The emergence of ICOs and the associated regulatory concerns (Part 1 of 2)
Cryptocurrencies and the underlying blockchain technology powering these networks have seen remarkable growth in the past year. The astronomical returns seen in early projects has caught the attention of investors, entrepreneurs, regulators, and media alike. As it relates to the legal profession, the emergence of cryptocurrency networks has opened a multitude of legal and regulatory questions.
In this two-part mini-series, we will attempt to give the reader baseline knowledge of the emergence of initial coin offerings and the legal concerns associated with it.
Part 1 — What are Initial Coin Offerings (ICOs)?
An easy way to understand Initial Coin Offerings (ICOs) is to compare them to the more commonly known Initial Public Offerings (IPOs).
IPOs signify the first time a company’s stock is offered to the public. They are often used as a method for generating the required capital to support the growth of emerging companies. Stocks offered to the public in an IPO represents ownership stake in that company.
Yet, despite being the traditional method for generating capital, IPOs have received criticism as being unduly expensive, time-consuming, and subject to immense regulatory authority.
ICOs on the other hand, offer a cheaper, more-efficient, and less regulated alternative to generating the same capital.
The reasoning behind this is that ICOs involve the distribution of “digitalized assets” on a blockchain network. These digitalized assets are known as “tokens”. Unlike stocks, tokens do not necessarily represent an ownership stake in a company, nor are they tied to an expectation of future profit. Rather, tokens can take on a variety of different forms.
For instance, a token could be used as a virtual currency (e.g. bitcoin), or be usable in a consumer application (e.g. messaging application) or network (e.g. file storage network). In these scenarios, investors who acquire tokens (i.e. through an ICO) can later “redeem” these tokens for goods and services produced by that same company.
These types of tokens are typically referred to as “utility tokens” because purchasers have an expectation of utility in a future functional marketplace. Such tokens are frequently used to represent a right to a certain value of future goods and services.
For these reasons — and more that are beyond the scope of this article — utility tokens are less likely to be considered securities.
Stay tuned for next week’s release of the second part to this series, which will focus on the regulatory issues of initial coin offerings in Canada.