Our insights on Blockchain, cryptocurrencies and initial coin offerings
We are still in the early days of the blockchain revolution – the technology needs further development and testing, and market participants need to experiment to find the use cases that are best suited to the benefits blockchains offer and recognise it is not a universal technology panacea. The legal analyses of blockchain solutions are in their early stages, and regulatory responses are not yet clearly defined.
Below we provide our insights on this evolving landscape, track key market developments and introduce our blockchain experts across the firm.
Bill 7637 – Luxembourg adds the missing piece for the issuance and circulation of blockchain securities – August 2020
Bill of law 7637 (the Bill) notably amends the Luxembourg act dated 6 April 2013 on dematerialised securities (the Dematerialised Securities Act 2013) by:
- expressly recognising the use of blockchain or other distributed ledger technology (DLT) to record the issuance of Luxembourg law governed dematerialised securities (by serving as the primary register of such issuance); and
- opening the role of the central account keeper to EU credit institutions and investment firms (meeting specific organisational and technological criteria).
The Bill is a continuation of the Luxembourg act dated 1 March 2019 which expressly recognised the use of DLTs in the context of the circulation of securities. The Bill gives legal certainty to issuers to directly issue DLT securities by keeping their securities’ registers on a distributed ledger (such as a blockchain).
The Bill also allows a broader array of players to facilitate such DLT issuances by acting as the central account keeper for such issuances.
By catering for the direct issuance of Luxembourg law governed securities on distributed ledgers, the Bill adds the missing piece to the Luxembourg legal framework for the issuance and circulation of securities within a DLT environment. This Bill reinforces Luxembourg as a legal hub for issuing DLT securities as issuers from around the world will be able to rely on a sound legal framework to issue and settle securities directly on DLTs.
Update: Cryptocurrency before English courts - February 2020
Just before Christmas we wrote about the decision in Vorotyntseva v Money-4 Limited, which was thought to be the second example of the English courts ordering a freezing order over cryptocurrency (along with Robertson v others, covered here). More decisions have emerged since then, as this area picks up pace.
Earlier this month in AA v Persons Unknown, the Commercial Court awarded a freezing order against a number of defendants in respect of Bitcoin which the claimant had paid in ransom after being hacked. As in Vorotysnesva and Robertson, the court was happy to find Bitcoin was a form of property capable of being subject of a proprietary injunction, and expressly referred to and endorsed the analysis in the recent UK Jurisdictional Task Force legal statement on cryptoassets (you can find A&O’s summary of the key points of that statement here).
We’ve also just learnt that another similar (unreported) order has been granted in a case that is going to trial early this year – so watch this space for what looks to be the first full trial in which the court will confront the substantive legal question of exactly what form of property cryptocurrency takes.
The High Court has granted a freezing order over GBP1.5million worth of Bitcoin and Ethereum cryptocurrency against a trading platform and its directors, in only the second known example of the court treating cryptocurrency as property.
The question of whether cryptocurrency is property is relevant to determining competing rights parties may have in it: Elena Vorotyntseva v Money-4 Limited t/a Nebeus.Com, Sergey Romanovskiy, Konstantin Zaripov  EWHC 2596 (Ch)
UK Jurisdiction Taskforce: The LawTech Delivery Panel Legal statement on cryptoassets and smart contracts - November 2019
The UK Jurisdiction Taskforce carried out a consultation earlier this year to identify the key questions that needed to be answered about English law's approach to cryptoassets and smart contracts. Following input from relevant stakeholders, including Allen & Overy, UKJT published its legal statement on the 18th November 2019.
Over the last few years, digital assets did not appear to fall within scope of French law or regulation as they could not be characterised as e.g. currency, electronic money, financial instruments.
The French Government has taken the initiative to create a cutting-edge legal framework in order to regulate the provision of digital assets services in France.
Over the recent months there has been a proliferation in the development of stablecoins, namely crypto-assets pegged in value to fiat currency or other assets.While the price fluctuations of other crypto-assets make them perhaps more attractive for speculation, the relative stability of stablecoins offers the possibility of cryptocurrencies being adopted for use in everyday transactions and of becoming a digital form of cash.
