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Q&A: Crypto Lawyers Talk 3AC Liquidation, ‘Code Is Law’

Crypto centralization and regulation would provide better protections for investors
Three Arrows Capital liquidation is a “test case” that could lead to a “raft of bankruptcy cases”

Blockchain and crypto may aspire to be fully permissionless, but in the meatspace of high-stakes finance, replete with conflicting interests and disparate regulatory regimes, litigation figures to become a prominent feature. 

Advocates often focus on the technology’s promise to eliminate middlemen or trusted third parties. So, where do lawyers — who often act as middlemen to establish trust between transactors — fit in?

Blockworks spoke with three crypto-focused lawyers to get their perspective on crypto’s need for legal counsel.

Timothy Spangler, Dechert LLP

Blockworks: What impact will the upcoming litigation surrounding Three Arrows Capital (3AC) and Celsius have on the crypto industry in the years to come?

Timothy Spangler

Spangler: This period of restructuring and bankruptcies will educate people in the space, and we’ll see that people who retained lawyers and increased levels of protection will have much better outcomes than people who said, “well, crypto is a take-it-or-leave-it environment, it’s all risk, all reward.” At this stage, it’s a conceptual hurdle to jump. People who are investing and building out businesses need to understand that at a high level, lawyers and protections move the needle.

Blockworks: What is a misconception people in the crypto space have about the law?

Spangler: So many people in crypto talk about “code is law.” Code says what code says and digital assets do what they do. Code isn’t law, code is code. Law applies to any sort of transaction, and the purpose of law is about shifting losses from where they fall to some other party. Historically, when the sums of money get larger, the amount of lawyering that goes on around those sums of money increases. And the sums of money are now sufficiently high around crypto that you’ll see that start to happen.

Blockworks: What do you make of the debate regarding whether decentralization is a myth in the crypto space?

Spangler: Decentralization is not a statement someone can say. Decentralization is a fact that needs to be established and proven. Wagging your finger in the air and saying “we’re decentralized” is not enough. If people set up a [decentralized autonomous organization] and are involved in its operation, it’s hard for that platform to be decentralized enough to protect those people from liability. People harm themselves because they act like they’re bulletproof and don’t have a care in the world and think they’re beyond the reach of law enforcement, and that’s the worst thing you can be. Liability is real. Prepare for it.

Timothy Spangler focuses his practice on the intersection of alternative investment management and financial technology, including the impact of blockchain, cryptocurrencies and digital assets on the financial services industry and the innovation economy.

William Brannan, Lowenstein Sandler LLP

Blockworks: How do you think US regulatory efforts in the crypto space are going to shake out?

William Brannan

Brannan: I’m not confident there’s going to be meaningful regulatory guidance in the short term — that hasn’t been the case for six, seven, eight years now. At this point, crypto is so diverse in its applications that you have a number of projects that seem to dip into different regulatory regimes. But these questions are not new — we’re now just seeing those questions become more important to find solutions to. Regulation is a little esoteric when the market is great and everyone’s making money, but it’s more pressing when the market is down and everyone is facing liquidity issues.

Blockworks: Should crypto companies strive for decentralization?

Brannan: There’s a constant tension between the principles of decentralization and what I think most retail investors are really looking for — between the tech entrepreneurs who are building these products and what the average customer wants. If crypto companies insert some level of centralization, the trade-off from a retail perspective may be worth it.

Blockworks: In the current market, a lot of crypto companies are facing insolvency. What should companies be doing to stay sustainable in the long term?

Brannan: If you’re a platform that faces retail customers, a huge element of creating a successful platform is making sure that you’re educating those retail customers. Retail customers see they can earn 12% yield on their cryptoassets, but it takes a long time to educate a customer on the risks involved. Losses become very concerning for the retail investor when they don’t understand what it is that they’ve bought into.

Will Brannan is a partner at Lowenstein Sandler and vice chair of Lowenstein Crypto, which provides counsel to the industry’s most sophisticated entrepreneurs, financial institutions, venture investors, asset managers and financial technology companies.

Paul Ferguson, Addleshaw Goddard LLP

Blockworks: What’s novel about the 3AC liquidation from a legal perspective?

Paul Ferguson

Ferguson: There’s an interesting provision in the liquidation order that says the liquidators have the power to sell any crypto or convert to fiat currency to protect against volatility. That provision has never existed before, but the price of bitcoin has plummeted, so creditors can transfer the money into a more stable asset. But no one quite knows how a liquidator is going to deal with cryptoassets.

Blockworks: How do you think the legal field feels about the liquidation?

Ferguson: 3AC is a test case. Everyone is watching what’s going to happen, and then you’ll see a whole raft of bankruptcy cases. People have lost their life savings in this.

Blockworks: And what will the broader outcome of those bankruptcy cases be?

Ferguson: I think you’ll see capital requirements like what exists for banks. If you’re going to take deposits from Joe Public, you’ve got to guarantee you can pay that back. Post-Lehman, most banks face stringent capital requirements, and I definitely foresee something similar happening in the crypto sphere. I don’t see how crypto platforms can survive without similar protections, and I don’t see why they’d want to. If you want people to give you their money, then why would you not want a requirement in place? And given the volatility of cryptoassets, the capital requirement will need to be greater than for fiat.

Paul Ferguson is a UK-based lawyer whose practice is centered around claims involving digital assets, cryptocurrencies, online trading platforms and the recovery of assets from cybercrime. His previous firm was employed by Craig Wright, who claims to be Bitcoin founder Satoshi Nakamoto.

Comments have been edited slightly for clarity and brevity.

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