With more than US $3 billion being raised by way of Initial Coin Offering (ICO) in 2017 and the price of Bitcoin breaking through the US $19,000 mark (and dramatically falling again), interest in ICOs and cryptocurrencies is at an all-time high.
Many commentators have noted that both the problem and appeal of ICOs is that they are not regulated by the Financial Conduct Authority (FCA).
What is an ICO?
An Initial Coin Offering (ICO) is a type of crowdfunding which is facilitated through the use of distributed ledger technology. Whilst distributed ledger technology is more commonly referred to as “blockchain”, it is more accurate to say that blockchain is only one type of distributed ledger technology.
Technically any company can launch an ICO, although the majority of ICOs have been by companies who specialise in distributed ledger technology-based products or services.
To launch an ICO, an issuer will typically issue an online “whitepaper” detailing the service or the product that the issuer wishes to raise money for, and the amount of funds it requires to develop the service or product. This is similar to a prospectus or admission document that a company is required to produce in connection with the admission of securities to trading on a stock market.
However, unlike a prospectus or admission document, there are no content requirements or minimum standards for whitepapers. This has contributed to the common misconception that all ICOs are completely unregulated.
The “subscription monies” will normally be in the form of a type of existing cryptocurrency such as BitCoin or Ether. Most fundraises will have a minimum target amount and there will normally be a contractual term of the fundraise which states if the minimum target is not raised, the “investment monies” will be returned to the investors.
What is a coin?
On an ICO, investors subscribe for “coins” or “tokens” created by an issuer. The amount of the fundraise will be dependent on the interest from investors.
Early “coins” and “tokens” were built from scratch and sold directly by each individual issuer. The majority of ICOs in the last two years have been built on top of existing cryptocurrencies and launched on ICO crowdfunding platforms such as Ethereum and NXT.
There is no market standard as to what rights each token gives to a tokenholder. Some tokens may resemble traditional securities whilst others may give the right to access or receive future services. It should be noted that a token is not in itself a type of share or dividend although some tokens may contain share or dividend-like rights.
Really no regulation?
A lack of FCA regulation is frequently quoted by some investors and issuers as being one of the key attractions of carrying out ICOs. In reality whether an ICO falls within the FCA’s regulatory boundaries can only be determined on a case by case basis.
It is certainly true that there are currently no UK laws or regulations that specifically address or refer to ICOs. In its September 2017 Consumer Warning about the Risks of ICOs, the FCA identified that, depending on how they are structured, some ICOs may involve regulated investments and firms involved in an ICO may be conducting regulated activities. The FCA also commented that some ICOs feature parallels with IPOs, private placements of securities, crowdfunding or even collective investment schemes.
Legal and financial issues to consider
Some of the key issues to be considered before any issuer carries out an ICO are:
Does the issue and trading of tokens fall into the definition of a specified investment and specified activity and accordingly fall under the general prohibition in section 19 of the Financial Services and Markets Act 2000 (FSMA) (i.e. that a person may not carry on a regulated activity in the UK, or purport to do so, unless they are either an authorised person or an exempt person)?
Is the token issue a collective investment schemes or alternative investment fund?
Will any of the content of the white paper or other marketing material fall foul of the offences of misleading statements and misleading impressions under section 89 and section 90 of the Financial Services Act 2012?
Will the tokens be considered electronic money under the EU’s second e-money directive (Directive 2009/110/EC)?
Is the token issue an offer of transferable securities to the public and consequently is a prospectus required under section 85 of FSMA?
Is the marketing of the ICO a financial promotion under section 21 of FSMA?
- Can the issuer and/or the platform identify the source of funds of its investors bearing in mind the core money laundering offences under s.327 and s.328 of the Proceeds of Crime Act 2002?
This list is non-exhaustive.
Civil liability may arise in respect of untrue or misleading statements in, or omissions from, a whitepaper or other marketing documents. Criminal liability may also arise in relation to misleading statements, deception or false representation.
Whilst a number of overseas jurisdictions have indicated that they will be bringing in new legislation in 2018 to specifically deal with ICOs and cryptocurrency, it is not clear that the FCA sees a clear need to consider changes to its existing regulatory framework to take account of this new use of distributed ledger technology.
Nonetheless, it is reasonable to expect the FCA will continue to look closely at ICOs and may bring enforcement actions in respect of investments or activities falling within the FCA’s existing regime. As the popularity of ICOs grow, we also expect private investors to start bringing civil claims against token issuers.
Views expressed in our blogs are those of the authors and do not necessarily reflect those of the Law Society.