In this publication with fintech consultant Hazem Danny Al Nakib, we not only provide an overview of the main stablecoin models, but we also explore the potential advantages of stablecoins and discuss how these need to be balanced against regulatory and policy goals covering matters such as consumer protection, financial services regulation, market integrity and financial crime.
Members of Washington, D.C.’s Financial Services Regulatory and Litigation and Investigations groups recently authored an article on U.S. and global cryptocurrency anti-money laundering risk considerations.
The chapter showcases A&O’s multi-jurisdictional reach and international knowledge of the global approach to AML regulations, incorporating insight from A&O lawyers in five jurisdictions.
For regulated financial institutions, the opportunities presented by cryptocurrencies and distributed ledger technology (DLT) are tied to significant operational and regulatory challenges, not least the implementation of anti-money laundering and counter terrorist financing (together, AML) regimes.
This article seeks to provide a high-level view of how the emerging cryptocurrency sector intersects with AML regulations. We identify cryptocurrency risk considerations, focusing on risks posed by customers who hold, produce, or otherwise interact with cryptocurrencies to a significant degree and by services provided to cryptocurrency markets.
Recent developments in the regulation of cryptocurrency exchanges and cryptocurrency trading in Poland - May 2018
Cryptocurrency exchanges and the cryptocurrency trading market have generally been unregulated so far in Poland. There are no pending legislative proposals aimed specifically at curbing cryptocurrency trading; however, upcoming new anti-money laundering legislation and recent steps taken by the Polish Financial Supervision Authority (the PFSA) may adversely affect the Polish cryptocurrency market.
The European Commission published an action plan for financial technology on 18 March 2018 as part of the EU’s work to complete the Capital Markets Union.
The action plan covers a wide range of topics, including a proposal for an EU Regulation on crowd-funding, setting up an EU Fintech Lab and continued monitoring of developments in crypto-assets and Initial Coin Offerings (ICOs). The action plan indicates that the EU, similarly to the UK and U.S., is positioning itself as open to innovation, with the EU Fintech Lab echoing the FCA’s regulatory sandbox and the Commodities Futures Trading Commission’s (CFTC) LabCFTC. At the same time, the EU is proceeding cautiously with respect to the regulation of crypto-assets and ICOs, meaning that EU institutions wishing to trade in these products still face the task of forming their own view of how to apply the current EU regulatory regime, with the possibility that the EU could at a future date introduce specific legislation.
At the end of 2017 Allen & Overy (A&O) assisted Nivaura with the issue of the world’s first cryptocurrency denominated, blockchain settled bond for Luxdeco, an online retailer of luxury furniture.
In this article, we will explain the structure of the two bonds that were issued, through the Financial Conduct Authority’s (FCA) second regulatory sandbox and analyse some of the legal issues presented. We will examine the end to end automation of a securities issue, with a particular focus on Nivaura’s Legal Markup Language (LML) and will then turn to the question of whether cryptocurrency is money or not.
Allen & Overy was delighted to have the opportunity to lead a workshop on Initial Coin Offerings at the recent Innovate Finance Global Summit. We had such an engaged audience and covered so much ground that we wanted to share some of the key points more broadly. We discuss what constitutes an ICO, the current regulatory climate, untapping an ICO’s potential, the legal considerations involved, and more.
Read the full workshop summary
Israeli Supreme Court grants injunctive relief to Bitcoin trading company against its bank, requiring the continuation of banking services – March 2018
On 25 February 2018, the Israeli Supreme Court, in what appears to be a landmark decision, granted temporary relief in favour of a crypto-currency (Bitcoin) trading company, Bits of Gold Limited (BoG) against its bank, Bank Leumi (Leumi).
The decision, whilst preliminary and not on the merits of the legal questions before it, contains insightful observations about the nature of risks inherent in crypto-currency trading and whether it is reasonable for a bank to impose a blanket prohibition on providing banking services on the ground that such risks are excessive and pose a significant risk for the bank not complying with anti-money laundering and terrorist financing obligations, amongst others.
