WSG Article: Ohio Embraces Blockchain Technology and Digital Assets

Ohio Embraces Blockchain Technology and Digital Assets

July, 2022 - David A. Lopez-Kurtz

I. Introduction

Rising interest rates and a general economic downturn in 2022 has impacted the value of digital assets, including the relatively well-established likes of Bitcoin and Ether. In addition to market headwind, momentum around federal digital assets regulation is growing, culminating in the proposed “Responsible Financial Innovation Act” (the “RFIA”). The RFIA would, among other things, clarify the treatment of decentralized autonomous organizations (“DAOs”) and create a new asset class – “ancillary assets” – which would encompass most digital assets (including those that qualify as investment contracts), and would be regulated as commodities by the CFTC.[1]

Despite the market downturn, and perhaps in response to movement at the federal level, the Ohio legislature has made digital assets a legislative priority in 2022. First, Ohio House Bill 177.05 (“HB 177.05”) passed in March. HB 177.05 grants Ohio governmental entities authority to leverage distributed ledger technology (“DLT”). A second bill, House Bill 585 (“HB 585”), would codify the legal status of DAOs in Ohio and Special Purpose Depository Institutions (“SPDI”) if passed.

There are important nuances to consider as market regulatory forces collide and the repercussions of such collisions echo throughout the blockchain technology and digital asset ecosystem.

II. Analyzing The Statutes: HB 177.05 & HB 585

a. HB 177.05: Ohio & DLT

Before HB 177.05, governmental entities in Ohio were limited in how they could leverage DLT. Adoption was relegated to half-cocked pet projects, including when, in 2018, Ohio became the first state to authorize the collection of taxes in Bitcoin through OhioCrypto.com.[2] Then-Treasurer Josh Mandel spearheaded the effort, ostensibly to solidify Ohio as a blockchain technology destination for entrepreneurs, investors, and early adopters. Despite some early momentum, OhioCrypto.com shut down in 2019 after worries mounted that the platform was created unlawfully.[3]

Now, with the passage of HB 177.05, governmental entities are explicitly allowed to leverage DLT, including blockchain technology, so long as such use is “in the exercise of [such governmental entity’s] authority.” [4] The scope of “governmental entity” is far-reaching, including any “political subdivision” as defined in Section 2744.01 of the Ohio Revised Code, thereby capturing any and all instrumentalities of the State of Ohio including any “municipal corporation, township, county school district, or other body corporate and politic responsible for governmental activities in a geographic area smaller than that of the state.”[5]

HB 177.05 regains momentum lost by OhioCrypto’s failure by giving governmental entities the leeway necessary to explore innovative solutions and applications afforded by DLT, even if tax collection remains an unviable use case. This momentum comes at an opportune time, as companies, including large, publicly reported companies, are devoting significant resources to exploring applications of blockchain technology to governance. HB 177.05 provides Ohio a competitive advantage over states that are ignoring the rise of alternative DLT use cases.[6] Companies devoted to exploring alternative DLT use cases may now find Ohio an acceptable sandbox in which to play.

B. HB 585: Ohio DAOs

Operating or joining a DAO has traditionally been a risky project. If enacted, HB 585 would clarify and codify the legal status of DAOs in Ohio.[7]

Under HB 585, all DAOs incorporated in Ohio would be required to file articles of organization with the Ohio Secretary of State, in the same way that a limited liability company would be organized.[8] It would be at this point – initial organization – that organizers would indicate whether the DAO will be member-managed (similar to a limited liability company) or algorithmically managed.[9] Further, if a DAO formed in Ohio elects to leverage smart contract technology, the articles of organization must include a publicly-available identifier of any such smart contract.[10]

Critically, Ohio DAOs would not have the ability to self-define what constitutes a quorum.[11] A quorum is met only when fifty percent of the DAO members approve an action.[12] Further, to the extent that an Ohio DAO leverages smart contract technology as part of its management, such contract must “be able to be updated, modified, or otherwise upgraded.”[13] Viewed from a critical eye, these two provisions might signal skepticism governance through smart contract. Alternatively, this can be seen as a critical embrace of smart contract technology as a means of corporate governance – similar to bylaws or an operating agreement, each of which must be disclosed to equity-holders in a corporation or a limited liability company as the case may be, smart contracts are simply joining a long line of governance mechanisms, each of which must be consented to by the participants in their respective corporate forms.

