Crimes Inside the Unregulated Blockchain Networks: Qualification Problems
While wide competition between the blockchain and the law as two tools of global human behavior regulator sounds like a Sci-Fi plot, implications of blockchain behavior regulation yet smaller by size but the same sort by nature are popping up constantly. An unregulated distributed ledger network is a social phenomenon. What is inside the DAO is not always covered by conventional law and instead is regulated by code and managed through a consensus mechanism. Meanwhile, elements of the DAO’s inner social structure are similar to that of the conventional world. There are assets, legal facts and acts, there is the behavior of DAO members, which potentially can violate rules of code, and it can also violate rules of conventional law: civil or criminal. In course of further development that may lead to a “reality split”, meaning the existence of some facts and acts important to individuals but existing only in the DAO realm. In order to cover blockchain unregulated network inner world by national jurisdictions, governments and technology developers are to find the solution to the information asymmetry problem and establish law enforcement mechanisms. This article will examine possible ways of legal qualification for criminal behavior inside the DAO and approach the problem of proving DAO facts in criminal and civil court procedure.
Key words: blockchain, social regulation, DAO, consensus mechanism, cybercrime
The ongoing boom in development of blockchain and its countless potential use cases in the virtual and physical realm raise expectations of a new technology that will change the world dramatically. A lot has been discussed about smart contracts, which in addition to being a secure and convenient way of data exchange and storage are a way of expressing parties’ wills. With many people being involved, the blockchain technologies are becoming the way to directly, reliably, and legitimately express the majority intentions. This can be a will of any social group. The blockchain technology can create an extraterritorial social regulator, which can limit the governments and present the channel for a more direct democracy.
The blockchain based social regulator, which is neither created nor sanctioned, managed or enforced by governmental institutions, could be called a Decentralized Autonomous Organization (DAO) regulator. DAO is often referred to the particular Decentralized Autonomous Organization that was launched on April 30, 2016 by several “anonymous” initiators as a virtual venture fund that attracted 10,000 to 20,000 (estimated) members (investors), accumulated around US$250M in digital currency and soon collapsed due to contract code bug allowing one of the DAO members to remove roughly US$50 million shortly after its launch. This DAO and its entire story served as a basis for theorizing and attempts to regulate structures of the kind. In July 2017, the SEC’s Division of Enforcement published a “report of investigation” (“The DAO Report”) making clear that The DAO violated the U.S. federal securities laws when it sold tokens with the goal of funding certain projects without registering the offering. Following this, scholars, lawyers, blockchain enthusiasts and regulators kept using the 2016 DAO as a specimen to analyze, criticize, support or admire. While the SEC made it clear that a token which functionally was an investment contract was in fact a security, it did not clarify other DAO related contexts. In particular case it did not provide guidance as to the facts and circumstances under which a token would not be a security, for instance, if a token had a consumptive use, or some non-incidental utility, what were the boundaries for when a sale of such a token was not a sale of a security? And in a wider context it did not determine what was DAO.
Here and after we will refer to the term DAO as to any blockchain based decentralized and autonomous structure managed by members (participants) according to the prescribed protocol which can be modified exclusively by the members via eternal consensus mechanism. DAO mustn’t obligatory serve any financial or quasi-financial purposes, it may not be an environment designated to exchange something. The essence of DAO as a mean of regulation is the consensus mechanism, which due to blockchain technology turns it into a boat managed by compound of wills of every person on board, which unless restricted by initial protocol can turn it into a rocket flying to the moon or multistory building standing in the quiet neighborhood. In navigation the ship not driven by trained captain responsible for the crew and passengers and following external national and international maritime rules is likely to sink. In blockchain world DAOs not regulated by external rules potentially can exist.
Independence from the governments does not mean there is no enforcement. Blockchain regulation can effectively employ most of implements currently used by online businesses to motivate the users to behave in desired mode. The blockchain enforcement system depends on the DAO nature. If the particular DAO manages or is integrated into payment system, violation of rules can result in feasible sanctions like additional fees and charges. Account blocking or limiting access to data are examples of non-monetary penalties. However, sanctions are only one tool in conventional law enforcement system. Public condemnation, propaganda of proper behavior and motivation can also work to prevent crimes or other unlawful actions.
