Initial Coin Offerings (ICOs) under global securities regulations

Initial Coin Offerings (ICOs) have witnessed a dramatic growth in the last few years, particularly within the blockchain ecosystem, but more broadly for innovative companies wishing to attract new categories of investors and customers through their online platforms.

ICOs are a new innovative way of raising funds by issuing digital tokens to the public, using blockchain technology. The latter has become very valuable across numerous sectors such as services, healthcare, manufacturing, supply chain management,
trade, finance, cross-border payments, etc. Its value lies in the fact that, combined with the distributed ledger concept, it can be used to produce a set of transactions with immutable history and irrefutable records.

This growth of ICOs, a significant number of which have presented similarities with existing financial instruments, has given rise to a strong legal debate under different jurisdictions on whether or not ICOs should be considered as securities, and indeed many regulators have treated them as such.

The purpose of securities laws is to protect investors, provide sufficient accurate information to make informed decisions, prevent deception and insider trading, and create fair and efficient capital markets (maintaining confidence in the markets, providing equal opportunities for investors, etc.).

ICOs are based on whitepapers that include in many instances inaccuracies, misrepresentations and even outright misleading or insufficient information, which put the investor at risk. The application of securities laws would ensure investor protection through prospectus requirements (instead of whitepapers), registration, disclosure documents and providing the public with all needed information to make an educated investment decision. The prospectus cannot contain misrepresentations or untrue or misleading statements, subject to strict liability for the issuing company and its directors towards investors, including the right to rescission. These strict requirements result in a costly operation to meet the required standards, including high compliance costs for dealing with regulators. This entails a slow and expensive process, in contrast with the intended purpose of ICOs.

Many jurisdictions, including the United States, seem to consider that ICOs generally fall under securities regulations, while some regulators such as the French and the Swiss tend to hold the opposite view. Other regulators such as the Chinese have completely banned ICOs, citing the grave risks presented by the predominantly fraudulent ICOs. This widespread fraud, combined with the failure of a significant number of ICOs, is what created a sense of urgency to regulate the market. However, the challenge remains in finding the correct approach, taking into consideration the below dimensions of this policy issue:

The legal nature of ICOs: while some ICOs may be covered by existing securities provisions, others may fall outside the realm of any current regulation, which is the case in many jurisdictions.
The need to balance between investor protection and fostering innovation: forcing a broad application of securities laws to ICOs might impede innovation and disregard the particularities of some specific types of token categories. It is highly important to adopt nuanced policies that recognize that at least certain crypto-tokens constitute a new form of technology for improving economic coordination, one that the decades-old securities law framework might not be well suited nor optimal to regulate.
The wider legal framework: Even when some tokens may be considered to be outside the realm of securities regulations, they would still fall under other highly important regulations that offer protection to consumers and safeguard the public interest, including existing consumer protection and anti-money-laundering laws.
The transnational nature of ICOs: Regulating on a domestic level without any transnational cooperation is not realistic in overseeing the market on the long run and is not well suited to govern the inherently decentralized blockchain technology.

In this paper, we shall maintain that the sound approach would be to create a technology-neutral transnational regulatory environment that supports innovation and allows it to occur and evolve, regulations that protect investors while still providing them with the choice and ability to decide for themselves whether to invest or not in such business ventures.

Based on other factors, including difficulty to enforce both global and domestic regulations, we argue for the adoption of an optional framework similar to the newly-proposed French system. A voluntary optional system would encourage serious ICO companies to voluntarily seek legitimacy and provides much needed clarity and legal certainty for the market within a clear and transparent process for token issuers, instead of forcing the application of current securities laws which were not initially intended to regulate such emerging technologies.

The key issue in the market is achieving public trust and ensuring consumer protection, which may be hard to attain without some kind of regulation or at least self-regulation. The aim should be to regulate the market in a way that achieves the balance between safeguarding innovation and protecting investors from the many risks presented by the ICO market. Even though the blockchain technology can securely authenticate transactions without the need for central authorities to process such transactions, it is hard to argue against the fact that central governmental or global institutions, at least for the time being, do play a major role in market stability and protecting investors from fraud, in addition to raising awareness amongst the public.

In the following chapters, we shall examine whether ICOs are considered as securities under several jurisdictions and different regulatory approaches to evaluating ICOs. We focus in particular on the SEC definition of securities based on the “Howey
test” precedent (Chapter 2) and we review the main global regulations on the subject (Chapter 3). We also examine two emerging trends in this field: Security Token Offerings, and a transnational legal framework of ICOs (Chapter 4). We finally conclude that, in order to achieve legal certainty and effective enforcement, there is a need for a transnational regulation that is specific to ICOs, with a clear classification of token categories (Chapter 5).

Chapter 2: The “Howey
Test” – Standing the test of time and technology

Securities offerings are subject to an array of legal requirements under U.S. law, including registration with the Securities and Exchange Commission (SEC). A digital asset is considered as a security, especially in the U.S. and Canada, based on whether it is classified as an investment contract. Thus, if an ICO meets certain specific criteria as set by precedents, it is likely to fall under securities regulations, although a thorough comprehensive assessment may be needed in many cases.

The definition of security adopted by the SEC is largely based on the test that the U.S. Supreme Court applied in 1946 in SEC v. Howey in order to determine whether an agreement is defined as an investment contract. The four pillars of what came to be known as the “Howey
test” initially instituted and implemented by U.S. case law were subsequently adopted by Canada’s Supreme Court in defining investment contracts.

In this chapter, we show how the “Howey test” stood the test of time and can still be used as a lens through which to examine whether an ICO falls under securities regulations. We do so by looking at the American regulatory framework and the application of the “Howey
test” by American regulatory authorities and American courts (Section 1), and then by providing an illustration of the ICO legal framework based on the four elements of the “Howey test” (Section 2).

Section 1: Strict regulation under existing laws – Assessment of whether ICOs may be “securities” based on their structure (USA)

The U.S. approach to ICO regulation can be given three main characteristics: first, it is focused on the objective of protecting the investor, based on the existing legal framework governing securities; second, it is characterized by an absence of any prior token categorization, which means that most ICOs and digital tokens are subject to being labeled as investment contracts and to falling under securities regulations; and third, it assesses whether ICOs may be considered as securities or investment contracts based on their structure, in reference to the four elements of the “Howey test” as laid out by the Supreme Court’s Howey precedent of 1946.

In this section, we give an overview of this approach, first by examining the SEC policy which falls in line with the “Howey test” (1.1), then by shedding the light on investor protection warnings issued by American authorities in regard to ICOs (1.2), and finally by examining a recent federal court ruling which also falls in line with the Howey precedent and considers that ICO fraud cases are subject to SEC oversight and securities laws (1.3).

1.1 The SEC and the “Howey Test”

The 1933 Securities Act stipulates that all securities offered in the United States must be registered with the SEC or must qualify for an exemption. Failure to comply with these regulations results in substantial criminal and monetary sanctions on both the issuers and the exchanges.