If enacted, HB 585 will position Ohio as a destination for DAO formation and the first Midwest state to codify DAOs.[14] That said, in order to maintain a competitive advantage, the Ohio legislature will need to consider increasing flexibility around DAO governance, just as the Wyoming legislature did when it recently passed an amendment permitting Wyoming DAOs to self-define a quorum.[15] This amendment allows Wyoming DAOs to scale more rapidly—a priority for developers and investors. As developers look for opportunities, jurisdictions that fail to accommodate the logistics of scale may fall behind.

C. HB 585: SPDIs

In addition to codifying DAOs, HB 585 would permit the formation of SPDIs—entities formed to provide custodial services over digital assets.[16] By permitting the creation of SPDIs, HB 585 would open Ohio to current and prospective entrepreneurs seeking to serve as depositors of digital assets (including cryptocurrencies). The bill distinguishes between three categories of crypto-assets:

(1) “Digital Consumer Assets,”

(2) “Digital Securities,” and

(3) “Virtual Currencies.”[17]

“Digital Consumer Assets” are defined broadly, including any digital asset “used or bought primarily for consumptive, personal, or household purposes”[18] as well as any “open blockchain token constituting intangible personal property as provided by law,” and “any other digital asset that is not a digital security or virtual currency.” This definition would likely capture non-fungible tokens, (commonly referred to as NFTs), so long as the NFTs are not used for speculative or investment purposes. “Digital Securities” would include any digital “investment property.”[19] “Virtual currencies” would include any digital asset used as money not recognized as legal tender in the United States.[20]

In addition to classifying digital assets, HB 585 contains numerous provisions that reduce risk associated with SPDIs, including the following requirements:

SPDIs would be required to hold highly liquid reserves backing 100% of the assets on deposit, as well as pledge the assets or furnish a surety bond to the Ohio Department of Commerce.[21]

Reserves would have to be held as on-premises U.S. dollars, currency held in a Federal Reserve Bank or FDIC insured financial institution, or other highly liquid investments such as treasuries.[22]

Any group wishing to charter an SPDI would need to meet a minimum capital of $10,000,000 in fully paid in capital stock.[23]

If enacted, HB 585 would position Ohio as an early leader in meeting the growing demand for crypto-servicing. SPDIs would provide institutional legitimacy to crypto-holders incorporated or doing business in Ohio, thereby helping to meet the growing demand for regulatory clarity and fostering a market for crypto-assets in Ohio.

III. Conclusion

As the value of cryptocurrencies and other digital assets continues to flex in response to market forces, the significance of alternative use cases of DLT, including DAOs, will grow. DLT, and more specifically blockchain technology, offers unique solutions for governance, back-office operations, supply chain maintenance, and other functions outside of simple value storage.

So-called “fly-over” states, such as Ohio, have the opportunity to attract market participants and the digital asset ecosystem by passing comprehensive digital assets legislation ahead of, or parallel with, federal legislation. As it was when part of the Northwest Territory, the passage of HB 177.05 and the proposal of HB 585, position Ohio at the dawn of a new frontier.

*Tanner Dowdy is a summer associate at Dinsmore & Shohl, LLP, and is not licensed to practice law.

[1] Responsible Financial Innovation Act, S. 4356, 117th Congress (2022).

[2] Cryptocurrency for Ohio Tax Payments, Blockchain Research Institute, (May 2019), https://www.blockchainresearchinstitute.org/wp-content/uploads/2019/06/Marke-Cryptocurrency-for-Tax.pdf.

[3] Id.

[4] House Bill 177, The Ohio Legislature, https://www.legislature.ohio.gov/legislation/legislation-summary?id=GA134-HB-177.

[5] O.R.C. 2744.01

[6] Id.

[7] House Bill 585, The Ohio Legislature, https://www.legislature.ohio.gov/legislation/legislation-summary?id=GA134-HB-585.

[8] Id.

[9] Id.

[10] Id.

[11] Id.