From the Blockchain to the ICOs Success: The Legal Challenges...2. CRYPTO VS. TOKENS AND SOME CHARACTERISTICS 2. (ICO) TOKENS Need another platform (e.g. Ethereum or Omni) to operate;

FROM THE BLOCKCHAIN TO THE ICOS SUCCESS: THE LEGAL CHALLENGES

Dr. Olivier Hance, Ph.D, LLM, MBA, TEP, ESQ.

Professor at the AMU & SHU Universities

Managing Partner at Hance Law Avocats

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1. THE TECHNOLOGIES:a) The Blockchain

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1. The Technologies:b) DAOs

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1. The Technologies:c) Smart Contracts (Example On Ethereum)

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1. The Technologies:d) Cryptocurrencies

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1. The Technologies:e) ICOs

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2. CRYPTO VS. TOKENSAND SOME CHARACTERISTICS

1. COINS (CRYPTOCURRENCIES)

Its own platform (Blockchain)

Function: Hold and transfer value

Bitcoin & AltcoinsAltcoins based on Bitcoins open-source protocol (but change of underlying code):

Namecoin, Peercoin, Litecoin, Dogecoin, and Auroracoin

Altcoins not based on BTC open course protocol (have created their protocols and blockchain):

Ethereum, Ripple, Omni, Nxt, Waves, and Counterparty

See https://coinmarketcap.com/ : list of coins with their platforms

I584 crypto-currencies and Total Market Cap: $334 772 207 112

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https://coinmarketcap.com/


2. (ICO) TOKENS

Need another platform (e.g. Ethereum or Omni) to operate;

Some tokens are issued to reward the servers running the Ethereum platform and a model to share computing resource and keeping some control on decentralised resources

ICO Tokens can have different functions: A Currency, used as a payment system between participants; A digital asset (a digital right) A means for accounting (number of API-calls, volume of torrent uploads)A share (stake) in a specific start-up Payment for using a system

689 ICO Tokens and Total Market Cap: $49 327 209 314

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3. (ICO) TOKENS ISSUANCE: TECHNICAL ASPECTS

Need another ICO platform to operate

⁼ A software platform through which the ICO can be conducted and token transactions validated

Different Platforms

Ethereum, Stellar, Omni, Waves, Counterparty, Bitshares, Ethereum Classic, and RSK

Each platform has its key technical or other benefits.

Ethereum = Smart contracts (with a specific standard largely widespread which allows smart contracts interoperability: ERC20)

Stellar is more focussed on market making and efficient order matching

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4. (ICO) SOFT AND HARD CAPS & TOKEN SALE MODELS

HARD:

Limit on the total contribution value that will be accepted; Once it reaches the hard cap, the organisation will refuse to accept additional contributions.

SOFT:

A soft cap is a total contribution amount which, once exceeded, will trigger a time limit on the remaining token offering period.

Those caps can be PUBLIC or HIDDEN

Various Sales Models including Fixed Exchange Rate, Dutch Auctions and Hybrid capped sales.

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5. TOKEN CHARACTERISTICS AND ECONOMICS

In Exchange of Bitcoin (BTC) or Ether (ETH) (the organisation then exchanges BTC/ETH against fiat);

Generally, anyone can buy tokens – however:

• Some prohibit US residents from contributing to avoid the US regulatory agencies

• Some required the investor to be an accredited investor to avoid securities law issues

Five Types of Tokens:

• Usage tokens: access and use a product or a service (form of prepayment)

• Equity tokens: provide equity-like benefits: profit sharing and/or voting rights

• Work tokens: allow the holder to work for the organisation and perceives revenues

• Community tokens: only allows a community to have its monetary policy

• Asset backed tokens: allows for implementation of some securitisation schemes through an ICO

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3. BLOCKCHAIN, DAOS & SMART CONTRACTS:LEGAL ISSUES

BLOCKCHAIN TOKENS & DAOs: Licences and Authorisations, Financial Law, Consumer Protection, Liability Issues, Legal Status, etc.

CRYPTOCURRENCIES: Civil Law, Tax Law, Money Laundering, etc.

SMART LEGAL AGREEMENTS: Legal Layer: e.g. enforceability?

BLOCKCHAIN & DATA PROTECTION: Data Protection, GDPR, etc.

