A European Perspective on the DAO Report
From the recent Bitcoin Cash fork to claims of a crypto-bubble, it seems like everyone is talking about cryptocurrency lately. And with data from CoinMarketCap currently valuing the public cryptocurrency market at US$134 billion, it is little wonder that there is so much interest in this topic right now.
For lawyers, the hot topic of the moment is the recent SEC report on The DAO, in which the US Securities Exchange Commission (SEC) took the view that certain tokens offered for sale by the Ethereum-based funding vehicle, The DAO, constituted "securities" for US securities law purposes. The effect of this decision is to bring token sales or Initial Coin Offerings (ICOs) (previously regarded as the "Wild West" of fundraising) within the remit of US securities regulation where certain conditions are met.
On the other side of the globe in the EU, the potential regulatory implications of the distributed ledger technology upon which token sales are based are only beginning to be explored by regulators. While certain national regulators have adopted policies and even laws dealing with cryptocurrency, as noted in the industry-backed, Blockchain Policy Initiative Report, "tokens and ICOs remain white spots on the EU regulatory map".
However, with some commentators predicting that the SEC's ruling in The DAO Report may lead to a surge in ICOs within the EU, EU regulators may find themselves under pressure to follow the SEC's lead and address the regulatory status of ICOs sooner rather than later.
EU Regulation of ICOs: Current State of Play
In the absence of a specific EU regulatory regime dealing with tokens and ICOs, they potentially fall within the scope of a wide range of EU and national laws and regulations – including tax laws, anti-money laundering laws, privacy laws and payment services laws. While all of these may have important legal and regulatory implications for ICOs, the key question from an EU regulatory perspective - similar to the US - is whether tokens could be classified as some form of securities for EU purposes, such that ICOs and token sales could fall within the remit of EU financial markets regulation.
The answer to this question in an EU context is not straightforward - as financial markets regulation in EU member states is governed by a combination of EU legislation and member states' national laws. In certain member states, the applicable EU legislation has not been fully implemented and, in others, there are well developed national laws which co-exist alongside the relevant EU rules. The result is a complex patchwork of legislation that is not uniform across every EU member state.
Is a Token a "Transferable Security" for EU purposes?
With the above said, the cornerstone of EU financial regulation is MiFID II (Directive 2014/65/EU), which seeks to regulate a large part of the EU financial markets ecosystem. For the purposes of determining whether a particular product (such as a token) is a security for EU purposes, MIFID II defines "transferable securities" as follows:
"classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as:
- shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares;
- bonds or other forms of securitised debt, including depositary receipts in respect of such securities;
- any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures."
Given the broad nature of the above definition, it is possible that, like in the US, some (but not all) types of token may constitute securities for EU regulatory purposes. Where this is the case, an offer of tokens to the public in the context an ICO could potentially be subject to the requirements set out in the EU Prospectus Regulation (Regulation (EU) 2017/1129) – including the requirement to publish a prospectus. This is obviously not good news for the entrepreneurs and innovators who, up to now, have been viewing ICOs as a "regulation-light" (or indeed, unregulated) alternative for raising capital.
However, like in the US, not every token will necessarily constitute a "transferable security" for the purposes of the above definition and not every ICO will necessarily be subject to EU securities laws. To determine whether this is the case would, to echo the SEC, require an analysis of the particular "facts and circumstances" in each case (in particular, the characteristics of the token and the structure of the ICO in question), having regard to the above definition and any applicable nuances under the national securities laws of relevant member states. Ultimately, we may see diverging approaches and positions being adopted by regulators and courts across different EU member states, which again, would not be an ideal result for entrepreneurs and innovators that currently look at ICOs as a simplified option for raising funding.
So where do we go from here?
In a report issued in February on Distributed Ledger Technology Applied to Securities Markets, the EU securities watchdog, ESMA (European Securities and Markets Authority), did not specifically address the subject of ICOs, noting that it would "continue to monitor market developments around [distributed ledger technology] to assess whether a regulatory response may be needed". However, having regard to the position reached by the SEC on The DAO and the continued uptick in ICOs since the SEC Report was released, now might be a good time to consider whether such a response is required.
Indeed, a clear regulatory response is something that would be welcomed by key players in the blockchain industry, who recently called on EU legislators to treat "tokens as a new asset class" in order to "address the multidimensional properties that this technologies exhibit". In the Blockchain Policy Initiative Report, led by Neufund and backed by other blockchain trailblazers like Kraken, BigchainDB, Golem and others, stakeholders called for a "simple, yet robust regulatory framework" that would be "coherent" across the EU. The Report noted that this would help to avoid the "risk of diverging national approaches to Tokens and ICOs which might stifle the innovation driving them".
There is much to be said for the coherent, pan-European approach proposed in the Report. This approach could serve the dual purpose of facilitating innovation (by allowing ICO organizers to access capital in EU markets within a clear and common regulatory framework); while also protecting EU investors – on a coherent and EU-wide basis - from the risks associated with cryptomarkets. Any policy adopted should ideally be "simple, yet robust" and strike an appropriate balance between the foregoing goals.
In the absence of a specific EU-wide policy, we are likely to see diverging regulatory responses emerge across the EU. This lack of coherency could potentially drive blockchain innovators from the EU to other international destinations – such as Singapore and Switzerland - that offer greater regulatory certainty and uniformity. It could also lead to forum shopping within the EU, in the event that certain EU jurisdictions or regulators are ultimately regarded as more "ICO-friendly" than others.
In the Report, stakeholders are calling for a "swift response" at EU level. However, how long it will actually take before there are any developments in this regard is anyone's guess. In the meantime, one thing is clear: With the New York Times reporting 46 new coin offerings in the two week period since the SEC's Report was published, and an additional 204 in the pipeline, there is no sign of the ICO markets cooling down any time soon. And from here on in, anyone participating in an ICO - whether as an issuer or an investor, in the US, the EU or elsewhere – should tread carefully: Because in the wake of The DAO Report, the days of the ICO regulatory Wild West are over.