Considerations on the Construction of Future Financial Regulations in the Field of Initial Coin Offering

Abstract

Legal issues of ICOs are significant in the contemporary financial world because this method of capital formation is becoming widespread. In spite of the significance of ICOs, there are no financial regulations in this field in the most important legal systems. Therefore, research concerning future legal provisions in the area of ICOs is needed. This paper concerns issues related to the scope and structure of future financial regulations applicable to ICOs. The author focuses on principles on which legal provisions in the field of ICOs should be based. National, European and international matters are discussed separately in this work. Matters regarding a future international organisation competent in issues of crypto-assets are elaborated. Furthermore, the author proposes to create a model convention on cryptocurrencies and bilateral agreements on the exchange of information in crypto-asset matters. Disclosure obligations, anti-manipulation provisions and anti-money laundering principles are also set out. Moreover, the author discusses issues regarding audit requirements, special methods of registration and innovative payment rules for crypto-asset purposes. Finally, recommendations concerning ICOs are made separately for national, European and international purposes. The author believes that the conclusions in this paper can be useful not only for legislators but also for international actors, European institutions and legal researchers.

1 Introduction

Initial Coin Offering (ICO) is thought to be the reason for significant future changes in financial and capital systems.¹ Furthermore, it is an important method of fundraising² which is used worldwide by new technological start-ups.³ Nonetheless, there are no special financial regulations concerning such matters in the most significant legal systems of the world.⁴

A future legal framework, which should be tailored for ICO purposes, will probably lead to broader acceptance of this method of building capital.⁵ This revolutionary tool of capital formation, which ICO is,⁶ should be regulated in new legal acts because current financial regulations seem to be incompatible with the issues discussed.⁷

Because of the fact that ICOs are in principle cross-border, internationally standardised legal solutions concerning issues elaborated in this paper should be developed.⁸ With such standardisation, financial regulations in the area of ICOs will become extremely effective. However, there is no worldwide consensus concerning regulations on ICOs.⁹

There are two possibilities which can lead to the entry into force of standardised legal principles concerning ICO matters. The first is related to the activities of the international community. The second can be achieved by developing a legal theory of cryptocurrencies.¹⁰

In view of the fact that none of the existing significant international organisations is currently involved in developing legal solutions in the area of cryptocurrencies,¹¹ model regulations in this field can be created only through legal research, legislative process and European legal integration. It is important to research issues regarding ICOs because the lack of well-designed regulations leads to legal uncertainty.¹² This legal uncertainty could be limited by lawmakers, regulators and international actors.¹³

In view of the above, a theoretical model of regulations in the area of cryptocurrencies should be designed. The author believes that this article can lead to the development of a legal theory of ICOs.

2 Theoretical Notion of Crypto-assets

2.1 General Remarks

Crypto-assets are virtual units of value or units of account,¹⁴ which are issued in principle through Initial Coin Offering.¹⁵ They are issued using blockchain technology,¹⁶ which enables disintermediate payments,¹⁷ capital investment¹⁸ and the purchase of digital services.¹⁹

Cryptocurrencies are varied because of the fact that they involve a wide range of applicability,²⁰ i.e. there are payment tokens,²¹ equity tokens,²² debt tokens²³ and utility tokens.²⁴ These types of cryptocurrencies should be discussed separately because different regulations should be created for each of these groups of crypto-assets.

2.2 Payment Tokens

Payment tokens²⁵ are also known as coins.²⁶ Such crypto-assets play a similar role as money.²⁷ Hence, they are a medium of exchange²⁸ and a store of value.²⁹

Payment tokens are often described as a decentralised surrogate for money³⁰ because they are an unofficial medium of exchange.³¹

Nevertheless, they are not legal tender³² (except in Japan³³). In view of the above, it should be stated that payment tokens are not money but have only significant features of money.³⁴

2.3 Security Tokens

2.3.1 General Remarks

Security tokens³⁵ are also called investment tokens.³⁶ Although they are varied,³⁷ they can be divided into two main groups:³⁸ debt tokens³⁹ and equity tokens.⁴⁰ Both are issued in exchange for fiat money or other cryptocurrencies.⁴¹ Equity tokens and debt tokens are discussed separately below.

2.3.2 Equity Tokens

Equity tokens are crypto-assets which are purchased to obtain capital flows or to gain profits related to their value changes.⁴² It means that they certainly have a financial nature.⁴³

Equity tokens are similar to shares.⁴⁴ In principle, they enable entitlement to dividends,⁴⁵ profits,⁴⁶ royalties⁴⁷ and voting rights.⁴⁸ Hence, they entitle their purchasers not only to typical rights of shareholders but also to rights related to e.g. royalties.⁴⁹

It is extremely important to distinguish between pure utility tokens as discussed below and equity tokens, which can have additional utilities.⁵⁰ Most of all, equity tokens have a financial nature, contrary to pure utility tokens.⁵¹

2.3.3 Debt Tokens

The main feature of debt tokens is that they do not give entitlement to any profits or rights, but do only involve the obligation for the issuer to pay back debt.⁵²

Consequently, these tokens are crypto-assets which are similar to debt securities.⁵³

2.4 Utility Tokens

Utility tokens are issued to build the loyalty of purchasers of digital services.⁵⁴ The majority of utility tokens should not be treated like securities, but there are significant exemptions,⁵⁵ which are related to the financial nature of such assets.⁵⁶ Nonetheless, most utility tokens have the nature of non-financial gift cards.⁵⁷

Some scholars state that utility tokens are similar to payment tokens but that they can be used only to buy specific services provided by their issuers.⁵⁸ However, it should be added that utility tokens have more applications than typical payment tokens.⁵⁹ Therefore, utility tokens can be understood as payment tokens created for special purposes.

Some legal practitioners believe that utility tokens cannot have features of traditional financial instruments.⁶⁰ However, the majority of these assets have such features⁶¹ because issuers of utility tokens offer access to their products in exchange for capital formation.⁶² Therefore, it may be stated that it is difficult to create pure utility tokens.

