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The Legal Challenges and Risks of Initial Coin Offerings (“ICO’s”)

ICOs are reported to have raised almost $1.3 billion globally from the start of 2017[1] and continue to grow rapidly despite the high risks and warnings. Globally the appetite to use this method to fundraise does not appear to be diminishing.

This article explores the legal challenges of initial Coin Offerings and also the risks associated with this model.

Initial Coin Offerings (ICO’s) involve the creation of digital tokens using distributed ledger technology and their sale to investors in return for a cryptocurrency.

What are Initial Coin Offerings?

An initial coin offering (ICO) is a crowdfunding strategy to raise capital through the creation and sale of a digital coin or token. Investors fundraise by transferring fiat currencies such as the US dollar, Bitcoin or other cryptocurrencies to the issuer in exchange for tokens.

Tokens represent a transfer value within the new coin’s ecosystem to other cryptocurrencies ecosystems. The underlying blockchain technology underpins the tokens by utilising cryptography to record transactions.[2]

There are a variety of tokens such as payment, utility and asset tokens, these classifications are generally classified as there are no agreed provisions of ICOs and the tokens that result from them internationally, each jurisdiction classify them differently.

Stock IPOs vs Crypto ICOs: What are the differences?

The ICO concept is compared to the Initial Public Offering process (“IPO”) where stocks from a private company are offered to the public. One or more investment bank and/or institutional investors underwrite an IPO. IPO’s are used by established large businesses and smaller younger companies seeking crowd fund capital to expand by issuing new shares to investors providing the company with investment for future growth and monetize investments held by private shareholders such as the founders of the business.[3]

The fundamental differences between an ICO and an IPO are that an ICO is an entry strategy by a startup to sell the project or product idea to enter the market, while an IPO enables an established private company to expand by diluting its ownership to the public.

Comparative table between an IPO and ICO

How to start an ICO?

Starting an ICO is not unlike a crowdfunding venture by an entrepreneur or startup that want to launch an initial coin offering. Typically a company will announce their plan to launch a token sale by publishing a white paper about what they intend to create and how the features and benefits of the tokens, including how much capital they are seeking to launch the venture.

The White paper is similar to a prospectus in an IPO in that it describes the project and the rights given to investors, determining the minimum and maximum amount of coins that need to be subscribed for the project to go live. The issuer through a smart contract on the blockchain instructs investors through their digital wallet to subscribe to a certain number of tokens[4].

Legal classification and regulatory frameworks

The regulatory status of cryptocurrencies, including tokens varies depending on the regulatory framework within that jurisdiction. Generally the consensus around ICOs is that they will fall within the existing legal regulatory regime.

ICOs raise a variety of legal issues with inconsistent legal doctrine and lack of relevant case law due to the wide variety of types of token and ICO set ups, it is not possible to generalise.

Below is a short comparative analysis of how different countries are classifying ICOs.

ICO Checklist

Before deciding on whether to participate in an ICO consideration should be given to the regulatory implications, legal structure, classification of the tokens and to be mindful of on-going compliance with governance as this is an area that is currently being developed by regulators in different jurisdictions. ICO’s are a new phenomenon. From a legal perspective the lack of regulation means that literally anyone can launch any project. As a dispute resolution expert I recommend t