The European Securities and Markets Authority (ESMA) has setting out its advice to other EU institutions on initial coin offerings and crypto-assets. The advice clarifies the existing EU rules which apply to categories of crypto-asset that qualify as “financial instruments”. It also explores gaps and issues in the current EU financial regulatory framework for consideration.
Crypto-assets, or cryptocurrencies, are digital assets that use strong cryptography and are designed to work as a means of exchange. Effectively, they can be thought of as encrypted on-line money. There are over 4,000 types of cryptocurrency now circulating, with well-known examples including Bitcoin, Ethereum, IOTA, EOS, Monero, Cardano, Ripple and Litecoin.
Unlike traditional currencies, cryptocurrencies are not controlled centrally by a bank or monetary authority. Rather, they operate through open and modification-resistant distributed ledger technology, typically blockchain. Whilst this can make cryptocurrency transfers very secure, the lack of any meaningful fiscal oversight or policy means the value of cryptocurrencies can fluctuate significantly and the assets themselves can potentially become vehicles for financing unlawful activities.
An initial coin offering (ICO), also known as initial token offering or initial currency offering, is a form of fundraising in which investors are issued cryptocurrency in the form of “coins” or “tokens”, rather than shares or other tradeable securities. Those coins or tokens may themselves be exchangeable for another kind of crypto-asset, typically Bitcoin and Ethereum.
ESMA has previously issued warnings both to investors about the high risks of investing in ICOs and to regulated firms about carrying on activity in relation to token offerings.
In its latest report, ESMA notes that some types of coin or token may not qualify as “transferable securities”. In this case, the coin issuer will not be required to draw up a prospectus as part of the ICO, removing a valuable protection for investors. Likewise, if the crypto-assets are not admitted to a regulated market (and in most cases, they will not be), the coin issuer may not be subject to requirements to issue periodic and annual financial statements or to report on changes in who holds its securities and voting rights.
In addition, if the crypto-assets are not admitted to a trading facility (which, for coins or tokens, is most likely to be a private “organised trading facility”), the Market Abuse Regulation will not apply. Investors would not be protected against potential insider trading or market manipulation, and the issuer would not be required to disclose inside information or report trades by its managers.
Even if these requirements do apply, ESMA notes that current regulation is not specifically geared towards coins, tokens and other crypto-assets.
Unsurprisingly, for crypto-assets that are currently regulated, ESMA has recommended extending the legislation so that it better reflects the nature of the assets. For those assets that are not regulated, ESMA is recommending putting protections in place, including anti-money laundering measures and suitable risk disclosures.
The report follows on from the UK Cryptoassets Taskforce’s report in October last year. You can read more about this in our blog here.