3 Definition of Crypto-Asset According to the Proposal for a MiCA Regulation

3.1 General Remarks

The European draft definition of a crypto-asset, which is contained in the proposal for a MiCA Regulation, seems standard as it is based on the notion of ‘digital representation of value or right’.⁶³ It is easy to see that this explanation of the notion is similar to the theoretical definitions elaborated above.

Furthermore, it should also be noted that the technological aspect of the European definition of cryptocurrencies is constructed correctly. It stems from the fact that crypto-assets, within the meaning of the proposal for a MiCA Regulation, should be stored or transferred by using cryptographic technology, which is defined in an extremely wide and technologically neutral way based on similarity to DLT technology.⁶⁴ Therefore, it seems difficult to avoid future applicability of the MiCA Regulation.

3.2 Main Groups of Crypto-Assets According to the Proposal for a MiCA Regulation

There are three main groups of crypto-assets in the proposal for a MiCA Regulation,⁶⁵ namely:

• a. ‘asset-referenced tokens’;⁶⁶

• b. ‘electronic money tokens’;⁶⁷

• c. ‘utility tokens’.⁶⁸

It should also be noted that there are financial tokens which are beyond the scope of MiCA.⁶⁹ Traditional European financial regulations apply to such assets.⁷⁰

Therefore, even if the MiCA Regulation enters into force, there may be tokens which would not be explicitly regulated in any European regulation.⁷¹ Hence, MiCA tokens and non-MiCA crypto-assets should be distinguished for theoretical and practical purposes.

Because of the fact that only certain crypto-assets would fall within the scope of the proposal for a MiCA Regulation, the creation of uniform European regulation for crypto-asset purposes should be considered.⁷²

Although the latter solution seems justified and correct, it may turn out to be extremely difficult. This is due to the variety of crypto-assets.⁷³ However, it will probably be necessary to create general regulation in the field of crypto-assets in the next phase of harmonisation of these matters.

In the current legal and factual situation in the European Union, two groups of crypto-assets should be discussed separately. The first concerns cryptocurrencies which fall within the scope of the proposal for a MiCA Regulation. The second consists of tokens to which traditional European financial regulations apply.

3.3 Tokens Beyond the Scope of MiCA

It should be repeated that most financial tokens do not fall within the scope of the proposal for a MiCA Regulation. In principle, such tokens are financial crypto-assets, which meet transferability criteria defined in general financial European regulations.⁷⁴ Hence, the MiCA Regulation would not be applied to crypto-assets that are transferable securities because issues relating to such assets are regulated in other European normative acts.⁷⁵

The above-mentioned legal solution related to financial transferable crypto-assets is similar to a ‘wait and see’ approach. Such a legal solution will be justified until the entry into force of a general European legal act in the field of crypto-assets which would apply to both financial and non-financial tokens.

The main problem related to financial crypto-assets is that the transferability of such assets should be tested in a precise manner. Theoretically, the features of financial crypto-assets are similar to those of ‘analogous’ financial instruments.⁷⁶

Moreover, special regulations designed for financial crypto-asset purposes could turn out to be discriminative or favourable. This means that such legal provisions would be incompatible with the European legal system.

Furthermore, there is the risk of legal competition between Member States⁷⁷ because national regulators and legislators are in principle free to create crypto-asset legal provisions. Therefore, such provisions can differ between Member States.⁷⁸

3.4 Tokens Within the Scope of MiCA

3.4.1 Asset-referenced Tokens

‘Asset-referenced tokens’ are asset-backed tokens,⁷⁹ which seem to be crypto derivatives. The value of such instruments should be based on the value of:

• a. several fiat currencies; or

• b. at least one other crypto-asset; or

• c. at least one commodity.⁸⁰

In view of the above, asset-referenced tokens are linked with various groups of assets, i.e. the following crypto-derivatives should be distinguished:

• a. currency crypto derivatives;

• b. tokenised crypto derivatives; and

• c. commodity crypto derivatives.

3.4.2 E-money Tokens

E-money MiCA tokens can be defined as a stable medium of exchange based on fiat currencies.⁸¹ This definition seems extremely narrow because these tokens are understood in a wider sense by legal theoreticians.⁸²

E-money tokens, which are proposed to be regulated in MiCA, would have to be authorised by a competent authority.⁸³ Furthermore, they should be issued only by an ‘electronic money institution’ or a ‘credit institution’.⁸⁴

The above definition has been constructed for the applicability of the MiCA Regulation. Coins based on fiat currencies should be regulated in European legal acts because they can influence currency stability and are substitutes of fiat currencies. Still, it would also be reasonable to regulate in European legal acts coins which are not based on fiat currencies. However, this will probably be done in a future phase of harmonisation of crypto-asset issues.

3.4.3 Utility Tokens

According to the proposal for a MiCA Regulation, a utility token is a crypto-asset which can be used only to buy particular goods or services.⁸⁵ Such a token should be accepted only by its issuer.⁸⁶

It is important to state that this definition is completely compatible with the above-mentioned notion of utility tokens constructed by legal theoreticians.⁸⁷ Therefore, this issue need not to be elaborated separately or in detail in this subsection.⁸⁸

3.4.4 Significant Tokens

According to the proposal for a MiCA Regulation, e-money tokens and asset-referenced tokens can be significant within the meaning of the discussed draft legal act.⁸⁹

The notion of significance is based on a number of criteria such as:

• a. the number of customers to whom crypto-assets will be offered;

• b. the value of the crypto-assets issued;

• c. the number of transactions related to those crypto-assets;

• d. the size of the issuer’s reserve of assets;

• e. the cross-border nature of the issuer’s activity; and

• f. the connection between the significant crypto-assets and the financial market.⁹⁰

Special regulations in the proposal for a MiCA would apply to significant asset-referenced tokens and e-money tokens.⁹¹ It is a good solution because the issuance of such assets should be related to particular obligations and principles as these instruments can play an important role in the European crypto market.

4 Notion of Initial Coin Offering

4.1 General Remarks

Initial Coin Offering is alternatively called Token Generating Event,⁹² Initial Crypto-asset Offering,⁹³ Security Token Offering,⁹⁴ Initial Issuance of Tokens⁹⁵ and Initial Membership Offering.⁹⁶ Each of these names is justified, but using the most common notion, namely Initial Coin Offering (ICO), is preferable and clear.

