Inspired by initial public offerings (IPO), initial coin offerings (ICO) are ways for a company to raise money by issuing a cryptocurrency instead of conventional shares. Although German and European regulators have not yet adopted laws specifically applicable to ICOs, this does not mean that ICOs are unregulated, as Blockchain enthusiasts may hope. The European Securities and Markets Authority has stated, “[Blockchain technology] does not liberate users from the need to comply with the existing regulatory framework”. The reason is that legislators customarily use fall-back provisions and broad, general definitions to cover new technologies; frequently, new technologies are regulated based on their function, making it easier to include them under existing law.
What is sold during an ICO?
The type of coin an investor obtains in an ICO is defined in the ICO’s white paper and in the “Terms and Conditions” applicable to the ICO purchasing contract.
- Some ICOs offer bare-bone coins which do not incorporate any rights. A prominent example is bitcoin.
- On the other hand, coins may be connected with a right the investor receives, e.g., a right to receive a dividend, a voting right, a license, a property right, a right to receive a performance in the future, etc.
How are coins qualified under the law?
German civil law differentiates between things, rights, and other objects (or: assets) – which category do cryptographic coins fall in? From a technical perspective, bitcoins and other cryptographic coins are not data which is stored on a person’s computer and which belongs to this person. Instead, being in the possession of a Bitcoin means that one proves to know a private key corresponding to a specific public key. Currently, experts favour the legal qualification “objects”/ “assets” to describe cryptographic coins under German laws.
From a regulatory point of view, the German Federal Financial Supervisory Authority (“BaFin”) qualified bitcoins as units of account and, thus, financial instruments (Section 1 (11) S. 1 Nr. 7 Alt. 2 KWG). According to BaFin, “Units of account are comparable to foreign exchange with the difference that they do not refer to a legal tender. Included are also value units which function as private means of payment in barter transactions and any other substitute currency that is used as means of payment in multilateral accounting on the basis of contracts under private law”.
How are ICOs regulated?
The manifold laws applicable to ICOs depend on the type of coin offered and a vast web of regulations will apply to both types: Contract Law must be obeyed since the coins are purchased by concluding a purchasing agreement. Consumer Protection Laws may also play a role in cases the coins are sold to consumers. In the bare-bone scenario, tax laws become very relevant, whereas securities laws are more important when the coins are connected to investor rights. From the securities and regulatory perspective, the Banking Act, Investment Act, Securities Trading Act, Payment Services Supervision Act and Prospectus Acts are of utmost importance.
To be clear, although there are many provisions which apply to ICOs, there is currently no law which applies specifically. European and German legislators are, of course, not prevented from drafting provisions which directly regulate ICOs. In fact, given the enormous amounts of money currently being raised through ICOs and the intensive discussions currently taking place, direct regulation is likely.
Applicability of German law
Of course, German regulatory law does not apply to all ICOs issued across the globe, but it is important to understand that the applicability of most regulatory laws does not depend on the company being based in Germany or the laws applicable to the ICO purchasing contract. Instead, German jurisdiction will mainly apply in cases where the ICO is marketed in Germany. This can be determined based on various indications, e.g.: Does the company provide information in German, on German websites? Is information on the ICO provided to potential investors in Germany? etc.
On the other hand, ownership of a company’s coin by a German citizen is in most cases not enough to trigger application of German regulatory law. This means that, from this regulatory perspective, a company is not necessarily required to check the nationality of an investor before issuing coins to that investor.
Regulators will face challenges
One of the biggest challenges regulators will face when adopting regulatory laws specifically applicable to ICOs is the potential lack of subjects of supervision. Who to approach, given that an ICO or another Blockchain application is simply a software running on a Blockchain? There are some ideas, of course, but for the moment, regulators have not yet published any opinions.
Conclusion: Sustainable ICOs require compliance
Although an ICO is a very attractive way to raise money with relatively little effort, companies should be aware of the fact that their financial and personal risks (e.g., fines, claims for damages, prison) are quite high, especially as the amount of funds raised increases. Sometimes, compliance can be reached with little effort and with minor changes in the ICO’s white paper. However, depending on the purpose of the ICO, the application of regulatory laws is often unavoidable meaning that, e.g., a permission of the authority may be required.