Author: Atharv Bhatkhande, Avantika University
Abstract:
Cryptocurrency is equally a revolution in technology as it is an economic revolution specifically created to circumvent, make irrelevant, and eventually exist beyond, the boundaries of established legal structures. Its very nature – decentralization, pseudonymity, immutability, and permission lessness – precludes an area of jurisdiction, and therefore customary mechanisms of legal enforcement are necessarily inapplicable. Any attempt at “regulating” crypto under 20th-century paradigms is impossible because an attempt to regulate the internet on the basis of law vs. fax machines. Lawyers will have a decision: reinterpret their definition of sovereignty, liability, and enforcement in this new environment or risk making law itself obsolete in the new frontier.
The din regarding cryptocurrency – hype over its “financial freedom” and threat of scams and ecologism – all too often loses the forest for the trees. With contract doctrines, property doctrines, tort doctrines, and constitutional jurisdiction doctrines well understood as a law student, an ominous and evil truth is revealed. Cryptocurrency in itself is a brazen, intentional attack on the pillars of state sovereignty and rule of law. Its final triumph is not in Bitcoin’s price, but in its proven ability to survive in an architecture explicitly designed to be outside the control of any centralized authority of juridical power to intimidate. It is not disruption; it is an internet-era constitutional crisis. We need to set aside earlier hopes for sane regulation or sane adoption.
The argument here is founded on an assumption which is axiomatic: Blockchain was created, constructed, and shared with the sole intention of structuring systems wherein the conventional legal control technologically becomes impractical or functionally not practicable to impose. The common problems of regulatory agencies globally are not being induced by funds or will but by incompatibility between legal toolkit and technological DNA. We, future attorneys, need to accept this grim reality, rather than holding on to precedent as it goes under. The law operates on hard facts, bounded spheres, and actual cures.
Blockchain technology, in its most iconoclastic “permissionless” versions such as Bitcoin and Ethereum, eradicate all of these in a systematic manner. Decentralization is the most deep and important of these. By spreading authentication of information and consensus through a global network of pseudonymous or anonymous nodes, there is no server to hack, no headquarters to take over, no CEO to subpoena. It creates an intensely proximate jurisdictional nexus issue of unprecedented scale. If a DeFi protocol is hacked for millions of dollars, who is to blame? The unnamed development team that can be dispersed across five continents with no corporate footprint? The decentralized global network of verifiers, each maybe in a different country? The immutable code of the smart contracts themselves? Using lex loci delicti commissi as a joke when “place” is a decentralized global ledger. Compliance is a whack-a-mole joke, hammering on-ramps on the margins like exchanges, as life in the middle keeps going on it unstop ableness.
The paradigmatic 2016 DAO hack is a dark omen. Presented with the pilfered millions of pilfered Ethers, the Ethereum community did not go to the courts; they established a contentious “hard fork” – a technical patch altering the blockchain’s history. This was not law; this was unbridled network consensus with technological muscle, illustrating irrevocably where true power lay at the time – not in a state nation, but in code and the people who possessed the power of its authorship. Pseudonymity, shortly afterwards tainted with anonymity, is a pale veneer of protection from attribution imposed by the law of blame. While work is documented in an open public book forever with alphanumeric wallet addresses (like “0xAbC123.”) linked to living body-and-soul humans under law, correlation of same requires additional investigating work at conventional exchange points at the centre of jurisdiction duress.
By such intentional disruption of the nexus, it is distorting the very doer-deed nexus on which tort, contract, and most importantly, anti-money laundering (AML) and combating financing of terrorism (CFT) regimes are based. It is a hypothetical legal construct to create “0xDef456.” who is committing fraud, breach of contract, or sanctions evasion with impunity in spite of the possessor party. Not random form, but an ethos to guide, the cypherpunk ethic of privacy and opposition to state control, in accordance with dogma against violating the veil of the corporation where attribution is deliberately obscured by underlying technology. The early heroes’ “Code is Law” dogma suggests the third reason for revolution: immutability. Transactions, once confirmed and written to the blockchain, are cryptographically placed in place and more or less unreversible.
Smart contracts execute precisely as written, with no human comprehension or context in between. That’s the exact opposite of two centuries of juridical development to infuse fairness and justice into hard-and-fast rules. Judicial concepts of mutual mistake, fraud in performance, duress, unconscionability, and force majeure are mechanisms for preventing or curing unjust results. Immutability of code on a blockchain provides nothing. If a bug in a program of a smart contract empties a user’s life savings through an unsuspected glitch (a despairingly frequent phenomenon in DeFi), the technical solution is usually a resigned “caveat emptor” – the code run. Such technology determinism is the notion contrary to judicial discretion in equitable remedies such as rescission or restitution.
