch 4; D Alpert, ‘Let Them Eat Debt’ in D Alpert, The Age of Oversupply (Penguin, 2013) ch 4. 95 eg see ‘Barclays, RBS and other banks face £1bn forex rigging lawsuit’ (The Guardian, 29 July 2019); ‘Barclays, Citigroup and JP Morgan among banks fined $1.2 billion for forex rigging’ (CNBC News, 16 May 2019).

Bitcoin and the Beginnings of a Blockchain-based Economy  17 Indeed, economists argue that private cryptocurrencies are a beneficial alternative for states whose citizens are affected by manipulative monetary policies, as they can induce competition that may ameliorate those manipulative tendencies.96 Where exchange rates between states are highly volatile, in relation to states that are buffeted by political uncertainty or fragility, private cryptocurrencies could even be perceived to be more stable as a store of value.97 However, Bitcoin and other cryptocurrencies are not monetary systems that serve a crypto economy as such. What this means is that cryptocurrencies are not used towards economic activities and development within a space that is unique to crypto goods or services, as this space has been relatively lacking until the development of the Ethereum blockchain in 2015. Hence their possibly distinguishing monetary qualities are overshadowed by their sub-optimal payment qualities. They have been adopted mostly in real economies that prize pseudonymity in payment, such as in dark economies for illicit trade in arms, drugs and identities.98 Transactions in cryptocurrency were discovered to power the infamous Silk Road, which was shut down by the US Federal Bureau of Investigation in 2017. The pseudonymous properties of cryptocurrency are also used to engage in layering and deception in money laundering.99 As a result, policy-makers are not in a hurry to confer legality upon cryptocurrency as money that should be socially accepted. However, policy-makers have, for instrumental reasons, extended anti-money laundering laws to cryptocurrency transactions while side-stepping the question of whether they are recognised as money in the economy and society. The European Anti Money-laundering Directive was amended in 2018 to require the registration of virtual currency exchange providers and storage services (wallets)100 and to subject them to the requirements of the Directive in relation to customer due diligence101 and monitoring, as well as reporting, in order to detect suspicions of money laundering.102 It may be argued that such a policy approach recognises cryptocurrencies as money, even if states do not regard them as legal tender.103

96 M Raskin, F Saleh and D Yermack, ‘How Do Private Digital Currencies Affect Government Policy?’ (NBER Working Paper, 2019). 97 P Benigno, LM Schilling and H Uhlig, ‘Cryptocurrencies, Currency Competition, and the Impossible Trinity’ (2019) at ssrn.com/abstract=3423326. 98 H Karlstrøm, ‘Do Libertarians Dream of Electric Coins? The Material Embeddedness of Bitcoin’ (2014) 15 Distinktion: Scandinavian Journal of Social Theory 23–36; DA Nair, ‘The Bitcoin Innovation, Crypto Currencies and the Leviathan’ (2019) 9 Innovation and Development 85–103. 99 BK Anderson, ‘Regulating the Future of Finance and Money: A Rational U.S. Regulatory Approach to Maximizing the Value of Crypto-Assets and Blockchain Systems’ (2018) 11 Bocconi Legal Papers 1; JW Bagby, D Reitter and P Chwistek, ‘An Emerging Political Economy of the BlockChain: Enhancing Regulatory Opportunities’ (2019) at ssrn.com/abstract=3299598. 100 Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU, Art 47(1). 101 Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU, Arts 10–24. 102 Arts 32–38, above, also see UK Proceeds of Crime Act 2002, s 330 regarding criminalising the failure to disclose. 103 Recognising as legal tender is the prerogative of the state, see C Proctor, ‘Cryptocurrencies in International and Public Law conceptions of Money’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 3.

18  A Legal Mapping of the Crypto Economy However, as the Preamble104 to the Anti Money-laundering Directive points out, the extension of such legislation to key intermediaries in cryptocurrency does not mean that there is implicit recognition of the moneyness of cryptocurrency. These intermediaries can equally be regarded as dealing in or safeguarding digital assets, and anti-money laundering regulations affect other at-risk lines of high-value business such as real estate, art, incorporations and gambling.105 The moneyness of cryptocurrency is adversely affected by not being a monetary system supporting an alternative crypto economy. Moreover, finite monetary systems like Bitcoin are also arguably sub-optimal as they are predicted to be deflationary in due course when the coin supply ceiling is hit. This anticipation may result in certain market behaviours that are sub-optimal, such as hoarding of Bitcoin by large holders in order to affect its future value and prevent deflation.106 Hence, the moneyness of many cryptocurrencies is arguably weakened by the self-regulatory behaviour on the part of their users. The sub-optimal monetary qualities of cryptocurrency have led to speculative activity with regard to them, as holders principally treat them as assets to buy and sell in anticipation of changes in value vis-a-vis fiat currencies.107 This has created high levels of volatility108 in cryptocurrencies. Bitcoin in particular has risen from a previous all-time high of US $18,000 per coin in January 2017 to over US $46,000 in February 2021. It was worth US $27 per coin in 2009. High volatility was also observed in cryptocurrency markets during the 2020 crisis relating to the coronavirus pandemic which affected all financial asset prices as market activity froze and asset-holders dashed for cash.109 Nevertheless, a view from economic sociology may assist in recognising the moneyness of cryptocurrencies. If as Geva and Geva suggest, a community accepts a form of private currency in order to discharge debt obligations, then the community’s endowment of moneyness upon the private currency should not be thwarted.110 This view has special traction in private law scenarios such as an action for price in a sale of goods situation suggested by Green111 and in actions where banker–customer duties may be argued in order to benefit a crypto currency customer who has entrusted safekeeping to a custodian.112 If the moneyness of cryptocurrency is not recognised, the lack of appropriate private law actions could cause great inconvenience and inefficiency, such as a seller of goods anticipating payment in cryptocurrency having to 104 Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU, Preamble 10. 105 Art 2(1), above. 106 I Mas and DKC Lee, ‘Bitcoin-Like Protocols and Innovations’ in DKC Lee (ed), Handbook of Digital Currency (Elsevier, 2015) ch 21. 107 N Tiwari, ‘The Commodification of Cryptocurrency’ (2019) 117 Michigan Law Review 612. 108 C Fink and T Johann, ‘Bitcoin Markets’ (2014) at ssrn.com/abstract=2408396; O Scailliet et al, ‘HighFrequency Jump Analysis of the Bitcoin Market’ (2017) at ssrn.com/abstract=2982298. 109 ‘Down 26%: Bitcoin Sees Worst Sell-Off in 7 Years as Coronavirus Spurs Flight to Safety’ (12 March 2020), at www.coindesk.com/down-26-Bitcoin-sees-worst-sell-off-in-7-years-as-coronavirus-spurs-flight-to-safety. 110 B Geva and D Geva, ‘Non-State Community Virtual Currencies’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019). 111 S Green, ‘It’s Virtually Money’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 2. 112 C Hare, ‘Cryptocurrencies and Banking Law – Are there Lessons to Learn?’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 9.

Bitcoin and the Beginnings of a Blockchain-based Economy  19 sue for failure of consideration in a barter trade instead of an action for price. Likewise, if a payment mandate instructed by a customer fails, it would be unable to enforce a breach of banker’s duty, but would have to enforce more generally under agency law for non-performance. However, should policy-makers recognise moneyness even though cryptocurrency is sub-optimal in those qualities compared to many fiat currencies? Avgouleas and Blair113 argue that the legality of money is not merely something that only sovereigns can confer, as community-based recognition for the acceptance of currency is also valid. However, legality ought to be based on objective criteria such as the relative retention of value in order to function credibly as unit of account, store of value and medium of exchange. As policy makers are not imminently engaging in integrating cryptocurrencies into the mainstream institutional architecture of money and payment services, any elevation to legitimacy and social acceptability would have to be based on self-generated endeavours. In this light the crypto community is endeavouring to generate private cryptocurrencies of improved characteristics to attain that benchmark.

i. Stablecoins The crypto community is experimenting with the development of stablecoins to improve the moneyness of cryptocurrency. A stablecoin is designed to mitigate the volatility of cryptocurrencies, and there are several techniques for doing so.114 These mechanisms are discussed in greater detail in chapter six. Stablecoins have largely been adopted as financial products and it remains a struggle to scale them into payment currency. Impending regulatory treatment of stablecoins is also likely to reinforce this treatment. Stablecoins have grown in popularity to assist holders of volatile cryptocurrency in hedging their positions and managing investment value. Tether, which is a cryptocurrency pegged against the US dollar, euro, and more recently the Chinese yuan, has achieved a massive market capitalisation.115 However, stablecoins, whose designs are discussed in greater detail in chapter six, are not perceived as optimally selfgoverned.116 Many stablecoins purported to be collaterised against conventional fiat currencies or financial assets do not offer transparency in relation to the integrity of their collateralisation.117 Algorithmic-controlled stablecoins that purport to maintain value by supply and demand calibration mechanisms are not necessarily stable or successful.118 The Financial Stability Board identifies the potential scaling-up of stablecoin ownership and their deployment in commercial and financial domains as posing 113 E Avgouleas and W Blair, ‘The Concept of Money in the 4th Industrial Revolution – a Legal and Economic Analysis’ (2020) at papers.ssrn.com/sol3/papers.cfm?abstract_id=3534701. 114 D Bullman, J Klemm and A Pinna, ‘In Search for Stability in Crypto-assets: Are Stablecoins the Solution?’ (ECB Occasional Paper, 2019) at papers.ssrn.com/sol3/papers.cfm?abstract_id=3444847. 115 Statistics at coinmarketcap.com/currencies/tether. 116 FSB, ‘Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements’ (October 2020), at www.fsb.org/2020/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements. 117 Avgouleas and Blair (2020) discuss how tether has become ‘untethered’. Also see ‘Fractional Stablecoin Tether only 74% Backed by Fiat Currency, Says Lawyers’ (30 April 2019), at cointelegraph.com/news/ fractional-reserve-stablecoin-tether-only-74-backed-by-fiat-currency-say-lawyers. 118 An example of which is Basis, which is now non-functional, see ‘Basis Stablecoin Confirms Shutdown, Blaming ‘Regulatory Constraints’ (13 December 2018), at www.coindesk.com/basis-stablecoinconfirms-shutdown-blaming-regulatory-constraints.

20  A Legal Mapping of the Crypto Economy systemic risk.119 This is because stablecoins have a mixture of bank deposit, collective investment scheme and payment functions in them, and regulatory arbitrage implications loom large. They may generate potential systemic risk if adopted at scale by retail users. Indeed, the FSB and IOSCO have identified similarities between stablecoins with payment mechanisms,120 electronic money,121 commodities,122 bank deposits,123 money market funds,124 securities125 and other collective investment schemes.126 The FSB has explicitly urged financial regulators globally to subject stablecoins to regulatory treatment,127 and now suggests that stablecoins may not fit within existing regulatory ontologies. The European Commission in particular has launched an agenda to regulate stablecoins as a type of cryptoasset product.128 At the time of writing, the Stable Act has been proposed in the US to regulate stablecoin issuers as deposit-taking institutions and subject to bank regulation.129 The UK130 is also consulting on the regulatory perimeter for stablecoins and cryptoassets, and has demonstrated leanings in favour of regulating stablecoins pegged to fiat currency or financial instruments. The Treasury is open-minded about leaving other forms of cryptoassets outside of the regulatory perimeter. The regulatory risks for stablecoins are significant although their potential for mobilising the crypto economy as well as providing a new asset class for institutional investors seems recognised. The debate on whether central banks should create digital fiat currencies is also underway,131 and it may be argued that such digital currency could be the perfect monetary support for the crypto economy,132 whose growth is discussed in the next sections. Chapter six discusses this in greater detail. First movers Sweden133 and China134 have 119 FSB, ‘Regulatory Issues of Stablecoins’ (October 2019) at www.fsb.org/wp-content/uploads/P181019.pdf. 120 ibid. 121 ibid, and Bullman et al (2019). 122 FSB (2019). 123 ibid. 124 IOSCO, ‘Statement on IOSCO Study of Emerging Stablecoin Proposals’ (2019), at www.iosco.org/news/ pdf/IOSCONEWSS550.pdf. 125 ibid. 126 FSB (2019). 127 FSB (2020). 128 European Commission, Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (September 2020), at ec.europa.eu/ finance/docs/law/200924-crypto-assets-proposal_en.pdf. 129 tlaib.house.gov/sites/tlaib.house.gov/files/STABLEAct.pdf. 130 HM Treasury, ‘UK Regulatory Approach to Cryptoassets and Stablecoins: Consultation and Call for Evidence’ (January 2021). 131 M Bech and R Garratt, ‘Central Bank Cryptocurrencies’ (2017) BIS Quarterly Review 55. Raskin and Yermack discuss the pros and cons of such policy as central banks may have wider choice sets in managing price stability but may be ill-equipped to carry out customer-facing banking tasks vis-a-vis citizens directly; see M Raskin and D Yermack, ‘Digital Currencies, Decentralised Ledgers and the Future of Central Banking’ (NBER Working Paper, 2016). 132 RC Hockett, ‘Money’s Past is Fintech’s Future: Wildcat Crypto, the Digital Dollar, and Citizen Central Banking’ (2019) 2 Stanford Journal of Blockchain Law and Policy 221. 133 ‘Now There Are Plans for “e-Krona” in Cash-Shy Sweden’ (Bloomberg, 26 October 2018) at www. bloomberg.com/news/articles/2018-10-26/riksbank-to-develop-pilot-electronic-currency-amid-cashdecline. 134 ‘What is China’s Digital Currency Plan?’ (Financial Times, 25 November 2019), at www.ft.com/content/ e3f9c3c2-0aaf-11ea-bb52-34c8d9dc6d84. Q Yao, ‘A Systematic Framework to Understand Central Bank Digital Currency’ (2018) 61 Science China at doi.org/10.1007/s11432-017-9294-5 seems to indicate that the Chinese move is pursuant to policy for greater state surveillance and monitoring of monetary flows.

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  21 experimented with central bank digital currencies, and there is a move towards exploring them operationally by leading jurisdictions.135 However, central banks seem to neglect the deployment of digital currencies in the crypto economy, choosing to focus on mainstream retail and remittance. It is observed that potential movements towards the regulation of cryptocurrencies or, at least, stablecoins, are afoot and this can pave the way for their legitimacy and competition with fiat currencies.136 The crucial ‘money’ link that needs to support the crypto economy is further fleshed out in chapter six, and the regulatory and institutional implications are discussed.

III.  Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy Unlike the development of fiat currency, which evolved from barter and privately issued money for the growing scale of exchange and transactions at domestic and international levels,137 Bitcoin was not a response to growth in a new crypto economy. The development of unique goods and services that can only be offered or are most optimally offered over a blockchain138 did not come about until the development of the Ethereum blockchain, which went live in July 2015. The achievement of the Ethereum blockchain is that it does not only function as a payment ledger; rather, it is an underlying infrastructure that supplies a ledger and a protocol token (ether) that codes in basic laws of functionalities that can then be used to develop more specific ‘smart contracts’. Smart contracts are automated algorithmic protocols that can execute pre-programmed functions, from transfer of value to other forms of coordination and exchange. The Ethereum blockchain therefore supports more forms of economic or social activity that can be carried out on a decentralised basis on a private network amongst peers. The ether is the native token of the Ethereum blockchain, just as the Bitcoin is the native token of the Bitcoin blockchain. However, Bitcoin’s functionalities are limited, and its script narrowly comprises transfer and recording functions. Compare this with the ERC-20 ether token, which is coded with more universal functional qualities such as transferring within allowance limits, from specified locations, approval protocols and permitting access to data. These universal qualities allow coders to build upon the token code with more specific functions which can be automated upon the satisfaction of certain conditions (smart contracts).139 Hence ERC-20 tokens are used for the building 135 BIS, ‘Central Bank Digital Currencies: Foundational Principles and Core Features’ (9 October 2020), at www.bis.org/publ/othp33.htm; ECB, ‘Report on a Digital Euro’ (October 2020), at www.ecb.europa.eu/euro/ html/digitaleuro-report.en.html. 136 DA Zetzsche, RP Buckley and DA Arner, ‘From Bitcoin to Libra and Digital Currencies’ (presentation at UCL Centre for Ethics and Law, 25 November 2019). 137 N Ferguson, The Ascent of Money (Penguin, 2012) chs 1, 2, also RC Hockett, ‘Money’s Past is Fintech’s Future: Wildcat Crypto, the Digital Dollar, and Citizen Central Banking’ (2019), at ssrn.com/abstract=3299555. 138 See A Romans, Masters of Blockchain and Initial Coin Offerings (CreateSpace Independent Publishing, 2018) discussing the genuine entrepreneurial business models based on blockchain and insights from Silicon Valley entrepreneurs, venture capitalists, etc. The book takes the view that ICOs should be used only for business models that are intrinsically conducted over the blockchain, and those that tack blockchain onto a business model that can operate otherwise ought to be distinguished. 139 See ‘ERC-20 Tokens Explained’ in cointelegraph.com/explained/erc-20-tokens-explained.

22  A Legal Mapping of the Crypto Economy of application tokens that are ERC-20 compatible, upon the Ethereum blockchain.140 These applications can then offer new opportunities for economic and commercial activity, such as the sale of CryptoKitties over the internet.141 Since 2015, business innovations built on this framework have exploded. Other application platforms with their own native coins have also been developed to compete with Ethereum, such as Tezos, Tron, Polkadot and Algorand. This section looks at how smart contracts can become the building blocks of new economic activities and communities. First, we consider the ‘permissioned’ blockchain, which is a closed community of economic actors that deploy smart contracts in order to improve the efficiencies of coordination in existing commercial arrangements. The challenges posed to legal framing and consequences for economic relationships in this space are incremental in nature. Next, we consider the permissionless blockchain, which is the public and open blockchain like the Bitcoin blockchain, and how economic activity more complex than payment transfer can be carried out. We consider the legal framing relating to activities on the permissionless blockchain in on-chain and off-chain aspects. ‘On-chain’ relates to activity that is completely carried out on the blockchain itself, without any need for external performance or information from beyond the blockchain. ‘Off-chain’ refers to the need for external information or performance beyond the blockchain. Finally, we consider the permissionless blockchain as an organising whole despite its distributed nature, such as embodied in the experiment relating to the decentralised autonomous organisation (DAO) set up by Slock.it.com,142 and the challenges to legal framing.

A.  Permissioned Blockchain and Business Networks The automation functionalities offered in smart contracts are perceived as able to ease coordination inefficiencies in business and commerce, such as in global transportation, corporate supply chains, etc. In these commercial arrangements, many commercial parties are involved in order to undertake intermediate steps or tasks, carry out verification, hand over to next intermediaries until the accomplishment of an end goal. The use of a blockchain allows all relevant parties to join a single ledger that is simultaneously distributed and that updates information in order for coordination to proceed. The ledger may also be regarded as tamper-proof and fail-safe, as unilateral and unauthorised adjustments are highly challenging unless a high level of collusion occurs. Reyes143 proposes that the attributes of the blockchain are ‘consensus, validity, uniqueness, immutability, and authentication’. These relate to blockchain’s ability to 140 J Rohr and A Wright, ‘Blockchain-based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets’ (2019) 70 Hastings Law Journal 463 on the difference between protocol and application tokens. 141 www.cryptokitties.co. 142 Slock.it is a blockchain company that built blockchain infrastructure for the DAO, a pioneering investment company initiative in 2016. The DAO failed after a cyberhacker exploited a flaw in its code; see slock.it and ‘The History of the DAO and Lessons Learnt’ at blog.slock.it/the-history-of-the-dao-and-lessons-learnedd06740f8cfa5?gi=45fc4b2b1f80. 143 C Reyes, ‘Cryptolaw for Distributed Ledger Technologies: A Jurisprudential Framework’ (2018) 58 Jurimetrics 283.

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  23 bring about coordination in dispersed environments where inherent cohesion is not high. Its consensus protocols can be highly logical and commensurate with incentives. Zachariadis et al also enumerate the blockchain’s properties to be ‘distributed, transparent, irreversible, peer-to-peer and run on computational logic’.144 For example, the IBM–Maersk hyperledger project is intended to record and track every step in transportation logistics so that each step needed can be triggered efficiently.145 These blockchains are however unlikely to be open to the public and cater for existing participants in business networks in order to improve on existing efficiencies. Business networks’ deployment of blockchain would likely be in a permissioned manner in order to improve on existing efficiencies and avoid the problems of open permissionless systems. However, in this manner, permissioned blockchains do not rely exclusively on decentralised and incentive-based consensus protocols to validate activities and transactions, such as in the Bitcoin blockchain discussed above.146 Since permissioned blockchains comprise of known and trusted participants, other trust mechanisms and protocols such as verification of identity are likely to be used for verifying blockchain activity. This overcomes the inherent inefficiencies associated with open and public blockchains where verification is necessarily designed to be costly in order for incentives to be aligned with the proper maintenance of the blockchain.147 Another example of a permissioned blockchain would be global payments blockchains supplied by Ripple, where trusted payment providers, banks and central banks are permissioned participants on the blockchain, utilising the XRP smart contract token to effect efficient cross-border payments.148 Although parties in a permissioned blockchain utilise automated protocols in smart contracts to execute functions and activities, these are likely to be derived from existing commercial practices.149 Automation can nevertheless give rise to new legal problems. Automation needs to be based on clearly defined conditions and it remains uncertain how qualitative judgment or discretion-based aspects can be built into the determination that conditions have been met.150 As such, one may expect smart contract glitches such as refusal or rejection of an activity due to the narrow parameters that have been defined. These may need to be overcome by some form of automated reporting so that human oversight and override can take over.151 144 M Zachariadis, G Hileman and SV Scott, ‘Governance and Control in Distributed Ledgers: Understanding the Challenges Facing Blockchain Technology in Financial Services’ (2019) 29 Information and Organisation 105. 145 C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) ch 7. 146 See eg A Donovan, ‘(Shadow) Banking on the Blockchain: Permissioned Ledgers, Interoperability and Common Standards’ in IH-Y Chiu and IG MacNeil (eds), Research Handbook on Shadow Banking (Edward Elgar, 2018) ch 11. 147 J Abadi and M Brunnermeier, ‘Blockchain Economics’ (2018) at www.nber.org/papers/w25407. 148 Discussed in Y-Y Hsieh, J-P Vergne and S Wang, ‘The Internal and External Governance of BlockchainBased Organizations Evidence from Cryptocurrencies’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 3; Campbell-Verduyn and Goguen (2019). 149 B Carron and V Botteron, ‘How Smart can a Contract be?’ in D Kraus, T Obrist and O Hari (eds), Blockchains, Smart Contracts, Decentralised Autonomous Organisations and the Law (Edward Elgar, 2019) ch 5. 150 E Mik, ‘Smart Contracts: Terminology, Technical Limitations and Real World Complexity’ (2017) 9 Law, Innovation and Technology 269. 151 R Brownsword, ‘Smart Contracts: Coding the Transaction, Decoding the Legal Debates’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 17.

24  A Legal Mapping of the Crypto Economy Commentators opine that smart contract operations in permissioned blockchains would not pose severe challenges to expected contractual framing and predictable legal consequences, as parties are known to each other in existing business arrangements underpinned by existing formal contracts. However, automation gives rise to potential erroneous consequences that may need to be undone, and the role of vitiating factors in contract law such as mistake would become much more important if there is no complete and foreseen provision in the allocation of risk and responsibilities under contract. Commentators opine that the doctrine of mistake should apply to undo smart contract operations that are due to code error, for example.152 This matter was tested in a Singapore case relating to automated transactions, although not in a blockchain context. The reasoning may have ramifications for application to smart contracts running on blockchains. In that case, automated trading of cryptocurrency pairs was triggered due to a failure in the exchange operator’s algorithmic processes which was exploited and not corrected by one of the counterparties’ trading algorithm. The exchange operator reversed the transactions in favour of the counterparty, who had lost out in having sold bitcoins for ether at an obvious undervalue. The other party sued the exchange operator for breach of contract and trust. The court held that there was no breach of contract as the transaction was vitiated by mistake, but struggled to apply the doctrine of unilateral mistake which required the party benefiting from the mistake to know that such a mistake has occurred. In automated execution environments, such knowledge had to be fabricated in legal reasoning and was ultimately imputed to the benefiting party by virtue of the foreknowledge of the software writer (acting as his agent to benefit him) who must have known of the flaws of the program that led to its exploitative behaviour in due course.153 Although this result accords with an instinctive sense of contractual integrity and fairness, its reasoning opens up a host of further questions about whether every use of automation software, which inherently contains flaws (as all software does), must be subject to a risk of contract vitiation by mistake. This may render automation software more legally risky. Further, this implication is ironic given that automation deployment is usually to combat the inconsistencies and errors on the part of human beings! This ruling on the mistake-prone nature of automation protocols would also affect smart contracts, as they are inherently automation protocols. The case reflects the challenges of human agency-centred contract law in the face of increasingly sophisticated forms of automation, although it is acknowledged that the first instance judge was unwilling to articulate a far-reaching statement of law in this novel context. That said, there is also a possibility that the deployment of smart contracts that work in an ex ante manner could reduce incidents and opportunities for ex post breaches of contract, achieving transactional finality and efficiency.154 However, where ­performance 152 B Carron and V Botteron, ‘How Smart can a Contract be?’ in D Kraus, T Obrist and O Hari (eds), Blockchains, Smart Contracts, Decentralised Autonomous Organisations and the Law (Edward Elgar, 2019) ch 5. 153 B2C2 Ltd v Quione Ltd [2019] SGHC(I) 03, commented by K Low at ‘Unpicking a Fin(e)tech Mess: Can Old Doctrines Cope in the 21st Century?’ (November 2019), at www.law.ox.ac.uk/business-law-blog/ blog/2019/11/unpicking-finetech-mess-can-old-doctrines-cope-21st-century. 154 C Catalini, ‘Blockchain Technology and Cryptocurrencies’ (2018) 19 Georgetown Journal of International Affairs 36.

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  25 of contractual obligations is off-chain, ie recorded but not necessarily perfected on the blockchain, there is still room for contractual non-performance such as delay or breaches of terms to occur. In such a case the blockchain is unable to function as a complete record of validity or immutability and it should not be misused or become a hindrance for parties seeking to enforce their real-world contractual rights.155 Another hazard that is cautioned by commentators relates to permissioned blockchains becoming large monopsonies of commercial or business networks, therefore posing barriers to entry to challenger businesses.156 A permissioned blockchain can become a defined space for a selective community that trusts, but is also vulnerable to, one another in terms of the information commons they have achieved and the relational investment made in the blockchain infrastructure. This may result in the community becoming closed and exclusive rather than open and accessible. It is queried to what extent permissioned blockchain infrastructures would become fortresses that would shut out opportunities for challenger businesses and participants.

B.  Permissionless Blockchains Permissionless blockchains are the radical new frontier for economic activity paving the way for the rise of the crypto economy. The Ethereum blockchain, a permissionless blockchain, provides a protocol infrastructure for participants to develop applications using the smart contract templates that can be deployed on the infrastructure. These applications can then connect participants in economic, commercial as well as social activity, effected through the functions coded in smart contracts. Commercial applications can facilitate the growth of distributed and peer-to-peer marketplaces, generating production and consumption activities of a new nature and producing new economic value. These activities would not just be transforming efficiencies and coordination in the existing economy. For example, new crypto-goods or services that are sold exclusively on the Ethereum blockchain can be developed, such as the sale of CryptoKitties, virtual representations of digital cat artworks that can be bought and ‘bred’ virtually in CryptoKitty communities.157 CryptoKitty producers could be individual artists that are able to produce cute digital renditions of cat artwork, and consumers could collect these unique pieces of artwork and breed them virtually. Smart contracts can also be coded to facilitate the purchase and sale of peer-to-peer services over blockchain networks, such as peer-topeer cloud storage for files, offered by Storj158 or Filecoin.159 These blockchain-based enterprises provide an alternative to cloud-based computing services that are offered by oligopolistic technology giants such as Apple, Google and Amazon. Crypto economy developments result in new commodification and opportunities for new forms of economic production to arise. Chapter two will discuss in greater 155 K Low and E Mik, ‘Pause the Blockchain Legal Revolution’ (2020) 69 International and Comparative Law Quarterly 135. 156 C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) ch 7. 157 www.cryptokitties.co. 158 storj.io. 159 filecoin.io.

26  A Legal Mapping of the Crypto Economy detail the phenomena of the new commodification in the crypto economy. At this point, we discuss the legal characterisation and issues for these new forms of economic transactions enabled by smart contracts on a peer-to-peer blockchain. The CryptoKitty marketplace may be described as on-chain only as the sale, purchase, completion and recording of the commercial transaction all take place on the Ethereum blockchain, and the exchange of value is made in ether, which is processed by the Ethereum blockchain’s mining protocol. In this manner the Ethereum blockchain is a monetary system producing its own (unlimited supply) currency and protocol token (in one), but also a commercial marketplace, a payment system and in essence, an alternative economy. Another example, Golem, is a distributed ledger separate from the Ethereum blockchain called Golem network,160 but is constructed based on open-source code for the Ethereum blockchain. In this manner, although it provides its own protocol infrastructure, it creates a commercial and value transfer system that is compatible with and arguably derived from the Ethereum blockchain. Nodes join the network in order to contribute and purchase excess computing processing power from other nodes, facilitated by smart contract tokens subscribed to by users and deployed on the network. This marketplace is not completely on-chain but also on-chain and off-chain, as performance is required beyond the confines of the blockchain in order to achieve transaction completeness. Users have to facilitate the connection and transfer of their processing power to those who wish to ‘rent’ such power on the Golem network. Further, new businesses such as peer-to-peer energy trading161 has become popular, such as in Germany and the Netherlands. These can be centrally provided by energy intermediaries such as utilities companies, or can be built upon a distributed ledger infrastructure to bring together a marketplace for prosumers, ie individuals who may produce excess energy at home, such as by using solar panels, and individuals who wish to purchase such excess energy from others. Individuals can act as suppliers and consumers at the same time on such networks, which is why they are referred to as ‘prosumers’.162 Similarly, peer-to-peer energy trading, whether taking place on centralised platforms or distributed ledger networks, would only work if complemented by off-chain legs. Off-chain devices are needed to verify that peer-level energy suppliers do indeed have excess energy capacities for sale. Off-chain verification devices are called ‘oracles’: smart contracts designed to receive information from an external trusted source for verification purposes.163 Oracles act as conditional triggers by providing information to the blockchain network in order to allow smart contracts to be executed for transactions. Off-chain infrastructure is also needed to connect buyer and seller

160 golem.network. 161 Peer-to-peer energy trading is growing in a number of Continental countries, eg see T Morstyn et al, ‘Using Peer-To-Peer Energy-Trading Platforms to Incentivize Prosumers to Form Federated Power Plants’ (2018) 3 Nature Energy 94; J Giles, ‘Peer to Peer Trading and Microgrids – the next Big Thing?’ (Regen, 21 February 2018), www.regen.co.uk/peer-to-peer-trading-and-microgrids-the-next-big-thing/. 162 H can Soest, ‘Peer-to-peer Electricity Trading: A Review of the Legal Context’ (2018) 19 Competition and Regulation in Network Industries 180. 163 P Waelbroeck, ‘An Economic Analysis of Blockchains’ (2018) at www.CESifo‐group.org/wp; J Arcari, ‘Decoding Smart Contracts: Technology, Legitimacy, & Legislative Uniformity’ (2019) 24 Fordham Journal of Corporate and Financial Law 363.

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  27 so delivery of energy can take place. This may be by way of a microgrid between the prosumers in a geographical proximity or may be drawn upon the national grid.164

i.  Legal Framing of Pre- and Post-sale Aspects of On-chain and On- and Off-chain Transactions It may be argued that on-chain-only crypto-economies pose few legal issues. These transactions are largely payment versus delivery, as coordinated by the smart contract application tokens on the blockchain. Hence, code supplants the need for law.165 Code provides the ex ante instructions for execution of activity, which would likely be discrete and complete, entailing little ex post or relational consequences. However, it may be argued that problem-free smart contracts should not be taken for granted.166 Pre- and post-sale issues arise equally for transactions that are on-chain-only as well as those involving on-and-off-chain legs, as these issues are common to peer-to-peer marketplaces and automated executions. Further, off-chain legs raise questions with regard to trusted infomediaries. There are issues with regard to pre-sale contexts in a blockchain marketplace. For example, what standards govern pre-sale information provision or representations? The CryptoKitty transaction is underpinned by bespoke licence conditions for the purchasers of CryptoKitties in relation to their use and what can be done to their art (or otherwise).167 Is purchasers’ attention drawn to these at a pre-sale stage, and could a disappointed purchaser who intended to adapt the kitty art obtain any redress for a mistaken impression as to his/her rights? In Golem’s business model, it is unclear how contractual precepts can fit with its business model and transactional paradigms. In the Golem network, smart contracts are programmed to match the demand side’s need for a computational task with suppliers’ spare computing capacity. The task is usually sharded and distributed to a number of nodes (eg 100 nodes for a complex graphics rendering task). In this sense, purchasers and suppliers have no intentionality to contract with each other, as orders are matched by automated protocols. However, each computer on the Golem blockchain may have a different vulnerability to failure depending on exposure to viruses, age and other hardware weaknesses. Are there standards or norms for informing nodes of the nature and risks of computational ‘renting’ they purchase? Would there be pre-sale standards such as disclosures in such a peer-to-peer marketplace? Further, uncertainties abound in the post-sale context as it is unclear if consumer protections would apply in a peer-to-peer marketplace, and whether private law precepts would offer remedies for ex post problems. For example, in Golem’s network, if the purchaser node’s (P) files become infected by a virus in one of the supplier node’s (S) machine, whether known or unknown to S, what law governs responsibility, liability and redress? The answer to this could lie in what representations were made, and whether 164 ibid. AA Masaru Yarime, K Tanakae and D Sagawa, ‘Review of Blockchain-Based Distributed Energy: Implications for Institutional Development’ (2019) 107 Renewable and Sustainable Energy Reviews 200. 165 P Tasca and R Piselli, ‘The Blockchain Paradox’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 1. 166 Mik (2017). 167 See the NFT licence, at www.niftylicense.org.

28  A Legal Mapping of the Crypto Economy there was any misrepresentation on P’s or S’s part. Further, it could depend on what reasonable care is required on both P’s and S’s part under general tort law. However, P’s and S’s relationship is created by automated matching on Golem’s system, so the question also arises as to whether responsibility should be assumed for the incompleteness or imperfections of automated protocols, by their developers. It is also possible that standard terms in the smart contracts in such networks would exclude all liability on developers’ and suppliers’ sides in order to mitigate uncertainty, leaving loss to lie where it occasions. For example, the Golem disclaimer is extensive, as it disclaims any liability for any losses of any kind that may be associated with the software provided by Golem for enabling participation in the peer-to-peer network, as well as any liability that may arise out of any contract between users inter se.168 Users are urged to understand that the software is experimental in itself and is not error- or bug-free. The exclusion of liability would not necessarily work if consumer law applies, such as under the Consumer Rights Act 2015.169 However, under the Act would individual nodes be regarded as ‘traders’ supplying services in the course of business? The duties of reasonable care and skill in supplying services under consumer contracts for providing services could be applicable and exclusions of liability would not be permitted for such statutory duties.170 It is however uncertain if the ‘consumer’ characterisation would apply if suppliers are also purchasers, as the Act does not clarify the nature of prosumers. In a peer-to-peer network where smart contracts are deployed and parties are acting as prosumers, both the technological and transactional paradigms pose challenges to legal characterisation based on certain assumptions in commerce, such as a businessto-consumer relationship. It is possible that contractual self-governance would arise, such as the CryptoKitty licence, and be sufficient for answering the legal questions that would arise. However, where contractual stipulations are not complete, questions arise as to the application of existing bodies of private and regulatory law. Möslein poses the question, if mainstream legal norms in contract, property, intellectual property, etc laws contradict the provisions of self-regulatory templates, licences and conditions,171 how would such contradictions be dealt with? Would the self-regulatory templates be regarded as a ‘choice of law’?172 Second, where and how would disputes that arise be resolved? Would completely self-regulatory blockchain-based adjudication m ­ echanisms then arise?173 If so, on what basis do they have jurisdiction and decision-making authority, and upon what principles do they adjudicate?174 What procedures and safeguards apply and would they be consistent with constitutional, due process and human rights? How would enforcement be carried out? 168 golem.network/disclaimer. 169 It is noted that cloud storage services are regarded as providing a service contract to consumers under the CRA 2015; see Competition and Markets Authority, ‘Consumer Law Compliance Review: Cloud Storage’ (27 May 2016), at assets.publishing.service.gov.uk/media/57472953e5274a037500000d/cloud-storage-findingsreport.pdf. Would peer-to-peer computing storage be regarded as similar or distinguished? 170 Consumer Rights Act 2015, s 57. 171 F Möslein, ‘Conflicts of Laws and Codes: Defining the Boundaries of Digital Jurisdictions’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 15. 172 ibid. 173 M Abramowicsz, ‘Blockchain- Based Insurance’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 10. 174 eg see the automated digital court based on an ‘honest’ community and big data analytics involving jurisprudential precedents, H Matsushima and S Noda, ‘Mechanism Design with Blockchain Enforcement’ (2020), papers.ssrn.com/sol3/papers.cfm?abstract_id=3554512.

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  29 More generally, Arcari175 questions whether transactions effected by smart contracts could be questioned as reflecting the intention of the contracting parties. Contracts can never be completely coded as it is inherently impossible to be able to code ex ante all possible eventualities in contractual performance in order to foreclose unexpected situations and issues from occurring.176 Questions would arise as to which jurisdiction’s contract laws should apply where there are cross-border transactions. In the absence of express stipulation, who bears the risk of errors in code, cyberhacking and force majeures such as internet outages that result in performance not being carried out at a stipulated time?

C.  Issues Particular to Off-chain Legs Off-chain support is necessary for peer-to-peer transactions on a blockchain when elements of the transaction cannot simply be performed and completed on-chain, such as where verification of information beyond the blockchain is required, or where ex post delivery of goods or performance of services are required off-chain. Oracles are smart contracts that can be used to verify externally available information in order to reduce the chances of error or fraud on the network. If in a peer-to-peer energy marketplace, a supplier (S) of harvested solar energy wishes to sell his/her excess capacity, S’s smart energy meter may be connected to the blockchain network in order to send information of actual capacity to be verified by the oracle. Oracles may however need to be maintained by regular human intervention in order to ensure that it is gathering information from accurate and updated information sources.177 There is also a need to ensure that data privacy and security concerns are addressed in relation to the oracle’s interaction with smart devices.178 This is pertinent for development of distributed ledger business platforms that serve the Internet-of-Things market.179 Off-chain legs of transactions regarding delivery and performance may also go wrong in conventional ways in terms of delay, defective goods, etc. These are likely to be dealt with under contract and sales laws, although what remains uncertain is whether consumer protection laws apply in peer-to-peer marketplaces. Further, questions may arise as to which jurisdiction’s relevant laws apply in a cross-border context.

D.  Dispute Resolution, Crisis Management and the Governance of a Commons Other than open legal questions regarding the responsibilities of contracting parties on peer-to-peer blockchains, there is also the question of developers’ liabilities and 175 Arcari (2019). 176 UR Rodrigues, ‘Law and the Blockchain’ (2019) 104 Iowa Law Review 680; also see generally M Finck, Blockchain Governance and Regulation in Europe (CUP, 2018). 177 Arcari (2019). 178 Waelbroeck (2018). 179 B Yu, J Wright, S Nepal, L Zhu, J Liu and R Ranjan, ‘TrustChain: Establishing Trust in the IoT-based Applications Ecosystem Using Blockchain’ (2018) 5 IEEE Computing 12; A Panarello, N Tapas, G Merlino, F Longo and A Puliafito, ‘Blockchain and IoT Integration: A Systematic Survey’ (2018) 18 Sensors 2575.

30  A Legal Mapping of the Crypto Economy responsibilities. The strategy of simply disclaiming liability for projects under development should be normatively questioned. Nevertheless, a blockchain-based business may initially be developed by one or more innovator/entrepreneurs, but is usually intended to become self-performing and sustaining in due course, as decentralised activity is coordinated by incentive-based protocols coded for the blockchain.180 In this manner, legal characterisation and questions shift from merely transactional ones to questions regarding the blockchain system as a whole. What is the nature of such a system and can it generate governance, norms and institutions of at least quasi-legal character to govern itself? All permissionless blockchains are written upon a mining protocol as a governing backbone. The mining protocol that deals with verification of transactions (such as in the Bitcoin protocol) is however a narrow function focused on ledger credibility and completeness. Hence, questions arise as to who would be incentivised to supply other common goods of the system, such as an ex post dispute resolution system, unless developers programme this into the protocol ex ante. Compared to the necessary principles of commons governance posited by Oström,181 the institutions of commons governance are only an emerging development on many blockchains, including the Ethereum blockchain. Oström posits that a community should identify the common resources and their boundaries, identify the extent of appropriation of subtractable resources that can take place, establish rules for appropriation and use, establish who makes the rules, monitors and carries out enforcement, establish mechanisms for dispute resolution, and to ensure that the system of commons governance is nested within and consistent with wider institutional context. The simple idea of de-hierarchicalisation,182 distributed participation by any and everyone, and the use of automated smart contracts do not necessarily bring about a self-performing, self-enforcing and problem-free marketplace or community. The needs for maintenance of the network and for resolving problems on the Bitcoin and Ethereum blockchains have brought about new ungoverned institutions such as oracles which can become points of failure or opportunity for fraud.183 Such institutions become trusted and yet are self-governing without an accountable basis for doing so.184 Crises in blockchain communities also call for ad hoc governance moments, but there is only emerging development of multilateral norms for the marketplace.185 Further, the location and powers for norm-setting can remain unpredictable186 or concentrated.187 In contrast, the need to resolve ex post problems is the raison d’être for the rise of institutions for governance and dispute resolution in conventional economy and society, ie the 180 eg Golem, Iungo, Swarm City all say so CHK. 181 E Oström, Governing the Commons: The Evolution of Institutions for Collective Action (CUP, 1990). 182 DWE Allen, C Berg and M Novak, ‘Blockchain: An Entangled Political Economy Approach’ (2018) at papers.ssrn.com/sol3/papers.cfm?abstract_id=3158805. 183 A Egberts, ‘The Oracle Problem: An Analysis of How Blockchain Oracles Undermine the Benefits of Decentralised Ledger Systems’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3382393. 184 ibid. 185 More discussion is found in ch 2 of this volume. 186 S Geiregat, ‘Cryptocurrencies are (Smart) Contracts’ (2018) 34 Computer Law and Security Review 1144. 187 A Walch, ‘Deconstructing ‘Decentralization’: Exploring the Core Claim of Crypto Systems’ (2019) at ssrn.com/abstract=3326244; M Tarasiewicza and A Newman, ‘Cryptocurrencies as Distributed Community Experiments’ in The Handbook of Digital Currencies (Elsevier, 2015) ch 10.

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  31 i­ nstitutions of law and justice.188 It cannot definitively be said that norms that evolve for blockchain networks are parallel universes and have no relation to existing institutions of law and justice.189 Many permissionless blockchains default to majority control as an institution of governance, and this has allowed rogue behaviour to prevail on a number of cryptocurrency blockchains where a rogue majority attains 51 per cent control of the nodes and is able to effect miscreant behaviour such as hacking and theft.190 In each case the founder developers of the network would intervene and create a fork in the blockchain so that rogue behaviour is excluded from the forked ledger.191 This however creates governance by forking, ie moving clusters of users into an adjacent ‘community’, without any further governance over rogue behaviour. Such governance is minimal and primitive192 as it avoids norm development, prevention and sanctioning, and it is queried if the ecosystem would become retarded in developing social character and culture. Further, such crisis management also does not cater for individual redress needs. It may be argued that the development of sociology in distributed ledger ecosystems must be kept to a minimum so as not to create rules of inclusion/exclusion, which are against the ethos of an permissionless system. However, it is queried to what extent economic activity or agency can flourish without the support of institutions such as legal institutions for commercial certainty and to incentivise investment.193 Further, it can be seen that founder developers, core coders and powerful miners on permissionless blockchains wield significant levels of power to affect the development of the underlying infrastructure.194 It may be argued that founder developers such as Vitalik Buterin and the Ethereum Foundation are reputationally trustworthy in terms of their competence and judgment. However, it is queried if institutions of authority, responsibility and accountability would be needed as more innovators populate the field. 188 eg see D Rodrik, ‘Getting Institutions Right’ (2004) at www.ifo.de/DocDL/dicereport204-forum2.pdf; D Rodrik, A Subramanian and F Trebbi, ‘Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development’ (2004) 9 Journal of Economic Growth 131 on the importance of legal institutions such as private property rights and regulatory frameworks. 189 K Yeung, ‘Regulation by Blockchain: The Emerging Battle for Supremacy between the Code of Law and Code as Law’ (2019) 82 Modern Law Review 207. 190 ‘Blockchain’s Once-Feared 51% Attack Is Now Becoming Regular’ (8 June 2018), at www.coindesk.com/ blockchains-feared-51-attack-now-becoming-regular. 191 ‘How many Bitcoin forks are there?’, at orkdrop.io/how-many-Bitcoin-forks-are-there; ‘Ethereum Executes Blockchain Hard Fork to Return DAO Funds’ (2016), at www.coindesk.com/ethereum-executes-blockchainhard-fork-return-dao-investor-funds; and attack on the already forked Ethereum classic in January 2019, see ‘Cryptocurrency Hackers Steal $1.5m of Ethereum Classic in Rare Attack’ (8 January 2019), at www. independent.co.uk/life-style/gadgets-and-tech/news/ethereum-classic-attack-cryptocurrency-Bitcoincoinbase-etc-a8716986.html. 192 M Zachariadis, G Hileman and SV Scott, ‘Governance and Control in Distributed Ledgers: Understanding the Challenges Facing Blockchain Technology in Financial Services’ (2019) 29 Information and Organisation 105. 193 Consumers and investors generally value trusted centralised institutions in the economic landscape, and commentators find that core code developers are informally regarded as such on distributer ledger platforms, see Y-Y Hsieh, JP Vergne, and S Wang, ‘The Internal and External Governance of Blockchain-Based Organizations Evidence from Cryptocurrencies’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 3. 194 A Walch, ‘In Cod(ers) We Trust’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 3, suggesting that core code developers should be subject to fiduciary duties, but see refute in R Haque, ‘Blockchain Development and Fiduciary Duty’ (2019) 2 Stanford Journal of Blockchain Law & Policy 1.

32  A Legal Mapping of the Crypto Economy Miners in particular are a powerful group in relation to the creation and distribution of wealth on the permissionless blockchains. Miners are a necessary institution for verifying and recording value transfers and they perform the underlying ‘clearing and settlement’ infrastructure for transactions on the Ethereum blockchain. As the volume of business applications grow on the Ethereum blockchain, miners can become an incredibly wealthy and powerful group, having significant market effects. Commentators have proposed more democratic195 as well as less costly forms of consensus protocols196 for mining so that wealth creation and power can be more distributed. In a self-governing state with minimal ex ante institutions, political realities would be created and it would be imperative to consider ex post governance and institutions for blockchain networks. What responsibilities and accountability should entail from nodes performing ‘institutional’ roles such as mining?197 Further, commentators have looked at the profiles of code developers and key miners, and argue that they are not merely atomistic entities unrelated to each other, but are socially networked and connected with each other,198 in order to coordinate crisis management action when needed.199 Such relational underpinnings of power reinforce the case for the need for institutions of governance on permissionless blockchains. Truly decentralised business models require coordination and efficiency at scale, which is not an easy balance to strike, as coordination is not always smooth and disputefree. Abadi and Brunnermeier200 discuss the necessary costliness and inefficiencies of payment verification on cryptocurrency blockchains such as Bitcoin because trust is not centralised but distributed. In this manner, can institutions that are needed for governance on blockchains be essentially distributed, without entailing high cost? It is queried how far the complex needs for institutions that create certainty, predictability and protection can be distributed in nature, to meet the needs of effectiveness and technological feasibility. Further, can market-based forces on permissionless blockchains that are marketplaces give rise to appropriate governance mechanisms that sustain the 195 Such as systems that continuously rotate miners so that mining power does not become concentrated in a few hands, see P Li, J Peng, L Yang, Q Zheng, and G Pan, ‘Crux – A New Fast, Flexible and Decentralized Consensus Algorithm with High Fault Tolerance Rate’ in M Qiu (ed), Smart Blockchains (Springer, 2018) 66–76; H Guo, H Zheng, K Xu, X Kong, J Liu, F Liu and K Gai, ‘An Improved Consensus Mechanism for Blockchain’ in M Qiu (ed), Smart Blockchains (Springer, 2018) at 129–38. 196 D Karakostas, A Kiayias, C Nasikas and D Zindros, ‘Cryptocurrency Egalitarianism: A Quantitative Approach’ (2019), at arxiv.org/abs/1907.02434 supporting the Proof of Stake approach for miners on the Ethereum blockchain. This entails miners staking their own ether wealth in proposing to verify transactions and is arguably less costly in terms of energy consumption. The commentators also argue that this approach is egalitarian as wealthy or less wealthy miners only earn in proportion to their wealth. However, see other novel ideas such as proof of burn, where miners offer to burn cryptocurrency in order for the burnt coins to be locked up in a common fund for the common good of the ledger; see F Saleh, ‘Volatility and Welfare in a Crypto Economy’ (2019) at papers.ssrn.com/sol3/papers.cfm?abstract_id=3235467; J Potts, E Rennie and J Goldenfein, ‘Blockchains and the Crypto City’ (2017) 59 Information Technology 285. 197 See P Hacker, ‘Corporate Governance for Complex Cryptocurrencies?A Framework for Stability and Decision Making in Blockchain-Based Organizations’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 7. 198 D Bousfield, ‘Crypto-coin Hierarchies: Social Contestation in Blockchain Networks’ (2019) 19 Global Networks 291. 199 F Musiani, A Mallard and C Méadel, ‘Governing What Wasn’t Meant to Be Governed: A ControversyBased Approach to the Study of Bitcoin Governance’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 7. 200 (2018).

Smart Contracts, the Ethereum Blockchain and the Rise of the Crypto Economy  33 marketplace?201 How would market failures be addressed? We turn now to the crypto community’s quasi-organisational innovation in the form of the DAO to see if the needs for governance on permissionless blockchains can be met.

E.  The Decentralised Autonomous Organisation A number of commentators view the permissionless blockchain that facilitates economy activity as situated between a market and hierarchy.202 The analogy with markets is apt as the Ethereum blockchain hosts marketplaces, like the platform economies of eBay, Etsy or Alibaba.com. The blockchain fosters contractual relationships between participants inter se, and participants have separate contractual relationships with the market operators themselves. However, the analogy is incomplete. Participants’ relationships inter se are situated in transactions as well as a collective community. Despite extensive disclaimers by developers of blockchains and blockchain applications, it remains a normative question whether participants should have clearly characterised relationships collectively and individually with entities that develop, maintain or solve problems on the blockchain. The permissionless blockchain network may be developed by a group of founding coders, but being by its nature permissionless and distributed, the network is not owned as an asset by the development entity, like a platform is owned by its corporate entity. It is uncertain how the permissionless blockchain network should be characterised in terms of legal entity, and whether it has any legal relationship with participants. For example, the network may introduce disclaimers as conditions for participation, apparently negating any relationship between the network and individual participants. However, participants can be users and co-creators on the permissionless blockchain network, contributing to ledger maintenance and code development.203 There exists a commons,204 and participants’ relationships with each other over the commons may not be regarded simply as atomistic market-based and contractual relations, but may have certain relational and interdependent aspects to them. In this regard it is queried as to whether there is a need to fashion a legal recognition and new categorisation of the permissionless blockchain network, and the consequent issues in relation to governance.205

201 M Fenwick and EPM Vermeulen, ‘Decentralization is Coming! The Future of Blockchain’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3450467. 202 P Goorha, ‘Blockchains as Implementable Mechanisms: Crypto-Ricardian Rent and a Crypto-Coase Theorem’ (2018) 1 The Journal of the British Blockchain Association 1; S Takagi, ‘Organizational Impact of Blockchain through Decentralized Autonomous Organizations’ (2017) 12 International Journal of Economic Policy Studies 22. 203 P De Filippi, ‘Translating Commons-Based Peer Production Values into Metrics: Toward CommonsBased Cryptocurrencies’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 23; A Killeen, ‘The Confluence of Bitcoin and the Global Sharing Economy’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 24. 204 Davidson et al (2018); D Appukuttan Nair, ‘The Bitcoin Innovation, Crypto Currencies and the Leviathan’ (2019) 9 Innovation and Development 85–103; Zachariadis et al (2019). 205 Above.

34  A Legal Mapping of the Crypto Economy Blockchain company slock.it has indeed carried out an experiment in order to build a completely decentralised organisation (DAO), which may serve as a template for permissionless blockchains becoming unique distributed communities yet bound by certain collective purposes. The first DAO welcomes anyone to join in order to co-fund and generate decision-making.206 The DAO was a pioneer template207 built on the Ethereum blockchain for smart contract applications, which had the following functions: (a) to enable participants to send funds in ether to an address on the blockchain, and for the address mentioned to receive the funds in a pooled form; (b) to enable participants to vote on where the pooled funds should be deployed, ie to indicate by vote the participant’s preference for investment; (c) to enable the recording and tallying of investment votes to meet the majority number trigger; and (d) to enable pooled funds to be sent to one or more investment opportunity destinations the majority of votes support. The pioneer template was a simple governance model, as acknowledged by slock.it, the developers, to kickstart the conceptual development of decentralised governance of a commons, ie the pooled funds. The developers envisaged that the open-source code for the DAO could become a template for the development of future DAOs, perhaps with more complex governance functions.208 Despite the failure of the first DAO, commentators are of the view that this is a futuristic vision of a distributed organisation that is de-hierarchical, removing itself of the need for centralised management, administrators and the agency problem between financiers and management,209 allowing direct governance by democratic participation by all funders, powered by carefully curated smart contracts. The DAO’s story ended in flames as an attacker exploited a flaw in the open-source code and managed to drain the pool of funds of about US $50million worth of ether, parking them in a child DAO. However, slock.it and key miners on the Ethereum blockchain decided to remedy the damage by implementing a hard fork so that an application (smart contract) was written in order to return ether that had been contributed to the DAO address, and the Ethereum blockchain therefore maintained a ledger clean of the theft.210 Although the implementation of the hard fork was pragmatic in order to resolve the harms caused to the DAO’s funders, it raised the question of not just the DAO’s governance protocols but the meta-level governance institutions that have been introduced ad hoc in order to resolve problems. The lack of articulated or clear norms of 206 Q DuPont, ‘Experiments in Algorithmic Governance: A History and Ethnography of “The DAO,” A Failed Decentralized Autonomous Organization’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 8. 207 See Slock.it, ‘The History of the DAO and Lessons Learnt’, at blog.slock.it/the-history-of-the-dao-andlessons-learned-d06740f8cfa5 where the DAO is described as an open-source project that is intended to inspire others to develop DAOs. 208 ibid. 209 O Oren, ‘ICO’s, DAO’S, and the SEC: A Partnership Solution’ (2018) 118 Columbia Business Law Review 617. 210 Described in slock.it, ‘The History of the DAO and Lessons Learnt’, at blog.slock.it/the-history-ofthe-dao-and-lessons-learned-d06740f8cfa5.

Tokenisation and Financing  35 governance gives rise to ad hoc decision-making and problem-solving which ironically contradicts the ethos of decentralisation and de-hierarchicalisation that blockchain developers wish to maintain. In view of the potential harm to investors that DAOs could pose, the US Securities Exchange Commission (SEC) has also regarded the DAO as an unregulated securities offering211 that did not enjoy any of the established exemptions including the less onerous crowdfunding regime212 which the DAO purported to beat in terms of access and efficiency for start-ups and investors.213 More exploration on fundraising by blockchainbased businesses will be made in section IV below, but it should be pointed out here that the SEC’s characterisation, though focused on unregulated public offers, nevertheless established an implicit assumption that the DAO is to be treated as a corporate entity. This is arguably anathema to the DAO developers who envisaged the DAO to be unshackled from corporate hierarchical structures. Indeed, a number of commentators are of the view that the SEC was wrong in terms of its organisational categorisation of the DAO, implying flaws in the SEC’s finding that an unregulated securities offering had been made.214 It is arguably unsatisfactory for the lacuna in legal entity/ organisational categorisation of the DAO to be addressed by forcibly fitting into the ‘corporation’ cubbyhole. Permissionless blockchain networks test the limitations and boundaries of existing private and regulatory law categories. In spite of the increased areas of legal uncertainty, commercial and business development have continued in the crypto economy, towards financing and fundraising from the public, in a self-regulatory manner. Section IV now turns to these and how regulatory intervention into financial regulation may provide the determinative legal word on blockchain-based businesses. However, such response, if any, is likely to be incomplete and distortive, and the book argues that a more holistic approach to law and regulation is needed, as mapped out in chapter two.

IV.  Tokenisation and Financing Legal uncertainties have not prevented innovators from developing business or commercial applications, especially on the Ethereum blockchain, and growing the crypto economy. Blockchain-based applications are written on a protocol blockchain, such as the Ethereum blockchain, for example, to facilitate activities such as the buying, selling and gaming with CryptoKitties. These applications, or ‘dApps’, are run on digital tokens containing smart contracts designed for the dApp’s purposes. The digital tokens 211 SEC, ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO’ (25 July 2017), at www.sec.gov/litigation/investreport/34-81207.pdf. 212 Regulation A + under the Securities Act 1933 which enacted the crowdfunding platform exemptions under the JOBS Act 2012. 213 Discussed in slock.it, ‘The History of the DAO and Lessons Learnt’, at blog.slock.it/the-history-of-thedao-and-lessons-learned-d06740f8cfa5 as being a more efficient and better way of fund-raising than leading crowdfunding platform Kickstarter. 214 Discussed in greater detail in relation to alternative perspectives proposed in ch 4 of this book. See Oren (2018); L Metjahic, ‘Deconstructing the DAO: The Need for Legal Recognition and the Application of Securities Laws to Decentralized Organizations’ (2018) 39 Cardozo Law Review 1533.

36  A Legal Mapping of the Crypto Economy that users deploy in dApps are in essence a representation of the (a) holder’s entitlement, (b) value, (c) information/data, (d) contractual task performance and (e) the currency of the system all in one.215 Tokenisation aims to create a form of hyper-efficiency216 so that the token itself manifests the right and capacity to transact, as well as the capacity to send and receive payment, while also being the standardised currency of the system. Tokenisation introduces an easy, user-friendly means of access to and use of dApps. This technological breakthrough can facilitate two new trajectories of business innovation. One is that tokenised marketplaces can become new platform economies for new virtual goods and services, such as CryptoKitties or virtual real estate. The second is that tokenisation facilitates the creation of new commodification in real economy assets and allows them to be easily liquefied and transacted.217 This development would be a step from the platform economies such as Uber, AirBnB, etc that have arisen in the sharing economy.218 Chapter two discusses in greater detail the changes to production and productivity that the crypto economy brings. At this juncture we turn to a key development in the crypto economy: the rise of fundraising for development businesses by sales of rights to future tokens. In 2017, significant economic activity in the crypto economy exploded in the form of fundraising for blockchain-based development projects. These can be projects to develop dApps on the Ethereum blockchain, or new blockchain infrastructure altogether. The fundraising exercises are known as ‘initial coin offerings’ (ICOs). In order to fund these projects, developers typically offer future rights in tokens in return for cryptocurrency from supporters of the project. Tokens are envisaged to be a bundled representation of rights in the project when it becomes live. Tokens are also capable of being assetised as they reflect the project’s value. Several commentators have started profiling the nature of future rights in tokens offered,219 which confer a variety of consideration in return for supporters’ funds. For example, utility tokens confer on subscribers a future right to use or enjoy certain services,220 and resemble a pre-sale of yet-to-exist rights or services for the project. Such future rights come in a different variety in terms of whether they may be user-based, 215 LJ Trautman, ‘Bitcoin, Virtual Currencies, and the Struggle of Law and Regulation to Keep Peace’ (2018) 102 Marquette Law Review 447; D Zelic and N Baros, ‘Cryptocurrency: General Challenges of Legal Regulation and the Swiss Model of Regulation’ in Conference Proceedings of 33rd International Scientific Conference on Economic and Social Development – ‘Managerial Issues in Modern Business’, Warsaw, 26–27 September 2018 (Springer, 2018) at 168. S Díaz-Santiago, LM Rodríguez-Henríquez and D Chakraborty, ‘A Cryptographic Study of Tokenization Systems’ (2016) 15 International Journal of Information Security 413 argues that multifunctional tokens are efficient. 216 C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) ch 5. 217 ibid; A Welfare, Commercialising Blockchains (John Wiley & Sons, 2019); Waelbrock (2018). This is explored in greater detail in ch 2. 218 Based on the idea of marketising access to assets instead of promoting traditional consumption to attain ownership of whole assets. This idea is possible as certain large assets like a home or car may be underutilised at times, such as a spare room or spare capacity in a privately owned car. Marketising access to such assets, such as in the home-sharing or ride-sharing business models of AirBnB, Couchsurfing, Uber, Lyft, and BlaBlaCar etc, can meet a variety of urban consumption needs. See A Sundarajan, ‘The Economic Impact of Crowd-sourced Capitalism’ in The Sharing Economy (MIT Press, 2016) ch 5; M Finck and S Ranchordas, ‘Sharing and the City’(2016) 49 Vanderbilt Journal of Transnational Law 1299. 219 P Hacker and C Thomale, ‘Crypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial Law’ (2018) European Company and Financial Law Review 645; DA Zetzsche, RP Buckley, DW Arner and L Foehr, ‘The ICO Gold Rush: It’s a Scam, it’s a Bubble, it’s a Super Challenge for Regulators’ (2019) 60 Harvard International Law Journal 267. 220 Zetzsche et al (2019).

Tokenisation and Financing  37 or include other participation rights.221 ‘Fun’ tokens may confer a benefit to the community at large or to another without consideration.222 Investment tokens confer on subscribers a right to participate in a form of investment and risk being classified as falling foul of existing securities regulation.223 Currency tokens may confer on subscribers a right to use for payment in a more interoperable manner than utility tokens.224 Tokens may also be coded with a mixture of the above-mentioned characteristics, depending on how they ought ultimately to function in the blockchain-based business project.225 A token is now an integrated digital representation that can be coded to represent novel economic interests and restructure economic relations. Indeed, the Token Taxonomy Foundation is a consortium led by established large technology giants such as Google and Microsoft, alongside blockchain enterprises such as R3, to develop a taxonomy for token rights and functions in order to provide clarity for such new business phenomena.226

A.  Fundraising by Blockchain-based Developers and Tokenisation Pre-sales of tokens are often regarded as the only viable way for developers to kickstart the blockchain-based project if venture capital is not forthcoming227 or where developers do not wish to relinquish their initial development and control rights of the project.228 Further, pre-sales may be the optimal means of fundraising for a business model that is to be decentralised in nature, creating a sharing economy for participants. Pre-sale purchasers are thus the funders and economic future of the blockchain-based system, and the developer’s role is largely facilitative and in relation to providing macro oversight, such as in controlling the money supply in the blockchain-based system in order to moderate access and distribution.229 Such a model can be distinguished from corporatised or centralised business models. The first ICO was made by the founder of Mastercoin, JR Willett, who wished to create a protocol layer upon the Bitcoin blockchain so that the Bitcoin blockchain could also facilitate the creation of digital assets and other application tokens, much like how the Ethereum blockchain supports application tokens.230 5,000 mastercoin tokens were sold, raising Willett US $500,000. This 221 C Goforth, ‘Securities Treatment of Tokenized Offerings under U.S. Law’ (2018) 46 Pepperdine Law Review 405. 222 Zetzsche et al (2019). 223 eg see SEC, ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO’ (25 July 2017) at www.sec.gov/litigation/investreport/34-81207.pdf, and this is canvassed in detail in section B. 224 G Papadopoulos, ‘Blockchain and Digital Payments: An Institutionalist Analysis of Cryptocurrencies’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 7. 225 Goforth (2018). 226 At tokentaxonomy.org. 227 See Chod et al (2018); L Lin and D Nestacorva, ‘Venture Capital in the Rise of Crypto Economy: Problems and Prospects’ (2019) 16 Berkeley Business Law Journal 533. 228 WA Kaal and M Dell’Erba, ‘Initial Coin Offerings, Emerging Practices, Risk Factors and Red Flags’ in F Moslein and S Omlor (eds), Fintech Handbook (CH Beck, 2018). 229 N Essaghoolian, ‘Initial Coin Offerings: Emerging Technology’s Fundraising Innovation’ (2019) 66 UCLA Law Review 294. 230 ‘Here is the Man who Created ICOs and This is the New Token He is Backing’ (Forbes, 21 September 2017).

38  A Legal Mapping of the Crypto Economy project has now become live and is known as Omni, which is a distributed layer upon the Bitcoin blockchain.231 The early ICO market thrived in a regulatory lacuna, discussion of which will be made shortly. Different types of offerings flooded the ICO market, but all sorts of business ideas came to market, whether a distributed ledger is of central importance to it or otherwise.232 Real and fake technopreneurs have been attracted to the ICO universe because of two reasons. The market is unable to distinguish projects for which a blockchain is truly central and that has elements of novelty and prospects of success, from projects that are scams.233 The second reason is that despite the self-regulatory nature of this domain, investors may be able to manage their risks by self-help, primarily through exit. Future rights in tokens have been quickly turned into financial assets that can be resold to mitigate risks or for a profit. Purchasers at pre-sales can usually trade away their tokens, on one of many digital asset exchanges that have now arisen all over the world,234 in exchange for more popular cryptocurrencies such as Bitcoin or ether, which can then be exchanged for fiat currencies. The liquefication of tokens fundamentally allows them to become financialised, turning tokens into crypto assets, which the Bank of England now defines as ‘generally held as investments by people who expect their value to rise’.235 Crucially the liquefication of tokens appeals to a wide range of potential purchasers as they need not be committed to the project and they can be speculators. Further, as there is uncertainty in terms of protection in private or regulatory law for purchasers of such tokens, its liquidity can be seen as a risk mitigator as tokens can be resold and the risk passed on before it materialises for any particular purchaser.236 In essence, the crypto economy has been transformed into a crypto investment economy by virtue of token financialisation. In theory, supporters of a development project willing to purchase future rights in tokens should be focused on the end products or services, and should be willing to hold the tokens until the project becomes live. However, this makes tokens illiquid and may not attract sufficient numbers of supporters. Hence, developers seek to have these tokens listed on secondary marketplaces allow these tokens to be traded for other cryptocurrency. This is in spite of tokens being in a pre-development stage and are not yet utilisable. As tokens can be traded immediately upon subscription and could potentially be liquid, they may be more attractive to supporters who are interested but transient in terms of commitment, and value the flexibility to relinquish the token for something else. The tradeability of tokens has changed their nature into investment assets, and opportunities of value arbitrage appeal to speculators and gamblers. It may be argued 231 www.omnilayer.org. 232 ‘A Failed ICO is Trying to Flog Itself on Ebay’ (Financial Times, 25 March 2019), at www.google.com/url? sa=t&rct=j&q=&esrc=s&source=web&cd=4&cad=rja&uact=8&ved=2ahUKEwjVo8vOzKLhAhXTWhUIHf jKCI0QFjADegQIBBAB&url=https%3A%2F%2Fftalphaville.ft.com%2F2019%2F03%2F25%2F15534987020 00%2FA-failed-ICO-is-trying-to-flog-itself-on-eBay-%2F&usg=AOvVaw2KgfoabkWpbkTIXrD4f3gs. 233 A Alexandre, ‘New Study Says 80 Percent of ICOs Conducted in 2017 Were Scams’ (2018), at cointelegraph.com/news/new-study-says-80-percent-of-icos-conducted-in-2017-were-scams. 234 The financialisation of token primary and secondary markets will be discussed in ch 2. 235 www.bankofengland.co.uk/knowledgebank/what-are-cryptocurrencies. 236 Or known as ‘the greater fool theory’, where people believe that the prices they pay for an asset are not irrational as there would be opportunities to pass these onto ‘the greater fool’ at a profit. See ‘Greater Fool’ (Financial Times, 23 August 2019).

Tokenisation and Financing  39 that such secondary markets should not thrive as investors would be uncertain of price formation and what feeds into this process. However, it is observed on marketplaces that although price formation is turbulent and empirical researchers document significant price volatility in token prices,237 speculative trading is incentivised and in turn feeds volatility, which provides more room for value arbitrage opportunities, in turn attracting more speculators.238 Concerns have grown over the increased global significance of the borderless ICO markets239 as well as scams240 and investor losses in the event of project failure.

B.  ICOs and Challenges in Regulatory Classifications Regulators have been observing the characteristics of ICOs and the reach of their regulatory regimes, and are also concerned for investor risks and losses. The sale of future rights in tokens comes close to resembling established practices for corporate fundraising, which is regulated under many jurisdictions’ securities regulation regimes. However, it can be argued that ICOs are different as future rights in tokens are a unique beast altogether, and they are essentially pre-sales. Pre-sales are also important in order to generate interest in the project under development, which would ultimately become a distributed marketplace dependent on network effects for its survival.241 Such presales also co-opt users into a space of co-developing the experimental software for the blockchain-based business in order to fix its bugs and refine it for ultimate launch.242 Most developers insist that such pre-sales are characterised as sales of future goods or services.243 The regulated routes to raise funds publicly would be in the form of a registered securities offering,244 exempt private offerings245 or online crowdfunding.246 Although 237 T Bourveau, ET De George, A Ellahie and D Macchiocchi, ‘Initial Coin Offerings: Early Evidence on the Role of Disclosure in the Unregulated Crypto Market’ (2018) at ssrn.com/abstract=3193392. 238 See B Algieri, ‘Price Volatility, Speculation and Excessive Speculation in Commodity Markets: Sheep or Shepherd Behaviour?’ (2012) at papers.ssrn.com/sol3/papers.cfm?abstract_id=2075579. 239 The ICO market capitalisation is about USD$15bn, according to coinmarketcap.com/tokens. 240 A number of scams and Ponzi schemes subject to SEC enforcement are discussed in Bagby et al (2019). 241 WA Kaal, ‘Crypto-Economics – The Top 100 Token Models Compared’ (2018), at ssrn.com/abstract=3249860. 242 Indeed, S Adhami et al, ‘Why do Businesses Go Crypto? An Empirical Analysis of Initial Coin Offerings’ (2018) 100 Journal of Economics and Business 64 documents these types of ICOs are most likely to succeed. 243 See the SAFT or Simple Agreement for Future Tokens, which has been developed as a template for ICO offerings clarifying that sales are of tokens for future use. Also see J Chod and E Lyandres, ‘A Theory of ICOs: Diversification, Agency, and Information Asymmetry’ (2018), at ssrn.com/abstract=3159528. 244 That needs to comply with securities regulation, such as under the Prospectus Regulation 2017 in the EU, or the US Securities Act 1933 regime that requires filing of a prospectus with the SEC. 245 This is provided for in US securities regulation such as under Regulation D or S, or issuers may benefit from lighter compliance regimes for small offerings such as under Regulation A or A-plus. In the EU, the Prospectus Regulation 2017 provides exemptions for small offers such as under 8 million euros in 12 months, or to 150 natural persons only, or where offerings are targeted at sophisticated or high net worth investors, or by virtue of being denominated in units of at least 100,000 euros each. 246 Regulation A plus in the US, and in the EU, this is not yet harmonised in regulation. The UK has introduced its own online crowdfunding regulation for companies wishing to offer unlisted securities in relation to a skeletal disclosure framework and obligations for the platform provider. Further investors are protected by investment limits, see FCA, ‘Loan-based and Invest-based Crowdfunding Platforms’ (2018), at www.fca.org. uk/publication/consultation/cp18-20.pdf.

40  A Legal Mapping of the Crypto Economy ICOs are different as pre-sales and do not, unlike equity securities, confer rights in corporate governance, it has been argued that the need for regulatory arbitrage may be the key reason for this form of fundraising. This means that blockchain project developers structure the fundraising as pre-sales of goods or services in order to avoid being classified as captured within the established regulatory regimes for fundraising.247 It is far from clear that ICOs would fall squarely within securities regulation in the US or the regulation of collective investment schemes in the UK. In relation to security, the Howey test248 was formulated in the US by courts in order to capture any form of solicitation for participation in opportunities based on an expectation of future profit. Investment opportunities relating to art, beavers, tulips, etc have been articulated to be offers of securities. The ‘securities’ concerned in those schemes are contractual rights, ie investment contracts made in relation to the subject of investment. Future rights in tokens embody both the investment contract and the eventual functionalities in the blockchain-based business, so should they be captured within the definition of ‘security’?249 The ‘investment contract’ category of securities defined in the Howey test and explicated in the SEC guidance seeks to capture tokens with trading and appreciative characteristics even if these exist alongside functional or potentially functional characteristics.250 The more dominantly functional tokens are to be, in comparison to their tradeability or potential to provide gain, the more likely they are not securities. A number of indicators are suggested by the SEC in order to determine if ICOs are closer to the end of the ‘financialised’ spectrum or the ‘functional’ end, such as whether centralised efforts exist to develop the project and arrange for tokens to be traded, as opposed to ministerial functions for the blockchain-based business. It would also be relevant whether the pre-sale is offered more broadly (presumably to attract investment interest) or more narrowly to a targeted market interested in functionality. However, the SEC’s presumption of functionality versus financialisation for characterising ICOs as securities offers can arguably be misplaced, as tokens would likely have both sets of characteristics. Financialisation need not undercut the functional characteristics that exist in an asset, as we think about residential property as being both fully functional and financialised in many developed economies. Further, it seems unduly restrictive to prevent tokens from being successful both functionally and financially. The approach presumes that genuinely functional tokens would be niche in nature and artificially delimits the prospects of blockchain-based businesses. Further, ICOs that refer to tokens’ appreciation of value would almost necessarily attract a ‘securities’ characterisation. The SEC took enforcement against Munchee, an ICO for tokens to be used in a food review application under development. The reason for enforcement is 247 U Rodrigues, ‘Semi-Public Offerings? Pushing the Boundaries of Securities Law’ (2018), at ssrn.com/ abstract=3242205. 248 HB Shadab, ‘Regulation of Blockchain Token Sales in the United States’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 13; and see ambiguity in Canada, T Witteveen, ‘Future Crypto-Concerns for Canadian Securities Regulators’ (2018) 33 Banking and Finance Law Review 265. 249 L Rinaudo Cohen, ‘Ain’t Misbehavin’: An Examination of Broadway Tickets and Blockchain Tokens’ (2019) 65 Wayne Law Review 81. 250 J Rohr and A Wright, ‘Blockchain-based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Market’ (2019) 70 Hastings Law Journal 463; also see in greater detail ch 2.

Tokenisation and Financing  41 that Munchee’s disclosure made reference to appreciation of token value by developers’ efforts and was on the financialised end of the spectrum for investment contracts.251 Henderson et al support a narrower interpretation in relation to whether appreciation in value is due to the centralised efforts of others.252 However, some commentators are of the view that reference to secondary market trading and possible appreciation of value introduces speculative and investment appeal, hence a securities classification may better cater for investor protection needs.253 In light of significant regulatory uncertainty for ICOs, developers have turned to new legal mechanisms, such as the SAFT agreement254 that provides a template for ICOs to be made only to accredited investors in the US, therefore exempting from having to register with the SEC as a public securities offer.255 This was undertaken in Filecoin, an ICO for developing a peer-to-peer cloud storage system, which did not attract enforcement.256 It may be argued that the SEC’s tough stance is possible because of the dominant US market for capital investments,257 and the deep private markets in the US for accredited investors remains attractive258 even if retail investors are excluded from these projects which in principle are community-based.259 In the EU and UK, Hacker and Thomale260 argue that ICOs of utility tokens are unlikely securities offers. Utility tokens would not confer equity participation and governance rights, which is typical of equity securities, or debt repayment and coupon rights, which is typical of debt securities. Maume et al261 however take the view that the European definition of securities turns upon liquidity in secondary markets and utility tokens should be treated as securities if they have become liquid tradeable assets. This view finds agreement with a number of other commentators who are of the view that secondary market tradeability is important for the capital formation process, so even if tokens also confer future utility upon users, their capital formation role should be acknowledged and attract securities-type regulation.262 Collomb et al also take the view that utility tokens serve the purpose of fundraising for the start-up and therefore the functional equivalent of securities issued by companies.263 The characteristics of 251 www.sec.gov/litigation/admin/2017/33-10445.pdf. 252 MT Henderson and M Raskin, ‘A Regulatory Classification of Digital Assets: Towards an Operational Howey Test for Cryptocurrencies, ICOs, and Other Digital Assets’ (2019) at ssrn.com/abstract=3269295. 253 TL Hazen, ‘Tulips, Oranges, Worms, and Coins – Virtual, Digital, or Crypto Currency and the Securities Laws’ (2019) 20 North Carolina Journal of Law and Technology 493; P Maume and M Fromberger, ‘Regulation of Initial Coin Offerings: Reconciling U.S. and E.U. Securities Laws’ (2019) 19 Chicago Journal of International Law 548. 254 saftproject.com/. 255 Regulation D. 256 Freshfields Bruckhaus Deringer, ‘Is FileCoin’s $200m ICO the first SEC-compliant token sale?’ (29 August 2017), at digital.freshfields.com/post/102edvn/is-filecoins-200m-ico-the-first-sec-compliant-token-sale. 257 S Gadinis, ‘The Politics of Competition in International Financial Regulation’ (2008) 48 Harvard International Law Journal 447. 258 ‘Investors, “starved for returns,” flood private markets in search of high-growth opportunities’ (13 August 2019), at www.cnbc.com/2019/08/12/investors-starved-for-returns-flood-private-markets.html. 259 Hacker and Thomale (2018). 260 Above. 261 Maume and Fromberger (2019). 262 D Boreiko, G Ferrarini and P Giudici, ‘Blockchain Startups and Prospectus Regulation’ (2019) 20 European Business Organisations and Law Review 665. 263 A Collomb, P de Fillippi and K Sok, ‘Blockchain Technology and Financial Regulation: A Risk-Based Approach to the Regulation of ICOs’ (2019) 10 European Journal of Risk Regulation 263.

42  A Legal Mapping of the Crypto Economy tradeability and fungibility264 may push us into the direction of characterising these close to securities, but the characteristics of functionality265 and non-redeemability, unlike equity securities,266 would likely push us into the opposite direction of distinguishing tokens from securities. The controversies surrounding whether established securities regulations apply to ICOs have resulted in diversity in regulatory responses focusing on this particular financialised aspect of the crypto economy. Chapter three takes this discussion further to show international regulatory diversity and competition in the positions taken in the US, UK, EU, Switzerland, Singapore, Thailand and a couple of European jurisdictions such as Malta. We however warn against myopic regulatory focus only on this financialised phenomenon in considering regulatory policy for the crypto economy generally. Fundraising is ultimately a part of the broader novel economic phenomenon that is the crypto economy. In the UK, an additional question is whether future rights in tokens can be regarded as units in a collective investment scheme.267 ICOs do not quite fit into the regulation of collective investment schemes as holders of tokens are not participating in a pooled investment, and tokens may not be held for expectation of profit alone.268 For example, it can be argued that the DAO discussed above is a collective investment scheme. However, although the DAO had features of pooling funds, there was no centralised management other than the majority voting protocol on the blockchain. The collective investment scheme regulation in the UK targets intermediaries who attract investors into pooled schemes they manage,269 hence the need to subject points of sale and the intermediaries themselves to duties governing their roles. No such discretionary power is similarly exercised over DAO participants by the protocol or the developers. Ultimately, ICOs raise a general sense of unease even if their market footprint remains modest.270 However, Azgad-Tromer271 critically questions what the argument over regulatory arbitrage is for. The determination of regulatory classification for ICOs has become a battle over legal ontologies, but does the application of securities regulation in its existing form actually deliver on the spirit of the regulation, ie investor protection in the ICO context? Much of securities regulation is disclosure-based regulation and it is uncertain that disclosure of highly technical code-based material to investors would help them much anyway. It can even be argued that tenets in sales law272 264 P Paech, ‘Securities, Intermediation and the Blockchain: An Inevitable Choice between Liquidity and Legal Certainty’ (2016) 21 Uniform Law Review 612 on the need for fungibility for financialisation. 265 J Preston, ‘Initial Coin Offerings: Innovation, Democratization and the SEC’ (2017–18) 16 Duke Law & Technology Review 318; Oren (2019). 266 Rohr and Wright (2019). 267 Financial Services and Markets Act, s 235. 268 IH-Y Chiu, Decoupling Tokens from Trading: Reaching Beyond Investment Regulation for Regulatory Policy in Initial Coin Offerings’ (2018) International Business Law Journal/ Revue de droit affaires internationale 265. 269 Even for exotic assets such as landbanks, see Asset Land Investment Plc v The Financial Conduct Authority [2016] UKSC 17. 270 DJ Cumming, S Johan and A Pant, ‘Regulation of the Crypto-Economy: Managing Risks, Challenges, and Regulatory Uncertainty’ (2019) 12 Journal of Risk and Financial Management 126. 271 S Azgad-Tromer, ‘Crypto Securities: On the Risks of Investments in Blockchain-Based Assets and the Dilemmas of Securities Regulation’ (2018) 68 American University Law Review 69. 272 Chiu, ‘Decoupling’ (2018), also discussed in brief in H Deng, RH Huang and Q Wu, ‘The Regulation of Initial Coin Offerings in China: Problems, Prognoses and Prospects’ (2018) 19 European Business Organisations Law Review 465.

Tokenisation and Financing  43 are more applicable and can be made protective for purchasers, with some modification or clarification.273 This issue is taken up again in chapter five, which proposes a bespoke regulatory regime for ICOs. Although ICOs is a development that has ultimately triggered regulatory responses, as chapter three discusses, this book warns against regulatory approaches focused only on financialised aspects of the crypto economy. The comprehensive and integrated approach to regulation advocated in this book avoids narrowly focusing on the financialisation of the crypto economy, resulting in unintended but unfavourable consequences for genuine innovation and new productivities.274 Such a concern may also have prompted leading technological developers to establish a Token Taxonomy Framework in order to provide standards for tokens’ economic functions and how such functional transparency can be expressed.275 This framework, discussed in chapter two, can drive greater standardisation and credibility in token creation, supporting the protection of purchasers of tokens in pre-sales and in secondary markets. To what extent should law reform be carried out to accommodate the developments in the crypto economy? In this innovative landscape, regulators may adopt a ‘watch and see’ attitude,276 fearing that hasty law reform may be outdated as technology moves on. For example, the European financial regulatory agencies, the European Banking Authority277 and European Securities and Markets Authority278 refrained for some time from developing regulatory pronouncements, taking the position that existing regulatory regimes should be ‘technologically-neutral’. Maijoor’s early speech279 indicated an aversion to design regulatory reform that chases after particular new technologies. Further, policy-makers and regulators are mindful of the effects of potential law reform upon existing economic actors and markets. It may be desirable to treat ‘risk equivalent’ activities280 as equivalent for regulatory purposes, so that investor protection can be secured in ICOs just as in relation to traditional securities or equity crowdfunding.281 Commentators are however undecided as to how the distinguishing features of ICOs should shape an adjusted regulatory regime that is proportionate and does not confer unfair advantage.282 This chapter argues that there is a need to look into significant regulatory reform in order to meet the needs of the rise of the crypto economy. Crypto economy developments raise issues of framing and characterisation that are not fully met by existing legal ontologies and parameters, exposing lacunae and uncertainties. Despite such legal and institutional uncertainties, business developers have taken innovations further, from automated contracting to assetisation of tokens. Tokenisation has the potential to bring 273 Chiu, ‘Decoupling’ (2018). 274 ch 2 of this volume. 275 tokentaxonomy.org. 276 N Cortez, ‘Regulating Disruptive Innovation’ (2014) 29 Berkeley Technology Law Journal 175 argues that hesitation may result in belatedness in regulatory policy. 277 EBA, ‘Report with Advice to the European Commission on Cryptoassets’ (December 2018), at eba. europa.eu/documents/10180/2545547/EBA+Report+on+crypto+assets.pdf. 278 S Maijoor, ‘Cryptoassets: Time to Deliver’ (speech, 26 February 2019). 279 ibid. 280 Collomb et al (2019). 281 But this assumption needs to be questioned in relation to how securities regulation would actually deliver on investor protection in ICO markets; see Azgad-Tromer (2018). 282 Collomb et al (2019).

44  A Legal Mapping of the Crypto Economy about novel and transformative economic effects, and would benefit from legal framing and the establishment of institutional certainty and support. That is preferable to a state of regulatory hesitation and inertia that fails to respond to economic transformations affecting increasing numbers of economic agents. In the next section we argue that regulators and policy-makers may adopt a ‘coherentist’, ‘regulatory instrumentalist’ or ‘technocratic’ approach283 to the challenges posed by technological revolutions. We argue that a ‘regulatory instrumentalist’ approach is timely.

V.  The Need for Law Reform Brownsword284 argues that in the face of technological change that poses challenges to existing legal ontologies and framing, a ‘coherentist’ approach may be taken by legal jurists and practitioners. This approach would be contrasted with a ‘regulatory instrumentalist’ approach (often associated with regulators or policy-makers) or a ‘technocratic’ approach, which is often associated with economists and policy-makers. A coherentist approach seeks to interpret new developments within the corpus and ontologies of existing legal frameworks. It seeks to reconcile and, indeed, develop the law in a coherent and continuing narrative. This approach is understandable as law can be perceived to inhere fundamental and social values in relation to justice and norms, and such a bedrock should be timeless. In this manner, new developments should prima facie be interpreted within the existing framing and ontologies, rather than assumed to be challenging them. However, as much as there is the ideal that law should be legislated or judicially articulated to reflect timeless human and social expectations, it is inherent in the nature of human and social expectations to be shaped by existing infrastructure, physical and social conditions. Hence, existing institutions are not always as timeless as hoped for. For example, the issues raised by the decentralised autonomous organisation are not easily accommodated within existing legal framing in business entity and organisation laws. Such laws offer choices in business entity formation and their legal consequences for human beings who wish to engage in enterprise. These laws are also built upon assumptions that relate to the needs of an industrialised economy with mass consumption as the main economic phenomenon. Corporate law that assumes hierarchy in coordination is not necessarily appropriate for the blockchain economy’s distributed ethos and structures.285 There may be flatter business entity laws such as for partnerships,286 but these cater for structures that reflect relational intensity and relatively contained numbers in participation. Are these suitable for permissionless blockchains that promote distributed access to total strangers across borders? That said, the coherentist approach is not entirely irrelevant as fundamental contractual concepts are envisaged to be relevant even if transactions are made in automated 283 R Brownsword, Law, Technology and Society (Routledge, 2019) 191–96. 284 ibid. 285 C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) chs 3 and 7; Davidson et al (2018); R Beck, C Müller-Bloch and JL King, ‘Governance in the Blockchain Economy: A Framework and Research Agenda’ (2018) 19 Journal of the Association for Information Systems 1020. 286 Suggested by Metjahic (2018) and Oren (2019), but ch 4 will deal with the sub-optimalities of partnership law for distributed ledger businesses.

The Need for Law Reform  45 mode. These transactions still reflect commercial intention, and there is a need to answer timeless questions regarding how risk is distributed between parties, whose responsibility it is to perform in what manner, and what the outcome should be.287 However, issues that are tearing at the seams relate to whether consumer protection is still relevant in peer-to-peer blockchain-based economies,288 and whether new commodifications (as will be discussed in chapter two) should be capable of proprietary (including intellectual property) and sales classifications in law. The common law does not recognise information to be capable of being defined as property,289 for example, and will such an interpretation impede or be made to cohere with a growing blockchain-based marketplace in personal data?290 However, a regulatory instrumentalist approach is focused on problem-solving, and in this manner, policy innovation is not disdained upon and law can be perceived as an optimal instrument to implement such policy. A regulatory instrumentalist approach arguably also lends itself to a ‘law and policy’ approach where law is deeply enmeshed within policy. In this way, the legal questions may not revolve only around legal framing and ontologies, but may be more instrumental in nature, such as relating to the promotion of certain innovations, or the need to control harm or circumscribe certain behaviour to achieve certain economic objectives. The regulatory instrumentalist view can account for the development of EU legislation being the primary tool for implementing policies that seek to foster the Single Market project.291 The regulatory instrumentalist approach may entail approaches such as enabling regulation292 in order to facilitate and legitimise certain activities that are perceived to be beneficial. The regulatory instrumentalist approach can also give rise to regulatory obligations or designs in order to secure certain standards in conduct and compliance.293 The perspective that law reform is needed for the blockchain economy is increasingly finding resonance, such as with the California Blockchain Working Group.294 A regulatory instrumentalist approach also supports the conception of a broad regulatory space295 so that regulatory

287 B Carron and V Botteron, ‘How Smart can a Contract be?’ in D Kraus, T Obrist and O Hari (eds), Blockchains, Smart Contracts, Decentralised Autonomous Organisations and the Law (Edward Elgar, 2019) ch 5. 288 eg peers trading on a P2P blockchain-based energy trading market are not conducting transactions B2B as they are not wholesale, and neither are they B2C as they are peers. Even if sales laws apply, consumer level protections may not, eg see H van Soest, ‘Peer-to-peer Electricity Trading: A Review of the Legal Context” (2018) 19 Competition and Regulation in Network Industries 180. 289 Your Response Ltd v Datateam Business Media Ltd [2014] EWCA Civ 281. 290 D Nasonov, AA Visheratin and A Boukhanovsky, ‘Blockchain-Based Transaction Integrity in Distributed Big Data Marketplace’ in Yi Shi et al (eds), Computational Science ICCS (Springer, 2018) 569–77; M Ha, S Kwon, YJ Lee, Y Shim and J Kim, ‘Where WTS Meets WTB: A Blockchain-based Marketplace for Digital Me to Trade Users’ Private Data’ (2019) 59 Pervasive and Mobile Computing 101078. 291 Regulatory harmonisation as a tool for single market integration is canvassed in for example, E Ferran, Building and EU Securities Market (CUP, 2004). 292 J Black, ‘Critical Reflections on Regulation’ (2002) 27 Australian Journal of Legal Philosophy 1. 293 C Parker and V Lehmann Nielsen, ‘Introduction’ in C Parker and V Lehmann Nielsen (eds), Explaining Compliance: Business Responses to Regulation (Edward Elgar, 2011). 294 M Benedetto Nietz, ‘How to Regulate Blockchain’s Real-Life Applications: Lessons from the California Blockchain Working Group’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3747231 on the general principles for considering law reform. 295 C Scott, ‘Analysing Regulatory Space: Fragmented Resources and Institutional Design’ [2001] Public Law 283–305 arguing that regulatory governance takes place in a space of multiple actors with resources and not centrally focused on regulators who have the power to command.

46  A Legal Mapping of the Crypto Economy governance is not confined to command-and-control techniques296 but can be implemented in a mixture of public and private-led techniques297 and co-regulation between public and private sector actors.298 This approach is preferred by this book and will be explored in greater detail in chapter two. A technocratic approach to the challenges of law and technology would also be focused on problem-solving, but is often not centred upon legal solutions. Such an approach may lean towards finding pragmatic solutions in order to negate the debates in law and regulation altogether, such as by relying on technological innovations. For example, if code can be written to perform and achieve desired ends by blockchain participants, then ‘code is law’, and there is no need for other institutions to govern the transaction or relationship. The hope that code would be complete as ‘law’ is however far from reality299 as blockchain developers all universally acknowledge the continuous evolutionary and non-bug-free nature of code.300 It may be argued that the problem-solving technique of code forking provides for the self-regulatory needs of the blockchain system. However, forking, which in essence is to part company, only allows exit to be the governance mechanism, and is not a course of action that any user who is unschooled in code is able to undertake. On the one hand, it may be argued that forking creates market choice for users, and market choice and competition would produce sufficient governance. On the other hand, market-based governance is only sufficient if all market participants are rational and also have roughly equal bargaining power. The former assumption cannot be made as users suffer from behavioural sub-optimalities, such as herding into a network because they perceive others to be doing so.301 Further, as manifested in relation to the ICO hype, users are often unable to discern which blockchain-based projects are credible. Bargaining power is also not equally distributed on blockchain-based networks as developers and miners undertake roles that distinguish their importance and clout,302 and nodes can collude 296 C Scott, ‘Regulating Everything: From Mega- to Meta-Regulation’ (2012) 60 Administration 61. 297 This is explored in ch 2 but encompasses delegated forms of regulatory implementation such as metaregulation, see C Coglianese and E Mendelson, ‘Meta-Regulation and Self-Regulation’ in R Baldwin, M Cave, and M Lodge (eds), The Oxford Handbook of Regulation (OUP, 2012) 146–68; JSF Wright, PG Dempster, J Keen, P Allen and A Hutchings, ‘The New Governance Arrangements for NHS Foundation Trust ­Hospitals: Reframing Governors as Meta-Regulators’ (2012) 90 Public Administration 351; C Parker, The Open Corporation (CUP, 2002); S Gilad, ‘It Runs in the Family: Meta-regulation and its Siblings’ (2010) 4 Regulation and Governance 485; J Black, ‘Paradoxes and Failures:‘New Governance’ Techniques and the Financial Crisis’ (2012) 75 Modern Law Review 1037. Also joint regulation such as involving private sector stakeholders, experts and users, in ‘smart regulation’ for example, see N Gunningham and D Sinclair, ‘Designing Smart Regulation’ (OECD Global Forum on Sustainable Development, Paris, 2–3 December 2004), at www.oecd.org/ environment/environmentinemergingandtransitioneconomies/37719119.pdf; N Gunningham, P Grabosky and D Sinclair, Smart Regulation: Designing Environmental Policy (Oxford University Press 1998, 2004). 298 On co-regulation, see M Finck, Blockchain Governance and Regulation in Europe (CUP, 2018); Finck and Ranchordas (2016). 299 P de Filippi and A Wright, Blockchain and the Law: The Rule of Code (Harvard University Press, 2018). 300 Such as the disclaimer at golem.network/disclaimer/. 301 D Langevoort, ‘Taming the Animal Spirits of the Stock Markets: A Behavioral Approach to Securities Regulation’ (2002) 97 Northwestern University Law Review 135. 302 A Walch, ‘Deconstructing “Decentralization”: Exploring the Core Claim of Crypto Systems’ (2019) at ssrn.com/abstract=3326244; W Al-Saqaf and N Seidler, ‘Blockchain Technology for Social Impact: Opportunities and Challenges Ahead’ (2017) 2 Journal of Cyber Policy 338; P Hacker, ‘Corporate Governance for Complex Cryptocurrencies? A Framework for Stability and Decision Making in Blockchain- Based Organizations’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 7;

The Need for Law Reform  47 or become large blockholders of tokens in order to affect the market price for tokens. The limits of market-based governance are classic problems that blockchain-based economies are not immune to, and questions can be raised regarding how market failures are to be addressed.303 Further, all self-regulating techniques to overcome market failures can be susceptible to questions of governance and accountability, such as how pre-programmed protocols to control behaviour are derived and whether oracles can be trusted. It is unlikely that self-regulation and market-based governance would be sufficient for blockchain-based economies. This book argues that law reform or broader institutional change should be expected, but law and policy-makers should not wait for technocratic solutions and then narrowly regulate those, or merely add patches to what can be ‘coherentised’. This book supports a regulatory instrumentalist agenda for considering the crypto economy in terms of its production and productivity, and the emerging structures for its organisation and governance in order to develop a more holistic regulatory framework. Such a framework is not a parallel universe of law and regulation, but it does add richness to the overall institutional governance of economy and commerce. The rest of this book embarks on this reform agenda.

DWE Allen, C Berg, and M Novak, ‘Blockchain: An Entangled Political Economy Approach’ (2018), at papers. ssrn.com/sol3/papers.cfm?abstract_id=3158805. 303 R Baldwin and M Cave, Understanding Regulation (OUP, 2003) ch 1 on market failures; A Ogus, ‘Economics and the Design of Regulatory Law’ in SF Copp (ed), The Legal Foundations of Free Markets (Institute of Economic Affairs, 2008) 115.

2 Rise of the Productive Crypto Economy and the Need for Regulation I.  Regulatory Capitalism The development of the crypto economy over the last 10 years has introduced the technologies of peer-to-peer virtual currency, permissionless blockchains as a species of distributed ledgers, automated protocols for transacting (known as smart contracts) and tokenisation as a means of economic participation and wealth creation. Berg et al recognise that the economic structuration offered by permissionless blockchains and the mode of exchange offered by tokenisation bring about a new form of institutional technology for economic activity.1 Although sceptics2 take the view that permissionless blockchain economies are not scalable,3 increasing amounts of new productive activity are arising in this space.4 When eBay revolutionised second-hand retailing in the 1990s by empowering ordinary consumers to sell their used goods, it profoundly affected the usual intermediaries of second-hand retail goods, such as charity shops, but also provided charity and antique shops with new opportunities to access online markets. Today, charity shops, antique shops in physical locations and online co-exist with the recycling economy populated by individuals on eBay.5 Similarly, although the platform economy furthered economic revolutions with new sharing business models such as Uber and AirBnB,6 traditional taxi companies and the hotel industry continue to coexist and compete with these business models. It is likely that the crypto economy will offer new economic activities, structuration and mobilisation alongside existing economic infrastructure, competing and ­coevolving in an increasingly complex landscape. Chapter one presented the limitations of existing law and regulations in dealing with private cryptocurrencies, smart contracts deployed on peer-to-peer blockchains, and the phenomenon of tokenisation. Different policymakers have also only introduced or considered incremental reform measures, such as 1 C Berg, S Davidson and J Potts, Understanding the Blockchain Economy (Edward Elgar, 2019) chs 3–5. 2 K Low and E Mik, ‘Pause the Blockchain Legal Revolution’ (2020) 69 International and Comparative Law Quarterly 135; E Schuster, ‘Cloud Crypto Land’ (November 2019), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3476678. 3 ‘Hype Springs Eternal; The Blockchain in Finance’ (The Economist, 19 March 2016). 4 See section II. 5 ‘eBay Totally Changed Shopping 20 Years Ago. Now Age Has Changed eBay’ (Huffington Post, 17 January 2017), at www.huffingtonpost.co.uk/entry/ebay-turns-20_n_5e8a27ce4b0b7a9633c5ab6?ri18n=true. 6 A Sundarajan, The Sharing Economy (MIT Press, 2016).

Regulatory Capitalism  49 targeted at initial coin offerings.7 A regulatory instrumentalist approach to the crypto economy may address current governance deficits and bring about greater mobilisation of the crypto economy within institutional frameworks. This chapter argues that the phenomenon of regulatory capitalism should be extended to the crypto economy, so that developments within it can be properly regarded as part of the capitalist evolution in generating economic wealth creation. In this manner, regulation would be regarded as a partner to these new economic developments, and not necessarily an inhibitor, a barrier to entry, or a premature legitimator. In the history of Anglo-American capitalism, the promotion of free and liberal markets is seen to be necessary for individual freedoms and success. However, free markets have been underpinned by regulatory capitalism. ‘Regulatory capitalism’ is defined as a symbiotic division of ‘labour’ between the state and the private sector where the role of the state in economic policy is that of ‘steering’ while the private sector is responsible for ‘rowing’.8 ‘Rowing’ depicts the work of actual service provision and technological innovation that is carried out by the private sector as commercial and business activity, while ‘steering’ refers to setting policy in order to influence, govern or incentivise behaviour or output in relation to ‘rowing’. The objectives of regulation are to steer away from the problems that unbridled markets give rise to, such as market failures, and to provide collective goods. Such moderation nevertheless supports markets so that they can work optimally. Extending regulatory capitalism to the crypto economy allows us to consider regulation as relevant for both enabling and governing this economic space. This does not mean that a coherentist approach is necessarily taken to fit crypto economy developments into existing bodies of private law or public regulation. The recognition that policy is needed for steering the rowing activities of the crypto economy means that we can consider the needs of the crypto economy as the starting point for the establishment of appropriate legal institutional architecture, whether this be a legislative recognition of smart contracts or distributed ledgers,9 clarifying the legal interpretation or regulatory perimeters of existing bodies of law,10 or more comprehensive establishment of bodies of new law or regulation.11 This starting point paves the way for legal innovation, if necessary.12 This chapter discusses the new productive activities observed in the crypto economy as the capitalist phenomena upon which regulatory capitalism should be founded. There are three forms of novel commoditisation that support new productivities. The first is that novel crypto goods or services are being developed and commoditised for new virtual marketplaces. The second is that new peer-to-peer services are developed and commoditised, made possible by blockchain infrastructure, for example in peer-to-peer 7 See ch 3. 8 Terms used in D Levi-Faur, ‘The Global Diffusion of Regulatory Capitalism’ (2005) 598 The Annals of the American Academy of Political and Social Science 12; J Braithwaite, Regulatory Capitalism (Edward Elgar, 2008) ch 1. 9 Discussed in relation to a few US states’ initiatives in S Blemus, ‘Law and Blockchain: A Legal Perspective On Current Regulatory Trends Worldwide’ (2017) 4 RTDF 1. 10 Such as undertaken by UK Jurisdiction Taskforce, ‘Legal Statement On Cryptoassets And Smart Contracts’ (November 2019), at 35z8e83m1ih83drye280o9d1-wpengine.netdna-ssl.com/wp-content/ uploads/2019/11/6.6056_JO_Cryptocurrencies_Statement_FINAL_WEB_111119-1.pdf. 11 As advocated in this book. 12 M Finck, ‘Blockchains: Regulating the Unknown’ (2018) 19 German Law Journal 665.

50  Rise of the Productive Crypto Economy and the Need for Regulation energy trading.13 The third is that new blockchain-based marketplaces are created for certain real-economy assets that are commoditised in new ways, primarily by tokenisation. These developments of new commoditisation and the rise of new marketplaces raise issues in relation to law and policy which include the following: (a) the need for legal institutions that provide for legitimacy and certainty of the economic activities pursued (or policy choices to the opposite); (b) the need for standards for conduct, whether in law, regulation or soft law, to govern the economic exchanges and relations created in crypto economy marketplaces; (c) the need to consider public interest issues that may arise in the crypto economy space and appropriate policy; and (d) the need to address specific issues such as whether intellectual property subsists in digital art created for blockchain-based marketplaces, whether peer-to-peer marketplaces are subject to general commercial laws and consumer protection, etc. These four levels of law and policy needs are not merely regulative in nature, as addressing them also enables the crypto economy to develop. Contents Protocol,14 a blockchain-based business had raised US $8 million in its initial coin offering. However, it shut down in early 2020 due to the lack of network effects on its platform, making the business unviable. It cited the negative perception of blockchain-based businesses due to the unregulated nature of cryptocurrency and the existence of illicit activities that has damaged perception of this economic space. Further, Auer and Claessens finds that regulatory announcements for facilitative law made by policy-makers trigger abnormal positive returns to cryptocurrency, suggesting that crypto economy participants desire a regulatory framework.15 However several other commentators disagree, finding that although regulatory announcements, particularly negative ones on money laundering or illegal activities in the crypto economy, cause cryptocurrency prices to fall, cryptocurrency prices sustain or perform best when there is a lack of regulatory interference at all.16 However, it has been opined that internal governance deficits on blockchains can damage the value of the cryptocurrency by reducing the network effects on a blockchain.17 This may suggest the need for governance standards, and it is far from accurate to suggest that regulation is definitely anathema to the crypto economy. There is room to consider the enabling nature of regulation that can be introduced and designed to facilitate crypto economic activities within an institutional fabric. 13 Competition in the energy sector, such as in the UK has long been a challenging issue, see for example, ‘Competition in the UK’s Electricity Market’ (2016), at assets.publishing.service.gov.uk/government/uploads/ system/uploads/attachment_data/file/556310/Electricity_competition.pdf showing that entrenched players (the Big 6 companies) continue to take over 80% of market share although new and smaller players are challenging such a trend gradually. 14 ‘Korean ICO Project Shuts Down, Says “Negative Perceptions” of Crypto Made Business Impossible’ (19 February 2020), at www.coindesk.com/korean-ico-project-shuts-down-says-negative-perceptions-ofcrypto-made-business-impossible?. 15 R Auer and S Claessens, ‘Regulating Cryptocurrencies: Assessing Market Reactions’ (September 2018) BIS Quarterly Review 51. 16 S Shanaeva, S Sharma, B Ghimire and A Shuraeva, ‘Taming the Blockchain Beast? Regulatory Implications for the Cryptocurrency Market’ (2020) 51 Research in International Business and Finance 101080. 17 N Carter, ‘Cryptoasset Valuation’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 4.

Regulatory Capitalism  51 In this manner, regulation is not stereotypically portrayed as a form of control or inhibition.18 It acts as a form of steering led by the public sector, in an albeit ‘decentred’ universe of economic and stakeholder actors with different resources and capacity.19 To regulate is to facilitate as well as to govern in a manner that takes into account the complexity of the landscape and the limitations of top-down command-and-control governance.20 The crypto economy is particularly complex21 as the economic actorhood in the crypto economy is highly dispersed and of a hybrid socio-economic nature. Regulation is traditionally addressed to corporate entities in the industrialised and corporatised economy of today, so that corporate entities undertake compliance in order to meet the needs of public goods or interest. In the crypto economy, it is unclear if we can design regulation to be addressed to specific entities, as it is uncertain if blockchain-based business developers are corporate entities, or whether blockchain networks are corporate entities. The dispersal of economic actorhood may make it difficult for regulatory responsibilities to be nailed down. We discuss the economic structuration and needs of the three forms of productivities in the crypto economy and highlight the needs for enabling regulation. As Ford predicts,22 regulation to meet the needs of innovation would have to be agile, flexible and experimental, built upon contemporary approaches including regulating self-regulation or soft law,23 and regulating alongside the regulated24 and other third-party initiatives.25 The book argues for a regulatory blueprint for the crypto economy dealing with the legal and governance needs of (a), (b) and (c) set out above. This blueprint applies to all crypto economy businesses, and specific sectoral issues that pertain to the particular types of crypto economy goods or services are not pursued. We also discuss novel financialisation trends in the crypto economy that are arising out of the new productivities of this economic space. To an extent the development of commoditisation in the crypto economy is reliant upon its financialisation. Some regulators, alarmed at these financialisation developments as potential routes of financial regulatory arbitrage, have been quick to respond. These responses may not take into account the more holistic picture and needs of the crypto economy. Hence, this book advocates a regulatory agenda first for the productive activities of the crypto economic activity, upon which appropriate financial regulation can be established. 18 B Orbach, ‘What is Regulation?’ (2012) 30 Yale Journal on Regulation Online 1. 19 J Black, ‘Critical Reflections on Regulation’ (2002) 27 Australian Journal of Legal Philosophy 1; ‘Decentring Regulation: Understanding the Role of Regulation and Self-Regulation in a “Post-Regulatory” World’ (2001) 54 Current Legal Problems 103. 20 ibid. 21 M Zachariadis, G Hileman and SV Scott, ‘Governance and Control in Distributed Ledgers: Understanding the Challenges Facing Blockchain Technology in Financial Services’ (2019) 29 Information and Organisation 105; P Hacker, ‘Regulating under Uncertainty about Rationality: From Decision Theory to Machine Learning and Complexity Theory’ in S Grundmann and P Hacker (eds), Theories of Choice. The Social Science and the Law of Decision Making (OUP, 2020). 22 C Ford, Innovation and the State: Finance, Regulation, and Justice (CUP, 2017). 23 Black (2001), (2002) above. 24 Such as meta-regulation, which is to set out broad frameworks of regulatory principles and outcomes and delegating the implementation to regulated entities, see discussion in C Parker, The Open Corporation (CUP, 2002); S Gilad, ‘It Runs in the Family: Meta-regulation and its Siblings’ (2010) 4 Regulation and Governance 485. 25 Joint regulation such as involving private sector stakeholders, experts and users, in ‘smart regulation’ for example, see N Gunningham, P Grabosky and D Sinclair, Smart Regulation: Designing Environmental Policy (OUP, 1998, 2004).

52  Rise of the Productive Crypto Economy and the Need for Regulation

II.  The Productive Crypto Economy: Three New Forms of Commoditisation New productivities in the crypto economy are supported by novel commoditisation developments.26 New commoditisation brings about new opportunities for the galvanisation of economic actorhood.27 For example, new peer-to-peer services on blockchains such as Golem allow individuals to commoditise their idle computing power and sell such capacity on Golem’s distributed computing marketplace.28 New commoditisation and economic mobilisation can produce developmental effects, overcoming: (a) limitations to economic mobility in the conventional spheres due to the need for production factors such as capital stock (real estate, inventory, etc), networks, qualifications, etc; (b) limitations to wealth distribution due to mobility limitations, power entrenchments, or institutional factors, etc; and (c) limitations of existing political economies such as entrenched patterns of privileges in capitalist societies,29 shareholder primacy in corporations, etc.30 Limitations to economic mobility are an increasingly important global issue.31 Economic mobility is depressed in the poorest countries but has also stalled in developed countries.32 In particular, family wealth,33 educational advancements34 and social connections35 are crucial factors that inhibit upward mobility for individuals,36 with some countries faring worse than others in patterns of social mobility.37 Limitations in mobility also contribute to growing distributive inequalities which in turn continue 26 The trend of new commoditisation that has been made possible by digitalisation is discussed in M Cherry, ‘Cyber Commoditisation’ (2013) 72 Maryland Law Review 381. 27 M Ertman and JC Williams, ‘Freedom, Equality, and the Many Futures of Commoditisation’ in Rethinking Commoditisation: Cases and Readings in Law and Culture (New York University Press, 2005) 303; A Sayer, ‘(De)commoditisation, Consumer Culture, and Moral Economy’ (2003) 21 Environment and Planning D: Society and Space 341. 28 golem.network. 29 J Ikerd, ‘Sustainable Capitalism: A Matter of Ethics and Morality’ (2008) 3 Problems of Sustainable Development 13; L Boldeman, The Cult of the Market (ANU Press, 2007), generally. 30 See extensive discussion in A Keay, ‘Shareholder Primacy in Corporate Law: Can it Survive? Should it Survive?’ (2010) 7 European Company and Finanacial Law Review 369. At the global level, shareholder primacy is argued to be the dominant model of the corporate economy, H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2000) 89 Georgetown Law Journal 439. 31 See OECD, ‘A Broken Social Elevator: How to Improve Social Mobility’ (2018), at read.oecd-ilibrary.org/ social-issues-migration-health/broken-elevator-how-to-promote-social-mobility_9789264301085-en#page5, which documents rising income inequality and poor prospects of social mobility in many developed countries, some faring worse than others. For a global view see World Bank, ‘Fair Progress? Economic Mobility across Generations Around the World’ (2018). 32 World Bank (2018), above, also see ‘Americans overestimate social mobility in their country’ (The Economist, 14 February 2018) in which is discussed research that shows the mistaken perception of Americans of the prospects for social mobility, which are often estimated to be higher than in reality. 33 OECD, ‘A Family Affair: Intergenerational Social Mobility across OECD Countries’ (2010), at www.oecd. org/centrodemexico/medios/44582910.pdf. 34 OECD (2018); World Bank (2018), Overview and chs 2–5. 35 World Bank (2018) ch 6. 36 The reference to ‘sticky ceilings’ for those already advantaged and ‘sticky floors’ for those already disadvantaged, in OECD (2018). 37 OECD (2018).

