Initial Coin Offerings (ICO), a term intentionally mirroring Initial Public Offerings (IPO), seem to be the new hype of the virtual currency community leading to an all-time high of the bitcoin of over 9.000$ this year. There is indeed a frenzy developing around ICOs, which have reached a record high of $1.7 billion in 2017, and sparked an increasing interest from regulators on the American, European and Asian continents. Thus, ICOs have become a venture capital-raising tool for start-ups developing projects and applications on the blockchain, while trying to escape the constraints of regulation. 

ICOs are indeed an alternative form of crowdfunding that have emerged outside the traditional financial sector and mostly finance projects on a public blockchain. Some projects manage to collect millions in a very short period of time. Given the speculative success of ICOs, the lack of clear regulation and the risks attached to them for investors, it comes with no surprise that regulators have increasingly started to scrutinize ICOs. The scrutiny leads to the conclusion that, depending on the structure of an ICO, securities law and other areas of financial or banking law may very well apply to such issuances. The Chinese and South Korean authorities went even a step further and simply cracked down on ICOs in September, requiring that funds be returned to investors. Other regulators have limited themselves to warning consumers about how dangerous ICOs are and concluded that regular financial law might be applicable on a case by case basis. The position of regulators is, thus, diverging and it is not certain that the solutions found in one jurisdiction can be transposed to another.  

How does an ICO work? Every ICO starts with a white paper, very similar to a prospectus, that describes the project and the rights given to investors. Very often the white paper determines a minimum and a maximum amount of coins that need to be subscribed in order for the project to go live. Most of the time the tokens are subscribed using either Bitcoin or Ether. The issuer puts in place a smart contract on a blockchain and investors instruct their digital wallet to subscribe to a certain number of tokens. By doing so, the wallet sends the amount of the requested digital currency to the smart contract address. The smart contract ensures the execution of the operation and the outcome of the ICO. If the minimum number of tokens is reached, it automatically transfers the digital currency into the wallet of the issuer and registers the tokens into the account of the subscribers. If the minimum amount is not reached, the smart contract automatically transfers the digital currency back into the wallet of the sender.

An ICO pursues either of two major aims: it can be used to put a new virtual currency in circulation or to finance a project. Depending on these two aims, the regulatory implications of ICOs might differ.

As well as being a financing method, an ICO also creates a completely new ecosystem. This being said, ICOs obviously pose risks, which uncertainty about their regulation only accentuates. The uncertainty is due both to the fact that the characterization of ICOs is still unclear and to their virtual nature, which makes regulating them more difficult. Besides the risks inherent to any kind of speculative investment, the particular risks of an ICO are related to the issuance of scam coins but there are also risks related to cybersecurity. There have already been examples of both.  

Even though there is no such thing as a legal vacuum or a regulation-free zone, as some defenders of cryptocurrencies and ICOs might want to think, two main problems arise when it comes to regulation. It is first necessary to characterize the tokens in order to apply a set of predetermined rules; this is already challenging given the diverging rights attached to tokens and their different uses. A token can be structured as a security, as a loan, as a voucher or simply as a currency. Secondly, once the relevant rules are determined, the conflict of laws and jurisdictions question kicks in. Here again, given the virtuality of cryptocurrencies and the blockchain, problems will arise. 

The complete paper is available here

Iris Barsan is a lecturer at the Faculty of Law of University Paris-East Créteil Val de Marne.