The European Securities and Markets Authority (ESMA) recently published two separate statements addressed to firms and investors on Initial Coin Offerings (ICOs). The statements provide some insight into ESMA's current thinking on ICOs which have gained much attention in the fast moving and ever-expanding cryptocurrency arena.
An ICO is a relatively recently devised means of raising capital by offering virtual coins or tokens that are created in exchange for legal tender or other cryptocurrencies such as Bitcoin, with the capital raised usually going towards initiating or completing the creation of a new cryptocurrency. As well as speculating on the value of the prospective cryptocurrency, initial investors will usually also gain additional rights such as rights to participate in the project and to vote on how it is run.
The ESMA statement addressed to firms warns that coins issued in an ICO may constitute financial instruments resulting in firms involved in such ICOs being considered as carrying out regulated activities in the EU. While noting that it is up to each firm to consider the applicable regulatory framework, ESMA identified the Alternative Investment Fund Managers Directive, the Fourth Anti-Money Laundering Directive, MiFID and the Prospectus Directive as regulatory regimes that are likely to apply.
The ESMA statement addressed to investors recognises the possibility that ICOs may operate in a wholly unregulated space. ESMA highlights this as a major risk associated with ICOs along with a number of other concerns in respect of ICOs referring to them as "extremely risky and highly speculative investments". Among the concerns voiced by ESMA regarding ICOs are:
- the likelihood of fraud or money-laundering;
- the high risk of investors losing all of their invested capital, as many ICOs are very early stage ventures with a high risk of failure that issue tokens which have no intrinsic value if the platform is not subsequently developed;
- the volatility of the prices of tokens, and the fact that not all tokens are traded on virtual currency exchanges, meaning a lack of exit options;
- that the information provided in many ICO whitepapers has been "unaudited, incomplete, unbalanced or even misleading"; and
- potential technological flaws.
As the capitalisation of Bitcoin and other cryptocurrencies continues to soar, with investor interest as high as ever, regulators are sure to keep a close eye on developments in this space.