Earlier in our articles, we have already considered what Initial Coin Offering is. However, we remind that the Initial Coin Offering (ICO) is a popular method among start-ups and other companies to raise capital. Investors participate in the collection of financial resources by transferring funds to the issuer in official currencies such as dollar, euro, yuan, etc. or in cryptocurrencies, for example, Bitcoins or Ethers, in exchange for digital tokens (Tokens, electronic coins). It is Tokens that confirm the rights of the holder to receive profit or the fulfillment of obligations on the part of the issuer. In addition, Tokens can be used to pay for services/goods of the issuing company. In contrast to the initial public offering (IPO), usually Tokens do not represent an ownership interest or receipt of dividends from the issuing company. Investors who participate in the ICO often expect to profit from the development of the activities of the company in the future, or play at increasing the value of Tokens (probably the brightest example at the moment is the rise in the price of Bitcoin).
Like all cryptocurrencies, Tokens are based on Blockchain (distributed ledger technology, which is resistant to fraud, since all transactions are electronically documented without the participation of any central authority), which is supported by a network of participants and computers.
By analogy with the IPO, the issuer can use the funds raised through the ICO to finance its activities, development of a certain project or simply future growth.
As a general rule, the company that intends to launch the ICO publishes its own so-called prospectus on its website and on the sites of other virtual platforms. In such Prospectus, the issuer usually describes its activities, as well as the structure and characteristics (features) of Tokens. In addition, the documentation may include a contract for the purchase of Tokens, which contains all the main conditions of sale, on which investors can purchase Tokens. Most ICOs were conducted at the international level, however, the requirements became more stringent last time and therefore the proposal can be valid only for certain markets (jurisdictions).
In general, the ICO market operates at a very high level. So, in 2016, more than USD 100 million were raised through the initial coin offering. Only in November 2017, the figure reached USD 740 million, while the total amount of funds raised for 2017 was more than USD 3 billion. It is still difficult to forecast for 2018, but taking into account the increasing popularity of this type of investment, it is expected that the total amount of investment will also increase.
Based on such an active growth in the popularity of ICO, potential issuers should be aware of the development of the regulatory and legislative framework for the ICO. In this article, we will consider how the regulation of the initial coin offering takes place in different jurisdictions.
Legal Classification of Cryptocurrency and Tokens
The status of cryptocurrency depends a lot on the jurisdiction in which they are issued and the rights that are associated with such a cryptocurrency.
So the US Commodity Futures Trading Commission in 2015 recognized the most popular cryptocurrency Bitcoin as a commodity. However, this definition applies exclusively to Bitcoins and does not apply to other cryptocurrencies or Tokens. In 2017, in its conclusion on the DAO cryptocurrency, the US Securities and Exchange Commission recognized the DAO as securities.
In 2017, the United Kingdom Financial Conduct Authority (“FCA”) launched the consultations on the application of cryptocurrency.
As for the European Union, despite the high level of harmonization of the legislation of the Member States, the approaches to the legal classification of cryptocurrencies vary considerably. So, earlier we have already written that the European Securities and Markets Authority has issued a statement regarding investor risks and companies participating in the ICO this year. This statement alert investors of the high risks of default by the issuer, market changeability, insufficient information provided and the vulnerability of technology. Similarly, it was concluded that the Tokens, on the basis of their structure, could be referred to the concepts of transferable securities or a financial instrument.
In France, the regulation of cryptocurrency is adapted by amending the legislation on payment services. The Swedish central bank is considering the validity for creating its own national regulated digital currency. In Germany, cryptocurrencies are recognized as a unit of account and are considered as a financial instrument.
The regulator of Canada determined that the proposals of cryptocurrency, including the sale of Tokens, including through ICO, should be qualified as securities. Singapore and Australia also define Tokens as securities.
