Initial Coin Offering, definition and regulation

Initial Coin Offerings (“ICO”) have gained increasing attention by crypto currency users, the media and the regulators. The rising price of Bitcoin, one of the most widely known and used crypto currencies, along with fraud scandals in different countries, have raised attention by the public and concern by the regulators. It is important for us that our clients and our professional team understand crypto currencies and ICOs to be able to make intelligent and well-informed decisions.

Initial Coin Offering, definition and regulation

Let’s start by addressing the definition of Initial Coin Offerings; an ICO, technically and more accurately referred to as a “Token Launch”, it is a vehicle to raise funds from investors and users alike, for the purposes of this article, we will refer to “Token Launch” or “ICO” indistinctively.

In an ICO process, we can identify two types of investors; the first group would be composed by the stakeholders, these are buyers of the token that will form integral part of the business performance of the product under the ICO, in other words, these are the actual users of the product and will enjoy the functionality of the token more than the value that the token may have in the future. The second group is composed by the speculators, buyers who only purchase the tokens with the intention to obtain future speculative gain on a subsequent sale.

Either group of buyers will purchase the tokens offered in an ICO process upon understanding of the official report from a certain company that wishes to undergo through an ICO process to further develop its products or services, this report is commonly known as “white paper”. The white paper will inform potential investors about the complexities, advantages and benefits of purchasing the token of a particular product or service. The purchase is commonly performed in crypto currencies such as Bitcoin or Ether and in some instances also through FIAT currency such as US dollar or Euro that may also be acceptable.

A token, different than a crypto currency, can have different functionalities desired by the developer, for example, to execute a certain business processes automatically when an operational condition has been accomplished. This functionality is also referred to as “Smart Contracts”, even though, there is wide debate regarding the denomination, as professionals in the legal sphere differ from developers regarding the understanding of a contract, for the purposes of this article, we will regard Smart Contracts as computed conditions agreed upon the buyer and the seller of a specific token.

Developers have rapidly adopted a single format for the development of new tokens and have mostly agreed on using the most standardized token format under a template called ERC-20 as decentralized application on the Ethereum network. This means that new tokens can be developed on the basis of the ERC-20 and do not have to build the code from the ground-up, allowing developers to develop alternative tokens faster than ever and therefore the increasing amount of ICOs currently in please worldwide.

An ICO, different than an Initial Public Offering, it does not necessarily sell ownership in a company, but rather gains product value or in the case of smart contracts, it can also represent diverse assets as vouchers, debentures,  or even objects in the real world.

As mentioned above, the ICO process will start with the drafting and publishing of a report also known as white paper, this report shall contain detailed information regarding the business, cap on the amount of money to raise, the time limit on the token sale, total number of tokens in circulation and in the sale, clear token value, and token deployment plan.

Under an ICO process, is very important to distinguish if the token is a security or not (utility token), for example, the US Supreme Court case of SEC v Howey[1] established a test, the “Howey Test”, for whether an arrangement involves an investment contract and if it is regarded as a security, therefore, being subject to securities laws and regulations.  The Howey test encompasses the following: 1. an investment of money; 2. in a common enterprise; and, 3. with an expectation of profits predominantly from the efforts of others. If the tokens undergoing an ICO are considered to be securities they will certainly have to abide by the SEC rules when the U.S. law is applicable. It is very unlikely and incredibly difficult to be able to prove that the tokens to be issued are only sold for utility purposes (our first group of investors – Stakeholders) or apply for exemption under the exceptions provided by Rule 506(c)[2] to relax regulations and requirements on the ICO.

From a different angle, more specifically, in the State of New York, the Department of Financial Services (regulator and supervisor) has taken a step forward to regulate crypto currencies and has created a “bitlicense” for those who intend to undertake an ICO process and have crypto currencies as a business. Many criticize the measures as it imposes tremendous financial burden on the start-up organizations that lack funding to maintain the high standards required to apply and maintain a license of this kind. The application fee alone is USD 5,000 and investors say that to satisfy the criteria of the bitlicense has a cost of USD 50 to 80 thousand per year, leading to many start-up organizations to move to other states or even outside the U.S.[3]

In other jurisdictions, such as Singapore, the regulation has taken similar steps forward, as the U.S. – S.E.C., when inserting the digital token issuing or ICO under the Securities and Futures Act (“SFA”) (Cap. 289). The regulation will apply under certain criteria that can regard the token as a capital market product. Under section 2(1) of the SFA, capital market products means any securities, futures contracts, contracts or arrangements for the purposes of foreign exchange trading, contracts or arrangements for the purposes of leveraged foreign exchange trading, and such other products as the Monetary Authority of Singapore (“MAS”) may prescribe as capital market products. If a token is considered as a share, debenture or unit in a collective investment scheme, it will be regulated under the SFA as securities.

