Listen to the whole thing.
Fun bits from yours truly at 28:20-32:00 and 40:30 – 43:00.
Listen to the whole thing.
Fun bits from yours truly at 28:20-32:00 and 40:30 – 43:00.
Today a new form of organisational governance is announced by OpenLaw, a subsidiary of the Brooklyn-based Ethereum fan club and sometimes software development company known as ConsenSys.
OpenLaw calls this allegedly new and improved beastie a “Limited Liability Autonomous Organization,” or “LAO.”
They tell us:
One of the first substantive experiments with the use of smart contracts to manage and coordinate economic activity was The Decentralized Autonomous Organization (known as The DAO).
In early May 2016, The DAO was launched on Ethereum, animating the thoughts and imagination of developers and technologists around the globe. The DAO aimed to operate as a venture capital fund for the crypto and decentralized space. The lack of a centralized authority reduced costs and in theory provided more control and access to the investors…
…There is a strong argument that if The DAO didn’t collapse for technical or legal reasons the boom of the ICO market would have been tempered if not entirely unnecessary.
That’s not quite right.
The first time this was done was in 2014, where Casey, Tyler and I proposed linking a DAO – properly, just some software that automated organizational governance using a permissioned Ethereum template – to a private organization, specifically a 501(c)(6) non-profit trade association. ConsenSys now re-packages this as if it were their idea.
The 2016 DAO was not, as ConsenSys claims, some noble decentralized experiment on Ethereum that had the potential to save the world and forestall the ICO boom. The absence of any punishment for anyone involved in the DAO fiasco likely encouraged the ICO boom.
For those of you who are new around here, the 2016 DAO was a commercially illiterate trash fire that collapsed and took hundreds of millions of dollars with it. Anyone with half a brain figured out it was doomed before it even launched. I have absolutely nothing good to say about it and neither should anyone else. It seems to me that the only folks who were surprised it collapsed were the Ethereum “luminaries” on its own advisory board.
After a lot of rambling about Coase’s Nature of the Firm and how reduction of transaction costs is next to godliness, OpenLaw tells us the following:
Using the tooling provided by OpenLaw, the LAO will be set up as a limited liability entity, organized in Delaware, using curated Smart Contracts to handle mechanics related to voting, funding, and allocation of collected funds. This entity will presumably limit the liability of LAO members and help clarify their relationship to avoid knotty questions related as to whether partnership law applies.
tl;dr – OpenLaw has discovered a Delaware corporation’s back office can be run with software. Carta does this today.
We will leave to one side, for the moment, what this structure’s effect will be on liability.
This structure will also provide members of the LAO with tax flow-through treatment by the Internal Revenue Service, such that tax is not paid by both the entity and a person holding a beneficial interest in the LAO.
Hold the phone, they’ve discovered an LLC.
The proposal goes on:
Members will be able to purchase interests in the LAO and the proceeds from the purchase will be pooled and allocated by members to startups and other projects in need of financing, using a voting mechanism and tools similar to Moloch DAO… In order to comply with United States law, membership interests of the LAO will be limited and only available to parties that meet the definition of an accredited investor — although there are arguments that LAO membership interests may not be securities.
Those arguments are, of course, wrong. Although I suspect ConsenSys folks should prefer if the situation were otherwise. In a late-2018 interview in now-shuttered ConsenSys-owned online magazine BreakerMag, ConsenSys founder Joe Lubin spoke of his affinity for token launches:
The token launches, if they’re for our own companies, end up bringing capital into those companies, and if they’re consumer utility tokens, you could consider that revenue. There are a bunch of those that have brought in many tens of millions of dollars. And we also help third parties do token launches.
The U.S. Securities & Exchange Commission has since taken a very dim view of the idea of the “utility token,” as we have seen from a number of enforcement actions that first were made public in 2018 and continue to be made public at a fairly brisk pace.
So where we are, or at least where any reasonable person should be, is that the “LAO” will be selling membership interests, that these membership interests will be regulated, at least in the United States, as securities, and accordingly that the registration requirements under the Securities Act of 1933 will apply to their sale unless an exemption applies. Unsurprisingly the LAO proposal elects to adopt this approach.
The proposal continues:
OpenLaw will help on an ongoing basis with any ongoing legal requirements and improve any tooling that may be necessary to maintain or enhance the LAO. However, OpenLaw will exercise no control over the LAO unless directed by the members.