Financial Regulation of ICO
It is absolutely objective that legal uncertainty regarding cryptocurrency is extrapolated to the initial coin offering. The customary regulation of crowdfunding is not applicable to the ICO, as in this case investors do not provide loans to the issuer. The purchase of Tokens issued under the ICO can be considered as the purchase of goods, acquisition of rights or securities.
In order to be able to launch the initial coin offering, companies-issuers choose jurisdictions that are more favourable to the ICO (eg, Singapore, Switzerland). Such companies register their offices in these countries and include a governing law clause about the applicable law in the documentation, thus limiting the applicable regulatory regimes. But even with this approach, one can not escape from uncertainty.
Applicable law will not always be limited by the state where the ICO occurs. If the issue of Tokens is oriented to investors who are in a different jurisdiction, then the rules of financial regulation of other country can be applied. The issuer will be obliged to restrict access to the information and documentation on ICO jurisdictions in which it is proposed to conduct an initial coin offering.
We will consider the main regulatory issues in different countries below.
Germany
The Federal Financial Supervisory Authority of Germany determines the applicability of certain national legislation, namely, on the basis of the the German Banking Act, the German Securities Prospectus Act, the German Capital Investment Code, the German Capital Investment Act, the Payment Services Supervisory Act in each individual case. The application of the legislation will, of course, depend on the contractual obligations of the ICO. So, if the acquisition of the right of participation is proposed as a result of the ICO, the provisions of the the German Securities Prospectus Act will be applied. In the case of capital investments – the provisions of the German Capital Investment Act are naturally applied. In any case, any trade, including an arrangement for acquisition, purchase and sale of Tokens, when determining the latest as a unit of account, will require as a general rule to obtain a general license from the German Federal Financial Supervisory Authority.
United Kingdom
The Financial Conduct Authority (hereinafter – “FCA”) issued a statement in September 2017 that determined that many ICOs are not subject to most regulatory acts without identifying specific reasons, although the FCA can conduct an analysis of each case.
France
The French Financial Market Authority (AMF) issued a consultation paper in 2017, which indicated that legal regulation of the initial coin offering is planned to be prepared in late 2017 after the end of the consultation period. Future regulation of the ICO is facilitated by certain framework proposals, according to which the initial coin offering can be regulated. At the moment, the AMF neither defines ICOs or Token, however, it is expected that such definitions will be contained in the proposed legislation.
European Union
The European Securities and Markets Authority (hereinafter referred to as the ESMA) has explicitly set out the application of potential regulation regarding the initial coin offering. Thus, ICOs in which Tokens are considered as transferable securities will be subject to the regulation of relevant applicable EU legislation. Thus, an assessment will be conducted in accordance with the following acts:
Prospectus Directive: the requirement to publish an agreed issue prospectus when securities are offered for public purchase. With some exceptions, the requirements of the directive will not apply if the proposal is only for investors who meet the requirements (as defined in the Directive) or for a limited number of investors (up to 150 individuals or legal entities) or in case the investment from each investor is at least EUR 100,000, or the minimum nominal value of one Token not less than EUR 100,000.
Markets in Financial Instrument Directive (as amended): licensing rules, product governance rules, pre- and post-trading transparency requirements, requirements of the adequate systems and controls, organisational requirements for trading platforms, etc.
Alternative Investment Fund Manager Directive: licensing requirements, conduct of business, prospectus and disclosure requirements, mandatory appointment of depositories and custodians, restrictions on the ratio of own and borrowed funds, and other.
The 4th Anti-Money Laundering Directive: requirements for due diligence of customers and ongoing monitoring of customer relations, requirements regarding systems and controls and record-keeping, reporting on suspicious activities and cooperation with the investigation that corresponding state body can conduct.
Switzerland
The Swiss Financial Market Supervisory Authority published a guidance in September 2017, according to which it was determined that, depending on the structure of the ICO, the provisions of the legislation on collective investment schemes and legislation on banking activities may apply to certain procedures. Accordingly, issuers should carefully consider the provisions of the applicable law in the construction of schemes for the initial release of coins, especially in Switzerland.