The implications of a Token Launch under this regulation will encompass the registration of a prospectus that must be prepared in accordance with the SFA prospectus requirements[4]. An offer may be exempt from these requirements if (similar to Rule 5069(c) in the U.S.): 1) the offer is a small and personal, in other words, having a pre-identified person with previous professional expertise or other connection with the issuer. Currently, the regulator caps the limit of offering to S$ 5 million within any 12-month period. 2) The offer is a private placement offer to not more than 50 persons within any 12-month period. 3) The offer is made to institutional investors only. And 4) the offer is made to accredited investors. [5]

Moreover, intermediaries are also subject to the regulations and must be licensed when: operating a platform that facilitates the offer or issuing of tokens; advising in respect of digital tokens; and, operating a trading platform.

More importantly, the regulator in Singapore, MAS, emphasizes that the regulations in place for Money Laundering and Countering the Financing of Terrorism should be in place. This includes obligations to report suspicious transactions and prohibitions from dealing with designated individuals and entities pursuant to the Terrorism Act (Cap. 325), among other related obligations.

The Monetary Authority of Singapore has issued a Guide to Digital Token Offerings[6], where besides providing the regulatory framework, it also provides with a few examples of the application:

  1. On the first case, we find when the securities regulations will not apply: Company A plans to set up a platform to enable sharing and rental of computing power amongst the users of the platform. Company A intends to offer digital tokens (“Token A”) in Singapore to raise funds to develop the platform. Token A will give token holders access rights to use Company A’s platform. The token can be used to pay for renting computing power provided by other platform users. Token A will not have any other rights or functions attached to it. Company A intends to offer Token A to any person globally, including in Singapore.

Application of the Securities regulations:

A holder of Token A will only have rights to access and use Company A’s platform, and the right to use Token A to pay for rental of computing power provided by other users. Token A will not provide its holder any other rights or functions attached to it. Hence, Token A will not constitute securities under the SFA.

Company A’s offer of Token A will not be subject to any requirement under the SFA or the Financial Advisers Act (Cap. 110).

  1. On the second case, we have a fundraising that will carry the obligation to have a prospectus under the SFA regulations: Company B is in the business of developing properties and operating commercial buildings. It plans to raise funds to develop a shopping mall by offering digital tokens (“Token B”) to any person globally, including in Singapore. Token B will be structured to represent a share in Company B, and will be a digital representation of a token holder’s ownership in Company B. Company B also intends to provide financial advice in relation to its offer of Token B.

Application of the Securities regulations:

Token B will be a share and constitute securities under the SFA.

The offer of Token B will need to comply with Prospectus Requirements, unless the offer is otherwise exempted under the SFA.

Company B will likely require a capital markets services license for carrying on business in the regulated activity of dealing in securities under the SFA, unless otherwise exempted.

To provide financial advice in relation to its offer of Token B, Company B will need to be a licensed financial adviser, unless otherwise exempt.

  1. On the third case, we have an example of a collective investment scheme and its treatment: Company C intends to offer digital tokens (“Token C”) to any person globally, including in Singapore. Company C will pool funds raised from the offer and use the funds to invest in a portfolio of shares in FinTech start-up companies (“Portfolio”). Company C will also manage the Portfolio. Holders of Token C will not have any powers relating to the day-to-day operations of Company C or the management of the Portfolio. Profits arising from the Portfolio will be pooled and distributed as payments to the token holders. The purpose of this arrangement is to enable token holders to receive profits arising from the Portfolio.

Application of the Securities regulations:

The arrangement established by Company C in relation to Token C will be a CIS (“Arrangement”).

On this basis, the Arrangement will have to be authorized under section 286 of the SFA, or recognized under section 287 of the SFA depending on whether the arrangement is constituted in Singapore or outside Singapore. The Arrangement will also be subject to the applicable requirements under Division 2 of Part XIII of the SFA, the SF(OI)(CIS)R and the Code on CIS.

On this basis, Token C will be a unit in a CIS, and constitute securities under the SFA. · On this basis, Company C will need to comply with Prospectus Requirements in respect of the offer of Token C, unless otherwise exempted under the SFA.

Company C will likely require a capital markets services license for carrying on business in the regulated activity of fund management under the SFA, unless otherwise exempted.

As no financial advisory service will be provided by Company C in respect of Token C, the FAA will not apply in relation to the offer of Token C.

  1. On the fourth case, we have an example of the extraterritorial applicability of the regulations: Company D is a Singapore-incorporated company with operations in Singapore. It intends to offer digital tokens (“Token D”) to members of the public, but the offering will not be accessible by persons in Singapore. Company D will pool the funds raised from the offer and use the funds to invest in a portfolio of shares in FinTech start-up companies. Company D will manage the portfolio of shares. Holders of Token D will not have any powers relating to the day-to-day operations of Company D or the management of the portfolio of shares. Profits arising from the portfolio of shares will also be pooled and distributed as payments to holders of Token D. The purpose of this arrangement is to enable token holders to receive profits arising from the portfolio of shares.

