Key things you should know about Cryptocurrencies and ICOs 

3rd May 2018 1731 - Blog Posts

Cryptocurrencies and ICOs regulation 

Cryptocurrency has been at the forefront of the media in recent months and increasing numbers of companies are turning to ICOs (initial coin offerings) as a means of raising investment funds. Opinions on cryptocurrency and ICOs regulation have been divided, while some critics believe it is a temporary phenomenon, many see it as a revolutionary transformation for fund raising that is here to stay.

What is cryptocurrency?

In simple terms, cryptocurrencies are digital currencies that are encrypted using cryptography, which is the use of encryption techniques to secure and verify transactions. Blockchain is the underlying decentralized ledger that records and validates transactions chronologically.

The difference between coins and tokens

To understand the ICO process, it’s important to grasp the difference between coins and tokens. All coins or tokens are viewed as cryptocurrency, even when coins do not function as a currency or medium of exchange. The term, cryptocurrency, encompasses Bitcoin, Altcoins – the majority of which are variants of Bitcoin – and tokens. Altcoins can be categorised further into those that use Bitcoin’s open-sourced blockchain, such as Namecoin or Peercoin and those that use a Blockchain they have created to support their own native currency, for example Ethereum or Ripple.

Tokens represent another asset that can lay on top of another blockchain. Creating tokens is much easier than creating Altcoins, as a standard template is followed on the blockchain. Tokens are usually distributed through an ICO in a similar process as an IPO.

ICOs regulation

What is an ICO?

An initial coin offering is an opportunity for firms to raise investment or funds much quicker than would be possible by raising shares or debt through an IPO. Rather than issuing shares, with an ICO, the company issues a token or coin, which can be used to provide access to, or purchase a product or service, or provide voting rights or a share in revenue. The biggest advantage of an ICO is that companies can raise funds in a shorter space of time with fewer regulatory concerns.

The key differences between an ICO and an IPO

The biggest difference is that currently ICOs have little or less regulatory oversight compared to IPOs. That’s not to say that regulatory bodies haven’t started to take an interest in ICOs regulation, so this is subject to change, but currently an ICO does not have the rigid regulatory framework of an IPO. As ICOs are a relatively new concept, they don’t have the track record or credibility of an IPO, as yet. ICOs usually take place within a short timeframe, which is another reason that they present a much quicker route to raising funds than an IPO.

Regulatory oversight

Currently there is little formal regulatory oversight of ICOs (although that may sometimes depend on the jurisdiction). Where a company looking to issue an IPO has a mandatory requirement to register with the regulatory authority and issue a prospectus as a legal document, a company looking to raise an ICO is often bound by no such constraints (again that largely depends on the jurisdiction). Some law firms in the UK would advise to run an ICO with the parameters that fit into one of the prospectus exemption rules, or to be ready to be bound to a normal IPO procedure.

Most companies choose to issue a white paper for an ICO, which normally contains key information on the purpose and mechanics of the project, but a white paper is not bound by any legal structure at present, or even mandatory. Evidently, issuing a white paper  is pretty much becoming a standard for any serious placement.

Despite the lack of formal ICOs regulation, BaFin, ESMA and the FCA all published statements on tokens and cryptocurrencies last year. German regulator BaFin noted the speculative nature of ICOs and issued a consumer protection warning on the subject. ESMA issued two warnings, one about potential risks and one advising that the structure used for ICOs could make them subject to regulation. The FCA issued a consumer warning specifically about the risks of investing in cryptocurrency contracts for differences. In the US, the Securities Exchange Commission has also issued warnings and guidance, and its chief, Jay Clayton, told reporters in April that most tokens were security tokens meaning that they were to be traded like stocks and fell under the agency’s regulatory purview. Observers expect the SEC to announce regulation of crypto markets by the end of this year.

The risks of ICOs

The main risk perceived is also one of the biggest benefits – the lack of regulatory oversight. There have been concerns raised that the unregulated nature of tokens can present a risk to economic structure and attract money laundering, and consequently this can lead to a reduced appetite for tokens. This argument has been countered, in part, by the fact that some categories of investors do not have access to regulatory protections anyway, and the risk could be negated by only selling tokens to investors with sufficient understanding of the market.

The benefits of ICOs

The lack of regulation is also a benefit as companies wishing to issue an ICO do not have to go through the laborious and costly process of obtaining FCA authorisation before launch. This makes an ICO a much quicker, easier and more efficient way to raise funds. The lack of geographical constraints is another benefit to ICOs – cryptocurrencies can be traded anywhere in the world, around the clock, creating an opportunity open to everyone. The transparency of blockchain is usually a major benefit. This transparency reduces the risk of errors and makes disputes less likely. Bear in mind, however, that not all blockchains are public. Also, in many cases, take Monero for example, the system is designed in a way to make the transactions much harder to trace and hence, anonymous. Also, privacy generally can be broken down into anonymity and untraceability. Being able to trace the token through all the pockets it exchanged over lifetime, does not automatically mean ability to identify the owners of those pockets

How to find out more

As interest in cryptocurrencies and ICOs regulation is burgeoning, Lawson Conner often run webinars and events to help you learn more about legalities and regulatory issues, so please contact us to let us know you are interested.