The Productive Crypto Economy: Three New Forms of Commoditisation  53 to adversely affect mobility.38 Growing inequalities in income and wealth have been documented in Piketty’s best-selling work,39 showing how wealth begets wealth, and in particular, how those with financial assets have been able to amass more wealth more rapidly as wages stagnate in many developed countries.40 Governments and policymakers are aware of these concerns and have at their disposal fiscal and redistributive tools. Many have also introduced institutional changes such as family-friendly and antidiscrimination laws to mobilise the female workforce.41 Further, policies that involve private sector provision such as financial inclusion aim to improve mobility by access to credit for key goods such as health, education and homes.42 However, governments and policy-makers do not often implement suitable policies, perhaps due to the lack of fiscal ability, lack of support in the political economy and institutional constraints.43 The decade of austerity in the UK that followed after the global financial crisis 2007–09 is an example of how governments have retreated from fiscal provision and have worsened the mobility and distributive aspects of the economy.44 Further, enlisting the participation of the private sector in addressing mobility and distributive issues, such as by financial inclusion, is a double-edged sword. Financial inclusion often relates to access to formal services such as banks45 or to credit.46 However, final inclusion often brings about negative effects of financialisation,47 such as financial institutions’ exploitations of financial customers,48 while not being responsible for their welfare.49 Further, access to credit can be very expensive,50 and the less well-off 38 World Bank (2018), ch 6. 39 T Piketty, Capital in the 21st Century (Penguin, 2014), discussed in ‘Thomas Piketty’s “Capital”, summarised in four paragraphs’ (The Economist, 5 May 2014). 40 K-H Lin and D Tomaskovic-Devey, ‘Financialization and U.S. Income Inequality, 1970–2008’ (2013) 118 American Journal of Sociology 1284; B Kus, ‘Financialisation and Income Inequality in OECD Nations: 1995–2007’ (2012) 43 Economic and Social Review 477. 41 Discussed in World Bank (2018) ch 6. 42 T Beck, A Demirguc-Kunt and R Levine, ‘Finance, Inequality and the Poor’ (2007) 12 Journal of Economic Growth 27; M Bruhn and I Love, ‘The Economic Impact of Expanding Access to Finance in Mexico’ in R Cull, A Demirgüç-Kunt and J Morduch (eds), Banking the World: Empirical Foundations of Financial Inclusion (MIT Press 2013) ch 6; C-y Park and R Mercado Jr, ‘Financial Inclusion, Poverty and Income Inequality’ (2017) The Singapore Economic Review 185. 43 Discussed in World Bank (2018) ch 6. 44 S Mew, ‘Contentious Politics: Financial Crisis, Political-Economic Conflict, and Collective Struggles – A Commentary’ (2013) 39 Social Justice 99. 45 F Allen, A Demirguc-Kunt, L Klapper and MS Martinez Peria, ‘The Foundations of Financial Inclusion Understanding Ownership and Use of Formal Accounts’ (World Bank Policy Research Paper, 2012), also see A Chaia, A Dalal, T Goland, MJ Gonzalez, J Morduch and R Schiff, ‘Half the World is Unbanked’ in R Cull, A Demirgüç-Kunt and J Morduch (eds), Banking the World: Empirical Foundations of Financial Inclusion (MIT Press, 2013) ch 2. 46 T Beck, K Kibuuka and ER Tiongson, ‘Mortgage Finance in Central and Eastern Europe – Opportunity or Burden?’ in R Cull, A Demirgüç-Kunt and J Morduch (eds), Banking the World: Empirical Foundations of Financial Inclusion (MIT Press, 2013) ch 10; Z Chen and M Jin, ‘Financial Inclusion in China: Use of Credit’ (2017) 38 Journal of Family Economic Issues 528. 47 K McCoy, ‘Wells Fargo fined $185M for fake accounts; 5,300 were fired’ (USA Today, 8 September 2016). 48 I Erturk, J Froud, S Johal, A Leaver and K Williams, ‘Financialisation, Coupon Pool and Conjuncture’ in I Erturk, J Froud, S Johal, A Leaver and K Williams (eds), Financialization At Work: Key Tests and Commentary (Routledge, 2008). 49 G Comparato, ‘Access to Credit’ in The Financialisation of the Citizen: Social and Financial Inclusion through European Private Law (Hart Publishing, 2018) 115–41. 50 This is an area studied by the UK FCA as high-cost credit for the vulnerable consumer is highlighted as an area of concern and in need of interventionist policies such as price caps and lender regulation, see FCA,

54  Rise of the Productive Crypto Economy and the Need for Regulation may also be less savvy regarding the financial management of their indebtedness,51 which could result in further descent into financial ruin.52 Economic mobilisation and development is not merely bettered by financial inclusion and financialisation, but by an expansion in the realm of productivity and access to such a realm. New entrepreneurial activity can be galvanised in the crypto economy based on the new and disruptive commoditisation to be discussed shortly. Major disruptive movements in industry and markets are often precursors to new wealth creation, such as the making of new technological enterpreneurs. New entrepreneurial activity is already budding in the market for initial coin offerings (ICOs),53 and amidst the noise and scams, there are genuinely interesting business developments in this sphere, discussed in sections A and B below. Hornuf et al’s study find that suspected cases of scams and fraud in their sample of over 1309 ICOs constitute 13.5 per cent of ICOs sampled, and only 12.6 per cent are confirmed cases of fraud or scams.54 This means that the majority of blockchain-based economic activity is intended to be genuinely entrepreneurial in nature. These new productivities and wealth-creating opportunities can mobilise new economic actorhood.55 For example, new entrepreneurs in the crypto economy have less need of conventional capital stock to start a business, and may have been impeded by such barriers to entry, whether it is the cost of a regulatory licence, or an existing vehicle that one can ‘Uberise’. A new entrepreneur who has the idea of creating a distributed ledger business model based on distributed Wi-Fi (Iungo) or distributed world-building (Decentraland) crucially only need the infrastructure of the Ethereum blockchain, which is open-source and free, as well as coding talent. Next, new blockchain-based business models can introduce new opportunities for financial inclusion56 (besides entrepreneurialisation, discussed above) that can avoid exploitative rent-seeking by remittance, payment and credit services offered by commercialised institutions. Peer-to-peer financial services may achieve less commercialised and more hybrid objectives, and can build in social goals and considerations.57 ‘FCA Publishes Outcome of High-cost Credit Review’ (2018), at www.fca.org.uk/news/press-releases/fcapublishes-outcome-high-cost-credit-review; also a critical account of financial inclusion and financialisation in P Mader, ‘Contesting Financial Inclusion’ (2017) 49 Development and Change 461. 51 S Lewis and D Lindley, ‘Financial Inclusion, Financial Education, and Financial Regulation in the United Kingdom’ (ADBI Working Paperm 2015); A Atkinson and F-A Messy, ‘Promoting Financial Inclusion through Financial Education: OECD/INFE Evidence, Policies and Practice’ (OECD Working Papers on Finance, Insurance and Private Pensions, No 34, OECD Publishing, Paris, 2013), at dx.doi.org/10.1787/5k3xz6m88smp-en; G Comparato, ‘Financial Education’ in The Financialisation of the Citizen: Social and Financial Inclusion through European Private Law (Hart Publishing, 2018) at 169–81. 52 Comparato (2018) at 115–41, above. 53 S Adhami et al, ‘Why do Businesses Go Crypto? An Empirical Analysis of Initial Coin Offerings’ (2018) 100 Journal of Economics and Business 64, and more in next section. 54 L Hornuf, T Kück and A Schweinbacher, ‘Initial Coin Offerings, Information Disclosure, and Fraud’ (CESifo Working Paper, 2019), at ideas.repec.org/p/ces/ceswps/_7962.html. 55 Y Chen, ‘Blockchain Tokens and the Potential Democratization of Entrepreneurship and Innovation’ (2017), at ssrn.com/abstract=3059150; G Wood and A Buchanan, ‘Advancing Egalitarianism’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 19. 56 Discussed by a number of commentators as creating new access opportunities to credit, eg J Guild, ‘Fintech and the Future of Finance’ (2017) 10 Asian Journal of Public Affairs 1; I Lukonga, ‘Fintech, Inclusive Growth and Cyber Risks’ (IMF Working Paper, 2018/201); M McCaffrey and A Schiff, ‘Finclusion to Fintech’ (Helix, 2017), at ssrn.com/abstract=3034175. 57 A Heikkilä, P Kalmi and O-P Ruuskanen, ‘Accessing Credit from Banks, Microfinance Institutions, and InformalGroups: What Is the Role of Social Capital?’ in R Cull, A Demirgüç-Kunt and J Morduch (eds), Banking the World: Empirical Foundations of Financial Inclusion (MIT Press, 2013) ch 14, for example, IH-Y Chiu

The Productive Crypto Economy: Three New Forms of Commoditisation  55 One area of achievement is that blockchain-based technologies have greatly revolutionised the payment services sector, providing services that are perceived to be cost-effective, quick and reasonably reliable.58 This can facilitate remittances,59 commercial payments, and new forms of social payments, such as micropayments to someone on an online forum that helps to solve a problem.60 This revolution can play a part in improving financial well-being and ultimately mobility and distribution. However, self-regulatory systems in payment and value transmission have given rise to concerns61 (discussed in chapter one), and their scalability could depend on new thinking in terms of regulatory policy and law. Further, start-up fundraising has been galvanised in the crypto economy as ICOs take the idea of peer-to-peer and distributed finance one step further from online crowdfunding.62 Online crowdfunding for small businesses is important as small businesses face high barriers for fundraising in regulatory regimes designed for mature companies.63 However, ICOs go even further in terms of allowing blockchain-based enterprises to directly appeal to investors to raise pre-development finance.64 At a more macro level, the crypto economy can develop into an economic model different from modern capitalist economies dominated by industrialisation, mass consumption and corporatisation. The embrace of shareholder primacy by the corporate sectors of the Anglo-American economic models65 has led to distributive patterns that benefit a top tier of elite and financial asset-holders,66 but has largely marginalised ordinary human capital. Human capital increasingly compete in labour markets that price them competitively while they share very little in corporate sector wealth creation.67 and EF Greene, ‘The Marriage of Technology, Markets and Sustainable (and) Social Finance – Insights from ICO Markets for a New Regulatory Framework’ (2019) 20 European Business Organisations Law Review 697. 58 M Treacher, ‘The Role of Digital Assets in Global Payments’ (2019) 12 Journal of Payments Strategy & Systems 9. The reliability is of course relative as open blockchains are not immune to attacks and forking, but the immutable ledger properties instil trust and confidence. 59 Discussed in R Cull, A Demirgüç-Kunt and J Morduch, ‘Introduction’ in R Cull, A Demirgüç-Kunt and J Morduch (eds), Banking the World: Empirical Foundations of Financial Inclusion (MIT Press, 2013) as a factor that may promote financial inclusion and social mobility. 60 For eg the KUDO coin, see gitcoin.co/kudos; or the Reddcoin used on Reddit.com, see reddcoin.com. 61 Such as raised in Lukonga (2018); E Lee, ‘Financial Inclusion: A Challenge to the New Paradigm of Financial Technology, Regulatory Technology and Anti-Money Laundering Law’ (2017) Journal of Business Law 473. 62 C Clarke and L Tooker, ‘Social Finance Meets Financial Innovation: Contemporary Experiments in Payments, Money and Debt’ (2018) 35 Theory Culture and Society 3; P de Filippi, ‘Blockchain-based Crowdfunding: What Impact on Artistic Production and Art Consumption?’ (2018), at ssrn.com/abstract=2725373. 63 How the public offer market has become skewed and inaccessible to retail investors is discussed in FCA, ‘Final Report on Reforming the Availability of Information in the UK Equity IPO Process’ (2017), at www.fca. org.uk/publications/policy-statements/reforming-availability-information-uk-equity-ipo-process, the rise of the private offer markets is significant, see McKinsey, ‘Private Markets Come of Age’ (2019) at www.mckinsey. com/~/media/McKinsey/Industries/Private20age/Private-markets-come-of-age-McKinsey-Global-PrivateMarkets-Review-2019-vF.ashx. 64 See vision in P De Filippi, ‘Translating Commons-Based Peer Production Values into Metrics: Toward Commons-Based Cryptocurrencies’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 23. 65 See H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2000) 89 Georgetown Law Journal 439; also L Strine Jnr, ‘Our Continuing Struggle with the Idea that For-Profit Corporations Seek Profit’ (2012) 47 Wake Forest Law Review 135. 66 P Ireland, ‘Financialisation and Corporate Governance’ (2012), at papers.ssrn.com/sol3/papers. cfm?abstract_id=2068478. 67 Wage stagnation is discussed in Institute for Public Policy Research Commission on Economic Justice, Time for Change: A New Vision for the British Economy (September 2017) at www.ippr.org/files/2017-09/ cej-interim-report.pdf. Inequality between CEO pay, which can be significantly tied to company share

56  Rise of the Productive Crypto Economy and the Need for Regulation Piketty’s iconic study mapped out the winners and losers of modern capitalism, and it would appear that the top one per cent of income-earners derive more of their income from wealth and investments such as capital gains and dividends than from wages.68 It is queried whether the development of crypto economies, seemingly based on an open-source, disintermediated ethos can enfranchise those who have been left out of the conventional race.69 Tokenisation and blockchain-based communities can also bring about a sharing economy,70 and light the way to a vision of the socially embedded market.71 Nevertheless, it can be argued that participation in the crypto economy must be premised upon the existing infrastructure that is already available to society, such as internet access and penetration. Hence, the crypto economy is only parasitic in nature. As documented in empirical research, most ICOs are generated in developed economies with advanced digital technologies,72 hence, institutional and infrastructural advantages matter. In this manner it can be argued that the crypto economy does not offer new avenues to development, but rather feeds off the dividends of development. As such, the crypto economy may not be so radically enfranchising after all in global development terms. Further, it has been observed that participation in blockchain maintenance, such as mining,73 requires enormous amounts of computing power that consume significant amounts of energy.74 Hence it is questionable to what extent participation in a blockchain-based business model is really accessible, as those who are wealthier and can afford energy have an advantage, as well as those in countries with more developed energy infrastructure or more competitive energy markets. Further, although the Ethereum blockchain infrastructure is open-source and free, entrepreneurs in blockchain-based businesses likely need coding expertise. If so, the distribution of entrepreneurial opportunities and wealth creation may be skewed values, and median worker pay has widened significantly over the years, measured on average at about 312 times the median wage earned by a salaried worker at the end of 2018 in the US, and also significant and continuing to widen in the UK; see L Mischel and J Scheider, ‘CEO compensation surged in 2017’ (Economic Policy Institute, 2018), at www.epi.org/publication/ceo-compensation-surged-in-2017; ‘UK pay gap between CEOs and staff widens’ (Reuters, 4 January 2019), at uk.reuters.com/article/us-britain-pay-report/ uk-pay-gap-between-ceos-and-staff-widens-lobby-group-idUKKCN1OY0R1. 68 Piketty (2014) at 244–65. 69 G Wood and A Buchanan, ‘Advancing Egalitarianism’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 19. 70 Similar to the perspective espoused in T Dagan, ‘Commoditisation without Money’ (2010), at ssrn.com/ abstract=1537586 where commoditisation allows certain provisions of rights or services to become more measurable so that value evaluation can be established where none existed. Such a perspective relates to attributing value, rather than focusing on monetising. 71 See for example Wood and Buchanan (2015). 72 W Huang, M Meoli and S Vismara, ‘The Geography of Initial Coin Offerings’ (2019) 55 Small Business Economics 77, at doi.org/10.1007/s11187-019-00135-y. 73 Mining is achieved by a proof-of-work consensus as validation protocol for a block to be added to the blockchain in the open ledger, as discussed earlier, ‘minting’ refers to proof-of-stake consensus as validation protocol, adopted in one of the forked Ethereum blockchains in order to overcome problems with mining that allow oligopolistic mining pools to control the integrity of the ledger. The proof-of-stake requires a minter to stake existing wealth in cryptocurrency in validating a block, so that there is ‘skin in the game’. 74 KJ O’Dwyer and D Malone, ‘Bitcoin Mining and its Energy Footprint’ (25th IET Irish Signals & Systems Conference 2014, and 2014 China–Ireland International Conference on Information and Communications Technologies (ISSC 2014/CIICT 2014)) 280–85, at digital-library.theiet.org/content/conferences/10.1049/ cp.2014.0699.

The Productive Crypto Economy: Three New Forms of Commoditisation  57 towards the new technopreneurs and those that can afford educational opportunities in these areas. Going by the concentration and success of ICOs in a few hotspots such as the US, the UK and Switzerland,75 it is also queried if forms of social connections (such as in Silicon Valley) matter for entrepreneurial endorsement, fundraising and success. If so, then the aspects that matter in conventional economies, such as infrastructure and socio-economic connections that have been identified to affect economic mobility and distribution, are also at play in the crypto economy. Development in the crypto economy may not be dispersed and distributed as envisioned and may give rise to new patterns of power and wealth concentration76 similar to those in the conventional corporate economies. We now examine three categories of new productivities observed in the crypto economy. These are based on three novel types of commoditisation and we discuss new opportunities for economic actorhood, productivity and inclusion.

A.  New Virtual Goods and Services in the Productive Crypto Economy First, the crypto economy facilitates the commoditisation of new virtual goods and services such as the sale of CryptoKitties or real estate in virtual worlds such as Decentraland. In 2021, the art world is experiencing a demand for non-fungible tokens, ie a digital proof of ownership rights to original digital artwork which can later be transferred.77 The digital title to a virtual artwork is arguably a new type of virtual good, offering the holder a unique right and not just an image file of artwork. Goods that exist in a virtual world are not a new phenomenon. In the 1990s, the Tamagotchi78 was highly popular as a virtual pet that one could raise as part of a gaming and interactive environment. Further, successful games that build virtual worlds such as Sims,79 and multiplayer online games such as World of Warcraft,80 Farmville,81 Second Life82 or its successor Sansar83 have provided gaming platforms and are owned by successful companies. Virtual worlds allow players to assume identities that they can develop, co-create the environment they operate in (within certain programmed rulebooks), and buy and sell virtual goods and services within the virtual world. 75 See icobench.com/stats. 76 Discussed in ch 1 and also see A Walch, ‘Deconstructing “Decentralization’”: Exploring the Core Claim of Crypto Systems’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 3; M Tarasiewicza and A Newman, ‘Cryptocurrencies as Distributed Community Experiments’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 10. G Vidan and V Lehdonvirta, ‘Mine the Gap: Bitcoin and the Maintenance of Trustlessness’ (2019) 21 New Media and Society 42. 77 ‘What are NFTs and why are some worth millions?’ (BBC News, 13 February 2021), at www.bbc.co.uk/ news/technology-56371912. 78 ‘Tamagotchi returns in wave of 1990s nostalgia toy joy’ (BBC News, 2 June 2019), at www.bbc.co.uk/ news/business-48362289. 79 A game developed by EA which is to be played on a set-top box. This game is based on a virtual town creation and role-playing within the virtual world. 80 worldofwarcraft.com/en-gb. 81 www.zynga.com/games/farmville. 82 secondlife.com. 83 www.sansar.com.

58  Rise of the Productive Crypto Economy and the Need for Regulation Gaming platform owners create wealth by subscriptions and sales of enhanced features to players, as well as in-game goods and services.84 The productive economy in the World of Warcraft includes mining for gold, producing items of weaponry, etc that can be sold in a closed economy but mimicking real-life economies with its own currency supply system and auction markets to match supply and demand. However, as the Tamagotchi is limited to its hardware and multiplayer online games provided by platform owners are usually closed systems, the crypto economy brings about the novel development of opening up access to virtual goods, services and worlds to all. Further, virtual goods and services are not limited to a gaming experience. This allows the commoditisation of virtual goods to be interfaced with mainstream life. This phenomenon entails from the decentralised or distributed nature of the business models involved. The decentralised or distributed nature of the production, sale and post-sale deployment of virtual goods or services means that these are not centrally controlled by a platform owner’s rulebook, although certain common protocols are encoded in the system for essential functioning, such as mining protocols. For example, the CryptoKitties marketplace is built upon the Ethereum blockchain and is open to all. Sellers of CryptoKitties are digital art creators, while purchasers may use the licensed property in the kitty art in relation to self-representation, or hobby collection and engagement in the game of breeding kitties.85 Kitties can be resold, or new kitties bred by an owner of kitties can be sold. CryptoKitties interface with real socio-economic life in more intensive ways than closed worlds of virtual goods and services in a gaming paradigm. The representation of kitties can be used on purchasers’ online social media pages. CryptoKitties, as well as bred kitties, can be treated as investible commodities. The collection of CryptoKitties can also be the social glue that holds certain online communities together. CryptoKitties do not merely exist in a closed gaming world, but can seep into participants’ and users’ socio-economic lives.86 A development from the digital art of CryptoKitties is the sale of non-fungible tokens representing unique ownership rights to digital artwork, a trend that has taken off since 2021. Digital artist Beeple started creating a digital picture every day from 2007, culminating in a digital collage entitled ‘Everydays: The First 5000 Days’ in early 2021. A non-fungible token (NFT) coded upon the ERC-721 template representing

84 For example, the World of Warcraft grossed almost US $10bn in revenues in 2017; see ‘World of Warcraft Leads Industry With Nearly $10 Billion In Revenue’ (26 January 2017), at www.gamerevolution. com/features/13510-world-of-warcraft-leads-industry-with-nearly-10-billion-in-revenue#KoFTcjgGFwB TxSu8.99. 85 ‘Blockchain, virtual goods and £80,000 cartoon cats: The strange world of CryptoKitties’ (New Statesman, 6 August 2018), at www.newstatesman.com/science-tech/social-media/2018/08/blockchain-virtual-goodsand-80000-cartoon-cats-strange-world. 86 Ducuing argues that it is important for regulation to provide a taxonomy of blockchain economy standards so that users can be sure that they are participating in a different sphere governed by these standards, and not on an online community pretending to be blockchained. The essay assumes the separateness of the crypto economy and the need for standards to maintain its difference and the unique experiences it provides. However, we argue that the crypto economy is not developed for such distinct existence and is intended to be transformative in terms of its porousness and openness to existing economies. See C Ducuing, ‘How to Make Sure My Cryptokitties Are Here Forever? The Complementary Roles of Blockchain and the Law to Bring Trust’ (2019) 10 European Journal of Risk Regulation 315.

The Productive Crypto Economy: Three New Forms of Commoditisation  59 the unique ownership right to the collage was auctioned by Christies and sold for US $69million,87 proceeds including ether. Other digital artists are following the trend in offering non-fungible tokens to unique slices or collections of digital artwork.88 The market for NFTs is a mainstreaming development from the pioneering commercialisation of CryptoKitties, and can arguably cover more creative goods than art, possibly also music and other collectibles. The crypto economy also supports virtual gaming, such as the multiplayer blockchain-based virtual world game Decentraland.89 Blockchain-based gaming may however bring about a new experience for users in terms of the potential for co-creation and not just playing by certain gaming rulebooks. Decentraland was developed by two software developers who have been involved in bitcoin-based businesses and projects. It is an application built upon the Ethereum blockchain that facilitates the creation of a virtual reality world. In Decentraland, participants may purchase standardised 33×33 feet of virtual land plots upon which they could build and develop as they please. Participants are incentivised to develop attractive points of interest and establishments in order to commoditise the virtual goods or services they wish to provide within their territories and to earn the currency of the world (MANA). Decentraland is not dominated by preloaded rulebooks as to how the world should be designed or managed, and it is left to participants and users to co-create it, with the intention of ultimate retreat by the developers. Participants may be able to freely bring to bear their values and preferences in treating their roles and assets in this virtual reality world, including organisational and governance phenomena, as well as individual pursuits of profitability in terms of in-game commoditisation and reselling of assets. Decentraland may not only be an escape from reality but an extension of participants’ and users’ socio-economic lives.90 Virtual consumption is a real economic phenomenon, whatever views we hold about the value of gold in World of Warcraft, or a virtual cup of coffee sold in a virtual themed café on Decentraland. Indeed, Lin critically queries if virtual consumption can be a form of sustainable consumption since no physical consumption and waste management are implicated.91 Virtual consumption may substitute for real consumption to an extent, in order to satisfy human desires in relation to ownership, deployment and enjoyment. However, sustainability aspirations may be undermined if physical consumption turns to hard and software goods, as well as energy, to satisfy the virtual consumption experience.92 Although the merits of virtual consumption are arguable, so are many lifestyles. Novel virtual commoditisation in the crypto economy is ultimately an extensive co-creative experience for participants and users that transcends more centrally controlled virtual universes created by corporate owners of multiplayer gaming platforms. Participants have the freedom and incentives to create and monetise commodities, assets, services 87 Beeple’s Opus, introduced at www.christies.com/features/Monumental-collage-by-Beeple-is-first-purelydigital-artwork-NFT-to-come-to-auction-11510-7.aspx. See ‘NFTs Boom as Collectors Shell Out to “Own” Digital Art’ (27 February 2021), at www.wired.com/story/nfts-boom-collectors-shell-out-crypto. 88 For example, ‘Grimes sells digital art collection for $6m’ (The Guardian, 2 March 2021), at www.theguardian.com/music/2021/mar/02/grimes-sells-digital-art-collection-non-fungible-tokens. 89 decentraland.org. 90 ‘What Is Decentraland?’ (28 October 2018), at coincentral.com/decentraland-mana-beginners-guide/. 91 A Lin, ‘Virtual Consumption: A Second Life for Earth?’ (2008) Brigham Young University Law Review 47. 92 ibid.

60  Rise of the Productive Crypto Economy and the Need for Regulation and even institutions, in order to build up from scratch communities and worlds. However, world-building and life-building on the virtual space is in a distributed and decentralised paradigm where we leave to individual incentives and endeavours to coordinate with each other. It is arguable that the virtual consumption worlds of digital art and Decentraland do not merely cater for individualistic consumption. Communities are ultimately built around the virtual goods. It is perhaps more obvious in virtual worlds such as Decentraland, where distributed spaces are ultimately maintained by the collective endeavours of participants. Even in the world of digital art consumption, consumers are usually part of communities for resale, such as on peer-to-peer marketplaces like Nifty Gateway.93 Further, it is queried if NFT collectors could also become virtual curators of online exhibitions and museums, further transforming the nature of art dissemination and appreciation. By default, incentive-based actions for participating in virtual consumption markets in the crypto economy is the only mode of action. Marketisation is however a limited means for addressing a more collective phenomenon such as a community. If the community grows in scale, commoditisation and more marketisation, economic opportunities, productivity and actorhood can arise. With scale, there also needs to be reckoning with a collective phenomenon, whether it relates to collective identity, values, ethos, collective goods such as commons, or pragmatic matters such as standards for reciprocity, institutions for certainty, institutions of decision-making, power and governance. More advanced matters such as the relationship and interfaces with conventional economy and society also need to be determined. It may be argued that crypto economies have a simple self-regulatory system of exit and forking. As chapter one discussed, permissionless blockchains such as bitcoin and Ethereum have adopted forking to cope with anti-social incidents. In a virtual and infinite space, forking can be carried out many times over. Self-governance by forking preserves the community of the likeminded together and excludes those who have chosen to disagree. In a virtual world such as Decentraland, which is open source and open to developers, participants and users, it may be argued that forking can also be used to exclude anti-social or unconstructive behaviour, therefore resolving problems without the need for building up of more complex institutions. However, how would forking damage the collectiveness of the world already built up? Is it really a viable means of dispute resolution or crisis management for all circumstances? Individual exit is also another means of self-regulation. The crypto economy is at the same time financialised, as tokens for participation are capable of secondary trading on a range of private digital asset exchanges. Hence, exit is available whether as a means of maximising one’s economic position or as a means of withdrawal from a collective phenomenon that one no longer agrees with. However, it is not clear whether voting with one’s feet, which is the ultimate effect of either forking or exit, is necessarily sufficient for self-regulation. Forking can affect values of assets, as the experience with forking in cryptocurrency has shown.94 It is 93 niftygateway.com/marketplace. 94 ‘What Are Forks and How Do They Impact the Price of Cryptocurrency?’ (30 November 2018), at commodity.com/cryptocurrency/what-are-forks.

The Productive Crypto Economy: Three New Forms of Commoditisation  61 a­ rguable if a Decentraland plot owner who has invested effort and MANA in her café would be sanguine about forking if forking results in environmental and locational changes to the café that affect its asset value. Forking also raises the question of whether communities that have chosen to go with either side of the disagreement have actually positively resolved their values and collective character. Forking may be a means of coping with disagreement but not necessarily a means for fostering collective identity and coordination. Is there a place for voice instead of exit in such communities?95 Ultimately, the market society intrudes in Polanyian terms moderating the unregulated and liberalising tendencies of the market,96 and normative narratives may then to determine how market relations are ultimately embedded within the broader social fabric.97 For example, normative discourses may arise in relation to what are the relevant commons98 in the blockchain community and how such commons should be governed.99 We observe nascent development in this area, largely led by the protocol developers on the Ethereum blockchain. For example, an Enterprise version of the Ethereum blockchain is being developed, and purports to facilitate more commons governance, such as dispute resolution, by essentially providing protocol infrastructure for permissioned blockchains that can become accessible by and to the permissionless one.100 Similarly the EOS blockchain focuses on building permissioned blockchains and in making only part of its source code open in order to ensure that code development is under control.101 Such governance developments ultimately lead to choices in terms of power structures and authority. Tezos insists on an open and permissionless ethos but promotes a rudimentary governance framework that allows nodes to delegate crisis management powers so that crises can be resolved more efficiently.102 These emerging developments reflect a need for collective governance and norms. At the other end of the spectrum are protocol blockchains such as Quorum,103 which is permissioned and closed, maintained by a corporate developer, using the JPM coin issued by global bank JP Morgan as its currency token. Such blockchain systems do not depart from conventional hierarchical systems of power and control. There is a need to consider how law and regulation can usefully influence and provide for commons governance in public blockchain-based environments, and 95 AO Hirschmann, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States (Harvard University Press, 1970). 96 K Polanyi, The Great Transformation: The Political and Economic Origins of Our Time, 2nd edn (Beacon Press, 2002). See critical discussion by K Gemici, ‘Karl Polanyi and the Antinomies of Embeddedness’ (2008) 5 Socio-Economic Review 33. 97 M Granovetter, ‘Economic Action and Social Structure: The Problem of Embeddedness’ (1985) 91 American Journal of Sociology 481. 98 C Karyotis and S Alijani, ‘Soft Commodities and the Global Financial Crisis: Implications for the Economy, Resources and Institutions’ (2016) 37 Research in International Business and Finance 350; LF Alvarez León, ‘Property Regimes and the Commoditisation of Geographic Information: An Examination of Google Street View’ (2016) 3 Big Data and Society 1. 99 E Oström, Governing the Commons: The Evolution of Institutions for Collective Action (CUP, 1990). 100 See ‘5 Reasons Why Enterprise Ethereum Is So Much More Than a Distributed Ledger Technology’ (Dec 2018), at media.consensys.net/5-reasons-why-enterprise-ethereum-is-so-much-more-than-a-distributedledger-technology-c9a89db82cb5. 101 eontechnology.org. 102 The second layer of scaling as proposed by Tezos, see ‘Marigold: layer-2 scaling for Tezos’, at medium. com/tezos/marigold-layer-2-scaling-for-tezos-7445b5a3b7be. 103 consensys.net/quorum. The infrastructure is however built on open-source Ethereum code.

62  Rise of the Productive Crypto Economy and the Need for Regulation s­ olutions should not only insularly be sought within a technologically driven environment (Brownsword’s ‘technological’ solution discussed in chapter one). Insights from this inquiry can also extend to private blockchains where governance needs may arise at scale. It can be queried whether a form of organisational law and governance institutions would be relevant, a question unresolved by the DAO innovation discussed in chapter one. The recognition of the need for governance institutions on permissionless, public blockchains is necessary for further development of the crypto economy space. Social discourse should interact with economic ones in order to critically interrogate the impact of new commoditisation such as whether new commoditisation exploits others’ economic needs,104 and whether institutions of justice need to be put in place.105 Law and regulation can provide institutions for the internal governance needs of blockchain communities, as well as moderate anti-social behaviour and market failures in such communities.106

B.  New Distributed Models of Peer-to-peer Services Next, we observe that peer-to-peer service marketplaces have arisen in a novel manner powered by permissionless blockchain technology and tokenisation. For those who travel frequently and need to remain connected to the internet, access to Wi-Fi on-the-go may be patchy and relying on mobile data charges is an expensive privilege. However, being connected in this way has increasingly become an important aspect of modern life. We can readily imagine visiting a foreign city and benefiting from being able to use an online map in order to locate a particular building, without suffering from patchy free Wi-Fi coverage or paying for expensive mobile data. Iungo’s107 business plan utilises a permissionless blockchain platform to link up private users’ Wi-Fis, so that at scale, a comprehensive network of Wi-Fi access can be constructed across the globe, as contributed by private users or ‘peers’. Participants on Iungo’s platform can rent their Wi-Fi access facilities to ad hoc users on-the-go. Participation in this system is tokenised by the ING token, which is the application token that codes in access to the global Wi-Fi network and enables transfer of value. This system is built upon the Ethereum smart contract template and is not directly built upon the Ethereum blockchain. This enables an inner economy powered by token-holders’ supply and demand, 104 N Fraser, ‘Can Society Be Commodities All the Way Down? Post-Polanyian Reflections on Capitalist Crisis’ (2014) 43 Economy and Society 541 in relation to ‘domination’ narratives. 105 N Smith, ‘Commoditisation in Law: Ideologies, Intractabilities, and Hyperboles’ (2009) Continental Philosophy Review at DOI 10.1007/s11007-009-9098-9 arguing that it is not making marketable that is the issue but underlying conditions that force people to commodify that matter for policy reform. 106 J Palomera, ‘Reciprocity, Commoditisation, and Poverty in the Era of Financialization’ (2014) 55 Current Anthropology S105. Further, there may need to be policy choices regarding commoditisation in the crypto economy; see arguments against excessive commoditisation in T Dagan, ‘Commoditisation without Money’ (2010), at ssrn.com/abstract=1537586; M Sandel, What Money Can’t Buy – The Moral Limits of Markets (Penguin, 2013); IG Cohen, ‘The Price of Everything, The Value of Nothing: Reframing The Commoditisation Debate’ (2003) 117 Harvard Law Review 689; K Krawiec, ‘Markets, Morals, and Limits in the Exchange of Human Eggs’ [2015] 13 Georgetown Journal of Law and Public Policy 349. 107 iungo.network.

The Productive Crypto Economy: Three New Forms of Commoditisation  63 which is unaffected by distortions that can be caused by holders of ether.108 Iungo’s peerto-peer global wireless internet access platform is novel and useful, and has the potential to challenge jurisdictional oligopolies for internet and telecommunications facilities in national jurisdictions. At scale, Iungo’s model can potentially become a peer-to-peer global utility. Another example discussed in chapter one, Golem109 is a peer-to-peer service marketplace that brings together participants who have idle computing power and users who wish to borrow others’ computing power to engage in computing tasks that may require significant capacity. For example, individual graphic artists or even some corporations may own computing systems with high processing capacity, and these systems may enjoy idle time when not in use, for example, on weekends or certain times of day/ night. The processing capacity of such computing systems can be rented out to others who need to borrow, via a connected channel or platform that links supply and demand together. Such users may be graphic artists – small animation studios, for example – that require significant computing power to render sophisticated graphics. Such tasks can usually be performed by supercomputers that are expensive to own, or can be performed by borrowing a host of computers joined together to supply the capacity needed. Golem provides such a peer-to-peer worldwide network for the supply and demand side, and participation in this economy is again tokenised, so that the GNT token provides access and instructions for execution of tasks, by protocols encoded within the system. Automated protocols are used to match tasks with suitable nodes’ computing systems, and a task is sharded, ie divided amongst a number of nodes in order to maximise the capacity needed for the task. In this manner the task is efficiently achieved and value creation is distributed amongst a number of nodes, establishing a wealth-creating system. It may be argued that Golem’s business model is not new as computing system farms that rent out computational capacity to others already exist. These arrangements are however in small or closed circles where trusted parties link up to a common closed channel in order to facilitate the borrowing or renting of computing power. Golem’s novelty lies in the scaling-up of such arrangements to a global marketplace without necessarily a relational fabric that underpins such arrangements, by participation in the permissionless blockchain platform and by tokenisation. Next, we also observe that there is also a rise in the markets for peer-to-peer cloud storage services. Key players in this field include Storj,110 Maidsafe111 and Filecoin.112 Essentially, peer-to-peer cloud storage services allow individual users (ie peers) to provide and rent out spare hard disk capacity in order to store other users’ files. This meets users’ needs for cloud storage where they are looking for either off-site storage of their files, usually for back-up purposes, or excess storage that their local systems are unable to provide. Such markets may in time rival cloud services provided by current technological giants Apple, Google or Amazon. Peer-to-peer cloud storage services would not use the gigantic servers that technological corporate giants have, but instead

108 See

discussion of ING tokens at iungo.network/ing-tokens.

109 golem.network. 110 storj.io.

111 maidsafe.net. 112 filecoin.io.

64  Rise of the Productive Crypto Economy and the Need for Regulation rely on the construction of a vast joined-up network of individual contributors. Such a business model potentially disrupts oligopolies that can be maintained by technological corporate giants, providing choice and price competition. They also arguably provide a more secure and private means of storage for users as their data and information is not at risk of being harvested for marketing purposes. Peer-to-peer cloud storage systems enable protocols that shard files in order to distribute data across nodes and to replicate copies of the data across nodes. In this manner, nodes do not have access to entire pieces of information that may compromise privacy. The downtime or failure of any one node is unlikely to compromise the location and retrieval of files.113 Further, peers on the supply side are paid for their services, which opens up a sharing economy for economic mobilisation of individuals. However, encryption is usually the responsibility of users before they initiate storage requests. Storj is built upon the Ethereum blockchain and participation is via its token, STORJ. The token embodies access and payment functions, and the protocols of the system allows developers to maintain the system and to distribute wealth by micropayments to participants who help to maintain the network where appropriate.114 In comparison, Filecoin aims to be fully decentralised with in-built extensive protocols to maintain such decentralisation and robustness at the same time. Filecoin tokens enable participation as storage nodes or retrieval nodes. Storage nodes are incentivised to perform mining functions in order to validate that nodes are indeed storing files as they promised, for payments in filecoin. The mining protocol is based on a proof of ‘space-time’ and proof of replication that allow miners to check on the state of nodes’ storage provision, based on a staking of collateral. This is unlikely as energy-intensive as proof-of-work on the Bitcoin blockchain. Reward by mining is seen as superior to reward by users directly for storage provision, as reward by mining ensures that storage nodes are paid for providing storage, and are not hostage to the whim of users who may disappear and cease paying for storage. Retrieval nodes are paid in filecoin for retrieving files and they do not perform storage functions.115 These examples show novel ideas that can potentially scale up to global marketplaces for services that may have been thought to be most efficiently provided by corporatised institutions, such as by national telecommunications companies, centralised cloud storage providers, etc. The crypto economy also provides opportunities for new economic mobilisation116 as individual users can now commoditise their Wi-Fi access capacity, idle computing power or storage space. The crypto economy creates new value chains. Value creation can be captured by new economic actors and new channels of delivery are constructed to satisfy users.117 Such global marketplaces are a further development 113 ‘Filecoin v. Sia, Storj & MaidSafe: The Crowded Push for Decentralized Storage’ (3 August 2017), at medium. com/tokenreport/filecoin-v-sia-storj-maidsafe-the-crowded-push-for-decentralized-storage-7157eb5060c9. 114 ‘An Overview of Tokens Uses, Flows and Policies at Storj Labs’ (5 December 2018), at storj.io/blog/2018/12/ an-overview-of-tokens-uses-flows-and-policies-at-storj-labs. 115 Discussed in ‘What is Filecoin’ (2018), at www.coindesk.com2Fwhat-is-filecoin-fil&usg=AOvVaw0MffwwGNva1k8FNF_zsQQ (read in cache as of 19 November 2019). 116 D Rodima-Taylor and WW Grimes, ‘Cryptocurrencies and Digital Payment Rails in Networked Global Governance: Perspectives on Inclusion and Innovation’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 6, that has extended insight beyond the cryptocurrency system. 117 AYL Chong, ETK Lim, X Hua, S Zheng and C-W Tan, ‘Business on Chain: A Comparative Case Study of Five Blockchain-Inspired Business Models’ (2019) 20 Journal of the Association for Information Systems 1308.

The Productive Crypto Economy: Three New Forms of Commoditisation  65 from the sharing economy phenomenon that has brought about new commoditisation and economic mobilisation since the 1990s. Developments in the 1990s brought about a flat economy,118 as access to the internet has changed economic structures and allow individuals, for example, to join in the supply side of the recycling or artisan economies on eBay119 and Etsy.120 The sharing economy121 takes the flat economy one step further by novel commoditisation – allowing the commercialisation of what Sundarajan calls ‘idle assets’122 or what Benkler refers to as ‘excess capacity’123 to be made marketable via a new means of access and connection, usually on online platforms. AirBnB, UbeR, Lyft and TaskRabbit are frequently referred to as business models in the sharing economy. AirBnB allows home-owners to make commercial use of their spare room in order to earn revenues from short-term holiday or business lodgers. The online platform brings together such home-owners and accommodation seekers, overcoming the conventional limitations that home-owners would have needed to meet if they intended to engage in commercialised holiday accommodation business. In a similar way, the business models in peer-to-peer blockchain marketplaces fall within the sharing economy, as people could commercialise their Wi-Fi access rights or personal computer capabilities or storage capacity, in order to share with those who need such facilities, and generate revenues from new economic mobilisation. However, peer-to-peer economies such as eBay or Etsy and sharing economies such as AirBnB create a commons that ultimately have to be governed. For example, the commons on a marketplace like eBay would be standards of behaviour on both the supply and demand sides that make the marketplace trusted and attractive, such as suppliers’ credibility in descriptions and service standards, and purchasers’ reasonable expectations and rights. These institutional commons feed into resource commons such as growth in the supply side, providing choice in the marketplace, and growth in traffic on the demand side. AirBnB also governs institutional commons such as supplyand-demand-side standards of behaviour. Supply-side participants need to provide standardised descriptions, and adhere to service standards. Demand-side participants need to behave in a credible and civic behaviour in relation to commitment to the booking and use of the holiday property. The entity most incentivised to protect the commons on a sharing economy platform would be the platform provider, usually a corporatised entity that owns the platform as an asset. Platform providers generate revenues and profits from platform traffic and are therefore interested in maintaining the network effects for the platform. In this manner, platform providers have generally introduced forms of centralised governance, rules for supply and demand sides, and informal penalty and enforcement systems in order to maintain the commons, such as AirBnB’s platform governance.124 The centralised 118 TL Friedman, The World Is Flat: A Brief History of the Twenty-First Century (Farrar Straus Giroux, 2005). 119 www.ebay.com. 120 www.etsy.com. 121 See A Killeen, ‘The Confluence of Bitcoin and the Global Sharing Economy’ in DKC Lee (ed), The Handbook of Digital Currencies (Elseiver, 2015) ch 24. 122 A Sundarajan, The Sharing Economy (MIT Press, 2016) 19 on ‘idle assets’. 123 Y Benkler, The Wealth of Networks (Yale University Press, 2006) 86. 124 G Leoni and LD Parker, ‘Governance and Control Of Sharing Economy Platforms: Hosting on Airbnb’ (2019) 51 British Accounting Review 100814. M Kornberger, D Pflueger and J Mouritsen, ‘Evaluative Infrastructures: Accounting for Platform Organization’ (2017) 60 Accounting, Organisations and Society 79.

66  Rise of the Productive Crypto Economy and the Need for Regulation aspects of governance and control on AirBnB’s part are aimed at maintaining certain levels of commonality and trust in order to be attractive for the user experience. Standardisation also creates positive externalities for all hosts that benefit from a collective trustworthy environment.125 Cohen also argues that such centralised governance also serves the purposes of manipulating network dynamics and preventing defection, catering for platform owner’s private interests in maximising the network effects created on the platform.126 Similar forms of centralised governance can be found on eBay, which has over the years instituted highly controlling house rules for the conduct of sale and purchase, and takes upon itself to adjudicate127 sales disputes in relation to lost or defective goods.128 Indeed, in recent litigation in the EU,129 the Court of Justice refused to regard Uber as an information intermediary matching drivers in their own cars with potential sharers who need a ride. Uber maintains extensive centralised governance of the platform business model, over the conditions of the ride, such as booking the car and the price, hence providing a taxi service instead of merely a ride marketplace.130 In contrast, decentralised blockchain platforms would likely be faced with coordination and governance deficits and it is questioned how far ex ante protocols, which are designed to serve functional and essential purposes, can cope with the social dimensions of governance issues. We discuss below an example relating to Steemit, a blockchainbased social media community which presents an alternative to corporatised social media such as Facebook or Twitter. Steemit experienced a forking battle in early 2020 which highlights the limitations of forking as a default governance mechanism and the need for more governance development on permissionless blockchains. Steemit is a social media platform purported to be ‘owned, developed and managed’ by its users, representing a decentralised and democratic alternative to conventional social media businesses. The network is managed by a delegated proof-of-stake system where users cast votes via their tokens to support a small number of witnesses or validators on the network who would oversee order and governance. The original developers of Steemit retained a huge stake of tokens but purported to hold these to support the network and not to intervene in governance matters. However, on 14 February 2020, Justin Sun of the Tron corporation, which 125 Above. See also OECD, ‘Trust In Peer Platform Markets’ (OECD Paper 263/2017) which discusses factors engendering trust in platforms such as secure payment systems, standardised user interfaces such as ratings and reviews, even if users do not critically evaluate terms of protection and their rights. 126 JE Cohen, ‘Law for the Platform Economy’ (2017) 51 UC Davis Law Review 133. 127 Platform adjudication of disputes not only happens on eBay (see resolutioncentre.ebay.co.uk), but also on Facebook, which provides a process for comment take-downs or account issues to be raised and disputed. However, platform adjudication is self-governed, and the observed deficits of accountability and transparency will be discussed shortly; see O Schwarcz, ‘Facebook Rules: Structures of Governance in Digital Capitalism and the Control of Generalized Social Capital’ (2019) 36 Theory, Culture and Society 117. 128 resolutioncentre.ebay.co.uk. Indeed, it may be regarded as unbalanced that an adjudication process is in place for buyer protection but sellers do not have such recourse for a bad buyer such as non-payment or other bad behaviour, as only reports can be made and negative feedback cannot be left. 129 Asociación Profesional Elite Taxi v Uber Systems Spain SL Case C-434/15 (December 2017); Request for a Preliminary Ruling under Art 267 TFEU from the tribunal de grande instance de Lille against Uber, Case C-320/16 (April 2018). 130 Para 40 of the judgment in Asociación Profesional Elite Taxi v Uber Systems Spain SL Case C-434/15 (December 2017). Also see A Stemler, ‘The Myth of the Sharing Economy’ (2017) 67 Emory Law Journal 197.

The Productive Crypto Economy: Three New Forms of Commoditisation  67 offers the protocol infrastructure Tron to rival other blockchain infrastructure such as Ethereum, bought the entire stake of Steem tokens from the developers. Steemit users became concerned about the prospect of moving onto the Tron blockchain which would be controlled by Sun’s company.131 On 2 March 2020, a few new accounts with large amounts of tokens, one of which was traced to Tron, staked to remove 20 of 21 witnesses from the elected Steemit community and to install their own witnesses, and in doing so, effected a hard fork to change the governance rules of the community.132 Three exchanges – Binance, Huobi and ­Poloniex – even staked their users’ tokens held in the exchanges’ custody to support the hard fork, with Binance saying that this seems a ‘maintenance’ issue.133 Users however got together over a seven-hour forum to coordinate a soft fork that effectively freezed Sun’s Steem tokens from being used to effect the changes observed and, within hours, Binance and Huobi had announced the cancellation of their previous votes. Sun tweeted to explain that he had observed a hacking incident on Steem and took action to protect the community.134 The battle of the forks has seen Sun back down from what may be observed as a governance coup on an open and decentralised blockchain.135 However, the Steemit community decided to part ways with Sun, and effected a hard fork to move their community off to Hive on 20 March 2020, replacing Steemit holders’ Steem tokens with Hive ones.136 It may be argued from this episode that forking is indeed a self-regulatory governance mechanism that can address governance crises. Users, unlike minority shareholders in a corporate organisation,137 can hold up to the majority by soft forking. Further, the threat to create a permanent fork would be taken seriously as it could diminish the value of the network for the intended controllers. However, as the Steemit episode shows, fractionalisation in the community could ultimately lead to a hard fork, which may have adverse financial consequences for some token-holders. Ad hoc forking is not necessarily an optimal governance measure, as this is ex post and crisis management in nature, and can be initiated only by users with development and coding capacity.138 Hence, the power to govern can only be exercised with technical expertise within the network, crucially affecting other users’ economic rights in terms of token valuations and also 131 ‘Why Crypto Should Care About Justin Sun’s Steem Drama’ (3 March 2020), at www.coindesk.com/ why-crypto-should-care-about-justin-suns-steem-drama. 132 ‘Steem Community Mobilizes Popular Vote in Battle with Justin Sun’ (3 March 2020), at www.coindesk. com/steem-community-mobilizes-popular-vote-in-battle-with-justin-sun. 133 ‘Binance Reverses Vote in Apparent Steem Takeover’ (3 March 2020), at cointelegraph.com/news/ binance-reverses-vote-in-apparent-steem-takeover-steemit-comms-head-resigns. 134 ‘Justin Sun Defends Steem Takeover After “Hackers” Freeze 65 Million Tokens’ (3 March 2020), at www. cryptoglobe.com/latest/2020/03/justin-sun-defends-steem-takeover-after-hackers-freeze-65-million-tokens. 135 However, the community’s distrust of Sun has ultimately led to a permanent hard fork of Steem users on 20 March, to be renamed Hive; see ‘Steem Hard Forks Today Over Fears of Justin Sun Power Grab’ (20 March 2020), at www.coindesk.com/steem-will-hard-fork-in-just-hours-over-community-fears-of-justin-sun-power-grab. 136 ‘Hive Hard Fork is Successful, STEEM Crashes Back to Earth’ (20 March 2020), at cointelegraph.com/ news/hive-hard-fork-is-successful-steem-crashes-back-to-earth. 137 For example, minority shareholders in a company that do not agree with management often only have the option to be bought out, albeit with the help of the court; see for example Zedra Trust Company v The Hut Group [2020] EWHC 5; Croly v Good [2010] EWHC 1 (Ch). 138 The decision-makers are empirically observed to be small cliques of highly influential developers. See J Parkin, ‘The Senatorial Governance of Bitcoin: Making (De)Centralized Money’ (2019) 48 Economy and Society 463.

68  Rise of the Productive Crypto Economy and the Need for Regulation their roles.139 Further, successful soft forking crucially relies on garnering sufficient support and such campaigns resemble governance by referenda. It may be argued that Steemit has a governance system of elected witnesses. However, Sun’s coup shows that such a governance system is riddled with gaps. There is also a need to determine if ex ante rules are needed in relation to exchanges’ voting the tokens they hold in custody. This seems eerily similar to but arguably worse than stock lending in the conventional financial space, as even stock borrowers usually refrain from voting on borrowed stock.140 Some commentators argue that anticipatory governance is needed for forking decisions, especially hard forks.141 Schrepel argues that exit is the quintessential mode of governance in a public and open blockchain, as opting into a blockchain allows one to trade-off institutional and legal certainties, or indeed, constraints, and it is up to one to choose to do so.142 An unhappy blockchain community participant can always exit the blockchain by liquidating tokens. This chapter argues, however, that exit does not necessarily meet the needs of those aggrieved by a lack of governance of the commons in the blockchain community. If one has become invested in a blockchain economy to a significant extent, such as by holding a large number of tokens and becomes reliant on peer-to-peer services for the staple carrying out of economic activity, it is not as easy to exit and find substitutes. In this case, even exit could be a story of grievance or grief which would be unaddressed by the relative lack of commons governance in the blockchain system. Drawing from the experience of the platform economy, would blockchain marketplaces be regarded as organisational in nature and in need of collective governance and institutions? In sharing economy platforms, platform owners’ incentives naturally give rise to governance norms, although platforms like Uber may wish to have the best of both worlds by maintaining centralised control yet avoiding having an organisational character for regulatory compliance purposes. However, what distinguishes the platform or sharing economy model from the peer-to-peer blockchain marketplaces is the manifest intent on the part of crypto economy developers to develop ultimately decentralised and self-sustaining systems, without the tyranny of platform or sharing economy platform owners’ governance or rules.143 For example, crypto networks such as Mycelia144 or Choon145 offer direct opportunities for music artists to sell their music, distinguishing from platform model Spotify, which maintains centralised governance over admission of artists’ work and

139 Above, and P Tasca and R Piselli, ‘The Blockchain Paradox’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 1. 140 See for example the ICGN Securities Lending Code of Best Practices (2007) at www.icgn.org/sites/ default/files/2007%20Securities%20Lending%20Code%20of%20Best%20Practice_0.pdf. 141 BD Trump, E Wells, J Trump and I Linkov, ‘Cryptocurrency: Governance For What Was Meant to Be Ungovernable’ (2018) 38 Environment Systems and Decisions 426. 142 T Schrepel, ‘Anarchy, State, and Blockchain Utopia: Rule of Law versus Lex Cryptographia’ in General Principles and Digitalisation (Hart Publishing, 2020). 143 R Beck, C Müller-Bloch and JL King, ‘Governance in the Blockchain Economy: A Framework and Research Agenda’ (2018) 19 Journal of the Association for Information Systems 1020; S Fiorentino and S Bartolucci, ‘New Governance Perspectives on the Sharing Economy. A Blockchain Application for the “Smart” Management of Co-Working Spaces with a Return for Local Authorities’ (2019), at ssrn.com/abstract=3478870. 144 myceliaformusic.org. 145 info.choon.co.

The Productive Crypto Economy: Three New Forms of Commoditisation  69 subscriptions.146 The decentralised Swarm City is intended to be a marketplace that would offer alternatives to sharing economy services to compete with AirBnB and Uber.147 Similarly Filecoin, as described above, is intended to be decentralised and selfsustaining based on the protocols for role specification and reward for storage miners and retrieval nodes. Even if decentralisation exposes governance deficits, it may be that the quest for organisational and governance norms would be counterproductive to the development of the crypto economy too. This is because centralised institutions could become tyrannical and extractive, a critique often levied against institutional developments in conventional developed economies that have not prevented social and economic disparities and inequalities. In today’s corporatised economies, rentier capital such as shareholders obtain significant gains from the generation of economic value by corporations, by extracting dividends or by buying and selling corporations like assets on securities markets that have become speculative arenas.148 This allows the rentier capital class to accumulate mainly financially generated wealth that far outstrips wealth creation by the deployment of labour, leading to grave disparities and inequalities in many developed countries.149 Further, elite executives that manage corporate economies command remuneration at pay ratios over a hundredfold compared to average workers whose productivities contribute to the creation of corporate wealth.150 The domination of wealth extraction by the rentier capital and managerial classes have caused concern as to whether capitalism is broken,151 especially in the light of the global financial crisis 2007–09 where taxpayers had to bail out large banks because they were social utilities too important to fail. This resulted in years of austerity in the UK, for example, while many shareholders and managers were not perceived to be sufficiently punished.152 146 P de Filippi, ‘Blockchain-based Crowdfunding: What Impact on Artistic Production and Art Consumption?’ (2018) at ssrn.com/abstract=2725373. 147 thisis.swarm.city. 148 K Ho, ‘Corporate Nostalgia? Managerial Capitalism from a Contemporary Perspective’ in G Urban (ed), Corporations and Citizenship (University of Pennsylvania Press, 2014). 149 G Krippner, ‘Accumulation and the Profits of Finance’ in I Erturk, J Froud, S Johal, A Leaver and K Williams (eds), Financialization At Work: Key Tests and Commentary (Routledge, 2008); K-H Lin and D Tomaskovic-Devey, ‘Financialization and U.S. Income Inequality, 1970–2008’ (2013) 118 American Journal of Sociology 1284; B Kus, ‘Financialisation and Income Inequality in OECD Nations: 1995–2007’ (2012) 43 The Economic and Social Review 477; G Dumenil and D Levy, ‘Financialization, Neo-liberalism and Income Inequality in the USA’ in I Erturk, J Froud, S Johal, A Leaver and K Williams (eds), Financialization At Work: Key Tests and Commentary (Routledge, 2008). 150 MJ Conyon and J Schwalbach, ‘Executive Compensation: Evidence from the UK and Germany’ (2000) 33 Long Range Planning 504. Modern evidence, see G Ferranini, N Moloney and M-C Ungureanu, ‘Executive Remuneration in Crisis: A Critical Assessment of Reforms in Europe’ (2015) 15 Journal of Corporate Law Studies 73. 151 G Mulgan, ‘The Essence of Capitalism’ in The Locust and the Bee (Princeton University Press, 2013) ch 3; C Hay and A Payne, Civic Capitalism (Polity Press, 2015). 152 The shareholders of failed UK bank Northern Rock were wiped out, see Harbinger Capital Partners v Caldwell (As the Independent Valuer of Northern Rock Plc)& Anor (Rev 1) [2013] EWCA Civ 492, but it is arguable that shareholders in HBOS and RBS did not suffer as Lloyd’s purchase (challenged to be too expensive by Lloyd’s shareholders but they lost; see ‘Lloyds shareholders lose out in HBOS court action’ (15 November 2019), at www.scotsman.com/business/lloyds-shareholders-lose-out-in-hbos-court-action-1-5046737)) and the state’s bailout of RBS saved shareholders’ skin. One senior manager at HBOS was fined and disqualified, but there was general outcry with regard to the limited enforcement carried out, see House of Commons and House of Lords, Parliamentary Commission on Banking Standards, ‘An Accident Waiting to Happen: The

70  Rise of the Productive Crypto Economy and the Need for Regulation Further such inequalities are accentuated during the Covid-19 pandemic reflecting entrenched patterns of economic privilege and the need for more social and economic mobility.153 Platforms are situated in the same mould as the corporatised economy and have generated significant wealth for platform owners that capitalise on network effects.154 This is not distributed to users who co-create wealth on the platforms.155 In this light, a self-sustaining crypto economic system which provides for economic needs while not allowing rent extraction by rentier capital or managerial classes seems not only efficient but also socially desirable in terms of the potential for democratising and making economic production and wealth creation more egalitarian. In this manner, developers of tokenised systems are providing infrastructure156 that have the potential to subvert the institutional structure of the corporatised economy altogether.157 An important development in the peer-to-peer services marketplace is the rise of DeFi, or decentralised financial services that take place over blockchain-based networks (discussed in chapter seven). These are meant to disintermediate many corporatised financial services for individuals and small businesses. Such disruption can be seen as desirable as incumbent financial institutions extract significant rent from users and have lost much social trust as a result of scandals.158 On the other hand, relations of trust and reliance pervade finance and DeFi may not be immune to needs of governance in order to instil confidence in participation. The rise of DeFi may exacerbate the need for governance development in the crypto economy. As Takagi opines, not all economic tasks are most efficiently or effectively carried out in an automated and decentralised fashion, and tasks requiring higher levels of human interaction, design or input would be difficult to automate.159 The crypto economy is increasingly varied in terms of economic activities and growing in scale. Automated smart contracts and decentralised governance may provide a starting point but are likely insufficient to supply continuing governance for more complex issues and bigger communities of users. At scale, the crypto economies of Iungo, Golem and Filecoin may become socio-economic communities in which the need for governing the commons would arise. There are institutional type commons relating to accepted standards of conduct and behaviour, and resource-type commons relating to how economic wealth creation in the community can be enhanced and distributed, for example by marketing, network visibility and other means of attracting and retaining traffic and users. A commentator Failure of HBOS’ (4 April 2013). The FCA has sinced reopened investigations which are ongoing, see ‘FCA investigation of HBOS delayed by further cache of evidence’ (13 June 2018). 153 ‘COVID-19 amplifies inequality. Fight back with long-term thinking’ (World Economic Forum, 15 July 2020), at www.weforum.org/agenda/2020/07/covid-19-amplifies-inequality-fight-back-with-long-term-thinking. 154 For example, see JM Barnett, ‘The Costs of Free: Commodification, Bundling and Concentration’ (2017) at papers.ssrn.com/sol3/papers.cfm?abstract_id=2916859 discussing Facebook. 155 IH-Y Chiu, ‘The Platform Economy’ in RM Barker and IH-Y Chiu (eds), The Law and Governance of Decentralised Business Models (Routledge, 2020) ch 7. 156 C Catalini, ‘Blockchain Technology and Cryptocurrencies’ (2018) 19 Georgetown Journal of International Affairs 36. 157 EPM Vermeulen, M Fenwick and W Kaal, ‘Why Blockchain will Disrupt Corporate Organizations – What Can be Learned from the “Digital Transformation”’ (2018) 1 The Journal of the British Blockchain Association 91. 158 See n 136. 159 S Takagi, ‘Organizational Impact of Blockchain through Decentralized Autonomous Organizations’ (2017) 12 International Journal of Economic Policy Studies 22.

The Productive Crypto Economy: Three New Forms of Commoditisation  71 discusses essential governance needs on crypto economies as being in two layers, the first is the layer regarding technological governance, which not all users are equally equipped to undertake and some participants with coding abilities would be more involved than others. The second layer relates to governance of the marketplace or community as discussed.160 As automated protocols in the form of smart contracts in tokens are unlikely to be complete, giving rise to no future problems, the self-sustenance of a blockchain system is an ongoing phenomenon. Although it is laudable that many of these developers wish to move onto new projects and are not focused on rent extraction like many corporatised platform owners, developing commons governance is still important for all users and participants. There is arguably a regulatory role for the institution of organisational and governance tenets on blockchain networks that may be optimal to meet internal coordination deficits, and would also help in building the interface between the crypto and conventional economies for meaningful economic mobilisation and development. Commons governance can and should be developed in a manner that minimises opportunities for tyranny or rent extraction, and it should not be assumed that centralised institutions or governance norms must lead to such results.161 Chapters four to seven of this book explore a new regulatory agenda in this light.

C.  New Tokenisation of Existing Real Economy Assets A major commercial development in the crypto economy relates to the tokenisation of real economy assets so that they can be bought and sold on blockchain-based marketplaces. Such real economy assets usually relate to commercial real estate, large hotels, infrastructural projects, other large projects or even whole villages, towns or communities that can be tokenised so as to be financed, co-owned and co-created to an extent. Tokenisation overcomes previous limitations such as indivisibility and illiquidity of these assets, and allows them to become divisible into standardised and tokenised parcels of rights which can then be traded, improving the financing opportunities for such projects and assets. It is also arguable that such tokenisation can apply to expensive assets such as art, designer clothing, antiques, private jets, yachts etc that can be co-financed and co-owned, etc. Private sector real estate tokenisation is already underway, as a new business model of Proptech.162 Real estate is both a staple and expensive asset for many individuals,163 but it has also become highly financialised.164 Tokenisation has been proposed to transform 160 M Rocas-Royo, ‘Decentralization as a New Framework for the Sharing Economy’ in RW Belk, GM Eckhardt and F Bardhi (eds), Handbook of the Sharing Economy (Edward Elgar, 2019) ch 17. 161 F Musiani, A Mallard and C Méadel, ‘Governing What Wasn’t Meant to Be Governed: A ControversyBased Approach to the Study of Bitcoin Governance’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 7; D Appukuttan Nair, ‘The Bitcoin Innovation, Crypto Currencies and the Leviathan’ (2019) 9 Innovation and Development 85–103. 162 ‘Asset Tokenization: The Most Significant Innovation in Real Estate in 100 years’ (2 July 2019), at medium.com/@ ghhasenstab/asset-tokenization-the-most-significant-innovation-in-real-estate-in-100-years-64d229bdd890. 163 P Saunders, ‘Quobands: A Funding Mechanism for Crowd Construction’ (2018), at papers.ssrn.com/sol3/ papers.cfm?abstract_id=3107645. 164 ibid, also see R Boyer, ‘Is a Finance-led Growth Regime a Viable Alternative to Fordism?’ (2000) 29 Economy and Society 111.

72  Rise of the Productive Crypto Economy and the Need for Regulation real estate ownership in two ways. The first is incremental in the sense that investors in real estate may be offered more choices in terms of how their investment rights may be structured and realised, as tokenisation offers divisibility and fractionalisation of asset rights. The second is more radical as tokenisation may relate not only to transformations in rights relating to real estate investment, but to rights in other aspects of ownership over the large asset in question, therefore bringing about social forms of transformation. Regulated collective investment vehicles such as real estate investment trusts (REIT) are the means by which investors can invest in real estate without needing to be able to afford a whole property. REITs are usually set up as companies or trusts165 under the Financial Conduct Authority’s (FCA) general regulatory regime for collective investment schemes.166 Investors do not own any slices of real estate owned by the REIT, but only the shares or units in the REIT. Such shares or units can be publicly tradeable if the REIT is listed on the London Stock Exchange or can be redeemed when an investor wishes to exit. However, as real estate assets are illiquid, investors’ redemption requests may not be immediately met, and often investors are subject to lock-up periods in order to reflect the illiquid nature of their investments.167 Tokenisation may improve the efficiencies of the existing REIT structure in several ways.168 One is that relevant and common information that is material to the performance of the REIT is made available to all investors equally on the blockchain system and improves transparency, such as information regarding the tenancy of real estate assets, maintenance records, etc. This helps facilitate greater confidence in investors trading REIT units amongst themselves, therefore improving liquidity in REITs.169 However, commentators from the MIT Digital Currency project170 doubt that tokenisation, which merely digitally represents the same right investors have in their shares or units in the REIT, can magically improve liquidity by a significant measure, given that the underlying assets remain of an illiquid nature. Nevertheless, tokenised REITs are being developed, such as the REIT for accredited investors in the US for a part of the luxury hotel estate of the St Regis Aspen Resort.171 Blockchain marketplaces and tokenisation for investors to carry out trading and sharing of large and expensive assets would not be unregulated and presumably nested within the existing regimes of laws and regulations for collective investment in these assets and interests.172 In this manner, we expect that tokenisation does not affect the 165 FCA Handbook COLL 1.2. 166 Collective investment schemes, defined under the Financial Services and Markets Act 2000, s 235, need to be authorised by the FCA in the UK. 167 Discussed in J Smith, M Vora, H Benedetti, K Yoshida and Z Vogel, ‘Tokenized Securities and Commercial Real Estate’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3438286. 168 P Laurent, T Chollet, M Burke and T Seers, ‘The Tokenization of Assets is Disrupting the Financial Industry. Are You Ready?’ (Deloitte & Touche, 2019), at www2.deloitte.com/content/dam/Deloitte/lu/Documents/ financial-services/lu-tokenization-of-assets-disrupting-financial-industry.pdf. 169 ibid, and ‘Waking up from the dream of real estate tokenization’ (7 June 2019), at www.unissu.com/ proptech-resources/waking-up-from-the-dream-of-real-estate-tokenization. 170 Smith et al (2019). 171 ‘Elevated Returns gets $18 million for St. Regis Aspen Resort “tokenized real estate” (9 October 2018), at venturebeat.com/2018/10/09/elevated-returns-gets-18-million-for-st-regis-aspen-resort-tokenized-real-estate/. 172 ie such a tokenised participation would still be participation in a collective investment scheme, and the regulatory regime is still attracted even if it relates to slices of real estate interest; see Asset Land Investment Plc v The Financial Conduct Authority [2016] UKSC 17; FCA v Capital Alternatives Ltd and Ors [2014] EWHC 144 (Ch).

The Productive Crypto Economy: Three New Forms of Commoditisation  73 extension of regulatory tenets such as authorisation of the collective investment scheme and the duties placed upon scheme operators. The blockchain marketplaces are likely to be permissioned and overseen by scheme operators. Nevertheless, there is a need to consider if existing regimes can cope with potential transformations that arise. How would blockchain platforms facilitate investors’ trading in a fair and orderly manner, for example? Can tokenisation give rise to transformations in investors’ rights, such as possibly offering investors who have tokenised interests in hotel rooms to also enjoy rights of stay? Proptech developments could give rise to new economic models in terms of shared financing and ownership of a range of expensive or luxury items such as fine art, antiques, designer clothing, furniture, private jets, yachts, scientific equipment, etc, or even joint and shared financing and development of infrastructural projects. For example, Saunders introduces the idea of quobands, which is a smart contract that facilitates fractional and divisible ownership rights over real and personal property.173 It is applied to two contexts. One is the tokenisation of fractionalised real estate rights in residential property. Tokenisation gives rise to a competitive market and purchasers would aim to purchase a majority of tokens in order to enjoy certain property rights. This is purported to be a more effective and democratic way to assist first-time purchasers to buy their first home, by building up token stakes to a majority level in order to enjoy rights of residence and quiet enjoyment and then to gradually buy up the rest of the tokens relating to the property in order to have exclusive ownership. In terms of the market economics, it is uncertain that the tokens market would necessarily be more affordable for first-time buyers, as supply limitations, which is the problem in the UK, could still exert inflationary pressures on tokens. The idea of fractionalised ownership above gives rise to the need for considering its fit with legal precepts. The legal artefact of proprietary ownership which is characterised by a right to exclude others from the boundaries of what one owns,174 is a legally and practically efficient way of delineating economic rights, providing certainty in social and economic relations. Fractionalised interests of a physical whole, eg a share of a three-bedroom house, requires new proprietary definitions and delineations. It may be argued that novel ideas in property rights development have not gone unregulated, as housing associations providing shared ownership schemes in the UK175 are subject to the Housing Minister’s oversight. The development of new legal interpretations and principles may be needed for defining and safeguarding the boundaries of fractionalised proprietary rights.176

173 Saunders (2018). 174 HE Smith, ‘Property and Property Rules’ (2004) 79 NYU Law Review 1719; O Lee Reed, ‘What is Property?’ (2004) 41 American Business Law Journal 459, both arguing that private exclusivity is the hallmark of a proprietary right, and not a positive bundle of rights. 175 See ‘Affordable home ownership schemes’ at www.gov.uk/affordable-home-ownership-schemes/ shared-ownership-scheme. 176 Such as developed in shared equity ownership schemes for affordable housing, or as Saunders (2018) discusses, rudimentary insights into majority token holding as conferring the right of possession and exclusive residential enjoyment in relation to a residential property.

74  Rise of the Productive Crypto Economy and the Need for Regulation Second, Saunders’ discussion extends to large infrastructural developments such as the Las Orillas village in Puerto Rico.177 It is envisaged that public and private sector entities can coordinate to facilitate a blockchain-based infrastructural project tokenising development rights to be leased to participants. This would provide the pooled financing required for development and leverage upon dispersed resources, efforts and innovation for development. The public sector and private sector entity founding the project retains the tokens, as well as governing and control powers, creating a unique social system apart from the rest of the country. On the one hand, such endeavours create experimental development exercises that may benefit the country in due course. On the other hand, it is uncertain whether such developments can result in adverse social transformations such as segregation and division. This discussion in this section deals with the interface between new technologies (in blockchains and tokenisation) and existing economies. There is also greater likelihood of permissioned blockchains being used than permissionless ones. However, Saunders’ vision of infrastructural tokenisation potentially creates a massive participatory permissioned blockchain, and easy assumptions of centralised governance in such blockchains cannot be made. Governance issues, creation and distribution of rights and the assumption of responsibilities and accountability would also arise, not dissimilar from permissionless blockchains. We turn next to a regulatory blueprint for the crypto economy, as a regulatory blueprint is likely to address internal governance needs as well as the institutional evolution of the crypto economy and its relationship with conventional economy and society. A regulatory blueprint is arguably also desirable for the interweaving of crypto economy practices with conventional economy and society, as this section has explored. We advocate a holistic regulatory blueprint that encompasses enterprise, innovation and development, while warning against focusing excessively on the financialised aspects to the exclusion of the former.

III.  A Blueprint for a Regulatory Agenda Developments in the crypto economy bring about revolutions in business models, competition and choice to economic actors existing and new. However, there are limits to self-governance and market-based governance.178 The potential for development and economic mobilisation in this space can be facilitated with a regulatory blueprint that provides both enabling and governance aspects. These are explored in chapters four to seven, dealing with: (a) an enabling framework for the economically productive and enterprise activities in the crypto economy; (b) a governance framework for the issues of public goods and public interest, in relation to the fundraising and monetary orders of the crypto economy; and



177 Saunders 178 M

(2018) 14. Finck, ‘Blockchains: Regulating the Unknown’ (2018) 19 German Law Journal 665.

A Blueprint for a Regulatory Agenda  75 (c) a regulatory framework for the aspects of financialisation that address public interest goods in relation to user protection, risk allocation and overall financial stability. Before we turn to these, we make two arguments. First, we argue that bottom-up initiatives such as the Token Taxonomy Initiative (TTI)179 are not sufficient to provide for the institutions and governance outlined above. Second, we argue that this holistic regulatory agenda is needed instead of targeted financial regulation that many jurisdictions are embarking on. The hazards of a narrow financial regulation-only approach are outlined.

A.  Why the Token Taxonomy is Not Sufficient TTI provides standardised lingo and concepts for token design so that there is greater clarity as to what tokens are and how they work. The TTI can guide both the supply and demand sides in the crypto economy towards greater confidence, as well as to improve the interoperability between different blockchains in the crypto economy. It aims to first define tokens as ‘fungible’, ‘non-fungible’ or ‘hybrid’. Fungible tokens are tokens that have the same value as any other in the same quantity, such as cryptocurrency, while non-fungible tokens represent unique assets, such as denoting a piece of handmade pottery. Hybrid tokens are likely to be the most common in the crypto economy as they combine a fungible element, such as a particularly priced ticket to a rock concert, and a non-fungible element, such as an allocated seat. On the base definitions of fungible, non-fungible and hybrid tokens, tokens can then be represented in templates, classes, behaviours and instances. Templates refer to the build infrastructure for the tokens, such as tokens built for deployment on the Ethereum blockchain. A token class refers to the type of economic good or right to use a service, usually by reference to existing economic sectors, such as airline tickets, club membership, etc. Token behaviours are the functions coded into tokens, many of which would be similar to what is already offered by the Ethereum smart contract template. A token instance would be the specific right, property, asset, etc that the token represents, such as a particular seat at a rock concert, a particular fraction of ownership of a dwelling house or a single-use right for exhausting certain loyalty points, for example. It is proposed that tokens be represented in a standardised symbolic form clarifying upfront its base, template, class, instance and behaviour characteristics so that a uniform understanding can be achieved of what tokens are or do. TTI standardisation would go some way towards promoting common understanding and confidence in use.180 However, this is not a self-regulatory regime as such. Specifying common understandings of the nature, build and functions of tokens does not mean that business standards would be aligned with social expectations or that the commons in the blockchain economy/community would be appropriately governed. 179 See tokentaxonomy.org. The site has since been superseded and the paper is found at github.com/InterWorkAlliance/TokenTaxonomyFramework/blob/main/token-taxonomy.md. 180 See also P Delimatsis, ‘When Disruptive Meets Streamline: International Standardization in Blockchain’ in D Kraus, T Obrist and O Hari (eds), Blockchains, Smart Contracts, Decentralised Autonomous Organisations and the Law (Edward Elgar, 2019) ch 4.

76  Rise of the Productive Crypto Economy and the Need for Regulation We have argued that transaction verification functions such as mining protocols that can be coded into tokens are important but not a comprehensive means of governance, and that incentive-based self-regulatory measures such as exit also do not meet more complex governance needs. Further, the TTI says nothing about the collective aspect of the blockchain community or economy.

i.  Need for an Enabling Regulatory Framework An enabling regulatory framework, as mentioned in section I, is important as it reflects the contractarian nature of participants’ relationships with each other in the crypto economy. The crypto economy comprises of contracting individuals via tokens, and it cannot be overly prescribed or standardised what individual economic agents wish to contract for themselves. Hence an enabling regulatory framework essentially facilitates freedoms, but would also provide default rules in order to meet the needs of the commons. Company law is an example of an enabling framework for conventional enterprise. In company law, norms are often categorised into enabling or mandatory types. Enabling norms are default rules that standardise a set of expectations or arrangements for governing the commons, such as decision-making processes in a company. These can however be modified and adapted according to the particular needs of corporate constituents.181 Mandatory rules are those that cannot be opted out or modified and usually reflect public interest in relation to the conduct of economic activity in or by the corporation. This chapter argues that an enabling framework is appropriate for the enterprise arrangements in the crypto economy. This does not mean an extension of company law, as chapter four explains. What we argue for is an enabling organisational law that would meet blockchain communities’ needs. Blockchain-based businesses are designed to sustain a continuing and self-maintaining community, whether it is Decentraland, Filecoin or Iungo. In the absence of bottom-up endeavours to frame or categorise the nature of coordination in the blockchain economy, enabling regulation can facilitate such coordination or supply such framing. This is not tantamount to saying that blockchain-based businesses are corporate-like creatures,182 partnership-like structures,183 etc. We propose that an enabling regulatory blueprint can provide standards or mechanisms for blockchain-based economy participants to choose how they may wish to coordinate. For example, Schneider184 suggests that enabling frameworks such as 181 B Cheffins, Company Law: Theory, Structure and Operation (OUP, 1997) 216ff; E Ferran, ‘Corporate Law, Codes and Social Norms – Finding the Right Regulatory Combination and Institutional Structure’ (2001) 1 Journal of Corporate Law Studies 381; I Omotayo Bolodeoku, ‘Contractarianism And Corporate Law: Alternative Explanations To The Law’s Mandatory And Enabling/Default Contents’ (2005) 13 Cardozo Journal of International and Comparative Law 433; I Ayres and R Gertner, ‘Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules’ (1989) 99 Yale Law Journal 87. 182 SEC, ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO’ (25 July 2017), at www.sec.gov/litigation/investreport/34-81207.pdf. 183 O Oren, ‘ICO’s, DAO’s, and the SEC: A Partnership Solution’ (2018) 2018 Columbia Business Law Review 617; L Metjahic, ‘Deconstructing the DAO: The Need for Legal Recognition and the Application of Securities Laws to Decentralized Organizations’ (2018) 39 Cardozo Law Review 1533. 184 N Schneider, ‘An Internet of Ownership: Democratic Design for the Online Economy’ (2018) 66 The Sociological Review Monographs 320.

A Blueprint for a Regulatory Agenda  77 ­ latform cooperativism can be introduced to provide a civic, democratic and reciprop cal environment for the blockchain ecosystem. These principles include principles on membership, participation, distribution, the balance between control and independence, education, training and information, concern for the community and principles for cooperation. In such a manner, regulatory support balances the freedoms in a distributed economic structure while addressing the necessity to protect and govern the commons.185 These are covered in greater detail in chapter four.

ii.  Regulatory Governance for the Commons, Public Goods or Public Interest As discussed, regulatory capitalism is an essential complement to economic industrialisation and the growth of capitalist activity and markets, in order to address harms not dealt with by market failures. Regulation also provides for a commons of standards, behaviour and infrastructure, and public interest needs.186 The crypto economy poses special challenges for regulation as two established characteristics of regulation may be inadequate or inappropriate in addressing the crypto economy. First, regulation is often addressed to regulated entities that are corporatised entities. Hence, regulation provides standards or compulsion that a corporatised entity would then have to internalise and organise within themselves to ensure compliance.187 Traditional command-and-control regulation that may be accompanied by strict liability provides the necessary incentive for corporations to comply. Second, even if regulation is not imposed in a traditional command-and-control manner and may be more flexible and modernised to take into account the complexities of compliance needs, regulatory techniques like process-based or meta-regulation are still corporate entity-focused.188 It assumes that flexible regulatory designs or principles will be interrogated by a corporate addressee which has internal systems, procedures and structures to secure compliance. As the crypto economy is based on publicly accessible distributed platforms with dispersed individual actors, and developers often wish to retreat from businesses after development is mature, regulatory techniques that are based on addressing corporatised entities may not be appropriate. However, addressing regulatory standards to individual users or participants is likely to be sub-optimal as the effort for compliance would be too dispersed amongst individual actors. Enforcement demands would also be too dispersed and regulators risk enforcement deficit across such a dispersed landscape. It is highly challenging to design a sufficiently robust incentive for individuals that would also be proportionate to their involvement. Nevertheless, crypto economy participants need such governance provision in relation to their commons in the blockchain-based business, as well as the wider commons in relation to society’s relationship with blockchain enterprises and economies. The 185 R Herian, ‘Regulating Disruption: Blockchain, GDPR, and Questions of Data Sovereignty’ (2018) 22 Journal of Internet Law 1. 186 Finck in German Law Journal (2018). 187 C Parker and V Lehmann Nielsen (eds), Explaining Compliance: Business Responses to Regulation (Edward Elgar, 2011). 188 Such as discussed in C Parker, The Open Corporation (CUP, 2000).

78  Rise of the Productive Crypto Economy and the Need for Regulation rights, responsibilities, values and institutions in blockchain-based businesses and the broader crypto economy as a whole need development. These issues are both of a commons nature and in public interest. Hence we argue that a social locus for the blockchain economy should also be established. A key means to achieve this is to confer on distributed associations legal personalities themselves. Such a collective identity, if established, can then foster a sense of belonging and commitment by participants and users, who then need to navigate internal arrangements and coordination via an enabling regulatory framework. This is fleshed out in chapter four. Next, we highlight two key areas of commons that are in need of governance norms. These are sketched here but more fully fleshed out in chapters five and six. First, the currency or money of the blockchain economy system is a commons that needs governance. Although mining protocols are staple in blockchain economies, there are many unresolved issues in relation to code development for the protocol currency, the integrity and use of the payment system native to the blockchain and distributive matters in relation to wealth creation and the dividends of development. Chapter six focuses on how such commons ought to be governed. Further, as blockchain-based businesses have engaged in fundraising from the public, this is an area not only susceptible to financial regulation, but more holistically should be considered as part of enterprise governance for the crypto economy. Policy choices need to be made taking into account of the crypto economy’s development needs and potential, and fundraising should be governed both as an enabling regime, as well as interfacing with the regimes that govern the offer of financial assets. Policy choices need to be balanced between fostering innovation and ensuring that investors are adequately protected against scams, frauds and unreasonably disappointed expectations. Financial regulation has been premised on (i) having no comprehensive product regulation in place but relying instead on extensive mandatory disclosure,189 (ii) refrain from regulatory standards in the sophisticated and high net-worth market,190 (iii) fashioning relational and conduct duties such as advice or execution standards where intermediaries are involved191 and (iv) regulating markets so that they can be places that investors are willing to participate in and largely trust. Chapters five and seven consider holistically the needs for crypto fundraising and financial development, and the tenets secured by financial regulation. These chapters consider how regulatory tenets may be relevant and appropriate regulatory design that takes into account of the distinguishing features of the crypto economy.

189 AC Page and RB Ferguson, Investor Protection (CUP, 1992) 59–77 on the proportionate nature of disclosure regulation; JC Coffee Jnr, ‘Market Failure and the Economic Case for a Mandatory Disclosure System’ (1984) 70 Virginia Law Review 717; JD Seligman, ‘The Historical Need for a Mandatory Corporate Disclosure System’ (1983) 9 Journal of Corporation Law 1. 190 RE Mendales, ‘Collateralized Explosive Devices: Why Securities Regulation Failed to Prevent the CDO Meltdown, and How to Fix it’ (2009) 5 University of Illinois Law Review 1359 critically discusses that the assumption that high-net-worth or sophisticated investors can fend for themselves can be questioned. 191 AM Pacces, ‘Financial Intermediation in the Securities Markets Law and Economics of the Conduct of Business Regulation’ (2000) 20 International Rev of Law and Economics 479 on the principal-agent problems in financial intermediation and the need for investor protection.

A Blueprint for a Regulatory Agenda  79

B.  The Need to Avoid Merely Focusing on Financial Regulation Finally, we argue that a regulatory agenda for the crypto economy must not exclusively be in the nature of financial regulation. This is because the development trajectories in the crypto economy are already highly financialised, and focusing on financial regulation reinforces that trajectory, which may in turn be counterproductive for the crypto economy’s productive development in due course. The new productivities of the crypto economy are intricately facilitated by financialisation. Financialisation not only provides opportunities to scale up commoditisation but also offers the self-regulatory blueprint of market-based discipline. An example would be business and small enterprise developers in the initial coin offerings market discussed in chapter one. Not only are future business participation and development tokenised and commoditised, but financialised in their being traded on secondary markets as assets as such. The financialisation of tokens is a major draw for both business developers and supporters/investors as the former may enjoy the attraction of network effects and the latter the appeal of liquidity. The financialisation and turning of tokens into assets provides financing solutions for development goals. For example, a community could tokenise a facility development in order to raise funds and to offer investors an opportunity to make both financial and social returns in the future. Token financing could revolutionalise social crowdfunding or impact investing for the future.192 The collection and categorisation of health data, for example, is mooted193 to be capable of forming the basis for issuances of public health bonds that can be more accurately priced, galvanising collective public investment into social needs. In this manner, blockchain-facilitated financialisation can transform the ways we address public health demands and their public financing. Tokenised finance is arguable an inherently self-regulatory system as it can facilitate market discipline and ultimately exit on a secondary market. The divestment of tokens by a holder of tokens is essentially a form of market discipline.194 Further, a marketplace for tokens further enhances opportunities for wealth creation as tokens can be held for trading gains or for productivity gains in the future. The financialisation of tokens arguably provides a self-sustaining system to address the protection of individuals’ interests. However, in its self-regulating state, increasing hyper-financialisation is taking place in the crypto economy as economic actors participate in this space not only to generate productivity but also to generate rentier income and passive yield.195 We caution against 192 See generally discussion on niche sources of social finance, OM Lehner (ed), Routledge Handbook of Sustainable and Social Finance (Routledge, 2016). 193 BM Till, AW Peters, S Afshar and J Meara, ‘From Blockchain Technology to Global Health Equity: Can Cryptocurrencies Finance Universal Health Coverage?’ (2017) 2 BMJ Global Health e000570, at dx.doi. org/10.1136/bmjgh-2017-000570. Also see how blockchains may facilitate bonds, and securitised assets, ‘Banking on the Blockchain: World’s First Crypto Bond’ (International Financial Law Review, January 2018); A Labbe, ‘Companies Bank on Blockchain Bonds to Cut Costs, Time’ (International Financial Law Review, 26 September 2017); L Rinaudo Cohen, L Samuelson, and H Katz, ‘How Securitization Can Benefit from Blockchain Technology’ (2017) 23 Journal of Structured Finance 51. 194 Consistent with the Simmelian notion of how the social framing of money can lead to certain transformations in terms of individual freedoms and social relations, generally G Simmel, The Philosophy of Money, 3rd edn (Routledge, 2004). 195 Such as ‘yield-farming’, discussed in ch 7 of this book.

80  Rise of the Productive Crypto Economy and the Need for Regulation excessive financialisation as the development of the crypto economy in relation to its emerging productivities and mobilisation can be undermined. Leaving the crypto economy to self-regulation exacerbates pressures to develop financialisation, as governance avenues become limited, and liquidity or exit become relied upon. High levels of financialisation in turn attract financial regulatory attention and any extension of regulation targeted at this space may become focused on financial aspects only. Such a regulatory agenda would neglect the holistic developmental potential in the crypto economy. For example, we query if the liquefication of development tokens sold at ICOs may ultimately cause the downfall of the dApp development project itself. Project developers may think that pre-sales of tokens secure a ready market for the future goods or services to be developed, but liquefication may adversely affect that expectation. There is a danger that premature financialisation of tokens exerts negative pressures on real entrepreneurial activity. The liquefication of tokens may attract purchasers who are not interested in using the tokens for future products or services, and only interested in trading. If a significant majority of token-holders do not participate in the real economic activities in the new project, the project could itself become undermined and made unviable.196 This phenomenon is not a new one, as Ho197 has written extensively on how modern corporations that are traded on secondary securities markets become commodities for investors. Investors may be disengaged from the real productivities of the corporation, while their activities on secondary markets put short-termist pressure on corporations to appear profitable in order to sustain investor sentiment in trading.198 Corporate strategies could ultimately be shaped in a sub-optimal manner and be excessively myopic.199 Although project developers may initially think that pre-selling tokens insulates the project from having to confer securities and governance rights on investors, the presence of largely speculative supporters for any project may still be an adverse phenomenon. Further, commentators have discussed the attraction of speculative gains to sleazy business developments or downright scams,200 therefore introducing into the crypto economy a slew of lemons that may dominate the market instead of genuinely innovative proposals. Next, the increasing financialisation of the crypto economy has brought powerful players into the ecosystem, many of those the same ‘winners’ in conventional economies – the already wealthy, the financial elite, institutions and corporations in the investment sector, who have played no small part in entrenching skewed patterns of distribution in conventional real and financial economies.201 The presence of these investors and 196 See A Romans, Masters of Blockchain (Venture Books, 2018) ch 4. 197 K Ho, ‘Disciplining Investment Bankers, Disciplining the Economy: Wall Street’s Institutional Culture of Crisis and the Downsizing of “Corporate America”’ (2009) 111 American Anthropologist 177. 198 C Helms, M Fox and R Kenagy, ‘Corporate Short-Termism: Causes and Remedies’ (2012) 23 International and Comparative Company Law Review 45; E Duruigbo, ‘Tackling Shareholder Short-Termism and Managerial Myopia’ (2011–12) 100 Kentucky Law Journal 531. 199 Above. 200 PP Momtaz, ‘Entrepreneurial Finance and Moral Hazard: Evidence from Token Offerings’ (2019), at ssrn. com/abstract=3343912, Hornuf et al (2019) find these to be the minority of ICOs but they still constitute about 12% of the sample. 201 G Krippner, ‘Accumulation and the Profits of Finance’ in I Erturk, J Froud, S Johal, A Leaver and K Williams (eds), Financialization At Work: Key Tests and Commentary (Routledge, 2008); G Epstein and A Jayadev, ‘The Rise of Rentier Incomes in OECD Countries: Financialization, Central Bank Policy and Labor Solidarity’ in GA Epstein (ed), Financialization and the World Economy (Edward Elgar, 2005) 46.

A Blueprint for a Regulatory Agenda  81 speculators may dwarf the individual token-holder investor.202 Indeed their ability to speculate in great amounts may contribute greater levels of volatility in crypto secondary markets, making these markets more deterring to individual token holders/investors. Regulators have responded to speculative and volatile cryptoasset markets by warning consumers not to participate in them.203 Although well-intentioned, such warnings may skew token offerings towards sophisticated or high-net-worth investors only, shutting out retail investors. The effect of such policies is that utility tokens would be primarily distributed to financiers, not ordinary individuals who may be seeking alternative economic actorhood in the crypto economy. Financiers’ incentives differ from those who may be seeking alternative economic actorhood in the crypto economy. Excessive financialisation of a nascent blockchain business may be adverse for its development and prospects. Indeed, retail investors could be persuaded that their participation in the crypto economy would only be safe if diversified and managed by financial intermediaries. In this manner, they may not participate directly in the economic activities of the crypto economy but instead herd into the financial speculative activities in the crypto economy, intermediated by financiers. The prospects of new economic mobilisation in the crypto economy would be adversely affected, if domination by financialisation distorts the participation, incentives and strategic developments of the crypto economy. Financial actors are poised to act as new intermediaries204 for the crypto economy as they may develop financial products, such as collective investment schemes, exchangetraded funds,205 etc in order to invite the participation of ordinary investors who seek exposure to the new crypto-asset class, or funds such as venture capital funds that are open to sophisticated but not ordinary investors.206 Although many crypto-asset exchanges do not erect barriers to trading entry,207 investors may be overwhelmed by the landscape of noise and choice or may not be confident in constructing portfolios for themselves. Existing financial intermediaries are moving into this space to intermediate

202 eg see research on crypto portfolio construction, Y Liu, A Tsyvinski and X Wu, ‘Common Risk Factors in Cryptocurrency’ (NBER Working Paper, 2019); S Bartolucci and A Kirilenko, ‘A Model of the Optimal Selection of Crypto Assets’ (2019), at arxiv.org/abs/1906.09632. 203 See FCA, ‘Consumer warning about the risks of investing in cryptocurrency CFDs’ (November 2017), at www.fca.org.uk/news/news-stories/consumer-warning-about-risks-investing-cryptocurrency-cfds; FCA, ‘Cryptoassets’ (7 March 2019), at www.fca.org.uk/consumers/cryptoassets; ‘ESAs warn consumers of risks in buying virtual currencies’ (12 February 2018), at eba.europa.eu/-/esas-warn-consumers-of-risks-in-buyingvirtual-currencies. 204 J Dewey, Blockchain and Cryptocurrency Regulation (Global Legal Group, London, 2019), at ssrn.com/ abstract=3305362 on the participation of existing financial actors in the crypto landscape and transforming more financial products and intermediation; C Harwick and J Caton, ‘What’s Holding Back Blockchain Finance? On the Possibility of Decentralized Autonomous Finance’ (2019), at ssrn.com/abstract=3373382; Y Liu, A Tsyvinski and X Wu, ‘Common Risk Factors in Cryptocurrency’ (NBER Working Paper, 2019) on treating cryptoassets as investible class. 205 WM Peaster, ‘Crypto & Blockchain Exchange-Traded Funds (ETFs) Launching in Europe’ (March 2019), at blockonomi.com/crypto-blockchain-etfs-europe; ‘Hashdex to Launch the Hashdex Nasdaq Crypto Index ETF’ (9 February 2021), at ‘www.coindesk.com/hashdex-to-launch-the-hashdex-nasdaq-crypto-index-etf on the launch of a crypto exchange-traded fund in the Bermuda Exchange accessible to non-US accredited investors. 206 L Lin and D Nestarcova, ‘Venture Capital in the Rise of Crypto Economy: Problems and Prospects’ (2019) 16 Berkeley Business Law Journal 533. 207 ie by brokers who intermediate exchange, and potential abuses; see N Gunningham, ‘Private Ordering, Self-regulation and Futures Markets: A Comparative Study of Informal Social Control’ (1991) 13 Law and Policy 297.

82  Rise of the Productive Crypto Economy and the Need for Regulation and seek rent, leveraging upon their incumbent status in conventional financial economies to capture the new investment space.208 The vision for an ‘alternative’ economic society in the crypto economy is increasingly cloudy as changes to the ecosystem may bring in old patterns and institutions that may become barriers to new economic mobility or new distribution possibilities. Financial actors are also developing derivatives of cryptoassets, in order to hedge their exposures to cryptoassets and to further develop opportunities for value arbitrage by speculation.209 Finally, the excessive population of the crypto economy by financial actors may induce slowness in regulatory development and thinking for the crypto economy, as regulators have often been content to leave financial markets alone where dominated by sophisticated or high-net-worth investors, believing that these actors would be able to bargain for contractual protections that suit their purposes and that regulatory standards are not necessary. This belief may not be well-founded as even institutional investors were criticised to be lacking in their understanding of financial innovation before the onset of the global financial crisis 2007–09.210 The FCA has also grappled211 with episodes of social outcry where marginally sophisticated business customers were mis-sold complex hedging financial products which caused them loss, and in respect of which they enjoyed no regulatory protection.212 In this manner, we may see regulatory interventions that shut out retail participation from the crypto economy, and leave unregulated a crypto economy dominated by financiers and private wealth. This may be quite different from the visionaries of innovation in the crypto economy that perceive it as a new level playing field distinguished from the conventional economy and its ills. In sum, although financialisation seems to be the self-governing answer to the crypto economy’s needs, we argue that it is neither adequate in relation to the governance needs discussed above, nor is it a salutary development for the future of the crypto economy. Further, it obscures regulators’ perception of the productive crypto economy and focuses their attention on financial regulatory aspects only. The focus on financial regulatory aspects has led regulators worldwide to adopt diverging positions on ICOs, as discussed in chapter three. This chapter strongly advocates a holistic perspective in developing a regulatory agenda for the crypto economy instead of patchwork and financially focused approaches.213

208 eg Fidelity, the asset manager, intends to provide crypto custodial services, eg M Leising and A Marsh, ‘Fidelity Is Said to Plan March Launch of Bitcoin Custody Service’ (Bloomberg, January 2019), at www.bloomberg.com/news/articles/2019-01-29/fidelity-is-said-to-plan-march-launch-of-bitcoin-custody-service; also see BNY Mellon’s move, ‘BNY Mellon Announces Crypto Custody and Spies Integrated Services’ (11 February 2021), at www.coindesk.com/bny-mellon-announces-crypto-custody-and-spies-integrated-services. 209 eg see ‘Cryptocurrency Liquidity Provider B2C2 OTC Receives FCA Authorisation’ (2019), at www. businesswire.com/news/home/20190131005215/en/Cryptocurrency-Liquidity-Provider-B2C2-OTCReceives-FCA. B2C2 OTC limited is a firm that provides crypto derivatives, ie contracts for differences for speculative trading based on predictions of crypto price movements. 210 Mendales (2009). 211 FCA, ‘Discussion Paper on a Duty of Care and Potential Alternative Approaches’ (July 2018) upon which no definitive result for regulatory policy was reached. 212 IH-Y Chiu and AH Brener, ‘Articulating the Gaps in Financial Consumer Protection and Policy Choices for the Financial Conduct Authority – Moving Beyond the Question of Imposing a Duty of Care’ (2019) 14 Capital Markets Law Journal 217. 213 IH-Y Chiu, ‘Pathways to European Policy and Regulation in the Crypto-economy’ (2019) European Journal of Risk and Regulation 738.

Co-regulation in Policy Development  83

IV.  Co-regulation in Policy Development Fostering an appropriate regulatory policy for radical innovations such as blockchain and tokenisation technologies is essentially a process that needs to be undertaken. This chapter argues that co-regulatory processes can feed into policy formulation and design. Co-regulatory measures may be fostered between the new industry, incumbent industry, stakeholders, regulators and international think tanks or associations, as relying on any one group of constituents would unlikely generate a fully informational and strategic matrix for initiatives. Industry actors are likely to be conflicted in their commercial interests, while regulators would be both users and deployers of technology, such as in regtech,214 using AI in predictive analytics215 and in embedding compliance-based technologies or surveillance in transactional traffic.216 Co-regulatory processes are necessary in light of the challenges posed to regulation as discussed above. Economic and social structuration novelties introduced by blockchain technologies in particular pose challenges to regulatory design. The co-regulatory landscape would foster dialogic and multilevel forms of regulatory design that may be nimble and leverage upon a range of governance resources, instead of being slow and wedded to old business models.217 The dialogue around technology and institutional response must incorporate balanced representation of the competing interests of different legitimate interest groups in the society,218 although, as Herian argues, blockchain entrepreneurs and enthusiasts are likely to champion self-regulation or ‘law by code’.219 There is also the hazard that multistakeholder forms of governance can give rise to space for dissonance and no clear course for policy. Nevertheless, incremental institutional change can only gradually be fostered by variety of governance methods and norms,220 from informal and selfregulatory, to third-party initiatives,221 soft law,222 smart regulation223 and ­regulatory 214 This is particularly experimented in financial regulation where regulators increasingly use AI to filter compliance reporting for concerning signals or to inform supervisory and enforcement action, see DA Zetzsche, RP Buckley, DJ Arner and J Barberis, ‘Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation’ (2017) 23 Fordham Journal of Corporate and Financial Law 31; also see concerns regarding technological judgments voiced in N Geslevich Packin, ‘Regtech, Compliance and Technology Judgment’ (2018) 93 Chicago-Kent Law Review 193. 215 The mechanics of predictive analytics and a discussion of pros and cons can be found in E Siegel, Predictive Analytics: The Power to Predict Who Will Click, Buy, Lie or Die (John Wiley & Sons, 2013). 216 R Auer, ‘Embedded Supervision: How to Build Regulation into Blockchain Finance’ (BIS Working Paper, 2019), at ssrn.com/abstract=3463885; D Yang and M Li, ‘Evolutionary Approaches and the Construction of Technology-Driven Regulations’ (2018) 54 Emerging Markets Finance and Trade 3256–71. 217 A Armitage, AK Cordova and R Siegel, ‘Design Thinking: The Answer to the Impasse Between Innovation and Regulation’ (2017) 2 Georgetown Technology Law Journal 3. 218 R Brownsword, Law, Technology and Society (Routledge 2019) ch 4. 219 R Herian, Regulating Blockchain: Critical Perspectives in Law and Technology (Routledge, 2019). 220 Brownsword (2019) ch 2. 221 Such as stakeholder initiatives that are not industry-led, eg investor-led ones such as Hermes, Investors’ Expectations on Responsible AI and Data Governance (April 2019), at www.hermes-investment.com/ wp-content/uploads/2019/04/investors’-expectations-on-responsible-artificial-intelligence-and-datagovernance.pdf. 222 KW Abbott and D Snidal, ‘Hard and Soft Law in International Governance’ (2000) 54 International Organisation 421 in which is offered the paradigm spectrum for characterising hard or soft law based on the qualities of precision, bindingness and enforcement. Even if standards may be specific, the lack of enforcement authority or an adjudicatory forum would still likely render such standards as soft law. 223 The involvement of stakeholders in ensuring corporate compliance, as discussed in N Gunningham, ‘The New Collaborative Environmental Governance: The Localization of Regulation’ (2009) 36 Journal of Law and

84  Rise of the Productive Crypto Economy and the Need for Regulation techniques that may be both externally addressed and internally embedded.224 The regulatory agenda can be developed to be inclusive as well as open-minded, and in this light, the ‘critical’ regulatory agenda proposed by Herian225 is welcome.

Society 145; N Gunningham and D Sinclair, ‘Smart Regulation’ in P Drahos (ed), Regulatory Theory (ANU Press, 2017, 1998 version) 133ff. 224 Such as legalising technological techniques or using ‘code as law’, discussed in Brownsword (2019) ch 3. 225 Herian (2019) ch 8.

3 Financial Regulators’ Approaches to the Crypto Economy I.  Regulatory Divergences Policy-makers across the world have been slow to take a proactive approach to the crypto economy. However, attention is increasingly turned to financial developments in the crypto economy as blockchain-based businesses raise development funds, and various forms of financialisation are being developed. This book advocates new policy approaches to blockchain business fundraising in chapter five, and other financial developments in chapter seven. In this chapter, we survey regulators’ responses to blockchain business fundraising in initial coin offerings (ICOs), in order to flesh out the predominantly coherentist regulatory thinking in many parts of the world. Regulators in different jurisdictions have taken rather different approaches towards ICOs.1 This is significant as regulators have been content to leave cryptocurrency such as Bitcoin unregulated since its introduction in 2009. However, ICOs have triggered a response from financial regulators,2 and this is arguably in relation to perceived arbitrage3 or the perceived opportunity for regulatory competition amongst securities regulators.4 We compare regulatory divergences for ICOs as these diverse approaches are institutionally shaped or affected by regulatory competition. In contrast, regulators have adopted relatively similar approaches to currency tokens as payment instruments, as discussed in chapter one, in terms of the universal extension of anti-money laundering laws. This is arguably in no small part due to the internationalisation of norms in this area5 and regional convergences such as in EU payment services regulation.6

1 A Blandin, AS Cloots, H Hussain, M Rauchs, R Saleuddin, JG Allen, B Zhang and K Cloud, ‘Global Cryptoasset Regulatory Landscape Study’ (September 2019), at ssrn.com/abstract=3379219, and see section II. Potentially, cryptoassets can cover currency such as bitcoin or ether as protocol tokens too, but this chapter adopts a narrower framing for its comparative purpose. 2 Blandin et al (2019). 3 eg U Rodrigues, ‘Semi-Public Offerings? Pushing the Boundaries of Securities Law’ (2018), at ssrn.com/ abstract=3242205. 4 IH-Y Chiu, ‘Decrypting the Signs of Regulatory Competition in the Crypto-economy’ (2020) 7 European Journal of Comparative Law and Governance 1. 5 The Financial Action Task Force’s recommendations on anti-money laundering; see www.fatf-gafi.org. 6 ch 1.

86  Financial Regulators’ Approaches to the Crypto Economy It may be queried as to why regulators have not sought coordination or convergence in the highly mobile and borderless ICO market. Although financial regulators engage in collective forums such as the Financial Stability Board (FSB), an international body that now has a clear mandate to oversee global systemic risks after the global financial crisis of 2007–09,7 it can be seen from documents issued by the FSB8 and the International Organization for Securities Commissioners (IOSCO)9 that national regulators have not sought international dialogue or convergence as the first step towards their consideration of regulatory policy in the new realm of ICOs. Indeed, international policy coordination or regulatory convergence is often an incentive-based and carefully considered manoeuvre, undertaken when problems of commons and mutual externalities compel such coordination.10 National regulators’ approaches reflect their engagement with a range of goals, from preventing regulatory arbitrage, investor protection to facilitating financial innovation to an appropriate extent. This may explain regulators’ preference for nationally based approaches. A number of jurisdictions have now pronounced the illegality of cryptoassets in different contexts and to different extents,11 while a number of jurisdictions explore a mixture of regulatory policy aimed at facilitating the useful innovations in the crypto economy while ensuring that the regulatory perimeter is appropriately extended, and regulatory arbitrage is prevented.12 This chapter provides a survey of the spectrum of divergent approaches in key jurisdictional examples, and argues that approaches based on prohibition are attempts at hegemonic domination, but they may encourage migration of activities. Approaches based on the existing regulatory perimeter, such as in the US or UK suffer from key blindspots in different ways. There are different driving factors for the adoption of divergent approaches, from institutionally based rationale to incentives for regulatory competition. However, we argue that on the whole, regulatory approaches narrowly targeted at the financial developments in the crypto economy are misplaced and miss much of the picture in relation to the growth of the crypto economy.

II.  Overview of Regulatory Approaches A number of jurisdictions have banned cryptoasset activities to different extents. China has banned cryptoasset commercial activity, ie purchasing, trading, intermediating cryptoasset investments, and exchange between fiat and cryptocurrency. The Chinese

7 www.fsb.org. 8 FSB, ‘Cryptoassets’ (May 2019), at www.fsb.org/wp-content/uploads/P310519.pdf. 9 IOSCO has not attempted to issue a clarification on cryptoassets’ characterisation but instead lists the divergent approaches of jurisdictions on its website; see www.iosco.org/publications/?subsection=ico-statements. 10 R Baldwin, M Cave and M Lodge, ‘Regulatory Competition and Coordination’ in Understanding Regulation: Theory, Strategy, and Practice (OUP, 2011); S Gadinis, ‘The Politics of Competition in International Financial Regulation’ (2008) 48 Harvard International Law Journal 447. 11 eg China, South Korea, Pakistan, Bangladesh, Ecuador, Bolivia and Kyrgyztan; see bitnewstoday.com/ market/bitcoin/countries-where-the-cryptocurrencies-are-banned-busted-for-bitcoin. 12 Switzerland, UK and the EU tend towards this approach. The US approach has a harsher tone with respect to preventing regulatory arbitrage, as will be discussed. Some jurisdictions such as Japan and Singapore take a more permissive approach by not extending the perimeter of certain financial regulations.

Overview of Regulatory Approaches  87 ban13 has been attributed to policy-makers’ concerns that cryptoasset investment and payment systems would facilitate the transfer of Chinese capital to overseas markets and evade capital controls put in place by the Government.14 Further, this ban is also in line with China’s crackdown on shadow banking in general, where financial activity has been shifting away from mainstream regulated institutions that are perceived to be too restrictive or expensive.15 However, a recent Shenzhen arbitral tribunal’s willingness to recognise property rights in cryptoassets so that they can be enforced16 creates confusion as to the legal position, as property rights illegally obtained in violation of the ban laws should be tainted by ex turpi causa. However, such a position may recognise the ‘grandfathered’ rights of cryptoasset holders acquired before the ban. This has not prevented the migration of crypto exchange activities elsewhere, for example Huobi and Binance are owned and operated by Chinese entrepreneurs and based outside of China, serving as offshore facilities. Important mining farms for maintaining the Bitcoin blockchain have also remained in China for a long time.17 Bans are also in place in jurisdictions such as Pakistan,18 Bolivia19 and Bangladesh20 where the use of cryptocurrency and cryptoassets, and the making payment or facilitation of transfer or investment in them are prohibited. These jurisdictions seem to be motivated by the need to protect the status of their national currency, to prevent erosion in use or value. In 2021, India has moved to ban cryptocurrency and would provide a transition period for users to cash out.21 South Korea has banned ICOs22 but, given its existing large markets in cryptocurrency trading, it does not ban cryptocurrency trading except that such trading cannot be anonymous.23 These prohibitive laws are more of a response to scams involving ICOs and money laundering allegations against poorly governed cryptocurrency exchanges. The concerns with regard to the unsafe nature of such investment assets also underlies Brazil’s ban on authorised local investment funds from investing in cryptoassets,24 13 ‘China Officially Bans All Crypto-Related Commercial Activities’ (August 2018), at bitcoinist.com/ china-officially-bans-crypto-activities/. 14 ‘China Bans All Crypto Events After Spending $3 Billion to Fund Blockchain Startups’ (22 August 2018), at www.newsbtc.com/2018/08/22/china-bans-all-crypto-events-after-spending-3-billion-to-fund-blockchainstartups. 15 eg see W Shen, Shadow Banking in China: Risk, Regulation and Policy (Edward Elgar, 2016) chs 5–9. 16 ‘Chinese Court Rules Bitcoin Should Be Protected as Property’ (26 October 2018), at www.coindesk.com/ chinese-arbitration-court-says-bitcoin-should-be-legally-protected-as-property. 17 ‘China, home to the world’s biggest cryptocurrency mining farms, now wants to ban them completely’ (South China Morning Post, 9 April 2019), at www.scmp.com/tech/policy/article/3005334/china-home-worldsbiggest-cryptocurrency-mining-farms-now-wants-ban. 18 ‘Pakistan bans cryptocurrencies’ (6 April 2018), at tribune.com.pk/story/1679446/2-pakistan-banscryptocurrencies. 19 ‘Bolivia’s Central Bank Bans Bitcoin’ (19 June 2014), at www.coindesk.com/bolivias-central-bank-bansbitcoin-digital-currencies. 20 ‘Central bank issues notice banning Bitcoin in Bangladesh’ (27 December 2017), at www.dhakatribune. com/business/banks/2017/12/27/bangladesh-bank-ban-bitcoin. 21 ‘India Grants Crypto Holders Reprieve Ahead of Likely Ban: Report’ (12 February 2021), at www. coindesk.com/crypto-india-ban-transitionary-period?utm_source=Sailthru&utm_medium=email&utm_ campaign=BITES%20FEB%2012%202021&utm_term=Blockchain%20Bites. 22 ‘Why South Korea had to ban crypto-ICOs’ (2 March 2019), at www.ccn.com/why-south-korea-bancrypto-ico-risk-billion-dollars. 23 ‘South Korea to ban cryptocurrency traders from using anonymous bank accounts’ (23 January 2018), at www.reuters.com/article/us-southkorea-bitcoin/south-korea-to-ban-cryptocurrency-traders-from-usinganonymous-bank-accounts-idUSKBN1FC069. 24 ‘Brazil regulator bans funds from buying cryptocurrencies’ (12 January 2018), at www.reuters.com/ article/brazil-bitcoin/brazil-regulator-bans-funds-from-buying-cryptocurrencies-idUSL1N1P71DV.

88  Financial Regulators’ Approaches to the Crypto Economy and in the UK’s and EU’s warnings against consumer participation in crypto markets.25 In Nigeria, financial institutions are banned from dealing in or exchanging for cryptocurrency,26 effectively not permitted to service accounts associated with cryptocurrency use. Regimes that introduce prohibitive laws do so for rather different reasons. Regimes that extensively prohibit crypto-economic activities do so because of the perceived institutional threat that cryptoassets pose to established currencies, institutions and regulatory controls. In this manner, the prohibitive response is addressed at the ‘anarcho-capitalist’ ethos underpinning the crypto economy.27 Regimes that introduce more targeted prohibitions tend to be driven by the need to protect consumers and the public, particularly because of historical scandals that fuel social appetite for regulatory intervention. Such targeted prohibitions may however result in institutional or sophisticated investor domination of the crypto economy.28 Nevertheless, prohibitive regulations do not prevent national activities from migrating elsewhere given the borderless nature of the crypto economy.29 Further, prohibitive regimes are necessarily circumscribed as they come too late – there is already wide circulation of cryptocurrencies that have become well accepted or adopted as ‘the monetary order’ for ICOs.30 As will be discussed below, a country31 that is introducing a regulatory regime for the crypto economy has even carved out exemptions acknowledging the ‘grandfathered rights’ of the pre-regulatory cryptocurrencies. That said, some prohibitive regimes may prohibit private cryptocurrency in order to promote their own digital currencies for domestic market use. This could have the effect of fencing in the domestic market and preventing leakage into other blockchains. For example, the Chinese ban does not affect its enthusiasm for developing the use of blockchain technology in mainstream commercial activity.32 Indeed, China has experimentally rolled out a digital yuan, a central bank digital currency (CBDC).33 The CBDC can become the native currency of blockchain-based businesses for the Chinese market, 25 See FCA, ‘Consumer warning about the risks of investing in cryptocurrency CFDs’ (November 2017), at www.fca.org.uk/news/news-stories/consumer-warning-about-risks-investing-cryptocurrency-cfds; ‘FCA bans the sale of crypto-derivatives to retail consumers’ (6 October 2020), at www.fca.org.uk/news/press-releases/ fca-bans-sale-crypto-derivatives-retail-consumers; ‘ESAs warn consumers of risks in buying virtual currencies’ (12 February 2018), at eba.europa.eu/-/esas-warn-consumers-of-risks-in-buying-virtual-currencies. 26 ‘Nigerian Central Bank Says Its Ban on Crypto Accounts Is Nothing New’ (7 February 2021), at www. coindesk.com/nigerian-central-bank-says-its-ban-on-crypto-accounts-is-nothing-new. 27 J Flood and L Robb, ‘Trust, Anarcho-Capitalism, Blockchain and Initial Coin Offerings’ (2017), at ssrn. com/abstract=3074263. 28 FCA, ‘Cryptoasset Consumer Research 2020’ (June 2020), at www.fca.org.uk/publication/research/ research-note-cryptoasset-consumer-research-2020.pdf, showing that although UK consumers may purchase cryptoassets without much background knowledge or research, the consumer footprint is small in cryptoasset markets. A slight increase from the same survey in 2019 was observed, but 75% of cryptoasset holders hold under £1,000’s worth, which means that the majority of consumers are not at severe financial risk. 29 ‘Why South Korea had to ban crypto-ICOs’ (2 March 2019), at www.ccn.com/why-south-korea-bancrypto-ico-risk-billion-dollars, discussing how project developers moved to use Japan as a base for token offerings instead, and M Huillet, ‘Skirting the Great Wall’ (4 November 2018), at cointelegraph.com/news/ skirting-the-great-wall-the-chequered-saga-of-crypto-in-china-2018. 30 Such as bitcoin, ether, litecoin etc, discussed in relation to the Thai regime below. 31 Thailand, see discussion later. 32 ‘China Bans All Crypto Events After Spending $3 Billion to Fund Blockchain Startups’ (22 August 2018), at www.newsbtc.com/2018/08/22/china-bans-all-crypto-events-after-spending-3-billion-to-fund-blockchainstartups/. 33 ‘China’s Central Bank Likely to Pilot Digital Currency in Cities of Shenzhen and Suzhou: Report’ (9 December 2019), at www.coindesk.com/chinas-central-bank-likely-to-pilot-digital-currency-in-cities-

Overview of Regulatory Approaches  89 and leaks of economic activity and capital out to other permissionless blockchain systems would be prevented. Although leading financial jurisdictions in the West have not adopted banning and draconian approaches that could signal unfriendliness to innovation, explicit bans have been adopted by the US and leading jurisdictions against the petro,34 a digital token invented by Nicolas Maduro, the dictator of Venezuela accused of electoral manipulation and not recognised by the US and many other states as the leader of Venezuela. The petro was purportedly based on the oil and natural resources reserves of Venezuela and would provide currency stability and avoid US economic sanctions. However, it suffers from an inherent lack of credibility as it is based on a forked chain of Dash, a private cryptocurrency, and there is no basis for the assertion that the petro is backed by the country’s natural resources. Many jurisdictions including the US are less unwelcoming of privately developed cryptocurrency or cryptoassets. Their approaches reflect a balance in relation to the desire not to stifle innovation, while ascertaining the needs for consumer and investor protection, and the risks to financial stability. Indeed, a few jurisdictions have started to introduce enabling regulation to attract the crypto economy, reflecting an incentive-based approach to regulatory policy driven by regulatory competition.35 Some jurisdictions however leave cryptoassets relatively unregulated, therefore facilitating ‘safe spaces’ for ICOs regarded as outside of regulators’ regulatory perimeter. However, not regulating also leads to a lack of clarity, and some jurisdictions are becoming proactively competitive by offering bespoke regimes that are designed to facilitate the crypto investment economy while providing clearer minimum standards. With a lack of international coordination, regulatory competition is alive in the space for regulating ICOs, as the crypto investment economy is borderless and highly mobile.36 The most notable regime providing a tailor-made regime for cryptoasset offerings is the EU, which, in light of Brexit, may be well placed to offer cryptoasset issuers an attractive capital markets regime. Recognised regulatory leaders in large conventional capital markets such as the US or UK have hitherto articulated mixed messages. They take a positive stance towards innovation,37 but they are also dominated by strong incumbent financial institutions that maintain close ties38 with regulators and policy-makers. Regulators may not wish

of-shenzhen-and-suzhou-report; ‘China’s digital currency: Beijing, Shanghai and Guangdong commit to new digital yuan trials in 2021’ (25 January 2021), at www.scmp.com/tech/policy/article/3119120/ chinas-digital-currency-beijing-shanghai-and-guangdong-commit-new. 34 ‘Venezuelan Petro against US Sanctions’ (17 July 2019), at cointelegraph.com/news/venezuelanpetro-against-us-sanctions-history-and-use-of-the-crypto. 35 Section V. 36 For a theoretical discussion, see W Bratton, J McCahery, S Piccioto and C Scott (eds), International Regulatory Competition and Coordination: Perspectives on Economic Regulation in Europe and the United States (Clarendon, 1997) ch 1 on how the mobility of incorporating entities matters for real regulatory competition. 37 eg Swiss Federal Council’s stance, see ‘Swiss Federal Council Opts for Minimal Regulation’ (CNN, 18 December 2018), at www.ccn.com/swiss-federal-council-opts-minimal-regulation; FCA, ‘Guidance on Cryptoassets’ (January 2019), at www.fca.org.uk/publication/consultation/cp19-03.pdf. The FCA also has a regulatory mandate to promote competition: Financial Services and Markets Act, s 1E. 38 The problem of regulatory capture of financial regulators is discussed for example in DC Hardy, ‘Regulatory Capture in Banking’ (IMF Working Paper, 2006) at ssrn.com/abstract=892925.