The decision ought to be seen as a boost to the virtual-currencies world in that it portrays it in a legitimate rather than illegitimate light. It would of course be very interesting to follow the actual outcome of the substantive determination of this case. A further observation which would be important for banks is that the Court seems to have concluded that banks possess sufficient tools to handle the risks posed by virtual-currencies activities leaving the only reasonable ground for refusal of such activities to be poor record of risk management and compliance by businesses seeking to carry out such activities.
Last year saw an explosion in interest in blockchain infrastructure and how it might be employed in financial markets. This article provides an overview of the efficiencies gained by using this infrastructure for bond issuances, focusing on one case study.
Allen and Overy (A&O) recently supported fintech company Nivaura with the world’s first cryptocurrency denominated, blockchain settled bond for LuxDeco, an online retailer of luxury furniture. The transaction took place in A&O’s tech innovation space, Fuse, and was part of the Financial Conduct Authority’s regulatory sandbox, which allows businesses to test innovative products, services, business models and delivery mechanisms in the real market, with real consumers.
To access the article, which first appeared in the February 2018 issue of IFLR, read more here.
FCA announce that it is to conduct a deeper examination in the Initial Coin Offering (ICO) market – December 2017
The FCA has announced that it is to “conduct a deeper examination of the fast-paced developments” in the Initial Coin Offering (ICO) market, following its study on distributed ledger technology (DLT). In September this year it issued a warning that investments in ICOs are “very high-risk” and “speculative”; however, the FCA has now made it clear that is considering whether there is a need for “regulatory action” in this area.
The FCA noted that a “well-functioning ICO market… can materially contribute to the development of DLT”, but that it was “critical” that issuers and promoters of ICOs take steps to allow investors to make fully-informed decisions when acquiring tokens.
The FCA’s statement is in-line with it previous comments on ICOs and reflects the growing regulatory focus on this market. Importantly however, the UK regulator continues to indicate an openness to the growth and proper use of ICOs and has confirmed that it would, in principle, welcome consumer-focussed offerings into the FCA Sandbox for controlled testing. Market participants who are considering an ICO should therefore ensure that any proposed offering complies with all aspects of applicable regulations and, in particular, can demonstrate that potential investors are able to make a fully informed decision before electing to acquire a token. Regulatory activity in this area is likely to continue to evolve in 2018 and should therefore be factored into any ICO structuring discussions as early as possible.
A link to the FCA Feedback Statement can be found here.
Nivaura executes world’s first automated cryptocurrency bond issuance supported by Allen & Overy – November 2017
The world’s first fully automated cryptocurrency-denominated bond issuance that is also cleared, settled and registered on a public blockchain infrastructure has been successfully completed by Nivaura, a fintech company that has developed a cloud-based service for the issuance and administration of financial instruments by small and medium-sized issuers. The transaction took place in Fuse – a tech innovation space based in Allen & Overy’s London offices – and was part of the Financial Conduct Authority’s regulatory sandbox, which allows businesses to test innovative products, services, business models and delivery mechanisms in the real market, with real consumers.
In further developments covering the regulation of initial coin offerings (ICOs), the European Securities and Markets Authority (ESMA) is the latest body to issue a warning to investors of the high risks relating to token sales. These follow the tone and content of announcements of other regulators including the FCA, which has previously flagged the untested nature of the technology, liquidity of tokens and level of disclosure provided by issuers. ESMA has also issued a statement to “draw the attention of firms involved in ICOs to the fact that they must give careful consideration as to whether their activities constitute regulated activities.” This reinforces statements of the SEC that existing securities laws and regulations must be taken into account when structuring token offerings.
The ESMA guidance goes on to suggest that “where the coins or tokens qualify as financial instruments it is likely that the firms involved in ICOs conduct regulated investment activities, such as placing, dealing in or advising on financial instruments or managing or marketing collective investment schemes. Moreover, they may be involved in offering transferable securities to the public.” ESMA also identified a non-exhaustive list of relevant EU rules for issuers to consider, including the Prospectus Directive, the Markets in Financial Instruments Directive, the Alternative Investment Fund Managers Directive and the Fourth Anti-Money Laundering Directive prohibits money laundering and terrorist financing.