The SEC recognized the general lack of information and uncertainty about current existing regulations and applicable laws regarding ICOs and cryptocurrencies, and issued a report of investigation in July 2017 on whether the U.S Federal securities laws are applicable to the offer and sale of DAO tokens. This report serves as a general guideline to the SEC initial position on the matter and how it would be evaluating ICOs going forward.

The approach of the SEC falls in line with U.S. Supreme Court decision Reves v. Ernst & Young, which concluded that “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called”, thus adopting a dynamic and wide approach given the complex nature of securities, which encompasses the fields of investment, finance, law and technology.

The definition of security adopted by the SEC is largely based on the “Howey
test.” According to the Supreme Court in SEC v. WJ Howey Co.:

“For purposes of the Securities Act, an investment contract (undefined by the Act) means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party”.

“The test of whether there is an “investment contract” under the Securities Act is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others; and, if that test be satisfied, it is immaterial whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value.”

The “Howey
test” thus relies on 4 cumulative elements to determine whether an investment contract is considered as a security:

Investment of money (this concept was extended by subsequent cases to include any form of consideration with value)
Common enterprise
Expectation of profit
Through the efforts of others.

This definition became the cornerstone of the SEC’s approach to dealing with ICOs.

1.2. Investor Protection Warnings issued by U.S. authorities

The United States Commodity and Futures Trading Commission (CFTC) issued a customer advisory warning in July 2018 entitled “Use Caution When Buying Digital Coins or Tokens”, urging customers to “exercise caution and conduct extensive research before purchasing digital coins or tokens, including those self-described as ‘utility coins’ or ‘consumption coins'”, given that a significant number of ICOs are fraudulent or end in failure.

The United States Financial Industry Regulatory Authority (FINRA), which is
a “non-governmental non-profit organization authorized by Congress to protect America’s investors by making sure the broker-dealer industry operates fairly and honestly”, published a “Report on Distributed Ledger Technology: Implications of Blockchain for the Securities Industry” in January 2017, where it considered the potential impact of the Distributed Ledger Technology (DLT) on the securities industry and regulatory considerations.

FINRA also recently issued an investor alert labeled “Initial Coin Offerings: Know Before You Invest” which included the following warning:

“Investors should be aware that ICOs differ significantly from initial public offerings (IPOs). Unlike stocks, ICOs typically confer no ownership rights in the company; and unlike bonds, ICOs do not involve investors lending money to the issuer. Instead, ICOs involve new technologies and products that are highly technical and complex, and investors can lose some or all of the money they invest in an ICO.”

FINRA listed the following six questions to ask before investing in any ICO:

Is the ICO a securities offering?
Are the persons selling the investment registered financial professionals?
What rights and benefits come with your ICO purchase?
How can you get your money back?
What does the company do and what is it offering?
Are there protections in place to guard against hacking and other cybersecurity threats?

Finally, it stressed on the importance of using caution when considering such investments and being alert to the signs of fraud such as any offers that claim to guarantee profits.

1.3. U.S. v. Zaslavskiy – A recent landmark decision

“In what appeared to be the first court decision to address the issue”, a recent ruling issued in September 2018 by the New York Federal District Court confirmed that U.S. securities laws can be applied in the prosecution of fraud cases in relation to ICOs. The Zaslavskiy case provides much needed insight as to how U.S. Courts are currently approaching the application of securities laws in general, and the “Howey test” in particular, to token sales and ICOs.

Maksim Zaslavskiy was charged by the SEC and the Department of Justice with violating antifraud and registration provisions of federal securities laws after launching two ICOs, REcoin and Diamond, that allegedly defrauded investors. The fraud allegations were based on the fact that investors were informed that REcoin was backed by actual real estate and Diamond was backed by actual physical diamond, while in both cases no physical assets or diamonds were owned by the issuer. Thus, the allegations did not relate directly to the actual cryptographic nature of the tokens nor the underlying technology. Zaslavskiy moved to dismiss the case, arguing that both token sales do not constitute securities offerings.

The court ruled on the potential application of federal securities law to these two specific ICOs. It did not consider that all ICOs are securities, but merely held that, assuming that the facts brought by the indictment were factually true, then a reasonable jury could find that these two specific ICOs are indeed securities offerings, thus leaving the final decision to the “ultimate fact finder”, i.e. the jury.

This particular ruling supports the SEC’s position as having authority over ICOs and that market manipulation and anti-fraud legal provisions and securities law do apply in this regard.

The U.S. v. Zaslavskiy
ruling given by District Judge Dearie concludes in summary that:

Whether a transaction or instrument qualifies as an investment contract is a highly fact-specific inquiry, making a clear reference to the test set forth in Howey, 328 U.S. at 293.
The above is especially true in the context of relatively new, hybrid vehicles which require case-by-case analysis into the economic realities of the underlying transactions.
Howey, 328 U.S. at 301 notes the importance of the “statutory policy of affording broad protection to investors”.
The question is whether the “elements of a profit-seeking business venture” are sufficiently alleged in the Indictment, such that, if proven at trial, a reasonable jury could conclude that “investors provide the capital and share in the earnings and profits; [and] the promoters manage, control and operate the enterprise,” also referring to Howey, 328 U.S. at 300.
The Indictment alleges sufficient facts that, if proven at trial, could lead a reasonable jury to find that REcoin and Diamond constituted “investment contracts.”

Judge Dearie proceeded to consider each element of the “Howey test” as to establish that a reasonable jury could conclude that REcoin and Diamond constitute “investment contracts.”

What is noteworthy in this approach is that in order to conclude that “the allegations in the Indictment, if proven, would permit a reasonable jury to conclude that Zaslavskiy promoted investment contracts (i.e. securities),” Judge Dearie did not consider the legal implications of the underlying technology nor debate the nature of the Token itself, nor did he ponder into the classification of Asset Tokens, Utility Tokens, Payment Tokens, Hybrid tokens, etc. The judge considered the nature of what was being offered by the issuer and how it was being offered in general, without going through the actual technicalities and specificities of the underlying technology.

It could be understood from this decision that not every single ICO is deemed to be considered an investment contract. Every ICO is unique and should be considered on a case-by-case basis, and a careful legal analysis is required in this regard under U.S. securities law.

We can conclude that what defines whether an ICO is an investment contract or not, is not its technological nature, but rather the nature of the transaction itself, or the object of the transaction, as measured by the Howey test as a general guideline.

The Zaslavskiy case is certainly a landmark decision in the sense that it is the first case dealing with the matter. However, it does not add much clarity for issuers who wish to venture into ICOs that do not constitute investment contracts. It is simply a case dealing with fraudulent criminal behavior.

Zaslavskiy pleaded guilty in November 2018 to conspiracy to defrauding investors through two ICOs.

In conclusion, the U.S. approach certainly provides the highest level of investor protection since almost every ICO is expected to comply with current securities regulations. This conservative stance was well expressed by SEC Commissioner Robert Jackson who recently stated to CNBC that “if you want to know what our markets would look like with no securities regulation, what it would look like if the SEC didn’t do its job? The answer is the ICO market”. In the same line, SEC Commission chairman Jay Clayton stated during a U.S. Senate hearing that “I believe every ICO I’ve seen is a security” which implies that almost every ICO conducted in the U.S. is likely to be subject to current U.S. securities regulations. However, given the complete disregard to token categorization, there remains a great margin of legal uncertainty for ICOs and digital tokens that may not constitute investment contracts nor fall within securities regulations.