This is a weird proposal. What OpenLaw is basically saying is that everyone in the transaction is going to be passive and OpenLaw will act as a corporate services provider.
This is similar to what one might see in a securitization, for example. In a securitization, a special-purpose entity/vehicle or SPV – usually a corporation rather than an LLC – is incorporated to be the legal owner of whatever the subject matter assets of the transaction might be. Two entities assume primary responsibility for the SPV’s continued existence: the corporate services provider, who shuffles paper and signs documents on its behalf, e.g., and the trustee, who is effectively God in that it decides how to enforce the terms of the transaction in relation to which the SPV has been created (but equally, and also like God, is extremely reluctant to interfere in corporeal affairs, except in the most serious of circumstances, and only then with express authorization from the beneficiaries whose interests the trustee represents).
LLCs are a slightly different ball game, so I am not sure that “exercising no control” over the LAO will actually work. LLCs are operated by managers – and if that manager is a co-owner, we refer to the manager as a “managing member” – who has authority to act on behalf of the LLC and also is liable for discharging certain duties, both to the LLC members and third parties with which it deals on their behalf. Manager-members owe all manner of fiduciary duties of fair dealing and disclosure to other members of the LLC.
Accordingly, this proposal can really only work if there is one LLC manager – OpenLaw or a delegate – or if all the LLC members are managing members, because I can’t see an LLC member who wants to be passive and keep their liability minimal stepping forward to assume these responsibilities on behalf of the rest of the crew. The buck has to stop with someone, at the end of the day, who assumes primary responsibility for the organization’s affairs (signing corporate filings, acting as the signatory on bank accounts, instructing counsel, replying to writs and subpoenas).
And then there’s this.
We also will be exploring on-chain verification of accredited status for the LAO using third-party oracle services (such as ChainLink) to streamline the onboarding process.
No. This is not how accredited investor verification works.
Much like the original Moloch design, members of the LAO will be able to ragequit and immediately retrieve back their fair share of unallocated funds based on their economic contribution (regardless of voting weight). With this safety mechanism in place, LAO members will always have the option to opt-out of the LAO should they disagree with aspects of the LAO membership, investment portfolio or need to rapidly receive back their assets.
What does this mean, exactly? From Simon de la Rouviere:
Moloch DAO always leaves a door open. Every time there is a vote, one can decide to exit (“ragequit”), turning non-transferable voting shares into transferable “loot tokens”. If you destroy your loot tokens, you can exit with your proportional amount of the organization’s resources (“treasury”).
I’m not sure this makes sense in a corporate setting. Let us suppose the LAO has ten members, Alice, Bob, Carol, Darren, Errol, Frankie, Gerard, Harry, Iphraim and Jimmy that each invest 10 ETH into a LAO.
The LAO takes its first vote and unanimously agrees to invest 90 ETH into a hot new Ethereum startup, CryptoMarmots. On its second vote, the LAO wants to invest 10 Eth into another hot Ethereum Startup, ScamTrainCoin, but Jimmy decides this is a bad investment and quits.
Under this proposal, Jimmy would take 9 ETH worth of CryptoMarmots’ rewards/equity/whatever and 1 Eth, meaning the LAO would only control 81 ETH worth of CryptoMarmot rewards/equity/whatever and have 9 ETH in cleared funds to invest in ScamTrainCoin.
So: the LAO now has 81 CryptoMarmot and 9 Eth and 9 members, Alice, Bob, Carol, Darren, Errol, Frankie, Gerard, Harry, and Iphraim. A new member, Kendrick, joins with 10 Eth. What happens when the LAO decides to invest the 19 ETH it now has available to spend? Does Kendrick’s new contribution entitle him to 10% of the existing pool of assets and 10% of the voting power? If so, this strikes me a raw deal; why wouldn’t he just start his own LAO where he has 100% of the voting power? Equally, why should he be entitled to dilute the CryptoMarmot “reward token” holdings earned by the other members and held in the common treasury when he quits?
How is this more than layering an unnecessary corporate intermediary between a project that is selling tokens and the (presumably accredited) investors who wish to buy them, with potentially adverse tax consequences when compared to simply buying them outright? Seeing as the management magic of Tim Draper/Marc Andreessen/Naval Ravikant isn’t here, what’s the point of tying it up in a corporate that has no management talent whatsoever?
And most importantly, even without the investment talent, how is this not regulated as if the talent were there and this constituted an investment company requiring registration under the Investment Company Act of 1940?