A reversal of a fraudulent transaction by a court is theoretically impossible on a fully decentralized chain except through creating another network-wide fork – having simultaneous legal (or, more realistically, illegal) reality, e.g., Ethereum Classic (ETC) forking from Ethereum (ETH) after the DAO hack. That hardness also fossilizes reason, freezing contractual language or juridical knowledge in a state of being and keeping them from evolving organically over time so that smart contracts become stale or dangerous when circumstances change. Lastly, their permission lessness is a necessary negation of gatekeeping regulation. With an internet connection, an individual can download a wallet, buy crypto (most often, peer-to-peer), play with DeFi protocols, mint an NFT, or even develop one’s own token, all without the permission of any financial regulator, central bank, or securities commission. It inverts the very nature “permissioned” character of finance today where banks need charters, brokers need licenses, and security offerings need registration or exemption.
Regulators, more used to seeing and greenlighting them first, before they go out, are perpetually in catch-up mode, trying to be one step ahead of what is occurring. Innovations such as algorithmic stablecoins or advanced yield-farm plays launch internationally the moment code goes live, side-stepping any form of pre-emptive oversight from regulators. Enforcement is turned around ex post facto, jurisdictionalized, resource-based, and in the vast majority of cases only available in weak peripheries (e.g., taxing centralized swaps or knowable sponsors), with underlying protocols left untouched. The repeated failure of the SEC to successfully apply the Howey Test (in SEC v. W.J. Howey Co.) to the enormous, constantly changing universe of crypto assets is a paradigmatic example of mismatch at a structural level. Is a development-sponsored token a security sold? How about a token allowing voting rights to be cast in a DAO? Or for use only to pay transaction fees? Permissiveness to issue tens of thousands of tokens renders classification and pre-approval a practical impossibility. The Proof is in the Long-Term Mayhem: Crypto’s criminality by design is not documented, but in the hack books, the cons, and the failure of regulation. From the exception of the DAO, think about the Mt. Gox collapse (2014), when it processed 70% of all Bitcoin transactions, jurisdictional authorities and anonymity hindered recovery for decades. The QuadrigaCX saga (2019) identified the last central weak link in otherwise decentralized systems, when the CEO passed away with the private keys (and control of $190M CAD).
The Terra/Luna (2022) and FTX (2022) blowups were not blowups but stress tests that proved the blanket failure of existing legal structures to prevent systemic risk or protect consumers in a bottomless, 24/7 world. Regulatory agencies such as SEC, CFTC, and their foreign equivalents impose fines and litigation (e.g., SEC v. Ripple Labs Inc. on the question of whether XRP is a security, SEC v. Coinbase), but the enforcement action is against knowable parties. (Typically centralized.) Or against some offerings but not against some underlying protocols per se or against their anon users thereof. The infrastructure networks – Bitcoin, Ethereum – remain unscathed, unhurt, by such enforcement measures.
The last pressure on Travel Rule compatibility (demanding sender/receiver reporting from VASPs) is directly put on the intermediaries, not on the peer-to-peer transactions forming the network. Case Laws Illustrating the Gap: Legal case law also illustrates the tension. Implicitly speaking to root protocol disobedience too frequently, it depicts the dilemma: Jurisdictional Quagmire: Wright v. BTC Core (trying to copyright and claim ownership of Bitcoin) shows that courts can’t use convenient laws (i.e., intellectual property or property) to utilize on distributed networks.
Who is the proper defendant? Where is the locus of control? Smart Contracts and Legal Intention: Cases as there are currently smart contract hacks (some of the hacks on DeFi, for example, the Poly Network hack) that put courts in a bind. If strict technical compliance with code has to be followed even where this equates to an apparent miscarriage of justice or frustrates parties’ ascertainable intention (an early principle of construction of contracts)? Or can a court attempt to impose an equitable result that technology defies? Few courts possess the technical expertise or jurisdictional sensitivity necessary to operate competently on-chain.
