Legal and Compliance Considerations for Web3 Fundraising

Fundraising is a critical step for any Web3 project. However, the regulatory landscape for Web3 is still evolving, which can make navigating the legal and compliance requirements complex. This essay provides an overview of the key legal and compliance considerations for Web3 fundraising globally. It is written for founders and core teams of Layer 1 blockchain projects and DeFi platforms, projects ranging from early-stage to growth-stage, the broader Web3 community, and potential partner VCs and ecosystem players.

Have you considered the legal implications of your Web3 fundraising strategy? Are you aware of the potential challenges and risks? By understanding the key legal and compliance considerations, you can help ensure that your fundraising efforts are successful and compliant with applicable laws and regulations.

One of the first things to consider is the tension between decentralization, a core principle of Web3, and the need for regulatory compliance. Balancing these two can be a significant challenge for Web3 projects.  

Securities Laws

One of the most important legal considerations for Web3 fundraising is securities law. In many jurisdictions, tokens issued in a fundraising may be considered securities. This means they are subject to securities laws, which can include registration requirements, restrictions on who can invest, and disclosure requirements.  

In the US, the Securities and Exchange Commission (SEC) has taken the position that many tokens offered and sold by Web3 companies are securities. The SEC uses the Howey Test to determine whether an investment contract exists. The Howey Test has four prongs: (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits, and (4) solely from the efforts of others. If a token is deemed a security, it must be registered with the SEC unless an exemption applies.  

For example, imagine a token offering where investors contribute money to a project with the expectation of profits based primarily on the efforts of the project team. This token offering would likely be considered a security under the Howey Test.

It's important to note that applying traditional legal frameworks, like the Howey Test, to Web3 projects can be challenging. The decentralized and often open-source nature of Web3 projects can make it difficult to fit them neatly into existing regulatory categories.  

Exemptions from registration requirements may be available for certain types of offerings, such as offerings to accredited investors or offerings that meet specific criteria under Regulation D of the Securities Act of 1933.  

A comprehensive legal opinion on your token can facilitate its listing on exchanges. This document should provide a detailed analysis of your token's compliance with relevant laws and regulations. A favorable legal opinion signals to investors and partners that your token issuance adheres to legal requirements, thereby reducing perceived risks and potentially attracting higher levels of investment.  

Legal Instruments for Web3 Fundraising

Web3 projects use various legal instruments for fundraising, each with its own set of legal and compliance considerations.

Some of the most common instruments include:

• Token Warrants: Token warrants grant the holder the right, but not the obligation, to purchase tokens in the future at a predetermined price. They are similar to options in traditional finance and offer investors a way to speculate on the future value of a project without immediate full investment.  

• SAFTs (Simple Agreements for Future Tokens): A SAFT is a contract that allows investors to buy tokens at a future date, typically upon the occurrence of a specific event, such as the launch of the token. SAFTs are often used in early-stage fundraising when tokens have not yet been issued.  

• Token Sale Agreements: A Token Sale Agreement is a contract that governs the sale of tokens to investors. It typically includes details such as the number of tokens being sold, the price of the tokens, and the vesting schedule.  

When choosing a legal instrument for your Web3 fundraising, it's crucial to

understand the token's role in your project's business model. This will help you determine which instrument is most appropriate for your needs and ensure that your fundraising strategy aligns with your long-term goals.  

Another important consideration is the use of a Special Purpose Vehicle (SPV) for token issuance. An SPV is a separate legal entity created specifically for issuing tokens. It can help isolate financial and legal risks, protecting the main business entity's assets and reputation.  

Tax Implications

The tax implications of Web3 fundraising can be complex. The tax treatment of tokens can vary depending on the jurisdiction and the specific facts and circumstances. For example, in Japan, the Web3 White Paper 2024 recommends that income taxation on crypto-assets held by individuals be subject to 20% separate taxation, rather than the current aggregate taxation of up to 55%. However, this is a recommendation, not the current law. Web3 businesses should consult with tax advisors to ensure they comply with all applicable tax laws.  

Data Protection and Privacy

Web3 businesses often collect and process large amounts of user data. This data may be subject to data protection and privacy laws, such as the General Data Protection Regulation (GDPR) in the European Union. Have you considered how your project will comply with GDPR when collecting user data? Web3 businesses must ensure they comply with these laws, which may require obtaining user consent, implementing data security measures, and providing users with certain rights regarding their data.  

The EU Data Act is another important regulation that aims to improve data accessibility and promote a competitive cloud market in Europe. It has implications for Web3 businesses by increasing transparency, mandating consent-based data processing, and enhancing individual control over data.  

Anti-Money Laundering (AML) and Know Your Customer (KYC)

Web3 businesses that deal with cryptocurrencies or other digital assets may be subject to AML and KYC regulations. These regulations require businesses to verify the identity of their users and monitor transactions for suspicious activity. This can help prevent money laundering and terrorist financing.  

Jurisdictional Considerations

Web3 fundraising often involves investors and participants from multiple jurisdictions. This can raise several cross-border legal and compliance issues. For example, Web3 businesses may need to comply with the laws of multiple jurisdictions. They may also need to consider the tax implications of cross-border transactions.  

Different jurisdictions have varying approaches to regulating Web3 activities. For example, the US has a more stringent regulatory environment compared to some other jurisdictions. In Asia, countries like Japan have been actively developing regulatory frameworks for crypto-assets and Web3.  

Intellectual Property

Protecting intellectual property is crucial for Web3 projects. This includes securing trademarks for project names and logos and ensuring that the project's code and other creative works are protected by copyright. Web3 businesses should have a clear strategy for managing and protecting their intellectual property assets.  

Consumer Protection

Web3 businesses must take steps to protect consumers from fraud and scams. This can include providing clear and accurate information about the project, its risks, and its potential rewards. It also involves implementing security measures to protect user funds and data.  

Virtual Asset Service Providers (VASPs)

Virtual Asset Service Providers (VASPs) are businesses that provide services related to virtual assets, such as cryptocurrency exchanges and custodian wallet providers. VASPs are subject to various regulations, including AML/KYC requirements and licensing obligations. Web3 businesses that fall under the definition of a VASP in their jurisdiction must ensure they comply with all applicable VASP regulations.  

Internal Organizational Structure

A well-structured internal organization is crucial for the legal and operational success of your Web3 project. This includes having clear legal agreements within your company, such as founder agreements, team contracts, advisor agreements, and IP rights assignments. If your project involves a Decentralized Autonomous Organization (DAO), you'll also need to consider the legal implications of DAO structuring.  

Conclusion

Web3 fundraising presents a unique set of legal and compliance challenges. By understanding these challenges and taking steps to address them proactively, Web3 businesses can increase their chances of a successful fundraising round while mitigating potential risks. This includes seeking legal counsel, understanding the applicable laws and regulations in each relevant jurisdiction, developing a comprehensive compliance plan, and choosing the right legal instruments for your fundraising needs. Remember to prioritize data protection and privacy, consumer protection, and intellectual property management. By taking a proactive and informed approach to legal and compliance matters, you can build a solid foundation for your Web3 project's long-term success.