There is no common definition of Initial Coin Offering.⁹⁷ Nonetheless, ICO is undoubtedly an alternative method of capital formation⁹⁸ and is regarded as a modern and innovative tool⁹⁹ used for capital formation purposes.¹⁰⁰

Initial Coin Offering is a process designed for issuing new crypto-assets.¹⁰¹ The mechanism is defined as the selling of digital assets to the public in exchange for money or other cryptocurrencies.¹⁰² This process is of a digital,¹⁰³ virtual¹⁰⁴ and online nature.¹⁰⁵ It should also be noted that ICO is more than only a fundraising method.¹⁰⁶ In particular, ICO can be used to create new digital assets¹⁰⁷ which have additional utilities.¹⁰⁸ Hence, ICOs should be regulated separately in new legal acts.

Through this method of capital formation, crypto-assets are sold to a wide range of investors.¹⁰⁹ Hence, ICO is similar to IPO which is organised for issuing traditional financial instruments.¹¹⁰ Some scholars even claim that each ICO is an unregulated IPO.¹¹¹ However, this is not a correct statement because there are many differences between ICOs and IPOs.¹¹² Therefore, a distinction should be made between these two financial processes.

ICOs are used especially to finance new projects, ideas and start-ups.¹¹³ However, well-established companies¹¹⁴ also organise ICOs to avoid regulations concerning IPOs.¹¹⁵ Therefore, it should be considered whether a new legal framework in the area of crypto-assets should be designed in such a way as to make it difficult or even impossible for traditional companies to organise ICOs.

4.2 Phases of Initial Coin Offering

ICOs are divided in phases.¹¹⁶ According to most scholars, there are three main phases of ICO: the pre-ICO phase, the real ICO phase and the post-ICO phase.¹¹⁷ Some researchers distinguish analogous phases: the ‘white paper’ phase, the primary market phase and the secondary market phase.¹¹⁸ Properly constructed new legal regulations in the field of ICOs should be based on this division

In the pre-ICO phase, issuers create ideas and plans related to tokens.¹¹⁹ During this phase, tokens are designed¹²⁰ and a white paper is prepared.¹²¹ In this phase, the white paper should be audited¹²² and the credibility of the issuer should be checked by the regulator.¹²³

In the primary market phase, crypto-assets are issued and sold to the public.¹²⁴ This phase is essential for the success of the Initial Coin Offering. Tokens are sold in exchange for fiat currencies or crypto-assets.¹²⁵

The post-ICO phase is related to the secondary market.¹²⁶ This phase is extremely important for the stability of the crypto-asset market. New financial regulations concerning the post-ICO phase should be focused on the functioning of crypto-exchanges¹²⁷ and the fulfilment of disclosure and reporting obligations by issuers.¹²⁸

4.3 Smart Contracts

Agreements concerning ICOs are often reached by using digital tools called smart contracts, which are programmable digital codes.¹²⁹ It is obvious that traditional ways of entering into contracts are not used in the case of completely digital assets.

In general, smart contracts are used to connect two persons (in the case of ICOs: issuer and investor) in order to achieve an agreement¹³⁰ which can be automatically executed.¹³¹ However, this tool has many additional utilities. For instance, it makes it possible to programme transactions¹³² and their rules.¹³³ Furthermore, smart contracts can be used to design tokens¹³⁴ and generate crypto-assets.¹³⁵ They can also be used as tools enabling investors to vote.¹³⁶

Because of the fact that smart contracts are pure IT tools, replacement of classical agreements by digital codes is thought to be extremely difficult.¹³⁷ However, it should be regulated that entering into a smart contract is legally binding and has the same effect as concluding a traditional agreement.¹³⁸ For instance, smart contracts are not regarded as legally binding agreements in Germany.¹³⁹ In that country, investors who did not sign a traditional agreement in writing cannot be protected by German general and traditional legal regulations.¹⁴⁰ Hence, issues regarding smart contracts should be regulated in new financial regulations so as to ensure protection of investors.

5 Current Legal Framework

5.1 General Remarks

There are a number of legal approaches to the discussed issues in contemporary legal systems.¹⁴¹ For instance, ICOs are banned in China and South Korea.¹⁴² In most countries, traditional financial ¹⁴³and civil¹⁴⁴ regulations are applicable to issues regarding cryptocurrencies.¹⁴⁵ Examples of such countries are the USA, Australia and the UK.¹⁴⁶ There are also countries with special regulations for crypto-assets,¹⁴⁷ e.g. France,¹⁴⁸ Gibraltar¹⁴⁹ and Malta.¹⁵⁰ Special Maltese and French regulations apply for instance to ICO issues.¹⁵¹

5.2 Applicability of Traditional Financial Regulations

In some countries, traditional financial regulations (especially regulations concerning IPOs) are applicable to ICOs.¹⁵² This stems from the assumption that some tokens have most of the features of traditional financial instruments,¹⁵³ which is related to the fact that ICOs are based on IPOs.¹⁵⁴ However, traditional regulations are ineffective in the case of such matters¹⁵⁵ because the differences between traditional financial instruments and digital assets are significant.¹⁵⁶ Therefore, it is high time to regulate ICO issues separately.

5.3 Applicability of General Contract Law

There are countries where general contract law applies to ICOs.¹⁵⁷ This is justified until smart contracts are treated as typical ‘analogous’ agreements (viz. a contract between issuer and investor is understood as a contract of sale¹⁵⁸ or a barter contract).¹⁵⁹ A contract of sale enters into force when cryptocurrencies are issued in exchange for fiat currencies,¹⁶⁰ whereas a barter contract is signed if crypto-assets are issued in exchange for other tokens.¹⁶¹

The application of general contract law to matters relating to crypto-assets is undoubtedly justified in the case of non-security tokens. Furthermore, general contract law can be applied to issues that are not regulated in traditional financial regulations.

5.4 Applicability of General Consumer Law

In some countries, regulations in the area of consumer law are applicable to issues regarding crypto-asset manipulation.¹⁶² Such legal provisions apply to both security and non-security tokens.¹⁶³

The discussed regulations should definitely be applicable to utility tokens without any exemptions. However, in the case of security tokens, legal provisions in the field of consumer law apply only to issues not regulated under general financial law until the moment special regulations on financial tokens enter into force.

In the case of European law, consumer protection regulations enacted under the general Market Abuse Regulation (MAR II)¹⁶⁴ are applicable to all kinds of financial tokens.¹⁶⁵ This is in line with the European ‘Digital Finance Strategy’.¹⁶⁶ However, it would be more accurate to separately regulate the protection of European investors who purchase transferable tokens through ICOs.

5.5 Regulators’ Guidelines

Some countries have non-binding guidelines related to issues regarding crypto-assets, created by regulators.¹⁶⁷ Such guidelines are useful for issuers because the applicability of current general financial regulations in these matters is explained in such documents.¹⁶⁸

The main disadvantage of these guidelines is that activity compatible with such guidelines cannot guarantee that issuers, developers and other operators do not breach the law.

5.6 Regulators’ Warnings

Although in most countries ICO issues are not yet regulated, many regulators publish warnings about this method of fundraising.¹⁶⁹ They can be useful not only for investors but also for issuers.

However, such warnings are extremely general and non-binding because regulators focus on indicating certain issues instead of solving existing problems.¹⁷⁰ Therefore, regulations should be created which limit the liability of persons who act in accordance with these warnings.

5.7 Innovation Hubs

Interesting examples of regulators’ support for crypto-asset companies are innovation hubs,¹⁷¹ such as, for instance, the Australian innovation hub.¹⁷² Innovation hubs are used to give issuers and other crypto-asset entrepreneurs non-binding advice on the applicability of traditional legal regulations.¹⁷³ They are useful because they lend particular advice concerning matters regarding cryptocurrencies.¹⁷⁴

Some scholars are even of the opinion that in the area of cryptocurrencies innovation hubs should be created instead of legal regulations.¹⁷⁵ In that case, legal rules which limit the liability of operators using support offered through innovation hubs should be developed .

5.8 Construction of Maltese Regulations in the Field of ICOs

Malta is a country where regulations on ICOs are in force.¹⁷⁶ These legal provisions are enacted in the Virtual Assets Act 2018,¹⁷⁷ which should be briefly discussed in this part of the article.

According to these regulations, the initial offering of virtual financial assets under Maltese jurisdiction must be preceded by the issuance and registration of a white paper which should comply with the principles defined, among others, in the First Schedule to the Virtual Financial Assets Act 2018.¹⁷⁸ According to this Act, the principles defined by the regulator are applicable to the information published on issuers’ websites.¹⁷⁹ There are also special regulations related to ICO advertisements.¹⁸⁰

Although Malta has jurisdiction for a wide range of disintermediated factual situations related to ICOs, in the case of cross-border Initial Token Offerings, the legal regulations, which are in force at the location of the crypto-exchange involved in the crypto-asset trade, should be applied.¹⁸¹

Crypto-asset undertakings should obtain a special licence and be registered in order to fulfil the Maltese legal requirements related to ICOs.¹⁸² Furthermore, a special agent should be appointed in the case of tokens issued under Maltese jurisdiction.¹⁸³ Such agent’s main obligation is to ensure accordance of an ICO with Maltese legal regulations.¹⁸⁴

The Maltese Virtual Financial Assets Act 2018 also contains detailed anti-manipulation measures.¹⁸⁵ They concern the prohibition of insider dealing and abusive strategies related to crypto-assets.¹⁸⁶

The Maltese legislator has also regulated issues related to audit requirements and liability of crypto-asset undertakings.¹⁸⁷ In view of the above, the Maltese financial system has undoubtedly been designed to ensure protection of crypto-asset investors.

5.9 Construction of French Regulations in the Field of ICOs

5.9.1 General Remarks

Legal regulations in the field of ICOs are also in force in France.¹⁸⁸ ICO issues are regulated in the French Code monétaire et financier.¹⁸⁹ The legal provisions are extremely general. They contain definitions of:

• a. tokens (‘jetons’);¹⁹⁰ and

• b. public offering of crypto-assets.¹⁹¹

Furthermore, issues regarding informative documents¹⁹² and authorisation related to tokens¹⁹³ are also regulated in this legal act.

5.9.2 Definition of Tokens

Under the French regulations, tokens are digital intangible assets which are registered virtually.¹⁹⁴ This definition seems correctly constructed because it is general and technologically neutral. However, it may turn out to be too broad in certain factual situations.

5.9.3 Notion of Public Offering of Tokens

The notion of ICO is not explicitly used in French regulations. The legal act in question contains a definition of public offering of tokens.¹⁹⁵ The notion is related to the offering of crypto-assets to the public through the mechanism of subscription.¹⁹⁶

The definition does not seem to be of a cryptographic and digital nature, but may prove useful. It is also technologically neutral and may therefore have practical value. Still, it should not be used in legal research.

5.9.4 Authorisation and Other Issues Regulated in French Legal Provisions

Each public offering of tokens should be authorised by the French financial supervisory authority (AMF).¹⁹⁷ In view of this fact, it is obvious that the issuance of crypto-assets is being supervised. The scope of this supervision is specified.¹⁹⁸

According to the French regulations, the competent supervisory authority is obliged to:

• a. examine if the issuer is reliable;

• b. confirm if the issuer is a legal entity; and

• c. check if the assets of the issuer are properly monitored and protected.¹⁹⁹

Furthermore, French issuers of tokens must publish documents containing useful information on the issuance of crypto-assets.²⁰⁰ Disclosure obligations of French crypto issuers are specified in general financial regulations,²⁰¹ but, as stated, the disclosure of useful information is regulated separately.²⁰²

5.9.5 Opinion on the French Legal Provisions on ICOs

The French legal provisions on crypto-assets seem extremely general. They do not have any especially designed features to deal with legal situations related to crypto-assets. The same regulations could be created for traditional financial instruments. They were probably enacted only to explicitly regulate that the issuance of crypto-assets should be authorised and supervised by the French financial authority.

6 General Remarks on the European Approach to Crypto-asset Issues

The European approach to crypto-asset issues is still evolving. In general, the European ideas related to such matters seem similar to the above-mentioned concepts common in legal research (also outside the European Union).