Section 2: The investment contract test in the context of a token offering or ICO

The legal framework governing ICOs as outlined in Section 1 above shows the limited legal certainty in this field. In the absence of case law and clear guidelines to navigate securities laws with regards to the technical aspects and particularities of ICOs, token developers and investors may find guidance in two types of references:

“Official” references such as the illustrative table established by Canadian Securities Administrators (CSA) Staff Notice 46-308 issued on 11 June 2018 under the title “Securities Law Implications for Offerings of Tokens”: this notice adopted the four elements of the “Howey test“, making a clear reference to the Canadian Supreme Court decision in Pacific Coast Coin Exchange v. Ontario (Securities Commission), whereby Canada had adopted a modified version of the “Howey test“. It established a detailed table identifying examples of illustrative situations that have an implication on the presence of one or more of the elements of an investment contract.
References provided by digital currency platforms themselves such as the Coin Base Blog which has introduced a fairly comprehensive “Blockchain Token Securities Law Framework” and also created a “Framework Tool” as a guide for developers and users of blockchain tokens based on a point system to assess whether a Token is likely to be considered as a security.

This grey area leads us back to the “Howey
test” for more structural legal guidance. Even though SEC v. Howey predates both the internet and blockchain technology, the court had stated that the definition of a security, and therefore of an investment contract “embodies a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profit”.

In this spirit, we will go through the four elements of the “Howey
test” and explore how they might be applied in the context of ICOs and how some specific Tokens might share similarities with traditional securities. The following combines a summary of both the CSA and Coinbase tables and applies them to the four elements of the “Howey test“, thus highlighting the scenarios in which an ICO is more likely to satisfy the cumulative elements of this test:

The investment of money

This is a straightforward condition where tokens are being offered in exchange for fiat money or virtual currency (even though cryptocurrencies might not be considered as “money” per se). This shall not apply when a token is “mined” i.e. earned or produced only through mining (e.g. airdrop to create a user base without raising capital, thus bypassing the first condition of the “test”) or offered for free with no monetary counterpart.

A common enterprise

The ICO is launched before the release of the platform, based only on the whitepaper without any existing platform; thus, the investor would be relying on the issuer to develop the platform.
The purpose of the ICO is to raise capital for development and growth.
The skills and expertise of the management are the most contributing factor to the value of the Token.
The developers hold and retain a significant number of Tokens (in contrast with a project where the promoters do not retain Tokens, i.e. where there may not be a common enterprise).
The returns are distributed equally to investors (in contrast with the case where the investor has a contributing role and effort in creating value for the Token).

The expectation of profit

The Token is offered prior to the release of the platform with the expectation that it will increase in value once the platform is developed.
Investors are not expected to actually use the product where the nature of the investment is based purely speculation (in contrast with the case where the token is marketed and sold based solely on its utility).
The Tokens are traded on a secondary market (in contrast with the case where the secondary market operations are restricted).
There are no restrictions on participation (in contrast with the case where some restrictions are imposed to make sure that the Token will be used based on its intended purpose).
The Token is speculative by nature, presenting features of a security (in contrast with the case where its primary function is to provide a utility).
There are limits on the investment amount or on the number of Tokens being offered (in contrast with the case where no limits are imposed on investment or number of offered Tokens).
Tokens have no real after-sale function, such as “SocialCoin” tokens (in contrast with the case where a token is only available to token holders e.g. “CloudToken”)
Investors are offered actual equity in the legal entity and are entitled to share profits/losses.
Issuer markets the Token as an investment (in contrast with cases where there is no potential for profit from using the Tokens, e.g. Tokens used to fund a social cause).

Through the efforts of others

The actual platform is not based on open source software/code.
Some action is required by a third party (custodian or intermediary) to affect the transfer of Tokens.
The value of the Tokens is likely to fluctuate (in contrast with the case where the value of the Token is fixed and predetermined).

It is to be noted that even though the above criteria are important in the assessment of securities and do show that the Howey framework has stood the test of time, regulators are more likely to consider all the different factors and look at the substance of the offer as a whole rather than just dealing with the matter as a simple checklist exercise, especially given the complex nature of the technology at hand.

Chapter 3: Different approaches to regulating ICOs

Although different countries have adopted different approaches to regulating ICOs, regulators have been unanimous about the risks presented by the ICO market. Global press releases and statements issued by regulators have consistently warned investors about the risks and dangers of ICOs given the wide occurrence of fraud and the many inaccuracies and misrepresentations found in published whitepapers. Most statements issued by relevant regulatory authorities seem to agree on the high risks associated with ICOs and advise investors to be extremely cautious. Common semantics are found in almost every single statement issued by relevant regulatory bodies across the globe, including terms such as: risk, scam, fraud, caution, warning, alert, etc.

However, in spite of fraud and risk warnings, the world has witnessed an increasingly large capital flow into ICOs, which is why regulators are aligned in the same general direction agreeing on the urgency to regulate the market. However, regulatory approaches vary widely. Different initial approaches were taken by regulators, ranging from a complete ban on ICOs, to a heavily regulated stance under pre-existing laws, to the creation of an ICO-friendly framework. Given that certain Token categories present similarities with financial instruments, the question facing regulators today is whether to regulate them under current securities laws or to develop new specific regulations to govern ICOs.

It should also be noted that given the transnational nature of ICOs, in the backdrop of this variety of regulatory approaches, and in the absence of a global definition of securities, entrepreneurs wishing to venture into ICOs face a legal uncertainty and unclear regulations which work against them. The safest approach for issuers in this case would be to comply with the more conservative regulations, an idea that we shall further develop in the subsequent chapter on emerging trends in ICO regulation.

We have already examined the regulatory approach of the U.S. who opted for strict regulation under existing laws and the assessment of whether ICOs may be considered as securities based on their structure and for which we dedicated a separate chapter, given its importance as arguably the biggest market for ICOs and its position as a major jurisdiction for the FinTech industry. Similar approaches by regulators opting to strictly regulate ICOs based on existing laws can also be found in Australia and Japan. As for Canada, it has adopted a more comprehensive approach in the form of a regulatory sandbox allowing extensive interaction and collaboration between companies and regulators.

This chapter is dedicated to an overview of the main regulatory approaches to ICOs found across the globe, other than in the U.S. In the following sections, we proceed to examine seven jurisdictions representing key players from Europe and Asia and adopting different regulatory approaches displaying these main regulatory trends:

The extreme approach, with a complete ban, such as adopted by China, South Korea and Macau (Section 1).
The absence of a specific regulatory framework, either with no clear token classification such as in Hong Kong, which adopts a similar approach to that of the U.S. (Section 2), or taking into consideration token classification such as in Germany (Section 3).
Flexible regulatory responses which are considered more favorable towards ICOs, either with an optional ad hoc legislation such as in France (Section 4) or with no ad hoc legislation but with an assessment of ICOs based on the classification of tokens such as in Switzerland’s “Crypto Valley” approach (Section 5).
Flexible regulatory response consisting of a specific DLT regulation without any clear token categorization such as in Gibraltar (Section 6).