INTELLECTUAL PROPERTY ON THE BLOCKCHAIN: IPR Protection on the BC and the BC to secure IPR protection

INTERNATIONAL PRIVATE LAW: Choice of Law and Choice of Jurisdiction

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1. BLOCKCHAIN LEGAL ISSUES:


A. DAOs ARE NOT RECOGNISED AS LEGAL ENTITIES, BUT…Uncertainty on DAO’s Legal RightsUncertainty on DAO’s Legal responsibilities and overall liabilityThey have a lot of internal rules, but little help when interactive legal system

(although commercial code could use them as the commercial good practices)

SOME POTENTIAL QUALIFICATIONSCourts could qualify (absent constitutive docs) as JV or General PartnershipThe adoption of the legal status of Protected Cell Companies (PCC) has also

been recommended

JURISDICTION AND APPLICABLE LAWDAOs could be created by many international contributors, some known, some

not… DAO’s tokens cannot be considered as shares if no entityShall it nevertheless be treated as securities? How to assign the ownership in the

product of contracts?

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2. DAOs LEGAL ISSUES:


B. CONTRACTING, TOKENS & LIABILITIES

CONTRACTING WITH DAO:

As of the first DAP, it was necessary to offer the contractors a legal service structure to invoice. The first service company was incorporated in Switzerland.

QUALIFICATION OF PARTICIPATORY TOKENS:

Means of access and voting to technological experiment on the Ethereum ecosystem + But also investment and potentially monetary value. Therefore, risks of qualification as a security and their sale as the sale of investment contract

LIABILITIES OF DAO & PARTICIPANTS: Liability Issues, but who is liable?This shall depend on the legal qualification of the DAP: if the partnership or JV,

it would be the members who would be liable. An avenue might also be to consider the service company liable, but this is

not obvious when the service company has a very limited role.

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2. DAOs LEGAL ISSUES:


A. SMART CONTRACTS & CONTRACTUAL FREEDOM

SMART CONTRACT? Execution of a contract by a computer when a consensus has been reached and when certain conditions are met. The technology allows therefore the programming of transaction implementing a business logic Therefore this implies and allows remote and complete performance of contractual obligations without interaction of a third party.

CONTRACTUAL FREEDOM: The parties of a contract should be allowed to decide to use the blockchain enabled automation of obligation enforcement. From this angle, nothing new compared to EDI. Except that the EDI operations are based on real world contracts which specify the security measures, the applicable law, and the competent jurisdiction.

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3. SMART CONTRACT LEGAL ISSUES


B. SMART LEGAL CONTRACTS…

I. For a smart contract to be qualified as a “legal” contract, it would need to respect the legal conditions of the contracts: mutual intent of the parties to be bound by the consequences of the contract.

II. The smart contract could certainly be a tool for enforcement of a contract. This is already the case (spit of coins between different parties at an ICO and notably the ICO service provider agreed in contact and inserted in a smart contract).

III. This could mean significant relief for enforcement and judiciary system. However, the smart can only play this role if the code is correct, i.e. shall execute the intent of the parties.

IV. There are Industry Initiatives to allow those “smart legal contracts” e.g. OpenLaw with legal agreement templates which can be modified and then embedded in a smart contract. The project also works on the negotiation of those contracts via Ethereum and integration with payment processors.

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3. SMART CONTRACT LEGAL ISSUES

4. CRYPTO-CURRENCIES: REGULATORY ISSUES

• E.g. EBA (13/09/2013), EBA Opinion (04/07/2014), CSSF Position (14/02/2014) & CSSF (14/03/2018)

1. Most of the authorities have emphasised technical and legal risks:

• ECJ (22/10/2015): mean of payment (therefore no VAT of fiat/crypto exchange);

• CSSF Position (14/02/2014): mean of payment + fiduciary money (scripturale) not cash money (fiduciaire);

• ECB (12/10/2016) & CSSF (14/03/2018): mean of exchange

• 5th Directive AML & CSSF (14/03/2018): no legal status as money

2. Legal status of Crypto-Currency

• CSSF Position (14/02/2014) & CSSF (14/03/2018)

• Pragmatic approach and the applicant must submit the business plan to CSSF

3. Lux: Crypto Issuers or Crypto/fiat Exchange platforms require a minima a payment service provider license & could be as e-money institutions

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4. Success stories in Luxembourg

SNAPSWAP:

October 2015: E-money provider license

Use, hold, and transact cryptos

First licence in the EU wit passporting to all the EU countries

BITSTAMP:

April 2016 (Effect 01/07/2016): E-payment provider license

Fiat/exchange platform

Advantages for Bitstamp (channels with banks) and protection for consumers

BITFLYER

January 2018: E-payment provider license

Fiat/Exchange Platform

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5. Timing is Key!

