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September 20, 2017

Overview and Analysis of ICO Regulatory Developments

This piece is part of our series looking at key issues related to the evolving token sale / ICO markets. We believe ICOs represent a genuine innovation with long-term potential, but we recognize the industry is currently experiencing growing pains, a wide range of project quality and sincerity, and popular misunderstanding. We are developing a framework for industry self-regulation and best practices that will help address these issues and create an even stronger foundation going forward.

Executive Summary

This piece is part of our series looking at key issues related to the evolving token sale / ICO markets. We believe ICOs represent a genuine innovation with long-term potential, but we recognize the industry is currently experiencing growing pains, a wide range of project quality and sincerity, and popular misunderstanding. We are developing a framework for industry self-regulation and best practices that will help address these issues and create an even stronger foundation going forward.

In this report, we lay the groundwork for this forthcoming framework. We put the key issues being discussed publicly in the context of broader market practices and the historical regulations around consumer and investor protection. We also summarize the past several months of regulatory action around the world, including developments in North America, China, and Europe, and attempt to distill implications from noise and sensation. These developments co-exist with a broader trend toward government adoption of blockchain technology and signs that the industry is already maturing, as we discussed in our recent commentary on Trends in Token Sale Proposals. Ultimately, we argue for cautious optimism that governments are taking measures to legitimize token sales rather than squash them, and that many companies issuing ICOs are already taking steps to anticipate regulatory concerns.


The subject of regulating Initial Coin Offerings (ICOs), frequently referred to as token sales, has lately garnered significant global attention amidst both an enormous increase in the size and scale of ICOs during 2017 and increasing concern that small investors may suffer losses at the hands of volatile, misrepresented, misunderstood or simply poorly conceived. Much of this so-called concern for small investors has taken the form of overgeneralized, breathless and frequently unsubstantiated statements that “ICOs are out of Control,” “Many ICO are scams” and that “The Mania poses a danger to retail investors,” to borrow several sub-headings from a recent Fortune piece.

Without unduly downplaying these concerns—we at Smith + Crown have consistently pushed the industry to adopt best practices—it is important to place these concerns into context. In a world where two of 2017’s top IPOs in traditional public markets, SNAP and Blue Apron, have together lost over $7 billion in market cap after having their IPOs underwritten by major Wall Street Firms, where sophisticated venture investors have watched ‘unicorns’ such as Theranos lose billions in market cap while being exposed as highly misleading and incompetent, at best, and where even within the highly regulated context of financial markets in the United States utter frauds such as Bernie Madoff’s ponzi scheme can lead to investors losing more than $18 billion, one wonders if ICOs, where lifetime raise totals amount to approximately $2.1 billion, truly represent the virtually unprecedented danger to the financial system that some may have us believe. Moreover, the ostensibly terrifying “Wild West” nature of the token sale market is continually contrasted with the supposed frictionless, rational, and perfectly functioning mainstream markets. Never mind that, as illustrated by this Bloomberg article describing the range of embedded conflicts of interest behind the scenes of the Snap IPO, and which shape virtually every other IPO, those idealized markets are little more than hallucinations.


Regardless of one’s perception of the actual danger to either investors or the broader industry, the growth of ICO listings and the amounts raised by ICOs both individually and collectively have been enormous, particularly over the last six months. This growth, and the development and maturation of the industry it represents, is occasion enough to reconsider the subject of best practices and how the industry can and should push itself and be challenged to evolve. As a research firm with a strong understanding of the ICO market we are close to the data and observe first-hand as trends within the industry emerge and evolve. Finally, our established position as activists arguing publicly for the industry to adopt and refine best practices, be them formal or informal, qualifies us to weigh on this matter that is both pressing and too often discussed in sweeping, generalized and less-than-fully informed manners.

