1. Introduction

Initial Coin Offerings (ICOs), also called token-sales, hence the first public issuance of coins or token by (usually) a company to investors against payment of an investment amount in cryptocurrencies (in particular Bitcoin and Ethereum) has become since the beginning of 2017 a well-established process to raise funds. It is, therefore, not surprising that legislators started to focus on coin offerings and their legal implications. The legal qualification of token/coin issuance, however, requires in depth knowledge of both, the crypto-sphere and the applicable law.

The purpose of the present articles is to analyse what kind of token/coins exist and how they could be legally regarded, in particular from capital markets law perspective. As lawyer (based in Austria) focusing on corporate and capital markets law with a passion for cryptocurrencies, I will try to build a bridge between the different forms of token/coins on the one hand and their legal review. The real challenge is that there is no world-wide capital market law but each jurisdiction has its own law in this respect and such law may become applicable to any token issuance if investors are able to participate in such token sale.

This article, where I would like to point out rather standard knowledge on token forms, shall be the start of journey followed by various other articles where I will go into more detail in the legal challenges in various jurisdictions[1].

2. What are cryptocurrencies from a legal perspective?

Cryptocurrencies imply that they may be regarded as currencies but from a legal point of view they are by no means currencies. Any regular currency is issued by a central body (e.g. a central bank) based on a legal regulation resolved upon (usually) by the parliament of a jurisdiction. Such law does also provide if and to which extent other currencies are regarded as valid legal currencies. For instance, the countries having the EUR as legal currency provide that their national banks are entitled to issue EUR based on an approval of the European Central Bank and recognize that any EUR issued by any national bank of any other country participating in the EUR is also regarded as valid legal currencies. Therefore, it is important to understand that at least so far cryptocurrencies are not regarded as valid legal currencies but they could have the function of a form of payment; however, the third party recipient must agree to accept such cryptocurrency as valid payment method inter partes. As long as this is not the case, no legally valid payment may be made.

Further, while legally valid currencies are issued usually by a centralized body, such as a national bank, cryptocurrencies aim to be based on decentralized networks, namely a blockchain[2]. A blockchain is – per definition – a block of different chains; hence, a continuous accumulation of information, which is chained up by cryptographic processes[3]. For instance, in case of bitcoin, transactions are reviewed by miners (e.g. to ensure that there is no double-spending), included into a block and then communicated to other minders in order to obtain consensus. This is actually “mining” and not, what is often seen in the media, the creation of new bitcoins.

The current proposal for a directive of the European Parliament and of the Council amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and amending Directive 2009/101/EC provides also for a definition of cryptocurrencies. It defines virtual currencies as “a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically"[4]. This definition aims to cover the main characteristics of virtual currencies, namely their decentralization and virtuality but is also quite broad as it does not require that such currencies are stored on a blockchain secured by cryptographic processes.

3. General Classification of Cryptocurrencies

As of the date hereof, there are about 2,000 cryptocurrencies which are listed on coinmarketcap.cap. Obviously there are much more virtual currencies which are not listed there and new cryptocurrencies are issued almost on a daily basis. The classification of coins and token is from a legal perspective of utmost importance. Capital markets laws provide for a strict regulation on the public issuance of certain instruments, such as – for instance – shares, requiring the publication of an approved prospectus in advance of an issuance, the failure of which can be sanctioned even with prison. An additional complexity arises that in various jurisdictions the issuance of coins or token could be regarded differently. What is legally compliant on one jurisdiction, does need to be necessary similar in another jurisdiction and regulators in such jurisdiction may commence legal actions against the issuer and their representatives. Therefore, before one considers an ICO, he/she should ideally make use of an international law firm to have carefully reviewed the structure of its token from a legal point of view. In case the token is regarded as security (or in numerous jurisdictions extending the definition of security to covers also investments), capital markets law applies and must be complied with in the context of a public token issuance.

In a first step, one should differentiate between token and coins:

All coins (such as, for instance, Bitcoin, Ethereum, Ripple, Stellar or NEO) have one and the same peculiarity, namely they are usually based and running on their own blockchain. Their existence is, hence, not depended on any other blockchain. A bit of an anomaly has probably IOTA as IOTA is not running on a blockchain but provides decentralized consensus solutions without a blockchain but using the so called IOTA-Tangle[5].
Token, such as ICON, BNB, OmiseGo, Zilliqua and Aeternity, are insofar different as they need to run on a third party blockchain until they set up their own blockchain (i.e. the mainnet). Most token are using the Ethereum blockchain (so called ERC20-token[6]), but could use, for instance, also other platforms, such as NEO (so called Nep-5 token[7]). Once a company launches its mainnet, i.e. its own blockchain, its issued token is regarded as a coin, e.g. the mainnet of EOS in June 2018.

