Web3 Lawyer: Understanding the Ethereum Foundation's 2024 report and facing Compliance challenges in the era of Trump

Author: Iris, Liu Honglin, ManKun Law Firm

The 2024 U.S. election finally came to an end, and Trump, who is widely followed and supported in the encryption industry, can be considered to have ‘returned to the palace’. I wonder if your friends’ circle was overwhelmed at that time. Unlike the previous administration, his return to the White House this time may bring a more friendly and Favourable Information regulatory environment for the encryption industry.

*Image source: X.com

During the election season, various ‘strange moves’ such as BTC strategic reserves, Mining Americanization, and the dismissal of the current SEC chairman have emerged. However, if we talk about the key regulations that will affect the development of encryption assets and Web3 projects in the next few years, it must be the Financial Innovation and Technology for the 21st Century Act (FIT21). Currently, the bill has been passed by the US House of Representatives with a high vote of 279:136 and is very likely to be passed by the Senate and enacted into law after Trump’s administration.

We all know that after most Web3 projects have grown in scale, they will choose to establish foundations to cooperate with local and global regulations. So, what impact will the FIT21 bill have on Web3 projects, especially the Web3 Foundation? First, let’s let lawyer Mancun summarize the core of FIT21 for everyone.

FIT21 Bill: Redefining encryption assets

The FIT21 Act, led by the Republican Party, not only responds to the long-standing concerns of the encryption industry about regulatory uncertainty, but also outlines clearer regulatory boundaries for the encryption industry, while also attempting to reduce potential market chaos from the source. The most notable aspect of this legislation is the redefinition of which encryption assets can be classified as ‘commodities’ rather than ‘securities’, which directly determines the type of regulation these assets will be subject to.

To achieve this goal, the FIT21 Bill has established three core evaluation criteria to help define the nature of assets and regulatory scope:

1. 20% Token control red line

The FIT21 Act stipulates that if the proportion of Tokens controlled by any single entity or related party exceeds 20%, the project will be classified as a security and will be subject to strict regulation by the SEC. The original intention of this provision is to prevent the market from being manipulated by a few large holders.

For projects that wish to be recognized as “commodities” and obtain more relaxed regulation, this “20% ceiling” is both a restriction and a compliance guideline. The project party needs to design a reasonable token distribution plan to disperse control among numerous holders, forming a distributed governance model rather than being controlled by a small core team.

2. Governance Structure of Decentralization

The FIT21 bill imposes strict requirements on the ‘Decentralization’ governance, aiming to ensure that the project’s decision-making mechanism truly achieves ‘decentralization’. This not only involves the decentralization of control, but also the transparency and independence of governance. For example, the project needs to introduce an open and transparent voting mechanism that allows Tokenholders to truly participate in key decision-making. In this way, governance is not only superficially decentralized, but also has substantial public participation.

In addition, the bill also proposes transparency standards for governance structure. Simply put, the project party needs to publicly disclose key governance rules and processes, such as the execution conditions for major decisions or the trigger rules for the code, so that Tokenholders can clearly understand how the project operates, reducing the possibility of ‘black box operations’ by the core team. This transparent governance structure can win more user trust for the project and is also an effective means of Compliance.

3. Disclosure and Transparency Requirements

The FIT21 bill is relatively flexible in its disclosure requirements, providing different disclosure standards based on the degree of Decentralization and the nature of the project. For projects that meet the Decentralization requirements and are classified as “commodities”, the bill allows them to enjoy relatively relaxed disclosure obligations. However, key financial information, Token distribution, and community governance proposals still need to be regularly disclosed to the public to ensure transparency. Projects deemed as securities, on the other hand, are required to undergo comprehensive financial disclosure on a regular basis, similar to traditional securities, to ensure investors’ right to information.

At the same time, in addition to establishing standards, the FIT21 bill has very humanely introduced the ‘safe harbor’ clause, providing a crucial Compliance transition period for encryption projects. For projects that have not yet fully achieved Decentralization, as long as the project party promises to reach the Decentralization standard within a specified time, they can continue to operate during the exemption period without being subject to strict securities regulation. This clause gives the project party time to gradually improve its governance structure and community management, reducing the short-term adjustment risks caused by Compliance pressure. This flexible buffer mechanism not only protects the innovation space of the project party, but also ensures its long-term Compliance direction, creating a stable policy environment for the healthy development of the encryption industry.

So, in the context of the foreseeable enactment of the FIT21 Act, how should Web3 projects respond, whether in terms of token governance or organizational structure?

Lawyer Mankun has long been recommending and assisting Web3 projects in setting up foundations to ensure global Compliance (for support, please add Mankun customer service: MankunLawFirm). At the same time, he has also repeatedly written about the advantages and establishment plans of setting up foundations, such as “Web3 Project Compliance: Why choose the Cayman Foundation for Tokenissuance?” and “Vitalik Buterin’s Selection: Why choose a Swiss foundation for Web3 project launch coin?”.

So, after establishing the foundation, how can this organizational structure meet the Decentralization standard of the FIT21 Act? Coincidentally, the Ethereum Foundation (EF) released its annual report for 2024. Lawyer Mankun interpreted it accordingly.

Three Key Points of Ethereum Foundation 2024 Report

The 2024 annual report released by the Ethereum Foundation consists of 27 pages in total, with concise language but very rich information. From organizational structure to treasury funds, and annual expenditure, the report of the Ethereum Foundation has clear disclosures, which also allows us to have a glimpse of the architecture and current situation of the world’s largest Web3 Foundation.

