Is Initial Coin Offering (ICO) Regulated?
The initial coin offering represents a recent phenomenon that gained momentum from the year 2017. Following the booming of digital currencies, the ICOs became an attractive fundraising method and alternative for equity financing. However, despite the increasing popularity of ICO projects, no strict and precise initial coin offering regulation in this area exists to date.
The aim of initial coin offering regulations should be to make it possible to distinguish serious projects from potentially fraudulent schemes. And to have reliable information to assess the quality of the projects of the firms involved.
Because of many risks and unknowns associated with ICOs, many financial authorities issued the warning regarding this type of investment.
Supposing that you already grasp relevant fundamental concepts, including blockchain and cryptocurrency, this briefing will give you a better picture of issues pertinent to initial coin offering regulation.
But before tackling the initial coin offering regulation, let’s deal with the definition of the initial coin offering itself.
Initial Coin Offering Definition
An ICO is a mode of financing that appeared very recently, with the development of the virtual currency concept. The ICO is a fundraising project, usually for startups, based on a distributed ledger technology such as blockchain. In exchange for the funds raised, the startups give “tokens” issued with blockchain technology which traders and investors can exchange on specialized platforms.
Simply said, an initial coin offering is a new, simple way to raise funds for whatever kind of business you like. We are free to say the ICO is a digital version of an Initial Public offering IPO. It just requires less paperwork and red tape.
ICOs and the Need for Initial Coin Offering Regulations
With billions of dollars raised through ICOs worldwide, it is clear that ICOs have become so important that they have caught the eye of business owners, consumers, and regulatory authorities.
Inherent risks associated with ICOs for investors call for strict regulations.
The first risk for an investor is the loss of part or all of the amount invested in the project. This risk is particularly persistent with ICOs because the funded project is often just an idea. The probability that the project will not succeed is very high.
Secondly, another important risk is the concealment of the origin of funds accentuated by the anonymity of crypto-asset transactions.
Although many businesses have reached success thanks to altcoins, many fraudulent entities see in ICOs the new opportunity to make profits.
The high risk involved in the ICO business model explains why many countries are trying to become the spearhead of the ICO regulation field.
What is an ICO Token?
A token offering can vary, ranging from simple financial rights such as access to a certain percentage of the startup’s profits to more complex financial benefits such as rights to gains made on the business activity.
Generally, the tokens represent the contract granting the right to purchase a company’s future products or services. The features and benefits of tokens differ depending on the project. The process of creation and offer of the new tokes is known as crowd sale or token sale.
Before the crowd sale, the token issuer must provide the white paper document. The white paper is an informative document that defines the scope of the project, the pace of the project execution, and the type of tokens with all their features and purposes.
There are different types of tokens, such as platform tokes, utility, security, and transactional tokens.
The token issuers, i.e., the founders of the project, must define if the tokens have utility or security value and so on.
To each type of different token, different rights are applied. The common questions arising are whether the ICO tokens are a speculative investment.
Lets’ see how different countries have chosen to reduce these risks as much as possible through the legislative framework.
Are ICO Tokens Regulated?
At this moment, there is no generally harmonized regulatory framework governing ICO tokens. Depending on the nature of the token, different rules could apply, and thus, a case-by-case analysis is necessary.
According to ESMA, tokens may stand for financial instruments, including transferable securities such as a company’s shares. But, the tokens that don’t fall in the securities category could not be covered by existing legislation. Since there is no clear legal framework for the ICO projects in the EU, it may lead to fragmentation of the EU market, opening the space for regulatory arbitrage.
The German Federal Financial Supervisory Authority argues that tokens in an ICO typically qualify as financial instruments. Still, the BaFin has decided that the German Stock Corporation Act would not apply to initial coin offerings.
The FCA (Financial Conduct Authority in the UK) has determined that many ICOs will breach the regulated frames. Moreover, each ICO needs to be evaluated on a case-by-case basis. Tokens falling into transferable securities may be regulated by federal security laws.
According to regulatory advisors, the tokens that don’t fall into the securities category should find the legislative framework within the Consumers law. It will enhance the investor protection and market transparency of utility tokens.
Does The Fourth Anti-Money-Laundering-Directive Apply to ICO?
The MLD 4 applies to a range of financial institutions. In principle, it depends on the qualification of the particular token offering whether issuers fall within the scope of the Fourth Anti-Money-Laundering-Directive. If that’s the case, the ICO project founders must provide due diligence reports to interested parties and cooperate with the relevant public authorities.
The Market Response to ICO Regulations
The ICOs have allowed startups to raise millions of dollars in days or even minutes. However, this is a complex area to grasp. Financial regulatory bodies and institutions even had to set up a pro-blockchain team to identify these new financing technologies and the emergence of new service providers on digital assets along with the associated risks.
Since the early stages of ICOs, the market has responded in various ways. Making a distinction between projects of pure blockchain implementation and projects involving tokens was the first step toward initial coin offering regulation.
Governments worldwide responded to the challenges of regulation of ICO projects and the cryptocurrency market in general. Let’s look at the two contrary examples of initial coin offering regulations in China and Switzerland.
Initial Coin Offering Regulation in China
China is a country with the most challenges due to its huge population. Chinese regulatory authorities have unanimously banned ICOs as an illegal fundraising model since the threats of fraudulent schemes are bigger due to Chinese demographics.
However, China has not totally given up on blockchain technology and research. Moreover, many municipalities have set up their own research facilities where they focus primarily on pure blockchain implementations. Meanwhile, the Chinese government is waiting for the other governments to experiment with the initial coin offerings regulation.
Initial Coin Offering Regulation in Switzerland
On the other side, today, Switzerland is popular as the “Crypto Valey.”
It became the leading country in terms of ICO projects due to the highly supportive attitude from the Swiss government. In recent years, the SFMSA is working on a legislative framework to increase the transparency of ICO projects.
US Initial Coin Offering Regulation
Regarding the US regulations, the authorities are in the process of determining if tokens fall into the securities category. If yes, the ICO tokens will be governed by securities law. In that way, the investors that issue the utility tokens incur the risk. Another heat subject raised debate across the Atlantic, namely the question of the rights enjoyed by token owners.
Unlike shares issued during an IPO, tokens issued during an ICO currently offer very few rights to investors other than benefit from certain services of the issuing company. Therefore, token holders do not have voting rights on the board of directors of the company or rights to receive any dividends.
In Conclusion
The market for ICOs has been booming in recent years. But regulators such as the SEC in the United States are constantly warning investors and the general public of the risks this method of fundraising poses. Nevertheless, ICOs have many advantages for both investors and entrepreneurs.
The current legal vagueness reinforces the crypto-skeptical climate. Investors are not certain of what legal status to give to crypto-assets that are not considered “currencies” in the eyes of the law but as intangibles, nor precisely at what rate profits will be taxed.
The business models relying on the issuance of new cryptocurrencies are often seen as beyond the reach of national regulations. In reality, evaluations, transaction volumes, and bases of cryptocurrency users show great sensitivity to the announcement of regulatory measures.
The impact varies depending on the type of measure announced. The general prohibition on cryptocurrencies, or the treatment thereof under the securities laws, produces the most unfavorable effects.
In general, cryptocurrency markets start to operate by relying on financial institutions. These markets are segmented by jurisdiction. And it puts the cryptocurrencies within reach of national regulations since there is little international convergence regarding the ICOs. When deciding where to launch an ICO, the investors have to take into account many disparities across various countries and the overall attitude towards them.
