EU may apply existing rules to Cryptos

  • By Carole Ann Furman

  • November 14, 2018
  • 1:36 am BST

Regulators across the planet are having to come to grips with the digital world and the fact that current regulations are not as specific as needed in this modern era. The U.S. Congress already held discussions in this area, and in the EU, the European Securities and Markets Authority (ESMA), the overlord of all financial regulatory matters in the union, has recently declared its position on the same issue. It has suggested that “existing financial rules” should apply for regulating most cryptocurrencies and Initial Coin Offerings (ICOs), but officials also noted that, “more clarification is needed.”

ESMA also designated that these assets fall under the new rules pertaining to the EU’s MiFID II (Markets in Financial Instruments Directive II), which went into effect last January. It was interesting to observe the folks at ESMA gracefully tiptoeing around which agency was empowered to take action and which was not. The primary issue that global regulatory bodies have to clarify is whether a crypto token is a payment device or an investment security. In the case of “asset tokens” which form the basis of an ICO to “pre-finance a new business model”, the Securities and Markets Stakeholders Group (SMSG) would need to determine if the asset resembled a commodity or a security.

Tokens issued in a traditional ICO do not necessarily confer any ownership in the proposed business model of the new enterprise. Entrepreneurs do not have to dilute their ownership, but the success of their project would increase the value of the tokens in a free market place, the payoff that investors would be seeking. This style of financing has never been considered in current security jargon across the planet and has caused a great deal of uncertainty. Several regulatory bodies have already ruled that, “in substance”, the tokens are close enough to shares to be considered as securities, and have meted out penalties accordingly with the perceived level of security code violations.

Tens of billions of dollars, euros, and other currencies have been raised to finance various ICOs across multiple jurisdictions to date. The threat of applying securities-based regulations to ICO tokens caused a brief momentum slowdown in 2017, but fundraisings in the pipeline proceeded anew after additional legalese was added to promotional materials. The fear now is that innovation will once again be stifled or the promoters will flee to countries where oversight is lax or nonexistent, the very reason that the ICO industry has been plagued with fraudulent offerings.

In any event, ESMA would like the SMSG to remove the confusion by expanding upon the definition of “transferable tokens” and also to define, when and if these transferable tokens “give right to a financial entitlement, they should be considered as MiFID transferable securities.” In order to address the potential flight of intellectual capital to more favorable jurisdictions, the ESMA report also recommended “the creation of national sandboxes and innovation hubs for token-based startups,” with ESMA ensuring the “sufficient quality, transparency and legal security of national initiatives.”