The State of ICO Regulation: Insights From 3 Lawyers

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Coin Governance System

8 min readSep 4, 2018

The regulation of the token economy is one of the most conflictive tasks within the ICO ecosystem. When you look at each jurisdiction, you could classify their approaches to the token industry in three different categories: restrictive, open or inactive (“wait and see”).

We wanted to get a global view of ICO regulation, how different countries approach the issue and in what ways ICO investors are protected against scams and bad practices in this “wild west” industry. To get insights, we’ve invited two lawyers from our ICO Expert Network to participate in this article and share their knowledge: Pablo Torres (Allen & Overy) and Sara Escalpés (Grant Thornton).

REGULATING THE TOKEN ECONOMY: A GLOBAL VIEW COUNTRY BY COUNTRY

By Pablo Torres
Lawyer at Allen & Overy

2017 saw the proliferation of cryptocurrencies and the surge of a new form of financing: Initial Coin Offerings (ICOs, for short). As the prices of these digital assets skyrocketed and investment into the sector poured in, regulators began to pay attention. Regulators were concerned, among other things, about the extreme price volatility of cryptocurrencies, the lack of consumer protection, and the potential of cryptocurrencies to undermine the current state of anti-money laundering and terrorist financing regulations.

These concerns have triggered various regulatory responses all over the world. While some regulators have banned cryptocurrency trading and ICOs altogether (China), others have undertaken a more proactive approach (Switzerland and Malta), attempting to define a clear legal framework where this new sector can flourish. Such marked differences in regulatory approaches have, foreseeably, led cryptocurrency-related businesses to flock to those jurisdictions in which regulation is lightest or clearest. Binance, one of the world’s largest cryptocurrency exchanges by trading volume, for instance, has relocated to Malta following a regulatory crackdown in China.

South Korea & China

In South Korea and China, countries that represented a large proportion of global cryptocurrency trading, financial authorities clamped down on ICOs. In September 2017, the People’s Bank of China prohibited ICOs and fiat-to-crypto trading because they were unlicensed financial activities. South Korea followed shortly thereafter. This has led many crypto businesses to relocate. It has recently been reported, however, that the South Korean legislative arm is pushing for the removal of the ban, preparing legislation to regulate ICOs and putting adequate investor protection in place.

Switzerland

In Switzerland, the Swiss Financial Market Supervisory Authority has issued guidelines on how it will assess ICOs and cryptocurrencies. These guidelines set out a framework for token categorisation, which will serve as the criteria for further legal and compliance requirements. This added legal certainty, coupled with Switzerland’s less stringent regulation on non-profits, has led many blockchain-related business to relocate to Switzerland.

Malta

Of those jurisdictions that are embracing blockchain and cryptocurrencies, Malta deserves special mention. The country has recently enacted regulations on blockchain-related activities and has created an independent supervising authority: the Malta Digital Innovation Authority.

European Union

The European Union does not currently have a specific legal framework governing blockchain-related activities, but European regulators are reportedly interested in preparing EU-wide regulation on the matter. In the meantime, each Member State is adopting its own approach.

United States

Finally, in the United States, the financial regulator has not yet defined the legal status of ICOs. The mainstream legal interpretation suggests that ICOs are investment contracts, thus categorising many cryptocurrencies as “securities”. This interpretation is based on the Howey test, under which investors acquiring cryptocurrencies make an investment and have a “reasonable expectation of profits” instead of acquiring tokens for purely utility purposes.

One thing is clear: there is an increasing awareness of the potential that blockchain has and the importance of regulating it adequately by guaranteeing investor protections without stifling innovation. We are likely to see serious attempts to pass comprehensive regulation on the matter in an increasing number of jurisdictions over the course of the next few years.

TOWARDS INVESTOR PROTECTION

By Sara Escalpés
Lawyer at Grant Thornton

As said, the emergence of cryptocurrencies and ICOs have peaked the attention of regulators from around the world for different reasons, one of the key ones being, the lack of investors’ protection in these kind of transactions.

The first common reaction from financial authorities with regard to ICOs has been the issuance of guidelines and warnings for investors, informing about the risks of investing in these kinds of assets.

This reaction is acceptable as a first step to protect investors, but to fully protect them legally it is necessary to regulate the ICO field as a whole, a circumstance which has not been prompted thus far. In this regard, European Securities and Markets Authority (ESMA) and financial authorities from each Member State continue to study the ICO space in an attempt to coordinate them within existing European regulation frameworks. The main difficulty lies in the international context derived from digitalization, which obliges authorities from different countries to cooperate in defining some minimum common standards.