Section 1: The complete ban policy (China, South Korea and Macau)

In September 2017, China instituted a complete ICO and token ban policy, and in January 2018, China’s National Internet Finance Association (NIFA) issued a statement warning from so-called “initial miner offerings” (IMO), i.e. disguised ICOs which are completely banned in China. In February 2018, China revealed plans to cut off internet access to sites that trade cryptocurrency and allow ICO investments and NIFA announced its intent to increase oversight of ICOs and cryptocurrencies. In December 2018, the Chief of China’s Municipal Bureau of Finance (MBF) stated that Security Token Offerings (STOs) fundraisers are also considered illegal in the country.

Raising concerns around the increasing risk of financial scams and fraud being conducted through ICOs as a fundraising tool, South Korea followed suit and announced that any party or financial institution involved in issuing of ICOs will be subject to severe penalties. According to Reuters, “South Korea bans raising money through initial coin offerings” including all kinds of ICOs and all forms of virtual currencies, a move that follows similar restrictions in China on ICOs.

In September 2017, the Monetary Authority of Macau also issued a statement under the title “Alert to Risks of Virtual Commodities and Tokens” explicitly prohibiting banks, financial institutions, and non-bank payment institutions from providing services for ICOs and cryptocurrencies.

We believe that such a complete domestic ban policy is neither effective nor realistic, as local platforms can shift to operating outside the territory while still being able to provide services to domestic users who can also bypass the internet ban through the Virtual Private Network (VPN), unless the country decides to also restrict all VPN access. Indeed, a recent investigation by the Xinhua News Agency revealed that it is possible to bypass China’s ICO ban, and that after China’s crypto regulations became more stringent, local virtual currency exchanges went overseas for registration — while appearing to be shut down within the country — and were still able to “provide trading services to domestic users.” The vice-president of the People’s Bank of China declared in a public statement that “digital currency is the inevitable future and the Chinese Central Bank needs to pay close attention to the development of crypto-currency that private sectors issued, like Bitcoin.”

Section 2: No specific regulatory framework with no clear token classification (Hong Kong)

The Hong Kong Securities and Futures Commission (SFC) takes a similar approach to that of the U.S. SEC. It neither adopts a specific regulatory framework for ICOs nor provides a clear token classification, leaving ICOs subject to the application of the existing securities regulations.

In September 2017, the SFC issued a statement on ICOs where it stressed that depending on the facts and circumstances of an ICO, digital tokens that are offered or sold may be “securities” as defined in the Securities and Futures Ordinance (SFO), and subject to the securities laws of Hong Kong. The SFC considers that digital tokens offered through an ICO representing equity or ownership interests in a corporation, shall be regarded as “shares”, tokens used to create or acknowledge a debt or liability may be considered as “debenture”, and token proceeds managed collectively by the ICO operator to invest in projects and resulting in dividends or profits shall be regarded as an interest in a “collective investment scheme” (CIS). According to the SFC, shares, debentures and interests in a CIS are all deemed as “securities”. Parties engaging in regulated securities activities are required to be licensed by or registered with the SFC irrespective of whether they are located in Hong Kong, so long as such business activities target the Hong Kong public.

The SFC included a cautionary statement highlighting the risks associated with ICOs, including money laundering and terrorist activities, given the anonymous nature of the transactions, and advised investors to be mindful of the potential risks involved in ICOs and investment arrangements involving digital tokens. As these arrangements and the parties involved operate online and may not be regulated, investors may be exposed to heightened risks of fraud.

Like the U.S. SEC, the SFC does not provide much clarity on how ICOs are expected to operate within the existing regulatory framework. The definition of investment schemes for instance is quite broad and may encompass tokens that may be outside the realm of securities. and the lack of a clear definition of utility tokens widens the grey area in that regard. Such legal frameworks that do not provide specific ICO regulations or detailed guidance are quite challenging to navigate for both investors and legal practitioners in terms of compliance in a somewhat grey area, and do not offer sufficient clarity for token issuers on how the existing framework is expected to apply to ICOs, especially with the absence of guidance from regulators as to the particularities and nuances of the issued tokens and their inherent natures and technical aspects.

Section 3: No specific regulatory framework, with the release of a token classification (Germany)

In November 2017, the Federal Financial Supervisory Authority of Germany (BaFin) released a statement, warning investors about the risk of investing in ICOs, branding them as a “highly speculative form of investment” and highlighting the numerous dangers of acquiring digital tokens through ICOs, including price fluctuations, lack of a liquid secondary market, insufficient information provided to investors, lack of legal requirements for white papers in contrast to regulated prospectuses, and vulnerability of ICOs to fraud, money laundering and terrorist financing.

However, although it has developed no specific regulation for ICOs, BaFin did take the initiative to release an advisory letter on the classification of Tokens underlying ICOs as financial instruments in the field of securities supervision. BaFin specified that it shall adopt a case by case assessment on whether tokens constitute financial instruments based on “the criteria set out in the statutory provisions under securities supervision law.”

BaFin stated that “a token has to meet the following criteria in particular” in order to be considered a security:

“transferability,
“negotiability on the financial market or capital market; trading platforms for cryptocurrencies can, in principle, be deemed financial or capital markets within the meaning of the definition of a security,
“the embodiment of rights in the token, i.e. either shareholder rights or creditor claims or claims comparable to shareholder rights or creditor claims, which must be embodied in the token, and
“the token must not meet the criteria for an instrument of payment (…).”

ICOs shall be assessed on a case-by-case basis based on the above criteria in order to establish whether existing local securities laws shall apply. Bafin emphasized that “in the assessment, the specific structure of the rights embodied in the token is the decisive factor. Taken by itself, the mere labelling of a token, for instance, as a “utility token”, is not relevant to the outcome of the legal analysis.” It is to be noted that relevant domestic laws will also apply to foreign issuers if they target German investors.

BaFin’s approach provides some clarity to issuers and investors regarding utility tokens and ICOs that may fall under securities laws in the absence of specific ICO regulations, although it remains widely criticized for being too vague in addition to the fact that there is no clarity with regard to investor protection pertaining to ICOs that fall outside securities regulations. As with most case-by-case basis regulatory responses, we feel that such an approach does not provide much legal certainty especially in the short and medium terms, as the ICO legal status will remain in a grey area pending the development of stable case law and the application of current regulatory frameworks by regulators over time on the wide spectrum of token offerings.

Section 4: Flexible regulatory responses – Optional ad hoc legislation (France)

In October 2017, the French “Autorité des Marchés Financiers” (AMF) released a discussion paper on ICOs aiming to gather different views from key players and stakeholders on the different means of supervision and launched the UNICORN program. The AMF stressed that ICOs involve high risks including:

Absence of specific regulation;
Risks related to the information documents;
Risk of loss of capital;
Risks of volatility or the lack of a market;
Risk of money-laundering and scams;
Risks associated with the projects financed.

