The Legal Status of Tokens, Crypto and ICOs
It wasn’t long ago that ICOs (Initial Coin Offerings) were raising staggering amounts of money — in January ICOs raised $1.6 billion. In the subsequent months, that dipped to $1.2 billion in February followed by another drop to $500 million in March. A major factor is the general cooling of the blockchain market, as the total market cap dropped from a high of $813 billion on January 7 to a first quarter low of $255 billion on March 29. However, another consideration is the confusion around the legal status of tokens and ICOs in general.
Are regulators going to crack down on the industry? What is legal and what is forbidden when it comes to tokens, crypto and ICOs?
As noted earlier this year, regulations around the ICO industry are still a work in progress. While some countries have refined their legal framework, other countries are still investigating the area, offering vague statements or taking ambiguous actions. Here’s a roundup of regulatory frameworks in jurisdictions with the most established regulations for ICOs and crypto.
An indication of how far the Swiss have come in terms of developing a viable, regulated ICO market is the fact that it is home to “Crypto Valley,” an area which has over 200 blockchain companies, including the Ethereum Foundation. Switzerland raised the second largest amount of ICO funds, only behind the U.S. Considering it’s a country of just over eight million people, it’s well on its way to becoming — as economics minister Johann Schneider-Ammann calls it — a “crypto nation.”
On February 16, the Swiss Financial Market Supervisory Authority (FINMA) published ICO guidelines. While there’s no specific Swiss regulation or case law yet, the guidelines point to the relevancy and primacy of existing money laundering and securities regulation. These include Anti-Money Laundering procedures, such as identifying the beneficial ownership as well as fair, reliable and efficient security trading procedures and proper information disclosures.
An interesting development is how FINMA is categorizing various types of token offerings. As each project has a different use and has a unique financial structure, there has been a lot of confusion about classifying an ICO as a utility or a security. Basing their framework around functionality and transferability criteria, FINMA created three ICO categories:
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Payment ICOs: For ICOs where the token is intended to function as a means of payment and can already be transferred, FINMA will require compliance with anti-money laundering regulations. FINMA will not, however, treat such tokens as securities.
Utility ICOs: These tokens do not qualify as securities only if their sole purpose is to confer digital access rights to an application or service and if the utility token can already be used in this way at the point of issue. If a utility token functions solely or partially as an investment in economic terms, FINMA will treat such tokens as securities (i.e. in the same way as asset tokens).
Asset ICOs: FINMA regards asset tokens as securities, which means that there are securities law requirements for trading in such tokens, as well as civil law requirements under the Swiss Code of Obligations (e.g. prospectus requirements).
Another jurisdiction that is crypto-positive is Japan. More than 3.5 million people are trading crypto in Japan, accounting for $97 billion in monthly trading in Bitcoin (March 2017). They were one of the first countries to legalize Bitcoin as legal currency and create laws for crypto exchanges.
A government-backed report released on April 5 outlines proposed ICO guidelines that will be deliberated by Japan’s Financial Services Agency. While still just a proposal, it does indicate that Japan wants to move forward in the area.
Some of the basic rules suggested by the report include:
- Properly identifying customers
- Anti-Money Laundering procedures
- Project tracking
- Protecting existing debt and equity holders
- Exchange standards for token listing
- Cyber-security standards
- Trading rules
In Canada, the regulatory status towards all things crypto is similar to many countries. Canada’s central bank governor, Stephen Poloz, called Bitcoin trading “gambling.” However, he did refer to blockchain as “a true piece of genius and it will be applied to many areas in the economy.” The Bank of Canada is working with other national regulators to determine global cryptocurrency regulatory rules: “we will be developing regulations around this space in due course. But what we are being careful to do here is to not stifle innovation.”
In regards to ICOs, Canadian regulators released CSA Staff Notice 46–307 on Aug. 24 of last year. “[A] coin/token may still be a ‘security’ as defined in securities legislation of the jurisdictions of Canada. Businesses should complete an analysis on whether a security is involved.”
That outlook parallels how ICOs are regulated in the U.S. — careful consideration on each step of the ICO process is necessary to ensure the offering is not a security, or if it is, ensure that the applicable security laws are followed.
Recently, a joint U.S. state/Canadian province security regulator operation — “Operation Cryptosweep” — initiated 70 investigations into suspicious crypto investment products. It’s vital that whichever jurisdiction an ICO is launched in, the regulatory rules are carefully followed, including proper identity verification. As with all other financial products and services, compliance with Anti-Money Laundering and Know Your Customer laws is imperative.