Initial Coin Offering ("ICO") is a fundraising activity which has been applied for funding purposes in recent years, especially within the scope of venture projects, and which works with blockchain technology. By means of ICOs, entrepreneurs implement their projects in a shorter time period compared to other funding mechanisms such as initial public offerings ("IPO"), and in return, it is aimed that the participants will earn income with the realization of the project.
Like crypto assets, ICOs have not been yet regulated in all aspects under Turkish law. However, the lack of a control institution or mechanism related to the process may cause difficulties in the process of creating a road map for the entrepreneurs and create difficulties for the participants in terms of distinguishing between legitimate and non-legitimate projects.
WHAT IS THE INITIAL COIN OFFERING (ICO)?
ICOs are defined as fundraising activities carried out in the creation of a distributed network structure and through coins or tokens issued in exchange for price currency specific to a project1. In this context, the basis of ICOs is investment projects based on the blockchain. The funding of these projects takes place through the sale of tokens. The token sale mostly takes place in exchange for more widely recognized coins, such as Bitcoin (BTC) or Ethereum (ETH). Token has emerged as another application example of ledger technology other than cryptocurrencies and refers to digital crypto assets that represent a certain value or benefit within a project ecosystem on a blockchain.2
In the ICO process, the token determines the interest of the participant in exchange for cryptocurrency. Tokens can be used as a means of payment (payment tokens), can refer to securities (security tokens), or can be used to access a product or service (utilitytokens). On a specific project basis3, the token's benefits to participants are determined by the team behind the project. However, tokens can be categorized in various ways in different legal systems according to the characteristics they contain. The definitions set by considering the technical, financial, or legal qualities of the token used in the classification may vary in different legal systems. Therefore, it should be noted that the categorization here is not something that can be uniformized globally. For example, it is possible for a token called a "security token" under Swiss Law to be a "utility token" under US law because it has capital market instrument characteristics.
Although the ICOs vary from project to project, in practice they often appear as the promotion of a project by publishing it on a website and announcing the date set for the token sale. On the website in question and mobile applications for some projects, a technical document (whitepaper) is published, which contains the details of the project, the road map, the mission and vision of the team behind the project, and the introductory information regarding the team.
The whitepaper can be compared to the prospectus we know from the IPOs. However, since there are no written rules regarding the regulation of the ICOs, unlike prospectuses, how the content of the whitepaper will be created, the information that should be included in its content, or the rules for its publication are entirely determined by the team managing the project. In addition to the Whitepaper, there is a secondary document called Yellow Paper, as we have come across in Ethereum. Although this document contains detailed information about the product or the service as in the Whitepaper, it can be defined as the second section, which aims to summarize the scientific details of the technology and includes all the specific details.
The purpose of the ICO is to provide funding support in the early stages of the project. Thus, the project is developed with the funding provided by the participants, who can be described as early supporters of the project. In practice, we often encounter structures in which the lower and upper limits are foreseen regarding the number of tokens to be sold during the ICO process. The lower limit indicates the minimum number of tokens that must be sold for the continuation of the project. If the lower limit is not reached, the coins paid by the participants in exchange for the token will be refunded. The upper limit shows the number of tokens sold that is sufficient for the ICO process to be considered successful. When the upper limit is reached, the ICO is completed, even if the end date of the token sale has not yet come.
The sale of tokens in the ICOs can be divided into different phases. In these cases, the start and end dates of the phases where the token sale will be made, how many tokens will be offered for sale and in which phase and the value of a token are specified in the Whitepaper published on the relevant website. In practice, in general, the price of the tokens offered for sale in the first phases is more affordable than in the later phases. It is possible to explain this situation that the project is being developed and valued as the fund is collected.
