Initial Coin Offerings: A regulated affair

 
With the increase in popularity of cryptocurrencies and blockchain-based solutions, an ever-growing number of technologically savvy entrepreneurs are attempting to raise capital through initial coin offerings or initial token offerings (collectively, “ICOs”).
 
For context, cryptocurrency, at a very high level, means a digital currency or asset that is created by an organization and which is not a traditional state-created fiat currency. It is traded like a commodity in exchange for other cryptocurrencies and sometimes fiat currencies. An ICO is basically an organization’s initial offering of their unique cryptocurrency, and in some respects is similar to an initial public offering of a corporation’s shares.
 
A blockchain is a running ledger of information that is verified in some manner and is stored simultaneously on numerous computers and information systems. When a package of information is duly verified (the processes for which will not be explained here), that verified “block” of information is permanently added to the running ledger or chain of information.
 
Some of the entrepreneurs referred to above, as well as some enterprising fraudsters, are engaging in ICOs in order to avoid the practical and legal complications of raising capital through traditional means, such as bank or venture capital financing, private placements of securities, and initial public offerings.
 
The issue is that, unbeknownst to many, in a number of cases an ICO will be considered to involve an offering of securities and will thus be subject to regulatory oversight of the appropriate security commissions.
 
On June 11, 2018, the Canadian Securities Administrators (“CSA”), which is principally a voluntary umbrella organization formed by all of the provincial and territorial securities regulators, released CSA Staff Notice 46-308 titled “Securities Law Implications for Offerings of Tokens”. This was in part a clarification of an earlier CSA Staff Notice, Notice 46-307, dated August 24, 2017, and titled “Cryptocurrency Offerings.”
 
The CSA confirmed its stated position that an ICO may involve the distribution of securities. This may be because an ICO may simply constitute a distribution of securities upon a reading of the appropriate legislation. This may also be because an ICO involves the distribution of an investment contract. The CSA has stated in part that when determining whether an ICO involves the distribution of an investment contract, “businesses and their professional advisors should assess not only the technical characteristics of the token itself, but the economic realities of the offering as a whole, with a focus on substance over form.”
 
In either case, very importantly, where an ICO involves a distribution of securities, the ICO would need to comply with appropriate securities laws. Exemptive relief may, however, be available.
 
The CSA has recognized that technological innovation lead by financial technology companies may outpace the development of the securities laws. In response to this recognition, the CSA has developed what it refers to as the “CSA Regulatory Sandbox.” This program essentially, per the CSA, provides “exemptive relief from certain securities law requirements to firms in the context of offerings of tokens that involve the distribution of securities, subject to conditions to ensure adequate investor protection.” Moreover, a number of the provincial securities regulators have designated certain persons or teams to administer such a program. 
 
The bottom line is despite some common wisdom to the contrary, an ICO may in fact constitute a distribution of securities that engages the application of securities laws. Further, if securities laws are engaged, it may, upon engagement with securities regulators, be possible to receive exemptive relief from the strict application of the securities laws.  
 
It is also evident that the navigation of securities laws as they apply to ICOs is complicated, and it is prudent that a firm seeking to launch an ICO receive the advice of appropriate professional advisors well in advance of the launch.