Cryptocurrency has become and will remain a mainstay of the digital economy, whether we like it or not. This article focuses on an increasingly common scenario: where one party uses cryptocurrency (i.e., digital assets such as Bitcoin, Ether) to pay the other party under the deal instead of using standard currency.
The crypto economy presents some unique contractual risks. Players in the crypto economy should not shy away from (or fear) deploying contract drafting expertise to protect themselves from risk. In fact, over and above the simple types of clauses covered by this article, there is a unique opportunity for them to work with their lawyers to craft bespoke contractual clauses that can be used to allocate these risks between them and their deal counterparties.
Here are three very simple contractual clauses that can be deployed for cryptocurrency-related deals (deals where one party is paying the other party using cryptocurrency) but which can help protect the parties from several preventable risks.
In the cryptocurrency world, wallets are the new bank accounts.
For those unfamiliar with the technical aspects of the wallets- access to a wallet is through a unique private key relating to the digital wallet in which the cryptocurrency is held. Therefore, a holder of a wallet must keep these private keys secure to prevent unauthorized access. It is also important to note that if a private key relating to any wallet is lost, destroyed, or otherwise compromised or unavailable, access to the cryptocurrency in that wallet is generally lost forever.
A wallet address is typically a long string of letters and numbers and it is therefore easy to get it wrong. In addition, a transfer of cryptocurrency on the blockchain cannot generally be reversed.
Therefore, if you are making payments pursuant to an agreement using cryptocurrency, the receiving counterparty should confirm that:
From a practical perspective, you may want to confirm that the counterparty is agreeable to do a “test transaction” in a small amount to help mitigate the risk of the above scenarios occurring.
For large-value deals, parties should also factor in the risk that the fiat-cryptocurrency exchange rate could vary significantly during periods of market volatility. This could be a particular risk at a time when the time taken to transfer a cryptocurrency through the blockchain network is longer than usual because of congestion in the network or other factors. If you are the party transmitting cryptocurrency to settle a payment obligation, you should consider having the recipient provide a contractual confirmation that your obligation to pay is fully discharged when you initiate the transmission of cryptocurrency in the agreed amount through the blockchain network (irrespective of when it is received by them).
Regulatory focus on the crypto economy is here to stay. There has been a particular concern among national and international regulators of late that cryptocurrency, because of its, pseudo-anonymous nature, could be easily used as a tool to facilitate financial crime.
Doing deals with a counterparty who happens to be engaged in a financial crime can have disastrous consequences for your organization. In addition to the reputational fall-out, there is a risk that you will have to hand over to a regulator any money that is later identified as the proceeds of a financial crime.
However, there is a very simple type of documentary armour that you can deploy to help protect your organization from this risk. The humble but powerful contractual tool that is a representation. As finance and M&A deal lawyers know well, a representation is often used in contracts as an indirect form of due diligence. Focusing a counterparty on the subject matter of a representation helps to speed up the process of identifying any actual or potential breaches (e.g., when they start to delete or trim down the subject matter of a representation is what is a classic due diligence “red flag” which then prompts a specific discussion on the exact nature of the counterparty’s concern with giving the representation).
As validation, see an example of some publicly available clauses used in contracts in the crypto economy.
|Extract from the Coinbase Singapore Terms: “You hereby represent, warrant, and undertake to Coinbase that you are purchasing Digital Currency with funds which are from legitimate sources and which do not constitute the proceeds of criminal conduct, or realizable property, or the proceeds of terrorism financing or property of terrorists, within the meaning given in the Corruption, Drug Trafficking and Other Serious Crimes (Confiscation of Benefits) Act (Chapter 65A) and the Terrorism (Suppression of Financing) Act (Chapter 325), respectively (or any other equivalent law in a jurisdiction outside Singapore) and which are not derived from or related to any unlawful activities. You further undertake not to use the Digital Currency to finance, engage in, or otherwise support any unlawful activities.” |
Extract from Coinbase U.S Terms: “During registration for your Coinbase Account, or at any other time deemed necessary by Coinbase, you agree to provide us with the information we request for the purposes of identity verification, providing Coinbase Services to you, and the detection of money laundering, terrorist financing, fraud, or any other financial crimes and permit us to keep a record of such information.”
Extract from Coinbase Europe Terms: “You may also be required to undergo “Enhanced Due Diligence”, where Coinbase may request that you submit additional information about yourself or your business, provide relevant records, and arrange for meetings with Coinbase staff so that Coinbase may, among other things, establish the source of your wealth and source of funds for any transactions carried out in the course of your use of Coinbase Services.”
Extract from a Business Combination Agreement: “In the past five years, no Company Group Member has purchased or sold Bitcoin, or any other digital asset, in a transaction involving a counter-party whose identity was not verified in accordance with the Company’s sanctions compliance policy and any applicable know your customer/anti-money laundering laws or regulations”.
Accordingly, in any contract in which you accept cryptocurrency as payments, you should consider having the counterparty give a representation to the effect that:
A critical risk mitigation tool for contract counterparties is the choice of governing law and jurisdiction. This is essentially choosing the turf for a potential contractual war. The transactional parties have the freedom to use this valuable legal tool in the form of choosing the right court to determine the rights and obligations of a new-age business since it would involve a careful and detailed analysis of a myriad of issues at the intersection of law and technology.
The parties need to carefully consider whether the courts that they are choosing would be willing and able to undertake such a sophisticated analysis. It is of course certainly worth considering the Singapore courts as an option. In the recent B2 C2 Quoine case, the Singapore courts undertook precisely such an analysis while adjudicating certain automated transactions conducted on a digitized cryptocurrency trading platform.
More practically you can get options of less intrusive and potentially less expensive forms of dispute resolution such as arbitration and mediation. These ADR tools are particularly useful in the crypto-economy as you have the flexibility to choose technical experts in the field if you are dealing with a “first-of-its-kind” issue.
Note: The views herein are my own and do not represent those of any firm or company that I am attached to. They do not constitute legal advice or opinion under the laws of any jurisdiction including Singapore.
 Section 4.26(e), (Core Scientific Holding Co.–Power & Digital Infrastructure Acquisition Corp. Agreement and Plan of Merger and Reorganization dated July 20, 2021 (governing law: Delaware)), https://www.sec.gov/Archives/edgar/data/1839341/000121390021037837/ea144540ex2-1_poweranddigi.htm
 The proposed implementation of the Travel Rule by national governments has caused a big controversy in the crypto economy. For details on the Travel Rule, refer to https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf.