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Benefits and characteristic on Assetization or Tokenization (of asset) are in part I and II of this series. We also looked already in detail at #STO_in_USA (II), since the US market displays strong interest and offers a large market-size. The goal of this series is to show that in theory everything can be tokenized, tangible and intangible, as token embedded smart contracts serve the same function as traditional paper-contract, and to showcase different legislations in different jurisdictions. Token have certain advantages over paperwork, some obvious, some not, eg. automatization of renewals, improved security through distributed technology consensus mechanism, impossibility to tamper, convenient reconciliation and auditability, and many more.
Tokenized Offerings USA
Regulation of Blockchain
In general, The United States does not currently have any law or regulation that comprehensively governs the use of blockchain and other DLTs. Industry-specific laws and regulations that govern products, services, and transactions. Blockchain technology is a technology like other eg. internet software, programs or infrastructure protocols which are treated alike. Most of the regulators concern are not the technology, but more the use of cryptocurrency, which is not a necessity when applying Blockchain eg within your supply chain or digital identity. Currently, federal and state agencies are actively exploring Blockchain technology, its opportunities and risks.
Regulation of Cryptocurrencies
No single U.S. regulatory agency regulates cryptocurrencies, and no comprehensive regulatory framework exists yet in the US regarding cryptocurrencies. However, federal regulations involving anti-money laundering (AML) and investor protection, general compliance of financial instruments, taxation, as well as state regulations for money transmission, and security trading/ investing impact the use of cryptocurrencies.
The two main agencies of the U.S. Department of the Treasury, the Financial Crimes Enforcement Network (FinCEN) and the Office of Foreign Asset Control (OFAC), directly regulate certain aspects of handling cryptocurrency. FinCEN has issued guidance since 2014 describing how certain types of businesses handling cryptocurrency may be considered regulated financial institutions for the purposes of U.S. anti-money laundering requirements.
Companies conducting Initial Coin Offerings (ICOs) may also be required to register with FinCEN.
The U.S. Commodity Futures Trading Commission (CFTC) considers Bitcoin, Ethereum and some other virtual currencies to be commodities under the U.S. Commodities Exchange Act.
The U.S. Securities and Exchange Commission (SEC) has begun issuing guidance pertaining to crypto-assets, particularly tokens that emerge from Initial Coin Offerings (ICOs).
The U.S. Internal Revenue Service (IRS), has considered cryptocurrency property for tax purposes. The IRS has particular interest in Securities camouflaged as Utilities in the cryptocurrency space.
Initial Coin Offerings
In February 2018, in testimony before the Senate Banking Committee, U.S. Securities and Exchange Commission (SEC) Chairman Jay Clayton affirmed his view that ICOs in general involve the offering of a security. An entire or project can conclude the Howey Test to prepare itself for security vs utility definitions before conducting/ creating a fundraise activity.
A digital asset could start-out as a security (for example, in a pre-sale) and, over time, become something other than a security, if the network on which the token or coin is to function is sufficiently decentralized, such that purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts > Bitcoin.
The SEC also warns about risks of ICOs with its "Howey Coin" offering, with its fake whitepaper, vague business plan, promises of guaranteed returns, and false celebrity endorsements.
Tokenized Offerings EU
Regulation of Blockchain
In general, the European Commission (EC) has continued to express support for Blockchain and Distributed Ledger Technology (DLT) as technology that promote trust, making it possible to share information online, and agree on and record transactions, in a verifiable, secure and permanent way. The EU has, so far, chosen not to officially regulate Blockchain and DLT - which makes sense since it is a technology! It will establish an appropriate legislative framework, and to address any legal uncertainties it creates, eg. EU Blockchain Observatory and Forum
Regulation of Cryptocurrencies
Similar to DLTs, the EU has so far held back from rushing into regulation of cryptocurrencies. The EC will work with the European Supervisory Authorities to develop a blueprint of best practices for regulatory sandboxes and it will work with the Blockchain Observatory and Forum on a comprehensive strategy for DLT, Blockchain and cryptocurrencies, addressing all sectors of the EU economy.
The majority of EU Member States (27 countries — excluding Croatia and Hungary, but including Norway) have agreed to form the European Blockchain Partnership (EBP), intended to avoid fragmented approaches to DLT.
The EU has no specific regulations on cryptocurrencies, which, until Libra was announced in June, had been considered a marginal issue by most decision-makers because only a fraction of bitcoins or other digital coins are converted into euros.
The EC proposed a regulation on European crowdfunding service for business, and campaigns worth up to one million Euro over a period of 12 months. The European Parliament Committee’s Report seeks expressly to exclude ICOs from the traditional crowdfunding regulations, rather calling on the EC to consider whether these need separate regulation.
The EU also adopted the Fifth AntiMoney Laundering Directive (5AMLD), which brings custodian wallet providers (CWPs) and virtual currency exchange platforms (VCEPs) into scope, based in the jurisdictions to be subject to similar obligations as other financial institutions (e.g., banks). These include registering with national anti-money-laundering authorities, and registration of security offerings.
Tokenized Offerings United Kingdom
The Financial Conduct Authority (FCA) has established a Sandbox, a structured and controlled environment, where firms willing to participate in the UK crypto-assets sector can apply and live-test their innovations under the regulator’s supervision. In this way, regulations can be created to meet the needs of the customers, investors and the innovators alike.
FinTech firms from other EU member states also use the Sandbox as a passporting mechanism for their business to the UK. EU firms may still apply to engage and operate in the Regulatory Sandbox, even in the event that the UK leaves the EU, although the passporting right conferred by membership within the EU may be potentially affected by Brexit.
Tokenized Offerings Liechtenstein
The Blockchain Act is addressed to ‘transaction systems based on trustworthy technology’ (TT systems). They are setting higher standards in the crypto-industry by not only regulating it, but also enabling a holistic legal framework. The goal is to ensure user and service provider protection and building trust in digital legal regulations. The “Token and Trustworthy Technology Service Providers Act” (TVTG) incorporates measures to combat money laundering and terrorist financing by subjecting service providers to due diligence rules and regulations.
The adoption of the law is important in the light of Liechtenstein being a member of the European Free Trade Association (EFTA) and, unlike neighboring Switzerland, the European Economic Area (EEA) as well. That means crypto companies based or represented in its jurisdiction will be able to enjoy easier access to the common European market as well as compatibility with the legal frameworks of other countries in the region.
The Blockchain Act aims to regulate tokens and the exchange of tokens in a legally secure manner, thus tapping the token economy to its full potential. Tokens are considered as representations of financial instruments and are consequently regulated in the Liechtenstein legal framework as so, by triggering the supervision of the Financial Markets Authority and corresponding licensing obligations. Licensing obligations exist on a case-by-case basis, depending on the type of business model, functions, and relevant criteria of the token. Tokens used as a method of payment are not covered under the scope of the regulation, and thus do not have any special statutory licensing obligation. The different types of licenses are applicable to the following offerings:
Regulated Security Token Offerings (STO)
Initial Public Offerings (IPO)
Initial Coin Offerings (ICO)
Other token sales
Tokenized Offerings Estonia
Estonia is considered to be very advanced in relation to the implementation of blockchain systems and cryptocurrencies. It intends to support innovation in the financial instrument industry by adopting a technologically-neutral approach towards these innovations, while creating new opportunities for issuers and investors alike.
Although crypto-assets do not have the same legal status as FIAT currency in Estonia, they can be exchanged amongst persons or be used as a means of payment. There is no specific Act or Regulation in Estonia’s legal framework dealing explicitly with crypto-assets and cryptocurrencies. Because of this, the legal nature of cryptocurrencies in the Estonian legal system remains unsettled, so much so that the framework does not provide a clear definition of the term ‘cryptocurrency’.
Estonia’s crypto-asset industry depends heavily on the anti-money laundering (AML)/counter- financing terrorism (CFT) regulation, and the Money Laundering and Terrorist Financing Prevention Act (MLTFPA) is the main source of legislation in the industry.
Initial Coin Offerings in Estonia are mainly regulated by the Estonian Regulator Finantsinspektsioon (EFSA), which issued unofficial guidelines on ICOs. The EFSA has specified that if a token falls under the definition of ‘security’ as stipulated in the Securities Markets Act and represent a unitholder’s share in the assets of a common fund, then that shall be considered as an STO. If this is the case, it will then be required to register a respective prospectus with the EFSA. The STO must fall under one of the following categories to be registerable with the EFSA:
An offer of securities is addressed solely to qualified investors
An offer of securities is addressed to fewer than 150 persons per Contracting State, other than
qualified investors
An offer of securities is addressed to investors who acquire securities for a total consideration
of at least 100,000 euros per investor, for each separate offer
An offer of securities with the nominal value or book value of at least 100,000 euros per
security
An offer of securities with a total consideration of less than 2,500,000 euros per all the
Contracting States in total calculated in a one-year period of the offer of the securities
Tokenized Offerings Gibraltar
DLT activities in Gibraltar are regulated under the DLT Regulatory Framework and must be licensed by the Gibraltar Financial Services Commission (GFSC). Thus, cryptocurrency exchanges must be regulated in Gibraltar. The framework, however, is limited to the provision of such services. So, Initial Coin Offerings (ICOs), are currently not regulated. Security tokens fall within the remit of the definition of a security with regards to its promotion and sale must be registered. Utility tokens and payment tokens are not captured by any regulatory framework.
