How to do an Initial Coin Offering (Part 3)
How to Choose the Best country for an Initial Coin Offering or Blockchain/Cryptocurrency Startup
With the advent of Initial Coin Offerings, or Token sales, there has been a noticeable interest in companies from all sectors that would like to understand the process of raising funds for their projects. Unfortunately many have a lack of understanding about the comparative regulation, laws, and the trends that are shaping corporate formation, tax, accounting, and governance in choosing the proper jurisdiction for these needs.
As stated in my earlier post: How to do an Initial Coin Offering (ICO) Disclaimer: My opinion is not legal advice. I am not a lawyer. This in no way should be considered legal advice, and my views do not represent the views of my employer, investors, or partners. Moreover, nothing written here should be construed as investment advice either, YOU SHOULD TALK TO A LAWYER.
Depending on your product or service, eg. whether it’s an access “Token” for a product or service, or a “Coin” for a security offering, you will need to know how to choose a facilitative jurisdiction and corporate formation for your project.
Below is the process that I go through when talking to our partners in constructing the proper vehicles for their initial coin offerings and their ongoing platform needs when selecting a jurisdiction.
- Does the jurisdiction have a high quality Regulator?
- Does the jurisdiction have a clear definition of a Cryptocurrency?
- Does the jurisdiction have clear Crowdfunding guidance?
- Does the jurisdiction have an Industry Advocacy Group(s)?
- Does the jurisdiction have the proper Corporate formations for your needs?
- Does the jurisdiction have a favourable tax policy?
- Does the jurisdiction have clear AML and KYC Guidelines?
- Does the jurisdiction have fair Data Privacy laws?
- Does the jurisdiction have efficient Infrastructure and access to talent?
- Does the jurisdiction have access and close proximity to key markets?
While this is not an exhaustive list of considerations, it will provide you with a basic framework for discussion with your lawyer, accountants, and other service providers.
1. Does the jurisdiction have a high quality Regulator?
The first thing to consider is the reputation and recognition of the regulator in the jurisdiction that you are considering. This is primarily dependent on the industry that you operate in, as jurisdictions are not all created equal, and many have great legal frameworks for some industries and horrible ones for others. Many times these jurisdictions have a high quality brand in a specific industry because that area is of significance to the territory and there are many participants in the industry that have decided to set up there and do business. The brand of the jurisdiction will make a major difference when it comes to opening up bank accounts and getting ancillary business and corporate services if the territory has a reputation for cooperation, transparency, and quality business operators.
The accessibility of a regulator is critically important as you will need to have direct interaction with them on a regular basis. The notion that you will be able to setup a company in a jurisdiction with a nominee director and a mailbox is a mythology straight from the Panama papers, and will not apply to small businesses operating in a global context. You should be able to get direct access to a representative without it feeling like you’re trying to contact god almighty.
These regulators typically tend to be smaller jurisdictions that have a large dependency on a certain industry and depend on on innovation to maintain the vitality of their society. The have a specialized outreach programs targeted at small businesses and founders and are quite aggressive in promoting their territory, because they understand the needs of these businesses and see it as vital to their economies.
Approach, licensing, and sandboxes
The jurisdiction should have a “Risk, and Principles-Based Approach” to licensing with a strong emphasis on stimulating innovation, entrepreneurship, and small business growth. It seems like a no-brainer, but some jurisdictions are quite fearful of new technologies and innovations. As a result, they set up moats around their industries to maintain incumbent positions because they feel the protection of existing jobs is more important than the creation of new jobs for the future.
You would be surprised at how often this perspective takes precedence in jurisdictions because regulators are ill equipped to understand new technologies and their political mandate is to maintain the economic status quo. Typically these territories make licensing and oversight extremely onerous for small business. Often the only organizations with permission and consent to participate in regulated industries are large multinational incumbents who have no intention of being innovative.
The existence of a regulatory sandbox is a good indication that a jurisdiction is open to innovation. It also shows a sign of willingness to work with small businesses to collaborate on regulatory frameworks that are in line with the body’s mandate, while still allowing for economic growth and the cultivation of new industries.
Consumer and investor protection
A regulator’s quality is primarily determined by how well it protects consumers and investors as well as how easily accessible they are in the event of a dispute or malfeasance. Therefore they should have clear guidelines on disclosure, consumer, and investor protection. Investors and consumers will feel a lot more comfortable about you, and your project, when they see a regulatory stamp of approval on your project, if necessary, because it gives them certainty that you are operating above board and provides a place they can go to in the event that something goes wrong.
