Advice for RWA Entrepreneurs: Legal Engineering is Crucial

Original Author: prestonbyrne

Original Compilation: Luffy, Foresight News

Before diving into the boring legal issues, let me tell you a story from ten years ago.

In June 2014, I co-founded the first permissioned blockchain company with two others. (Yes, this should be the first permissioned blockchain company, as noted in an article about us published by Mike Casey in The Wall Street Journal a year later.) We had three co-founders: Iraq War hero and legal hacker Casey Kuhlman, distinguished quantum mathematician and LLL smart contract coder Dr. Tyler Jackson from the University of Guelph, and myself.

The project originated from a competition, specifically a bounty announced by Bitcoin enthusiast and Hoppean anarchist Olivier Janssens shortly after the 2014 Bitcoin conference in Amsterdam. Around the same time, Brock Pierce, who was famous for Mighty Ducks and is now known for his collaboration with industry leader Blockchain Capital, was elected to the board of the Bitcoin Foundation. This was considered a controversial move in some circles. Pierce had mixed with some bad actors in Hollywood during his youth, and his opponents pointed to these experiences as reasons against his involvement in the management of the Bitcoin Foundation.

I was not involved in that fight. However, for the sake of this story, you should know that Pierce's opponent, Janssens, was involved. In fact, he was so angry about Pierce's election that he announced a $100,000 bounty, attempting to replace the Bitcoin Foundation with computer code. Casey, Tyler, and I quickly formed a team to design, code, and publish a white paper explaining the first Ethereum DAO, which we called Eris, that would allow users to operate non-profits and conduct crowdfunding on a new, yet-to-be-launched platform called Ethereum, specifically on the proof-of-concept version 3 of Ethereum.

Janssens was dismissive of our use of a blockchain platform that was not Bitcoin, and he awarded a $50,000 (instead of $100,000) prize to then Bitcoin core developer Mike Hearn for his slides. (Hearn famously exited Bitcoin in anger during the bear market two years later in 2016.) Janssens also generously awarded our team a $10,000 second prize to alleviate our plight.

This prototype later became the first permissioned blockchain client and ultimately completed tasks such as the first commercial paper application for the R3 bank consortium and the first bond prototype deployed by Deutsche Bank.

In other words: we set out to merge the crypto world with the real world. We failed, and frankly, most other similar experiments over the next decade also ended in failure.

While we were quite unsuccessful in selling software, our ten-person workshop successfully convinced banks that our prototype was viable. And during the years of competing with companies that plagiarized our ideas, we were also successful. They would call, pretending to want to invest, and then raised millions of dollars using their traditional finance backgrounds, trying to steal our thunder, like Blythe Masters' Digital Asset Holdings and R3. They had no originality, and trying to mimic us was a bad idea because we were still too early.

I tell you this story now because I see it resurfacing in two areas: first, in the DAO space, where experiments with new types of organizations often confuse the software of the organization. Secondly, in the so-called RWA (i.e., "real-world assets") space, I see new entrepreneurs eager to follow up on the massive victories of cryptocurrencies by building more bridges between our industry and traditional finance in the form of ETF approvals.

We have learned some lessons from the past, and you must relearn them, hoping this is the easy way rather than the hard way. One of the lessons is…

The combination of RWA and blockchain requires legal engineering.

If you read our Eris white paper, we wrote ten years ago:

"One of our primary design goals is to continue designing and building DAOs that fully comply with legal and regulatory obligations. Below are the types of features included in Eris version 0.1, which we combine with real-world legal entities (preferably non-profits) so that these organizations can benefit from the significant efficiencies brought by blockchain and cryptographic technology while still complying with the laws of their jurisdictions."

Keep in mind that we wrote this article in 2014, before Ethereum and DeFi emerged.

After the ETF, I believe the era of on-chain RWA may be upon us. Some smart young people will solve this problem, while most will not. I have seen and will continue to see many projects that call themselves "DAOs," ignoring the legal structural part of the puzzle, creating a token, and then hoping it will solve everything. For example, the first large DAO, known simply as "The DAO" in 2016, appeared two years after our DAO but completely botched the legal structure, and even without reentrancy errors, it was doomed to fail.

Algorithmic stablecoins like Basis and clone versions of Luna are other projects that did not comply with the law. I read their white papers and saw nothing but a cargo cult-like legal thinking, indicating that the authors' understanding of basic financial law and economics was roughly equivalent to that of a freshman in a bottom-ranked business school.

Many of these project founders in their twenties come from Stanford, Princeton, Google, and Jane Street, yet in real life, they are as foolish as a hammer. Look at how Basis and Luna, in particular, dealt with concepts like "bonds," "stocks," the Federal Reserve, taxes, and promises of "predictable returns under all economic conditions." Unsurprisingly, these projects all ended in failure.

As we enter another cryptocurrency boom, I expect to see and have already seen many developers building and deploying incomplete new asset protocols or immature DAOs that lack very basic legal elements, hoping that a bull market will solve the problems their code did not. Hear me out: a bull market will not fix your incomplete projects; it will only exacerbate the consequences of mistakes.

You can avoid these mistakes. Of course, the lesson is that when you want to build products for people beyond shitcoin degens (I consider myself one at certain times of the day), you must do more upfront design work and consider the "real-world" part of "RWA," leaving nothing out.

For blockchain developers exploring the RWA space, my advice is: Remember that RWA on the blockchain is a permissioned system on a permissionless system, a permissioned smart contract on a permissionless chain. Assets must have their own rulebook, which is separate and distinct from the chain on which the asset resides.

That rulebook is always a legal rulebook. Smart contracts must respond to court orders, so they will almost certainly require administrative revocation/"master key," which can rewrite any aspect of the asset's ownership or behavior as needed (of course, without deleting the asset's state changes, as that is impossible). Compliance with legal procedures, including revocation, is a necessary condition for market acceptance.

When you build these things, make sure you have a lawyer who is very familiar with the asset class you are working with, understands the rulebook of that asset class, and is not placed in the legal department but integrated into the business function. In other words, integrate that lawyer into your development team early to ensure your specifications align with real-world requirements.

By doing so, you will have a better chance of building an application that fundamentally changes the way these assets are owned and traded.