The regulations are based on nine core principles which provide that DLT service providers must:
Conduct their business with honesty and integrity.
Pay due regard to the interests and needs of customers and communicate with them in a way that is fair, clear and not misleading.
Maintain adequate financial and non-financial resources.
Manage and control their business effectively, and conduct business with due skill, care and diligence; including having proper regard to risks to its business and customers.
Have effective arrangements in place for the protection of customer assets and money when responsible for them.
Have effective corporate governance arrangements.
Ensure that all systems and security access protocols are maintained to appropriate high standards.
Have systems in place to prevent, detect and disclose financial crime risks such as money laundering and terrorist financing.
Be resilient and have contingency arrangements for the orderly and solvent wind down of its business.
The reason behind a principle-based approach is to allow flexibility and innovation.
Tokenized Offerings Switzerland
Well, there is a ‘blockchain/ICO working group’ set up by the Swiss Federal Government to ensure that the country is kept abreast with developments in the sector.
The Financial Market Supervisory Authority (FINMA) issued a series of statements with the intention of regulating the landscape, including the publication of guidelines on the regulation of ICOs already in February 2018. The ‘Federal Act on the Amendment of Federal Laws in light of the Developments regarding DLT’ is expected to be promulgated in January 2020.
However, as of yet, there is no legislation which specifically regulates DLT assets.
The following analysis is based on the ‘Guidelines for enquiries regarding the regulatory framework for initial coin offerings (ICOs)’ issued by FINMA.
FINMA categorizes tokens into three categories, based on their underlying economic function:
Payment tokens: tokens which are intended to be used, now or in the future, as a means of payment for acquiring goods or services
Utility tokens: tokens which are intended to provide access digitally to an application or service by means of a blockchain-based infrastructure
Asset tokens: represent assets such as a debt or equity claim on the issuer, and tokens which enable physical assets to be traded on the blockchain
ICOs are subject to regulation based on whether the tokens on offer are classified as securities, based on the definition in the Financial Market Infrastructure Act; “standardized certificated or uncertificated securities, derivatives and intermediated securities, which are suitable for mass trading.”
Currently, there is no specific legislation regulating ICOs.
Tokenized Offerings Germany
The German federal government passed a comprehensive blockchain strategy which will foster the technology and mitigate the risks regarding its implementation. The strategy aims to unleash the potential of blockchain and distributed ledger technologies (DLT) in the country, supporting the digital transformation in several sectors and preventing risks related to their use and data abuses.
The German Federal Financial Supervisory Authority (BaFin) published an advisory letter on the ‘Supervisory classification of tokens or cryptocurrencies underlying “initial coin offerings” (ICOs) as financial instruments in the field of securities supervision’, with the aim or providing some clarity on the relevant legal implications.
The following definitions for the three identified classes of tokens:
Payment tokens: used as a mean of payment, usually have no other function or limited functions beyond payment
Securities tokens: Represent membership rights or shares involving assets in the issuer’s future revenues, similar to equities and debt instruments
BaFin classifies payment tokens as financial instruments in the form of units of account. Units of account are not legal tender, but have the function of replacing currency in private payment. This classification implies that certain authorization requirements pertaining to financial instruments might be applicable to payment tokens. Payment tokens might require authorization if they are used for purposes other than payment. Financial services involving payment tokens might thus require licensing. Furthermore, certain obligations are imposed such as due diligence requirements, establishing internal safeguards and record-keeping.
Utility tokens: use is limited to the issuer’s network to purchase goods or services
Pure utility tokens which solely provide the acquisition of goods or services and not financial compensation are not subject to regulation. If such tokens take a hybrid form, such as features of payment and securities tokens, an in-depth assessment must be carried out and subsequently the token might be classified as a unit of account and financial instrument thus being subject to the pertinent regulations.
Equity tokens
A token may be classified as a financial instrument based on the definitions found in the German Securities Trading Act and MiFID II. A token may be classified as:
A security;
A unit in a collective investment undertaking;
A capital investment; or
An underlying asset for a derivative contract.
