Law and Legislation for ICOs

Ensuring your blockchain project or ICO is compliant with current law and legislation

This article on ICO law is part of our “How to Launch an Initial Coin Offering” comprehensive guide. If you are interested in understanding all the necessary aspects involved in launching an ICO and are looking for a deeper ICO checklist we recommend you download our guide here.

The fast pace with which the blockchain space has moved has made it very difficult for legislators to keep regulations relevant and up to date.

The absence of ICO-related regulations, however, does not mean that blockchain startups and their ICOs are exempt from the law. It is quite the opposite. Teams that decide to run an ICO should be extra careful and determined to be compliant to avoid inadvertently committing any offenses.

Below you can find a series of aspects you need to understand before you launch your project or ICO. This will require seeking advice and counseling from professionals who can help you better define some of these matters.

Corporate formation

One of the legal matters that must be navigated relates to what kind of structure will be chosen for the project. If you have not decided on the structure of your business, you might fall into a default general partnership, where all founders would be operating under full personal responsibility for all actions performed during the business.

One of the most common practices when doing an ICO is to separate the operating entity from the token issuer company. This is done for several reasons including separating legal liability and also choosing different business entity types according to the function of each entity. For example, foundations and trusts are commonly used entities to run ICOs but are not the best option to operate a business.

One advantage of such a separated structure is that the two entities may be located in different jurisdictions. Your operating entity could be located in almost any jurisdiction without any risk as long as you abide by the current legislation. On the other hand, for your token issuer company, you might want to choose the jurisdiction with more friendly or flexible legislation. You can find more about these in the next sections.

NOTE: When running an ICO what typically matters is where the investors are located and not where the issuing entity is. You should consider this when you decide what investors you will whitelist for your sale.

How to choose the right jurisdiction

Even though legislation continues to lag behind the industry, many national authorities have begun to issue guidelines for ICO investors. While these guidelines are not 100% ideal, they should be seen optimistically, as progress of a kind. It is essential to understand that they are being developed with investor protection in mind, and with a desire to make the space more transparent.

That said, regulations and guidelines vary significantly between jurisdictions. They depend on several factors such as how authorities perceive cryptocurrencies, securities laws, consumer and investor protection laws, AML regulatory frameworks, and on the jurisdiction’s willingness to promote blockchain innovation.

Many jurisdictions are trying to attract progressive entrepreneurs to their territory and are quite open to helping you succeed. Below you can find some elements to look for when deciding on a jurisdiction:

– Cooperation with industry

Some jurisdiction’s frameworks may seem very flexible and work well for traditional industries, but this might not be the case for new and disruptive projects that involve cryptocurrencies.

Look for an emphasis on stimulating innovation, entrepreneurship, and small business growth. Having an open policy and cooperative approach will make a significant difference when it comes to opening bank accounts and getting ancillary business and corporate services.

– Access to legal and industry representatives

Any cooperation to help with setting up an entity or open an account will be to little or no avail if you have no access to legal and industry representatives. Running an ICO will demand a lot of direct interaction with authorities on a regular basis. The jurisdiction you select should provide direct access to an informed representative that you can easily contact to retrieve a quick response.

– Consumer and investor protection

Investors and consumers will feel more secure with their investment in your project if they see you have a regulatory stamp of approval from a jurisdiction that protects their interests. It gives them certainty that you are operating above board and provides a place they can go to argue any grievances should something go wrong.

In general, a regulator’s quality can be primarily determined by how well it protects consumers and investors and how easily accessible they are in the event of a dispute.

– Clear definition of cryptocurrency

A clear definition shows that the jurisdiction is already aware or involved in the industry and probably moving forward with more structured and definitive legislation. A definition may also signal how welcoming a jurisdiction is of “coins” and/or “tokens.” Be sure to read and analyze the definition for these in the jurisdiction you choose.

– Industry Advocacy Group(s)

Any jurisdiction which has an active industry advocacy group working to develop regulations and an amicable environment for blockchain projects should earn a lot of points on your list.

A strong and active advocacy group not only shows that a jurisdiction is robust, but it also provides you with allies and a group with whom to work with on the policies of your company.

– Kinds of corporate formations

Structuring a distributed and international small business is not easy. Making sure that the jurisdiction has the proper legal vehicles for your project is critical. Like we mentioned above, the trend in the blockchain and cryptocurrency industry is to have a foundation as the main vehicle to accept tokens and govern your ecosystem, but this does not mean it is the best, nor the only one.

Make sure to design your business structure with experts in the field to know what your needs will be. Some of the leading jurisdictions for blockchain projects and ICOs are:
– Singapore
– Hong Kong
– British Virgin Islands
– Cayman Islands
– Isle of Man

(As the industry develops these may change a lot with some of these being less friendly and new jurisdictions coming up. Estonia, Belarus, and Slovenia are moving fast to become crypto-friendly countries for example.)

Remember. Even though these jurisdictions are leading the way in many respects, each one will have their benefits and drawbacks. When it comes to choosing a jurisdiction for your ICO, it’s vital to examine what your specific needs are and what you are willing to trade off.

Securities & commodities laws

Despite a large number of legal aspects to consider, the most significant concern for most projects is whether their token falls under the category of securities.