90  Financial Regulators’ Approaches to the Crypto Economy to stifle innovation, nor do they wish to prematurely legitimise the crypto investment economy. Further, leading regulatory jurisdictions have after the global financial crisis 2007–09 reformed financial regulation to a significant extent, such as in relation to ensuring comprehensive coverage by the regulatory perimeter and enhancing macrolevel supervision over financial activities, markets and institutions.39 Hence, these regulators may tend towards the perception that the regulatory perimeter is sufficiently expansive and well constructed. The sections below present a spectrum of regulatory approaches which is summed up in Figure 3.1 below. These approaches are discussed in turn before this chapter turns to overall critical reflections. Figure 3.1  Spectrum of regulatory approaches towards ICOs and crypto finance Prohibitive – banning the crypto economy, eg China, Bangladesh, Pakistan

Prohibitive minus – banning or restricting certain financial developments but not all the crypto economy, eg S Korea

Facilitative but restrictive – extension of existing regulations, eg US

Facilitative but permissive – selfregulatory/limited extension of regulation, eg UK, Switzerland

Enabling regimes to encourage crypto economy and financialisation, eg Malta, Thailand

III.  Facilitative but Permissive Regimes Regimes that are popular for the establishment of digital asset exchanges and ICOs have often become that way as a result of regulators refraining from extending the regulatory perimeter. In this section we discuss the UK, Switzerland and Singapore as regimes that apparently defend their regulatory perimeter and financial regulatory reputations but leave a large section of cryptoassets unregulated. The UK may however be compelled40 to consider its unregulated position in light of the EU’s proposed bespoke regulatory regime for ICOs. Switzerland first proposed the three-fold classification of cryptoassets as payment, securities and utility tokens. In 2018, Switzerland clarified that payment and utility tokens are not subject to securities law, and indirectly permitted them to be offered as being outside of the securities regulatory perimeter, via the process of seeking a ‘no-action’ letter from FINMA.41 Only offers of securities tokens are to be in compliance with securities regulation. Singapore also clarifies that only tokens that are equivalent to shares, debentures or securities-based derivative contracts or units in 39 See generally M Andenas and IH-Y Chiu, The Foundations and Future of Financial Regulation (Routledge, 2014). 40 HM Treasury, ‘Regulatory Approach to Cryptoassets and Stablecoins’ (January 2021), at assets.publishing. service.gov.uk/government/uploads/system/uploads/attachment_data/file/950206/HM_Treasury_Cryptoasset_ and_Stablecoin_consultation.pdf. 41 ‘How FINMA’s ICO Guidelines impact future ICOs in Switzerland’ (KPMG, 26 February 2018), at home. kpmg/ch/en/home/insights/2018/03/how-finmas-ico-guidelines-impact-future-icos-in-switzerland.html. Also see D Zelic and N Baros, ‘Cryptocurrency: General Challenges of Legal Regulation and the Swiss Model of Regulation’ paper presented at 33rd International Scientific Conference on Economic and Social Development, ‘Managerial Issues in Modern Business’, Warsaw, 26–27 September 2018.

Facilitative but Permissive Regimes   91 collective investment schemes are caught within its regulatory perimeter for capital markets products.42 Singapore enacted a Payment Services Act in 2019 to capture cryptocurrency exchanges as digital token service providers, but the definition of dealing in digital tokens excludes developers who issue them to subscribers, and only covers centralised crypto exchanges.43 Although no formal exemption regimes are articulated in ­Switzerland or Singapore, coherentist approaches are taken to defend the existing regulatory perimeters for securities and payment regulations. In this manner, the sales of future rights in utility tokens, which are the majority of ICOs, may be implicitly not covered and unregulated. Indeed, examples of utility tokens not covered by Singapore’s regulatory perimeter are provided in the Monetary Authority’s guidance.44 This approach reflects the desire to embrace innovation and prevent existing regulation from unduly stifling such innovation. Further, this approach also strengthens the appearance of the robustness of existing regulation and law. Such an approach is essentially based on not expanding the existing regulatory perimeter. The Financial Conduct Authority (FCA) in the UK, after consulting on the regulatory perimeter for cryptoassets,45 has adopted the three-fold token classification first adopted by the Swiss authority. The FCA clarifies46 that only tokens that confer investment and/or governance rights would fall within the scope of securities tokens, and that payment and utility token offerings do not have to comply with securities regulation. Other commercial or business regulations such as anti-money laundering, advertising and data management laws however apply across the board and hence participants in the financial aspects of the crypto economy should not see themselves as beyond regulation totally. Further, engagement by financial advisers, brokers and markets in relation to cryptoassets could be subject to existing regulatory regimes for regulating these entities. The FCA is also keen to emphasise that it provides consultation opportunities for innovation and the regulatory sandbox provides a safe space for testing innovations that may need financial regulatory authorisation.47 The three-fold token classification approach allows the UK, like Switzerland and Singapore, to delineate the regulatory perimeter, achieving a form of refrain from over-regulating the crypto economy. The chief benefit is that such implicit permission may be a way of keeping the productive crypto-economic sphere from being stifled by regulation. Indeed, the Swiss have also engaged in dismantling existing outdated legal and technological barriers to participation in the crypto economy. The Swiss Federal Council has finalised a report48 resulting in legislation in Switzerland. Laws are now introduced to enable legal recognition and treatment of digital and data-based assets as 42 Monetary Authority of Singapore, ‘A Guide to Digital Token Offerings’ (26 May 2020), at www.mas.gov. sg/-/media/MAS/Sectors/Guidance/Guide-to-Digital-Token-Offerings-26-May-2020.pdf (MAS Guidance). 43 Part 3, Sch 1 and s 13. 44 eg Case studies 1, 8, 9, MAS Guidance (2020) 10, 16–17. 45 FCA, ‘Consultation: Guidance on Cryptoassets’ (January 2019)’ at www.fca.org.uk/publication/consultation/ cp19-03.pdf. 46 FCA, ‘Guidance on Cryptoassets Policy Statement’ (July 2019), at www.fca.org.uk/publication/policy/ ps19-22.pdf. 47 ch 5; and ibid. 48 ‘Swiss Federal Council Opts for Minimal Regulation’ (18 December 2018), at www.ccn.com/swissfederal-council-opts-minimal-regulation; ‘Swiss Government Makes Moves to Encourage Crypto Businesses’ (1 July 2020), at www.coindesk.com/swiss-government-makes-moves-to-encourage-crypto-businesses.

92  Financial Regulators’ Approaches to the Crypto Economy assets such as in civil enforcement and insolvency administration. The UK, Switzerland and Singapore remain highly popular jurisdictions for conducting utility token issuances due to the permissive stances adopted.49 It can be argued that this is tantamount to a race to the bottom, although the jurisdictions appear to defend their existing securities, investments and payment services laws and regulations. However, it may also be argued that the self-regulatory approach reflects the perception that blockchain-based businesses are self-regulatory in nature, and crucially rely on peer-to-peer exchange and do not create business–consumer relationships. This regulatory approach would not cater for the governance of the commons in blockchain economies,50 the needs for which are discussed in chapter two. Although popular ICO jurisdictions have not taken an extensive approach to their regulatory perimeter, this could be a gateway to regulatory arbitrage.51 In this respect US regulators have acted more forcefully, but the desire to promote innovation on the other hand countervails the development of consistency and clarity in US regulatory policy. We turn to these shortly, but we observe that jurisdictions such as Switzerland and Singapore that have adopted permissive policies by a limited form of regulatory interpretation have also begun to introduce new protective laws in order to deal with the externalities generated by permitting crypto economic activities. These laws ensure that anti-money laundering laws and tax laws are not compromised, and that the foray of financial intermediaries into digital assets is properly scrutinised. Singapore’s Payment Services Act is one such response. Under the Act, customers using cryptocurrency payment tokens are entitled to the same standard of protection as other customers using conventional payment services, and regulatory fragmentation and arbitrage is minimised. In the EU, tokens that meet the characteristics of payment instruments can only be offered in compliance with existing regulation in relation to anti-money laundering regulations.52 The UK has started consultation53 on whether the regulation of financial promotion should be extended to cryptoassets even if they are not securities tokens, signalling an ambiguous approach, as cryptoassets may at the same time be within the regulatory perimeter for financial regulation, but not fully. The UK regulates the marketing of promotions for financial products and services by requiring that such communications be made in a responsible and regulated manner by authorised financial intermediaries,54 49 icobench.com/stats under ‘Top countries by raised funds’. 50 Oström (1990); OECD, ‘Trust In Peer Platform Markets’ (OECD Paper 263/2017); M Cantero Gamito, ‘Regulation.com. Self-Regulation and Contract Governance in the Platform Economy: A Research Agenda’ (2017) 9 European Journal of Legal Studies 53; M Rocas-Royo, ‘Decentralization as a New Framework for the Sharing Economy’ in RW Belk, GM Eckhardt and F Bardhi (eds), Handbook of the Sharing Economy (Edward Elgar, 2019) ch 17. 51 Rodrigues (2019). 52 The EU has also brought crypto-currency transactions within its anti-money laundering regime by the 5th Anti-Money Laundering Directive amending Art 2(1)(3) of the Anti-Money Laundering Directive 2015, at Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU, at/eur-lex.europa.eu/ legal-content/EN/TXT/?uri=CELEX%3A32018L0843. 53 HM Treasury, ‘Cryptoasset Promotions: A Consultation’ (July 2020), at assets.publishing.service.gov.uk/ government/uploads/system/uploads/attachment_data/file/902891/Cryptoasset_promotions_consultation.pdf. 54 Financial Services and Markets Act 2000, s 21; FCA Handbook COBS 4.2–4.10.

Facilitative but Restrictive Regime – The US Regulatory Approach  93 their delegates or by exempt persons.55 By exploring whether to subject promotions for cryptoassets to this regulatory regime, the FCA does not clarify whether and what financial product cryptoassets may be. Although the policy is aimed at consumer and investor protection, the approach at the same time signals a continuing minimalist regulatory stance on cryptoassets. The Treasury has, arguably in light of the EU’s proposal to offer cryptoassets a bespoke regulatory regime,56 now embarked on a consultation on whether cryptoassets should be regulated and to what extent. The consultation is framed in open-ended terms without signalling a preference for specific regulation. The dynamic position in the UK reflects the policy-makers’ and regulators’ balancing of contesting needs and considerations of regulatory competition. Other jurisdictions have also taken patchwork approaches to cryptoassets and the crypto economy, possibly reflecting the balances they aim to strike between promoting innovation and protecting investors and consumers. This patchwork approach is on the one hand proportionate and deals with observed problems, but on the other hand misses a more holistic picture of the crypto economy as a productive space for economic development. Canada and Japan are introducing specific regulations to deal with problems that have already surfaced. Canada57 has introduced securities intermediary regulation for cryptoasset custodial and exchange enterprises, after the failure of the QuadrigaCX cryptoasset exchange.58 Japan, although well known for its liberal stance on cryptoasset exchanges, is also introducing regulatory standards59 for crypto intermediaries such as exchanges and derivatives dealers after the spectacular failure of bitcoin exchange Mt Gox60 in 2013 and the cyber-heist at Coincheck in 2018.61 Regulators seem to be still missing the larger picture of the crypto economy as a whole.

IV.  Facilitative but Restrictive Regime – The US Regulatory Approach In comparison with the ‘facilitative but permissive’ regimes discussed above, the approach in the US is relatively mixed and unclear. The US features a mixture of statebased and federal approaches to the crypto economy reflecting the dilemmas in its enabling as well as protective policy orientations. This may also be attributed to its 55 Exempt persons in the Financial Promotions Order 2005, but exempt persons are subject to the same standards of communications and conduct governing authorised financial intermediaries, see Atlantic Law LLP v FSA (Upper Tribunal March 2010). 56 Discussed below. 57 ‘Canada Proposes Regulatory Framework for Cryptocurrency Exchanges’ (15 March 2019), at www.coindesk.com/canada-proposes-regulatory-framework-for-cryptocurrency-exchanges; ‘New Guidelines Subject Canadian Crypto Exchanges to Securities Laws’ (18 January 2020), at news.bitcoin.com/newguidelines-subject-canadian-crypto-exchanges-to-securities-laws. 58 ‘$150 Million Scandal of Canada’s Biggest Crypto Exchange Sees New Twist in Dead CEO’s 2014 Interview’ (17 February 2019), at www.ccn.com/150m-scandal-canadas-biggest-crypto-exchange-ceo-2014-interview. 59 ‘Japan Implements Significant Changes to Cryptocurrency Regulation Today’ (30 April 2020), at news. bitcoin.com/japan-changes-cryptocurrency-regulation. 60 D Pollock, ‘The Mess That Was Mt. Gox: Four Years On’ (9 March 2018), at cointelegraph.com/news/ the-mess-that-was-mt-gox-four-years-on. 61 ‘Japan Authorities Raid Coincheck After $500 Million Heist’ (Bloomberg, 2 February 2018), at www. bloomberg.com/news/articles/2018-02-02/japan-authorities-raid-coincheck-office-after-500-million-heist.

94  Financial Regulators’ Approaches to the Crypto Economy sectoral regulatory system that introduces a multiplicity of goals for financial regulation stewarded by each agency.62 Nevertheless, it is home to the largest and oldest cryptocurrency exchange, Coinbase, and at the height of 2017 was the top ICO jurisdiction. Regulatory policy in the US is very much crafted along the lines of established sectoral delineations. The regulatory regime for money service businesses is applicable to cryptocurrency, the regulatory regime for securities offers is applicable to ICOs and the regulatory regime for commodities, futures and derivatives trading is applicable to crypto derivatives. There are policy indications at state level in relation to welcoming innovation and the new opportunities that the crypto economy can offer.63 However, federal regulators, ie the Securities and Exchange Commission (SEC) and the Commodities and Futures Trading Commission (CFTC), signal tougher stances against regulatory arbitrage and the need to secure investor protection and market integrity.64 The dilemmas and patchwork approaches towards ICOs in the US are unlikely to be resolved as a whole due to the delineation of jurisdiction between states, the SEC and CFTC. Further, the sectoral-based regulatory approach in the US means that stablecoins have been categorised with deposit products and have been proposed to be subject to bank regulation.65 It has been mooted in the US that a federal regulator for cryptoassets, broadly including currency, securities and derivatives, should be instituted to overcome the potential inconsistencies in legal interpretation caused by sectoral and existing regulatory delineations.66 Such change seems unlikely, however, as the proposed Cryptocurrency Act 2020, which promotes an enabling regime to recognise cryptoassets, is still structured along the same sectoral lines.67 Money service businesses are regulated by both states and federally, with the Financial Crimes Enforcement Network (FinCen) federally responsible for anti-money laundering enforcement if money laundering is implicated in cryptocurrency transmissions.68 Many states do not explicitly licence and monitor cryptocurrency businesses and therefore leave these unregulated by default.69 This is increasingly regarded as untenable as consumer protection is not secured and some call for adoption of uniform laws on regulating cryptocurrency businesses as money service businesses.70 As chapter one discussed, New York introduced its BitLicense scheme71 in 2015 and the Uniform Regulation of Virtual Currency Businesses Act has been enacted in Rhode Island. 62 HE Jackson, ‘Regulation in a Multi-sectored Financial Services Industry’ (1999) 77 Washington University Law Quarterly 319. 63 Over money service businesses, see discussion below. 64 See discussion below. 65 tlaib.house.gov/sites/tlaib.house.gov/files/STABLEAct.pdf. 66 Congress Considers Federal Crypto Regulators In New Cryptocurrency Act of 2020’ (19 December 2019), at www.forbes.com/sites/jasonbrett/2019/12/19/congress-considers-federal-crypto-regulators-in-newcryptocurrency-act-of-2020/#3964f8ca5fcd. 67 www.congress.gov/bill/116th-congress/house-bill/6154/text?q=%7B%22search%22%3A%5B%22cryptocurrency+act%22%5D%7D&r=1&s=2. 68 SD Hughes, ‘Cryptocurrency Regulations and Enforcement in the U.S.’ (2017) 45 Washington State University Law Review 1. 69 ‘Bitcoin and Cryptocurrency Laws in All 50 States’ (30 June 2018), at coiniq.com/bitcoin-andcryptocurrency-laws-usa. 70 SJ Hughes and ST Middlebrook, ‘Advancing a Framework for Regulating Cryptocurrency Payments Intermediaries’ (2015) 32 Yale Journal on Regulation 295. 71 NY Comp Code Rules & Regs. tit 13, ch 1, pt 200 (2015), at www.dfs.ny.gov/legal/regulations/adoptions/ dfsp200t.pdf.

Facilitative but Restrictive Regime – The US Regulatory Approach  95 The Regulation of Virtual Currency Businesses is derived from the Uniform Laws Commission’s endeavours to introduce a standardised template for states regulating virtual currency money service businesses.72 The Uniform Act potentially covers all forms of tokens, but explicitly excludes securities or commodities. Policy clarification in relation to the scope of the regulatory perimeter remains tentative. In part this is due to the difficulty in classifying tokens within existing regulatory regimes,73 but neither the SEC nor CFTC shows signs of admitting that the regulatory perimeter may itself be limited for the nature of the innovations under examination.74 The legal uncertainty in clarification is exacerbated by the jurisdictional delineations between states, the SEC and CFTC,75 which are not always easy to resolve. Since the SEC’s investigative report that the ICO made by the decentralised autonomous organisation (DAO) was an unregistered securities offering,76 it is clear that tokens that confer some form of ultimate investment interest would be categorised as a security. The SEC’s guidance77 has however developed further to capture utility tokens along a functional–financialised spectrum, as discussed in chapter one, and this has caused many developers to be risk averse to ICOs, preferring to offer future rights in tokens to accredited investors under Regulation D instead.78 Guseva argues that this approach is also sub-optimal as the information environment in private placements is not any more improved for investors.79 The SEC treats many cryptoassets that are listed for secondary trading as prima facie securities, as trading is meant to enhance investment value. However, this ignores the self-regulatory underpinning of secondary market trading as offering liquidity and exit for supporters. To sacrifice such liquidity may damage the prospects of the project itself. This approach is sub-optimal as the SEC’s might80 has the potential to stifle legitimate queries regarding the doctrinal fit of the Howey test to token offerings. In the case relating to the DAO, the SEC characterised the DAO’s token issuance as a security offering because tokens were issued to participants to contribute to a common enterprise, and participants reasonably expected to earn profits through the 72 See www.uniformlaws.org/committees/community-home?CommunityKey=e104aaa8-c10f-45a7-a34a0423c2106778, also discussed in ch 1 of this book. 73 R Brownsword, ‘Regulatory Fitness: Fintech, Funny Money, and Smart Contracts’ (2019) 20 European Business Organisations Law Review 5. 74 The SEC’s approach is focused on making coherentist interpretations of token offerings in relation to the definition of ‘security’; see above; Clayton’s response to Ted Budd, at coincenter.org/files/2019-03/claytontoken-response.pdf; SEC, ‘Statement on Digital Asset Securities Issuance and Trading’ (16 November 2018), at www.sec.gov/news/public-statement/digital-asset-securites-issuuance-and-trading. The CFTC is also focused on interpreting the nature of crypto activities to determine if they fall within its jurisdictional scope; see CFTC, ‘CFTC Staff Issues Advisory for Virtual Currency Products’ (21 May 2018), at www.cftc.gov/PressRoom/ PressReleases/7731-18, again reflecting a coherentist approach; see Brownsword (2019) above. 75 Historical contentions over jurisdiction are discussed in DR Fischel, ‘Regulatory Conflict and Entry Regulation of New Futures Contracts’ (1986) 59 The Journal of Business S85. 76 SEC, ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO’ (25 July 2017), at www.sec.gov/litigation/investreport/34-81207.pdf. 77 www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets. 78 M Mendelson, ‘From Initial Coin Offerings to Security Tokens: A U.S. Federal Securities Law Analysis’ (2019) 22 Stanford Technology Law Review 52. 79 Y Guseva, ‘Cryptoassets: A Cost-Benefit Analysis of Enforcement Actions and Securities Regulation’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3547787. 80 ‘Two ICO Issuers Settle SEC Registration Charges, Agree to Register Tokens as Securities’ (16 November 2018), at www.sec.gov/news/press-release/2018-264.

96  Financial Regulators’ Approaches to the Crypto Economy DAO’s principal objective, which was to fund other projects for a profitable return. As discussed in chapter one, this is criticised by Oren81 and Metjahic82 as they find more resemblance between the DAO and private partnerships. Subscribers each actively vote to signal their support for particular projects and are not passive or dependent on the efforts of others. It may be argued that the platform was developed by others, but it is unclear if such development alone is proximate to investors’ reasonable expectations of profit. Investors’ reasonable expectations of profit are based on their informed voting for funding particular projects. The lack of clarification as to the extension of the regulatory perimeter serves a deterrent purpose against scams but may be over-inclusive. At the time of writing, the SEC has filed lawsuits against Ripple Labs Ltd and its senior executives for its ICO of XRP tokens, which the SEC regards as an unregistered public offering of securities.83 Ripple Labs Ltd has however been thought of as being at the forefront of innovation.84 It is arguably not optimal that the US continues to lack holistic policy thinking in respect of innovations in the crypto economy and its financial development.85 The SEC’s approach is likely to funnel ICOs down safe exemptions in relation to small offers such as Regulation A or A+, or Regulation D for accredited investors. This may severely curtail retail participation. As blockchain-based businesses are fundamentally peer-to-peer networks that provide opportunities for anyone to join in the enterprise and financialised aspects,86 the prevention of retail participation in the name of retail investor protection ironically leads to the result of their marginalisation from an innovative economic frontier. This may be contrary to the ethos and intentions of blockchain-based business developers. Further if developers are forced to fundraise in private markets, the demographics of the crypto economy can be radically shaped by involving financiers instead of economic actors from a diverse landscape. The SEC seems open to explore no-action letters with potential ICO developers, but these soundings are relatively unclear87 and such letters seem difficult to secure.88 The uncertainty relating to the regulatory characterisation of ICOs also affects other financial developments in the crypto economy. Digital asset exchanges involved in trading tokens would have to be registered as exchanges or broker-dealers, if these 81 O Oren, ‘ICO’s, DAO’s, and the SEC: A Partnership Solution’ (2018) 2018 Columbia Business Law Review 617. 82 L Metjahic, ‘Deconstructing the DAO: The Need for Legal Recognition and the Application of Securities Laws to Decentralized Organizations’ (2018) 39 Cardozo Law Review 1533. 83 ‘SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering’ (22 December 2020), at www.sec.gov/news/press-release/2020-338. 84 How the XRP token is used is detailed in ‘14 Common Misunderstandings About Ripple And XRP’ (7 March 2019), at www.forbes.com/sites/thomassilkjaer/2019/03/07/14-common-misunderstandings-aboutripple-and-xrp/?sh=2774178371d0; and also see ‘Ripple Receives Praise From American Express’ (18 ­December 2018), at cryptodaily.co.uk/2018/12/ripple-receives-praise-from-american-express. 85 A number of commentators suggest that dedicated policy thinking is needed and possibly a tailor-made regime; see Rodrigues (2019); J Rohr and A Wright, ‘Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets’ (2017), at ssrn.com/abstract=3048104. 86 A Killeen, ‘The Confluence of Bitcoin and the Global Sharing Economy’ in DKC Lee (ed), The Handbook of Digital Currencies (Elsevier, 2015) ch 24. 87 H Vandelay, ‘SEC Hints at Flexibility for Crypto Startups Through “No Action” Letter’ (14 December 2018), at bitcoinnews.com/sec-hints-at-flexibility-for-crypto-startups-through-no-action-letter. 88 ‘SEC’s First Crypto ‘No-Action’ Letter Took 11 Months to Secure’ (3 April 2019), at www.coindesk.com/ secs-first-crypto-no-action-letter-took-11-months-to-secure.

Facilitative but Restrictive Regime – The US Regulatory Approach  97 are regarded as securities.89 It is queried if policy-makers would take a view towards enabling crypto economy activities, such as in the case with regard to enabling online crowdfunding.90 Joined-up thinking is not yet evident, and we turn to the CFTC’s approach. The CFTC’s remit extends to trading in various derivative contracts specified in legislation. The Commodities Exchange Act administered by the CFTC requires registration of trading operators and empowers the CFTC to exercise enforcement authority over fraudulent or manipulative activity on markets.91 Although the CFTC’s Advisory does not clarify what tokens are likely to be treated as ‘commodities’,92 a number of enforcement decisions potentially have wide import. In the CFTC’s enforcement against My Big Coin Pay Inc,93 which is a token designed to be a cryptocurrency interchangeable for other cryptocurrencies, but purportedly backed by gold, the decision can be interpreted narrowly or more broadly. A narrower interpretation would be confined to the CFTC’s enforcement against fraudulent schemes, as My Big Coin was issued in order to fund the founder’s lavish lifestyle and not for project development. This is similar to the enforcement against McDonnell,94 and such enforcement may signal that non-fraudulent token offers may not attract enforcement. However, the basis for enforcement against fraudulent schemes is that a commodity is involved and the characterisation of My Big Coin as a commodity95 would potentially implicate most currency tokens of a similar nature. Further, as utility tokens are presales and would likely involve future delivery beyond the spot market exemption of 28 days, they could also fall within the definition of commodity futures.96 It remains unclear whether tokens designed as exchange or currency tokens would be caught if spot delivery can be achieved. The CFTC’s enforcement against Bitfinex,97 a crypto trading platform that allows leveraged trading and future delivery beyond 28 days, and Coinflip,98 a crypto trading platform in swaps and options, seem to indicate that enforcement is based on the ‘futures’ aspects of trading. 89 SEC, ‘Statement on Digital Asset Securities Issuance and Trading’ (16 November 2018), at www.sec.gov/ news/public-statement/digital-asset-securites-issuuance-and-trading. 90 Regulation A+. 91 US Commodity Exchange Act 7 US. § 2a(1)(A)–(C). 92 CFTC, ‘Customer Advisory: Use Caution When Buying Digital Coins or Tokens’ (July 2018), at www.cftc. gov/sites/default/files/2018-07/customeradvisory_tokens0718.pdf. 93 CFTC v My Big Coin Pay Inc (26 September 2018), at www.cftc.gov/sites/default/files/2018-10/enfmy bigcoinpayincmemorandum092618.pdf. 94 ‘Court Orders Defendants to Pay over $1.1 Million in Penalties and Restitution in Connection with the “Vicious Defrauding of Customers”’ (24 August 2018), at www.cftc.gov/PressRoom/PressReleases/7774-18. 95 See decision above, where Justice Zabel refers to the definition of ‘commodity’ in the Commodity Exchange Act in order to determine the nature of My Big Coin and found in favour of the CFTC’s argument that My Big Coin is a commodity. 96 Commentators have noted that over the years, although the CFTC’s jurisdiction has broadened over all sorts of commodities, there is also a rise in the liberation of trading in their derivatives. Hence inclusion within the scope of ‘commodity’ is not the same as achieving a prohibitive effect, see AG Balmer, Regulating Financial Derivatives (Edward Elgar, 2018) ch 8; C Muellerleile, ‘Speculative Boundaries: Chicago and the Regulatory History of US Financial Derivative Markets’ (2015) 47 Environment and Planning 1805. 97 ‘CFTC Orders Bitcoin Exchange Bitfinex to Pay $75,000 for Offering Illegal Off-Exchange Financed Retail Commodity Transactions and Failing to Register as a Futures Commission Merchant’ (2 June 2016), at www.cftc.gov/PressRoom/PressReleases/pr7380-16. 98 In the Matter of Coinflip, Inc, d/b/a Derivabit, and) Francisco Riordan and the CFTC (17 September 2015), at www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/ enfcoinfliprorder09172015.pdf.

98  Financial Regulators’ Approaches to the Crypto Economy There is potentially comprehensive jurisdiction that the CFTC can assert over tokens if an expansive interpretation of ‘commodity’ is taken.99 However the CFTC’s advisory seems to respect the SEC’s jurisdiction over tokens ‘if initial buyers are told that the developers or promoters will bring them a return on their investments, or if the buyers are promised a share of future returns of the project’.100 The lack of clarity between the SEC’s and CFTC’s jurisdiction reflects a historical tension between the regulators in asserting jurisdiction over new financial instruments.101 This stalemate of clarification heightens legal risk for ICOs. Even if clarity between the SEC and CFTC is not achieved, the overall perception of extensive regulatory nets that may overlap and capture regulatory arbitrage could constitute an effective deterrent approach in the US to ICOs. Empirical research presents contrary findings as to the proportion of scams in the ICO universe,102 therefore raising the question whether a strongly deterrent approach is necessary. A deterrent approach would only be efficient if it effectively weeds out ICO scams while preserving incentives for genuine entrepreneurship in the crypto economy. Hence it is important to discern if the expansive regulatory nets cast by the SEC and CFTC are over-inclusive. It may be argued that the CFTC’s enforcement is targeted at scams, and being ex post in nature, it is not severely disincentivising to genuine entrepreneurs that wish to conduct an ICO. However, the SEC’s regulatory net is wide and ex ante in nature, and captures many ICOs as long as some financialised characteristics exist alongside functional ones. The fostering of beneficial and genuinely innovative developments requires different and proportionate regulatory policy thinking, such as a framework like Regulation A+ that is aimed at fostering online crowdfunding, or the Uniform Law Commission’s enabling regulatory framework for virtual currency business. US policy on the crypto economy would benefit from joined-up thinking amongst the various regulatory locations for regulatory development and reform. Further, the proposed Stable Act103 in the US reflects an agenda to regulate stablecoin issuers, whose product may be pegged to the US dollar or to any other foreign currency. They would be regulated as deposit-taking institutions to be authorised by the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of Currency. In this manner, stablecoins would be treated as deposits and bank regulation is extended to stablecoin issuers. This proposal is likely to find traction in the US, over the more enabling regime in the Cryptocurrency Act,104 which proposes to legitimise various types of cryptoassets but does not provide detail in terms of their regulatory oversight. Cloots argues that the Stable Act is likely to result in many private stablecoins being outlawed for circulation in the US.105 Nevertheless, the Office for 99 N Tiwari, ‘The Commodification of Cryptocurrency’ (2019) 117 Michigan Law Review 612. 100 See CFTC Customer Advisory (July 2018) above. 101 Fischel (1986) above. 102 A Alexandre, ‘New Study Says 80 Percent of ICOs Conducted in 2017 Were Scams’ (2018), at coin telegraph.com/news/new-study-says-80-percent-of-icos-conducted-in-2017-were-scams, compared to Hornuf et al (2019) that estimate about only over 10% as unviable or scams. 103 tlaib.house.gov/sites/tlaib.house.gov/files/STABLEAct.pdf. 104 www.congress.gov/bill/116th-congress/house-bill/6154/text?q=%7B%22search%22%3A%5 B%22crypto-currency+act%22%5D%7D&r=1&s=2. 105 AS Cloots, ‘DeFi: Regulatory Approaches, Risks and Promises’ (NUS Centre for Banking and Financial Law lecture, 1 April 2021).

Enabling Tailor-Made/Special Regimes   99 Comptroller of Currency takes a permissive stance allowing crypto custodial services to be provided as part of bank services.106 This may pave the way for incumbent banks to develop tokenisation projects, whether related to the crypto economy or otherwise, as will be discussed in chapter seven. Although regulation like the Stable Act addresses the recent saga of Tether’s settlement with the New York Attorney-General,107 and also addresses shadow banking and money laundering risks with private stablecoins, there are two concerns. One is that a number of stablecoin projects are intended to serve the monetary order of the crypto economy, and little thought is given to the enterprise and developmental aspects of the crypto economy in such strategies of financial regulatory extension. Second, the sectoral approach to financial regulation does not fully capture innovative characteristics, such as the multifunctional nature of stablecoins as both payment instrument and asset. There are early indications in the US towards confronting the limitations of a sectoral approach. In March 2021, a cross-party Bill was introduced in Congress to enable the SEC and CFTC to form a cross-sectoral working committee to clarify the status of cryptoassets with a view towards supporting innovation in the US.108 We now turn to jurisdictions that have attempted to distinguish themselves by holding out attractive and forward-looking regimes for the relocation of crypto-economic activities and investments. The section below provides a survey of key examples of jurisdictions that are trying to gain first-mover advantage in the landscape of regulatory competition by providing enabling regulatory regimes for the crypto economy.

V.  Enabling Tailor-Made/Special Regimes We now turn to jurisdictions that have taken the approach of providing tailor-made regulatory regimes to facilitate crypto economy activities and investment. These jurisdictions seek to capture financial aspects of crypto economy activities such as securities or investment activity, offering a relatively pared-down framework compared to conventional regulatory regimes. These initiatives may be based on the perceived benefits of regulatory competition: to attract ICOs to emerging financial jurisdictions in order to boost their regulatory market share. The enabling regimes may also be based on the desire to attract issuer relocations, hence bringing in for the local economy incorporation fees and other revenues related to professional services in the jurisdiction concerned.109 The early movers in this space tend to be smaller jurisdictions with 106 ‘US Regulator Green-Lights Banks for Cryptocurrency Custody Services’ (23 July 2020), at news.bitcoin. com/us-regulator-banks-cryptocurrency-custody. 107 ‘Cryptocurrency firms Tether and Bitfinex agree to pay $18.5 million fine to end New York probe’ (CNBC, 23 February 2021), at www.cnbc.com/2021/02/23/tether-bitfinex-reach-settlement-with-new-york-attorneygeneral.html#:~:text=Cryptocurrency%20firms%20Tether%20and%20Bitfinex%20reached%20an%20 agreement%20with%20the,a%20closely%2Dwatched%20legal%20dispute. 108 H.R.1602 – To direct the Commodity Futures Trading Commission and the Securities and Exchange Commission to jointly establish a digital asset working group, and for other purposes, at www.congress.gov/ bill/117th-congress/house-bill/1602?q=%7B%22search%22%3A%5B%22mchenry+AND+%5C%22digital+ asset%5C%22%22%5D%7D&s=1&r=2. 109 H Eidenmuller, ‘The Transnational Law Market, Regulatory Competition, and Transnational Corporations’ (2011) 18 Indiana Journal of Global Legal Studies 707.

100  Financial Regulators’ Approaches to the Crypto Economy aspirations for growing their capital markets. The EU has however joined this space with an agenda for cryptoasset regulation that also provides for pan-European offers to be made, an enabling measure for market access. It may be queried whether regulatory regimes designed with the incentives of regulatory competition in mind may over-emphasise the financial aspects of the crypto economy so as to attract mobile investment capital. It remains to be seen whether such incentives may underpin a race to the top or bottom in terms of regulatory standards.110

A. Thailand An early proactive regime that has already passed legislation is Thailand. Thailand offers an authorisation regime111 for ICOs whether they are designed to function as crypto-currency (ie medium of exchange), utility tokens (ie conferring rights in respect of future goods or services) or securities tokens (ie conferring rights in respect of participation in investment). The Thai regime also caters for authorising ICO portals (ie the platforms used for conducting token offers), digital asset exchanges, brokers and dealers. However, recognising that regulation operates in a landscape where the unregulated crypto economy has already established its own marketplaces and practices, a list of seven established cryptocurrencies are exempt from the regime and authorised as permitted media of exchange for tokens.112 Further, if an ICO of utility tokens is made for goods and services already in use, such offerings are exempt, suggesting that this would be treated as general sales and not investment products. Central bank operations in the digital crypto sphere would also be exempt, and intermediaries dealing in digital assets pegged at a fixed exchange rate to the Thai baht (stablecoin) could also be exempt if they satisfy compliance with anti-money laundering regulations. The Thai authorisation regime seems to be a pared down version of the securities regulation model, appealing to attract crypto businesses. It requires issuers to file a registration statement and prospectus containing the key aspects of business plan, token type and rights conferred, the source code and the terms and conditions of the smart contracts used for executing token subscription. The disclosure statements are vetted by the authorised ICO portal over which the token offering must be conducted as well as by the Office of the Securities Exchange Commission (SEC). Issuers are to be registered corporate personalities in Thailand, and the SEC seems to reserve discretion in vetting if the company’s management is of good repute, has a ‘fundamentally sound business plan’, and is financially sound, from its audited financial statements. ICOs may be made to sophisticated, high-net-worth and institutional investors, and retail investors subject to an investment cap for minimising their exposure. The Thai regime also regulates ICO portals, digital asset exchanges, digital asset brokers and dealers that are incorporated in Thailand. They are subject to initial capital regulation, perhaps to prove that they are sufficiently capitalised and unlikely to engage 110 DD Murphy, The Structure of Regulatory Competition: Corporations and Public Policies in a Global Economy (OUP, 2007) ch 3. 111 Baker McKenzie, ‘A Complete Guide to Cryptocurrencies and ICOs in Thailand’, at www.bakermckenzie. com/-/media/files/insight/publications/2018/09/bk_thailand_completeguidecryptoicos_sep18.pdf?la=en. 112 Bitcoin, Bitcoin Cash, Ethereum, Ethereum Classic, Litecoin, Ripple and Stellar.

Enabling Tailor-Made/Special Regimes   101 in scams. These are imposed with regulatory obligations not unlike their functional equivalents in the financial economy, but in a relatively skeletal manner. Key regulatory obligations include maintaining a robust and secure operational system, having sound governance in the firm, being compliant with anti-money laundering regulations and complying with customer protection. Thailand offers a gateway for legitimising the activities of the crypto investment economy. The numbers of crypto exchanges and digital asset brokers licensed in Thailand have increased steadily, from three in early 2019113 to 13 in 2020.114

B.  Individual European Jurisdictions Prior to the European Commission Proposal 2020 Malta offers a tailor-made regulatory regime for blockchain-based businesses under the Innovative Technological Arrangements and Services Act (ITASA)115 and virtual assets under the Virtual Financial Assets Act (VFAA).116 This offers broader thinking than a financially focused regime, as the ITASA caters for recognition of blockchain-based enterprises as legitimate registered enterprises in Malta subject to certain standards of governance and accountability. This regime is discussed in greater detail in chapter four. Although regulatory policy in Malta seems to be more holistic in considering the crypto economy in terms of its enterprise organisational aspects as well as fundraising, both pieces of legislation are somewhat path-dependent upon established traditions, such as corporate and securities law and regulation. The ITASA and the VFAA are not necessarily connected as the VFAA is based on the offering of virtual assets, presumably by any legal person in Malta, and not only by innovative technological arrangements. Virtual financial assets are defined to exclude electronic money and financial instruments, as these are caught within the scope of existing European legislation.117 Tokens for sales of goods or services confined to use within a blockchain system and not tradeable on exchanges would also be excluded. The VFAA requires issuers of virtual assets to be a legal person in Malta, and a white paper with items of mandatory disclosure must be filed and published. A summary that is in plain language and more narrative in nature should also be published for ease of use by retail investors. This curiously mimics the Prospectus Regulation regime, but is relatively pared down. Investor protection is further secured by limiting investment to 5,000 euros per retail investor. The VFAA provides for some general principles for the conduct of issuers, such as the management of conflicts of interest, conducting business with integrity, due care, skill and diligence and instituting proper control.118 These mimic the standards of the EU Markets 113 ‘Thailand’s Finance Ministry Grants Licenses to Three Crypto Exchanges’ (CNN, 9 January 2019), at www.ccn.com/newsflash-thailands-finance-ministry-grants-licenses-to-three-crypto-exchanges. 114 ‘Thailand Has Now Licensed 13 Cryptocurrency Service Providers’ (28 July 2020), at news.bitcoin.com/ thailand-licensed-13-cryptocurrency-service-providers. 115 www.justiceservices.gov.mt/DownloadDocument.aspx?app=lom&itemid=12874&l=1. 116 See summary of Malta Virtual Financial Assets Act by Grant Thornton, at www.grantthornton.com.mt/ industry/fintech-and-innovation/The-Malta-Virtual-Financial-Asset-Act. 117 Malta Virtual Financial Assets Act, s 2. 118 ibid, s 9.

102  Financial Regulators’ Approaches to the Crypto Economy in Financial Instruments Directive 2014 to an extent, but are relatively open-ended, and it is uncertain if any regulatory enforcement supports such duties. This is because the Maltese regime for investor protection lies chiefly in civil liability for a white paper which contains untrue, misleading, inconsistent and inaccurate statements.119 The Act also requires an issuer to appoint a virtual financial agent that would be responsible for the anti-money laundering compliance side of fundraising, in relation to the standards of due diligence consistent with the European legislation on anti-money laundering. On the whole the Maltese regime seems to offer a light version of the EU’s gold standards for securities and investment regulation. There are however features that suggest a limited level of investor protection in order to attract issuers. For example, the civil liability regime for white papers is premised upon wilfulness and gross negligence, rather high levels of proof for investors compared to the conventional securities regulation regime. It may be argued that as all blockchain-based businesses are in experimental phases, it would be challenging for issuers to represent perfectly the functionalities, performance or desired outcomes of the business. Hence a higher standard of proof for investors alleging breaches of disclosure is required for liability to be established for genuine egregiousness. However, it is not apparent why the tentativeness of code functionalities cannot be clearly caveated so that investors are clear about their risks. In this way, a simple standard of negligence can apply instead. Further, the Act’s rules on insider dealing and market manipulation also seem to be in favour of issuers and markets rather than investors, as discussed below. The VFAA also provides a regime for regulating key intermediaries. The Act provides a definition for blockchain-based digital asset exchanges, and seeks to authorise secondary trading markets and related intermediaries involved in virtual financial assets. Digital asset exchanges are regulated in relation to prudential requirements and their risk governance and compliance capacity.120 In particular, digital asset service providers are themselves organised as blockchains; they would need to meet the organisational requirements for blockchains under the Innovative Technological Arrangements Act, which we discuss in detail in chapter four. Service providers would be licensed as virtual financial asset service providers and overseen by the new Maltese Digital Innovation Authority. Services providers are defined in an open-ended manner in order to accommodate the provision of new forms of services, and there are not many specific regulations on their conduct, except in relation to custodial functions. As entities offering custodial functions face risks of theft and loss of customers’ assets, a duty121 similar to that found in the Markets in Financial Instruments Directive 2014 to safeguard client moneys and assets applies. Service providers with custodial functions need to respect clients’ ownership rights, perform duties of record-keeping and reconciliation to clarify these rights and put in place adequate systems to protect them.122 It is not altogether clear in terms of the demands placed on service providers in relation to their cybersecurity systems as the regime does not articulate or prefer any particular industry standards. 119 ibid, s 10. 120 Also see C Buttgieg and C Efthymiopoulos, ‘The Regulation of Crypto Assets in Malta: The Virtual Financial Assets Act and Beyond’ (2019) 13 Law and Financial Markets Review 30. 121 Art 16(8). 122 Virtual Financial Assets Regulation 2018, s 14.

Enabling Tailor-Made/Special Regimes   103 The VFAA criminalises acts of insider dealing and market manipulation similar to the EU Market Abuse Regulation 2014,123 but only if these are committed intentionally.124 This is a significant lowering of the strict liability standard125 applied in the EU for insider dealing and market manipulation. This makes it more attractive to more service providers and issuers although investor protection may be relatively limited. There is also no provision in relation to civil recovery for investors in such situations. It is also observed that virtual financial asset service providers are not subject to obligations in relation to market surveillance and such as under the EU’s ‘gold standards’.126 It can be questioned whether the regime for anti-market abuse in the Maltese Act is sufficiently rigorous for investors to feel assured participating in crypto exchanges. In sum, the VFAA provides a pared-down version from existing regulatory regimes in order to strike a balance between attracting issuers and protecting investors. The trade-offs seem to be made in standards for investor protection, and it remains to be seen if enabling regimes like the VFAA would favour the supply side excessively.127 Next, France has also passed legislation128 to provide a visa for ICOs subject to a skeletal framework of disclosure, asset custodial protection and anti-money laundering regulation. This visa allows ICOs to enjoy avenues of public solicitation in France, as long as the offerings are made via a corporate form registered in France. The French law does not make non-conforming ICOs illegal, possibly recognising that it is futile to do so given their borderless nature. The visa is thus an optional scheme for issuers, designed to attract them by offering the backing of legality and legitimacy. However, the visa scheme is underpinned by very skeletal regulation and investors are still left to a highly self-regulatory framework. The French regime also introduces an authorisation framework for digital asset exchanges. This regime is optional as long as digital asset exchanges do not offer exchange services for legal tender, in which case the fully fledged regulatory regimes for payment services providers would apply. Regulations are also being relaxed to permit institutions to make investments in cryptoassets subject to prudent limitations in relation to exposure and liquidity management.

C.  EU Regulatory Regime for Cryptoassets In September 2020, the European Commission unveiled a proposal129 to regulate cryptoassets in order to enable their marketing across the EU. This purports to be a 123 Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC. 124 Virtual Financial Assets Act, Arts 34–36. 125 Such as articulated in the case of Spector Photo Group and Van Raemdonck v Commissie voor het Bank-, Financie- en Assurantiewezen (CBFA) (Case C-45/08). 126 EU Markets in Financial Instruments Directive 2014, Arts 18, 19, 31; FCA Handbook MAR 5, 5A, 5AA. 127 IH-Y Chiu, ‘Decrypting the Signs of Regulatory Competition in the Crypto-economy’ (2020) 7 European Journal of Comparative Law and Governance 1. 128 Action Plan for Business Growth and Transformation Act (passed on 11 April 2019), summary at www.amf-france.org/en_US/Reglementation/Dossiers-thematiques/Fintech/Vers-un-nouveau-regimepour-les-crypto-actifs-en-France. 129 European Commission, Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (September 2020), at ec.europa.eu/ finance/docs/law/200924-crypto-assets-proposal_en.pdf.

104  Financial Regulators’ Approaches to the Crypto Economy tailor-made regime for cryptoassets, therefore reflecting the policy-makers’ acceptance that cryptoassets offer different features from other financial products, and that it would be inappropriate to fit their regulation within existing regulatory ontologies. Cryptoassets are defined as digital representations of value or rights, with reference to electronic storage and transfer via distributed ledger technology. The Commission established three regulatory regimes for cryptoassets, and a regime for cryptoasset service providers in general. Cryptoassets that are collateralised stablecoins, or assetreferenced, as well as those that electronically reference fiat currencies, or known as ‘e-money’ tokens, are regulated differently from the rest of cryptoassets. Cryptoassets, other than asset-referenced or e-money cryptoassets, can be publicly offered across the EU, regulated by way of legal entity registration in any Member State and the publication of a prescribed white paper which contains mandatory disclosure. However, exemptions are made for offers not exceeding one million euros in 12 months; made to up to 150 natural persons; or made to professional investors only. If the cryptoassets are obtained by gratuitous helicopter drops, or by mining, or are unique and non-fungible in nature, they are also not subject to the public offer regulatory regime. Although the prescribed white paper is less onerous than the well-developed mandatory disclosure regime of prospectus disclosure for securities,130 the categories of transparency required are ideologically derived from such established regimes, ie in relation to developers’ information, legal entity information, information regarding rights of holders, etc. The mandatory disclosure regime is accompanied by market discipline in terms of civil responsibility for inaccurate or misleading disclosure. However, unlike the Maltese regime that aims at investor protection by capping investment, the Commission’s approach is to import the consumer protection tenet of cooling-off rights by allowing for a mandatory 14-day period for withdrawal by investors. Further, issuers are not subject to ex ante approval but to general duties of fair and honest dealing, and conflicts of interest management vis-a-vis investors. In comparison to the Maltese regime for disclosure and civil liability, the Commission’s proposal may be more onerous with more prescriptions. Nevertheless, the passport for making an offer throughout the EU may be attractive to issuers. It will be of interest to see if issuers would favour established regimes such as the UK, Singapore and Switzerland that implicitly permit unregulated ICOs for utility tokens or be attracted to explicit offering regulation that give them a sense of legitimacy. The regimes discussed in this section essentially offer legitimising opportunities for ICOs, attracting issuers to buy into the legal certainties provided in the tailor-made regulatory regimes. The regimes discussed above also attempt to attract issuers and service providers by incentivising incorporation in their jurisdictions. It is however uncertain if this coheres with the needs of the blockchain-based community. First, if the issuer to be incorporated is the developer, the developer may not wish to be formalised as a company and be subject to a state’s company law rules. This is because in some blockchain projects such as Filecoin131 and Decentraland,132 the developers envisage withdrawal from the project as it becomes mature, so that the blockchain can be left entirely into the hands

130 Prospectus 131 filecoin.io.

Regulation 2017, Art 6.

132 decentraland.org.

Enabling Tailor-Made/Special Regimes   105 of the community of participants to operate and maintain. The need to incorporate and maintain ongoing compliance with company or securities rules may be disincentivising. Next, it is queried whether the legal entity for incorporation in question refers to the blockchain community of participants. How should a blockchain platform be treated in terms of legal organisation? Blockchain systems are often regarded as peer-to-peer marketplaces and not legal persons such as corporations. The corporation is a hierarchical legal person and does not reflect relational realities in the blockchain system. If there is indeed a regulatory lacuna in relation to the treatment of the community of participants that comprises the blockchain system, would such enterprises not be able to attain ‘legal entity’ status, except perhaps in Malta, as only Malta offers a tailor-made legal organisational regime for blockchain platforms?133 If a blockchain platform were to forcibly be fit into an existing organisational category in a Member State, would token-holders have clarity in relation to the governance of the system and their rights? In a peer-to-peer blockchain system, there is no ready ascertainment of the management organ. Would miners or core developers be regarded as taking on that role and the significant responsibilities that normally attach to management?134 It remains unclear if token holders are the equivalent of shareholders of incorporated companies and whether the rights, duties and liabilities established in corporate law jurisprudence should apply. These questions are not answered by either the Commission or Member States at the moment. The Commission’s regulation of asset-referenced and e-money token issuers further involve more demanding prudential regulation modelled upon banking and electronic money institution regulations. More prescriptive rules on organisational and governance aspects such as business continuity, security and corporate governance are provided, as well as greater accountability to users/investors and their protection. These aspects are discussed in chapter six. Further, the Commission’s proposal also subjects cryptoasset service providers to regulation. These service providers are defined under an umbrella term and only special duties are explicated for custodial functions and centralised trading exchanges. The universe of cryptoasset service providers is not well defined and there is a lack of engagement with novel intermediary services arising in the crypto-financial economy, such as token rating services or decentralised exchanges, discussed in chapters five and six respectively. It remains to be seen if the general conduct and prudential regulations applicable to these broadly defined service providers would be appropriate. Looking back at the regulatory spectrum in Figure 3.2 below, this chapter draws together critical reflections on global regulators’ approaches. Figure 3.2  A spectrum of regulatory approaches in relation to the crypto economy

Prohibitive – banning the crypto economy

Prohibitive minus – banning or restricting certain financial developments but not all the crypto economy

Facilitative but restrictive – extension of existing regulations

Facilitative but permissive – selfregulatory/limited extension of regulation

Enabling regimes to encourage crypto economy and financialisation

133 See ch 4. 134 A Walch, ‘In Cod(ers) We Trust’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 3.

106  Financial Regulators’ Approaches to the Crypto Economy

VI.  Critical Reflections on Global Regulators’ Approaches The prohibitive jurisdictions discussed above are largely averse to the anarcho-capitalist ethos of the crypto economy, and such sentiments can be based on various rationales perceived to be important for the protection of institutions in those jurisdictions. Scams and scandals in the unregulated landscape of ICOs cannot be totally weeded out, and it is observed that despite these problems, jurisdictions that are open to innovation and are less institutionally defensive remain willing to engage in policy balances vis a vis developments in ICOs. The US reflects tensions in being both facilitative and restrictive. Although cryptocurrency exchange, ICOs and stablecoin projects have grown in volume in the US, there is increasing legal risk due to the potential assertion of regulatory jurisdiction by the SEC or CFTC over ICOs and the possible extension of bank regulation for stablecoins. This assertion of jurisdiction is largely based on the increasing financialised aspects of the crypto economy, and the needs of investor protection. The crypto economy itself does not seem to be an object for policy assault, given that New York and the Uniform Law Commission have both proposed facilitative and thus, legitimising, regimes for the commercial use of virtual currency that is not legal tender. Other facilitative jurisdictions such as Switzerland, Singapore and the UK adopt the interesting approach of limited extension of existing regulation only to tokens that clearly fall within securities regulation. They clarify the lack of jurisdiction over utility tokens which are the majority type of ICOs, potentially leaving business as usual. However, this ambiguity seems unsustainable as these jurisdictions, eager to defend the robustness of their regulatory reputations, have increasingly extended coherentist regulatory requirements to crypto businesses, such as in relation to tax, anti-money laundering, and in the UK, financial promotion regulation for the purposes of securing consumer protection. At the other end of the spectrum, some jurisdictions adopt a welcoming approach and provide for facilitative regulation for ICOs in bespoke regulatory regimes. These are designed to attract the migration of crypto economy activities and the crypto investment economy. However, although the EU Commission’s proposal is situated at this end of the spectrum, its regulatory requirements are relatively demanding, as a result of its twin aspirations to build capital markets but to secure high-quality standards that are credible. Nevertheless, it remains to be seen if the regulatory regimes on offer cohere with the needs of the crypto economy, as their requirements for local incorporation and registration may not be appropriate for certain blockchain-based platforms. Despite the diversity of regulatory approaches, there is a distinct trend that is being fostered. Whether jurisdictions are somewhat restrictive or facilitative with different levels of permissiveness, the net result is likely that consumer or retail participants in the crypto economy may become diminished in favour of institutional or sophisticated investor participation. Some proactive tailor-made regimes may level the playing field more explicitly so that retail participation is not discouraged. For example, both Th ­ ailand and Malta allow retail participation subject to a cap. Overall, the regulatory trend of focusing on financial regulation for the fundraising aspect of the crypto economy exacerbates a particular type of financial development: the dominance

Critical Reflections on Global Regulators’ Approaches  107 of institutional or sophisticated investors focused upon investment activities and not necessarily economically productive activities. In sum, we suggest that there are a few key blind spots that are not dealt with in the array of regulatory policies above that deserve to be distinctly considered. These ultimately relate to the state of financialisation of the crypto economy, and regulators should carefully consider if they are fostering such financialisation by decision or default. Regulatory policy in relation to these key blind spots are crucial to fostering the development and shape of the crypto economy. These are: (a) the special nature of utility tokens; (b) the role played by established and unregulated cryptocurrencies such as bitcoin and ether (and their forked versions) in the crypto economy; (c) the application of access restrictions to the crypto economy such as accredited or sophisticated investor exemptions and restrictions applied to consumer or retail participation; and (d) the interfaces between conventional financial economies and the crypto economy. First, we argue that ICOs of utility tokens are special, and that pre-sales are not designed merely to evade securities regulation. If a project is genuinely optimally developed over a distributed ledger and is a distributed business model facilitating peer-to-peer transactions, ICOs of utility tokens not only provide finance for the development of the project, but they are relevant to building up the peer-to-peer community for the project when it becomes live. Utility tokens serve both financial and economic purposes and are unique in nature. They cannot be easily compared to securities financing. In a model of securities financing, investment interests are held by those who are envisaged to have restricted participation or governance rights with regard to the real economic productivity of the business, while the productivity of the business is centrally orchestrated by managers.135 However, in ICOs for utility tokens, subscribers could become co-creators or workers in the ledger, therefore intimately connected with the real productivity of the new business. This model has the potential to bring about a new form of distributive capitalism in that participants would create and distribute wealth in the system without reserving residual rights to initial capital providers of the business. This model is also decorporatised without being subject to centralised management having control of corporate assets and allocation decisions. In this manner, the distributed ledger business model can be economically transformative. However, if ICO purchasers merely participate in a project that reserves value creation to initial capital providers and subscribe to a centrally managed model, then such token-holders would more disadvantaged than under a corporatised model of business that provides for governance rights. In other words, it is important to discern the economic sociology136 of each utility token to determine if its business and financing model is novel. Where such economic 135 A Alchian and H Demsetz, ‘Production, Information Costs and Economic Organisation’ (1972) 62 The American Economic Review 777; MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305. These economic depictions of the place of the shareholder are in relation to residual claims over corporate assets at the end of its life or as having delegated powers of management and control to managers appointed for the corporation. 136 See generally C Trigilia, Economic Sociology (Blackwell, 2002) on the need to embed economic actors within broader social contexts and networks.

108  Financial Regulators’ Approaches to the Crypto Economy sociology does not resemble the functional equivalent of a conventional corporatised model, we propose the development of a new regulatory policy for both the blockchainbased enterprise as a unique organisational phenomenon (explored in chapter four) and for pre-development fundraising (explored in chapter five). ICOs should not merely be governed by extensions from securities regulation policy, or be completely left unregulated, as the lack of regulation would leave gaps in governance, rights, obligations or distribution unaddressed. ICO subscribers also suffer from the inherent inability to select ‘good’ businesses given that pre-development finance raises more severe issues of credence goods and information asymmetry. It is not always optimal to leave to unregulated markets to distinguish between the lemons and worthwhile projects, and interested participants, deterred by lemons, can withdraw from the economic space altogether. Second, the jurisdictions surveyed above have focused on extending or designing regulatory policy for the financial aspects of the crypto economy at the risk of being myopic in relation to the wider crypto economy. Financial regulation policy has grabbed regulators’ attention since the global financial crisis,137 and regulators see the similarities between activities in the crypto investment economy and conventional financial economies. However, given the wide circulation of established cryptocurrencies and mining operations, is it sufficient merely for policy-makers to insist that bitcoin or ether are not legal tender, while they support crypto-economic activities that have the potential to create real wealth? This may be why Thailand has adopted the unique regulatory innovation of recognising seven cryptocurrencies as legitimate ‘pairs’ for token offerings and they are exempt from its new regime that purports to cover all crypto investment activities. However, the monetary order in the crypto economy remains unaddressed. Chapter six explores the options for the monetary order of the crypto economy and argues that further regulatory thinking and policy is needed. Third, the focus on financial and securities regulatory policy could create distorting effects for the development of the crypto economy. Many jurisdictions take the view that where accredited or sophisticated investors are involved, the application of securities or financial regulatory regimes can be exempted or waived as these do not require the levels of protection in regulation which are usually based on the retail investor.138 In the US, token offerings are already skewed towards accredited investors only, shutting out retail investors. This book advocates against coherentist measures that aim to fit crypto economy and asset developments into existing regimes for corporations and securities that can be adverse to the productive and development potential of the crypto economy. Finally, as focus on the financial aspects of the crypto economy would incentivise more financialisation of the crypto economy, the book is concerned that financialisation of the crypto economy raises implications for interfaces with conventional financial economies and financial stability.139 Conventional financial institutions searching for 137 Andenas and Chiu (2014). 138 For example Regulation D, also in the EU and UK, prospectus exemptions in the Prospectus Regulation 2017, and exemptions from restrictions in financial promotions, see UK Financial Promotions Order 2005, ss 48–51. 139 The need to understand connections is important for mitigating financial stability risks that are infectious or contagious; see MY Abolafia, ‘The Institutional Embeddedness of Market Failure: Why Speculative Bubbles Still Occur’ in Markets on Trial: The Economic Sociology of the U.S. Financial Crisis (Emerald Insight, 2015) 177–200; M Schneiberg and T Bartley, ‘Regulating or Redesigning Finance? Market Architectures, Normal Accidents, and Dilemmas of Regulatory Reform’ in Markets on Trial, above at 281–307.

Critical Reflections on Global Regulators’ Approaches  109 yield140 are highly mobile and are attracted to deepen the connections between the crypto investment economy and conventional financial economies.141 Further, shadow banking opportunities can arise if cryptoassets become capable of being used for collateralised financing and supporting the growth of asset bubbles and debt.142 In other words, increasing financialisation of the crypto economy can in due course bring about more integration between the conventional financial sectors and the crypto economy, and heighten risks for both. However, early empirical observation during the Covid-19 pandemic, which adversely affected conventional financial asset prices (due to the adverse shock to conventional economic and corporate activity), reveals that cryptoassets may be uncorrelated and may be a plausible avenue of diversification for asset management.143 Regulators should address more holistically the governance144 of the crypto economy and of its financialised aspects, but not to frame the governance of the crypto economy only in relation to its financialised aspects. In this widely distributed and seemingly borderless space, regulatory governance can be developed on the basis of decentredness145 and flexibility,146 as discussed in chapter two. However, such frameworks need to be based on a sound economic-sociological understanding of the nature of participation in the crypto economy, so that policy thinking for the crypto economy is developed in socially embedded terms,147 and any regulatory framework should 140 ‘Hunt for yield pushes more investors into riskier assets’ (Financial Times, 29 November 2016), at www. ft.com/content/9ab40034-a4db-11e6-8898-79a99e2a4de6. 141 There is discussion regarding treating cryptoassets as a ‘new asset class’ for institutional investors; see N De, ‘Morgan Stanley Report Says Crypto Now An Institutional Asset Class’ (1 November 2018), at www. coindesk.com/morgan-stanley-says-crypto-is-a-new-institutional-asset-class; Ernst & Young, ‘Cryptocurrencies and Cryptoassets- Managing the New Asset Class’, at www.ey.com/gl/en/industries/financial-services/ ey-cryptocurrencies-and-cryptoassets. 142 This follows Hyman Minsky’s financial instability hypothesis that riskier behavioural patterns take root as consumption of credit increases, which is a tempting tendency towards wealth growth. See H Minsky, ‘The Financial Instability Hypothesis’ (Levy Institute Working Paper, 1992), at www.levyinstitute.org/pubs/ wp74.pdf, also ‘Minsky’s Moment’ (The Economist, 30 June 2016), at www.economist.com/economicsbrief/2016/07/30/minskys-moment. Also see warnings in S Omarova, ‘New Tech v. New Deal: Fintech As A Systemic Phenomenon’ (2019) 36 Yale Journal on Regulation 735. 143 ‘In COVID-19’s Wake, the New Normal Creates Crypto Opportunities’ (18 July 2020), at cointele graph.com/news/in-covid-19s-wake-the-new-normal-creates-crypto-opportunities. But see opposite view which finds cyclical correlations between cryptoassets and the real economy: UW Chohan, ‘The Coronavirus Lesson: Do Cryptocurrencies offer a Counter-cyclical Hedge?’ (2020), at papers.ssrn.com/sol3/papers.cfm? abstract_id=3566265. 144 Governance in a decentralised space such as the crypto economy can pose challenges as jurisdictionally limited regulators and state-backed law may be restricted in application, but see JN Rosenau and EO C ­ zempiel (eds), Governance without Government (CUP, 2001) chs 1, 2, theorising a governance concept that can be pluralist and not tied to state-backed law. Although the volume applies to international governance, there are insights are decentralised and borderless spaces such as the crypto economy. 145 J Black, ‘Critical Reflections on Regulation’ (2002) 27 Australian Journal of Legal Philosophy 1 in which decentred regulation is explained, see ch 2 of this book. 146 This usually means regulatory design that is not in the style of command-and-control but rather is open-textured in terms of co-implementation by regulators and the regulated and other stakeholders, being pluralistic in nature, and also entailing a range of flexible incentives and tools to secure compliance. See C Ford, ‘Macro- and Micro-Level Effects on Responsive Financial Regulation’ (2011) 44 University of British Columbia Law Review 589. Indeed, Ford asserts that such design is crucial for forward-looking regulation that is needed to keep pace with and govern the rise of innovation, see C Ford, ‘Innovation-framing Regulation’ (2013) 649 The ANNALS of the American Academy of Political and Social Science. 147 We take broadly economic sociologists’ view that economic spaces and marketplaces feature networks of actors in interaction that reflect many relational characteristics including psychological, culturally and

110  Financial Regulators’ Approaches to the Crypto Economy be multi-nodal in nature.148 Such a multi-nodal governance framework incorporates multiple stakeholders and is foundational for the establishment of debates149 in order to develop institutional and distributional tenets in the crypto economy.150 In this manner, the building of governance frameworks also brings us closer to the vision of embedded markets in society as envisaged by Polanyi.151 The next four chapters propose taking a multi-nodal perspective of the crypto economy in order to consider its governance. An appropriate regulatory agenda can involve a mixture of enabling, mandatory and self-regulation in providing legitimacy and certainty to the enterprise of a blockchain-based business. Such a regulatory agenda is proposed to involve: (a) an enabling regime for the business formation of blockchain-based entities and the determination of internal governance for the collective interests and commons of the blockchain community; (b) a facilitative regime for developmental fundraising that would seek to meet blockchain project developers’ needs, balanced against the need for protection for ICO subscribers; (c) the provision of a framework for governing the monetary order of the crypto economy; and (d) the regulation of the financial development in the crypto economy. Chapters four to seven take these in turn.

institutionally shaped behaviour beyond incentive-based behaviour; see M Lounsbury and PM Hirsch, ‘Markets On Trial: Toward a Policy-Oriented Economic Sociology’ in Markets on Trial: The Economic Sociology of the U.S. Financial Crisis (Emerald Insight, 2015) 5–26; BG Carruthers and SL Babb, Economy & Society, 2nd edn (Sage, 2013) generally. 148 We do not adopt the mathematical plotting of social network analysis, but rather identify the locations of participation, power and governance in order to feed into policy thinking in relation to institutional and distributional choices. See however J Scott, Social Network Analysis: A Handbook (Sage, 1987). 149 What is envisaged would be the fielding of voices in order to debate and forge governance frameworks and institutions, in possibly a Habermasian deliberative manner, which envisages a framework for discourse that is achieved at an objective, truthful and rational level. The Habermasian discourse is built upon the sharing of facts, the rational communication of knowledge without bias of political or partisan position, and inclusive two-way discussions which results in a mutual understanding and achievement of consensus. The summary above is distilled from Habermas’s various works; see J Habermas, The Theory of Communicative Action: Vol 1, Lifeworld and System: A: Critique of Functionalist Reason (Beacon Press, 1984 and 1987); Communication and the Evolution of Society (Beacon Press, 1979); Moral Consciousness and Communicative Action (MIT Press, 1990); Justification and Application: Remarks on Discourse Ethics (NT Press, 1993), Between Facts and Norms: Contributions to a Discourse Theory of Law and Democracy (Polity Press, 1996). 150 This is drawn from Fligstein’s analysis of the architecture of marketplaces that the economic sociology of marketplaces maps networks of actors, institutional tenets and political economy features such as distributions of power and wealth. See N Fligstein and R Calder, ‘Architecture of Markets’ in R Scott and S Kosslyn (eds), Emerging Trends in the Social and Behavioural Sciences (2015), at sociology.berkeley.edu/sites/default/ files/faculty/fligstein/architecture%20of%20markets%20Calder%20Trends.pdf. 151 B Lange, F Haines and D Thomas (eds), Regulatory Transformations: Rethinking Economy–Society Interactions (Hart, 2015) ch 1 on rethinking regulatory policy beyond economic paradigms, as markets are not driven by narrow economic logics devoid of a full sense of humanity in participation, hence, governance should be conceived of in a holistic manner taking into account of the social nature of markets and relations; also K Polyani, The Great Transformation, 2nd edn (Beacon Press, 2002) Part II.

4 Facilitating the Crypto Economy: The Law of Business Organisations and Governance I.  Introduction to the Organisational Perspective of Blockchain-based Business Although the productive crypto economy has emerged without much legal architecture so far, an enabling legal framework will be crucial for its future development and scalability. We look to the law of organisational formation as a key enabler of enterprise and entrepreneurship, just as the introduction of legislation allowing the formation of private joint stock companies in the nineteenth century has enabled the flourishing of private enterprise during the Industrial Revolution.1 The law of organisational formation primarily deals with the organisation of productive assets and production of wealth amongst a number of private parties, providing a governance template for the commons amongst them, securing a level of certainty and confidence in engaging in economic relations.2 Blockchain-based enterprises are held out to be distributed peer-to-peer networks, therefore defying hierarchical organisation and centralised authority.3 However, this does not mean that there is no relevant framework of organisation applicable to them. Assumptions of organisational hierarchy or centralised authority may benefit certain configurations of economic relations, hence the law for the for-profit corporation provides for a certain governance framework of hierarchy and authority. These assumptions may not apply to other economic relations, hence other organisational forms, such as the limited partnership4 in the UK, provides for flexible and flatter structures based on equality or consensus.5 One does not have to treat a blockchain-based 1 A Sanctuari, ‘The Joint Stock Company in Nineteenth Century England and France: King v. Dodd and the Code de Commerce’ (1993) 14 Legal History 39. 2 J Michie, ‘The Importance of Ownership’ in J Michie, JR Blasi and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 1. 3 W Kaal, ‘Decentralised Autonomous Organisations via Blockchain Technology’ (2020) 5 Annals of Corporate Governance 101, at papers.ssrn.com/sol3/papers.cfm?abstract_id=3652481&fbclid=IwAR3FUNzI PD4Z7tus_OamvKenGrTWCq4Xi1SpAeKQnREFviVjVGz5vTJHUJY. 4 Limited Liability Partnerships Act 2000. 5 For example, Reg 7 of the Limited Liability Partnerships Regulations 2001 sets out that members should be treated equally in terms of distribution and are equally entitled to take part in management, reflecting a default template of non-hierarchical, mutually respecting and equal inter-relations.

112  Facilitating the Crypto Economy business as anti-organisational just because it is unlikely to fit with the hierarchical and management-centred structure in a typical corporation. Further, a blockchain-based business does not have to be regarded as anti-organisational in order to maintain its core peer-to-peer and distributed characteristics. The three archetypes of blockchain-based enterprises discussed in chapter two show that there are unmet collective or governance needs, even though participants intend to maintain a high degree of autonomy on such peer-to-peer platforms. Governance needs for the commons may be more optimally addressed if we recognise the need for, broadly, an organisational framework defined in its widest terms. The lack of an organisational perspective for a blockchain-based business means that we fall by default to treating it as a marketplace where each participant is an atomistic economic unit contracting in bilateral relations. The framework for market-based relations and bilateralism does not cater for collective good, expected standards, norms and governance of the commons.6 An organisational perspective at the very least introduces the possibility of governance development for blockchain-based businesses on the basis of transaction cost-efficiency7 for all participants, such as for credible dispute resolution mechanisms. Going beyond treating interactions on blockchain networks as incentive-based and economically focused, an organisational perspective also provides for the social content of the blockchain ecosystem. Indeed, Kaal argues that the developers of blockchainbased businesses inherently recognise its broadly defined organisational character in providing for the DAO8 template and its subsequent evolutions.9 This book argues that the blockchain-based business should be treated as an organisation in itself, and it is not sufficient that the developer or founder of the blockchain-based business is an organisation, such as a corporation like Tron or a foundation like Ethereum. This is because the developer is a distinct participant on the blockchain itself, interacting with other users and volunteers. The developer may in some cases own the platform as an asset, especially in a permissioned blockchain, just like AirBnB or Uber which own their platforms and have rights to extract rents from the value produced on the platforms. In this corporatised model for platform businesses, platform owners have created extensive wealth for themselves,10 although such reward may be justified by their usually extensive governance roles for the platform. This business model may not be the vision of many blockchain business developers who envisage a much flatter framework and distributive ethos in such a peer-to-peer paradigm.11 The open-source nature of many

6 Discussed extensively in ch 2. 7 Based on the economic theory of organisation, that organisational governance and rules reflect what participants would optimally want, given the needs of the nature and frequency of interaction and the nature of the common assets that participants are interested in, see O Williamson, ‘The Economics of Organisation: The Transaction Cost Approach’ (1981) 87 American Journal of Sociology 548. 8 See ch 1 of this book. 9 Kaal (2020). 10 IH-Y Chiu, ‘The Platform Economy and the Law of Organisations and Governance’ in RM Barker and H-Y Chiu (eds), The Law of Organisations and Governance- Responding to Decentralised Business Models and Digital Transformation (Routledge, 2021) ch 7. 11 ‘Democatizing the Platform Economy: The Quiet Revolution Through Blockchain’ (August 2019), at coinjournal.net/news/democratizing-the-platform-economy-the-quiet-revolution-through-blockchain/.

What Organisational Form for Blockchain-based Business?  113 blockchain developments is in contrast with the private property notions that underpin conventional platform economies. In sections II and III we explore the essential organisational needs of blockchainbased businesses, and discuss whether the current business organisational forms on offer cater for these needs and what gaps there may be. We then critically query if a separate organisational form for the blockchain-based business such as recognised in Malta as ‘innovative technological arrangements’12 should be provided as an enabling legal framework. Section IV then discusses whether the blockchain-based business as a distinct organisational outfit ought to enjoy separate legal personality, and the benefits and drawbacks of such conferment. Section V concludes by recommending an enabling framework for the blockchain-based business that would be flexible, incorporating a variety of choice sets.

II.  What Organisational Form for Blockchain-based Business? Many permissionless blockchains purport to be free of centralised control and tyranny, and are entirely self-maintained by the incentive-based participation and efforts of disparate nodes.13 In this manner, a blockchain is arguably anti-organisational as only the atomistic incentives of individual nodes and the binary exchanges that occur through smart contracting matter. A conceptualisation of the blockchain that attempts to introduce some form of collective perspective in relation to nodes’ inter-relations can seem contradictory in nature.14 However, ‘organisation’ is not merely a concept understood narrowly, such as in relation to hierarchical structures of control. At its broadest appeal, ‘organisation’ refers to the derivation of order from chaos, and such order need not be based only upon an economically driven or rational ordering of things.15 Although classical sociology and organisational theory focus on functional categories of ordering that serve industrialised purposes and appeal to the rational economic man,16 organisational theory increasingly recognises structures and orders as being driven and shaped by multifaceted, dynamic and subjective forces of 12 The Innovative Technology Arrangements and Services Act introduced in 2019, at www.justiceservices. gov.mt/DownloadDocument.aspx?app=lom&itemid=12874&l=1. 13 J Flood and L Robb, ‘Trust, Anarcho-Capitalism, Blockchain and Initial Coin Offerings’ (2017), at ssrn. com/abstract=3074263. 14 D Bousfield, ‘Crypto-coin Hierarchies: Social Contestation in Blockchain Networks’ (2019) 19 Global Networks 291. 15 G Burrell, ‘Chaos: the Unspeakable Other to Origins and Organizing’ in T Peltonen et al (eds), Origins of Organising (Edward Elgar, 2018); FJ Paris Bonet, M Peris-Ortiz and I Gil Pechuán, ‘Basis for a General Theory of Organisations’ (2011) 49 Management Decision 270; B Üsdiken, ‘History and Organization Studies: A Long-Term View’ in M Bucheli and RD Wadhwani (eds), Organizations in Time: History, Theory, Methods (OUP, 2013) ch 2 on how classical theories have influenced business and management studies. 16 T Peltonen, ‘Rational Modern Organisation’ in Organisation Theory (Emerald Insight, 2016) ch 4; R Collins, ‘Weber’s Last Theory of Capitalism’ in N Woolsey Biggart (ed), Readings in Economic Sociology (Blackwell, 2002) ch 10.

114  Facilitating the Crypto Economy sense-making or control.17 These forces include power18 and social relations,19 and poststructuralist concepts relating to meaning and identity construction in relationships.20 A permissionless blockchain may define each participant’s nature of participation as commercial and limited by the functionalities of the smart contract code they deploy. However, participants are more than merely ‘exchangers’ or ‘transacters’. Some participants are more powerful than others, such as core developers and miners, as discussed in earlier chapters,21 and they inevitably take on more extensive roles and exert different extents of real power over others, such as by being able to decide on the forking of a blockchain. Participants are also not necessarily faceless, nameless and atomistic, as transactions and repeat transactions can build up more intense social connections. In the Decentraland example discussed in chapter two, participants are enrolled in a blockchain virtual society. In this context, social sense-making and interaction would be taking place in such an environment besides commercial inter-relations. Permissioned blockchains may be perceived as clearly more organisational in nature, as there are identified members, rights, obligations and expectations of conduct, entry and exit conditions and other tenets to govern the operation, management and responsibility for the blockchain.22 We argue that although permissionless blockchains seem to skirt organisational phenomena such as governing the commons and having governance frameworks in place, organisational aspects can be discerned and organisational needs arise. Although it may be argued that a permissionless blockchain ‘hangs together’ by trustless trust, yet as argued by de Filippi et al,23 there is implicit trust in the phenomena of mathematic rigour underlying code and the distributed nature of power. These cannot be taken for granted to be fail-proof and needs for governance continue to arise. Drawing upon Oström’s24 theoretical work on governing the commons, we posit that organisational and governance needs on blockchains arise in nine ways: (a) the veracity of pre-programmed code on the blockchain; (b) entry, exit and nature of participation of users, including participation in governance and the establishment of governance norms or institutions; 17 T Peltonen, ‘Interpretive Organisation Theory’ in Organisation Theory (Emerald Insight, 2016) ch 5. 18 S Clegg, ‘Managing Organization Futures in a Changing World of Power/Knowledge’ in C Knudsen and H Tsoukas (eds), The Oxford Handbook of Organization Theory (OUP, 2005) ch 21. 19 M Granovetter, ‘Economic Action and Social Structure: The Problem of Embeddedness’ (1985) 91 American Journal of Sociology 481. 20 T Peltonen, ‘Postmodern Organisation Theory’ in Organisation Theory (Emerald Insight, 2016) ch 7; DD Dionysiou and H Tsoukas, ‘Understanding the (Re)creation of Routines from Within’ in H Tsoukas, Philosophical Organisation Theory (OUP, 2018) ch 2; H Tsoukas, ‘Don’t Simplify, Complexify: From Disjunctive to Conjunctive Theorizing in Organization and Management Studies’ in H Tsoukas, Philosophical Organisation Theory (OUP, 2018) ch 16; R Chia, ‘Organization Theory as a Postmodern Science’ in Christian Knudsen and Haridimos Tsoukas (eds), The Oxford Handbook of Organization Theory (OUP, 2005) ch 5. 21 A Walch, ‘In Cod(ers) We Trust’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 3. 22 Such as discussed in A Donovan, ‘(Shadow) Banking on the Blockchain: Permissioned Ledgers, Interoperability and Common Standards’ in IH-Y Chiu and IG MacNeil (eds), Research Handbook on Shadow Banking (Edward Elgar, 2018) ch 11. 23 P De Filippi, M Mannan and W Reijers, ‘Blockchain as a Confidence Machine: The Problem of Trust & Challenges of Governance’ (2020) 62 Technology in Society 101284. 24 There is other literature that have applied Oström’s principles directly to blockchains too; see D Rozas, A Tenorio-Fornés, S Díaz-Molina and S Hassan, ‘When Oström Meets Blockchain: Exploring the Potentials of Blockchain for Commons Governance’ (2019), at ssrn.com/abstract=3272329, also SJ Shackleford and

What Organisational Form for Blockchain-based Business?  115 (c) the allocation of responsibilities or powers, and the need for standards and accountability; (d) dispute resolution amongst participants; (e) monitoring anti-social behaviour and sanctions; (f) the identification of commons, including collective assets, powers, rights over assets and distributive aspects; (g) systems of trust amongst participants; (h) frameworks or protocols for crisis management; and (i) how relationships should be framed between third parties and the blockchain or dApp community as a whole, such as relationships with regulators and authorities. We explore each organisational need in a permissionless blockchain in turn below. (a) The veracity of programmed code on the blockchain: This refers to whether the smart contract tokens that participants hold function in the manner that they are described when sold. Blockchain business developers do not necessarily disclose their source codes in ICOs,25 and participants may not be clued up sufficiently in programming language to understand if code disclosed would work according to representations made at token sales or according to reasonable expectation.26 This chapter posits that there is a collective good in the expectation that smart contract functionalities that are represented by developers should meet reasonable functional expectations, although the experimental nature of code is acknowledged. In this environment of information or expertise asymmetry between code developers and token purchasers or holders, the question arises as to whether there is a need for an institution of verification for smart contract code, even if represented with development caveats? This issue is taken up again in section V below. (b) Entry, exit and nature of participation of users, including participation in governance and the establishment of governance norms or institutions: Blockchainbased businesses allow participants to enter or exit by purchasing or selling the tokens issued by the business. The relative lack of extensive membership criteria is consistent with the open and permissionless nature of public blockchains and the business applications residing on them. There are two levels of governance in a blockchain ecosystem such as Ethereum. One relates to the governance at protocol level of the infrastructure, such as the governance of the Ethereum blockchain. The second relates to the governance of users, members and participants in the decentralised application (dApp) business’s own community, such dApp residing on the Ethereum blockchain. Where a blockchain business developer constructs its own protocol, both levels of governance S Myers, ‘Block-By-Block: Leveraging the Power of Blockchain Technology to Build Trust and Promote Cyber Peace’ (2017) 19 Yale Journal on Law and Technology 334 arguing that applying Oström’s principles to blockchain would enhance its fail-safe properties to serve the common good. 25 T Bourveau, ET De George, A Ellahie and D Macchiocchi, ‘Initial Coin Offerings: Early Evidence on the Role of Disclosure in the Unregulated Crypto Market’ (2018), at ssrn.com/abstract=3193392. 26 In S Cohney, D Hoffman, J Sklaroff and D Wishnick, ‘Coin-operated Capitalism’ (2019) 119 Columbia Law Review 591, a survey of code revealed by 50 ICOs was carried out and the commentators found significant cases of discrepancies between what white papers promise and what the code actually implements or does not do.

116  Facilitating the Crypto Economy may be regarded as fused or integrated, and more scope is provided for users, members and participants to determine governance. Where a business is built upon an existing protocol infrastructure such as the Ethereum blockchain, as a dApp, the dApp developer can design governance norms for its own community, but may not necessarily be involved in shaping the governance norms of the protocol infrastructure. The optimal choice between instituting governance protocols at protocol or application levels is not clear-cut. Protocol-level institutions may offer standardisation and off-the-rack adoption for many dApps, and therefore appeal to businesses for convenience and efficiency. However, dApp-level governance would likely serve the unique needs of the business, and protocol level governance should provide for sufficient flexibility for dApps to develop governance protocols for their needs. At the protocol level, the most developed governance aspect relates to maintenance of the blockchain by miners. Hence the mining protocol, which achieves for the blockchain the functions of payment validation and data maintenance, is the key governance institution. Mining protocols can be designed differently on different permissionless blockchains, for example the proof-of-work protocol in the Bitcoin blockchain. This protocol requires open competition to submit proof of work, and rewards the fastest and best-resourced miner. The sub-optimalities of the proof-of-work protocol include high levels of energy consumption, waste of ‘work’ and inefficiency.27 Competitive mining has frequently led to perverse incentives and attacks amongst miners.28 In particular, it has been queried if miners should be subject to certain standards of conduct.29 Further, miners now join mining pools to combine forces in order to produce hash rates that may compete with industrialised mining farms using dedicated equipment such as ASICs to mine (especially Bitcoin).30 The governance of mining pools is a selfregulatory matter but it can be queried if pool governance and rule sets would shape mining behaviour.31 Further, mining farms are corporatised profit-centred participants on the blockchain and it should be queried as to how they may shape the nature of the blockchain ecosystem. The Ethereum blockchain has experimented with new forms of governance to make mining more accessible and egalitarian. For example, the mining protocol includes the provision of ‘uncle rewards’ to compensate miners who have proposed sound blocks of transactions but are ultimately not chosen as the head block.32 The Ethereum blockchain is also moving to a proof-of-stake system where miners deposit a stake 27 Discussed in ch 1. 28 Y Wang, C Tang, F Lin, Z Zheng and Z Chen, ‘Pool Strategies Selection in PoW-Based Blockchain Networks: Game-Theoretic Analysis’ (2019) 7 IEEE Access 8427. 29 A Walch, ‘Deconstructing ‘Decentralization’: Exploring the Core Claim of Crypto Systems’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch3. 30 Solo mining is no longer possible or profitable, and individuals join mining pools in order to maximise chances of successful mining; see P Chatzigiannis, F Baldimtsi, I Griva and J Li, ‘Diversification Across Mining Pools: Optimal Mining Strategies under PoW’ (2019), at arxiv.org/pdf/1112.4980v1.pdf. 31 M Rosenfled, ‘Analysis of Bitcoin Pooled Mining Reward Systems’ (2011), at arxiv.org/pdf/1905.04624v2. pdf. 32 But even ‘uncle’ rewards can be attacked and hijacked; see SM Werner, PJ Pritz, A Zamyatin and WJ Knottenbelt, ‘Uncle Traps: Harvesting Rewards in a Queue-based Ethereum Mining Pool’ at the ACM ValueTools Conference, 12–15 March 2019, Palma, Spain, 127, at doi.org/10.1145/3306309.3306328.

What Organisational Form for Blockchain-based Business?  117 of cryptocurrency locked away in the blockchain in order to be selected for mining. Miners are selected by algorithmic processes which take into account size of stake, age of coins, previous mining records, etc in order to distribute the mining work in a more inclusive manner and to mitigate the sub-optimalities of a purely competitive system.33 Nevertheless, although the proof-of-stake system may be more inclusive, it can be quite expensive for miners to enter the fray. For developers of new protocol infrastructure, designing an optimal mining protocol can be challenging, as the mining system can be stalled even before the platform starts operations, as experienced with Filecoin. Filecoin’s mainnet launched on 15 October 2020 but the proof-of-stake consensus protocol costs miners a significant amount of tokens in their staked capital. Consequently, five miners switched off their computers to protest against the ‘unjust’ model of governance.34 This has prompted developers to tweak the mining protocol in order to allow rewards to be dropped for miners to incentivise their work. Further, other than mining protocols, other aspects of governance and decision-making could be relatively under-developed35 and vary amongst blockchains. Ex ante design in governance protocols need dynamic adjustment post-design and during operations. Further, a governance framework is itself needed for both the design and adjustment of governance protocols. Founders and developers of protocol code are highly important governance players on permissionless blockchains such as the Ethereum blockchain. They may reserve rights to control technological development and token supply policies.36 Further, those who are able to join as volunteer coders or dedicate resources and efforts to do so would be able to gain more influence over governance. This manner of self-selection is self-regulatory in nature and could give rise to powerful clusters. Norm development on permissionless blockchain is likely dominated by those with coding expertise or huge stakes of tokens or resources. Small clusters of influential code developers or significant token-holders could be disproportionately ­powerful,37 crucially debunking the myth of democratic or equal participation which is an important ethos underlying permissionless blockchain networks. Some participants may neither be equipped with coding expertise nor have economic resources for mining, yet have an interest in governance and how the commons on the blockchain network should be protected. Would such participants become disempowered and marginalised, and forced to exit?

33 ‘From Cardano to Ethereum, 2020 Could Be Deciding Year for Proof-of-Stake’ (7 October 2019), at www. coindesk.com/from-cardano-to-ethereum-2020-could-be-deciding-year-for-proof-of-stake. 34 ‘Filecoin Miners Go On Strike One Day After Mainnet Launch, Prompting Early Reward Release’ (19 October 2020), at www.coindesk.com/filecoin-miners-go-on-strike-one-day-after-mainnet-launchprompting-early-reward-release. 35 Such as discussed in relation to the bitcoin blockchain, A Spithoven, ‘Theory and Reality of Cryptocurrency Governance’ (2019) 53 Journal of Economic Issues 385. 36 C Catalini and JS Gans, ‘Initial Coin Offerings and the Value of Crypto Tokens’ (2019), at papers.ssrn. com/sol3/papers.cfm?abstract_id=3137213. 37 BE Howell, PH Potgeiter and BM Sadowski, ‘Open-Source or Open-Slather? Governing Blockchain Applications as Common-Pool Resources’ (2019), at ssrn.com/abstract=3427166.

118  Facilitating the Crypto Economy It can however be argued that as the blockchain development space becomes more competitive, developers may compete to improve blockchain governance in order to attract application developers and user communities. Further, dApp developers can themselves provide a further layer of their own governance rules on top of infrastructure protocols. The increased need for developing mechanisms and norms of governance on permissionless blockchains is recognised.38 It is observed that user communities on permissionless blockchains are experimenting with governance development for the commons.39 One example is Decred, a protocol infrastructure offering its own cryptocurrency, which features a democratic hybrid-consensus voting system for proposals to be submitted for governance and change. Participants are able to participate in voting on such proposals,40 and proposals may also be abandoned or participants may abstain. Voting is however moderated by administrators, and the system allows discussions by participants to be initiated before voting is approved. Such a governance system may be inclusive and dialogic, but proposals may be stalled by extended debates. Administrators may be hampered from initiating voting due to discussion hold-up and this could also be an indirect form of pressure to compel abandonment of proposals. It is uncertain how effective such governance by referendum would be. Further, democratic set-ups, such as on the Dash blockchain,41 do not necessarily encourage equally engaged behaviour from all nodes. Voter apathy is also experienced on Uniswap, a dApp on the Ethereum blockchain, whose first governance voting session failed to garner sufficient votes for passing a key proposal.42 Further, there is the possibility of collusion amongst users who carrying out manipulative activities to subvert democratic processes in order to gain power.43 It may be argued44 that game theory provides potential for designing collective decision-making mechanisms that are accessible and less burdensome. Commentators propose a system whereby decision-making protocols can be designed to incentivise participants to act on particular focal issues. These ‘decision junctures’ could be structured as ‘yes/no’ voting options which make it accessible and easy for participation. However, it is unclear if all decision proposals can be framed as binaries, and theorists also acknowledge that such framing can be distorted by manipulation.45 Visionaries in the blockchain development space, such as Vitalik Buterin, urge blockchain governance to be developed at the protocol level, and also at the dApp level. 38 Also see C Reyes, ‘(Un)Corporate Crypto-Governance’ (2020) 88 Fordham Law Review 1875. 39 Democracy may be a starting point, such as in the Dash blockchain governance, but over time, inert nodes may not vote and influential groups may collude and garner most power over decision-making; see L Mosley, H Pham and Y Bansal, ‘Towards a Systematic Understanding of Blockchain Governance in Proposal Voting: A Dash Case Study’ (2019), at ssrn.com/abstract=3416564. 40 proposals.decred.org. 41 Mosley et al (2019). 42 ‘Uniswap’s First Governance Vote Ends in Ironic Failure’ (20 October 2020), at www.coindesk.com/ uniswaps-first-governance-vote-ends-in-ironic-failure?utm_source=newsletters&utm_medium= blockchainbites&utm_campaign=&clid=00Q1I00000LtSLoUAN. 43 N Cowen, ‘Markets for Rules: The Promise and Peril of Blockchain Distributed Governance’ (2019), at ssrn.com/abstract=3223728. 44 M Abramowicsz, ‘The Very Brief History of Decentralized Blockchain Governance’ (2019), at ssrn.com/ abstract=3366613. 45 ibid.

What Organisational Form for Blockchain-based Business?  119 Moreover, the supply of good governance infrastructure at protocol level may provide a ‘public good’ for dApp developments residing on the blockchain. He proposes in his blog three forms of decentralised governance that can be explored for the Ethereum blockchain.46 First, futarchy protocols can provide a governance framework for the Ethereum blockchain. This idea is derived from economist Robin Hanson’s vision of a political futarchy47 where citizen’s votes for or against a policy are accompanied by pay-offs, and these predictive markets will be used to choose winning policies. Buterin envisages that governance proposals can be coded precisely for token holders to vote upon, and token holder apathy is overcome as the holder of tokens is compelled to choose one or the other option, fully engaged in betting for or against an outcome. This may not prevent market manipulation where tokens are simply bought or sold by those who wish to influence a particular outcome, but can form a starting point for coders to consider how a market for governance and policy-/decision-making can be created, therefore bypassing the need for centralised institutions. Next, governance protocol can be based on holacracy. Holacracy allows roles for the blockchain system to be defined, along with eligibility criteria and responsibilities of those roles. The foundational tenets of this governance model can be found in the Holacracy Constitution.48 Role-takers would then be able to shape norm development as they interact with other role-takers, in terms of putting forward, supporting or abandoning governance proposals. The Holacracy model does not avoid centralisation as the developers of code that provides role definitions and eligibility arguably perform a centralising act (ie ‘Ratifers’, according to the Holacracy Constitution). Role-takers are clusters of power and influence within the blockchain ecosystem, although governed by protocols and co-governing each other (as ‘Partners’, according to the Holacracy Constitution). Finally, liquid democracy49 could also form the basis of governance protocol on permissionless blockchains. This model more simply defaults to one-token-one-vote, but token holders can delegate their rights to others to vote, or take back the vote as token-holders see fit. Arguably, delegated proof-of-stake systems such as on Steem, discussed in chapter two, is an example of liquid democracy. This flexible participatory system caters for those who choose to engage for issues that matter, and participants can delegate to others when they are less intensely concerned. Such flexible democratic participatory systems arguably surpass representative democracies where power can be concentrated in the hands of a small group of elites. This model also arguably overcomes the problems of referendum-based democracies, which may be too cumbersome. (c) The allocation of responsibilities or powers, and the need for standards and accountability: Whatever governance protocols or frameworks that may be adopted

46 V Buterin, ‘An Introduction to Futarchy’ (October 2014), at blog.ethereum.org/2014/08/21/introductionfutarchy also discussing other governance innovations. 47 R Hanson, ‘Vote Values but Bet Beliefs’, at mason.gmu.edu/~rhanson/futarchy.html. 48 www.holacracy.org/constitution. 49 B Ford, ‘Delegative Democracy’ (2002), at bford.info/deleg/deleg.pdf.

120  Facilitating the Crypto Economy for a blockchain system, developers, miners, users, participants and other role-takers would need to be defined.50 For example, whose responsibility would it be to review oracles adopted in the system to ensure that they are accurate and up to date? In particular, the governance for token supply is of crucial importance as this affects the level of economic activity, wealth creation and investment value of tokens held by participants.51 Collective thinking is needed in each permissionless blockchain or dApp community to develop the responsibilities and standards of behaviour that are attached to defined and allocated roles, in terms of both ex ante definitions and ex post adjustment. Such collective thinking should be channelled through governance protocols. It is not sufficient for collective thinking only to arise at points of crisis management or amongst small groups of highly influential coders and miners.52 Governance mechanisms should constitute a constitutional or charter-type order which provides clarity to participants in terms of their membership, roles, allocations of power and responsibility, as well as decision-making mechanisms and participation.53 Further, communities on permissionless blockchains and dApps are not necessarily decoupled from the broader socio-economic fabric of society. Conventional socio-economic values can be relevant guiding frames for the community, and become incorporated into governance protocols. For example, the value of long-termism in economic value-creation suggested by Calcaterra,54 or responsible capitalism55 and objectives relating to community good or sustainability.56 Developing governance protocols paves the way for collective thinking mobilisation and other collective endeavours such as establishing collective values and identities, therefore enriching the social fabric in blockchain and dApp communities. (d) Dispute resolution amongst participants: As chapter one argued, although smart contracts perform precisely instructed functions, the contractual relationship between transacting parties may not be problem-free. Disputes can arise in relation to transactions on permissionless blockchains and their dApps, due to incomplete contracting, problems in the off-chain legs of contractual relations, as well as in relation to unexpected or anti-social behaviour. Such disputes are not resolved by exit alone. The scalability and sustainability of blockchain-based businesses could depend on having credible dispute resolution institutions for participants.57

50 Such as in commons-based peer production projects such as open-source software and Wikipedia, where there are volunteer leaders and moderators, suggested in Rozas et al (2019). 51 Catalini and Gans (2019). 52 Abramowicsz (2019). 53 E Alston, ‘Constitutions and Blockchains: Competitive Governance of Fundamental Rule Sets’ (2019), at ssrn.com/abstract=3358434. 54 C Calcaterra, ‘On-chain Governance of Decentralized Autonomous Organizations’ (2019) at ssrn.com/ abstract=3188374. 55 See ‘Business Roundtable Redefines the Purpose of a Corporation to Promote “An Economy That Serves All Americans”’, at www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-acorporation-to-promote-an-economy-that-serves-all-americans. 56 More discussed under Section C. 57 Discussed in M Abramowicsz, ‘Blockchain- Based Insurance’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 10.

What Organisational Form for Blockchain-based Business?  121 Dispute resolution protocols could be provided at the infrastructure level as it can be transaction cost-efficient for all dApps on the permissionless blockchain to be able to access a collective good. However, dispute resolution can also be coded at application level so as to more precisely deal with the needs of the dApp business. Commentators58 have discussed examples of dispute resolution systems (such as Aragon’s) that provide for disputes to be decided by arbiters who are selected into that role based on reputation scores. OpenBazaar assigns a notary to every contract so as to perform dispute resolution functions. Notaries are also scored by user ratings and feedback. Commentators are also modelling an automated enforcement mechanism that mimic legal enforcement, ie the ‘digital court’,59 in order to enforce precisely coded obligations. (e) Monitoring anti-social behaviour and sanctions: The permissionless blockchain and dApps residing on it are both a marketplace and community where transactions are arguably nested within a social fabric.60 As such, certain behaviour may be regarded as anti-social or uncivic if it falls below the standard of reciprocity and mutuality expected on the network. Norms of behaviour may be unspoken but generally accepted tenets become a glue to hold a community of participants together. Non-adherence to community-defined standards would also attract consequences in order to preserve the social fabric of the network and to deter undesirable behaviour. The SushiSwap saga provides an illustration of peer or community pressure working to bring about certain behavioural standards.61 SushiSwap, a community forked from decentralised exchange UniSwap and led by Chef Nomi, its founder developer, experienced a crisis when Chef Nomi liquidated his entire stake for US $13m-worth of ether, effecting an ‘exit scam’ upon the community and causing the price of Sushi governance tokens to collapse. However, community peer pressure eventually forced Chef Nomi to return the entire gain in order for SushiSwap holders to rebuild the community and carry out market operations to stabilise the price of the tokens.62 This episode shows that purely atomistic and selfish actions are not necessarily allowed to go scot-free. However, blockchain communities can potentially benefit from more developed forms of ex ante governance in terms of conduct norms and standards. As discussed in chapter two, forking is a common coping mechanism to deal with abusive or undesirable behaviour on permissionless blockchains. However, forking may splinter a previously integrated community and is not altogether without cost. It would likely be beneficial to consider other governance-based means of sanctioning anti-social behaviour, and frameworks for crisis management. (f) The identification of commons, including collective assets, powers, rights over assets and distributive aspects: The commons of every permissionless blockchain and 58 W Kaal and C Calcaterra, ‘Crypto-Transaction Dispute Resolution’ (2017–08) 73 Business Lawyer 109. 59 H Matsushima and S Noda, ‘Mechanism Design with Blockchain Enforcement’ (2020), at papers.ssrn. com/sol3/papers.cfm?abstract_id=3554512. 60 Granovetter (1985). 61 J Kim, ‘Big Fish in a Big Pond: Exploring Some Novel and Some Familiar Legal Issues Posed by DeFi and Sushiswap – Part A’ (Oxford Business Law Blog, 20 October 2020), at www.law.ox.ac.uk/business-law-blog/ blog/2020/10/big-fish-big-pond-exploring-some-novel-and-some-familiar-legal-issues. 62 ‘Sushiswap Creator Returns $14 Million After Community Cries Exit Scam’ (11 September 2020), at news.bitcoin.com/sushiswap-returns-14-million-exit-scam/.

122  Facilitating the Crypto Economy dApp includes any areas of common interest such as governance norms and institutions, as discussed above, and common assets. One commentator is of the view that the code for a permissionless blockchain and its smart contract protocols should be regarded as common assets, as participants are usually free to contribute to their development.63 Further, common data should also be treated as common assets. The consideration of common assets is for the purposes of considering how distributive frameworks and norms should be developed,64 as new economic structures in blockchains facilitate thinking about distribution in new ways, unshackled from the distributive patterns associated with organisational phenomena such as the for-profit company.65 Further, instituting distributive governance may mitigate episodes of private proprietisation and wealth extraction in an abusive or unfair manner, which would not be prevented if left in a self-regulatory state. Commentators discuss the Tezos blockchain in relation to distributive concerns.66 Tezos is a platform developed by the Tezos Foundation which is owned by a company Dynamic Ledger Solutions (DLS). The company is in turn owned by founders, the Brietlands and their venture capital partners. A pre-sale of tokens at a discount took place for founders and venture capital partners before the public sale of tokens, and it seemed that the public sale of tokens provided an early exit opportunity for venture capital partners ahead of the project delivering anything palpable. The intellectual property rights of Tezos are owned by DLS, and DLS contracts with the Tezos Foundation in relation to the release of funds and disbursement for stages of development, as well as the right to use intellectual property belonging to DLS. The corporate structures sitting atop of Tezos resemble corporate owners of conventional platform economies. Founders have openly squabbled with the Foundation’s executive officers who are more concerned with the future of Tezos as a project. Tezos is still a developmental project whose release has been delayed due to its governance problems, primarily over rights relating to the use of assets. Next, Wahrstätter67 finds that powerful blockholders on the Ethereum blockchain enjoy significantly lower gas fees for transaction verification than many ordinary users, suggesting that self-governance would lead to distributively sub-optimal results even in a decentralised environment. Distributive protocols that cohere with the social ethos of the blockchain community may be needed to reflect and secure an optimal ethos and policy. Consideration can be had as to whether restraints for blockholders’ rights, or increased accountability, paternalistic policies such as token rationing or distribution may be appropriate.

63 S Tendon and M Ganado, ‘Legal Personality for Blockchains, DAOs and Smart Contracts’ (2018) 1 RTDF 1. 64 A Arvidsson, ‘Situating the Sharing Economy: Between Markets, Commons and Capital’ in RW Belk, GM Eckhardt and F Bardhi (eds), Handbook of the Sharing Economy (Edward Elgar, 2019) ch 2. 65 Kaal (2020). 66 ‘What is Tezos- The Most Updated Deep Dive’, at blockgeeks.com/guides/what-is-tezos; ‘What Lessons can be Learnt from Tezos ICO Debacle’ (22 October 2017), at cointelegraph.com/news/what-lessons-can-belearnt-from-tezos-ico-debacle. 67 A Wahrstätter, ‘Stablecoin Billionaires – A Descriptive Analysis of the Ethereum-based Stablecoin Ecosystem’ (2021), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3737404.

What Organisational Form for Blockchain-based Business?  123 Distributive governance is important for permissionless blockchains and dApps seeking to distinguish themselves from conventional platform economies. In this manner, we may expect more egalitarian governance frameworks and norms, such as the Ethereum Foundation’s development in adjusting mining protocols to be more inclusive. Mining is not the only instance where distributive norms are formed. It can be considered as to whether other roles should be rewarded and how, such as in relation to arbiters and dispute resolution roles. Distributive norms also extend to restraints against potential abuse of power, as well as sanctions in relation to compensation and punishment. (g) Systems of trust amongst participants: Where a blockchain community facilitates longer-term or repeat transactions, would parties trust in the smart contracting code alone or would parties look for other indicia of trust so as to guide transaction preferences accordingly? Should there be review and feedback or rating systems68 pertaining to users that offer crypto goods or services on dApps? It may be argued that automated protocols for service provision, in Golem or many peer-to-peer cloud storage systems, perform the sharding of tasks and work distribution in order to prevent users’ preferences or biases from distorting the marketplace. Such automated protocols facilitate a nameless form of commerce but possibly in a more egalitarian manner. However, treating all participants equally can also be susceptible to hazards, as poorly performing participants can free-ride on good ones. Blockchain communities as marketplaces would face challenges in deciding whether to develop frameworks for differentiation amongst participants or to resist these efforts and prevent at the same time a race to the bottom in performance standards. Systems of differentiation can be regarded as systems for elitism, but at the same time can work as systems of trust. If a system of trust is to be instituted, there would also need to be institutions to maintain the system and resolve disputes about ratings and feedback. Further, Kaal69 also demonstrates that reputation and its representation in decentralised blockchain communities can be important for the development of governance protocols. DevDAO is currently experimenting with reputation-based tokens so that users can build up credibility (or otherwise), forming the basis for the allocation of governance power.70 (h) Frameworks or protocols for crisis management: As permissionless blockchains and their dApps exist on an online environment, cybersecurity risks and attacks are a common source of crisis. These threaten to steal wealth, defy expected rights and damage confidence in the public blockchain. An exploitation of protocol code bugs can be damaging for many dApps and their communities. Crisis management by blockchain-based communities (discussed in relation to Steem in chapter two) has often been reactive and ad hoc, and most likely results in forking.71 It is queried whether 68 M Möhlmann, T Teubner and A Graul, ‘Leveraging Trust on Sharing Economy Platforms: Reputation Systems, Blockchain Technology and Cryptocurrencies’ in RW Belk, GM Eckhardt and F Bardhi (eds), Handbook of the Sharing Economy (Edward Elgar, 2019) ch 23. 69 (2020). 70 ibid. 71 Critically discussed in K Low and E Mik, ‘Pause the Blockchain Legal Revolution’ (2020) 69 International and Comparative Law Quarterly 135.

124  Facilitating the Crypto Economy ex ante allocations of crisis management powers and the institution of governance protocols may be useful, or whether a crisis necessitates decision-making on the spot and therefore defies preparation. Ex ante preparations and frameworks can serve two purposes. One is to allocate roles to code developers so as to review and patch bugs on a regular basis, in order to improve the resilience of the code. The other is to allow crisis management powers to be subject to pre-agreed safeguards, such as decisionmaking or accountability mechanisms. This helps to mitigate the discretionary nature of crisis management, especially in the hands of a few powerful code developers and miners. Ex ante preparation for crisis management has been acknowledged by Maker DAO as being important after its Black Thursday crisis on 12 March 2020. Maker DAO, which provides a protocol for users to draw out stablecoin dai against ether collateralisation, suffered a crisis when ether prices dropped dramatically, putting pressure on the liquidation of collateral to stabilise the supply of dai.72 Although the crisis was eventually managed by capital injection from a financier investor, Maker DAO has subsequently engaged in introducing certain protocol overrides for crisis management.73 On the other hand, it may be argued that external threats to a blockchain community are inherently contained as the transparency and trackability of transactions would constrain external hackers and thieves. Where a cyberhacker exploited a bug in the smart contracts for decentralised finance protocol bZx, stolen tokens were tracked down and the thief persuaded to return them.74 Ad hoc episodes of crisis management can be successful based on the inherent transparency and robustness of blockchain infrastructure, and the social galvanisation of the entire community affected. It may be argued that every crisis is different and it would not necessarily be superior to have a governance protocol for dealing with crisis management. (i) How relationships should be framed between third parties and the blockchain or dApp community as a whole, such as relationships with regulators and authorities: It should not be presumed that the permissionless blockchain communities and dApp communities residing on them do not have collective identities. It may be expedient or necessary for the blockchain-based or dApp community to be regarded as the collective representation of its participants in certain circumstances. Schneiders’ and Shipworth’s article,75 for example, discusses a peer-to-peer energy trading network that runs on blockchain technology. However, the network as a whole needs to be treated as an aggregate entity in itself when transacting with the national grid. Further, regulators may wish to regard the blockchain-based or dApp community as an aggregate entity in relation to meeting regulatory standards collectively. Hence, it is relevant to consider how the community’s aggregate identity ought to be conceived and how it relates to representation of its participants. It is also relevant to consider 72 ‘MakerDAO’s Problems Are a Textbook Case of Governance Failure’ (17 March 2020), at www.coindesk. com/makerdaos-problems-are-a-textbook-case-of-governance-failure. 73 ‘Maker Debt Crisis Post-Mortem Recommends New Safeguards’ (29 April 2020), at cointelegraph.com/ news/maker-debt-crisis-post-mortem-recommends-new-safeguards. 74 ‘Defi Platform Bzx Recovers Stolen $8.1 Million From Hacker’ (16 September 2020), at news.bitcoin.com/ defi-platform-bzx-recovers-stolen-8-1-million-from-hacker/. 75 A Schneiders and D Shipworth, ‘Energy Cooperatives: A Missing Piece of the Peer-to-Peer Energy Regulation Puzzle?’ (UCL Energy Institute Working Paper, 2018).

The Applicability of Existing Organisational Regimes in Law  125 how third-party relations with the community ought to be framed, for the purposes of legal obligations, rights and enforcement. A conception of the blockchain-based or dApp community as an aggregate entity also reinforces the needs for internal governance protocols, as internal frameworks and protocols need to be developed in order to distribute the implementational needs for compliance efforts. In light of the nine organisational needs for blockchain-based communities, whether at the level of infrastructure or dApps, we turn to explore whether the existing legal frameworks for organising collective and enterprisal activities have anything to offer.

III.  The Applicability of Existing Organisational Regimes in Law We now explore the fit between permissionless blockchain-based businesses and existing organisational regimes in UK law, in order to critically consider the extent to which legal regimes meet the nine organisational needs discussed above.76

A.  The Company The company is the most popular legal organisational form for commercial activities in the UK77 and in many jurisdictions around the world. It is a legal vehicle that allows collective endeavour towards a for-profit purpose, enjoying separate legal personality to hold and manage its own assets.78 Collective endeavour in the company is organised in a hierarchical structure towards the deployment, use or exploitation of those assets, for value creation.79 The collective purpose of the company is protected by its separate legal personality,80 which at the same time forms the basis for limited liability of members of the company. Limited liability is a policy choice81 that is aimed at incentivising entrepreneurship as individuals exposed to unlimited personal liability can be risk averse and refrain from engaging in enterprise, therefore holding back the potential for economic wealth creation that would ultimately benefit private as well as public interest. At one level, it can be argued that many permissionless blockchain-based businesses are commercial in nature, facilitating transactions such as in virtual reality 76 Kaal (2020) also discusses the inappropriateness of fitting blockchain enterprises into corporate or partnership structures per se, but survey approaches in Delaware and Switzerland where hybrid approaches with established organisational vehicles are used. 77 There are over four million registered live companies on the UK Companies House register, for example; see Companies House, ‘Incorporated Companies Statistics in the UK’, at www.gov.uk/government/statistics/ incorporated-companies-in-the-uk-october-to-december-2020/incorporated-companies-in-the-uk-octoberto-december-2020. These statistics show incorporation growth even during the Covid-19 pandemic. 78 H Hansmann and R Kraakman, ‘Organisational Law as Asset Partitioning’ (1999), at deepblue.lib.umich. edu/bitstream/handle/2027.42/41206/wp252.pdf?sequence=1&isAllowed=y. 79 MC Jensen, ‘Value Maximization and the Corporate Objective Function’ (Harvard Business School Working Paper, 2000), at pdfs.semanticscholar.org/1b7d/5fcd1fd8e99a8127957a27abf8e818080b97.pdf. 80 Established in Salomon v A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22. 81 PG Mahoney, ‘An Essay in the History of Corporate Law’, at www.law.virginia.edu/pdf/faculty/hein/ mahoneyp/34ga_l_rev873_2000.pdf.

126  Facilitating the Crypto Economy (Decentraland) or virtual art (CryptoKitties) and such a commercial nature seems aligned with what companies are incorporated for. However, the for-profit purpose of the company has entailed a certain insular focus on shareholder wealth creation especially in the liberal market economies of the West, such as the US and UK.82 The primacy of shareholders in both theoretical and practical depictions of corporate practice83 has entailed concerns as it is a contributing factor to the growing disparity between financial wealth and other productive wealth in many developed economies.84 Further it is questioned if the focus on corporate wealth creation as primarily benefiting shareholders would result in marginalisation of relevant issues such as the social fabric surrounding the corporation,85 impact on the planet86 and the public good.87 It is arguable that companies in more managed market economies such as Germany and Japan are less insular as the social pact with respect to human capital pronouncedly affects corporate purpose and culture, also known as the ‘political economy effect’.88 That said, it has been argued that shareholder primacy is not itself the problem, the real issue being that of short-termism.89 If companies are pressured to only consider short-term profit generation, for example by shareholders and capital markets, then their myopic focus can obscure the wider context in which a company is operating. Corporate conduct can then become disengaged from collective good and what is socially acceptable.90 In this regard, some corporations have been more susceptible to being short-termist than others, and the corporate form itself is not necessarily the cause of this.91 As the US and UK are highly popular jurisdictions for blockchain enterprises, with the US having at least a 50 per cent market share of the crypto economy,92 the suitability of the company as a legal organisational form for blockchain-based businesses is an important question. 82 The importance of shareholder primacy, see A Keay, ‘Shareholder Primacy in Corporate Law: Can it Survive? Should it Survive?’ (2010) 7 European Company and Financial Law Review 369. At the global level, shareholder primacy is argued to be the dominant model of the corporate economy, H Hansmann and R Kraakman, ‘The End of History for Corporate Law’ (2000) 89 Georgetown Law Journal 439. 83 P Ireland, ‘The Financialization of Corporate Governance’ (2009), at ssrn.com/abstract=2068478. 84 See discussion in ch 2 of this book. 85 In terms of stakeholderism or even a communitarian form of corporate ethos, both lacking in the US and UK corporate law models and corporate culture, see RE Freeman, ‘A Stakeholder Theory of the Modern Corporation’ reproduced in MBE Clarkson (ed), The Corporation and Its Stakeholders (University of Toronto Press, 1998) 125; MM Blair and LA Stout, ‘A Team Production Theory of Corporate Law’ (1999) 85 Virginia Law Review 247; JE Parkinson, Corporate Power and Responsibility: Issues in the Theory of Company Law (Clarendon Press, 1995); K MacDonald, ‘The Socially Embedded Corporation’ in J Mikler (ed), The Handbook of Global Companies (John Wiley & Sons, 2013) ch 22. 86 eg PwC, ‘From Promise to Reality: Does Business Really Care about the SDGs?’ (2018), at www.pwc.com/ gx/en/sustainability/SDG/sdg-reporting-2018.pdf. 87 G Scherer and G Palazzo, ‘Toward a Political Conception of Corporate Responsibility: Business and Society Seen from a Habermasian Perspective’ (2007) 32 Academy of Management Review 1096. 88 S Vitols, ‘Varieties of Corporate Governance: Comparing Germany and the UK’ in PA Hall and D Soskice (eds), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage (OUP, 2001). 89 Explained in Corporate Values Strategy Group, Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management (Aspen Institute Business and Society Programs, 2009), at www.aspeninstitute.org/publications/overcoming-short-termism-call-more-responsibleapproach-investment-business-management. 90 J Bakan, The Corporation: The Pathological Pursuit of Profit and Power (Robinson Publishing, 2005). 91 A Winston, ‘Is the Business Roundtable Statement Just Empty Rhetoric?’ (Harvard Business Review, 30 August 2019), at hbr.org/2019/08/is-the-business-roundtable-statement-just-empty-rhetoric. 92 Statistics from icobench.com/stats.