Bitstamp: 2 years to get the license

“Your license in 6 months”?

40 entities in the pipeline?

6. & EU Institutions?

In favour of the process

However, largely pro new regulation, e.g. EU Parliament Resolution 26 May 2016

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5. ICOS: LEGAL & REGULATORY ISSUES

1. CONSUMER PROTECTION

No requirement of Technological and Legal Due Diligence (vs. IPO);

No pre-review and approval of the contractual documentations which can contain very dangerous provisions for the consumer;

No protection against a glitch/flaw in the smart contracts (rare, but happened with DAO in 06/2006)

Token Valuation is not reviewed or audited – no protection against risks of pure bubbles or even Ponzi Schemes.

Risks for unexperimented consumer not to main or secure keys and to be stolen by a hacker. This is very severe, as when the security is compromised, it is forever and with no possibility of “password resetting”

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2. Criminal Risks

Hackers attack (see above: DAO of private key compromised)

Phishing Scams: the criminal impersonates an organisation starting an ICO. Once the payment of the crypto has been made, it is irreversible. They usually register domain names close to the ones of the real organisation or hack a real organisation and change the address of payment

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A. USE OF LOCK UP AGREEMENTS

In IPO, there are Lock-Up Agreements & Provisions: the founders or key executives cannot sell rapidly their shares and run away with benefits.

Protection against founders selling an overvalued company

Those cash-outs in BTC or ETH can create market price distortions, especially as they go along with other massive exchanges post ICO to pay bills and finance projects

They could be fixed by best practices

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3. MARKET REGULATIONS


B. Market regulations against market manipulation

Small Community: Very few powerful players, less than 50, a lot of them in Russia and China;

Manipulation in the first days of the ICOs: the promoter borrows for one week BTC, for instance, to buy the token and simulate success of the ICO. This pushes the price up and launches the IPO. Those tokens are then sold with substantial benefits after the tokens appreciation.

Insider information: temptation to conclude deals with platforms or between large platers on the basis of inside information. Criminal law not adapted.

Pure manipulation and fraud to investors: some association of players can decide jointly to sell massively tokens to decrease the value. When the investors buy massively (with loans in BTC) and when the price sky-rockets again, they sell… Pumping and Dumping. Criminal Law not adapted.

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B. Market regulations against market manipulation (Continued)

Release and communication of false or misleading information: to influence the pricing of a listed instrument. Pumping and Dumping. Criminal law not adapted.

Spoofing through non bona fide orders: a trader submits a buy or sell order and cancels the order before execution. Objective = manipulate the market price by pushing the other investors to follow the move.

Spoofing tough Scare walls: the trader buys a very large buy order at a certain price. This pushes others to offer at a higher price, otherwise their orders shall not be executed.

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AML Regulations vs. Anonymity of the buyers & Tax Evasion

Tokens are sent from and to crypto-addresses, but the buyer is not necessarily identified. Technically the buyer could be identified, but some blockchains are organised to protect this anonymity (e.g. Montenegro);

There is also a serious risk that the investment in the cryptos might itself be a means to achieve money laundering or to use so laundered money;

The operation of the ICO itself may constitute a tax evasion (e.g. no declaration of realised capital gains)

Regulatory Treatment of the ICO and Financial Law:

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4. REGULATORY ISSUES


China (04/09/2017) ICOs are banned and completed ICOs have to refund their token buyers;

Singapore: AML & Financial law if securities are issued (registration of prospectus with MAS) and registration of the intermediaries (Statement MAS, 01/08/2017). For the others, no direction and no guidance.

