Imagine creating a product that sells data, such as a mapping or telecommunications service. These are capital-intensive businesses with immense startup costs. Barriers to entry may seem insurmountable – after all, if you wanted to compete with Verizon or AT&T, the cost and availability of cell phone towers alone would be cost-prohibitive. Same with competing against Google Maps or Apple. It is essentially impossible for a startup to compete with companies that are effectively public utilities.

How is DePIN useful and what are some examples?

Enter decentralization. While currently associated with largely speculative financial transactions and niche non-fungible token (NFT) projects, decentralized/permissionless networks have great potential to expand beyond the merely virtual and into the physical space. The Helium communications network and Hivemapper’s mapping data services are just two great examples. Helium crowdsources its network by leasing physical space to install its smaller, lower-powered antennae. Instead of 400-foot massive, high-watt cell towers, the network runs on hundreds or even thousands of densely distributed smaller transmitters. Helium’s own cryptocurrency (HNT) comes in as a rewards system – for installing an antenna, passing proof of service tests, and increased use of the particular location, the landlord earns Helium tokens (HNT) (or associated IOT or MOBILE tokens), which can then be sold or exchanged on the open market. Locations that are used more frequently earn more tokens, incentivizing the optimal location and operation through economics principles.

Hivemapper works in a similar manner, but with road mapping. Hivemapper sells its proprietary dashcams, which users can buy, install, and use to collect data from their vehicles, which is then uploaded in exchange for HONEY tokens. Like HNT, HONEY can be sold or traded on an exchange. The benefit to Hivemapper is that it essentially collects data in exchange for self-created tokens and sells dashcamps on top. Hivemapper does not invest in significant infrastructure, like Google’s mapping cars or their specialized cameras. Hivemapper instead recruits – and decentralizes – the process for collecting road data that would otherwise be cost prohibitive. As an additional efficiency, this results in more up-to-date road data, as it is collected from more sources than a single Google Maps car that drives through a particular route on an infrequent basis.

This application (and benefits) of decentralization and crowdsourcing to data collection and aggregation, as well as other physical applications are significant. For example, a company could use a decentralized token incentive structure to collect environmental or weather data, which then could be sold to private parties for development purposes, aid in agriculture, and otherwise create significant inexpensive, up-to-date data aggregation. Social science applications abound, as a company could incentivize information gathering and consensus-based verification with a properly-designed token system.

DePIN must still comply with existing physical and financial regulations.

While novel, DePINs must still fit into the existing physical and financial regulatory schemes. For example, Helium’s network must comport with FCC standards on communications devices, radio frequencies, transmission power, and other administrative matters. Further, the fact that companies like Hivemapper and Helium essentially create their own currency, must also fit into existing securities and money transmission laws, both on a federal and state-by-state level. Companies cannot simply raise funds through initial coin offerings and bypass normal securities regulations. If selling tokens, companies must engage in Security Token Offerings (or STOs), which are conducted similar to private placements and disclosed on Form D with the Securities and Exchange Commission. Otherwise, companies may structure their tokens as “utility” tokens, which means that consumption (and not investment or speculation) must be the primary motivation for the purchase. For instance, if users who earned the HONEY token could consume that token and use it to pay for a Hivemapper premium subscription (giving themselves access to premium map and road condition content for example), the HONEY token would likely be classified as a “utility” token and not fall into the “investment contract” designation under the Howey test.

How do utility tokens fit into the DePIN economy?

A “utility” token with non-investment or consumptive utility is essential to a DePIN ecosystem. However, this is also problematic, as essentially the company must not only pay out a token like HNT in exchange for data and bandwidth, but also accept HNT as payment for tangible services. From a company perspective, the tangible services cost fiat dollars – capital and labor cannot be purchased for a manufactured token. Further, the price of a token like HNT is hardly stable. HNT currently trades at about $6.60 to HNT. In November 2021, HNT traded for over $50 per HNT. Unstable token prices limit the consumptive use of cryptocurrencies and tokens, making them more suitable for long-term holding or short-term speculation. Further, it is tempting for a startup to simply issue tokens to raise capital – under the guise of a future consumptive use or simply the “this will go up in value as we expand” argument. This reality defeats the non-investment utility argument and renders tokens susceptible to classification as unregistered securities.

Companies have attempted to address these issues through use of associated tokens (IOT and MOBILE are directly earned by Helium network or hotspot hosts, the burn-and-mint protocol, use of “data credits” or “map credits,” and various fees. For example, Filecoin, a decentralized file handling platform, collects base fees for storage deals, batch fees for adding storage capacity, overestimation fees that related to optimized gas usage (gas being the cost of transacting the cryptocurrency), and penalty fees collected from those who do not provide storage as promised. Those who want to store data using Filecoin pay fees in FIL. FIL is also the reward paid out to those who provide storage or retrieval services on the Filecoin network.

What are specific legal challenges facing DePIN projects?

While innovative, DePIN businesses face an uncertain regulatory landscape, particularly in the United States. At a minimum, a business considering DePIN should consider the following:

1. Physical regulatory considerations – are there zoning laws, telecommunications regulations, licensing requirements, or other physical considerations that affect my business?
2. Legal liability – what are my obligations to the persons who contribute to my network or project? Are they contractors or employees? Are there any insurance or liability risks that I need to cover through contracts or terms of use?
3. Financial legality – is my token really a “utility” token for consumptive non-investment use? How is my token created? How is it used? Is that use supportable under the current regulatory framework and the Howey test?

Some commentators predict that DePIN will be the next big thing in crypto and lead to mass adoption of decentralized blockchains in day-to-day business and life. The benefits are easy to see: lower costs, greater accessibility, crowdsourced reliability, security. However, there are also many complex legal regulatory considerations. Contact the experienced attorneys at Artaev at Law PLLC for a consultation about your next big project.

Disclaimer: This article is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

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