The Applicability of Existing Organisational Regimes in Law  127 Indeed, a shareholder primacy ethos, even if in need of moderation and reform,93 can be constrictive for blockchain communities. There is scope for arguing that blockchain enterprises generally reflect a different ethos. Blockchain communities can be perceived to offer opportunities for developing commercial applications that are alternatives to mainstream products or services that have been excessively shaped by the corporate profit-maximisation ethos, therefore presenting a different way to frame commercial activity. Some blockchain-based enterprises explicitly profess an alternative ethos, such as valuing social reciprocity, fairness, etc. Swarm City,94 for example, is a blockchain-based business that aims to provide alternative businesses such as to Uber and AirBnB, offering a different vision of shared urban life. Corporatised platforms in the platform economy such as Uber have been criticised for exploiting their gig economy drivers.95 There are also numerous blockchain-based businesses such as Audius that are regarded as alternatives to Spotify,96 the music platform that is criticised for rewarding artists inadequately.97 However, difference offered by blockchain-based enterprises may be overstated. In essence, blockchain-based enterprises allocate membership and participation to token-holders who are essentially financiers. In this way, there is no difference between such enterprises serving the interests of their financial capitalists and conventional for-profit corporations. Indeed, the lack of a clear legal characterisation of token-holders’ governance roles and rights is arguably more prejudicial for token-holders than conventional shareholders who benefit from the company law framework. The company as an organisational form benefits from a long history of development of roles and rules in relation to organising its internal relations. Corporate assets form the foundation for organising the company, and company law provides for a hierarchical structure for role division and specification in relation to how corporate assets are supplied and deployed. Economists regard such a hierarchical structure and its

93 The UK has embarked on ‘moderation’ of the excesses of shareholder primacy in the UK, since 2006 under the director’s duty of ‘enlightened shareholder value’, see A Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Routledge, 2012); PL Davies, ‘Enlightened Shareholder Value and the New Responsibilities of Directors’ (Lecture at the University of Melbourne Law School, 2005), at www.cclsr. law.unimelb.edu.au/download.cfm?DownloadFile=BC82395E-09AD-DB76-F1D0B2AFFB41CF9D. Also reforms to be more stakeholder oriented and responsible can be found in various places, such as the EU Non-financial Disclosure Directive 2014, discussed in IH-Y Chiu, ‘Unpacking the Reforms in Europe and UK Relating to Mandatory Disclosure in Corporate Social Responsibility: Instituting a Hybrid Governance Model to Change Corporate Behaviour? (2017) 5 European Company Law 193. Also see reform under Theresa May’s Government from 2016, Provision 5 in the UK Corporate Governance Code 2020 requiring the inclusion of employee voice. The Business Roundtable in the US has also offered a statement of responsible capitalism in 2019; see www.businessroundtable.org/business-roundtable-redefines-the-purposeof-a-corporation-to-promote-an-economy-that-serves-all-americans. However, critique on its cosmetic nature, and not essentially moving away from shareholder primacy, is found in L Enriques, ‘The Business Roundtable CEOs’ Statement: Same Old, Same Old’ (9 September 2019), at promarket.org/2019/09/09/ the-business-roundtable-ceos-statement-same-old-same-old. 94 thisis.swarm.city. 95 B Rogers, ‘Employment Rights in the Platform Economy: Getting Back to Basics’ (2016) 10 Harvard Law and Policy Review 480; A Di Minin, L Mendonca, E Ormala and P Evans, ‘Assessing the Platform Economy’ (2016) 32 Issues in Science and Technology 13. 96 blocksdecoded.com/blockchain-music-streaming/. 97 ‘Musicians Hit Back Against Spotify’s Attempt To Lower Pay’ (12 April 2019), at www.forbes.com/sites/ dannyross1/2019/04/12/musicians-hit-back-against-spotifys-attempt-to-lower-pay.

128  Facilitating the Crypto Economy legalisation to be efficient.98 Shareholders are providers of capital towards the acquisition of corporate assets and this capacity provides the basis for defining their roles and powers.99 Shareholders may be involved in the managing of corporate assets for the corporate purpose, but they may also choose not to, delegating the management powers to the managerial body, which comprises the board of directors and their delegates, ie corporate employees at various levels of seniority and organisational hierarchy.100 Where managers and shareholders are not the same persons, the chief relational paradigm for internal relations in a company is regarded as agency-based in nature,101 and this is reflected in the law’s allocation of powers and accountability to the managerial body, such as the imposition of fiduciary duties102 and reporting duties.103 In this manner, the corporate form and company law provides for well-established jurisprudence for the roles and responsibilities in internal relations, power and accountability, standards of conduct. It may be argued that such well-established jurisprudence is an attractive point for blockchain-based businesses and their token-holders alike, as there is institutional support for establishing the distribution of rights and for clarifying internal relations. Such institutional support offers confidence as well as efficiency for people aiming to carry out enterprise together, especially if disputes need to be resolved. In company law, dispute resolution in relation to companies’ internal relations is also clearly provided, such as in the UK’s Foss v Harbottle104 rule where internal mechanisms are first provided to be exhausted, and frameworks for externalising disputes are then made available and supported in legal and judicial institutions. Further, corporate assets also provide the basis for distributive rules with regard to how value generated by the company is to be distributed.105 However, blockchain enterprises that wish to pursue different models of power and distributive allocations would likely find the corporate model to be unsatisfactory. It is arguable that the corporate model promotes the interests of the shareholder and managerial classes, therefore creating elitism and distributive superiority in favour of these vis a vis other stakeholders who play a part in generating corporate wealth overall, such as employees. Powerful managers can negotiate good levels of compensation tied to the generation of shareholder value106 and in this manner 98 AA Alchian and H Demsetz, “Production, Information Costs and Economic Organisation” (1972) 62 The American Economic Review 777; O Williamson, ‘Corporate Governance’ (1984) 93 Yale Law Journal 1197. 99 Shareholders’ powers such as in constitutional amendment (UK Companies Act 2006, s 21), removal of directors (s 168), approval of substantial transactions (ss 190–214) and executive pay packages (s 439A) are examples of such monitoring powers in relation to directors’ use of corporate assets. 100 Arts 3 and 4, Model Articles for Private and Public Companies pursuant to the UK Companies Act 2006 represents a typical paradigm for division of powers between shareholders as a body in the general meeting and directors as body known as the board. 101 MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305. 102 UK Companies Act 2006, ss 170–77. 103 There are various duties in corporate transparency, the basic one being annual reporting of audited financial statements (see ss 393–414), non-financial reporting (ss 414A, 414CA and 414CZA), as well as reporting of company pay ratios (Sch 8, para 19A). 104 (1843) 67 ER 189. 105 Shareholder primacy; see n 78. 106 Executive compensation has reached phenomenally high levels, and it is reported that public companies’ chief executives can earn over 100 times more than the average worker in the company; see ‘UK bosses

The Applicability of Existing Organisational Regimes in Law  129 enjoy significant distributive benefits. Other stakeholders such as those contractually bound to the company – employees, suppliers, customers, etc – do not share in the company’s wealth creation and are allocated their dues under contract. In liberal market economies such as the US and UK, grave inequalities have been observed between executive pay and average workplace pay.107 Ordinary workers see themselves as sharing less corporate wealth compared to their executive bosses, and their needs have been regarded as secondary to the needs for paying dividends.108 In liberal market economies in particular, the for-profit corporation is not seen as a vehicle for bringing about greater egalitarianism. In blockchain-based businesses, it could be arguably contrived and contestable to fit new and important roles of participants into the elite roles of shareholders or managers, versus other stakeholders. How would volunteer code developers and miners be treated, for example? Although miners are financial capital providers, they also provide important governance functions. Code developers’ and miners’ roles are also different from the managerial class who are generally delegated with executive powers. These roles are different from the managerial class and more specific in nature, and so susceptible to different governance frameworks. To regard these as the equivalent of the corporate managerial body may seem over-inclusive. Further, it is arguable that it is also not appropriate to treat token-holders like corporate shareholders. Token-holders contribute capital to the platform by buying tokens but they are at the same time users and can be involved as miners and developers too. It is likely that the definition of roles, responsibilities, powers and accountability in blockchain-based businesses need to cater for new dynamics and multifaceted roles in order to reflect and protect the commons of expected social behaviour. Further, not all blockchain-based networks are simply for-profit in nature. They may be developed for multiple purposes that are both commercial and pro-social. For example, participants in blockchain-based businesses such as Decentraland are collectively building a community. In blockchains like these, levels of social happiness, neighbourliness and community pride could be as important as the financial value of one’s virtual reality. In blockchains such as Swarm City or Iungo, the global wireless internet platform, or Golem, the global computing capacity marketplace, participants are part of a project of reciprocity, providing accessible and cost-effective service to the community. Such business models are different from those of mainstream corporations focusing on the commercial purpose of being service providers. Hence, fitting blockchain-based businesses into the corporate mould could be damaging to the multifaceted ethos that

earn 117 times average worker despite pay cut’ (BBC News, 21 August 2019), at www.bbc.co.uk/news/ business-49411245. 107 Above. 108 For example, companies that are financially strapped would still insist on paying shareholder dividends, whether as public companies needing to please investors in the securities market or private markets where controlling shareholders exert disproportionate influence, and this is often at the expense of raising workers’ welfare or addressing pension deficits. See House of Commons Work and Pensions, Business, Innovation and Skills Committees, ‘First Report of the Work and Pensions Committee and Fourth Report of the Business, Innovation and Skills Committee of Session 2016–17’ (July 2016) on the collapse of BHS in 2016; BEIS and Work and Pensions Parliamentary Committee, ‘Carillion’ (2018) on the collapse of publicly listed company Carillion.

130  Facilitating the Crypto Economy such networks can foster. We are of the view that blockchain-based businesses can benefit from being framed as legal organisations that are not companies and therefore not baggaged with the structural assumptions and narrowly focused ethos that have developed in the corporate sectors of liberal market economies. In general, enterprisal diversity can be encouraged in order to pave the way for a more diverse and resilient economy.109 In light of the above, it can be asked whether social enterprise forms are more applicable to blockchain-based businesses, such as the community interest company (CIC) in the UK or the B Corp in the US. These forms may allow blockchain-based businesses to take on a legal organisational form derived from company law while serving a richer array of commercial and pro-social objectives.

B.  Social Enterprise Forms Social enterprise forms, whether in the UK or US, are derived from the tenets supporting the corporate form, such as separate legal personality, and the governance of common assets and interrelations. They are distinguished from the for-profit company largely on the basis of purpose and ethos, entailing differences in governance and distributive aspects. In the UK, the CIC can only be formed with approval of the Office of the Regulator of Community Interest Companies, if the objective of the company is to benefit the community.110 CICs cannot be political associations,111 but otherwise there is considerable freedom to frame their community benefit objectives. It may be said that CICs can be structured as for-profit companies limited by shares, hence catering to both commercial and community objectives. CICs are accountable every year in terms of the community benefit achieved and their stakeholder engagement,112 so that directors may show how corporate assets have been deployed for the right purposes. They are required to make financial reporting and provide for governance rights in a manner applicable to companies.113 In this manner, the CIC recognises purposes other than for-profit purposes, but it is a limited extension beyond the for-profit company. For blockchainbased businesses with a mixture of objectives, there remains uncertainty that they are aligned with the ‘community objective’ requirement. First, blockchain-based businesses may have global borderless communities and this may not be regarded as benefiting communities in the UK in particular. Second, blockchain-based businesses can revolve around precise purposes (due in part to their reliance on automated smart contracting) such as providing cloud file storage, and it is uncertain if such precise remits can be recognised as conferring a community benefit. Ultimately as community benefit is

109 G Ferri and A Leogrande, ‘Entrepreneurial Pluralism’ in J Michie, JR Blasi and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 2. 110 Companies (Audit, Investigations and Community Enterprise) Act 2004, the test of whether a company’s objective is in the community interest is according to a reasonable person test; see s 35. 111 The Community Interest Company Regulations 2005, Reg 3. 112 Reg 26, above. 113 Part 3, above and the Companies (Audit, Investigations and Community Enterprise) Act 2004, s 32.

The Applicability of Existing Organisational Regimes in Law  131 not defined, the Regulator can exercise discretionary power to interpret the scope of community benefit, and it remains to be seen if blockchain-based businesses can be integrated within this space. It can also be argued that setting up a peer-to-peer platform is itself a form of community-building around a shared purpose and thus confers community benefit. The equivalent of the CIC in the US is the benefit corporation, which is incorporated explicitly to pursue certain public and stakeholder interests. According to its model legislation, the benefit corporation should embrace a mandatory public benefit purpose in its charter, to achieve ‘A material positive impact on society and the environment, … taking into account [its] impacts … as reported against a third-party standard’.114 What is uncertain about the interpretation of ‘mandatory public benefit purpose’ is the scope of ‘public benefit’, and whether catering for particular community needs, such as cloud storage, would be recognised as sufficiently social or public. The Delaware legislation frames the benefit corporation as having the objective to balance stockholders’ financial interests with public benefit.115 In this sense, one wonders if the scope of ‘public benefit’ would be too wide, and whether blockchain-based businesses’ community-focused ethos would be sufficiently aligned. Should public benefit objectives be expressed in terms such as relating to the environment, human health, under-served and low-income communities,116 or can more narrowly be focused on a defined community? A key advantage in social enterprise legislations is the recognition of greater inclusiveness in organisational governance. The Model Benefit Corporation legislation states that directors need to take into account a wide range of stakeholder and socially responsible factors in decision-making and clearly do not subscribe to shareholder primacy.117 Annual reporting of the achievement of public benefit must be made and such report should be publicly available.118 Although elements of inclusiveness are detected, which can resonate with blockchain-based businesses, the presumption is that a central managerial organ exists. This is not necessarily instituted in blockchain-based businesses. That said, express disavowing of shareholder primacy and catering for non-financial types of value creation can be useful principles for blockchain-based businesses. Governance and distributive policies are left rather open, but as the benefit corporation is still derived from the corporate structure, like the CIC, governance and distributive policies would still be centred around shareholders and directors. Social enterprises such as the CICs and benefit corporations, although distinct legal structures from the corporate form, are essentially derived from the company structure. It is presumed that shareholders provide capital and that they delegate management to a board. The CIC legislation provides for roles, responsibilities, power and accountability structures accordingly. The CIC arguably does not fully cater for the organisational needs of the permissionless blockchain-based business, as the structural assumption of shareholders entrusting to

114 Model Benefit Corporation Legislation v2017, ss 102, 201, which is used as the basic template for most of the US states’ benefit corporation legislation, at benefitcorp.net/sites/default/files/Model%20benefit%20 corp%20legislation%20_4_17_17.pdf. 115 Delaware Code Annotated tit. 8, §§ 361–368 (2013) at § 362. 116 Model Benefit Corporation Legislation v2017, ss 102, 201. 117 s 301, above. 118 s 401, above.

132  Facilitating the Crypto Economy the board does not fit neatly with blockchain-based businesses’ flat structures and the newly defined roles such as for code developers, miners, arbiters, etc. In terms of distribution, CICs may declare dividends in favour of shareholders.119 This may be unduly restrictive as it is derived from company law tenets, and does not consider wider scopes and rationales for distributive policies. Further, the CIC does not envisage or allow public fundraising, and this would fundamentally be unsuitable for permissionless blockchain-based businesses that seek token financing for development. The social enterprise corporate vehicles discussed above do not fully meet the organisational peculiarities and needs of the permissionless blockchain-based business, because these provide for hybrid objectives in a manner that may be too narrow or wide for blockchain-based businesses and their communities. Further, entrenched assumptions in relation hierarchical agency-based structures do not necessarily apply. Hence, the consequent governance and distributive policies of such corporate vehicles are not likely suitable for blockchain-based businesses. We turn to other enterprise vehicles before considering if a bespoke law of organisations and governance is needed for blockchain-based businesses.

C.  The Cooperative The cooperative is an organisational form that is distinguished for its solidarity ethos amongst members, and it exists chiefly to promote and protect members’ interests and meet their needs.120 In the UK, the Co-operative and Community Benefit Societies Act 2014 provides an enabling legal framework and governs the formation and registration of cooperatives. It is envisaged that members of the cooperative would fund it (and are referred to as ‘shareholders’),121 and may also have their financial needs met by the cooperative, as legislation expressly enables the cooperative to meet members’ financial needs such as by lending to members.122 A cooperative is however free to determine its purpose and objects, and its governance framework. It is envisaged that there would be an agency-based delegation structure where committees and officers exercise ‘managerial-like’ powers,123 but their governance is left open-ended and is very much up to the private bargaining amongst members. The Act also provides enabling powers for the cooperative as it is a separate legal person that can hold its own assets and make investments.124 The cooperative provides a more open-ended and non-prescriptive legal structure that may fit with blockchain-based businesses’ needs. Further, the cooperative structure

119 The Community Interest Company Regulations 2005, Part 6. 120 A Fici, ‘The Essential Role of Co-operative Law and Some Related Issues’ in J Michie, JR Blasi and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 38. 121 Co-operative and Community Benefit Societies Act 2014, s 14. 122 s 34, ibid. 123 s 14, ibid. 124 ss 26, 27, ibid.

The Applicability of Existing Organisational Regimes in Law  133 may reflect an ethos more aligned with blockchain-based communities. Commentators are of the view that there are certain core expectations of cooperatives although the law does not overly prescribe these. Many take the view that the essence of cooperatives is to look after the interests of their members,125 as well as to mobilise collective action in advancing members’ interests as a whole.126 Hence, the financial value creation of the cooperative is embedded in those respects rather than generated by productive processes and wealth creation.127 In light of that ethos, although not prescribed, cooperative governance mechanisms are generally democratic, such as one-member-one-vote,128 and lean towards being egalitarian where distributive policies are concerned.129 There may also be other forms of governance frameworks but the overall impression is that such governance frameworks tend to promote voice, as being consistent with the solidarity ethos.130 However, the inward orientation of cooperatives have also been subject to debate, and it is often queried whether the cooperative ethos could usefully extend this business form to advance activities for public good such as advancing sustainability causes.131 Some blockchain enterprises find affinity with the cooperative ethos, such as democratic governance and more egalitarian distributive policies.132 For example, Fairmondo is a German platform cooperative that runs an online marketplace for ethical goods and services,133 and Resonate.is,134 is a Berlin-based ethical music streaming company that aims to strike a fair distributive balance for the supply and demand sides of downloadable music. Another platform cooperative is Stocksy United (based in Canada) that aims to promote the distribution of high-quality usable images whilst ensuring distributive fairness between the supply and demand sides.135

125 H Henrÿ, ‘Co-operative Principles and Co-operative Law Across the Globe’ in J Michie, JR Blasi and C  Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 4; C Gould, ‘The Co-operative Business Model: The Shape of Things to Come’ in J Michie, JR Blasi, and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 42, Fici (2019), above. 126 C Borzaga and EC Tortia, ‘Co-operation as Co-ordination Mechanism: A New Approach to the Economics of Co-Operative Enterprises’ in J Michie, JR Blasi and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 5. 127 Z Adams and S Deakin, ‘Enterprise Form, Participation, and Performance in Mutuals and Co-operatives’ in J Michie, JR Blasi, and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 16; W Davies, ‘Corporate Governance Beyond Neoliberalism: Agency, Democracy, and Co-Operation’ in J Michie, JR Blasi, and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 31. 128 BJ Reynolds, ‘The One Member-One Vote Rule in Cooperatives’ (2000) 15 Journal of Cooperatives, NCERA-210 1. 129 eg see MH Bruun, ‘Egalitarianism and Community in Danish Housing Cooperatives’ (2011) 55 Social Analysis 62. 130 Davies (2019), above; P Crouchman, ‘Governance and Organizational Challenges’ in J Michie, JR Blasi and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 17. 131 Borzaga and Tortia (2019). 132 T Kollmann, S Hensellek, K de Cruppe and A Sirges, ‘Toward a Renaissance of Cooperatives Fostered by Blockchain on Electronic Marketplaces: A Theory-Driven Case Study Approach’ (2019) Electronic Markets, at doi.org/10.1007/s12525-019-00369-4. 133 www.fairmondo.de/global. 134 resonate.is. 135 www.stocksy.com.

134  Facilitating the Crypto Economy However, blockchain-based businesses may find the cooperative structure limited and unsuitable when it comes to development funding as there is no provision for cooperatives to make public offers of tokens. Indeed blockchain-based businesses that wish to do so often prefer to be open-ended about their membership, as entry and exit can be based on market-based decisions and not exclusively based on social identification or affinity with a particular ethos or objectives. Although cooperative members are envisaged to be financial contributors, financial contribution is embedded within the broader solidarity ethos of the cooperative. The cooperative ethos would likely guide its entry and exit conditions in relation to applicants’ fit for membership. Further, it may be argued that the assumption made for cooperatives, ie that there would be shareholders and officers and/or committees, does not apply squarely to blockchain-based businesses. Nevertheless, the assumptions in the cooperative structure are less fixed than for corporate structures, and the committee structure can accommodate unique roles such as miners, code developers and arbiters. Finally, for blockchain-based businesses that do not identify with the cooperative ethos, such as democratic governance or the principal objective of looking after its members, they would unlikely find the cooperative structure suitable, even though legislation is rather open-ended in terms of purpose and governance. The historical development of cooperatives,136 and observed practices and the work of the International Cooperative Alliance137 define broadly the purposes and expectations for a typical cooperative. While some blockchain-based businesses would find resonance with these, others may not.

D.  The Limited Liability Partnership Finally, the organisational vehicle of the limited liability partnership (LLP) should be considered in terms of its suitability for permissionless blockchain-based businesses. The LLP is a corporate vehicle introduced in the UK in 2000 initially to facilitate the conversion of professional partnerships into separate legal personalities with limited liability, while allowing professional partnerships such as accounting, legal, surveyors’ and other professional firms to maintain their partnership structures and ethos. However, the application of the LLP was expanded during the legislative process as it was thought useful to make available this organisational vehicle to other commercial activities where organisers wish to take advantage of a corporate form with limited liability while having the flexibility to determine internal arrangements, without being shackled to the hierarchical agency-based structures that the company form provides.138 Hence the LLP can be used for business and commercial activities beyond professional

136 V Zemagni, ‘A Worldwide Historical Perspective on Co-operatives and Their Evolution’ in J Michie, JR Blasi, and C Borzaga (eds), The Oxford Handbook of Mutual, Co-Operative, and Co-Owned Business (OUP, 2019) ch 7. 137 www.ica.coop/en. 138 Discussed in V Finch and J Freedman ‘The Limited Liability Partnership: Pick and Mix or Mix-Up?’ [2002] Journal of Business Law 475.

The Applicability of Existing Organisational Regimes in Law  135 partnerships, and has been keenly used as investment structure vehicles such as for hedge funds. The LLP enjoys separate legal personality in order to hold its own assets and is therefore able to manage and protect common assets, achieving asset partitioning from members. The LLP offers features that are different from the dominant company structure in a few key respects. First, it is arguable that a financial basis for membership is not necessary for the LLP, like it is for the company and the cooperative. Membership in corporate forms and cooperatives is based on contributing to the capital of the organisation, but the LLP does not adopt shares in its articulation of membership. The LLP’s members are those who subscribe their names to the incorporation document,139 and hence the LLP has freedom to determine if financial contribution is a condition or otherwise for such membership. Second, the LLP offers freedom for members in structuring their internal relations and governance. Although legislation provides a default template140 for internal governance, case law has held that the actual agreements for internal governance and relations in LLPs would prevail to determine partners’ obligations and duties vis a vis each other.141 In the absence of agreement, the default template draws from partnership law, which emphasises the consensual, equal and good faith nature of partnerships. For example, the default template envisages that partners would all contribute to management of the LLP’s business and would share equally in the profits of the business.142 Further legislation provides for all partners to be regarded as agents for contracting on behalf of the LLP and to bind the LLP to arrangements made in the course of business.143 The default template emphasises the consensual quality of partnerships that treat all partners as equal contracting parties vis a vis each other, so no member should be expelled unless there are ex ante agreements on the removal of members and grounds for doing so.144 Addition of members is also subject to consensus of all other members.145 Partners are expected to owe each other reciprocal duties, such as accounting of information fairly and fully,146 and not to derive personal benefit from the LLP’s business or to compete with it, unless with prior consent of the LLP.147 In this manner, the LLP caters for relatively flat and non-hierarchical structures, largely amongst individuals who treat each other as equals, and who are prepared to extend reciprocal respect and accountability to each other. The characteristics above can be suitable for blockchain-based businesses as the ethos of flat structures and equality is aligned with theoretical equality for nodes on blockchains. Further, membership that is not necessarily based on financial contribution

139 Limited Liability Partnerships Act 2000, s 4. 140 Limited Liability Partnerships Regulations 2001, Reg 7. 141 F & C Alternative Investments Holdings Ltd vs Barthelemy and Culligan [2011] EWHC 1731 (Ch). 142 Limited Liability Partnerships Regulations 2001, Reg 7. 143 Limited Liability Partnerships Act 2000, s 6. 144 Limited Liability Partnerships Regulations 2001, Reg 6; Hosking v Marathon Asset Management LLP [2016] EWHC 2418 (Ch). 145 Limited liability Partnerships Act 2001, Reg 7. 146 ibid. 147 ibid.

136  Facilitating the Crypto Economy allows flexibility in relation to who can become a node on the protocol blockchain or dApp residing on the blockchain. Some commentators148 have also argued that blockchain-based organisations such as the DAO discussed in chapter one are closer to partnerships as they adopt a consensual structure for members to make decisions. The LLP’s offer of contractual flexibility in governing internal relations may also be attractive as it allows blockchain community participants to agree on tailor-made arrangements suitable for their community. However, a drawback of such open-ended flexibility is that transaction costs for participants’ bargaining would be high, and in this light, organisational vehicles with more ready-made governance templates present lower transactional costs for blockchain-based business entrepreneurs. Further, as nodes on protocol blockchains or dApps residing on blockchains may be located all over the world, there may be no social fabric underpinning their transactional interrelationships. In this manner, it is queried if there would be collective action failures amongst nodes securing collective governance agreements for themselves. The openendedness offered in the LLP template may give rise to opportunities for certain nodes to collude and exert dominant influence or for more aggressive nodes to exert influence by being first-movers. The assumption underlying the LLP’s freedom to determine membership and its internal governance and arrangements is that there is a level of social fabric and trust amongst members that foster peer regard, respect and mutual reciprocity.149 Perhaps certain blockchain communities may develop thicker social bonds inter se as they mature, but this is likely not an assumption that can be made for all blockchainbased businesses in early stages. Indeed, as blockchain-based businesses allow users to be pseudonymous, the quality of the social fabric on blockchains is likely different from that sustaining typical partnerships comprising highly interdependent relations. Further, even mature blockchains such as Bitcoin experience anti-social behaviour such as 51 per cent rogue attacks. Hence there seems a weak case for making assumptions about the fit between blockchain-based businesses and the more tightly knit underpinnings of the LLP. Further, it may be argued that although the LLP purports to offer flexibility for partners to govern their relations vis a vis each other, the directors’ disqualification regime in the UK applies to LLPs, raising questions as to whether the company law framework for directors’ duties is implicitly imported for partners in LLP, therefore restricting their freedom to structure internal relations amongst themselves. Under the disqualification regime, company directors of failed companies may be subject to disqualification proceedings initiated by the Secretary of State for Business, if such directors are regarded as unfit. Unfitness is usually tied to breaches of directors’ duties.150 The company law

148 O Oren, ‘ICO’s, DAO’s, and the SEC: A Partnership Solution’ (2018) Columbia Business Law Review 617; L Metjahic, ‘Deconstructing the DAO: The Need for Legal Recognition and the Application of Securities Laws to Decentralized Organizations’ (2018) 39 Cardozo Law Review 1533. 149 As derived from partnership law generally, see generally G Morse, Partnership and LLP Law (OUP, 2015). 150 Director Disqualification Act 1986, s 6.

The Applicability of Existing Organisational Regimes in Law  137 framework for directors’ duties151 includes holding directors to exercise their powers for a proper purpose,152 in good faith,153 with due care and skill154 and to inform of conflicts of interest and seek ex ante approval for such.155 These go beyond the default template in relation to partners’ interrelations discussed above, and are potentially regarded as mandatory in nature, due to the express application of the directors’ disqualification regime in legislation. It would likely be inappropriate and unduly constricting for blockchain-based businesses if their nodes are subject to the full range of directors’ duties. Ultimately the LLP also suffers from the lack of a facilitative framework for public fundraising, making its distinguishing feature of not being financially oriented also a disadvantage. This structure is not likely to cater for blockchain-based businesses on all fours although there are useful characteristics to consider. Nevertheless, in all the organisational vehicles discussed so far, a common feature emerges that would likely benefit blockchain-based businesses: they all enjoy separate legal personality and limited liability. Section IV below conducts a dedicated discussion of the benefits and drawbacks of separate legal personality and limited liability for blockchain-based businesses and argues on the whole that it would be beneficial for blockchain-based businesses to have such characteristics. This is because the nine organisational needs discussed above are best supported by these characteristics. Separate legal personality also provides an organisational starting point for internal relations, governance, standards of conduct, trust systems, crisis management and dispute resolution matters. In light of the likelihood that none of the existing legal organisational forms fully cater for permissionless blockchain-based businesses, we may consider two approaches. One is an approach derived from existing organisational law, such as providing an organisational form for the blockchain-based business but derived from an established form, eg the ‘limited liability company’ provided in the law for corporations, partnerships and associations’ in Vermont.156 The second is to treat blockchain-based businesses as novel structures and to provide enabling and governing legislation for them in a tailor-made manner. We take each approach in turn.

151 Companies Act 2006, ss 170–77. 152 s 171, ibid, and this has been interpreted to disallow directors from taking actions that interfere with the powers and composition of the general meeting of shareholders, even if benefit for the company’s interest can be ascertained; see Howard Smith v Ampol Petroleum [1974] AC 821; JKX Oil and Gas Plc v Eclairs Group Ltd [2015] UKSC 71. 153 s 172, ibid, Re Smith & Fawcett Ltd [1942] Ch 304. 154 Standard of negligence but higher standard can apply to directors with expertise and qualifications, s 174, ibid; Re D’Jan of London of London [1994] 1 BCLC 561; Re Produce Marketing Consortium (No 2) [1989] BCLC 520. 155 s 175, ibid. There are debates as to when a conflict of interest really arises when directors use their knowhow after resignation in their new business, versus taking away property or information from the company, see Island Export Finance Ltd v Umunna [1986] BCLC 704; Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200, CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704. Conflicts of interest are also deemed to arise if a director takes advantage of an opportunity s/he comes across in the course of business although the company would not be exploiting it; Bhullar v Bhullar [2003] EWCA Civ 424. 156 legislature.vermont.gov/statutes/chapter/11/025.

138  Facilitating the Crypto Economy

E.  Adapted Corporate Organisational Form The state of Vermont in the US now provides for the blockchain-based limited liability company (BBLLC) as part of the statutes for corporate incorporation and law. Under Vermont law, a BBLLC may be incorporated if it meets the special characteristics of adopting blockchain technology, and participants are defined by virtue of their being a node and each having a copy of the ledger of the blockchain, as well as holding tokens in order to participate in the blockchain network.157 A BBLLC must specify in its articles of organisation (equivalent to the company’s constitution in the UK) that it elects to be a BBLLC and is able to meet the Act’s definitional characteristics of the BBLLC.158 Vermont LLC law is relatively minimalist and provides a wide berth of freedom for corporate organisation and governance. The limited liability of the Vermont LLC is clearly provided159 and few mandatory provisions pertain to members’ contributions and protection of capital,160 managers’ fiduciary duties,161 members’ rights to protect and enforce agreed rights and to take derivative actions,162 winding-up petitions and the protection of third-party rights,163 and the effecting of mergers and acquisitions.164 It may be surmised that such law is largely enabling in nature, facilitating voluntary constituents of LLCs to design and implement more precise governance arrangements, subject to standards only where rights and third-party concerns need to be addressed. In this manner, the BBLLC enjoys freedom to specify its organisational and governance arrangements, and a template is usefully provided at a high level for guiding governance design, meeting many of the nine organisational needs discussed above. The statute recognises that participants may take on multiple roles such as being developers and miners165 and that the mining protocol is of foundational importance to the blockchain network.166 Further, the broadly framed template for BBLLCs to specify governance arrangements167 addresses the organisational needs such as: needs relating to the purpose of the blockchain; governance rights such as in relation to voting and decision-making, as well as code changes; distribution and allocation of responsibilities such as for security breaches; the freedom to allocate centralised decision-making aspects; entry and exit requirements; distributive rules in relation to how interests are represented and catered for; and norms in relation to rights and obligations in general. It is helpfully stated that these governance arrangements prevail where they may be contrary to what is stated under general LLC law.168

157 s 4171, ibid. 158 s 4172, ibid. 159 s 4042, ibid. 160 ss 4053, 4056, 4057, ibid. 161 s 4059, ibid, as consistent with the minimum standards that would be imposed on managers under a hypothetical bargain paradigm; FH Easterbrook and DR Fischel, The Economic Structure of Corporate Law (Harvard University Press, 1991) ch 1. 162 Sub-chapter 9, Vermont Statutes on Corporations, Partnerships and Associations. 163 Sub-chapter 7, ibid. 164 Sub-chapter 10, ibid. 165 s 4174, ibid. 166 s 4175, ibid. 167 s 4173, ibid. 168 ibid.

The Applicability of Existing Organisational Regimes in Law  139 As Vermont LLC law is generally open-ended, the extent of importing presumptive baggage from LLC law into the blockchain universe is mitigated. However, as it is still expressly stated that the BBLLC is subject to federal and state law where not exempted,169 one disadvantage of providing for the BBLLC as part of LLC law is that the articles of organisation for the BBLLC need to be fully express in overriding unsuitable or contrary provisions, such as assumptions that only managers and shareholders have powers and rights in an LLC.170 In this manner the onus is on BBLLC incorporators to ensure that they not only cater positively for how the BBLLC should be organised, but also cater comprehensively for what needs to be removed from the general LLC corpus of law from the BBLLC’s articles. This exercise is necessary in case conflicting provisions in the LLC law become incorporated for BBLLCs and create problems in the future. One queries whether this adapted approach is superior to the provision of a completely new legal form. One advantage of the adapted approach is that it can provide limited liability for BBLLCs in an uncontroversial manner because the BBLLC is regarded as an offshoot of the LLC. Although the Vermont provision may be a starting point, it is welcome by blockchain developers. Kaal171 discusses the first blockchain enterprise that has already incorporated a BBLLC bringing its DAO governance within the BBLLC structure.172 Further, this adapted approach also seems popular in Swiss incorporations of blockchain-based limited liability enterprises. The other approach is to treat the blockchain-based business as a unique organisational phenomenon. Such an approach may be better placed to provide an enabling legal framework for the permissionless blockchain-based business,173 as inappropriate ‘fits’ with existing legal structures can be avoided. For this approach, we discuss Malta’s Innovative Technological Arrangements and Services Act passed in 2019 as a key example of how to provide for such an alternative organisational form in law.174

F.  New Legal Organisational Form? Malta introduced a piece of legislation in 2019 providing for the official recognition of innovative technological arrangements (ITAs) including distributed ledger-based arrangements such as blockchains.175 The aim of the Act seems to be to grant certified status to ITAs in order to provide legitimacy for their operations and public confidence in participating in them. This is arguably an enabling legal framework that can give blockchain-based businesses legitimacy, at least in Malta, and is a starting point from which more can be developed. This enabling framework sits alongside but is different 169 s 4176, ibid. 170 s 4054, ibid. 171 (2020). 172 ‘dOrg Founders Have Created the First Limited Liability DAO’ (11 June 2019), at www.coindesk.com/ dorg-founders-have-created-the-first-limited-liability-dao. 173 This is also mooted in the US context where Nielsen argues that US legal forms in terms of partnerships, LLCs and the corporation are not suitable for the DAO, and recommends the creation of a hybrid organisational form to be legally recognised; see T Nielsen, ‘Cryptocorporations: A Proposal to Legitimise Decentralised Autonomous Organisations’ (2019), at ssrn.com/abstract=3334579. 174 At www.justiceservices.gov.mt/DownloadDocument.aspx?app=lp&itemid=29078&l=1. 175 para 1, First Schedule of the Innovative Technological Arrangements and Services Act.

140  Facilitating the Crypto Economy from the Virtual Financial Assets Act discussed in chapter three, which deals specifically with fundraising and the issuance of crypto-assets. The lack of certification does not necessarily render an innovative technological arrangement illegal, as permissionless protocol blockchains such as bitcoin and Ethereum blockchains are global and borderless, and have been sustained despite the lack of legal recognition from any national jurisdiction. However, the certification for legitimacy can be attractive in order to incentivise development of competing protocol infrastructure as well as to enable dApps on existing protocol blockchains to be legitimised. The enabling legislation has potential to reduce the organisational cost for dApps as organisational norms and governance templates may be offered, and dApps also gain some legitimacy towards public fundraising. The Maltese Act provides that ITAs can be certified by the Malta Digital Innovation Authority (MDIA) in relation to their qualities, attributes, features, behaviours and other aspects as the MDIA may determine.176 This caters for the first organisational need discussed in section II in relation to the veracity of the programmed code on the blockchain. The MDIA recognises that, different from extant organisational forms, the blockchain is crucially an organisational form that is established and sustained by certain technological promises; ie what is purported to be carried out by the smart contracts on the blockchain and whether they work as expected. Hence, it is important to verify that the code that powers the blockchain-based business is fit for purpose. The fundamental fitness of code is the foundation upon which all other organisational needs can be met. In order to certify the ITA,177 the MDIA requires that: (a) the fitness for purpose of the ITA is declared by the ITA’s administrators and shareholders; (b) software and code has been certified by a registered systems auditor; (c) the ITA has a technical administrator to ensure proper management of the technological systems; and (d) the ITA is in a position to comply with applicable rules and laws so that its activities are adherent to ‘legality, integrity, transparency, compliance and accountability’.178 At first glance the MDIA’s certification does not seem to be based on its own technical assessment, but rather on its acceptance of the assurance provided by the ITA’s influential persons and an independent systems auditor. This is understandable as it may not have relevant direct expertise. However, such a regulatory structure can incur the hazards of meta-regulation, which is a regulatory design that relies inevitably on delegating actual implementation to the regulated subject and gatekeepers. In such a regulatory structure, the MDIA must be able to maintain effective oversight over the defined responsible persons as well as the third-party gatekeepers.179 Otherwise, such a regulatory approach can devolve into a merely self-regulatory state.

176 s 8, ibid. 177 ibid. 178 s 7, ibid. 179 The broad hazards of meta-regulation in the financial sector diagnosed as contributing to the global financial crisis 2007–09 are discussed in IH-Y Chiu, Regulating (from) the Inside: The Legal Framework for Internal Control in Banks and Financial Institutions (Hart, 2015); see relevant citations in chs 1, 5 and 6.

The Applicability of Existing Organisational Regimes in Law  141 As the Act does not presume any particular governance or internal relations structures to be optimal for ITAs, it attaches responsibility to persons broadly defined who are perceived to be in control over making decisions for the ITA. For this purpose, nodes with mere votes without definitive influence over assets or decision-making are not regarded as administrators.180 There is also a tentative conceptualisation of ‘shareholders’ as there is no assumption that membership is financially determined or that powers are dependent on financially determined membership. However, the term does capture those with controlling rights or decision-making powers on the ITA, defined as having at least 25 per cent of ‘say’. Although such terms are used tentatively, this experimental starting approach attempts to identify persons with some degree of power or responsibility, while leaving the ITA with flexibility as to the rest of its internal relations and governance arrangements. The Act requires the MDIA to be satisfied as to the fitness and propriety of administrators and controlling shareholders (as broadly defined above). However, it is unclear how this is to be implemented if the category of eligible persons is dynamic in nature. For example, the identity of administrators could change as volunteer code developers join in or drop out, and controlling shareholders may change depending on how the ITA determines the allocation of decision-making rights. It may however be said that the MDIA’s certification lasts only for two years181 subject to renewal, and changes can be reviewed at times of renewal. Nevertheless, if an ITA can code in internal governance in such a manner that no controlling powers or decision-making rights would arise amongst clusters of participants, and all decision-making is by consensus or referendum, how would the Authority deal with this? Further, what criteria for fitness and propriety are applied? Is it optimal for the MDIA to accept assurance with respect to the technical functionalities of the ITA on the basis of the satisfaction of personal characteristics of administrators and shareholders? Next, the Act creates a new body of gatekeepers: the systems auditor to verify the technical functionalities of the software and code for the ITA’s smart contracts. It is uncertain what qualifications are needed for this role and whether this role would require accreditation, either by the regulator or a third-party professional body. How would the programming profession be coopted in the development of professional standards as well as ethics to support this role?182 It is highly likely that the MDIA would inevitably rely on the systems auditor’s assurance in relation to the technical functionalities of the ITA and it would be important to ensure that such persons are subjected to credible and robust conduct, as well as supervision. There is no provision in the Act for developing codes of conduct other than subjecting systems auditors to constant renewal of registration in two-year periods. Further, it is also unclear if such certification can be robust as computer code inevitably contains bugs, and what the tolerance level should be at a professional level. Just as we struggle to define the extent of tolerance for auditors’ non-detection of problems in a reasonable assurance audit,183 180 para 2, Fourth Schedule. 181 Third Schedule. 182 Such as the Blockchain Association, at theblockchainassociation.org. 183 See proposed reform to auditing standards in the wake of accounting scandals in the UK such as Patisserie Valerie’s falsified accounts in 2019, the unexpected collapse of Thomas Cook Travel in 2019, as well as earlier

142  Facilitating the Crypto Economy how should the expectation for systems auditors be defined in relation to the new task of technical assurance? The MDIA requires satisfaction as to the ITA’s ‘legality, integrity, transparency, compliance and accountability’ in order to certify the ITA. It is unclear to what extent the certification guarantees the merit of ITAs in relation to these qualities, and indeed how these qualities may be defined. In relation to legality, it is likely that adherence to anti-money laundering laws and data protection laws, ie the EU General Data Protection Regulation,184 would apply, in addition to sectoral laws that may apply to the particular business of the ITA in question, but it is uncertain if consumer protection laws would apply to ITAs that may be regarded as peer-to-peer in nature.185 Hence, the Act does not resolve the ambiguities regarding the application of specific areas of extant law to ITAs, much of which is discussed in chapter one. In the face of such ambiguities, it is unclear how the MDIA can be satisfied of the ITA’s legality, unless it is merely relying on proxy indicators. Would this require code to be inherently programmed to be legally compliant? Would this require the identification of a responsible compliance or monitoring role in order to provide this area of governance for the ITA? The mandatory requirement for a permanent and independent compliance role has been instituted in the financial sector in order to gatekeep internally against the firm’s non-compliance with regulatory requirements.186 Would this be considered for ITAs? It is also uncertain if compliance relates only to Maltese laws, and is extended to laws such as in other European Member States or elsewhere. Beyond legality and compliance, what would ‘integrity’ mean? Would this relate to ethicality, and if so, what standards would apply? In relation to transparency and accountability, the Act does not specify any particular reporting obligations, and it is not known if these relate to existing sectoral regulatory requirements or to internal governance arrangements such as internal accountability mechanisms. If the latter is taken into account, there is no explicit provision in the Act catering for particular qualities of internal governance arrangements. Although the Act requires the ITA to be legally compliant with existing laws, it is uncertain how any non-compliance would be enforced, after certification has been granted. The Act crucially does not provide for ITAs to have separate legal personality, an issue debated but dropped in Malta.187 Hence, would enforcement have to be targeted at administrators, controlling shareholders or responsible roles in relation to compliance? Given the possibilities that these categories of persons may be changing

insolvencies such as Carillion Plc in 2018; Sir Donald Brydon, ‘Assess, Assure and Inform: Improving Audit Quality And Effectiveness: Report of the Independent Review into the Quality and Effectiveness of Audit’ (December 2019), at assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/ file/852960/brydon-review-final-report.pdf. 184 Schneiders and Shipworth (2018) do not think that current corporate vehicles such as the cooperative or LLP would be certain of complying with the GDPR; see CMS, ‘The Tension between Blockchain and GDPR’ (January 2019), at cms.law/en/int/publication/the-tension-between-gdpr-and-the-rise-of-blockchain-technologies. 185 Discussed in ch 1, but contended for in Tendon and Ganado (2018). 186 Chiu (2015) ch 2. 187 Discussed in M Ganado, ‘Maltese Technology Foundations – Initial Thoughts on an Important Proposal’ (2018), at ssrn.com/abstract=3245783.

The Applicability of Existing Organisational Regimes in Law  143 or outside of Malta, enforcement against individuals could be remote and ineffective. Although the Act requires a resident agent in Malta to be appointed for ITAs188 whose controllers are abroad, such resident agent is protected from personal liability where ITAs are themselves non-compliant, or where legal or judicial proceedings are initiated against ITAs. Next, the Act requires a technical administrator to be ‘in office at all times’.189 This is presumably in order to attend to technical troubleshooting, but implicitly provides for a mandatory internal governance requirement. Although the consequence is not clearly stated, compromises or failures in effectively instituting a technical administrator may place the ITA’s certification in question or be regarded as a regulatory breach. In the latter case, it is uncertain where liability would attach since the ITA does not enjoy separate legal personality. It is also questioned if some form of personal liability would be attached to the roles of technical administrators as this could be disincentivising for some participants to assume such a role. What would be the extent of commitment required and what standard of care should technical administrators be held to? If technical administrators refer to code developers, would this provision distort the incentives or motivations for individuals to undertake such a role? Should blockchainbased businesses provide a reward system for volunteers taking on the role of technical administrators? Is there scope for the internal governance mechanisms to develop a satisfactory distributive system to incentivise individuals to take on various roles of responsibility set out in the Act, and to compensate individuals for their efforts and risks? Although the Act provides a starting point to consider blockchain-based organisational forms differently, the legitimating conditions for this new organisational form are arguably still in need of development. The Act inevitably provides for some assumptions of internal governance and control, and it remains uncertain if these would be aligned with the essential functional and governance roles in blockchain-based businesses. It is questioned if it is an overkill to prescribe responsibility that attaches to administrator, shareholder, technical administration and compliance roles. Further, we argue that the Act’s lack of provision of separate legal personality, which can form the basis for internal governance mechanisms to develop, and the Act’s lack of consideration for internal governance templates, are significant flaws. These flaws detract from the enabling nature of the legal framework and may create distorting effects. In particular, responsible individuals could be incentivised to extract a high price within the blockchain-based network for taking on responsibility in defined roles, and this could distort distributive designs in the network. Further, there needs to be more consideration for how the gatekeeping capacities of systems auditors should be fostered and supervised. The Maltese Act is one of the first in the world to provide a tailor-made legal framework for blockchain-based businesses, but it leaves many important issues unclarified, chief of which is separate legal personality, which, we argue below, is fundamental to



188 s 189 s

15, Innovative Technological Arrangements and Services Act. 7, Innovative Technological Arrangements and Services Act.

144  Facilitating the Crypto Economy meeting the organisational needs for blockchain-based businesses. Further, the Act also reflects a difficult balance between providing for internal governance flexibility while standardising certain regulatory expectations and governance criteria. We argue in the next section that, on balance, separate legal personality should be part of an enabling legal framework for blockchain-based businesses. Section V fleshes out the essential conditions for a blueprint in enabling organisational law that can address all nine organisational needs identified earlier.

IV.  Separate Legal Personality In this section we argue that it would on balance be beneficial for a blockchain-based business to enjoy separate legal personality and limited liability for its members.190 Separate legal personality for the blockchain-based business allows it to conduct external relations and forms the basis for internal governance to be developed. In essence, if a blockchain-based business does not enjoy separate legal personality, any external relations aspects, such as being an addressee of regulation, or in relation to pursuing a legal action or being pursued, would have to be attached to participants or selected participants. This can result in unexpected or arbitrary impositions of responsibility or conferment of power upon individuals. The Maltese Act gives rise to these questions as its identification of responsible roles leaves a lacuna in relation to the personal liability for individuals in those roles. Tendon and Ganado191 argue that in the absence of separate legal personality, liability for third-party harms or damage would have to attach to ‘a nearest person’ to the blockchain-based entity. The compulsion to find such a person can lead to contrivance and there may not actually be any well-placed nearest person. If, for example, harms are caused in aggregate by many disparate actions amongst blockchain participants, should liability be attached to an identified code developer for working on the most recent or proximate version of the code that contributed to harm? The need to seek a nearest person in order for external relations or accountability can create behavioural distortions and unintended consequences for the dynamics within the blockchain community in relation to behaviour on the part of individuals who may be regarded as exposed. For example, such individuals may seek to be over-compensated for their risk exposure and therefore lobby to bring about a distributive policy that may be imbalanced. On the contrary, if separate legal personality is conferred on the blockchain-based business, then the legal person fronts its external relations, and can organise common assets, as well as internal relations and governance in order to distribute the burden of compliance or liability. Ganado discusses the likelihood of blockchain-based businesses having to grapple with roles and responsibilities in relation to contracting with oracles and monitoring their fitness for purpose. Hence there are aspects of external relations

190 Also

see Kaal (2020).

191 (2018).

Separate Legal Personality  145 common to the community as a whole besides liability for external harms and accountability to regulators. Participants can be made to contribute towards common assets to address external relations and liability. Such an approach would resemble a form of mutualisation amongst participants, and gives rise to further governance development over common assets as participants agree on how to share risks and loss.192 Managing external relations is a matter of commons needs, and blockchain-based businesses would benefit from an enabling legal framework that steers them towards generating useful internal relations, order and governance mechanisms to meet those needs. Separate legal personality also benefits blockchain-based businesses in relation to taking collective legal action. For example, in the case of the DAO, the DAO aggregates blockchain participants’ funds in order to make investments selected by referendum. What if misrepresentation is afterwards discovered on the part of the investee entity? It would make sense for the DAO to be able to sue on the basis of fraud or negligent misrepresentation to recover compensation for investors instead of having investors sue individually. In the latter case, investors may be disincentivised to sue if the amount implicated is small and they suffer from the lack of economies of scale, or the collective action problem. The ability of the DAO to sue would ensure that justice can be sought more effectively and efficiently. Finally, it benefits regulators to be able to address regulatory obligations directly to the blockchain-based business as a legal personality, in relation to obligations that are relevant to the productive whole of the business, and not only in relation to individual conduct. The implementation of compliance would be a matter for the internal governance of the blockchain-based community. As in the case of responding to external third-party actions, the blockchain-based business would also front regulatory liability. This allows the blockchain-based business to collectively develop internal relations and governance to manage such compliance and liability. However, it can be argued that although much regulation today is addressed to corporate entities and they are expected to internalise these obligations and secure compliance within their organisations, corporate entities have become more irresponsible under this meta-regulatory framework.193 Individuals are incentivised to be sloppy about compliance, since they take no personal ownership for compliance,194 and they are shielded behind the corporate veil as the corporation fronts liability and bears the cost.

192 It is noted that contrary arguments are offered in P Østbye, ‘Who is Causally Responsible for a Cryptocurrency?’ (2019), at ssrn.com/abstract=3339537 where individual responsibility is preferred to group responsibility. 193 This is because as corporations are left to implement, their internalised discretion and implementation are often not sufficiently monitored by regulators, therefore resulting in a state of delegated self-regulation which ‘races to the bottom’. The promises of meta-regulation were discussed in C Parker, The Open Corporation (Cambridge University Press, 2002) and C Parker, ‘Meta-Regulation: Legal Accountability for Corporate Social Responsibility?’ in D McBarnet, A Voiculescu and T Campbell (eds), The New Corporate Accountability: Corporate Social Responsibility and the Law (Cambridge University Press, 2007) and critique in C Ford, ‘New Governance, Compliance, and Principles-Based Securities Regulation’ (2008) 45 American Business Law Journal 1. 194 As is the case in the financial sector, below.

146  Facilitating the Crypto Economy This critique has been taken seriously in the banking and financial sectors where regulatory reforms have now been made to introduce personal liability for senior managers and certain certified persons in specified roles, for negligent failures in compliance and breaches of individual conduct.195 It can however be counter-argued that such a personal liability regime is not the norm as many other sectors do not impose such a regime, and regulators continue to deal with regulated corporate entities as a whole. The banking and financial sector culture in particular has been singled out to be criticised for moral obliviousness and irresponsibility, and regulatory reforms into control and culture are therefore exceptional measures to restore public trust.196 We take the view that the hazards experienced in the meta-regulation of the banking and financial sector ought not to deter regulators from taking this approach to addressing blockchain-based businesses. This is because it can be over-inclusive and disproportionate to frame regulatory standards for individual liability when some outcomes are the result of collective actions. This does not deter appropriate standards for individual conduct to also be established, where appropriate. Blockchain-based businesses are then facilitated to develop internal governance and relations to respond to external demands, and smart contracts deployed on the blockchains can embed a distribution of legal and compliance requirements for all participants.197 It may be argued that the conferment of separate legal personality on blockchainbased businesses is unnecessary and contravenes the ethos of participants who seek deformalised ways of transacting as an escape from the mainstream economy. The conferment of separate legal personality for blockchain-based businesses only compels organisational and governance structures to be developed, and this is cumbersome and counterproductive for the crypto economy that promotes decentralisation, flexibility and freedom.198 However, we are of the view that permissionless blockchain-based businesses can only thrive with network effects and at scale. As incomplete smart contracts are unable to provide for the meeting of collective needs, and the governance and protection of the commons, many private permissionless protocol blockchains have started to develop more governance frameworks in response to collective needs.199 This trajectory arguably reflects the long-term needs of blockchain-based infrastructure and businesses in sustaining social confidence and network effects.

195 See IH-Y Chiu and J Wilson, Banking Law and Regulation (OUP, 2019) ch 11. This regime, found in the Financial Services and Markets Act 2000, ss 66A, 66B, and the Financial Conduct Authority Handbook SYSC  24.2, FIT and COCON chapters, as well as the Prudential Regulation Authority’s Rulebook under Allocation of Responsibilities and Conduct Rules, is known as the Senior Managers and Certified Persons Regime attracting personal liability for breach. 196 In relation to the objective of restoring public trust, see House of Commons and House of Lords, Parliamentary Commission on Banking Standards, ‘Changing Banking for Good’ (2013). 197 Tendon and Ganado (2018). 198 Flood and Lachlan (2017). 199 M Fenwick and EPM Vermeulen, ‘A Sustainable Platform Economy & the Future of Corporate Governance’ (ECGI Working Paper, 2019), at ssrn.com/abstract_id=3331508 on stakeholder-based platform governance on platforms, and have potential application to blockchains; see M Fenwick and EPM Vermeulen, ‘Decentralization is Coming! The Future of Blockchain’ (2019) at papers.ssrn.com/sol3/ papers.cfm?abstract_id=3450467.

An Enabling Legal Framework and Conclusion  147

V.  An Enabling Legal Framework and Conclusion Blockchain-based businesses give rise to commons, and therefore organisational and governance needs. Drawing from the discussion in chapter two, this chapter argues that nine organisational and governance needs should be addressed. Although existing corporate vehicle structures provide for some aspects of blockchain-based businesses’ organisational needs, such as asset partitioning, and standardised templates for internal relations and governance, none of the existing legal organisational vehicles examined in this chapter cater fully for blockchain-based businesses’ needs. We also examine the adapted legislative regime for the Vermont BBLLC and Maltese legislation to certify innovative technological arrangements (which include blockchain-based businesses). Although these recognise unique features of the blockchain-based network, such as the primacy of smart contracts and flexible needs for internal governance, we have highlighted gaps in the regimes that can be further worked on. One achievement in the Maltese legislation is the need for technological verification, which this book supports as important for participatory confidence in the blockchain-based business. There are however difficulties with regulatory and third-party certification, and it is arguable that new cadres of service providers would need to arise to support the institutional legitimation of blockchain-based businesses. Crucially, this chapter argues for the need to clarify that blockchain-based businesses have separate legal personality, and this can be conferred at the level of the protocol blockchain, as well as each dApp residing on protocol blockchains with their defined communities of token-holders. The book recommends the institution of an enabling legal framework for blockchainbased businesses, and this section sets out the essential aspects of such a legal framework and regulators’ new roles. The book supports an enabling legal framework that is not merely adapted from company law, and prefers the Maltese adoption of the term ‘ITA’. The definition of a new organisational category can be a useful starting point to see blockchain-based businesses in novel light, so that development policy is not overly shackled by existing legal concepts. Reyes discusses usefully policy-makers’ increasing awareness of the utility of blockchains and the introduction in Delaware corporate law for shareholder registries to be hosted on blockchains.200 However, she also rightly points out that such incremental recognition would give rise to more legal reforms needed to facilitate this new technological–economic architecture. In this manner, a purely adaptive approach in law to the organisational and governance needs of blockchain-based businesses may be limited. Next, we support the Maltese recognition that technological verification is necessary for the blockchain-based business seeking registration. Although many business developers use open-source code and allow their code to be publicly scrutinised, only people with software expertise can assess the quality and functionality of the code. The Maltese model does not expect regulators to technically vet the code as it seeks to rely on responsible persons and systems auditors. We suggest that improvements can be made to address the issues raised in the Act’s certification system. In particular, 200 C Reyes, ‘Cryptolaw for Distributed Ledger Technologies: A Jurisprudential Framework’ (2018) 58 Jurimetrics 283.

148  Facilitating the Crypto Economy regulators need to be satisfied as such of the technological verification of the code and should not merely adopt self-certification by responsible persons or third-party certification as sufficient proxy indicators. Further, the technological functions of code work at protocol and application layers. Where a blockchain-based business is built upon a protocol infrastructure such as the Ethereum blockchain, the protocol programming is usually accepted by the application developer as is. In vetting the technological functions of code, regulators should not seek to impose burdens on application developers in relation to protocol programming that is beyond their control. However, application developers can be asked to justify their choice of protocol infrastructure and in what respects protocol programming meet their business enterprise and community needs. The regulator should vet the technological functions of application-level code in relation to transactional as well as governance aspects. The Maltese Act is arguably too open-ended in terms of what extent of technological verification is sought, and whether verification is confined to functional aspects. As the blockchain-based business is both a transactional network and community, the governance aspects that are coded should also be vetted as these have implications for participants’ rights, responsibilities and expectations. The nine organisational and governance needs identified earlier can provide a broad framework in order to guide blockchain-based businesses in terms of what aspects of organisation and governance to provide for. The broad framework based on these needs also leaves substantial flexibility without being overly prescriptive. In this respect, the Maltese approach of identifying and assigning roles to certain clusters of blockchain participants may be overly presumptive. Further, regulatory vetting of the transactional and commercial aspects of application-level code is likely to involve some complex aspects. Application-level code would likely deal with information properties, implicating regulatory issues such as data management in the blockchain-based network. Further, application-level code leverages upon the payment system code that infrastructure protocol provides. It is therefore questioned whether regulatory verification of code should extent to regulatory oversight of the native payment systems in blockchains. It may be argued that a business regulator or registration house such as the UK Companies House is unable to deal with these aspects as they implicate data protection and payment services regulation. Indeed, this book argues that regulatory vetting of code is itself likely to implicate an extensive range of matters. This requires regulatory shifts and coordination amongst regulatory agencies in order to meet the news of new economic structures and architecture. The payment services regulator and the data protection authority should, for example, be included in the regulatory vetting agenda for the registration of blockchain-based businesses. The role of regulatory oversight for the native payment systems on blockchains is discussed further in chapter six. Moving onto the question of whether an enabling legal framework should provide for substantive standards of organisation and governance for the blockchain-based business, this chapter argues that a clear substantive standard of separate legal personality should be provided, and that excessive prescription for governance detail for blockchain-based businesses should be avoided. It should be explicit that blockchainbased businesses enjoy separate legal personality upon successful registration. Whether this is a blanket privilege or only in relation to particular aspects may be subject to

An Enabling Legal Framework and Conclusion  149 further policy consideration and development. On balance, we are of the view that this privilege facilitates business and governance development and the pros and cons of granting this privilege can be monitored for future adjustments to the policy. Enabling legislation can provide that the blockchain-based business’s governance arrangements must be disclosed to the regulator/s and all participants. Governance functions may be coded and therefore subject to regulatory vetting as discussed above, but it can be envisaged that not all governance details may be coded. Hence, transparency of these details would still be needed, for example in a manner similar to the company’s constitution,201 or corporate charter. Regulation should broadly require the nine organisational aspects identified in this chapter to be explicitly addressed202 but not to be excessively prescriptive.203 In this manner, the enabling legislation can achieve ex ante transparency and comparability of the governance frameworks offered by different or competing blockchain-based businesses. Finally, we consider to what extent regulators should enrol the capacities of thirdparty gatekeepers such as the Maltese requirement for systems auditors. This book places emphasis on regulators’ primary satisfaction in code verification, and such a vetting role should be carried out by a range of regulators, from business regulators to data protection and payment services regulators.204 The support of the technological profession is nevertheless invaluable. This is also consistent with the regulatory vision of coregulation argued in chapter two, where we envisage new technological regulation to involve a complex landscape of private and public sector actors. Regulators need to ascertain if the technological profession is ready to contribute to such gatekeeping expertise and perhaps play a part in mobilising their professionalisation. Software coders often move in informal circles on discussion forums and open-source code repositories, and the question arises as to whether recognition can be given to groups of software coders such as to reputable trade associations and professions.205 Policy-makers could consider establishing a form of a regulatory authority to oversee coders who are willing to undertake the task of assurance of blockchain-based businesses’ code. It may also be beneficial to have two assurance reports by coders selected by the regulator in order to inform the regulator of the quality and fitness of the code, and any flaws (which are inevitable). These reports assist the regulator to determine its risk tolerance level for certifying a blockchain-based business, and these reports can also be made transparent to participants. It is likely inevitable that regulators need to develop some extent of their own technological capabilities so 201 Companies Act 2006, s 17 which articulates that the constitution creates enforcement rights between members and the company and between members inter se, therefore providing the monitoring framework for adherence to the agreed governance framework. Alston goes further and sees the governance framework for permissionless blockchains as akin to public constitutions; see E Alston, ‘Constitutions and Blockchains: Competitive Governance of Fundamental Rule Sets’ (2019) at ssrn.com/abstract=3358434. 202 A McCullagh and J Flood, ‘Blockchain’s Future: Can the Decentralised Blockchain Community Succeed in Creating Standards?’ (2019), at ssrn.com/abstract=3404087. 203 Dynamism is advocated in Calcaterra (2019). 204 To be elaborated further in ch 6. 205 J Evetts, ‘Professionalism in Turbulent Times: Changes, Challenges and Opportunities’ (Propel International Conference, Stirling, 9–11 May 2012); H Birden, N Glass, I Wilson, M Harrison, T Usherwood and D Nass, ‘Defining Professionalism in Medical Education: A Systematic Review’ (2014) 36 Medical Teacher 47.

150  Facilitating the Crypto Economy as not to be overly reliant on or be captured by third-party gatekeepers.206 Further, the history of the audit profession as discussed in the wake of Enron in the 2000s207 and the Brydon Review in the UK almost 20 years after208 should provide warning lessons regarding regulatory reliance on third party gatekeepers in verifying regulatory conditions.

206 R Moorhead, ‘Precarious Professionalism: Some Empirical and Behavioural Perspectives on Lawyers’ (2014) 67 Current Legal Problems 447. 207 JC Coffee Jnr, ‘Understanding Enron: “It’s About the Gatekeepers, Stupid”’ (2002) 57 Business Lawyer 1403; Gatekeepers (OUP, 2002). 208 Sir D Brydon, ‘Assess, Assure and Inform: Improving Audit Quality And Effectiveness: Report of the Independent Review into the Quality and Effectiveness of Audit’ (December 2019), at assets.publishing.service. gov.uk/government/uploads/system/uploads/attachment_data/file/852960/brydon-review-final-report.pdf.

5 The Financing of Blockchain-based Business Development and the Need for Regulation I.  Why a Tailor-made Regulatory Regime for Fundraising is Needed Many blockchain-based business developers engage in fundraising exercises that involve sales of future rights in tokens, ie pre-sales of tokens to be developed for the blockchain project. These pre-sales are for tokens that are not yet operative, but will be when the blockchain project becomes live. This technological and financial innovation, for yet to be developed assets, brings about a new form of financialisation, as the global public is invited to support the crypto economy directly. As chapter three discussed, regulators in many jurisdictions, especially those overseeing developed securities markets, have turned their attention to token pre-sales. Regulators perceive the need to manage regulatory arbitrage from their established securities regimes and to address frauds and scams in unregulated token pre-sales. Token pre-sales (or initial coin offerings) raise particular dangers as issuers do not offer protection under recognised forms of organisations or fundraising laws. However, this is because the blockchain project under development has not attained organisational form and is ‘pre-incorporation’ in nature. Chapter four proposed an enabling framework for the organisation and governance of blockchain-based businesses, and fundraising may be perceived as a natural companion in the enabling framework. However, what is different from conventional businesses is that fundraising at the stage of the initial coin offering (ICO) takes place before the business has developed. Fundraising is ‘pre-incorporation’ in nature, premised upon a business idea and developers’ plans as to how the idea should be technologically executed. This is a novel point in time for business fundraising as securities fundraising is usually premised upon a degree of maturity of the company. Even venture capitalists funding start-up companies are facing an already-incorporated company with perhaps some initial operations.1 ICOs necessarily take place with no 1 B Zider, ‘How Venture Capital Works’ (Harvard Business Review, 1998), at hbr.org/1998/11/ how-venture-capital-works on the relative rarity of venture capital funds investing in start-up and very young stages of companies. Further, even investment in young companies is premised on some track record, like the

152  The Financing of Blockchain-based Business Development relevant track record for investors to observe, and the informational environment for investors may be unprecedentedly thin. This is not necessarily an issue of information asymmetry typical in corporate fundraising paradigms, ie that issuers have more information held to their chests than available to investors. This is an environment of information anaemia as both issuers and investors are wading into a speculative venture with much information to discover. As ICOs are different from conventional corporate fundraising in key aspects, token issuers have treated this area as not regulated by existing regimes for fundraising such as securities or crowdfunding regulation. We argue below that a tailor-made regulatory regime is needed for token pre-sales as the existing regimes are not an appropriate fit, and is it not optimal for token pre-sales to be self-regulatory. It may be argued that although the proposition for both issuers and investors is a risky one, in an environment of information anaemia, this can be dealt with contractually between them. Issuers usually present in their White Papers what they purport to sell investors, ie future tokens that would be converted into certain rights of use, transfer or even investment upon the successful completion of the blockchain-based business project. Investors should decide for themselves if this is worth the consideration they are transferring to the issuer. This self-regulatory state has been in existence since ICOs started to be offered in 2017. It can be argued that an enabling regulatory framework is not necessary as the ICO market has been highly successful. At its peak, Fromberger and Haffke2 estimate that ICOs have raised over US $14bn which is roughly about 40 per cent of the value of US initial public offers of securities in that year or 30 per cent of the private venture capital market. Hence, funding seems ready and vibrant without any particular regulatory framework in place in the three largest ICO jurisdictions at that time, namely the US,3 UK and Singapore.4 However, with the arrival of lemons on the ICOs market,5 the US SEC decided to subject many ICOs to securities regulation, plugging a regulatory gap in investor protection in the immediate term. ICOs in the US have fallen in volume, with many issuers opting to meet the requirements for exemption from securities regulation. Issuers now choose to offer only to accredited investors future tokens that are contractually framed as security rights.6 Conceding that ICOs resemble securities offers does not necessarily meet the conceptual needs of credible regulatory policy, nor does this ensure that ICOs are appropriately regulated. As chapter one has discussed, the characterisation of future tokens within existing regulatory regimes is problematic for uneasy and incomplete fits

company’s patent applications; see D Engel and M Keilbach, ‘Firm-level Implications of Early Stage Venture Capital Investment – An Empirical Investigation’ (2007) 14 Journal of Empirical Finance 150. 2 M Fromberger and L Haffke, ‘ICO Market Report 2018/2019’ (2020), at ssrn.com/abstract=3512125. 3 The US has seen a drop in ICOs since the SEC toughened its stance, see discussion in ch 3. 4 These jurisdictions explicitly do not capture tokens that do not squarely fit into the definition of conventional securities within their securities regulation regimes, leaving a ‘self-regulatory’ lacuna for many ICOs; see discussion in ch 3. 5 Such as the failed ICO Sponsy, acknowledged to be a lemon taking advantage of the blockchain hype but not really having an innovation to offer. See ‘A failed ICO is trying to flog itself on eBay’ (Financial Times, 25 March 2019), at ftalphaville.ft.com/2019/03/25/1553498702000/A-failed-ICO-is-trying-to-flogitself-on-eBay-. 6 saftproject.com.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  153 with securities7 or collective investment funds.8 The continued application of existing regulatory regimes is likely to result in contrivance in the structures of token pre-sales as well as regulatory interpretations. Further, as many issuers fearful of falling within securities regulation regimes opt to structure their issues within exemptions, this results in offerings made only to sophisticated investors. This is a phenomenon that chapter two argues is ultimately contrary to the economic structure of the blockchainbased business. The exempt regime also does not cater for new investor protection standards, as these are left to be privately determined. The legal risk for not complying with existing securities or financial regulations remains high. The divergences of regulatory approaches outlined in chapter three means that issuers run the risk of multiple legal risks in different jurisdictions by conducting an ICO that is potentially borderless. We are of the view that it is important to provide a regulatory regime for ICOs that caters for the unique needs of issuers and for investor protection. Such a regulatory regime provides transaction cost-efficiency for investors who would otherwise have to individually bargain for appropriate terms or carry out costly diligence,9 both of which do not occur in reality, as investors would likely take the standard terms of the offer10 and follow others’ herding instincts.11 In the absence of a regulatory regime, self-regulation is neither real nor viable.12 Instituting a regulatory regime produces a public good for investor protection, underpinning the resource of public confidence for ICO fundraising. We explore below in detail why the existing fundraising regimes of securities and crowdfunding regulations do not apply appropriately to ICOs. We also argue that although the EU Commission recognises the unique nature of cryptoasset offerings, the regime proposed seems too path-dependent on ideology underpinning securities and crowdfunding regulation and can benefit from more precise consideration of the pre-development and pre-incorporation nature of ICOs.

A.  Why Distinguish ICOs from Securities and Crowdfunding Regulation Fitting ICOs into securities or crowdfunding regulation is sub-optimal. This section first compares the similarities and differences between ICOs and securities offers as this 7 J Rohr and A Wright, ‘Blockchain-based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets’ (2019) 70 Hastings Law Journal 463; P Maume and M Fromberger, ‘Regulation of Initial Coin Offerings: Reconciling U.S. and E.U. Securities Laws’ (2019) 19 Chicago Journal of International Law 548; A Collomb, P de Fillippi and K Sok, ‘Blockchain Technology and Financial Regulation: A Risk-Based Approach to the Regulation of ICOs’ (2019) 10 European Journal of Risk Regulation 263; HB Shadab, ‘Regulation of Blockchain Token Sales in the United States’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019), at ch 13; J Lausen, ‘Regulating Initial Coin Offerings? A Taxonomy of Crypto-assets’ (2019) at ssrn.com/abstract=3391764. 8 P Hacker and C Thomale, ‘Crypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial Law’ (2018) 15 European Company and Financial Law Review 645. 9 FB Cross and RA Prentice, ‘The Economic Value of Securities Regulation’ (2006) 28 Cardozo Law Review 333; JC Coffee, ‘Market Failure and the Economic Case for a Mandatory Disclosure System’ (1984) 70 Virginia Law Review 717. 10 Cross and Prentice (2006). 11 MB Fox, ‘Regulating Public Offerings of Truly New Securities: First Principles’ (2016) 66 Duke Law Journal 673. 12 More on this shortly.

154  The Financing of Blockchain-based Business Development comparison has been most frequently made.13 We then turn to compare the ICO with equity crowdfunding. This chapter shows that the assumptions underlying the securities or crowdfunding regulatory regimes in relation to issuer characteristics and investor protection do not neatly cater for ICOs. Hence securities and crowdfunding regulatory design may under-cater for ICOs or cater inappropriately in some aspects. Such an analysis yields insight as to the unique needs of ICOs that warrant a different regulatory regime. Such a regime can nevertheless derive some useful tenets from securities or crowdfunding regulation.

B.  Similarities to and Differences from Initial Public Offers The examination in this section is of particular relevance to the jurisdiction/s that treat ICOs as being captured within the regime of securities regulation, notably by the US SEC, as discussed in chapter three. This treatment is arguably not well placed due to a number of key differences between IPOs and ICOs.

i.  Information Asymmetry Fox14 has argued that in an initial public offer (IPO), the information asymmetry between issuers and investors is at its greatest level as there is a lack of prior information on the issuer in the market.15 Many commentators also argue that such information asymmetry needs to be overcome by mandatory disclosure regulation as market mechanisms do not supply optimal information.16 Issuers are likely to be selective and keep unfavourable information hidden, so information would neither be complete nor balanced.17 Market mechanisms such as credit-rating agencies, analysts or auditors are not fully reliable due to their conflicts of interest and track record of failures and unreliability.18 Further, reading the signals from more informed investors is not optimal as more informed market participants may not be accurately identified.19 In this baseline scenario which is self-regulating in nature, issuers’ voluntary disclosure and information intermediaries’ opinions would be, in sum, unlikely to meet the levels of information optimality for investors. Optimal information for investors is defined by Coffee as being comprehensive, standardised and comparable,20 and by Fox as being socially optimal, a level that would not be produced based on private incentives alone.21 13 See n 7. 14 Fox (2016). 15 AC Prtichard, ‘Revisiting Truth in Securities Revisited: Abolishing IPOs and Harnessing Private Markets in the Public Good’ (2013) 36 Seattle University Law Review 999 recommends a periodic disclosure regime for public companies apart from IPOs so as to provide an informationally rich ‘prior’ environment to IPOs. 16 Cross and Prentice (2006); Fox (2016). 17 Cross and Prentice (2006); Coffee (1984). 18 Cross and Prentice (2006); Fox (2016). 19 A Ferrell, ‘The Case for Mandatory Disclosure in Securities Regulation around the World’ (2007) 2 Brooklyn Journal of Corporate Financial & Commercial Law 81. 20 Coffee (1984). 21 MB Fox, ‘Rethinking Disclosure Liability in the Modern Era’ (1997) 75 Washington University Law Quarterly 903.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  155 In this landscape, mandatory disclosure elevates and standardises the quantity of disclosure, and levels the playing field amongst issuers. However, the quality of disclosure in terms of presentation and accessibility22 or in terms of meaningfulness23 is not necessarily guaranteed. Nevertheless, the focus on financial statements produced using a set of recognised professional accounting standards provides a basis for investors’ rational assessments of issuers and the prospects of their securities.24 Issuers generally stand to benefit from mandatory disclosure regimes as the adverse selection problem is averted,25 and cost of capital is lowered.26 Commentators27 point out that voluntary disclosure in the ICOs market is selective and sub-optimal and ICOs suffer from a higher rate of project failure. Hence, being subject to securities regulation may arguably offer the ICOs market the prospect of averting a market for lemons. However, the cost of compliance can still deter small issuers.28 The regulatory regime for IPOs is generally regarded as deterring for small or medium-sized businesses, as the cost of fundraising exceeds the benefits, given relatively lower amounts of funds sought to be raised. For pre-development blockchain-based enterprises, the IPOs regime is similarly deterring in terms of cost.29 In an ICO, investors also face information asymmetry. However, it can be argued that the nature of information asymmetry is different from the situation of an IPO. Hence, the mandatory disclosure items for an IPO may be inapplicable to an ICO. For example, blockchain business developers would find it difficult to adhere to the items for mandatory disclosure, which presume that the business has a track record prior to fundraising. Mandatory financial disclosures include audited financial statements for the previous five years of trading, and this cannot apply to pre-development blockchainbased businesses. The ICO issuer seeks funding at an early start-up stage that is usually predevelopment.30 At this stage of the project, the ICO issuer’s information or knowledge regarding the project may comprise a mixture of fact and plans31 as compared to an

22 TA Paredes, ‘Blinded by the Light: Information Overload and its Consequences for Securities Regulation’ (2003) 81 Washington University Law Quarterly 417. 23 J McClane, ‘Boilerplate and the Impact of Disclosure in Securities Dealmaking’ (2019) 72 Vanderbilt Law Review 191 on the use of vague boilerplate statements in prospectuses that do not offer meaningful evaluation. 24 Z Goshen and G Parchomovsky, ‘The Essential Role of Securities Regulation’ (2006) 55 Duke Law Journal 711, and the efficient capital markets hypothesis; E Fama, ‘Efficient Capital Markets: A Review of Theory and Empirical Work’ (1970) 25 Journal of Finance 383. 25 Ferrell (2007). 26 CA Botosan, ‘Disclosure and the Cost of Capital: What Do We Know?’ (2006) 36 Accounting and Business Research sup 1, 31; L Fauver, G Loureiro and AG Taboada, ‘The Impact of Regulation on Information Quality and Performance around Seasoned Equity Offerings: International Evidence’ (2017) 44 Journal of Corporate Finance 73. 27 S Howell, M Niesser and D Yermack, ‘Initial Coin Offerings: Financing Growth With Cryptocurrency Token Sales’ (2019) at www.nber.org/papers/w24774 show that investors do select amongst ICOs based on several factors such as what is disclosed in the ICO white paper. 28 BJ Bushee and C Leuz, ‘Economic Consequences of SEC Disclosure Regulation: Evidence From The OTC Bulletin Board’ (2005) 39 Journal of Accounting and Economics 233. 29 The cost of an IPO is mentioned in E Howell, ‘An Analysis of the Prospectus Regime: The EU Reforms and the “Brexit” Factor’ (2018) 15 European Company and Financial Law Review 69. 30 Collomb et al (2019). 31 For example, what is being sold is the ‘market opportunity’ in Iungo’s white paper; see iungo.network/ wp-content/uploads/2019/01/IUNGO-whitepaper-V1_4.pdf.

156  The Financing of Blockchain-based Business Development IPO where the issuer has already been in operation and has a track record to provide facts. Indeed, some White Papers provided by issuers have undergone version updates and they show themselves to be temporary documents rather than susceptible to being a prospectus for a securities offering.32 There may still be value in asking ICO issuers to disclose the salient facts that bridge information asymmetry between them and investors, but disclosing plans, assumptions and opinions would not necessarily provide investors with a sense of certainty in evaluating the offer. Hence, it is suggested in this chapter that a regulatory regime for ICOs should not be merely based on mandatory disclosure as is key to securities regulation. Regulatory design needs to cater for how disclosed plans should be treated in terms of investor expectations. Reliance on mandatory disclosure alone would mean that issuers can be penalised by regulatory and civil enforcement33 for deviation from plans. However, what if such deviation is optimal for the project to be viable? Investors are more optimally protected if issuers make good decisions in the interests of the project as a whole, and such ongoing conduct is not regulated optimally by the imposition of ex ante disclosure at an early stage of the project. Exclusive reliance on mandatory disclosure means that market discipline is exercised by finding liability for defective disclosure. This may be disproportionate given the tentative nature of pre-development disclosure for a blockchain-based project. Moreover, disclosures of financial estimates, as opinions, may not be actionable anyway under conventional disclosure breaches.34 Next, mandatory disclosure for IPOs is seen as a measure that corrects the market failure of a default position of sub-optimal levels of information. In the ICO situation, the market failure position seems exacerbated as there would be an absence of information on the part of the issuer, and the market for information intermediaries is not yet well established.35 This may give rise to the argument that mandatory disclosure is all the more necessary. However, compared to the informational context for IPOs, ICOs inherently suffer from a much thinner and more speculative information context. If mandatory disclosure is relied upon as an ex ante investor protection measure, investors would have the mistaken impression that the ex ante disclosure is a sufficient basis for their decision. In the case of ICOs, investor protection should be much more of an ongoing regime because of the early and speculative nature of any ex ante disclosure that is made by issuers. Hence, this chapter takes the view that some form of post-sale protection is more appropriate and excessive reliance on ex ante mandatory disclosure is limited for investor protection. Further, as ICOs relate to blockchain-based businesses powered by smart contract tokens, the technological development of the project is central. It is questioned to what extent technical facts or plans should be disclosed and whether investors can adequately assess these.36 Arguably, only technically savvy investors would likely be able to make appropriate assessments of the technological feasibility or innovative value of the project,

32 Above. 33 E Rock, ‘Securities Regulation as Lobster Trap: A Credible Commitment Theory of Mandatory Disclosure’ (2002) 23 Cardozo Law Review 675. 34 Ball v Banner 2000 WL 824097. 35 Such as ICO ratings services that are as old as ICOs themselves. 36 For example, see Filecoin’s technical descriptions in its white paper at filecoin.io/filecoin.pdf.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  157 and even sophisticated investors defined in conventional securities regulation may not have the requisite level of competence.37 The current assumption made in conventional securities regulation that accredited or sophisticated investors can fend for themselves and that offers made to them can be exempt from securities regulation would need to be revisited.38

ii.  Agency Problems Securities regulation is also important for addressing the agency problems between investors and the managers of corporate issuers. Ex ante prospectus disclosure ties managers to facts and behaviour that they should not deviate from39 and continuing disclosure regimes serve two purposes. One is pursuant to the efficient capital markets hypothesis so that managers will be bound to continually feed relevant news into the price formation processes for securities in secondary markets. This allows investors to protect themselves by market liquidity and choosing to exit.40 Second, continuing disclosure allows investors to gain information in order to exercise market discipline by voice.41 Other forms of market discipline can also be facilitated such as the market for corporate control.42 Agency problems are also acute in an ICO situation but, again, securities regulation may not be the panacea. Investors hand over money to developers of the blockchainbased project and trust that they would bring about an honest and dedicated process of business and technical development to launch the project in due course. However, many blockchain-based projects are decentralised and code is made open source, so in theory, ICO subscribers can co-participate in development, and the project’s destiny is not only in the hands of developers. In this manner, the agency problems are different in nature between developers and ICO subscribers, as between corporate managers and investors, with the latter’s management being more opaque and closed to investors’ interventions. In this manner, agency problems can be ameliorated if ICO subscribers can co-participate in code development, achieving a form of monitoring akin to the type of corporate governance involvement by venture capital funds in start-up investees.43 Hence, why should there be a need for expensive ex ante and continuing

37 AR Zhang et al, ‘The Regulatory Paradox of Initial Coin Offerings: A Case Study Approach’ (2019) at ssrn. com/abstract=3284337. 38 ‘Investors in Polychain Capital’s Crypto Hedge Fund Saw 1,332% Gains – If They Stomached the Dips’ (30 March 2020), at www.coindesk.com/investors-in-polychain-capitals-crypto-hedge-fund-saw-1332-gainsif-they-stomached-the-dips, showing that sophisticated investors like hedge funds have made huge losses as well as gains in a market that is still novel. 39 Fox (2016). 40 M Kahan, ‘Securities Law and the Social Costs of “Inaccurate” Stock Prices’ (1992) 1991 Duke Law Journal 977. 41 PG Mahoney, ‘Mandatory Disclosure as a Solution to Agency Problems’ (1995) University of Chicago Law Review 1047. Also envisaged in the concepts of shareholder ‘stewardship’ or engagement such as in Arts 3g-I, Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement. 42 Discussed in A Gurrea-Martínez and NR León, ‘The Law and Finance of Initial Coin Offerings’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 6. 43 UR Rodrigues, ‘Financial Contracting with the Crowd’ (2019) 69 Emory Law Journal 397.

158  The Financing of Blockchain-based Business Development disclosure regimes which are actually more distant for monitoring and amelioration of agency problems? Fromberger and Haffke’s survey of ICO characteristics, however, shows that many ICOs do not offer such co-participation and high levels of decentralisation in project development.44 The majority of ICOs are for projects to be centrally led and developed by a group of developers. In this situation, ICO subscribers would be worse off than securities holders as securities holders are protected by both disclosure regimes and corporate law frameworks that provide for shareholders’ rights, to a lesser or greater extent depending on the jurisdiction concerned.45 Securities holders at least have certain frameworks in which to exercise voice or exit, but both options are not necessarily open to ICO subscribers. Although many pre-sold tokens list on secondary cryptoasset exchanges, developers have the discretion whether to list, and this is often not promised in white papers.46 ICO subscribers also have to brave the informationally less optimal secondary markets that are highly volatile.47 In this manner, agency problems can be more acute in ICOs than for IPOs. Hence, this chapter will suggest that governance by way of providing for ICO subscribers’ rights of monitoring at the post-sale stage is a preferred option to exclusive reliance on mandatory disclosure regimes in securities regulation. Information-based governance is likely to be weak and limited as the market for information intermediaries in cryptoassets is not yet well developed.48 A model closer to venture capitalist monitoring of investee companies, which involve monitoring in terms of business development, governance and crucially, use of proceeds, is likely to be both viable and meets the interests of investor protection.49 Further, other agency problems in the ICO context abound and are not addressed in the self-regulatory landscape. First, the retention of tokens by founder-developers of blockchain-based projects can give rise to agency problems. A number of commentators50 observe that token purchasers respond well to token retention by founder-developers 44 (2020). 45 eg, see M Siems, ‘Shareholder Protection around the World’ (2007) at www.cbr.cam.ac.uk/fileadmin/ user_upload/centre-for-business-research/downloads/working-papers/wp359.pdf. 46 Fromberger and Haffke (2020), showing that tokens may not be listed until 180 days after the crowdsale, and the timeframe is neither promised nor necessarily predictable. 47 T Bourveau, ET De George, A Ellahie and D Macchiocchi, ‘Initial Coin Offerings: Early Evidence on the Role of Disclosure in the Unregulated Crypto Market’ (2018), at ssrn.com/abstract=3193392 on what affects token price volatility on secondary markets. 48 Some commentators are of the view that absent established intermediaries, nascent intermediaries such as analyst ratings can generate insights for crowds and such ratings have been proving useful for predicting longer term ICO performers. See J Lee, T Li and D Shin, ‘The Wisdom of Crowds and Information Cascades in Fintech: Evidence from Initial Coin Offerings’ (2018), at papers.ssrn.com/sol3/papers.cfm?abstract_ id=3226051; T Bourveau, ET De George, A Ellahie and D Macchiochi, ‘Information Intermediaries in the Crypto-Tokens Market’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3193392. However, other commentators are of the view that the ratings services such as ICOBench and ICOData provide flawed ratings even for crypto businesses that do not need to use a blockchain; see C Feng, N Li, MHF Wong and M Zhang, ‘Initial Coin Offerings, Blockchain Technology, and White Paper Disclosures’ (2019), at ssrn.com/ abstract=3256289. 49 Rodrigues (2019). 50 T Davydiuk, D Gupta and S Rosen, ‘De-crypto-ing Signals in Initial Coin Offerings: Evidence of Rational Token Retention’ (2018), at ssrn.com/abstract=3286835 on token purchasers being aware of this risk and therefore tend to flock to projects where developers retain tokens as a signal of commitment; OECD, Initial Coin Offerings for SME Financing (2019), at www.oecd.org/finance/ICOs-for-SME-Financing.pdf, 15–16.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  159 as this signals commitment on the part of the developer to the project. Tokens are credence goods whose destiny lies initially at the hands of the developer, and developers’ retention of tokens is akin to risk retention and having skin in the game.51 However, token retention can also result in founder-developers having dominant power over the blockchain project when it becomes live, storing up potential governance problems in due course.52 Founders’ block-holding can also affect tokens’ secondary market prices if manipulative selling occurs. In the absence of agreed lock-ins, or a schedule for unwinding, as well as an agreed governance framework for blockholders’ exercise of power, token retention is a double-edged sword. Founder-developers of projects also offer discounted tokens at exclusive pre-sales before the crowdsourced ICOs take place. These selective pre-sales are made to associates and even sophisticated investors such as venture or hedge funds, such as in the case of Tezos.53 They are perceived as inherently disadvantageous to other ICO subscribers, as the early buyers often make a significant gain in the secondary market after the listing of the cryptoassets.54 However, empirical researchers have also found that selective pre-sales generate market confidence and lead to better pricing in secondary markets.55 It has also been queried if these favoured purchasers engage in market manipulative tactics such as ‘pump and dump’ in order to exploit secondary markets.56 In the absence of a corporate or organisations law framework that may govern issues such as buy-backs and dilution, founder-developers have immense power in making decisions on token supply, such as whether supply is capped or uncapped, and how supply may increase or reduce, have implications for participation, governance and the investment value of tokens. Commentators are of the view that founder-developers in control of token supply have fundamentally contrary incentives to ICO subscribers and the agency problem is endemic.57 Before the project goes live, the value of tokens remains speculative and founderdevelopers may conduct additional rounds of fundraising. But this would likely cause value dilution for existing holders if they wish to sell in secondary markets.58 Where projects have gone live, token purchasers may wish to see higher levels of supply so that network effects would add value to their tokens. In some cases, founder-developers may wish to constrict supply by buying back and burning tokens in order to artificially inflate their value in the face of rising demand.59 These agency issues would be governed by 51 ibid. 52 eg, the governance coup in relation to Steem discussed in ch 2. Also see ‘Steem Hard Forks Today Over Fears of Justin Sun Power Grab’ (20 March 2020), at www.coindesk.com/steem-will-hard-fork-in-just-hoursover-community-fears-of-justin-sun-power-grab. 53 ‘What Lessons can be Learnt from Tezos Debacle’ (22 October 2017), at cointelegraph.com/news/whatlessons-can-be-learnt-from-tezos-ico-debacle. 54 OECD (2019). 55 S Adhami, G Giudici and S Martinazzi, ‘Why Do Businesses Go Crypto? An Empirical Analysis of Initial Coin Offerings’ (2018) 100 Journal of Economics and Business 64. 56 OECD (2019); T Li, D Shin and B Wang, ‘Cryptocurrency Pump and Dump Schemes’ (2018), at papers. ssrn.com/sol3/papers.cfm?abstract_id=3267041. 57 LW Cong, Y Li and N Wang, ‘Tokenomics and Platform Finance’ (2019), at ssrn.com/abstract=3472481. 58 WA Kaal and M Dell’Erba, ‘Initial Coin Offerings: Emerging Practices, Risk Factors, and Red Flags’ in F Möslein and S Omlor (eds), Fintech Handbuch (CH Beck, 2019), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3067615. 59 Cong et al (2019).

160  The Financing of Blockchain-based Business Development corporate law frameworks regarding pre-emption rights that give shareholders some control over potential dilution60 and buy-back approval processes which again allow shareholders to vote on these decisions.61 There may be useful tenets in corporate law and securities regulation62 that one can consider in terms of addressing similar or equivalent problems in blockchain-based business financing practices. In sum, ICOs raises governance issues that are unaddressed and that create significant agency problems. Mandatory disclosure as a primary tool in regulating IPOs may not fully address the unique issues raised by ICOs.

C.  Similarities to and Differences from Equity Crowdfunding It can be argued that fundraising by blockchain-based businesses can be governed by recent regulations for equity crowdfunding. After all, there are many similarities and the DAO purported to be a derivation of online equity crowdfunding.63 In an ICO, founder-developers are reaching out to a global crowd as in equity crowdfunding, and the pre-development business seems to be at a similar or earlier stage than many small and medium-sized businesses participating in online equity crowdfunding.64 The US and UK have started to regulate online equity crowdfunding in a more tailor-made manner, recognising the need for small business financing and the inappropriateness of applying the full force of securities regulation.65 Indeed, those positioned to comply with securities regulation are now exclusively mature companies seeking significant funding levels. The cost of preparing a prospectus for an IPO is likely in the region of £1.3 million,66 and unless a company can afford this and is asking to raise funds in excess of such cost, the public offer is not likely a viable or appealing fundraising route. In the PwC survey of IPOs in Europe in 2019,67 the largest IPOs in the UK, Germany, Italy, France and Sweden raised over thousands of millions in euros.68 These are companies that have already attained a certain level of maturity and are using the funds for next stages of growth. The IPO market is thus not the default means of fundraising for most companies, especially for younger or start-up companies, simply

60 Such as UK Companies Act 2006, ss 561–73. 61 Such as UK Companies Act 2006, ss 658–69. 62 eg see NJ Sherman, ‘A Behavioral Economics Approach to Regulating Initial Coin Offerings’ (2018) 107 Georgetown Law Journal Online 17. 63 See Slockit.com, ‘The History of the DAO and Lessons Learned’ (24 August 2016), at blog.slock.it/ the-history-of-the-dao-and-lessons-learned-d06740f8cfa5. 64 E Ackermann, C Bock and R Bürger, ‘Democratising Entrepreneurial Finance: The Impact of Crowdfunding and Initial Coin Offerings (ICOs)’ in A Moritz, JH Block, S Golla and A Werner (eds), Contemporary Developments in Entrepreneurial Finance (Springer, 2020) 277. 65 AR Stemler, ‘The JOBS Act and Crowdfunding: Harnessing the Power – and Money – of the Masses’ (2013) 56 Business Horizons 271; M Hollow, ‘Crowdfunding and Civic Society in Europe: A Profitable Partnership?’ (2013) 4 Open Citizenship 68, at ssrn.com/abstract=2333635. 66 Howell (2018). 67 PwC, ‘IPO Watch Europe’ 2019, at www.pwc.co.uk/audit-assurance/assets/pdf/ipo-watch-q4-2019-annualreview.pdf. 68 Nexi Spa in Italy raised over 2,065m euros on the Borsa Italiana, Teamviewer AG raised over 1,969m euros on Deutsche Börse, and Network International Holdings plc raised over 1,414m euros on the London Stock Exchange.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  161 because they are unable to afford the regulatory compliance and may not have the requisite trading records demanded by established stock exchanges.69 This is despite the likelihood that younger or start-up companies are likely to be most in need of funds. As regulators treat the prospectus as the gold standard for crowdfunding by corporations, US and UK regulators treat equity crowdfunding regulations as an exception to securities regulation. Hence, in the US, equity crowdfunding is limited to a target of US $1.07m for the first 12 months, thereafter rising by the rate of inflation,70 while in the UK, equity crowdfunding is limited to under one million euros (that can be raised to eight million euros) as the ceiling above which an issuer must comply with securities regulation to publicly solicit for funds.71 These ceilings are at the lower end of the ICOs market as surveyed by Fromberger and Haffke,72 showing US $1m to be at the lowest end of funds raised for an ICO and US $1bn to be at the highest end of funds raised. Many ICOs are targeted to raise funds in at least double digits in millions in US dollars. In both the US and UK, companies seeking to raise funds via online equity crowdfunding must join a regulated platform such as Kickstarter and73 Seedrs,74 and be subject to platform rules. There is a moderate level of regulation imposed on platforms as they provide the interface with the public and therefore need to conduct their business to provide for adequate investor protection.75 The US, EU and UK now impose platform regulation which allows platforms to subject issuers to certain rules in order to achieve platforms’ compliance.76 Under EU legislation, platforms are responsible for providing a reduced but standardised disclosure77 to investors. This necessitates platform operators to subject the issuers who wish to be listed on the platform to responsibilities for information provision. Platforms are also to conduct their own due diligence and should be properly governed to avoid conflicts of interest so that investor protection can be secured.78

69 Such as five years of trading records and audited financial statements for admission to the London Stock Exchange. 70 Securities Act 1933, s 4(a)(6), as amended by the JOBS Act 2012, and SEC’s Regulation Crowdfunding Release Nos 33-9974; 34-76324; File No S7-09-13, at www.sec.gov/rules/final/2015/33-9974.pdf. 71 Art 1(3), EU Prospectus Regulations 2017 still applicable in the UK, see Financial Conduct Authority Handbook at www.handbook.fca.org.uk/instrument/2019/FCA_2019_80.pdf. 72 (2020). 73 www.kickstarter.com. 74 www.seedrs.com. 75 Regulation (EU) 2020/1503 of the European Parliament and of the Council of 7 October 2020 on European crowdfunding service providers for business, and amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937; UK FCA’s policy statement 2014 and interim stock take end of 2016 in preparation for new regulations, at www.fca.org.uk/static/documents/policy-statements/ps14-04.pdf; www.fca.org. uk/publication/feedback/fs16-13.pdf. 76 ibid; also sub-part C and D of the SEC’s Regulation Crowdfunding, www.ecfr.gov/cgi-bin/retrieveECFR? gp=&SID=1953aa064d1468365955b4fe231250d5&mc=true&n=pt17.3.227&r=PART&ty=HTML. The SEC’s approach targets issuers for regulatory compliance directly as well as platform intermediaries. The approaches in the EU and UK tend to focus on platforms as the primary target of regulatory compliance. 77 This is not imposed under the UK regime but is introduced in the EU’s Regulation for Crowdfunding Service Providers (2020), see note 75, at Art 12(2)(q) and 23. 78 The EU’s Regulation for Crowdfunding Services Providers (2020) addresses conduct and governance regulation in relation to prudence (Arts 4, 11), avoidance of conflict of interests (Art 8), duty of due diligence (Art 5) and investor protection requirements such as investor eligibility checks (Art 21).

162  The Financing of Blockchain-based Business Development Blockchain-based businesses are able to make direct offers to ICO subscribers and do not need to join a platform. The ICOs are carried out via smart contract protocols on a peer-to-peer basis and platform intermediaries are not required. If, for example, a dApp to be built on the Ethereum blockchain engages in an ICO, the Ethereum blockchain should not be regarded as performing an equivalent role as online crowdfunding platforms. Being a permissionless blockchain, the entry of the dApp business is not gatekept by any particular entity on the Ethereum blockchain. It would also be inappropriate to extend platform regulation to the Ethereum blockchain as a whole, this issue further complicated by the unresolved question of who the legal entity is to be imposed with regulatory requirements. It is not clear to whom the regulatory rules in relation to investor protection,79 or in the case of loan-based crowdfunding, business continuity,80 risk management81 and prudential rules82 would be attached. Both the US and UK provide for investor protection in online equity crowdfunding by limiting the possible maximum investor outlay to a percentage of their disposable net assets.83 The implicit encouragement towards investor diversification may limit investors’ risks, but might discourage investors from being engaged with their investee business. For ICO subscribers, being incentivised towards greater passivity seems contrary to the greater monitoring needs required for the ICO context. Hence investor limitations imposed in the regulation of online equity crowdfunding may not be appropriate.84

D.  Should ICOs be Regulated by Product Governance Generally? The above argues that neither securities regulation nor the regulation of online equity crowdfunding really cater for issuers’ and investors’ needs in ICOs. A question that arises at this juncture is whether policy-makers should consider regulating ICOs under a more general regime of product regulation or governance. Product regulation is not the norm in financial regulation and has developed in an uneven and patchwork manner in the course of financial regulatory reform. This means that financial regulation has seldom prescribed the features of investment products, leaving the design of such products to market forces and allowing the market to judge their quality. Corporate securities as financial assets have always been regulated chiefly by mandatory disclosure. Disclosure is a regulatory mechanism that facilitates independent investor ­judgement85 and is not as intrusive as ‘command and control’ types of regulation which

79 Auch as the FCA Handbook COBS 4.7.7–10 on limiting communications to sophisticated investors and to retail investors only if suitability requirements are complied with as if investment advice is provided. 80 FCA Handbook COBS 18.12 on appropriate senior management and risk governance as well as business continuity planning. 81 ibid. 82 ibid. 83 Securities Act 1933, s 4(a)(6), as amended by the JOBS Act 2012; FCA Handbook COBS 4.7.10, for retail investors. 84 Rodrigues (2019). 85 AC Page and RB Ferguson, Investor Protection (CUP, 1992) 59–77.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  163 prescribe specific standards that are more paternalistic in nature. Mandatory disclosure does not warrant the safety or viability of an investment product, but provides a sufficiently transparent environment in order to allow users to make informed choices and to deal with false descriptions.86 This lack of regulatory intrusion into financial product design has continued as financial products such as collective investment funds have developed and have also been made subject to disclosure regulation,87 with only minimal product regulation. European undertakings for the collective investment in transferable securities (UCITs) that are marketed on the basis of being highly liquid and safe are subject to portfolio diversification requirements88 and can only be invested in marketable instruments traded on public financial markets.89 The lack of product regulation in more innovative and complex products such as derivatives and securitised products allowed financial innovation to be privately governed, such as by voluntary associations90 and contract.91 After, as these products were heavily implicated in the origins of the crisis, regulatory tightening for centrally cleared derivatives contracts has occurred in the EU,92 and securitised products are made subject to risk retention requirements to prevent moral hazard in their origination.93 In light of post-crisis perceptions that financial innovation can be and self-serving94 for the financial sector and may even bring about harmful levels of social risk,95 European policy-makers have decided to address product governance instead of a fully fledged regulatory model of product regulation, which may require ex ante vetting and approval like for drugs or food. In the UK there is also social appetite for some form of product governance as Ferran96 has observed a long history of misselling where consumers are 86 W Cage, ‘Regulating Through Information: Disclosure Laws And American Health Care’ (1999) 99 Columbia Law Review 1701. 87 Arts 68–76, Consolidated text: Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (recast); FCA Handbook COLL 4.1 as applying to collective investment schemes that are non-UCITs. 88 Arts 50–53, EU UCITs Directive 2009. 89 Art 2, UCITs Directive 2009 on the definition of ‘transferable securities’. 90 Such as the ISDA Master Terms for derivative contracts, at www.isda.org/a/23iME/Legal-Guidelines-forSmart-Derivatives-Contracts-ISDA-Master-Agreement.pdf. 91 P Tufano, ‘Financial Innovation’ (2002), at www.econ.sdu.edu.cn/__local/C/FD/E1/0D52B9FEF69707C D0C56B1D782B_9DDECC5E_3498C.pdf on how financial innovation often take contractual forms to deal with risk management, agency costs, market incompleteness, etc. 92 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories which mandated centrally cleared derivatives for most classes of trading instruments; AG Balmer, Regulating Financial Derivatives: Clearing and Central Counterparties (Edward Elgar, 2018). 93 Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012, Art 6. 94 D Awrey, ‘Towards a Supply-Side Theory of Financial Innovation’ (2013) 41 Journal of Comparative Economics 401; D Awrey, ‘Complexity, Innovation, and the Regulation of Modern Financial Markets’ (2012) 2 Harvard Business Law Review 235. 95 BJ Henderson and ND Pearson, ‘The Dark Side of Financial Innovation’ (2009) at ssrn.com/ abstract=1342654; A Maracci, ‘European Regulatory Private Law Going Global? The Case of Product Governance’ (2017) 18 European Business Organisations Law Review 305. 96 EV Ferran, ‘Regulatory Lessons from the Payment Protection Insurance Mis-selling Scandal in the UK’ (2012) 13 European Business Organisations Law Review 247–70.

164  The Financing of Blockchain-based Business Development targeted to be sold financial products, often added on to staple financial products such as mortgages, without adequate consideration of their suitability. The UK regulator has responded with law reforms in relation to duties at point of sale97 and remedies for consumers,98 but perhaps a longer-term solution that deals with the products of financial innovation may be needed. Product governance comprises of procedural duties imposed on product ­manufacturers99 and distributors100 under the EU Markets in Financial Instruments Directive that covers investment services firms. These require product manufacturers to put in place processes and governance frameworks to ensure that product design is targeted at a suitable101 end-investor market and will exclude unsuitable investors. The characteristics and risks of such products are considered not only for suitability but also in relation to appropriate management of conflicts of interests. Product distributors need to ensure that they receive sufficient communication and explanation from product manufacturers and come to independent and well-governed judgments on the suitability of the end-investor target market.102 This procedural approach103 arguably targets internal processes and firm culture in managing financial innovation and product generation. However, Colaert crucially points out that this regime does not specifically cover investment funds as well as direct offer products not generated by investment firms, ie corporate securities and online equity and loan crowdfunding products.104 It may be queried if the product governance regime should be extended to all financial products, whether these are direct offer products or products generated and designed by financial sector intermediaries. In this manner, pre-development tokens sold at ICOs could be regarded as financial assets and be generally caught within such a broad regime. As profiled by Lausen,105 most tokens, even if they have functional characteristics and would be used exclusively in the protocol infrastructure or dApp for which they are issued, also have a mixture of financial characteristics106 such as transferability and secondary tradeability. Some utility tokens are even designed with rights to future participation in profits. 97 For example, ‘Guidance for firms on the fair treatment of vulnerable customers’ (July 2020), at www.fca. org.uk/publications/guidance-consultations/gc20-3-guidance-firms-fair-treatment-vulnerable-customers. 98 Such as consumer redress schemes, Financial Services and Markets Act 2000, s 404. 99 Commission Delegated Directive (EU) 2017/593 of 7 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits, Art 9. 100 ibid, Art 10. 101 Suitability refers to meeting three criteria, ie that investors’ objectives are met, they understand the risks involved and that they are financially able to bear those risks, Art 25, Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61, enacted in FCA Handbook COBS 9 and 9A. 102 Discussed in V Colaert, ‘Product Governance: Paternalism Outsourced to Financial Institutions?’ (2019), at ssrn.com/abstract=3455413. 103 Maracci (2017). 104 Colaert (2019). 105 J Lausen, ‘Regulating Initial Coin Offerings? A Taxonomy of Crypto-assets’ (2019), at ssrn.com/ abstract=3391764. 106 Such as institutional involvement; see C Fisch and PP Momtaz, ‘Institutional Investors and Post-ICO Performance: An Empirical Analysis of Investor Returns in Initial Coin Offerings (ICOs)’ (2020), at papers. ssrn.com/sol3/papers.cfm?abstract_id=3427025.

Why a Tailor-made Regulatory Regime for Fundraising is Needed  165 Nevertheless, the principles of the product governance regime may not be appropriate for direct offer products including ICOs. They are imposed on investment firms as these stand in a principal–agent relationship107 with their customers in relation to information and expertise asymmetry, inducing a relationship of trust and reliance. Hence, product governance rules are based on the duty of suitability that is applied to investment advisors. Often investment firms’ relationships with their customers are also ridden with conflicts of interest. The relationship between issuers and investors is often not of the same nature, and it can be queried why issuers should be burdened with providing suitable investment products for an end-target market. It would mean that corporations as well as ICO project developers would be subject to an ex ante legal duty of considering how their offers of assets would be financially suitable for certain target investor markets. On the one hand, this may induce consideration and care before fundraising, as issuers have to justify why the offered assets are suitable for investors, but the duty may also be impossible and expensive to comply with as issuers will have to conduct extensive due diligence into their target markets.108 Genuine issuers can become risk-averse, and possibly focus only on sophisticated or expert markets.109 This duty may however play a part in deterring frauds or scams110 as insincere issuers would find the efforts to comply with such an ex ante duty too costly for them. It can be argued that the product governance regime is under-inclusive for investor protection in direct offer products such as securities and ICOs. The product governance regime embeds a general, as distinguished from individual-facing or specific duty of suitability towards customers in product manufacture and distribution. It is uncertain if any breaches, for example of procedural governance in product design, could entail civil actions by customers against product manufacturers or distributors. In this manner, product governance works as only ex ante principles for issuers rather than as a potential source of market discipline for them. Finally, we query if bespoke regimes for ICOs discussed in chapter three, such as the EU Commission’s proposal, the Maltese Virtual Financial Assets Act or the Thai Law for cryptoasset offers have achieved the right balance in introducing tailor-made offering regimes. As chapter three discussed, the regimes introduce pared-down versions of mandatory disclosure, drawing inspiration from securities regulation. However, the information asymmetry conditions in IPOs and ICOs differ, as argued earlier, and we 107 AM Pacces, ‘Financial Intermediation in the Securities Markets Law and Economics of the Conduct of Business Regulation’ (2000) 20 International Review of Law and Economics 479. 108 An alternative would be to take up Choi’s proposal that investors should be regulated and categorised by the regulator so that issuers can then target their intended market; see SJ Choi, ‘Regulating Investors Not Issuers: A Market-Based Proposal’ (2000) 88 California Law Review 279. 109 Colaert (2019), and see empirical research that seems to bear out a risk averse product innovation culture where client needs and regulatory risk feature large, K Asante, R Owen and G Williamson, ‘Governance of New Product Development and Perceptions of Responsible Innovation in the Financial Sector: Insights From an Ethnographic Case Study’ (2014) 1 Journal of Responsible Innovation 9. 110 Although Fromberger and Haffke’s (2020) study show almost 70% of tokens having lost all of their value from ICO and over 90% trading below the ICO price, research by L Hornuf, T Kück and A Schweinbacher, ‘Initial Coin Offerings, Information Disclosure, and Fraud’ (CESifo Working Paper, 2019) at ideas.repec.org/p/ ces/ceswps/_7962.html show that a small fraction are scams, and D Liebau and P Schueffel, ‘Cryptocurrencies and ICOs: Are They Scams?’ (2019), at ssrn.com/abstract=3320884 show that this fraction is even lower, possibly at about 2.2% of ICOs. This may indicate that poor performance for many ICOs is attributable to poor business projects that are being subject to the natural forces of creative destruction and competition.

166  The Financing of Blockchain-based Business Development caution that it may induce a false sense of assurance to rely on mandatory disclosure for investor protection. It is arguable that none of these regimes sufficiently grapple with the predevelopment or pre-incorporation nature of the blockchain-based enterprise. This chapter argues shortly that the pre-development or pre-incorporation nature of the blockchain-based enterprise should give rise to concerns regarding post-sale monitoring in order to ensure that development of the project is genuinely carried out. Although the Commission’s proposal provides for an ex post element in relation to withdrawal rights within 14 days of subscription for the offer, and this is helpful for investors who have been unthinkingly swept up in an ICO hype, some voluntary mechanisms that issuers institute currently exceed the regulatory mechanisms for investor protection. For example, issuers’ voluntary adoption of soft caps may provide even stronger protection for investors in relation to refund rights.111 The Commission’s proposal arguably provides for ongoing duties that issuers owe to investors in relation to fair and honest treatment, management of conflicts of interest and transparency. It is however uncertain how these ongoing duties protect investors in terms of establishing a breach and enforcement consequences. Further, would these ongoing duties expire when the development project becomes live? This chapter argues that a focus on ex ante regulatory obligations, whether extensive disclosure or product governance duties, would unlikely cater for investor protection needs in relation to an ICO. These regimes can be too onerous for issuers, while at the same time under-inclusive in many respects, and do not cover novel issues and practices in relation to investor protection needs. We offer a regulatory blueprint in the next sections focusing on a mixture of ex ante regulation and ex post monitoring. An ex post regime presents fewer barriers to entry for blockchain-based project developers, but may meet investor protection needs more fully in terms of inducing proper conduct on the part of developers and ultimate project release. This chapter argues that the regulatory blueprint offered below strikes a better balance between investor protection and pro-innovation objectives than those discussed in chapter three.

II.  A Blueprint for Regulating Token Financing In ICOs, developers of blockchain-based business projects are seeking development funds to start a project, often based only on an idea,112 a vision and perceived technical routes to achieving the realisation of the idea. As such, business plans can be imprecise and may adapt and change with the discovery of obstacles or new possibilities. ICOs therefore raise unique issues in relation to the needs for investor protection. These investor protection needs are as follows: (a) ICOs likely take place at a business pre-development or pre-incorporation stage. This is different from securities offers where issuers are already incorporated and 111 Discussed below. 112 M Ofir and I Sadeh, ‘ICO vs IPO: Empirical Findings, Information Asymmetry and the Appropriate Regulatory Framework’ (2020) 53 Vanderbilt Journal of Transnational Law 525, also at papers.ssrn.com/sol3/ papers.cfm?abstract_id=3338067; Feng et al (2019).

A Blueprint for Regulating Token Financing  167 have a track record by the time they come to market. Hence, one of the goals of ICOs would be to take a project to a stage ready for release. This chapter envisages that point in time to be congruent with the point in time a blockchain-based business could be registered as envisaged under chapter four. We submit that investors’ objectives would be to fund the development of the project in order for the project to arrive at a point ready for business and entity registration. The entity registration and legitimation discussed in chapter four is hence a necessary complement to the fundraising regime for ICOs. (b) Investors run an acute risk of project failure as is normal with new and young businesses.113 Researchers in the topic of business failure have identified external drivers for failure such as economic and market conditions, consumer market changes, lack of external advisers or business partners, failure of customers or supply-side factors. Internal drivers for business failure include initial undercapitalisation, weaknesses in management, weakness in financial budgeting and control, lack of industry experience, weakness in marketing skills, human resources management, and in governance such as being self-serving and overly optimistic.114 Moreover, it is argued that even where external factors exist, the skilfulness and adaptability of the entrepreneur/s who are key persons would be crucial in either weathering difficulties or submitting to failure.115 In particular, inexperienced or weakly skilled entrepreneur/s, as well as the lack of financial management skills in the development team are usually first signs of a crisis for a young business.116 In this manner, it can be argued that internal factors are important for the prospects of a project. Lausen117 also notes that a majority of projects are developed in a centralised manner before becoming viable for decentralised self-sustenance. Hence, a regulatory regime addressing investor protection must address the risks of internal factors for business failure, revolving largely around the skill sets, experience and competence of responsible persons for development. (c) The ICO is a model of fundraising that exacerbates investors’ risk. This is because of the frontloading model of reward for a project yet to be developed. A successful ICO which raises for example US $100million has rewarded the developer/s before they have started to embark on the business and technical development. This creates perverse behavioural incentives that are contrary to the needs of investor protection. The frontloading model may induce perverse incentives such as laziness in expending effort as the reward is already obtained.118 Developers may 113 About 50% of small businesses fail by their third year; see citations in J Ropega, ‘The Reasons and Symptoms of Failure in SME’ (2011) 17 International Advancements in Economic Research 476. 114 RN Lussier, ‘Reasons Why Small Businesses Fail’ (1996) 1 The Enterpreneurial Executive 10 containing a meta-review of literature on reasons for small business failure and a hand-collected qualitative set of data; also see more generally MARC and RSM, ‘Classification and Analysis of Major European Business Failures’ (Research Project Commissioned by the European Contact Group, October 2005). 115 Ropega (2011). Also see V Scherger, HP Vigier and MG Barberà-Mariné, ‘Finding Business Failure Reasons through a Fuzzy Model of Diagnosis’ (2014) XIX Fuzzy Economic Review 45 on how decision-making by management on the key perceived external factors, as mediated by management’s experience, skills, behavioural limitations and judgment, is crucial for business failure or otherwise. 116 ibid. 117 (2019). 118 See TC Belinfanti, ‘Beyond Economics in Pay for Performance’ (2012) 41 Hofstra Law Review 91 on behavioural implications from compensation design, which can be analogically used here.

168  The Financing of Blockchain-based Business Development be tempted to shirk or underperform since accountability is self-regulatory. This frontloading model is also heavily imbalanced between developers and investors as developers enjoy the gain at an early stage while investors are left to bear the risk of business unviability or loss of investment value. (d) Investors need to be able to discern between possibly viable business ideas from well-intentioned ‘fluff ’ and downright scams. Feng et al demonstrate that investors are not well-placed to do so as their evaluations of white papers do not necessarily lead them to optimal investment decisions.119 The commentators find in particular that many white papers contain business proposals that do not need to use a blockchain but nevertheless are contrived to fit into blockchain in order to benefit from the ‘blockchain hype’. More than half of these proposals have been well subscribed by investors and indeed well-rated by ICO rating services. Investors are not always fooled but investors have been exploited in a self-regulatory environment by sub-optimal white papers.120 Further exploitation can take place at many levels of deception, as apparently credible ICOs can make certain promises that the code does not ultimately fulfil or can be unilaterally altered by developers without due disclosure. These discrepancies are not as easily detected by investors.121 These risks are not likely to be mitigated by the gold standard of mandatory disclosure for securities regulation or the investment limits chiefly deployed in the regulation of online equity crowdfunding.122 However, disclosure regulation can still perform a role for signalling quality, such as in relation to internal factors for success discussed in (b), or signals of integrity, such as in relation to (d). Mandatory disclosure can require greater comprehensiveness and standardisation so as to countervail the sub-optimal qualities of selective, vague, incomplete and imbalanced disclosures.123 As Zetzsche et al have empirically observed, the quality of voluntary disclosure in ICOs, in the form of white papers, is currently sub-optimal in most cases.124 For example, white papers would omit information on governing law and how investors may be protected. White papers also have scant detail on how proceeds are managed or used and what the milestones of a project are.125 There is therefore some value in having a form of mandatory disclosure obligation to deter the lemons from arriving on the market, as the cost and burden of complying with such mandatory disclosure may prove not to be worthwhile for those. However, mandatory disclosure is unlikely to help investors in relation to (a) and  (c), as disclosure may be too premature for ferreting out the viability prospects 119 (2019). 120 ibid; DA Zetsche, RP Buckley, DW Arner and L Föhr, ‘The ICO Gold Rush: It’s a Scam, It’s a Bubble, It’s a Super Challenge for Regulators’ (2019) 60 Harvard International Law Journal 267. 121 Revealed in the code audit carried out by S Cohney, D Hoffman, J Sklaroff and D Wishnick, ‘Coin-operated Capitalism’ (2019) 119 Columbia Law Review 591 in relation to 50 ICOs which show a significant number of code deviations from what was promised in the white paper. 122 C Brummer, T Kiviat and JR Massiari, ‘What Should Be Disclosed in an Initial Coin Offering?’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 7. 123 Cross and Prentice (2016). 124 (2019). 125 ibid.