US: AML & Financial law if securities are issued (25/07/2017, SEC: Security qualification depends on the economics of the transaction, e.g. profit sharing) + registration of many players (e.g. brokers). If not security: not clear.

Russia: AML, Focus on Taxation (Capital gains) & Financial Law?

UK: Sandbox to Blockchain companies to test innovative products without respect of all regulations.

EU: AML.

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5. REGULATORY TREATMENT OF ICOs & FINANCIAL

LAW: INTERATIONAL – CLASSICAL TOUR


A. SWITZERLAND FINMA Guidelines (16/02/2018): Crypto-friendly, Zug canton, but AML & Financial

Law if securities issued. If not, seems to be unregulated + plan to introduce a crypto friendly license (comp. Gibraltar).

Positions taken are very clear in terms of securities Payment tokens: are NOT treated as a Security Utility tokens: if they are not for investment purposes: then NOT treated as a security Asset tokens: treated as A SECURITY (this covers rights of interests sold as the occasion of

an ICO)

Position completed by the qualification as deposits or Collective Investments: in principle no but depends on explicated criteria

Very practical approach with a table of solutions provided + a questionnaire for interested parties + a fintech special e-mail to send the request for qualification of the projects

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LAW: INTERATIONAL – INNOVATION TOUR


B. Malta

New Consultation (finished end of March) on creation of the Malta Digital Innovation Authority, Framework for providers & new Virtual Currency Act: a new authority + a certification by auditors and legal status for decentralised platforms and smart contracts + the IT auditors shall also certify the ICO from a technology standpoint;

Adoption of a clear “Financial Instrument Test” criterion to determine if securities law is applicable.

For the ICOs which do not offer securities, there shall be disclosing obligations, regulation of white paper and licensing requirements for some providers.

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C. Gibraltar

GFSC February 2018:

AML & Financial law if securities are issued (registration of prospectus)

Need to adapt a clear legislation for all ICOs recognised

Regulation needed for the ICO and for all the main intermediaries

with the key points covered: AML, financial crimes, regulated sponsors, codes of practice, public register & new criminal offence + regulation of intermediaries and providers of ancillary services.

Objective: the three regulations should be adopted by the end of October 2018.

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D. Lichtenstein

• Fact Sheet on ICOs, 10/9/2017;

• Emphasized clearly all the ICOs’ risks

• The design and the function of the tokens are decisive to implement a regulatory framework. Even the AML depends on this.

• In principle: the tokens which have characteristics of equity securities or other investments require the publication of a prospectus

• It does dot seem that the rest of the ICOs are regulated or that there is an intention to regulate;

• In fact, it is only recommended to submit the white paper and a business plan to the FMA for be confirmed that a prospectus registration is not required.

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E. Luxembourg

CSSF Warning, 14/3/2018

No specific regulation, no guarantee, no regulatory protection & high risks!

For all the ICOs: AML Procedures;

CSSF’s threat to consider that the ICOs could be regulated by applicable financial law and ICO could be an attempt to circumvent this regulation…

no clear definition, no precise criterion. Still very vague and not instrumental for the clients.

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5. ICO RELATED AGREEMENTS

This a misconception. This is not the practice anymore.

Even small ICOs have a more elaborated set of contractual documents.

But this misconception is largely spread: Lawyers, National Regulatory Authorities, Providers

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1.“Misconception/ There is only a White Paper”

5. ICO RELATED AGREEMENTS

TEASER;

PRIMER;

OTHER MARKETING DOCS PUBLICLY CIRCULATED.

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2. MARKETING DOCUMENTS WHICH NEED LEGAL REVIEW

3. LEGAL AND CONTRACTUAL DOCUMENTS

WHITE PAPER: can be very detailed and very complete.

TERMS & CONDITIONS: crucial document which can contain very crucial provisions. Those T&Cs regulate the ICO or the pre-ICO if there is one;

PRE-ICO PURCHASE AGREEMENT;

TOKEN PURCHASE AGREEMENT ( e.g. SAFT).

MANY THANKS!

[email protected]

www.hance-law.com

+352 274 404

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Documents

From the Blockchain to the ICOs Success: The Legal Challenges...2. CRYPTO VS. TOKENS AND SOME CHARACTERISTICS 2. (ICO) TOKENS Need another platform (e.g. Ethereum or Omni) to operate;