Legal risks of registering your digital tokens and how we solve them for KickCoin
Legal status of tokens is a very important topic for any founder or cryptoinvestor. Read what KICKICO’s very own law expert, Alexei Natarov, has to say about it.
What is a digital token and why does the government care?
It is only natural that blockchain technology attracts thorough attention from investors and businessmen because it makes international deals, information storage, and transfer significantly cheaper.
All blockchain technologies are based on peer-to-peer network and cryptographic hash algorithms. That is what guarantees that information is transferred within the network safely and openly with no risk of undesired modification.
A digital token is the asset produced by blockchain technology, a cryptographically protected verification that its owner has the right to access a certain value or perform certain actions.
Smart contract is used to issue and support digital tokens, or execute functions on the Ethereum blockchain. It is a code, that programs the order in which peers interact within a P2P-network.
Before blockchain came along a third party confirmation was necessary to guarantee the validity of data transfer. Such guarantees are provided by banks, exchanges, states or escrow agents. Now, with the decentralization of blockchain this mediator is no longer needed. Digital tokens and smart contracts allow direct transfer of digital values (Bitcoin, Ethereum etc.) and any other form of values in digital form (i.e shares, obligations, art, music etc).
This is how blockchain technology will change the whole business paradigm and transform many industries. This is why digital tokens are not your familiar e-money and a smart contract is not like a classic business contract; being different, they need their own government regulations.
Government regulations for ICO
Nowadays all the government regulation that blockchain technologies and cryptocurrency operations get is limited to official commentary from the financial regulating organs (i.e state bank or tax collecting establishment) or private statements made by officials. Any legal regulation is still in progress, although Switzerland, Singapore, and Gibraltar have taken promising steps forward.
For the further success of our project we at KICKICO are working together with law expert Alexei Natarov, the author of this article. We are paying a lot of attention to what is going on with ICO regulation around the world.
Until recently all the cryptocurrency regulation applied to exchanges and mining. Back in 2014 several states of the European Union (Luxembourg, Slovenia, and others) and the USA stated that cryptocurrency exchange platforms are Money Transmitters and therefore must follow the laws regulating these kind of services. For example, they must obtain a special license, log all the cryptocurrency operations and perform KYC (Know Your Customer). Exchanges could operate without a Money Transmitter License in Montana, South Carolina and New Mexico, and several US states came up with a special Bitlicense.
As for miners, the common regulation approach was the following: pay your taxes upon converting crypto to fiat and we won’t interfere. In some countries, like Germany, mining pools must obtain a license.
This regulation did not directly influence ICOs. But recently on July 25th, a new SEC report on ‘the DAO’ was released. It concerned the ICO held by Slock.it UG (Germany) and stated that any person or company issuing securities based on blockchain and offering them to US citizens or on the territory of the United States must register such an offer according to the US law unless there is a legal exclusion.
Then on August 1st Singapore MAS released a statement about digital token sales. It was noted that if the digital tokens constitute products regulated under the Securities and Futures Act, issuers of such tokens would be required to lodge and register a prospectus with MAS prior to the ICO, unless exempted.
So according to both the SEC report and the MAS statement each ICO must be considered separately to determine if its token is a security or not. Basically, the SEC and MAS just voiced what was already a common understanding among ICO founders and contributors.
Existing status quo for ICOs reads as follows: if a token is similar to a security by its nature then its issue and offer must be licensed according to the regulation of law. Now what was obvious for legal experts has become a standard for everyone on the market (founders, investors and promoters). This has caused a certain buzz in the media, mostly because many newsmakers ignored that the SEC and MAS both gave a hint that not all digital tokens are securities.
This came as no surprise to projects that cared enough to investigate the legal status of their token.
After government regulators explained the legal risk of ICOs, business owners have had to adjust and take the necessary measures to make their project compliant.
Is it a security or not?
This must be the first question to answer when starting an ICO.
As MAS stated in its report, ‘the types of digital tokens offered in Singapore and elsewhere vary widely. Some offers may be subject to the SFA while others may not be’. A digital token can be used to be exchanged to another value and therefore is a security. Another token serves as a representation of a token-holder’s rights to receive a benefit or to perform specified functions.
Studying SEC and MAS reports we decided that it won’t influence our decision to introduce our own digital token, KickCoin, with our upcoming ICO. KickCoin is not a security according to US or Singapore law.
Another way to check if a digital token represents a security or an investment contract — the Howey test. It says that to become a security a digital token should meet three criteria:
1) token is offered for money or another value (SEC’s ‘The Dao’ report adds cryptocurrencies to the list)
2) investments are made in a company
3) income that the token is to provide is earned by other people’s effort (passive income)
KickCoin digital tokens are meant to be used inside KICKICO:
- to finance crowdfunding projects launches
- to vote for projects on the platform. Community would support or downvote moderators and advisors on the platform using a small amount of KC
- to buy additional attributes for campaigns, such as badges
- to pay for additional services such as marketing, translations, artwork etc.
- other payments and processes inside KICKONOMY, which are currently in design
So when we offer KickCoins to our community we do not offer them shares in our company, rights to the product, or managing rights. KC are to be used only on the platform as an internal currency in KICKONOMY. It has a potential to make many processes easier and cheaper for our founders.
Unfortunately, government regulation for ICOs is still rather unpredictable, and our current understanding of it may be different from the one financial regulators have. We also understand that there might be some speculative activity with KC that come not from our offer, but from cryptoinvestors who would like to resell it.
For our community’s safety we’ve made a decision not to offer KickCoin in the USA since the notion of security and investment contract are very wide there and in the DAO report the SEC did not provide a detailed list of types of digital tokens. This may change if we get a commentary about KickCoin’s status from a US government regulator.
The mission of the KICKICO platform is to make crowdfunding better, faster and easier using blockchain technologies, removing the third party between founder and backer. This will lower the costs for startups, allowing them to spend more of their funds on the project.
This solution is currently used during Initial Coin Offerings or Token Sales.
We developed a system that uses smart contracts in crowdfunding to use on the KICKICO platform. Our goal is to make ICOs available to everyone, with no special knowledge needed.
We will have a constructor that not only creates a campaign (like Kickstarter), but a smart contract for it too. Right now we have successfully closed the PreICO and are preparing for our own ICO.
We do understand that it is necessary to be very cautious using blockchain and cryptocurrencies in crowdfunding and other business, because at this point there is no unified regulation or tax collection solution.
How to legally hold an ICO on KICKICO platform
As for now our advice based on the experience and research is this:
1. Monitor how the government financial regulators’ position on cryptocurrency and blockchain changes with time. It can influence the ICO procedure, cryptocurrency value, and taxes.
2. Follow the regulator’s recommendations if such are available. If you know that your digital token may be seen as a security or your business requires a license in the state your company is registered in, take preventive steps to make it legal.
3. Get a commentary from your regulator if you are not certain about the nature of your token.
4. Prepare an ICO plan far enough ahead to have sufficient time to meet all the necessary legal conditions. Registering a security digital token with the SECmay take 20 days.
5. Use a ‘sandbox’ — special legal zones that are established around the world to test new products without legal risks. You can find them in Dubai, United Kingdom (Gibraltar), and Singapore. Soon there will be a new one in China.
Today there is enough commentary on regulating the blockchain business and the legal factor can’t be ignored any more. Understanding the risks of cryptocurrencies we are going to use best practices to exclude money laundering, fraud and other unlawful activities on our platform. KICKICO will provide guides for the founders and strictly moderate projects to keep the business legal.