Another important difficulty which is currently taking place in this context relates to the level of flexibility which regulation should afford regarding ICOs. At this point, financial authorities have two conflicting interests to consider: investor protection vs. innovation. In other words: obligations to inform investors making them fully aware of the risks taken when investing in ICOs vs. the opportunity to develop new business models and promote innovation by means of companies and start-ups.

Having these two conflicting interests on the table, the solution would reside in the level of flexibility which can be applied, but where the same flexibility needs to be correctly allocated in the legal framework. This means that, in fact, regulation is necessary in ICOs field, not only in order to protect investors (which should be the main objective) but also to avoid legal uncertainty which, if not addressed, could render some companies with serious investing potential, unable to partake in this market due to the aforementioned legal uncertainty.

However, despite the need for regulation, the rules must be adapted to each use case and each different type of ICO, which leads to the analysis of each different type of token (some which are used to access or buy a service or product, others to grant participation rights, exchanged for traditional or virtual currencies, etc.). It is at this point where flexibility is required. A flexible regulation set up in this context means regulation adapted to the different circumstances in which an ICO can be developed. This involves studying, amongst other aspects, the different purposes for which a token is issued, different factors which could make them successful, as well as their technical make-up.

Once having studied these elements, rules should be able to categorize different types of ICOs and demand different levels of compliance in terms of investors’ protection depending on the criteria defined by law. In this regard, creating specialized bodies who are able to evaluate on a case by case basis could be also worthwhile considering

In conclusion, flexibility in this context does not mean lack of regulation nor allowing companies and startups issuing ICOs in accordance to their own criteria. Flexibility means having regulation adapted to the set of circumstances that surround different kind of ICOs and tokens, and protect the investors according to them.

THE ROLE OF THE SELF REGULATION

By Alejandro Gómez de la Cruz
Lawyer and CEO at Coin Governance System

As stated above, regulation is one of the key factors that will determine the future of to Token Sales, as it will shape how ICOs need to be done: KYC prior to the sale, licenses regarding securities issuance, secondary markets, etc.

However, regulation (strictly speaking) is not the only factor that governs this market. Governance and self-regulation play a key role here, it may even be more important than the imperative regulation to create a sustainable environment.

An example of how the market self regulates itself to avoid bad practices is the case of hard caps: most of the ICOs at the beginning had no cap, or they had a hidden cap. This particular practice has been mostly eradicated from the market as investors see this as a lack of transparency by the ICO launcher. This incorrect practice has not disappeared due to regulation, it has disappeared thanks to the self-regulation of the market.

Decentralized governance

Decentralized governance is a hot topic when it comes down to blockchain in general: how to self-regulate the functioning of a certain blockchain and how to propose new developments on the top of an open protocol. Basically: how to reach consensus in decentralized networks.

When it comes to ICOs, decentralized governance has become a hot topic as has happened to blockchain. Most ICOs are born centralized: a centralized company that issues tokens with a centralized team that develops the biggest part of the product. Governance is more important here than we think to make ICOs work in the long run.

Complexity of regulation VS self-regulation

If we look closely to the ICO ecosystem, this often happens:

A company in jurisdiction A, creates another company in a jurisdiction B to launch an ICO
The token is sold to people located in jurisdiction A, B, C, D…
Buyers from jurisdiction U (…nited S…) cannot purchase tokens
The token gets listed in exchanges located in jurisdictions C,F, H, L which sells those tokens in jurisdictions A to Z

Leaving aside the compliance aspects to build the above mentioned structure, in the case that someone (specially investors) has a dispute under this structure, the tools provided by the regulators are quite complex to be applied (in time) to solve the disputes that could arise from an ICO, given the amount of jurisdictions that would be involved in the conflict.

That is why decentralized governance could solve many issues that the current legal framework is far from being capable to solve. This is one of the reasons that pushed us to develop the Coin Governance System, a self-regulating protocol that allows investors to withdraw the contributed funds in case an ICO turns out to be a scam or has bad management of the raised funds.

The peculiarity of this solution is that it is fully built on Ethereum, which is open source, and that it can be implemented in any Token Sale. The magic resides in the programmability of assets provided by blockchain, which makes it more efficient to build tools that could potentially make this ecosystem safer. If you would like to know more about this solution that aims to make ICOs safer through self-regulation, please visit take a look at our website.

Webinar on ICO Regulation & Protection of ICO Investors

On October 2 at 18:00 (CEST), we’re organizing a webinar on ICO regulation and investor protection, in which Pablo Torres, Sara Escalpés and I will discuss the current regulatory framework and our future visions on it. If you’d like to participate, than please reserve your spot here.