EVALUATION OF ICOS IN TERMS OF CAPITAL MARKETS LEGISLATION
ICOs are often an investment method for technology projects or platforms. On the platform in question, tokens function like money in payment services. In essence, during the ICO process, the possibility of future growth and widespread use of the platform in question is evaluated. Thus, the participants can buy tokens early and when the project is fully developed, use their tokens or earn income by selling them at a higher value. For participants to support an ICO project, it is sufficient for them to own the coin used in the project. Since there is no regulation on these issues in Turkish legislation, the procedures required for the participants to buy shares from public joint-stock companies, such as opening a securities account in a bank, are not foreseen in the ICOs. This can be considered an advantage for the investors in the ICOs in terms of ease of operation.
To understand the place of ICOs in the Turkish legal system, it is essential to determine the legal nature of the tokens. However, the variety of uses of the tokens makes it difficult to make this determination. Whether the tokens can be considered as capital market instruments is an issue that should be discussed under the Capital Markets Legislation. According to the legislation, capital market instruments consist of "other capital market instruments determined by the Board to be within this scope, including securities and derivative instruments and investment contracts". The Capital Markets Board ("CMB") first informed the brokerage firms that "Considering that there is no regulation or definition regarding cryptocurrencies in Turkey and that virtual currencies are not among the elements that can form a basis for derivative instruments within the scope of the CMB, at this stage, spot or derivative transactions based on virtual currencies for customers should not be made."4 However, this explanation is only related to Bitcoin, and it is also likely that the tokens sometimes have properties such as securities due to the variety of uses. Likewise, the statement in the said notification that Bitcoin cannot be subject to derivative transactions may not prevent tokens from being considered as derivative instruments when evaluated in terms of transaction purpose and characteristics. It is intensely mentioned in the doctrine that US law is the guide to defining the Investment Contracts, which are considered Capital Market Instruments under the legislation. The U.S. Securities and Exchange Commission ("SEC") decides whether an asset is a security or not using four criteria from the U.S. Supreme Court's decision in the SEC v. W. J. Howey Co. case. These criteria are determined as (i) the existence of an investment, (ii) the formation of a joint enterprise of that partnership, (iii) the promise of profit by the issuer, and (iv) the existence of a profit to be obtained as a result of the efforts of the third parties.5 This practice, called the Howey Test, determines if the token is a security, and the ICO in question will fall under the supervision of the SEC.
As a result, an evaluation should certainly be made considering the characteristics of the token to be issued within the scope of an ICO. Because, by the decision of the CMB dated September 27, 2018, and numbered 47/1102, it is emphasized that whether these practices fall within the jurisdiction of the Capital Markets Board should be evaluated on a case-by-case basis.
While there is uncertainty even in terms of the legal nature of the token, it is very difficult to make an assessment within the scope of the CMB legislation in terms of ICOs. Since ICOs are not yet subject to detailed legal regulations compared to IPOs, ICO projects are easier to set up and launch.6 Although it is possible to compare ICOs to IPOs, IPOs can only be carried out by joint-stock companies and if a joint-stock company wants to go public, it must obtain the permission of the Ministry of Commerce following the permission to be given under the detailed legislation of the CMB.
Considering the nature of the material value collected within the scope of the ICO, the realization of the ICO without following a special procedure such as an IPO should be evaluated in terms of CMB legislation. Crowdfunding within the CMB legislation is the "collection of money from the public through crowdfunding platforms to provide the funding needed by a project or venture company within the principles determined by the Board without being subject to the provisions of this Law on investor compensation". However, as stated in the preamble of Article 107 of Law No. 7061 on the Amendment of Certain Tax Laws and Certain Other Laws, the provision of financing by collecting other tangible values that will not be considered money to ensure the development of crowdfunding has been excluded from the scope of the CMB legislation. It is possible to conclude that the financing of ICOs by collecting crypto money instead of money from the public cannot be considered crowdfunding. However, although it is possible to comment that the statements in the announcement made under the abovementioned decision of the Decision-Making Body of the CMB dated September 27, 2018, and numbered 47/1102, may be characterized as crowdfunding according to the nature of the asset value collected from the public within the scope of some ICOs, the information or details contained in the relevant announcement are not sufficient to make this characterization. As a result, it does not seem possible to make a definitive assessment until the legislator makes regulations in terms of ICOs and tokens or until the CMB's decisions contain more detailed evaluations in this regard and these issues are clarified.