Courts and legislation
The courts and legislation that govern regulators are key indicators of how well reforms can go through, and how well they will protect you in the event another jurisdiction comes after you for doing something that is lawful in your territory but at odds with another. Understand that many jurisdictions are part of international treaties and alliances, so you will still have to operate in a global context, but it’s important the courts are also there to protect your interests as they align with the jurisdiction. Again, smaller countries with direct democracies where you can propose legislation are great because you can interact with regulators in person to propose legislation and guidelines that help advance the interests of the jurisdiction and the ecosystem at large.
Economic development and industry outreach
How well a regulator endeavors to advance economic development while providing safeguards for consumers and protecting the jurisdiction’s reputation is also of vital importance, as the saying goes: “One bad apple can spoil the bunch” is a reality. You want the regulator to be constantly refining itself and attracting high quality teams and businesses to help build the ecosystem and the reputation. The more a jurisdiction’s community and reputation grow, the better it is for everyone.
Governing authorities that have a keen desire to develop robust and speedy interactions with small business and have a demonstrated record of facilitating innovation, while also ensuring the continuation of regulatory objectives that protect consumers and investors is no doubt a challenge. But some jurisdictions do it better than others.
When you are considering a jurisdiction, the regulator’s accessibility, insights, and clarity on their objectives are primary indicators of their commitment to you, your business, and your industry.
2. Does the jurisdiction have a clear definition of a Cryptocurrency?
Coins, and Tokens, what’s the difference? — Some clarity is needed to establish the difference between “Coins” and “Tokens”. My preference is to use the term “Token Generating Event” or “Token Sale” where “Token” can more aptly describe an offering that provides access, and participation in a decentralized product or service. In addition to this, I prefer to refer to security based offerings as “Coins” or Initial Coin Offerings, where the Coin is a way to describe an event that is licensed and regulated by a governing body, and that represents an investment contract.
The Financial Action Task Force defines cryptocurrency as:
‘a digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction. It is not issued nor guaranteed by any jurisdiction, and fulfils the above functions only by agreement within the community of users of the virtual currency.
Virtual currency is distinguished from fiat currency (a.k.a. “real currency,” “real money,” or “national currency”), which is the coin and paper money of a country that is designated as its legal tender; circulates; and is customarily used and accepted as a medium of exchange in the issuing country.
It is distinct from e-money, which is a digital representation of fiat currency used to electronically transfer value denominated in fiat currency. E-money is a digital transfer mechanism for fiat currency — i.e., it electronically transfers value that has legal tender status.’
Most countries and jurisdictions around the world hold the above definition of cryptocurrencies, especially if they are treaty to the FATF. Many jurisdictions have defined what a cryptocurrency is NOT, but, few jurisdictions have granted guidance and clarity to what a virtual currency IS. Those that have defined cryptocurrencies go to the top of my list as understanding, or at least defining the features of cryptocurrencies is a crucial first step in the design of facilitative regulatory frameworks, as well as Token sale models.
3. Does the jurisdiction have clear Crowdfunding guidance?
Does the jurisdiction have laws or guidelines in place for “Crowd-funding” that democratizes funding, inspires entrepreneurial innovation, and provides the appropriate foundation for sustainable economic development?
This is an area where most jurisdictions a woefully lacking, and what is necessary for initial coin offerings for security based events. Without a crowdfunding guideline of law in place, securities based offerings become way too onerous and difficult to do under current securities and banking laws. Here is one area of regulation where america leads many jurisdictions as under the JOBS act, crowdfunding of securities is permitted under a current securities regulatory framework, but slightly adjusted for small business. The US is a good benchmark for other countries that have crowdfunding regulation in place as it provides clarity on how to protect investors and consumers and also guidance on an progressive small business funding.
A good framework for understanding a crowdfunding design is if the guidance has provisions for tiered participation eg.
Non sophisticated investor
May invest “X” maximum per opportunity
May invest up to “X” per platform per year
Must sign a ‘Risk Acknowledgement’ form
Minimum net worth of “X”
May invest up to “X” per platform per year
Must sign a ‘Risk Acknowledgement’ form
Must confirm that they are experienced in making investments into early stage, high risk, illiquid businesses
Minimum of “X” net worth
No limits on how much they may invest
Must confirm that they are experienced in making investments into early stage, high risk, illiquid businesses
Crowdfunding provides an alternative finance option to traditional funding especially for securities based coin offerings and jurisdictions that have introduced pragmatic and progressive regulations balanced with strong consumer protection.