A Blueprint for Regulating Token Financing  169 of the project referred to in (a) or the behavioural tendencies of project developers in (c).126 Unlike for mature companies that come to market and have a track record, developers are not necessarily able to offer risk discussion and estimates of investment value and performance, for investors to determine if (a) can be achieved. It is unclear if investor protection in relation to the risks in (a) and (c) may be better served in a regulatory design that involves co-opting investors as monitors of the progress of business development.127 This relationship can be structured as a statutory ‘partnership’ although the analogy with partnerships is not perfect as investors would not be involved in equal intensity as developers. The concept of partnership however affords investors rights of fair treatment, inspection and accountability.128 Further, where investors are technically savvy, there is room for developers to consider their co-involvement. The proposal for a statutory partnership is based on the preincorporation nature of the blockchain-based project under development, which has not yet attained an entity status. In the alternative, regulatory provision can explicitly be made for investors’ post-sale monitoring rights as unique rights. Such an approach may be beneficial in being not derived from an existing body of law such as partnerships, and also less open-ended in the framing of legal rights. In particular, a specific monitoring right for investors can be provided to countervail the perverse incentives in (c) by allowing investors to monitor the stages of business development in order to release funds in staged financing. Such monitoring rights address the risks of the frontloading model of ICO financing which allows developers to collect a massive amount of proceeds before the project has even begun. This perverse incentive can adversely affect blockchain-based project development even if the development team comes with impressive credentials.129 A regulatory design that co-opts investor monitoring and milestones of achievement may be important for incentivising developers’ continuing effort so that perverse incentives do not exacerbate the already high risks for business viability for new and young businesses. This model is closer to the financial contracting model in venture capital investment arrangements which Rodrigues130 argues can be applicable to ICOs. Further, ex post rights for investors should extend beyond monitoring to certain financial rights such as withdrawal and refunds. We propose a regime for such ex post rights drawing inspiration from the wrongful trading regime in company law. 126 This seems to be supported empirically in D Boreiko and NK Sahdev, ‘To ICO or not to ICO – Empirical Analysis of Initial Coin Offerings and Token Sales’ (2018), at papers.ssrn.com/sol3/papers.cfm?abstract_ id=3209180, who show that the longer-term fate of ICO performance has little to do with the quality of disclosure or signalling. This is in spite of the initial fundraising success being affected by the quality of voluntary disclosure. 127 The Partnership Act 1890, s 1 defines a partnership as ‘carrying on business in common with a view to profit’. Such business relations extend to a wide range of commercial relations of with which an ICO ­developer–investor relationship can be analogised. Further, commentators also posit that the DAO, which was an early template of how investors could invest into a blockchain-powered enterprise, should be treated as close to a partnership; see O Oren, ‘ICO’s, DAO’S, and the SEC: A Partnership Solution’ (2018) 118 Columbia Business Law Review 617. 128 Partnerships Act 1890, ss 24–30, but subject to modification as appropriate to the project. This is discussed further under ‘Schedule of Commitment’ below. 129 X Deng, YT Lee and Z Zhong, ‘Decrypting Coin Winners: Disclosure Quality, Governance Mechanism and Team Networks’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3247741. 130 (2019).

170  The Financing of Blockchain-based Business Development Under the wrongful trading regime in company law,131 directors are under a duty not to continue trading if a business is reasonably regarded as past the point of recovery.132 Directors’ discharge of that duty is based on an objective test of reasonableness,133 and the point of ‘no return’ is usually before the onset of actual insolvency.134 This regime aims to maximise protection for creditors so that corporate assets are preserved to the maximum amount possible and companies would not be wasting assets by trading beyond a point of expected recovery. Similarly, this chapter argues that developers can be made subject to a similar duty so that return of investors’ funds should be made upon a reasonable diagnosis of impending unviability of the blockchain-based project. Such ex post rights may however exacerbate pressure on developers, and there needs to be a balance in enforcing such rights. This is explored in detail shortly. This chapter argues that a regulatory blueprint for ICOs should comprise of two key aspects. One is ex ante in nature, dealing with mandatory disclosure to the extent of deterring frauds and scams, and providing investors with a basis for discerning these. This chapter proposes that mandatory disclosure should relate to indicators of integrity, as discussed below. The second aspect is a regulatory design that facilitates post-sale investor monitoring, as well as to exercise ex post rights to mitigate their risks. Such ex post monitoring and rights should be contained in a Schedule of Commitment binding on developers and investors, to be discussed below. Our proposal means that there would be lower barriers of entry to ICOs as mandatory disclosure does not extract an excessively high upfront cost. However, investors should be protected against inappropriate ex post conduct by project developers.

III.  Mandatory Disclosure Proportionate mandatory disclosure should be imposed on developers, in order to achieve the purpose of scam/fraud detection. Further, empirical research has confirmed that investors welcome the voluntary white paper,135 even if the quality in such papers varies. For this purpose, this chapter suggests that mandatory disclosure should apply regardless of the type of investor at which the offering is pitched. The assumptions in conventional securities regulation regarding exemptions from mandatory disclosure if offers are made to certain sophisticated or high-net-worth investors should not apply, as these investors are unlikely able to fend for themselves in an equivalent manner as in relation to conventional securities offers. The technological aspects of ICOs and the inherently informational anaemic environment surrounding ICOs are as disadvantageous to accredited investors as for retail investors.

131 UK Insolvency Act 1985, s 214. 132 Official Receiver v Doshi [2001] 2 BCLC 235; Grant & Tickells (joint liquidators) v Ralls and Hailstones (2016) EWHC 243. 133 Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275, [1999] BCC 26. 134 BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112. 135 Adhami et al (2018); S Howell, M Neissner and D Yermack, ‘Initial Coin Offerings: Financing Growth with Cryptocurrency Token Sales’ (2019), at ssrn.com/abstract_id=3201259; C Fisch, ‘Initial Coin Offerings (ICOs) to Finance New Ventures’ (2019) 34 Journal of Business Venturing 1.

Mandatory Disclosure  171 To this end, mandatory disclosure should not be designed to be derived from securities regulation or exemptions like Regulation A+ in the US,136 or the EU crowdfunding document, ‘Key Investment Information Sheet’.137 These feature too much derivation from securities regulation. Rather, mandatory disclosure should be based on optimal needs for scam/fraud identification, so that the cost for compliance is not disproportionate and achieves a common social good desired by both developers and investors, ie to combat adverse selection for issuers and to foster a market for confidence by investors. This chapter does not see ex post litigation based on disclosure and absolute liability138 as the chief protection for investors. Developers may not be located in the same jurisdiction as investors, or may have dissipated investment proceeds and are unable to satisfy judgments. As ex post compensation for investors may be a remote prospect, market discipline accompanying mandatory disclosure is not likely the optimal form of investor protection. Mandatory disclosure, however, is able to serve a public interest purpose of highlighting sub-optimal signals from ICOs and could play the role as deterring mechanism for scams or frauds. There should also be an active role for regulatory enforcement139 against scams or frauds, as such regulatory actions underpin credible markets. This chapter suggests that much of the substantive investor protection should be found in post-sale regulatory mechanisms rather than ex ante disclosure as in securities regulation. In this manner, the intensity required in ex ante mandatory disclosure should be proportionate to what it is likely to achieve. This chapter suggests that the mandatory disclosure document should focus on indicators of integrity in order to weed out scams or frauds. The mandatory disclosure document should include: (a) information relating to the development team that signal integrity; (b) information relating to the blockchain-based business project that signal integrity;140 (c) information relating to the nature of the pre-sold tokens, their anticipated rights and functionality, and their pricing at the ICO; (d) information relating developers’ key relationships with third parties; and (e) information relating to the details required for the Schedule of Commitment discussed below.141 Although some aspects are similar to the EU Commission’s regulation for the white papers of cryptoasset offerings, our proposal may be less demanding and relevant. Each item of disclosure in (a) to (e) is further elaborated below. 136 Discussed in Rodrigues (2019). 137 Art 23, EU Regulation of Crowdfunding Services 2020, above. 138 Fox (2016). 139 JC Coffee, ‘Law and the Markets- The Impact of Enforcement’ (2007) 156 University of Pennsylvania Law Review 229. 140 (a) and (b) are particularly related to the quality of the ICO; see D Blesag, ‘Dynamics of Voluntary Disclosure in the Unregulated Market for Initial Coin Offerings’ (2018), at www.researchgate.net/profile/ Daniel_Blaseg/publication/326849740_Dynamics_of_voluntary_disclosure_in_the_unregulated_market_ for_Initial_Coin_Offerings/links/5b696802a6fdcc87df6d6a39/Dynamics-of-voluntary-disclosure-in-theunregulated-market-for-Initial-Coin-Offerings.pdf; R Amsden and D Schweizer, ‘Are Blockchain Crowdsales the New “Gold Rush”? Success Determinants of Initial Coin Offerings’ (2019), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3163849. 141 A meta-review provided to show what voluntary disclosures have taken place; see Ofir and Sadeh (2020).

172  The Financing of Blockchain-based Business Development Much of the information under (a) to (e) would likely be generated by developers without the necessity for incurring third-party expense, and this chapter suggests it can be optional whether developers seek external verification of their disclosure. Third-party verification can be welcomed by the market in an environment of inherent information anaemia, and it is arguable that gatekeepers may also share in liability if developers are unable to compensate.142 However, gatekeeper liability cannot be disproportionate to their responsibility, and their legal risk may result in extraction of high premiums for their services, which would be disincentivising and unhelpful for entrepreneurs. On balance, it is suggested that third-party verification should be optional so that market practices can be allowed to develop for further observation. The mandatory disclosure document should be registered with the securities or financial services regulator, such as the FCA in the UK. As under the Prospectus Regulation regime, the regulator is not expected to carry out merit-based vetting but should check the document for completeness, consistency and comprehensibility.143 Perhaps the criteria under the Prospectus regime should not be rigidly applied, as critique has been raised against the vagueness of the criteria and how they could become a form of merit vetting.144 Nevertheless, regulatory checking for completeness and for the lack of obvious contradictions can be useful for investors.

A.  Information Relating to the Development Team that Signals Integrity Consistent with a number of commentators’ recommendations, the mandatory disclo­ sure document should contain sufficient information about the development team, their identities, their nationalities and places of domicile, their qualifications and experiences.145 Fisch, for example, finds that due to the intensely technological nature of blockchain-based business projects, investors in particular look for developers’ technical capabilities.146 These have become proxy for investor confidence in the prospects of project, although empirical research does not show a clear relationship between the team’s characteristics and a project’s ultimate success.147 Further, in view of research discussed above,148 relating to how key decision-makers affect the fortunes of new and young businesses, the development team should provide for how the team 142 A Hamdani, ‘Gatekeeper Liability’ (2003/04) 77 South California Law Review 53. 143 Art 20, Prospectus Regulation 2017, and Arts 36–38, Commission Delegated Regulation (EU) 2019/980 of 14 March 2019. The EU Commission’s proposal also does not require merit vetting but does not apply the minimal standards established under the Prospectus Regulation 2017. 144 P Schammo, ‘The Prospectus Approval System’ (2006) 7 European Business Organisations and Law Review 501. 145 Zetzsche et al (2019); Hacker and Thomale (2018). 146 C Fisch, ‘Initial Coin Offerings (ICOs) to Finance New Ventures’ (2019) 34 Journal of Business Venturing 1; L Burns and A Moro, ‘What Makes an ICO Successful? An Investigation of the Role of ICO Characteristics, Team Quality and Market Sentiment’ (2018), at www.researchgate.net/publication/327920924; L Ante, P Sandner and I Fiedler, ‘Blockchain-Based ICOs: Pure Hype or the Dawn of a New Era of Startup Financing?’ (2018) 11 Journal of Risk and Financial Management 80; Howell et al (2019) and Blaseg (2018). 147 Deng et al (2019). 148 See n 116.

Mandatory Disclosure  173 meets the needs of financial, human resource, technical, management and marketing skills. It would also be useful to set out if the development team has had any previous convictions, or director or professional disqualifications in any jurisdiction as a signal of integrity.149 However, we must recognise the limit to such disclosures in light of empirical research findings that these signals do not proxy well for the success of blockchain-based projects.150

B.  Information Relating to the Blockchain-based Nature of the Business Project As pointed out by Feng et al,151 many ICOs are launched by developers whose projects do not even need a blockchain and are disingenuously riding on the blockchain hype. As such, mandatory disclosure should explain why the business project is blockchain-based and why blockchain technology is necessary for the business.152 Mandatory disclosure should include sufficient detail about why the business project relies on network effects and how network effects create value for the business proposal. Sufficient detail on choice of protocol infrastructure, how the business operates, the nature of smart contracts to be deployed and technical detail should be provided,153 but it may be optional as to whether the source code should be provided. Commentators find that disclosure of source code can boost credibility in the ICO as technologically savvy investors may be able to ascertain if the code will indeed work.154 Further, there is research to suggest that investors are sensitive to the quality of the code as reflected in the number of revised versions or the history of bug-fixing of the code on Github.155 However, there is contrary research on investors’ inability to discern code quality.156 It is also uncertain if such disclosure may lead to fraudulent imitators who would arrive on the market as competitors157 and jeopardise the development project’s position.158 Further, disclosure of the source code may not be very useful as code development is part of project development and can be expected to be revised. Hence, on balance, we argue that it should be optional as to whether the source code would be disclosed in full. Ofir and Sahdev159 propose that third parties should be used to certify the source code for the project in order to verify quality for investors. It is uncertain how useful 149 This is information required for financial regulators’ assessment of integrity in evaluating if applicants for authorisation to carry out regulated financial business meet the requirements of ‘fit and proper’; see FCA Handbook, FIT chapter. 150 Deng et al (2019). 151 (2019). 152 Ofir and Sahdev (2019). 153 Feng et al (2019). 154 Proposed in Hacker and Thomale (2018); Adhami et at (2018) and Blesag (2018); Howell et al (2019). 155 Howell et al (2019); Fisch (2019); Bourveau et al (2018). 156 Cohney et al (2019). 157 L Hornuf, T Kück and A Schwienbacher, ‘Initial Coin Offerings, Information Disclosure, and Fraud’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3498719. 158 Bourveau et al (2018) on competitive erosion of advantage not necessarily by scams. 159 (2019).

174  The Financing of Blockchain-based Business Development this is at an early stage of the project’s development. This book proposes that code certification should take place at the point of the project’s readiness for registration under chapter four. At this juncture, investors would be able to have an opportunity to launch redress movements for mis-disclosures, deceptions or omissions if the certification reveals material discrepancies from the technological functions earlier represented.160 However, even discrepancies between disclosures made at the pre-development stage of the blockchain project and its completed state for registration should not necessarily entail opportunistic investor litigation. We should discern if such discrepancies adversely affect the technological functions and value of the blockchain platform in the longer term.161 In this respect, the mandatory disclosure regime should not be regarded as serving mainly compensatory purposes for investors. Next, the mandatory disclosure document should provide for the intentions of the development team in bringing the project to the stage of registration envisaged in chapter four. The document should set out which registration jurisdiction is targeted and what processes in preparation for registration are put in place. This is of importance to investors as they are envisaged to be involved in forging the governance arrangements for the blockchain-based business as it becomes ready to go live.162 The mandatory disclosure document should provide for a candid discussion of business risks that may affect the viability and value of the business, such as the lack of network effects or market interest, or technological difficulties or obstacles, as much as can be foreseen by the development team.163 In such disclosure, regulators should scrutinise for boilerplate statements that may be vague or meaningless.164

C.  Information Relating to the Nature of the Pre-sold Tokens, their Anticipated Rights and Functionality, and their Pricing at the ICO The mandatory disclosure document should also include a clear and precise description of the nature of the pre-sold tokens and the rights that will be conferred when the project becomes live.165 This book envisages that projects should be aimed towards being brought to a point of registration and functionality, at which point there would be regulator-mandated vetting of the code,166 discussed in chapter four. Developers should be incentivised to ensure that the nature of, and rights to be attached to, the pre-sold tokens are as described at point of sale. Cohney et al167 discuss a survey of 50 ICOs where significant discrepancies between the white paper disclosures and the code were discovered in many ICOs. Hence it is important to consider 160 Although such discrepancies are found in Cohney et al (2019). 161 Deng et al (2019) finds that token value in the long run depends on the value of the blockchain-based platform in terms of its technological and innovative value and the network effects on the platform. 162 Discussed in ch 4. 163 JL Campbell, H Chen, DS Dhaliwal, H-M Lu and LB Steele, ‘The Information Content of Mandatory Risk Factor Disclosures in Corporate Filings’ (2014) 19 Review of Accounting Studies 396. 164 McClane (2019). 165 P Stastny, ‘Underpricing in ICOs’ (2018), at ssrn.com/abstract=3206323. 166 ch 4. 167 (2019).

Mandatory Disclosure  175 investor compensatory redress where their legitimate expectations, especially in relation to rights in tokens, are adversely affected. We are less minded to support extensive compensatory litigation for differences in technological or functional aspects are necessary to or beneficial to the project’s ultimate development. Further, the mandatory disclosure document should disclose how the development team has priced the ICO.168 As will be discussed shortly in relation to the Schedule of Commitment, the mandatory disclosure document should identify what the financing threshold is and why the threshold is sought.169 The development team should provide reasons for supporting the threshold sought and the funding threshold should not merely be based on comparison with similar projects that have raised funds. In order to support pricing, the development team may have worked on a basis of threshold development funds needed and optimal network effects for the blockchain-based project, or may have worked on the basis of projected future investment value discounted for the present. Any basis for pricing should be rationally and clearly explained. Further, mandatory disclosure should be made of the intended use of proceeds170 to achieve each milestone of development, and to provide for the ongoing processes and junctures of accountability in relation to use of proceeds. The document should explain how accountability is made to investors, the frequency and level of detail of reports to be expected. It should also set out to what extent costs and fees incurred in the ICO would be charged against the proceeds.171 As will be discussed below in relation to the duties in the Schedule of Commitment, the development team should disclose their ICO policies for token retention, subsequent rounds of financing, other relevant financing policies and how they serve the purposes of the blockchain-based project.172 These are important to investors for evaluating the price of the ICO.

D.  Information Relating to the Development Team’s Relationships with Third Parties Third-party relationships that the issuer would be engaged with include custodial arrangements with an escrow agent for staged financing,173 in relation to our proposal below. Such arrangements must be disclosed including relevant details for the governance and administration of such arrangements, as well as any conflicts of interest between the development team and the escrow agent. Voluntary third-party relationships may include third-party certifiers of the mandatory disclosure document, ICO rating services, secondary market operators any perhaps any other financial intermediary entity involved in the advisory, fundraising or postsale processes. These relationships, including the roles of the third parties, their legal 168 Zetzsche et al (2019). 169 C Catalini and JS Gans, ‘Initial Coin Offerings and the Value of Crypto Tokens’ (2019), at papers.ssrn. com/sol3/papers.cfm?abstract_id=3137213 argue that the financing threshold is often based on ‘divide the money’ perceptions ie what is perceived to be what the demand side is willing to pay. 170 Also see Hacker and Thomale (2018). 171 Zetzsche et al (2019). 172 Also see Ofir and Sahdev (2019); Hacker and Thomale (2018). 173 Zetzsche et al (2019).

176  The Financing of Blockchain-based Business Development entity information, regulatory information and conflicts of interest with the development team should be disclosed. Certifier arrangements should be disclosed in relation to the extent of assurance provided and what the level of assurance means.174 This section of mandatory disclosure is also related to relevant duties under the Schedule of Commitment to be discussed shortly.

E.  Other Information Relating to the Details Required for the Schedule of Commitment The Schedule of Commitment below deals with the ex post protection of investors in ICOs. The Schedule is envisaged to provide the template of post-sale duties and governance between the development team and investors. Details should not be excessively prescribed in regulation but a baseline of protective governance would be likely in the common interests of all investors. The exact details of post-sale governance in the Schedule between issuers and investors should be part of the mandatory disclosure document. Further, the Schedule would also provide for duties in relation to public interest, which is the avoidance of money laundering in ICOs, to be discussed shortly. The above sketches out a regulatory blueprint for mandatory disclosure which more proportionately relates to what mandatory disclosure can be expected to achieve in the unique situation of ICOs. Commentators also moot the regulation and imposition of duties such as due diligence and independence for information intermediaries, eg rating services or analysts involved in ICOs.175 This can be useful especially if investor reliance on such services can be shown to be significant.176 This chapter takes the view that mandatory disclosure cannot optimally work as the only investor protection mechanism in ICOs and we turn to discuss the blueprint for a regulatory regime in relation to post-sale governance and conduct.177

IV.  Ex Post Monitoring and Rights in a Schedule of Commitment The post-sale governance of ICOs is necessary in view of the needs of investor protection in highly risky pre-development financing. Such a governance framework should ideally feature post-offer monitoring and governance, in order to counterbalance the limitations in investor protection that can be achieved by ex ante mandatory disclosure. 174 Whether this is limited assurance or reasonable assurance depending on what extent of diligence was agreed and carried out. 175 C Liu and H Wang, ‘Initial Coin Offerings: What Do We Know and What Are the Success Factors?’ in S Goutte, K Guesmi and S Saadi (eds), Cryptofinance and Mechanisms of Exchange (Springer, 2019) 145–64; Lee (2018). 176 Such as for credit-rating agencies, which entailed their regulation in the EU from 2009; see also A Kruck, Private Ratings, Public Regulations: Credit Rating Agencies and Global Financial Governance (Palgrave Macmillan, 2011) chs 1 and 3. 177 Also see A Gurrea-Martínez and N Remolina León, ‘The Law and Finance of Initial Coin Offerings’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 6.

Ex Post Monitoring and Rights in a Schedule of Commitment  177 This section calls such a governance framework a Schedule of Commitment, in order to reflect the nature of duties and ongoing monitoring that issuers and investors are bound to each other. The Schedule of Commitment deals with monitoring mechanisms for mitigating three key ongoing risks in project development after the token sale. The first is investors’ investment risk, in terms of monitoring the development of value creation and being able to ‘pull the plug’ to safeguard the remaining funds for return if the project should become unviable.178 The second is investors’ agency risk in relation to putting in place appropriate incentives to motivate the optimal development of the project. Investors’ agency risk is acute as ICOs allow developers to obtain frontloaded rewards before the project has even begun its development. As perverse behavioural problems may occur due to such frontloading,179 an appropriate governance system for managing developers’ incentives should be instituted. The third aspect is public interest risk in relation to financial crime. As cryptocurrency transfers can be made pseudonymously, investing in ICOs can be seen by money launderers as a channel for investing illicit proceeds without being discovered.180 Some developers have voluntarily undertaken know-yourcustomer due diligence procedures in order to weed out money laundering and signal to investors that they are not associated with fraud. Lee et al have found that this bears a relationship to demand at ICOs and their success.181 This chapter argues that a mandatory duty to gatekeep financial crime should be imposed on the development team at ICOs. The anti-money laundering duties imposed under EU legislation currently attach only to cryptocurrency exchanges or remittances.182 Although such a duty is arguably owed to regulators instead of investors, the Schedule is not merely a private law instrument between issuers and investors. We argue shortly that the nature of the Schedule is tripartite so as to enrol issuers, investors and regulators in a scheme of commitments that reflect both private and public interest concerns. The Schedule of Commitment contains provisions relating to conduct, and it is proposed in this chapter that these standards of conduct can be algorithmically coded so that smart contract protocol can be used to effect these standards of conduct. Indeed, the enabling regulatory framework for the Schedule provides the mandatory basis for such smart contract protocol to be developed, facilitating the phenomenon of ‘law as code’.

A.  Schedule of Commitment for Addressing Investors’ Investment Risk First, we address investors’ investment risk and how adequate investor protection can be secured in a post-sale context. Investors should be able to monitor the project’s progress, 178 Discussed earlier in relation to applying the principle of creditor protection against wrongful trading. 179 Discussed earlier. 180 L Haffke, M Fromberger and P Zimmermann, ‘Cryptocurrencies and Anti-Money Laundering: The Shortcomings of the Fifth AML Directive (EU) and How to Address Them’ (2020) 21 Journal of Banking Regulation 125–38. 181 (2018). 182 Art  47(1), Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU.

178  The Financing of Blockchain-based Business Development and staged financing should be the norm to prevent funds from being dissipated and unrecoverable in the event of non-development and unviability. It is arguable that some ICO developers have adopted voluntary practices such as soft caps to protect investors. We turn to examine those and offer a staged financing agenda, which this chapter argues should form the basis of a standardised post-sale template for investor protection. The provision of such an investor protection template in regulation need not exclude other provisions investors may wish to bargain for vis a vis issuers.

i.  Soft Caps The Schedule of Commitment should provide for developers’ position on whether there is a soft cap that applies to the ICO.183 Soft caps are minimum funding levels required for the development of the project as envisaged by developers. If a soft cap is not met, developers usually commit to return the funds received, as there is no point pursuing a project with less-than-optimal funding and support. The existence of a soft cap is an early mechanism for investment risk mitigation as investors’ funds can be returned at an early stage in view of signs of lacklustre support.184 However, Ofir and Sahdev185 find that only a minority of developers introduce soft caps and the existence of a soft cap does not predict success of the ICO. An ICO can be successful depending on the quality of the development team,186 the perceived attraction of the business project and its technical credibility187 and media hype,188 especially on social media. Hence, a soft cap may not be crucial to investors’ decisions. A soft cap can also be self-fulfilling and induces a perception that makes the offer less attractive to investors. It can also be argued that other investor protection mechanisms are more important, such as voluntary escrows,189 issuer retention and lock-ups.190 Due to the ambiguity of soft caps being a clear investor protection mechanism, this chapter does not propose that it be mandatory for developers to issue a soft cap.

ii.  Appointment of Escrow Agent Next, the Schedule should require developers to appoint an independent third-party escrow agent to hold the proceeds of the ICO, to be subject to regulation and free from conflicts of interest.191 The escrow agent should be a regulated financial institution, or 183 The issue of hard caps is discussed in section B below. 184 Hence some commentators find that this is welcome by investors; see Amsden and Schweizer (2019). However, Bourveau et al (2018) find that this may cause the ICO to be unsuccessful if the cap is set too high. 185 (2019). 186 See n 146. 187 Fisch (2019); Bourveau et al (2018); Amsden and Schweizer (2019); Ante et al (2018). However, the disclosure of increased business and technical details may not be a signal for quality if these are unverified, as suggested by Cohney et al (2019), also Howell et al (2019), which finds that the existence of the white paper as such is a driver for ICO success. 188 Burns and Moro (2019); Ante et al (2019); Bourveau et al (2018); Blaseg (2018), but Howell et al (2019) find less of a correlation. 189 Discussed below; also see Blaseg (2018). 190 Discussed below; also see Blaseg (2018); Bourveau et al (2018). 191 Much like the custodial duties and gatekeeping duties imposed on hedge fund depositaries in Art 21, Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment

Ex Post Monitoring and Rights in a Schedule of Commitment  179 custodial provider, the regime for which is discussed in chapter six. It is envisaged that the escrow agent would in return for a fee not disproportionate to the offer proceeds, provide certain gatekeeping services in relation to the custody and release of proceeds, subject to regulatory duties. The regulation of escrow services is discussed in greater detail in chapter six and inspiration is drawn from the regulation of conventional custodial services such as fund depositaries in existing regulation.192

iii.  Escrow-controlled Staged Financing and Governance Investors’ investment risk should be mitigated by a mechanism of staged financing similar to those adopted in venture capital arrangements.193 Staged financing can be theoretically analogised with the principle of pay for performance, that ICO proceeds should not be regarded as ‘reward-in-hand’ by developers, but should be regarded as earned upon the achievement of pre-defined milestones in the project. ‘Pay for performance’ is often treated as an agency-based principle that controls the extraction of excessive remuneration.194 It can also be regarded as a resource-based principle that draws out the optimal productivity in human capital.195 Pay for performance is a relevant framework for the post-sale monitoring regime in ICOs, as ICO proceeds can be seen as frontloaded remuneration that development team should earn in stages to deliver the blockchain-based business project for release to ICO subscribers. Developers may then seek to gradually withdraw from the completed project and move on to something new as blockchain-based businesses are often built to be self-sustaining with decentralised governance.196 In this manner, ICO proceeds are regarded as compensation for developers’ intellectual effort and time, and not used for physical investment in assets, equipment, etc as would be in the case of securities offer proceeds for a conventional corporation. The post-sale monitoring mechanism for investors’ investment risk should be based on framing ICO proceeds in the agencybased and resource-based paradigms discussed above, so that the ‘reward’ aspect of the proceeds can arguably be governed by pay-for-performance principles. Pay-for-performance, if well-designed, should be able to motivate towards the deployment of optimal effort by the development team.197 We also need to avoid the Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010. Such depositaries are often regulated financial institutions and imposed with an explicit duty to act fairly and honestly for the benefit of the investors of the fund, although there is no direct contractual relationship between them and the depositary, which contracts with the hedge fund entity as such. 192 ibid. 193 Rodrigues (2019). 194 L Bebchuk and J Fried, Pay without Performance: An Unfulfilled Promise (Harvard University Press, 2006), often regarded as the managerial theory of remuneration which is agency-based; H-C Kuo, D Lin, D Lien, L-H Wang and L-J Yeh, ‘Is There an Inverse U-Shaped Relationship between Pay and Performance?’ (2014) 28 North American Journal of Economics and Finance 347. 195 A Bayo-Moriones, JE Galdon-Sanchez and S Martinez-de-Morentin, ‘The Diffusion of Pay for Perfor­ mance across Occupations’ (2013) 66 Industrial and Labour Relations Review: Journal of Work & Policy 1115. 196 Discussed in relation to Decentraland, for example, in ch 2. 197 CC Durham and KM Bartol, ‘Pay for Performance’ in EA Locke (ed), Handbook Of Principles Of Organizational Behavior: Indispensable Knowledge For Evidence-Based Management (John Wiley & Sons, 2009) ch 12; AJ Aquila and CL Rice, Compensation as a Strategic Asset: The New Paradigm (AICPA, 2009) chs 11 and 12.

180  The Financing of Blockchain-based Business Development design of performance metrics that can be gamed.198 Pay-for-performance designs should also avoid incentivising short-termist199 or excessively calculative behaviour.200 Properly designed with behavioural insights,201 pay-for-performance need not shut out holistic considerations such as conscience,202 or having a sense of responsibility for the enterprise and stakeholders as a whole.203 We propose that the development team should set out reasonable and regular milestones for the project, preferably with a number of indicators for each milestone. These should broadly relate to value creation in the long term and avoid being excessively superficial or short-termist.204 The attainment of these milestones should also be verifiable by escrow agents or other third parties. For example, milestones may include functionality achievements such as key feature testing phases, proof of concept release, beta versions, etc.205 Investors can also be asked to test beta versions and milestone attainment can be based on meeting a certain level of investor approval or independent third-party verification, then notified to escrow agents. In attaining levels of investor approval, the developer’s own tokens for voting should not count. Venture capital contractual arrangements for software development start-ups could provide useful starting templates for milestone definition.206 This chapter proposes that where a milestone is not clearly reached, the development team should be given an opportunity to review and revise the milestone and propose an alternative and reasonable milestone that may be achieved and contributes to the project’s success within a certain period. This prevents investors from succumbing to risk averse tendencies and pulling the plug on the project too early. Further, it is proposed that 10 per cent of the proposed milestone release should be awarded anyway to the development team as remuneration for efforts, as often, pay should not only be based on output and should take into account of fairness and holistic assessment.207 As a general principle it is proposed that the attainment of milestones should involve investor approval in the majority, discounting the developer’s retained tokens. Investors can also opt for independent third-party verification, although chapter four 198 CC Vershoor, ‘The Pay-for-Performance Misnomer’ (January 2015) Strategic Finance 12, at sfmagazine. com/wp-content/uploads/sfarchive/2015/01/ETHICS-The-Pay-for-Performance-Misnomer.pdf. 199 LA Bebchuk and JM Fried, ‘Paying for Long-Term Performance’ (2010) 158 University of Pennsylvania Law Review 1915. 200 LA Stout, ‘Killing Conscience: The Unintended Behavioral Consequences of Pay for Performance’ (2014) 39 Journal of Corporation Law 525. 201 TC Belinfanti, ‘Beyond Economics in Pay for Performance’ (2012) 41 Hofstra Law Review 91 on using behavioural insights to avoid poor remuneration designs and to incentivise and motivate optimally. 202 Stout (2014). 203 J McConvill, ‘Executive Compensation and Corporate Governance: Rising above the Pay-for-Performance Principle’ (2006) 43 American Business Law Journal 413. 204 A Bryson et al, ‘Empirical Literature’ in T Boeri, C Lucifora, and KJ Murphy (eds), Executive Remuneration and Employee Performance-Related Pay: A Transatlantic Perspective (OUP, 2013) ch 8. 205 N Hanakawa, H Lida, K-I Matsumoto and K Torii, ‘Generation of Object-Oriented Software Process Using Milestones’ (1999) 9 International Journal of Software Engineering and Knowledge Engineering 445. 206 Rodrigues (2019). 207 PS Deo, ‘Designing Performance-based Incentives’ (2011) 16 Corporate Finance Review 18; A Bryson et al, ‘Theoretical Implications’ in Boeri et al (2013) ch 7; P Yiftachel, I Hadar, D Peled, E Farchi and D Goldwasser, ‘The Study of Resource Allocation among Software Development Phases: An Economics-Based Approach’ (2012) Advances in Software Engineering, at doi.org/10.1155/2011/579292 on how economic concepts such as cost, quality and output assessment do not map neatly onto software development stages.

Ex Post Monitoring and Rights in a Schedule of Commitment  181 has discussed the challenges in relation to recognising verification expertise. It may be argued that these processes are cumbersome, but they can be automated for investor voting, facilitated by periodic reporting on development progress. In the alternative, developers can be required to design milestones and indicators for their achievement by relying on objective metrics so that the attainment of those metrics automates the release of the relevant tranche of escrow funds. The hazard with this approach is that investors do not meaningfully monitor project development. It is proposed that where investor approval is not utilised as the gatekeeping device for release of funds in escrow, investors should nevertheless have the right to veto against release of funds. Vetoing investors could however succumb to perverse perspectives, hence, vetoing investors should be required to clearly explain their disagreement with the milestone assessment. Their veto should also be subject to investor approval on a majority or super-majority basis. This process is similar to minority shareholders in a company putting resolutions to vote at the general meeting.208 Nevertheless, in the vote on investors’ veto, the developers’ and initiating vetoers’ votes should not count. As initiating a veto requires diligence and expertise on the part of vetoing investors, opportunistic and frivolous vetoes may be deterred. On balance the veto mechanism is unlikely to create too many disincentives and hurdles for developers, but ensures that developers are conscious of investors’ residual powers and accountability to them. If the veto is successful, we propose that the development team should be given an opportunity to review and revise the milestone and propose an alternative and reasonable milestone that may be achieved within a certain period of time. Further, it is proposed that 10 per cent of the proposed milestone release should be awarded anyway to the development team as remuneration for efforts, discussed above. It can be argued that where projects are subject to revised milestones, developers and investors need to prepare for the project’s unviability risks. Where a revised milestone fails to be achieved, developers must put the termination of the project to a majority vote in order to protect against unnecessary dissipation of yet-to-be-released proceeds. If such a vote succeeds, the escrow agent should release the remaining funds back to investors, retaining a final 10 per cent of remaining funds for the development team in recognition of effort. The proposal above seeks to achieve distributive fairness as performance is not based narrowly on output and the development team’s efforts are recognised. However, investors are also protected appropriately against the inherent risks of new and young businesses, and are able to get a proportionate refund for ultimately disappointed expectations. The refund should not be in full as the development team may not have totally failed in their part of the consideration.209 The final 10 per cent payment to the development team also avoids a high reward for failure.210 208 UK Companies Act 2006, ss 303, 314–16. 209 These statutory provisions overcome the rigidity of the common law remedies such as in restitution where investors’ concerns are for fair refunds for expectations not met, the discussion of the rigidities of total failure of consideration can be found in G Virgo, ‘Failure of Consideration: Myth and Meaning in the English Law of Restitution’ in D Johnston and R Zimmermann (eds), Unjust Enrichment: Key Issues in Comparative Perspective (CUP, 2002) ch 4; G Virgo, ‘Failure of Consideration’ in The Principles of the Law of Restitution (OUP, 2006) ch 12. 210 High levels of remuneration can result in sub-optimal performance induced by over-confidence and misjudgement; see SA Bank and GS Georgiev, ‘Paying High for Low Performance’ (2016) 100 Minnesota Law Review Headnotes 14; Belinfanti (2012).

182  The Financing of Blockchain-based Business Development It may be argued that the governance mechanisms for monitoring performance for staged financing are onerous and unattractive for developers. Developers may also consider the availability of secondary markets for pre-sold tokens as sufficient for investor protection.211 However as Fromberger and Haffke have found, not all tokens are listed on secondary markets or soon after issuance.212 Further, the loss of value in secondary trading for over 90  per  cent of tokens means that secondary trading is not an optimal means for investor protection. The governance mechanisms for staged financing outlined above may also shape the market in such a way as to incentivise better-considered and researched projects to be offered to investors. These regulatory standards contribute towards market development towards commercial maturity. It may be queried whether the escrow arrangement would be affected by third-party rights, such as where third-party creditors of the development team may rank above investors. It is thus important to clarify the property status of proceeds in escrow; the proceeds held in escrow not be treated as the issuer’s property213 that can be subject to enforcement to meet the issuer’s contractual or other obligations to third parties or subject to collateralisation. The proceeds can be treated as held on trust for investors in a pool and not transferred to the issuer as a matter of legal categorisation. In this manner the escrow agent holds on express trust for the investors and not the issuer. This characterisation can be supported as there are in-built mechanisms for conditional release of the funds to the issuer. In the alternative where the proceeds are regarded as property of the issuer, albeit subject to conditional release, the English law device of the Quistclose trust214 can to an extent protect investors. In case law implementing such a trust, monies lent for a specific purpose would be regarded as ringfenced for their purpose. The improper use of such monies entails a resulting trust of such monies being held for the benefit of beneficiaries’ of the monies and tracing of such monies is also available.215 However, there are limitations to how the Quistclose trust may be used to protect investors as an express intention to hold on trust needs to be evinced.216 The preferred approach to safeguard investors’ interest is to clarify that proceeds raised are not property of the issuer and held in express statutory trust for investors, with transfer of property occurring only upon release of the proceeds according to the fulfilment of release conditions. This is arguably consistent with the regulation of custodial arrangements for customers’ monies and assets held by investment firms.217 In sum, the mechanisms outlined in this section for protecting investors’ investment risk focus on staged financing implemented with the help of an escrow agent. We offer a menu of choice in relation to whether investor approval or veto should be utilised as the means for investor monitoring in staged financing. However, the details of milestones

211 Amsden and Schweizer (2019). 212 (2020). 213 A Hudson, ‘Quistclose Trusts’ on Equity and Trusts (Routledge, 2016) ch 22. 214 Barclays Bank v Quistclose Investments Ltd [1970] AC 567; applied in Twinsectra v Yardley Ltd [2002] 2 AC 164.  215 ibid. 216 Bellis v Challinor [2015] EWCA Civ 59. 217 Art 16(8), EU Markets in Financial Instruments Directive 2014; also clarified in In the matter of Lehman Brothers International (Europe) (In Administration) and In the matter of the Insolvency Act 1986 [2012] UKSC 6.

Ex Post Monitoring and Rights in a Schedule of Commitment  183 cannot be excessively prescribed. We also propose that escrow agents should be subject to regulatory governance and supervision. This regime co-opts investors’ own governance capacity alongside regulatory governance.218

B.  Schedule of Commitment for Investors’ Agency Risk Second, the Schedule of Commitment should provide for how investors’ agency risks can be mitigated in relation to certain aspects of issuer practices. These risks relate to risks that investors may incur in relation to issuers’ behaviour at ICOs and in project development that may affect investors’ monitoring or rights. Three are discussed here as they are observed to be common practices adopted in the ICO markets, but this is not meant to be exhaustive for the regulatory blueprint. They are: the developers’ retention of tokens and how the vesting, use and unwinding of such tokens may pose agency risks to investors; developers’ pre-sales to institutional investors before the crowd sale at more favourable terms; and whether the ICO is subject to a hard cap which would mean that maximum token supply is fixed. The Schedule of Commitment provides scope for investors and issuers to include other matters of conduct that affect investors’ perception of agency risks.

i.  Token Retention The retention of tokens by founder-developers is often seen in positive light by investors, as founder-developers would have skin in the game and signals commitment and confidence in their development project.219 Commentators find that token retention bears a positive relationship to funding success and project completion.220 However, token retention can be designed in a number of ways and these affect investors’ agency risk. For example, if tokens are retained but can be sold off quickly in a secondary market, the impression of ‘skin in the game’ would be only skin-deep. Further, there are also governance hazards with founder-developers’ retention of large volumes of tokens, as they would be able to exercise disproportionate power and may disincentivise investment by other investors. Howell et al’s221 and Blaseg’s222 empirical research on what makes a successful ICO223 provides insight into investors’ preferences regarding token retention. They find that 218 The coordinative and interdependent nature of financial regulation has been discussed since J Black, ‘Enrolling Actors In Regulatory Systems: Examples from UK Financial Services Regulation’[2003] Public Law 63; C Ford, ‘Innovation-Framing Regulation’ (2013) Annals of the American Academy of Political and Social Sciences, at papers.ssrn.com/sol3/papers.cfm?abstract_id=2289978. 219 Adhami et al (2018). 220 T Davydiuk, D Gupta and S Rosen, ‘De-crypto-ing Signals in Initial Coin Offerings: Evidence of Rational Token Retention’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3286835. 221 (2019). 222 (2018). 223 Defined differently by different commentators, as success indicators include successful funding achieved, as well as listing on a secondary market and price performance for a number of days thereafter. Ante et al (2019) also opine, ‘The term “success” is somewhat misleading, as it can be applied to funding success, venture success, secondary market access, or return on investment’ (at 2).

184  The Financing of Blockchain-based Business Development token retention subject to lock-ups as well as a vesting schedule are important. Lock-ups refer to periods of prohibition from disposal of tokens by founder-developers. A vesting schedule refers to an incentive mechanism where tokens may be reserved in a pool and vested in founder-developers in stages. The vesting schedule provides an incentive mechanism for performance on the part of founder-developers while also ‘locking up’ the pool during the period of development. It is proposed that the Schedule of Commitment should provide for mandatory token retention by developers, but not to overly prescribe how token retention should be implemented. The development team can offer their policy on lock-ups and/or a vesting schedule so that retention design can be shaped by market innovation and investor choice. This allows market insights to be developed as to what practices are valued by investors. It is proposed that the implementation of token retention should be subject to regulatory supervision. This is because Cohney et al224 have found discrepancies between white paper disclosures on token retention and the implementation of the code in completed projects. There are instances where no implementation code has been written for token retention despite the white paper’s promises that token retention would take place. The veracity of token retention policies can be examined at the point of code verification at the registration of the blockchain-based business discussed in chapter four. Regulatory verification would be well-positioned to discover deviations from token retention representations. Token retention promises not carried out or significantly deviated from should entail civil actions that investors could bring against issuers at that point.

ii.  Presales to Favoured Investors Ahead of Crowd Sale Presales of tokens can be carried out to venture capitalists and institutional investors, usually at a discount, before the presale of tokens to the crowd. Such presales are arguably important to the development team in terms of securing financial backing ahead of the crowd sale. The existence of professional financial backing is also a favourable signal at the ICO. In particular, these presales could also signal the optimal price level agreed with professional investors, providing more confidence to investors in the crowd sale. However, Amsden and Schweizer225 take an opposite view, as investors could view presales as reflecting developers’ lack of confidence in the crowd sale. Moreover, financiers may receive more favourable terms than other investors in the ICO. For example, if they received a discount from the price at the ICO, they could cash out with an early profit in secondary markets where the token is listed. At worse, presale investors who have received huge discounts could be privy to pump and dump schemes. In this manner, such investors may not really be interested in seeing a project through but may be invested in order to make a short-term profit. That said, Momtaz finds that presale deals with discounts or ‘money left on the table’ average at about eight per cent of such institutional presales.226

224 (2019). 225 (2018). 226 P

Momtaz, ‘Initial Coin Offerings’ (2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3166709.

Ex Post Monitoring and Rights in a Schedule of Commitment  185 Adhami et al find that presales are attractive to ICO investors for reasons of positive signalling as mentioned above.227 Stastny228 finds that presales to professional investors result in less underpricing in the tokens listed on secondary markets than if such a presale had not been carried out. Adhami et al find that tokens are underpriced at over 50  per  cent where presales to professional investors take place, and over 89  per  cent otherwise,229 compared to the initial public offer markets. However, other commentators do not find presales to professional investors as providing a necessarily positive signal for investors in the crowd sale.230 It is proposed that presales to professional investors should arguably not be prohibited for the potentially useful effects it may have on pricing and investor signalling. Further, this would also be consistent with the regulation of initial public offers as bookbuilding with institutional investors is allowed in the UK’s regime. However, even in that regime, regulators have recognised the disadvantages that retail investors may suffer and have endeavoured to bring in regulatory reforms.231 These reforms relate to making the information environment more equal for retail investors, but do not actually affect the practice of issuers offering more advantageous terms to institutional investors during book-building.232 In the same manner, presales ahead of the ICO to the public should not be prohibited, but its potential agency problems can be subject to certain regulatory standards, such as comprehensive transparency. We propose that the volume of presales to professional investors should be disclosed as part of the mandatory disclosure document, and the range of discounts be clearly disclosed as well. In this manner investors can make an informed judgement as to the signalling effect of these disclosures. There is also scope for considering if regulatory standards should provide that presales must take place within a sufficiently close period to the ICO to the public, so that the crowd sale benefits from the useful signalling effects of the presale. A presale that takes place far ahead of a crowd sale may more likely be perceived as intending to reward early and selected financiers.

iii.  Token Supply ICOs can be capped or uncapped in terms of the amount of tokens offered to raise funds. In a capped offer, the development team predetermines the maximum amount of tokens that would be offered to raise funds. This would be a hard cap, meaning that token supply is fixed and would not be increased after the blockchain project becomes live. An early example of a capped token supply policy is the Bitcoin system which is capped at a supply of 21 million bitcoins with a schedule for supply release. A hard cap can instil investor confidence as investors could be attracted to the prospect of higher valuations if demand for the tokens rise after the project becomes live. The asset prices for bitcoin

227 (2018). 228 (2018). 229 Found in Adhami et al (2018). 230 Ante et al (2019); Amsden and Schweizer (2019). 231 FCA, ‘Reforming the Availability of Information in the UK Equity IPO Process’ (2017), at www.fca.org. uk/publications/policy-statements/reforming-availability-information-uk-equity-ipo-process. 232 FCA Handbook COBs 11A.

186  The Financing of Blockchain-based Business Development have risen spectacularly to almost US $50,000 per bitcoin in early 2021. Further a hard cap would mean that investors are not subject to the risks of dilution. Some commentators are of the view that hard caps are preferred for investor certainty and protection,233 and indeed empirical research seems to show that ICOs with hard caps are more popular with issuers and seem attractive to investors.234 However, hard caps are disadvantageous to issuers as the amount of funds that could be raised becomes limited235 and the issuer may have to carry out a token rationing policy where hard caps are in place and offers are over-subscribed.236 Kaal and Dell’Erba also argue that not having a hard cap allows for future fiscal and monetary governance in the blockchain-based community, adjusting to supply and demand needs.237 Further, blockchain projects such as those that develop new protocol infrastructure may find that a capped supply inhibits future commercial benefits and developmental potential. The most popular protocol infrastructure for blockchainbased commercial applications, the Ethereum blockchain, does not institute capped supply. However, not having a fixed token supply allows developers to carry out subsequent rounds of financing, and these can prejudice existing token holders in view of pricing depreciation on secondary markets in the face of greater supply. Further, subsequent rounds of financing could be issued at discounts from the previous.238 Nevertheless, although the Ethereum blockchain is not coded with a hard cap, the price of ether has risen manifold over the years. Token value depreciation has not taken place, as outweighed by strong network effects and increased participation on the Ethereum blockchain. Issuers have been innovating in this space, recognising the pros and cons of capped token supply policies for issuers’ interests and investor protection. These innovations aim to facilitate optimal price formation and ICO uptake in a more interactive manner. Issuers have introduced innovations such as interactive ICOs or auction-based ICOs in order to allow the market to play a part in price formation and facilitate more optimal uptake of tokens.239 In an interactive ICO, issuers may broadcast blocks of tokens offered over a period of, say, 30 days, and investors may specify their maximum valuation for tokens in each block. Smart contract protocols can provide for investors’ bids to be cancelled if their maximum valuation is lower than the final closing price. Further, rewards can be given to early takers and withdrawal rights (ie a cooling-off period) can also be built in during the period of the interactive ICO.240 An auction-based ICO is also interactive, posting maximum offer prices for willing takers, with programmed reductions in price over time.241 Both innovations aim to maximise market responses 233 Catalini and Gans (2019). 234 Howell et al (2019); Stastny (2018). 235 Ante et al (2019). 236 Howell et al (2019). 237 Kaal and Dell’Erba (2018). 238 Howell et al (2019). 239 M Dell’Erba, ‘From Inactivity to Full Enforcement: The Implementation of the “Do No Harm” Approach in Initial Coin Offerings’ (2020) 26 Michigan Technology Law Review 175. 240 J Teutsch and V Buterin, ‘Interactive Coin Offerings’ (2017), at people.cs.uchicago.edu/~teutsch/papers/ ico.pdf. 241 ‘Crypto ICO Metronome Raises $12 Million in Unconventional Auction’ (8 August 2018), at www. coindesk.com/crypto-ico-metronome-raises-12-million-in-unconventional-auction.

Ex Post Monitoring and Rights in a Schedule of Commitment  187 while providing a form of investor protection towards finalising the token supply. However, market participation can often be irrational242 and market-based approaches that purport to offer investor protection could still be complemented by regulatory standards. As issuers are incentivised to maximise both offer uptake and price, issuers’ control over the offer process to determine optimal supply and price would not necessarily be adequate for investor protection. Interactive ICOs can exploit investors’ behavioural biases such as herding. It is worthwhile considering regulatory standards that impose mandatory withdrawal rights for interactive ICOs that take place over a period, including those that use auction-based approaches. Further, in view of the ambivalent nature of hard caps as serving investors’ interest, we do not propose that hard caps be made mandatory, but token supply policies should be subject to clear and extensive disclosure.

C.  Schedule of Commitment in Relation to Public Interest Concerns Finally, this chapter proposes that the Schedule of Commitment should reflect public interest concerns too as investors collectively benefit from the imposition of such obligations on issuers. The key public interest obligation that issuers should meet is anti-money laundering control in ICOs. The Schedule of Commitment is arguably a novel regulatory design. It encapsulates a relational paradigm between issuers and investors, as it contains mandatory aspects of regulative standards such as in relation to escrow arrangements or token retention policies, but also contains enabling templates that facilitate detailed choice to be made between investors and issuers for the purposes of investor protection. The adherence to the Schedule is not merely a matter of private or civil obligation but also of regulatory compliance. It is proposed that the Schedule of Commitment be regarded like a multi-stakeholder covenant where investors and issuers are provided with private law rights and obligations vis a vis each other and the regulator is actively coopted where mandatory standards should be introduced and regulatory enforcement should be carried out. This is akin to the multistakeholder covenant for Dutch banks in relation to their roles in overseeing human rights risks in their borrowers’ projects. Such covenants are entered into by government agencies, Dutch banks and the banking trade association in order to govern banks’ roles in setting policies in relation to human rights due diligence in their lending activities.243 The due diligence policies are likely to be fostered by the banks themselves and the trade association may play a part in offering best practices and advice. These are binding between banks and their borrowers, hence reflecting the private law rights and obligations between them. However, the involvement of government agencies provides 242 C Masiak, JH Block, T Masiak, M Neuenkirch and KN Pielen, ‘Initial Coin Offerings (ICOs):Market Cycles and Relationship’ (2019) Small Business Economy, at doi.org/10.1007/s11187-019-00176-3. 243 B Thompson, ‘The Dutch Banking Sector Agreement on Human Rights: An Exercise in Regulation, Experimentation or Advocacy’ (2018) 14 Utrecht Law Review 84.

188  The Financing of Blockchain-based Business Development supervision over private parties’ adherence to the due diligence policies, and provides scope for regulators to articulate the human rights standards or outcomes that need to be achieved. The Schedule of Commitment could be structured as a multistakeholder arrangement as well. This would allow regulators’ governance standards to standardised and incorporated, and regulatory enforcement can take place in addition to civil enforcement in case of breach. Such an arrangement is novel and arguably important for investors in this new fundraising landscape. The three-way bonding in the Schedule of Commitment would provide enforcement interdependency for investors and regulators so that both civil and regulatory enforcement can reinforce each other. We turn now to examine specific regulatory provision for anti-money laundering duties for issuers in the Schedule of Commitment. Investing in ICOs can be attractive for money launderers in order to generate proceeds in cryptocurrency244 which can be transferred pseudonymously. Further, Haffke et al245 also discuss the rise of tumbler services that are meant to obscure the public key addresses of cryptocurrency holders. These can be exploited by money launderers. In order to promote an enabling environment for genuinely beneficial blockchain-based businesses and their fundraising, the regulation of anti-money laundering conduct in fundraising is necessary.246 In terms of voluntary practice, Ofir and Sahdev’s survey of practices shows that there is mixed evidence of voluntary adoption of due diligence or know-your customer processes by issuers, as issuers may not wish to deter investment, and such processes can present hurdles to investors. Further, even genuine investors not involved in illicit money laundering may not wish to disclose too much personal information.247 However, other commentators show that issuers who implement due diligence or knowyour customer processes are attractive to investors. Bourveau et al show that having these processes correlate with more successful fundraising. Investors seem to value issuers having such an anti-money laundering screening process, signalling that the ICO is not being associated with frauds or scams.248 Further, Momtaz249 finds that issuers who implement such processes have more successful ICOs in that subsequent underpricing in secondary markets, if any, is significantly reduced. However, Momtaz attributes that effect to the due diligence processes yielding another collateral benefit for issuers, ie that issuers are able to price the ICO appropriately based on knowing who their investors are. Hence, these ICOs suffer from less underpricing when tokens are subsequently listed on secondary markets. 244 For example, cyberhacking for ransom as discussed in the case of AA v Persons Unknown and Bitfinex [2019] EWHC 3556. 245 L Haffke, M Fromberger and P Zimmermann, ‘Cryptocurrencies and Anti-Money Laundering: The Shortcomings of the Fifth AML Directive (EU) and How to Address Them’ (2020) 21 Journal of Banking Regulation 125. 246 This gap is pointed out as being left in the EU’s 5th Anti Money Laundering Directive 2018 in relation to bringing crypto currency exchanges and wallets into its scope, but leaving out issuers of tokens and ‘tumbler’ services. See Haffke at al (2020). 247 (2019). 248 (2018). 249 (2019).

Ex Post Monitoring and Rights in a Schedule of Commitment  189 We propose that investor due diligence should be a mandatory requirement in the Schedule of Commitment for issuers.250 It may however be argued that corporate issuers of securities are not burdened with due diligence processes for investors, and this may seem to be an undue burden for issuers. However, the initial public offer process is one in which the corporate issuer is assisted by key intermediaries. The underwriter, usually an investment bank is a regulated financial institution subject to anti-money laundering compliance.251 Further, in secondary trading markets, investors carry out buying and selling through brokers who are also regulated investment intermediaries and subject to anti-money laundering regulations.252 The employment of the regulated financial sector carries with it the benefit of established channels by which anti-money laundering obligations attach. As ICOs are technologically enabled direct offers, issuers would not be able to benefit from riding upon the compliance institutions that financial intermediaries have already put in place, and will have to undertake such compliance themselves. Nevertheless, there is significant technological development of anti-money laundering services, such as algorithmic due diligence software to assist compliance professionals.253 This requirement to institute antimoney laundering processes by ICO issuers would entail some cost but may not be highly forbidding.

D.  How Mandatory Disclosure and the Schedule of Commitment Protect Investors – Consequences of Breach This section has discussed mandatory disclosure and post-sale governance in the form of a Schedule of Commitment to protect investors in ICOs. On investors’ governance rights and continuing participation in the blockchain-based project after it has become live, it is envisaged that the organisational and governance frameworks discussed in chapter four would apply. Investor protection in ICOs would be realised by enforcement against breaches of mandatory disclosure requirements as well as breaches of conduct in the Schedule of Commitment.

250 Also see G Kondova and P Shanmuganathan, ‘Knowing Your Customer: Empirical Implications for Raising Capital through Initial Coin Offerings (ICOs)’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_ id=3549478 which argues that such a regulatory requirement also improves ICO credibility and benefits issuers. 251 The application of anti-money laundering regulations to the regulated financial sector is extensively, comprising of procedural and reporting obligations; see generally IH-Y Chiu and J Wilson, Banking Law and Regulation (OUP, 2019) ch 14. 252 See general FCA Handbook SYSC 6. 253 McKinsey, ‘The new frontier in anti–money laundering’ (November 2017), at www.mckinsey.com/ business-functions/risk/our-insights/the-new-frontier-in-anti-money-laundering; R Soltani et al, ‘A New Algorithm for Money Laundering Detection Based on Structural Similarity’ in ‘IEEE 7th Annual Ubiquitous Computing, Electronics & Mobile Communication Conference (UEMCON)’ (2016), at 10.1109/ UEMCON.2016.7777919; Deloitte and UOB, ‘The Case for Artificial Intelligence in Combating Money Laundering and Terrorist Financing’, at www2.deloitte.com/content/dam/Deloitte/sg/Documents/finance/ sea-fas-deloitte-uob-whitepaper-digital.pdf presenting a case study of United Overseas Bank in Singapore.

190  The Financing of Blockchain-based Business Development In terms of breaches of mandatory disclosure, both regulatory and civil enforcement consequences can be attracted, just like under the regime for initial public offers.254 However, it can be argued that issuers in ICOs may suffer undue legal risk where technological disclosures at pre-development stage are deviated from during project development. Where development divergences relate genuinely to technological or functional performance, such divergences being intended to preserve and not damage investment value, it is questioned whether investors should be allowed to sue. Civil action against issuers should not be opportunistic and place other token holders in jeopardy. Moreover, multiple civil actions may not yield compensatory justice or be productive. It is thus proposed that where a disclosure-based breach occurs, regulatory enforcement as a form of collective action is preferred, and such regulatory enforcement must be complemented by a civil compensation aspect if successful. It is proposed that successful enforcement be based on the extent of damaged trust between the issuers and investors. As the fundraising pertains to a development project jointly supported by issuers and investors, the basis of trust for common enterprise, much like in a partnership, sustains the relational paradigm between issuers and investors. Investors should not be compelled to carry on with the relational paradigm in a significant loss of trust. Where a mandatory disclosure breach has occurred in the development stages of a blockchain-based project, successful enforcement should be based on whether this results in a significant loss of trust. This standard differs from absolute liability in US securities litigation or negligence in the UK equivalent, as such liability standards are based on compensating investors for having suffered sub-optimal information affecting their allocative decisions. As disclosure deviations for development projects can be made for genuine purposes, to make the project functionally or technologically successful, this chapter does not support an absolute liability approach to disclosure deviations. Further, a negligence-based liability approach seems inappropriate where the information environment is speculative and thin for a development project anyway. Hence, we propose an ex post basis for liability rather than an ex ante basis such as absolute or negligence-based liability as in securities litigation. A significant loss of trust can be premised on investors’ reasonable scepticism that the project would be functional or viable in due course, upon the discovery of the disclosure deviations. If regulatory enforcement is initiated, we propose that the independent escrow agent holding the remaining undisbursed proceeds to the issuer must be notified and should suspend any disbursement. Upon successful enforcement, investors should be allowed to initiate a termination vote on the project as failure of trust engendered by the breach would have been established. Such a vote should disregard the development team’s retained tokens for voting purposes. Upon a successful termination vote, either by a majority or super-majority determination, the independent escrow agent should refund investors in proportion according to their contributions of what is left of the funds. This would be in addition to any compensation order in relation to successful enforcement, but such compensation orders are likely to have to be pursued off-chain in the usual manners of civil enforcement.

254 UK

Financial Services and Markets Act 2000, ss 90, 90ZA and 91.

Ex Post Monitoring and Rights in a Schedule of Commitment  191 As to breaches of the Schedule of Commitment, these would be of graver concern to investors if issuers do not initiate programmed code for the Schedule as they have committed or tamper with code in order to effect deviation. Off-chain actions in relation to civil and regulatory enforcement would likely have to be pursued. We also propose that regulatory enforcement could play the role of a collective action for investors, and the initiation of a regulatory action should trigger the suspension of disbursement of funds to issuers. We similarly propose that upon successful conclusion of the enforcement action, investors should be allowed to trigger a termination vote for the project, as trust between the issuers and investors would have been damaged. The above is a blueprint for an interdependent and co-reinforcing enforcement relationship between civil and regulatory actions. This is arguably novel and goes further than the traditional dual enforcement structure of concurrent regulatory and civil actions for securities litigation as it envisages more interdependency between investors and regulators. Investors and regulators rely on each other’s capacities to detect non-compliance and problems, as well as to carry out enforcement for deterrence and compensatory purposes. Such interdependence is also in the interest of regulatory learning and for shaping future standards and expectations in both civil and regulatory enforcement, contributing to the development of a fair and credible investor protection regime in ICOs.

E.  Is Dual-class Financing an Issue? Finally, we deal with whether the debates in conventional corporate finance in relation to dual-class share structures are relevant for ICOs. Blockchain-based businesses may give rise to opportunities to design governance structures, hence why not dual-class tokens? Dual-class shares in conventional corporate finance are controlling minority shares which carry disproportionately larger voting rights compared to cash-flow rights. Indeed, they may be regarded as separating cash-flow rights from voting rights.255 They have often been used to ensure controlling power for founder-developers of companies that choose flotation, in order to shield against pressures in the securities market such as short-termist stockholder pressures and the market for corporate control.256 Such shares have been subject to much debate as they can be regarded as disadvantageous to other shareholders who are exposed to financial risk while control is entrenched.257 However, controlling minority founder-shareholders are often longtermist and have companies’ strategic interests in mind258 and many have shown to 255 AW Winden, ‘Sunrise, Sunset: An Empirical and Theoretical Assessment of Dual-Class Stock Structures’ (2018) 118 Columbia Business Law Review 852. 256 ibid, A Anand, ‘Governance of Dual Class Share Firms’ (2019) Annals of Corporate Governance, at ssrn. com/abstract=3104712. 257 LA Bebchuk, R Kraakman and G Triantis, ‘Stock Pyramids, Cross-Ownership and Dual Class Equity: The Mechanisms and Agency Costs of Separating Control From Cash-Flow Rights’ in R Morck (ed), Concentrated Corporate Ownership (University of Chicago Press, 2000) 445–60. 258 Y Allaire, ‘The Case for Dual-class of Shares’ (2018), at ssrn.com/abstract=3318447; AH Choi, ‘Concentrated Ownership and Long-term Shareholder Value’ (2018) 8 Harvard Business Law Review 53.

192  The Financing of Blockchain-based Business Development be capable of adding value to the company, albeit in an inverted U-shaped curve259 over time. It is queried if this debate is relevant for ICOs where blockchain-based businesses also feature founder-developers. Would they be incentivised to reserve to themselves tokens of significant governance power? It is argued that the incentives that lead to dual-class shares in conventional corporate finance may not exist in the ICO landscape. Founder-developers of blockchain-based businesses are most concerned about being remunerated for bringing the project to a live release, and not necessarily about perpetual control after that. Indeed, the ethos of setting up a blockchain-based project is to ultimately provide a self-sustaining and decentralised network/community for users to manage and govern,260 and developers often wish to move on to the next project. Further, developers who seek to retain control for some time tend to do this via token retention policies, ie to reserve a significant amount of tokens for themselves rather than to code tokens differently in order to accord special governance rights. The latter would also make the tokens offered to other investors phenomenally less attractive and likely less liquid, and could jeopardise the ICO altogether. Evidence from dual class offerings of small business firms on online equity crowdfunding platforms shows that such offerings are highly unpopular and could jeopardise the issuer’s fundraising prospects altogether.261 In sum, there is no marked development towards the equivalent of dual-class tokens in ICO markets. However, there is possibly also some traction to make it mandatory that ICO issuers should offer the same tokens to all investors, ie that the characteristics of tokens offered should not be differently coded for different groups of investors.

V.  Establishing a Unique Regulatory Regime for Pre-development Fundraising This chapter provides for a regulatory blueprint for regulating ICOs at a preorganisational stage for the blockchain-based business project. This is a unique time of business development, unlike for companies in securities regulation and deserves to be treated differently in relation to issuers’ needs and investor protection. As such, we offer a blueprint to foster a regulatory regime that institutes mandatory disclosure to the point of filtering out frauds and scams, as well as post-sale governance in a unique multistakeholder arrangement called the Schedule of Commitment, between the regulator, issuer

259 H Kim and R Michaely, ‘Sticking around Too Long? Dynamics of the Benefits of Dual-Class Voting’ (2019), at ssrn.com/abstract=3145209; LA Bebchuk and K Kastiel, ‘The Untenable Case for Perpetual Dual-class Stock’ (2017) 103 Virginia Law Review 585 on the loss of efficiency or value creation beyond certain conditions or time of entrenchment. But S Nüesch, ‘Dual-class Shares, External Financing Needs, and Firm Performance’ (2016) 20 Journal of Management and Governance 525 does not find outperformance necessarily even in the early stages of dual-class ownership. 260 For example, in the case of Filecoin. 261 D Cumming, M Meoli and S Vismara, ‘Investors’ Choices Between Cash and Voting Rights: Evidence from Dual-Class Equity Crowdfunding’ (2018), at ssrn.com/abstract=3351940.

Establishing a Unique Regulatory Regime for Pre-development Fundraising  193 and investors. This Schedule introduces a three-way public–private relational paradigm for governing issuers’ conduct, investors’ expectations and rights as well as enforcement for both compensation and deterrence. The Schedule of Commitment is also crucially an enabling regulatory framework that forms the basis for smart contract programming of expected conduct into code, so that standards can be met by automated execution upon certain triggers and conditions. This enabling framework provides for mandatory aspects that would deliver investor protection outcomes, leaving other aspects to be determined by market practice, so that market innovation can develop. This unique regulatory framework for pre-development financing reflects a decentred form of governance and fosters relational interaction between issuers and investors, and among investors inter se, in order for them to engage in further arrangements for organisation and governance of the blockchain platform when it becomes live and ready for registration, as discussed in chapter four. This is consistent with the enabling ethos in chapter four, which supports the economic freedoms and development potential in the crypto economy. However, economic activity and development is underpinned by regulatory capitalism, which supports the introduction of governance standards where there are market failures and the need for public goods to cater for the commons and the protection of public interest. Chapter six now turns to the protection of another commons that all blockchain systems need to safeguard, ie their monetary order. Although there may be other issues of commons in sectoral-specific businesses in the crypto economy, the book avoids discussing sector-specific regulation which is explored in literature elsewhere.262

262 Such as law and technologically generally, data protection and privacy in M Finck, Blockchain Regulation and Governance in Europe (OUP, 2018); on competition law see I Lianos, ‘Blockchain Competition: Gaining Competitive Advantage in the Digital Economy – Competition Law Implications’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 18. Many books focus on the financial sector as a particular use sector of blockchain, but there are many other applications in existing B2B commerce, peer-to-peer commerce, etc as discussed in ch 2.

6 Regulating the Monetary Order of the Crypto Economy I.  The Private Monetary Order in the Crypto Economy The existing monetary system of the crypto economy is made up of privately issued currencies that do not meet the conventional qualities of moneyness and are competing against one another. Cryptocurrencies do not meet the qualities of moneyness1 largely because they have become speculative financial assets, rather than merely because they are private in nature. Non-affiliation to the sovereign or state can be disadvantageous for private cryptocurrency as it cannot be regarded as legal tender. However, that should not of itself result in the sub-optimal quality of moneyness in private cryptocurrencies.2 Commentators show that where currencies compete, private currencies that are issued to stimulate productivity are beneficial, as they can compete to become responsive to productive users’ needs. They can become stable over time, as econometric modelling shows that private competing currencies issued by banks for productive use can over the long term produce stability,3 aligned with the Hayekian thesis. Some commentators have even shown how privately issued currencies can compete beneficially with fiat currencies in the same economic space, in order to spur developments of improved quality in fiat currencies,4 or to protect from welfare loss where fiat currencies are weak and adversely affected by ‘selfish’ government policies.5 The crypto economy can theoretically work on privately issued cryptocurrencies. Further, it may be argued that it is necessary for the crypto economy to work on privately issued currencies as sovereign-backed fiat money is not programmable for value 1 ie medium of exchange, store of value and unit of account; see MK Brunnermeier, H James and J-P Landau, ‘The Digitalization of Money’ (2019), at www.nber.org/papers/w26300. 2 E Avgouleas and W Blair, ‘The Concept of Money in the 4th Industrial Revolution – a Legal and Economic Analysis’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3534701. 3 FA Hayek, Denationalisation of Money (Institute of Economic Affairs, 1976); see R Kroszner, ‘The Conquest of Worldwide Inflation’ (2007) 27 Cato Journal 135 on how the Hayekian vision has played out in international currency competition and has conquered inflation worldwide, but see critique, A Martin and SL Schreft, ‘Currency Competition: A Partial Vindication of Hayek’ (2006) 53 Journal of Monetary Economics 2085. 4 J Rietz, ‘Secondary Currency Acceptance: Experimental Evidence with a Dual Currency Search Model’ (2019) 166 Journal of Economic Behavior and Organization 403; J Fernández-Villaverde and D Sanches, ‘Can Currency Competition Work?’ (NBER Working Paper 2019), at www.nber.org/papers/w22157. 5 M Raskin, F Saleh and D Yermack, ‘How Do Private Digital Currencies Affect Government Policy?’ (2019), at www.nber.org/papers/w26219.

The Private Monetary Order in the Crypto Economy  195 transfer in blockchain protocol. Commentators argue that the digitalisation of money brings forth opportunities to reconfigure money, such as bundling unprecedented functions into money or segregating money’s characteristics in innovative and attractive ways.6 Further, as blockchain-based businesses are purposed for peer-to-peer economic activity, cutting out rent extraction by middlemen so that more of the producers’ or consumers’ surpluses can be captured by end-to-end users, it is a natural consequence that middlemen for payment services such as banking or payment services systems are also technologically ‘programmed out’. The self-sustaining nature of private cryptocurrencies is however put in doubt due to the following factors: (a) the lack of governance for the commons of cryptocurrencies, which affects their key role as mediums of exchange; (b) the commoditisation of cryptocurrencies, which adversely affects their roles as supplying a unit of account and store of value, and in turn adversely affects their role as mediums of exchange. These factors undermine private cryptocurrencies’ bid to optimal moneyness. On (a), it can be argued that the peer-to-peer crypto economy’s disdain for rent-extracting middlemen in payment services may be misplaced as such middlemen are crucial to the governance infrastructure for payment services, therefore sustaining the commons. It can be argued that middlemen in payment services such as banks and other intermediaries in the financial sector perform useful services to sustain the institutions of payment certainty, integrity and consumer protection. Hence, they are remunerated accordingly. Banks and payment services providers, as discussed in chapter one, provide verification services in order to comply with anti-money laundering regulations, operate regulated payment systems, and provide customer protection by being subject to certain standards of efficacious payment transfer and protection against unauthorised use or fraud.7 Further, in the UK and EU, reforms to payment services regulation have been extensive. The Open Banking initiative is intended to end banks’ stranglehold on the payments market, which has allowed them to extract excess rent from users.8 Services providers that are not bank-based are now given legitimacy to innovate in payment systems, providing useful and innovative competition for payment initiation and money management.9 Regulation has also targeted rent 6 Brunnermeier et al (2019). 7 IH-Y Chiu, ‘A New Era in Fintech Payment Innovations? A Perspective from the Institutions and Regulation of Payment Systems’ (2017) 9 Law, Innovation and Technology 190. 8 Competition and Markets Authority, ‘Retail Banking Market Investigation’ (August 2016), at assets. publishing.service.gov.uk/media/57ac9667e5274a0f6c00007a/retail-banking-market-investigation-full-finalreport.pdf that has led to the ‘Open banking’ initiative; see www.openbanking.org.uk. 9 Payment Services Regulations 2017, regs 14, 18, for example, showing the authorisation regime being moderated for payment services providers that are more limited and not at the same scale as banks. This comes from the EU Payment Services Directive 2015, Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC, that has liberalised the payment services markets, allowing modularisation of payment activities under Annex 1 and their authorisation by national regulators, subject to certain compliance requirements and standards of behaviour. These new players are crucially empowered by guarantee of rights to access payment systems and bank account information; see Arts 35, 36.

196  Regulating the Monetary Order of the Crypto Economy extraction by capping fees that dominant players such as Visa and Mastercard can charge.10 In other words, regulation governs the commons in payment systems in mainstream commerce and has evolved to respond to users’ needs. In theory, competition can stimulate innovations in governing the commons of private cryptocurrencies so that self-generated standards can meet users’ needs. It is observed that users’ need for speed has resulted in relatively quick confirmation rates for transactions, in a matter of seconds, on the Ethereum blockchain.11 The Bitcoin blockchain has remained comparatively slow and consumes significant resources for verification.12 On the whole private cryptocurrency is subject to rudimentary forms of governance focused on transaction confirmation and ledger-building. Governance needs such as dispute resolution or antimoney laundering remain works in progress, although cryptocurrency exchanges and money service businesses are regulated in respect of anti-money laundering. On (b), the commoditisation of cryptocurrencies has begun with Bitcoin. As ­chapter  one has discussed, the Bitcoin blockchain provided for a payment system parallel to the mainstream systems, in order to serve the real economy, as Bitcoin was not designed to serve a wholly different productive crypto economy. The latter is a more recent phenomenon made possible with the development of the Ethereum blockchain. As an alternative currency, Bitcoin competes with fiat currencies and has to become interchangeable with fiat currencies. If bitcoin can only be earned by mining or by gratuitous transfer, it would have no competitive traction as there would be too few channels to meet demand. Hence, private exchanges arose all over the world13 in order to offer exchange between bitcoin and fiat currencies. The value for such exchange became determined by social and community sentiment14 and speculation,15 as the institutions for governing bitcoin’s prices are too rudimentary.16 Just as fiat currencies have been commoditised in international trade,17 despite being managed and moderated in their prices by national policies, central banks and publicly available 10 Regulation (EU) 2015/751 of the European Parliament and of the Council of 29 April 2015 on interchange fees for card-based payment transactions, or the Interchange Fee Regulation 2015. 11 HJ Singh and A Senhaji Hafid, ‘Transaction Confirmation Time Prediction in Ethereum Blockchain Using Machine Learning’ (2019), at arxiv.org/pdf/1911.11592.pdf, 1. 12 M Tarasiewicz and A Newman, ‘Cryptocurrencies as Distributed Community Experiments’ in DKC Lee (ed), Handbook on Digital Currencies (Elseiver, 2015) ch 10; B Geva, ‘Cryptocurrencies and the Evolution of Banking, Money, and Payments’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 2; A Lipton, ‘Toward a Stable Tokenized Medium of Exchange’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 5. 13 Such as Coinbase, Bitfinex, Binance, etc. 14 N Carter, ‘Cryptoasset Valuation’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 4; Rietz (2019); U Milkau and J Bott, ‘Digital Currencies and the Concept of Money as a Social Agreement’ (2018) 12 Journal of Payments Strategy & Systems 213, but the social underpinnings do not confer on such currencies stability as volatility can still result from how the community perceives and uses the currency, eg for illict purposes. 15 M Gronwald, ‘Is Bitcoin a Commodity? On Price Jumps, Demand Shocks, and Certainty of Supply’ (2019) 97 Journal of International Money and Finance 86; C Fink and T Johann, ‘Bitcoin Markets’ (2014), at ssrn.com/abstract=2408396. 16 Capped mining rewards and capped supply in bitcoin provides a broad framework to regulate price, but market sentiment has been the main driver of significant inflations and fluctuations. H Nabilou and A Prüm, ‘Central Banks and Regulation of Cryptocurrencies’ (2019), at ssrn.com/abstract=3421417. 17 AM Endres, ‘Currency Competition: A Hayekian Perspective on International Monetary Integration’ (2009) 41 Journal of Money, Credit and Banking 1251.

The Private Monetary Order in the Crypto Economy  197 information in relation to international trade and politics, bitcoin became highly commoditised and its price volatile, mimicking, in several researchers’ findings, the prices of exhaustible commodities such as oil.18 The commoditisation of bitcoin has invariably affected other private cryptocurrencies even if they have been developed for different purposes. First, the first generation ‘alt’ coins19 that were developed after bitcoin, such as Dogecoin, Litecoin, or Monero, had to become interchangeable with both bitcoin and fiat currencies in order to achieve scaling. Alt coins appeal to those already holding bitcoin, and provide diversification from bitcoin for those who wish to treat cryptocurrencies as assets. Next, even for newer cryptocurrencies that are geared towards being fundamentally functional, such as ether, their scalability would be greatly enhanced by joining the same market for interchangeability with bitcoin, alt coins and fiat currencies. The commoditisation of private cryptocurrencies can adversely affect their roles as units of account and store of value. Volatile prices of cryptocurrencies means that the ‘real’ value of a crypto good or service is fluctuating constantly, rendering the unit of account function devoid of real meaning for market participants. Both producers and consumers could be compelled to constantly trade in and out of their holdings in order to manage value, resulting in more financialised behaviour than is necessary for sustaining commerce. This environment can deter the scalability of the crypto economy as mainstream users may not be willing or able to undertake such efforts in order to compensate for the poor unit of account and store of value roles of private cryptocurrency. It may however be counterargued that users can also be drawn to the state of the monetary order, as they can both experience commercial transactions in crypto goods and services while managing the investment aspect of the private cryptocurrency they hold. In this manner, private cryptocurrencies can offer both payment utility and investment utility to holders. However, going by Hayek’s assumption that economic agents ultimately want price stability,20 and the fact that central banks around the world safeguard this as their main mandate, it can be argued that most users would unlikely enjoy the price volatility of their private cryptocurrency holdings meant for transactional purposes,21 even if a small part of them would also desire price volatility for investment arbitrage. Indeed bottom-up solutions have been developed to satisfy this seemingly contradictory coincidence of wants – both price stability for crypto commerce and price volatility for crypto investment. These are in the form of private stablecoins. Private stablecoins are the market response to the crypto economy’s needs for a credible monetary order. We turn to discuss what these are and what purposes they serve. We argue that private stablecoins reflect the need for cryptocurrency to be connected to institutionally accepted monetary orders and would ultimately call into question the sustainability of the ‘privateness’ of cryptocurrency. Indeed, regulatory agendas for private stablecoins are being developed, but usually in a siloed manner in relation to their financial product characteristics. 18 Gronwald (2019). 19 ‘What Are Altcoins and How Do They Differ From Bitcoin?’, at cryptonews.com/guides/what-arealtcoins.htm. 20 Hayek (1976). 21 Avgouleas and Blair (2020).

198  Regulating the Monetary Order of the Crypto Economy

A.  Private Stablecoins Private stablecoins (henceforth ‘stablecoins’) are designed to maintain their market values within certain parameters, therefore providing price stability. They can be exchanged for private cryptocurrencies and provide a mechanism for cryptocurrency users to store value in a more stable manner. Stablecoins can also be used as payment currency if compatible with protocol programmining on the relevant blockchain. We first survey how these stablecoin values are stabilised and critically consider their implications for establishing the monetary order of the crypto economy. The European Central Bank22 has surveyed two key techniques in the design of stablecoins. One relates to maintaining stable values as pegged to or based on collateral, such as certain fiat currencies or even a basket of fiat or crypto-currencies. The second technique is by coding in automated protocols so that coin values respond to excess demand or supply. These protocols perform central-bank-like monetary functions. The protocols could be triggered to airdrop when supply needs to be boosted in order to maintain price stability for the stablecoin. If supply needs to be contracted in order to prevent price deflation, protocols could be deployed to incentivise users to lock or sell the stablecoins for a fee in order to build up reserves, and reserves can be used to purchase stablecoins on the market for lock up or burning in order to reduce the monetary supply. Protocols could also be used to purchase or sell bonds or shares from or to users, depending on the need to increase or reduce the supply of stablecoins.23 Stablecoins built on the second technique are known as ‘algorithmically managed stablecoins’ and likely to be more compatible with assuming the role of payment currency.24 However, empirical research has found algorithmically managed stablecoins to be less than successful in achieving stability in value. Algorithmic techniques can be subject to manipulation and hidden strategies for value determination,25 and this may be more sub-optimal than market-determined prices for private cryptocurrency. Ampleforth26 is developed as an algorithmically managed stablecoin that responds to demand conditions, and is meant to be uncorrelated with other cryptocurrencies. However, algorithmically managed stablecoins can be challenging to design in terms of the trigger protocols, and such algorithms need to be resistant to collusion and manipulation.27 Further, what governance systems are needed for protecting the

22 Hayek (1976). 23 This is the model for Basis, a stablecoin, but Basis has since shut down from December 2018, see ‘Basis Stablecoin Confirms Shutdown, Blaming ‘Regulatory Constraints’ (December 2018), at www.coindesk.com/ basis-stablecoin-confirms-shutdown-blaming-regulatory-constraints. 24 Opined in IGA Pernice, S Henningsen, R Proskalovich, M Florian, H Elendner and B Schuermann, ‘Monetary Stabilisation in Cryptocurrencies – Design Approaches and Open Questions’, 2019 Crypto Valley Conference on Blockchain Technology, IEEE, 2019, at papers.ssrn.com/sol3/papers.cfm?abstract_ id=3398372; M Mita, K Ito, S Ohsawa and H Tanaka, ‘What is Stablecoin?: A Survey on Price Stabilization Mechanisms for Decentralized Payment Systems’ (2019), at arxiv.org/abs/1906.06037. 25 ibid. But there is also evidence of increasing refinement and innovation; see D Cerezo Sánchez, ‘Truthful and Faithful Monetary Policy for a Stablecoin Conducted by a Decentralised, Encrypted Artificial Intelligence’ (September 2019), at arxiv.org/abs/1909.07445. 26 www.ampleforth.org. 27 Calcaterra et al (2019).

The Private Monetary Order in the Crypto Economy  199 commons of the stablecoin community? For example, NuBits provides a democratic voting system for governance amongst its stablecoin users, but the governance system is slow and inefficient due to user inertia.28 Algorithmic stabilising techniques can become highly complex and susceptible to bugs and flaws. Yam, a decentralised finance experiment attempting to offer an algorithmic stability mechanism for its coin against the US dollar, was initially greeted in the crypto economy with much hope. However, a serious bug was discovered shortly after a successful ICO, and the entire project has been written off.29 Even Ampleforth has experienced a good measure of price volatility.30 Collaterised stablecoins are designed by hard pegging against a fiat currency such as the US dollar,31 or soft pegging against a basket of currencies, such as suggested by the Libra Association.32 Other providers such as PegNet offer a stablecoin pegged to a basket of fiat as well as cryptocurrencies.33 Commentators are of the view that stability in value can be maintained, but this depends on how issuers manage the trading arbitrage and collateralisation levels.34 The stablecoin with the greatest market capitalisation is Tether. It is a stablecoin with pegged features, primarily to the US dollar and euro. However, pegging stablecoins to known financial assets or commodities, including established fiat currencies, would merely transfer the coin’s inherent volatility problem to be externally managed by the drivers that influence fluctuations in the price of such financial assets or commodities.35 Fiat currencies also fluctuate based on market perceptions of the sovereign’s economic prospects and are not immune from crashing. Further, where private cryptocurrencies are pegged or collateralised upon a basket of financial assets or fiat currencies, or both, it is uncertain how each asset or currency would be weighted in the basket and how the stablecoin operator would carry out operations to maintain the peg. It has been commented that there is opacity and uncertainty as to whether pegged stablecoins that rely on collateralisation are really 100 per cent collateralised.36 In that regard the New York Attorney-General commenced investigations into Tether to determine if its peg claim may be fraudulent37 and settled with Tether and Bitfinex for a

28 Moin et al (2019). 29 ‘Defi Implosion: YAM Token Market Cap Plummets to Near Zero Founder After Claims He “Failed”’ (14 August 2020), at news.bitcoin.com/defi-yam-token-market-plummets-near-zero-founder-failed. 30 https://coinmarketcap.com/currencies/ampleforth. 31 Suggested ibid. 32 The private cryptocurrency libra is renamed as Diem as of 1 December 2020; see white paper at www. diem.com/en-us/white-paper. 33 PegNet, discussed in ‘The Stablecoin Anathema’ (Financial Times, 31 October 2019). 34 RK Lyons and G Viswanath-Natraj, ‘What Keeps Stablecoins Stable?’ (2020), at papers.ssrn.com/sol3/ papers.cfm?abstract_id=3508006. 35 A Moin, E Gün Sirer and K Sekniqi, ‘A Classification Framework for Stablecoin Designs’ (2019), at arxiv. org/abs/1910.10098. 36 ibid, C Calcaterra, WA Kaal and V Rao, ‘Stable Cryptocurrencies: First Order Principles’ (2019), at ssrn.com/ abstract=3402701; (2020) 61 Washington Journal of Law and Policy 193. Further, it was revealed that Tether was only 74% backed; see ‘‘Fractional Stablecoin Tether only 74% Backed by Fiat Currency, Says Lawyers’ (30 April 2019), at cointelegraph.com/news/fractional-reserve-stablecoin-tether-only-74-backed-by-fiat-currency-say-lawyers. 37 ‘New York’s investigation of cryptocurrency Tether hits fresh delay’ (Financial Times, 20 January 2021).

200  Regulating the Monetary Order of the Crypto Economy sum of US $18.5m.38 The settlement means that the credibility of the peg would not be examined as a legal issue and neither parties admit wrongdoing in relation to Tether’s loan to Bitfinex, which was asserted by the NY Attorney-General as putting Tether in a position that would have been insufficiently collateralised. Some collateralised stablecoins are pegged to a basket of conventional financial assets and fiat currencies, as well as other cryptocurrencies, such as PegNet.39 It is uncertain how such a basket that includes some rather volatile assets would improve the purported stablecoin’s stability. Further, such stablecoins rely on protocols that fetch externally trusted information (an oracle) on the market values of relevant collateral in the basket. Relying on the oracle and its predefined source/s of information would bring in a centralised institution for the stablecoin’s monetary system.40 To avoid having centralised institutions that may threaten to undermine its decentralised ethos, PegNet offers to operate a distributed system for setting the value of the basket of currencies to which its stablecoin is pegged. Participants on the PegNet system may send in external sources for values of each currency in the basket. The aggregate value of the basket is then to be determined by an algorithm working on the combined sources contributed by participants. The opacity of the algorithm, however, obscures the apparently distributed system of participation in fixing the stablecoin’s value. Further, such a system can tempt manipulators to collude in attempting to fix collateral values for the peg. Other collateralised stablecoin projects attempt to avoid pegging to other financial assets or commodities due to the weaknesses of the collateralisation mechanism. Saga, for example, is designed as a collateralised stablecoin that is not 100 per cent collateralised – it is pegged fractionally against deposits matched to the IMF’s special drawing rights. This provides it with the aura of greater stability than that currently offered by other projects. In most of the pegged and collateralised stablecoin projects above, the bid to stability is made in relation to conventional financial assets and commodities. This reflects the limitations in private cryptocurrency as an ultimately self-sustaining monetary order. Seeking to construct interfaces with conventional financial assets and commodities also create legal and regulatory risk for stablecoin projects, as these now resemble conventional financial products.41 In the future it is opined that stablecoins could be pegged to more objective/composite benchmarks such as the consumer price index or even GDP.42 However, the latter mechanisms assume that crypto economy prices move in the same or similar manner to the conventional economy or that levels of productivity are matching in nature. It remains uncertain if such an assumption would be sound. 38 ‘Cryptocurrency firms Tether and Bitfinex agree to pay $18.5 million fine to end New York probe’ (CNBC, 23 February 2021), at www.cnbc.com/2021/02/23/tether-bitfinex-reach-settlement-with-new-york-attorneygeneral.html#:~:text=Cryptocurrency%20firms%20Tether%20and%20Bitfinex%20reached%20an%20 agreement%20with%20the,a%20closely%2Dwatched%20legal%20dispute. 39 PegNet, discussed in ‘The Stablecoin Anathema’ (Financial Times, 31 October 2019). 40 Pernice at al (2019). 41 Such as collective investment schemes or money market funds; see DA Zetzsche, RP Buckley and DW Arner, ‘Regulating LIBRA: The Transformative Potential of Facebook’s Cryptocurrency and Possible Regulatory Responses’ (2020) Oxford Journal of Legal Studies, at doi.org/10.1093/ojls/gqaa036; and at ssrn. com/abstract=3414401. 42 Calcaterra et al (2019).

The Private Monetary Order in the Crypto Economy  201 So far, the majority of stablecoins that are of pegged and collateralised nature are treated as assets or investments for users to purchase, although stablecoins are increasingly programmed to be compatible with major blockchains in order to also serve as payment currency. Tether is programmed as an ERC-20 token as well as a tBTC token on the Omni-layer of the bitcoin blockchain. The most prominent stablecoin on the Ethereum blockchain is Dai,43 which is designed to maintain a constant value tied to the US dollar, via a loan-and-collateral mechanism whereby users can draw out dai based on collateralising their holdings of ether or approved Ethereum-based tokens in a vault and adjusting their levels of collateralisation based on the ether–USD volatility. Fluctuations in ether would mean the need to over-collateralise in order to maintain the holdings of dai and it has been reported that the collateralisation ratio can be as high as 300 per cent.44 The issuers of dai have developed governance and business model protocols to make dai attractive to hold, as well as to develop its stability. First, policies for the governance and business model of dai are determined by a democratic voting mechanism amongst holders of the dai governance token MKR. The issuers of dai have created a savings app for dai holders, so that if dai holders save or lock their dai in the app, they would earn interest on their dai.45 This interest rate is determined by the MKR holders by voting governance and is usually slightly lower than the rate imposed on creating dai. This business model strategically discourages users from treating dai as a hedging mechanism for ether. Next, the issuers of dai have also created protocols for maintaining the stability of dai by incentivising market making in dai so that the supply and demand of dai can be moderated automatically according to market conditions and would be less likely to suffer from bubbles or crashes.46 In this manner, dai seems to be poised to become a private cryptocurrency to hold, and increasingly to be deployed as payment currency on the Ethereum blockchain. Although its collateralisation and stabilisation protocols are now crucial to its credibility, and over-collateralisation can still present cost and inconvenience to users, it can be argued that dai’s stability mechanisms premised upon collateralisation may be a transition phase for the establishment of dai as a self-maintaining cryptocurrency. It is necessary now for dai to be transformed from ether, the productive cryptocurrency of the Ethereum blockchain. However, if sufficient dai enter into circulation so that the value of dai may be maintained by protocols regarding demand and circulation as such, then the value of collateralisation may become moot. This would be similar to the uncoupling of established fiat currencies from being backed by gold. The circulation of dai at February 2021 is about US $2.3billion while the ether circulating supply is over US $178 billion.47 Further, in the US, two registered money service businesses, Circle and Coinbase, the latter of which is also a cryptocurrency exchange, have launched the USD Coin, 43 developer.makerdao.com/dai/1. 44 Moin et al (2019). 45 oasis.app/save. 46 makerdao.com/en/whitepaper#use-of-the-mkr-token-in-maker-governance. 47 ‘Over 90% of Ether Supply Is Now in ‘State of Profit,’ Says Glassnode’ (4 August 2020), at cointelegraph. com/news/over-90-of-ether-supply-is-now-in-state-of-profit-says-glassnode; ‘Trillions of Dai Required in Future to Maintain Maker’s Current Value’ (7 May 2020), at cointelegraph.com/news/trillions-of-dairequired-in-future-to-maintain-makers-current-value.

202  Regulating the Monetary Order of the Crypto Economy ie a  digital version of the US dollar to be fully compatible with major blockchain protocols.48 This could arguably be the ultimate stablecoin for the US market or even the global market, given the reserve currency status of the US dollar. This was launched in 2018 and Circle in particular has been developing suites of tools to help application developers adopt the digital currency into their businesses.49 On 24 March 2020, Solana, a new protocol blockchain, was launched with the intention of adopting a Korean-based stablecoin Terra, which interfaces with the South Korean currency and Terra’s conventional payment network in South Korea.50 There are thus significant efforts to make private stablecoins capable for adoption and circulation in the crypto economy. However, in their bid for stability, developers have become closer to electronic money issuers or conventional financial asset managers. The evolution of the monetary order of the crypto economy has become more integrated with the conventional monetary and financial orders, not less integrated in the form of standalone systems. In this manner, regulatory extension would not be unexpected for the development of stablecoins.51 Stablecoins have risen in popularity as conventional financial institutions are starting to diversify into holding these as assets perceived to be uncorrelated with other financial asset movements.52 During the Covid-19 crisis, stablecoin issuers reported huge demand as conventional businesses sought hedging by holding them.53 This diversification into stablecoins by conventional financial institutions and businesses may be an upward trend, but this trend reinforces the financial product features of stablecoins, inevitably attracting regulatory attention, as will be discussed shortly. Regulatory attention to stablecoins was in no small part galvanised by Diem, formerly known as Libra. Diem, the token to be developed by the Diem Association, formerly Libra Association of which Facebook is a founding member, is poised to be a game-changer.54 Diem is intended to be issued by the Diem Association, based in Geneva, Switzerland. Its founding members, led by Facebook, includes payment services company PayU, retailers Farfetch and Uber, streaming service Spotify, telecommunications company Iliad, digital asset and cryptocurrency exchanges such as Coinbase and Anchorage, cryptocurrency payment service Xapo, blockchain developer Bison Trails and a number of venture capital funds and not-for-profit multilateral organisations such as Women in Banking. The Association’s initial plan was to develop a global payments blockchain that facilitates payment in a private stablecoin. The stablecoin will be issued in return for fiat currency that is held in a reserve backed by low-risk assets such as deposits and government securities in order to ensure each coin is fully backed 48 See www.circle.com/en/#. 49 See www.circle.com/en/developers. 50 ‘Solana Blockchain Adds Korean Stablecoin Terra for Better Payments’ (15 April 2020), at www.coindesk. com/solana-blockchain-adds-korean-stablecoin-terra-for-better-payments. 51 FSB, ‘Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements’ (October 2020), at www.fsb.org/2020/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements. 52 PwC, ‘Key Observations in Stablecoin Evolution’ (2019), at www.pwc.com.au/pdf/stable-coin-evolutionand-market-trends.pdf. 53 ‘Circle CEO Claims ‘Explosive’ Stablecoin Demand From Everyday Businesses’ (17 April 2020), at www. coindesk.com/circle-ceo-claims-explosive-stablecoin-demand-from-everyday-businesses?utm_source= newsletters&utm_medium=blockchainbites&utm_campaign=&clid=00Q1I00000LtSLoUAN. 54 libra.org/en-US/association.

The Private Monetary Order in the Crypto Economy  203 and stable in value.55 The reserve would be managed by asset managers and custodians subject to the Association’s oversight. Transactions would be validated by the founding members who are the validator nodes on the blockchain. Despite this set-up being a blockchain, it is in fact to be centrally managed by the Association, which would extract rent from users on an ongoing basis. This is not fully distributed unlike in other private cryptocurrencies. Commentators have cast doubt on different aspects of Libra, as originally designed. Some commentators queried if the coin could be stable at all, being 100 per cent collateralised against fiat currencies in the world, some of which highly illiquid and volatile.56 Indeed Libra’s prices could fluctuate in the free market based on market participants’ perceptions about the quality of the Association’s reserves.57 It was also questioned if it would become costly to use Libra if the cost of maintaining illiquid and unpopular national currencies becomes high.58 Other commentators wondered to what extent Libra would be useful as an alternative remittance system as large players would unlikely use this. This is because any gains from the investment management of the reserves accrues to the Association and its members, and users are not members.59 As Facebook is in a position to galvanise two billion users worldwide to participate in its private stablecoin initiative, the potential scalability of Libra has attracted the attention of regulators. Financial Stability Board Chair Randall Quarles and former Bank of England Governor Mark Carney have warned that the use of Libra could generate systemic risk,60 a warning that had not so far been aimed at the cryptofinance market.61 Indeed, the FSB62 urged regulators to monitor the systemic risks of Big Tech companies in financial services, and this would not be limited to Facebook. Further, Zetzsche et al opine that the Libra Association’s relationship with its users could be categorised as a regulable collective investment scheme or a money market fund.63 In this manner, the Association’s investment management of its reserves should be regulated to protect beneficiaries’ best interests.64 In the US, the issue of the Libra coin could 55 Originally in the retired version of the Libra white paper at libra.org/en-US/about-currency-reserve/ #the_reserve. 56 Zetzsche et al (2020). 57 Z Kakushadze and W Yu, ‘iCurrency’ (August 2019), at ssrn.com/abstract=3444445. 58 Zetzsche et al (2020). 59 Kakushadze and Yu (2019). 60 ‘Global regulators deal blow to Facebook’s Libra currency plan’ (Financial Times, 25 June 2019), at www. ft.com/content/0c1f3832-96b1-11e9-9573-ee5cbb98ed36. 61 Mark Carney, in a letter as Chair of the Financial Stability Board to the G20 Finance ministers and central bankers, 13 March 2018, at www.fsb.org/wp-content/uploads/P180318.pdf. 62 FSB, ‘BigTech in Finance: Market Developments and Potential Financial Stability Implications’ (9 December 2019), at www.fsb.org/wp-content/uploads/P091219-1.pdf. 63 Zetzsche et al (2019). 64 If the Libra/Diem Association is indeed offering a collective investment scheme service for users, there are implications for registration and authorisation, perhaps as a European Undertakings in Collective Investments in Transferable Securities (UCITs) scheme, which would be subject to prudential rules, conduct rules in relation to marketing and ongoing disclosure and management companies for UCITs would also need to be regulated and subject to conduct duties; see Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (recast); Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company.

204  Regulating the Monetary Order of the Crypto Economy risk being categorised as a security. The FSB65 explicitly urged national regulators to ensure that stablecoins would be fully regulated, whether as adaptations of existing regimes or as more tailor-made regimes, but covering essential issues in relation to antimoney laundering, customer protection, risk management and governance, business continuity, recovery and resolution. Further, researchers have modelled the potential for scalable stablecoins like Libra to attract substantial inflows of retail funds. They warn of severe risks to bank funding as well as to investor protection and financial stability, if the management of stablecoins should be sub-optimal, in relation to impaired balance sheets or a liquidity run.66 Coming under enormous regulatory pressure, Facebook has tweaked its Libra business model,67 which is now renamed as Diem. The Diem Association will issue single-currency tokens against major fiat currencies to be used in a permissioned payment system across the globe. This may mean that the payment system would function more like an international remittance system rivalling other international payment systems; an extended version of WePay, for example.68 In this manner, crypto economy developers would unlikely be attracted to adopt Diem as it may not be compatible with major blockchains such as Ethereum, and is more shackled to the mainstream economy. The Diem network is also unlikely to compete with the Ethereum blockchain as it does not offer a protocol infrastructure for dApp development. The Diem system is likely to be more removed from interface with the crypto economy. Although the Diem Association continues to maintain its aspiration to develop a stablecoin that is supported by multicurrencies, it is uncertain if the original business model can be ultimately developed.69 The stablecoin industry is poised to face regulatory development, and such development is likely to further shape stablecoin development. The FSB’s recommendations potentially cover both algorithmic and collateralised stablecoins, in relation to their being traded, issued and redeemed, their being stored and safekept, as well as their being used as means of remittance or payment. Crucially, it is not clear whether the regulation of stablecoins would make it more or less difficult to allow them to be compatible with blockchain protocol. On the one hand, it may be argued that regulated stablecoins would provide users with more confidence in participating in the crypto economy. On the other hand, regulatory risk for stablecoin issuers as well as regulatory compliance may significantly affect stablecoin designs and development. In this respect the US and EU seem to have taken different approaches. The stablecoin is proposed to be regulated by the Stable Act as a bank-issued product similar to a deposit.70 In that manner, 65 FSB (2020). 66 M Adachi, M Cominetta, C Kaufmann and A van der Kraaij, ‘A Regulatory and Financial Stability Perspective on Global Stablecoins’ (5 May 2020), at www.ecb.europa.eu/pub/financial-stability/ macroprudential-bulletin/html/ecb.mpbu202005_1~3e9ac10eb1.en.html#toc1. 67 ‘Facebook’s Libra overhauls core parts of its digital currency vision’ (Financial Times, 16 April 2020), at www.ft.com/content/23a33fcb-1342-4a18-be39-504e8507f752. 68 The payment system provided as part of the WeChat social media and messenger platform for mainly Chinese customers. 69 ‘Facebook is shifting its Libra cryptocurrency plans after intense regulatory pressure’ (The Verge. com, 3 March 2020), at www.theverge.com/2020/3/3/21163658/facebook-libra-cryptocurrency-tokenditching-plans-calibra-wallet-delay. 70 tlaib.house.gov/sites/tlaib.house.gov/files/STABLEAct.pdf. See ch 3 for discussion.

The Private Monetary Order in the Crypto Economy  205 the regulation establishes the key claim between depositor (holder of stablecoin) and issuing institution, but its deployment in the crypto economy could be unfettered. In the EU, however, the stablecoin is proposed to be regulated more like an investment product. Such an approach may reinforce stablecoins’ investment nature and affect their potential development in the monetary order of the crypto economy. The European Commission released its proposal in September 2020,71 treating stablecoins as a suis generis financial product. The Commission’s proposal, referring to ‘asset-referenced’ cryptoassets, apply only to collaterised stablecoins. The scope of collateralised stablecoins is wide, including those being collateralised against fiat currencies, any commodity or even any other cryptocurrency. This is a bespoke regime to regulate issuers of stablecoins in order to address the credibility of collateralisation and the protection of holders’ rights. Although the regulation of stablecoins is supported in this book, we argue that such regulation should be appropriately considered. Stablecoins have collateralised asset as well as payment features, which we argue should be regulated according to function. A functional approach to regulation would also ensure that innovative designs can be appropriately governed and do not easily fall outside the regulatory perimeter. The Commission’s proposal focuses only on stablecoins’ asset properties and treats cryptoassets with monetary or payment qualities in a completely distinct category. The UK has also demonstrated similar regulatory interest for fiatbased stablecoins and stablecoins linked to existing financial instruments, therefore unlikely to subject algorithmically programmed stablecoins or private cryptocurrency to regulation.72 Unlike the Commission, the UK’s approach is more open-ended in its consultation as no definitive preference for regulatory policy is expressed. The Commission’s proposal purports to regulate stablecoin issuers on the basis of merit-vetting of their applications to issue asset-referenced cryptoassets. Issuers need to produce a white paper to apply for approval. An exemption is however made for stablecoin issues of less than five million euros in a 12-month period or issues exclusively made to professional investors. Issuers need to be legal entities established within the EU. Merit vetting is based on information regarding the issuer’s governance, ownership and voting rights, internal organisation, control and business continuity policies as well as policies for investor relations. Further, merit vetting is also based on disclosures in the white paper relating to the reserves backing the asset-referenced cryptoasset, custody arrangements, investment policies and holders’ rights and relations with the issuer. Asset-referenced cryptoasset issuers are subject to prudential regulation of at least 350,000 euros or two per cent of reserves in their own equity capital. This is similar to regulation applying to investment funds.73 Significant crypto-asset issuers whose 71 European Commission, ‘Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937’ (COM593 final, September 2020), at ec.europa.eu/finance/docs/law/200924-crypto-assets-proposal_en.pdf. 72 HM Treasury, ‘UK Regulatory Approach to Cryptoassets and Stablecoins: Consultation and Call for Evidence’ (7 January 2021), at www.gov.uk/government/consultations/uk-regulatory-approach-tocryptoassets-and-stablecoins-consultation-and-call-for-evidence. 73 eg Art 7, Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS): on referencing assets under management for the purposes of calculating

206  Regulating the Monetary Order of the Crypto Economy stablecoin attains large market capitalisation or has a significant user base would need to provide for increased prudential regulation at three per cent of reserves and be subject to increased governance and conduct of business regulation. In relation to regulation of the organisational and governance robustness of assetreferenced crypto-asset issuers, the Commission’s proposal draws from the regulation of investment firms.74 Similar regulatory provisions are proposed in relation to management and controllers’ good repute and competence, control and governance, security and business continuity, conflict of interest management, custody of reserve assets and the requirement for external audit. Further, ongoing transparency regarding reserve composition and custody is required, and investment of reserves can only be made in highly liquid financial assets. These requirements are modelled strongly after investment firm and regulated investment fund provisions, such as UCITs in relation to investment composition. Significant asset-referenced cryptoassets are expected to adhere to more extensive governance and control regulations and liquidity management regulation. The acquisitions of stablecoin issuers would also be subject to regulatory vetting and control. Further, the Commission’s proposal deals with the protection of stablecoin holders’ rights. Stablecoin holders are treated like investors in investment funds, hence provisions focus on their valuation and redemption rights.75 General duties are imposed on stablecoin issuers to treat holders equally and fairly, and to manage conflicts of interests properly. Holders can also expect clear communication of their rights and are able to take disclosure-based civil actions for misdisclosure in white papers. They are also provided with the benefit of a mandatory complaint-handling procedure that the issuer needs to institute. It is queried if importing regulatory tenets from the regulation for investment firms or funds in the EU is appropriate for regulating stablecoins, as little consideration seems to be made with regard to new technological properties surrounding stablecoins. To what extent is the management of the collateralised stablecoin automated, for example? Would regulators be able to judge if code programmed to refer to collateral asset values from particular sources is fair or inappropriate management of conflicts of interest? How would issuers meet the business continuity obligations if they rely on third-party sources of information? The treatment of stablecoins as being akin to investment funds with particular promises of collateralisation, value at redemption and, likely, liquidity, could affect the design of stablecoins, especially in relation to other characteristics such as payment. The Commission’s treatment of stablecoins frames holders’ rights as vis a vis issuers in terms of redemption and the proper governance of issuers, but misses questions such as the fungibility of such coins and their ability to be used for payment if compatible with blockchain protocol. A question that would arise is whether a stablecoin like

prudential requirements; or art 9, Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010. 74 Art 9, Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU. 75 Akin to Arts 76, 84–85, UCITs Directive 2009/65/EC above; Arts 19, 23, AIFM Directive 2011/61/EU above.

The Private Monetary Order in the Crypto Economy  207 dai would be caught within the scope of the proposed Regulation, and whether dai’s payment characteristics would be jeopardised due to regulatory framing. In particular, the Commission’s proposal prohibits stablecoin issuers from paying interest, therefore mitigating regulatory arbitrage with deposit-taking banks. This however likely affects a new form of financial activity in the crypto economy called ‘yield-farming’, involving stablecoins, as discussed in chapter seven. The regulatory legitimacy for collateralised stablecoins in the EU may come at the price of business versatility and innovation. Further, the investment management cost incurred by stablecoin issuers would be imposed on holders of stablecoins. Crucially, the regulatory framing for stablecoins may artificially limit stablecoins’ development of payment properties in the crypto economy. Unlike the Commission’s proposal, the UK seems to envisage stablecoins being used as payment instruments and seeks to consult in that respect. There is indication of policy-thinking that is more open to the multifunctionality of stablecoins.76 In view of stablecoin regulations being focused on their fit with existing financial regulation, their deployment in the productive crypto economy seems neglected. This chapter argues that there is still a need to address if and how a regulatory agenda may enable and govern the monetary order of the crypto economy. We shortly explore two options. One is that where private cryptocurrency or other crypto tokens, including stablecoins, are used for payment purposes, this function ought to be regulated and brought within a regulatory oversight mechanism for payment functions. This is because payment functions underpin the productive and commercial aspects of the crypto economy. The second is to consider developments to support the deployment of a programmable fiat cryptocurrency, either in the form of the central bank digital currency or digital fiat currency issued by private sector providers, such as the USD Coin offered by its licenced money service business. In this respect the EU Commission’s proposal purports to regulate issuers of e-money tokens as programmable tokens denominated in fiat currencies. This regulatory regime will however be aligned with that applicable to existing banking or electronic money institutions.

B.  Interoperable Coins Another issue that has gained traction in the monetary order of the crypto economy is the availability of interoperable coins across different permissionless blockchains. The Ethereum blockchain is currently the most popular protocol infrastructure for the crypto economy, but there is intense competition amongst providers of alternative protocol infrastructure. Other innovations have arisen to compete with the Ethereum blockchain to supply protocol infrastructure to facilitate application developments, including NEO,77 Tron,78 Algorand,79 Polkadot,80 etc. However, empirical research

76 HM

Treasury (2021) above.

77 neo.org.

78 tron.network.

79 www.algorand.com. 80 polkadot.network.

208  Regulating the Monetary Order of the Crypto Economy finds that a lot of traffic on some competitors to the Ethereum blockchain are back and forth transfers and do not reflect genuinely productive economic activity.81 Nevertheless it is important to address the fragmentation of the cryptoeconomy across different permissionless blockchain infrastructure, as these are not interoperable. Theoretically, users would need to hold different types of currency tokens in order to participate in different protocol infrastructure as each protocol infrastructure issues its own native token which run on differently programmed native code. Users are starting to welcome a kind of currency fungibility, much like how fiat currencies seamlessly navigate domestic economies, or like how the euro operates across the euro area. Innovators are developing tokens that can be interoperable between different permissionless blockchains, and this technology is in the form of wrapper tokens, where users can have their currency tokens, say in bitcoin, exchanged for wrapper tokens that are coded to have a wrapper compatible with the protocol of another blockchain, such as EOS.82 These developments are emerging, and seem to work in a paired manner only, between consenting protocol developers. This development seems some way off from creating a multiple interoperable token across all manners of protocol infrastructure. The EOS–Bitcoin wrapper project is currently undertaken by a company pTokens, whose developer is the Chief Technological Officer of Tether, sister company of Bitfinex, a cryptocurrency exchange. This development however raises certain issues, such as: (a) whether the supply of wrapper tokens would affect the supply of native tokens, by bypassing any particular supply cap such as the bitcoin cap, and what this means for the governance of the blockchain and the price of its cryptocurrency; (b) whether wrapper tokens function also as hedge products like stablecoins and should attract regulatory attention; (c) whether there are governance standards for issuing of wrapper tokens and whether developers could take arbitrary actions such as terminating particular pairings by changing code and leaving users stranded; and (d) how the conduct of wrapper token issuers, such as exchanges, should be treated, in terms of currency exchange or investment services. Ultimately, a functional approach to regulating crypto tokens may be the most appropriate to address their multifunctional nature, in relation to payment and exchange, assetisation, hedging, and even banking, as will be discussed in chapter seven. A functional approach to regulation would also be able to adapt to the innovations in different types of tokens, but clearly interrogating their fundamental functional purposes.

81 D Perez, J Xu and B Livshits, ‘Revisiting Transactional Statistics of High-scalability Blockchain’ (3 June 2020), at arxiv.org/abs/2003.02693. 82 ‘Tether’s CTO hopes a new EOS-Bitcoin interoperability bridge could one day make tether cheaper and faster because users will be able to make transactions on less-congested blockchains’ (25 April 2020), at www.coindesk.com/new-crypto-bridge-will-make-tether-transactions-cheaper-cto-says?utm_source=news letters&utm_medium=blockchainbites&utm_campaign=&clid=00Q1I00000LtSLoUAN.

The Objectives for Regulating the Payment Systems in the Crypto Economy  209

II.  The Objectives for Regulating the Payment Systems in the Crypto Economy It is arguably highly challenging to subject private cryptocurrencies to any jurisdiction’s regulation. However, there is a case to be made for users to be protected in engaging with private payment systems that utilise private cryptocurrencies and other privately produced digital tokens for payment purposes. The governance of commons on permissionless blockchains is still developing, and there are useful lessons from regulating conventional payment systems. There is scope for governance and norm development in relation to the commons of payment functionality. We argue that a regulatory framework is desirable to address the needs of the commons, including: cost and quality in the execution of payment; dispute resolution needs; and public interest concerns such as preventing the payment system form being used for financial crime.83 However, such a framework may not address the problems of private cryptocurrency volatility. There are two possible solutions for the volatility problem: the first is that a relatively stable and digitally programmable fiat currency takes the place of private cryptocurrencies in the crypto economy; the second is to subject stablecoins to both payment regulation proposed in this chapter, as well as financial regulation discussed in chapter seven. This would allow stablecoins that gain social acceptance to become credible payment instruments. This section turns first to regulating the payment functionality in dApps and protocol infrastructure. Before this, one can argue that regulation is tantamount to legitimating private cryptocurrencies and policy-makers need to consider if that is desirable. However, even without institutional legitimation, private cryptocurrencies have proliferated since bitcoin and have developed towards building the crypto economy. Hence, a deliberate policy of not legitimating private cryptocurrency is neither likely to prevent courts from recognising it as money in an appropriate case, such as Skatteverket v David Hedqvist,84 or as valid consideration for transactions.85 These judicial clarifications are ad hoc in nature and there is no certainty that treatment as money would prevail in all cases. Other than collateralised stablecoins, private cryptocurrencies are not a claim against an issuer86 that can be fungible and assignable. As Gleeson explains, the lack of recognition as money may mean that actions in debt for private cryptocurrency would be unavailable, and actions would be based on the sterling equivalent of the private cryptocurrency, which would be treated as money’s worth.87 The legal risk of characterisation88 affects holders’ rights where payment issues give rise to disputes. Disputants would suffer significant fluctuation risk given the volatility of private cryptocurrencies. 83 Similar to but adapted from conventional payment systems issues, see n 9. 84 Request for a preliminary ruling from the Högsta förvaltningsdomstolen, Case C-264/14. 85 S Green, ‘It’s Virtually Money’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 2. 86 Avgouleas and Blair (2020). 87 Gilbert v Brett (1604) Davis 18; Jugoslavenska Oceanska Plovidba v Castle Investment Co Inc [1974] QB 292, discussed in S Gleeson, The Legal Concept of Money (OUP, 2019) 9.9. 88 Gleeson (2019) 7.6, 7.7.