The AMF stated the following:

“The first assessment indicates that while some of the ICOs identified may be covered by existing legal provisions (regulation applicable to intermediaries in miscellaneous assets, to the public offering of financial securities, or to managers of alternative investment funds, in particular), most of these issues would fall, in the current state of the law, outside of any regulation for which the AMF ensures compliance.”

It went on to
suggest that multiple approaches could be used to resolve the matter, including issuing
ad hoc legislation adapted to ICOs. The three options identified by AMF are as follows:

Promote best practices without changing existing legislation;
Extend the scope of existing texts to treat ICOs as public offerings of securities;
Propose ad hoc legislation adapted to ICOs.

The AMF received 82 responses from key players in the industry, including digital economy players, individuals, finance professionals, market infrastructures, academics and law firms. According to the AMF, the majority of respondents agreed with its third option as laid out above, i.e. that of an ICO-specific regulation:

“Respondents unanimously consider that an information document is necessary to inform buyers of tokens and that it should include, at a minimum, information on:

The project related to the ICO and its advancement;
The rights conferred by the tokens;
The accounting treatment of funds raised during the ICO.

For almost all respondents, this document should also allow for the identification of the legal entity responsible for the offer, its managers and founders, and their competences. Moreover, it could be the subject of approval granted by the AMF or a special-purpose institution.”

The AMF does not seem to consider that most ICOs fall under current French securities regulations. Given that under French law
“tokens do not generally fall into any of the categories of the applicable law that defines financial securities”, token issuers are seemingly unrestricted by regulation. While this could be favorable to innovation, it puts the investors at risk by not providing them with sufficient means to distinguish serious offers from abusive ones.

To resolve this regulatory gap, France announced a draft law in September 2018 (“Projet de loi relatif à la croissance et la transformation des entreprises” known as the “PACT” Law) introducing a new legislative framework governing ICOs. French regulators took a very comprehensive approach to dealing with the matter, and a new draft law “relative to the growth and transformation of enterprises” was introduced, proposing in its Article 26 the creation of a new regulatory regime governing initial token offerings by introducing amendments to the monetary and financial code. The said article gives the AMF the right to grant visas to entities wishing to offer tokens in the French market aiming to finance projects, subject to respecting certain rules and regulations intended to prevent abuse and protect investors. The AMF shall examine the relevant white papers and establish a publicly communicated “white list” of companies labeled to have respected the rules and regulations granting them more credibility towards investors, which is the cornerstone of the proposed legislation.

This new legislative framework provides a definition for both Tokens and ICOs, whereby a token constitutes any intangible property representing, in numerical form, one or more rights that can be issued, registered, conserved or transferred using a shared electronic registration mechanism that allows the identification, directly or indirectly, of the owner of said property.

The new law defines an ICO as any offer to the public, in any shape or form, to purchase tokens. The same article excludes ICOs targeting a limited number of persons; such number shall be specified by the AMF. Tokens presenting the characteristics of securities would nonetheless remain subject to the relevant existing regulations.

Being subject to the new proposed law is optional, as Article 26 states that any issuer proceeding with a public offer of Tokens and who solicits a visa from the AMF within the conditions of article L.552-4 and subsequent articles is subject to the obligations of the same chapter. Said article L.552-4 stipulates that prior to any public Token offering, issuers can solicit a visa from the AMF. Issuers must establish a document destined to provide the public with all useful information pertaining to the proposed offer and the issuer himself. This information document and all promotional communications shall present a content that is exact, clear, non-misleading and which allows the comprehension of the risks associated with the offer.

Article 26 also introduces a framework for digital asset intermediaries, including crypto-active trading platforms, custody services, crypto-active investment and advisory services, and other related services. These intermediaries may seek approval from the AMF which will verify the reliability and professionalism of these intermediaries. Compulsory registration for anti-money laundering control, will be imposed on exchange platforms between cryptocurrency and conventional currencies and to the custody services of tokens, in application of the 4th anti-money laundering directive revised. Article 26, which relates to the creation of a French system of token offers, also instills on
the AMF the task of examining the documents drawn up by the token issuers – “white papers” – and may also require issuers to acquire the status of a legal entity registered in France, set up a mechanism for sequestrating the funds raised, and providing investors with a wide knowledge database. The issuers would appear on a “white list”, which the AMF would communicate to the general public, allowing to identify the actors who respect these rules and provide them with much needed credibility towards the market. Tokens with the characteristics of a financial security would nevertheless remain subject to the relevant regulations.

The French legislators are also well aware that international regulation and cooperation are crucial in this regard. Indeed, it is stated in the “PACT” Law that, in anticipation of European and international rules, necessary in overseeing ICOs that are by nature transnational, it seems desirable, to better protect the investors and “legitimate” projects, by allowing the AMF to issue a visa to companies who wish to issue tokens intended in particular for the French market for the financing of a project or an activity, provided that they respect certain rules thus avoiding fraud, abuse, scams and misinformation and better informing and protecting investors.

We believe that the French approach is very sensible as to create an optional system giving the choice to entrepreneurs to “brand” their ICOs with a formal license to operate and at the same time still allowing investors the opportunity to decide for themselves in choosing where to invest in the spirit of a true free market, while notably acknowledging and stressing the need for common international rules crucial to govern ICOs that are transnational by nature.

The adopted Article 26 introduces a visa for token issuers, under the supervision of the AMF, which will examine the compliance of token offers and related documents with a set of requirements to ensure transparency and investor confidence. This visa will remain optional. It will result in the publication of a whitelist by the AMF of programs that have received this visa.

Finally, this flexible legal framework will surely attract serious ICO projects by providing legal certainty and clear guidelines for issuers and allowing investors free access to credible information to make educated investment decisions.

Section 5: Flexible regulatory responses – no ad hoc legislation – the assessment of ICOs based on the classification of tokens (Switzerland)

On 29 September 2017, the Swiss Financial Market Supervisory Authority (FINMA) published guidance number 04/2017 (FINMA 04/2017) where it laid out its position on ICOs and considered areas where they may be subject to existing regulations.

The purpose of FINMA is to provide market participants “with information on how it will deal with enquiries regarding the supervisory and regulatory framework for ICOs. The guidelines specify the information required by FINMA to process enquiries from market participants and also set out the principles on which FINMA will respond to them.”

FINMA 04/2017 considers that “how ICOs are structured from technical, functional and business standpoints varies markedly from offering to offering. There is no catch-all definition.” It also considers that “ICOs are currently not governed by any specific regulation, either globally or in Switzerland.” Furthermore, it notes that “due to the underlying purpose and specific characteristics of ICOs, various links to current regulatory law may exist depending on the structure of the services provided.” This concerns various areas according to FINMA, including provisions related to money laundering, Banking law, securities trading collective investment schemes which could apply to ICOs.

On 16 February 2018, FINMA also published its guidelines for enquiries regarding the regulatory framework for ICOs (FINMA 02/2018), which laid out the principles to be applied when assessing specific enquiries, and acknowledged that “there is no generally recognized classification of ICOs and the tokens that result from them, either in Switzerland or internationally.” FINMA thus based “its own approach to categorization on the underlying economic function of the token.”