Most of all, it should be stated that the European institutions aim to develop legal solutions related to crypto-assets and ‘digital revolution’.²⁰³ The main example of this approach is the publication of the proposal for a MiCA Regulation which is planned to be applicable only to utility tokens, e-money tokens and other crypto-assets that do not meet the transferability criteria.²⁰⁴

In the case of entry into force of the MiCA Regulation, future European legal provisions in the field of crypto-assets would be based on separate approaches related to particular types of assets and specified groups of entities.²⁰⁵ Hence, the MiCA Regulation would lead to fragmentation of legal approaches to different crypto-assets.²⁰⁶ Furthermore, in the MiCA proposal, issuers and crypto-service providers are governed by different regulations.²⁰⁷ This is related to the fact that the legal and factual situations of these groups greatly differ.

Reconciliation between new technologies and traditional financial provisions is thought to be problematic.²⁰⁸ Therefore, general European financial regulations have to apply to tokens, which are transferable securities, also if the MiCA Regulation enters into force.²⁰⁹ This distinction between transferable and non-transferable tokens will lead to further fragmentation of crypto-asset issues in the European legal system.²¹⁰ Such a construction of European legal provisions relating to crypto-assets should be temporary. It will probably exist until European general crypto-asset regulations enter into force.

7 Role of the International Community in the Process of Creating Standardised Financial Regulations in the Area of Cryptocurrencies

7.1 General Remarks

It is difficult to develop effective national regulations in the area of ICOs.²¹¹ Many scholars are therefore of the opinion that it is necessary to design an international legal system concerning ICOs and other issues related to cryptocurrencies.²¹² This stems from the justified idea that financial regulations concerning ICOs should be internationally standardised.²¹³

However, none of the significant international organisations is currently involved in coordinating the creation of such regulations.²¹⁴ Therefore, a new international organisation should be set up that would be competent in crypto-asset matters. Under the auspices of such an organisation, a new international legal system for cryptocurrencies could be developed.

7.2 Treaties on Matters of Cryptocurrencies

The above-mentioned international organisation should play a significant role in the preparation of an international treaty on cryptocurrency matters. Such a treaty would lead to uniformity of legal provisions concerning cryptocurrencies and ICOs. The most important regulations of this treaty should be legal provisions related to jurisdiction in matters of crypto-assets.²¹⁵

The international legal system should provide for bilateral treaties on the exchange of information in these matters so as to provide for effective countermeasures against international crypto-asset manipulation and money laundering.²¹⁶

7.3 Internationally Recommended Regulations in the Field of Crypto-Assets

Instead of an international treaty, the development of non-binding model regulations at international level could be considered. Alternatively, global guidance on ICO matters could be developed.²¹⁷

The above-mentioned international solutions could lead to world-wide uniformisation and standardisation of cryptocurrency issues. In that case, it would not be necessary to reach international consensus on these matters.

8 New Legal Theory of Regulations in the Field of Initial Coin Offering

8.1 General Remarks

It is doubtless that a new legal framework concerning crypto-assets should be created in the future.²¹⁸ In most countries there are no special regulations,.²¹⁹ This stems from the fact that crypto-asset trade is not common yet²²⁰ and is still in the beginning phase²²¹ although it is starting to become mainstream.²²² Furthermore, legislators are aware that the shape of the crypto-asset market is still evolving.²²³ Therefore, a ‘wait-and-see’ approach in the area of cryptocurrencies is still justified in contemporary legal systems.²²⁴

Nonetheless, it is necessary to discuss the shape of future legal regulations concerning crypto-assets. It is obvious that the entry into force of a new legal framework should be preceded by the creation of a new theory of crypto-financial law.²²⁵

8.2 General Principles of a New Legal Framework in the Field of Crypto-assets

Fundamental general principles of a future legal framework should be created before complex legal solutions concerning Initial Coin Offering are developed.²²⁶

First of all, a legal framework in the area of ICOs should be flexible²²⁷ in order to prevent future problems related to outdated legal regulations. This is crucial because the crypto-asset market and new financial technologies are still changing.²²⁸

Furthermore, new financial regulations should be protective of investors but should not discourage entrepreneurs.²²⁹ In view of the above, legislators should not limit the development of a modern financial market, but this should not lead to a ‘Crypto Wild West’.²³⁰

New legal regulations in the area of Initial Coin Offering should be general in order to make it impossible to avoid them.²³¹ It is also important to create clear principles related to jurisdiction in these matters.²³²

A new legal framework in the area of ICOs should be technologically neutral in order to be resistant to changes in financial technology and prevent avoidance of crypto regulations.²³³

Finally, new financial regulations should focus on counteracting scams and fraud.²³⁴ However, they should not be too complex so as not to have a negative influence on the development of the crypto-asset market.

8.3 Scope of the New Regulations

New legal regulations in the field of ICOs should concern especially jurisdictional matters,²³⁵ issues of taxonomy,²³⁶ disclosure and reporting requirements,²³⁷ anti-money laundering principles,²³⁸ anti-fraud provisions,²³⁹ payment rules,²⁴⁰ liability insurance requirements,²⁴¹ registration obligations,²⁴² licence obligations,²⁴³ audit obligations,²⁴⁴ legal provisions concerning intermediaries,²⁴⁵ legal principles related to rating agencies, and secondary market issues.²⁴⁶

8.4 Jurisdictional Issues

Because of the fact that crypto-asset trade is borderless and virtual,²⁴⁷ developing effective principles of jurisdiction in the area of cryptocurrencies is extremely difficult.²⁴⁸ Jurisdictional problems are probably the main reason for the lack of regulations in the field of ICOs.²⁴⁹

Therefore, internationally binding principles of jurisdiction should be created. Such principles can be based on the notion of issuers’ beneficial owners²⁵⁰ or the place of issuers’ management.²⁵¹ Regulations based on the place of registration may be ineffective because many entrepreneurs could decide to establish mailbox companies in blockchain paradises so as to avoid undesirable jurisdictions.²⁵²

It could also be considered to base the rules in question on the jurisdiction of the purchaser of the crypto-assets. Such jurisdiction could be valuable for anti-money laundering purposes.

