Web3 Regulation Talks with ICON.PARTNERS: Vision, Challenges, and Legal Guidance [Part 2]

At Dexola — an advanced Web3 software development company — we are strongly dedicated to push the boundaries of technological innovation. Meanwhile, we understand the crucial need to balance innovation with legal compliance.

For this reason, we believe that our strategic partnership with ICON.PARTNERS, a leading international law firm that specializes in Web3 regulations, will help us provide our clients with even more complex and legally revised technical solutions.

To explore the legal landscape and difficulties faced by the emerging tech industry, we’ve interviewed leading experts from ICON.PARTNERS:

• Viacheslav Ustimenko, CEO and co-founder;
• Vladyslav Udianskyi, a senior lawyer specializing in blockchain and fintech;
• Oleksii Los, a senior lawyer focused on Web3 & AI technologies.

The conversation turned out to be very concentrated and extremely interesting. We’re publishing the whole interview in two parts under the general title “Web3 Regulation Talks with ICON.PARTNERS.”

In part 1, Alex Stupakov, Dexola’s delivery director, speaks with experienced lawyers about the fundamental principles of Web3, the typical legal challenges encountered by startups, the complexities of tokenomics, and the risks associated with wine tokenization as a real-world asset.

The complete version of the first part is available here.

In the latter half of the interview, you’ll uncover some surprising insights about the growing regulatory challenges in the crypto industry, especially around stablecoins and real estate tokenization.

The conversation dives into how ICON.PARTNERS navigates complex legal landscapes, the necessity of regulation to protect investors, and the delicate balance between innovation and compliance in the blockchain space.

We hope you find it engaging!

Disclaimer: This interview does not provide legal or financial advice. The information presented is for general informational purposes only. We are not responsible for any actions taken based on the content of this interview. Readers should consult with a professional before making any decisions.

Alex: What are the primary challenges facing the crypto industry today? How does ICON.PARTNERS contribute to resolving them?

Vlad: The main issues include regulatory uncertainty, fraud risks, and compliance complexity. ICON.PARTNERS helps address these issues by providing legal consultations, support with company registration, assistance in developing tokenomics, and compliance with the legislation of various jurisdictions. 

We also help protect intellectual property and resolve disputes, which is particularly important for startups.

Oleksii: Especially in blockchain-related companies, we also pay attention to the legal aspects of smart contracts to verify that they comply with legal requirements. This is particularly important for DeFi projects, where the lack of regulation can lead to serious consequences.

Slava: I would add that we often work with clients in forming their company and understanding all legal aspects at the early stage. This includes tokenomics auditing and helping in negotiations with regulators. We’re particularly strong in dealing with regulators because we’ve already built good relationships with many of them.

Alex: Given the options of the Baltics, the US, Texas, or offshore jurisdictions, where would you recommend registering the company?

Vlad: We typically conduct a strategic assessment to identify the client’s specific needs before recommending onshore or offshore incorporation. Historically, offshore jurisdictions were favorable for crypto projects due to regulatory flexibility compared to Europe’s stricter approach to innovation. 

However, recent regulatory developments there have introduced greater legal certainty, potentially shifting this dynamic. At the same time, with legal certainty, new issues have arisen, as now MiCA Regulation requires most of the third-country companies to establish a presence in Europe, like offices, obtain authorization to serve EU residents, with some exceptions like reverse solicitation, conduct appropriate marketing campaigns and publish whitepaper.

That’s why ordinarily our strategic assessment includes the following business objectives: target market, geographical location of operations, tax benefits, ease of management, or legal certainty.

Oleksii: Moreover, while offshore jurisdictions can offer tax advantages and flexibility, regulatory compliance remains vital. Considerations include data protection laws, since many data protection laws have extraterritorial reach, KYC/AML requirements, as anonymity ideas do not absolve companies from obligations to meet those rules, and, crucially, securities regulations. 

In Europe, for example, considering the nature of the token being issued, the requirements are completely different. If it is qualified as a financial instrument (security token), the applicable regulation isn’t MiCA but MiFID-2, necessitating a prospectus instead of a whitepaper. 

Moreover, offshore businesses shall remember that the Howey test does not apply uniformly across all jurisdictions, since each country has its own features regarding security tokens. 