Extending emerging Moloch designs further, LAO members can also continuously claim their fair share of profits provided by tokens received from projects that receive investment from the LAO, further incentivizing collective LAO diligence, voting participation, and membership stability.
Again, this also doesn’t make sense. Seeing as the LAO has chosen to operate itself as an LLC rather than a fund, it is likely that LAO members would insist on “continuously claiming their fair share of profits,” as the pass-through nature of an LLC means that each member’s proportion of profits will be taxed and reportable on the members’ own personal or corporate returns each and every year and possibly even quarterly. Seeing as tokens can fluctuate wildly in value, how are profits to the LLC to be calculated?
To accept funding, projects will submit an application and be required to create a Delaware legal entity and OpenLaw will provide a set of standardized documents to streamline the process. If the project is later stage, OpenLaw will work with the project to ensure that the LAO can provide funding, given the project or entity’s then-current legal structure.
Is OpenLaw planning on becoming a law firm as well?
Through this approach, a project can conceivably submit a request for funding and receive funding from the LAO in days. Below is a quick preview of how fast funding can be received.
Although it’s easy to make fun of investors, the fact is that the better ones are extremely skeptical and perform a ton of due diligence before deciding to pull the trigger on an investment. The slowness of funding from a VC firm is not a function of paper-based legacy systems causing delays. It is a human problem where people simply don’t want to give their money away unless you’ve generated sufficient FOMO/investor tingles.
The LAO and similar structures could lead to increased development of secondary trading for LAO interests either through private markets or potentially even on public exchanges, potentially leading to a future of publicly traded venture capital funds.
Maybe. But I’ll bet it won’t. There’s a reason VCs stay private, e.g. they don’t like or want the scrutiny that being public involves.
We’re not looking at anything more complex than a Delaware LLC, with some weird corporate governance arrangements that probably don’t work, and funky tax consequences, that requires OpenLaw’s constant involvement/SaaS offering in order to function.
The marketing strikes me as typical Ethereum complexity theatre, lots of bespoke jargon and an absence of straight talk. I can discern no way that the LAO would be necessary for, let alone desirable for, the facilitation of venture investments from the perspective of an investor. Without active, third-party management, the LAO simply adds another layer of complexity (and risk!) where a normal equity crowdfunding platform would just let the investor buy the product directly, hold it directly, exercise his rights directly, and pay taxes on his own investment returns only rather than dealing with the calculation of a proportional share of the profits and losses of an LLC in which he has a minority stake.
It does have a set of pre-written investment documents written for it. It appears to be unapologetically marketed at the Ethereum community so it’ll probably attract some investment. It is unlikely to have any impact beyond that limited audience.
On an entirely unrelated point, I am often asked what my opinion is about DeFi. I include all types of DAOs in this umbrella. Including, for example, MakerDAO’s DAI stablecoin.
My initial response is always the same, and it’s always exactly five words long:
DeFi is cargo cult finance.
What does this mean?
As put by Richard Feynman:
In the South Seas there is a cargo cult of people. During the war they saw airplanes land with lots of good materials, and they want the same thing to happen now. So they’ve arranged to imitate things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head like headphones and bars of bamboo sticking out like antennas—he’s the controller—and they wait for the airplanes to land.
They’re doing everything right. The form is perfect. It looks exactly the way it looked before. But it doesn’t work. No airplanes land. So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential, because the planes don’t land.
And this is how that looks:
With that, dear reader, I bid you good evening.
Knut Karnapp posed this very interesting question over on Twitter. His answer:
To me you own a part of the Bitcoin UTXO set uniquely assigned to you, and only you — by virtue of the corresponding private key. With this comes great responsibility. If you lose your private key, you lose your bitcoins. If your private key gets stolen civil law may dictate that the key itself and the UTXOs accessed by it are still “yours”. As far as the Bitcoin network is concerned though the private key grants power of disposition to whomever is in possession of said key.
That’s a solid answer from a de facto point of view, where continuing knowledge of the private key basically == what most people commonly refer to as control, or ownership. From a workaday transactional standpoint I basically agree with it wholeheartedly. De jure, on the other hand…
“Ownership” is more than mere control; it is a legal concept and law is a local phenomenon. Accordingly, when you ask yourself whether and how something is owned, it’s generally a safe assumption to begin, in the first instance, by looking at the governing law of the asset and asking what that governing law says.