Technological Reality vs. Overregulation: SEC v. Ripple-type cases turn on whether a particular token sale was an unregistered sale of a security under the Howey Test. Despite being contractually obligated to protect investors, these examples say nothing at all to our case: How do you regulate issuance and trading of thousands of tokens preloaded permissionless onto international networks in the rearview mirror? A victorious ruling for Ripple does not somehow grant the SEC enforceable control over the XRP ledger as a thing or its pseudonymous participants. Conclusion: Navigating the Inevitable – A Call for Legal Evolution “The conclusion is inevitable: Cryptocurrency works in a world purposefully designed to be a legal terra nullius.
Its indigenous technologies present insurmountable challenges to enforcement and operation of existing laws.”.
The new argument is not that it’s difficult to regulate but rather that traditional regulation in its current form and practice is technically incompatible with the inherent nature of permissionless, decentralized blockchains.
Attempt to stuff legal square pegs into such cryptographic round holes is pointless exercise squandering humongous resources on wastage with very peripheral, low-impact on the underlying networks.
This is not a call for anarchy or acceptance of lawlessness. This is a call for revolutionary legal evolution. The future requires: Paradigm Shift Identification: Lawyers, regulators, and judges need to overcome the cognitive map of thinking crypto as finance or securities law alone. We require new legal lexicon and thinking model for decentralized systems, digital bearer assets, and algorithmic governance. Tech-Savvy Regulation: Regulation must aim at interfaces to the vintage system (exchanges, custodians, fiat gateways) and measurable objectives (reduction of systemic risk, consumer protection stipulations on product offered, illicit finance controls at entry/exit points), rather than quixotic attempts at regulating unregulatable central protocols. Principles-based regulation is potentially more responsive than rules-based. Embracing Innovation in Enforcement: New openness to tech solutions of compliance (such as privacy-safeguarding analytics, zero-knowledge proofs for regulated disclosure) and global cooperation on an unprecedented scale is unavoidable. The notion of jurisdiction itself must be reconstructed in the digital age.
Rebuilding Legal Liability: We need to build liability attribution models in decentralized space – perhaps based on governance token holders, de facto-controlling central devas, or even “protocol liability” as a theoretical construct in general. Principles of agency and vicarious liability must be re-defined digitally.
Preparation for “Lex Cryptographia”: We can anticipate the development of a new generation of traditional “law” guided by community consensus, protocol changes (voting based on tokens), and decentralized arenas for dispute resolution (nascent and obstreperous as they are now). Counsellors will need to observe and learn to operate within these new systems.
Denial of the insurrectional reality infused in crypto code is professional misconduct. The crypto-decentralization tide of attorneys has hit the recalcitrant case of classical legal sovereignty. Something is breaking down. As would-be lawyers, our decision isn’t whether to wrestle with this fact, but how we redefine our vocation so that it is healthy to it. The era of attorneys who understand casebooks so they understand no code is limited. The future will be owned by the person who can chart the new uncharted legal landscape of the blockchain.
FAQS
Q: Aren’t regulators finally taking action? SEC/FCA/etc. are suing the world!
A: Regulator action is generally against centralized players (issuers, exchanges) or identified, recognized Ponzi schemes. They don’t, and can’t, stifle utilization of the underlying Bitcoin or Ethereum networks, or substantially police pseudonymous participants in de facto decentralized protocols. The suits are fascinating on a market cleaning basis but treat symptoms, not underlying architectural defiance.
Q: Isn’t this implying that crypto is for criminals?
A: Like money, there will be criminal usage (like money), but technical circumvention of compliance measures impacts all usage on the network, both positive and negative. The underlying issue is the circumvention of legal enforcement tools and tools in a blanket framework, and it crosses with consumer protection, contract enforcement, and financial stability as much as it crosses with anti-crime policy. With criminalization as gadgetry, it overstates how great the legal issue is.
Q: And then stablecoins and Central Bank Digital Currencies (CBDCs)? Don’t they constitute regulated crypto?
A: Every one of the big stablecoins (e.g., USDC, USDT) has a central issuer that is reserve-backed and hence exposed to traditional regulation. CBDCs are a different type – electronic embodiments of sovereignty money, issued and regulated by central banks, subject to current jurisdictions of law. They are employing some applications of blockchain but not the very basic permissionless, decentralized, pseudonymous applications that embody legal disobedience envisaged here.
Q: What is it that you are concerned about if you are a law student?
A: Deep understanding of the technology (smart contract, blockchain operation, fundamentals of cryptography), conflict of laws, international law, foundations of financial regulation, new fields such as DAO governance and digital asset law, and knowledge abilities in examining complex systems. Technical proficiency is no longer an option. Think outside precedent; think about how law may or ought to operate in a world that is decentralized.