Below we survey recent developments relative to the question of regulating ICOs, then share our views about what formal (regulatory) and informal (industry best practices) steps we feel would most effectively help the industry move forward in a constructive manner. Ideally a balance can be found allowing new projects to emerge and continue to raise money from a wide pool of  future users, community members, and investors and in a way that also encourages the most promising projects to attract the broad and enthusiastic support they merit within an environment where project supporters, investors, and regulatory bodies can all find satisfaction with an evolving field of best practices relative to crowdsourced ICOs.

Brief Detour into the History of Consumer and Investor Protections in the United States

Regardless of whether ICOs are securities offerings, they at least constitute some kind of financial transaction, and regulatory structures that govern two of the most important kinds of transactions—consumer purchases and investments—will be relevant. As such, a brief historical detour exploring the underlying intentions behind what has become a complex network of regulatory structures in the United States is useful.  We take the United States as our example because Smith + Crown is based in Portland and because American financial markets are often considered to be amongst the most developed, in many cases setting standards that are adopted or emulated in other jurisdictions.

The broadest theme of the protection of consumers in the United States is generally one of legislation emerging piecemeal as a response to specific historic moments and concerns. A well-known yet relevant example is Upton Sinclair’s 1905 expose of the horrific conditions within the Chicago meatpacking industry. The outrage generated by publication of The Jungle and other muckraking writers and publications of the era was directly responsible for the creation of the Food and Drug Administration (FDA.) Related to the FDA is the Federal Trade Commission (FTC), born out of Woodrow Wilson’s trustbusting actions of a similar era, which focuses upon unfair, deceptive, or fraudulent practices affecting consumers. The FTC also includes the Bureau of Consumer Financial Protection which has a variety of areas of authority related to advertising, marketing and financial practices. While the FTC has not been an active participant in public conversations or enforcement activities related to the ICO markets, its role as an investigative body relative to consumer complaints or accusations of fraud suggests that it would be unsurprising if some of the worst actors in the ICO space find themselves with opportunities to meet some of its representatives in the future.

More frequently mentioned in conversations about ICOs and regulations is the Securities and Exchange Commission (SEC). Just as the FDA and FTC emerged from specific moments, so too does the SEC have its origins in a specific moment. Historically, throughout the 19th and early 20th centuries opposition to attempts to erect regulatory structures governing financial markets in the United States was very strong, particularly in the booming years following World War I. The market crash of 1929, and its widespread repercussions, led to congressional hearings and enquiries, the creation of the Securities Act of 1933, and ultimately the establishment of the SEC in 1934. The SEC is tasked with two broad rubrics, protecting investors from fraudulent activity and ensuring market integrity. These, in turn, are supported by two broad, overarching guidelines, that:

  • Companies publicly offering securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.
  • People who sell and trade securities—brokers, dealers, and exchanges—must treat investors fairly and honestly, putting investors' interests first

While the current level of either wrongdoing or concern regarding ICOs is hardly of a scale comparable to that generated by Upton Sinclair’s era or work, two important observations emerge from this historic consideration. One is that much of the most significant legislative activity is in United States has been in response to specific moments. The second is that the general theme of protecting investors from fraudulent activity is a commonsensical, well-intentioned, yet broad directive that could easily justify a wide range of official interventions into the ICO markets and broader cryptocurrency space. The industry would be well-served to collectively work towards the establishment of a widely followed set of best practices. This would help the industry improve its image, would create an environment where fraudsters and their practices would clearly stand out, and would encourage regulators to maintain a generally light touch towards the activities of the primarily good actors within the space, one that understandably addresses the often justified concerns of regulators and investors yet allows the industry and its novel technologies and practices to continue to develop and evolve. The alternative is allowing this current surge in ICO interest to become its own historical moment that prompted a wave of retaliatory regulatory actions.

Trends In the ICO Industry

Much of the impetus for these discussions of the need for regulations or self-regulation of the ICO space is a direct response to the growth of the ICO market during 2017. The below chart shows monthly ICOs and the amounts raised and makes clear why token sales have suddenly received such attention.


