Three Scenarios for Regulations Governing Initial Coin Offerings

By Nizam Ismail

Regulators worldwide are looking at Initial Coin Offerings (ICOs) with keen interest, as ICOs gain traction as an efficient manner of direct fund raising for blockchain-based enterprises. ICOs have also afforded an alternative means of investment for investors.

The approach taken by regulators thus far has been varied —

1. A handful of jurisdictions (these tend to be in the minority) have outrightly banned ICOs.
2. Some jurisdictions introduced specific regulations even for utility tokens.
3. Some have taken the view that so long as the tokens do not fall within the regulatory definition of securities or regulated activities, these are allowed or tolerated. Most regulators will have issued investor alerts on the risks of ICOs.

Gaps in Regulations

Financial services regulators often see it fit to regulate an activity as it crosses a materiality threshold. Regulators often consider issues such as assymetry of information (between issuers and consumers), conflicts of interest, market abuse (e.g. pump and dump schemes, market manipulation, insider trading) or consumer protection in general.

In the context of ICOs, impetus for regulation could focus on specific issues such as mandating certain disclosures in Whitepapers to enable investors to make informed decisions, regulation of forward-looking promises or projections, addressing liability for any false or misleading statements in Whitepapers, putting in place a framework for communications with investors post ICOs on evolution of projects, addressing market abuse on tokens that could take place in exchanges (whether they are regulated or not).

Regulators are also cautious about moving ahead of the game from their peers (especially in the absence of international benchmarks set by supranational bodies), and issuing regulations before they fully understand how ICOs work, and their impact (both positive and negative) on enterprises and the investing public.

Looking ahead, I would like postulate 3 scenarios on the future of ICO regulations.

Scenario 1 — Doom and Gloom

Under Scenario 1:

1. Most jurisdictions place an outright ban on ICOs.
2. ICOs take place underground or in certain “safe haven” jurisdictions.
3. ICO issuers tend to be dominated by opportunists and fraudsters.
4. Legitimate businesses are denied an access to funding opportunity.
5. Investors are denied an alternative investment opportunity.

Scenario 2 — Heavy-Handed Regulations

Under Scenario 2:

1. Regulations are very prescriptive, closely modelled after securities regulations (e.g. requiring prospectus requirements) and places a heavy compliance burden on issuers.
2. There are a limited number of ICOs, given the heavy compliance burden.
3. ICO issuers tend to be established companies which can afford the cost of running ICOs.
4. Startups and smaller companies will not be able to afford the cost of issuing ICOs.

Scenario 3 — Balanced and Sensible Regulations

Under Scenario 3:

1. Regulators work closely with industry to issue sensible regulations
2. The industry seeks it fit to introduce self-regulatory initiatives to complement regulations
3. Investor education efforts are carried out by the industry and regulators in collaboration.
4. A disclosure-based regime evolves, in name and in spirit.
5. ICOs are seen as a responsible way of fund raising by a wide spectrum of enterprises — startups, established companies and even listed companies.
6. Investors see ICOs as a viable alternative investment class.

Drivers for Scenarios

Here are some factors which will drive the outcome of the scenarios for ICO regulations:

1. Issuer responsibility: full and frank disclosures in Whitepaper, addressing and disclosing conflicts of interests, delivery of promises in Whitepaper, responsible marketing, responsible usage and accountability on proceeds of ICOs, continued engagement post-ICO.
2. Level of investor complaints on ICOs, which will depend on incidence of fraud or scams.
3. Extent of market abuse in exchanges
4. Regulators taking a keen interset in understanding mechanics and value of ICOs
5. Self-regulatory mechanisms by the industry.

This is likely to be a quickly-evolving space. The outcome of ICO regulations will largely depend on the interplay of these drivers.

Nizam Ismail is Partner and Head of Financial Services of RHTLaw Taylor Wessing, and co-Founder of RHT Compliance Solutions. He draws upon his experience as a former regulator, former prosecutor and former head of compliance of international investment banks, to advise blockchain companies on regulatory and legal issues. He is a Fellow in the Singapore University of Social Sciences, Head of the Regulatory Sub-Committee of ACCESS (Blockchain Association in Singapore) and a founding member of the Global ICO Transparency Alliance.