The development of DAO’s will inevitably affect the growing danger of some cybercrimes as well as reshape the law enforcement system. The paper will address some specific crime types such as, for example, identity theft, which are particularly sensitive for blockchain communities, the specifics of developing blockchain enforcement system and its correlations with conventional enforcement system.
While blockchain and cryptoasset advocates keep cherishing hopes that “this innovation may fundamentally reinvent the economic models upon which much of the world is built”, policymakers in the US and across the world are worried that an increase in money laundering and the attendant facilitation of illegal activity is an inevitable side effect of growing popularity of blockchain technology. Nonetheless, solid evidence of large scale money laundering using cryptocurrencies has thus far not materialized. According to European Parliament study PE 619.024 – July 2018 “Cryptocurrencies and blockchain” “the full scale of misuse of virtual currencies is unknown” which generally means that authorities do not have a good representation of full scale of blockchain tools/assets use in financial system and wider in economic activity. The reason for that is that in order to count something one should know what to count and have a counting method. In case of blockchain tools both components are rather obscure.
To have an idea of what an isolated blockchain could be like we can take a blockchain-powered forum accessible only to its members. There are many platforms available online for free and allowing to start an online forum on any topic. Some of these platforms are tools to start an unregulated forum, allowing “founder/founders” to only customize a protocol, but after it is started forum lives on its own and any restrictions, rulings or changes of initial protocol are possible exclusively through consensus mechanism imbedded in this tool. From the first glance there is nothing to regulate as that is just a “virtual chat parlor”, it is neither a tool to be used as the means of payment or exchange nor mechanism to record transactions. However, some intersections with legal reality may still occur. First group of cases is related to public law violations. Let us assume one of the members of such DAO is distributing direct calls to engage in terrorism, which violates public law of a country to which he or hosting entity of this forum or threat in this message may be directly or indirectly linked. Qualification of such behavior will definitely lie in the area of criminal law. Evidentiary process will be complicated. It will be hard for police to identify such law violations and if identified then find anonymous violator. Even if detected and caught, only the person who posted the message is likely to be legally responsible as there is no one responsible for the forum content in general, but it is all about criminal law and is out of the scope of this article. Another example is the situation when one DAO member considers his dignity or business reputation to be insulted by other network members. To be exact only his pseudonymous reputation and dignity can be affected. Will law protect the rights of insulted persons? Here we come to an awareness problem. Who is aware of what has happened? Obviously, the person who feels abused. But probably no one else. Talking about other DAO members, assuming they are anonymous, we cannot identify who is aware of such potentially harmful information and whether they paid any attention to it at all. Hardly the person considering himself affected can prove anything in court: in the best-case scenario he can bring as a proof a print screen of someone’s post. It can be even impossible to legally prove his claim to be considered “owner” of anonymous/pseudonymous account or be somehow associated with it. We will come to understanding that this abuse hardly exists anywhere else but in the abused person’s mind and has little difference with the situation when someone abused him in his dream. Courts may protect interests of individuals and entities but under the conditions that such interest can be legally identified.
How to legally deal with what is inside? The way the things are mostly treated now is to ignore unless there is any external link giving a legal qualification to the fact, action or asset. The only possible legal intervention point is not upon the blockchain itself, but rather identifiable humans that promote blockchain enterprises and can be held liable for their workings. For unrestricted networks organized purely on the blockchain, there are no legal intervention points for default rules to fill unless coders affirmatively create them. There is no space for default law; law has no purchase on the blockchain. But even for an unrestricted DAO legal intervention point appear in the intersection of the blockchain and the corporeal world. When someone sells Bitcoin for money or exchanges it for goods or services, he drops from DAO reality to conventional reality and has to follow tax or civil law regulations. To simplify this thought one can state that we have to apply tax rules whenever the crypto asset has valuation or/and becomes means of exchange to non-crypto assets. Although the exchange of crypto to non-crypto assets to some extent brings the transaction to the regulatory perimeter, it still does not eliminate questions on the status of cryptoasset. Laws of various countries require declaring transactions exchanging cryptoassets to money or other material assets, they apply tax rules to such transactions and even try to tax proceeds from events happening inside the DAO, such as hard fork or air drop. However, there is still no clarity on whether a DAO participant can get legal protection in case he considers his rights to be violated “within the DAO” or whether DAO assets can be inherited. Using the analogy of law we could assume that when a person becomes part of an unregulated DAO his consent to accept related civil law risks and to get no legal protection is implied. Gambling regulation is a good analogy. In many countries gambling is legal, however legislators promote a negative social attitude to this activity applying various restrictions. The gambler as a rule can not get legal protection if he thinks a casino cheated him as well as he can not bring to the court the claim to withdraw debt as a result of a card game. However, if the gambler wins something, he still has to line up with tax law requirements to declare the income and pay tax, sometimes even on a higher rate than on other types of income.
