Blockchain technology enables professionals around the world to work together on non-fungible token projects, create new cryptocurrencies, build decentralized crypto exchanges or DEXs, and interact with other aspects of web3.
However, because commercial transactions in the crypto space often lack formal arrangements, such as written contracts or company formation, parties may be exposed to unnecessary fees, liability risks, and even adverse tax consequences.
While having a written contract is not a panacea, a recent case illustrates how a party’s litigious position becomes stronger with a written contract.
exist Bendtrand Global Services Inc v Silver MedalIn one case in the Northern District of Illinois, the founders and developers of a proposed DEX struck a handshake agreement over the software. The founders claimed that after paying all the agreed fees, the developers were unable to deliver the software.
In the absence of a written agreement, founders can face protracted and costly litigation and not be able to recover delay costs or lost opportunity costs.
possible liability risk
Traditional legal protections that limit liability risk are useful when dealing with business risk partners in the cryptocurrency industry.
if Bentrang Show that no written agreement can negate plaintiff’s traditional cost-saving measures, such as agreed limitations of liability, choice of law and venue, representations and warranties, liquidated damages, and other terms.
Without these terms, the parties’ intent would have to be explained by reviewing email and messaging platforms, and litigation costs would increase.
Additionally, parties may find themselves in inconvenient forums or have to prove their financial outlay in order to receive any damages.
Too many written agreements also lack attorney input and consist of sample agreements or orphaned clauses found by parties through search engines. Such creations are often filled with internally inconsistent and confusing terminology, and the enforcement of these protocols is problematic.
Considering that authentication and verification is a big benefit of blockchain, having no written agreement seems counterproductive.
Furthermore, in the absence of company formation and compliance with corporate formalities, business venture partners are likely to be treated as general partnerships, which under the rules of most jurisdictions makes them liable for debts, fines or penalties against such partnerships. Judgment bears joint and several liability.
Decentralized Autonomous Organizations are a new type of entity structure that is gaining popularity in the blockchain community, possibly with thousands of members on different continents, without a central leadership and without the usual corporate-style liability protections.
Members of such partnerships may face personal liability for the actions of the DAO and other members (who may be located abroad) without knowledge of any bad behavior that may occur.
Generally, when participants sell or trade virtual currency, they will pay tax on any capital gains from the transaction, as the IRS has classified virtual currency as property since 2014.
Blockchain companies enjoying the bull market are forced to set aside up to 40% of short-term profits. Organizations that do not have an agreement on tax allocations have difficulty correctly calculating taxes owed. Furthermore, thanks to the transparency of the blockchain, the IRS is able to track and account for transactions.
Regulations surrounding cryptocurrencies lag behind developing market practice, and without a written agreement detailing how taxes are handled, wallet owners will be held accountable to the IRS for the wallet’s taxes.
Unfortunately, for many blockchain projects, the wallet is associated with the founder and there is no written agreement on how the tax will be distributed.
For an industry that operates through smart contracts and values transparency, the lack of written agreement is appalling. Many in the blockchain industry are willing to trust anonymous strangers based on the exchange of messages on social media or messaging apps.
Unless there are laws in place that take into account the market realities of the crypto space, the lack of proper protocol will cost founders, investors and transacting parties time, money and worry.
This article does not necessarily reflect the views of the Office of State Affairs, the publishers of Bloomberg Legal and Bloomberg Tax, or their owners.
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John Cahill is a partner in Wilson Elser’s White Plains, NY office. His practice focuses on cryptocurrencies, especially NFTs, and he studies current trends to ensure clients comply with any current and developing legal restrictions.
Jana S. Farmer is a partner in the office of Wilson Elser White Plains. She chairs the firm’s Arts Law practice and is a member of the firm’s Intellectual Property and Technology practice. She focuses on the development, acquisition, licensing and exploitation of intellectual property, including transactions involving NFTs.