Blockchain technology enables professionals from around the world to collectively work on non-fungible token projects, create new cryptocurrencies, create decentralized cryptocurrency exchanges or DEXs, and participate in other facets of the web3.
However, because business deals in the crypto space often lack formal agreements, such as written contracts or corporate formation, the parties can expose themselves to unnecessary expense, liability risks, and even adverse tax consequences.
Although having a written contract is not a panacea, a recent case illustrates how one party’s litigation position would have been much stronger with one in place.
In Bendtrand Global Services SA v. Silvers, a case in the Northern District of Illinois, a founder and developer of a proposed DEX signed a handshake agreement for the software. The founder claims that after paying all the agreed expenses, the developer was unable to deliver the software.
Due to the lack of written agreements, the founder is likely to face lengthy and costly litigation and the inability to recover costs of delay or costs of lost opportunities.
Potential Liability Exposures
Traditional legal protections that limit liability exposures are helpful when dealing with business partners in the cryptocurrency industry.
As the Bentrand sample, not having a written agreement can deny plaintiffs traditional cost-saving measures, such as agreed-upon limitations of liability, choice of law and venue, representations and warranties, damages, and other clauses.
Without these terms, the intent of the parties must be interpreted by reviewing emails and messaging platforms, all while increasing the costs of litigation.
In addition, the parties may find themselves in inconvenient forums or may have to prove their financial outlay before they can recover damages.
Too many written agreements also lack the involvement of attorneys and are made up of parties finding sample agreements or isolated clauses through a search engine. Such creations are often full of internal inconsistencies and confusing terminology, and the application of these agreements is in doubt.
Considering that authentication and verification are a significant benefit of blockchain, not having a written agreement seems counterproductive.
Furthermore, without corporate formation and following corporate formalities, partners in business ventures are likely to be considered a general partnership, which, under the rules of most jurisdictions, exposes them to joint and several liability for debts, fines or lawsuits against said company. .
Decentralized autonomous organizations, a novel entity structure that is gaining popularity in the blockchain community, can have thousands of members on different continents, with no central leadership, and no usual corporate protections against liability.
A member of such a society may face personal liability for the actions of the DAO and other members (perhaps located abroad) where they are unaware of any wrongdoing that may have occurred.
Generally, when participants sell or trade virtual currencies, they will pay capital gains tax on the transaction because the IRS has classified virtual currencies as property since 2014.
Blockchain companies that enjoyed the bull market were forced to set aside up to 40% of their profits for the short term. Organizations without agreements addressing tax allocation have difficulty correctly calculating taxes due. Additionally, due to the transparent nature of the blockchain, the IRS is able to track and account for transactions.
Regulations surrounding cryptocurrencies lag behind developing market practices and in the absence of a written agreement detailing how taxes are handled, the wallet owner will be liable to the IRS for wallet taxes. .
Unfortunately, for many blockchain projects, the wallet is tied to a founder and there is no written agreement on how taxes will be allocated.
For an industry that operates through smart contracts and values transparency, the lack of written agreements is staggering. Many in the blockchain industry are willing to trust anonymous strangers based on an exchange of messages on social media or messaging apps.
Until there are laws in place that take into account the realities of the crypto space market, the lack of appropriate agreements will cost founders, investors, and transacting parties time, money, and worry.
This article does not necessarily reflect the views of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or their owners.
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John Cahill is an associate in the Wilson Elser office in White Plains, New York. His practice focuses on cryptocurrencies, NFTs in particular, and researches current trends to ensure clients comply with current and developing legal restrictions.
Jana S. Farmer is a partner in the White Plains office of Wilson Elser. He chairs the firm’s Art Law practice and is a member of the firm’s Intellectual Property and Technology practice. He focuses on the development, acquisition, licensing and exploitation of intellectual property, including transactions involving NFTs.