With the welcoming of the Blockchain era came the revolutionary innovation of the new go to crowdfunding method for companies and individuals wanting to develop a business or simply an idea. With a project idea in mind, an Initial Coin Offering, better referred to as an ICO, is used as a means of crowdfunding through the creation of digital tokens offered in return to contributions. The raised funds will then be used to fund project development and marketing.
The attractiveness of ICOs is a culmination of the various advantages over traditional Initial Public Offerings (IPOs) including currently the lack of specific regulatory oversight, the possibility of raising funds in a shorter period of time and the incorporation of smart contracts using trust-based blockchain technology. Another key difference between the two is that whilst IPOs work by issuing securities to investors, hence regulated at law, the hosting of an ICO might be unregulated if the tokens pertaining to it are strict utility tokens, as opposed to regulated security tokens or those having elements of security tokens which would fall in a ‘grey area’, the regulation of which is being currently discussed by Parliament.
It is therefore vital for start-ups to seek expert legal advice during the initial stages of launching an ICO to ensure compliance with the law and ultimately, a successful ICO. Below is a 6-step legal guide to be considered before taking the plunge into the world of ICOs.
1. Choice of jurisdiction
It appears that many countries are in a race to issue regulatory frameworks with respect to Distributed Ledger Technology (DLT) and ICOs, striving to attract companies and individuals by offering financial opportunities and a safe jurisdiction with a solid regulatory framework. Amidst all this, Malta seems to be a forerunner in the sector, being the small crypto island that is attracting an impressive multitude of potential ICO organisers and boasting a list of successful ICOs to which this jurisdiction has been a home.
The Maltese Government has been outspoken regarding the changes that Maltese legislation would need to undergo in the ambit of this revolutionary technology and a number of regulations are being discussed by Parliament, including a Bill on a Virtual Financial Assets Act. In understanding of the imminent economic value posed by blockchain technology, Malta’s Prime Minister Joseph Muscat has stated that “(cryptocurrencies are) the inevitable future of money” and is striving to ensure a pro-active attitude in the face of this rapid technological movement.
Another important jurisdictional consideration that plays a big role in the strategic planning of an ICO is taxation. Malta as an EU member State with a favourable tax system further makes it an appealing and wise choice of jurisdiction to organise an ICO.
Many renowned crypto-exchanges such as Binance and OKEX are already moving or considering moving their offices to the island. Malta is expected to grow into a blockchain hub, providing a healthy competitive edge from other countries who have already implemented such DLT regulations.
2. Choice of entity/structure
The next step after determining the jurisdiction, is the setting up of the corporate structure through which the ICO will be organised. The Maltese limited liability company (LLC) is an ideal legal entity which ensures a legal basis for ICO companies and generally limited liability in case the ICO is not a success. Another legal entity through which an ICO can be run would be a foundation, which historically has been favoured in other jurisidctions such as Switzerland but which is also gaining traction in Malta.
When considering the choice of the corporate structure, one should also keep in mind the requirement of having a bank account capable of receiving funds for the purposes of the ICO. The Founders and Advisors of an ICO should therefore make sure that they receive proper legal guidance and advice on all other related matters.
3. Obtain a legal analysis of your token.
Having decided on the jurisdiction and the preferred legal entity through which to run the ICO, the next step would be that of obtaining a legal analysis of the token. This analysis is mainly required to determine whether it is designed as a utility token or security token, or anywhere in between. This determination is crucial in terms of understanding what regulatory and compliance obligations would be applicable. It is also important to remember that nearly all crypot exchnages will only list a token if it is a utility token. Generally in the current legal environment we would therefore advise a Client wto launch an ICO that issues a token which is purely utilitarian in nature.
ICO start-ups also need to obtain an analysis and subsequent legal and financial advice on their tokenomics to validate the token ecosystem. Through analysis and calculations of the tokenomics, advisors will advise the ICO companies as to the amount of tokens to be minted and distributed in consideration of the funds required to be raised, setting the hard cap and the soft cap, the value of the token and the distribution of tokens and funds. Tokenomics are therefore based on four key factors, these being:
• Token design
• Token utilisation
• Token supply and demand
• Token distribution
By identifying the nature of the token and how it can be utilised, founders can calculate the token’s worth. This will lead to identifying the token supply and demand, consequently obtaining a perfect equilibrium of supply and the projected customer demand. Last but not least it is important to understand how the token will be distributed to the contributors.
4. Write a detailed white paper.
This fourth step marks the point where the idea behind the project and the ICO supporting it are communicated to the potential contributors, being either a selected few or the public at large. This is done through the issuing of a White Paper which is ultimately the marketing document or the so-called ‘sales pitch’ upon which potential contributors decide whether to contribute to the ICO or otherwise. The white paper should:
• outline the project – a solution to a problem;
• outline the services offered by the company;
• give details of the ICO;
• describe the use and nature of the token;
• state the token price;
• give information on the tokens and funds distribution;
• introduce the team behind the project;
• serve as a proper marketing document.
Drafting a White Paper also requires full understanding of any underlying legal implications arising from the nature of the token as explained above. This, therefore, requires that a White Paper undergoes a detailed legal review to ensure the company carrying out the ICO, as well as its Founders and Directors are not exposed to any regulatory risks and secure an enhanced exposure of the project.
A well-written White Paper is therefore vital to ensure that:
• it gives the correct and necessary information;
• it stands out from amongst similar projects;
• it attracts contributors;
• it guides potential contributors to make an informed assessment of the project.
5. Know your client
Attracting contributors is important, knowing who the contributors are is even more essential. ICO companies need to ensure that throughout the ICO, they maintain an effective KYC procedure with regards to all contributors. Such procedure should be in line with national and European anti-money laundering and prevention of funding of terrorism regulations. ICO companies should therefore seek expert legal advice on adequate KYC procedures and solutions.
6. Legal relationships with various token holders
Legal relationships between companies that issue the token further to an ICO and token holders themselves are built through smart contracts on the blockchain. However, since ICOs are still not widely regulated, the contracts regulating such relationships should be detailed enough to cover all risks and liabilities. Therefore, it is essential that a company running an ICO seeks expert legal advice for the drafting of full-proof smart contracts to regulate their legal relationship with each and every contributor.
Starting your ICO and require Legal services? Check us out!
E&S Group, is a licensed corporate services provider in Malta with a keen focus on ICO, Blockchain, Tokenomics, and Crypto advisory. Our firm has helped more than 40 clients to run an ICOs to launch their project. If you require legal advice in relation to blockchain, crypto, ICOs and tokernomics, E&S Group, are here to help you achieve your dream! Visit our website to know more about our services. https://ellulschranz.com