The scale of this growth illustrates why this trend would attract the attention of regulators, as well as the press, hackers, and fraudsters, all looking to exploit these trends in the interests of job security.


Equally troubling, the mainstream press has been having a field day chronicling the progress of the cryptocurrency markets and particularly ICOs. Celebrity endorsements by Floyd Mayweather and Paris Hilton that border on the ridiculous, incessant banner ads flashing “Last Chance!” “Buy Now!” and “Don’t Miss Out!” give a virtual feeling of actually being in a 19th Century Gold Rush outpost, and the emergence of misconceptions such as “They raised $10 million with only a cobbled together whitepaper” certainly create a strong contrast, at least superficially, with traditional investment worlds as they are commonly imagined. And in keeping with the image of a “Wild West” Gold Rush town with lurid tales of the frauds and fraudsters lurking behind every corner, or perhaps white paper in this context, abound in the mainstream press where getting clicks often appears to be more valued than trying to tell a nuanced story.

As if often the case, the realities of the ICO world are considerably more complex. On the one hand, the practice of employing banner ads, whether aggressive and obnoxious or more restrained, truly is a bad practice that only makes the entire space look shady. If a company cannot cultivate an audience for its tokens amongst potential users of its service, or professionals in its sector who understand the role and value of its project, it should probably not further undermine its image and prospects by flashing “Don’t Miss Out!” above a link to its token sale at random internet users. But if banner ads understandably have a massively disproportionate effect in shaping public perceptions of the sector, (while also aiding the SEC to compile a shortlist of companies to potentially investigate for unlicensed securities dealing) the reality is only a small percentage of ICOs employ them. Unfortunately we have not tracked as a separate category the fundraising or subsequent performance of ICOs running banner ads, but we can say that none of the top ICOs have them.

The case of celebrity endorsements, regardless of whether #Thisisnotanad accompanies the image or not, is equally fertile as an opportunity to evaluate the sector. While Mayweather’s ads in favor of ICOs are simple advertisements where one can debate their taste, quality or efficacy as with any other form of marketing, Paris Hilton’s appearance lends itself to a more substantial discussion. When Hilton promoted Lydian Coin, adding #Thisisnotanad to the Instagram post, she only raised further questions. She suggested she is not being paid for the ad because she, like any investor, is planning to buy Lydian tokens in the ICO. However, given the utter lack of disclosure in the ICO world it is entirely possible that some other arrangement, something resembling what most people would consider “compensation,” could also have been arranged. If a company, for instance, wanted to organize a super-special pre-sale for a favored client to buy 1 million tokens, or 10 million, for $1, prior to the public sale, investors would be completely unaware of this transaction. Not only do investors have no way of uncovering the details of any such transaction, not even as an anonymized expense under “marketing costs” as a public company would do that would at least provide a glimpse of amounts dedicated to marketing, but this highlights the utter lack of transparency in the ICO space. This issue of lack of disclosure pervades the space, from lack of clarity on corporate structures, to token ownership, token ownership rights, or even financial affairs, and is both a red flag for regulators but also a limitation on the sector’s growth and public image.

While a number of voices have been raised from within the industry addressing this state of affairs, many of the most energetic responses have come from global securities regulators charged with ensuring market compliance and protecting investors. From places as diverse as China, Singapore, Russia, Canada, Thailand, Hong Kong, England, and the United States, to cite a portion of the list, numerous comments and warnings have been made. These arguments generally fall within a few key themes. One, rooted in the history and broad concerns of consumer and investor protection, makes repeated mention of the risks posed to individual investors by these trends. The second is a widespread sense that ICOs and the companies employing them represent important trends and innovations that are worthy of consideration. Many regulators have expressed both a nuanced appreciation of the need to consider ICOs on an individual basis, given the variety of structures they can take, even as worry over how the nature of these innovations represent challenges to existing regulatory structures and practices. These regulatory responses, as seen in the United States but in large number of additional countries, also include in nearly every instance the statement that a number of these ICOs are, despite the claims of their backers, likely most accurately described as securities. China’s recent decision to decree a categorical ban upon all ICO appears to represent a third approach, whether that decision becomes permanent or not. Our final observation is of a consistent tension between different regulatory bodies even within individual countries as they offer different and frequently conflicting assessments of the blockchain, cryptocurrencies, and ICOs, and the risks and opportunities they present. This tension further complicates the situation for the industry, as possible actions and rulings could come from a variety of bodies.