Lawyer Mankun specially reminds: For Web3 projects that want to establish a foundation, this report is a “template room” for Compliance. Next, in combination with the FIT21 bill, we will dissect the Compliance path for the ETH Foundation to deal with regulation. Everyone, please “take good notes”.

1. Decentralization Governance

The Ethereum Foundation detailed the functions and division of several key teams in its 2024 annual report, including development teams, research departments, ecosystem support teams, and the Risk Management group. These teams operate independently and supervise each other, not only with clear division of labor in technical development and project support, but also demonstrate the foundation’s commitment to decentralization in governance architecture. For example, the development team focuses on technical upgrades of the core protocol, the research department is responsible for future innovation exploration, and the ecosystem support team promotes community education and ecosystem expansion. These functional divisions prevent decision-making authority from being overly centralized in a single team, ensuring governance decentralization.

In addition, the foundation also decentralizes some decision-making power to coin holders and ecosystem participants through community voting and open proposals, allowing the community to truly participate in the future development of the project. In this way, not only are the team’s functional boundaries clear, but governance also remains transparent and community-oriented. This governance model fundamentally meets FIT21’s requirements for Decentralization, reducing the risk of single control and providing guarantee for the long-term healthy development of the project.

2. Treasury Funds Holding

The Ethereum Foundation’s 2024 annual report disclosed its current treasury holdings. The data shows that the Ethereum Foundation currently holds $788.7M in encryption assets, of which 99.45% is ETH, which is worth approximately $784.4M. Based on the current ETH market data, the total amount of ETH held by the Ethereum Foundation is about 261,000, accounting for approximately 0.22% of the total supply of ETH.

This data shows that the proportion of ETH Holdings in the Ethereum Foundation remains relatively low, which avoids excessive market impact and reduces the liquidity pressure of concentrated holdings. It is much lower than the 20% red line set by the FIT21 Act, ensuring that ETH will no longer be accused by the SEC of being a security issue. In addition to encryption assets, the Ethereum Foundation also holds approximately 300 million US dollars of TradFi assets, such as Fiat Currency and bonds, ensuring its ability to resist risks in market fluctuations.

This diversified fund management approach not only increases financial stability, but also demonstrates the Ethereum Foundation’s commitment to decentralization and transparency. This ‘lightweight Holdings + diversified allocation’ financial strategy also provides an important reference for other Web3 projects: while promoting ecological development, it ensures long-term financial support through reasonable allocation, laying a solid foundation for achieving a more resilient rise in the ever-changing regulatory environment.

3. Annual Financial Data

The 2024 annual report of the Ethereum Foundation provides detailed disclosure of the financial situation in the past two years, clearly demonstrating the use and management of funds between 2022 and 2023. The data shows that the foundation’s expenses are mainly focused on three major zones: core development, ecological funding, and operational reserves, covering aspects such as security upgrades of the core protocol, ecological support, and risk management.

Specifically, the report shows that the Ethereum Foundation has made significant investments in core protocol development over the past year, including the development of Layer 2 scaling technology, Zero-Knowledge Proof, and other emerging technologies to maintain the innovation and security of the Ethereum network. In addition, the Foundation has increased funding for the ecosystem, supporting developer communities and incubating various new projects to drive the long-term development of the Ethereum ecosystem. These funding programs cover project incubation, education and training, and community activities, providing momentum for the sustainability of the Ethereum network.

The transparent and open fund management strategy of the Ethereum Foundation meets the requirements of financial disclosure under the FIT21 Act, providing a strong reference for Compliance in the future development of the Web3 industry. At the same time, this transparent data disclosure also helps to build market trust and establish Compliance and resilience for the sustainable development of projects.

Mankiw’s Advice

At present, with Trump’s accession, the FIT21 bill seems to have reached a “nail on the board” level. Just like the impact of the EU MiCA bill on the global regulation of encryption assets, once the FIT2 bill is officially passed by the Senate and legislated, it is bound to have an equally important impact on the qualification of global encryption assets. Therefore, whether it is for Web3 projects that want to establish a foundation or have already been established and are considering Compliance regulation, it is necessary to take a copy of this “homework” from the ETH Foundation.

• Reasonable distribution of Token to ensure the implementation of decentralized governance

The 20% control red line proposed by the FIT21 bill requires many projects to be more cautious in token distribution. Therefore, it is crucial to design a reasonable token distribution plan at the early stage of the project. By introducing longer governance mechanisms such as token holder voting and community proposal management, decision-making power is gradually decentralized to community members. This transparent governance model not only helps projects meet the Decentralization standards of FIT21 but also greatly enhances community participation, laying a solid foundation of support for the project.

• Diversify fund holdings to enhance financial stability

The diversified fund allocation demonstrated by the Ethereum Foundation is a typical conservative strategy, covering not only holding encryption assets, but also including TradFi tools such as Fiat Currency and bonds. Web3 project parties can also refer to diversification in fund management to avoid concentration of a single asset, especially the market fluctuation risk caused by the high volatility of encryption assets. Through flexible allocation, project parties can maintain sufficient liquidity and risk resistance in market fluctuations, ensuring financial stability and providing reliable support for the long-term development of the project.

• Focus on information disclosure and transparency building

Under the FIT21 framework, information disclosure has become one of the key factors affecting project Compliance. Web3 projects actively disclose transparency in fund flows, Token distribution, governance mechanisms, and other aspects. Reference can be made to the disclosure method of the Ethereum Foundation, which regularly discloses key information such as project development progress and fund utilization, providing reliable reference data for the community and investors. This not only helps Compliance, but also enhances community trust and reduces potential legal and reputational risks.