Although similarities in governmental attitude to gambling and unrestricted distributed ledger networks are obvious, the subjects are strongly different. That is not only because gambling is seen as an extremely opaque zone implying high risks whenever blockchain is in opposite described as new instrument of trust and is considered a secure way to store data and record transactions virtually excluding possibility of forgery. But that is rather because of the type of each phenomenon: gambling is a very specific type of activity (business for one side, entertainment for another) and blockchain is a tool with wide range of ways to be used. Endless number of activities from gambling to charity can employ distributed ledger technology. Thus, accepting that such consent to irreciprocal regulation presumption may be applicable to unregulated DAO’s, the arguments behind it are different. The governments are just technically incapable of providing legal enforcement mechanisms within the DAO. And as there is something that they cannot control they don’t want their citizens or residents to be part of it. Hence if talking about assets in unregulated DAO’s and everything that happens with them with no interactions to corporeal world there are only two options for the legislator left on the table: to ignore it or to ban it. Ban has already become a popular idea. According to the official proposal of TAX3 committee of European Parliament “for some aspects relating to some cryptocurrencies [generally everything related to unregulated anonymous blockchain networks] a ban should be considered”. Several counties made significant steps ahead and introduced bans and restrictions to legislation.
What happens if someone commits a crime “inside DAO”? This question falls into two: “has this violation really happened?” and “how to prove it has happened?”
What happens if rule of code contradicts to the rule of law?
To approach these questions let us find some examples of crimes that theoretically can be committed within the DAO without touching “external reality”.
Example 1. Criminal code of Finland. Chapter 30 “Business offences” Section 2 – Unfair competition offence (769/1990). “A person who in business uses a false or misleading expression concerning his or her own business or the business of another and in this way causes loss to the business of another shall be sentenced for an unfair competition offence to a fine or to imprisonment for at most one year”. Could this offence be committed inside an unregulated DAO? Business is not obligatory exchanging goods or services for money, it could be also an exchange of one service to another, which could be kept in the DAO perimeter.
Example 2. ARTICLE 225-1 of the Penal Code of French Republic: “Discrimination comprises any distinction applied between natural persons by reason of their origin, sex, family situation, physical appearance or patronymic, state of health, handicap, genetic characteristics, sexual morals or orientation, age, political opinions, union activities, or their membership or non-membership, true or supposed, of a given ethnic group, nation, race or religion”. We can imagine that discrimination type defined by article 225-1 of the Penal Code of French Republic can be committed against a natural or legal person inside the DAO, and hence should be punished by three years’ imprisonment and a fine of €45,000 in case for example it consists… of the refusal to supply some services inside the DAO or subjecting the supply of such services to a condition based on one of the factors referred to under article 225-1;
Example 3. U.S. Criminal Code § 709. False advertising or misuse of names to indicate Federal agency: “Whoever falsely advertises or represents, or publishes or displays any sign, symbol or advertisement reasonably calculated to convey the impression that a nonmember bank, banking association, firm or partnership is a member of the Federal reserve system […] shall be punished as follows: a corporation, partnership, business trust, association, or other business entity, by a fine under this title; an officer or member thereof participating or knowingly acquiescing in such violation or any individual violating this section, by a fine under this title or imprisonment for not more than one year, or both”. A nickname or avatar used to identify a blockchain network account can be justifiably treated as crime under this section.
These are just a few examples of crimes that can occur inside the blockchain, but even they eloquently demonstrate how complicated are the legal denominations of everything happening inside the DAO.