Key Regulatory Developments


Gibraltar Welcomes ICOs

One useful starting point for considering some of the different official statements and views begins, in a sense, in Gibraltar where the government issued an initial consultation document on cryptocurrencies in January 2016, expressing a desire to launch a dialogue about how Gibralter might create structures and regulations supporting the emergence of new startup activity on the island. The process became more formal in mid 2017. In May of 2017 Gibraltar’s Digital Currency Summit explored ideas to more formally welcome, and grant legal status to, blockchain-focused companies as well as companies conducting ICO’s. While no formal results have been issued to date, regulations have been targeted for January 2018.

Switzerland Maintains its Role

Another country that has taken a generally welcoming stance towards the industry is Switzerland. Long known as a global financial and banking center, the country’s emergence as a center of blockchain and cryptocurrency activity is in some ways unsurprising. Neither has the development of this role been accidental, as the Swiss Government has deliberately created a regulatory environment welcoming these startups even as a number of Swiss municipalities have emerged as active participants in the development of different blockchain based programs related to civic and administrative roles and functions. Examples include digital identity projects or programs for some tax payments to be made in Bitcoin in the Canton of Zug, and even the Swiss Railways selling Bitcoin at ticketing kiosks. While some efforts to support more welcoming environments for cryptocurrency startups have been defeated in the Swiss Parliament, the overall trend of Switzerland representing a highly welcoming atmosphere for the sector, whether through government grants, the interest of Swiss universities in working with start-up companies, or supportive tax policies, remains firmly in place.

The US SEC Says DAO Tokens Were Securities

If the openness of Gibraltar and Switzerland towards facilitating the growth of the blockchain and crypto community represents a clear positive trend, any mood of optimism those developments generated was dampened in July 2017 when arguably the most publicized of recent regulatory moments, one that established a climate of uncertainty that continues to hang over the market like a Sword of Damocles, made news. The event in question was the SEC’s well-publicized ruling that The DAO tokens should be considered securities. In many ways this ruling was unsurprising, even expected by many. The basic tenants of the Howey test in determining whether a financial product qualifies as a security (that of investing money in a common enterprise with the expectation of profit to come largely from the work of others) are clear, and while there is debate about how many of the recently issued tokens fail this test, at least a few instances have provided clear examples of tokens that are most accurately described as securities. That the SEC would state as much was not completely surprising. Often overlooked in reactions to this ruling was the relatively nuanced and open-minded SEC comments to the effect that the declaration of a particular token as a security would depend upon the specific facts and circumstances surrounding each sale. This last can arguably be viewed as the most significant aspect of the ruling by suggesting that the SEC maintains a degree of open mindedness towards classifying tokens with distinct uses and attributes under different statutes. As for the ruling that some tokens are best considered securities, we are reluctant to view this as a dramatic moment for ICOs, for—and this will be discussed at length below—many of the implications of classifying a token as a security are already beginning to be addressed by the industry as the developing trend of growing self-regulation, professionalism, and refinement of best practices towards which the industry is moving.

Other SECs: Some ICOs Might Be Securities Offerings

That less than a week after the SEC ruling The Monetary Authority of Singapore (MAS) issued a virtually identical statement, to the effect that the tokens sold in some ICOs may well be classified as securities, only illustrates the relatively unremarkable nature of the SEC ruling. The variety of nations that have since seen one or another regulatory body issue a similar warning about the potential risks posed by ICOs has since become considerable, including Russia, Canada and England, to cite just three, to the extent that such comments have almost ceased to be noteworthy each time another such comment is made.

