The key strategies behind the Bancor lawsuit in the DeFi project, and how Web3 projects can avoid US jurisdiction?

The court finally ruled that Bancor and its founders are foreign entities, mainly operating in Israel and Switzerland, with insufficient connection to the United States. The US court has no jurisdiction and cannot apply US securities laws. The court suggested that the plaintiff file a lawsuit in Israel, and the case was therefore dismissed in the United States.

Author: Aiying

Recently, a federal judge in Texas, USA, dismissed a securities class action against the Bancor protocol and its founders. The case stemmed from Bancor's previous introduction of the "impermanent loss protection" feature, which promised to provide protection for cryptocurrency investors against temporary losses caused by market fluctuations. This feature attracted a large number of liquidity providers, and the platform's funds once exceeded $2.3 billion. However, in 2022, Bancor suspended this feature under market pressure, causing losses to investors. As a result, investors filed a lawsuit, accusing Bancor of violating securities laws, fraud, and breach of contract.

Here, Aiying reminds industry practitioners that although Bancor is a decentralized protocol, the defendants in the class action are not the protocol itself, but the companies, founders, and team members associated with its development, operation, and promotion. Decentralized protocols are usually developed by an initial team or company and play a crucial role in the early operation. Therefore, they may become the subject of legal action, and decentralization does not mean complete exemption from liability, especially when the governance and control of the protocol still partially reside with the development team.

However, in the end, the court ruled that Bancor and its founders are foreign entities, mainly operating in Israel and Switzerland, with insufficient connection to the United States. The US court has no jurisdiction and cannot apply US securities laws. The court suggested that the plaintiff file a lawsuit in Israel, and the case was therefore dismissed in the United States.

I. Key points of the court's ruling: Jurisdiction and applicable law issues

The court emphasized that although the plaintiffs are US investors, this fact alone is not sufficient to prove a close connection between the case and US jurisdiction. The principle of jurisdiction requires a substantial connection between the defendant and the jurisdiction, and most of Bancor's transactions and operational activities occur outside the United States, failing to meet this condition.

At the same time, this case also reflects the limitations of the extraterritorial effect of US securities laws. The Securities Act of 1933 and the Securities Exchange Act of 1934 are the core laws of the US securities market, but their scope of application is mainly limited to securities issuance and trading activities within the United States. These laws generally do not apply to foreign companies or multinational projects unless the transactions explicitly occur in the United States or have sufficient connection to the United States.

Aiying believes that the court's ruling emphasizes the limitations of the application of US securities laws, especially in cross-border crypto projects. Although crypto assets have global liquidity, US securities laws do not automatically apply to all projects related to US investors unless it can be proven that the activities of these projects have a substantial connection to transactions within US jurisdiction. This also means that operators of cross-border crypto projects are not necessarily bound by US laws and may need to comply with the laws of their home country or face legal action in other countries.

II. How to avoid US jurisdiction

The key to avoiding US jurisdiction like Bancor lies in taking a series of measures to ensure that the project is as detached as possible from US laws and regulations. Bancor's ability to successfully avoid the jurisdiction of US courts is mainly because its operating entities and founders are located in Israel and Switzerland, and its project activities mainly occur outside the United States. This allows Bancor to effectively avoid the impact of US securities laws through legal and territorial strategies. To emulate Bancor's approach, the following measures can be taken:

1. Incorporate the company in a country outside the US

Like Bancor, register and operate the company in other jurisdictions, such as Switzerland, Israel, or other countries friendly to crypto projects. This can effectively avoid direct jurisdiction under US laws.

2. Ensure founders and team are not in the US

Bancor's founders and key team members are all located outside the US. If the founders and team are in the US, they will automatically be subject to US laws.

3. Avoid providing services to US investors

Restrict US investor participation: Bancor explicitly states that it does not provide services to US citizens or residents, strictly limiting their participation in token sales. You can ensure that US investors cannot participate in token sales or use your platform through user agreements, KYC (Know Your Customer) procedures, geoblocking technology, etc.
Geoblocking: Use IP address filtering and technical means to prevent US users from accessing the project's website or participating in token sales. This technology can reduce the exposure of your project in the US market.

4. Avoid promotion in the US

Like Bancor, avoid any form of marketing or promotion in the US. Ensure that the project's promotional activities do not use US social media, advertising platforms, or news channels to avoid attracting the attention of US investors.

5. Use the "Regulation S" exemption

If you cannot completely avoid international market exposure, you can, like Bancor, utilize the Regulation S exemption clause in US securities laws. Regulation S allows securities issuance outside the US market but requires you to ensure that these securities do not flow back to the US. This can reduce conflicts with US securities laws.

