By Shane Brett, CEO and co-founder of GECKO Governance

Token sales are a relatively recent fundraising phenomenon used to launch new companies or fund future development projects. According to ICODATA.IO, startups raised more than $3 billion in the first two months of 2018, representing half the cumulative total of funds raised through Token Sales in 2017 ($6.1bn). Furthermore, the total number of Token Sales in the same period represents half of the total completed in 2017 – illustrating the continued popularity of this disruptive fundraising mechanism.

This exponential growth has led to the increased the attention of regulators across the globe, with regulatory bodies engaging with Token Sales and token issuers in a variety of ways.

Token Sales bear the hallmark of a crowdfunding campaign, but rather than offering a copy of a product, digital tokens are issued. These tokens commonly take two forms:

Utility Tokens: digital coupons giving contributors access rights to a product or service which will be developed using the token sale proceeds. Utility tokens do not confer ownership of company or project shares or equities, offer no financial dividends, and can be traded on the open market.

Securities: In contrast to utility tokens, some Token Sales are completed as registered securities offerings, with the tokens - which offer financial returns or serve as investment vehicles for contributors - are treated by regulators in a similar manner to equities, bonds, and derivatives.

While the regulatory regime for securities is well-established, the regulation of utility tokens is still emerging internationally, with major regional variations in terms of pace and potential implications for token issuers and holders.

Compliance with relevant regulatory standards is frequently promoted as 'best practice' for token sales, but there are limited cohesive guidance from regulators, leaving this fast-growing industry to self-regulate, or not regulate at all.

In response to the explosion of the crypto and token market, regulators in some jurisdictions have moved to block this new form of capital raising, but many recognize, and indeed embrace, the innovative potential of this emerging market, while recognizing that it needs to be accompanied with comprehensive, right-sized regulation.

For example, Token Sales are banned for all businesses and individuals by order of the People’s Bank of China. Chinese Token Sales that have completed their funding cycles must refund any tokens raised. The Peoples Bank of China have also indicated it will investigate any company or individual found to be in violation of this ruling.

By contrast, in November 2017, the European Securities and Market Authority ('ESMA') - the European super regulator - declared that Token Sales represent a high risk to investors and that firms dealing with Token Sales must meet relevant regulatory requirements. This suggests that the European Union ('EU') is ready to embrace Token Sales, representing a reversal of previously expressed skepticism towards the fundraising phenomenon.

The ESMA statement warned that coins issued in a Token Sale may constitute a financial instrument and may be considered as carrying out regulated activities within the EU. While noting that it is up to each individual token issuer to consider the applicable regulatory framework, ESMA highlighted AIFMD, the Fourth Anti-Money Laundering Directive, MiFID and the Prospectus Directive as those which are likely to apply.

Adopting a similar approach to European regulatory bodies, the Monetary Authority of Singapore ('MAS') has issued a guide on “Digital Token Offerings,” in a similar vein to the ESMA statement – outlining its expectations on the treatment of digital assets and tokens under current securities laws. The guide states that any Token Sale deemed a "capital market product" under the Securities and Futures Act can be regulated by the MAS. This includes tokens that infer an ownership interest in a corporation or product, debt, or a share in an investment scheme.

While the aforementioned regulatory bodies set out their approach to Token Sales with some clarity, the Canadian Securities Administrators has determined that Token Sales are to be considered as securities offerings but will only be subject to regulation on a 'case-by-case' basis. In an attempt the address this regulatory chasm, the Canadian authorities have developed a “regulatory sandbox” for the purposes of regulating fintech projects that would not normally fit into the national regulatory scheme.

The lack of legal and regulatory clarity surrounding Token Sales is even more pronounced in the United States, where Token Sale rules vary widely from state to state. State-specific legislation surrounding token markets range from instituting no regulatory frameworks at all, to regulations requiring deposits equal to or greater than all local transactions, to regulations requiring a license for businesses to engage in activities within the space.

Within the United States, there are currently no regulations banning Token Sales at a federal level, although Token Sales are expected to be registered and licensed the same as if they were not Token Sales, including registering with the Securities Exchange Commission if the Token Sale is to sell or trade securities. The SEC recently stated that some tokens may be classifiable as securities and may therefore be subject to SEC rulings in the future. A number of SEC commissioners maintain that the majority of Token Sales constitute securities offerings, and should be treated as such. As regulatory “best practices” develop over time -- Token Sales are increasingly expected to implement standardized AML and KYC procedures. Failure to adhere to these practices may leave a Token Sale open to legal action in the future.

Early Adopters

In terms of early adopters, Australia has been one of the first countries to formally launch Token Sale regulations, which require Token Sales that involve combined investment to adhere to the Corporations Act, to keep track of those shares (if the Token Sale issues shares), to issue a disclosure document, and acquire a financial services license where the Token Sale offers financial advice to customers.

However, like Canada, Australia has moved to issue draft legislation which would allow the establishment of a regulatory sandbox for FinTech startups, which would allow them to operate without being fully licensed.

The Isle of Man has gone one step further, and has confirmed that that the Island has been developing a permissive regulatory apparatus designed to encourage and facilitate the continued growth of the nascent Token Sale industry, defying current global trends.

Similarly, the Gibraltar Blockchain Exchange (GBX) is harnessing and promoting the growth of the blockchain industry and is aiming to be a world-leading token sale platform and cryptocurrency exchange, seeking to create a new era of trust, openness and global acceptance for the crypto industry. The GBX benefits from Gibraltar’s forward-thinking Distributed Ledger Technology Regulatory Framework which came into effect on 1 January 2018. With a wealth of international examples to choose from, it is apparent that the message being sent by regulators is that they are focused on existing regulatory requirements, reminding firms and potential investors that existing regulations may apply but that the onus is on those involved in Token Sales to make a determination on what regulations, if any, apply.

It remains unclear whether unanimously agreed guidelines will be issued soon for this nascent industry. A constant stream of regulatory commentary has forced token sale projects to take self-regulation seriously in the interim – so that they can attract a more traditional, institutional type of investor. In order to provide accountability, comfort and transparency to investors, an industry governance standard needs to be developed and embraced by the industry.

If the maturing blockchain and crypto industry is to provide accountability, comfort and transparency to market participants and potential investors, an industry governance standard needs to be developed and embraced by token issuers. Only a proactive approach to project governance and compliance will allow Token Sales to continue to flourish as dialogue surrounding regulation turns to action by national and international bodies.

Shane Brett is CEO and co-founder of GECKO Governance - the first RegTech solution that will manage the ICO governance process from start to finish.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.