It is estimated that early stage start-ups have raised over a billion US dollars through initial coin offerings (“ICO”) globally in the past 12 months alone.
In Singapore, TenX, a secure transaction protocol across blockchain networks, recently raised almost USD 80 million. Singapore-based Cofound.it launched the sale of its own digital currency, called CFI, to launch an ICO platform. The purpose of the company is to bridge up-and-coming start-ups with potential investors and expert advisors, while allowing the start-ups to launch their own ICOs using their platform. Its pre-sale of tokens raised almost USD 15 million.
On 25 July 2017, the US Securities and Exchange Commission (“SEC”) ruled that “coins” offered in a prominent ICO by an issuer, The DAO, were in fact securities and should therefore be subject to federal securities laws (“SEC Ruling”).
Following the SEC ruling, the Monetary Authority of Singapore (“MAS”) clarified the regulatory position on the offer of digital tokens (coins) in Singapore on 1 August 2017 (“MAS Clarification”).
Nature of the Digital Token
In the MAS Clarification, it is stated that if the new digital token represents securities (as opposed to mere virtual currency), the ICO and the subsequent trading of the new coins will likely need to meet the requirements set out in the Securities and Futures Act (“SFA”) and the Financial Advisers Act (“FAA”), and also the anti-money laundering and counter financing of terrorism requirements.
The pertinent question is whether digital tokens issued in an ICO fall within the definition of “securities” under the SFA.
MAS cited the following examples:
- Digital tokens representing ownership or security interest over an issuer’s assets or property may be considered an offer of shares or units in a collective investment scheme.
- Digital tokes representing debt owed by an issuer may be considered a debenture.
Therefore, to decipher whether an ICO may be subject to prevailing regulations, one has to lift the “token veil”- that is to look at the underlying terms of the proposed token issuance, and assess whether it falls within the list of securities as prescribed under the SFA.
Creating a New Class of Securities
An ICO is typically deployed by the issuers as a fund-raising mechanism. Therefore, it is common for digital tokens to be issued in exchange for investment received. From a purposive approach, it is difficult to see why investors subscribing to ICO tokens should not be afforded protection in a transaction which, when stripped to its core elements, does not materially differ from that of equity or loan based crowdfunding.
Instead of trying to fit digital tokens into the traditional moulds of securities, such as shares, debentures, etc., and having to spend resources lifting the “token veil”, it is suggested that all digital tokens issued by way of ICOs should fall within a new class of products prescribed as securities if they fulfil explicit criteria to be established by the MAS.
In this regard, although the three-limb test in the SEC Ruling has its roots in the concept of “investment contract” found in the US Securities Act and subsequent cases, it may be useful (with appropriate adjustments) in defining this new class of securities: (i) making an investment in a common enterprise; (ii) with a reasonable expectation of profits; and (iii) such profits being derived from the managerial efforts of others.
Suggestions for ICO Regulations
At present, all entities which are engaged, directly or indirectly, in the business of dealing in securities are required to obtain a Capital Markets Services (CMS) license from MAS, together with sizeable contingency deposits. For example, crowd funding platforms are subject to base capital and minimum operational risk requirements of SGD 50,000.00, even if they only target accredited or institutional investors and do not handle or hold customer monies, assets or positions.
However, the advent of ICOs, and the deployment of blockchain technology to underwrite the transactions, has now allowed for the recording and maintenance of transactions on a de-centralized ledger without relying on a unilateral accounting system. Therefore, from a risk management perspective, MAS may consider further dulling the capital requirements for a CMS license in respect of ICOs.
An adjustment may also be made to the exemption thresholds for ICOs. Currently the Small Offers Exemption in the SFA may exempt an issuer from the need to prepare a prospectus for any fund-raising project of up to SGD 5 million any 12-month period, subject to disclosure of key risks. It is suggested that the quantum be adjusted upwards for companies conducting ICOs, in view of the reduced risks (associated with the ICO platform).
MAS has communicated that intermediaries in virtual currencies will be regulated to combat money laundering and terrorist funding risks. Certainly, these regulations should also apply to secondary trading platforms for the newly issued digital tokens. On the other hand, the limited risks carried by virtual tokens which function purely as currencies mean that MAS may maintain its stand of observance for now.
The births of cryptocurrencies and subsequently, ICOs, were predicated on unshackling users from the unwieldy burden imposed by central regulators. Hence, imposing overly restrictive controls on activities related to them would defeat their raison d’être. Accordingly, the MAS has maintained that it will adopt a proportional approach towards regulation amidst a landscape of exponential growth in the fintech industry.
For now, the MAS Clarification will likely have a chilling effect on ICOs seeking to issue tokens which behave substantially like securities.
Nonetheless, judging by previous efforts to alleviate compliance burdens during the onset of definitive crowdfunding regulations, it is without doubt that a similarly definitive, well-measured and considered strategy to regulating ICOs will be put in place in time to come.
It is however proposed that such a strategy be put in place sooner rather than later, as it will enhance Singapore as a destination for companies looking to raise funds and the ensuing international investments.