In the World of ICO’s: The Legal Implications of ICO Tokens

ICOs have gained immense popularity but questions remain about their legality. This article attempts to shed some light on that.

The phenomenon of ICOs is relatively new, and yet it has already managed to help projects aggregate close to $4 billion. The excitement has also drawn attention from regulators like the U.S. SEC, the Monetary Authority of Singapore, the U.K.’s Financial Conduct Authority, and, most notably, the People’s Bank of China who has completely banned ICOs in the country.

Still, not all ICOs are the same. The year 2017 saw numerous new terms devised in order to give the phenomenon a new name: token generation events, contribution campaigns, initial token offerings, etc. There even is a SCO, i.e. secondary coin offering, which describes a second fundraising campaign held by the same company in the form of issuing and selling digital tokens.

As the industry matures, it is becoming increasingly important to know the legal peculiarities inherent in this new realm that isn’t properly regulated yet. The SEC, for instance, sued several companies like Tezos and Giga Watt for violating the securities legislation.

According to the team of lawless.tech, it all comes down to the kind of token a particular project uses to raise funds. In its recent post, the team outlined the basic kinds of ICOs that are currently in use.

App Tokens / Utility Tokens

Utility tokens entitle their users to use the respective project’s products or services.

“A business model with app tokens is more attractive to contributors and potential users, since the token will be useful within a product and will remain in circulation (otherwise users won’t be able to use a platform or network). As one of the key features, a utility token is easier to sell to a wider audience,” the post reads.

App tokens are quite popular amidst companies. They are less likely to be considered securities, and therefore bear lesser risks of litigation. The model was used by projects like Enigma, Storj, and Tierion.

Security Tokens

As their name suggests, security tokens act as securities and therefore are more likely to draw attention from regulators. They have to comply with all laws on securities in order to avoid litigation and other legal problems, the lawless.tech team says.

“Securities tokens seem to be a more attractive investment than utility tokens, since they give token holders some specific rights regarding the issuer company (e.g. voting rights, profit sharing rights). However, this model entails additional risks related to securities legislation. For example, a company running an ICO may be fined for violations of an emission prospectus or for offering securities tokens without observing the legislative rules. Thereby, it’s important to observe all statutory rules concerning securities legislation or use specific exemptions that make a legitimate offering of securities possible,” the blog post reads.

This model was used by projects like The DAO and Blockchain Capital.

Finally, there is another kind of an ICO, which focuses on a non-commercial agenda.

Donation Campaign

In this case, it’s more like charity: participants buy tokens to support the team, its idea, and the development of their product while receiving nothing in return.

“Over the sale of utility tokens, all funds are collected by an LLC or another type of company. In the case of a donation campaign, all funds go to a non-profit foundation. This model implies using a different corporate structure,” the blog post states.

Even though this seems a charitable effort, the donation-focused approach does not fully protect companies from having problems with regulators. Tezos, for instance, used the donation campaign model and still found itself in the courtroom.

In their another post, the lawless.tech team suggests a list of measures that a company may assume to mitigate the legal risks while holding an ICO of some form, which include refraining from any profit-related promises and developing a platform or at least an MVP prior to starting the campaign.

Still, the risk remains there as long as there is no explicit regulatory framework dealing with this new phenomenon.