210  Regulating the Monetary Order of the Crypto Economy Regulation can mitigate the hazards for users89 of private cryptocurrencies for payment purposes, and such hazards should be minimised as users participate in the commerce and business of the productive crypto economy, furthering economic development in this economic space. In this manner, designing regulation for the payment purposes of private cryptocurrencies is not on the basis that they are ‘good enough’ to be regarded as money. Rather, given their sub-optimalities, regulation underpins the commons needs in relation to their payment functions, and in this manner meets the needs of the community of users, both on the supply and demand sides of the market. Should regulation first and foremost confer the status of ‘legal tender’ upon private cryptocurrencies? One should also consider the Thai regulatory approach discussed in chapter three that recognises seven well-established private cryptocurrencies as legitimate and not in need of jurisdictional approval. The latter approach however suffers from under-inclusion as social acceptance of new private cryptocurrencies is a dynamic and changing phenomenon. Further, to exclude established private cryptocurrencies from regulation avoids dealing with the functional aspects that users engage with and need protection for. This chapter argues that it is not necessary to confer legal tender status on private cryptocurrencies. As Proctor argues,90 state recognition of what is legal tender is based on its sovereign status in providing the public good of legal tender. Legal tender provides a right for citizens to have a universally accepted means of discharge of debt.91 Not being legal tender does not mean that a private cryptocurrency cannot be treated as money for payment purposes. The state’s monopoly over the issue of money is neither assumed in national nor international law. A number of commentators accept a social theory of money that gives recognition to what social communities regard as money circulating in use amongst themselves.92 There is no need to confer on private cryptocurrencies that same status of a public good, as this does not prevent contracting parties from choosing to use them. However, with a sufficient community that adopt and use private cryptocurrencies, the public good, or more appropriately, the commons good, is in relation to the transfer protocols and how these meet users’ common needs. Hence, the regulatory agenda should be focused on the regulation of the payment functionality within permissionless blockchain systems. The regulation of payment functionality within permissionless blockchain systems does not need to refer to legal tender. For example, EU legislation dealing with definitions of money do not deal with ‘legal tender’ as it is a national concept. This does not prevent harmonised EU-wide legislation from being introduced to deal with how money transfer transactions are regulated, such as under the Electronic Money, 89 A Spithoven, ‘Theory and Reality of Cryptocurrency Governance’ (2019) 53 Journal of Economic Issues 385; IC Lazcano, ‘A New Approach for ‘‘Cryptoassets” Regulation’ (2019) 35 Banking and Finance Law Review 37. 90 C Proctor, ‘Cryptocurrencies in International and Public Law conceptions of Money’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 3. 91 C Proctor, Mann on the Legal Aspect of Money (OUP, 2012) ch 2.24. 92 JS Nelson, ‘Cryptocommunity Currencies’ (2019), at ssrn.com/abstract=3308645; Rietz (2019); B Geva and D Geva, ‘Non-State Community Virtual Currencies’ in D Fox and S Green (eds), The Law of Cryptocurrencies (OUP, 2019) ch 11.

The Objectives for Regulating the Payment Systems in the Crypto Economy  211 Payment Services and Anti-Money Laundering Directives. Money can be defined in relation to what is accepted as currency in a Member State,93 which includes legal tender and what courts accept as monetary obligations.94 Money can be defined as value that is recognised as a claim upon an issuer.95 Such definitions of money fulfil the aim of protecting those who are engaged in the commercial systems that rely on the circulation of fungible consideration that is accepted as money. Private cryptocurrencies used for transfer and exchange in a permissionless blockchain system can enjoy being defined as money for the purposes of payment execution. Regulatory focus should be placed on the conduct and commons of the payment system in the permissionless blockchain.96 This does not however mean that private cryptocurrencies’ monetary qualities become magically enhanced or that they are equivalent to legal tender. A question however arises as to whether recognition of moneyness would also lead to recognition of private cryptocurrencies’ fungibility so that proprietary actions can no longer attach to them. This may be disadvantageous where illegal proceeds in private cryptocurrency are being traced, such as in the case of AA v Persons Unknown and Bitfinex.97 It is arguable that freezing actions such as in AA would still be available as moneyness does not affect the traceability of the coins. The bitcoin blockchain allows precise transfer outputs and inputs to be recorded, facilitating traceability, and this function and feature of the ledger should not affect the moneyness of the coins or indeed diminish such moneyness. However, a different view can be taken, ie that a choice in legal interpretation must be made between proprietary characterisation and fungibility. Gleeson posits a hypothetical where a claimant for unpaid private cryptocurrency in a sale may find herself in an unenviable situation where there is a third-party claim against the cryptocurrency to be paid to her, such as where she had dealt with a cryptocurrency thief. It seems highly likely that what the [claimant] would want would be a combination of the benefits of a money claim – no nemo dat risk and certainty of entitlement – alongside the relative freedom of the constraints of the Sale of Goods legislation resulting from characterisation as barter. The key point here is that a court is most unlikely to allow this outcome.98

On balance, moving away from a barter characterisation of private cryptocurrency transfers helps in enhancing the appeal of crypto economy commerce and its scalability. Further, proprietary rights over private cryptocurrency are not necessarily the optimal way to protect holders from loss or theft. We propose that regulation can be designed to look after holders of private cryptocurrency and assets in a more optimal manner, to be discussed shortly. 93 Art 2, Payment Services Directive 2015. 94 See n 83. 95 Art  2, Electronic Money Directive, Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC on the definition of ‘electronic money’. 96 Also see A Belke and E Beretta, ‘From Cash to Central Bank DigitaCurrencies and Cryptocurrencies: A Balancing Act Between Modernity and Monetary Stability’ (2020) 47 Journal of Economic Studies 911. 97 Discussed in ch 1, [2019] EWHC 3556 (Comm). 98 Gleeson (2019) 7.94.

212  Regulating the Monetary Order of the Crypto Economy This chapter proposes a regulatory framework for the payment functionalities and systems in blockchains utilising private cryptocurrencies. Payment functions should be carried out to meet user expectations in an institutionally compatible manner, ie to meet reasonable expectations in cost and quality of execution, and to be relatively free from financial crime, and there should be certainty in relation to dispute resolution. If the payment instrument concerned is a collateralised stablecoin, which is usually managed by an issuer, such stablecoin is susceptible to two types of regulatory frameworks. One is that any asset or investment management function of the stablecoin may be susceptible to financial regulation, discussed in chapter seven. Second, the payment aspect that can be performed by the stablecoins should be governed under the regulatory framework for payment systems and functions proposed here. Payment systems on permissionless blockchains are embedded in the infrastructural protocol such as on the Ethereum blockchain. DApps can accept ether as payment and rely on the mining protocols on the Ethereum blockchain for transaction validation and finality. However, dApps may organise value transfers in the form of their own tokens which are based on ERC standards, and in that manner run a payment interface on top of the infrastructural protocol. As the Ethereum blockchain is becoming congested due to increased volumes of transactions being processed, off-chain solutions have been proposed for payment transfer and settlement. These ‘Lightning Networks’99 allow users to opt into an offchain network which is private in nature and does not need to broadcast transactions to the main blockchain. Nodes are incentivised to help route payments between end users by constructing routing traffic, for a fee. All participants deposit collateral into the Network in order to generate capacity to transfer or to route other nodes’ payments. Routing nodes in particular will have to deposit collateral commensurate with the capacity they desire to have for routing functions. In a competitive environment, routing fees cannot be too high or too low as users would not select routing nodes that are expensive, or nodes would withdraw from the Network.100 In this manner, it is uncertain if the offchain solution would definitely promote lower cost for bilateral payment transfer on the Network. The offchain solution is also more private, and potentially anonymous,101 raising issues in relation to attracting money laundering. Further, offchain payment systems branching off from the main blockchain also give rise to commons issues, as there is uncertainty in terms of standards governing users’ expectations. If Alice selects Charlie as routing node to pay Bob, and Charlie is hacked and drained of all collateral, what would be Alice’s and Bob’s rights and remedies? There is also a lack of clarity in terms of the relationship between governance protocols on the main blockchain and its offchain systems.

99 See lightning.network; also ‘Ethereum Founder Acknowledges Promising Solution To Blockchains’ Scalability Problem’ (Forbes, 14 May 2018), at www.forbes.com/sites/andrewrossow/2018/05/14/ ethereums-founder-acknowledges-promising-solution-to-blockchains-scalability-problem. 100 L Bertucci, ‘Incentives on the Lightning Network: A Blockchain-Based Payment Network’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3540581. 101 See discussion in ‘The lightning network is due for a privacy boost’ (14 August 2018), at www.coindesk. com/the-code-for-an-anonymous-lightning-network-is-now-live on the trajectory towards more anonymity on lightning networks.

The Objectives for Regulating the Payment Systems in the Crypto Economy  213 Casual online searches reveal that Bitcoin users, for example, have experienced a day’s lag in transaction verification,102 and conventional bank transfers by Faster Payments103 or by credit or debit cards in the UK are considerably faster and more reliable. The distributed characteristic of payment protocols may sacrifice efficiency because of aversion to any form of centralisation.104 Organisational sociologists since Weber and Parsons105 have however depicted how efficiency needs drove rational organisational endeavours and the evolution of hierarchical structures. Hence, disavowing centralisation is not necessarily optimal. The concentration of power in mining or routing capacity also produces a form of centralisation. Without governance or institutionalisation, increasingly powerful actors on permissionless blockchains would not be held to responsibilities or reasonable accountability. On the immutablity characteristic of distributed ledgers, users may not always be served by this. In episodes where permissionless blockchains came under attack and collective action was needed to address these, Low and Mik argue106 that core code developers and dominant mining pools have managed to unravel immutability.107 But what is unsatisfactory is that only such clusters of power can create forking and effectively reverse rogue transactions while individual users have no right to cancel or reverse transactions that may be made in error or are somehow unauthorised.108 One self-help blog109 advises a user who wishes to cancel a transaction to essentially send the cryptocurrency twice, to deliberately manufacture a double-spend transaction, in the hope that both transactions would be cancelled and the coins would revert to the user. Such a self-help measure seems wasteful and inefficient, besides its potential to undermine the integrity of transactions on the blockchain. There are insufficient self-regulatory mechanisms on blockchains to deal with errors, disputes and problems. This would only compel users to seek help in private law and in national courts,110 leading to ad hoc and unsystematic interventions into purportedly immutable transactions. It would benefit permissionless blockchain commerce that payment protocols provide much more governance, certainty and transaction costefficiency for users. The regulation of conventional payment systems is premised upon a few highlevel principles, viz certainty in the execution of the payment transaction, consumer 102 ‘Why is my Crypto Transaction Unconfirmed?’, at wirexapp.com/help/article/why-is-my-cryptotransaction-unconfirmed-0061. 103 www.fasterpayments.org.uk. 104 E Schuster, ‘Cloud Crypto Land’ (LSE Working Papers 2019), at papers.ssrn.com/sol3/papers.cfm? abstract_id=3476678. 105 Discussed in T Peltonen, ‘Rational Modern Organisation’ in Organisation Theory (Emerald Insight, 2016) ch 4; NJ Smelser and R Swedberg, ‘Introduction to Economic Sociology’ in The Handbook on Economic Sociology, 2nd edn (Princeton University Press, 2005) ch 1. 106 K Low and E Mik, ‘Pause the Blockchain Legal Revolution’ (2020) 69 International and Comparative Law Quarterly 135. 107 ‘Understanding the DAO Attack’ (25 June 2016), at www.coindesk.com/understanding-dao-hackjournalists. 108 ‘Can my Transaction be Cancelled or Reversed?’, https://support.blockchain.com/hc/en-us/ articles/211162263-Can-my-transaction-be-canceled-or-reversed-. 109 ‘Can a Bitcoin Transaction be Reversed?’, at bitcoin.stackexchange.com/questions/197/can-a-bitcointransaction-be-reversed. 110 Schuster (2019).

214  Regulating the Monetary Order of the Crypto Economy protection, prevention of financial crime and competition, such as in the Open Banking initiative.111 In conventional payment systems, certainty in payment execution is underpinned by the institutions of clearing and settlement frameworks that are subject to regulatory standards and oversight.112 In a peer-to-peer payment system on a blockchain, there are no ‘clearing and settlement’ facilities but the functional equivalents of settlement and clearing are performed via the consensus protocols in mining.113 The self-governance nature of such consensus protocols has revealed weaknesses. Apart from weaknesses in relation to possible abuses of power, such as attacks amongst miners in competitive systems,114 and possible collusive 51 per cent attacks by miners, permissionless blockchains could experience bottlenecks in transaction verification with increased volumes, such as on the Ethereum blockchain.115 These bottlenecks in transaction verification result in user experience of unpredictability in terms of the efficiency of transaction verification and fluctuating cost.116 The cost of transaction verification, or ‘gas fees’, on the Ethereum blockchain may also be affected by clusters of oligopolistic power in mining pools, a phenomenon that has arisen particularly in the bitcoin blockchain.117 The self-governing nature of consensus mining protocols may not be able to offer consistency and reasonableness in the quality and cost of payment execution for users. Secondly, it may be argued that consumer protection is irrelevant in the world of private cryptocurrency payment as cryptocurrency users are in peer-to-peer systems. In conventional payment systems, we may view payment intermediaries as commercial outfits with unequal bargaining power and greater access to resources than consumers, hence warranting the imposition of regulatory standards for intermediaries in order to protect consumers.118 Private cryptocurrency systems are differently structured as intermediaries’ power and operations are replaced by decentralised networks and automated protocols. Nevertheless, there are new power clusters that can arise on these systems. New power clusters may relate to code developers whose work affects payment functionalities, and mining pools and clusters that are able to influence transaction verification efficiency and price. There is a case for considering if their conduct should be subject to standards in order to meet users’ needs of reasonable transaction execution quality and cost, availability of dispute resolution that is fair and credible, and keeping the system untainted by financial crime. 111 n 9. 112 Chiu (2017). 113 A Savelyev, ‘Some Risks of Tokenization and Blockchainizaition of Private Law’ (2018) 34 Computer Law and Security Review 863. 114 Y Wang, C Tang, F Lin, Z Zheng and Z Chen, ‘Pool Strategies Selection in PoW-Based Blockchain Networks: Game-Theoretic Analysis’ (2019) 7 IEEE Access 8427. 115 See ‘Congested Ethereum hosts 96% of DeFi transactions’ (23 October 2020), at forkast.news/ ethereum-defi-transactions-congestion-scaling-ponzi-report. 116 ‘Ethereum posts new highs as DeFi gas fees go through the roof ’ (4 February 2021), at cointelegraph.com/ news/ethereum-posts-new-highs-as-defi-gas-fees-top-1-000-on-complex-protocols. 117 F Musiani, A Mallard and C Méadel, ‘Governing What Wasn’t Meant to Be Governed: A Controversy-Based Approach to the Study of Bitcoin Governance’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 7; M Campbell-Verduyn and M Goguen, ‘Blockchains, Trust And Action Nets: Extending the Pathologies of Financial Globalization’ (2019) 19 Global Networks 308. 118 The European Electronic Money Directive and Payment Services Directive are structured on this basis.

The Regulation of the Payment and Mining Protocols  215 Thirdly, it is in the public interest as well as the interest of the commons of the payment system that illicit and abusive use is avoided, such as for money laundering and financial crime. Hence regulatory obligations should apply to prevent private cryptocurrency payment systems from being used in this manner. Haffke et al argue that the current regime under the EU’s Anti Money Laundering Directive does not sufficiently address money laundering risks in private cryptocurrency payments as regulatory obligations are only addressed to cryptocurrency service providers such as exchanges and wallets.119 Finally, it can be argued that conventional payment systems allow large financial intermediaries, notably banks, to consolidate network effects and impose oligopolistic rents on users of payment services. Therefore, the regulation of conventional payment systems to improve competition is regarded as necessary, such as under the Open Banking initiative.120 Private cryptocurrencies are, on the other hand, already in a competing paradigm as they are not normally interoperable on different permissionless blockchains. Regulation of private cryptocurrencies may be contrary to natural competition if regulation creates skewed effects such as entrenching well-established private cryptocurrencies. Hence the regulatory regime would need to balance the benefits of market innovation and choice, while ensuring that the payment commons for users would be protected. Based on the above rationale for regulation, we argue that the regulatory framework needs to address the following: (a) The regulation of the payment and mining protocols in terms of payment functionalities and standards. These relate to the quality and cost of payment execution, redress for users or fair and credible dispute resolution, and the prevention of financial crime. (b) Provision for the responsibility, duties and liabilities on the part of service providers that arise to serve the payment system in private cryptocurrencies, such as (i)  wallets that are used for the custodial safekeeping, and (ii) exchanges for exchanging in and out of private cryptocurrencies (with other private cryptocurrencies or fiat currencies). These groups of service providers have become important intermediaries in the payment systems of private cryptocurrencies despite the peer-to-peer and decentralised nature of permissionless blockchains.

III.  The Regulation of the Payment and Mining Protocols in Terms of Payment Functionalities and Standards First, we propose that the regulatory regime should address the payment protocols that effect payment transfers, verify transactions and build the transactional ledger. This is not in order to introduce a one-size-fits-all regime for how code ought to be written, 119 L Haffke, M Fromberger and P Zimmermann, ‘‘Cryptocurrencies and Anti-Money Laundering: The Shortcomings of the Fifth AML Directive (EU) and How to Address Them’ (2020) 21 Journal of Banking Regulation 125. 120 See n 8.

216  Regulating the Monetary Order of the Crypto Economy but to allow regulators to supervise how the code works for reasonable user protection under operating and stressful conditions. Such regulatory oversight is important so that the commons of payment systems, albeit in private cryptocurrency, can be aligned with regulatory objectives in achieving payment certainty and adequate user protection. The existing regulatory regime for payments addresses payment intermediaries, such as service providers that initiate payment, and those that clear and settle them.121 This regulatory methodology does not apply neatly to the crypto economy. The crypto economy starts with the assumption that transactions can be made end-to-end directly and intermediate service providers can be avoided. Unlike in the conventional economy where businesses outsource payment handling to regulated intermediaries, payment functions would have to be reintegrated within business functions in the permissionless blockchain environment. It is apparent that it could be difficult to attach regulatory obligations to individual nodes on main blockchains and offchain systems. To undertake regulatory oversight of the traffic of transactions on permissionless blockchains would be rather demanding. The default position of civil redress, with its uncertainties and complexities as discussed in chapter one, would apply to individual situations. However, we propose that regulatory standards can provide some ex ante governance in relation to blockchain-based businesses’ adoption and use of payment functionalities.

A.  Regulatory Oversight for Payment Functionalities Regulatory oversight of the payment functionalities on a permissionless blockchain would be based on their registration of blockchain-based businesses discussed in chapter four. As chapter four proposes that the technological functions of smart contracts deployed by the blockchain-based business be vetted ahead of registration, such vetting includes the payment functionalities coded in the smart contracts. The ‘integration’ model of business and payment handling in the crypto economy, unlike the conventional business model of outsourcing specialist functions like payment handling, requires a different approach to business registration. In this manner, the regulatory design integrates at a broader level the regulatory roles over business and finance, and requires new thinking in regulatory collaboration amongst agencies such as between the business and financial regulators and in particular, the UK Payment Services Regulator, an independent office set up under the auspices of the Financial Conduct Authority. The regulator does not need to prescribe standards for payment functionalities as such. Business registrants should disclose to the regulator: (a) how the smart contracts for payment functionalities meet users’ needs for integrity and certainty in payment and reasonable cost in effecting payments; (b) how the smart contracts for payment functionalities are aligned with anti-money laundering in crypto-commerce; and (c) what users’ rights are in relation to complaints and disputes and how these are effected, for the purposes of regulatory vetting. Regulatory vetting can verify if the

121 EU

Payment Services Directive 2015.

The Regulation of the Payment and Mining Protocols  217 smart contract code works as purported and we envisage that regulators should raise issues for improvement if these are found. It may be argued that payment functionalities are not within the business registrant’s control if reliance is placed on the protocol infrastructure and its offchain systems. However, with competing permissionless blockchains, a dApp developer makes a choice of protocol infrastructure to which it is bonded. Permissionless blockchains are in constant states of innovation allowing many to participate in code development that is open-source. Hence, it is arguably not onerous for a dApp developer to justify choice of protocol payment infrastructure and how these functionalities meet users’ needs and the public interest of deterring money laundering. There are also developments on the horizon in relation to third-party standards for blockchains, such as being developed by the International Standards Organization (ISO).122 Regulators can consider to what extent recognition can be given to them in relation to regulatory approval. It may however be queried if regulatory approval for a business that adopts a payment protocol as part of the permissionless blockchain infrastructure would create an automatic presumption in favour of the payment protocols in that permissionless blockchain. If the regulator accepts the appropriateness of the mining protocol say, on the Ethereum blockchain for a particular dApp, it should not be taken to mean such protocol is presumed appropriate for another business, as each business needs to demonstrate why the infrastructural protocol achieves the regulatory objectives and standards in relation to qualities of user protection and prevention of financial crime. We also propose that regulatory vetting takes place in an interactive interface, such as in a sandbox where regulators can test the smart contract functionalities in a short period of time before decision-making. The sandbox provides an environment for the blockchain-based business developer to demonstrate the outworking of payment protocols. Pursuant to the FCA’s express mandate to promote competition in financial markets, it has launched Project Innovate123 to support technological revolutions in finance (‘fintech’,124 and financial regulatory compliance solutions, called ‘regtech’, and ‘techfin’,125 which refers to financial services provided by non-finance companies).126 This is in response to the growing trend in fintech innovations that have arisen to fill market gaps and exploit new efficiencies after the global financial crisis 2007–09 that hit many traditional financial institutions. The Innovation Hub provides a process for regulatory engagement with innovators so as to shed light on how innovation and 122 See ISO’s development of blockchain standards. 123 See www.fca.org.uk/firms/innovate-innovation-hub. 124 Price Waterhouse Coopers, ‘Blurred Lines: How Fintech is Shaping the Financial Services Industry’ (March 2016); Arner et al, ‘The Evolution of Fintech: A New Post-Crisis Paradigm?’ (2015), at ssrn.com/ abstract=2676553. 125 DA Zetzsche et al, ‘From Fintech to Techfin: The Regulatory Challenges of Data-Driven Finance’ (2017), at papers.ssrn.com/sol3/papers.cfm?abstract_id=2959925. 126 DW Arner et al, ‘FinTech, RegTech and the Reconceptualisation of Financial Regulation’ (2017) 37 Northwestern Journal of International Law and Business 371, also ssrn.com/abstract=2847806; FCA, ‘Call for Input: Supporting the Development and Adoption of RegTech’ (November 2015) and ‘Feedback Statement: Call for Input: Supporting the Development and Adoption of RegTech’ (July 2016).

218  Regulating the Monetary Order of the Crypto Economy regulation affect each other.127 The Innovation Hub comprises several aspects such as advice and support for innovators, event days for engagement between the FCA and interested constituents, and the Regulatory Sandbox, which is a regulatory mechanism for innovation testing and bringing to market.128 The Regulatory Sandbox is a novel regulatory approach. It allows the regulator to proactively seek new firms or pre-regulatees, moving away from the previous position of being passive and reactive.129 Such a proactive approach has the potential to capture an increasing scope of financial innovation that can be effectively governed with regulatory oversight. This approach also emphasises the relational paradigm between firm and regulator130 and signals a new dimension of regulatory responsiveness’131 in co-opting firm and industry opinions to feed into regulatory policies and decisions. A key tenet in Regulatory Sandbox is regulatory suspension in the test environment. Regulation is suspended in whole or in part, in order to allow financial innovations to demonstrate their outworking in the market. Such regulatory suspension is temporary and would be clearly delimited in terms of its expiry. In order to be eligible for such regulatory suspension, firms undergo an extensive selection process. Thereafter, the regulatory suspension is closely supervised. The regulators set out not to overburden new firms or innovations, while mitigating any potential social harm this may cause. Firms are subject to closer-than-normal scrutiny during the Sandbox period, but gain insight as to how their models may be tweaked or amended in order to fully graduate into regulated status and come to market. We suggest that as part of the registration process for blockchain-based enterprises, developers should engage with regulators in demonstrating how payment protocols would work. The Sandbox period allows regulator–business interaction that can generate feedback for business to make adjustments in order to secure regulatory objectives. The Sandbox also provides an environment for payment protocols to be tested under assumptions of different conditions such as normal and stressed ones. For example, payment protocols should be tested under conditions of volume and under the stressful condition of an attack on the permissionless blockchain. This principle is not dissimilar to scenario-based stress-testing employed in much of banking and financial regulation.132 Stress-testing also helps enterprise developers to further develop governance protocols in case of crisis management needs.

127 See interview with Martin Wheatley (CEO of FCA 2013–15), at play.buto.tv/DWCTY. 128 www.fca.org.uk/firms/innovate-innovation-hub. 129 N Cortez, ‘Regulating Disruptive Innovation’ (2014) 29 Berkeley Technology Law Journal 175. 130 Described as a ‘performative turn’ in regulation, I Lianos, ‘Law, Fintech, and the Performative Turn in Regulation’, paper delivered at the Blockchain Technology and a New Financial Order conference, Centre for Law, Economy and Society (19 June 2017) argues that the regulator now makes regulatory policy and decisions within a new ‘society’ of innovators, the financial industry, socially embedding such policies and decisions, perhaps distinguishing from merely being economically driven. 131 ‘Responsiveness’ in regulation first developed in relation to enforcement and securing proportionate enforcement that reinforces meaningful compliance; see I Ayres and J Braithwaite, Responsive Regulation (OUP, 1992). This was subsequently developed responsiveness in the supervisory process see R Baldwin and J Black, ‘Really Responsive Regulation’ (2008) 71 Modern Law Review 59. 132 Basel Committee, ‘Principles for Sound Stress-testing Practices and Supervision’ (May 2009), at www.bis. org/publ/bcbs155.pdf.

The Regulation of the Payment and Mining Protocols  219

B.  Regulation of Miners? There is the option of considering if regulation should be extended to miners who provide the essential payment settlement and clearing services for users on permissionless blockchains. Mining is now dominated by mining pools which combine many individuals’ hash power or mining farms133 that are corporatised entities mining on an industrial scale.134 Hence it may be possible to attach regulatory treatment to these. Mining pools and farms can be regulated in terms of their conduct as well as their governance in order to ensure that they are able to maintain service levels that meet regulatory expectations. However, as many of these are dispersed across jurisdictions worldwide especially where energy resources are cheaper, attaching any domestic regulatory regime to them is challenging in the absence of an international effort. It is mooted that a fiduciary duty can attach to coders and large miners due to their power in maintaining permissionless blockchains.135 A fiduciary duty is usually imposed to restrain a person from acting in self-interest when the interest of another ought to be preferred, such as where there is entrustment of power or property.136 Applying to the function of mining, does this mean that miners must act in the interests of users whose transactions they are validating? It may be argued that even conventional clearing and settlement intermediaries do not owe such a duty to their users. Persons who undertake these functions for payment users are incentivised to do so, and the standards and expectations of conduct are better governed by a regulatory core. Such a regulatory core can include reasonable service standards, non-abusive exercise of power for example. It is preferable to develop such a regulatory core than to transpose the fiduciary duty into this context. In sum, we propose that every blockchain-based enterprise seeking to be registered as a business organisation under the framework outlined in chapter four should be subject to merit vetting of the payment protocols it adopts or develops. This exercise is distinct but not disengaged from the more general verification of smart contract code suggested in chapter fourz, pertaining to commercial purposes and functionalities. The vetting processes should be carried out under regulatory frameworks integrated

133 Although the growth of mining pools does not seem to be oligopolistic; see LW Cong, Z He and J Li, ‘Decentralized Mining in Centralized Pools’ (2018), at www.gsb.stanford.edu/sites/gsb/files/fin_11_19_cong. pdf. 134 ‘These are the largest Bitcoin mining farms in the world’ (1 July 2018), at www.digitaltrends.com/cooltech/largest-bitcoin-mining-farm. Mining as big business is also recognised in A Blandin, G Pieters, Y Wu, T Eisermann, A Dek, S Taylor and D Njoki, ‘3rd Global Cryptoasset Benchmarking Study’ (2020), at www.jbs. cam.ac.uk/wp-content/uploads/2020/09/2020-ccaf-3rd-global-cryptoasset-benchmarking-study.pdf. 135 A Walch, ‘In Cod(ers) We Trust’ in I Lianos, P Hacker, S Eich and G Dimitropoulos (eds), Regulating Blockchain (OUP, 2019) ch 3. 136 ‘A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.’ See Mothew (T/A Stapley & Co) v Bristol and West Building Society [1996] EWCA Civ 533. See also G Virgo, Principles of Equity and Trust, 2nd edn (OUP, 2016) 15.1; M Conaglen, The Nature and Function of Fiduciary Loyalty (2005) 121 Law Quarterly Review 452.

220  Regulating the Monetary Order of the Crypto Economy between the business registration regulator and the Payment Systems Regulator. In this manner, the economic structuration novelties posed by the crypto-economic space has implications for institutional regrouping as well.

IV.  Regulating Key Payment Service Providers – Wallets and Custodial Services Providers The rise of third-party service providers in the crypto economy is an illustration of the limitations of a peer-to-peer ethos in commerce. For example, wallet services are crucial in the payment systems of permissionless blockchains as users essentially have to securely store their private cryptocurrency, which is a digital string of data. Further, cryptocurrency exchanges provide the crucial service of allowing users to access private cryptocurrency systems by exchanging fiat for private cryptocurrency. The regulatory agenda needs to address private cryptocurrency service providers in terms of responsibilities for their services and how they facilitate crypto economy activities. Wallet providers safekeep the cryptocurrency and cryptoassets belonging to holders. Wallets are addresses for private safe-keeping purposes, initiations of transfer and recording of receipt. They provide a portal for initiating cryptocurrency transactions or cryptoasset transfers, and keep record of balances and rights to them. Cryptocurrency and cryptoassets (collectively called ‘tokens’ herein) are intangible in nature and wallets provide proof of and accessibility to the rights one has over tokens recorded in the wallet. Wallets provide users with first, a private key for holders so that only they can unlock the wallets. Based on the private key, wallets are able to generate the public key for token-holders whenever they wish to send an address to others who intend to transfer tokens to them. The public key bears a relationship to the private key and is conceptually similar to the address of a mailbox that belongs to a person and is an address broadcast to the world. In this manner, the private key can be thought of as the householder’s key to his/her mailbox which entitles the householder to access mail received. As tokens are intangible goods, the private key is as good as the right to the tokens themselves. Loss of private keys would mean the loss of the ability to access tokens kept at the address, and is tantamount to the loss of the tokens as such. Private keys are usually extremely long strings of alphanumeric characters that bear a relation to their respective public keys in cryptographic terms.137

A.  Types of Wallets There are different types of wallet services for different purposes. Some wallets are multicurrency while there may be bitcoin-only or ether-only wallets that support these two major private cryptocurrencies. One, cryptocurrency exchanges offer wallet accounts, in order for users to easily exchange fiat currencies into private cryptocurrency and vice versa or amongst different cryptocurrencies. Cryptocurrency exchanges

137 See

crypto.stackexchange.com/questions/12378/what-exactly-is-inside-a-private-key.

Regulating Key Payment Service Providers  221 may act as dealers, such as Coinbase in relation to the popular cryptocurrencies of Bitcoin, Bitcoin Cash, Ether, Litecoin, etc. Coinbase also provides marketplaces for other private cryptocurrencies and cryptoassets, ie that they do not act as dealer but facilitate exchange amongst users. As cryptocurrency exchanges attract network effects and is a natural location for wallets, they are also popular targets for cybertheft. A well-known episode of an exchange hack that left it insolvent was Mt Gox in early 2014.138 All 850,000 bitcoins held in custody at Mt Gox were stolen, worth US $473 million at the time. Binance, another popular exchange based in Taiwan and Japan, also suffered a security breach in 2019 and lost two per cent of its bitcoin held for customers in ‘hot wallets’.139 A ‘hot wallet’ is connected to the internet and therefore facilitates transactions quickly and easily, but is less secure as it is exposed to cyberhacking. Cryptocurrency exchanges face the dilemma of having to keep users’ wallet accounts safe while facilitating transactions with ease. Many cryptocurrency exchanges implement various types of custodial services in hot and offline wallets known as ‘cold wallets’ that are not exposed to the internet. The amount of cryptocurrency or cryptoassets in hot wallets are generally kept to a minimum in order to facilitate liquidity, but exchanges largely implement cold wallets for custodial purposes. Some cryptocurrency exchanges even require multiple signatures to authorise transactions in order to enhance security.140 Cryptocurrency exchanges have become highly competitive in this area, and have invested in greater security screening, governance and the provision of voluntary compensation funds to repay affected customers.141 However, the fact that they are a natural focal point for custodial services and that they manage customers’ private keys are important for us to consider the extension of appropriate regulatory oversight in the interests of customer protection. In many respects, cryptocurrency exchanges’ functions are similar to bank custodial services142 as well as brokerage services. For the purposes of peer-to-peer transactions on permissionless blockchains, users would benefit from having their own wallet accounts on standalone desktop and mobile applications in order to be in control of their private keys.143 These accounts are usually ‘hot wallets’ as they are meant to provide an address to the relevant blockchain network in order to effect transactions. However, greater security for users may be achieved by virtue of their decentralised nature – that users remain fully in control and the wallet provider does not keep private keys and are less susceptible to focused cyberhacking. There are dedicated bitcoin wallet providers such as Mycelium144 and Samourai.145 138 ‘Inside the Bizarre Upside-Down Bankruptcy Of Mt. Gox’ (22 March 2018), at https://www.theverge. com/2018/3/22/17151430/bankruptcy-mt-gox-liabilities-bitcoin. 139 ‘Hackers Steal $40 Million Worth of Bitcoin From Binance Exchange’ (8 May 2019), at www.bloomberg. com/news/articles/2019-05-08/crypto-exchange-giant-binance-reports-a-hack-of-7-000-bitcoin. 140 ‘The Safest Exchanges in the World’, at www.cryptimi.com/exchanges/exchanges-with-the-best-wallets. 141 ‘Binance offers full refund after $40m hack’ (8 May 2019), at www.asiatimes.com/2019/05/article/binanceoffers-full-refund-after-40m-hack. 142 KV Tu and MW Meredith, ‘Rethinking Virtual Currency Regulation in the Bitcoin Age’ (2015) 90 Washington Law Review 271. 143 C Gola and A Caponera, ‘Policy Issues on Crypto-assets’ (2019), at dx.doi.org/10.25428/2532-554X/7. 144 wallet.mycelium.com/index.html. 145 samouraiwallet.com.

222  Regulating the Monetary Order of the Crypto Economy Greenaddress.it offers specific security measures to mitigate the risks of exposure for hot wallets by generating a new address for each user transaction so that users’ trails and information would not be easily discerned on the internet.146 MyEtherWallet147 is dedicated to ether transactions, and urges users to generate new QR codes for their public and private keys after each transaction for security purposes.148 Multicurrency wallets like Breadwallet,149 Coinomi150 and Lumi151 provide support for a range of popular private cryptocurrencies. Wallet services have innovated significantly to address user security, but it remains uncertain what responsibilities providers have towards users in terms of user compromise or loss of keys, as contractual limitations abound.152 Moreover a number of these services also provide financial dashboard services to help users manage their crypto and real finances, and some also provide exchange services with fiat currencies.153 These different services should attract different considerations in relation to customer protection and appropriate standards of conduct. Finally, users can purchase offline storage devices for cryptocurrency or cryptoassets, in the form of hardware. Ledger Nano154 and Trezor155 provide hardware devices specifically designed for downloading and storing cryptocurrency or cryptoassets offline, and provide screen-based interfaces for users to easily monitor their balances. These can help users ensure safety from cyberhacking, but users need to keep the hardware safe and its access secure. Since these hardware wallets are physical goods and services, relevant issues pertinent to them may be governed by commercial sales law, such as relating to fitness for purpose, warranties and recovery procedures should the hardware fail. Hardware wallet suppliers provide a recovery seed when the hardware is set up, which is usually a list of 12, 18 or 24 words that store all the information needed to recover the wallet. It is however users’ responsibility to ensure that the recovery seed is written down accurately and safely kept. Offline storage devices provide less convenience if users wish to trade frequently. Offline wallets are developing innovation in order to provide easier and more convenient access, such as interfaces with trading or other financial dApps.156 In this manner, new issues may arise in terms of their accessibility and security features, meeting user protection needs. They may not be used exclusively for user storage but will likely complement one or more of the types of hot wallet services described above. The EU Commission has proposed a regulatory regime for cryptoasset service providers, including for custodial services.157 The inspiration is drawn largely from 146 greenaddress.it/en. 147 www.myetherwallet.com. 148 ‘Guide on Ethereum Wallets: Mobile, Web, Desktop, Hardware’, at cointelegraph.com/ethereum-forbeginners/ethereum-wallets. 149 brd.com. 150 www.coinomi.com/en. 151 lumiwallet.com. 152 For example, brd.com/terms, where responsibility is disclaimed even for errors and inaccuracies relating to the core services; edge.app/terms-of-service, where it is explicitly stated that users are responsible for their accounts and loss of access is not the wallet provider’s responsibility. The usual disclaimers regarding the reliability of the service also feature. 153 Such as offered by Edge: edge.app. 154 www.ledger.com. 155 trezor.io. 156 Such as Ledger’s partnership with Compound Finance: compound.finance. 157 European Commission Proposal 2020, above.

Regulating Key Payment Service Providers  223 the regulation of investment firms in relation to custody of client assets.158 This chapter, however, argues that the regime for cryptoasset service providers may be flawed as the umbrella term ‘service providers’ capture different types of services, and imposing common prudential or conduct of business regulations on them may be inappropriate. Although custodial services enjoy some dedicated treatment in the proposed regulation, they are also subject to generally applicable umbrella provisions. The proposal below is arguably more tailored, and cater for the needs of wallet users who not only use them for cryptoassets in the investment sense, as envisaged by the Commission’s proposal, but also for safekeeping cryptocurrency for payment and transfer purposes. The below argues that wallet providers should be subject to a regulatory blueprint comprising of the following aspects: (a) appropriate customer protection standards; and (b) prevention of money laundering.

B.  Customer Protection Existing financial sector intermediaries are highly regulated in terms of customer protection because of their positions of control and trust vis a vis customers. Their control over customers’ monies and assets is regulated by the statutory trust rule under the Markets in Financial Instruments Directive. This rule mandates best practices in segregating client monies and assets and the limited use of title transfer collateral clauses.159 Further, financial intermediaries’ positions of power and trust have entailed regulation in relation to conflict-of-interest management,160 communications,161 advisory162 and execution duties.163 Specific duties for payment services providers in relation to authentication, service standards and risk allocation have also been earlier discussed. It has been argued that similar functions performed by service providers in the crypto economy should be regulated similarly.164 Haentjens et al165 survey a range of different contractual practices amongst wallet providers and cryptocurrency exchanges and find that some exchanges may characterise their arrangements with customers as more ‘contractual’ rather than ‘custodial’ in nature, in relevant legal documentation. Some cryptocurrency exchanges record customers’ rights to cryptocurrency in pooled and not segregated addresses, and may control their private keys. Where exchanges control the private keys to users’ tokens, they can use the rights attached to tokens in a proprietary manner and this creates uncertainty as to customers’ proprietary rights. In an episode involving the Steemit community, three exchanges – Binance, 158 Art 16(8), Markets in Financial Instruments Directive 2014/59/EU, above. 159 Art 16(8) EU Markets in Financial Instruments Directive (MiFID, 2014), FCA Handbook CASS 7. 160 Art 23, MiFID 2014, FCA Handbook SYSC 10. 161 Art  27, MiFID 2014, Arts  44, 46, 47, 49, MiFID Commission Delegated Regulation 2017/565; FCA Handbook COBS 4.1. 162 Art  25(2), MiFID 2014; Art  54, MiFID Commission Delegated Regulation 2017/565; FCA Handbook COBS 9 and 9A. 163 Art 27, MiFID 2014, Arts 64–66, MiFID Commission Delegated Regulation 2017/565, FCA Handbook COBS 11.2, 11.2A, 2B for non-MiFID and MiFID business. 164 The ‘same risks same rules’ principle advocated in Expert Group on Regulatory Obstacles to Financial Innovation (ROFIEG), ‘30 Recommendations On Regulation, Innovation and Finance’ (December 2019). 165 M Haentjens, T de Graaf and I Kokorin, ‘The Failed Hopes of Disintermediation: Crypto-custodian Insolvency, Legal Risks and How to Avoid Them’ (2020), at ssrn.com/abstract=3589381.

224  Regulating the Monetary Order of the Crypto Economy Huobi and Poloniex – purportedly staked their users’ tokens under their custody to support a hard fork proposed by controlling Steem token-holders linked to Justin Sun.166 Although the exchanges reversed their decisions subsequently, it is queried if this is behaviour expected by users, and whether regulatory frameworks are necessary to clarify, standardise and regulate custodial arrangements and their governance implications. It may be argued that as exchanges provide access to token-holders’ rights over their tokens, they are not in the same custodial position as over conventional monies and assets. However, it can be argued that control over private keys, which is as good as control over the rights to tokens, should be regarded as proprietary in nature, hence giving rise to a custodial relationship with customers. Indeed, in the New Zealand case of Ruscoe & Moore and Ors v Cryptopia (in liquidation), the judge had no hesitation in holding that cryptoassets are a species of personal property and that the relationship between the insolvent exchange and users is that of a trust.167 In light of the legal uncertainties of contractual governance between users and cryptocurrency exchanges,168 regulators should consider whether custodial functions should be subject to the statutory trust rule imposed under the EU Markets in Financial Instruments Directive 2014. It may be argued that such a rule imposes cost on exchanges that provide customers with wallets and the cost could be passed onto customers, affecting their ease of access to transactions. However, such a rule provides greater certainty in customer protection and standardises user expectations in relation to wallet providers that are able to control users’ private keys. Can it then be argued that decentralised wallets should attract less customer protection regulation as they provide apps that customers operate independently and therefore seem remote from positions of control or trust? Customers are in control of their private keys and the keys are not in wallet providers’ custody. It is arguable that these wallet providers, many of them small businesses in comparison to established cryptocurrency exchanges, should not be subject to the custodial ‘gold standard’ discussed above. However, aspects of customer protection can be improved. Many wallet applications are mobile phone applications, easily downloadable from application stores. They provide a user interface for users to send and receive tokens, and generate the private–public key pair for users to interact on permissionless blockchains. Users are given a recovery phrase at set-up and remain completely responsible for accessing the wallet. It is typical of wallet apps to disclaim legal liability for users’ loss of passwords and inability to access the wallet,169 and even for malfunctions, security issues, and any other reasons for loss of access. Users typically also accept a legal term that makes the user responsible for all relevant legal compliance and that the wallet is not responsible for this.

166 ‘Binance Reverses Vote in Apparent Steem Takeover’ (3 March 2020), at cointelegraph.com/news/ binance-reverses-vote-in-apparent-steem-takeover-steemit-comms-head-resigns. 167 [2020] NZHC 728. 168 L Gullifer, H Chong and H Liu, ‘Client-Intermediary Relations in the Crypto-Asset World’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3697946. 169 ‘Crypto User Loses Over $100K in Bitcoin While Transferring His Wallet’ (9 January 2021), at news. bitcoin.com/crypto-user-loses-over-100k-in-bitcoin-while-transferring-his-wallet.

Regulating Key Payment Service Providers  225 Based on existing market practice, the contractual limitations in favour of decentralised wallet providers are extensive.170 It is queried if such disclaimers are justified and whether regulatory standards can provide a better balance for customers. It would not be unreasonable to impose on decentralised wallet providers a duty to maintain the user interface against unexpected or unreasonable error, as this is the essence of what they provide. For example, users of wallets have experienced ‘loss’ of incoming transfers or unauthorised transfers out of their wallets.171 However, it may be argued that many of these wallets are free to download, hence attaching regulatory obligations to these may result in the passing on of cost to customers. Further, it may be in customers’ interests that regulators impose obligations on wallet providers, whether on an exchange or decentralised, to maintain certain service standards and business continuity.172 Service standards may include reasonable access to wallets, no undue interruption in service times and contingent plans for business continuity if attack incidents occur. There is also the issue of whether the security standards173 that wallet providers need to institute should be standardised or qualitatively mandated? With technological innovation it may be challenging to be prescriptive about what cybersecurity standards should be implemented. However, setting a broad benchmark can induce market development towards optimal solutions. Regulators can also consider whether there should be rules regarding compensation for cyber theft, such as mandatory insurance174 or the provision of a compensation fund.175 Cyber hacking is rife in the crypto space, and not all loopholes in code can be closed to desist the determined smart hacker.176 In this regard, the allocation of responsibility provisions applicable in payment services regulation can provide some inspiration for a regulatory blueprint. Payment account providers have to reimburse users in case of unauthorised use,177 but this is imposed under the Payment Services Directive largely in view of the unequal bargaining power between banks and retail customers and the well-resourced profile of most banks. It is arguable that many cryptocurrency exchanges stand in a similar position vis a vis their customers.178 However, would such a standard for allocation of loss be onerous for decentralised wallet service providers? Regulators also need to find out if market practices are competitive in these

170 See n 152. 171 See www.reddit.com/r/Bitcoin/comments/1d0155/a_brief_analysis_of_the_security_of. 172 Solitopoulou and Ligot (2019). 173 Standards such as International Organization for Standardization (ISO) or the National Institute of Standards and Technology (NIST) ones, see SW Rae and L Mastersmith, ‘Crypto Asset Trading in Canada: Entering a New Era of Regulation’ (2019) 35 Banking and Finance Law Review 153. 174 ibid. 175 Such as Binance’s fund that was used to compensate affected customers after the 2019 hack. 176 Such as the attack on Uniswap, a decentralised exchange in April 2020 which lost almost US $1.1 million; see ‘Hackers steal $25 million worth of cryptocurrency from Uniswap and Lendf.me’ (19 April 2020), at www. zdnet.com/article/hackers-steal-25-million-worth-of-cryptocurrency-from-uniswap-and-lendf-me. 177 Arts 73, 74, EU Payment Services Directive 2015 on full refunds for unauthorised use and capped refund less 50 euros in case the customer was simply negligent. 178 SJ Hughes and ST Middlebrook, ‘Advancing a Framework for Regulating Cryptocurrency Payment Intermediaries’ (2015) 32 Yale Journal on Regulation 295 argues that the payment regulations standards in Art 4A, UCC should apply to cryptocurrency payment providers.

226  Regulating the Monetary Order of the Crypto Economy areas and whether regulatory standardisation is likely to achieve benefits and overcome market failures. It is queried whether regulatory burdens for customer protection would merely drive innovative small businesses in wallet application development out of business and pave the way for existing players such as PayPal,179 banking institutions180 and credit card providers such as Visa181 to dominate in wallet service provision. Mainstream financial institutions are increasingly interested in bringing crypto finance to the conventional economy. On the one hand, these institutions are already regulated financial services intermediaries and may be in a better position to protect customers. However, chapter seven warns regulators not to ‘sleepwalk’ into their regulated entities undertaking new activities. Particular risks in relation to crypto financial activity should be subject to regulatory review and the consideration of appropriate regulatory governance. Further, the competition position in this landscape should be reviewed in order to ensure that customers benefit from choice but not a race to the bottom in relation to reasonable protective expectations. It is observed that wallet providers may diversify into providing other ‘financialtype’ services for customers, such as currency conversion services182 which effectively means that the decentralised wallet service provider is also a currency broker or brokerdealer. Some wallet service providers offer dedicated channels to buy or sell tokens with specific third-party cryptocurrency exchanges.183 Any conflict of interests in such processes would be opaque and it is arguably in customers’ interests to have accountability of wallet providers’ relationships with third parties. Further, wallet providers such as Argent184 are integrating with DeFi applications in order to help holders of tokens manage their finances and yield. Regulators need to be mindful of new ways of service bundling or integration in the crypto economy that exacerbate challenges for financial regulators who are used to sectoral delineations in types of financial services offered. Should execution obligations (such as best execution for retail customers) be imposed on brokerage-like functions?185 Wallet providers who provide such dealer services can be in a position of conflicts of interest with customers. Hence, general conflicts of interest management regulation can be relevant to their broker-like functions.186 If services are provided so that customers are recommended to make investments with their cryptocurrency or assets, it needs to be considered if existing regulatory duties 179 ‘PayPal’s Crypto Products Coming to the UK in Months’ (11 February 2021), at www.coindesk.com/ paypals-crypto-products-coming-to-the-uk-in-months. 180 ‘US Banks Can Now Offer Crypto Custody Services’ (23 July 2020), at www.infosecurity-magazine.com/ news/us-banks-can-now-offer-crypto. 181 ‘Visa Reveals Bitcoin And Crypto Banking Roadmap Amid Race To Reach Network Of 70 Million’ (3 February 2021), at www.forbes.com/sites/billybambrough/2021/02/03/visa-reveals-bitcoin-and-cryptobanking-roadmap-amid-race-to-reach-network-of-70-million/?sh=13916ee4401c. 182 Edge, Breadwallet for example. 183 For eg Coinomi’s dedicated routing to Simplex to buy or sell cryptocurrencies, Metamask routes these orders to Coinbase. 184 www.argent.xyz. 185 Art 27, MiFID 2014, Arts 64-66, MiFID Commission Delegated Regulation 2017/565, FCA Handbook COBS 11.2, 11.2A, 2B for non-MiFID and MiFID business. 186 Art 23, MiFID 2014; Art 33, MiFID Commission Delegated Regulation 2017/565; FCA Handbook SYSC 10.1.4-5.

Regulating Key Payment Service Providers  227 on communications187 and advice188 should be extended or adjusted. In particular, should conflicts of interest be permitted in advisory functions, ie where advisory entities may be entitled to commissions in relation to customers’ investment decisions?189 Where service providers rely on artificial intelligence to provide analytical insights for customers, it needs to be ascertained if advisory duties can be attracted and under what circumstances.190 Regulators should also consider if contractual exclusion of advisory duties is allowed,191 and how such a duty could arise. In other words, although wallet providers prima facie appear to be part of the payment services regulatory landscape, there is significant potential for financial business integration. In this manner, regulatory agendas and supervision need to be integrated as well. More consideration of crypto finance and regulatory needs are explored in chapter seven.

C.  Anti-money Laundering Conventional systems of payment regulation are highly intertwined with anti-money laundering compliance as payment systems are an obvious channel for illicit moneys to be transferred and layered.192 As private cryptocurrency has become a means for money laundering,193 should anti-money laundering regulation be applied to wallet providers? In relation to cryptocurrency exchanges, users who wish to open wallet accounts are akin to customers of bank or financial institutions, in light of the custodial functions that they assume. As conventional financial institutions are subject to due diligence requirements for customers at initiation of relationship,194 on an ongoing basis,195 and enhanced due diligence for perceived higher risk transactions,196 jurisdictions197 187 Art 24(3)–(5); 27, MiFID 2014, Arts 44, 46, 47, 49, MiFID Commission Delegated Regulation 2017/565; FCA Handbook COBS 4.1 188 Art 9, MiFID Commission Delegated Regulation 2017/565; FCA Handbook COBS 9A.2.2–3 for a rather wide scope of dealings, COBS 9.1 for non-MiFID retail business. 189 Such as commissions from product providers. The UK bans product provider commissions for investment advisers, FCA Handbook COBS 6.1A. 190 Robo-advisers generally need to be designed in adherence to the same advisory duties; FCA’s Advice Unit at www.fca.org.uk/firms/advice-unit. 191 Available against sophisticated counterparties, such as discussed in JP Morgan Chase Bank (formerly known as The Chase Manhattan Bank) (a body corporate) and Others v Springwell Navigation Corporation (a body corporate) and by Counterclaim Springwell Navigation Corporation (a body corporate) v JP Morgan Chase Bank (formerly known as The Chase Manhattan Bank) (a body corporate) and Others [2008] EWHC 1186 (Comm), also discussed critically in C Band, ‘Selling Complex Financial Products to Sophisticated Clients: JP Morgan Chase v Springwell: Part  1’ (2009) 24 Journal of International Banking Law and Regulation 71; Murphy v HSBC Bank plc [2004] All ER (D) 211. For a more recent case, the contractual modification by an investment bank to owe only a duty not to engage in gross negligence was upheld, see Camarata Property v Credit Suisse [2011] EWHC 479. 192 F Schneider and U Windischbauer, ‘Money Laundering: Some Facts’ (2008) 26 European Journal of Law and Economics 387. 193 eg ‘Liberty Reserve digital cash chief jailed for 20 years’ (BBC News, 9 May 2016), at www.bbc.co.uk/ news/technology-36247289. 194 Art 11, EU Anti-money Laundering Directive 2015; Money Laundering Regulations 2017, reg 27. 195 Arts 13, 14, EU Anti-money Laundering Directive 2015; Money Laundering Regulations 2017, reg 30. 196 Money Laundering Regulations 2017, reg 33. 197 Defined in Commission Delegated Regulation (EU) 2016/1675 of 14 July 2016 supplementing Directive (EU) 2015/849 of the European Parliament and of the Council by identifying high-risk third countries with strategic deficiencies.

228  Regulating the Monetary Order of the Crypto Economy or persons,198 it is warranted that exchanges that offer wallet accounts should similarly adhere to these standards.199 The intermediation roles played by conventional financial institutions allow them to monitor trails of monies and assets in order to spot suspicious transactions. They are thus subject to governance requirements for monitoring and identifying such transactions in order to investigate them,200 as well as to external reporting to regulators.201 It is arguable that exchanges are placed in a similar position and should be subject to similar governance requirements and suspicious transactions reporting. Indeed, the EU Anti-Money Laundering Directive 2019 requires cryptocurrency exchanges and ‘custodian wallet providers’ to be subject to the requirements above.202 Custodian wallet providers are however limited to wallet providers that control the private keys of holders, as in the case of many exchange wallet accounts. In this manner, decentralised wallet accounts controlled by users and hardware wallets are not covered. It may be argued that such application of regulation is proportionate as third-party service providers can only be effective gatekeepers against money laundering if they have some form of control, over information as well as intermediation. If their business model does not involve such control, they are not well placed to be gatekeepers in anti-money laundering, and obligations imposed can be onerous. However, wallet providers may be incentivised to design their services to appeal to privacy for wallet holders, while minimising their chances of being captured by the EU regulation. Many wallet applications are downloadable on a mobile phone and there is often no registration process needed for installation of the application. However, wallet application providers do provide a user interface for initiating transactions and receipt of cryptocurrency or cryptoassets. Some application interfaces contain a history of transactions as well. In this manner, many wallet applications do provide server services to host user information, and it is queried whether they should be subject to an extent of gatekeeping obligations in anti-money laundering. It should also be carefully considered whether proportionate point-of-sale checks should be required for decentralised wallet providers too, just as such requirements have been introduced for sale of alcohol, tobacco, knives and even bleach.203 However, it may be argued that decentralised wallets provide only minimal levels of services. Crucial services such as cryptocurrency exchange would be performed by a different third-party, even if the wallet provider directs users to such third parties. In this way, if users of decentralised wallets necessarily interface with a cryptocurrency

198 Such as politically exposed persons, Arts 18–23, EU Anti-money Laundering Directive 2015. 199 A Solitopoulou and S Ligot, ‘Legal Challenges of Cryptocurrencies: Isn’t It Time to Regulate the Intermediaries?’ (2019) 5 European Company and Financial Law Review 652. The extension of anti-money laundering regulation has indeed been achieved in many countries, including the UK and EU, the US, Singapore, Switzerland etc, as discussed in ch 3. 200 Largely to be found in FCA Handbook SYSC 6. The need for adequate policies and control is also stated in Art 46, EU Anti-money Laundering Directive 2015. 201 Proceeds of Crime Act 2002, s 330. 202 Art 2 of the EU Anti-money Laundering Directive 2015 as amended in 2018, Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU. 203 Control of Poisons and Explosives Precursors Regulations 2015, on control of underage sales. Bleach was included as a spate of acid-splashing attacks were reported in London.

Regulating Key Payment Service Providers  229 exchange for their transactions at some point,204 it is arguable that imposing antimoney laundering obligations on exchanges is sufficient. Can we treat decentralised wallet providers are sufficiently ‘downstream’ so that regulatory coverage is not necessary for them in order to meet the regulatory objective of preventing financial crime? This is premised on the assumption that cryptocurrency exchanges are a focal point where convergence of users’ transactions would take place. If users however engage exclusively in peer-to-peer cryptocurrency or cryptoasset transfers, or trade on completely decentralised exchanges, using their decentralised wallets, it is possible for these transactions to be outside of the gatekeeping and supervisory purview of the EU Directive.205 Marian206 proposes an incentive-based regulatory regime to combat pseudonymity in cryptocurrency transactions so as to improve the identification of transaction trails and anti-money laundering efforts. It is proposed that a tax be levied for pseudonymous transactions, and such a tax should be collected by commercial entities such as blockchain-based businesses and intermediaries that facilitate such transactions. In this manner, wallet services, whether based on an exchange or decentralised, would be caught within the scope of this regime. The waiver of pseudonymity allows users to be exempt from the tax. Such a proposal would attract more record-keeping obligations for businesses and service providers in the crypto economy, but it may be argued that information protocols can be coded relatively easily in smart contracts. The tax collected could also be used to subsidise extra cost incurred by crypto economy businesses and service providers. The advantage of this proposal is that it is incentive-based and allows crypto economy users to make a calculated decision. Regulators can monitor if changes occur in the state of opacity in the crypto economy in order to determine if further measures are needed.

D.  Rise of Non-fungible Token Custody Providers? With the rise in popularity of sales of non-fungible tokens (NFTs), usually coded based on the ERC-721 or ERC-155 templates, the crypto economy is catering for demand in representations of ownership rights to unique virtual goods. A high-value market in NFTs is most noticeably growing in relation to digital art.207 NFT intermediaries such as auction brokers need to consider user protection in the face of possible attacks that may undermine users’ rights over such expensive assets. Nifty Gateway has experienced a cyberhack that resulted in users’ payment information being stolen and used in an

204 See D Dupius and K Gleason, ‘Money Laundering with Cryptocurrency: Open Doors and the Regulatory Dialectic’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3681297, arguing that anti-money laundering obligations for cryptocurrency exchanges are quite robust and evasion tactics such as privacy coins or decentralised exchanges have their drawbacks. However, peer-to-peer transactions present a significant risk. 205 Dupius and Gleason (2020). 206 O Marian, ‘A Conceptual Framework for the Regulation of Cryptocurrencies’ (2015) 82 University of Chicago Law Review 53. 207 ‘NFTs Boom as Collectors Shell Out to “Own” Digital Art’ (27 February 2021), at www.wired.com/story/ nfts-boom-collectors-shell-out-crypto.

230  Regulating the Monetary Order of the Crypto Economy unauthorised manner to purchase NFTs.208 NFTs also need to be safekept by custodial services providers, and these service providers may provide a service similar to a wallet provider but there are arguably a few needs differences on the part of NFT holders. Where NFTs are of high value, it is queried if contractual governance for user security alone may be sufficient, and whether user protection would demand other more robust standards. It is also questioned if there is a case for NFT custodial providers to be subject to unique standards of prudential regulation in order to ensure that risk and losses can be managed prudently and absorbed adequately. It also remains uncertain to what extent NFT custodial providers need to provide for unique transactional interfaces besides facilitating the trading or transferring of the token. If the NFT’s public address may be used for other purposes, for example, ‘proof ’ purposes for exhibition curations, or renting of rights, how should custodial services providers facilitate these in a manner that is safe and robust for token-holders? NFT custodial providers may be derived from more ‘financially focused’ wallet providers, but may also become more sectorally defined.209 For example, Trustology is a cryptocurrency and asset wallet provider branching into NFT custody.210 The business model of the custodial service provider can include financial functions such as payment and other functions facilitating cryptoassets as financial assets. Such a business model can coexist with non-financial functions over assets too, as the commodification of digital art raises the question how such NFT assets should be characterized – as financialisable assets or virtual goods capable of financial deployment? In such a dynamic landscape, there are limits to the financial regulation of service intermediaries and custodial services providers, and the more holistic regulation for user protection would need to be considered. It is arguable that the main regulatory aspects of customer protection and anti-money laundering remain common needs and are a starting point. However, regulators should be prepared to engage with unique new needs, issues and regulatory characterisation altogether.

V.  Regulating Cryptocurrency Exchanges The cryptocurrency exchange has arisen in importance in the purportedly disintermediated crypto economy. It can facilitate trading in and out of private cryptocurrencies and cryptoassets for other cryptocurrency or fiat currencies. The cryptocurrency exchange may also be the first port of call for anyone who is contemplating participating in the crypto economy for the first time, as one may not be able to obtain cryptocurrency by mining. As the cryptocurrency exchange has become a major point of interface for many participants of the crypto economy, it can be seen as a natural subject of regulation, in order to meet various regulatory objectives – from

208 ‘Lessons From the Nifty Gateway NFT Heist: Not Your Keys, Not Your Art’ (17 March 2021), at www. coindesk.com/nifty-gateway-nft-hack-lessons. 209 eg ‘Hex Trust Launches Licensed Custody Service for Non-Fungible Tokens’ (3 March 2021), at www. coindesk.com/hex-trust-launches-licenced-custody-service-for-non-fungible-tokens. 210 www.trustology.io.

Regulating Cryptocurrency Exchanges  231 securing the integrity of the crypto economy to securing appropriate business standards for customer protection.211 Canada has, for example, subjected cryptocurrency exchanges to its existing regulatory regime for securities markets. There is also opinion in the EU that exchanges can fall within the Markets in Financial Instruments regulatory regime for trading markets,212 but this would be overtaken by the Commission’s proposals to regulate cryptocurrency exchanges. In Canada, a guidance has been issued in early 2020 to treat many cryptocurrency and cryptoasset exchanges as equivalent to securities trading markets for the purposes of regulatory oversight.213 First, we examine the approach that treats cryptocurrency exchanges as a species of securities trading markets so that regulatory arbitrage is not encouraged. Next, we examine a range of tailor-made regulatory regimes, including the Commission’s regulatory proposals to regulate cryptoassets service providers, which include cryptocurrency exchanges.

A.  Coherentist Extension of Securities Markets Regulation? Securities markets regulation can be extended to marketplaces that allow trade in securities tokens, ie cryptoassets characterised as securities anyway. This is the approach taken in the US, UK, Singapore and Switzerland. Such an approach is not the same as extending the wholesale application of securities markets regulation to cryptocurrency exchanges, as exchanges trading in utility tokens and cryptocurrency not characterised as securities would unlikely be treated as markets for securities tokens. In Canada, guidance issued in early 2020214 clarifies that trading venues for cryptoassets that are securities or derivatives are subject to securities markets regulation. The Canadian guidance only exempts trading platforms from being regarded as securities markets if the cryptoassets traded are not securities, derivatives or contracts to purchase, and if the trade results in immediate delivery of the cryptoasset to its intended recipient without further intermediation on the part of the market. The latter requires that the market operator has transferred ownership, possession and control of the cryptoasset to the user and has no further involvement. The application of this condition means that, if a wide interpretation of securities, derivatives or futures contracts is taken, many cryptocurrency exchanges that offer wallets for users and are in possession of their private keys would not fulfil the conditions for exemption. The implication 211 Market regulation is often seen as essential for achieving the governance of commons and public goods; see R Lee, ‘Regulation and Governance of Market Infrastructure: Global Perspective’ in Running the World’s Markets (Princeton University Press, 2011) ch 4; A Rechtschaffen, Capital Markets, Derivatives and the Law (OUP, 2009) ch 9; AG Balmer, Regulating Financial Derivatives (Edward Elgar, 2018) chs 4–8. For contrary views see SG Lazzarini and P Carvalho de Mello, ‘Governmental Versus Self-Regulation of Derivative Markets: Examining the U.S. and Brazilian Experience’ (2001) 53 Journal of Economics and Business 185; MB Sundel and LG Blake, ‘Good Concept, Bad Executions: The Regulation and Self-Regulation of Automated Trading Systems in United States Futures Markets’ (1990–91) 85 Northwestern University Law Review 748. 212 Solitopoulou and Ligot (2019). 213 ‘CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets’ (16 January 2020), at www.bcsc.bc.ca/Securities_Law/Policies/Policy2/PDF/ 21-327__CSA_Staff_Notice__-_January_16__2020. 214 CSC Guidance (2020) above.

232  Regulating the Monetary Order of the Crypto Economy of the regulatory guidance is that cryptocurrency exchanges would be differentiated in regulatory terms by whether they are centralised or decentralised business models. Centralised exchanges may be treated as securities trading markets while decentralised ones may be completely unregulated. The more general question that is raised is whether the same principles and indeed rules for securities markets and trading facilities should apply to cryptocurrency exchanges because of their similar market nature, aside from the issue of whether what is being traded are securities or otherwise. IOSCO has developed some thinking on this question as it takes the view that similar hazards for users and for market integrity and stability arise in cryptocurrency exchanges as in conventional financial markets.215 In the EU, commentators216 also argue that whether or not cryptoassets are classified as securities, it is imperative to regulate these markets to the same standards as authorised ‘multilateral trading facilities’ under the EU Markets in Financial Instruments Directive 2014217 as similar needs arise for users’ protection. Users’ protection needs can be affected by how well-governed a market is. The quality of market governance affects users, such as relating to: whether business continuity is planned for and whether disruptions to service and indeed crises are well managed; whether customer assets are safeguarded; whether fair and orderly conditions such as price transparency, anti-market abuse monitoring are maintained; whether there are clear criteria for determining how and why a cryptoasset is listed; whether conflicts of interest are managed; and whether there are standards of conduct in dealing with users. Drawing from the EU’s standards in the Markets in Financial Instruments Directive and Regulation 2014 applicable to electronic trading facilities provided by investment firms, common needs for customer protection in securities trading markets and cryptocurrency exchanges are as follows: (a) Authorisation of exchanges on the basis of capital adequacy,218 the soundness of management and major shareholders,219 and the soundness of organisational, governance and control mechanisms,220 including business continuity planning221 and sound risk management.222 (b) Maintenance of robust criteria for listing instruments,223 for the membership of brokers and broker-dealers,224 the management of conflicts of interest in relation to the listing, membership and user protection roles,225 and to exercise credible discipline over members.226 215 IOSCO, ‘Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms’ (May 2019), at www.iosco.org/library/pubdocs/pdf/IOSCOPD627.pdf and ‘Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms’ (February 2020). 216 Solitopoulou and Ligot (2019), and more generally, Rae and Mastersmiths (2019). 217 Art 5(2), MiFID 2014. 218 Art 15, MiFID 2014. 219 Arts 9 and 10, MiFID 2014, and Art 13 on potential acquirers of investment firms including multilateral trading facilities. Arts 45–46 for regulated markets are more stringent, and may be excessive considering the scale of some cryptocurrency exchanges. 220 Art 16, 47, MiFID 2014. 221 ibid; Art 48, MiFID 2014. 222 Arts 16, 19, 47, MiFID 2014. 223 Art 51, MiFID 2014, as applicable to regulated markets. 224 Arts 36, 53, MiFID 2014. 225 Art 23, MiFID 2014. 226 Art 53, MiFID.

Regulating Cryptocurrency Exchanges  233 (c) Provision of transparency such as pre-trade best bids and offers to a sufficient depth,227 and post-trade information.228 (d) Provision for orderly trade execution, settlement and finality.229 (e) To monitor, keep under surveillance and manage trade orderliness such as antimarket abuse surveillance,230 the management of algorithmic high frequency traders, especially in relation to their liquidity provision roles,231 and the provision of mechanisms to deal with extreme price volatility such as circuit breakers in ‘flash crashes’.232 (f) To keep extensive records of details of financial instruments traded in order to assist regulatory authorities in their information needs for oversight and supervision for prevention of money laundering and market abuse.233 These requirements are arguably extensive, but they relate to the positions of control market operators have over the markets they operate. These requirements also reflect a balance of interests amongst different groups of users in securities market trading. It can be questioned whether a full gamut of exchange regulation should be applied to cryptocurrency exchanges. Further, it is also observed that cryptocurrency exchanges are structured in a variety of different business models along a centralised–decentralised spectrum. The EU and a number of jurisdictions discussed in chapter three have opted for a lighter approach to regulating cryptocurrency exchanges as operators of markets and in relation to user protection. These reflect policy-makers’ cognisance of the need for a proportionate approach to these new business entities. Although it may be argued that the full extent of securities market trading regulation is excessive, the proposed tailormade regimes may also suffer from under-inclusive deficits or are in a mould that is too reliant on securities market regulation. The regulatory design should arguably not be based on merely reducing from the burdens of securities market trading regulation, but on fitness with the innovative business models in this space.

B.  New Regulatory Regimes for Cryptocurrency Exchanges The EU Commission’s proposal to regulate cryptoasset exchanges comes under its umbrella provision for regulating service providers in general.234 Service providers, broadly defined, need to be subject to merit vetting for authorisation, including being formed as a legal entity in a Member State and being able to provide information on its governance, organisational and control policies. These include information regarding management and controllers in order to satisfy regulators of good repute and competence. This requirement does not necessarily fit with how cryptoasset 227 Arts 3, 8, 12–18, Markets in Financial Instruments Regulation 2014. 228 Arts 10, 21, 21, MiFIR 2014, subject to authorised deferral. 229 Art 18, 37, MiFID 2014. 230 Arts 31, 54 MiFID 2014; FCA Handbook MAR 5, 5A, 5AA. 231 Art 17, MiFID 2014; FCA Handbook MAR 7A. 232 Art 48, MiFID 2014. 233 Art 16, MiFID 2014. 234 See generally the proposed Markets in Cryptoassets Regulation (2020), at eur-lex.europa.eu/legal-content/ EN/TXT/?uri=CELEX%3A52020PC0593.

234  Regulating the Monetary Order of the Crypto Economy service providers may be organised in terms of decentralised enterprises. There are also prudential regulations applicable to service providers akin to those applicable to banking or investment firms. The Commission’s proposal provides specifically for cryptoasset exchanges, in relation to issues very similar to the list distilled from the MiFID 2014 above. In this manner, although the Commission’s proposal suggests that the authorisation for cryptoasset exchanges is a sui generis regulatory regime, this regime is not really tailor-made and highly derived from existing securities market trading regulations. Cryptoasset exchanges may be centralised or decentralised to different extents along a spectrum. The Commission’s proposal pertains to centralised trading exchanges and may miss the unique aspects of decentralised exchanges. There is room to engage more intensely with the business innovations that are being developed for crypto trading and exchange, in order to fashion appropriate regulatory governance. We discuss the centralised and decentralised business models observed in cryptoasset exchanges and offer suggestions as to what different approaches should apply. We also observe that other tailor-made regimes for cryptocurrency exchanges are more minimalist than the EU Commission’s proposal. It is queried whether the minimalist character follows from a pro-fundraising policy agenda. As chapter three has discussed, jurisdictions focused on facilitating the market for ICOs and seek to attract ICOs to them may provide for the regulation of related service providers, such as cryptocurrency exchanges. Such regulatory regimes may be relatively light in order to further the agenda for regulatory competition. The Thai regulatory regime allows cryptoassets to be offered by registered issuers and upon meeting certain conditions. In order to support the primary markets for cryptoassets, the regime also provides for the registration of digital asset exchanges. These are envisaged to meet certain minimum capital requirements and must demonstrate good organisational governance, internal control and compliance with laws especially in relation to anti-money laundering governance. The Maltese regime provides more generally for service providers, of which the virtual asset exchange is one. The standards of conduct required are similar to the Thai regime in relation to general governance and control requirements, but there is a particular imposition of custodial duties upon service providers that keep and manage customers’ assets, such as wallets, discussed above.235 It is arguable that although broadly framed in character in relation to control and governance, specific anti-money laundering obligations and custodial duties deal with the most crucial aspects of public interest and user protection. However, it is arguable that some key aspects of market governance are missing. These are in the areas of anti-market abuse surveillance,236 transparency regulation, for example, of pre-trade prices and post-trade price information237 and the management of conflicts of interests, for example in relation to relationships with issuers whose tokens are admitted to listing, wallet providers who route customers to certain exchanges. The absence of duties to maintain market conduct such as anti-market abuse surveillance is particularly

235 ch

3.

236 Arts 18,

237 Markets

19, 31, MiFID 2014; FCA Handbook MAR 5, 5A, 5AA. in Financial Instruments Regulation 2014 covers this extensively.

Regulating Cryptocurrency Exchanges  235 disconcerting as empirical research reports extensive rigging and pump-and-dump schemes on cryptocurrency exchanges,238 as well as wash trades that give the impression of high-volume trading.239 There is room to consider more specific regulatory governance for cryptoasset exchanges.

C.  Regulating Centralised and Decentralised Features of Exchanges Cryptocurrency and cryptoasset exchanges (hereinafter ‘cryptoasset exchanges’) adopt different models along a spectrum of centralisation–decentralisation. Centralised cryptoasset exchanges may feature one or more of the following characteristics: (a) acting as dealer and not just market for certain cryptoassets, particularly the more established cryptocurrencies;240 (b) acting as wrapper token issuers, in what may be regarded as an equivalent of currency conversion and ICO bundled in one;241 (c) acting as listing organiser for ICOs, although it is uncertain what such services involves, whether a full suite of advisory services are involved or otherwise;242 (d) broadcasting of real-time prices for cryptocurrencies and cryptoassets,243 although it is not certain if the broadcast price is best on the last-traded transaction or the current best offer/bid; (e) using algorithmic mechanisms to match trades, where the exchange is not acting as dealer;244 (f) offering wallet services to users associated with the trading account; and245 (g) offering services such as margin or leverage to users.246 Decentralised exchanges do not provide wallets for users, but rather facilitate their trading direct from users’ own wallets.247 Some decentralised exchanges operate protocols to match token swappers only, building upon the Ethereum blockchain so that all

238 DJ Cumming, S Johan and A Pant, ‘Regulation of the Crypto-Economy: Managing Risks, Challenges, and Regulatory Uncertainty’ (2019) 12 Journal of Risk and Financial Management 126; J Kamps and B Kleinberg, ‘To the Moon: Defining and Detecting Cryptocurrency Pump-And-Dumps’ (2018) 7 Crime Science 18. 239 LW Cong, X Li, K Tang and Y Wang, ‘Crypto Wash Trading’ (2020), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3530220. 240 Such as Coinbase, Bitfinex, Binance, which all offer dealer rates for popular cryptocurrencies into fiat currencies like the US dollar. 241 Discussed in section I above. 242 Raised in Rae and Mastersmiths (2019). 243 Most exchanges have a landing page of price information, but comparing them shows significant spreads. There is opacity as to how price discovery information is derived, eg Coinbase (www.coinbase.com), Huobi (www.huobi.vc/en-us), Binance (www.binance.com/en/markets) and Bitfinex (www.bitfinex.com/stats). 244 eg Idex (idex.market/usdc/eth). 245 eg Coinbase offers both centralised and decentralised wallet services; Bithumb (en.bithumb.com) offers centralised wallet services, also Binance. 246 eg Bithumb and Poloniex (poloniex.com/lending#BTC) have lending services; Binance and Huobi provide margin services. 247 eg Paradex (app.paradex.io), which allows peer-to-peer trading of ERC tokens. Paradex was acquired by Coinbase in May 2018 as part of the expansion and diversification of Coinbase’s business.

236  Regulating the Monetary Order of the Crypto Economy transactions are settled on-chain between parties directly and verified by general mining protocols.248 However, other decentralised exchanges may provide some semblance of centralised services as a number of decentralised exchanges act as market makers for certain cryptocurrencies and quote prices for cryptocurrency pairs.249,250 An important and growing decentralised exchange is the liquidity pool model where users contribute their tokens to a pool by swapping their tokens for the exchange’s token at published prices maintained by algorithmic protocols.251 The liquidity pool facilitates more efficient token-swapping than in conditions of pure barter. One of the most popular decentralised exchanges is Uniswap, which provides an automated liquidity protocol to incentivise participants to contribute tokens to a pool in return for a percentage share of the pool’s trading fees. An exchange protocol also runs to match token-swapping contracts.252 Decentralised exchanges have been involved in constant innovation such as facilitating liquidity pools, governed by users in a decentralised manner, in order to provide both convenience and speed that centralised exchanges provide, but offering greater privacy and less public visibility.253 However, the barriers to entry for less experienced users may be quite high, and such users may prefer to look for a one-stop service provided by centralised exchanges.254 We argue that regulatory design for cryptoasset exchanges should be sensitive to the features of centralisation and decentralisation. Further, decentralised exchanges should not offer an obvious space for regulatory avoidance. Hence, this chapter proposes a functional approach to regulation based on what features are offered by exchanges, rather than an entity-based approach. Such an approach more likely keeps up with innovation. Our proposal ensures that investor protection can be achieved where exchanges are in control of certain matters that affect investors’ welfare, but such regulation should be proportionate in order not to make centralised provision of services unviable or disincentivised, as such services can be highly desirable for investors. Our proposal also ensures that decentralised exchanges are not able to skirt regulatory oversight or responsibility just because they prefer not to take control or responsibility over certain aspects of service provision. Where aspects of service are decentralised and users are left to manage for themselves, our proposal ensures that there is adequate disclosure of the processes and risks for doing so, and users can come to an informed decision as to whether to use decentralised services and what consequences there may be. In relation to services (a), (b), (d) and (e) above, centralised exchanges can offer speedy liquidity to users seeking to trade, and a convenient one-stop shop interface. But users face several hazards. First, are exchanges conflicted in their dealing with the user? Second, do users obtain a best-possible price? How are users assured that they are treated fairly when subject to exchanges’ mechanisms for queuing and matching 248 Such as Kyberswap Network (www.kyberswap.com/swap) and Radar Relay (radarrelay.com/index.html). 249 Idex, for example (idex.io). 250 Idex. 251 eg Volentix (volentix.io/#). 252 uniswap.org. 253 WA Kaal, ‘Digital Asset Markets Evolution’ (2021) Journal of Corporation Law, forthcoming, at ssrn.com/ abstract=3606663. 254 ‘Decentralized Exchanges Set To Accelerate in 2021’ (13 February 2020), at cryptonews.com/exclusives/decentralized-exchanges-set-to-accelerate-in-2021-9221.htm, expressing optimism for decentralised exchanges, but also pointing out the cons.

Regulating Cryptocurrency Exchanges  237 their orders? As identified by IOSCO,255 when exchanges act as users’ intermediaries but also as dealers, it is important for users to know how price discovery is made and how conflicts of interest are managed. Although the EU Commission’s proposal addresses the management of conflicts of interest and order execution as a general obligation for all cryptoasset service providers, there is scope for more tailored regulatory provision. For example, would requiring exchanges to make pretrade transparency of the five best bids/offers, similar to that imposed on securities markets, be desirable for users and entail efficient compliance by exchanges? The Commission’s proposal tends towards this direction but does not specify the exact depth of the pre-trade transparency that needs to be made, potentially causing concern in terms of what best practices are required. In relation to issuing wrapper tokens, centralised exchanges can be treated as issuers for wrapper tokens. Should such an issue be subject to regulatory oversight like an ICO? A wrapper token has to work as a native currency token on another blockchain, and users are purchasing an expected functionality. Should exchanges be imposed with obligations to ensure that such issues are subject to ICO regulation as discussed in chapter five, or at least a form of sales law to ensure that wrapper tokens work as intended? Further, users are also concerned as to how the centralised exchange maintains a fair or orderly trading environment.256 Centralised exchanges are the dominant players in the crypto economy at the moment and many maintain rather opaque policies in the currently unregulated environment. Users may wish to know if the exchange has any policy to monitor market abuse such as rigging and pump-and-dump incidences. Securities and conventional financial markets are subject to a regulatory duty to conduct market surveillance, monitoring and to report to regulators if suspicious activities are discovered.257 As market abuse is a known problem on many cryptoasset exchanges, there may be a case for exchange operators to institute such mechanisms and subject them to proper governance and oversight. Indeed, such market monitoring can also be algorithmically programmed and may not be an onerous investment for cryptoasset exchange operators. It is also queried if market manipulative schemes can arise in a decentralised context such as the liquidity pool. Manipulators could raise or squeeze volumes of token contributions to pools to affect the algorithmic adjustment of prices for contributors. Should some form of oversight obligation be imposed on pool operators or be required to be algorithmically programmed? Commentators have found that Uniswap’s pools of liquidity are generally deep and pricing protocols are robust to produce a market generally without arbitrage.258 However, they warn that liquidity pools that are smaller can be more easily manipulated by small pricing changes. IOSCO and the EU are concerned that centralised exchanges need to maintain a policy for managing service disruptions, downtimes and business continuity, especially in the volatile landscape of cryptoasset prices where the timing of a trade can matter very much to a user. We suggest centralised exchanges should develop and disclose business continuity and disruption management policies to users. There is also room 255 IOSCO (2019). 256 IOSCO (2019). 257 Arts 31, 54 MiFID 2014; FCA Handbook MAR 5, 5A, 5AA. 258 G Angeris, H-T Kao, R Chiang, C Noyes and T Chitra, ‘An Analysis of Uniswap Markets’ (2019), at web. stanford.edu/~guillean/papers/uniswap_analysis.pdf.

238  Regulating the Monetary Order of the Crypto Economy to consider if obligations to compensate users should be imposed in due course for failures in those respects. The European Commission’s proposal provides for cryptoasset service providers in general to be protected by insurance, but it is not explicit that a duty to compensate should arise. In this manner, it may be left to private law as to whether customers would be able to obtain redress against an exchange where a grievance occurs. In the interests of the certainty of users’ rights, the EU should consider harmonising users’ enforceability against centralised exchanges. We have discussed (e) under the regulation of wallets in the previous section, and we now turn to services (b) and (f). These have not been identified by IOSCO, but the European Commission has identified the issue as sufficiently important for regulatory provision in order to provide non-discriminatory and fair admission to cryptoasset listing. Exchanges should also clarify the criteria for their listings, their relationships with cryptoasset issuers and any conflicts of interest. In particular, some centralised exchanges issue their own coins and list them on their own platforms, clearly engaging in conflicts of interest. Centralised exchanges should produce listing policies, and how they manage conflicts of interest, and to publicly disclose such policies. So far, the approach suggested above deals mainly with centralised features in trading that are provided or controlled by exchanges. As users rely on the robustness and fairness that may be supplied by exchanges with these centralised features, these features should be regulated by standards that govern the conduct of these centralised features, as suggested above. Such an approach is appropriate relative to what is under the exchange operator’s control and which affects users’ expectations, rights or welfare. In this manner, there may be similarities between the regulatory standards governing conventional centralised exchanges for financial instruments and cryptoasset exchanges with centralised features. Finally, we argue that where exchanges offer leverage or margin services, they are directly engaged with users’ financial welfare. Hence, we suggest that an imposition of a duty of best interests similar to under the Markets in Financial Instruments Directive may be warranted for exchanges that extend credit to users to facilitate trading.259 Such an umbrella duty can give rise to more specific conduct expectations such as a duty of suitability, which requires the exchange to ascertain customers’ information regarding investment objectives, financial ability to bear risks and the customer’s understanding of the nature of the transaction.260 The exchange’s decision to provide margin or leverage increases the risk of exposure for users and there is scope to argue that this should be held to a suitability standard261 based on the information elicited.262 Such a regulatory standard in particular deals with exchanges’ assessment that customers are reasonably able to bear the financial risks they take on. This duty would go some way towards disincentivising irresponsible extension of leverage or margin provision, affecting customer welfare and market price stability. This duty is arguably important given the fact that customers’ margin in private cryptocurrency is already subject to the inherent volatility in private cryptocurrency values, exacerbating users’ financial exposure risks. It is not

259 Art 24, 260 Art 24, 261 Above. 262 Above.

MiFID 2014. MiFID 2014; Arts 54, 55 MiFID Commission Delegated Regulation 2017/565.

Regulating Cryptocurrency Exchanges  239 only centralised exchanges that provide leverage services but purportedly decentralised exchanges too, such as Dolomite263 and Futureswap.264 Hence, the regulatory standards that govern exchange conduct should apply to exchanges which provide the relevant centralised features where standards of conduct should be attached, whether exchange operators call themselves centralised or decentralised exchanges. In this manner, exchanges should not avoid regulatory coverage just because they may call themselves decentralised exchanges. This functional approach means that decentralised exchanges that provide dealer services, for example, should be governed by standards in relation to trading transparency disclosure, conflicts of interest management, etc. In this manner, our proposal avoids the lacuna in the EU Commission’s proposal that deals with centralised exchanges like conventional securities trading facilities and misses decentralised exchanges.265 For services on trading marketplaces that are completely disintermediated, such as token-swapping, there are still centralised features that bring the network effects together. These can be in the form of liquidity pools,266 and even in an over-the-counter peer-to-peer direct trading context, matching algorithms are a form of commons maintained by the operator for users’ needs, such as price preferences in the form of limit orders,267 or Airswap’s ‘one-transaction’ protocol to ensure that swapping achieves finality.268 This chapter recommends market operators should be subject to regulatory standards of conduct where user protection is implicated, in different ways in relation to their provision of centralised and decentralised services. Users should also benefit from extensive disclosure so that their roles and responsibilities on marketplaces that have decentralised features can be fully informed. We propose that where exchanges call themselves ‘decentralised’, they should identify in what aspects they are decentralised, according to the services in (a) to (f) above. Where there are any aspects of services that are functionally under the provision or control of the provider,269 these should not be regulated differently from the centralised exchanges discussed above. Many decentralised exchanges offer an extent of commons to users, and users should be provided with some protection in relation to users’ reasonable expectations. For example, by providing a matching service, however minimal, the matching protocols are the commons of the network. This chapter proposes that such commons should be governed, and there are two levels of governance. One is that the decentralised exchange operator should be subject to regulatory governance. It may be argued that this could be difficult if the decentralised operator is itself a network with no certain legal identity as a whole. One way to resolve this is to require all blockchain-based 263 dolomite.io/?ref=t0g4u0. 264 www.futureswap.com. 265 Regulators’ focus on centralised exchanges would likely allow decentralised exchanges to be excluded, as opined in I Salami, ‘Decentralised Finance: The Case for a Holistic Approach to Regulating the Crypto Industry’ (2020) 35 Journal of International Banking and Financial Law 496 dealing with anti-money laundering regulation as applicable to centralised exchanges and wallet providers, but not decentralised operators. 266 Such as Volentix (n 256) and Uniswap (uniswap.org). 267 Kyberswap network (www.kyberswap.com/why-kyberswap). 268 trader.airswap.io, where finding a match within a recent time period in order to achieve swap finality is programmed in the protocol. 269 For example, Idex holds itself out as a decentralised exchange but provides trade execution and price discovery.

240  Regulating the Monetary Order of the Crypto Economy businesses to be registered in the framework proposed in chapter four, and regulatory requirements attach to the personality of the registered entity. Otherwise, responsibility for regulatory implementation and compliance should lie with the governance body of the decentralised exchange.270 The second level of governance pertains to the automated protocols for exchange, contract, liquidity, etc. These should be subject to governance standards in terms of the functionality and robustness of the protocols, so that user protection can be secured. The business registration process in chapter four provides for code to be vetted and ongoing releases to be subject to reporting and review. The functionality and performance of automated protocols are crucial to decentralised exchanges. These protocols, which are the provision of commons for users, should be subject to regulatory oversight and, in accordance with chapter four’s processes, thirdparty auditing as well. Further, regulators may require that protocols embed regulatory standards such as embedding sound policies for conflict-of-interest management, proof of best execution for users, etc, as discussed above, as users face similar issues in relation to trading on a decentralised exchange as on a centralised one. In what manner can a user have confidence in the exchange protocol for executing a most favourable swap within specified parameters? How many quotes could the user request for exchange or what depth of quotes would be available to users? How can a user know if there are no opaque rules on priority for certain users over others? If a user’s swap fails, it may be opaque as to whether the operator’s protocol has failed somehow, or there is an issue with the wallet service provider. Users should be able to require accountability as to the functionalities, performance and common failure modes of automated protocols. Users should also be able to expect some form of redress mechanism if they have paid transaction fees for failed transactions or tokens are lost in the process. It is rare for exchanges to offer merely billboard type services and refrain from matching transactions in any way, as such minimalism is unlikely to facilitate the building up of network effects and liquidity. Operators of decentralised exchanges also achieve network effects and are arguably in a position to monitor signs of market abuse. Hence, exchanges that facilitate peer-to-peer trading, matching services and those providing liquidity pools should draw up and disclose an anti-market abuse policy. Decentralised exchanges may also need to provide for policies of business continuity and disruption management. Where decentralised exchanges provide off-chain settlement, such as in an off-chain network to avoid the traffic and gas fees on the Ethereum blockchain, the governance of such a network should be subject to the same standards of oversight as applicable to centralised exchanges.271 This is because functionally, the off-chain settlement system would be under the purview of the operator and users rely on the operator’s governance protocols that provide for settlement robustness, reasonableness of cost and user protection. This regulatory blueprint offers a proportionate regulatory approach to different aspects of centralised and decentralised according to the exchange’s capacity to control and monitor, in a manner that affects customers’ welfare. Subjecting centralised and decentralised exchanges to functional regulation also prevents disincentivisation from 270 For example, UNI holders are governance token-holders and can vote on governance decisions on Uniswap, and the Kyberswap network is governed by KNC token-holders. 271 For example, Idex’s layer 2 settlement system: blog.idex.io/all-posts/idex-20-no-compromises.

Regulating Cryptocurrency Exchanges  241 providing centralised services and regulatory arbitrage by the adoption of decentralised models. For aspects of services that are decentralised, exchanges should disclose what risks there are to users due to the decentralisation, and to what extent users should be responsible for themselves. Such disclosure should be fair and balanced, and not selective or downplaying of risks to customers. For example, where exchanges do not offer custodial services they should clearly explain what this means for users and how users need to maintain their wallets and private keys.272 They should also explain the risks involved in connecting users’ wallets to the operator’s network. Users should be on-boarded only upon a genuinely informed basis that they have understood the disclosures made. It may be argued that exchanges offering decentralised features can offer boilerplate disclosures that users would not bother to read and merely agree with in an online context. There is scope to consider if ex ante regulation is necessary for such decentralised exchanges in terms of the types and profiles of customers they should admit. In the alternative, exchanges can be placed under an obligation to draw up policies for their admission criteria, in particular to consider if their services are suitable for more experienced customers that require less help and service. Their admission policies should be based on clearly reasoned criteria and should be subject to regulatory supervision. Finally, although decentralised exchanges hold out their services in the appeal of giving users greater privacy, these venues should not be locations for regulatory arbitrage in order to avoid anti-money laundering obligations.273 At the moment, many decentralised exchanges provide interfaces that allow users to connect their wallets to the network and indicate their swap preferences, all without any form of formal onboarding. It may be said that this is the essential feature of a decentralised protocol. However, in this manner, accountability to users is not owed even where certain policies or features are centralised, such as exchange and contract protocols, and off-chain settlement networks. Further, trading activity is disintermediated although facilitated by the operator, and the operator may disclaim any responsibility for trade monitoring or anti-money laundering compliance. We argue that exchanges that provide liquidity pools ultimately consolidate network effects and this is akin to a centralised feature. Hence, onboarding requirements and anti-money laundering due diligence should be imposed on operators of liquidity pools even though they are labelled as decentralised exchanges.

D.  Marketplaces for Non-fungible Tokens? Finally, it should be queried whether any of the above analysis applicable to cryptocurrency and cryptoasset exchanges should also apply to marketplaces for non-fungible tokens. Non-fungible tokens representing rights in collectible or customised goods are 272 Often decentralised exchanges provide an interface for users to connect their wallets and start trading, but security risks are often borne by users. See ‘DeFi security risks – Is it safe to connect wallet to DeFi platforms?’ (23 September 2020), at coinguides.org/defi-safety-security on the security risks associated with bugs in smart contract code that are enabled to access users’ wallets and perform transactions. 273 Salami (2020).

242  Regulating the Monetary Order of the Crypto Economy increasingly transforming digital commerce,274 and marketplaces for such tokens are also likely to become new developments in the crypto economy.275 It may be argued that marketplaces for non-fungible tokens should not count as exchanges for financial-type instruments, hence should fall outside of the EU’s regulatory proposal as well as the book’s blueprint for the regulation of the crypto economy. However, whether marketplaces for non-fungible tokens should be treated similar to conventional platform markets in the recycling economy, such as eBay, could depend on the evolution of non-fungible tokens in the crypto economy as financialised assets and trading instruments. Assets of intrinsic utility, such as commodities, can be assetised and financialised in the form of derivatives contracts and traded. Further, marketplaces for high-value transfers, such as in art, attract anti-money laundering compliance, which extends to high-risk outfits beyond financial institutions.276 Hence it remains to be seen how non-fungible tokens may evolve in the crypto economy, and the question can be kept open as to how markets for such tokens should be treated and regulated. In the next section we examine the possibility of the central bank digital currency in addressing the monetary weaknesses of private cryptocurrencies in the crypto economy. The integration of the central bank digital currency would also pave the way for integration of payment services, anti-money laundering and conventional financial services regulation with the crypto economy.

VI.  Central Bank Digital Currencies and the Crypto Economy The rise of the crypto economy is one of the factors for many countries’ central banks considering issuing a digital currency, although central banks’ considerations span wider policy considerations – such as in relation to how consumers demand money,277 whether there are any benefits to fiscal278 and monetary policy,279 and how this may change the structures of the current banking and financial systems.280 The central bank digital currency, if programmable with private blockchains, can provide an easily 274 See ch 2. 275 ‘Binance-Owned WazirX Launches India’s First NFT Platform’ (7 April 2021), at www.coindesk.com/ binance-owned-wazirx-launches-indias-first-nft-platform?utm_source=Sailthru&utm_medium=email& utm_campaign=NODE%20APRIL%206%202021&utm_term=Blockchain%20Bites. 276 EU Anti-money laundering Regulation 2018/843, Art 2(1)(i). 277 C Barontini and H Holden, ‘Proceeding with Caution – A Survey on Central Bank Digital Currency’ (2019), at ssrn.com/abstract=3331590; T Khiaonarong and D Humphrey, ‘Cash Use Across Countries and the Demand for Central Bank Digital Currency’ (IMF Working Paper, 2019), at www.imf.org/en/ Publications/WP/Issues/2019/03/01/Cash-Use-Across-Countries-and-the-Demand-for-Central-BankDigital-Currency-46617 on an opposite view, ie the need for physical cash amongst populations. 278 eg see J Barrdear and M Kumhof, ‘The Macroeconomics of Central Bank Issued Digital Currencies’ (Bank of England Staff Working Paper, 2016), at www.bankofengland.co.uk/research/Pages/workingpapers/default. aspx. 279 for eg ibid; U Bindseil, ‘Central Bank Digital Currency – Financial System Implications and Control’ (2019), at ssrn.com/abstract=3385283. 280 eg T Mancini-Griffoli, MS Martinez Peria, I Agur, A Ari, J Kiff, A Popescu and C Rochon, ‘Casting Light on Central Bank Digital Currency’ in C Brummer (ed), Cryptoassets: Legal, Regulatory, and Monetary Perspectives (OUP, 2019) ch 12.

Central Bank Digital Currencies and the Crypto Economy  243 accessible means by which ordinary consumers can participate in the crypto economy without having to hold volatile cryptocurrency. Competition from such programmable fiat currency may also put to test the demand for private cryptocurrency. Dow argues that the rise of private currencies in the crypto economy should not be the main factor for central banks to issue digital currencies, and the market failures and governance problems relating to private cryptocurrencies should be separately addressed.281 Indeed, the central bank digital currency (CBDC) has been discussed in much broader contexts by central banks, and this policy is not seen as necessarily connected to the crypto economy.282 This section takes stock of the thinking developed regarding CBDC and argues that although there is a broader agenda for CBDC, central banks do not refer to the crypto economy at all in their policy papers. Such disengagement may also be a missed opportunity.

A.  The Development of Central Banks’ Thinking Regarding Digital Versions of Fiat Currencies Policy discussions regarding the design and possible implementation of CBDC do not cater for the crypto economy, but pertain to the conventional or mainstream economy. Central banks have progressed from a research stage on CBDCs to a clearer stage of experimenting with production and issuance.283 In the research stage, central banks have discussed two potential designs of issuance. One is a token-based issuance of CBDC (or bearer-based design), and the other is an account-based design. The token-based design would pose less disruption if introduced, as CBDC could be issued as tokens that users would hold in existing custodialproviding financial intermediaries. This entails minimal disruption to the commercial and intermediation structures in the existing economy.284 Financial institutions would however need to develop technological capacity similar to private cryptocurrency wallet providers to undertake such custodial functions. Retailers would also need to develop technological capacity to receive such payment. This change is likely incremental in nature to industry and would avoid disruptive phenomena such as may occasion under an account-based design. On the other hand, a more radical design, ie account-based design, would allow users to directly have accounts at central banks in order to safekeep their CBDCs. This means that the central bank is directly engaged in retail payment systems operationally and not merely as a regulator or supervisor. Account-based CBDCs supported by new payment infrastructure based at central banks could enhance payment efficiency, and the ECB in particular views this as a means to provide pan-European payments 281 S Dow, ‘Monetary Reform, Central Banks, and Digital Currencies’ (2019) 48 International Journal of Political Economy 153. 282 ECB, ‘Report on a Digital Euro’ (October 2020), at www.ecb.europa.eu/euro/html/digitaleuro-report. en.html. 283 BIS, ‘Central Bank Digital Currencies: Foundational Principles and Core Features’ (9 October 2020), at www.bis.org/publ/othp33.htm. 284 MK Brunnermeier, H James and J-P Landau, ‘The Digitalization of Money’ (2019), at www.nber.org/ papers/w26300.

244  Regulating the Monetary Order of the Crypto Economy infrastructure as a public good.285 However, it is uncertain what real economic effects entail with account-based CBDC. Would account-based CBDC dramatically enhance commercial and consumption activity, especially within the Single European Market? The digitalisation of payment currency has progressed from payment cards to userfriendly forms of payment led by fintechs in e-commerce and cashless real commerce. The digitalisation of money in payment cards catered for the rise of the consumption economy as credit is bundled with payment, transforming the nature of relatively accessible consumer credit.286 Fintechs have innovated to challenge the inefficiencies of payment and remittance monopolies,287 galvanising greater adoption of cashless transfers.288 The continuous movement of innovation in the fintech space shows that we are not lacking in digital payment interfaces and the digitalisation of money. Hence, it is queried as to why we may need a public good in the form of the CBDC as an open and competitive space is continually fostered in electronic money and payment innovations.289 Nevertheless, account-based designs also provide novel benefits such as more direct monetary policy, where central banks could make helicopter drops or experiment with negative interest rates in order to affect consumption behaviour.290 Further, account-based designs would attract depositors who would see central banks as failsafe and bank runs could be virtually abolished.291 Potential disruption could result however, if depositors switch en masse from banking institutions to the central banks. That said, central banks that wish to mitigate severe disruption to the private sector could provide policies to remunerate CBDC holdings above a certain level negatively, hence disincentivisng disruptive behaviour from users.292 Fiscal policy can also be integrated into account-based CBDC as CBDC can be issued based on government debt.293 Account-based CBDC can also be perceived to be more democratic in nature as it offers a universal rollout for all citizens.294

285 ECB (2020), at www.ecb.europa.eu/pub/pdf/other/Report_on_a_digital_euro~4d7268b458.en.pdf, Panel discussion, ECB Legal Research Conference on Central Bank Digital Currencies, 5 October 2020. 286 G Garcia, ‘Credit Cards: An Interdisciplinary Survey’ (1980) 6 Journal of Consumer Research 327, at www. researchgate.net/profile/Gillian_Garcia/publication/24099328_Credit_Cards_An_Interdisciplinary_Survey/ links/56323c4008ae58487808d2da/Credit-Cards-An-Interdisciplinary-Survey.pdf. 287 IH-Y Chiu, ‘A New Era in Fintech Payment Innovations? A Perspective from the Institutions and Regulation of Payment Systems’ (2017) 9 Law, Innovation and Technology 190. 288 See www.thebusinessresearchcompany.com/report/fintech-market. 289 The role of the Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC (Payment Services Directive 2015). 290 Bindseil (2019); H Nabilou, ‘Testing the Waters of the Rubicon: The European Central Bank and Central Bank Digital Currencies’ (2019) Journal of Banking Regulation, at doi.org/10.1057/s41261-019-00112-1. 291 MK Brunnermeier and D Niepelt, ‘On the Equivalence of Private and Public Money’ (2019) 106 Journal of Monetary Economics 27; A Cukierman, ‘Welfare and Political Economy Aspects of a Central Bank Digital Currency’ (2019), at cepr.org/active/publications/discussion_papers/dp.php?dpno=13728. 292 U Bindseil, ‘Tiered CBDC and the Financial System’ (January 2020), at www.ecb.europa.eu/pub/pdf/ scpwps/ecb.wp2351~c8c18bbd60.en.pdf. 293 Barrdear and Kumhof (2019). 294 Nabilou (2019); H Nabilou and A Prüm, ‘Central Banks and Regulation of Cryptocurrencies’ (2019), at ssrn.com/abstract=3421417 on financial inclusion being achieved.

Central Bank Digital Currencies and the Crypto Economy  245 However, central banks issuing account-based CBDC would have to be prepared for structural changes. First, central banks would act as payment services providers as users would expect to make and receive transfers out of and into their CBDC accounts.295 This role adds to the central banks’ responsibilities in terms of antimoney laundering and payment services compliance. Central banks would have to be prepared for customer service interfaces and these demands can be onerous.296 It may be queried if it is indeed necessary for central banks to engage with these ­obligations297 and what purposes central banks seek to achieve with account-based designs. Appropriate policies also need to be in place to mitigate deposit migration out of banks. Major changes to the deposit base for banks can affect banks’ lending function, which is the private creation of money.298 Commentators are uncertain as to how severe this effect would be as banks are still able to obtain other sources of funding and customers may not dissipate their deposits entirely with the banking sector.299 Commentators are of the view that account-based CBDC should be limited in design so that customers do not fully replace access to private financial services with CBDC.300 The private creation of money301 is not a function that central banks wish to undertake and it remains important to ensure that banking institutions can continue to carry out this important role. Commentators raise the possibility that central banks need to invest back into banks to support their roles in private creation of money so that credit is available for economic development.302 While this may be a new tool of banking supervision as central banks can supervise banks more closely and incentivise prudent and desirable lending behaviour, it also greatly enhances central banks’ powers over banks and such enhanced powers need to be subject to new safeguards and accountability. A hybrid design combining the token-based and account-based designs is mooted by Didenko et al.303 This design envisages that only approved financial intermediaries would hold CBDC accounts directly at central banks, and they would intermediate the holding of CBDC by customer/users in a separate system, which can be blockchain-based, 295 H Leinonen, ‘Electronic Central Bank Cash: To Be or Not to Be?’ (2019) 13 Journal of Payments Strategy & Systems 20. 296 ibid. 297 B Eichengreen, ‘From Commodity to Fiat and Now to Crypto: What Does History Tell Us?’ (2019), at www.nber.org/papers/w25426. 298 Nabilou (2019); Bindseil (2019). 299 Banks can compete by offering higher interest rates for savings than the CBDC account; see D Andolfatto, ‘Assessing the Impact of Central Bank Digital Currency on Private Banks’ (2018), at doi.org/10.20955/ wp.2018.026; J Chiu, M Davoodalhosseini, J Jiang and Y Zhu, ‘Central Bank Digital Currency and Banking’ (Bank of Canada Working Paper, 2019). 300 M Kumhof and C Noone, ‘Central Bank Digital Currencies – Design Principles and Balance Sheet Implications’ (Bank of England Working Paper, 2018), at www.bankofengland.co.uk/working-paper/ Working-papers suggest that CBDC should not be convertible into bank deposits. 301 R Senner and D Sornette, ‘The Holy Grail of Crypto Currencies: Ready to Replace Fiat Money?’ (2019) 54 Journal of Economic Issues 966 on why the cryptoeconomy’s monetary order of private cryptocurrencies would always be limited compared to the extensive financialisation of the fiat monetary order. 302 YS Kim and O Kwon, ‘Central Bank Digital Currency and Financial Stability’ (Bank of Korea Working Paper, 2019), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3330914. 303 AN Didenko, DA Zetzsche, DW Arner and RP Buckley, ‘After Libra, Digital Yuan and COVID-19: Central Bank Digital Currencies and the New World of Money and Payment Systems’ (2021), at papers.ssrn. com/sol3/papers.cfm?abstract_id=3622311.

246  Regulating the Monetary Order of the Crypto Economy interacting with the central bank. This hybrid model interposes between retail users and central banks so that central banks would not need to undertake customer relations, for example. This allows central banks to perform payment reconciliation functions, therefore offering directness and efficiency, but relieves central banks of front-end operations in relation to customer due diligence and relations. The rollout of the Chinese digital yuan is based on such a hybrid model.304 In terms of moving forward to experimentation with production or launching, the global trend seems to be centred upon transforming existing mainstream payment services.305 The Swedish central bank has already carried out a pilot project based on the perceived decrease in demand for physical cash in the real economy. Central banks also appear to be mainly considering the deployment of CBDC for retail payments,306 although institutional and wholesale payments are also on the radar screen.307 CBDC can in theory facilitate quicker and cost-effective payment transfer with the benefit of increased trackability, integrating in existing commercial structures.308 However, in practice, central banks acknowledge some heavy lifting ahead in relation to developing CBDC for retail payment. First, the back end of such digital currencies in terms of issuance, plugging into commercial payment systems, as well as clearing and settlement, require thinking in terms of new infrastructure that may be needed, especially if such infrastructure is to become decentralised to leverage upon blockchain technology.309 The front end also requires thinking in terms of new user interfaces, convenience of use, robust custodianship of users’ CBDC and resilience from data loss and cyber hacking.310 Finally, central banks need to keep under review how such a digital currency would affect existing providers of electronic money, deposit accounts and even credit.311 In particular, if retail consumption is powered by debt, then payment services providers that provide credit-based payment such as credit cards would still have a distinct edge, and it can be queried if the heavy lifting and cost involved in developing CBDC for retail use is worth the benefits.

B.  CBDC for the Crypto Economy? We turn to consider the potential of the CBDC in meeting the needs for the monetary order of the crypto economy. Although central banks omit discussion of the crypto economy space in their plans for CBDC, it is argued that this may be a blindspot. The crypto economy is to date only developing payment currencies that aspire to monetary 304 ibid. 305 ECB (2020), the Chinese rollout of the digital yuan also co-opts existing regulated bank and financial services providers for the mainstream economy; see A John, ‘Explainer: How does China’s digital yuan work?’ (Reuters, 19 October 2020), at www.reuters.com/article/us-china-currency-digital-explainer-idUSKBN27411T. 306 BIS (2020). 307 Podcast accompanying BIS (2020), at www.bis.org/publ/othp33.htm. 308 Mancini-Griffoli et al (2019). 309 ECB (2020); BIS (2020). 310 ibid. 311 ibid. In this respect the BIS (2020)’s foundational principle for introducing CBDC is to do no harm while promoting co-existence with cash and innovation. This may extend to preserving financial stability in connection with private sector institutions and infrastructure, while not reducing the scope for innovation.

Central Bank Digital Currencies and the Crypto Economy  247 qualities, most of the innovations occurring in the space of stablecoins. There is a role for the CBDC, with its already-established monetary qualities, to play a part in the crypto economy in terms of facilitating and mainstreaming it. The issuance of the CBDC for integration in the crypto economy can facilitate the building out of an onshore infrastructure that connects to the peer-to-peer crypto economy. Hockett312 describes a vision where local governments should be responsible for facilitating peer-to-peer payments and commerce, so as to ‘build out’ a peer-topeer value transfer platform that can become integrated nationally. He argues this is superior to the private crypto economy, which is fragmented between different protocol infrastructures that are currently not easily interoperable.313 This vision represents an ultimate mainstreaming of the peer-to-peer commerce model, led by the enabling actions taken by government. This vision would also crucially bring about the benefit of terminating financial intermediaries’ rent extraction in the money flows that users create in the real economy. CBDC could be considered in terms of its enabling effect in the crypto economy, as a public sector institution that mobilises the crypto economy and facilitates its ultimate integration with the mainstream economy. The CBDC, if it is programmable into the protocol infrastructures of the crypto economy, can pave the way for the galvanisation of commerce and investment in the crypto economy. Blockchain-based businesses can appeal more directly to mainstream consumers used to fiat currencies, and possibly draw in greater participation from mainstream users. Both businesses and consumers may also prefer the greater familiarity and predictability in the digitalised fiat currency in relation to it being a store of value, unit of account and medium of exchange. Fundraising by blockchain-based businesses conducted in CBDC can also be more generally appealing to mainstream retail and institutional investors. It can be argued that the launch of the USD Coin by Circle and Coinbase would make it unnecessary for the Federal Reserve, for example, to consider launching a CBDC. Hence, for the needs of the monetary order of the crypto economy and its wider appeal, private sector providers can lead the innovation for digitalising and programming fiat currency tokens. There is no need for the CBDC to be developed for this. Although the USDC has achieved a significant market capitalisation,314 there is still strong and devoted following for private cryptocurrency, perhaps due to their asset inflationary appeal. Leading private cryptocurrencies, such as ether and bitcoin, experiencing significant inflationary trajectories in early 2021, are increasing in their asset appeal, which may in turn damage their prospects as payment instruments. Further, programmable versions of electronic fiat currency are ultimately claims against electronic money issuers, hence the scalability of USDC depends on the financial soundness and capacity of private issuers to meet claims. Such scalability limits would not be experienced with CBDC. 312 R Hockett, ‘The Democratic Digital Dollar: A Peer-to-Peer Savings & Payments Platform for Fully Inclusive State, Local, and National Money & Banking Systems’ (2019), at ssrn.com/abstract=3470931. 313 Interoperability can be developed amongst permissioned private blockchains, but is only emerging in relation to permissionless blockchains; see R Belchoir, A Vasconcelos, S Guerreiro and M Correia, ‘A Survey on Blockchain Interoperability: Past, Present, and Future Trends’ (2020), at arxiv.org/pdf/2005.14282.pdf. 314 Ranked 12th largest in market capitalisation by Coinmarketcap; see coinmarketcap.com/currencies/ usd-coin.

248  Regulating the Monetary Order of the Crypto Economy However, some blockchain-based business developers may hold the view that the crypto economy should not be integrated with the mainstream economy and should be ‘sovereign resistant’.315 This reflects the anarcho-capitalist ethos that underpinned the invention of the bitcoin blockchain.316 In this manner, the issuance of a CBDC which may be programmable for the crypto economy may be unwelcome as the crypto economy should be maintained as a space described by Schrepel317 as deliberately designed to facilitate choice for those who wish not to be subject to the rule of law. However, this may not be a universal view held in all quarters of the crypto economy. First, Howell et al318 in their survey of initial coin offerings made by blockchain-based business developers mention that developers could offer a choice of acceptance in fiat or cryptocurrency, showing that some developers would like to appeal more broadly to investors. Second, the call by the FSB to regulators to subject stablecoins to regulation could result in reforms that would intervene in the unregulated market-based efforts to integrate stablecoins into protocol infrastructure. In this manner, the market may have to accept that they need to work with regulatory institutions if stablecoins are used. The inroad into stablecoin regulation can kickstart changes in market views and responses, and perhaps pave the way for the crypto economy to be more receptive of integration with the conventional economy. There are however two conditions for the CBDC’s integration into the crypto economy. One is that the CBDC has to be programmable and therefore accessible to app developers. There is virtually no discussion of such development in central bank discussions regarding the CBDC. Indeed, most discussions regarding the CBDC assume the need for various extents of central bank control and direct relationships with users.319 This seems to indicate that central banks perceive a greater need to maintain control over digitalised currency and its issuing policies, and it is arguably a contrary direction to release and make open source relevant code for private app development.320 Central banks can benefit from discourse with crypto economy developers in terms of the programmability and development of the CBDC.321 However, we observe that

315 Quoted in ‘Libra Scales Back Global Currency Ambitions in Concession to Regulators’ (16 April 2020), at www.coindesk.com/libra-scales-back-global-currency-ambitions-in-concession-to-regulators. 316 J Flood and L Robb, ‘Trust, Anarcho-Capitalism, Blockchain and Initial Coin Offerings’ (2017), at ssrn. com/abstract=3074263. 317 T Schrepel, ‘Anarchy, State, and Blockchain Utopia: Rule of Law versus Lex Cryptographia’ in General Principles and Digitalisation (Hart Publishing, 2020), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3485436. 318 S Howell, M Niesser and D Yermack, ‘Initial Coin Offerings: Financing Growth With Cryptocurrency Token Sales’ (2019), at www.nber.org/papers/w24774. 319 BS Fung and H Halaburda, ‘Central Bank Digital Currencies: A Framework for Assessing Why and How’ (Bank of Canada Staff Discussion Paper, 2016). 320 Also discussed during Panel discussion, ECB Legal Research Conference on Central Bank Digital Currencies, 5 October 2020. 321 Private cryptocurrencies have been through many developments, post-problem upgrades and improvements, as well as innovation from many quarters. Programmability lessons as well as lessons for robustness and resistance against tampering and hacking can be learnt, especially if decentralised architecture using peer-to-peer blockchains is envisaged in CBDC deployment. See M Conti, S Kumar E, C Lal and S Ruj, ‘A Survey on Security and Privacy Issues of Bitcoin’ (2017), at arxiv.org/pdf/1706.00916.pdf, also discussing other cryptocurrency, their development and qualities.

Concluding Remarks  249 central bank policy papers are focused on discourse with existing financial services intermediaries in terms of integration and operationalisation. Pfister,322 for example, argues that the integration of CBDC into the crypto economy could be by virtue of a wholesale-only CBDC held by already licenced financial institutions so that they can intermediate payment in the crypto economy. This is the approach taken in the Chinese rollout of the digital yuan. In this manner, the space for developing CBDC may be centred around incumbent financial services institutions, and the nature of CBDC would remain intermediated. Both features are unlikely to cohere with the development of disintermediated payment protocols in the crypto economy and the new business structures therein. The second condition is that CBDC is not introduced into the crypto economy to outlaw private cryptocurrencies, but as a competing currency alongside existing private cryptocurrencies. DApp developers likely desire to offer a choice of multiple currencies, including the CBDC, to be attractive to users. CBDC would therefore be integrated into the crypto economy within the existing monetary order of permissionless blockchains and their scale of economies, in order to test demand and to bridge the institutional discourse with the crypto economy. In this manner, the deployment of CBDC by dApp developers would be subject to the same payment protocol regulation proposed earlier in this chapter.

VII.  Concluding Remarks The crypto economy has introduced one of the most challenging institutional innovations in this decade, in terms of a private monetary order and infrastructure to support peer-to-peer value transfer. As discussed in chapter one, the law is still ambivalent between whether private cryptocurrency is money or property, while not being able to clearly reconcile the implications of possession of both characteristics. It is however not the clarification of coherentist application of the law that would resolve the institutional challenge brought to us by private cryptocurrencies. The self-governing nature of automated transfer protocols and the commons in permissionless blockchains are still being developed, and key service providers such as wallet services and cryptoasset exchanges, along a centralised–decentralised spectrum, have arisen to meet users’ needs. The growth in scale of the crypto economy and the proliferation of institutional novelties should not remain fringe phenomena while policy-makers pursue narrow directions in relation to stablecoins or CBDC. This chapter argues for a more comprehensive agenda in enabling and governing the value transfer orders of the crypto economy in order to secure user protection as well as to address the public ills of money laundering or financial crime that can take place through the crypto economy.323

322 C Pfister, ‘Central Bank Digital Currency: One, Two or None?’ (Banque de France Working Paper, 2019), at publications.banque-france.fr/sites/default/files/medias/documents/wp-732.pdf. 323 eg see ‘270 addresses are responsible for 55% of all cryptocurrency money laundering’ (15 February 2021), at www.zdnet.com/article/270-addresses-are-responsible-for-55-of-all-cryptocurrency-money-laundering.

