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Urgent need for action on ICO regulations

by Alexandra Cain | 01 Apr 2019
Market participants are calling for much tighter regulation around the controversial area of initial coin offerings, amid concerns issuers are fleecing ordinary Australians of funds without adequate consumer protections. 

ICOs are a form of crowdfunding through which businesses underpinned by a digital currency raise money by selling tokens. Tokens are usually a proxy for credit with the issuer, which can be redeemed for the products and services it is developing.

Aleksander Svetski, co-founder of digital currency investment platform, has argued in a submission to Treasury ICOs should stand for ‘Illegal coin offering’. 

In the document he says, “anyone considering an ICO should … realise that what you’re thinking about is likely the wrong way to go about it. Anyone who’s done an ICO should take serious note. You’ve likely done the wrong thing, and whether your malevolence was intentional, or due to your incompetence, you should also be held accountable — whether legally, financially or reputationally.”

Svetski argues ICOs have failed almost anyone who has participated in one, suggesting they have been, “used as a Rube Goldberg machine to circumvent securities law and investor rights.” Rube Goldberg machines take a simple task and make them more complex. 

He believes thanks to lax regulations around how these schemes should be marketed, many ICOs have purposely used unethical marketing practices to attract investors and speculators, rather than conscript people who will actually be able to use the tokens typically offered through ICOs. 

Svetski says many projects for which tokens are being raised through ICOs will never eventuate and the tokens investors have purchased may be next to worthless, “due to being largely pointless.” 

Commenting on the regulatory environment for ICOs, John Bassilios, special counsel at law firm Hall & Wilcox, notes regulation of ICOs depends on the features of the token, but more clarity on how tokens are defined is required.

“The existing financial regulations are strong enough regarding tokens as a financial product. But there are some issues around ICOs involving utility tokens – a utility token is an online currency allowing you to buy goods and services. Currently, utility tokens are at significant risk of coming under the managed investment scheme regime, which is inappropriate for their use.
 
“If the token has the features of a financial product then it should be regulated as a financial product. But if the ICO involves a utility token then it should be regulated differently – regulations would need to require full disclosure and responsibility from those who produce the white paper for the ICO.”

Svetski notes in the ICO fundraising model, investors wear all the risk and the fundraiser is exposed to none. Investors have no rights, no equity and no legal recourse, while fundraisers get access to a lucrative capital raising with no need to give up any equity, be profitable or deliver a successful project. But not all market players are as negative as Svetski towards ICOs.

“Since the ICO boom of 2017, which was frankly crazy, regulators in the UK, Europe, Australia and the US have had time to catch up and review whether current laws and regulations are sufficient to apply to tokens and other digital assets, and have issued updated guidelines,” says Ava Lawrence, a partner at blockchain consultancy 51North.io.

“Further regulatory clarification in more countries will come. Remember we are still in the early days of the development of blockchain technology and managing its economic and societal impacts,” she adds. 

Lawrence says people running ICO projects are exploring whether they could be set up as loyalty schemes. “Loyalty points offer an alternative regulatory path forward for utility tokens both in Australia and other jurisdictions.”
 
Loyalty points or schemes are defined in Australia as a non-cash payment facility and are not considered to be a financial product under the Corporations Act. Lawrence says tokens need to be carefully structured to keep within these guidelines, while still providing the holder with some value.
 
“I’m a big fan of security and equity tokens for asset-backed projects. However, I believe there is still a place for utility tokens despite the crash of the market, particularly for consumer products or services such as sports, gaming and food and beverage projects. ICOs offer a way to market to a broad range of retail clients which allows for a ready-made loyal consumer base primed for the release of the products and services. Loyalty-type functions built into utility tokens align with these marketing aims.”
 
With Treasury’s initial consultation phase now over, the next step is to have government agree regulation for ICOs is required, says Bassilios. 

“They could then consider implementing a further consultative process to liaise with industry. Hopefully this would address priority areas such as definitions of tokens, to provide more clarity around how we define an ICO – particularly around whether the ICO relates to a financial product or a utility token. Understanding the definitions could then pave the way for regulations around utility tokens. After consulting with industry government could create draft legislation.”

As this suggests, there’s still a long way to go before ICO regulations are properly established, but there’s a pressing need for action to ensure consumers and investors are properly protected.

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