With certain things, like securities, the governing law of the issuing jurisdiction/entity and the governing law of the instrument (if different) are likely to be dispositive. International bearer securities, e.g., utilize well-worn issuance frameworks like the New Global Note structure, which divides up legal and beneficial title in the underlying security by contract in a manner that is highly certain and leaves little room for ambiguity. With real property (an apartment, a house, some land) you usually look to the law of the situs as the starting point for that inquiry. Generally speaking it’s the same story for chattels, save where ownership of those chattels is represented by a certificate of title or the like.
The problem with Bitcoin, of course, is twofold.
First, Bitcoin does not avail itself of existing categories of property, like chattels or instruments; indeed, it defies them in many respects. As a consequence, any contractual or systemic understanding of the thing – to the extent one exists at all – is going to be implied, and seeing as courts haven’t really grappled with foundational questions about what Bitcoin is, we don’t know what that implication will look like. The best we can do for now is guess what the boundaries of that implication, once set down in writing, will be. We will call this the Classification Problem.
Second, a bitcoin does not really have a physical location, and is a fundamentally global good – it exists on every computer which runs a full node, and is arguably issued everywhere and nowhere at the same time. But the Classification Problem will be determined by reference to local, not global, rules. We will call this the Forum Problem.
The “Forum Problem” is a simple one; Bitcoin has no identifiable origins, no clear home, so each different country/jurisdiction in which litigation over Bitcoin is brought (in the case of the U.S., the states and the various federal jurisdictions) will feel entitled to apply its own rules to the asset. For the majority of commercial arrangements, harmonization can probably be achieved by choice-of-law clauses among the counterparties to the transaction.
The “Classification Problem” is where things get more interesting. Here we ask what rules each jurisdiction would apply if some litigation arose which involved fundamental questions about the nature of ownership as it pertains to Bitcoin the asset. Usually, those fundamental questions are not in dispute in the kind of workaday litigation that comes before the courts. Courts take judicial notice of who owns what bitcoins based on the facts of the case; Alice sold some bitcoins to Bob, there are no competing claims to the bitcoins and the question is whether one of the parties reneged on the high-level commercial terms of the deal.
What hasn’t happened yet, and what invariably will happen as more and more cases hit the courts, is that someone will ask the question, “what property classification do we apply to Bitcoin – WTF is it that Bob actually owns?” This is because, at its core, a bitcoin is really, in its purest essence, only a solution to a randomly-generated math problem. Because the problem is very hard, the combination of a UTXO plus the ability for a recipient to spend it, armed with the knowledge of the relevant private key, is treated by most of us today as property. That “property” creates a write permission on a massively distributed cryptographic ledger which nobody controls, although control of that write permission can be transferred to other users of that database by spending the associated coins to those other users.
Because the secret embodied by a private key one does not know is very difficult to obtain – and impossible to obtain on a commercial timescale with existing technology – people call Bitcoin a “digital bearer asset.” Bitcoin is most assuredly not a bearer asset or chattel, though. Nor is it a documentary intangible, as it is not a contract and is silent, apart perhaps from the provisions of the MIT Licence, as to what a court should do when presented with one (more on that below). Unlike physical goods which can only exist in one place at one time, it is conceivable that with a powerful enough computer, the solution could be found entirely honestly by a third party simply doing some math and stumbling upon the answer at random, or by asking the right questions and exploiting some as-yet-undiscovered weakness in the implementation.
Bitcoin might, therefore, be better described as a digital I-know-something-you-don’t-yet-know asset. “Yet,” because the information is not secret (in the same way as a trade secret, e.g.) or impossible to ascertain; it’s out there waiting to be ascertained by someone clever enough, or a computer powerful enough, to figure it out. The term “cryptoasset” that is cavalierly thrown around by your garden-variety ICO bro inadvertently turns out to be an accurate description for this new class of ownership. Lawyers wishing to confer dignity on the phrase might call it “crypto-property” instead.
If we really wanted to make it our own and de-emphasize the “there’s a lot of cryptography in this thing” aspect of Bitcoin, which is not legally relevant, in favor of an laser-focused emphasis on exclusive knowledge of the secret key as being dispositive for control and highly relevant for ownership, I might suggest the radical step of changing the spelling of the prefix to “krypto,” per the original Greek κρυπτῷ, so we’re left with “krypto-property.”
Who owns the solution to that really hard to solve, but solvable nonetheless, math problem? I ask this question, which seems like an obvious or even pedantic one, only because I am fairly certain that the world’s two largest common-law jurisdictions – England and Wales, and the United States – would reach different conclusions.