250  Regulating the Monetary Order of the Crypto Economy To this end the regulatory agenda needs to be better acquainted with technological developments, and regulatory agencies need to be prepared for more coordinations as innovations challenge the boundaries of existing regulatory perimeters. In particular, the author has elsewhere argued that the CBDC can perform a useful role in the institutional integration of the crypto economy.324 Policy-makers should not continue to marginalise or ignore an integration-based and holistic regulatory agenda for the crypto economy.

324 See IH-Y Chiu, ‘Building out the Crypto-economy in Europe: A Proposal for Central Bank Digital Euros’ (2021) European Law Review, forthcoming.

7 Regulating Crypto Finance I.  Productive and Hyper Forms of Financialisation So far, this book has focused on the crypto economy in terms of its innovative and productive aspects, focusing on novel business ideas, enterprise forms and the need to provide enabling and governance initiatives for a new productive space within the paradigm of regulatory capitalism. This approach can appear to neglect the obvious elephant in the room, which is finance. It is crypto finance that has drawn mainstream attention to the crypto economy, from the invention of private cryptocurrencies discussed in chapters one and six to the concerns surrounding initial coin offerings (ICOs) discussed in chapters three and five. This book places finance in its context, as the crypto economy is not merely crypto finance.1 However, it also acknowledges the rise of crypto finance as a major economic activity in the crypto economy. The treatment of many crypto financial activities is currently uncertain in terms of regulation. ‘Finance’ is a term that carries with it many established notions in terms of its regulatory ontologies, designs and standards. It is too easy for us to latch onto existing paradigms2 in discussing crypto finance without considering how the technological disruptions underlying crypto finance have changed financial business models, relations and risk. In this final chapter, we argue that law and policy for crypto finance should be based on answering two questions: (a) why regulate crypto finance; which allows us to understand (b) how crypto finance should be regulated. In this way, we would not merely be seeking to fit the how of financial regulation to crypto finance phenomena in a coherentist manner. First, in answering the why question, this chapter suggests that there should be a distinction made between the ‘productive’ financialisation of a capitalist economic system and its ‘hyper’ financialisation. This difference underpins an essential policy choice for regulating crypto finance and the extent of regulatory scope. Financialisation is often defined as ‘the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies’.3 This definition does not encapsulate why private financial 1 See www.stateofthedapps.com/platforms/ethereum, which lists dApps on the Ethereum blockchain by sector. Although online gaming seems to dominate the dApp industry, finance is a highly developed sector alongside a variety of other sectors such as media and social. 2 See the coherentist approach discussed in ch 1, and approaches taken by jurisdictions such as the US to initial coin offerings discussed in ch 3. Editorial, ‘Taxonomies of Digital Assets: Recursive or Progressive’ (2019) 2 Stanford Journal of Blockchain Law & Policy 1. 3 GA Epstein, ‘Introduction: Financialization and the World Economy’ in GA Epstein (ed), Financialization and the World Economy (Edward Elgar, 2005) 3.

252  Regulating Crypto Finance actors and services have become so important – which is to mobilise the economic activities of capitalist orders. Financial investment is needed for productive investment in order to generate productivity and wealth creation for economic actors.4 According to the legal theory of finance,5 it is the creation of legally recognised and enforceable financial claims that makes finance possible for allocation to the productive economy. For example, corporations – the economic engines for productivity – rely on debt, which creates financial claims in terms of recurring repayments and interest, and rights to collateral; as well as equity, which creates financial claims in terms of rights of distribution and governance in corporations.6 In the crypto economy, ICOs can be regarded as a financialised phenomenon as claims to future tokens that would embed certain protocols and rights are created in return for funds sent to developers of dApps or blockchain infrastructure.7 These claims do not provide for similar entitlements or rights as under conventional corporate finance claims in debt or equity. Functionally, the nature of creating claims in return for funds is the same as in conventional corporate finance,8 except that the content of such claims is novel, and the enforcement mechanism for such claims is technologically reliant. ICOs are thus a form of productive financialisation as claims are created in order for enterprise development to take place, in the hope of creating network effects and peer-to-peer economic mobilisation in the crypto economy.9 The creation of financial claims in order to mobilise the productive economy, however, cannot be decoupled from the other side of financialisation, which is the creation of fungibility and tradeability of these financial claims as financial assets.10 This development is arguably necessary as the rise of secondary markets and liquidity underpin investor confidence in participating in the creation of financial claims, allowing exit for investors. Productive financialisation essentially supports the creation of financial assets, but this then opens up the opportunity for financial assets to be arbitraged and speculated upon by those seeking purely financial yield that is unconnected to productivity generation.11 This chapter calls such financialisation ‘hyper’ financialisation as based on speculative or short-termist profit-seeking behaviour. Critical literature on financialisation has often focused on the negative effects of hyper-financialisation, such as: the fuelling of asset price bubbles and crashes that ultimately result in social cost;12 4 JB Foster, ‘The Financialisation of Capitalism’ (2007) 58 Monthly Review 11, at www.greeneconomics.net/ Financialization.pdf. 5 K Pistor, ‘A Legal Theory of Finance’ (2013) 41 Journal of Comparative Economics 315. 6 E Ferran and LC Ho, Principles of Corporate Finance Law (OUP, 2014) Part III, and ch 15 on debt, and Parts II and IV generally on equity finance. 7 See chs 1, 5. 8 A Collomb, P de Fillippi and K Sok, ‘Blockchain Technology and Financial Regulation: A Risk-Based Approach to the Regulation of ICOs’ (2019) 10 European Journal of Risk Regulation 263. 9 There is also empirical research suggesting that volatile cryptocurrency prices do not significantly affect ICO demand, showing that demand is not based on merely speculative incentives; see C Masiak, JH Block, T Masiak, M Neuenkirch and KN Pielen, ‘Initial Coin Offerings (ICOs):Market Cycles and Relationship’ (2019) Small Business Economy, at doi.org/10.1007/s11187-019-00176-3. 10 Foster (2007). 11 ibid; speculation and arbitrage are essentially connected with human behavioural tendencies, but policy steering can affect these in developing solutions; see RJ Shiller, ‘Speculative Asset Prices’ (2014) 104 American Economic Review 1486. 12 ‘What are the economic costs of asset price bubbles?’ (2 September 2015), at www.weforum.org/ agenda/2015/09/what-are-the-economic-costs-of-asset-price-bubbles; J Stiglitz, Freefall: Free Markets and the Sinking of the Global Economy (Penguin, 2010).

Productive and Hyper Forms of Financialisation  253 the widening of the wealth gap between those whose returns are from financial assets and those relying on productive wealth generation;13 and the adverse impact on the corporate economy whose productivity may be hollowed out in order to generate financial yield, through financial engineering.14 It may however be argued that the development of speculative financial assets like derivatives is the necessary flip side of financial assetisation that supports productive economic activity. The two developments cannot be clearly decoupled.15 Speculative behaviour is pursuant to selfish needs, but is part of the process for discovering price in financial markets.16 Nevertheless, speculative opportunities can create opportunities for misallocation away from productive economic activities, and are typically not of a character consistent with patient finance.17 Policy-makers have generally not taken steps to disincentivise speculative aspects of financial activity. However, we observe that although productive and hyper forms of financialisation both arise in the crypto economy, the slowness on the part of policy-makers in developing an appropriate regulatory agenda has brought about accelerated growth in hyper forms of financialisation. The productive financialisation in the crypto economy, led by the ICO boom from 2017,18 has created a range of tradeable financial assets, especially in terms of ERC tokens issued by dApp developers. Besides secondary trading in these tokens, innovative financial engineering involving these tokens is being developed to generate yield for holders. Indeed, it is queried whether the secondary market devaluation of many token prices19 has led to development of financial engineering in order to support yieldseeking needs. In the decentralised finance (DeFi) universe, which refers primarily to the provision of financial products or services in a peer-to-peer manner that does not involve conventional financial intermediaries,20 financial claims such as loans similar to that in the conventional economy are being generated. These DeFi loans crucially mobilise tokens as financial assets in new ways. DeFi peer-to-peer loans are organised by platform operators which construct liquidity pools. As there is no centralised underwriting loan writing authority, platform operators pool together myriad users’ cryptoassets in liquidity pools so that other users can borrow these by providing their 13 K-H Lin and D Tomaskovic-Devey, ‘Financialization and U.S. Income Inequality, 1970–2008’ (2013) 118 American Journal of Sociology 1284; E Hein, ‘Finance-dominated Capitalism and Redistribution of Income: A Kaleckian Perspective’ (2013), at ssrn.com/abstract=2198919; B Kus, ‘Financialisation and Income Inequality in OECD Nations: 1995–2007’ (2012) 43 The Economic and Social Review 477; G Dumenil and D Levy, ‘Financialization, Neo-liberalism and Income Inequality in the USA’ in I Erturk, J Froud, S Johal, A Leaver and K Williams (eds), Financialization At Work: Key Tests and Commentary (Routledge, 2008). 14 P Ireland, ‘The Financialization of Corporate Governance’ (2009), at ssrn.com/abstract=2068478. 15 D Alessandrini, ‘Regulating Financial Derivatives? Risks, Contested Values, and Uncertain Futures’ (2011) 20 Socio and Legal Studies 441. 16 ibid; E Avgouleas, ‘A New Framework for the Global Regulation of Short Sales: Why Prohibition is Inefficient and Disclosure Insufficient’ (2010) 15 Stanford Journal of Law, Business and Finance 376. 17 eg see AL White, ‘The Grasshoppers and the Ants: Why CSR Needs Patient Capital’ (2006), at www.tellus. org/pub/The%20Grasshoppers%20and%20the%20Ants%20-%20Why%20CSR%20Needs%20Patient%20 Capital.pdf in which the casino culture of financial markets is contrasted with long-term investing by corporates, in particular, in corporate responsibility. 18 ‘2017’S ICO Boom Was The Bubble That Will Never Recover’ (9 August 2019), at bitcoinist.com/2017sico-boom-was-the-bubble-that-will-never-recover. 19 ibid. 20 S Coelho-Prabhu, A Beginner’s Guide to Decentralized Finance (DeFi), at blog.coinbase.com/a-beginnersguide-to-decentralized-finance-defi-574c68ff43c4.

254  Regulating Crypto Finance own cryptoasset collateral. Users on the supply side of the market may for example deposit ether tokens in Compound,21 and earn interest whenever transactions occur within the pool which generate pool fees. Users can also be on the demand side of the market and borrow from the pool as long as adequate collateral (in another cryptoasset) is provided by depositing into the pool. Over-collateralisation such as at 150 per cent or more of the value of borrowing is generally required to compensate for market volatility of cryptoasset prices. The rise of platform pools deploying decentralised automated protocols for pool deposit, collateralisation, exchange and borrowing is a spectacular phenomenon. Different platforms cater for different users holding different types of tokens with the intention of generating yield. SushiSwap, for example, accepts any ERC token as collateral to participate in its pools.22 Applications such as Idle23 even provide a meta-search service for users in order to compare yield performance across different pool providers and their pools. It is queried whether the manner of DeFi loans made in the collateralised loan model described above is similar to the productive financialisation of real economy lending where a bank lends to small or large enterprises in order to carry out productive activities, such as purchasing inventory24 or carrying out a project.25 Collateralised DeFi loans described above seem more catered towards the exchange of tokens amongst users in order to arbitrage between tokens to generate purely financial yield.26 Although structured as debt claims, DeFi collateralised loans seem to cater only for those who already possess crypto capital and do not seem to be related to enterprise development. The case of flash loans (ie uncollateralised DeFi loans) is even more clearly removed from productive financialisation. Flash loans are provided by lending pools to users who need to be able to return liquidity to the pool within one transaction block.27 In other words, borrowers of such flash loans are generally withdrawing tokens from the pool for very quick arbitraging purposes, such as swapping collateral in another pool, in order to make a quick financial yield. If the liquidity is not returned to the pool, the lending protocol reverses the transaction to return the pool’s status to the liquidity level before the flash loan so that the pool’s liquidity is unaffected and the pool therefore does not suffer a default. The flash loan protocol has however been exploited by a flash borrower who took two flash loans, one from Uniswap and one from Aave, in order to deposit on ValueDeFi and conduct exchange between cryptocurrencies in rapid succession to exploit the exchange protocols on Value DeFi. Value DeFi suffered a US $6 million loss.28

21 compound.finance. 22 app.sushi.com/farms/permanent. 23 idle.finance/#. 24 Such as inventory financing for businesses to buy stock secured against the inventory as collateral. 25 Such as project finance where banks may participate to lend to a project special purpose vehicle in a nonrecourse manner, collateralised against the project. 26 ‘Collateralized Loans in DeFi’, at defirate.com/collateralized-loan. 27 ‘Performing a Flash Loan’, at docs.aave.com/developers/tutorials/performing-a-flash-loan, a key player in this field being Aave Protocol, docs.aave.com/faq. 28 ‘Value DeFi protocol suffers $6 million flash loan exploit’ (14 November 2020), at cointelegraph.com/ news/value-defi-protocol-suffers-6-million-flash-loan-exploit.

Productive and Hyper Forms of Financialisation  255 The hyper forms of financialisation developing in the DeFi universe raise concerns. One area of concern lies in user protection in terms of whether users are adequately informed and protected in relation to the transactions they are engaged with.29 In particular, many have commented on the complexity of financial transaction chains in DeFi designed for arbitrage and that users may be adversely affected if there are software bugs.30 DeFi flash loans are also regarded unsuitable for those unfamiliar with Ethereum programming.31 Another area of concern lies in the systemic effects and financial risk for many users, as DeFi systems of automated protocols can be used to create significant but inflexible and irreversible effects.32 In other words, the policy objectives of user protection and financial stability are relevant to DeFi systems. Another key concern of hyper-financialisation in the crypto economy is the extent to which hyper-financialisation may be damaging to the productive aspects of the crypto economy. In the conventional financial economy, hyper-financialisation has been criticised to be damaging, in relation to corporate and investor short-termism as mentioned above.33 Such hyper-financialisation generally occurs over a cycle of instability, following a Minskian trajectory,34 and may be observed in time. In this manner, ex ante macroprudential financial supervision, as has been implemented in the UK and many other jurisdictions,35 could mitigate its adverse effects. In the crypto economy, hyper-financialisation may occur in a much more compressed timeframe due to the automation of protocols. It is queried how systemically damaging automation, rigidity and irreversibility of bad consequences may be.36 Further, if crypto economy participants are drawn to hyper-financialisation for quick profit-making, would the crypto economy be dominated by such financial development, crowding out other forms of enterprise and innovation? Hyper forms of financialisation raise issues of a different nature from productive financialisation, although the two phenomena are tightly coupled. In this light, this chapter argues that the regulatory policy for productive forms of financialisation should be fashioned differently from that for hyper forms of financialisation. These choices in regulatory policy, which answer the why question to regulating crypto finance, can then provide the basis for regulatory ontologies, design, content, standards and regulators’ supervisory architecture.

29 In a peer-to-peer context, protection is often not provided as freedom of contract between parties is deemed as sufficient governance. However, Verstein questions this and advocates consumer protection in peer-to-peer lending. This arguably can be extended to a blockchain context; see A Verstein, ‘The Misregulation of Person-to-Person Lending’ (2011) 45 UC Davis Law Review 445. 30 F Schär, ‘Decentralized Finance: On Blockchain- and Smart Contract-based Financial Markets’ (2020), at ssrn.com/abstract=3571335; ‘The DeFi “Flash Loan” Attack That Changed Everything’ (27 February 2020), at www.coindesk.com/the-defi-flash-loan-attack-that-changed-everything. 31 ‘Performing a Flash Loan’, at docs.aave.com/developers/tutorials/performing-a-flash-loan. 32 P Paech, ‘The Governance of Blockchain Financial Networks’ (2017) 80 Modern Law Review 1073; HJ Allen, ‘Driverless Finance’ (2020) 10 Harvard Business Law Review 157. 33 See nn 13–15. 34 HP Minsky, The Financial Instability Hypothesis (Levy Economics Institute Working Paper, No 74, 1992), at www.levyinstitute.org/pubs/wp74.pdf. 35 Bank of England Act 1998, ss 9A–9R amended by UK Financial Services Act 2012; the Office of Financial Research established in the Dodd-Frank Act 2010. 36 Paech (2017).

256  Regulating Crypto Finance

A.  Policy Choice for Productive Financialisation This book supports an enabling regulatory regime for supporting the productive forms of financialisation in the crypto economy, as has been extensively set out in the preceding chapters. This paradigm is not dissimilar from the enabling and regulative orders for banking, securities and investment regulation in the conventional economy.37 However, speculative financial activity coexists alongside productive financial activity in the conventional financial economy,38 and the volumes of the former have raised concerns. For example, investment funds and their managers have been criticised to be shorttermist, making returns out of short-term price arbitrage of securities as financial assets instead of perceiving their roles as patient capitalists investing in real productive growth over the long term.39 Further, financial derivative contracts have been used for hedging and risk management purposes but also blatantly for speculative purposes.40 Financial innovation has often appealed to short-term competitive and profit-seeking needs by financiers41 and decoupled from social utility.42 The double-edged nature of financial products seems to be a necessary phenomenon in finance as the weeds and wheat grow together.43 It may be argued that it is impossible to regulate ‘out’ financial activity that are more speculative than supportive of productive uses as the utility of financial transactions can be multifaceted.44 However, it may also be argued that regulators do not engage in controlling speculation because such activities are usually undertaken amongst sophisticated and wholesale sector financial participants, excluding retail participants. Many developed financial jurisdictions have adopted regulatory policies that leave wholesale markets largely untouched based on two assumptions. The first is that sophisticated participants dealing with each other at arm’s length in the financial markets would be able to negotiate contractual governance between themselves. Over time, 37 See M Andenas and IH-Y Chiu, The Foundations and Anatomy of Financial Regulation (Routledge, 2014) ch 1. 38 Foster (2007). 39 Corporate Values Strategy Group, ‘Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management’ (Aspen Institute Business and Society Programs, 2009), at www. aspeninstitute.org/publications/overcoming-short-termism-call-more-responsible-approach-investmentbusiness-management; UK Department of Business Innovation and Skills, ‘The Kay Review of UK Equity Markets and Long-Term Decision Making’ (Final Report, 23 July 2012); E Duruigbo, ‘Tackling Shareholder Short-Termism and Managerial Myopia’ (2011–12) 100 Kentucky Law Journal 531. 40 G Poitras, Risk Management, Speculation and Derivative Securities (Elseiver Academic Press, 2002); L Stout, ‘Risk, Speculation, and OTC Derivatives: An Inaugural Essay for Convivium’ (2011) 1 Accounting Economics and Law 2. 41 E Avgouleas, ‘Regulating Financial Innovation: A Multifaceted Challenge to Financial Stability, Consumer Protection, and Growth’ in N Moloney, E Ferran and J Payne (eds), Oxford Handbook of Financial Regulation (OUP, 2015). 42 ‘City is too big and socially useless, says Lord Turner’ (The Telegraph, 26 August 2009), at www.telegraph. co.uk/finance/newsbysector/banksandfinance/6096546/City-is-too-big-and-socially-useless-says-LordTurner.html, on many financial activities in the City of London being of dubious social utility, opinion in the wake of the global financial crisis 2007–09. Also see critical perspectives on financial innovation in D Awrey, ‘Towards a Supply-Side Theory of Financial Innovation’ (2013) 41 Journal of Comparative Economics 401; D Awrey, ‘Complexity, Innovation, and the Regulation of Modern Financial Markets’ (2012) 2 Harvard Business Law Review 235. 43 Reference to The Holy Bible (NIV), Matt 13:30. 44 Alessandrini (2011).

Productive and Hyper Forms of Financialisation  257 privately fostered market-based governance should be sufficient. This assumption underpinned the lack of regulatory governance in the markets for short-term lending between financial institutions based on collateralised instruments (which can be rehypothecated many times over) prior to the global financial crisis of 2007–09,45 and also derivatives markets46 and investment funds such as hedge funds catering only to sophisticated investors.47 The second assumption is that as retail investors are not involved in complex and sophisticated sectors of the financial markets, the public interest footprint of such activities is less significant, and regulators need not dedicate resources to control or monitor such activities. This also explains why there are carve-outs and exemptions from regulatory application where only sophisticated investors are involved, such as in securities regulation.48 Both assumptions helped to maintain a proportionate financial regulatory system, which, on the one hand, meets the risk-based ideology that regulators subscribe to, allowing them to allocate regulatory resources efficiently to problems of greatest social visibility and demand;49 but, on the other hand, meets the interests of the financial sector to push back against excessive regulation.50 Lothian also argues that this regulatory ‘dualism’ underpins excessive financialisation in the US.51 However, the global financial crisis 2007–09 rendered the above assumptions questionable as sophisticated participants such as AIG that wrote an excessive amount of derivative contracts found itself dangerously unable to honour its commitments and had to be rescued by the Treasury due to public interest ramifications of its potential insolvency.52 Wholesale sector participants could not necessarily manage a systemic event of market risk.53 Nevertheless, although regulators responded by introducing regulatory governance over financial markets and activities that only sophisticated investors would participate in, such as derivatives and repo markets, the nature of much of this governance enhanced and did not replace market-based governance. Regulatory governance still avoided being overly prescriptive where sophisticated market participants are involved. 45 ‘Fed scholars: A run on the repurchase market caused the financial crisis and will probably happen again’ (23 May 2011), at repowatch.org/2011/05/23/fed-scholars-a-run-on-the-repurchase-market-caused-the-financialcrisis-and-will-probably-happen-again; H McVea, ‘Restoring Regulatory Credibility and Preventing “Repo Runs”: A Cautionary Tale’ (2019) 30 European Business Law Review 1. 46 M Greenberger, ‘Derivatives in the Crisis and Financial Reform’ in MH Wolfson and GF Epstein (eds), The Handbook of Political Economy of Financial Crises (OUP, 2013). 47 ‘Hedge Funds Not a Primary Cause of the Financial Crisis, but Could Contribute to Systemic Risk’ (19 September 2012), at www.rand.org/news/press/2012/09/19.html; P Lysandrou, ‘The real role of hedge funds in the crisis’ (Financial Times, 1 April 2012), at www.ft.com/content/e83f9c52-6910-11e1-9931-00144feabdc0. 48 Such as Regulation D, Securities Act 1933 in the US, and EU Prospectus Regulation 2017, Art 1(4)(a). 49 J Black, ‘The Emergence of Risk-Based Regulation and the New Public Risk Management in the United Kingdom’ [2005] Public Law 512. 50 S Deakin, ‘The Rise of Finance: What Is It, What Is Driving It, What Might Stop It?’ (2008) 30 Comparative Labour Law and Policy Journal 67; S Piccioto and J Haines, ‘Regulating Global Financial Markets’ (1999) 26 Journal of Law and Society 351; C Bradley, ‘Private International Law Making for the Financial Markets’ (2005) 29 Fordham International Law Journal 127. 51 T Lothian, Law and the Wealth of Nations (Columbia University Press, 2016) 101. 52 ‘Fed’s $85 Billion Loan Rescues Insurer’ (NY Times, 16 September 2008), at www.nytimes.com/2008/09/17/ business/17insure.html. 53 S Schwarz, ‘Systemic Risk’ (2008) 97 Georgetown Law Journal 193; S Schwarcz, ‘Regulating Complexity in Financial Markets’ (2009) 87 Washington and Lee Law Review 211.

258  Regulating Crypto Finance In derivatives markets, more standardisation and central clearing of derivatives are called for in order for risks to be made more transparent, and for central clearing parties to interpose with ex ante risk management between parties.54 In rehypothecation markets, there is mandatory transparency regarding collateral reuse55 but it is still up to parties to determine if they would transact upon such terms. Even where wholesale markets such as foreign currency and gold markets were embroiled in scandals regarding price manipulation,56 the UK opted for self-regulation by allowing an industry-based standards board to be established to provide self-governing standards and discipline.57 Hence, even with public interest in the risk management of sophisticated financial sector participants’ exposures, such as in relation to speculative forms of trading, regulatory governance over these activities remains indirect, leveraging upon market parties scrutinise transactions and determine what is optimal for their risk positions. For example, retail investment funds in the EU are regulated on a product basis,58 but hedge funds that may be marketed only to sophisticated investors are regulated in relation to managers’ prudential and conduct aspects,59 leaving sophisticated investors to figure out for themselves the wisdom of particular fund strategies and their prospects.60 The relative refrain of regulatory governance in controlling speculative or ‘socially useless’61 financial activities is not immune from criticism.62 This regulatory tendency, manifest in the mainstream financial sector, would arguably be no different in the crypto financial universe. For example, Bitcoin derivatives have been allowed to be marketed to sophisticated participants as self-certified by two US major commodities trading exchanges.63 54 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories; AG Balmer, Regulating Financial Derivatives (Edward Elgar, 2018). 55 Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012, Art 15. 56 ‘Forex scandal: How to rig the market’ (BBC News, 20 May 2015), at www.bbc.co.uk/news/ business-26526905; ‘London Gold Fix study suggests decade of bank manipulation’ (28 February 2014), at financialpost.com/investing/london-gold-fix-study-indicates-decade-of-bank-manipulation. 57 The Fixed Income, Currencies and Commodities Markets Standards Board was set up as an industry body to oversee wholesale market conduct after the scandals regarding forex and gold rigging emerged, and see Bank of England, ‘Fair and Effective Markets Review – Final Report’ (10 June 2015), at www.bankofeng​ land.co.uk/report/2015/fair-and-effective-markets-review---final-report. 58 Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). 59 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010. 60 For example, Grayscale, one of the largest asset managers for cryptoassets and currencies, say clearly that their products are not registered with the SEC (grayscale.co/faq), and are exclusively marketed to accredited investors. This absence of fund regulation would be similar to the UK and EU, and marketing exemptions also exist for promotions made exclusively to such investors. 61 See n 42. 62 Avgouleas (2015); A Chadwick, ‘Regulating Excessive Speculation: Commodity Derivatives and the Global Food Crisis’ (2017) 66 International and Comparative Law Quarterly 625 on why financial speculation should be regulated if these activities entail adverse real economic consequences. 63 G Patti, ‘The Regulation of Financial Product Innovation Typified by Bitcoin-Based Derivative Contracts’ (2018–19) 38 Review of Banking and Financial Law 765, at ssrn.com/abstract=3380770; L Reiners, ‘Bitcoin

Productive and Hyper Forms of Financialisation  259 The exemption from securities regulatory requirements in the US and EU for token offers made to sophisticated investors only,64 and exemption from specific cryptoasset regulations proposed in the EU for token offers65 made only to professional investors are examples of the continued application of similar regulatory ideology. The FCA has also banned all crypto derivatives and exchange-traded notes from being sold to retail investors.66 This measure, being limited to retail investors, would allow sophisticated investors to dominate in speculative activity involving crypto derivatives.67 Sophisticated investors also have more resources to engage in speculation, and in this manner, consumer protection measures against participating in speculative and highly risky financial activities have nothing to do with reducing the level of such activities. However, we also observe contrary directions such as the first approved listing of a Bitcoin exchange-traded fund in Canada, allowing retail participation.68 Although this approach democratises participation for retail investors in crypto finance, retail investors’ interest in the exchange-traded fund would be for the purposes of gaining exposure to Bitcoin and enjoying its upsides, without real engagement with the crypto economy. As chapter three has argued, financial regulation trajectories such as the above may reshape the crypto finance universe as a space for financier speculation and may undermine productive financialisation and the participation of ordinary peers in the blockchain-based economy. We argue that a different policy choice is needed in order to enable the productive financialisation in the crypto economy, supported by retail participation. Further, the rise of acute, automated forms of speculation in the crypto finance universe should provide regulators with an opportunity to consider their roles in governing hyper forms of financialisation. The section below discusses four possible approaches.

B.  Policy Choices for Hyper-financialisation Four sets of policy choices can be considered in relation to governing the levels of hyperfinancialisation in the crypto economy. First, a policy choice can be made to ensure that those engaged in it are able to manage the risks of their activity and avoid entailing adverse consequences to others or to the financial system in general. This policy choice would however not necessarily seek to drive down the volumes of hyper-financialisation. Second, moving along the spectrum of intensity of governance or control, excessive Futures: From Self-Certification to Systemic Risk’ (2019) 23 North Carolina Banking Institute 61. The CBOE stopped offering Bitcoin futures contracts in 2019 but the Chicago Mercantile Exchange still offers Bitcoin futures contracts. 64 n 42. 65 European Commission, Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (September 2020), at ec.europa.eu/ finance/docs/law/200924-crypto-assets-proposal_en.pdf. 66 ‘FCA bans the sale of crypto-derivatives to retail consumers’ (6 October 2020), at www.fca.org.uk/news/ press-releases/fca-bans-sale-crypto-derivatives-retail-consumers. 67 The largest global crypto derivative offerings, from OKEx, Binance and Huobi centre on major cryptocurrencies such as Bitcoin, ether, Litecoin, Bitcoin cash; see www.huobi.com/en-us/markets/?tab=dm; www. binance.com/en/futures; and www.okex.com/derivatives/futures/usd-btc-weekly. 68 ‘North America’s First Bitcoin ETF Gets Green Light in Canada’ (15 February 2021), at www.bloom​ bergquint.com/markets/purpose-investments-says-canadian-regulators-approve-bitcoin-etf.

260  Regulating Crypto Finance levels of speculative financial activity can be discouraged by incentive-based regulation, much like how microprudential regulation is intended to calibrate the risk-taking behaviour of banks69 and other financial institutions.70 Third, a more definitive policy stance can be taken against speculative financial activity so that speculative forms of financial instruments may be subject to pre-vetting and approval. Finally, financial regulators could consider positively developing allocative steer for financial resources, so that financial capital is not directed to merely speculative financial activity but to productive causes. The first policy choice is aligned with the current regulatory approaches in major financial jurisdictions such as the UK, EU and US, where regulators respond to market failures.71 In this manner, hyper-financialisation is not regarded as an anathema as such, but only to be subject to governance and control in relation to sub-optimal effects observed. For example, high-frequency traders intending to benefit from tiny arbitrage in securities markets are governed in the EU by a mandatory obligation not to withdraw liquidity arbitrarily if their presence in markets has become relied upon as a marketmaking mechanism.72 In this manner, regulators see the speculative trading activities as being beneficial in the sense of constant liquidity provision but aim to moderate only the possible sub-optimal effects. Although micro-prudential regulation goes some way to moderate financial institution risk-taking, including being engaged with speculative financial activities,73 and in the UK, structural reforms74 have been introduced to separate retail banks from other parts of market-based banking activities, including speculative types of trading activities, such regulations are based on broader financial stability considerations.75 Such interventions are also generally backward-looking, after scandals or crises,76 in order for financial institutions to internalise social cost that was not internalised before. Regulators are unlikely to make prescription in terms of ‘what not to do’ in relation to speculative financial activity engaged by financial institutions.

69 For credit institutions in the EU, see Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49; Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012. See IH-Y Chiu, ‘Rethinking the Law and Economics of Post-Crisis Micro-prudential Regulation- The Need to Invert the Relationship of Law to Economics?’ (2019) 38 Review of Banking and Financial Law 639. 70 Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014; Directive (EU) 2019/2034 of the European Parliament and of the Council of 27 November 2019 on the prudential supervision of investment firms and amending Directives 2002/87/EC, 2009/65/EC, 2011/61/EU, 2013/36/EU, 2014/59/EU and 2014/65/EU on a microprudential regime for investment firms. 71 FCA, ‘Economics for Effective Regulation’ (2016), at www.fca.org.uk/publication/occasional-papers/ occassional-paper-13.pdf. 72 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, Art 17. 73 See below. 74 Financial Services (Banking Reform) Act 2013 ss 142Aff amending the Financial Services and Markets Act 2000. This is a result of recommendations made by Independent Banking Commission, ‘Final Report’ (2011), at bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf. 75 Discussed in IH-Y Chiu and J Wilson, Banking Law and Regulation (OUP, 2019) chs 8–10. 76 EA Posner and A Vermeule, ‘Crisis Governance in the Administrative State: 9/11 and the Financial Meltdown of 2008’ (2009) 76 University of Chicago Law Review 1613.

Productive and Hyper Forms of Financialisation  261 Regulatory governance is crafted more along the lines of imposing duties on financial institutions to manage risk prudently, and provide for plans in order to prevent any fallouts from damaging the wider financial system, such as by making recovery and resolution plans.77 It may be argued that disincentivising forms of regulation, principally in microprudential regulation, are powerful constraints against sub-optimal levels of risk-taking, whether in productive or speculative financial activities. Microprudential regulation has been greatly enhanced since the global financial crisis 2007–09 in order to moderate financial institutions’ risk-taking behaviour so that they could conservatively ‘count’ the potential cost of risk.78 In this manner, the risks of hyper-financialisation can be reflected in higher regulatory cost, therefore having a disincentivising effect on such activity. After the global financial crisis, opaque securitised products attract a high regulatory cost, in order to disincentivise poorly originated, packaged and sub-transparent financial instruments that have been priced wrongly prior to the crisis.79 However, it can be argued that hyper-financialisation can take place with respect to well-designed and transparent financial instruments, also financial instruments well traded in liquid markets. In this manner, disincentivising regulation aimed at particular risks to financial institution solvency or liquidity are not always aligned with reducing speculative levels of activity as such. Financial markets participants that stand to gain much from speculative activity would essentially manage their regulatory cost in order to minimise such cost, and do not necessarily seek to reduce or cease engagement with certain speculative activities. The first two policy approaches, ie ex post regulation targeted at market failures and micro-prudential regulation, arguably do not take a definitive stand against hyperfinancialisation as such. Macroprudential or counter-cyclical types of ­regulation80 developed after the global financial crisis, and it may be queried if they finally address Gerding’s criticism that law and regulation do not curb speculative behaviour but instead facilitate such behaviour. Gerding argues that law often facilitates financial asset price bubbles as policy-makers refrain from prematurely damaging market conditions81 even if speculative activities are rife. Macroprudential supervision is intended to pre-empt market trends that appear risky on a forward-looking basis. However, although introduced after the global financial crisis, macroprudential regulators have behaved in a measured fashion as neither the UK nor EU have taken positive actions in view of asset price bubble signs such as in the housing market82 77 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council. 78 IH-Y Chiu, ‘Rethinking the Law and Economics of Post-Crisis Micro-prudential Regulation – The Need to Invert the Relationship of Law to Economics?’ (2019) 38 Review of Banking and Financial Law 639. 79 ie attracting a standard 1250% risk-weight, Arts 251–59, CRD IV Regulation (EU) No 575/2013. 80 A Baker, ‘The Gradual Transformation? The Incremental Dynamics of Macroprudential Regulation’ (2012) 7 Regulation and Governance 417. 81 EF Gerding, Law, Bubbles, and Financial Regulation (Routledge, 2016). 82 ‘Financial Policy Committee statement on housing market powers of Direction from its policy meeting, 26 September 2014’ (2014), at www.bankofengland.co.uk/-/media/boe/files/statement/2014/fpc-statementfrom-its-policy-meeting-26-september-2014.pdf, but the powers were not exercised, despite the European Systemic Risk Board’s warning to the UK in 2016; see www.esrb.europa.eu/pub/pdf/warnings/2016/161128_ ESRB_UK_warning.en.pdf.

262  Regulating Crypto Finance or in equity markets.83 Instead, macroprudential policy has been most pronounced in relaxing microprudential requirements in the wake of the Covid-19 pandemic to allow businesses and households needing financial support to access more borrowing.84 Moving along the spectrum of policy choice towards taking a more definitive stand against forms of speculative hyper-financialisation, it can be argued that financial instruments that promote highly or purely speculative financial activity should be subject to control in terms of regulatory gatekeeping. In this manner, financial products and instruments should be subject to pre-vetting or comprehensive product regulation, in order to be marketed or released, even to sophisticated investors. Allen argues that in an age of highly automated financial transactions, which is termed ‘driverless finance’, a precautionary approach is warranted to pre-vet financial innovations, in order to prevent severely destabilising occurrences from taking place.85 This argument is largely premised upon financial stability concerns and would allow regulators to vet the code of automated financial transactions, such as those facilitated by tokenisation on blockchains, in order to assess safety. Regulators could demand that developers include code that builds in safeguards against systemic stability risks. Extending Allen’s argument further, it is arguable that public policy choices regarding automated finance may not be confined only to stability risks but also to other public interest aspects in the crypto financial universe, such as whether productive economic activity is undermined and whether excessive forms of speculation are crowding out the crypto economy. In this manner, regulators could consider the application of a range of powers specific to product control, ie product intervention, product governance or, more comprehensively, product regulation, coupled with the regulation of gambling. In the UK and EU, product intervention powers were first introduced in the wake of the global financial crisis.86 Product intervention would not involve ex ante vetting of products and their authorisation before release. However, regulators could subject the design or marketing of financial products to certain conditions in order to combat the risks they pose to consumer protection and financial stability objectives. The EU’s product intervention regime allows national authorities to impose permanent bans or other conditions, as well as the European Banking and Securities Markets Authorities to issue temporary bans or other conditions, in relation to any type of financial instrument within ESMA’s governing scope (ie securities, derivatives and fund products) or structured deposits and products within the EBA’s governing scope, or a financial activity or practice, to address the consumer protection or financial stability objectives.87 The UK’s product intervention objectives are arguably wider than those introduced under EU legislation as they can also be exercised in relation to meeting the market integrity objective. This means products that may be speculative and distorting of markets 83 ‘ESMA Sees Potential Decoupling of Financial Market Performance and Underlying Economic Activity’ (14 May 2020), at www.esma.europa.eu/press-news/esma-news/esma-sees-potential-decoupling-financialmarket-performance-and-underlying. However, no action is yet discussed at the macroprudential level. 84 IH-Y Chiu, A Kokkinis and A Miglionico, ‘Debt Expansion as “Relief and Rescue” at the Time of the Covid-19 Pandemic: Insights from the Legal Theory of Finance’ (2020–21) 28 Indiana Journal of Global Legal Studies 29. 85 HJ Allen, ‘Driverless Finance’ (2020) 10 Harvard Business Law Review 157. 86 Financial Services and Markets Act 2000, s 137D amended by Financial Services Act 2012. 87 Arts 40–42, Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (MiFIR).

Productive and Hyper Forms of Financialisation  263 can potentially be considered for product intervention.88 The UK Financial Conduct Authority’s powers are also wider in scope, as product intervention can be exercised against any specified agreement (of financial transaction), or particularly to specified persons. Product intervention may be in the form89 of banning products, at the most severe end, or limiting the scope of marketing and promotion, or attaching more severe conditions at point of distribution or sale, such as disallowing non-advised sales. The regulator could also require the use of warning labels or impose additional requirements in the process of product design and development,90 or impose recovery, enforcement and compensation rights against financial institutions for the benefit of their customers, or order the unenforceability of obligations against customers.91 Examples of product intervention carried out by ESMA include a continuing ban against marketing contracts for differences and binary option products to retail customers since June 2018.92 The UK FCA has permanently banned the marketing of binary option products to retail investors,93 and has also issued a year’s ban from late 2019 on marketing to retail investors mini-bond products composed of largely illiquid securities.94 The FCA has also banned all crypto derivatives and exchange-traded notes from being sold to retail investors.95 As can be observed, product intervention is regarded as an exceptional measure in an otherwise liberal financial market, and this is reflected in the qualifications set out in EU legislation for the exercise of this power.96 Further, it has been sparingly used, focused on consumer protection contexts. We have argued above that the regulatory dualism of leaving sophisticated investors to speculative financial activity without much regulatory oversight is significantly contributory to the levels of hyper-financialisation observed in both the conventional and crypto financial spheres. There is a need to consider if product intervention powers can go further beyond being merely consumer-focused. A couple of commentators opine that even for sophisticated or institutional participants, product risks do feature, such as in relation to insurance products that may be traded between reinsurers.97 The refrain from i­ntervening into sophisticated participants’ markets continues to be an underlying ideology for financial regulation. However, regulators should call to mind that such 88 Financial Services and Markets Act 2000, s 137D(1)(b), amended by Financial Services Act 2012. 89 Discussed in FSA, ‘Product Intervention’ (January 2011) DP11/01, at www.fsa.gov.uk/pubs/discussion/ dp11_01.pdf, ch 6. 90 FCA, ‘The FCA’s Use of Temporary Product Intervention Rules’ (March 2013), at www.fsa.gov.uk/static/ pubs/policy/ps13-03.pdf, finally in FCA Handbook PROD 2.2.6. 91 Financial Services and Markets Act 2000, s 137D(7), amended by Financial Services Act 2012. 92 See www.esma.europa.eu/policy-activities/mifid-ii-and-investor-protection/product-intervention. 93 FCA, ‘PS19/11: Product Intervention Measures for Retail Binary Option’s (29 March 2019), at www.fca. org.uk/publications/policy-statements/ps19-11-product-intervention-measures-retail-binary-options. 94 FCA, ‘Temporary intervention on the marketing of speculative mini-bonds to retail investors’ (26 November 2019), at www.fca.org.uk/publications/temporary-product-interventions/temporary-intervention-marketingspeculative-mini-bonds-retail-investors. 95 ‘FCA bans the sale of crypto-derivatives to retail consumers’ (6 October 2020), at www.fca.org.uk/news/ press-releases/fca-bans-sale-crypto-derivatives-retail-consumers. 96 Also see V Colaert, ‘The MiFID and PRIIPs Product Intervention Regime: In Need of Intervention?’ (2020) 17 European Company and Financial Law Review 99, at papers.ssrn.com/sol3/papers.cfm?abstract_ id=3440557. 97 M Goldby and A Keller, ‘Product Intervention as a Macroprudential Tool: the Case of Catastrophe Bonds’ (2019) 51 George Washington International Law Review 1, discussing the systemic risks in catastrophe bond markets and the need for product intervention as macroprudential policy.

264  Regulating Crypto Finance refrain has allowed sophisticated investors and complex financial products to bring about systemic risk leading up to the global financial crisis 2007–09.98 Product governance powers have been introduced in the EU more recently in 2017. This regime imposes internal procedural regulation for product manufacturers and distributors, so that they are required to consider a suitable target market and the risks to this target market, during the process of product design.99 Distributors are also to perform an independent assessment of product suitability for the target market ahead of marketing, but are compelled to obtain comprehensive information from product manufacturers in order to make their independent assessments.100 Product governance seems ex ante in nature, and can achieve a regulative effect in terms of aligning financial institutions’ incentives in product innovation with public interest objectives in terms of consumer welfare and protection. At best, such a regime can shape behaviour and culture at firms in an ex ante manner without being prescriptive as to regulators’ gatekeeping of each product. However, as discussed in chapter five in relation to ICOs, product governance rules are aimed at internally regulating firms’ conduct and seems procedural in nature.101 It is uncertain if any shortfalls give rise to investor enforcement as each aggrieved investor still needs to establish a case for unsuitable personal advice102 given to him/her. Further, it is uncertain what regulatory enforcement is possible against product manufacturers or distributors. Enforcement under these rules may not be warranted even where there may be individual cases alleging unsuitable personal advice in relation to these products. Unsuitable personal advice for any particular aggrieved individual may not be causatively linked to manufacturers’ or distributors’ policies in product governance. In this manner, it is uncertain if product governance rules provide sufficient incentives and compulsion to financial institutions to design products responsibly, as the legal risks posed to them may be limited. Both product intervention and product governance rules still defer significantly to the freedom of financial institutions to engage in innovation (even if self-interested) and to bring them to market. Product intervention is largely based on ex post evaluations as currently practised, and product governance provides only a broadly framed regime for internal proceduralisation. Financial regulation has so far avoided more intense measures such as comprehensive product regulation where financial products are subject to pre-vetting, even if they have complex features.103 It is questioned if the time has come for such an approach in relation to crypto financial products in order to mitigate excessive speculation and hyper-financialisation that poses risks to users, consumers, 98 RE Mendales, ‘Collateralized Explosive Devices: Why Securities Regulation Failed To Prevent The CDO Meltdown, And How To Fix It’ (2009) University of Illinois Law Review 1359. 99 Commission Delegated Directive (EU) 2017/593 of 7 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to safeguarding of financial instruments and funds belonging to clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or any monetary or non-monetary benefits, Art 9. 100 Art 10, ibid. 101 A Maracci, ‘European Regulatory Private Law Going Global? The Case of Product Governance’ (2017) 18 European Business Organisations Law Review 305. 102 Suitability refers to meeting three criteria, ie that investors’ objectives are met, they understand the risks involved and that they are financially able to bear those risks, Art 25, Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61, enacted in FCA Handbook COBS 9 and 9A. 103 EA Posner and EG Weyl, ‘An FDA for Financial Innovation: Applying the Insurable Interest Doctrine to the Twenty-First-Century Financial Markets’ (John M Olin Law & Economics Working Paper No 589, 2012),

Productive and Hyper Forms of Financialisation  265 the economic development of the crypto economy as well as the stability of its financial universe.104 Such an approach can also be infused with the regulation of gambling in general.105 The Gambling Act 2005 in the UK explicitly provides for gambling activities to be licensed so that they can be subject to continuous oversight and specific conditions imposed by the Gambling Commission.106 These broadly framed gatekeeping and licensing powers are for the purposes of preventing crime and disorder resulting from gambling, preventing vulnerable or young people from being exploited and to ensure that gambling activities are conducted fairly and openly.107 A similar ethos for regulating hyper-financialisation and speculative financial activities is arguably applicable. Dedicated supervision can be extended over speculative crypto financial activity for specified public interest objectives such as harm prevention, stability preservation and promotion of productive economic development. In this manner, we call for a form of product regulation in crypto finance, for the purposes of the above objectives. It may be argued that such a regulatory stance applied to crypto finance would be inconsistent with the regulation of other mainstream financial products. This chapter suggests that the product complexity and opacity exacerbated in a dynamic technological context for crypto finance warrants special attention at the moment. Moreover, product regulation in this area can provide regulators with experimental learning on how a broader product regulation agenda may be carried out. In light of continued problems in retail investment discovered in the UK,108 there may be a case for introducing product regulation more generally. Product regulation may be criticised to be paternalistic in nature, and regulators need not necessarily make the right judgments about what innovations to gatekeep. Involving regulators in the ex ante approval of financial products could stifle innovative efforts.109 On the other hand, product regulation that exists in the books can be implemented in a relaxed manner, therefore not amounting to meaningful gatekeeping at all. The final policy choice we discuss along the spectrum is that of allocative regulation in relation to how financial resources are allocated. This policy paradigm would likely be regarded as paternalistic as it would involve public sector steering (though not necessarily exclusively) in relation to allocation of financial capital, radically affecting available at papers.ssrn.com/sol3/papers.cfm?abstract_id=2010606; ST Omarova, ‘License to Deal: Mandatory Approval of Complex Financial Products’ (2012) 90 Washington University Law Review 63. 104 Discussed in section below. 105 J Brito, H Shadab and A Castillo, ‘Bitcoin Financial Regulation: Securities, Derivatives, Prediction Markets, and Gambling’ (2014) 16 Columbia Science and Technology Law Review 144. 106 www.gamblingcommission.gov.uk/home.aspx. 107 Gambling Act 2005, s 1. 108 Such as retail investment in illiquid funds that collapsed in late 2019 leading to significant losses; ‘Investors in collapsed Woodford fund to get half their cash in January’ (Reuters, 13 December 2020), at www. reuters.com/article/us-woodford-inv-fund/investors-in-collapsed-woodford-fund-to-get-half-their-cash-injanuary-idUKKBN1YH1N4; the issue under the investigation of the FCA at the time of writing; the mis-selling of unregulated mini-bond products by failed investment firm London and Capital Finance, a subject of the Gloster inquiry, see Rt Hon Dame Elizabeth Gloster DBE, ‘Report of the Independent Investigation into the Financial Conduct Authority’s Regulation of London Capital & Finance plc’ (December 2020), at assets. publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/945247/Gloster_ Report_FINAL.pdf. 109 AI Ogus, ‘Regulatory Paternalism: When is it Justified?’ in KJ Hopt, E Wymeersch, H Kanda and H Baum (eds), Corporate Governance in Context: Corporations, States, and Markets in Europe, Japan, and the US (OUP, 2005) ch15.

266  Regulating Crypto Finance the freedoms of private sector market participants to do so. But on the other hand, this policy paradigm may be seen as a form of structural reordering, so that institutions, policies and structures may be changed in response to the more fundamental and normative question of how finance should be put to work. We refer to Lothian’s work on this as well as the structuralist vision proposed by Omarova and Hockett. In Lothian’s final work,110 she argued that a new vision for finance should be fostered, so that financial resources can be allocated, in a highly democratised and socially inclusive manner, to real production, and not merely to chase after financialised pursuits and profits. Her broad paradigm-shifting agenda called for policy change towards accumulation of savings instead of debt in developed countries such as the US; deep policy reform to stimulate the supply side so that productive activity can be generated in order to attract the demand side for investment; and the development of an industrial policy so that the channels for meeting economic development needs would not merely be dominated by private sector financialisation. She called for a broad policy steer towards financing real productivity and moving away from speculative transactions and financial activity that would have no social contribution.111 The applicational implications include public sector leadership in allocation, such as through industrial policy or public–private partnership vehicles,112 as well as regulatory frameworks that constrain speculative activities, such as by way of a Tobin tax.113 It may be argued that such proposals for change requiring heavy lifting would likely face opposition, in terms of the extent of institutional change required and the cost of implementation. Omarova and Hockett also argue that regulatory reform can bring about a new allocative steer for financial capital. Omarova and Hockett114 argue that financial intermediation is ultimately a finance franchise granted by the public sector, based on the monetary order backed by the sovereign. Hence, finance should serve public interest purposes such as developmental purposes in the economy. Although the sovereign does not provide the monetary order in the crypto economy, it can be argued that the creation of money in the conventional economy does support the crypto economy as much of cryptocurrency is transformed and not innately produced, eg by mining. In this manner, regulative steer can be warranted to provide support for the productive financialisation of the crypto economy,115 while mitigating the adverse effects of speculative or hyper-financialisation. Allocative financial regulation is not the norm in many developed financial jurisdictions as there is a hazardous fine line with central planning. The distinct disadvantages of central planning include possible corrupt practices in terms of political steering, as well as poor or inefficient judgments. In sum, policy choices along the spectrum of greater paternalism or public sector ordering offer possibilities for bringing speculative

110 T Lothian, Law and the Wealth of Nations (Columbia University Press, 2016), ch 2. 111 Indeed, Lothian (2016, 104) argues for speculative transactions without any service to the productive economy to be banned. 112 Also Lothian (2016) 105ff. 113 ‘The Tobin tax explained’ (Financial Times, 28 September 2011), at www.ft.com/content/6210e49c-930711de-b146-00144feabdc0. 114 RC Hockett and ST Omarova, ‘The Finance Franchise’ (2017) 102 Cornell Law Review 1143. 115 Discussed in chs 5 and 6 of this volume.

Trends in Regulating Crypto Finance  267 activity and hyper-financialisation under control, as the berth for private sector freedom is more constrained. There are, however, hazards with such approaches which can seem authoritarian, which on the face of it is in opposition to the ethos of the crypto economy. The fine balances of regulatory capitalism in facilitating productive financialisation but taming hyper-financialisation may not be easy to achieve. Such choice sets are underpinned by ideological preferences and social values, and are reflected in regulatory design. It is nevertheless possible that authoritarian risks in policy choice sets can be subject to regulatory design mechanisms that mitigate such risk, by having accountable and inclusive regulatory spaces where regulators’ discretion can be subject to co-regulation and ex post scrutiny. This chapter has so far set out the broad policy choices for productive and hyperfinancialisation in the crypto economy, such considerations not being evident in extant policy discussions at the time of writing. Regulatory design should be based on policy choices made with regard to supporting productive financialisation (or otherwise), and taking a stance on hyper-financialisation. This would be preferred to a coherentist approach of fitting crypto financial developments into existing financial regulation categories. We turn in the next section to developments in crypto finance to date, critically discussing emerging regulatory initiatives. In examining the emerging regulatory treatment, possible flaws and lacunae, this chapter highlights the hazards of a coherentist approach to fitting crypto financial developments into existing regulatory regimes, or to develop new regimes heavily drawn from existing frameworks, such as the EU Regulation for Markets in Cryptoassets discussed earlier in this book. We provide at the end of this chapter a high-level framework for regulatory policy and design.

II.  Trends in Regulating Crypto Finance It is asserted that ‘Digital currencies are more regulated than you think’,116 demystifying the myth that crypto finance, broadly defined, is simply unregulated and left in the Wild West. A good number of crypto finance products are not marketed in the shadows and about 40 per cent of crypto service providers are subject to a form of formal regulation,117 usually by way of extension from existing regulatory frameworks. Indeed, being regulated in a coherentist manner can shore up an appearance of legitimacy, as institutional fit seems to be achieved. However, we argue that there is a need to consider not only innovative crypto finance that appears to be uncategorised or unregulated under extant financial regulation, but also the already-regulated forms of crypto finance and service providers, to consider if extant regulation really addresses the why of regulating them. Existing regulatory frameworks may be under- or over-inclusive, but these gaps may not be purposefully interrogated due to our satisfaction that regulation is in place.

116 ‘Opinion by Craig Salm of digital asset manager Grayscale’, 11 May 2020, at www.investmentnews.com/ digital-currencies-are-more-regulated-than-you-think-192634. 117 A Blandin, G Pieters, Y Wu, T Eisermann, A Dek, S Taylor and D Njoki, ‘3rd Global Cryptoasset Benchmarking Study’ (Cambridge Centre for Alternative Finance, 2020).

268  Regulating Crypto Finance First, there are many already-regulated crypto finance products, particularly those that offer speculative exposure to Bitcoin and other major cryptocurrencies. These are traded on regulated exchanges and markets in the US and EU. These are regulated in a similar manner as their conventional financial counterparts in terms of derivative products. The relatively light regulatory oversight over these can be attributed to one or both market characteristics, ie intermediation by established regulated markets and the availability only to sophisticated investors.

A.  Crypto Hedge Funds, Derivatives and Exchange-traded Products Crypto hedge funds are relatively lightly regulated in the US and EU in relation to their investment strategies. In the US, such products are available only to sophisticated investors, as availability to retail investors entails more onerous mutual fund regulation.118 In the EU, although hedge fund managers are subject to the regulatory requirements in the Alternative Investment Fund Managers’ Directive, and this allows them to market (to an extent) to retail investors,119 there is little regulatory reach over the funds themselves. Funds can be incorporated offshore and have significant freedom to employ investment strategies as they see fit.120 In practice, crypto hedge funds usually engage in speculative trading of major cryptocurrencies to take advantage of price volatility in order to make trading gains.121 The assets under management are growing,122 largely from family wealth offices and high-net-worth individuals, as institutional interest remains cautious.123 Although such products cater for the portfolio diversification needs of sophisticated investors124 with certain risk appetites, the dominance of speculative activities is clear, and this universe seems largely to cater for the already-wealthy in order to fund speculation in crypto finance. Crypto derivatives, most significantly Bitcoin derivatives such as futures and options, can be offered by regulated providers, usually regulated markets or exchanges, providing a venue for legitimate exposure to speculative trading in cryptocurrency. In the US, the CME Bitcoin futures and options contracts offered by the Chicago

118 PwC, ‘2020 Crypto Hedge Fund Report’ (2020), at www.pwc.com/gx/en/financial-services/pdf/pwcelwood-annual-crypto-hedge-fund-report-may-2020.pdf. For a critique of the relatively lighter regulatory regime, see E Mokhtarian and A Lindgren, ‘Rise of the Crypto Hedge Fund: Operational Issues and Best Practices for an Emergent Investment Industry’ (2018) 23 Stanford Journal of Law Business & Finance 112. 119 Art 43, Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010. 120 Preamble 10, ibid. There is provision for fund level transparency to investors, such as in terms of prudential matters such as leverage levels employed, but market discipline is heavily relied upon as the modus of governance. 121 PwC (2020). 122 ibid, ie twofold over the course of 2019–20. 123 ibid. Also see ‘UK’s first regulated crypto hedge fund set to close down after failing to attract investors’ (22 July 2020), at www.fnlondon.com/articles/uks-first-regulated-crypto-hedge-fund-set-to-close-downafter-failing-to-attract-investors-20200722. 124 One of the largest global crypto hedge fund managers is Grayscale (grayscale.co).

Trends in Regulating Crypto Finance  269 Mercantile Exchange125 is the avenue for retail investors to be exposed to cryptocurrency via many registered brokers.126 The CME Bitcoin futures product is self-certified in the US. Regulatory governance is not extended over the product, as it suffices for existing trust to be reposed in the Exchange as a regulated and accountable institution to the CFTC.127 In the UK, sophisticated investors can gain exposure to crypto derivatives offered by regulated exchanges such as Kraken.128 Regulated exchange-traded products are popular with investors, as these products, traded on an exchange with daily liquidity, provide exposure for investors who have the freedom to liquidate their risks readily on the markets. There are many EU national regulators who oversee exchange-traded crypto derivative products, allowing these services to be passported across the EU by virtue of national regulation and oversight of the exchanges themselves. Brokers such as Kraken, Coinshares and IG Index used to offer these products to retail investors in the UK,129 but the FCA brought in a ban on marketing and selling such products to retail customers on 6 January 2021, attracting criticism in terms of locking retail investors out of portfolio diversification.130 It is uncertain if shadow trading by retail investors in the UK could migrate to unregulated offshore exchanges such as Huobi, Binance, OKex, etc.131 It is also noted that these exchanges offer leverage facilities to allow investors speculate in these cryptocurrency derivative contracts.132 The UK ban is based on consumer protection against highly risky financial products, but it is not a strong statement against speculative financialisation in the crypto economy. Sophisticated and institutional investors are unaffected by the ban. The US SEC has so far taken a strict view to exchange-traded products, especially the exchange-traded fund. It has taken the view that the underlying liquidity and market conditions for cryptoassets that would be included in such funds do not meet the criteria met by conventional securities assets that underlie exchange-traded funds.133 However, this policy may be set for change as the SEC is considering inter-agency coordination and learning in order to apprise the crypto ETF properly for marketing to the 125 CME Bitcoin futures; see www.cmegroup.com/trading/cryptocurrency-indices/cme-options-bitcoinfutures-frequently-asked-questions.html. The CBOE’s futures product has been relatively uncompetitive compared to the CME’s and has been pulled, ‘Cboe pulls the plug on bitcoin futures trading – for now’ (15 March 2019), at www.marketwatch.com/story/cboe-pulls-the-plug-on-bitcoin-futures-trading-for-now-2019-03-15. 126 Such as Ameritrade, one of the largest brokerages in the US that offer accounts for trading in CME bitcoin futures. 127 Reiners (2019). 128 www.kraken.com/en-gb/features/futures. 129 coinshares.com/etps/xbt-provider, a significant provider of exchange-traded products to retail investors, many of which approved and listed on EU exchanges outside of the UK. 130 ‘FCA bans the sale of crypto-derivatives to retail consumers’ (6 October 2020), at www.fca.org.uk/news/ press-releases/fca-bans-sale-crypto-derivatives-retail-consumers. 131 Largest offshore crypto derivatives exchanges compiled by Coingecko; see www.coingecko.com/en/ exchanges/derivatives; also see Huobi’s introduction to its futures platform at support.hbfile.net/hc/en-us/ articles/360000113102-Introduction-of-Huobi-Futures, for example. 132 Leverage is offered on major offshore crypto derivatives exchanges, eg OKEx (www.okex.com/spot/ margin-trade); Poloniex (poloniex.com/support/aboutMarginTrading); ‘Huobi Futures Locked Margin Mechanism: How Does It Work and What Are The Advantages’ (15 July 2020), at medium.com/huobidm-news-roundup-archieves/huobi-futures-locked-margin-mechanism-how-does-it-work-and-what-arethe-advantages-55b420518e2a. 133 ‘SEC Quashes Dreams of Bitcoin ETF With Another Rejection’ (Bloomberg, 26 February 2020), at www. bloomberg.com/news/articles/2020-02-26/sec-quashes-dreams-of-bitcoin-etf-with-another-rejection; but Americans may be able to trade crypto exchange-traded notes, which are not fund products but unsecured

270  Regulating Crypto Finance public.134 It may be argued that although crypto exchange-traded products are available for speculative purposes, they are not particularly harmful. Massive retail uptake is stemmed in the US and UK at the time of writing and institutional allocation is cautious. It may also be argued that such speculative financial activity is not harmful to the crypto economy as increased demand for cryptocurrency can further the development of the crypto economy too. However, speculation in cryptocurrency does not help to create a stable monetary order or reinforce productive financialisation in the crypto economy. The availability of crypto derivative products still constitutes a fringe movement in the developing asset classes for financial allocation, as important financial intermediaries such as banks are disincentivised from holding crypto financial assets. Holdings of such assets entail high levels of microprudential regulatory cost.135 There is also legal uncertainty in terms of using crypto holdings as collateral in order to drive financial transactions and leverage.136 Potential disadvantageous treatment of crypto financial assets as collateral can disincentivise excessive amounts of their holding by conventional financial institutions. Borrowing in fiat against crypto collateral still tends to be nonconventional and relatively expensive.137 In sum, regulators seem to tolerate some extent of assimilation of crypto financial assets in mainstream financial economies, without much change to extant financial regulatory regimes. This position is however dynamic in nature and depends largely on regulators’ perception of financial stability risks from crypto financial assets. As more crypto financial innovations emerge or more institutional diversification takes place into crypto financial products, albeit for speculative purposes, regulatory initiatives and policy over these may be changed. Although the extension of regulation provides more certainty, and can be enabling for market developments, as this volume has argued, the regulatory legitimation of crypto finance needs to be considered in terms

debt products based on exposure to cryptocurrency, as American Depositary Receipts on Nasdaq Sweden, ‘U.S. Investors Can Now Trade Bitcoin ETN On Swedish Exchange’ (25 June 2019), at www.investopedia.com/ news/us-investors-can-now-trade-bitcoin-etn-swedish-exchange/. 134 ‘Cryptocurrency ETFs under active consideration, says SEC Chair’ (Financial Times, 16 October 2020), at www.ft.com/content/9f2c1303-678e-486e-b3f1-d4f234f85f47. Further, a new Bitcoin ETF application is pending before the SEC at the time of writing; see ‘NYDIG Files for Bitcoin ETF, Adding to Firms Hoping 2021 Is When SEC Finally Says “Yes”’ (16 February 2021), at www.coindesk.com/nydig-files-for-bitcoin-etfadding-to-firms-hoping-2021-is-when-sec-finally-says-yes. 135 The prudential treatment of cryptoassets held by regulated entities such as banks is under international development, but banks in the UK are asked to consider their risks carefully in in holding cryptoassets for investment; BIS, ‘Designing a Prudential Treatment for Crypto-Assets’ (December 2019), at www.bis.org/bcbs/ publ/d490.htm; and the PRA may reserve the discretion to impose regulatory cost under its supervisory powers (Pillar 2), see ‘Letter from Sam Woods: Existing or planned exposure to crypto-assets’ (28 June 2018), at www. bankofengland.co.uk/prudential-regulation/letter/2018/existing-or-planned-exposure-to-crypto-assets. 136 This is because existing treatment of how cryptoassets are held or safekept for the purposes of security may not fit well with the US Uniform Commercial Code, Art 9; see KN Johnson and SE Hsu Wilbur and S Sater, ‘(Im)Perfect Regulation: Virtual Currency and Other Digital Assets as Collateral’ (2018) 21 SMU Science & Technology Law Review 115; KV Tu, ‘Perfecting Bitcoin’ (2018) 52 Georgia Law Review 505, or in common law, see X Foccroulle Ménard, ‘Cryptocurrency: Collateral for Secured Transactions?’ (2019) 34 Banking and Finance Law Review 347. H Tjio and Y Hu, ‘Collective Investment: Land, Crypto and Coin Schemes: Regulatory “Property”’ (2020) 21 European Business Organisations Law Review 171 argues for regulatory intervention to legitimise the financial property character of various assets including cryptoassets. 137 X-T Nguyen, ‘Lessons from Case Study of Secured Transactions with Bitcoin’ (2018) 21 SMU Science & Technology Law Review 181.

Trends in Regulating Crypto Finance  271 of what regulators are legitimating. In particular, poorly considered regulatory designs may create impressions of legitimacy for consequences that are unintended. Next, we observe that many regulated financial institutions are carrying out cryptotype innovation in a space that may not be captured by existing regulation. This presents new challenges for financial regulators as they need to be vigilant in relation to how such activities affect existing regulatory scope and supervision. Regulators especially need to take care that existing regulatory regimes may be under-inclusive and may provide a false sense of assurance if simply applied to innovations, even if undertaken by alreadyregulated entities.

B.  Bank-based Platform Coins The JPM Coin is being developed by global banking behemoth JP Morgan in order to facilitate direct instantaneous transfers between clients who hold accounts at JP Morgan.138 Using a blockchain infrastructure, institutional clients can complete transfers to each other directly, without needing centralised reconciliation within JP Morgan’s systems. This allows for speedier remittance than if a centralised reconciliation system were used. In terms of same-jurisdiction transfers, the use of the JPM Coin need not add any efficiency as centralised systems may already be at this level of efficiency, such as Faster Payments transfers available in the UK.139 However, for international remittances, the JPM Coin could increase speed of transfer and minimise exchange rate fluctuation risk between parties. In Austria, Raffeisen bank has issued an RBI Coin to effect instant bank-to-bank or bank-to-business payments on a permissioned blockchain, joining up forces with other players in the banking sector so as to create sufficient internal economies.140 In a new development, a number of financial institutions in the UK who are members of Corda,141 a permissioned blockchain architecture provided by R3 that services bank-to-bank transactions, have come together to form a cooperative called Cordite in order to issue a digital currency the XKD.142 The XKD will be used on Corda for bank-to-bank transfers.143 The XKD may facilitate speedier transfers for financial institutions who are not clearing banks that benefit from the UK’s Faster Payments framework, and therefore allows these financial institutions to work together towards greater competitiveness and efficiency. The UK and Austrian initiatives may be confined to local transfers and direct customer participation seems not envisaged. In this manner, JP Morgan’s innovation to facilitate business customer transfers within its large internal cross-border network is pioneering and revolutionary. This initiative may

138 See www.jpmorgan.com/solutions/cib/news/digital-coin-payments. 139 www.fasterpayments.org.uk. 140 ‘Raiffeisen Bank Bringing Blockchain Interoperability to Its Stablecoin Project’ (22 October 2020), at www.coindesk.com/raiffeisen-bank-bringing-blockchain-interoperability-to-its-stablecoin-project?utm_source= newsletters&utm_medium=blockchainbites&utm_campaign=&clid=00Q1I00000LtSLoUAN. 141 See corda.network/governance/board-election/. 142 ‘XKD’ (October 2020), at cordite.foundation/the_white_paper/xdc_white_paper.pdf. 143 ‘R3 Corda Network Set to Go DeFi With XDC Digital Currency’ (20 October 2020), at www.coindesk. com/r3-corda-network-xdc-token-cordite-society.

272  Regulating Crypto Finance meet the needs for instantaneous transfer especially on a cross-border basis, as inefficiencies in remittance has been a long-running problem.144 Payments for international trade can be improved in radical ways, perhaps eliminating the need for extant instruments such as letters of credit, as well as the inconvenience of chains of documentation and delays in payment in international trade. How should permissioned platform tokens like the JPM or XKD Coin be treated in regulatory terms? Should regulators ignore the coins themselves and continue to regulate the banking institutions involved in terms of their banking services and payment functions? Or should the issue of the coins themselves raise regulatory attention for specific treatment? JPM coins are issued to users to effect blockchain-based transactions across JP Morgan’s banking books. For the RBI or XKD coin, they are minted and issued by financial institution members who are nodes on the permissioned blockchain, and it is surmised that customer users are not involved. The latter seems to be an innovation in relation to payment, clearing and settlement infrastructure but the production of new financial instruments cannot be ruled out, as the Chainstack introduction to XKD clarifies.145 The JPM Coin can arguably create new financial claims for banking customers. As customer users are involved, the JPM Coin is a claim against the issuer in favour of the customer, and also a payment token held by the customer. If issued against a positive balance in the customer’s account with the bank, the coin is a transformation from the deposit claim against the issuer, but it is uncertain if the transformation of the deposit into the coin would affect its characterisation, for example, in relation to deposit guarantee protection. If it is issued as a form of credit, the coin represents indebtedness, possibly against collateral, and it is imperative that such credit creation be not treated as a form of shadow banking that is not accounted for in banks’ prudential management. There is also the issue of whether it is transferable and fungible as collaterised ‘money’ so that a customer can collateralise this in favour of a third party, for example. Further, it is unclear whether the RBI or XDK coin can be used to represent new financial claims, and if so whether there is a risk of shadow banking and regulatory arbitrage. As the JPM Coin can effect international transfers for business clients within the internal blockchain provided by JP Morgan, can such a platform substitute for international payment architecture currently maintained under the aegises of Swift?146 Further, can such a platform permit large value transfers currently routed through central banks such as the Fedwire maintain by the Federal Reserve Board147 or the Bank of England’s real-time gross settlement system?148 The diversification away from centralised payment and settlement architecture is also a trend observed with the RBI or XKD Coin. These seem to be tokens that are used to improve the efficiencies of inter-bank

144 V Cleland, ‘Cross-border payments – innovating in a changing world’ (speech, 13 October 2020), at www. bankofengland.co.uk/speech/2020/victoria-cleland-keynote-presentation-at-the-central-bank-paymentsconference-2020. 145 chainstack.com/marketplace/cordite. 146 www.swift.com. 147 www.federalreserve.gov/paymentsystems/fedfunds_about.htm. 148 www.bankofengland.co.uk/payment-and-settlement.

Trends in Regulating Crypto Finance  273 payment, clearing and settlement. The pertinent regulatory issues are therefore whether such networks create pockets of self-regulatory payment architecture and how these should be overseen. Payment clearing and settlement infrastructures are arguably public goods149 that operate under an institutional architecture coopting public sector oversight.150 Would the same regulatory regimes apply to these new blockchain-based payment and settlement platforms, and would there be a need for new standards in light of new technology? In particular, can large value transfers be made via these coins, and what are the implications for central banks’ roles in providing large value transfer architecture and supervising them?151 Can large value transfers be migrated away from central banks’ settlement systems, and what risks does this pose for financial stability? It may however be argued that in light of the Federal Reserve’s operational error in its Fedwire real-time gross settlement system for large value transfers that resulted in a suspension of service for a few hours,152 central bank systems are no guarantee for financial stability too. The proliferation of permissioned blockchains for interbank settlement and clearing may provide diversification that reduces systemic risk. In dealing with the JPM, XKD or RBI Coin, it is possible that regulators would treat an innovation from an existing regulated entity as subsumed within an existing regulatory regime. This is because some regulators, such as in the US, undertake entity-based regulation. Indeed, the proposed Stable Act153 in the US could reinforce an approach that allows incumbent authorised banking institutions to develop tokenisation under the current regulatory regime, not attracting new regulatory considerations. The Act proposes to regulate all stablecoin issuers as deposit-taking institutions, hence disallowing private stablecoins to be issued outside of the bank regulatory perimeter. Such an approach could force stablecoin projects pegged to the US dollar or other foreign currency to be outlawed in the US unless authorisation is obtained for the issuer to operate as a deposit-taking institution. The Act’s focus may be to weed out private stablecoin issuers who would unlikely meet bank authorisation requirements. It may be argued that, although this means that only established banks can develop stablecoin projects, the Act subjects every stablecoin proposed to be issued to a six-month notice, presumably to invite regulatory scrutiny. This would not bring about an automatic recognition of stablecoin projects issued by regulated entities, but it remains to be seen if incumbents would be subject to strong scrutiny. The UK has moved away from sectoral regulation since the 2000s, but sectoral legacies still loom large in its ‘regulated permissions’ regime.154 The legacies of regulatory ontologies for regulators, particularly influenced by sectoral boundaries, are likely to

149 IH-Y Chiu, ‘A New Era in Fintech Payment Innovations? A Perspective from the Institutions and Regulation of Payment Systems’ (2017) 9 Law, Innovation and Technology 190. 150 Banks as payment services providers would be subject to the Payment Services Directive 2015 regime, but a clearing bank is also subject to peer-level governance in the UK Payments Administration Limited for retail payment clearing: www.ukpayments.org.uk/what-we-do. 151 www.bankofengland.co.uk/payment-and-settlement. 152 ‘US central bank payment system down for ‘hours’’ (BBCNews, 25 February 2021), at www.bbc.co.uk/ news/business-56186658. 153 tlaib.house.gov/sites/tlaib.house.gov/files/STABLEAct.pdf. 154 Financial Services and Markets Act 2000, s 19 and Sch 2.

274  Regulating Crypto Finance affect regulatory perceptions of boundaries, in responding to crypto finance. Regulators should take care that existing regulatory boundaries for already-regulated entities do not obscure them from perceiving and scrutinising innovations that raise new regulatory issues. Further, coordination between relevant regulatory agencies such as microprudential re gulators, payment services regulators and the administration of the financial services or deposit compensation scheme would be optimal for advancing policy thinking.

C.  Coins with Dollar Parity Coins that purport to maintain dollar parity, such as the USD Coin,155 issued by New York regulated money services business Circle is a programmable ERC-20 token for the Ethereum blockchain, seeking also to become programmable in other blockchains. It is captured within the regulatory perimeter for money service businesses in the US although it is unclear whether existing regulation fully accounts for its novel features. It is also queried whether, under the Stable Act, Circle would need to be authorised as a deposit-taking institution. In substance, it may be argued that the USD Coin is similar to Tether, an assetreferenced stablecoin which is, at the time of writing, unregulated.156 The USD Coin purports to be fully collateralised to maintain parity with the US dollar and is a claim upon the issuer, much like Tether. However, as the USD Coin is issued by an already-regulated money services business, the regulatory ontology of ‘payment and money service business’ provides framing for Circle’s regulatory obligations in relation to the USD Coin.157 This regulatory ontology focuses Circle’s obligations in relation to prudential regulation, in order to meet claims issued against the USD Coin, anti-money laundering, customer due diligence, transaction monitoring and reporting, and accountability to FinCen. This regulatory ontology focuses on the USD Coin’s use for payment in the conventional as well as crypto economies. The USD Coin’s regulatory treatment raises questions in relation to the future of regulatory policy for asset-referenced stablecoins that purport to maintain parity with the US dollar. With the US considering the Stable Act at the time of writing, it is uncertain if the issuer of the USD Coin will maintain its status as a regulated money service business or be required to fall in line with bank regulation, which may be regarded as an overreach.158

155 www.circle.com/en/usdc. 156 The lack of regulation for Tether has however entailed ad hoc approaches such as fraud investigations carried out by the NY Attorney-General and Tether’s non-admission settlement; see ‘NY AG’s $850M Probe of Bitfinex, Tether Ends in an $18.5M Settlement’ (23 February 2021), at www.coindesk.com/ny-ags-850m-probeof-bitfinex-tether-ends-in-an-18-5m-settlement. 157 support.invest.circle.com/hc/en-us/articles/360000209826-What-licenses-does-Circle-have-andare-you-regulated-by-someone-. 158 See ‘Stable Coin Regulation, With A Focus On The STABLE Act’ (Forbes, 20 December 2020), at www.forbes.com/sites/vipinbharathan/2020/12/20/stable-coin-regulation-with-a-focus-on-the-stableact/? sh=6edca55a3e5a.

Trends in Regulating Crypto Finance  275 The USD Coin would pose challenges to the EU’s regulatory treatment as it possesses e-money characteristics, but is also an asset-referenced stablecoin. The EU’s approach to asset-referenced stablecoins reflects its appreciation for the ‘asset management’ aspect of the stablecoin, as the regime resembles money market fund management. In this manner, users benefit from a range of investor protection and accountability flowing from the asset management functions of stablecoin issuers. However, the shortfall in the EU’s approach is that the payment aspect of asset-referenced stablecoins is ignored and there is no provision for them to be so utilised. This could frustrate stablecoin issuers who intend these instruments to be capable of multifaceted functions. In this manner, regulatory characterisation in both the EU or US may be under- and over-inclusive at the same time. There is a lack of joined-up regulatory thinking in relation to the multifunctional aspects of crypto finance. The USD Coin has grown in market volumes since March 2020, and although there is steady adoption of the USD Coin as a payment token, its exponential growth is due to its use in DeFi yield farming, such as through DeFi loans discussed earlier in this chapter.159 Crypto financial assets often offer multifaceted forms of market uses, some of which can be productive, such as for payment purposes, and some of which can reinforce speculative forms of hyper-financialisation. Regulatory policy for such innovative products needs to transcend existing regulatory categories and engage with fundamental objectives. Coherentist applications of existing regulatory regimes gives rise to issues of inappropriate fit and gaps. We acknowledge that an effort has been made by the EU to offer tailor-made regulation for crypto financial assets and cryptoasset service providers,160 and we turn to examine to what extent the tailor-made regime addresses the novelties that are being developed. In chapters three and five, we suggested that regulatory design for ICOs in the EU is excessively derived from securities regulation and is not altogether appropriate for pre-development financing in ICOs. In this section, a similar trajectory is detected for the regulation of cryptoasset service providers and asset-referenced stablecoins in the EU. We point out the deficits of this derivative approach.

D.  Cryptoasset Service Providers Although the decentralising properties of blockchain is what drives new business models in the productive crypto economy, as discussed in chapters two and six, crypto finance is not always decentralised. Many new service providers and intermediaries have arisen in this space. The table below provides a snapshot of the intermediaries in the crypto financial space.

159 ‘Coinbase and Circle-Backed Stablecoin USD Coin Breaks $1B Market Cap’ (3 July 2020), at ­cointelegraph. com/news/coinbase-and-circle-backed-stablecoin-usd-coin-breaks-1b-market-cap. 160 Proposed Markets in Crypto-assets Regulation, at eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELE X%3A52020PC0593.

276  Regulating Crypto Finance Financial activity Commercial payment, for dApp services or virtual goods

Intermediaries involved Developers of payment protocol Wallet provider Stablecoin issuer

Investment (primary market)

ICO issuer and developer, including pooled structures like DAO Cryptoasset exchange if conducting an offering Cryptoasset rating services, eg ICOBench

Exchange or trading

Centralised cryptoasset exchange Wallet provider Decentralised liquidity pool Decentralised services short of transaction execution, eg information matching

Saving

Savings dApp and interest rate provider Liquidity pool, decentralised or otherwise

Arbitrage or speculation

Centralised crypto or conventional exchanges offering derivative products Exchange-traded products issuer Cryptoasset fund manager Liquidity pools Market making protocols/platforms Stablecoin issuer

In connection with the productive crypto economy, chapters five and six have discussed regulatory proposals for a number of service providers, such as wallet providers, centralised and decentralised exchanges. These service providers may perform services resembling those of their conventional financial sector counterparts, but can also provide services in new ways, therefore changing the nature of risks in relation to their service provision, or offer novel combinations of services. However, the trend is that many regulators tend to treat crypto financial service providers and their conventional financial sector counterparts similarly. Even in jurisdictions that are developing specific crypto finance regulations, crypto financial service providers are treated in broad-brush or vague ways, and inappropriate forms of regulation could be extended to them. First, there is an issue of scope of regulatory application. Service providers in the EU’s proposed Markets in Crypto-assets Regulation are not defined in terms of the categories of services provided, and a broad-brush and vague approach is also taken in the Maltese Virtual Financial Assets Act. Should the scope of application be interpreted to refer only to service providers related to cryptoasset offers, given the context of the legislations? However, the proposed EU Regulation also deals with e-money tokens. So, would ‘service provider’ extend to payment-related service providers? Further, would rating services for ICOs be regarded as caught within the scope of service providers, but remains unspecifically mentioned in either the proposed EU legislation or Maltese Act?

Trends in Regulating Crypto Finance  277 As the Maltese Act also requires service providers organised as blockchain-based businesses to adhere to the Innovative Technological Arrangements Act that deals with organisational and governance aspects, would this requirement extend only to service providers organised as blockchains? If service providers do not serve solely the crypto economy, how would overlaps between mainstream financial regulation and regulation extended to crypto finance be reconciled?161 There is clarity in the proposed EU Regulation that banks and existing regulated electronic money institutions are exempt from further regulation pertaining to the issue of digital money tokens. However, one queries if this treatment is under-inclusive as special characteristics of tokenisation carried out by regulated banks and e-money institutions should be carefully considered for regulatory policy. In particular, we have proposed in chapter six that regulatory oversight of payment functions and infrastructure in the crypto economy should be designed differently, in terms of code-vetting and pre-emptive testing. The treatment of service providers grouped together under a generic label is arguably unsatisfactory. The proposed EU Regulation extends the same prudential and conduct regulations over the universe of service providers, but it is queried if this is both over- and under-inclusive. Service providers are susceptible to different types and intensities of user engagement, and the same conduct regulation applicable to all may be inappropriate. For example, even if it can be argued that the duty to manage conflicts of interest can be framed at a level of generality that is not unwarranted, the nature and extent of conflicts of interest for each type of service provider differ, and specific policy should be considered where more significant forms of harm can occasion to users. Service providers also carry out different extents of decentralisation, using automated protocols to replace centralised service provision, as discussed in chapter six in relation to decentralised exchange and trading services. Should conduct risks in relation to each of the service providers set out in the table above be more carefully interrogated in order to develop more appropriate policy? Further prudential regulation is meant to moderate the financial risks of intermediation activities so as to prevent risks of failure and wider disruptive risks to the financial system. According to the table of service providers, it needs to be determined if prudential regulation should apply to any of them, and to what extent. Prudential implications may be attracted for savings service providers, for example, but it may be argued that in a decentralised crypto financial universe, prudential regulation is unwarranted as risk is not centralised upon intermediaries. Automated protocols for collateralisation are programmed for each participant to bear his/her share of risk. Should such selfregulation be sufficient? Should providers of liquidity pools, for example, not be treated collectively for prudential purposes? If providers of centralised features, whether for liquidity pools, protocols to govern decentralised trading services or other DeFi services, should be treated as a collective entity for prudential regulatory purposes, then the question arises as to what the prudential regulation is for. Would we be seeking to apply prudential regulation to constrain levels of risk build-up in these platforms, or would we be applying prudential regulation for loss absorption in case of unexpected events? 161 This issue was raised critically in DA Zetzsche, F Annunziata, DW Arner and RP Buckley, ‘The Markets in Crypto-Assets Regulation (MICA) and the EU Digital Finance Strategy’ (2020), at papers.ssrn.com/sol3/ papers.cfm?abstract_id=3725395.

278  Regulating Crypto Finance A blanket approach in prudential regulation seeking to ensure that there is conventional shareholder equity backing the service provider may be an inappropriate policy, whose purposes are also unclear. Further, the proposed EU Regulation and Maltese Act provide more distinct treatment of cryptoasset exchanges. The familiarity with centralised exchanges has caused development of regulation very much in the vein of mainstream trading markets, and targeted at centralised exchanges. The proposed EU Regulation, as well as the Thai and Maltese regimes recognise and regulate centralised cryptoasset exchanges. However, this may leave decentralised exchanges either in a vacuum or inappropriately regulated.162 In sum, this chapter raises concerns in relation to excessive coherentism on the part of financial regulators dealing with financial developments in the crypto economy, as well as in the conventional financial economy where cryptoassets may be assetised. Financial regulators’ treatment of novel developments such as the stablecoin and DeFi also raise concerns with regard to coherentist approaches. We propose below that unpacking different stablecoins may mean different regulatory approaches to them, along the lines of functional regulation. Further, the movement of DeFi raises distinct issues that are not similar to credit and lending.

E.  Novelties for Regulatory Policy: Asset-referenced Stablecoins The asset-referenced stablecoin is an exponentially growing industry as both crypto economy users and mainstream financiers have flocked into this space.163 As discussed in chapter six, Tether is an example of an off-chain-managed stablecoin, while Dai is an example of an on-chain-managed stablecoin. The USD Coin discussed above resembles Tether but is subject to different regulatory treatment. Tether and Dai are currently unregulated, but there is potential that they could be captured by the proposed Stable Act and EU Regulation. We discuss here that different stablecoins should be functionally interrogated and this reveals differences in terms of functional characteristics and purpose of use. In this manner, perhaps it is even inappropriate to have an overarching umbrella regime to regulate stablecoins indiscriminately. Tether International Limited is incorporated as a company based in the British Virgin Islands, and its business model is to issue Tethers or USDT, purportedly maintaining parity with the US dollar. This business model has now extended to fiat currencies such as the euro,164 yuan165 and gold.166 Tether is a programmable cryptocurrency that can be accepted as payment on the Ethereum blockchain or on the Omni layer of the Bitcoin blockchain. In the alternative, USDT can be held for hedging purposes against the volatility of cryptocurrency such as bitcoin and ether. In the US, Tether is incorporated as Tether Limited dealing only with accredited investors.167 The USDT is warranted to 162 I Salami, ‘Decentralised Finance: The Case for a Holistic Approach to Regulating the Crypto Industry’ (2020) 35 Journal of International Banking and Financial Law 496. 163 ‘Stablecoins post triple-digit growth in 2020, but institutional rivals loom’ (11 September 2020), at cointelegraph.com/news/stablecoins-post-triple-digit-growth-in-2020-but-institutional-rivals-loom. 164 tether.to/usd₮-and-eur₮-now-supported-on-ethereum. 165 tether.to/tether-now-supports-offshore-chinese-yuan-cnh-launches-cnht-stablecoin. 166 gold.tether.to. 167 Clause 3.3, tether.to/legal.

Trends in Regulating Crypto Finance  279 be backed up by reserves and transparency is provided by daily publication of reserve levels.168 Tether offers a contractual promise of redemption personal to each verified Tether customer, but such a promise is subject to various limitations in relation to reserve liquidity. It may be argued that the redemption right is not dissimilar to the promise to repay a deposit or a promise to redeem at par value in relation to a money market fund. In this manner, regulatory design could be targeted at issuers in terms of prudential provision and robust and credible management of reserves. The US Stable Act would treat Tether as a stablecoin equivalent to a deposit. The proposed European Regulation169 also focuses on reserve maintenance and redemption robustness. Issuers are in sum subject to prudential regulation, mandatory audit and accountability, though the EU regime is somewhat lighter than the regime for money market funds, for example.170 Both the US and EU approaches are derivative in nature, but it may be said that the EU proposal is more proportionate as the fall gamut of equivalent regulation applicable for conventional finance is not applied. Bank regulation would be applied in full to stablecoin issuers in the US under the Stable Act. It can be argued that the nature of Tether’s financial promise, which is the back-end mechanics of how Tether works, should not be isolated from Tether’s front-end purpose. Tether serves a significant speculative market for hedging against the price volatility of bitcoin, as it is held by many mainstream and crypto investors in the place of fiat currencies for speculating against bitcoin.171 Further, many bitcoin derivatives offered by cryptocurrency exchanges are settled in Tether.172 Hence, Tether’s main purpose seems to be acting as the programmable alternative to the US dollar that enables swift changes of position in and out of bitcoin for speculative trading purposes. In this manner, it should be queried whether the regulatory ontology for Tether should be confined to the technical nature of its financial promise, or should be extended to its market purpose, connecting with the wider policy concerns regarding hyper-financialisation. Regulating asset-referenced stablecoins in the manner proposed by the EU Regulation could give such products more legitimacy and promote more participation, reinforcing speculative forms of financialisation in the crypto economy. Such consequences should be carefully considered in designing regulatory regimes, and regulators could consider clarifying the status of stablecoins as well as regulating use purposes. Different from Tether or the USD Coin, Dai is an on-chain collateralised stablecoin with payment, investment/reserve management as well as deposit and savings features.173 As discussed in chapter six, Dai is issued by Maker DAO to anyone who wishes to lock approved collateral in a ‘vault’ for the issue of dai. Such collateral includes ether, as well as Ethereum-based tokens approved by the governance body for Maker DAO, ie the holder of MKR tokens. Dai is soft-pegged to the US dollar, hence the value

168 wallet.tether.to/transparency. 169 European Commission Proposal (2020). 170 Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on money market funds. 171 ‘Sizable Portion of Tether’s $4.5B Growth Comes from Exchange Fiat’ (21 July 2020), at cointelegraph. com/news/sizeable-portion-of-tethers-45b-growth-comes-from-exchange-fiat. 172 ibid. 173 makerdao.com/en/whitepaper#use-of-the-mkr-token-in-maker-governance.

280  Regulating Crypto Finance of collateral locked in vaults is determined by price oracles approved and trusted by the governance body, and oracle mechanisms are crucial to determining if the vault is sufficiently collateralised. Withdrawers of dai can use this for spending or for saving, such as in the Oasis app,174 which generates a savings rate determined by the MKR tokenholders in the governance body. The savings rate is a mechanism for affecting demand for dai so that a market for dai can be built up. Price stability for dai is maintained by market makers or keeper nodes that run a protocol on their computers to automatically buy or sell dai in accordance with market demand conditions to keep parity with the dollar. Keepers also participate in collateral liquidations which are automatically deployed if a vault triggers certain risk parameters. Withdrawers of dai can redeem collateral by repaying the dai and a stability fee. A number of financial promises are made with regard to holding dai; ie that the stability of dai is maintained by demand-led decisions that determine the savings rate for dai, the market-making protocols and collateralisation protocols. Although the latter two are automatically deployed, the Maker governance body determines and regularly votes on policies in relation to the interest rate for dai savings and collateralisation risk policies. These governance powers also underpin the selection of price oracles which affect the automatic deployment of collateralisation policies and other discretionary matters such as system upgrades or shut-downs in an emergency. In sum, users’ financial claims are totally reliant on the robustness of Maker’s governance, where decision-making powers are held by holders of the MKR tokens. MKR tokens were publicly auctioned by Maker DAO to raise dai. The dai system ran into a crisis in March 2020 when ether price volatility triggered large scale liquidation protocols for collateral. The governance body stepped in and secured capital injection from financiers to stabilise the system.175 At the time of writing, Paradigm Capital, a digital asset management firm based in San Francisco is the major holder of MKR tokens.176 It may be argued that due to the nature of the financial promise made in relation to dai in terms of creation and redemption, dai can be governed along the same ideology as that applicable to offchain collateralised stablecoins. However, it can also be argued that dai should be ontologically different from other collateralised stablecoins. As Lipton et al argue,177 different stability mechanisms can give rise to different taxonomies or ontologies, such as whether the stabilisation mechanism is based on a claim against reserve, or a claim against good faith in stabilisation practices or policies. It can be argued that dai should be ontologically different from other collateralised stablecoins, as its stability mechanisms premised upon collateralisation may be a transition phase for the establishment of dai as a self-maintaining cryptocurrency. In this manner, the protocols that moderate market conditions for dai in order to prevent speculative disruptions to dai’s stability are likely of more importance as dai matures in terms of adoption and 174 oasis.app/save. 175 ‘The Market Collapse of March 12–13, 2020: How It Impacted MakerDAO’ (1 April 2020), at blog. makerdao.com/the-market-collapse-of-march-12-2020-how-it-impacted-makerdao. 176 ‘Paradigm Is Biggest Winner of MakerDAO Lending System’s MKR Governance Tokens, to Cover $4.5 Million of Undercollaterized Debt’ (1 April 2020), at www.crowdfundinsider.com/2020/04/159604paradigm-is-biggest-winner-of-makerdao-lending-systems-mkr-governance-tokens-to-cover-4-5-millionof-undercollaterized-debt. 177 A Lipton, A Sardon, F Schär, and C Schüpbach, ‘From Tether to Libra: Stablecoins, Digital Currency and the Future of Money’ (2020), at arxiv.org/pdf/2005.12949.pdf.

Trends in Regulating Crypto Finance  281 circulation. This model of transitional collateralisation and soft-pegging, which should ultimately pave the way for a self-sustaining payment currency, is the model explicitly adopted by Reserve, another asset-referenced stablecoin.178 In this manner, can it be argued that payment regulation is most appropriate for such stablecoins? The governance of such stablecoins can be subject to a co-regulatory system of oversight involving the governance body and regulators. Despite the structures of asset management that are involved in collateralisation and reserve management, could these be less important for regulatory policy and design, in view of a more purpose-led inquiry into what dai serves and how it is used? The universe of stablecoins presents products of different designs that serve predominantly different purposes, and pose different risks to users. We could adopt a purpose-led approach so that stablecoin functions are regulated to commonly accepted standards for their use purpose/s. Yet the purpose-led approach can be hazardous. This is because significant use changes can occur in this technologically mobile and agile universe, and dai is now significantly deployed as collateral for DeFi loans in yield farming strategies, to be discussed more below. Users of dai in this manner rely upon its nature as a financial asset and its value stability features in order to arbitrage with other tokens to generate yields based on price differences in different markets. Hence, in order to protect users of dai whose interests lie in the value stability features of the stablecoin, the proposed EU Regulation’s approach that focuses on reserve management may seem most in keeping with their latest needs. That said, the combination of different types of financial claims and financial uses that stablecoins can be put to raises the broader issue of whether a multifaceted or multifunctional crypto financial product should be regulated as a unique product as a whole, or functionally along different aspects. Further, being an onchain stablecoin instead of an offchain stablecoin like Tether, dai is governed and managed differently. An offchain stablecoin may be said to be governed in a similar manner to fund management under the control of the asset manager. However, dai is governed by automated protocols, although a governance body designs its policies and engages in crisis management. In what ways should regulatory policy differ between onchain and offchain stablecoins? Could onchain stablecoins, whose governance is more decentralised and transparent, be subject to a meta-regulatory or coregulatory regime where self-governance and experimentation are permitted within certain frameworks? Regulatory design addressed to decentralised forms of coordination such as in a DAO cannot be the same as addressed to a corporatised entity. In addressing a decentralised structure, Auer proposes ex ante and technologically embedded forms of regulatory governance,179 such as embedding regulatory accountability in governance tokens. Protocols may have to be considered for periodic transparency to be made to regulators. Further, the equivalent of external audit could be built into the governance system. A number of algorithmically managed stablecoins may be characterised as stablecoins that aim towards becoming self-maintaining currencies for the crypto economy. Algorithmically managed stablecoins are usually on-chain stablecoins, purporting to 178 reserve.org/our-vision. 179 R Auer, ‘Embedded Supervision: How to Build Regulation Into Blockchain Finance’ (BIS Working Paper 2019), at www.bis.org/publ/work811.htm.

282  Regulating Crypto Finance maintain price stability, usually within a narrow range, soft-pegged to the US dollar.180 They may be collateralised in an initial phase,181 but ultimately seek to be self-sustaining, managing price stability by responding to market conditions, where sufficient circulation and liquidity have been achieved.182 Fundamentally, such projects are designed to be for payment purposes, and regulatory policy for payment protocols and services should arguably be most applicable. It is queried whether soft pegging to a fiat currency, without a reserve mechanism, would be outlawed under the US and EU legislations. Or would the stablecoins with an initial reserve mechanism be subject to full regulatory treatment proposed in the US and EU, even if the reserve mechanism is intended to be phased out? For example, Ampleforth and Reserve tend towards de-pegging and becoming self-maintained in due course.

F.  Novelties for Regulatory Policy: DeFi One of the most structurally challenging phenomena for regulators is the rise of DeFi.183 This is because DeFi allows retail participation in rather complex hedging financial activities, driven by automated algorithmic protocols. Although DeFi seems to be self-governed by precise smart contract protocols and offers a range of democratising opportunities for individuals to participate in financial yield-generation, there are two concerns. One is that governance needs are not completely addressed by automation, and the suite of risks that an individual is exposed to can be highly uncertain. These risks include technical/security risks of protocol exploitation and transactional complexity, economic risks in terms of potential financial loss and governance risks in terms of problem-solving and crisis management.184 The second is that speculative forms of hyper-financialisation are encouraged and the normative approach to these trends ought to be addressed. DeFi allows token-holders to engage in financial yield generation, potentially stripping out rent-extracting intermediaries.185 On the Compound platform,186 users can deposit their tokens into liquidity pools, ready to be swapped with others who have matching demands. The participation in the Compound pools yields a deposit-like interest rate for the token lender, who locks up his/her tokens in the Compound smart contract in return for a Compound token. Such yield is akin to yield made by wholesale financial institutions such as in prime brokerage in conventional finance. The holder of 180 eg Reserve (reserve.org/our-vision); E Kuo, B Lles and M Rincon-Cruz, ‘Ampleforth: A New Synthetic Commodity’ (2019), at www.ampleforth.org/papers; also the failed Basis project, see N Al-Naji, J Chen and L Diao, ‘Basis: A Price-Stable Cryptocurrency with an Algorithmic Central Bank’ (2018), at www.basis.io/ basis_whitepaper_en.pdf. 181 Reserve (above) and the failed Basis project (above). 182 Reserve (above), but Ampleforth seeks to be managed without a reserve from the start. 183 ‘Five Years In, DeFi Now Defines Ethereum’ (1 August 2020), at www.coindesk.com/five-years-in-definow-defines-ethereum. 184 SM Werner, D Perez, L Gudgeon, A Klages-Mundt, D Harz and WJ Knottenbelt, ‘SoK: Decentralized Finance (DeFi)’ (2021), at arxiv.org/pdf/2101.08778.pdf. 185 Y Chen and C Bellavitis, ‘Blockchain Disruption and Decentralized Finance: The Rise of Decentralized Business Models’ (2020) 13 Journal of Business Venturing Insights e00151, at doi.org/10.1016/j.jbvi.2019. e00151. 186 compound.finance.

Trends in Regulating Crypto Finance  283 the Compound token can further generate yield on the Compound token by depositing it into another liquidity pool, or may use the Compound token as collateral for swapping with another token that may be generating yield in another liquidity pool. On the Uniswap platform,187 users deposit their tokens into paired liquidity pools by locking their tokens into a smart contract, in exchange for a Uniswap token. The Uniswap token is coded with protocols to provide users with yield that is dependent on the liquidity conditions of the pool. High demand and usage of the relevant paired pool would be more rewarding for users, and users also potentially earn more yield if they lock up more tokens and provide more liquidity, therefore being entitled to sharing more from the proceeds of the pool. Again, the Uniswap token can be further collateralised in yield farming, or deposited in other liquidity pools. It is also possible for Uniswap users to trade against the smart contract in order to exploit opportunities for highyield generation in changing liquidity conditions. Such financial participation creates opportunities for financial yield generation similar to those enjoyed by conventional broker-dealers in market-making, an activity that is shut to ordinary retail financial participants. The freedom of asset transformation for yield-farming is made possible by the technology of tokenization, but may only be limited by the lack of interoperability between blockchains. Service providers such as Idle188 have arisen in this space to provide users with comparative information on pool prices across blockchains, and can automate executions to manage users’ assets to facilitate yield-farming. These DeFi examples above offer a form of democraticised access to asset creation and transformation for ordinary retail users. Further, Compound and Uniswap are governed in a decentralised manner where users are free to propose protocol changes, governance decisions, etc to be voted upon.189 Is DeFi the beginning of a new form of finance altogether that challenges the conventional delineation between wholesale and retail finance? How such regulators respond? It can be argued that DeFi is ultimately self-regulating, graduating from any need for externally imposed governance or regulation. This is because DeFi is based on democratic participation and not the opaque intermediation processes that conventional financial institutions engage in and charge their customers for. Further, DeFi is based on full or excess collateralisation for risk management locked in smart contracts that are defined to perform precise protocols. Even where losses may occasion to individuals, such as by way of collateralisation top-ups or liquidation in response to volatile token prices, the sort of systemic seizure that conventional financial institutions may experience, threatening the loss of business continuity or financial stability could be unlikely. Even the price volatility crisis experienced by Maker DAO discussed above was resolved by way of private governance and capital injection. There are, however, a few points of concern. First, each DeFi platform provides its own precisely defined protocols in smart contracts, and these tend to be rigid as certainty is required to cater for safe collateral lock-up and for how financial reward is made. As is general with smart contract governance, unforeseen problems may arise

187 uniswap.org/docs/v2/protocol-overview/how-uniswap-works. 188 idle.finance/#.

189 uniswap.org/docs/v2/governance/overview;

and compound.finance/governance.

284  Regulating Crypto Finance in due course.190 In particular, commentators have modelled attacks on protocols.191 It may be argued that these will be solved by democratic governance on DeFi platforms. However, ex post problem-solving in rapid automated transactional contexts may be too late for victims. Further, governance risks also persist in that participants involved in governance may have conflicting interests.192 For example, some of the largest voters on Compound are financial institutions such as hedge funds, and it is uncertain if their governance would be conflicted by their profit-seeking agendas. Next, as yield farmers look to swap tokens in multiple venues in order to exploit the opportunities for yield maximisation, one commentator has queried how a bug or flaw in one smart contract protocol may affect the chain of transactions and whether such linkages would then result in systemic impact for the DeFi landscape.193 Further, wallet providers also need to be able to keep up with the transactions194 and cannot become weak links for hackers and exploitations. One example of significant loss happened when a protocol bug was exploited by a hacker against ValueDeFi in a flash loan transaction.195 Nevertheless, it may be argued that the ValueDeFi loss is due to the availability of uncollateralised flash loans. Collateralised business models may not be so adversely affected. Third, yield farming can rely on extremely short-term strategies speedily executed with the help of automated smart contract protocols. Hence DeFi supports speculative trading arbitrage at speed and potential exploitation amongst users. It is uncertain how such speculative forms of hyper-financialisation is ultimately helpful for productive aspects in the crypto economy. For example, a user may deposit dai into Compound to earn a 10 per cent interest rate196 and receive a c-dai token in return from the Compound protocol. The c-dai token can be deposited into SushiSwap, in order to borrow a riskier paired token, say, issued by a recent dApp developer, that may benefit from hype and rising secondary market prices. Suppose the holder of the riskier token knows of inside information regarding the dApp developer’s risk, the loan can be made for timely arbitrage to generate yield on the token’s price, by perhaps swapping with another investor for USDC on Airswap.197 The final investor holding the ‘hot potato’ token may suffer loss in relation to the value of the token, as well as collateralisation and liquidation loss based on the lending protocols enforced by both SushiSwap and Compound. Other attacks such as pump arbitrage and oracle manipulation are discussed by commentators, and although these are more prevalent in a flash loan context,198 these episodes 190 WA Kaal, ‘Digital Asset Markets Evolution’ (2021) Journal of Corporation Law, forthcoming, at ssrn.com/ abstract=3606663. 191 K Qin, L Zhou, B Livshits and A Gervais, ‘Attacking the DeFi Ecosystem with Flash Loans for Fun and Profit’ (2020), at arxiv.org/pdf/2003.03810.pdf. 192 Werner et al (2021). 193 F Schär, ‘Decentralized Finance: On Blockchain- and Smart Contract-based Financial Markets’ (2020), at ssrn.com/abstract=357133. 194 A-D Popescu, ‘Decentralised Finance (DeFi) – The Lego of Finance’ (2020) 7 Social Sciences and E ­ ducation Research Review 321. 195 ‘Value DeFi Suffers $6M Flash Loan Attack’ (16 November 2020), at www.coindesk.com/value-defi-suffers6m-flash-loan-attack. 196 eg see ‘DeFi yield farming, explained’ (26 September 2020), at cointelegraph.com/explained/defiyield-farming-explained. 197 www.airswap.io. 198 Qin et al (2020).

Trends in Regulating Crypto Finance  285 show that self-governance is often not immune to determined fraudsters or scammers who exist alongside arbitrageurs and speculators.199 Finally, there is a need to determine if service providers that arise to help tokenholders compare pool prices or even manage their assets directly, should be subject to standards of conduct of business for user protection. There is however a vision of democratisation, diversity, openness, inclusiveness, competition and even resilience associated with decentralised spheres. Even if we may be concerned about some extent of financier dominance in the voting power on the Compound platform,200 users who do not favour such governance can choose to join other liquidity pools or diversify their participation. A competitive landscape where power is diffuse can promote innovative problem-solving.201 Further, decentralised platforms can contribute to overall financial system resilience as different types of financial assets are created and transformed, and the systemic risks of homogeneity at scale may be mitigated.202 Perhaps what DeFi needs is not a retreat from, but an organic partnership with, governance notions so that certain social expectations can be met, such as of civic behaviour, standards of problem-solving and systemic sustenance. Avgouleas and Kiaiyas,203 writing on how fintech ought to transform the financial ecosystem, propose a more diverse landscape for financial actors working in asset transformations of various novel forms and over different horizons, interfacing with users in different ways. Diversity will add to market competition and is key to resilience, ultimately promoting more holistic socio-economic goals. Crucially the authors propose that decentralised systems of finance should be governed by a mixture of self-governance, partnered governance between regulators and the industry, as well as stakeholders, and a continuous and dynamic comonitoring of the system.204 We argue that policy-makers and regulators should engage with developers in the crypto economy and crypto financial universe in partnered coordination to generate ex ante protocols for decentralised financial ecosystems that embed regulatory and governance objectives to protect the commons. In this manner, developments in Regtech205 199 Chen and Bellavitis (2020); the levels of cryptoasset crime and fraud although not overwhelming, are noted in M Tiwari, A Gepp and K Kumar, ‘The Future of Raising Finance – A New Opportunity to Commit Fraud: A Review of Initial Coin Offering (ICOs) Scams’ (2020) 73 Crime, Law and Social Change 417. 200 Financiers such as Paradigm and Polychain Capital are dominant voters; see compound.finance/ governance. 201 R Rajan, The Third Pillar (Penguin, 2020), advocating for localised communities to enjoy more power alongside states and markets. In this manner, decentralisation and fragmentation of power is not necessarily to be regarded as sub-optimal. 202 E Avgouleas and A Kiayias, ‘The Architecture of Decentralised Finance Platforms: A New Open Finance Paradigm’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3666029. 203 ibid. 204 ibid. 205 The rise of the Regtech industry, driven by data-based governance in financial regulatory reporting and automated compliance framed by such information returns, can be integrated into ex ante regulatory regularisation of automated finance. See eg DA Zetzsche, DW Arner, RP Buckley and RH Weber, ‘The Future of Data-Driven Finance and RegTech: Lessons from EU Big Bang II’ (2019), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3359399. The growth of Regtech is charted in E Schizas et al, ‘The Global RegTech Industry Benchmark Report’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3560811. Types of Regtech are critically discussed in L Enriques, ‘Financial Supervisors and Regtech: Four Roles and Four Challenges’ Revue Trimestrielle de Droit Financier 53 (2017), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3087292.

286  Regulating Crypto Finance which facilitate the financial industry’s automated compliance with regulations can be leveraged upon for further integration with crypto finance.206 Such partnered coordination should also extend to ex post monitoring and audit for DeFi platforms in order to solve problems and engage in system improvement. It is queried if regulatory involvement would result in governance convergence, such as amongst international regulators.207 There may be pros and cons to regulatory convergence, as regulatory homogeneity can lead to stagnation in governance and augment systemic risks if a flaw is subsequently discovered in regulatory mechanisms. However, international consistency can promote certainty and clarity for the crypto financial industry. DeFi raises ontological, design, standards and architectural challenges for regulators. In the section below, we propose a high-level framework for rethinking regulatory policy formulation, ie the how to regulate crypto finance. This is intricately connected to the why question for regulatory policy. Our high-level matrix for regulatory design in the next section integrates the objectives of regulatory policy more tightly with regulatory design, with the recognition that automation, decentralisation and innovation are structural changes that influence the how question for regulation. We argue that the high-level matrix, rather than narrow prescriptive suggestions, is a better way forward in order to accommodate the dynamic nature of innovations and regulators’ different considerations.

III.  A Framework for Developing the Regulatory Agendas for Crypto Finance In determining appropriate regulatory responses to novelties in crypto finance, policymakers have often discussed issues such as resemblance to existing regulatory ontologies and arbitrage,208 types of risks and the corresponding regulatory objectives that need to be addressed in managing those risks,209 as well as scale of risks in order to warrant regulatory intervention.210 In the EU, the purported introduction of cryptoasset regulation211 206 Arguably the industry of Regtech can be further interfaced with crypto finance developments; see support for the inherent coordinative possibilities in governance opened up by Regtech in V Colaert, ‘RegTech as a Response to Regulatory Expansion in the Financial Sector’ (2018), at papers.ssrn.com/sol3/ papers.cfm?abstract_id=2677116; AY-P Yang and C-Y Tsang, ‘RegTech and the New Era of Financial Regulators: Envisaging More Public-Private Partnership Models of Financial Regulators’ (2018) 21 University of Pennsylvania Journal of Business Law 354, at papers.ssrn.com/sol3/papers.cfm?abstract_id=3382005. 207 DW Arner, RP Buckley and DA Zetzsche, ‘Decentralised Finance’ (2020), at www.ssrn.com/ abstract=3539194. 208 eg, the initial approach taken by the FSB, ‘Addressing the Regulatory, Supervisory and Oversight Challenges Raised by “Global Stablecoin” Arrangements’ (14 April 2020), at www.fsb.org/wp-content/uploads/ P140420-1.pdf on stablecoins; A Collomb, P de Fillippi and K Sok, ‘Blockchain Technology and Financial Regulation: A Risk-Based Approach to the Regulation of ICOs’ (2019) 10 European Journal of Risk Regulation 263 on ICOs’ similarity to securities offerings. 209 Such as financial stability risks; M Adachi, M Cominetta, C Kaufmann and A van der Kraaij, ‘A Regulatory and Financial Stability Perspective on Global Stablecoins’ (5 May 2020), at www.ecb.europa.eu/pub/ financial-stability/macroprudential-bulletin/html/ecb.mpbu202005_1~3e9ac10eb1.en.html#toc1. 210 ibid. 211 European Commission Proposal (2020), at ec.europa.eu/finance/docs/law/200924-crypto-assets-proposal_ en.pdf.

A Framework for Developing the Regulatory Agendas for Crypto Finance  287 and the CBDC212 are also pursuant to market-building, deepening pan-European infrastructure and linkages. The debates in these rationales, sometimes competing, do not necessarily yield clear conclusions for policy-makers and regulators. This book argues that regulatory policy should be enabling in nature for the productive aspects of the crypto economy, hence the regulatory agendas to support productive financialisation, as set out in chapters four to six. However, other forms of crypto finance should be subject to more considered thinking instead of a coherentist approach. This chapter has discussed thus far the challenges that developments in crypto finance pose to existing regulatory regimes. Although existing regulatory regimes are not completely inapplicable as the same principles of investor protection underlie fundraising regulation for example, and similar concerns for user protection underpin payment systems in conventional and crypto spheres, crypto finance raises challenges in terms of structuration changes. Modes of participation are structurally changed by blockchain technology and smart contracts. Crypto finance also raises challenges in terms of multifunctionality of tokens in a manner likely to pose difficulties for regulatory mandates established during times where assumptions made of certain technological states existed, and where certain types of actors were dominant and private–public negotiations for policy balances were struck. In this manner, this chapter argues against predispositions towards coherentist application of existing regulation and urge regulatory dynamism and agility to consider the implications for governance. This section explores a framework towards developing regulatory agendas, instead of arguing for specific regulatory solutions as such. The blueprint set out below, which offers a framework for thinking about how regulators can respond to crypto finance governance needs, is one that can be engaged in on a constant basis in order to assess and address new developments. We endeavour to offer a high-level matrix for the key aspects of the ‘regulation enterprise’,213 in order to allow the characteristics of crypto finance to be mapped against it. In this manner we break down the regulatory enterprise into four component elements which are like the building blocks of regulatory design. Regulators should then map particular regulatory objectives and rationales against these building blocks in order to build up appropriate regulatory designs for crypto finance. These four components are: (i) regulatory ontologies, ie the categories of subject matter within the scope of regulators’ mandates;214 (ii) regulatory design, ie referring to the methodologies for addressing the subjects of regulation and methodologies to take account of risks in regulatory ontologies;215 (iii) regulatory content, ie the substantive and procedural rules, standards that comprise the compliance obligations for regulated entities;216 212 ECB, ‘Report on a Digital Euro’ (October 2020), at www.ecb.europa.eu/euro/html/digitaleuro-report. en.html. 213 T Prosser, ‘Introduction: Two Visions of Regulation and Four Regulatory Models’ in The Regulatory Enterprise (OUP, 2010) 11. 214 ibid; also B Morgan and K Yeung, An Introduction to Law and Regulation (CUP, 2012) ch 2; M Cave and R Baldwin, Understanding Regulation (OUP, 2011) ch 2. The rationales for regulation underpin the regulatory set-up and mandates. 215 Regulatory design and strategies often involve different ways of securing cooperation and compliance by regulated subjects; see Cave and Baldwin (2011) ch 3; Morgan and Yeung (2012); also see M Andenas and IH-Y Chiu, The Foundations and Future of Financial Regulation (Routledge, 2014) ch 3. 216 Cave and Baldwin (2011) ch 4, Morgan and Yeung (2012); C Parker and VL Nielsen, Explaining Compliance: Business Responses to Regulation (Edward Elgar, 2011).

288  Regulating Crypto Finance and (iv) regulatory architecture, ie the set-up, organisational and networked aspects of regulatory bodies.217

A.  The Development of Regulatory Ontologies and Need for Dynamism First, regulation comprises of regulatory ontologies, ie the definitions of what subject matter falls within the scope of regulation. Regulators often have broadly framed mandates, such as consumer protection and market confidence to be maintained by the FCA. Law is utilised as the instrument that establishes the regulatory agency and its mandate, such as the UK PRA’s and FCA’s mandates,218 and the manner in which the regulatory agency’s operations are carried out, such as in rule-setting and enforcement. Regulators applying their broadly framed mandates would engage in the legal interpretation and definition of their regulatory parameters. Determining regulatory ontologies may be regarded as pursuant to such an exercise. In this manner, regulatory ontologies are legalised categories for regulatory action, and are intimately infused with regulatory objectives. Risks219 in markets, as well as private sector activities and transactions, are mediated through the lens of regulatory objectives, so that regulators can determine appropriate policy against such risks. Regulatory policy is usually not premised on zero failure, as it may be impossible with regulatory resources to prevent all wrongdoing and financial losses. Over time, certain policies associated with certain risks coalesce into regulatory ontologies. Although this is not a necessary consequence, many regulatory ontologies developed in financial regulation have become sectorally based. How do regulatory ontologies such as bank regulation arise, for example? Banks arose as entities providing a unique model of full intermediation of financial capital, making their promises crucially based on their solvency. The regulatory mandate is in relation to the public interest in protecting bank solvency while promoting their economic development roles.220 Hence, regulatory frameworks designed towards that purpose coalesce around the regulatory ontology of ‘bank regulation’, making such ontology tied to a certain type of financial entity. Being tied to a type of financial entity makes for a sound ontology as long as the nature of governed risks continue to exclusively reside with that type of entity. If the type of entity in question engages in new business lines, or other types of entities undertake similar risks, then the regulatory ontology should be more meaningfully tied to the nature of risk incurred for particular purposes, rather than type

217 RA Abrams and MW Taylor, ‘Issues in the Unification of Financial Sector Supervision’ (IMF Working Paper, 2000), at www.imf.org/external/pubs/ft/wp/2000/wp00213.pdf on choices of regulatory architecture in financial regulation, for example. 218 Financial Services and Markets Act 2000, ss1C–1E and 2B, amended by Financial Services Act 2012. 219 OECD, ‘Risk and Regulatory Policy’, at www.oecd.org/gov/regulatory-policy/risk.htm; C Hood, H Rothstein, R Baldwin, J Rees and M Spackman, ‘Where Risk Society Meets the Regulatory State: Exploring Variations in Risk Regulation Regimes’ (1999) 1 Risk Management 21. 220 HS Scott, ‘Models-Based Regulation of Bank Capital’ in R Cranston (ed), Making Commercial Law (Clarendon, 1997) 378.