USA
The application of securities legislation to the ICO depends on how Tokens are classified. The US Securities and Exchange Commission (heirafter – SEC) has defined in its explanations that Tokens can be considered as securities, subject to certain criteria. Recent reports have shown that Tokens will be considered as securities if they directly or indirectly provide buyers with investment opportunities. Accordingly, Tokens can not be offered without registration with the SEC or receipt of a reply that there is no need for registration. In the event that Tokens are still identified as securities, their issue will have to be registered with the SEC and the prospectus of emission must comply with the current legislation.
China
The situation in China with ICO and cryptocurrencies is very interesting. So, in September 2017, the Chinese government issued a decree that admitted the primary issue of coins as illegal and called on all companies that are somehow involved in this process to stop such activities. Shortly thereafter, there has been a ban on the operation of platforms for the exchange of cryptocurrency. However, it is expected that such prohibitions are temporary – until the adoption of the relevant legislative regulation that is being discussed at the moment.
What to expect in the future
The relevant state bodies of different countries of the world show different approaches to the regulation of the initial issue of coins.
Thus, some states seek to recognize Tokens as securities and apply appropriate legislation to their regulation. It gives greater security to the investors. At the same time, the regulatory approaches are still very different, as there is no consensus on regulation of both ICO and cryptocurrency, which complicates the process of launching an ICO.
Despite the difference in approaches to regulation, almost all countries are united in their approach to the application of anti-money laundering legislation.
In conclusion, we would like to note that the initial issue of coins is a new and insufficiently known way for the companies to attract capital. The regulation of this process at the moment is not unified and the approaches of various organizations of all countries differ. At the same time, despite the structure and definition of Tokens, the issuing companies are obliged to provide investors with full and detailed information on the proposed operation and provide investors with the opportunity to make informed decisions.
Non-compliance with applicable laws will naturally lead to negative consequences for issuers. Therefore, it is preferably to obtain qualified legal assistance before starting all the procedures related to the initial coin offering, both to the issuer and investor.
Earlier in our articles, we have already considered what Initial Coin Offering is. However, we remind that the Initial Coin Offering (ICO) is a popular method among start-ups and other companies to raise capital. Investors participate in the collection of financial resources by transferring funds to the issuer in official currencies such as dollar, euro, yuan, etc. or in cryptocurrencies, for example, Bitcoins or Ethers, in exchange for digital tokens (Tokens, electronic coins). It is Tokens that confirm the rights of the holder to receive profit or the fulfillment of obligations on the part of the issuer. In addition, Tokens can be used to pay for services/goods of the issuing company. In contrast to the initial public offering (IPO), usually Tokens do not represent an ownership interest or receipt of dividends from the issuing company. Investors who participate in the ICO often expect to profit from the development of the activities of the company in the future, or play at increasing the value of Tokens (probably the brightest example at the moment is the rise in the price of Bitcoin).
Like all cryptocurrencies, Tokens are based on Blockchain (distributed ledger technology, which is resistant to fraud, since all transactions are electronically documented without the participation of any central authority), which is supported by a network of participants and computers.
By analogy with the IPO, the issuer can use the funds raised through the ICO to finance its activities, development of a certain project or simply future growth.
As a general rule, the company that intends to launch the ICO publishes its own so-called prospectus on its website and on the sites of other virtual platforms. In such Prospectus, the issuer usually describes its activities, as well as the structure and characteristics (features) of Tokens. In addition, the documentation may include a contract for the purchase of Tokens, which contains all the main conditions of sale, on which investors can purchase Tokens. Most ICOs were conducted at the international level, however, the requirements became more stringent last time and therefore the proposal can be valid only for certain markets (jurisdictions).
In general, the ICO market operates at a very high level. So, in 2016, more than USD 100 million were raised through the initial coin offering. Only in November 2017, the figure reached USD 740 million, while the total amount of funds raised for 2017 was more than USD 3 billion. It is still difficult to forecast for 2018, but taking into account the increasing popularity of this type of investment, it is expected that the total amount of investment will also increase.
