The long road to regulating ICOs

This year may be remembered as the one where Initial Coin Offerings (ICOs) began to seriously disrupt global investment markets, introducing start-ups and small companies to a radically new way of raising money by launching crowdfunding campaigns using cryptocurrency tokens.

ICOs, also known as token sales, are events where digital tokens are issued to investors over a blockchain-based platform for use in a smart contract. Issuers accept cryptocurrencies — like Bitcoin or Ethereum — from investors in exchange for a proprietary digital medium of exchange on the platform, which is referred to as a token.

By April, ICOs worldwide had already raised $6.3 billion for technology start-ups, which was more than that raised by ICOs in the whole of 2017.

Local regulations

In a big move for the UAE and a first for the region, detailed rules on ICOs are being prepared by the Emirates Securities and Commodities Authority (Esca), and will be enacted in the first-half of 2019, permitting UAE-based companies to raise capital via these crowdfunding events, as an alternative to traditional investment methods like venture capital and IPOs.

Esca is also working with stock markets in Abu Dhabi and Dubai to prepare trading platforms for these new cryptocurrency assets. The regulator has decided that ICOs will be considered as securities in the UAE for the purposes of regulation, and that digital tokens require a strict degree of oversight. It’s the view also shared by the majority of developed economies.

Mostly, investors purchase tokens after reading an issuer’s white paper, which will usually be a summary of the technological innovation proposed by the company and their target market.

Startups then use the funds raised from token sales to start or develop their projects. In some cases, a startup will also require that its tokens be redeemed to purchase its products or services. Future customers of the company will also need to purchase and redeem tokens for access.

Issuers may also have their tokens listed on cryptocurrency exchanges to trade against other cryptocurrencies, to create liquidity and value.

Investors in ICOs purchase the tokens at launch, hoping that if the product, service or network succeeds in gaining popularity, then the value of the tokens may increase, and could also be sold to other buyers for a profit on a cryptocurrency exchange.

These are investments with a very high degree of risk.

However, that has not dissuaded many average investors from participating in ICOs anyway.

Cryptocurrency has been actively transforming capital markets, and it is on the radar of the Gulf’s high-net worth investors.

Hot crypto-businesses

According to the Support Legal Group, which has experience structuring UAE-based technology start-ups operating in the crypto sector, regulating ICOs is an encouraging development for the UAE economy. However, there are questions about the Esca’s decision to regulate ICOs as securities in the UAE. Securities rules are difficult and expensive to comply with.

For start-ups, adherence is practically impossible until they have reached maturity. There are alternative views, which espouse a more lenient policy toward the peer-to-peer crowdfunding technology, in order to nurture this innovative finance raising method. The “hottest” locations for crypto businesses to set up are Gibraltar, Malta, Bermuda and the US state of Wyoming. Each has taken steps to pass some form of legal framework, and do not consider ICOs as securities. Instead, they have adopted nuanced policies that recognise the new type of technology behind crypto-tokens. They do not view tokens as having the features and characteristics of securities such as shares, debentures or units in a fund, and so the offer of such tokens is unlikely to be an offer of securities.

They argue it is better to manage these tokens with consumer protection and anti-money laundering laws, rather than with burdensome securities regulations.

Cryptocurrency has been actively transforming capital markets, and cryptocurrency is on the radar of the Gulf’s high-net worth investors, more than half of whom are based in the UAE and Saudi Arabia. Until the details are released, investors in the UAE should be wary of participating in unregulated ICOs, and understand what rights are attached to a digital token and what underlying factors could affect its value.

Also, it is important to be wary of guarantees of any future value, as there is no widely-accepted standard for placing value on a digital token.