Meanwhile, Governments Are Embracing Blockchain Technology

The second theme of our consideration of the ways governments are relating to ICOs and blockchain related projects is to point a wide range of tentative and exploratory steps to embrace blockchain technology and its functionalities into the business and operations of government. That many of those countries where securities regulators are pointing out the dangers of cryptocurrencies and ICOs also have branches of government actively exploring ways to incorporate blockchain technologies represents an obvious point of tension. In the United States—somewhat ironically considering that the SEC DAO ruling and general concern about possible regulatory action from the SEC continues to cast a global shadow over the industry’s development—there are several government projects underway to incorporate blockchain technology. Amongst these, the U.S. Government’s Emerging Citizen Technology program is exploring a variety of ways of incorporating new technologies such as blockchain into government operations. Other projects have even extended to the municipal level, with Idaho’s capital of Boise recently announcing a partnership with Uledger to improve aspects of the city’s operations and recordkeeping. Ironically, this partnership between Boise and Uldeger, which is currently preparing its own ICO, was announced a day prior to the SEC’s chief accountant directing additional comments in the industry’s direction when he concluded a speech at a conference of banks and savings institutions with reminders that securities laws may apply to some ICOs and that while ICO issuers need to pay careful attention to their recordkeeping and filing status, even investors in ICOs need be concerned about the implications for their own tax status and potential liabilities. While Uledger’s coin appears to well outside the bounds of those considered securities, one hopes their record keeping will be of sufficiently high quality that the SEC will be able to avoid the awkwardness of raiding any offices in Boise amidst investigative or enforcement activities.

This pattern of conflicting messages also extends well beyond the United States. The news that an advisor to President Putin is planning a $100 million ICO to develop a large-scale bitcoin mining operation suggests a considerable degree of high-level Russian interest in the potential for cryptocurrencies. On the other hand, the Bank of Russia (which, incidentally, is not a regulatory body) has issued a series of warnings regarding the potential for small investors to suffer losses through involvement in cryptocurrencies and ICOs. These conflicting comments illustrate again one of the fundamental tensions surrounding cryptocurrencies and ICOs, that of high-level interest and a sense that significant new practices and structures are emerging, contrasted with repeated references to the concerns that small investors may suffer losses, perhaps even at the hands of sophisticated criminals or conmen.

China Bans ICOs

Any discussion of ICOs and regulation would of course be incomplete without discussion of China. Longstanding Chinese popular interest in Bitcoin, and commercial interest in cryptocurrency mining, hardly needs mentioning. Partly as a reflection of that interest, China has also had, for much of 2017, a booming ICO market with an estimated 65 offerings raising as much as $398 million from more than 100,000 individuals. However, estimates for the number of outright frauds amongst ICOs launched within mainland China have ranged as high as 90% of those offerings. If this number is even close to the truth it would represent a fairly compelling explanation of why Chinese authorities acted as they did in announcing their recent ban on ICOs. Responses have been dramatic and varied, as one might expect in the initial period following such a declaration. The Chinese Statement calling for ICOs to be banned, for funds received from ICOs to be returned, and for exchanges to stop trading in the tokens, appears definitive upon first reading. But a variety of observers have argued that this is merely an attempt to calm the market and restore order while the government attempts to better understand the situation. Time will tell, but concerns that the move represents the end for cryptocurrencies certainly appear overly dramatic.