First issue we have to address is to determine the meaning of “happened” in case something happened inside the DAO. Criminal law is often divided on whether objectivity or subjectivity should be predominant in determining culpability. Should we look at act or intent for deciding guilt? The widespread belief that we should not countenance thought crimes leads most writers to claim that there should be an actus reus element to each criminal offence. In this regards we are to enlist a number of qualification problems yet unresolved neither by legislators, nor by courts. In Example 1 we are to determine whether exchanging something inside the blockchain perimeter is a type of trade or business. In Example 2 the question is if there can be any distinction applied between anonymous account holders by reason of their origin, sex, family situation, physical appearance, sexual morals or orientation, age, political opinions, nation, race, religion, etc. In Example 3 we need to verify whether an anonymous account holder which has avatar or account name somehow conveying the impression of a relationship to Federal reserve system could be treated as someone advertising, publishing or even displaying such sign if the rest of DAO members are unknown due to anonymity which can theoretically mean that they are potentially not human beings but algorithms.
Proof of facts of “DAO life” is another extremely complicated matter. By now we failed to find any court cases where parties relied primarily or completely on blockchain technology. In 2015 Ross Ulbricht – founder of the Silk Road Dark Web online market – was convicted of money laundering, conspiracy, drug and hacking-related offences. Obviously, to prove his guilt investigators were tracing blockchain transactions in order to demonstrate that he had control over the wallets. It was used for attribution evidence that he was in fact managing the criminal organization along with other episodes. But it was a relatively small part of a wide set of evidences presented to the court. It is important to mention that the authenticity wasn’t challenged in course of the trial. The United States District Court for the Southern District of New York as well as the United States Court of Appeals for the Second Circuit and the Supreme Court of the United States were not looking deep into the technology. The evidence structure presented solely a financial transaction that X went from wallet A to wallet B that belongs to Y.
The traditional evidence theory as a rule provides us with three major types, including: documentary evidence (including digital evidence), physical evidence, and testimony. Some also mention demonstrative evidence, scientific evidence and prima facie evidence.
One of the blockchain technology promising implications is to create and preserve trustworthy records able to serve as alternative sources of evidence of rights, entitlements and actions. This might bring an illusion that finding digital evidence to prove DAO facts and bringing it to court is a viable and even an easy task. However, if we are talking about anonymous unrestricted networks it is not the case. In courts parties are given fair opportunity to present whatever proof they can collect. For example, in the US anything can be used as an evidence as long as the court acknowledges it as admissible. But the way the distributed ledger works it would not allow presenting in court technical protocols proving anything except such disclosure is prescribed in underlying protocol or approved through consensus mechanism by DAO members. If not, then no electronic evidence can be presented in court unless the network is hacked by police or a plaintiff. Even in case DAO rules sanction information release, courts may still find such proof unacceptable due to lack of digital information source authenticity proof. Meanwhile, in absence of sanctioned information release there could be hardly anything more than a print screen presented. In Examples 1 and 3 it is critical to establish who were confused by false advertising or use of misleading name. Even in Example 2, the discrimination is a relative category: in social relations there should be a benchmark majority to allow measuring discrimination affecting anyone due to its social, religious, racial or other status. Most imaginable crimes that can be committed inside the DAO presuppose publicity or dissemination of information. Just one example from Criminal code of Germany: Chapter 11 Section 166 “Revilement of religious faiths and religious and ideological communities”, “Whoever publicly or by disseminating material (section 11 (3)) reviles the religion or ideology of others in a manner which is suitable for causing a disturbance of the public peace incurs a penalty of imprisonment for a term not exceeding three years or a fine”. To prove presence of public may appear to be an impossible task for a fully anonymous distributed ledger network.
The same problem is affecting potential use of testimony in courts to prove blockchain facts. It might be technically impossible to prove that a particular person (a witness or a victim) is the one standing behind the anonymous account. The affidavit may become a possible solution, oath can be other option but in many countries (especially in continental law systems) some more solid proofs will be requested to prevent declaring testimony inadmissible evidence.
Physical evidence, demonstrative evidence and scientific evidence can hardly be imagined having a broad use in proving DAO facts. The prima facie evidence can probably become instrumental in future when unregulated anonymous DAOs will become large-scale and widespread.
