Challenges and opportunities of blockchain technology to legal services

Web 3.0 in the focus of VC investors

Web 3.0 and decentralized finance (DeFi) have recently attracted substantial VC investments. The Emerging Tech Indicator by PitchBook, which is based on the evaluation of investments by selected, particularly successful VC firms, shows a total volume of over $6 billion (early and seed stage) for a rolling twelve-month period up to March 31, 2022, of which just under $2 billion was invested in the first quarter of this year alone. These investment volumes took the top position in each of the periods mentioned, well ahead of the following sectors such as bio- and fintech. Fundraising through the sale of tokens has not yet even been taken into account when determining these figures, so the real volume is presumably substantially higher.

Selected large scale Web 3.0 and DeFi deals in the first quarter of 2022 include a $450 million Series Seed round for US-based Yuga Labs, parent company of the Bored Ape Yacht Club NFT collection, and a $400 million Series A round for FTX's US trading subsidiary. The Tom Brady backed NFT platform Autograph secured $170 million in a Series B round. Binance Labs, a subsidiary of crypto exchange Binance, most recently raised $500 million to invest in Web 3.0 start-ups.

Embedded in the development of Web 3.0 is the continuing emergence of the Metaverse, i.e., internet-based, permanently established and interconnected virtual worlds in which users can move in real time – for example, using virtual and augmented reality. A number of powerful players from various industries are involved in the evolution of the Metaverse. With Games Fund One, Andreessen Horowitz (also called a16z) has recently launched a $600 million fund, which focuses on investments in the gaming sector of the Metaverse. With a $2 billion investment from Sony and Lego, Fortnite developer Epic Games is pursuing its own Metaverse-related plans. The gaming industry was arguably a major focus of VC investments in the past year of 2021.

Leading financial institutions such as JP Morgan are yet skeptical of the further funding development: JP Morgan expects a 50% decline in crypto investments by the end of this year. The entire crypto industry has recently suffered from a deteriorating financial environment.

New legal territory: Metaverse, tokens and fundraising

Like any major technological development, the move from Web 2.0 to Web 3.0 raises a variety of legal and regulatory questions. For example, the development of the Metaverse could pose challenges to players, particularly in terms of competition or copyright law and, by its very nature, data protection law. Since the Metaverse is not bound by national borders, effective legal advice requires a cross-border approach by specialized legal experts with a particular footprint in IT and data privacy laws such as Taylor Wessing, which was recently named "Law Firm of the Year" in IT-law by the German business newspaper Handelsblatt.

For VC investments in particular, the aforementioned funding trends through tokens may also have legal implications. In principle, the diverse nature of tokens makes a clear legal classification of tokens (and the related rights and legal framework) difficult. The issue applies at both European and national level ­– there has been no harmonization of the EU regulatory framework to date, with the result that the regulations in the member states differ significantly. From a regulatory perspective, the question of whether the sale of tokens in the context of an Initial Coin Offering ("ICO") triggers prospectus or permission obligations is of great importance, which in turn depends on the legal nature of the specific tokens offered as part of a funding round. The German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) for example, distinguishes in its regulatory framework between utility tokens, payment tokens and security tokens. The latter generally constitute securities and are therefore highly regulated. BaFin also recognizes the existence of hybrid tokens that combine characteristics of different token categories. Thus, classification in individual cases regularly requires the support of specialized experts. There is also a need for comprehensive legal advice on the part of investors, for example on tax or M&A-related issues, considering the special characteristics of crypto assets.

Hence, new legal perspectives arise for future VC (token) investments. ICOs require the agreement of an appropriate legal framework between the companies and the investors. This is achieved through the conclusion of so-called token (purchase) agreements. Continuing best practices and standards for their structuring are not yet emerging in Germany. In any case, we believe that ICOs will establish themselves further as a financing channel in Germany. Taylor Wessing will continue to closely follow and shape the ongoing development of Web 3.0-related topics and offer clients specifically tailored legal solutions.

Co-Autor: Philipp Bergjans