FINMA 02/2018 categorized tokens in three main classes: payment tokens, utility tokens and asset tokens, while stating that these categories are not mutually exclusive, and adding a fourth “category” referred to as hybrid tokens where “the individual token classifications are not mutually exclusive. Asset and utility tokens can also be classified as payment tokens (referred to as hybrid tokens). In these cases, the requirements are cumulative; in other words, the tokens are deemed to be both securities and means of payment.”

FINMA bases its approach in defining whether tokens are considered securities on the Financial Market Infrastructure Act (FMIA), which distinguishes between standardized certificated or uncertificated securities. FINMA also clearly states that it shall not consider payment tokens as securities. Furthermore, utility tokens shall not be treated as securities when their underlying function “is to grant the access rights and the connection with capital markets, which is a typical feature of securities, is missing.” FINMA states that it “treats asset tokens as securities.” And further elaborates on the legal implications of treatment as a security.

These two documents, FINMA 04/2017 and FINMA 02/2018, summarize the debate regarding ICOs and constitute a comprehensive approach given the lack of specific regulations that govern the field.

FINMA further identifies four development stages: pre-financing, presale (voucher token), pre-operational token and operational token. For instance, FINMA suggests that asset tokens are not subject to any regulation in the pre-financing stage, while they fall under securities regulations in the remaining three development stages.

Switzerland
adopted a very comprehensive “case-by-case basis” approach as laid out by FINMA’s assessment of ICOs based on the classification of tokens into three main categories, namely: payment tokens that may be subject to anti money laundering regulation, utility tokens that remain outside the scope of regulation (with some exceptions) and asset tokens that mostly fall under the securities regulations (issuing market is not regulated while the main focus is on regulating the secondary market).

The above approach and clear guidelines set out a solid legal framework for ICOs, and much needed legal certainty, that attracted many companies to relocate to Switzerland. The Swiss approach goes over the technicalities and categorization of Tokens in much details and does not suffice itself with a broad definition of Tokens and ICOs as we have seen in the new French legal framework.

It is also noteworthy that Switzerland endorsed the creation of The Swiss Crypto Valley Association which unveiled its code of conduct for ICOs. The core values include: trust, transparency, collaboration, integrity, innovation and quality, security and beneficence. The Swiss Government also supported the launch of a Blockchain Task Force, with the aim to cement its regulatory framework surrounding blockchain startups and ICOs. Thus, in addition to “Crypto Valley”, a Swiss hub for companies developing projects based on blockchain technology, the government’s Federal Council introduced a regulatory enabling startup to experiment with their projects. Involving private actors in compliance, regulation and governance encourages self-regulation and is always crucial in a complex legal context of a transnational nature.

The Swiss regulatory response presents many advantages namely token categorization, active involvement from regulators with the industry and support of self-regulation through nonprofit organizations such as the Crypto Valley Association, all within a technology neutral regulatory framework.

In the absence of global regulations governing ICOs both the Swiss and French responses seem to be very comprehensive as to the nature and technicalities of ICOs and it would be worth considering a regulatory approach combining the best of the two frameworks once they have been tested in the near future.

Section 6: Flexible regulatory responses – Specific DLT regulation with no clear token categorization (Gibraltar)

Gibraltar’s “Financial Services (Distributed Ledger Technology Providers) Regulations 2017” came into operation on 1 January 2018. Based on these new regulations, all Distributed Ledger Technology (DLT) providers are subject to registration and authorization by the Gibraltar Financial Services Commission (GFSC), which also published on its website an overview of the DLT framework. According to the GFSC:

“The DLT framework applies to activities, not subject to regulation under any other regulatory framework, that use DLT for the transmission or storage of value belonging to others. Firms and activities that are subject to another regulatory framework continue to be regulated under that framework. A flexible, adaptive approach is required in the case of novel business activities, products, and business models. We consider that regulatory outcomes remain central but are better achieved through the application of principles rather than rigid rules. This is because for businesses based on rapidly-evolving technology such hard and fast rules can quickly become outdated and unfit for purpose.”

The GSFC laid out nine Regulatory Principles where any DLT provider must:

1. conduct its business with honesty and integrity. Such assessment shall be based on several basic elements namely: honesty, integrity, reputation, skill, competence, care, experience and financial position.

2. pay due regard to the interests and needs of each and all its customers and must communicate with its customers in a way which is fair, clear and not misleading. In this regard, the GSFC stressed on the importance of transparency disclosure and compliance.

3. maintain adequate financial and non-financial resources.

4. manage and control its business effectively, and conduct its business with due skill, care and diligence; including having proper regard to risks to its business and customers. DLT Providers are expected to apply good, forward-looking risk management practices.

5. have effective arrangements in place for the protection of client assets and money when it is responsible for them.

6. have effective corporate governance arrangements.

7. ensure that all systems and security access protocols are maintained to appropriate high standards.

8. have systems in place to prevent, detect and disclose financial crime risks such as money laundering and terrorist financing.

9. be resilient and develop contingency plans for the orderly and solvent wind down of its business.

In these nine regulatory principles, the GSFC addressed most regulatory concerns related to ICOs, even though ICOs are not directly regulated in Gibraltar but the underlying technology is.

As laid out by the GSFC, its regulatory approach is flexible and adaptive, aimed to achieve its outcome through the application of principles rather than rigid rules, in order to cope with the rapidly changing and technically complex innovative technology at hand.

However, this regulatory approach does not categorize tokens. Specific ICO regulations are still needed to complement the DLT framework with clear token classification and assessment.

Section 7: Conclusion

Most international regulatory responses to ICOs aimed at preventing fraudulent behavior. The diversity of the regulatory spectrum is very important.

Some regulators chose to ban ICOs in their jurisdictions indefinitely (China) or temporarily (South Korea). This complete ban approach is based on concerns of fraud and criminal behavior. This approach might help prevent the risks associated with the technology however the countries adopting this approach will fall behind once the market stabilizes and won’t be able to benefit from the potential applications of the technology.

Far from imposing a ban on ICOs, the U.S. SEC opted nonetheless for a strict approach for the assessment of whether crypto tokens constitute securities, which is based on the “Howey
test” as established by the U.S. Supreme Court. This approach leads to the consideration that most ICOs constitute securities in the sense of U.S. securities laws.

Other regulators decided to implement an ICO-friendly regulatory framework in order to attract serious projects (France, Gibraltar) while most regulators adopted a case-by-case approach based on token classification (Switzerland, Germany). The laissez-faire approach promotes the development of the new technology. The absence of regulatory restrictions might encourage capital inflow into such jurisdictions. However, without appropriate regulations, the many risks that regulators have warned about will be predominant in the market.

In addition to regulatory diversity and divergences, ICOs are inherently transnational, which exposes investors to various risks including legal uncertainty, dissimilar regulations, and regulatory arbitrage. Thus, international cooperation in regulating ICOs is crucial. This could be achieved through common transparency requirements, establishing international standards and global cooperation in contending fraud.

