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What are the regulatory issues of ICOs?

Whether you are a project holder or an investor, considering ICOs requires that you precisely analyse the legal constraints likely to apply in the various countries potentially involved.

The token economy, and especially ICOs, is based on a fast-changing underlying technology: blockchain. Yet, the related regulatory framework has generally not changed at the same speed. Depending on the jurisdiction involved, the law has not, or only partially, addressed this technological evolution. Although the gap between technology and law certainly generates some level of uncertainty, it also offers stakeholders the opportunity to be innovative and to use the existing regulatory regime as a strategic framework governing their project.

Once again, a case-by-case analysis is necessary to address the regulatory issues of each individual project. Nevertheless, a token’s legal qualification appears as the cornerstone of any legal analysis to be undertaken by stakeholders.

One of the main questions is determining whether tokens qualify as securities. A positive response may trigger, for example, the application of a whole set of rules applicable to IPOs  or the regime governing services related to financial instruments .

In practice, this depends of course on the characteristics of the token but also on the countries involved, as there is no worldwide harmonised regulatory answer to this question. The array of positions taken so far by governments, regulators and legislators regarding ICOs is extremely wide, ranging from “regulatory sandboxes” that enable issuers to test their activities under a simplified regime in certain countries, to the full and systematic application of Securities Law in others.

The absence of consistency is of particular importance for operations like ICOs that are generally largely international by nature and do not limit their scope to any single country. Issuers, and potential intermediaries involved, must carefully consider the various national laws that could apply to their offer.

For instance, they could consider the location of potential token holders, the local regime applicable to their operation, and the mechanisms aimed at ensuring that ICOs are not regulated in other countries which, as recently demonstrated [in the XXX case], could otherwise lead to a significant risk of litigation and enforcement procedures.

It is worth bearing in mind that the qualification of the tokens determines the rules applicable not only to the issuer, but also to all the other stakeholders in the operation. In fact, token qualification:

  • determines the rules and the legal protection that investors/users may enjoy. For example, it impacts the content of the information document (whitepapers and/or terms and conditions) to provide to potential token holders.
  • impacts the accounting and tax regime that potential token holders will be subject to when acquiring tokens.
  • defines the rules and responsibilities that other actors, such as intermediaries, need to comply with, for instance requirements as regards anti-money laundering and “know-your-customer” (KYC) obligations.

Lastly, besides the analysis of token qualification, an holistic and casuistic review must be carried out to perfectly understand the full scope of rules that ICO participants must implement, as each operation has its own specifics. For instance, depending on the type of users or investors targeted, certain fields of law, such as the Consumer Law in France, might become applicable and thereby significantly influence the nature of claims that token holders may have against the issuer or the intermediaries involved.

Although ICOs may be, on the long term, a remarkable innovation broadening the scope of funding options for project holders, they continue to raise a number of issues that must be anticipated carefully to ensure that they offer, to all the initiatives that they finance, the opportunities that they promise.

2) Règlement (UE) 2017/1129 du Parlement européen et du Conseil du 14 juin 2017.

 

>> Read our “Pacte Act” | Initial Coin Offerings poised to enjoy an ad hoc regulatory regime in France client alert of 20 June 2018