This topic gained particular notoriety when the SEC released an investigative report concluding DAO Tokens were securities, and because so much speculation and uncertainty exists right now, anxiety levels are very high. Nobody wants the SEC calling on your phone.

Most jurisdictions have yet to take a clear stance on whether tokens or which tokens, if any, will be considered securities. In other words, just because authorities haven’t come out yet and said that some specific tokens would be regarded as securities doesn’t mean it will stay this way in the future.

Non-US investors are not subject to US Securities laws, so some ICOs target only non-US investors. But this does not mean they are completely covered as it’s very easy to mask your location on the Internet and not all identity verifications (especially on exchanges) are exhaustive.

One of the most common ways of figuring out if your ICO might be considered a security offering is to run it through the US Supreme Court Howey Test. However, be wary of interpreting these results as definitive. Regulators use several other methods to define your token and even all of this cannot give you a definitive answer.

There are currently several organizations working in the blockchain space to clarify these uncertainties. One such organization is Coin Center – a nonprofit focused on policy issues facing cryptocurrencies. Coin Center has published a Framework for Securities Regulation of Cryptocurrencies and a more specific Securities Law Framework for Blockchain Tokens.

– AML and KYC laws

In almost every legal jurisdiction, no matter what the legal definition of cryptocurrency is, you will almost always be required to abide the financial surveillance laws.

These are better known as the Know Your Customer (KYC) and Anti-Money Laundering (AML) rules. In simplest terms, these are laws that mandate that “financial institutions” (a broad category of businesses offering financial services) must collect and retain information about their customers and share that information with the appropriate regulatory entities.

Regulated entities are traditionally required to collect a government-issued ID + a utility bill for a person, in this case, your customers. However, this may vary according to the jurisdiction you are operating under, and if your entity is considered non-regulated, these requirements could be less.

Your KYC related activities depend on how your token is defined. If it falls under the security category, KYC regulations must be fully adhered to (not to mention many other considerations like making sure purchasers are accredited investors). On the other hand, if your token is considered a utility, legislation tends to be more flexible.

– Crowdfunding laws

Although the concept of ICOs and crowdfunding through tokens is revolutionary, not every aspect of it is entirely new. Some of the problems have been dealt with before.

In mid-2016, the US implemented Title III of the JOBS Act, which legalized equity crowdfunding for non-accredited investors. At its core, it is very similar to what ICOs have come to deliver on: democratize the funding process and allow the raising of funds from a crowd or community and not just a small elite of venture capitalists. Analyzing the crowdfunding laws in the jurisdiction in which you hope to launch is an option.

– Taxation

Specific taxation frameworks on ICOs are still not entirely defined. In addition to this lack of regulation, the fluctuation of cryptocurrencies presents another challenge as to how to run your business.

It’s wise to choose a jurisdiction which provides a favorable tax policy to minimize future headaches. 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.

Particularly if you are not running a foundation, a low tax jurisdiction, with a clear categorization of what a cryptocurrency is and how it is taxed, will help the management and accounting side of your project immensely.

– Advertising (of token)

The language you use to refer to your token may have an impact on whether your token is deemed a security. Every promotional material you use for your ICO can and will get examined, so it’s crucial that no language misrepresents your offering.

Jargon and technical language won’t protect you. Everything you write can be scrutinized. (Including, social media, Reddit, messaging apps, etc.).

To protect yourself, be sure to set specific guidelines on how to refer to your token from the beginning and make sure that your team members follow diligently. It is always a good idea to seek the counsel of a lawyer to review all of your promotional documents, your website, token terms, and any other material.

When it comes to the legal aspects of your blockchain project and ICO you can never be too careful. There are many shortcuts and ways to bend the rules, but on the long run, this will mostly generate more problems than solutions.

With new tokens and cryptocurrencies going mainstream, and with the huge influx of money the industry has seen lately, I expect that more and better guidelines and legislation will appear. In the meantime, be sure to comply with the current ones and get professional advice to be in control of all of the above.

Key points:

1. Developments in the blockchain space have occurred more rapidly than most legislators can handle. Hence regulations are not up to date with emerging blockchain business and financing models.

2. While specific regulations are still being developed, founders should be wary and conduct their operations with the utmost care by complying with current legislation as much as possible.

3. The minimum aspects of compliance to be addressed concern corporate formation, securities laws, AML & KYC laws, taxation, and the advertising of tokens. There are, however, many other aspects that need to be examined by founders and professional counsel.

For more details on each of the steps and more in-depth explanations download our “How to Launch an Initial Coin Offering” comprehensive guide.

If you’re planning an ICO, Token Deck is our Initial Coin Offering solution that makes the ICO process safe, compliant and easy. Check it out!

If you have any questions or would like to connect you can find me on Twitter or email me at [email protected] I’m always interested in meeting people working, learning, or involved with the blockchain space.

Disclaimer This document does not constitute legal or investment advice nor should be taken as such. You should not rely on it and if seeking to do an ICO or any other related activity you should seek separate professional counsel. It is for informational purposes only. Views do not represent the views of my employer, investors, or partners. Furthermore, the blockchain industry and technology is undergoing constant development so this post is intended as a guide at the current moment of publication and the issues and topics, and therefore the guidance, covered are vulnerable to change and development. The reader should bear this in mind when reading.

Also published on Medium.