8.5 Normative Taxonomy of Cryptocurrencies

Normative taxonomy of cryptocurrencies is not merely a theoretical issue. Payment tokens, utility tokens and investment tokens should be treated in different ways by regulators and legislators. For example, the Maltese Virtual Financial Assets Act is applicable only to financial tokens.²⁵³ Regulations concerning pure utility tokens should be focused on jurisdictional issues and anti-fraud rules, whereas regulations in the area of security tokens and payment tokens should be more complex and more developed.²⁵⁴ They should concern not only issues of jurisdiction²⁵⁵ and manipulation²⁵⁶ but also matters related to registration of issuers,²⁵⁷ disclosure obligations,²⁵⁸ reporting standards²⁵⁹ and secondary market principles.²⁶⁰

8.6 Registration Obligations

It is obvious that payment tokens and security tokens should be registered by their issuers.²⁶¹ In many countries, crypto-assets are currently registered in registers which were created for traditional financial purposes.²⁶² In some countries, there are special registers of crypto-assets for anti-money laundering purposes (e.g. in Australia)²⁶³ and general registers of crypto-assets (e.g. in Malta and Gibraltar).²⁶⁴ Central registers of crypto-assets, crypto-asset issuers and ICOs should be kept in all countries.²⁶⁵ The creation of an international register for crypto-asset purposes should also be considered.

Current methods of registration in the field of cryptocurrencies are based on standard solutions applicable to traditional financial instruments.²⁶⁶ However, crypto-assets have many digital features which can enable the entry into force of new methods of registration. For instance, the development of automatic methods of registration, which could be directly connected to smart contracts, could be considered.²⁶⁷ Such a solution could prove extremely effective in the case of ICOs. Hence, the obligation to register new tokens through smart contracts seems particularly innovative and ideally tailored to crypto-assets.

8.7 Licence Obligation

The quality of the professional activities of crypto-asset issuers, crypto-asset intermediaries, crypto-asset rating agencies and other institutions involved in crypto-asset trade could be ensured by the obligation to obtain special licences.²⁶⁸ Special requirements²⁶⁹ should be included in regulations, imposing on crypto-asset issuers the obligation to obtain special licences.²⁷⁰

8.8 Payment Rules

Each ICO can turn out to be a scam.²⁷¹ Therefore, several regulators from different countries decided to publish official warnings concerning ICO issues.²⁷² However, such a solution is not effective and even naïve.

The most effective method of counteracting fraud committed by crypto-asset issuers seems to be special payment rules for ICO purposes. Some scholars postulate that payments for tokens should be made into a separate bank account²⁷³ which could be prepaid.²⁷⁴ This would be a good solution because it could protect crypto investors. Other researchers are of the opinion that tokens and money paid for cryptocurrencies issued should be held by third-party custodians.²⁷⁵ Such a model would lead to additional control over crypto issuers.

All the above-mentioned rules seem reasonable because they make it difficult for crypto-asset issuers to misappropriate investors’ money or tokens.²⁷⁶

8.9 Anti-money Laundering Regulations

It is obvious that legislators should create special legal provisions to counteract money-laundering in the area of ICOs.²⁷⁷ Such regulations should be countermeasures against the anonymity and pseudonymity of investors and entrepreneurs.²⁷⁸

KYC (Know Your Customer) obligations should be imposed on issuers.²⁷⁹ Still, such obligations should not merely consist of a voluntary declaration of the investor. Investors should prove their identity through a bank transfer, digital signature or in another effective way.

Furthermore, countermeasures against the anonymity of investors should be supported by regulations on the international exchange of information in crypto-asset matters.²⁸⁰ For instance, it is suggested to create an International Information Sharing Agreement.²⁸¹

8.10 Disclosure Regulations

8.10.1 General Remarks

In principle, no special rules concerning disclosure obligations in the case of ICOs are in force²⁸² (except in the Maltese financial legal system²⁸³). It is obvious that such regulations could limit fraud.²⁸⁴ However, in some countries traditional financial regulations concerning prospectuses are applicable to ICOs.²⁸⁵

Instead of prospectuses, issuers of crypto-assets use several methods to communicate with potential investors. The most common method of disclosure of information on ICOs is the issuance of white papers, which are similar to prospectuses.²⁸⁶ Additionally, issuers use special forums, issuers’ websites and social media as channels of communication with future purchasers of their coins and tokens.²⁸⁷ In Malta, white papers, issuers’ websites and advertisements of ICOs must comply with binding legal regulations.²⁸⁸

There is no doubt that disclosure obligations should be imposed not only on issuers of crypto-assets but also on investors²⁸⁹ and that false disclosure of information should lead to civil, penal and administrative liability.²⁹⁰

8.10.2 Disadvantages of White Papers

Although disclosure of information on cryptocurrencies through white papers is the most common method of communication between issuers and future token holders, such documents have many major disadvantages.²⁹¹

First of all, there are no special regulations concerning mandatory information which should be in these white papers.²⁹² This leads to informational asymmetry.²⁹³

Furthermore, the information in the white papers is not reviewed and audited by experts.²⁹⁴ For this reason, such information is frequently misleading.²⁹⁵

It should also be noted that there are no special liability rules which could apply to issues regarding white papers. In some countries, spreading misleading information through white papers can lead to liability under consumer protection law²⁹⁶ and civil law.²⁹⁷

Such misstatements should be prohibited under penalty of law. Legal principles related to civil liability could also be designed for the issuance of unreliable white papers, because there are often omissions and misinformation in those documents.²⁹⁸

Finally, current white papers are often difficult to understand. They should therefore be written in plain English.²⁹⁹

8.10.3 Proposals for Mandatory Information to Be Disclosed in White Papers

It is obvious that new legal provisions related to white papers should include a list of mandatory information to be disclosed,³⁰⁰ such as:

