Initial coin offerings (ICOs) have played an increasingly significant role in discussions concerning blockchain-related projects.
Regulators have recently begun to crack down on ICOs, and now the German Federal Financial Supervisory Authority (BaFin) has joined in.
In most cases, ICO-related discussions have been focused on the following:
- How may the various kinds of tokens be divided into the commonly discussed classes of tokens, i.e. "cryptocurrency tokens", "security tokens" and "utility tokens"?
- Following classification, which regulatory regime should apply to each token class?
BaFin made a statement in February that provided guidance regarding which supervisory law generally may be triggered in an ICO. The applicable regulations include the following, although a case-by-case assessment will be needed:
- MiFiD II/the German Securities Trading Act
- The German Securities Prospectus Act
- The German Capital Investment Act
- The German Banking Act
- The German Capital Investment Code
- The German Payment Services Supervision Act (ZAG)
- The German Insurance Supervision Act.
Potential issuers of tokens should bear in mind that BaFin did not comment on the potential implications deriving from consumer protection laws or anti-money- laundering laws, which could also place obligations on the issuer in an ICO.
A notable element of the statement is the indication that BaFin might only regard such tokens as "units of account" within the meaning of the German Banking Act that serve as means of payment on the network, i.e. cryptocurrency tokens. Whether or not tokens that exclusively provide for features other than being used for payment purposes will be subject to the German Banking Act will depend on whether or not they meet the qualifications for any of the other types of a financial instrument set out therein.
Regrettably, BaFin did not provide clear guidelines on how to classify tokens, or information on when a token will not be regarded as a security within the meaning of the German Securities Trading Act, or a transferable security within the meaning of Article 4 (1) (44) MiFiD II. Instead, BaFin stated that any tradable and negotiable token that is not to be regarded as a payment instrument shall be regarded as a (transferable) security and will therefore trigger the respective regulation if it represents any i) shareholder-like claims, ii) contractual claims or iii) any other claim comparable to i) and ii).
The scope for a (non- security) utility token would therefore be restricted to tokens that only factually give their holder access to a platform and/or a service without giving the holder any contractual claim.
The approach taken by BaFin might shift the focus of discussions into the field of civil law. The pure wording of BaFin's statement indicates that securities laws shall be triggered in case any (negotiable and tradable) claim is granted in favour of a token's purchaser. BaFin's statement does not rule out the possibility that such a claim may, under German law, also result from implication. As a result, to avoid securities law regulation, an issuer will have to make sure that, inter alia, the token grant agreements, the whitepapers, and potentially any of the issuer's declarations towards purchasers, do not give rise to a contractual claim that is embodied by the token.
In connection with the German Payment Services Supervision Act it remains unclear whether or not certain tokens may be regarded as e-money. An older statement by BaFin indicated that tokens created "from thin air", i.e., from an algorithm without transferring any claim against the issuer (such as Bitcoin), do not constitute e-money. Therefore, neither any services related to such tokens, nor their issuance, require approval under the German Payment Services Supervision Act. If tokens are created via a smart contract, e.g., on the Ethereum network, and also transfer a claim to the holder, this caveat does not apply. Some scholars argue that such tokens may be regarded as e-money if further requirements are met. BaFin's reference to Section 10 ZAG in its recent statement, in case a third party is involved in a token transaction, could be interpreted as confirmation of this understanding.
It therefore remains sensible to approach a lawyer if an ICO is planned. It is to be expected that more authorities acros Europe will issue statements regarding the treatment of ICOs, which could have an effect on BaFin's approach.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.