Based on such an active growth in the popularity of ICO, potential issuers should be aware of the development of the regulatory and legislative framework for the ICO. In this article, we will consider how the regulation of the initial coin offering takes place in different jurisdictions.
Legal Classification of Cryptocurrency and Tokens
The status of cryptocurrency depends a lot on the jurisdiction in which they are issued and the rights that are associated with such a cryptocurrency.
So the US Commodity Futures Trading Commission in 2015 recognized the most popular cryptocurrency Bitcoin as a commodity. However, this definition applies exclusively to Bitcoins and does not apply to other cryptocurrencies or Tokens. In 2017, in its conclusion on the DAO cryptocurrency, the US Securities and Exchange Commission recognized the DAO as securities.
In 2017, the United Kingdom Financial Conduct Authority (“FCA”) launched the consultations on the application of cryptocurrency.
As for the European Union, despite the high level of harmonization of the legislation of the Member States, the approaches to the legal classification of cryptocurrencies vary considerably. So, earlier we have already written that the European Securities and Markets Authority has issued a statement regarding investor risks and companies participating in the ICO this year. This statement alert investors of the high risks of default by the issuer, market changeability, insufficient information provided and the vulnerability of technology. Similarly, it was concluded that the Tokens, on the basis of their structure, could be referred to the concepts of transferable securities or a financial instrument.
In France, the regulation of cryptocurrency is adapted by amending the legislation on payment services. The Swedish central bank is considering the validity for creating its own national regulated digital currency. In Germany, cryptocurrencies are recognized as a unit of account and are considered as a financial instrument.
The regulator of Canada determined that the proposals of cryptocurrency, including the sale of Tokens, including through ICO, should be qualified as securities. Singapore and Australia also define Tokens as securities.
Financial Regulation of ICO
It is absolutely objective that legal uncertainty regarding cryptocurrency is extrapolated to the initial coin offering. The customary regulation of crowdfunding is not applicable to the ICO, as in this case investors do not provide loans to the issuer. The purchase of Tokens issued under the ICO can be considered as the purchase of goods, acquisition of rights or securities.
In order to be able to launch the initial coin offering, companies-issuers choose jurisdictions that are more favourable to the ICO (eg, Singapore, Switzerland). Such companies register their offices in these countries and include a governing law clause about the applicable law in the documentation, thus limiting the applicable regulatory regimes. But even with this approach, one can not escape from uncertainty.
Applicable law will not always be limited by the state where the ICO occurs. If the issue of Tokens is oriented to investors who are in a different jurisdiction, then the rules of financial regulation of other country can be applied. The issuer will be obliged to restrict access to the information and documentation on ICO jurisdictions in which it is proposed to conduct an initial coin offering.
We will consider the main regulatory issues in different countries below.
Germany
The Federal Financial Supervisory Authority of Germany determines the applicability of certain national legislation, namely, on the basis of the the German Banking Act, the German Securities Prospectus Act, the German Capital Investment Code, the German Capital Investment Act, the Payment Services Supervisory Act in each individual case. The application of the legislation will, of course, depend on the contractual obligations of the ICO. So, if the acquisition of the right of participation is proposed as a result of the ICO, the provisions of the the German Securities Prospectus Act will be applied. In the case of capital investments – the provisions of the German Capital Investment Act are naturally applied. In any case, any trade, including an arrangement for acquisition, purchase and sale of Tokens, when determining the latest as a unit of account, will require as a general rule to obtain a general license from the German Federal Financial Supervisory Authority.
United Kingdom
The Financial Conduct Authority (hereinafter – “FCA”) issued a statement in September 2017 that determined that many ICOs are not subject to most regulatory acts without identifying specific reasons, although the FCA can conduct an analysis of each case.
