Fundraising via ICO

A Regulatory Perspective

An initial coin offering (ICO) is a concept that has come to real prominence during the last three years, alongside the rise of blockchain or distributed ledger technology (DLT), as a way for businesses utilising blockchain to raise funds.

Conceptually, it sits somewhere between crowdfunding and a traditional initial public offering (IPO), offering investors tokens, as opposed to equities, in exchange for their investment funds.

The significant difference from an IPO or a private equity raising, is that the tokens don’t automatically infer an ownership stake in the business, but instead often provide a different benefit to the buyer. Utility tokens are usually limited in number and integral to the business model of the issuer, giving a right to participate in the goods or services offered by the issuer. Other tokens may infer a right to receive a dividend, a voting right, a license, a property right or a right to participate in the future performance of the issuing company. In this case, the token issuance is referred to as an STO (Security Token Offering). In some jurisdictions, such as Switzerland, it may also be referred to as a payment token, but either way, this type of token is likely to fall under securities regulations.None of these rights are always guaranteed, however, because of the nascent nature of regulation within the sector.

Despite the immature, largely untested regulation in certain jurisdictions, ICOs have proved incredibly successful, with issuers raising 2.8 billion euros globally through ICOs in 2017.

This popularity seems to lie with the transparency and ease of access associated with blockchain technology. As an example, many start-ups have chosen to issue their tokens on the Ethereum blockchain, using the cryptocurrency Ether, or their own currency, as a method of purchase. This allows investors to purchase and hold tokens from a laptop, without requiring the services of expensive brokers, agents or advisors.

The obvious problem with an unregulated, or newly regulated, industry though, is the lack of any real safety net for investors. Due to the global and virtual nature of many blockchain companies, there is very little recompense possible if investments fail or are discovered to be scams. There is also currently very little oversight as to the quality and sustainability of many of the issuers coming to the ICO market.

Many legislators are scrambling to catch up, and major authorities such as the US Securities Exchange Commission (SEC) and the French Autorité des Marchés Financiers (AMF) are already thinking outside the box in an effort to incorporate the ICO phenomenon into national legislation in a fair and appropriate fashion. One major debate revolves around how to categorise the tokens issued, whether they should be subject to existing securities laws, or should instead be classified as commodities or simple assets. The answer lies in the nature of the token and what it can be used for – leaving room for grey areas to exist.

This difficulty in identifying the true nature of tokens, extends to other relevant areas, such as secondary exchanges and tax treatments, and will require significant cooperation between major regulators on a global stage to resolve satisfactorily.

Within the following report, we assess the pros and cons of ICOs, asking why they should be used, as opposed to other forms of capital raising, and which companies or business models they are most appropriate for. We also get an update on current legislative developments from nine legal experts representing different, but equally progressive, jurisdictions across the globe, taking their views on how ICOs can best be policed on a national and supra-national level.

Finally, we look at secondary exchanges and discuss how profits from tokens should be treated when crystallised by ICO investors.