The cryptocurrency industry has shown incredible growth over the last 2 years. Although the buzz around Bitcoin, ICOs and blockchain technologies has calmed down in comparison to December 2017, it is still a very hot topic. And there is a good reason behind this.
Starting from early 2017, the overall market capitalization has grown tenfold from $20 billion to $200 billion having reached its maximum of almost $832 billion in January of this year. According to the statistics, ICOs raised $6 billion last year and already $20 billion this year. At the same time, reports say that 80% of the projects launched this year are a scam.
The cryptocurrency market capitalization according to coinmarketcap.com
In such a situation, various government authorities globally are making attempts to regulate the blockchain industry in order to protect end users from financial loss. The difficulty with legalizing cryptocurrencies is that this industry is so vigorously developing that few people within related governing bodies have a firm understanding of how it works. So instead of creating the zones that would help blockchain projects legally develop and bring the new technologies to mass implementation, legal structures are erring on the side of blocking them altogether. There are no common rules or even recommendations applicable across all regions, which makes it even more difficult for blockchain projects to conduct business legally.
However, blockchain technologies are here to stay, so some steps towards legalization are necessary. There are various legal aspects a project should consider when launching security tokens, domestically and internationally.
US cryptocurrency regulation
In the US, there has not been a common consensus amongst legal structures about what cryptocurrencies are.
- The Commodity Futures Trading Commission (CFTC) calls Bitcoin a commodity.
- The Internal Revenue Service (IRS) calls it a property.
- The Securities and Exchange Commission (SEC) defines tokens issued by ICOs as securities.
It seems that due to the lack of understanding, each legal structure defines cryptocurrencies in their own way and there is no single standard. For our discussion of an ICO’s legal requirements, we will use the SEC’s definition of cryptocurrency.
As we’ve already said in a previous article , most tokens issued by ICOs fall under the definition of a security. So if your plan to launch an ICO, the most secure way would be to assume that your tokens are securities.
It will aid the discussion on SEC regulations to be on the same page in terms of definitions.
Key terms in securities regulation
According to the SEC’s definition, general solicitation implies advertising securities via different mass media, such as newspapers and magazines, public websites, broadcasts on TV and radio, etc. It doesn’t include factual information about your business and the information that your existing investors share with their personal network in order to attract more funds for your project.
Some of the SEC exemptions that will be discussed further in this article “preempt” state securities laws. In a typical situation, if a company sells securities it must fit both state security laws and federal regulations. In the case of preemption, the security doesn’t have to be registered with the state regulators and comply with all the laws.
According to the SEC, restricted securities cannot be freely exchanged and the owner has to meet the following 5 conditions in order to sell such securities:
- Holding Period. To sell restricted securities there us a latency period of 6-12 months that must be complied with.
- Current Public Information. The issuing company must provide investors with adequate information about its business, directors, and the state of its finances before releasing any securities for sale.
- Trading Volume Formula. Affiliates cannot sell more than 1% of the outstanding shares during any three-month period.
- Ordinary Brokerage Transactions. Brokers cannot receive a greater than normal commission.
- Filing a Notice of Proposed Sale with the SEC via Form 144.
Now that the we are on the same page with key definitions we can review main exemptions that would keep security issuers from having to do a complete registration with the SEC.
3 main exemptions for security issuers
When issuing security tokens you must register them as securities with the SEC. The exception to this rule is when one of these 3 exemptions can be applied to your tokens: Reg D, Reg A+, or Reg CF.
There are 3 special rules for issuers within Reg D: Rule 506(b), Rule 506(c), and Rule 504. The differences between them are described in the table below.
|Rule 506(b)||Rule 506(c)||Rule 504|
|Annual offer limit||None||None||$5M|
|General solicitation||No||Yes||Permitted in certain situations|
|Investor requirements||Unlimited accredited investors. Up to 35 sophisticated, but non-accredited investors||Unlimited accredited investors||None|
|SEC filing requirements||Form D||Form D||Form D|
|Restriction on resale||Restricted||Restricted||Restricted|
|Preemption of state registration||Yes||Yes||No|
If a company seeks to raise a large amount of capital across the US the rules 506(b) and 506(c) will suit it best as they both imply no limit on the capital to be raised and preempt state registrations.
These rules also have special requirements for investors. Only accredited investors can participate in the funding of such companies which means that an investor must have a net worth of at least $1,000,000 or have received $200,000 in income over the last 2 years.
Rule 504 is most applicable if a company is seeking local funding. With this rule, there are no restrictions for investors, but the amount of capital raise is limited to $5 million.
The characteristics of Reg A+ can be found in the table below.
|Tier 1||Tier 2|
|Annual offer limit||$20M||$50M|
|General solicitation||Permitted before qualification||Permitted before qualification|
|Investor requirements||None||Non-accredited investors subject to limits|
|SEC filing requirements||Form 1-A + two years of financial statements||Form 1-A + two years of financial statements (annual, semi-annual, current)|
|Restriction on resale||No||No|
|Preemption of state registration||Yes||Yes|
Reg A+ works best for companies that are seeking less than $50 million from non-accredited investors. The target audience for this exemption is established startups.