• a. the issuers’ and developers’ identity;³⁰¹

• b. the beneficial owners of the issuer;³⁰²

• c. the location of the issuer;³⁰³

• d. the status and basic features of the issuer;³⁰⁴

• e. information on the issuer’s activity;³⁰⁵

• f. technical information on the tokens issued;³⁰⁶

• g. price of the tokens and methods of payment;³⁰⁷

• h. number of tokens that are planned to be issued;³⁰⁸

• i. rights of the investors;³⁰⁹

• j. goals of the fundraising;³¹⁰

• k. risks related to the ICO organised;³¹¹

• l. investment strategy;³¹²

• m. detailed description of the financed project;³¹³

• n. usability of the financed project;³¹⁴

• o. information on potential investors and the distribution of tokens;³¹⁵

• p. predicted duration of the financed project;³¹⁶

• q. predicted profits from the investment;³¹⁷

• r. auditor’s opinion on the financed project;³¹⁸

• s. information on the complaint procedure;³¹⁹

• t. information on the financial guarantees;³²⁰

• u. information on the reserve of assets;³²¹

• v. information on the risks related to the crypto-assets;³²²

• w. information on issues regarding custody;³²³

• x. information on the suitability of the ICO procedure for the financed project;³²⁴

• y. information about tax issues significant for investors;³²⁵

• z. the issuer’s plans for the future.³²⁶

Furthermore, there are researchers who believe that Initial Business Plans should be attached to the white papers,³²⁷ which would be a good idea. It could even be considered to attach other documents, such as, for example, as stated in the MiCA proposal, summaries and warnings.³²⁸

8.10.4 Reporting Obligations

Disclosure obligations should also be fulfilled through temporary reporting,³²⁹ This means that issuers should be obliged to report amendments in the information included in the white papers, whereas owners of crypto-assets should be obliged to inform regulators of the purchase and disposal of their tokens.³³⁰

8.11 Anti-manipulation Regulations

Fraudulent ICOs are frequent.³³¹ Some financial specialists even believe that all ICOs are scams,³³² which seems exaggerated. However, counteracting manipulation and fraud in the field of ICOs is undoubtedly an extremely important task of legislators and regulators.³³³ In Malta, for instance, insider trading, illegal disclosure of information and abusive strategies related to crypto-assets are prohibited.³³⁴

Primary market manipulation should especially be counteracted by auditors, whereas countermeasures against secondary market manipulation³³⁵ should impose obligations on crypto-exchanges and other trading platforms.³³⁶

8.12 Audit Requirements, Rating Agencies and Lists of Trusted ICOs

The quality of crypto-assets and ICOs should be evaluated in an organised and professional way.³³⁷ Such evaluation can be prepared by auditors³³⁸ or rating agencies.³³⁹ Eventually, regulators can draw up lists of trusted ICOs.³⁴⁰

There are those who believe that token holders should be protected through supervision and monitoring of ICOs by auditors and lawyers.³⁴¹ They are quite right because ICOs should be supervised by reliable professionals. A serious problem is also the fact that the due diligence obligation does not exist in the case of ICOs.³⁴²

The role of rating agencies in these matters is currently played by listing platforms.³⁴³ Contrary to rating agencies, the quality of information provided by listing platforms is unstandardised.³⁴⁴ Legal regulations should be created as regards mandatory obligations to be fulfilled by such platforms.

It is important to add that France has an official white list of trusted ICOs.³⁴⁵ A similar register exists in Gibraltar.³⁴⁶ Such an idea could certainly be applied instead of audit requirements and regulations concerning listing platforms.

In view of the above, legal regulations concerning the evaluation of ICOs should be designed. Such regulations could concern listing platforms, audit obligations and official lists of trusted ICOs.

8.13 Liability Insurance

A significant problem related to ICOs is the lack of mandatory liability insurance.³⁴⁷ This obligation should be imposed on issuers of tokens, developers of ICOs and other institutions involved in ICOs. This legal solution would protect investors.

8.14 Regulations Concerning Crypto-asset Intermediaries

Although the crypto-asset world is thought to be disintermediated,³⁴⁸ there are crypto-asset intermediaries such as crypto exchanges,³⁴⁹ clearing houses,³⁵⁰ wallet providers³⁵¹ and custody service providers.³⁵²

Issues related to the activities of such enterprises should be regulated because they can have an impact on the proper functioning of the crypto-asset market.³⁵³

It is obvious that all crypto-asset service providers should be neutral and independent of issuers.³⁵⁴ It seems extremely difficult to design standardised regulations concerning crypto-asset intermediaries because such intermediaries are greatly varied.³⁵⁵ The most important matters to be regulated in these legal provisions are jurisdictional issues regarding such enterprises.

8.15 Secondary Market Regulations

Crypto exchanges play a significant role in the post-ICO phase.³⁵⁶ Therefore, a proper and effective legal framework should be set up as regards the secondary crypto-asset market.³⁵⁷

The most important legal task in such matters is the creation of jurisdictional rules related to crypto exchanges. This is obvious because conflicts of laws and avoidance of jurisdiction can become serious problems for the effectiveness of future regulations in the field of ICOs. So-called blockchain paradises, which are countries enabling the avoidance of jurisdiction in crypto-asset matters, should be counteracted.³⁵⁸

In the legislative process concerning secondary market regulations, lawmakers should also focus on anti-manipulation and anti-money laundering matters.³⁵⁹ It is especially important to create crypto-asset secondary market regulations based on current KYC (Know Your Customer) rules.³⁶⁰

Finally, it is also necessary to impose registration, reporting and auditing requirements on crypto exchanges. Legal provisions on such issues should lead to improvement of the quality of crypto-asset services.

Such regulations would undoubtedly increase investors’ security. They should be tailored for crypto-asset purposes but can be based on traditional financial legal solutions. This is extremely important because secondary market manipulation is a frequent occurrence.³⁶¹

9 Recommendations for Legislators

First of all, legislators should emulate the regulations in force in other countries, which can thus lead to unofficial harmonisation of legal solutions regarding ICOs. This consideration is especially important in the field of jurisdictional matters. A similar strategy is recommended in the case of non-binding international and supranational legal documents in the area of cryptocurrencies (such as the MiCA proposal), which should also be adapted by national lawmakers.

Furthermore, national financial regulations concerning ICOs should be based on well-considered principles.³⁶² Such principles could be:

• a. technological neutrality;³⁶³

• b. flexibility;³⁶⁴

• c. effectiveness;³⁶⁵ and

• d. general nature of new solutions.