The lack of legal regulations on ICOs brings along some disadvantages for entrepreneurs. Although legal regulations impose obligations, they also draw a road map in the procedural sense. While creating the Whitepaper and planning the stages of the ICO, the uncertainty of the steps to be taken legally and the lack of any road map create difficulties for entrepreneurs. The legal regulations regarding the IPOs though have been set forth in detail in many regulations and communiqués following the Capital Markets Law. In addition, the guides and information booklets prepared by the CMB are important road maps for entrepreneurs.
It is very difficult for the participants to distinguish between legitimate activities and fraudulent activities since all the documents related to ICO projects are prepared by entrepreneurs. In the abovementioned Bulletin No. 2018/42 dated September 27, 2018, the Capital Markets Board warns the investors that the money collected for the ICOs may not be used for the specified purposes and that there may be incomplete and misleading information in the documents provided by the sellers. In addition; it is stated that many of the ICOs are outside the jurisdiction and duty of the regulatory bodies and are not subject to any regulation and supervision.
One of the most important advantages of the ICOs for entrepreneurs is that ICOs can provide a high amount of liquidity and reach hundreds of participants in a short period because they are built on a decentralized structure with a unique characteristic feature of blockchain technology.7 Because it is possible to access and transact the coin network based on the ICO from anywhere in the world. However, we should point out that there are regulations and restrictions on ICOs in some countries. For example, in China8 and South Korea, ICOs are completely banned. In this context, entrepreneurs are required to take action according to the legislation of the countries to be transacted, otherwise, it is possible to face sanctions.
EVALUATION OF THE LEGAL RELATIONSHIP BETWEEN THE ICO PROJECT ENTREPRENEUR AND THE PARTICIPANT WITHIN THE SCOPE OF TURKISH LAW
According to Article 24 of the Law on International Private Law and Procedural Law, the law chosen by the parties is applied to the dispute, as an ICO transaction may be considered to contain an element of foreignness. If the parties do not choose the applicable law, the law most intensely related to the contract will be applied to the contractual relationship. In this sense, the law of the habitual residence of the debtor of the characteristic performance, that is, the party promising the project with the ICO will be applied. A habitual residence is generally defined in the doctrine as the place where one's real-life relationships continue, where the person resides and where they want and will to reside9.
When we evaluate the Whitepaper that is created as a result of an ICO, it is possible to say that there is a contractual relationship between the ICO project entrepreneur and the participant. According to Article 1 of the Turkish Law of Obligations ("TLO"), the two main elements of the establishment of a contract are mutual and appropriate declarations of intention. In Article 8 of the TLO, the public proposal is stated as follows: "Displaying goods by showing the price or sending tariffs, price lists or the like shall be considered as a proposal unless otherwise clearly and easily understood." In terms of ICOs, it should be evaluated whether the proposal includes the essential elements of the contract. In most ICO projects, the details of the token price and sale are stated in the Whitepaper. In this context, it is possible to say that the legal nature of the Whitepaper is a suggestion. On the other hand, the participant's purchase of tokens will also be acceptable, and the moment the token is purchased can also be considered as the moment of establishment of the contract. In light of this situation, in case of any dispute, the general provisions of the TLO regarding contractual debt relations will be applicable.
Assuming that the contract is established in the manner mentioned above, within the scope of ICOs, it can be considered that a contract for the exchange of goods as defined in Article 282 of the TLO has been concluded between the entrepreneurs and participants. However, this situation requires that the contract be regulated in compliance with the mandatory regulations within the TLO. Therefore, the contract shall be binding between the parties unless there is a matter that eliminates the validity or claim ability of the contract or the contractual debts.