Canada Introduces a New Pathway for ICOs

Like other countries, Canada’s securities regulators have also weighed in on the question of ICOs, the Canadian case is a particularly insightful one in terms of illuminating the tensions shaping official responses to the ICO trend. On the one hand, the Transactions and Reports Analysis Centre of Canada (FINTRAC) has issued the almost obligatory statement expressing its concern about the dangers of money laundering and other crime enabled by the anonymity of cryptocurrency transactions. As elsewhere, however, not every comment or reaction to emerge from Canada has been negative, and Canadian regulators have shown considerable flexibility in their approaches. While cautioning that many of the ICOs that have appeared in the market may most accurately be designated as securities, even if the sponsoring companies claim otherwise, they have also acknowledged that legitimate instances of token sales that are not considered securities do exist. Much like the SEC stated, the encouraging comment that “Every ICO/ITO is unique and must be assessed on its own characteristics,” illustrates a willingness to consider individual cases rather than resort to categorical, industry-wide bans. But if the above response from Canadian regulators represents the standard response amongst global securities regulators, other Canadian developments are more intriguing, and suggestive of future possibilities.

Perhaps influenced by the country’s relative familiarity with publicly listing venture-orientated companies such as mineral exploration groups or, more recently, medical marijuana startups, aspects of the official Canadian response have been considerably more innovative than those of their American neighbors, or most other countries for that matter.  One example comes from Quebec, where the province’s Autorite des marches financiers (AMF) has announced plans to allow Impak Finance, a start-up bank currently completing its own ICO, to enter the AMF’s ‘regulatory sandbox’ program for exploring new financial and investment structures and opportunities. By incorporating Impak into its structures the AMF is allowing Impak to bypass certain listing requirements associated with public companies, such as a prospectus outlining for investors the commercial enterprise and its operations, instead allowing Impak’s white paper to satisfy its listing requirements. (In reality, the solution seems to have been to upgrade Impak’s white paper so that it closely resembles an Offering Memorandum that any public Canadian company would file.) Most interestingly, spokespeople for the AMF have indicated that following the planned two-year trial the regulator will evaluate whether a permanent exemption from established securities filing requirements might be made for a wider range of ICO’s. Crucially, a key aspect of this evaluation will center around questions of investor protections, and perceptions of the adequacy of whitepapers and other ICO-related disclosures in satisfactorily explaining the nature and risks of investing in ICO projects. As an AMF spokesperson noted, "If nobody has made a complaint [asserting] that they weren’t protected enough in the sense of the securities and regulatory environment, then we’ll consider granting permanent relief to the filer.”  The results of this trial will undoubtedly be followed closely by a very wide range of public and private sector groups.

While the above statement is encouraging, a larger point of importance can be extracted from the situation of Impak Finance, specifically in observing that its white paper was of sufficiently high quality that it could be transformed into a document considered acceptable by financial regulators within a securities context. This suggests that at least in certain cases, the white papers filed by companies preparing ICO’s are becoming increasingly professional and containing much of the information that investors in a wider range of markets are accustomed to employing in their due diligence. This improvement in the quality of white papers and their disclosures and clarity towards both technical and business objectives is a trend we have been observing lately, likely linked to the growing presence of legal assistance in drafting white papers. While Impak was obliged to add a number of items and disclosures such as audited financial statements, clarification of the rights of token holders, a promise to maintain ongoing disclosures including audited financials, and for company executives to assume liability for the veracity of information contained in the white paper, the actual difference between this white paper and the best of the white papers already being written by the stronger projects we are seeing—regardless of whether they are actively seeking to market “a security” or otherwise win the approval of securities regulators—is actually rather modest. The implication is significant as it suggests a path forward for the entire industry that may well evolve out of these Canadian experiments. Importantly, if the industry was not already evolving to demand better white papers from companies preparing ICOs in terms of disclosures, business plans, and explanations of the rights of token holders, then the final steps Impak was able to make to upgrade its own documents would like have been too big a leap for the company to comfortably make.