The statements continue the theme of regulators around the world closely monitoring ICOs and putting issuers on notice that existing securities laws and other rules apply to token offerings. Issuers will need to structure their offerings accordingly when issuing tokens which are securities.
ICO Statement Investors
ICO Statement Firms
Initial Coin Offerings (ICOs) are increasingly coming under the spotlight of regulators. The U.S. SEC has already taken legal action against the sponsors of two ICOs. China has banned ICOs. We take a look at regional regulatory responses to ICOs, and, with a focus on Hong Kong we consider the key issues of whether "coins" or "tokens" are regarded as securities, and the repercussions if they are. ICOs are an innovative way of raising capital, but their future success will depend on a coordinated and proportionate regulatory response.
In the latest regulatory development in relation to Initial Coin Offerings (ICOs), China has announced that ICOs are illegal and investigations have been launched into a large number of ICO platforms. The announcement came in a joint statement made by the People’s Bank of China, the Cyberspace Administration of China, the Ministry of Industry and Information Technology of the People’s Republic of China, the State Administration for Industry and Commerce of the People’s Republic of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission.
While a more stringent response than in other markets, the announcement reflects the increased attention ICOs are now attracting from regulators. Companies seeking to raise funds through an ICO will need to take into account the development in the way they structure and market their offering and to comply with the evolving and differing regulatory treatment of ICOs around the world.
SEC files its first enforcement action against alleged sponsors of initial coin offerings - September 2017
On September 29, 2017 the U.S. Securities and Exchange Commission (the SEC) filed a civil complaint in the U.S. District Court for the Eastern District of New York against the sponsors of two “initial coin offerings” (ICOs) for alleged violations of U.S. securities laws.1 This is the SEC’s first enforcement action against sponsors of an ICO, and it highlights the SEC’s increasing attention towards potential violations of securities laws involving this emerging technology.
On Monday, September 25, the United States Securities and Exchange Commission (the SEC), the U.S. regulator of the securities industry, announced two new initiatives that are likely to impact the blockchain and cryptocurrency industries.
The SEC’s initiatives involve the creation of a new ‘Cyber Unit’ which will work as part of the SEC’s Enforcement Division and the creation of a ‘Retail Strategy Task Force’ which will develop initiatives to identify misconduct that impacts retail investors. Both initiatives have the potential to affect the increasingly prevalent ‘initial coin offering’ or ‘ICO’ form of financing that has grown significantly since 2016.
In a new paper Nivaura CEO and Product Architect Dr Avtar Sehra, Allen & Overy debt capital markets partner Phil Smith and Phil Gomes, Senior Vice President of U.S. B2B Digital for communications marketing firm Edelman, explore the dynamics within the market for initial coin offerings (ICOs).
On 1 August, the Monetary Authority of Singapore (MAS) issued a press released stating that the offer or issue of digital tokens in Singapore will be regulated by MAS if the digital tokens constitute products regulated under the Securities and Futures Act (Cap. 289) (SFA). MAS’ clarification comes in the wake of a recent increase in the number of initial coin (or token) offerings (ICOs) in Singapore as a means of raising funds and after the SEC also offered regulatory guidance on the likely treatment of token sales.
On 25 July 2017, The U.S. Securities and Exchange Commission issued an investigative report cautioning market participants that offers and sales of digital assets by "virtual" organisations are subject to the requirements of the federal securities laws. Such offers and sales, conducted by organisations using distributed ledger or blockchain technology, have been referred to, among other things, as "Initial Coin Offerings" or "Token Sales".
On Friday 21 July, 2017, Delaware's Governor John Carney signed into law amendments to Delaware's General Corporation Law to account for the use of blockchain technology in corporate recordkeeping.1 The legislation will be implemented beginning 1 August, 2017 and represents the culmination of an ongoing industry consultation and is part of a broader blockchain initiative. The initiative includes a concurrent technology project with partner Symbiont and was originally announced by former Delaware governor Jack Markell in May 2016. The initiative also covers efficiencies in public record keeping and securities filings, which are not within the scope of this article.