Reg CF, gives companies get the easiest option to issue securities, but they are also limited by the amount of capital to be raised (only up to $1.07 million).
|Annual offer limit||$1.07M|
|General solicitation||Permitted with limits on advertising|
|Investor requirements||Limitations based on annual income and net worth|
|SEC filing requirements||Form C + two years of audited financial statements|
|Restriction on resale||12 months|
|Preemption of state registration||Yes|
As you can see, in the US, the process of issuing securities has robust regulations. As most tokens issued by ICOs fall under the definition of a security, the projects raising capital this way would most benefit from finding an exemption they qualify for, to avoid a full registration with the SEC which is a costly and invasive process.
Security token services
The list of exchanges and other services presented here is not full and more will surely be created in the near future as security tokens gain popularity. However, this list can give you some guidance on where to start.
- Polymath. This service allows you to create your own security token and has made a big step towards tokenizing the global economy.
- Airswap. Service enabling you to instantly buy and sell security tokens. No registration is required. Simply connect the service to your wallet and start trading.
- Republic. A platform that connects startups and investors.
- SeedInvest. Another platform helping startups and investors find each other.
- Harbor. This platform helps businesses seamlessly migrate their securities to the blockchain.
- Swarm Fund. Another service that helps tokenize assets.
How security tokens are regulated in other countries
Now that we’ve reviewed cryptocurrency regulation in the US, let’s take a look at what steps are made in other countries towards cryptocurrency legalization.
There are no special laws regarding cryptocurrencies in the United Kingdom. Cryptocurrencies are not considered legal tender there and exchanges are required to register with the Financial Conduct Authority (FCA). However, legal regulations are always changing and we will most likely see new cryptocurrency guidelines by the end of 2018.
Cryptocurrencies are not legal tender in Canada and there is no consistency regarding cryptocurrency exchanges at the provincial level. Despite this fact, cryptocurrencies have been taxed by the Canada Revenue Agency since 2013. In August 2017, the Canadian Securities Administrators (CSA) qualified cryptocurrencies as securities.
Although cryptocurrencies are not legal tender in Singapore, this region is more friendly and allows trading on cryptocurrency exchanges without registration. According to Singapore’s authorities, Bitcoin is regarded as goods and thus it is the subject to appropriate taxation.
After the People’s Bank of China banned Bitcoin transactions in 2013 and then prohibited all ICOs and cryptocurrency exchanges in 2017, it is no surprise that cryptocurrencies are illegal in this region. One of the world’s largest exchange platforms, Binance, had to move its business to Malta after the new legislation was implemented. However, cryptocurrency enthusiasts are finding workarounds to buy and sell cryptocurrencies on foreign platforms.
Both cryptocurrencies and cryptocurrency exchanges are legal in Australia. Cryptocurrencies are treated as property and exchanges must register with AUSTRAC.
Previously, cryptocurrencies were subject to a double taxation in this area. However, according to the latest ruling of local authorities, cryptocurrencies are now treated as property and are subject to Capital Gains Tax (CGT).
So far, Japan has proved to be the most progressive in regards to cryptocurrency regulation. In Japan, cryptocurrencies are legal tender under the Payment Services Act and exchanges must register with the Financial Services Agency. According to the National Tax Agency, all gains on cryptocurrencies should be considered as “miscellaneous income” with the tax rate falling between 15% and 55%.
Although South Korea is the home to many blockchain conferences, cryptocurrencies are not legal tender here. Exchanges must register with the Financial Supervisory Service and are subject to thorough monitoring. Since there is no official statement on what cryptocurrencies are, they are still tax free, however, a taxation system will be implemented by the Ministry of Strategy and Finance in 2018.
In India, cryptocurrencies are not legal tender. Exchange platforms are still legal, but authorities have placed huge obstacles in their way and make it very difficult for them to operate. Legal authorities have not defined a position regarding taxation, either.
Of all the European countries, Switzerland can be considered the most progressive towards cryptocurrency legalization. Cryptocurrencies are legal in Switzerland, as are exchanges. Crypto can even be used to pay for some goods and services.
On the subject of taxation, it should be pointed out that cryptocurrencies are considered to be assets by the Swiss Federal Tax Administration (SFTA) and thus they are subject to the Swiss wealth tax.
The European Union (EU)
There is no special legislation for cryptocurrencies in the EU. Cryptocurrencies are considered to be legal in the majority of the Union’s members, but the regulations for exchanges vary across the countries. The taxation system is not consistent either, but many countries charge up to 50% on the capital gains.
Although much is still unclear about blockchain’s future and there is no consistent regulation that can be applied globally, some steps have been implemented in localities already. Progress is being made. Regulations are moving forward. Free zones for crypto projects are being created. Time will tell how blockchain and related cryptocurrencies will be implemented and accepted worldwide to improve our lives.
the link to the first article about security tokens