4. Does the jurisdiction have an Industry Advocacy Group(s)?
A strong industry advocacy group that’s on the ground and working on the behalf of everyone in the industry is a key highlight to a jurisdiction, and an indication to how robust the ecosystem is in that territory. The composition and makeup of the group, should include regulators that are a part of the member group so that they are active and involved in the industry and not just there for networking, schmoozing and to look cool infront of their colleagues.
Even better is when the advocacy group acts like a think tank and policy pusher on your behalf, and is guided by industry professionals who have a beneficial mutual interest in seeing policy implementation and thought leadership emerge from the group.
This type of activity coupled with direct access to policy and lawmakers makes it much easier for small businesses to access the key resources of the jurisdiction, meet key influencers, and setup with low friction. It also allows new entrants to participate in the expansion of the community.
5. Does the jurisdiction have the proper corporate formations for your needs?
The proper legal vehicles are essential for the structuring of your distributed and international small business. The trend in the blockchain and cryptocurrency industry is to have a foundation as the main vehicle to accept tokens and govern your ecosystem.
Look for jurisdictions that have a modern Foundation’s act that is in the tradition of those of the most prominent civil jurisdictions. Foundations are entities with a separate legal personality than the founder(s) which can hold and deal with property in their own name as absolute legal and beneficial owner, for the specific purposes that are detailed at the outset.
This separation is very important to decentralized systems, as governance is, and continues to be a challenge to the ecosystem, and the construction of a proper vehicle with independent leadership sends a strong signal to your community that you’re in this for the long term.
The purposes of a foundation can be very wide, and need not be charitable, and indeed can be “anything capable of fulfilment” as long as they are not illegal, immoral, or contrary to public policy.
Foundations have the unique feature of holding property for specific purposes. They are a legal entity, with a structure similar to that of a corporate, with a management board, often referred to as a council, and allow for the separation of ownership and administration of the assets. Foundations are typically set up for asset protection, succession planning, to safeguard assets from economic or political uncertainty or as protection against creditors or liabilities.
Given the dynamics of the blockchain and cryptocurrency industry, a strong regulator with a good reputation, coupled with the proper corporate formation is an effective way to organize your projects resources across community development, research, treasury, and independent governance.
Companies limited by guarantee and charities, are not “Not-for Profit” Foundations.
Foundations are not widely available in most jurisdictions and the various legislations come with nuanced approaches, so founders need to be careful in selecting the right type of vehicle. I have a distinct preference for foundations, but many founder’s seem to conflate “Not-for-profit” across foundations, Societies, and Charities. These are not the same thing, and come with a variety of distinctions that may or may not be conducive to your offering and your ongoing project
I was recently contacted by a founder who did not conduct a holistic approach to selecting their jurisdiction and nominated vehicle. She did not talk to a lawyer, was not aware of the regulations in the territory. She was clearly offering a security but decided to use a company limited by guarantee, which is a form of member society, and naively misunderstood the very distinct differences between a “not for profit” foundation and a member society.
Just because these two vehicles are “not for profit” does not mean that can act in the same way. They are generally governed by different and distinct acts, that may or may not be beneficial to your offering and overall structure. It is therefore best that founders discuss these details with a lawyer, and not jump into a formation that you are not certain will serve your needs.
To top it off, the only “kyc” she did was not to accept investments from Americans. I was obviously concerned, but moreover very upset, that this individual did such little homework, and put their entire ecosystem and their own credibility on the line while also making it much harder for everyone else in the industry to get recognition for compliant projects.
6. Does the jurisdiction have a favorable tax policy?
One of the many overlooked challenges for blockchain/cryptocurrency startups is how the fluctuations of cryptocurrencies will affect your ability to run your business. Essentially, your finance or accounting person will have to be a quasi-hedge fund manager to make sure you maximize the value from your recent or ongoing funding. Each jurisdiction, based on their categorization of a cryptocurrency will require you to report tax on either; Sales tax, VAT, capital gains, or all of them.