6. Design tokens to avoid being classified as securities

Ensure that the token design is more likely to be considered a "utility token" rather than an investment tool. This can be achieved by avoiding excessive promises of returns, emphasizing the token's utility on the platform. Bancor avoids tokens being considered securities by providing liquidity functions rather than solely as investment tools.

7. Choose non-US law and dispute resolution mechanisms

In user agreements and token sale contracts, clearly specify the application of non-US legal systems and choose non-US dispute resolution mechanisms.

III. Aiying's compliance recommendations for the industry

1. Importance of compliance review

For practitioners in the crypto industry, compliance is no longer a "remedial measure" after the project's success but should be one of the core tasks before the project goes live. Regardless of the project's size, strict compliance reviews are needed before launch to ensure that its operating model, legal structure, and promotional materials comply with legal requirements. This not only helps to avoid potential legal risks later on but also enhances the project's legitimacy and credibility, gaining the trust of investors.

Especially in cross-border crypto projects, the complexity of compliance is significantly increased. Different countries have different regulatory requirements for cryptocurrencies and blockchain technology. For example, in some countries, crypto assets may be considered securities and require strict registration and disclosure, while in other countries, cryptocurrencies are classified as commodities or property, subject to different legal systems. This difference means that practitioners must have in-depth knowledge of the legal frameworks in each target market, especially the provisions related to securities laws, taxation, anti-money laundering (AML) regulations, and consumer protection laws. Therefore, compliance teams must have cross-border legal experience and keep up with changes in regulatory policies in various countries.

2. Choice of legal dispute resolution mechanisms

Cross-border projects often face legal overlaps in multiple jurisdictions, so Aiying suggests that it is crucial to clearly choose the applicable legal system and dispute resolution mechanism during the project design phase. Through contract terms and user agreements, the project can pre-determine which laws apply to its operations and which country's laws and courts should resolve disputes in the future. This advance planning can not only avoid jurisdictional disputes but also improve the efficiency of dispute resolution.

In the Bancor case, the US court ruled that it lacked jurisdiction and suggested that the plaintiff file a lawsuit in Israel. If the project party had clearly specified the applicable law and jurisdiction from the beginning, it might have reduced investors' misunderstandings about jurisdictional issues, thereby avoiding legal disputes. Therefore, practitioners can strengthen the design of dispute resolution mechanisms in the following ways:

Choose arbitration over litigation: In cross-border situations, arbitration is often more flexible and efficient than litigation. Many projects choose international arbitration as the primary mechanism for resolving disputes because it can avoid conflicts of jurisdiction in multiple countries and provide a relatively neutral platform for arbitration awards.
Set clear choice of law clauses: Practitioners can explicitly specify in user agreements or whitepapers which country's legal system should apply to the project. This not only helps the project party better control legal risks but also helps users and investors understand their rights and obligations.
Designate jurisdictional courts or arbitration institutions: Practitioners can stipulate in contracts which country's courts or arbitration institutions will be responsible for handling legal disputes. This can prevent investors from filing multiple lawsuits in different countries in the future, leading to complex legal proceedings.

When designing these mechanisms, it is also important to ensure that they comply with the legal requirements of the host country and can be effectively enforced. For example, some countries may not recognize certain types of arbitration awards, so the project party needs to ensure the effectiveness of its dispute resolution clauses globally.

IV. Compliance Challenges for Cross-Border Web3 Projects

For cross-border crypto projects, compliance is not a simple task. Different countries have different regulatory laws, especially in the operation of trading platforms or protocols for crypto assets, the issue of territoriality is particularly prominent. Each country's laws have its own standards and requirements, such as which assets are considered securities, and what kind of investor protection measures are required. This means that cross-border crypto projects cannot only consider the regulations of one country but must ensure compliance with legal requirements in multiple jurisdictions.

The compliance challenge for cross-border crypto projects also lies in the need for operators to understand and comply with the legal requirements of different countries, including securities laws, anti-money laundering regulations, and investor protection regulations. The legal standards vary greatly between countries, with some countries having relatively lenient regulations, while others have strict regulations on crypto assets. Without understanding these differences, crypto projects may easily become embroiled in legal disputes or even face the risk of shutdown.

Furthermore, cooperation and conflicts between different jurisdictions make things even more complex. For example, a crypto project may have investors from multiple countries, which means it needs to simultaneously comply with the legal requirements of multiple countries. Some countries may conduct joint investigations or regulations, while others may conflict with the laws of other countries. In this situation, balancing these legal requirements and reducing legal risks becomes a challenging issue that crypto project operators need to pay special attention to.

Court ruling: Link to the judgment

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