France
The French Financial Market Authority (AMF) issued a consultation paper in 2017, which indicated that legal regulation of the initial coin offering is planned to be prepared in late 2017 after the end of the consultation period. Future regulation of the ICO is facilitated by certain framework proposals, according to which the initial coin offering can be regulated. At the moment, the AMF neither defines ICOs or Token, however, it is expected that such definitions will be contained in the proposed legislation.
European Union
The European Securities and Markets Authority (hereinafter referred to as the ESMA) has explicitly set out the application of potential regulation regarding the initial coin offering. Thus, ICOs in which Tokens are considered as transferable securities will be subject to the regulation of relevant applicable EU legislation. Thus, an assessment will be conducted in accordance with the following acts:
Prospectus Directive: the requirement to publish an agreed issue prospectus when securities are offered for public purchase. With some exceptions, the requirements of the directive will not apply if the proposal is only for investors who meet the requirements (as defined in the Directive) or for a limited number of investors (up to 150 individuals or legal entities) or in case the investment from each investor is at least EUR 100,000, or the minimum nominal value of one Token not less than EUR 100,000.
Markets in Financial Instrument Directive (as amended): licensing rules, product governance rules, pre- and post-trading transparency requirements, requirements of the adequate systems and controls, organisational requirements for trading platforms, etc.
Alternative Investment Fund Manager Directive: licensing requirements, conduct of business, prospectus and disclosure requirements, mandatory appointment of depositories and custodians, restrictions on the ratio of own and borrowed funds, and other.
The 4th Anti-Money Laundering Directive: requirements for due diligence of customers and ongoing monitoring of customer relations, requirements regarding systems and controls and record-keeping, reporting on suspicious activities and cooperation with the investigation that corresponding state body can conduct.
Switzerland
The Swiss Financial Market Supervisory Authority published a guidance in September 2017, according to which it was determined that, depending on the structure of the ICO, the provisions of the legislation on collective investment schemes and legislation on banking activities may apply to certain procedures. Accordingly, issuers should carefully consider the provisions of the applicable law in the construction of schemes for the initial release of coins, especially in Switzerland.
USA
The application of securities legislation to the ICO depends on how Tokens are classified. The US Securities and Exchange Commission (heirafter – SEC) has defined in its explanations that Tokens can be considered as securities, subject to certain criteria. Recent reports have shown that Tokens will be considered as securities if they directly or indirectly provide buyers with investment opportunities. Accordingly, Tokens can not be offered without registration with the SEC or receipt of a reply that there is no need for registration. In the event that Tokens are still identified as securities, their issue will have to be registered with the SEC and the prospectus of emission must comply with the current legislation.
China
The situation in China with ICO and cryptocurrencies is very interesting. So, in September 2017, the Chinese government issued a decree that admitted the primary issue of coins as illegal and called on all companies that are somehow involved in this process to stop such activities. Shortly thereafter, there has been a ban on the operation of platforms for the exchange of cryptocurrency. However, it is expected that such prohibitions are temporary – until the adoption of the relevant legislative regulation that is being discussed at the moment.
What to expect in the future
The relevant state bodies of different countries of the world show different approaches to the regulation of the initial issue of coins.
Thus, some states seek to recognize Tokens as securities and apply appropriate legislation to their regulation. It gives greater security to the investors. At the same time, the regulatory approaches are still very different, as there is no consensus on regulation of both ICO and cryptocurrency, which complicates the process of launching an ICO.
Despite the difference in approaches to regulation, almost all countries are united in their approach to the application of anti-money laundering legislation.
In conclusion, we would like to note that the initial issue of coins is a new and insufficiently known way for the companies to attract capital. The regulation of this process at the moment is not unified and the approaches of various organizations of all countries differ. At the same time, despite the structure and definition of Tokens, the issuing companies are obliged to provide investors with full and detailed information on the proposed operation and provide investors with the opportunity to make informed decisions.
Non-compliance with applicable laws will naturally lead to negative consequences for issuers. Therefore, it is preferably to obtain qualified legal assistance before starting all the procedures related to the initial coin offering, both to the issuer and investor.