However, if the project aims to issue utility tokens without any promises of returns or profits, then offshore jurisdictions can be used with some considerations. For example, our approach always aims to balance short-term benefits with the company’s long-term objectives, ensuring sustainable growth for the crypto project.

Alex: I understand, but let’s break down a simple case: a crypto wallet. It doesn’t issue any tokens; it’s just a service platform. Does it matter where it’s registered?

Vlad: The regulatory implications for a crypto wallet service platform can vary significantly depending on whether it’s custodial or non-custodial, since custodial ones often fall under VASP regulations in many jurisdictions.

For a non-custodial crypto wallet that’s purely a service platform, the registration location may have less significance from a regulatory standpoint, as they’re generally treated more like software companies. However, it’s not entirely irrelevant, since the company’s location can affect tax obligations and corporate governance.

Oleksii: There are various concepts established in existing regulatory frameworks that apply to providers involved in cryptocurrency activities. In MICA, it’s referred to as CASP — Crypto-Asset Service Provider. In most jurisdictions, the term used is VASP — Virtual Asset Service Provider.

This mainly pertains to exchanges, specifically platforms that offer custodial services. These services include storing funds for users, handling transactions on their behalf, placing orders, and similar activities.

These platforms are involved in currency exchange, including fiat-to-crypto and crypto-to-fiat transactions. Essentially, these off-ramp services deal directly with either the user’s virtual assets, crypto assets, or fiat currency. Therefore, structuring the custodial service provider’s business necessitates a more meticulous approach.

On the other hand, if we’re talking about a non-custodial crypto wallet, which is just software, there isn’t a strong need to go offshore or create a complex corporate structure. However, such businesses can still take advantage of more favorable taxation, data protection obligations, and general business regulations, by opting for a more complex structuring.

Alex: Yes, but what about the Tornado Cash case? They didn’t hold any funds, but they were still heavily prosecuted.

Slava: Tornado Cash is not just a non-custodial wallet, but a decentralized mixer or tumbler service.  Tornado Cash was labeled a “mixer” because it increased anonymity by mixing funds, making it hard to trace their origin. Such obscure of trace qualitatively differentiates Tornado Cash from a simple non-custodial software mentioned by my colleagues.

Therefore, since Tornado Cash created additional value to its non-custodial service by mixing funds without clear oversight, such additional value attracted regulatory attention for allegedly facilitating money laundering.

Vlad: That’s why, this case doesn’t mean all non-custodial wallet providers are at risk of similar prosecution. This case underscores the regulatory focus on functionality rather than custody status. While basic non-custodial wallet functions remain largely unregulated, any additional features that could be perceived as obscuring transaction trails may attract regulatory scrutiny.

This is why mixers like Tornado Cash can face some troubles. Providers should carefully consider the implications of implementing privacy-enhancing features, even if they’re optional. Moreover, KYC/AML regulations still apply even to non-crypto service providers, causing them to have robust KYC/AML procedures.

Alex: Ok, I guess we’ve covered that pretty well. Now let’s talk about how you handle complex requests with uncertain outcomes. What principles guide you in these cases?

Oleksii: Our approach is similar to the one you described in your work. We study the client’s request and then inform them about potential challenges, existing practices, critical risks and propose solution.

For instance, when tokenizing real estate, the process’s complexity depends heavily on the approach. Directly tokenizing property is challenging due to absence of legal mechanisms to do it straightforward and already existing legal procedures on ownership transfer under civil laws.

The idea behind tokenization is to make illiquid assets like real estate liquid. However, this raises questions about how to allocate ownership shares, manage rights, and distribute rental income to token holders.

Vlad: In this situation, on one hand, smart contracts offer a powerful tool to automate and create agreements. On the other hand, they don’t replace the need for traditional legal documentation. That is why, in such complex situations, we would find the solution, using the available legal options. And there are already some cases to back that up.

With the real estate tokenization, such can be structured to represent indirect ownership through tokenized shares in a corporation that holds the property. Such a corporate structure enables fractional ownership and enhanced liquidity, effectively simplifying access to traditionally illiquid assets.

Moreover, such projects have already safely existed in the U.S. Another example may be DAOs, even though many jurisdictions still don’t recognize DAOs, we are able to arrange the entire structure and draft bylaws that way, which helped the community to reach the most decentralization.

