Hong Kong Lawyer

MARCH 2018

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30 www.hk-lawyer.org • March 2018 ICO Utility Tokens and the Relevance of Securities Law By Syren Johnstone A braham Lincoln famously posited that if one calls a tail a leg it doesn't mean that a dog has five legs. Similarly, a blockchain-based token offered in an initial coin offering ('ICO') may, irrespective of how it is called, be a security subject to securities laws applicable to the primary market as well as secondary market activities. ICOs are an example of how new technology is changing the way the public capital market is accessed by businesses, typically start-ups, in need of capital. The legal treatment of tokens remains unclear in many jurisdictions, which is increasingly problematic as ICO activity has ballooned from around US$300 million during 2013 to 2016 to well in excess of US$5 billion in 2017. As Hong Kong is now considering its potential status as an ICO hub, it is essential that regulatory agencies and market professionals come to grips with a better understanding of how tokens are, or may be, regulated. A focus of this article is "utility tokens". Unlike tokens that clearly operate like equity or debt (via payments, voting rights, etc), utility tokens present problems as regards their legal characterisation. The nature of a utility token is to permit the holder to access a service provided by the issuer's platform. This is typically a pre-sale made by a start-up seeking capital to develop the promised service. While token- holder rights bear resemblances to, for example, licensees, franchisees, or club memberships, utility tokens may have other features that lend securities-like properties to them. Regulatory attitudes Regulatory and practice attitudes (in markets that have not banned ICOs) have evolved with the ICO market and roughly fall into three phases. Around the end of 2016, ICOs were generally considered to be undesirable owing to the risk of mis-disclosure and fraud, risks magnified by the speed and ease at which money was able to be raised – eight figure US dollar sums were able to be raised in a matter of minutes or hours with no regulatory oversight. The origin and subsequent use of funds being transacted also raise money laundering and terrorist financing concerns. By this time it had already been widely understood that blockchain technology is important to future economic development. Tokens are important in this context because they collectively facilitate a blockchain-based ecosystem that provides operational functionality – imagine that one had train carriages but no train tracks. Going into 2017 regulators were adopting a more cautionary watching role, reluctant to inhibit evolution.

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