In recent years there has been growing global interest in digital currencies such as crypto-currency. With this growth, comes an increase in the number of businesses seeking to issue their own digital coins or tokens to the market and to raise funds through initial coin offerings (ICOs) (also known as initial token offerings).
An ICO is a form of fundraising that allows organisations to raise funds from investors for a variety of projects, including to assist in the development of new coins or distributed ledger technology related services. Funds are raised by offering new coins for sale to investors in exchange for other crypto-currencies or cash via the internet. Investors are usually attracted to these investments based on the proposed uses that can be made of the new coins in the future, and so the rights attached to a new coin can be critical to its success.
ASIC has released information sheet 225 (INFO 225) to provide guidance to businesses that are considering raising funds through an ICO. This information sheet makes it clear that the rights attached to a coin or token are also critical to determining the legal compliance requirements of trading the coin and conducting an ICO. This article outlines some of the key regulatory considerations for businesses when structuring a new coin and its ICO.
Trading of coins on a financial market
If the underlying coin in an ICO is found to be a financial product, then any digital currency exchange platform that facilitates the sale or purchase of these coins may amount to the operation of a financial market, which requires certain licensing in Australia.
Some recognised financial products include an interest in a managed investment scheme, a share in a company, a derivative or a non-cash payment facility.
We have outlined how an ICO may fall within these categories below.
Is your ICO a managed investment scheme?
A managed investment scheme involves the contribution of assets to obtain an interest in a scheme in circumstances where the assets are pooled to produce a financial benefit or interest in property but without the contributors having any day-to-day control over operation of the common enterprise. Some common examples of managed investment schemes include real estate investment trusts, managed funds, timeshare schemes and trusts in which members of the public collectively invest in passive income activities, such as shares or property.
ASIC has noted that the offering of new coins in an ICO could amount to a managed investment scheme if the value or the returns of the digital coins offered is affected by the pooling of funds from contributors or use or management of those funds under the arrangement. If an ICO falls within the definition of a managed investment scheme, it will be subject to certain disclosure, registration and licensing obligations under the Corporations Act.
Is your ICO an offer of shares?
An offer of shares in a company grants the shareholder with certain rights relating to the company. The most common share issues are of ‘ordinary shares’, which carry ownership rights, voting rights, dividend entitlements and rights to claim on the residual assets of the company.
The coins that are usually offered under an ICO generally only provide access to the particular service or project that is being developed. However, if the rights attaching to the coin are similar to the rights attaching to an ordinary share, ASIC may determine that the coin is effectively a share. In this case, the business running the ICO will be required, among other things, to prepare and offer a prospectus to potential investors containing all the information that investors reasonably require to make an informed investment decision.
Is your ICO an offer of a derivative?
A derivative is a product that derives its value from an underlying instrument or reference asset. This underlying instrument could include a share, currency or commodity, such as precious metals or another crypto-currency.
If an ICO offers a coin that derives its price or returns from the price movements of underlying assets, e.g. the coin entitles its owner to payment if the value of gold increases, then this may be a derivative that is subject to certain obligations under the Corporations Act.
Does your ICO involve a non-cash payment facility?
A non-cash payment (NCP) facility allows people to make payments, other than by physical delivery of currency.
ASIC has stated that coins offered under an ICO are unlikely to be NCP facilities. However, an ICO may involve an NCP facility if it includes an arrangement that facilitates payments to numerous payees in non-cash form (such as where the digital coin is the consideration for the transaction in substitution for Australia currency) or if payments that started in non-cash form are converted to fiat currency for completion of a payment.
There are also certain licensing requirements for transfers constituting non-cash payment facilities.
Misleading or deceptive conduct
Businesses that conduct ICOs should also be cautious not to mislead or deceive potential investors, or provide statements containing false information when they are promoting their ICOs. This will help ensure that they do not breach the Australian Consumer Law prohibitions against misleading or deceptive conduct.