To sum up my idea, working with clients, we strive to provide them with the most comprehensive view of possible solutions for them to choose the best one from the business point of view.

Slava: On my part, I want to emphasize that we don’t take risks when something isn’t feasible. We never tell the client, “Maybe we’ll get lucky.” That’s not how we do business. If it’s legally allowed, has been done before, falls within the current legal framework, and the client is ready to navigate the challenges and processes involved, we’re fully prepared to support them every step of the way. 

However, if we face something precarious, we will always try to mitigate those risks, use any available sandbox or get the opinion of regulators, so that even very innovative companies could launch their ideas and not be obstructed by the legal uncertainty.

Alex: The American tokenization story sounds inspiring. How do such precedents impact the development of the legal framework?

Slava: Innovative projects are indeed impacting legal frameworks, particularly those in regulatory sandboxes. These initiatives are prompting regulators to address gray areas, but their influence remains limited, especially in real estate.

However, regarding the U.S. real estate tokenization, the impact remains questionable. Because, despite the lack of specific laws for real world asset tokenization, other legal frameworks, like civil and administrative laws, still apply. 

For example, in Ukraine, transferring real estate requires a written contract and official registration, which can’t be accomplished simply by transferring a token. In fact, tokenization creates some complex structures, but they do not actually transfer ownership of the property itself.

Vlad: I’m totally with Slava on this. As seen with Marshall Islands’ DAOs, demand for these structures has stimulated legal updates. However, real estate tokenization faces more significant hurdles. 

In reality, blockchain can sometimes be an unnecessary addition. While blockchain is intended to simplify and make processes more transparent, it may not be suitable for real estate tokenization. In today’s context, with no algocracy, every transfer of that token would require a series of legal procedures to truly transfer ownership rights.

Unlike with DAOs, it’s unlikely that countries will completely overhaul their civil codes and property laws to accommodate real estate tokenization. The required investment and rework of existing frameworks are too substantial. Instead, we’re likely to see gradual, targeted adjustments to legal interpretations and regulations as the technology evolves and proves its value.

Alex: So, are you saying that government institutions are hindering progress?

Oleksii: Not exactly. The state needs control measures, which is why we see lawsuits and regulations against major companies and exchanges like FTX and Binance. The state is interested in blockchain but not in letting the industry become a “Wild West” where everyone does whatever they want.

Without regulation, the state loses its ability to protect citizens’ interests. For instance, if someone profits from an ICO and later faces legal issues, they’ll be dissatisfied. They want projects to thrive and make more money, but when a project fails or turns out to be a scam, they blame the government for not acting quickly enough.

Vlad: This creates a dilemma. On one hand, the crypto community advocates for decentralization and anonymity. On the other hand, when they lose money to scams, they demand investor protection. 

Therefore, regulation and control are necessary to protect participants’ rights and interests. This is especially important with different types of tokens, like stablecoins, utility tokens, and payment tokens, which all require clear legal definitions and responsibilities.

Alex: Oh yeah, stablecoins are starting to become a big issue.

Slava: Indeed! One of the trends over the past two years has been increasing regulation around stablecoins, driven by incidents like LUNA and UST. These events were a wake-up call for regulators, highlighting the need for protective measures. 

Even for qualified investors, stablecoins tied to the dollar must have clearly defined reserves, such as cash or cash equivalents. 

Alex: Thank you for sharing your insights on this fascinating topic. This has been an incredibly informative discussion! I’m sure our audience will find your expertise invaluable.

As we wrap up, I’d like to express our sincere gratitude for your time, thanks for sharing your knowledge. Your insights helped us to understand the complexity of Web3 regulation. It provides our readers with a clearer understanding of the legal challenges and opportunities in this space.

***

To our followers, we hope this interview has been as enlightening for you as it has been for us. As we conclude our “Web3 Regulation Talks with ICON.PARTNERS,” we extend our gratitude to the legal experts at ICON.PARTNERS for sharing their invaluable expertise.

We also want to thank our readers for joining us on this journey of exploration and knowledge. While this marks the end of our interview, the world of Web3 continues to evolve, and we encourage you to stay informed and engaged.