It’s therefore imperative that you try to find a low tax jurisdiction, with a clear categorization of what a cryptocurrency is and how it is taxed. Accounting for cryptocurrency is a developing area in the same way that initial coin offerings and blockchain business model best practices have not emerged yet. Save yourself the stress: manage and account for the fluctuations, and find a jurisdiction that allows you to account for this, if you’re not running a foundation, in a low tax territory.
7. Does the jurisdiction have clear AML and KYC Guidelines?
Clear guidelines on AML/KYC especially for startups in the form of a workbook, that isnt 300 pages thick, is a great indicator that the regulator and the jurisdiction is facilitative to the industry. Typically all jurisdictions will follow the best practices of the FATF, but may have additional requirements in order to create jobs in their territory such as.
- The business should be carried out onshore with a legal entity in the territory
- The business has a minimum of “X” resident company directors
- Banking to be carried out onshore in the territory
- Principal servers to be hosted onshore and in territory
- Registered investors information to be held onshore and in territory
These can typically be supplied by a local Corporate Service Provider eg. for compliance. In most cases the bare minimum of KYC/AML and compliance you will have to incorporate is:
- Documented due diligence process
- Identity verification
- Due diligence procedures for participants of “high risk”
- Beneficial ownership of business clients
- Monitoring of suspicious behavior
- Ongoing record keeping
This may or may not be required for your token sale, and ongoing platform needs. It depends on the selected jurisdiction, your project scope and the nature of your industry.
8. Does the jurisdiction have fair Data Privacy laws?
If you’re still here after the KYC/AML section of this post, and not turned off by some of the requirements previously discussed, you will be happy to know that there are jurisdictions that not only take KYC/AML seriously but also put a lot of emphasis on consumer data privacy. This can in some cases, relieve some of the compliance burdens of ongoing monitoring and the storing of investor information.
Countries like Switzerland, Iceland, Netherlands, and Norway are known for their respect for data privacy and I would encourage you to compare their data privacy laws as they serve the needs of AML/KYC in their jurisdictions. Countries like the US in comparison to the EU have very strict surveillance laws like the Banking Secrecy Act that literally compel you to surveil your network for suspicious behaviour and are a little late to the “right to be forgotten” laws that are becoming the defacto data laws of the EU.
9. Does the Jurisdiction have efficient infrastructure and access to talent?
Living in Hong Kong, and frequently travelling to Singapore for the last 15 years has made me appreciate modern infrastructure and the efficiency that facilitates the ease of doing business. In fact, I may be completely spoiled now, but there is nothing more insufferable about a country that has terrible airports, dodgy electricity, and spotty wifi. When I select a jurisdiction, the infrastructure is not taken for granted, especially because blockchain and cryptocurrency networks are not the easiest projects to maintain.
Efficient infrastructure is sometimes an important factor in the attractiveness of a place for high technology talent, and I don’t mean app developers. Talent, especially for cyber security, given that jurisdictions put a high premium on AML/KYC have to be a part of the decision-making process when choosing a jurisdiction. Unfortunately, this is where most of the territories will fall short. Many of them are remote, and they are not setup for this level of talent. Many have built their economies on traditional financial services, and as a result, there is a lot of “Fin” but not much “tech”.
10. Does the jurisdiction have access and close proximity to key markets?
Many of the jurisdictions that meet the criteria above will not have the talent required for you to run your business. You will therefore either need to have close proximity and access to influential markets such as London, NYC, Singapore, Hong Kong or similar hubs that will be able to supplement your team to comply with governing bodies under your structure. Given that most teams and platforms are decentralized this shouldn’t be too difficult, in fact, this is something that founders should embrace in our global and hyper connected world. The notion that you will be able to find everything you need in your city, at your budget, where everyone can commute into their cubicle filled office space, is a fantasy that stems from the days of the industrial revolution up until about the late 90s. I’ve been encouraged that the regulators I have talked to along with the founders we work with are open to this, and in many cases prefer remote teams, cloud services, working across time zones, keeping flexible workspace, and using their favourite airline to get most of their work done.
Token generating events are just the beginning of a long and in some respects complicated process. It’s important to examine your needs and what you are willing to trade off when it comes to a jurisdiction. There are many great jurisdictions out there that are trying to attract progressive entrepreneurs to their territory and open to helping you succeed.
If this seems a bit confusing I would encourage you to go back and read my original post on How to do an ICO. It will put all of this in more context.
or check out part 2 : How to know if your Token is a Security