Based on the wide spectrum of regulatory responses that we have detailed in the previous sections, we can draw the following conclusions:

A complete ban policy is neither effective from the enforcement perspective, given the inherent decentralized nature of the technology, nor realistic, given that it would only drive issuers to operate in other jurisdictions and impede innovation by targeting local investors.
The strict application of existing securities laws on ICOs may prove effective in the short term for ensuring investor protection. However, it may not achieve legal certainty as it would disregard the fact that under many global jurisdictions, certain token categories fall completely outside securities regulations, also leaving many token sales outside the realm of any applicable law.
Legal certainty cannot be achieved without a specific ad hoc ICO legislation that takes into consideration and establishes a flexible token classification framework that can cope with the dynamics of the technology at hand.
Regulating the underlying technology i.e. DLT should be the very foundation of any regulatory approach along with a specific ICO framework.
Continuous collaboration between public and private actors and the creation of regulatory sandboxes may prove very effective in improving regulations and achieving compliance.
A global unified legal framework is crucial to regulate the inherently transnational technology at hand, especially that unified definitions and legal terminology is inexistent for basic concepts such as securities and token classifications. What may be considered as a financial instrument or investment contract falling under securities laws in one jurisdiction may not be considered as such in several other jurisdictions. The same ICO may thus be governed by several conflicting regulations, resulting in high costs for compliance and subjecting issuers and investors to complex cross-border disputes.

Based on the above, we maintain that a flexible unified global regulatory approach preferably optional and based on clear elaborate token classification and that encourages the involvement of non-State private actors mitigates the risks of fraud and allows legitimate companies to thrive while still allowing investors to make their own educated decisions.

Chapter 4: Emerging trends in ICO regulation

In this chapter, we explore two emerging trends, which are both related to the technical and market needs and specificities of ICOs, and also heavily influenced by private actors, namely trading platforms and ICO issuers.

First, we explore the observed shift from ICOs to Security Token Offerings (STOs) (Section 1), and then we discuss the emergence of a transnational legal framework for ICOs (Section 2).

Section 1: From ICOs to STOs

With the emergence of blockchain technologies, numerous businesses and investors wanted to exploit this new opportunity to raise money and make profits. The ICO industry attracted billions of dollars in investments along with heavy scrutiny from regulators. This new opportunity faced major setbacks like fraud and lack of transparency and regulation, which made it a highly risky venture when compared to the century-old classical means of investment (private placements and public offerings) that are strictly regulated and offer basic protections for investors.

As the SEC and other global regulators have been increasing the pressure by considering that most ICOs are considered as securities, a new concept materialized in the form of “security tokens platforms” like POLYMATH and may be laying the foundation for a shift from ICOs to STOs.

STOs can be defined as “any blockchain based representation of value that is subject to regulation under security laws. That includes tokens representing traditional assets like equity, debt, derivatives, and real estate, and it also includes pre-launch utility tokens that are deemed securities by the SEC.”

Given that security tokens are by nature financial securities, issued tokens would be backed by actual assets, profits or dividends. STOs are touted to achieve both compliance with current regulations and satisfy the need and increasing demand and interest in more efficient, less costly, faster global technology-based investment methods. They may help fundraising on a global scale and thus use the full potential of the blockchain technology and limit investors exposure to fraud.

STOs may allow Tokens to be the natural evolution of company shares in the form of digital shares that support innovation, capital raising and growth of small tech companies within the framework of regulation to ensure stability, certainty and clarity.

As traditional securities already have digital records (stocks, bonds and securities all have electronic records) and are being traded online and in digital form, the aim of tokenized assets and STOs is to achieve a transfer of the already digitized form of securities to the blockchain technology.

STO proponents argue that STOs present many advantages including:

The possibility to trade on 24/7 markets in contrast with the U.S. stock market for instance that on opens weekdays between 9.30 a.m. and 4.00 p.m. creating more market opportunities and liquidity and the possibility to unify global trading.
Increasing the efficiency and opportunities of the “Fractional ownership” concept through tokenized securities.
Automation and faster settlement of securities trading and asset ownership transfers, which could be shortened in timespan from days to minutes.
Reducing costs of securities issuance and post issuance process notably administrative costs which will in turn also increase liquidity and market depth.
Automated compliance: “when securities are tokenized, compliance can be automated, which means that regulated trade will no longer be restricted to walled gardens. Security tokens will be able to trade anywhere, including decentralized exchanges.”

However, STOs could face serious challenges, namely finding favorable jurisdictions and legal frameworks that recognize and allow tokenized securities, without which the appropriate trading platforms cannot operate legally.

What remains to be seen is whether STOs, as a concept of strict compliance of security tokens, are the natural evolution of ICOs or just an attempt to simply self-regulate by applying existing regulations to the blockchain technology. Despite their many advantages, STOs may be undermining the very foundation of decentralized technology by granting centralized governmental institutions strict control over security tokens, which also goes against the inherent intended anonymity initially intended by the blockchain community.

Section 2: Towards a transnational legal framework for ICOs

The immediate question that comes to mind while considering regulatory responses to the emerging ICO market is whether the enforcement of local or even potentially global unified regulations is realistic or possible. In this section, we explore the question of enforcement and compliance in this field (2.1), before examining the emergence of a much-needed transnational approach to ICO regulation (2.2).

2.1. The question of enforcement and compliance

Given the nature of the technology, it could be argued that the only way to stop fraudulent ICOs is to stop non-compliant exchanges. The theory that a centralized authority like the UN, EU or local governments can prevent ICOs from operating or heavily regulate them is not realistic from a technical perspective. A single country, or even a group of countries cannot stop the people involved in the management and creation of these currencies or tokens.

It may be simple and realistic to ban a technology running on a centralized server or through a central organization, but the blockchain technology presents much complicated challenges in this regard from a purely technical perspective.

“One of the advantages of blockchain is that it can’t be tampered with. Each block that is onto the chain carries a hard, cryptographic reference to the previous block. That reference is part of the mathematical problem that needs to be solved in order to bring the following block into the network and the chain. Part of solving the puzzle involves working out random number called the “nonce.” The nonce, combined with the other data such as the transaction size, creates a digital fingerprint called a hash. This is encrypted, thus making it secure. Each hash is unique and must meet certain cryptographic conditions. Once this happens a block is completed and added to the chain. In order to tamper with this, each earlier block, of which there are over half a million, would require the cryptographic puzzles to be re-mined, which is impossible.”

Because the blockchain is not centralized, it also means that if one part of it went down, the whole network would not collapse. So even if several miners went out of action for example, transactions would still work.

Based on the above, we believe that regulatory responses constructed on a complete ban policy or a strict implementation of existing securities laws may prove effective on the short term, but are neither realistic nor effective on the long term.

2.2. ICOs and transnational law

When private actors operate in multiple jursidictions, they start to self-regulate in order to comply with all domestic regulations involved. Hence emerges a new soft transnational law coming from the private actors themselves. In this case, domestic regulators who no longer own the exclusivity of legal enforcement are only able to “nudge” these private actors towards a particular direction. This is only one element of the transnational ICO puzzle.