The number of cryptocurrency and blockchain related patent applications being submitted and published in the U.S. has nearly doubled in 2017. Data from the U.S. Patent and Trademark Office (USPTO) database, analysed by CoinDesk, indicates that there were 390 patent applications broadly related to blockchain technology published between January and July of this year.
Overall, this represents a 90% increase compared to the same period in 2016, when 204 applications were sent to the USPTO.
The World Economic Forum (WEF) recommends a multi-stakeholder approach to the stewardship of blockchain and cryptocurrencies in a new report. WEF says that blockchain, or distributed ledger technology, could soon give rise to a new era of the Internet even more disruptive and transformative than the current one. It sees the key to enabling this transition being the formation of a multi-stakeholder consensus around how the technology functions, its current and potential applications and how to create the regulatory, cultural and organisational conditions for it to succeed.
A smart contract is a set of promises, agreed between parties and encoded in software, which, when criteria are met, are performed automatically. Smart contracts were written about in the 1990s by Nick Szabo, and have received renewed interest recently as a result of the “blockchain revolution” stemming from the technology underlying Bitcoin. Smart contracts do not need a blockchain to work, but they do need an underlying trusted network or mechanism, which blockchains provide conveniently and efficiently. We look at possible uses to which smart contracts could be put in the finance context and explore and look at how the law might view smart contracts.
"Chain reactions”, two articles from our 2016 Annual review, explain what blockchain, the ‘Computationally Efficient Trust Engine’ is and explore its impact on lawyers.
A Decentralized Autonomous Organization (DAO) is a computer program, running on a peer-to-peer network, incorporating governance and decision-making rules. The earliest DAOs are software controlled community organisation experiments which seek to re-implement certain aspects of traditional corporate governance, replacing voluntary compliance with a corporation’s charter with actual compliance with pre-agreed computer code. ‘The DAO’ is the most prominent example of a DAO. It gained significant media attention after it raised the equivalent of USD168 million from individual investors in its initial creation phase, making it the world’s biggest crowdfunding project to date. However, on 17 June 2016, a weakness in The DAO’s code was maliciously exploited and it became materially compromised. It is unlikely to recover. In this paper we look at how DAOs work, and consider some of the potential legal issues associated with DAOs, including where liability might lie in the event of a problem.
The recent suspension of trading on Hong Kong based Bitcoin exchange Bitfinex following the apparent theft of approximately USD60m worth of bitcoins is the latest in a series of Bitcoin thefts. With Bitcoin still in its relative infancy, some jurisdictions have taken steps to integrate Bitcoin into their financial regulatory system, while regulators in Hong Kong have not yet done so. With Bitcoin increasingly having real-world impact on everyday citizens, the question of how Bitcoin regulation should be approached becomes increasingly pressing.
In their engagement to date with the emerging cryptocurrency sector, the United States Commodity Futures Trading Commission (the CFTC), and many other regulatory bodies, have broadly adopted a “wait and see” approach to adapting their regulatory frameworks, seeking where necessary to apply existing regulations to this nascent space in as coherent a manner as possible. This approach has so far been largely successful, with enforcement actions by regulators taken against dangerous Ponzi schemes and unlicensed exchanges. However, this approach has come under scrutiny, as just two months prior to the 2 August, 2016 hack of Bitfinex the CFTC had issued an order, following the conclusion of an investigation into the Hong Kong based cryptocurrency exchange.
The Committee on Economic and Monetary Affairs (CEMA) has prepared a draft motion for a European Parliament Resolution on virtual currencies (VCs) and distributed ledger technology (DLT). In our alert, we review the substance of the CEMA motion and offer some early recommendations for companies exploring opportunities in this area. The CEMA position clearly demonstrates that the EU legislator has a keen interest in the opportunities and risks associated with VCs and DLT. In this respect, it is encouraging to read that there is a call for “smart regulation” and a recognition that the regulation should also allow these new technologies to develop.