We would also like to point out that, if an ICO project is created to deceive the participants and the entrepreneurs benefit at the expense of the participants, the crime of aggravated fraud through information systems can be mentioned under Article 158 of the Turkish Criminal Code.
In particular, in the absence of regulation or supervision of the domestic authorities in the crypto money market, it can be considered that there will be information asymmetry between the entrepreneurs and investors of the transaction. With the idea that one of the main elements of the crime is caste, what should be considered when making an assessment is to determine the credibility and accuracy of the information provided by the Whitepaper. One of the most difficult issues to detect fraud is the identification of the suspect. However, in practice, the fact that the ICO project is not an organization in which the entrepreneur is registered makes this determination quite difficult.
Since the ICOs are blockchain-based, the project can be reached from anywhere in the world. As a result, large masses of participants can be reached, and high amounts of liquidity can be obtained in a short period of time. However, the legislation of the countries where the transactions are made regarding the ICOs should be evaluated separately or the regulations or sanctions in the legislation of the country in question should be examined.
Under Turkish law, there is no special procedure that can be applied to the ICOs, nor there is a legal obstacle to the ICO transaction. However, for each ICO transaction, it is necessary to evaluate the material value to be collected in the transaction and the characteristics of the token to be issued within the scope of the ICO. In this sense, ICO entrepreneurs need to do legal modelling as well as commercial modelling.
1. Blockchain Turkey, Blockchain Technology and Terminology Study, pg.24. For Internet access: https://bctr.org/dokumanlar/Blokzinciri_Teknoloji_Terminoloji.pdf Date of Access: 23.02.2022
2. Blockchain Turkey, Blockchain Technology and Terminology Study, pg.19. For Internet access: https://bctr.org/dokumanlar/Blokzinciri_Teknoloji_Terminoloji.pdf Date of Access: 23.02.2022
3. ARAALAN, Cemal, "Crypto Asset Initial Offer (ICO) and Evaluation of the Issue in terms of Turkish Law and Some Country Practices", Journal of Banking and Finance Law, Volume No.:10, Number No.:40, 2021, s.886-888
4. Capital Markets Board's Letter dated 1.12.2017 and numbered 32992422-299-E.13447 https://www.tspb.org.tr/wp-content/uploads/2017/12/Genel-Mektup-785-Sanal-Paralara-Dayal%C4%B1-%C4%B0%C5%9Flemler-hk..pdf (Date of Access: 8.06.2022)
5. https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets (Date of Access 3.06.2022)
6. ARAALAN, Cemal, "Crypto Asset Initial Offerings (ICO) and Evaluation of the Issue in terms of Turkish Law and Some Country Practices", Journal of Banking and Finance Law, Volume No.:10, Issue No.:40, 2021, p.892
7. Tevetoglu (n2) 189
8. Minneapolis, W. K., Professor at University of Saint Thomas School of Law, Director of the Private Investment Funds Institute, (2018). Initial Coin Offerings: The Top 25 Jurisdictions and their Comparative Regulatory Responses (as of May 2018). Stanford Journal of Blockchain Law & Policy. https://stanford-jblp.pubpub.org/pub/ico-comparative-reg
9. Number, a.g.e., p. 118, Gelgel-Günseli, Öztekin, Custody in State Law, Child Abductions, Problems Related to Adoption, Istanbul Commerce University Journal of Social Sciences Y.:4 h.:8 Fall 2005/2 p.132; Özkan, Isil, Residence in Private Law of States, Bribed Re-Evaluation of Dwelling, and Workplace Binding Points, Natural Publications, September 2004, p. 83. (Live Since: Res. Asst. Pakize Ezgi AKBULUT, Authority of Turkish Courts in Disputes Concerning Family Law According to the Code of Civil Procedure No. 6100 and the Impact of These Provisions tothe International Private and Procedure Law (Mohuk) No. 5718)
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