Blockchain technology allows professionals around the world to collaborate on non-fungible token projects, create new cryptocurrencies, build decentralized crypto exchanges or DEX, and engage with other facets of the web3.
However, since business transactions in the crypto space often lack formal regulations such as written contracts or the formation of a company, the parties may be exposed to unnecessary costs, liability risks and even adverse tax consequences.
Although a written contract is not a panacea, a recent case shows how a party’s position in a dispute would have been much stronger had a contract been in place.
in the Bendtrand Global Services SA vs. Silvers, a case in Illinois’ Northern District, a founder and a developer of a proposed DEX struck a software handshake deal. The founder claims that after paying all the agreed costs, the developer was unable to deliver the software.
In the absence of written agreements, the founder is likely to face lengthy and expensive litigation and an inability to recover delay costs or lost opportunity costs.
Possible liability risks
Traditional legal protections that limit liability risk are useful when dealing with business venture partners in the cryptocurrency industry.
As the Bentrand As can be seen, the lack of a written agreement can deprive plaintiffs of traditional cost-saving measures such as agreed limitations of liability, choice of law and venue, representations and warranties, penalties and other clauses.
Without these conditions, the intention of the parties must be interpreted by checking emails and messaging platforms, while the litigation costs increase.
In addition, the parties may find themselves in uncomfortable forums or need to prove their financial expenses before claiming damages.
Also, many written agreements lack the assistance of lawyers and are drawn up by parties using a search engine to find sample agreements or isolated clauses. Such creations are often fraught with internal inconsistencies and confused terminology, and enforcement of these agreements is questionable.
Considering that authentication and verification are key benefits of blockchain, not having a written agreement seems counterproductive.
In addition, business venture partners without incorporation and following corporate formalities are likely to be considered general partnerships, subjecting them to joint and several liability for the debts, fines, or judgments against such partnership under the rules of most jurisdictions.
Decentralized autonomous organizations, a novel corporate structure gaining popularity in the blockchain community, can have thousands of members on different continents, no central governance, and no common corporate form liability protections.
A member of such a partnership may be held personally liable for the actions of the DAO and other members (possibly overseas) if they are unaware of any wrongdoing they may have committed.
Generally, when participants sell or trade virtual currencies, they pay taxes on any capital gains from the transaction since the IRS has classified virtual currencies as property since 2014.
Blockchain companies enjoying the bull market have been forced to set aside up to 40% of their short-term profits. Organizations without tax allocation agreements have difficulty properly calculating the taxes owed. Additionally, due to the transparency of the blockchain, the IRS is able to track and account for transactions.
Regulations surrounding cryptocurrencies lag behind evolving market practices, and without a written agreement on how taxes will be handled, the wallet owner will be held accountable to the IRS for taxes on the wallet.
Unfortunately, in many blockchain projects, the wallet is tied to a founder and there is no written agreement on how taxes are to be distributed.
For an industry that operates with smart contracts and values transparency, the lack of written agreements is appalling. Many in the blockchain industry are willing to trust anonymous strangers based on a message exchange on social media or messaging apps.
Until there are laws that take into account the market realities of the crypto space, the lack of proper agreements will cost founders, investors and transaction parties time, money and worry.
This article does not necessarily represent the opinion of the Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Information about the author
John Cahill is an associate in Wilson Elser’s office in White Plains, NY. His practice focuses on cryptocurrencies, specifically NFTs, and he researches current trends to ensure clients comply with all current and evolving regulatory restrictions.
Jana S Bauer is a partner in Wilson Elser’s White Plains office. She heads the firm’s fine arts practice and is a member of the intellectual property and technology firm. She focuses on the development, acquisition, licensing and exploitation of intellectual property, including in transactions with NFTs.