Assessing cooperative structures’ suitability for cryptonetworks
In a recent article, Jesse Walden, founder of Variant Fund, and Connor Spelliscy, Co-Founder of the Blockchain Association, argue that cryptonetworks and projects, with executive teams domiciled in the US, could circumvent the legal issues with their networks’ cryptoassets being classified as securities by structuring their projects and token economies along the lines of traditional cooperatives, rather than corporate structures.
Among other points, the authors suggest that US-based projects have been suffering from a lack of leadership due to founding teams seeking to give up as much power and influence over their projects as early as possible, as to reduce the likelihood of US regulators determining that token holders are benefiting from their efforts, in the spirit of the Howey test’s “efforts of others” clause. Referring to court cases concerning cooperatives from 1975 and 1976 respectively, Walden and Spelliscy posit that, if US projects could satisfy the same criteria that were cited in the aforementioned cases, then the projects may be able to operate as cooperatives. Therefore, founding teams would be able to play a far more active role in their respective cryptonetworks. Specifically, the authors recommend that projects:
- Introduce cooperative governance structures (although there may be no need to formally register as cooperatives).
- Remove any direct relationship between the number of tokens held and voting power, and instead move towards a one member, one vote governance structure.
- Incorporate KYC checks so that members can be verified as independent actors.
- Limit token transfers to and between only whitelisted members, i.e. those who have passed KYC checks.
- Focus on the native token’s utility and do not advertise or focus on token price – whether native tokens can appreciate in value under this structure is an open question in the authors’ view.
- Any earning from the cryptonetwork should be distributed based on a member’s usage of or contribution to the network, rather than token holdings.
- Raise funds only from members and debtholders, and not pure investors.
In addition to these recommendations, the article raises some other interesting points worthy of consideration. For one, it suggests that traditional cooperatives are optimized explicitly for the benefits of involved stakeholders, as opposed to shareholders who are otherwise without stake in the case of corporations. Given that cryptonetworks often solicit the resources of and consumption by multiple independent groups, the authors suggest that they may be better modeled around cooperatives. Furthermore, they argue that cooperative-based cryptonetworks need not give up a strong executive body since it is well established for coops to elect directors and managers for policymaking and operations respectively.
While the article certainly highlights a potential alternative path for US-based blockchain projects, we should be clear that neither of the authors are lawyers nor has there been any review or feedback that we are aware of by any lawyer specializing in cooperative law or the classification of cryptoassets. Whether the cited cases have established any form of precedent that would be relevant to blockchain projects today is also unclear. Furthermore, given the relatively stringent recommendations, referenced above, the cost for transitioning to a cooperative structure would be relatively high for most projects and, as such, may be viewed mostly as an interim solution for some projects until the SEC provides greater clarity concerning cryptonetworks and their respective token economies.
Perhaps the largest question left unanswered is whether members of a cooperative cryptonetwork would be able to financially benefit from the appreciation of the underlying token. By removing direct token financial incentives, a network may struggle to attract the stakeholder interest and engagement, from an initial capital raise via a sale than they would otherwise, thus hurting their growth. Despite these issues, the authors are to be commended for their study and providing a potential alternative, even if interim, path forward for US-based teams who are willing but hesitant to play much more active roles in the cryptonetworks that they have founded.