Legal Uncertainty from Exchange Tokens and Initial Coin Offerings

Initial Coin Offerings: Issues of Legal Uncertainty Report: Initial Coin Offerings: 30 July 2019

1. Initial Coin Offerings (“ICOs”) typically use Distributed Ledger Technology (“DLT”) to offer transferable units (“coins” or “digital tokens”) that confer various rights on the holder of record.  ICOs can be considered a means of fundraising using blockchain technology.  The legal characterisation of ICOs has emerged as an integral factor in the discussion around their regulation.  Coins issued in an ICO may resemble a digital voucher of receipt in respect of rights.  The nature of these rights varies and, therefore, the characterisation of any given ICO is likely to be fact-dependent.  A closely-related question is whether ICO issuance—or any attendant primary or secondary investment activity—falls within the existing regulatory perimeter.
2. This paper provides an overview of ICOs and the legal uncertainties which could arise from framing ICOs under specialised regimes.
3. It analyses the existence of new market participants that are key to the cryptoasset market value chain and whether they should be regulated, including by considering whether activities of these actors that do not map neatly onto traditional regulated securities activities should also be regulated or permissioned. 
4. It also analyses the limitations of existing product regulation and activities in this field with examples of regulatory “underlap” and considers what kind of bespoke regime could be constructed from existing financial regulations.
5. http://fmlc.org/wp-content/uploads/2019/07/ICOs-paper.pdf

On 23 October 2019, the Financial Markets Law Committee (FMLC) published a paper discussing issues of legal uncertainty arising from exchange tokens.

6. The letter provides a brief summary of regulatory and non-legislative developments with regards to virtual currencies, and explores the possible characterisation of exchange tokens as property, money and e-money.
7. It also analyses the approach to virtual currencies taken by the EU in its anti-money laundering (AML) regime (that is, the Fifth Money Laundering Directive ((EU) 2018/843) (MLD5)), the uncertainty arising from such an approach and the impact of the uncertainty.
8. MLD5, which comes into effect in January 2020, is one of the first legislative frameworks to regulate the use of exchange-type virtual currencies.
9. As the FMLC explains, it exemplifies the difficulty faced by legislative and regulatory authorities in defining virtual currencies so as to capture their varied characteristics and functions.
10. The FMLC is concerned that the limited definition of virtual currencies in MLD5 could give rise to a number of unintended and unhelpful consequences.
11. These include the direct consequences of under-regulation and confusion as to the categorisation of virtual currencies and how legislative definitions apply.
12. In addition, there are the indirect consequences of increased criminal activity and attempts by entities to remain outside the regulatory perimeter.
13. The FMLC explains that the principle aim of MLD5 was to limit the use of money for the purposes of money-laundering and terrorist financing. The result of the exclusions in the definition of virtual currencies is that it leaves loopholes, by means of which persons or entities might be able to engage in those activities.
14. Among other things, the FMLC notes that it might be useful to use the non-legislative definitions of the types of virtual currencies in any attempt to legislate virtual currencies so as to provide market and legal certainty. In the context of MLD5, it suggests that guidance on what a "legally established currency" might be, or how EU and UK authorities perceive that a currency might attain the legal status of money, might be useful.
15. Following HM Treasury publishing a consultation paper on implementing MLD5, the FMLC wrote to HM Treasury, in July 2019, to express its concerns about its proposed definition of virtual currencies (
16. http://fmlc.org/wp-content/uploads/2019/10/Report-on-Exchange-Tokens-and-Money-Laundering.pdf