Reflections on FINMA’s new ICO guidelines

Federal Palace of Switzerland in Bern

Last Friday, FINMA, the Swiss financial market supervisory authority, published guidelines which provided well needed clarifications on the regulation applicable to the different kinds of tokens issued during ICOs.

In its analysis, FINMA distinguishes 3 kinds of tokens: payment tokens, utility tokens, and asset tokens. What’s new and what’s not?

Concerning payment tokens, a.k.a. cryptocurrencies, little has changed. All that is required is compliance with anti-money laundering regulation, in other words a thorough KYC to verify the identity of the beneficial owner. Such processes can easily be outsourced to specialized online service providers, approved by FINMA, which can conduct digital identification of beneficiaries.

Regarding utility tokens, the major change is that such tokens will be considered securities if the service cannot be used at the point of issuance.

This is of utmost importance, given that most utility tokens issued today are used to finance the development of startups by forward selling their products or services. Such schemes can easily be abused, as tokenholders have little control over the funds which have been collected during an ICO — and therefore might never be able to use the service they’ve purchased. By re-qualifying such ‘forward’ utility tokens, FINMA forces issuers to use a security token to finance product development, which in my humble opinion is a better fit given the risks taken by investors.

Asset tokens, a.k.a. cryptosecurities, are the major breakthrough in the guidelines unveiled by FINMA.

Such tokens are defined as ‘blockchain-based units’ which represent ‘participations in real physical underlying, companies, or earnings streams, or an entitlement to dividends or interest payments’ and are ‘standardized and suitable for mass standardized trading‘. In the eyes of FINMA, such ‘tokens are analogous to equities, bonds or derivatives.’ As a consequence, they fall under the Swiss Stock Exchange Act. However, they are ‘essentially unregulated’ should they be ‘self-issued’, but they may result in ‘prospectus requirements under the Swiss Code of Obligations’.

What does this mean? Asset tokens, or cryptosecurities, are regulated in Switzerland. This is good news for investors because any company issuing them will be liable under Swiss law for whatever claims are associated with such tokens. Should issuers not keep their word, investors will have the full arsenal of the Swiss financial regulation at their fingertips to enforce their rights. On the other hand, the requirements applicable to such tokens are manageable, and consist mostly of issuing a prospectus and sticking with its terms. This is good news for entrepreneurs and companies, because it means that such tokens can easily be issued to finance on-going operations or new ventures.

Through these new guidelines, Switzerland has become a country where companies can easily issue an equity or debt instrument suitable for mass trading on the blockchain. Switzerland is now the ‘Crypto Nation’.

The intentions set forth by Swiss Economic Minister Johann Schneider-Ammann last month are not empty words. What are the consequences?

The most immediate impact is that the pool of investors available for non-public Swiss companies has been vastly expanded. While until now the pool of capital accessible to such companies was limited to venture capital or private equity, it now includes every individual in Switzerland and many more across the world. From now on, a startup or a SME in Switzerland can finance itself by selling its shares or debt to individual investors across borders. The supply of capital, and thus the cost of capital in Switzerland, has been reduced — literally at the stroke of FINMA’s pen.

Economists have long been studying the effect of stock market liberalizations, i.e. the opening of equity markets to foreign investors, in the past decades. Clearly, such liberalizations have been associated with economic expansions in the considered geographies.

Certainly, the actions taken today in Switzerland regarding cryptosecurities will have a positive economic impact, and will be studied with great interest by future scholars.

Also, and because Switzerland is engaged in a competition with other financial centers such as Dubaï and Singapore, it is my expectation that asset tokens will become similarly regulated in other key geographies as well — and in the long term become a common traded instrument the world over.

It is my appreciation that the coming of age of cryptosecurities will have an impact far beyond the stock market — and in particular on the real estate asset class. Valued at over 200 trillion dollars, real estate is the biggest asset class available today, and it is also helplessly illiquid. This severely restricts the ability of investors to buy and sell it, and therefore the mobility of homeowners and the value of real estate as an investment vehicle. As cryptosecurities become ubiquitous, real estate assets will become much easier to invest in, and the collective mobility of the homeowners will greatly increase. Home usage will be decorrelated from home ownership, and this will have far reaching societal and economic consequences.

The blockchain was born in the wake of the 2008 financial crisis, when people lost faith in the financial system. Now, barely 10 years later, the blockchain is being integrated into the very fabric of our economies.

It will enable small companies to access to an unprecedented pool of capital, real estate to become liquid and investors to access investment opportunities the world over. We are living in exciting times, marking the dawn of a more efficient, and hopefully more equitable, economic system.