A sense of the actual space between the strongest of the white papers currently being written and the demands of (Canadian) securities regulators is more clearly seen in examining a recent publication that has largely gone overlooked. The Canadian Securities Administrators (CSA) in an August 2017 staff notice on cryptocurrency offerings expressed their willingness to work with blockchain startups to allow ICO’s to find their place within the official world of investment alternatives. The notice also provides a more comprehensive consideration of the space between white papers and a prospectus or offering memorandum such as a public company raising would file in association with a fundraising, and in doing so illustrates how the requirements of regulators do not appear to be either terribly burdensome or too far ahead of where the blockchain industry seems to be leading with its own emerging standards and best practices, some of which we identified in an article last week. The CSA remarks that the tokens from certain ICOs are best described as securities, and that any tokens earning that designation must be regulated as such if the companies operate in Canada or have Canadian investors. Interestingly, the notice goes on to describe a scenario where ICOs complete anti-money laundering (AML) and know-your-customer (KYC) procedures and, in effect, substitute a slightly modified white paper allowing them to acquire an accepted status within the Canadian regulatory system. As the demands of the modified white paper are little different than the form the best white papers take today (e.g. project and sector description, use of funds, features of the tokens and liquidity, insider ownership of tokens, proposed timelines, management identity and background.) Other additions rarely seen in ICO documents include sections on the material risks of investing and on the remuneration paid of payable to the management team and advisors, as well as the inclusion of audited financial statements. These additions represent only modest changes from established practices and could relatively easily be incorporated into existing white papers. The final change that this CSA documents requires, at least in our reading of the document, is that while the CSA would allow the modified white paper to stand in for the more detailed offering memorandum or prospectus most companies are required to file, this would also trigger certain ongoing filing requirements while establishing the white paper as an official document for which the management team would be responsible, including facing civil penalties from investors should it subsequently shown to be have included falsehoods or misrepresentations.

Our interpretation of this document is that it is a highly significant one that will come to be seen as increasingly important. One reason is that the document offers, in effect, a roadmap even for companies with tokens that are classified as securities, to be accorded legal status within Canada—and from there likely elsewhere, including the United States—and to raise money from investors through an ICO. The additional requirements imposed upon companies hoping to follow this path—such as assuming liability for the veracity of statements in the white paper and filing audited financials—are rather modest impositions for honest, well-intentioned teams. Most striking about the proposals made by Canadian authorities is the recognition that the distance between where the industry has already arrived and a path to legal status in North America is relatively modest. Particularly promising is that an accommodation of this nature, with improved reporting and disclosure giving additional confidence to investors and comfort to regulators, could bring a new legitimacy to the sector that could ultimately proves crucial in allowing the space to grow into the next stage of its development where new, more mainstream investors and institutional capital have the confidence and legal clarity to enter the space and drive the next round of innovation.

Isle of Man

Finally, while these Canadian developments are promising, it must be noted that Canada is hardly the only region to make recent indications to the effect that developing structures to ensure legal status for companies completing ICOs, including those that list tokens that are clearly securities. The Isle of Man has an ongoing process exploring the creation of legal categories for cryptocurrency startups including those completing ICOs. Gibraltar has indicated that similar discussions are underway. While information on the exact proposals under consideration in Gibraltar have yet to be revealed, the original target for their release was no later than January 2018, so the date could well be approaching. Overall, we suspect the general principles seen in the Canadian example will reappear in additional jurisdictions until their basic ideas—well-prepared white papers with transparent disclosures effectively serving as security documents for which executives and directors are willing to assume liability and maintain ongoing reporting—will emerge as the industry baseline.

Conclusions and Thoughts on a Likely Path Forward

Amongst the most substantial trends we expect to see going forward is the continuing pattern of governments in different regions and at different levels moving to incorporate blockchain and cryptocurrency startups, as well as their funding and sale mechanisms, into legal and regulatory structures, and even to begin to compete to create welcoming environments intended to attract firms in the sector. Initial stirrings in this regard can already be observed. Just as Canada is exploring ways to create a sort of middle ground that allows ICOs to exist within current regulatory structures, the Isle of Man and Gibraltar are also exploring ways to create structures allowing ICOs to be legally compliant. An illustration of how this competition might play out comes from Switzerland, where the municipality of Chiasso recently announced it would be accepting bitcoin for some tax bills. In announcing this policy the Mayor of Chiasso hinted at competition with the nearby Swiss canton of Zug, also recognized as a hotbed of the blockchain-based startups operating within Switzerland’s “Crypto Valley.” Tellingly, and hinting at the logic that we expect will drive this competition between nations, regions, and municipalities, the mayor suggested that emerging fintech and blockchain startups offer opportunities for the region to rebuild tax revenues lost in the years since the financial crisis as the traditional banking sector has struggled, and that luring these new firms to the region was a clear goal. Similar motives were acknowledged in statements from the Isle of Man’s Department of Economic Development, where one official was quoted as saying “Our understanding and analysis of the ICO market is that it represents a massive vertical market for us.”

