How to Build Regulatory Compliant Web3
Mike Frisch, Partner, Croke Fairchild Morgan & Beres
Paul Hsu, Founder & CEO, Decasonic
Of the many challenges facing founders in Web3, perhaps the most daunting is the uncertain regulatory environment. All well-intentioned entrepreneurs want legal certainty and clarity.
But in the U.S. alone, Web3 founders face an ever-evolving collection of laws and regulations that apply (or don’t) depending on a host of shifting considerations. Efforts at new regulation in the U.S. and overseas further complicates the picture, as founders need to plan for what may be coming with the next Congress.
Innovation can oftentimes speed ahead of regulation.
This ambiguity in regulation can present challenges or opportunities for founders and investors to navigate. Paul Hsu has helped build billion dollar Web2 products from scratch, and now with blockchain projects that scale for mainstream adoption. Mike Frisch helped to develop the regulatory framework for crypto at the CFTC and now works with Web3 founders.
Based on our collective experiences, we have compiled a list of five key areas a Web3 founder should collaborate with a trusted legal advisor:
1. Engage a trusted legal advisor to architect the strategy.
Web3 founders need what Dane Lund at AllianceDAO calls a “legal architect” – a trusted advisor and thought partner who can help navigate your project through all the stages of growth. We recommend that speaking with a trusted attorney is one of the first things that Web3 founders should do.
For one, most projects need a legal entity like an LLC to protect the members of the team (and investors) from unlimited personal liability should things go wrong. Choosing the right entity, in the right jurisdiction, is an important foundational decision that can have lasting ramifications if a poor choice is made. The corporate form, how to incorporate, and where to incorporate are all decisions that founders should not make alone.
What’s more, an hour at the very start can be invaluable because of a concept lawyers call “issue spotting.” A lawyer may not have all the answers right away, but an early dialogue can often help a founder identify potential issues or pitfalls and start to plan on how to address them.
2. Drive optionality when raising capital
Given the wide range of web3 investors and financing options for most companies in Web3 we recommend consulting with your attorney whenever you seek to raise capital.
Optionality is important, and founders should seek to avoid being locked into a specific structure that may be a poor fit when taking on investors.
For example, SAFTs have fallen out of favor for many applications, and other structures (e.g. SAFE + warrants) better permit founders to pivot as their plans evolve. There are token only deals, SAFE only considerations, priced rounds, convertible debt, among the many potential ways to finance your company.
3. Embrace a legal & product design collaboration
More than in most industries, Web3 product design is closely bound with legal design. With that in mind, your legal architect will be at least tangentially involved in all the aspects of product strategy and design, including if applicable: tokenomics, the mechanics of DAO governance, and other aspects of the ecosystem you’re building.
It’s relatively easy to make tweaks to design based on legal input before a product launches. But we’ve seen examples of mature projects with thousands of users that launched without a legal review. By then, a project is well-defined in the eyes of the market and the technology is baked in, and the options for change are significantly more limited.
4. Demonstrate a commitment to compliance
The best and most lasting companies make regulatory compliance a part of their DNA. This means that as companies grow, they invest in the policies, procedures, and partnerships to ensure that compliance becomes a competitive advantage for them.
First and foremost, this means that founders must make the effort to build a culture of doing the right thing. It also means investing where appropriate and necessary, for example, in geo-fencing certain services, age-restrictions, thoughtful privacy policies, KYC/AML, OFAC control, trade surveillance, anti-manipulation, and so on.
Even young companies should be able to defend their decisions if called upon to do so by regulators. This is impossible to do unless you’re working with a trusted attorney.
5. Monitor developments in regulation
Laws continue to evolve. The right attorney who is plugged in to what’s happening in the relevant centers of power can help founders plan for these changes. She can also be a conduit to industry groups, self-regulatory associations, and other consortia that can allow your voice to be heard in the right policymaking venues without making yourself a target of government attention. Moreover, guidance from your legal counsel can help inform a self-regulatory approach, embracing what will help to define responsible innovation.
We are early in Web3 and the legal and regulatory framework continues to evolve to catch up to this innovation. The best founders embrace this uncertainty, solve key problems left open by Web2, and help define how to best impact society for the better.