Now, of course Bitcoin is treated as various things by various agencies of the state – most significantly, as “property,” by both the IRS (American taxman) and HMRC (English taxman). But that doesn’t answer the question of what kind of property the stuff actually is.
In England, for example, longstanding precedent has held that “the right to confidential information is not intangible property;” see Oxford v. Moss, (1979) 68 Cr App Rep 183 (a student cheating on a test by reading the answer sheet in advance could not be convicted of theft, as the answer to the test – as pure information – was not intangible property and therefore incapable of being stolen). This principle nukes the notion that a private key is worth more than the paper that you [really should not] have written it on.
At the same time, English law may have an equity, which looks a lot like a property interest in confidential information that has been misappropriated, that gives a party wronged (i.e., for our purposes, the person from whom knowledge of a private key was wrongfully obtained) a right to restitution. Anyone looking for the detailed treatment should read the section “Information as Property” at page 1 in Palmer & McKendrick’s Interests in Goods (1998).
I wrote a fairly lengthy analysis on the English law in this area back in the day, which, annoyingly, I have since lost. TL;DR, if an attacker fraudulently obtains a private key, English law provides a a remedy, but if an attacker should stumble upon a key by accident or by brute force, it probably doesn’t. This is unsatisfactory but it’s what we’ve got.
Contrast this with the U.S. position, where the courts have found that property rights can subsist in pure information such as unpublished or recently-published news (INS v. Associated Press, 248 U.S. 215 (1918)) or straightforwardly analogize doctrines such as relativity of title as a hack/workaround (e.g. Popov v. Hayashi, WL 31833731 Ca. Sup. Ct. 2002). Incidentally, a relativity-of-title-theory approach would also solve, for most practical purposes, what the inimitable Izabella Kaminska described as “Bitcoin’s Lien Problem” in 2015; it strikes me that that theory of ownership should be fairly good fit with UTXO-based systems where one can trace title to a given coin perfectly, give notice of theft or fraud efficiently, and prove current “possession” with a high degree of precision. Crucially, it might prevent an attacker – even an accidental one – from getting superior title to the Bitcoin he obtains, as long as the courts or the legislatures decide that’s how they want to crack that nut.
Equally, and another idea I have noodled on, is that Bitcoin’s code is really the first “smart contract” in that the code embodies a binding contractual understanding among the users. However, the fact that the code can be forked by consensus of the users to say anything at any time suggests to me that a court would likely conclude that there was not a clear intention to create a contract by running the code and so might refuse to enforce a particular mode of operation on the users of the network (see e.g. Jones v. Padavatton,  EWCA Civ 4). Incidentally this absence of a contractual understanding/effective ousting of the jurisdiction of the court is why Bitcoin cannot and should not be described as a chose in action.
Wrapping up, the reason that the matter of Bitcoin’s ultimate classification as property hasn’t come up yet is because, in common practice, ownership disputes are resolved at a higher conceptual level than inquiring about the “nature of a bitcoin itself” – when I deposit coins at an exchange, e.g., it ought to be pretty clear from the exchange’s TOS that if I have a balance on the exchange, I can ask the exchange to spend an amount equal to that balance back to me on request and, if they fail to do so, I can ask a court to force the exchange to render specific performance or pay damages. A dispute of that kind, of which there have been many, doesn’t ask at what point title transferred and what the fundamental nature of that title is, because it doesn’t have to. It looks instead at the contractual obligations between the counterparties and whether those obligations were satisfactorily performed.
One could write chapter and verse comparing these two jurisdictions and their treatment of Bitcoin as an asset. That said, it’s a Friday night and I have places to be, so for now it will have to suffice to say only that the question has no answer and at some point, probably sooner rather than later, there is going to be a case that explores these fundamental issues (I am frankly shocked that Oxford v. Moss hasn’t been raised yet in any of the UK-based Bitcoin fraud prosecutions).
I look forward to reading those decisions.
Too good not to share.
So the FCA’s Cryptoassets Task Force Report is out today. Compared to the last time the FCA chimed in on crypto, there are few surprises/not a lot to write home about.
For this reason, rather than writing a blog post, I have decided to go all “Web 2.0” on everyone by writing a Twitter thread instead.
Very pleased to catch up with Adam B. Levine, Stephanie Murphy, and my good friend Jonathan Mohan on the original (and still best) Bitcoin podcast, Let’s Talk Bitcoin, for the first time since 2014.