A Framework for Developing the Regulatory Agendas for Crypto Finance  289 of entity. In similar reasoning, partial intermediation services where financial entities do not intermediate investors’ risks, leaving them to bear capital risks themselves, give rise to investor protection risks such as misselling, as a principal–agent problem. In this manner, regulatory design for the purpose of ameliorating the principal–agent problem attaches to partial intermediation service providers, regardless of entity. Regulatory ontologies for ‘securities’, ‘funds’ or activities such as ‘advice’ and ‘brokerage’ arise in order to address particular investor protection risks in each of these aspects. Regulatory ontologies are constantly faced with challenge and such challenge is sharpened by confrontation with the novelties in crypto finance. First, regulation based on type of entity (sectoral-based) is challenged when entities take on new risks.221 Further, entities in a particular sector may develop risks that overlap with other sectors, due to scale of activity and changes in social expectations,222 or the carrying out of activities in shadow banking.223 Goodhart and Lastra224 argue that financial innovation often entails boundary challenges for law and regulation as unregulated entities perform the equivalent of regulated activities or regulated entities undertake new and unregulated activities, raising questions for an appropriate institutional response. The UK has moved away formally from sectoral regulation to functional, activitybased regulation,225 and has instituted regulatory architecture226 to manage the changes from sectoral regulatory ontologies. The EU has also, in its reform of payment services regulation, broken away from the sectoral stranglehold of banks upon payment services and introduced new regulatory ontologies in payment services227 in order to open up competition and clarify the rationales for regulating payment services providers. Developing regulatory ontologies according to regulatory risk and rationales is nevertheless a work in progress, as the sectoral legacy can still potentially bring about confusion. For example, in relation to the USD Coin regulated as a money service business in the US,228 we ask whether this is the right regime, or is the bank regulation regime in the Stable Act

221 Such as banks becoming universal banking groups engaged in market risk and trading activities; see AE Wilmarth Jnr, ‘The Transformation of the Financial Services Industry: 1975–2000, Competition, Consoli­ dation and Increased Risks’ (2002) University of Illinois Law Review 215; EF Brown, ‘The Continuum of Financial Products’ (2020) 25 Stanford Journal of Law Business & Finance 183. 222 Such as the systemic profiles of large asset managers that hold trillions under assets in management and being able to affect market pricing systemically; Financial Stability Board, ‘Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities’ (12 January 2017), at www.fsb. org/2017/01/fsb-publishes-policy-recommendations-to-address-structural-vulnerabilities-from-assetmanagement-activities. 223 See eg IH-Y Chiu, ‘Transcending Regulatory Fragmentation and the Construction of an Economy– Society Discourse: Implications for Regulatory Policy Derived from a Functional Approach to Understanding Shadow Banking’ (2016) 42 Journal of Corporation Law 327. 224 CAE Goodhart and RM Lastra, ‘Border Problems’ (2010) 13 Journal of International Economic Law 705. 225 Financial Services and Markets Act 2000, s 19 and the ‘regulated permissions’ regime based on activity and not entity for regulatory approval. 226 The ‘twin peaks’ architecture governed by regulatory objectives. The Prudential Regulation Authority has the mandate to maintain the stability of financial institutions and the Financial Conduct Authority promotes consumer protection, competitive markets and guards against risks to market integrity. 227 Arts 5, 35–37, Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 ­November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC. 228 The regulation of money service businesses is critically examined in D Awrey, ‘Bad Money’ (2020) 106 Cornell Law Review 1, at ssrn.com/abstract=3532681.

290  Regulating Crypto Finance more appropriate, or are both ill-fitting regimes for the multifunctional novelties in the Coin? Sectoral legacies in financial regulation can potentially obscure the perception of need for new or changing regulatory ontologies. The regulatory ontology of ‘securities’ is regarded by the US SEC as sufficiently elastic to accommodate ICOs,229 although this may be doubted in other quarters where new regulatory ontologies for ICOs are proposed.230 Regulators should map out their existing regulatory ontologies underpinned by regulatory objectives and the targeted risks, and be prepared to engage in ontological dynamism, recognising current limitations and assumptions. Regulatory ontologies can then be considered for expansion to capture more manifestations of similar risk, as well as accommodate divisions and sub-sets, or give rise to new ontologies altogether where ‘ontological fits’ have reached their limits. For example, the regulatory ontology for ‘hedge fund’ may have been based on certain assumptions in terms of fund management strategy and investor sophistication, but these assumptions may change. If investment strategies involving crypto finance become complex and inscrutable even by sophisticated investors, then questions may arise as to whether extant regulatory ontology accommodates novel investment risks.231 The DAO232 also raises issues in terms of regulatory ontology as the ‘collective investment fund’ ontology does not neatly apply although similar risks entail. The risks pertaining to a collective investment fund lie in the principal–agent problems in the central management of pooled assets. However, the risks that DAOs incur pertain to problems in the management of pooled assets as may occasion from failure in automated protocols and decentralised governance protocols. Should the new technologically based risks form a basis for a new regulatory ontology for DAO-governed financial products? New intermediaries such as code-vetters required under the Maltese Innovative Technological Arrangements Act 2019 could also give rise to a new regulatory ontology,233 and it is expected that new technologically based definitions of risk could form the basis for new regulatory ontologies. Another example would be multifunctional crypto financial products such as the asset-referenced stablecoin discussed above. Asset-referenced stablecoins resemble managed investment pools, which is the ontological treatment that the European Commission proposes to extend to them.234 At the same time, as Singh argues, 229 www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets. 230 J Rrustemi and NS Tuchschmid, ‘Fundraising Campaigns in a Digital Economy: Lessons from a Swiss Synthetic Diamond Venture’s Initial Coin Offering’ (2020) 10 Technology Innovation Management Review 53; also European Commission Proposal (2020). 231 In the EU and UK, the Alternative Investment Fund Managers Directive 2011 governs fund managers’ conduct and prudential management, but not the products. Promotion and marketing is also relatively unregulated, as is the case in the US. This position is queried in E Mokhtarian and A Lindgren, ‘Rise of the Crypto Hedge Fund: Operational Issues and Best Practices for an Emergent Investment Industry’ (2018) 23 Stanford Journal of Law Business & Finance 112. 232 Q DuPont, ‘Experiments in Algorithmic Governance: A History and Ethnography of “The DAO,” A Failed Decentralized Autonomous Organization’ in M Campbell-Verduyn (ed), Bitcoin and Beyond: Cryptocurrencies, Blockchains, and Global Governance (Routledge, 2018) ch 8; O Oren, ‘ICO’s, DAO’S, and the SEC: A Partnership Solution’ (2018) 2018 Columbia Business Law Review 617 on a different organisational perspective of the DAO from SEC, ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO’ (25 July 2017), at www.sec.gov/litigation/investreport/34-81207.pdf. 233 V Villanueva Collao and V Winship, ‘The New ICO Intermediaries’ (2019) 5 The Italian Law Journal 731, at ssrn.com/abstract=3540250. 234 European Commission Proposal (2020).

A Framework for Developing the Regulatory Agendas for Crypto Finance  291 blockchain-based assets like tokens have significant velocity for transfer and fungibility, making them as good as money235 for payment purposes. Are regulators able to cope with multifunctional crypto financial products and should these be regulated under different regulatory ontologies that deal with different risks, or should these be regulated under a new regulatory ontology that may more holistically take account of the total matrix of risks posed by these innovations? Regulators should map out the risks posed by each type of crypto financial activity and intermediary service in order to examine what regulatory objectives are to be pursued in relation to those risks, and to what extent those risks could be ameliorated by self-governance, as commons governance is arising in decentralised financial platforms.236 Where the incentives for commons governance are misaligned with public goods, or commons governance is inadequately fostered, regulatory governance may be better placed to provide such governance for example in relation to anti-money laundering, anti-market abuse237 and systemic stability. Regulatory mapping of crypto finance risks should be compared to the risks and objectives addressed in existing regulatory ontologies in order to determine if ontological fits can be found. New regulatory policy would involve debates in how regulatory ontologies should be framed, and these are not merely technocratic discourses.238 They involve discourse on normative underpinnings,239 as well as political bargains240 as new constitutive orders241 are ultimately forged in constructing or extending a regulatory enterprise. The rise of crypto finance in its multiple forms of manifestations compel regulators to engage with the needs of ontological dynamism in the shifting boundaries of their regulatory enterprises.

B.  Regulators Need to Approach Regulatory Design with an Open Mind In conventional finance, regulators deal with corporatised entities as their regulated subjects. Regulatory design has evolved from prescribing compliance obligations and enforcement for non-adherence, ie ‘command-and-control’, to a variety of models of 235 M Singh, ‘How Programmable Digital Assets May Change Monetary Policy: Collateral and Financial Plumbing’ (Bloomberg, 4 September 2020). 236 Davidson (2019). 237 ‘The Mechanics of Market Manipulation’ (30 November 2019), at www.coindesk.com/the-mechanicsof-market-manipulation. 238 RH Pildes and CR Sunstein, ‘Reinventing the Regulatory State’ (1995) 62 University of Chicago Law Review 3. 239 Such as the extent to which measurable economic phenomena in market mechanisms and self-regulation should influence institutional and policy choices, discussed in AE Kahn, The Economics of Regulation: Principles and Institutions (MIT Press, 1988) 15–18; or that social policies and common good are underpinned by the regulatory state, over and beyond economically efficient and minimalist regulation; see CR Sunstein, After the Rights Revolution: Reconceiving the Regulatory State (Harvard University Press, 2003). 240 eg M-F Cuéllar, ‘Coalitions, Autonomy, and Regulatory Bargains in Public Health Law’ in D Carpenter, SP Croley and DA Moss (eds), Preventing Capture: Special Interest Influence in Regulation and How to Limit It (CUP, 2020) ch 12, at papers.ssrn.com/sol3/papers.cfm?abstract_id=1974690. 241 CD Shearing, ‘A Constitutive Conception of Regulation’ in J Braithwaite and P Grabosky (eds), B ­ usiness Regulation and Australia’s Future (ANU Press, 1993) ch 5, at www.anu.edu.au/fellows/jbraithwaite/_ documents/Articles/Business%20Regulation%20and%20Australias%20Future.pdf#page=79.

292  Regulating Crypto Finance engagement with the regulated to secure compliance. Regulators can engage corporatised entities, which have internal capacities and resources, to codesign standards and procedures to meet regulatory objectives, in models of enforced self-regulation242 or meta-regulation (and its variants).243 Regulators can also coopt third parties to be gatekeepers of compliance,244 or to co-enforce compliance.245 Regulators are able to adopt flexible strategies in engaging and negotiating with regulated entities in securing compliance, without necessarily maintaining an adversarial relationship with them.246 Conventional regulatory designs are built around regulator engagements with corporatised entities, involving human discretion and procedural implementation. The regulator is able to count the number of regulated entities on its register,247 and may have established points of contact in regulated firms to engage in conversation. Regulators are also able to navigate organisational and governance phenomena248 in firms and address regulatory content at these. Regulators are able to pin down responsible individuals in corporatised organisations and impose personal responsibility on them,249 an initiative that the UK regulators have spearheaded since the global financial crisis. These regulatory designs could be severely challenged in the crypto financial context.250

242 Enforced self-regulation can involve privately generated standards to which regulated entities bind themselves and are publicly accountable for doing so, but this regime can be subject to shaping by self-interest; see for example, BM Hutter, ‘Is Enforced Self-regulation a Form of Risk Taking?: The Case of Railway Health and Safety’ (2001) 29 International Journal of the Sociology of Law 379. 243 C Parker, The Open Corporation (CUP, 2002) arguing for a form of corporate conscience that would be shaped and reinforced by procedural forms of regulation that attempt to change culture and behaviour. Metaregulation inevitably involves some form of devolved implementation of procedures by organisations to meet public regulatory goals; see C Ford, ‘New Governance, Compliance, and Principles-Based Securities Regulation’ (2008) 45 American Business Law Journal 1, but the hazards of this, ie effective self-regulation without supervision, has been criticized; see C Scott, ‘Regulating Everything: From Mega- To Meta-Regulation’ (2012) 60 Administration 61; J Black, ‘Paradoxes and Failures: “New Governance” Techniques and the Financial Crisis’ (2012) 75 Modern Law Review 1037. It is also argued that management-based regulation which prescribes procedural regulation to meet public regulatory goals also engages with how organisations respond to compliance needs: C Coglianese and D Lazer, ‘Management-Based Regulation: Prescribing Private Management to Achieve Public Goals’ (2003) 37 Law and Society Review 691. 244 Such as the audit profession, critically discussed in M Power, The Audit Society (OUP, 1997) and lawyers, auditors and analysts as external gatekeepers; see critical discussion in J Coffee, Gatekeepers (OUP, 2002). For internal gatekeepers, see banks’ internal control functions; see IH-Y Chiu, The Legal Framework for Internal Control in Banks and Financial Institutions (Hart, 2015). 245 N Gunningham, P Grabosky and D Sinclair, Smart Regulation: Designing Environmental Policy (OUP, 1998, rep 2004). 246 I Ayres and J Braithwaite, Responsive Regulation: Transcending the Deregulation Debate (OUP, 1992). 247 The combined register for the FCA and PRA, at www.fca.org.uk/firms/financial-services-register. 248 There is a lot of regulation targeted at the governance aspects of financial services firms, their organisational aspects that affect robustness, treatment of clients, business continuity, prevention of money laundering and crime, cybersecurity, risk management, remuneration, conflicts of interest management, etc; see for example Art 16, Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, also see IH-Y Chiu and J Wilson, Banking Law and Regulation (OUP, 2019) chs 11 and 12, and earlier overview of regulation’s intersection with organisational and governance aspects in financial institutions, IH-Y Chiu and M McKee (eds), The Law of Corporate Governance in Banks (Edward Elgar, 2015). 249 The senior managers and certified persons regime that institutes personal responsibility for organisational compliance by senior managers overseeing key areas of responsibility in financial institutions; Financial Services and Markets Act 2000, ss 66A, 66B, amended in 2013. 250 C Ford, Innovation and the State: Finance, Regulation and Justice (CUP, 2017) on the continued relevance of regulatory design developments to informing policy for regulating innovations.

A Framework for Developing the Regulatory Agendas for Crypto Finance  293 In the face of developments in crypto finance, it may be argued that regulators do not necessarily have to jettison the strategies they have developed over the years dealing with corporatised entities, as similar outfits still exist in crypto finance. Entities that provide points of intermediation and exchange can be regarded as being in a similar position to corporatised regulated entities. For example, the centralised cryptoasset exchange and even decentralised exchanges providing aspects of centralised services can be subject to regulatory designs that impose responsibilities at entity-level or on responsible persons.251 Further, intermediaries that underwrite claims or rights for crypto investors are in a principal–agent relationship with them and generate similar risks that warrant conventional investor or consumer protection.252 New entities with business models that support crypto financial markets, such as ICO rating services,253 could also arguably attract regulatory obligations if there is sufficient public interest in relation to their responsibilities assumed in information intermediation. In this manner, regulatory design need not be radically overhauled but could be adapted and extended. Where crypto finance service providers organise their business models in forms different from corporatised entities, or their assumed forms may not be legally recognised, such as the DAO,254 how should regulatory design be adapted in order to attach responsibilities and accountability appropriately? Where such organisation results in a substantive change in the nature of risk assumption and distribution, the issue is even one for regulatory ontology – should there be new ontological framing for the financial activity in question, and in that manner shape appropriate regulatory design? The DeFi universe raises many such challenges for regulators. For example, participants in liquidity yield farming atomise the risk of lending by each contributing collateral and assuming risk commensurate with the level of collateralisation. Such atomisation of risk is a radically different model from a bank engaging in full intermediation that centralises credit risk on its own books. Would financial risk be sufficiently self-governed this way? It can be argued that participants’ financial risk may be more affected by what they cannot control, ie governance protocols for the liquidity pools. In this manner, should regulators focus on the principal–agent risk between governance holders on DeFi platforms and non-governance participants? If so, this would entail regulatory design and principles in a different manner than in conventional regulation dealing with lending. Regulators may focus on meta-regulatory oversight of governance protocols and on the governance body responsible for such development, rather than the DeFi activities themselves. However, if large-scale losses occur and the regulator is compelled to respond, consideration can be had as to whether standards in financial activity conduct should be instituted, and in particular, be embedded in automated protocols. 251 Discussed in ch 6. 252 eg discussed in relation to Diem’s stablecoin issuance and management; R Rirsch and S Tomanek, ‘Facebook’s Libra: A Case for Capital Markets Supervision?’ (2019) 13 Journal of Payments Strategy and Systems 255. 253 Empirical evidence shows some extent of investor reliance, and that would raise questions whether investors are adequately protected without regulatory standards; see T Bourveau, ET De George, A Ellahie and D Macciochi, ‘Information Intermediaries in the Crypto-Tokens Market’ (2019), at ssrn.com/abstract=3193392; D Boreiko and G Vidusso, ‘New Blockchain Intermediaries: Do ICO Rating Websites Do Their Job Well?’ (2019) 21 The Journal of Alternative Investments 67–79. 254 The decentralised autonomous organisation discussed in chs 1 and 4.

294  Regulating Crypto Finance For example, Auer proposes that regulatory design should be embedded in technological designs that serve regulatory objectives,255 as the need for ex ante problem-solving intensifies in a context of automation and transaction irreversibility on a permissionless blockchain. Should regulators consider the possibility of becoming nodes on financial transaction blockchains,256 so that regulatory supervision is embedded contemporaneously? Regulators need to maintain an open mind where structural differences present themselves, radically changing from the familiar engagement paradigms with corporatised entities.

C.  Regulators Need to Consider Reframing or Reform of Regulatory Standards and Content Regulators may have become used to key regulatory tools such as: mandatory disclosure and transparency, in relation to financial products publicly offered;257 conduct of business regulation where intermediaries and customers are in a principal-agent relationship;258 and prudential regulation, as well as organisational and governance regulation where the solvency and stability of the institution should be maintained for the protection of the financial system as well as customers.259 These established tools should not, however, become an end in themselves, and regulators should consider if they are indeed applicable to crypto finance risks and regulatory objectives. Faced with crypto finance, which is often described as ‘money legos’ that can be combined in many novel ways,260 regulators would need to engage in reconsidering ontologies and designs (as discussed above), and such an exercise would also entail 255 R Auer, ‘Embedded Supervision: How to Build Regulation Into Blockchain Finance’ (BIS Working Paper, 2019), at www.bis.org/publ/work811.htm; ‘Embedded Supervision: How to Build Regulation into Libra 2.0 and the Token Economy’ SUERF Policy Note 159 (2020), at www.suerf.org/policynotes. 256 I Cedillo Lazcano, ‘A New Approach for ‘‘Cryptoassets” Regulation’ (2017–18) 35 Banking and Finance Law Review 37. 257 JC Coffee Jnr, ‘Market Failure and the Economic Case for a Mandatory Disclosure System’ (1984) 70 Virginia Law Review 717 for a discussion on fundamental rationales; see EU Prospectus Regulation 2017, Art 6; UCITs Directive 2009, Art 76, Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 Novemberember 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs), Arts 5–12, Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 Novemberember 2019 on sustainability‐related disclosures in the financial services sector, Arts 8–9 (on marketing of sustainably labelled investment products). 258 For investment firms generally, Arts 23–28, MiFID 2014; also fund managers, see Arts 17–23, Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company; Arts 12, 14, Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010. 259 This is commonly used for bank regulation, see extensive discussion in Chiu and Wilson (2019) chs 8, 9; investment firm regulation in MiFID 2014, Art 15; Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 Novemberember 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014 for non-systemically important investment firms, as well as funds under the UCITs Directive 2009 (Art 7); AIFMD 2011 (Art 9). Money market funds for example need to first be authorised as a UCITs or managed by an AIFM, hence subject to prudential requirements that way, see Art 4, Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on money market funds. 260 A-D Popescu, ‘Decentralised Finance (DeFi) – The Lego of Finance’ (2020) 7 Social Sciences and Education Research Review 321.

A Framework for Developing the Regulatory Agendas for Crypto Finance  295 rethinking or reframing of regulatory standards and tools. Regulators need to consider what regulatory standards or content are appropriate for the nature of the risks they wish to address in new phenomena in crypto finance. For example, whether and how new service providers or intermediaries should be regulated depends on the nature of claims generated, the reliance placed on them and the need to protect social trust.261 Regulatory standards may also be more stringently calibrated where levels of social trust required to be maintained are high. For example, we argued in chapter five that although there are similarities in the regulatory objectives for governing fundraising in ICOs and IPOs, the main regulatory tool for IPOs, ie disclosure and transparency regulation at point of sale, is not appropriate for ICOs. Although both types of fundraising exercises involve sales of credence goods, the risks in relation to credence goods like predevelopment tokens should be differently regarded from the risks in sales of conventional securities. In offering conventional securities, price can be based to an extent on existing information regarding the issuer, although historical information cannot predict performance. Where an ICO is concerned, there is arguably no real basis for an upfront price, by the sheer nature of its predevelopment status. However, tokenisation is made possible by new technology, even if what is sold is a premature bundle of future use and investment rights. Hence, unlike in an IPO where the modus of regulation is to hold issuers to account for the price represented, a similar regulatory methodology would not be appropriate for ICOs. An ex post model of accountability is arguably more appropriate, as issuers’ performance are judged ex post in order to be entitled to funds.262 In this manner, we do not agree with the proposed European Regulation’s approach that relies on mandatory disclosure in the form a white paper for cryptoasset offers, as being the main modus of regulatory governance. Such an approach is arguably too derivative and has not fully engaged with the differences that should be recognised for regulatory ontology and design, which should then shape regulatory tools and standards. Regulatory standards and tools would likely need to be adjusted or reformed in light of new mappings in terms of risk and responsibility dispersion in crypto finance. If, as mentioned above, regulators treat liquidity pool governance as the source of risk for financial participants, appropriate regulatory methodology to address such risk may be to: (a) attach ex post governance accountability to responsible persons, such as code developers; or (b) to specify certain ex ante governance standards that need to be embedded within protocol, such as standards that prevent manipulation, front-running etc; or (c) to require continuous supervision by having the regulator established as a node. Option (c) may be similar to developments in SupTech which allow regulators to make regulations machine-readable and to facilitate automated compliance and reporting from regulated entities.263 SupTech is however in an emergent phase and there may be limits to embedding regulatory standards into ex ante protocol programming – in

261 KM Stein, ‘Investor Protection in the Digital Age’ (2020) 85 Brooklyn Law Review 631. 262 ch 5 of this volume. 263 HJ Allen, ‘Experimental Strategies for Regulating Fintechs’ (2020), at ssrn.com/abstract=3533240 arguing that this space is still developing as regulators are using Suptech largely for building large data-sets or processing voluminous regulatory reports, or in fraud detection and anti-money laundering compliance. Also see S Zeranski and IE Sancak, ‘Digitalisation of Financial Supervision with SupTech’ (2020) 35 Journal of International Banking Law and Regulation 309.

296  Regulating Crypto Finance relation to the nature of the standards and the fact that risks may not all be foreseen and fore-managed. The choice of regulatory methodology would depend on the extent of the risk that is sought to be addressed, the level of regulators’ resources,264 the technological robustness of regulatory compliant protocols, etc. If, for example, there is a need to prevent money laundering in liquidity pools, then such a risk could justify option (c) even if option (c) may be regarded as an overkill for dealing with participant protection risk. Option (c) may also mitigate participant risk as participants could suffer collective adverse consequences if anti-money laundering enforcement takes place against the pool.265 Whether regulatory tools in relation to systemic stability in conventional finance are as applicable in crypto finance may also be queried. In crypto finance, which is highly reliant on decentralised participation, the unravelling of social trust and ‘run’ on any particular platform or project could be destabilising and exacerbate losses that may be suffered by every participant. The execution of automated protocols exacerbate such destabilisation,266 as experienced by Maker DAO in March 2020. In this manner, crypto financial systems may be less resilient than in conventional finance where key institutions can play centralised roles offering stabilisation, such as on the part of central banks, significant market makers and central counterparties for derivatives trading. Nevertheless, are crypto finance platforms as interconnected with each other as financial institutions may be in conventional finance, warranting systemic stability oversight and standards? Can it be argued that instability episodes, such as suffered by Maker DAO, are likely to be contained in scale and can be privately governed? In this manner there may not be a need for systemic stability standards to be introduced in crypto finance, at least as yet. Finally, regulators need to consider regulatory methodology in terms of public and private enforcement, and how these can be effective, in terms of who the enforcement is addressed to and what discipline is sought to entail. Further, would public and/or private enforcement be embedded in technological protocols?

D.  Regulators Need to Consider Agility in Regulatory Architecture to Respond to Crypto Finance Developments Since the rise of financial supermarkets267 in the 2000s, the reorganisation of financial services and markets has compelled many regulators to rethink the appropriateness and responsiveness of regulatory architecture.268 In particular, the UK opted for a single 264 See C-Y Tsang, ‘From Industry Sandbox to Supervisory Control Box: Rethinking the Role of Regulators in the Era of Fintech’ (2019) Journal of Law, Technology and Policy 355. 265 Such as the enforcement against BitMex by the Department of Justice in the US; this has caused Bitcoin volatility and it remains uncertain how users and their funds may be adequately protected; see ‘Giant cryptocurrency exchange BitMEX hit with criminal and civil money laundering charges’ (Fortune, 1 October 2020), at fortune.com/2020/10/01/giant-cryptocurrency-exchange-bitmex-hit-with-criminal-andcivil-money-laundering-charges. 266 Discussed in W Magnuson, ‘Artificial Financial Intelligence’ (2020) 10 Harvard Business Law Review 337, at papers.ssrn.com/sol3/papers.cfm?abstract_id=3403712. 267 Wilmarth (2000). 268 E Ferran and CAE Goodhart (eds), Regulating Financial Services in the 21st Century (Hart, 2001); Brooklyn Law School Conference, ‘Do Financial Supermarkets Need Super Regulators?’ (2003) 28 Brooklyn Journal of International Law 1.

A Framework for Developing the Regulatory Agendas for Crypto Finance  297 regulator, the Financial Services Authority, in order to administer a seamless and holistic regulatory agenda for financial services across the board, not limited to sectoral boundaries.269 Although the single regulator has come to an end, the UK’s ‘twin peaks’ approach after the global financial crisis embeds regulatory agency coordination at formal and informal levels.270 Regulatory architecture can affect regulators’ agility in responding to regulatory issues in ontologies, design and standards. In the US, the maintenance of sectoral boundaries has, as discussed in chapter three, resulted in different regulators acting upon different aspects of the crypto economy, such as FinCen in relation to cryptocurrency providers and businesses, the SEC in relation to cryptoasset offerings and the CFTC in relation to fraudulent cryptocurrency offerings which they regard as commodities,271 and some aspects of derivative trading. Fragmented regulatory treatment poses significant regulatory risk to the crypto economy due to potential inconsistency of approaches, and does not reconcile with more enabling state-based approaches for encouraging blockchain-based enterprises. It could however be argued that the early extension of legal and regulatory risk shapes crypto financial behaviour to be more circumspect in the crypto economy,272 overall having a discouraging effect upon lemons. That said, in considering whether to permit cryptocurrency exchangetraded funds, the SEC has now explicitly stated that it is working with the Office of the Comptroller of Currency and the CFTC, hence taking an inter-agency approach to fully apprise of cryptocurrency ETFs due to their multifunctional nature.273 Further, a crossparty Bill was tabled in Congress in March 2021274 to enable the SEC and CFTC to form a cross-sectoral working committee in order to clarify the status of cryptoassets. The first signs of regulatory agency coordination reflect the perception in the US of needs that traverse traditional regulatory boundaries. In responding to crypto finance, and more generally financial innovation, regulatory architectural agility would be beneficial in relation to enabling regulators to embrace greater openness in considering ontological, design and standards adjustments, as well as to tap into a greater pool of technocratic expertise and resources that can be potentially joined up. In this manner, jurisdictions with single regulators may be able to enjoy such agility and economies of scale. However, going by the Financial Services Authority’s ill-fated experience,275 a single regulator need not always work, as the large single regulator can still be internally organised along sectoral lines, or internally manage its resources with poor regulatory judgment.276 The internalisation of all 269 First established by the Financial Services and Markets Act 2000; see E Ferran, ‘Examining the UK’s Experience in Adopting a Single Financial Regulator Model’ (2003) 28 Brooklyn Journal of International Law 257. 270 Financial Services and Markets Act, s 3D, 3E, amended in 2012. 271 A Kogan, ‘Not All Virtual Currencies Are Created Equal: Regulatory Guidance in the Aftermath of CFTC v. McDonnell’ (2019) 8 American University Business Law Review 199. 272 M Dell’Erba, ‘From Inactivity to Full Enforcement: The Implementation of the “Do No Harm” Approach in Initial Coin Offerings’ (2020) 26 Michigan Technology Law Review 175. 273 ‘Cryptocurrency ETFs under active consideration, says SEC Chair’ (Financial Times, 16 October 2020), at www.ft.com/content/9f2c1303-678e-486e-b3f1-d4f234f85f47. 274 H.R.1602 – To direct the Commodity Futures Trading Commission and the Securities and Exchange Commission to jointly establish a digital asset working group, and for other purposes, at www.congress.gov/ bill/117th-congress/house-bill/1602?q=%7B%22search%22%3A%5B%22mchenry+AND+%5C%22digital+ asset%5C%22%22%5D%7D&s=1&r=2. 275 Dismantled in order to make way for two regulatory agencies organised by objective, Financial Services Act 2012. 276 Financial Services Authority, ‘The Turner Review’ (2009), at www.actuaries.org/CTTEES_TFRISKCRISIS/ Documents/turner_review.pdf, 2.7–2.9.

298  Regulating Crypto Finance financial regulatory activities under one roof can also render regulatory activity more inscrutable. Hence, single regulators need to inculcate a responsive culture to financial innovation and be internally nimble in terms of management and organisation, as well as sufficiently engaged with a diverse range of external stakeholders.277 Although the UK has now opted for a ‘twin peaks’ regulatory architecture where prudential supervision of systemically important institutions lies with the Bank of England,278 and supervision of conduct of business, financial crime and market activities lies with the Financial Conduct Authority,279 the UK has been keen to ensure that financial regulation is not fragmented and regulators remain capable of joining up perspectives, resources and initiatives. Mandatory coordination is instituted for the financial regulators in the UK.280 This structure is also seen at the pan-European level, where the European agencies that are supervisors of national regulators are organised along sectoral lines,281 but work extensively in a coordinated fashion in a formal Joint Committee grouping282 and in relation to overseeing signs of systemic risk.283 We suggest that whether financial regulators are organised as single regulators with many departments or along objective-based or sectoral lines, creating networked linkages amongst different pools of technocratic expertise is crucial for developing regulatory responsiveness and regulatory innovation. For example, where stablecoins are ontologically treated as managed investment pools as well as payment mechanisms, as discussed earlier, the UK FCA should consider pooling together regulatory expertise in collective investment fund, money market fund and payment provider supervision in order to forge perspectives for stablecoins, in relation to ontologies, design as well as standards. Where regulators need to reach outside of their agency boundaries to work with other public sector agencies, this should be encouraged and enabled.284 We suggest particularly that networked linkages and architecture should be forged between enterprise/business regulators for blockchain-based enterprises and financial regulators. For example, ICOs raise an issue in terms of enterprise development and legitimation, as well as in relation to sale of a financial product that becomes tradeable. Regulatory networks, linkages and greater agility within and beyond structural setups would also facilitate regulatory innovations such as joint task forces or committees to deal with specific issues and concerns, or hazards. Further, regulatory innovations such as sandboxes or innovation hubs can be instituted for activities that challenge 277 eg S Omarova, ‘Bankers, Bureaucrats, and Guardians: Toward Tripartism in Financial Services Regulation’ (2012) 37 Journal of Corporation Law 621. 278 The Prudential Regulation Authority; see Financial Services and Markets Act 2000, s 2B, amended in 2012. 279 The Financial Conduct Authority, see Financial Services and Markets Act 2000, ss 1C–1E, amended in 2012. 280 Financial Services and Markets Act 2000, ss3D–3Q, amended in 2012. 281 The European Banking Authority, European Securities and Markets Authority and European Insurance and Occupational Pensions Authority established in 2010. 282 See discussion in IH-Y Chiu, ‘Power and Accountability in the EU Financial Regulatory Architecture: Examining Inter-agency Relations, Agency Independence and Accountability’ (2015) European Journal of Legal Studies 68. 283 In relation to the Authorities’ work in feeding into the European Systemic Risk Board. 284 Although legislative clarification may be required in the interests of public accountability, see eg critique against the Fed’s extensive mandates in the wake of the Covid-19 pandemic, D Zaring, ‘The Government’s Economic Response to the Covid Crisis’ (2020) 9, at ssrn.com/abstract=3662049.

A Framework for Developing the Regulatory Agendas for Crypto Finance  299 ontological paradigms, regulatory design and standards, in order for regulators to engage with innovators at an early stage.285 In this manner, a network of regulators that may be concerned with an innovation can engage with the innovation and innovators in coordinated spaces,286 a need particularly relevant in light of the sectoral regulatory architecture maintained in the US.287 Discourse and networks in governing innovation can extend two ways. First, horizontally across financial and business sectors more generally. The engagement space between regulators and innovators can be extended more broadly beyond financial activities to enterprisal activities as these are tightly interwoven. Second, agile and open structures in financial regulatory architecture at national, and EU levels also helps promote discourse at international levels,288 which is important given the global nature of crypto finance. The need for agility in regulatory architecture is more pressing than ever in light of the ontological dynamism posed by DeFi. Regulators need to be willing to engage outside of their traditional domains and in inter-agency collaborations to consider suitable regulatory policy that is holistic in nature. Regulators cannot rely merely on Regtech or Suptech to catch up with automated finance, as these can only be calibrated based on the regulatory policy choices in ontology, design and standards for crypto financial phenomena.289 Although commentators opine that regulators are instinctively protective of their regulatory turf,290 other research has found regulators more focused on problem-solving291 and being open to agency regrouping, especially as a response to crisis management.292 Preparedness for dynamism may be needed even if a crisis context is not yet perceived. Business and financial regulators need to respond the needs in growth and scale in the crypto economy and its financial universe.

285 See FCA, ‘Regulatory Sandbox’ (2015); IH-Y Chiu, ‘A Rational Regulatory Strategy for Governing Financial Innovation’ (2017) 8 European Journal of Risk Regulation 743. It is argued however that sandboxes may be too tied to existing regulatory regimes and that innovation hubs provide more open structures for regulators to engage with innovation; see DW Arner, RP Buckley, DA Zetzsche and R Veidt, ‘Building Fintech Ecosystems: Regulatory Sandboxes, Innovation Hubs and Beyond’ (2020) 61 Washington University Journal of Law and Policy 55. 286 HJ Allen, ‘Regulatory Sandboxes’ (2019) 87 The George Washington Law Review 579. 287 MM Piri, ‘The Changing Landscapes of FinTech and RegTech: Why the United States Should Create a Federal Regulatory Sandbox’ (2019) 35 Banking and Finance Law Review 233. 288 D Ahern, ‘Regulators Nurturing FinTech Innovation: Global Evolution of the Regulatory Sandbox as Opportunity Based Regulation’ (2020), at papers.ssrn.com/sol3/papers.cfm?abstract_id=3552015. There is a loose network called the GFin of a few voluntary global regulators engaged in discourse to explore common interest and issues; see GFin, ‘One Year On’ (2019), at static1.squarespace.com/static/5db7cdf53d173c0e010e8f68/ t/5dbfaaca6b4e151deddc42ae/1572842207667/GFIN-One-year-on-FINAL-20190612+%28CLEAN+VERS ION%29.pdf. 289 The need for human judgment to be made at regulators’ end in terms of what regtech achieves and how supervisory purposes are achieved remains important; see N Geslevich Packin, ‘Regtech, Compliance and Technology Judgment Rule’ (2018) 93 Chicago-Kent Law Review 193. See also E Micheler and J Jiang, ‘Regulatory Technology – Eight Policy Recommendations’ (2019), at papers.ssrn.com/sol3/papers. cfm?abstract_id=3423899. 290 Regulatory turf laws, attributed to extreme versions of public choice theory is referred to in WW Buzbee, ‘A Theory of Regulatory Gaps’ (2003) 89 Iowa Law Review 1. 291 SP Croley, ‘Theories of Regulation: Incorporating the Administrative Process’ (1998) 98 Columbia Law Review 1. 292 BM Hutter and S Lloyd-Bostock (eds), Regulatory Crisis: Negotiating the Consequences of Risk, Disasters and Crises (CUP, 2017).

8 Upcoming Trends and Concluding Remarks As the blockchain innovation entails structural implications for economic and financial relations,1 this book proposes approaches for regulating and governing the crypto economy in ways that reflect a paradigmatic shift instead of extending from existing regulatory frameworks and assumptions.2 The book argues that there is a growing productive crypto economy that leverages upon blockchain technology to offer new virtual goods and peer-to-peer services, and novel forms of tokenisation that interface with the conventional economy (chapter two). Such a productive economic space can provide opportunities for economic mobilisation and development. There is scope for regulatory agendas to enable and provide necessary goods such as commons governance and to mitigate externalities such as the migration of financial crime and financial fraud to this space. The book explores the institutional shifts required to provide legitimation and enabling for the productive crypto economy. Implications are explored in terms of enterprise and organisational regulation for blockchain-based enterprises (chapter  four), payment systems regulation for the adoption of cryptocurrency (chapter six) and fundraising regulation for pre-development blockchain projects (chapter five). Enabling regulation nevertheless provides for governance aspects in order to address collective hazards and goods, and this book proposes new regulatory agendas to strike such a balance. In making our proposals, the book refers to and draws comparisons with existing regulatory approaches and proposed reforms in a number of different jurisdictions. At the time of writing many of the proposed legislations, such as in the UK, EU and US, have been mooted but not yet formalised. The book’s discussions are pitched at the level of regulatory policy and will hopefully remain relevant for critical reflection even if new legislations are formally adopted after the publication of this work. This book is concerned in particular with the observation that financial regulators have become most attracted to designing policy for the crypto economy, focusing on the financial product aspects of certain innovations, such as stablecoins. In comparison, there is a relative neglect of the enterprise novelties and productive crypto economy as described above. There are hazards in concentrating only upon the financial aspects

1 S Davidson, P De Fillippi and J Potts, ‘Blockchain and the Economic Institutions of Capitalism’ (2018) 14 Journal of Institutional Economics 639. 2 Coherentism, as referred to in R Brownsword, Law, Technology and Society (Routledge, 2019) 191–96.

Upcoming Trends and Concluding Remarks  301 of the crypto economy, as discussed in chapter three. In particular, the innovative and business potential offered in the crypto economy can be adversely affected by inappropriate financial regulation. In this regard this book critically offers rethink of developments in crypto finance, and challenges the extension of existing financial regulation to them in a derivative manner. Many aspects of crypto financial activities should be examined carefully for policy consideration, and the book discusses a new regulatory blueprint for designing financial regulatory oversight of peer-to-peer financial activities (chapter seven). As the crypto economy and its financial spheres are evolving in a dynamic manner, it remains for the book to offer two visions of possible future trends. One is that the structural implications of the blockchain-based enterprise and financial economies gain a wider footprint and profoundly challenge the structuration of economic and financial activities and regulatory frameworks. For example, what if DeFi platforms such as Uniswap and Compound become sufficiently popular that their native tokens, which are swapped for cryptocurrency and stablecoins, become a new form of currency for circulation and transactions? The constant developments and innovations in private cryptocurrency and cryptoassets would open up new frontiers in economy, finance and society. Regulators would more than ever be faced with challenging demands in relation to the purposes and efficacy of their regulatory and governance frameworks. In this light, can the EU’s proposal for a Markets in Crypto-assets Regulation be really future-proof? The second is a vision that may perhaps be more realistic. Economic and financial incumbents would unlikely ignore innovative challenges that threaten their relevance. We already see acquisitions of blockchain-based enterprises by incumbents, especially in finance,3 and it remains uncertain how incumbents may absorb crypto economy innovations and shape them according to their corporatist frameworks and agendas, and how innovations may change the incumbents in terms of their business models. In this manner, it can be argued that challenges for regulators may be mitigated in terms of structural and paradigmatic shifts in regulatory ontologies and designs, as regulators would continue to be able to deal with a majority of regulated entities in familiar corporate forms. However, new forms of regulatory arbitrage may occur with business changes that entail from the combination of incumbents and innovation. Regulators should heed the lessons from the demise of London and Capital Finance in relation to maintaining narrow regulatory categories and failure to look at a regulated entity’s activities as a whole.4 The second vision may be more incremental and less disruptive, but hazards may lie in subtle changes, and in this manner, regulators need to continue to respond to dynamic trends.

3 ‘Blockchain buyouts are the new M&A’ (2 November 2020), at www.information-age.com/blockchainbuyouts-are-new-ma-123492490. 4 Rt Hon Dame Elizabeth Gloster DBE, ‘Report of the Independent Investigation into the Financial Conduct Authority’s Regulation of London Capital & Finance plc’ (10 December 2020), at assets.publishing.service.gov. uk/government/uploads/system/uploads/attachment_data/file/945247/Gloster_Report_FINAL.pdf.

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INDEX Introductory Note References such as ‘178–79’ indicate (not necessarily continuous) discussion of a topic across a range of pages. Wherever possible in the case of topics with many references, these have either been divided into sub-topics or only the most significant discussions of the topic are listed. Because the entire work is about the ‘crypto economy’, the use of this term (and certain others which occur constantly throughout the book) as an entry point has been minimized. Information will be found under the corresponding detailed topics. absolute liability  171, 190 abuses market  103, 233, 237, 240 potential  81, 123 account-based CBDCs  243–45 accountability  128–29, 142, 144–45, 168–69, 175, 240–41, 274–75, 298 accounting  65, 134–35, 155, 256 accounts, wallet  220–21, 228 accredited investors  41, 72, 81, 95–96, 108, 152, 170, 258 actions civil  13, 165, 184, 190–91, 206 collective  133, 146, 190–91, 213 regulatory  171, 191, 288 activities commercial  22, 86, 88, 125, 127, 134 consumption  25, 244 economic  2, 22, 48, 50–51, 68, 70, 193, 195 financial  251, 253, 256, 258–63, 265–66, 291, 293, 301 gambling  265 investment  99, 107 manipulative  97, 118 market  18, 298 speculative  18, 81, 256, 259–63, 265–66, 268, 270 actorhood, economic  51–52, 57, 81 actors  82, 109–10, 252, 287 economic  22, 64, 74, 79, 96, 107, 252 financial  81–82, 251, 285 administration  175, 274 administrators  34, 118, 141–43 technical  140, 143

agencies  216 credit-rating  154, 176 government  187 regulatory  148, 250, 288, 297 agency problems  34, 157–59 agency risks  177, 183 aggregate entities  124–25 agility  287, 296–99 AirBnB  36, 48, 65–66, 69, 112, 127 airdrops  14, 198 Airswap  239, 284 Algorand  22, 207 algorithmic processes  24, 117 algorithmic protocols, automated  21, 282 algorithmically managed stablecoins  198, 281 allocation of risk, power and responsibilities  8, 15, 24, 115, 119–20, 138, 146, 225 alt coins  1, 12, 197 ambiguities  40, 106, 142, 178 Ampleforth  198–99, 282 anarcho-capitalist ethos  88, 106, 248 anti-money laundering  85, 102, 106, 196, 215–16, 227–30, 242, 245 compliance  102, 189, 227, 241–42, 295 due diligence  241 duties  177, 188 enforcement  94, 296 law  55, 85, 92, 142 obligations  189, 229, 234, 241 regulation(s)  92, 100–1, 103, 189, 195, 227–28, 239, 242 anti-social behaviour  115, 120–21, 136 applicability of existing organisational regimes in law  125–43 application developers  118, 148, 202

330  Index application tokens  22, 37, 62 arbitrage  92, 252, 254–55, 260, 276, 281, 284, 286 regulatory  3–4, 40, 42, 86, 92, 94, 98, 241 architecture  9, 110, 148, 285 regulatory  15, 288, 296–99 artwork  25, 57 digital  50, 57–60, 229–30 asset management  109, 275, 281 asset managers  82, 203, 281 asset partitioning  135, 147 asset-referenced stablecoins  274–75, 278–82, 290 assetisation  43, 208 assets  36, 59–60, 71–72, 99, 102, 201–2, 223–24, 270 blockchain-based  42, 291 collective  115, 121 common  112, 122, 130, 135, 144–45 corporate  107, 127–28, 130, 170 expensive  71–72, 229 financial  162, 164, 199–200, 252–53, 256, 270, 275, 281 virtual  101 audited financial statements  100, 128, 155, 161 auditors  141, 150, 154, 292 systems  141–43, 147, 149 austerity  53, 69 authentication  22, 223 authorisation  10, 73, 173, 195, 203, 233–34, 262, 273 regimes  100, 195 automated compliance  285–86, 295 automated executions  27, 193 automated protocols  23–24, 27–28, 123, 240, 277, 281, 290, 293 automation  23–24, 255, 282, 286, 294 autonomy  3, 112, 291 autopoiesis  2–3 bank-based platform coins  271–74 bank deposits  20, 207 bankers  18, 203, 298 banking  7, 9, 53–55, 114, 146, 195–96, 208, 260–61 institutions  226, 244–45, 272 shadow  87, 99, 272, 289 banks  52–54, 187, 194–95, 244–45, 270, 272–73, 288–89, 292–93 central  4, 16, 20–21, 23, 196–97, 242–46, 248, 272–73 clearing  271, 273 regulation  20, 94, 98, 106, 274, 279, 288, 294

bargaining power, unequal  214, 225 barriers to entry  25, 49, 54, 166, 236 barter  19, 21, 211, 236 baskets of currencies  198–200 BBLLCs, see blockchain-based limited liability companies benefit corporations  131 best execution  226, 240 best interests  203, 238 Binance  67, 87, 221, 223, 235, 269 Bitcoin  1–2, 5–19, 21, 31–34, 196–97, 221, 258–59, 278–79 and beginnings of blockchain-based economy  4–21 blockchain  4–7, 9, 12–13, 15–16, 21–23, 37–38, 116–17, 196 as payment system  5–16 derivatives  258, 268, 279 and fiat currencies, exchange between  196–97 futures  268–69 Bitcoin Cash  100, 221, 259 Bitfinex  15, 97, 188, 199–200, 208, 211, 235, 274 Bithumb  235 block  6, 56, 115, 186 blockchain, communities, see blockchain-based communities blockchain-based business development  151–94; see also business development blockchain-based businesses  39–40, 76–78, 110–13, 119–21, 125–37, 139–40, 143–49, 300–1 developers  51, 96, 151, 217, 248 permissionless  125, 131–32, 134, 137, 139, 146 registration  148, 216 blockchain-based communities  61–62, 76, 104–5, 121–25, 127, 133, 136, 144–45 blockchain-based economy  4–5, 7–19, 23, 25, 44–45, 68, 76, 78 blockchain-based enterprises, see blockchain-based businesses blockchain-based limited liability companies (BBLLCs)  138–39 blockchain-based networks  25–26, 29, 31–32, 70–71, 112–13, 117, 138, 147–48 blockchain-based projects  37, 151, 156–59, 169–70, 173–75, 185–86, 189–90, 192 blockchain developers  35, 46, 139 blockchain economy, see blockchain-based economy blockchain ecosystem  77, 112, 115–16, 119 blockchain enterprises, see blockchain-based businesses

Index  331 blockchain infrastructure  22, 25, 49, 67, 124, 252, 271 blockchain marketplaces  27, 68, 73 blockchain networks, see blockchain-based networks blockchain platforms  73, 105, 174, 193 blockchain projects, see blockchain-based projects blockchain protocol  195, 204, 206 blockchain systems  17, 30, 61, 68, 71–72, 101, 105, 119–20 blockchain technology  2, 41, 79, 83, 111, 115, 123–24, 286–87 blockchains, see also Introductory Note Bitcoin  4–7, 9, 12–13, 15–16, 21–23, 37–38, 116–17, 196 Ethereum  21–37, 61–62, 115–19, 162, 186, 196, 201, 207–8 global payments  23, 202 governance on permissionless  32–33, 118 peer-to-peer  26, 29, 45, 48, 65, 68, 248 permissioned  2, 22–25, 61, 74, 112, 114, 271–73 permissionless  22–34, 60–61, 74, 112–23, 207–9, 211–21, 249, 271–73 protocol  35, 61, 136, 147 public  23, 62, 115, 123 bodies of law  3, 49 boilerplate statements  155, 174 borderless ICO markets  39, 86 borrowers  187, 254 boundaries  28, 30, 35, 73, 250, 274 Breadwallet  222, 226 broker-dealers  96, 226, 232 brokers  81, 91, 100, 189, 229, 232, 269 bugs  39, 124, 141, 199, 241, 284 business, money service  94, 196, 274 business continuity  204, 206, 225, 232, 237, 240, 283, 292 business developers, blockchain-based  51, 96, 151, 217, 248 business development blockchain-based  151–94 blueprint for regulating token financing  166–70 ex-post monitoring and rights in schedules of commitment  176–92 and mandatory disclosure  170–76 need for tailor-made regulatory regime for fundraising  151–66 pre-development fundraising  192–94 schedules of commitment  176–92 business models  21, 64–65, 201, 204, 228, 230, 278, 293 business networks  22–23, 25

business organisations and governance  111–51; see also governance blockchain-based businesses  111–13 enabling legal framework and conclusion  147–51 existing organisational regimes  125–44 organisational form for blockchain-based business  113–25 separate legal personality  144–47 business plans  62, 100, 166 business projects, blockchain-based  37, 152, 166, 171–72, 179, 192 business regulators  148–49 c-dai tokens  284 capacity  29, 36, 51–52, 63, 128, 149, 191, 212 excess  29, 65 capital  89, 128–29, 131, 135, 138, 155 financial  260, 265–66, 288 gains  14, 56 human  55, 126, 179 markets  22, 40, 96, 100, 106, 153, 155, 157 rentier  69–70 capitalism regulatory  2–3, 48–52, 77, 193, 251, 267 responsible  120, 127 capped supply  185–86, 196 CBDCs (central bank digital currencies)  20–21, 88, 207, 242–50, 287 account-based  243–45 and crypto economy  242–49 deployment  246, 248–49 development  246, 249 central banks  4, 16, 20–21, 23, 196–97, 242, 248, 272–73 thinking regarding digital versions of fiat currencies  243–46 central counterparties  163, 258, 296 centralisation  119, 213, 235–36 centralised exchanges  105, 232, 234, 236–40, 278 cryptoasset  235, 276, 278, 293 centralised governance  65–66, 68, 74 centralised institutions  9, 31, 69, 71, 119, 200 centralised intermediaries  7, 9 centralised management  34, 42, 107 certification  140–42, 174 third-party  147–48 CFTC (Commodities and Futures Trading Commission)  94–95, 97–99, 106, 269, 297 jurisdiction and enforcement  97–98

332  Index characterisation  11, 14–15, 35, 43, 86, 97, 209, 211 regulatory  16, 96, 230, 275 charity shops  48 CICs (community interest companies)  130–32 Circle  10, 201–2, 247, 274 circulation of cryptocurrencies  88, 98, 108, 201–2, 211, 281–82, 301 civil actions  13, 165, 184, 190–91, 206 civil enforcement  14, 92, 156, 188, 190 claims  11–13, 209, 211, 247, 252, 272, 274, 280 financial  252–53, 272, 280–81 classes  75, 81, 163 new asset  20, 109 clearing  214, 246, 272 banks  271, 273 cloud storage  28, 131 peer-to-peer  41, 63–64, 123 clusters  6–7, 141, 148 of power  119, 213–14 CME Bitcoin futures  268–69 co-regulation  46, 267 in policy development  83–85 code, see also Introductory Note application-level  148 developers  31–32, 115, 117, 119–20, 124, 129, 143–44, 213–14 development  33, 61, 78, 157, 173, 217 exploitation  12, 15 open-source  26, 34, 147 programmed  115, 140, 191 smart contract  114–15, 219, 241 source  61, 100, 115, 173 verification  149, 184 coherentism  3, 44, 231–33, 249, 251, 267, 275, 287 Coinbase  94, 201–2, 221, 226, 235, 247 Coinomi  222, 226 coins  5–6, 11–13, 15–16, 18, 197, 199, 202–3, 211 alt  1, 197 bank-based platform  271–74 with dollar parity  274–75 interoperable  207–8 JPM  61, 271–73 RBI  271–73 stolen  13, 15 XKD  272 cold wallets, see offline wallets collateral  252, 254, 270, 272, 279–81, 283, 291, 293 collateralisation  19, 199, 201, 205–6, 277, 280–81, 283–84, 293 collateralised stablecoins  104, 199–200, 204–7, 209, 212, 279–80

collective actions  133, 146, 190–91, 213 collective assets  115, 121 collective governance  61, 68 collective investment  72, 163, 203, 205, 258, 270 funds  153, 163, 290, 298 schemes  20, 40, 42, 72–73, 81, 91, 200, 203 collusion  22, 46, 118, 136, 198, 200 command-and-control  109, 291 commerce  1, 22, 28, 47, 111, 210, 220, 247 commercial activities  22, 86, 88, 125, 127, 134 commissions  164, 227, 264 commitment  38, 65, 78, 143, 158, 171, 175–79, 181–93 commodifications, new  25–26, 36, 45 commodities  10, 20, 58, 80, 94–95, 97–98, 199–200, 205 Commodities and Futures Trading Commission, see CFTC commoditisation  4 new forms  49, 52–74 common assets  112, 122, 130, 135, 144–45 common interests  122, 176, 299 common law  13, 45, 270 commons  65, 75–78, 110–12, 114–15, 145–47, 195–96, 209–12, 239–40 governance  30, 61, 68, 71, 114, 209, 291, 300 institutional  65 communities  30–31, 60–62, 67, 70–71, 120–21, 123–25, 129–30, 132–33 blockchain-based  56, 104, 123, 125, 133, 145, 186 dApp  115, 120, 124–25 of participants  105, 121 user  70, 118 community benefit  130–31 community interest companies, see CICs companies  39, 41, 104–5, 135, 137, 151, 160–61, 191–92 for-profit  111, 122, 129–30 mature  55, 160, 169 as organisational regime  125–30 public  128–29, 154 company law  76, 126–28, 130, 132, 136, 147, 169–70; see also corporate law compensation  123, 128, 179, 193, 225 competence  31, 157, 167, 206, 233 competition  26, 28, 41–42, 45–46, 50, 195–96, 214–15, 289 regulatory  85–86, 89, 93, 99–100, 103, 234 competitive markets  73, 289 complexities  51, 77, 163, 216, 255–56

Index  333 compliance  45, 77, 90, 92, 140, 142, 144–46, 292 automated  285–86, 295 obligations/requirements  10, 146, 195, 287, 291 regulatory  161, 187, 204 Compound tokens  282–83 computing power  52, 56, 63–64 conduct of business regulation  78, 206, 223, 294 confidence, market  16, 159, 288 conflicts of interest  137, 165–66, 175–76, 206, 226–27, 232, 237–38, 277 management  101, 104, 206, 223, 232, 234, 237, 239–40 consensus  6, 22, 110–11, 135, 141 protocols  23, 32, 214 consistency  8, 92, 172, 214, 286 consumer protection  8, 11–12, 45, 50, 255–56, 262, 288–89, 293 laws  29, 142 consumers  8, 25–26, 28, 88–89, 93, 106–7, 163–64, 213–14 retail  88, 259, 263, 269 contracts  23–24, 27–30, 76, 82, 121, 129, 231, 240 derivative  97, 163, 242, 257, 269 contractual governance  224, 230, 256 control  31, 65–66, 205–6, 221, 223–24, 228, 236, 239–40 corporate  157, 191 convenience  15, 116, 222, 236, 246 conventional corporate finance  191–92, 252 claims  252 conventional financial economies  82, 107–9, 255–56, 278 conventional financial institutions  202, 227–28, 270, 283 conventional payment systems  15, 213–15 conventional platform economies  113, 122–23 convergence  86, 229 regulatory  86, 286 cooperatives  132–35 coordination  21–23, 25, 32, 76, 78, 86, 203, 205 partnered  285–86 regulatory agency  297 core developers  31, 105, 114, 213 corporate assets  107, 127–28, 130, 170 corporate control  157, 191 corporate entities  33, 35, 51, 145 corporate forms  103, 126, 128, 130–31, 134–35, 301 corporate governance  40, 105 corporate law  44, 52, 55, 69, 76, 125–26, 138, 147; see also company law frameworks  158, 160

corporate vehicles  132, 134, 142 corporations  69, 76–77, 80, 105, 107–8, 112, 126, 137–39 for-profit  111, 129 corporatised economy  3, 51, 69–70 corporatised entities  65, 77, 281, 291–94 costs  7, 155, 160, 201, 203, 212, 214–15, 224–25 agency  163 social  252, 260 transaction  136 counterparties  24, 163 central  163, 258, 296 courts  11, 14, 24, 40, 66–67, 209, 211 Covid-19 pandemic  70, 109, 125, 262, 298 credence goods  108, 159, 295 credibility  43, 65, 89, 123, 173, 200–1, 205 credit  8, 53–54, 109, 196, 238, 244–46, 272, 278 credit cards  8, 244, 246 providers  8, 226 credit-rating agencies  154, 176 crime, financial  177, 209, 212, 214–15, 217, 249, 298, 300 crisis management  29, 31, 60, 67, 115, 120–21, 123–24, 281–82 crowdfunding  152–54, 161 equity  4, 43, 154, 160–61 online  39, 55, 160–62, 168 crypto derivatives  82, 88, 94, 259, 263, 268–69 crypto economy, see Introductory Note crypto finance  226–27, 251, 259, 265, 267–68, 274–75, 286–87, 289–99 risks  291, 294 crypto goods  17, 123, 197 crypto investment economy  38, 89–90, 101, 106, 108–9 cryptoasset exchanges  93, 231, 233–38, 241, 249, 276, 278 centralised  235, 276, 278, 293 cryptocurrency  231, 235, 241 cryptoasset prices  237, 254 cryptoasset service providers  104–5, 222–23, 231, 237–38, 275–78 cryptoassets  14, 81–82, 85–95, 103–4, 109, 220–24, 230–35, 269–70 EU regulatory regime  103–5 cryptocurrencies, see also Introductory Note circulation  88, 98, 108, 201–2, 211, 281–82, 301 established  100, 108, 235 and law and regulation of money  16–21 popular  38, 221, 235 private  16–17, 88–89, 194–201, 209–12, 214–16, 220–21, 242–43, 247–49 regulating exchanges  230–42 volatile  19, 243

334  Index cryptocurrency exchanges  10–11, 13, 93–94, 201–2, 220–21, 223–25, 227–30, 234–35 new regulatory regimes  233–35 regulating  230–42 cryptocurrency service providers  10, 101, 215 CryptoKitties  22, 25, 27, 35–36, 57–59, 126 currencies fiat, see fiat currencies virtual  10–11, 13–15, 18, 36, 81, 88, 98, 106 currency tokens  37, 61, 85, 97, 208 custodial arrangements  175, 182, 224 custodial duties  178, 234 custodial functions  102, 105, 224, 227, 243 custodial services  11–12, 221–23, 241 providers  220, 230 custodians  15, 18, 203 custody  10–11, 67–68, 179, 206, 221, 223–24 customer due diligence  17, 246, 274 customers  11–12, 165, 221, 223–27, 238, 240–41, 245, 272 protection  101, 195, 204, 221–24, 226, 230–32 retail  225–26, 263, 269 cyberhacking  12, 14, 22, 29, 124, 221–22, 225, 229 dai  124, 201, 207, 278–81 stability  201, 280 users  281 damage  15, 34, 50, 95, 144, 247 DAOs (decentralised autonomous organisations)  22, 33–35, 42, 75–76, 95–96, 136, 145, 290 Maker  124, 279–80, 283, 296 dApps  35–36, 115–16, 120–23, 136, 140, 162, 212, 251–52 community  115, 120, 124–25 developers  116, 118, 217, 249, 252–53, 284 developments  119, 204 Dash  1, 89 data protection  149, 193 de-hierarchicalisation  30, 35 dealer services  226, 239 dealers  100, 221, 235, 237 debt  15, 55, 109, 209–10, 246, 252, 266 Decentraland  54, 57, 59–60, 76, 104, 114, 126, 129 decentralisation  35, 64, 69, 146, 235–36, 241, 277, 285–86 decentralised autonomous organisations, see DAOs decentralised exchanges  105, 225, 229, 234–36, 239–41, 276–78, 293 decentralised governance  34, 70, 119, 179

decentralised wallets  224–26, 228–29 defective goods  29, 66 DeFi  70, 253–55, 271, 275, 278, 282–86, 294, 299 loans  253–54, 275, 281 platforms  241, 283–84, 286, 293, 301 Value  254 Delaware  125, 147 delegated proof-of-stake systems  66, 119 demand side  63, 65, 75, 133, 210 democratic governance  133–34, 284 democratisation  7, 285 deployment  19, 21, 23–24, 59, 69, 75, 205, 207 deposit-taking institutions  20, 98, 273–74 depositaries  179, 203, 294 deposits  200, 202, 204, 245, 254, 272, 279, 282 derivatives  94, 97, 163, 231, 257–58, 262, 265, 268–70 crypto  82, 88, 94, 259, 263, 268–69 markets  231, 257–58 trading  94, 296–97 design  43, 45, 47, 117, 245, 281, 294–95, 297–99 account-based  243–45 of stablecoins  198–99, 204, 206 deterrence  98, 191, 193 developers  33–34, 36–39, 41–42, 66–67, 112, 157–59, 166–74, 177–84 application  118, 148, 202 blockchain  35, 46, 139 core  31, 105, 114, 213 dApp  116, 118, 217, 249, 252–53, 284 founder  31, 121, 158–60, 183–84, 191 project  80, 88, 169–70 development financial  78, 85–86, 96, 106, 110, 255, 267, 278 governance  61, 66, 70, 112, 118, 145, 149 institutional  15, 27, 69 project  97, 158, 173, 177, 183, 190 projects  38, 166, 183, 190 regulatory  82, 98, 204 of stablecoins  19, 202, 204 teams  167, 169, 171–82, 184, 190 relationships with third parties  175–76 Diem  199, 202, 204; see also Libra digital artwork  50, 57–60, 229–30 digital assets  18, 37, 41, 55, 92, 99–100, 202, 251 exchanges  38, 90, 96, 100, 102–3, 234 digital currencies  1, 20–21, 33, 54–57, 88–89, 196, 242–43, 246 central bank, see CBDCs digital tokens  35, 89, 91

Index  335 digital yuan  88–89, 245–46, 249 digitalisation  52, 195, 244 directors  128, 130–31, 136–37, 170, 173 disbursement  122, 190–91 disclaimers  28, 33, 46, 222, 225 disclosure  102–4, 155–58, 166, 168–69, 171–74, 185, 187, 241 information relating to blockchain-based nature of business project  173–74 information relating to development team signalling integrity  172–73 information relating to development team’s relationships with third parties  175–76 information relating to nature of pre-sold tokens, anticipated rights, functionality and pricing  174–75 mandatory, see mandatory disclosure regulation  163, 168 sundry information required for Schedule of Commitment  176 voluntary  154–55, 168–69, 171 discounts  122, 159, 184–86 discrepancies  115, 168, 174, 184 discretion  158, 267, 270 discretionary power  42, 131 disputes  28, 66, 120–21, 123, 128, 209, 213, 216 resolution  29–30, 60–61, 115, 120–21, 128, 209, 212, 214 disqualification regime  136–37 disruption  3, 70, 232, 243–44, 251 distributed ledgers  6, 9, 23, 26, 31, 38, 48–49, 51 distributed systems of validation  9 distributive fairness  133, 181 distributive governance  122–23 diversification  39, 109, 197, 202, 235, 272–73 portfolio  268–69 Dogecoin  1, 197 dollar parity, coins with  274–75 drivers for institutional change  1–48 drugs  17, 163 dual-class financing  191–92 due diligence  102, 161, 165, 176, 188 policies  187–88 processes  188–89 duties  102, 135–37, 164–65, 170, 175–77, 219, 227, 238 custodial  178, 234 fiduciary  31, 128, 138, 219 regulatory  179, 237 of suitability  165, 238 dynamism ontological  290–91, 299 regulatory  287–88

e-money, see electronic money eBay  33, 48, 65–66, 152, 242 economic activities  2, 22, 48, 50–51, 68, 70, 193, 195 productive  208, 253, 262 economic actorhood  51–52, 57, 81 economic actors  22, 64, 74, 79, 96, 107, 252 economic mobilisation  52, 54, 64–65, 71, 74, 252, 300 new  64–65, 81 economic mobility  52, 57, 70, 82 economic relations  22, 37, 73, 111 economic sociology  18, 107, 110 economic space  1–2, 49–51, 108–9, 194, 210 economies of scale  145, 297 efficiency  4, 9, 22–24, 32, 35, 213–14, 217, 271–72 egalitarianism  32, 70, 116, 129, 133 electronic money  7–8, 10, 20, 101, 210–11, 244, 246 issuers  202, 247 tokens  104, 207, 276 embedded markets  56, 110 empirical research findings  56, 165, 170, 172–73, 183, 186, 198, 207 employees  128–29 enabling frameworks  74, 76, 113, 139, 151, 193 legal  3, 111, 113, 132, 139, 144–45, 147–48 enabling regimes  78, 90, 94, 98–105, 110 enabling regulation  10, 45, 51, 76, 89, 300 enabling regulatory frameworks  76–78, 98, 152, 177, 193 enforcement  28, 30, 39–41, 97–98, 142–43, 189, 263–64, 296 civil  14, 92, 156, 188, 190 private  296 regulatory  102, 171, 187–88, 190–91, 264 enterprises  44, 61, 96, 99, 105, 110–11, 125, 127–28 common  95, 190 development  252, 254, 298 social  131–32 equality  111, 135 equity crowdfunding  4, 43, 154 and ICOs  160–66 ERC-20 tokens  21, 201 ERC tokens  235, 253–54 errors  13, 24, 28–29, 213, 222, 273 escrow  181–82 agents  175, 178–83, 190 arrangements  182, 187 ETFs, see exchange-traded funds ether  21, 24, 26, 34, 85, 107–8, 201, 278–79

336  Index Ethereum  22, 30, 60, 62, 67, 112, 115, 117 blockchain  21–37, 61–62, 115–19, 162, 186, 196, 201, 207–8 Ethereum-based tokens  201, 279 Etsy  33, 65 European Commission  20, 101, 104–5, 153, 205, 222, 231, 238 ex post monitoring  166, 170, 176–77, 179–91, 286 ex post rights  169–70 excessive financialisation  80–81, 257 exchange operators  24, 237 exchange protocols  236, 240, 254 exchange-traded funds (ETFs)  81, 259, 269, 297 exchanges centralised, see centralised exchanges cryptoasset, see cryptoasset exchanges cryptocurrency, see cryptocurrency exchanges decentralised  105, 225, 229, 234–36, 239–41, 276–78, 293 digital asset  38, 90, 96, 100, 102–3, 234 regulated  268–69 regulating centralised amd decentralised features  235–41 execution  1, 27, 63, 212–13, 296 automated  27, 193 best  226, 240 exemptions  14, 39, 100, 108, 152–53, 170–71, 229, 259 existing real economy assets, new tokenisation of  71–74 existing regulatory regimes  91, 95, 152–53, 267, 271, 273, 275, 287 exit  60–61, 68, 76, 79–80, 114–15, 117, 120, 157–58 conditions  114, 134 expectations  40, 42, 76, 80, 83, 114–15, 191, 193 reasonable  65, 96, 115, 212, 239 social  44, 75, 285, 289 expertise  137, 181 asymmetry  115, 165 Facebook  66, 70, 202–4 facilitative but restrictive regimes, United States  93–99 facilitative regimes  90–91, 93, 95, 97, 105 fairness  24, 127, 180, 238 distributive  133, 181 farming, yield  79, 207, 275, 281, 283–84, 293 farms, mining  116, 219 FCA (Financial Conduct Authority)  53–55, 72, 91, 161, 216–18, 263, 288–89, 298 bans  88, 259, 263, 269

Federal Reserve  98, 247, 272–73 Fedwire  272–73 fees  164, 175, 179, 196, 198, 212, 264 gas  214, 240 fiat currencies  14, 16, 18–21, 194, 196–200, 202–3, 207–8, 278–79 digital  20, 207 established  199, 201 programmable  209, 243 fiduciary duties  31, 128, 138, 219 Filecoin  25, 41, 63–64, 69–70, 76, 104, 117, 156 finality  212, 233, 239 finance automated  262, 285, 299 conventional  279, 282, 291, 296 conventional corporate  191–92, 252 crypto  226–27, 251, 259, 265, 267–68, 274–75, 286–87, 289–99 financial activities  251, 253, 256, 258–63, 265–66, 291, 293, 301 financial actors  81–82, 251, 285 financial assets  162, 164, 199–200, 252–53, 256, 270, 275, 281 speculative  194, 253 virtual  101–2 financial capital  260, 265–66, 288 financial claims  252–53, 272, 280–81 Financial Conduct Authority, see FCA financial crime  177, 209, 212, 214–15, 217, 249, 298, 300 financial crisis, global  82, 86, 90, 256–57, 261–62, 264, 292, 297 financial economies  80, 101, 270 conventional  82, 107–9, 255–56, 278 financial entities  288–89 financial inclusion  53–55, 244 financial innovation  82, 86, 163–64, 218, 256, 262, 264, 297–98 financial institutions  11, 88–89, 226–27, 242–43, 260–61, 263–64, 271, 292 conventional  202, 227–28, 270, 283 regulated  178–79, 189, 271 financial instruments  20, 101, 164, 231, 233, 238, 260–62, 264 new  98, 272 financial intermediaries  81, 92, 189, 223, 245 authorised  92–93 financial markets  82, 217, 251, 253, 256–57, 293 financial participants  256, 283, 295 financial products  81–82, 163–64, 262, 264–65, 269–70, 289–91, 298, 300 financial regulation  3–4, 86, 217–18, 251–52, 256, 263–64, 286–88, 301 need to avoid exclusive focus on  79–82

Index  337 financial regulators  20, 173, 216, 226, 271, 278, 286, 298–300 approaches to crypto economy  85–111 critical reflections on approaches  106, 106–11 permissive regimes  90–93 regulatory divergences  85–86 tailor-made/special regimes  99–105 US approach  93–99 financial risks  88, 191, 238, 255, 277, 293 financial stability  5, 75, 89, 245, 255–56, 262, 273, 283 risks  270, 286 Financial Stability Board, see FSB financial statements, audited  100, 128, 155, 161 financialisation  38, 40, 42–43, 53–55, 79–82, 107–8, 251–53, 255–65 excessive  80–81, 257 productive and hyper forms  4, 251–67, 270, 279, 287 financing, see also fundraising of blockchain-based business development and need for regulation  151–94 pre-development, see pre-development fundraising staged  169, 175, 178–79, 182 terrorist  17–18, 92, 177, 189, 228 and tokenisation  35–44 fitness  10, 140–41, 144, 149, 222, 233 for purpose  140, 144, 222 flash loans  254–55, 284 flexibility  38, 109, 116, 134, 136, 141, 146, 148 for-profit companies/corporations  111, 122, 129–30 for-profit purposes  125–26, 130 forking  9, 12, 31, 46, 60–61, 66–67, 121, 123 hard  34, 67–68, 224 founder-developers  31, 121, 158–60, 183–84, 191 fractionalisation  67, 72 frameworks  43–44, 46–47, 109–10, 112, 119, 123–24, 148, 287–99 enabling  74, 76, 113, 139, 151, 193 governance  110–11, 114, 117, 119, 129, 132–33, 149, 176–77 high-level  4, 267, 286 legal  44, 125, 143, 147, 292 regulatory  8, 47, 50, 209, 212, 215, 219, 266–67 framing  43–44, 76, 85, 118, 169, 274 legal  22, 27, 44–45 France  103, 160 fraud  29–30, 54, 171, 173, 177, 188, 192, 195 deterring  165, 170 free markets  49, 203 freedom  52, 76–77, 130, 135–36, 138, 264, 266, 269 individual  49, 79

fringe phenomena  5, 249 frontloading model  167–69 FSB (Financial Stability Board)  248 functional approach to regulation  205, 208, 236, 239–40, 278, 289 functionalities  1, 40, 42, 171, 174, 217, 219, 240 smart contract  115, 217 technical  141 functions  15–16, 21, 25, 37, 204–5, 211–12, 219, 226 custodial  102, 105, 224, 227, 243 technological  148, 174, 216 fundraising  4, 35–37, 40–42, 55, 78, 101–2, 151–65, 188; see also financing by blockchain-based developers and tokenisation  37–39 exercises  36, 151, 295 public  132, 137, 140 funds  34, 36, 160–61, 177–79, 181–82, 185–86, 268–69, 294–96 collective investment  153, 163, 290, 298 exchange-traded  81, 259, 269, 297 hedge  135, 157, 159, 257–58, 284, 290 money market  20, 200, 203, 279, 294, 298 pooled  34 release  122, 181 venture capital  81, 151, 157, 202 fungibility  42, 206, 211, 252, 291 futures  94, 97, 231, 259 CME Bitcoin  268–69 galvanisation  52, 79, 244, 247 gambling  18, 262, 265 gaps  12, 15, 56–57, 68, 108, 113, 267, 275 regulatory  152, 299 gas fees  214, 240 gatekeepers  140–41, 150, 172, 228, 292 liability  172 third-party  140, 149–50 gatekeeping  142, 177, 229, 264–65 global financial crisis  82, 86, 90, 256–57, 261–62, 264, 292, 297 global marketplaces  63–64 global payments blockchains  23, 202 gold standards  16, 102–3, 161, 168, 224 Golem  26–27, 30, 52, 63, 70, 123, 129 good faith  135, 137, 219, 280 goods  8, 14, 16, 18, 39–40, 48, 100–1, 300 collective  49, 60 credence  108, 159, 295 crypto  17, 123, 197 defective  29, 66 public  9, 51, 74, 77, 119, 154, 193, 231 virtual  57–60, 230, 276

338  Index Google  25, 37, 63 governance  29–33, 46–47, 68, 108–12, 114–21, 130–35, 144–48, 281–87; see also business organisations and governance bodies  240, 279–81, 293 centralised  65–66, 68, 74 collective  61, 68 commons  30, 61, 68, 71, 114, 209, 291, 300 contractual  224, 230, 256 corporate  40, 105 decentralised  34, 70, 119, 179 deficits  49, 66, 69 democratic  133–34, 284 development  61, 66, 70, 112, 118, 145, 149 distributive  122–23 frameworks  110–11, 114, 117, 119, 129, 132–33, 149, 176–77 internal  62, 74, 110, 135–36, 141–47 market  232, 234 market-based  46–47, 74, 257 needs  62, 71, 74, 76, 112, 114, 147–48, 282 norms  68–69, 71, 78, 114–16, 122 on permissionless blockchains  32–33, 118 post-sale  176, 189, 192 product  163–65, 262, 264 protocols  116–17, 119–20, 123–24, 212, 218, 293 regulatory  183, 235, 239, 257–58, 261, 269, 291, 295 rights  41, 80, 91, 107, 130, 138, 189 risk  102, 162 standards  50, 188, 193, 208, 240, 295 systems  68, 118, 198–99, 281 templates  111, 140 government agencies  187 grandfathered rights  87–88 gross negligence  8, 102, 227 hackers/hacking  15, 31, 67, 124, 225, 246, 248, 284 hard caps  178, 183, 185–87 hard forks  34, 67–68, 224 hardware  58, 222 wallets  222, 228 hazards  140, 146, 210, 232, 236, 267, 298, 300–1 moral  80, 163 HBOS  69–70 hedge funds  135, 157, 159, 257–58, 284, 290 crypto  268, 290 hedging  19, 202, 208, 256, 279, 282 hierarchical structures  113, 125, 127, 132, 134, 213 holders  18–19, 205–6, 209, 211, 220, 279–80, 282, 284 securities  158

stablecoin  206–7 token  105, 107, 119, 127–29, 224, 226, 282, 285 hot wallets  221–22 Howey test  40, 95 human capital  55, 126, 179 Huobi  67, 87, 224, 235, 269 hybrid objectives  54, 132 hyper-financialisation  4, 251–52, 255, 279 policy choices for  259–67 speculative forms  275, 282, 284 ICOs (initial coin offerings)  36–43, 54–57, 94–96, 98–100, 151–62, 164–79, 183–92, 251–52 auction-based  186 and challenges in regulatory classifications  39–44 and equity crowdfunding  160–66 ex-post monitoring and rights in Schedule of Commitment  176–92 and initial public offers  154–60 interactive  186–87 issuers  155–56, 189, 192 markets  38, 152, 155, 161, 183, 192 need to distinguish from securities and crowdfunding regulation  153–54 regulating  89, 162, 192 subscribers  108, 110, 157–59, 162, 179 successful  167, 183, 188, 199 of utility tokens  41, 100, 107 identities  15, 17, 23, 57, 120, 141, 172 idle computing power  52, 63–64 immutability  22, 25 incentives  23, 59, 68, 77, 81, 86, 100, 264 perverse  6, 116, 167, 169 inclusion  57, 64, 97, 127 financial  53–55, 244 inconvenience  15, 18, 201, 272 incumbents  70, 249, 273, 301 indebtedness  54, 272 individual conduct  145–46 individual freedoms  49, 79 industrial policy  266 inefficiencies  18, 23, 32, 116, 244, 272 inequalities  69–70 information  22–23, 29, 55–56, 152, 156–57, 205–6, 233, 238 anaemia  152, 172 asymmetry  108, 152 environment  95, 185, 190 intermediaries  154, 156, 176 relating to blockchain-based nature of business project  173–74

Index  339 relating to development team signalling integrity  172–73 relating to development team’s relationships with third parties  175–76 relating to nature of pre-sold tokens, anticipated rights, functionality and pricing  174–75 infrastructure  21, 54, 57, 75, 77, 244, 246, 249 protocol  25–26, 116–18, 148, 164, 204, 208–9, 217, 247–48 initial coin offerings, see ICOs initial public offers, see IPOs innovation  1–2, 42–43, 91–93, 95–96, 217–18, 246–48, 271–73, 299–301 hubs  217–18, 298–99 technological  5, 46, 49, 225 innovative technological arrangements, see ITAs innovators  208, 217–18, 299 insider dealing  102–3 insolvency  11–12, 14, 92, 142, 170 institutional change  83, 266 drivers for  1–48 institutional investors  20, 82, 100, 109, 164, 183–85, 247, 269 institutional legitimation  147, 209 institutions  2, 30–32, 60–62, 78, 80, 114–15, 122–24, 195–96 existing  16, 31, 44 financial  11, 88–89, 226–27, 242–43, 260–61, 263–64, 271, 292 key  2, 296 legal  31, 50 integration  2, 31, 109, 226, 242, 247–49, 286 integrity  6, 140, 142, 168, 170–71, 173, 213, 216 intellectual property  28, 45, 122 intentions  29, 59, 96, 174, 182, 202, 254 interactive ICOs  186–87 interests  132–33, 137–38, 164–66, 175–76, 219, 225–27, 232–34, 237–38 best  203, 238 common  122, 176, 299 conflicts of, see conflicts of interest public, see public interest interfaces  71, 107–8, 200, 202, 204, 228, 230, 241 intermediaries  78, 100, 102, 214, 228–29, 275, 277, 293–95 centralised  7, 9 financial  81, 92, 189, 223, 245 information  154, 156, 176 regulated  8, 216 intermediation  81, 228, 231, 268, 288, 293 financial  78, 165, 266 internal governance  62, 74, 110, 135–36, 141–47

internal market  8, 195, 211, 244, 289 internal relations  127–28, 135–37, 141, 144–45, 147 and governance  135, 144–45, 147 International Organization for Securities Commissioners, see IOSCO international trade  16, 196–97, 272 internet  6, 22, 62–63, 65, 76, 221–22 interoperability  23, 75, 114, 247, 283 interoperable coins  207–8 interpretation, legal  2–3, 49, 94, 211, 288 investment activities  99, 107 investment firms  164–65, 182, 206, 223, 232, 234, 260–61, 294 investment funds  164, 205–6, 256–57 investment strategies  268, 290 investment value  95, 168–69, 175 investments  34, 37–38, 40, 42, 91–92, 98–100, 151–52, 206 collective  72, 163, 203, 205, 258, 270 contracts  40–41 regulation  3, 102, 256 risk  177, 179 investors  41–42, 72–73, 78–81, 102–4, 152–57, 161–62, 164–93, 268–70 accredited  41, 72, 81, 95–96, 108, 152, 170, 258 high-net-worth  81–82, 170 institutional  20, 82, 100, 109, 164, 183–85, 247, 269 and issuers  152, 154, 165, 176–77, 187, 190–91, 193 professional  104, 184–85, 205, 259 protection  41–43, 101–4, 152–54, 156, 161–62, 165–67, 176–78, 186–87 retail  81, 100–1, 108, 185, 257, 259, 263, 268–69 sophisticated  107–8, 153, 157, 159, 162, 257–59, 262–64, 268–69 IOSCO (International Organization for Securities Commissioners)  20, 86, 232, 237–38 IPOs (initial public offers)  152, 165–66, 185, 189–90, 295 and ICOs  154–60 ISO (International Standards Organization)  217, 225 issuers  100–4, 151–56, 161–62, 165–66, 182–93, 205–6, 272–74, 295 corporate  157, 189 and investors  152, 154, 165, 176–77, 187, 190–91, 193 stablecoin  20, 98, 202, 204–7, 273, 275–76, 279 Italy  160

340  Index ITAs (innovative technological arrangements)  101, 113, 139–43, 147 Iungo  30, 54, 62, 70, 76, 129, 155 JPM Coin  61, 271–73 jurisdictions  3, 85–87, 89, 92–95, 98–99, 106, 108, 151–53 regulatory  90, 106 justice  31, 44, 62, 145 keys private  5–6, 12, 14, 220–24, 228, 231, 241 public  5–6, 15, 188, 220 kitty art  27, 58 Kyberswap Network  236, 239–40 laundering, money  13, 17–18, 92, 94, 176–77, 212, 215, 227–29; see also anti-money laundering law of business organisations and governance, see business organisations and governance law reform  43, 164 need for  44–48 ledgers  6, 9, 14, 21–22, 32, 34, 56, 107 distributed  6, 9, 23, 26, 31, 38, 48–49, 51 main  12–13 legal entities  33, 35, 105, 162, 205, 233 legal frameworks  44, 125, 143, 147, 292 legal framing  22, 27, 44–45 legal institutions  31, 50 legal interpretation  2–3, 49, 94, 211, 288 legal mapping of the crypto economy  1–48 Bitcoin and beginnings of blockchain-based economy  4–21 need for law reform  44–48 smart contracts, Ethereum blockchain and rise of the crypro economy  21–35 tokenisation and financing  35–44 legal personality  78, 122, 145 separate  113, 125, 130, 134–35, 137, 142–48 legal uncertainties  35, 95, 224, 270 legality  17, 19, 103, 140, 142 legitimacy  2, 19, 21, 103–4, 139–40, 267, 271, 279 legitimation  7, 10, 167, 209, 271, 298, 300 institutional  147, 209 lemons  80, 108, 152, 155, 168, 297 leverage  74, 82–83, 115, 235, 238, 246, 258, 269–70; see also margin liability  27–30, 102, 105, 143–45, 172, 190, 215 absolute  171, 190 gatekeepers  172 limited  125, 134, 137–39, 144 personal  143–44, 146 strict  77, 103

liberal market economies  3, 126, 129–30 Libra  202–4; see also Diem licences  10, 28, 94 lightning networks  212 limited liability  125, 134, 137–39, 144 limited liability companies, see LLCs limited liability partnerships, see LLPs linkages  284, 287, 298 liquefication of tokens  38, 80 liquidity  41–42, 79–80, 204, 206, 240, 252, 260–61, 282–83 pools  236–37, 239, 241, 253, 276–77, 282–83, 285, 293 Litecoin  1, 88, 100, 197, 221, 259 LLCs (limited liability companies)  138–39 LLPs (limited liability partnerships)  111, 134–37, 142 lock-ups  178, 184 London Stock Exchange  72, 160 losses  28, 39, 220, 222, 224–25, 283–84, 293, 296 mainstream economy  2, 10, 146, 204, 243, 246–48 maintenance  6–7, 12, 23, 30, 57, 67, 116, 297 Maker DAO  124, 279–80, 283, 296 management  105, 107, 111, 114, 167, 204–6, 232–33, 289–90 centralised  34, 42, 107 of conflicts of interest  101, 104, 206, 223, 232, 234, 237, 239–40 risk  12, 15, 162–63, 203–4, 258, 288, 292, 294 managerial classes  69–70, 128–29 managers  69, 107, 128–29, 138–39, 157, 256, 258 asset  82, 203, 281 senior  69, 146, 292 mandatory disclosure  155–57, 162–63, 165–66, 168, 170–71, 173, 175–76, 294–95 documents  171–72, 174–76, 185 and investor protection  189–91 regimes  104, 155, 158, 174 manipulation  118, 198, 291, 295 margin  235, 238 market-based governance  46–47, 74, 257 market confidence  16, 159, 288 market governance  232, 234 market makers  236, 280 market participants  46, 197, 203 marketing  70, 92, 103, 203, 262–64, 269, 290, 294 marketplaces  26, 30, 32–33, 65, 69, 71, 123, 241–42 blockchain  27, 68, 73 global  63–64 for non-fungible tokens  241–42 peer-to-peer  25, 27, 29, 50, 60, 62–63, 105

Index  341 markets  54–55, 61–63, 101–3, 154–59, 231–35, 256–60, 262–65, 275–77 capital  22, 40, 96, 100, 106, 153, 155, 157 competitive  73, 289 conditions  167, 201, 261, 269, 282 derivatives  231, 257–58 developments  182, 225, 270 discipline  79, 104, 156–57, 165, 171, 268 embedded  56, 110 failures  33, 47, 49, 62, 77–78, 153, 156, 260–61 financial  82, 217, 251, 253, 256–57, 293 free  49, 203 ICO  152, 155, 161, 183 integrity  94, 232, 262, 289 internal  8, 195, 211, 244, 289 manipulation  102–3, 119, 291 mechanisms  154, 291 operators  33, 231, 233, 239 regulated  232, 268 secondary  38–39, 41, 43, 79–81, 102, 157–59, 182–86, 188–89 securities  45, 69, 80, 129, 191, 231–32, 237, 260 regulation  231, 233 mass consumption  44, 55 MDIA (Malta Digital Innovation Authority)  140–42 medium of exchange  19, 100, 194–95, 247 merit vetting  172, 205, 219, 233 meta-regulation  46, 51, 77, 140, 145–46, 292 micro-prudential regulation  260–61 milestones  168–69, 175, 180–82 attainment  180 release  180–81 miners  6–7, 12–13, 32, 114, 116–17, 120, 129, 214 regulation  219–20 mining  6, 32, 56, 58, 116–17, 123, 213–14, 219 farms  116, 219 pools  7, 116, 214, 219 protocols  30, 76, 78, 116–17, 212, 215, 217, 219 minority shareholders  67, 181 misrepresentation  28, 145 misselling  163, 289 MKR tokens  279–80 mobilisation, economic, see economic mobilisation mobility  52–53, 55, 89 Monero  1, 197 monetary order  4, 74, 99, 108, 110, 266 central bank digital currencies and crypto economy  242–49 objectives for regulating payment systems  209–15

private  194–209 regulating crypto currency exchanges  230–42 regulating for crypto economy  194–251 regulating key payment service providers  220–30 regulating payment and mining protocols  215–20 monetary policy  16, 242 money laundering  13, 17–18, 92, 94, 176–77, 212, 215, 227–29; see also anti-money laundering money market funds  20, 200, 203, 279, 294, 298 money service businesses  94, 196, 274 moneyness  15, 18–19, 194, 211 monitoring  17, 20, 157–58, 162, 169, 176–77, 183, 228 multifunctionality  99, 207–8, 281, 287, 290–91, 297 national regulators  86, 195, 204, 269, 298 native tokens  21, 208, 301 natural persons  39, 104 negligence  102, 137, 190 gross  8, 102, 227 network effects  50, 65–66, 70, 146, 173–74, 215, 221, 239–41 networks  6–7, 26, 28–33, 64–67, 121, 212, 239–41, 299 blockchain-based  46, 70, 129, 143, 147–48 business  22–23, 25 lightning  212 peer-to-peer  28, 96 private  5–6, 21 new asset class  20, 109 new commodifications  25–26, 36, 45 new productivities  43, 49, 51–52, 54, 57, 79 new tokenisation of existing real economy assets  71–74 NFTs, see non-fungible tokens no-action letters  90, 96 nodes  6–7, 26–27, 31–32, 61, 63–64, 135–38, 212, 294–95 non-compliance  142, 191 non-fungible tokens (NFTs)  57–59, 75, 229–30 marketplaces for  241–42 novelties  10, 275, 286, 289 objectives hybrid  54, 132 regulatory  216–18, 230, 286, 288–92, 294–95 obligations  135, 138, 142, 145, 187, 189, 225, 237–38 regulatory  45, 101, 145, 166, 215–16, 225, 274, 293 offchain legs  22, 25–27, 29, 120

342  Index offchain systems  212, 216–17 Office of the Comptroller of Currency  98–99, 297 offline wallets  221–22 on-chain activities  22, 26–27, 279 online crowdfunding  39, 55, 160–62, 168 ontological dynamism  290–91, 299 ontologies  44–45, 280, 288, 297–99 regulatory  251, 255, 273–74, 279, 287–91, 293, 295, 301 opacity  157, 199–200, 226, 229, 235, 240, 261, 265 Open Banking initiative  195, 214–15 open source  60, 157, 248 code  26, 34, 147 options  4, 97, 108, 118, 158, 207, 263, 268–69 oracles  26, 29–30, 47, 144, 200, 280 organisational forms  111, 137, 140 adapted corporate  138–39 for blockchain-based business  113–23 companies  125–30 cooperatives  132–35 LLPs (limited liability partnerships)  111, 134–37, 142 new legal  139–44 social enterprises  130–32 organisational governance  112, 131 organisational needs  114, 147–48, 277, 292 organisational perspective  111–13, 290 ownership  36, 59, 72–73, 75–76, 111, 128, 205 rights  14, 57–59, 73, 102, 229 pandemic, Covid-19  70, 109, 125, 262, 298 Paradex  235 participants  33–34, 58–60, 76–78, 105, 112, 114–24, 143–46, 148–49 communities of  105, 121 financial  256, 283, 295 market  46, 197, 203 sophisticated  256–58, 263 partnered coordination  285–86 partners  49, 119, 135–37 venture capital  122 partnerships  44, 111, 125, 134–39, 142, 160, 169, 190 patchwork approaches  3, 82, 93–94 pay-for-performance  179–80 payment  5, 8–10, 15–19, 54–55, 90–91, 215–16, 243–44, 272–74 currency  19, 198, 201, 244 execution  209, 211, 214–15 functionalities  209–10, 212, 214–15 regulatory oversight  216–18

functions  20, 64, 207, 210, 212, 216, 272, 277 instruments  8, 85, 92, 99, 207, 212, 247 peer-to-peer system  16, 204, 214 protocols  213, 215, 217–19, 276, 282 purposes  207, 209–10, 275, 282, 291 services  7–8, 10, 195, 211, 215, 242, 244, 289 providers  8, 10, 103, 195, 223, 245–46, 273 regulating key providers  220–30 regulations  8, 85, 148, 195, 225, 289 regulators  148–49, 274 systems  5, 7, 9, 195–96, 204, 211–13, 215–16, 244–45 conventional  15, 213–15 PayPal  8, 226 peer-to-peer blockchains  26, 29, 45, 48, 65, 68, 248 peer-to-peer cloud storage  25, 41, 63–64, 123 peer-to-peer energy trading  26 peer-to-peer marketplaces  25, 27, 29, 50, 60, 62–63, 105 peer-to-peer networks  28, 96 peer-to-peer services  25, 49, 52, 68, 300 new distributed models  62–71 peer-to-peer transactions  29, 107, 221, 229 peg  199–200 PegNet  199–200 perceptions  50, 52, 90, 92, 98, 178, 183, 290 performance  22, 24, 26, 29, 165, 179–81, 240, 295 permissioned blockchains  2, 22–25, 61, 74, 112, 114, 271–73 permissionless blockchain-based businesses  125, 131–32, 134, 137, 139, 146 permissionless blockchains  22–34, 60–61, 74, 112–23, 207–9, 211–21, 249, 271–73 governance  32–33, 118 personal liability  143–44, 146 personal property  13, 73, 224 personality, legal, see legal personality perverse incentives  6, 116, 167, 169 petro  89 physical cash  242, 246 platform coins, bank-based  271–74 platform economies  33, 36, 48, 68, 92, 112, 127 conventional  113, 122–23 platforms  63, 65–66, 68, 70, 96, 100, 112, 161–62 owners  58, 66, 68, 70, 112 providers  39, 65 regulation  161–62 policies  20, 49–50, 53–54, 81, 237–38, 241, 243–44, 277–81 monetary  16, 242 regulatory  42–43, 86, 107–8, 218, 274–75, 277–78, 281–82, 286–88 token retention  184, 186–87, 192

Index  343 policy choices  2, 50, 78, 82, 251, 259, 262, 266–67 policy-makers  16–17, 43–44, 47–48, 53, 162–63, 249–50, 253, 285–87 policy thinking  96, 109–10, 274 Polkadot  22, 207 Poloniex  67, 224, 235, 269 pools  34, 182, 184, 236–37, 254, 283, 296–98 liquidity  236–37, 239, 241, 253, 276–77, 282–83, 285, 293 managed investment  290, 298 mining  7, 116, 214, 219 of technocratic expertise  297–98 post-sale governance  176, 189, 192 power and accountability  128–29, 298 controlling  141, 191 decision-making  141, 280 discretionary  42, 131 and governance  60, 110 pre-development fundraising  108, 176, 275 unique regulatory regime for  192–93 presales  39, 97, 184–85 to professional investors  185 prices  18–19, 121, 174–75, 184–88, 196–97, 207–8, 236–37, 295 cryptoasset  237, 254 discovery  237, 239 secondary market  159, 284 stability  20, 197–98, 282 token  39, 253 volatility  197, 199, 268, 279 principal–agent relationships  165, 289–90, 293 private creation of money  245 private cryptocurrencies  16–17, 88–89, 194–201, 209–12, 214–16, 220–21, 242–43, 247–49 private enforcement  296 private keys  5–6, 12, 14, 220–24, 228, 231, 241 private law  12–13, 49, 213–14, 238 private monetary order  194–209 private networks  5–6, 21 private stablecoins  4, 98–99, 197–207, 273 problem-solving  35, 45–46, 282, 284–85, 299 product design  164–65, 263–64 product governance  163–65, 262, 264 product intervention  262–64 product manufacturers  164–65, 264 product regulation  78, 162–63, 262, 264–65 productive activities  51, 107, 254, 266 new  48–49

productive crypto economy  3, 111, 196, 207, 210, 275–76, 300 blueprint for a regulatory agenda  74–82 co-regulation in policy development  83–85 new forms of commoditisation  49, 52–74 new goods and services  57–62 regulatory capitalism  48–52 rise and need for regulation  48–85 productive financialisation  251–55, 261, 263, 265–67, 270, 287 policy choice for  256–59 productivity  47, 49, 51–52, 54, 57, 60, 79, 252–53 real  80, 107, 266 products  162–65, 258, 262, 264, 268–69, 279, 281, 290 derivative, see derivatives securitised  163, 261 professional investors  104, 184–85, 205, 259 profits  38, 40, 42, 65, 69, 95–96, 164, 169 programmed code  115, 140, 191 prohibitive regimes  87–88, 90, 105 project developers  80, 88, 169–70 project development  97, 158, 173, 177, 183, 190 proof-of-stake  56 systems  116–17 delegated  66, 119 property  13–15, 28, 45, 72–73, 75, 87, 137, 182 intellectual  28, 45, 122 personal  13, 73, 224 residential  40, 73 rights  73, 87, 211, 223 prospectuses  39, 100, 155–56, 160–61, 172 prosumers  26–28 protocol blockchains  35, 61, 136, 147 protocol infrastructure  25–26, 116–18, 148, 164, 204, 208–9, 217, 247–48 choice  148, 173, 217 protocols  63–64, 115–16, 123–25, 198, 200–1, 239–40, 280–81, 283–85 exchange  236, 240, 254 infrastructural  212, 217 level  115–16, 118–19 programming  148, 295 proof-of-work  116 smart contract  122, 162, 177, 186, 282, 284 providers  7–8, 12, 128, 199, 207, 239, 277 credit card  8, 226 platform  39, 65 service  102–5, 215–16, 223, 227, 229–30, 233–34, 275–78, 283 wallet  11–12, 221, 223–28, 230, 234, 239, 276, 284

344  Index prudential regulation  105, 205, 230, 234, 274, 277–79, 294 prudential requirements  102, 206, 260, 294 public blockchains  23, 62, 115, 123 public companies  128–29, 154 public fundraising  132, 137, 140 public goods  9, 51, 74, 77, 119, 154, 193, 231 public interest  74, 76–78, 176–77, 215, 217, 258, 262, 288 objectives  264–65 purposes  171, 266 and schedules of commitment  187–89 public keys  5–6, 15, 188, 220 purchasers  27–28, 38, 43, 58, 65, 73, 80 Quadriga CX  12 qualifications  52, 137, 141, 172 quobands  73 ratings  66, 123, 158 RBI Coin  271–73 real economies  16–17, 109, 196, 246–47 real economy assets, new tokenisation  71–74 real estate  18, 52, 57, 71–72 real estate investment trusts, see REIT real productivities  80, 107, 266 real-time gross settlement system  272–73 reasonable expectations  65, 96, 115, 212, 239 reasonableness  170, 214, 240 recognition  15, 49, 62, 101, 131, 149, 209–11, 217 legal  33, 91, 140 redemption  206, 279–80 reforms  98, 127, 141, 185, 195, 248, 289, 300 regulatory  2–3, 43, 108, 146, 185, 266 refunds  169, 181, 221, 225 registration  97, 141, 147–48, 174, 216, 218, 228, 234 regulated entities  51, 270, 273, 287, 289, 292, 295, 301 regulated markets  232, 268 regulation, see also Introductory Note amending  161, 258, 260, 262, 294 bank  20, 94, 98, 106, 274, 279, 288, 294 of crypto finance  251–300 framework for developing regulatory agendas  286–99 productive and hyper forms of financialisation  251–67 trends  267–86 disclosure  78, 155, 163, 168 enabling  10, 45, 51, 76, 89, 300 existing  91–92, 106, 179, 271, 274, 287 financial  3–4, 78–79, 86, 251–52, 256, 263–64, 286–88, 301

micro-prudential  260–61 miners  219–20 payment services  8, 85, 148, 195, 225, 289 platforms  161–62 product  78, 162–63, 262, 264–65 prudential  105, 205, 230, 234, 274, 277–79, 294 securities  39–40, 42–43, 90–91, 106–7, 152–58, 160–62, 168, 170–71 smart  46, 51, 83–84, 292 transparency  234, 295 regulators  81–83, 145–49, 216–18, 224–30, 262–65, 270–74, 285–88, 290–99 financial  85–86, 89, 216, 226, 271, 278, 286, 298–300 national  86, 195, 204, 269, 298 need to approach regulatory design with open mind  291–94 need to consider agility in regulatory architecture  296–99 need to consider reframing or reform of regulatory standards and content  294–96 payment services  148–49, 274 single  297–98 regulatory agencies  148, 250, 288, 297 regulatory agendas  2–4, 74–82, 84, 207, 210, 220, 227, 250 appropriate  110, 253 framework for developing  286–99 insufficiency of token taxonomies  75–79 need to avoid exclusive focus on financial regulation  79–82 new  4, 71, 300 regulatory arbitrage  3–4, 40, 42, 86, 92, 94, 98, 241 regulatory architecture  15, 288, 296–99 regulatory blueprint  74, 166, 170, 176, 183, 192, 223, 225 regulatory capitalism  2–3, 48–52, 77, 193, 251, 267 regulatory characterisation  16, 96, 230, 275 regulatory competition  85–86, 89, 93, 99–100, 103, 234 regulatory convergence  86, 286 regulatory design  83, 154, 156, 169–70, 267, 279, 286–87, 291–94 appropriate  78, 287, 293 regulatory enforcement  102, 171, 187–88, 190–91, 264 regulatory frameworks  8, 47, 50, 209, 212, 215, 219, 266–67 enabling  76–78, 98, 152, 177, 193 regulatory governance  183, 235, 239, 257–58, 261, 269, 291, 295

Index  345 regulatory objectives  216–18, 230, 286, 288–92, 294–95 regulatory obligations  45, 101, 145, 166, 215–16, 225, 274, 293 regulatory ontologies  251, 255, 273–74, 279, 287–91, 293, 295, 301 development and need for dynamism  288–91 existing  20, 104, 286, 290–91 new  289–91 regulatory perimeter  20, 49, 86, 89–92, 95–96, 205, 273–74 regulatory policy  42–43, 86, 107–8, 218, 274–75, 277–78, 281–82, 286–88 new  108, 291 regulatory reforms  2–3, 43, 108, 146, 185, 266 regulatory regimes  15, 93–94, 99–101, 104, 106, 152–56, 231, 234 existing  91, 95, 152–53, 267, 271, 273, 275, 287 regulatory requirements  106, 142, 162, 189, 240, 259, 268 regulatory risks  20, 200, 204, 289 regulatory standardisation  11–12, 226 regulatory standards  78, 182, 185, 187, 214, 216, 238–39, 293–95 regulatory vetting  148–49, 206, 216–17 REIT (real estate investment trusts)  72 relational paradigms  4, 128, 187, 190, 218 remittances  21, 54–55, 177, 204, 272 rent  26, 62–63, 82, 195 extraction  70–71, 195, 247 rentier capital  69–70 reserves  13, 16, 192, 198, 202–3, 205–6, 270, 279–82 resilience  124, 246, 285 responsibilities  27–32, 119–20, 128–29, 141, 143–44, 222, 239–41, 292–93 responsible capitalism  120, 127 responsible persons  10, 147–48, 167, 293, 295 responsiveness  218, 296 retail consumers  88, 259, 263, 269 retail customers  225–26, 263, 269 retail investors  81, 100–1, 108, 185, 257, 259, 263, 268–69 retail participation  82, 96, 106–7, 259, 282 retail payments  15, 246, 273 retail users  20, 246 reward  6, 64, 69, 112, 116–17, 167, 179, 185–86 rights  11–13, 71–74, 104–5, 138–39, 179–91, 205–6, 223–24, 252 anticipated  171, 174 decision-making  141 grandfathered  87–88 property  73, 87, 211, 223

third-party  138, 182 in tokens  36, 38–40, 42, 95, 151, 175 voting  191–92, 205 withdrawal  166, 186 risk allocation  75, 223 risk governance  102, 162 risks financial  88, 191, 238, 255, 277, 293 management  12, 15, 162–63, 203–4, 258, 288, 292, 294 regulatory  20, 200, 204, 289 systemic  20, 203, 257, 259, 263–64, 273, 285–86, 298 to users  264, 281 robustness  64, 91, 106, 124, 238, 240, 248, 280 role-takers  119–20 rule of law  68, 248 sales  25–26, 36, 39, 58, 211, 228–29, 263, 295 laws  29, 42, 45, 237 sandboxes  217–18, 298–99 scalability  55, 111, 120, 197, 211, 247 scams  36, 38–39, 54, 78, 98, 165, 168, 170–71 scandals  16, 70, 106, 258, 260 schedules of commitment  171, 175–79, 181–93 for addressing investment risk  177–83 and investor protection  189–91 and public interest concerns  187–89 Second Life  57, 59 secondary markets  38–39, 41, 43, 79–81, 102, 157–59, 182–86, 188–89 prices  159, 284 sectoral legacies  273, 289–90 securities  40–42, 90–91, 94–97, 104–5, 108, 152–57, 231–32, 256 conventional  152, 170, 295 holders  158 laws  35, 40–41, 78, 85, 90, 93, 153, 157 markets  45, 69, 80, 129, 191, 231–32, 237, 260 regulation  231, 233 regulation  39–40, 42–43, 90–91, 106–7, 152–58, 160–62, 168, 170–71 tokens  90–92, 100, 231 transferable  163, 203, 205, 258 securitised products  163, 261 self-governance  60, 74, 122, 281, 285, 291 self-regulation  46–47, 51, 55, 60, 79, 81, 152–53, 231 enforced  292 self-regulatory templates  28 senior managers  69, 146, 292 separate legal personality  113, 125, 130, 134–35, 137, 142–48

346  Index service providers  102–5, 215–16, 223, 227, 229–30, 233–34, 275–78, 283 cryptoasset  104–5, 222–23, 231, 237–38, 275–78 financial  246, 276 third-party  220, 228 wallet  12, 225–26, 240 service standards  65, 223, 225 services  10–12, 56–59, 100–2, 222–23, 235–36, 238–39, 241, 276; see also Introductory Note dealer  226, 239 decentralised  236, 239, 276 settlement  200, 212, 214, 233, 240, 246, 273–74 infrastructures  272–73 shadow banking  87, 99, 272, 289 shareholders  69, 105, 126, 128–29, 131–32, 139–41, 157–58, 160 controlling  129, 141–42 minority  67, 181 primacy  52, 55, 126–28, 131 shares  72, 90, 130, 135, 191, 198 dual-class  191–92 sharing economy  36–37, 56, 64–65 short-termism  126, 180, 252, 256 single regulators  297–98 skills  12, 28, 101, 137, 167, 256 smart contracts  1, 14–15, 21–35, 48–49, 140–41, 146–47, 216, 283 code  114–15, 219, 241 Ethereum blockchain and crypto economy  21–35 protocols  122, 162, 177, 186, 282, 284 templates  25, 62, 75 tokens  23, 26, 115, 156 smart regulation  46, 51, 83–84, 292 social costs  252, 260 social enterprise forms  130–32 social expectations  44, 75, 285, 289 social fabric  2, 61, 120–21, 126, 136 social trust  15, 70, 295–96 social values  44, 267 sociology  2, 31, 53, 61, 69, 108, 112, 114 soft caps  166, 178 soft law  50–51, 83 software  11, 24, 28, 140–41 solidarity ethos  132–34 sophisticated investors  107–8, 153, 157, 159, 162, 257–59, 262–64, 268–69 sophisticated participants  256–58, 263 source code  61, 100, 115, 173 speculation  39, 82, 252, 256, 259, 262, 270, 276 excessive  39, 264

speculative activities  18, 81, 256, 259–63, 265–66, 268, 270 speculative forms  258, 260, 279 of hyper-financialisation  275, 282, 284 speculative trading  39, 82, 268 speculators  38–39, 81, 285 Spotify  127 stability  7, 16, 19, 32, 194, 198–202, 289, 294 financial  5, 75, 89, 245, 255–56, 262, 273, 283 price  20, 197–98, 282 systemic  5, 291, 296 Stable Act, proposed  20, 98–99, 204, 273–74, 278–79, 289 stablecoins  19–21, 98–100, 198–202, 204–9, 212, 247–49, 278–82, 298 algorithmically managed  198, 281 asset-referenced  274–75, 278–82, 290 collateralised  104, 199–200, 204–7, 209, 212, 279–80 design  198–99, 204, 206 development  19, 202, 204 holders  206–7 issuers  20, 98, 202, 204–7, 273, 275–76, 279 managed  198, 281 private  4, 98–99, 197–207, 273 projects  99, 106, 200, 271, 273 regulation  204–5, 207, 248 staged financing  169, 175, 178–79, 182 stakeholders  83, 109, 126–29, 131, 180, 285 standardisation  43, 66, 116, 168, 258 regulatory  11–12, 226 standardised templates  95, 147 standards  76–77, 101–3, 119–21, 214–15, 232, 238–40, 285–87, 295–99 gold  16, 102–3, 161, 168, 224 regulatory  78, 182, 185, 187, 214, 216, 238–39, 293–95 service  65, 223, 225 Steem  67, 119, 123, 159 Steemit  66–68, 223 Storj  25, 63–64 strict liability  77, 103 structures  44, 66, 76–77, 113, 128, 136–37, 153, 191 corporate  122, 131, 134 flat  132, 135 hierarchical  113, 125, 127, 132, 134, 213 institutional  70, 76 subscribers  36–37, 91, 96, 107 subscriptions  38, 58, 69, 166 suitability  126, 134, 164, 238, 264 duty of  165, 238 supervision  19, 183, 188, 218, 227, 233, 292, 298 regulatory  184, 241, 294

Index  347 suppliers  8, 26–29, 65, 129 supply  19, 62–63, 65, 75–76, 133, 159, 198, 208 capped  186, 196 monetary  16, 198 side  63–65, 75, 103, 133, 210, 254, 266 tokens  120, 159, 185–87 Suptech  295, 299 Sushiswap  121, 254, 284 sustainability  120, 133, 197 Sweden  20, 160, 270 Switzerland  36, 42, 86, 89–92, 104, 106, 228, 231 systemic risks  20, 203, 257, 259, 263–64, 273, 285–86, 298 systemic stability  5, 291, 296 systems auditors  141–43, 147, 149 Tamagotchi  57–58 taxonomies  37, 58, 280; see also ontologies technical administrators  140, 143 technocratic expertise, pools of  297–98 technological functions  148, 174, 216 technological innovation  5, 46, 49, 225 templates  34, 39, 41, 75, 112, 138, 176, 180 default  111, 135, 137 governance  111, 140 self-regulatory  28 smart contract  25, 62, 75 standardised  95, 147 terrorist financing  17–18, 92, 177, 189, 228 Tether  19, 99, 199–201, 208, 274, 278–81 Tezos  22, 61, 122, 159 Thailand  42, 88, 100–1, 106, 108, 210, 234, 278 theft  15, 31, 34, 102, 124, 211 third-party certification  147–48 third-party gatekeepers  140, 149–50 third-party rights  138, 182 third-party verification  172, 180 token financing  79, 132 blueprint for regulating  166–70 token-holders  105, 107, 119, 127–29, 224, 226, 282, 285 token taxonomies, insufficiency  75–79 Token Taxonomy Initiative (TTI)  75–76 tokenisation  36, 43, 48, 50, 62–63, 71–74, 273, 277 and financing  35–44 and fundraising by blockchain-based developers  37–39 tokens  36–43, 73–76, 79–80, 119–22, 151–53, 158–59, 182–86, 281–84 application  22, 37, 62 currency  37, 61, 85, 97, 208 digital  35, 89, 91 dual-class  191–92

ERC  235, 253–54 ERC-20  21, 201 Ethereum-based  201, 279 financialisation  38, 79 liquefication  38, 80 MKR  279–80 native  21, 208, 301 offerings  80, 88, 95, 108 pre-sold  171, 174, 182 retention  158–59, 175, 183–84 policies  184, 186–87, 192 rights in  36, 38–40, 42, 95, 151, 175 smart contract  23, 26, 115, 156 supply  120, 159, 185–87 Uniswap  283 utility  36–37, 41, 90–91, 95, 97, 100, 104, 106–7 wrapper  208, 235, 237 trade, international  16, 196–97, 272 tradeability  38, 40, 42, 252 trading  72–73, 80, 86–87, 95, 97, 170, 230–31, 238 derivatives  94, 296–97 secondary  41, 60, 95, 182, 253 speculative  39, 82, 268 transaction costs  136 transactions offchain legs  22, 25–27, 29, 120 peer-to-peer  29, 107, 221, 229 validation  6, 212 verification  30, 122, 213–14 transferable securities  163, 203, 205, 258 transfers  5–6, 9, 14, 21, 87, 211–12, 220, 271–72 transparency  19, 66, 72, 104, 124, 140, 142, 149 regulation  234, 295 Tron  22, 67, 112, 207 trust  24, 66, 70, 123, 182, 190–91, 219, 223–24 loss of  190 in peer platform markets  66, 92 social  15, 70, 295–96 systems of  115, 123 trusts  25, 72, 182, 224 resulting  182 TTI (Token Taxonomy Initiative)  75–76 Uber  36, 48, 65–66, 68–69, 112, 127, 202 UCITs (undertakings for collective investment in transferable securities)  163, 203, 205, 258, 294 unauthorised use  8, 195, 225 uncertainties, legal  35, 95, 224, 270 uncle rewards  116 underpricing  185, 188

348  Index undertakings for collective investment in transferable securities, see UCITs unequal bargaining power  214, 225 uniqueness  22 Uniswap  118, 225, 236, 239–40, 254, 283, 301 units of account  8, 16, 19, 194–95, 197, 247 USD Coin  201, 207, 274–75, 278–79, 289 user communities  70, 118 users  63–64, 208–10, 212–17, 219–24, 235–41, 243–49, 253–55, 280–85 individual  63–64, 77, 213 mainstream  197, 247 protection  8, 216–17, 229–30, 233–34, 239–40, 255, 285, 287 utility tokens  36–37, 41, 90–91, 95, 97, 100, 104, 106–7 ICOs of  41, 100, 107 validation protocols  56 transactions  6, 212 validity  6, 22, 25 valuations  185–86, 206 value creation  63–64, 125, 131, 177, 180, 192 social  44, 267 transfers  9, 272–73 venture capital funds  81, 151, 157, 202 partners  122 veracity  114–15, 140, 184 verification  22–23, 29, 115, 148, 196 code  149, 184 regulatory  148, 184 technological  147–48 third-party  172, 180 transaction  30, 122, 213–14 Vermont  137–39 vetting  100, 148, 163, 216, 262 merit  172, 205, 219, 233 regulatory  148–49, 206, 216–17

virtual currencies  10–11, 13–15, 18, 36, 81, 88, 98, 106 virtual goods  57–60, 230, 276 new  36, 57, 300 unique  229 virtual worlds  57, 60 visas  103 volatility  16, 18–19, 32, 39, 81, 196, 209, 238 problem  199, 209 voluntary disclosure  154–55, 168–69, 171 votes  34, 67, 96, 118–19, 141, 160, 181, 190 voting  60, 68, 118, 138, 180 rights  191–92, 205 wallet accounts  220–21, 228 wallet providers  11–12, 221, 223–28, 230, 234, 239, 276, 284 custodian  228 decentralised  225, 228–29 wallets  11, 215, 220–22, 224–25, 231, 234–35, 238, 241 cold  221 decentralised  224–26, 228–29 hardware  222, 228 hot  221–22 offline  221–22 types  220–23 wealth  32, 53, 56, 58, 70, 110–12, 257, 266 creation  32, 48, 56, 70, 78–79, 120, 125, 133 extraction  69, 122 withdrawal  60, 104, 169 rights  166, 186 World of Warcraft  57–59 wrapper tokens  208, 235, 237 XKD  271–73 yield farming  79, 207, 275, 281, 283–84, 293 yuan, digital  88, 245–46, 249