Unless a specialized legislation or sustainable court practice appears providing that legal qualification for anything happening or existing inside a DAO is to be characterized by the essential components of any crime – a voluntary act or omission and a certain state of mind or intent – there are few arguments that can allow criminal jurisdiction of any country to cover internal world of a blockchain network. But even in case legislation steps ahead, proving DAO facts according to traditional criminal procedure rules will be anything from hard to impossible. That signifies that we are potentially about to evidence a period of the “reality split”. In case of further technological advances and DAO popularity growth, there would be facts and acts important to individuals but existing (provable) solely in DAO realm. DAO environment is posing two fundamental problems to regulators. The first is an information asymmetry problem; the second is an execution power problem and unless a significant advance in legislation or technology is made, we see few chances for national criminal jurisdiction to cover this field. The solution to ban and block is likely to become popular outcome among regulators, but its efficiency strongly depends on technical matters and is outside of the scope of this article.
Inability of the conventional law to cover DAO world will fuel blockchain regulation to fully take its place forming a parallel regulatory system. Limping legal relationships may become a widespread problem. Relationships ‘limp’ whenever the legal position of parties varies when considered from the viewpoint of different legal systems. In case of DAO there will be facts, actions, acts, assets and all other legally significant issues existing in the distributed ledger but legally not existing in the outside world. We assume that in course of time conventional regulation will somehow take control over this “blockchain world” but meanwhile the development of unregulated DAOs may become an interesting challenge not only for its members and legal practitioners but also for legal theorists who are to accommodate this new body into basic concepts of law.
BANTA, N., CAHN, N. R. (2019). “Digital Asset Planning for Minors”. Probate & Property, Jan./Feb. 2019, p. 44.
BRENIG, C., ACCORSI, R., MÜLLER, G. (2015). “Economic Analysis of Cryptocurrency Backed Money Laundering”. ECIS 2015 Completed Research Papers. https://aisel.aisnet.org/ecis2015_cr/
DUFF, A. (2018). “Theories of Criminal Law”. Stanford Encyclopedia of Philosophy https://plato.stanford.edu/archives/sum2018/entries/criminal-law
FLETCHER, G. P. (1978). Rethinking Criminal Law. Boston: Little, Brown & Co.
HOUBEN, R., SNEYR, A. (2018). Cryptocurrencies and blockchain. http://doi:10.2861/280969
KLAYMAN, J. A. (2019). The rise of the security token. In: Blockchain & Cryptocurrency Regulation 2019. 1st ed. London, p. 64.
QUARANTA, R. (2019). An overview of the Wall Street Blockchain Alliance. In Blockchain & Cryptocurrency Regulation 2019. 1st ed. London, p. 14.
RODRIGUEZ, U. R. (2019). “Law and the Blockchain”. Iowa Law Review, vol. 104, p. 679.
STEFFEN, J. C., KORVER, M. R., WYDER-HARSHMAN, E., BAUMERT, M., HAYES, E. (2019). Panel II: Blockchain Regulation and Criminal Law. The John Marshall Journal of Information Technology & Privacy Law, vol. 34 (1).
The Criminal Code of Finland. https://www.legislationline.org/documents/section/criminal-codes/country/32/Finland/show
The German Criminal Code. https://www.gesetze-im-internet.de/englisch_stgb/englisch_stgb.html#p1571
The Penal Code of the French Republic. https://www.legislationline.org/documents/section/criminal-codes/country/30/France/show
U.S. Code. https://www.law.cornell.edu/uscode/text/18/709
US SECURITIES AND EXCHANGE COMMISSION (2017). Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207 (July 25, 2017). https://www.sec.gov/litigation/investreport/34-81207.pdf.
U.S. v. Ulbricht. 1 2017 U.S. App. LEXIS 9517 (2nd Cir. May 31, 2017).
WERBACH, K. (2018), The blockchain and the new architecture of trust. Cambridge: Mit Press. P. 171.