Legislators should also enact regulations enabling crypto-asset enterprises to automatically fulfil their registration, reporting and disclosure obligations through smart contracts.³⁶⁶

It should be possible to apply general consumer law, contract law and financial law in the case of issues not regulated in new regulations. This means that new regulations should be supported by traditional legal solutions. However, legislators should mainly counteract the development of a so-called ‘Crypto-Wild West’.³⁶⁷ In this way, there should be no crypto-asset areas without regulations.

In the framework of these regulations, legislators should pay special attention to payment rules,³⁶⁸ anti-scam regulations, anti-manipulation principles³⁶⁹ and the effectiveness of liability insurance requirements.³⁷⁰ Furthermore, crypto-investigation units should be set up³⁷¹ and it should be made difficult or impossible for well-established companies to use ICOs to avoid regulations concerning IPOs.³⁷²

In addition, obligations related to counteracting primary and secondary market manipulation should be imposed on crypto-asset intermediaries. A well-developed system of crypto licences should be set up as well.³⁷³

A well-organised system of support for investors and entrepreneurs should also be created. For instance, regulators could draw up lists of trusted crypto-asset issuers and crypto exchanges.³⁷⁴ Furthermore, national authorities should develop official platforms which could contribute to arriving at a professional and binding interpretation of the new legal regulations.³⁷⁵

10 Recommendations for the European Union

In view of the above considerations related to a European legal framework, a crypto-asset legal order compatible with the proposal for a MiCA Regulation would undoubtedly be extremely complicated, heterogenous and difficult to apply.

Therefore, general European regulations in the field of crypto-assets should be created. Such legal provisions should be well thought out so as not to be discriminative or favourable in comparison with general regulations in the field of financial instruments.

Crypto-asset regulations should definitely be harmonised.³⁷⁶ There are also justified opinions that the MiCA Regulation and financial European provisions should be coordinated.³⁷⁷

It is also obvious that current proposals for regulations in the field of crypto-assets are temporary. Hence, it is necessary to design comprehensive legal regulations regarding cryptocurrencies in the next phase of harmonisation of these matters.

11 Recommendations for the International Community

An international system of standardised regulations in the field of crypto-assets needs to be developed. Such a system could be based not only on a multilateral treaty but also on bilateral agreements.³⁷⁸ Furthermore, a new international organisation whose tasks would concern crypto-asset matters, could be created.³⁷⁹ Model regulations in the area of crypto-assets could be developed under the auspices of such an organisation.

There is no doubt that international uniform principles of jurisdiction should be enacted in an international treaty on crypto-asset matters,³⁸⁰ with respect to the fact that jurisdictional rules should be the same in all countries as jurisdictional conflicts in the area of ICOs are to be avoided.

Furthermore, the international community must counteract blockchain paradises and crypto-mailbox companies.³⁸¹ In view of the above, issues related to the exchange of information in crypto-asset matters should be regulated in bilateral agreements.³⁸² It would also be a good idea to conclude model bilateral conventions on the exchange of information in these matters.³⁸³

12 Conclusions

Although most countries have adopted a ‘wait and see’ approach in the area of Initial Coin Offerings,³⁸⁴ new regulations should be designed to ensure a proper functioning of the token market.³⁸⁵

New regulations should not be ‘ad hoc’,³⁸⁶ which means that a legal theory of cryptocurrencies and a legal theory of Initial Coin Offering should be created before legal acts concerning these matters enter into force.³⁸⁷ Furthermore, new crypto regulations in Member States should be based on the solutions included in the proposal for a MiCA Regulation. This is regardless of whether the MiCA will enter into force or not. It stems from the fact that the relevant legal provisions should be uniform.

First and foremost, new crypto-asset regulations should be general and technologically neutral.³⁸⁸ Such a solution should make it difficult to avoid new legal provisions. Technologically neutral regulations should also be resistant to future changes in financial and cryptographic technologies.

Regardless of technological neutrality, disclosure and reporting obligations should be fulfilled automatically through smart contracts.³⁸⁹ A similar solution could be applicable to registration.³⁹⁰

Furthermore, it is necessary to elaborate a taxonomy of tokens and Initial Coin Offering. This is crucial because Initial Coin Offerings of payment tokens, investment tokens and utility tokens should be subject to different legal regulations.

Regulations on payment and security tokens should definitely act as countermeasures against fraud, whereas in the case of financial regulations concerning utility tokens, legislators and legal theoreticians should focus on general principles of consumer protection.

The most complex regulations should concern investment tokens. Such legal provisions should be based on current financial regulations but must differ from them because of the fully virtual nature of crypto-assets.

The main legal problem of cryptocurrencies, which should be solved immediately, is the jurisdictional issue. Principles of jurisdiction should be discussed in an international forum under the auspices of an international organisation competent in such matters.

However, none of the existing international organisations is involved in the process of designing future crypto-asset regulations.³⁹¹ Therefore, such regulations should be created at national level. Until international regulations enter into force, national principles of jurisdiction in the field of ICOs should be based on the location of the beneficial owners of the issuers or the location of the purchasers of crypto-assets.

It is recommended that the new legal framework in the area of investment tokens should be based on a detailed division of ICO phases.

Regulations concerning the pre-ICO phase could concern especially audit requirements and disclosure obligations related to white papers and the process of obtaining licences.³⁹²

Regulations applicable to issues regarding primary market trade should be developed. New regulations should be applied to payment,³⁹³ registration,³⁹⁴ anti-money laundering (especially Know Your Customer obligations)³⁹⁵ and mandatory liability insurance requirements.³⁹⁶

Regulations applicable to the post-ICO phase should focus on reporting obligations and the proper functioning of crypto exchanges, other crypto-asset intermediaries and listing platforms.³⁹⁷ Furthermore, obligations related to counteracting secondary market manipulation should be imposed on crypto-asset intermediaries.³⁹⁸

There is no doubt that new financial regulations in the area of ICOs should be well conceived and resistant to technological changes. Because of the fact that the crypto-asset trade is global, new regulations should be internationally uniform.