In order to be classified as a security, a token must satisfy the following criteria:
Transferability;
Negotiability on a financial or capital market;
Embodiment of rights in the token representing shares or claims; and
Not meet the requirements of an instrument of payment.
Tokens which are classified as security are subjected to capital markets laws for securities. This entails specific obligations such as publishing a prospectus pursuant to the Securities Prospectus Act and the EU Prospectus Regulation, and the rules pertaining to trading obligations and market supervision established in MiFIR.
Tokenized Offerings Malta
The Maltese Virtual Financial Assets Act (VFAA) regulates Virtual Financial Assets (VFAs) which are defined as any form of digital medium recordation that is used as a digital medium of exchange, unit of account, or store of value and that is not electronic money, a financial instrument or a virtual token. The Malta Financial Services Authority (MFSA) is the competent authority which regulates VFA service providers. The VFA Act stipulates that all VFA service providers must obtain a license from the MFSA.
The VFA Rulebook issued by the MFSA lists the 4 classes of licenses which a prospective service provider must obtain:
Class 1: License holders authorized to receive and transmit orders and/ or provide investment advice in relation to one or more virtual financial assets and/ or the placing of virtual financial assets. Class 1 License Holders are not authorized to hold or control clients’ assets or money.
Class 2: License holders authorized to provide any VFA service but not to operate a VFA exchange or deal for their own account. Class 2 License Holders may hold or control clients’ assets or money in conjunction with the provision of a VFA service.
Class 3: License holders authorized to provide any VFA service but not to operate a VFA exchange. Class 3 License Holders may hold or control clients’ assets or money in conjunction with the provision of a VFA service.
Class 4: License holders authorized to provide any VFA service. Class 4 License Holders may hold or control clients’ assets or money in conjunction with the provision of a VFA service.
The VFA Rulebook stipulates that Service Providers must have risk management policies and procedures in place, and a risk management function which implements such policy. License Holders must also ensure that IT infrastructures ensure privacy and confidentiality, and security of stored data.
The VFA Rulebook also stipulates specific requirements for different classes of licenses. For example, where a license holder is authorized to hold or control clients’ assets the License Holder must hold such assets in segregated accounts, among other obligations.
The VFAA defines Initial Virtual Financial Asset Offering (IVFAO) as “a method of raising funds whereby an issuer is issuing virtual financial assets and is offering them in exchange for funds”. Thus, under the Maltese framework, an IVFAO is the equivalent of an ICO with requirements such as 1) an issuer must be a legal person duly formed in Malta, whose business must be managed according to the dual control principle; whereby at least two individuals direct or manage the business, 2) the issuer must commence the IVFAO within 6 months from the date of registration of the whitepaper with the MFSA, 3) an issuer must also draw up a compliance certificate and an AML/CFT Report on an annual basis.
In order to offer VFAs to the public in or from within Malta, the Issuer must register a whitepaper with the MFSA which complies with the requirements set out in the VFAA. The process for registration consists of the following steps:
Financial Instrument Test
Appointment of a VFA Agent
Fit and Proper Test carried out by VFA Agent on the issuer
Establishing a Cyber-Security Framework & secure I.T. infrastructure
Drawing up of whitepaper & smart contracts disclosure
Submitting the following documents to the MFSA:
Whitepaper and any supplementary documentation signed by the Board of Administration;
Copy of the Financial Instrument Test signed by the Board of Administration and endorsed by the VFA Agent;
Confirmation from the Systems Auditor that the Issuer’s Innovative Technology Arrangement complies with MDIA guidelines;
Annual audited Accounts for each of the last three (3) financial years, and/or if the Issuer is part of a Group – the consolidated accounts of the Group;
Certified copy of constitutional documents; and
Payment of whitepaper registration fees of €8,000
The Issuer is also subject to certain ongoing obligations, including:
Record Keeping for a minimum of 5 years which records must be accessible to the MFSA;
Annual filing of the following documents to the MFSA:
o theAnnualComplianceStatementsubmittedbyVFAAgentonbehalfoftheIssuer;o theAuditedFinancialStatements;and
o theAuditorReport.
Once the IVFAO is complete, the Issuer must draw up an Annual Compliance Statement and pay the Annual Supervisory Fees.
...to be continued...
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Sources: Blockchain Advisory, GBBC, CB Insights, Dilendorf Khurdayan, BlockState, Manhattan Street Capital, Investopia, Reuters, IWS FinTech