ICO Goes Extra Mile to Protect Contributors

Ask anyone in the crypto-sphere, and they’ll tell you the hot topic these days is regulation. After a couple of years of ‘wild west’ ICO and cryptocurrency explosion, governments have begun to crack down.

Yet, some companies are taking the necessary steps to comply with the SEC regulations, thereby assuring their investors that they are a safe company to support. While this requires more time and far more effort, companies are seeking to protect their contributors and themselves as well.

Cappasity embraces change

One company, Cappasity, has sought to create a token (the ARToken) for use within its own 3D VR image creation and distribution ecosystem, and has decided to comply with SEC regulations to protect their contributors. The company has hired the DLA Piper firm of Blockchain technology and legal experts to represent them through this process.

In order to better understand what Cappasity is planning, and how complex the ICO regulation scene really is, Cointelegraph sat down with the firm’s representative, Leo Batalov. The interview is fascinating, and should reassure investors that Cappasity is willing to go the extra mile to make sure its contributors are safe.

Cointelegraph: Let’s start with the basics. Is ICO a legal way of fundraising? Are there any countries where it is specified as illegal?

Leo Batalov: An ICO can be a legal way to fundraise. An ICO, like any fundraising, must comply with applicable laws though. To start with, an ICO must comply with the securities regulations in the issuer’s jurisdiction and in every jurisdiction where the issuer makes offers or sales of its tokens. Securities regulations would apply if the token is a security within the meaning of the local law.

Additionally (and even if the token is not a security), the issuer would have to comply with other applicable laws, such money laundering, privacy data protection, payment transmittal and so on. Different laws would apply in different jurisdictions and to different types of tokens, and the issuer would need to analyze all of these laws to be compliant.

As of today, the regulators in China and South Korea have banned ICOs.  Regulators across the globe announced that they will scrutinize ICOs because of the risk of them being financial scams. However, so far only China and South Korea have decided to prohibit ICOs completely, rather than regulating them.

CT: Speaking of illegal, what in your opinion is going on in China? First it was reported that ICOs have been completely banned there. Later, there were reports that the ban may be lifted in the future. What’s the overall goal of the Chinese government here, and how possible is it to conduct an ICO there right now?

LB: I can’t even begin to guess the Chinese government’s plans here. The regulatory situation globally is extremely fluid. Things change daily, not even monthly or weekly. So, it is quite possible that the Chinese regulators clarify or change their position. Cryptocurrency trading volumes in China are some of the highest in the world, and the trading is difficult to monitor. I believe this concerns the Chinese government, which generally keeps close control of what is going on in China.

I don’t believe it is legally possible to conduct an ICO in China. This means that a Chinese company cannot be an issuer, and offers and sale of tokens cannot be made in China.

CT: When preparing for a campaign, what specific things does a company have to take care of, from a legal standpoint?

LB: I would advise to first determine the countries where the company plans to fundraise. This should give the issuer a universe of jurisdiction - which laws it needs to analyze. Inevitably, the issuer would need to determine whether the token is a security, and if not, what it is under local law. After that, as I mentioned, the issuer would need to analyze other laws, which will depend on the nature of the token.

CT: The Howey test is a topic which always comes up when it comes to conducting an ICO in the US. What is it and why is it important?

LB: The Howey test is primarily important for US ICOs as it’s used to determine whether an instrument is an investment contract, a type of security under the US securities laws. Applying the Howey test to your token might be a useful exercise even for non-US ICOs.

Without being hyper-technical, US securities regulations distinguish several types of securities. For example, shares in a company with rights to dividends, voting rights and the like are clearly securities. The Howey test is used to determine whether an investment scheme that does not easily fall under a specific category of security (such as a stock or bond) is an investment contract, and thus a security, or not. The Howey test is named after the case SEC v. Howey where the US Supreme Court laid out the analysis for what constitutes an investment contract, and cases that followed built on it. An arrangement is an investment contract (a security) if it involves 1. an investment of money; 2. in a common enterprise; 3. with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

Many ICOs would fall into this category, and if they do, they need to comply with US securities regulations. Most ICOs involve the purchase of tokens for another cryptocurrency (an investment of money), in a common enterprise (the business of the ICO issuer), with a reasonable expectation of profits (most token purchasers expect their tokens to appreciate in value) from the efforts of another (the ICO issuer’s management team). Obviously, each token is unique and not all tokens are investment contracts. The Howey test gives a framework to decide whether or not an issuer is required to comply with US securities regulations.

CT: Utility and security tokens: what is the difference, and how does it impact the legality of a fundraising campaign?

LB: A so-called “utility token” is a token that is not a security under the Howey test or otherwise. If a token is not a security, the issuer is not required to comply with applicable securities regulations. For example, a “utility token” may represent a right to receive goods or services in the future, effectively being a pre-payment. A “utility token” would generally give the issuer significantly more flexibility to market and sell its tokens.

CT: What additional legal considerations are there, other than whether the token is classified as a security? Income taxation? Consumer protection?

LB: Plenty. I already mentioned anti-money laundering, privacy data protection, payment transmittal (some ICO issuers take the position that their token is the “internal currency” of the platform or the ecosystem they are building). Depending on the token and the type of business, other laws and regulations might apply. These, however, would not be ICO-driven, and instead are the business model driven.

Taxation is always a concern. In connection with an ICO, the issuer should consider whether the ICO proceeds are taxable. This will depend on the issuer’s jurisdiction of incorporation and other factors.

CT: Do you have any expectations regarding the future of ICO regulation? How will governments around the world approach this matter, and what impact will their efforts have on the market?

LB: I don’t have a crystal ball, but I expect the regulations to tighten in the short term, because many ICOs are non-compliant (and are abused by the promoters). In the long term, however, I expect this area to become reasonably regulated, with regulations striking the right balance between the fundraising efficiencies and investor protection.