As early as 1956, Philip Jessup discussed the emergence of a transnational legal order and defined transnational law as “all law which regulates actions and events that transcend national frontiers. Both public and private international law are included, as are other rules which do not wholly fit into such standard categories”.

ICOs present many elements of transnationalism:

They are transnational instruments both by nature and at the level of enforcement and compliance.
Soft regulatory tools are starting to emerge when it comes to ICOs, mainly in order to adapt to the transnational nature of these instruments: some national regulators are resorting to soft transnational tools (such as the whitelist published by the AMF in France in order to identify credible actors on the market), and some private actors are adopting transnational rules of their own initiative (such as STOs).
New technologies are leading to a reality where Law is not generated by one state or a group of states; it comes from private actors as well: the ICO industry will come to propose its own regulations.

Blockchain technologies are transnational by nature. Extending the realm of domestic laws or creating new ad hoc domestic regulations is by itself insufficient and might be even obsolete, resulting in an uncertain fragmented market. Regulators need to approach the matter from a common global perspective. Given the transnational nature of ICOs, even the best among domestic laws may become obsolete in regulating the market. Hence the need for a global regulatory framework.

The French optional regulatory framework and the Swiss flexible approach do seem well suited to provide solid grounds for a transnational regulatory response involving both public and private actors in a combined effort to regulate the market. Both French and Swiss regulators acknowledged the urgency to regulate the market from a global perspective. Without this global approach, we will see a fragmented ICO market subject to different laws in terms of tax, securities, AML, etc. Regulatory arbitrage is also one of the main concerns in this regard.

We have also seen a recent collaboration between a group of European countries taking place through the “Southern European Countries Ministerial Declaration on Distributed Ledger Technologies” where the Ministers of Cyprus, France, Greece, Italy, Malta, Portugal and Spain (hereafter referred to as Southern European Countries) met in Brussels on the 4^th of December 2018. They stressed on the importance of the blockchain technology and its role in transforming the economy. As a “technology based on trust”, they consider it has the potential as a game changer in “education, transport, mobility, shipping, land registry, customs, company registry, and healthcare amongst others to transform the way that such services are delivered”, which would result in “the enhancement of e-government services but also increased transparency and reduced administrative burdens, better customs collection and better access to public information”. The Southern European Countries committed to hold regular meetings at technical level to ensure that best practices in DLT application are shared with each other in the context of the European Blockchain Partnership.

In such globally complex legal and technical matters, a specific framework should be implemented that goes beyond the outdated legal perspective that divides between local and international law, and even public and private law that may be unfit to govern these issues. A new understanding of regulation is required which is where the transnational approach becomes relevant and allows both public and private international actors to play a significant role on the international level. This transnational non-central norm creation process, as opposed to the state centric system of law, is better suited to govern decentralized technologies such as blockchain and ICOs. There is also a need for common global definitions and a unified terminology for tokens, crypto assets and securities and common criteria for assessing ICOs.

In the absence of a true transnational legal framework, we might see many soft law initiatives, similar to STOs, that may eventually develop into actual international hard regulations.

Chapter 5: Conclusion

This paper has raised a series of issues and questions around the nature of ICOs, their current regulatory framework, and the best way towards achieving an effective and transparent regulation of ICOs. It sought answers to the following questions:

Are all ICOs considered as securities? And if not, how should different token categories be treated and regulated?
Are securities laws suitable to regulate ICOs? And are they compatible with a decentralized environment through blockchain technology initially intended to operate outside the realm of banks, governments, domestic laws and central authorities and institutions?
Is the application of local laws alone without a unified global perspective sufficient or effective in regulating the market?
Is strict enforcement of local or even international laws possible to prevent fraudulent or rogue ICO companies from continuing their operations?

As discussed above, different regulatory approaches have developed with the aim to resolve the many risks presented by ICOs. The main challenge remains to find the balance between what might seem as two conflicting targets, namely consumer protection and encouraging innovation.

Some jurisdictions have not addressed how and whether the use of blockchain technology or ICOs will be regulated, while others have sought to clarify and amend existing legislation to address the immediate risks associated with ICOs (e.g. anti-money laundering and tax issues).

The initial unanimous reaction by global financial authorities consisting of issuing risk warnings for investors and advising against investing in ICOs is certainly understandable but not sufficient to achieve the intended target of consumer protection. Issuing drastically distinctive and contradictory domestic laws in each jurisdiction will not fulfill the purpose either.

In order to achieve true legal protection, legal certainty, and market stability, it is crucial to regulate ICOs on a global scale, which requires full cooperation by global public and private actors to regulate the field or at least at the first stage agree on a minimum level of common definitions, standards and criteria for basic concepts underlying the field, including a common definition for securities instruments and token classification. In this regard, we have seen some initiatives on the EU level and the Southern European Countries initiative.

A truly global unified regulation will achieve legal certainty allowing to create the right environment for serious investors and major player to develop the market. However, this global legal framework should take into consideration the complexity of the new technology and the different types of tokens being issued and their technical characteristics; it should be flexible and nuanced. Self-regulation is also very important and should be highly encouraged.

ICOs are offered and operate over the internet, targeting a global audience. A mere compliance with domestic laws is not sufficient in this case. An ICO company operating from one jurisdiction may be subject to multiple foreign laws and has a wide multijurisdictional customer base. Foreign laws must be studied carefully and accounted for when launching an ICO. Considering the matter from a global perspective is thus inevitable.

For instance, how is any law firm expected to advise ICO companies on any new project with the presence of a wide spectrum of distinct and often conflicting applicable laws in different jurisdictions, and how is any company expected to comply with all these laws, adding to the complexity and cost of launching an ICO?

ICOs present many risks for both investors and issuers, who may find themselves exposed to litigation in multiple jurisdictions due to legal uncertainty and different complex local laws, due to the nature of ICOs operating outside geographical restrictions and boundaries.

Still, it seems very difficult for the time being to define a clear legal framework for ICOs in the face of a transnational and decentralized technology. Only general recommendations or guidelines founded on transparency and supported by regulators can meet the disparity of ICOs and their intrinsic flexibility.

A strict regulatory stance that restricts ICOs to being defined as securities and a strict centralized governance over a decentralized technology seems to be self-defeating for a very promising technology that is very valuable in many sectors. A balanced optional regulatory approach would drive the market towards valuing quality over the quantity of ICOs. Flexibility should be emphasized over coercion, which will not only fail to prevent access to the technology, but will redirect it to other favorable jurisdictions and even worse, to the
dark web and shadier aspects of the internet. Global initiatives like the EU and the Southern European Countries initiative, i.e. global governance, is better suited to cope with the technology.

The irony of the current blockchain regulatory dilemma is that the technology that was built to enhance confidence, by creating an unquestionable irreversible automated record of data transaction, no longer inspires that confidence due to the widespread scams and frauds occurring in the ICO market.

Another paradox is that the blockchain technology that is decentralized and nongovernmental by nature is now being increasingly governed and regulated by traditional centralized governmental institutions which may seem self-defeating and contradictory as to the nature and purpose of the technology.

Will the dream of decentralization lead the blockchain community to become subject to extreme and hyper centralization? We certainly hope not.

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