ICO/Token Sale as a Revolutionary Fundraising Method

Apparently, revolution is the first thing that comes to the minds of many people when they hear about Ukraine. Last year undoubtedly proved Ukraine’s ability to be among leaders of the global digital currency revolution. It is true that very few businesses and opinion leaders managed to escape the so-called crypto hype. ’Blockchain’, ’Bitcoin’, ’mining’, ’token’ and ’ICO’ have deservedly become part of the terminology most frequently used in the media and day-to-day jargon. Proper and timely introduction of these definitions into both national legislation and regular business activities is crucial for Ukraine in its advancing the country’s investment climate.

Global Trends in ICO Project Financing

According to the State of the Token Market research conducted by Fabric Ventures and TokenData, in 2017 more than USD 5.6 billion was raised through an alternative way of project financing, known as Initial Coin Offering (ICO) and/or Token Sale. As such, ICO is an unconventional project financing method that enables businesses to raise capital from multiple sources by selling digital tokens/coins. Such sale is normally based on Blockchain technology. Unlike the purchase of stocks in a regular Initial Public Offering (IPO), ICO vehicle allows investors to directly benefit from it by trading the ICO token on various exchange platforms or use it as a payment method on digital market places. Businesses are interested in ICO due to this rapid and relatively easy way of raising capital, which most commonly does not involve sharing ownership of their company with third parties.

In general, countries can be divided into three groups based on their approach to ICO regulation. The first group includes countries with a positive legal climate for ICO projects. As of today, such countries are Switzerland, Luxembourg, Gibraltar, Israel, Japan, Belarus (recently), etc. Another group of countries has either banned ICO (South Korea, China) or issued strict regulations (Hong Kong, Singapore). The third group of countries has a neutral approach, yet no legal definition has been issued of what an ICO is. Ukraine, alongside Georgia, Estonia, UK, Peru, Poland, etc. belongs to this group.

It is common that a White Paper, Smart Contract and Token Sale Agreement are the main documents providing legal guidelines for ICO projects. White Paper is a marketing tool, normally used in B2B and B2C that helps prospective investors to make a positive decision about your project. A Smart Contract is an algorithm used to carry out transactions on Blockchain. A Token Sale Agreement is a legally binding contract executed to properly conduct the purchase of tokens from a company.

Despite the priority of national regulations of ICO, foreign legislation is sometimes applicable to the procedure. This happens if a foreign country has a globally recognized influence. A number of countries, like Switzerland, the UK, South Africa, Japan, France, etc. have agreed to cooperate with the United States on the use and implementation of their federal laws and regulations. As an example of such federal regulations, globally applicable to ICO projects, the Securities Act of 1933 and Securities Exchange Act of 1934 can be mentioned that potentially involve the sale of securities. To determine whether an ICO and/or Token Sale involves a securities offering, the Howey Test is used. If securities are involved, then a Token Sale shall be registered with the Security Exchange Commission (SEC) or exempted from registration.

If token sales involve virtual currency, the regulations of the Financial Crimes Enforcement Network (FinCEN) apply. According to FinCEN, ’virtual currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction’. 

Ukrainian Market

Project financing via ICO and/or Token Sale is a new phenomenon on a Ukrainian market, unlike private equity and venture financing. 2017 has been marked with unprecedented interest from both startups and well-developed businesses for ICO project financing. Hacken, DMarket, Smartlands, to name a few, are globally recognized ICO projects with Ukrainian roots. According to the Ernst and Young report on ICO, Ukraine is in the world’s Top-16 countries with around USD 30 million in ICO crowdfunding. The amount is relatively small compared to venture financing, which is no surprise as there is no specific regulation in Ukraine, neither allowing nor favoring ICO. The most popular industries for ICO project financing are IT, E-commerce, cybersecurity, agriculture and F&B. 

Unfortunately, Ukraine is not yet fully deprived of the risks for business at various levels. The lack of proper tax regulation of cryptocurrency activities, hostile actions of state authorities regarding crypto-businesses and the impossibility to resolve disputes related to cryptocurrencies in court motivates ICO project financing participants to subdue their transaction to foreign laws. Businesses stick to international corporate structuring incorporating legal entities in various jurisdictions with a favorable crypto-investment climate. A basic ICO corporate structure may include one or two operational entities in Ukraine (i.e. possessing the necessary permits for business operation in Ukraine). One of them shall be incorporated in one of the above-mentioned crypto-loyal jurisdictions. Another one shall be registered as a vanishing entity, i.e. for the purpose of token collection and their further exchange to fiat currency. The latter shall also be used for such purposes as trademark registration and IP rights possession. An operating company in Ukraine, therefore, receives fiat (real) money, rather than cryptocurrency, for the avoidance of risks related to the usage of crypto-money. Agreements regulating cryptocurrency investments (in most cases agency agreements) are also usually executed under foreign legislation. This enables the parties involved to rely fully on chosen dispute resolution forums with a history of cryptocurrency-related cases.

If for whatever reason an ICO undertaking happens to be registered in Ukraine, it may face a number of regulatory barriers that are rarely seen in most crypto-loyal jurisdictions. Overregulation of currency exchange operations, absence of legal instruments of crypto-to-fiat currencies exchange, the weak status of shareholders agreements and its enforceability in Ukrainian dispute resolution forums, as well as the unclear taxation procedure for crypto funds raised during ICO project financing, all add to Ukraine’s unattractiveness for digital currency financing and its vulnerability. To make prospective investors adopt decisions in favor of Ukrainian jurisdiction, it is necessary to react in a timely manner to innovative financial tools and ensure the loyalty of the Government, sufficient to design a modern and up-to-date regulatory environment for ICO.