Token are usually issued through a public issuance, e.g. an initial token offering. It is, however, also possible to issue token legally on the basis of a private placement or, for instance, technically through airdrops where either token are issued against performance of certain multimedia activities (e.g. twitter, facebook) and are, therefore, legally speaking not free of charge but are issued against certain services or to holders of certain other coins at a certain block high or time (such as the airdrop of Callisto to Ethereum Classic-holders in March 2018[8]). Consideration is legally seen quite broad and any services provided against issuance of token are also a form consideration. In whatever technical form a token is issued, such issuance must be reviewed from a legal perspective (e.g. it may constitute a private placement but also a public offering).

4. Classification of Token

Token many be differentiated on the basis of the function, technical implementation, use and purpose and you can find plenty of overviews in the World Wide Web. In the legal literature also different methods were used. For instance, Rohr/Wright, are differentiating between protocol token und app token, whereby app tokens may classified into investment tokens und utility tokens[9]. Hacker/Thomale differentiate on the basis of the purpose of the token and provide for a classification of token into currency token, utility token und investment token[10]. From a legal point of view, a classification on the basis of the purpose makes most sense:

Currency coins/token: The main purpose of currency token is the payment function. They embody a certain value and are, therefore, also a form to store value. They can be used to pay third party services (obviously only if and to the extent such person accepts such form of payment). Currency coins are in particular Bitcoin, Bitcoin Cash, Monero, Dash and Litecoin. Usually such coins/token do not provide for other purposes, in particular the bitcoin platform cannot be used for smart contracts.
Utility token: Utility token (such as, for instance, Steem) do not aim to be a store of value or to be used for payment purposes. Their main aim is to provide the holder with access to certain services. In some cases such services are already available as of the token issuance or they need to be developed going forward. In addition, numerous utility token are tradeable on crypto-exchanges and, hence, can be used also as a speculative investment. In fact, numerous ICOs are advertising that their token will be soon listed on a token exchange. Most ICOs are executed using utility token – at least the issuers are claiming that their token constitutes a pure utility token. However, legally speaking, whatever an issuer is claiming is quite irrelevant as it is a decision of the regulator and finally the courts to determine if a utility token may constitute a form of security (or any other form of investment covered by the applicable capital laws). We will see in the jurisdictional analysis (which I envisage to publish soon) that there is a lot of room to debate.
Investment token: Investment token are comparable to shares. The holder of an investment token has a dividend right against the issuer and also voting rights. An example of an investment token is Iconomi (ICN). ICN token embody a pro rata ownership right in relation to the ICN platform and dividend and voting rights[11]. Also reward systems could have the effect that a token is rather regarded as investment token than pure utility token. As investment token are very similar to shares, it also quite likely that capital markets law may apply to the issuance of such token.
Stable token: Stable token are asset backed token, i.e. they are backed by another asset (such as gold or another cryptocurrency) or fiat (such as USDT, where 1 USDT should constitute 1 USD). While the advantage of such token is a safe haven in the volatile cryptocurrency market, from a legal point of view their public issuance may constitute a security-like issuance requiring full compliance with applicable capital markets laws.
Hybrid token: A hybrid token is a token which embodies different functions of currency token, utility token and investment token. NEO, for instance, embodies a form of a dividend right (as the holder is enabled to receive a certain amount of GAS), which makes NEO at least close to an investment coin; however, on the other hand it offers also utility functions as it enables, for instance, a secondary tokenization, which makes NEO close to a utility coin; finally, it has also a payment function, as ICOs token running on the NEO platform can be subscribed by paying with NEO; hence, NEO also includes a currency function.

5. Conclusion

The above evidences that token may be in a different way classified. The classification is, however, from a legal point of view of utmost importance. A token that could be regarded as security-like requires compliance with the relevant capital market laws. Given that the consequences could be for the issuer and its representatives quite severe, a detailed and thoroughly review of the token structure should not be underestimated. Going forward we will go into details and the legal status in various key jurisdictions. Let’s see where we will end up – stay tuned!

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[1] See also in German: Dobrowolski, Überblick über die unterschiedlichen aufsichtsrechtlichen Rahmenbedingungen für Initial Coin Offerings, GesRZ 2018, 147. [2] Antonopoulos, The Internet of Money I, 1f. [3] Antonopoulos, Mastering Bitcoin: Unlocking Digital Cryptocurrencies, 163ff. [4] Proposal for a directive of the European Parliament and of the Council amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and amending Directive 2009/101/EC dated 5 July 2016, COM(2016) 450 final, see: https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52016PC0450&from=EN. [5] IOTA Whitepaper: https://assets.ctfassets.net/r1dr6vzfxhev/2t4uxvsIqk0EUau6g2sw0g/45eae33637ca92f85dd9f4a3a218e1ec/iota1_4_3.pdf [6] https://etherscan.io/tokens. [7] https://neoguide.io/nep-5-tokens-2/. [8] https://callisto.network. [9] Rohr/Wright, Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets (2017) 22, available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3048104. [10] Hacker/Thomale, Crypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial (2017) 12, available at: https://ssrn.com/abstract=3075820 or http://dx.doi.org/10.2139/ssrn.3075820. [11] Iconomi-Whitepaper, page 8, see; https://coss.io/documents/white-papers/iconomi.pdf.