Application of the Securities regulations:

As the offer of Token D will only be made to persons based overseas (i.e. Token D will not be offered to any person in Singapore), Part XIII of the SFA will not apply to the offer.

Company D may nevertheless be carrying on the business of fund management in Singapore if it operates the management of portfolio of shares in Singapore. If so, Company D will require a capital markets services license for carrying on business in fund management, unless otherwise exempted.

As no financial advisory service will be provided by Company D in respect of Token D, the FAA will not apply in relation to the offer of Token D.

  1. On the fifth case, we have an example of using a cryptocurrency as a debenture: Company E plans to set up a platform that helps start-ups raise funds from investors through digital token offerings (“Offerings”). To facilitate the Offerings, Company E will set up one entity (“Entity”) which will be used as a vehicle to make investments into a start-up, for every start-up that will make Offerings. Investors who wish to invest into a start-up will provide a loan to the respective Entity (“Loan”). In return, the Entity will issue to the investors, digital tokens that are unique to the start-up (“Token E”). Token E will be offered to any person globally, including in Singapore. Token E will represent the rights of an investor as a creditor of the Loan provided to the Entity. Company E’s platform will also operate as a market to facilitate trading of Token E among investors using Company E’s platform. In addition, Company E intends to provide financial advice to investors on the Offerings.

Application of the Securities regulations:

Token E will be a debenture, and constitute securities under the SFA.

An Entity will need to comply with Prospectus Requirements in respect of an Offering, unless otherwise exempted under the SFA.

Company E, in facilitating the purchase or sale of Token E on its platform, may require a capital markets services license for dealing in securities under the SFA, unless otherwise exempted.

Depending on the business activities that an Entity undertakes on Company E’s platform, the Entity may require a capital markets services license for dealing in securities under the SFA, unless otherwise exempted.

To provide financial advice to investors in relation to an offer of Token E by an Entity, Company E must be a licensed financial adviser unless otherwise exempted.

Company E is likely be operating a securities market in relation to the trading of Token E. On this basis, Company E will have to be approved by MAS as an approved exchange or recognized by MAS as a recognized market operator under the SFA, unless otherwise exempted.

  1. On this last case, we have an example of the treatment to a trading platform: Company F is planning to set up a virtual currency exchange platform that allows users to exchange virtual currencies (such as Bitcoin) that do not constitute securities, to fiat currencies. In its initial years of operation, the platform will be configured such that trading of digital tokens constituting securities will not be allowed. This restriction may be lifted after a few years.

Application of the Securities regulations:

On the basis that Company F’s virtual currency exchange will not allow trading of any products regulated under the SFA, the SFA will not apply.

Company F should re-assess its position should it intend to trade in any digital tokens that constitute securities under the SFA. For instance, upon lifting the abovementioned restriction, Company F will likely be operating a securities market in relation to the trading of digital tokens that constitute securities. On this basis, Company F will need to be approved by MAS as an approved exchange or recognized by MAS as a recognized market operator under the SFA, unless otherwise exempted.

Additionally, organisations that are looking to apply technology in an innovative way to provide financial services may apply for a regulatory sandbox, upon which, regulations may be relaxed[7]. This application will be subject to certain space and duration depending on the financial service to be experimented. The criteria are the following:

  • Innovative technology, existing or new and use in an innovative way.
  • Address a problem or bring benefits.
  • Ability to render the services in Singapore and subsequently internationally.
  • Preparation of test scenarios and expected outcomes.
  • Boundary conditions that sufficiently protect the interests of consumers and the industry.
  • Exit strategy.

 In conclusion, cryptocurrencies are increasingly gaining importance; the regulators in different countries are taking different measures to either tax the operations or simply insert them into a security-type of operation that will be regulated under the securities regulations. This is understandable, as many businesses have opted to raise funds under an ICO rather than an IPO. However, businesses that had the aim to raise funds through this vehicle had as major incentive of unknown or none regulations on the ICO process, that made ICOs easy, as it lacked several requirements, and cost-effective vehicles to raise funds.

Nevertheless, once having a complete understanding of the regulations in place and the objective of the ICO process well defined, it should be relatively straight forward to launch a regulated ICO in compliance with the regulations in place. It is important to understand the options available and to have proper advice on the structure of the ICO and on the drafting of the white paper.


[1] SEC v. Howey Co., 328 U.S. 293 (1946). Available Here

[2] Rule 506(c) available Here

[3] Final rules: 23 NYCRR Part 200 Virtual Currencies. Available Here

[4] Guidelines on good drafting practices for prospectuses, available Here

[5] To analyze this requriements in more detail, please refer to the Guidelines on the Advertising Restrictions in Sections 272A, 272B and 275. Available Here

[6] A Guide to Digital Token Offerings, Monetary Authority of Singapore. Available Here

[7] For more information regarding this particular topic, please refer to: FinTech regulatory sandbox guidelines, MAS. Available Here


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