The idea of imminent competition amongst governments and regions to create the most welcoming business and regulatory environments for ICOs and the companies employing them may seem unlikely in the current climate of concern in the ICO market, over potential SEC statements, and over whatever ultimate policies the Chinese will develop regarding ICOs and cryptocurrencies more broadly. However, the somewhat ironic trend identified above, that of the intriguing tension between regulatory concerns about the risks posed by ICOs, and perhaps cryptocurrencies more broadly, with the speed at which the industry is growing, developing, and expanding into new areas, in part with the support of different government agencies that are themselves emerging as users of the blockchain in a variety of ways, provides a clue into the forces that may lead to an eventual resolution. Put another way, the obvious paradox of government agencies employing blockchain tools and technologies while securities regulators seek to limit ICOs, the main fundraising vehicles for many of those same companies, is both inescapable and a situation that will likely not persist.

At Smith + Crown our own views are that in the near future ICOs are likely to acquire far more accepted legal status, likely even for those tokens classified as securities. We expect this to arrive as a result of two intertwined forces. One, alluded to above in reference to competition between individual Swiss cantons, is the desire of governments to legalize the sector in order to capture the innovative activity, diverse business development, and ultimately revenue, that ICOs and the startup companies running them, represent. As governments seek to welcome ICOs they will explore the range of legal and regulatory steps that will strike the appropriate balance of market and investor protection in conjunction with the structures necessary to allow the industry to continue to develop. The second trend is the growing movement towards professionalism and best practices displayed by companies proposing ICOs, a trend we alluded to in an article last week. As this develops further we suspect it will both encourage regulators seeking to work with a rapidly emerging industry but also facilitate that convergence by bringing ICO best practices more inline with the basic concerns of regulators. The result will likely be, roughly as seen in the case of Impak Finance, that bridging the gap between the best practices and disclosures already seen in the better industry white papers and the requirements of regulators will be relatively straightforward for most projects.

Our position is that in many important ways best practices in the ICO space are already moving towards models that are relatively close to the requirements of regulators, often in a movement led by companies themselves as they seek to draw attention to their own best practices in order to differentiate themselves from the...less upstanding elements of the industry. If the industry, and particularly the lawyers, service providers, advisors, and investors operating within it actively encourage and even pressure companies towards adopting and furthering these best practices the pace of development and adoption of these new approaches can be further increased. The result would be beneficial to individual companies and the sector more broadly, especially as it would allow investors to participate in ICOs with more confidence, and even for new pools of capital to being to enter this sector, and even to ordinary internet users no longer subject to flashing ICO banner ads urging them to “Buy Now!”

In part II of this longer piece we propose a number of ideas we consider to be strong starting points for a broader set of industry guidelines and best practices. Amongst them we argue that the trends towards increasing disclosure prior to the sale itself, as well as promises of ongoing disclosures in the form of audited annual financial statements, lengthened vesting periods for insider token holdings, and efforts to reduce the frenzied nature of free-for-all ICOs that lend themselves to errors and scams must be central to any serious efforts for the industry to evolve. That many recent ICOs have incorporated some or all of these ideas suggest we are not too far ahead of the curve, but pressuring companies to make these ideas standard features of ICOs will win favor with regulators, increase the appeal of the sector to potential backers not yet onboard, and perhaps most significantly, shine a bright light on the limited number of companies not employing these best practices.