ICOs v Crowdfunding: A Regulatory Perspective

The regulatory approach towards ICOs and crowdfunding is increasingly divergent. Learn why, and what lessons this could hold for your ICO/ cryptocurrency project

ICOs were a headline FinTech development of 2017 — they became widely known as a new, potentially low-cost means of capital raising for start-ups (and increasingly, existing companies). This somewhat overshadowed the use of a hugely popular FinTech development that emerged in around 2015: crowdfunding.

As we’ve written elsewhere, ICOs are a little like a hybrid between IPOs and crowdfunding. ICOs take the potentially low costs, popularity, and broad range of potential investors/purchasers associated with crowdfunding. They can also have some of the attractive ‘investment potential’ associated with IPOs (which is typically lacking from crowdfunding).

This ‘investment potential’ has seen vast growth in a wildly speculative market. In turn, we have increasingly seen proposed ICOs being shut down by regulators around the world: their success brought about a regulatory approach which could prove to be the Achilles heal of this new capital raising method.

Crowdfunding: the Regulatory Experience

The regulatory approach towards crowdfunding is somewhat polarised to the regulation of ICOs.

Although there was some initial regulatory uncertainty and reservations as to how they should be treated, since crowdfunding gained popularity in around 2015, the general regulatory approach has been overwhelmingly positive.

Many countries amended their regulatory regimes to better enable entities to carry out crowdfunding. For instance, the UK, Australia, and Singapore amended aspects of their legal regimes to better accommodate the use of crowdfunding capital raising. Such reforms focused particularly on corporations/financial law — the legal regimes where many of the ‘securities law’ issues that have proved problematic for ICOs are typically found.

Additionally, some countries have developed ‘regulatory sandboxes’ which can extend to crowdfunding (and in some cases were introduced as part of crowdfunding legal reforms.) Regulatory sandboxes typically offer various concessions and exemptions from having to comply with certain requirements, designed to lower the compliance costs for eligible start-ups.

Why the different regulatory treatment between ICOs and crowdfunding?

In short, because regulators see some important policy differences between crowdfunding and ICOs.

The first is image. From a government/regulator perspective, it may seem that certain ICO purchasers need greater legal protection — they are buying tokens against the backdrop of media reports of returns of >1,000%, but they do not fundamentally understand the risks or technology. There is also a concern as to the prevalence of ‘scam ICOs’.

Crowdfunding meanwhile, does not have the same overall image of promising to bring ‘mum and dad’ investors into the world of finance and make them overnight millionaires.

The second issue is more of a legal one. The rights granted by ICOs are, by and large, much closer to buying securities or making some form of investment with the prospect of a reward than crowdfunding agreements.

It may be that the treating prospective ICOs in the same way as IPOs or larger-scale, conventional capital raising is ‘overkill’.

Arguably, there is a need for legal frameworks to more clearly recognise some sort of legal ‘mid-point’ between IPOs-type arrangements and crowdfunding (and Lupercal has broadly advocated law reform to reflect this approach) but for now, many regimes do not have one.

Why does this matter?

At first glance, knowing the policy issues regulators/governments are trying to address might not seem particularly useful. The ICO industry is now probably too large for the operations of individual ICOs to have much short-term impact on changing the industry’s image (except for the worse, where there are major reports of nefarious ICOs).

But there are two key ways this knowledge can help your project:

1. Securities v Utility Tokens

Designing token models to be broadly more aligned with crowdfunding-type rights, rather than IPO-type securities, could broadly reduce the chances that the tokens are legally characterised as securities (and make them more likely to be utility tokens) when the tokens are reviewed by ICO lawyers.

Further, some projects (for instance, those with a very low risk tolerance) could be better suited to being run more like crowdfunding arrangements.

2. Managing Regulatory Risks

Secondly, as we’ve written elsewhere, an underlying problem with ICOs is that they are available to the ‘world at large’, so projects can be subject to multiple areas of law in just about every country in the world!

Projects that understand the underlying policy objectives and concerns held by governments and regulators could be better able to understand what the law is trying to achieve, and work with regulators to achieve a better outcome.

Potentially, this may help them design their ICO to increase the likelihood of ‘in principle’ legal compliance. This can be an important aspect of managing regulatory risk, and could reduce the amount of legal work required on a project.

Lupercal Capital and its team of cryptocurrency experts has provided strategic consulting on ICOs and blockchain to existing businesses and start-ups to help them unlock the potential of crypto-technology.

If you’re thinking of an ICO or blockchain adoption, we’d love to hear from you — go to lupercalcapital.com, or email us at [email protected].

If you’re interested in regulatory developments in cryptocurrency, check out CryptoRDB, the most comprehensive database on cryptocurrency regulation.