YOUNG, J. (2017). “China ban on ICO is temporary, licensing to be introduced: official”. https://cointelegraph.com/news/china-ban-on-ico-is-temporary-licensing-to-be-introduced-official
 See US SECURITIES AND EXCHANGE COMMISSION (2017). Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207 (July 25, 2017). https://www.sec.gov/litigation/investreport/34-81207.pdf.
 KLAYMAN, J. A. (2019). The rise of the security token. In: Blockchain & Cryptocurrency Regulation 2019. 1st ed. London, p. 64.
 QUARANTA, R. (2019). An overview of the Wall Street Blockchain Alliance. InBlockchain & Cryptocurrency Regulation 2019. 1st ed. London, p. 14.
 See BRENIG, C., ACCORSI, R., MÜLLER, G. (2015). “Economic Analysis of Cryptocurrency Backed Money Laundering”. ECIS 2015 Completed Research Papers. https://aisel.aisnet.org/ecis2015_cr/
 HOUBEN, R., SNEYR, A. (2018). Cryptocurrencies and blockchain. http://doi:10.2861/280969
 RODRIGUEZ, U. R. (2019). “Law and the Blockchain”. Iowa Law Review, vol. 104, p. 679.
 BANTA, N., CAHN, N. R. (2019). “Digital Asset Planning for Minors”. Probate & Property, Jan./Feb. 2019, p. 44.
 See for example: WERBACH, K. (2018), The blockchain and the new architecture of trust. Cambridge: Mit Press. P. 171.
 HOUBEN, R., SNEYR, A. (2018). Cryptocurrencies and blockchain. http://doi:10.2861/280969
 See e.g. YOUNG, J. (2017). “China ban on ICO is temporary, licensing to be introduced: official”. https://cointelegraph.com/news/china-ban-on-ico-is-temporary-licensing-to-be-introduced-official
 First question that appears before scrolling through criminal codes of various countries is how to link any action committed solely within the DAO to any jurisdiction? Numerous court cases worldwide prove that for the last decade courts have elaborated sophisticated ways to legitimize jurisdictional decisions over virtual realm. Just one example to illustrate this point: in 2018 the United States District Court for the Southern District of New York was hearing the Alibaba Group Holding Company VS Alibabacoin Foundation case. The Alibabacoin Foundation was a Cayman entity. Alibaba sued Alibabacoin for a trademark infringement and took court action to the Southern District of New York. The defendants challenged court jurisdiction as they were neither domiciled nor had offices in New York, even their servers were located in Minsk (Belarus). However, they failed because in prejudicial discovery it was found that Alibabacoin Foundation had some e-mail addresses that were traced to a New York resident on its accounting records, and that New York resident made several transactions in Alibabacoin Foundation and that was enough to apply jurisdiction of the state of New York Court for the Southern District (Alibaba Group Holding Ltd. v. Alibabacoin Found., 18-CV-2897 (JPO), 2018 WL 5118638 (S.D.N.Y. Oct. 22, 2018). Based on this and many other cases we can assume that absence of physical presence will not become an obstacle for the courts to start hearing DAO cases.
 The Criminal Code of Finland. https://www.legislationline.org/documents/section/criminal-codes/country/32/Finland/show
 The Penal Code of the French Republic. https://www.legislationline.org/documents/section/criminal-codes/country/30/France/show
 U.S. Code. https://www.law.cornell.edu/uscode/text/18/709
 FLETCHER, G. P. (1978). Rethinking Criminal Law. Boston: Little, Brown & Co.
 DUFF, A. (2018). “Theories of Criminal Law”. Stanford Encyclopedia of Philosophy https://plato.stanford.edu/archives/sum2018/entries/criminal-law
 U.S. v. Ulbricht. 1 2017 U.S. App. LEXIS 9517 (2nd Cir. May 31, 2017).
 STEFFEN, J. C., KORVER, M. R., WYDER-HARSHMAN, E., BAUMERT, M., HAYES, E. (2019). Panel II: Blockchain Regulation and Criminal Law. The John Marshall Journal of Information Technology & Privacy Law, vol. 34 (1).
 Federal Rules of Evidence. Art. 4. Rule 401.
 German Criminal Code in the version published on 13 November 1998 (Federal Law Gazette I, p. 3322), as last amended by Article 2 of the Act of 19 June 2019 (Federal Law Gazette I, p. 844).