A legal opinion is based on the nature of token as utility token or security token based on token functions and concept. Today, Initial Coin Offerings (ICOs) have developed a strong digital presence all over the world. They are innovative ways to acquire adequate funds for new businesses and projects. However, even though crypto investments have been growing rapidly with the advent of newer models like the Stock Transfer Orders (STOs) there is an absence of formal legislations that deal with ‘crypto-assets. In the European Union, any crypto-asset derives legal value based on the nature of its token as only those that qualify as securities can be subject to laws applicable on financial assets. Conversely, only utility tokens such as cryptocurrencies are free from such legislation. At the same time, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) has pointed out that ICOs are incapable of operating legally and any administrator of digital assets is governed by FinCEN’s regulations. Thus it is always important to obtain suitable legal advice through an Opinion Letter on the structure of the asset and the laws relating to it, to circumvent any liabilities.
Since a transaction is governed by parties who are invested in or are affected by the transaction, it is often recommended that the individuals who will be contractually obligated by the transaction, take the legal opinion of a qualified third party. Such an opinion helps them draw a legal conclusion for the transaction and helps analyze the responsibilities of each party in the transaction. Often, parties hire competent professionals such as lawyers to address any issues in the transaction and to provide such legal opinions to the parties. It must, however, be noted that a legal opinion must not be deemed as a substitute for legal aid. Clients must recognize that when they obtain a legal opinion letter, they are merely being advised with regards to their questions and not receiving a “Guide to Action”.
For blockchain and crypto projects, a token can only be considered as a security token if the token provides a share of ownership in the crypto project. On the other hand, utility tokens do not relate to security in a project. To prepare an effective utility token legal opinion letter for a crypto project, the analysis needs to cover all features of utility token, including but not limited to, issuance of utility tokens, factors impacting the price of utility tokens, distribution of utility tokens, and the like.
There are various methods that are deployed for staking of utility tokens. As an illustration, the utility token staking method can use a node processor that stakes an amount of crypto assets on a value blockchain by sending the amount of crypto assets from a staker address on the value blockchain to an address of a smart contract on blockchain. In response to the staking, the node processor creates a certain number of utility tokens on blockchain. Subsequently, on blockchain, the staker address is linked to the number of utility tokens that have been made. The number of utility tokens that are created is backed by the number of crypto assets that are staked on the blockchain. Also, there can be a fixed exchange rate between the number of crypto assets that are staked on the blockchain and the number of utility tokens that are created on the utility blockchain.
Initial Coin Offerings (ICO) list their issued tokens in a cryptocurrency exchange to maintain liquidity. This liquidity depends on the nature and function of the token and thus is often referred to legal professionals before they are introduced in the market. The legal Opinion in this matter is drafted with the goal of either confirming the classification of a token as a security asset or not. They ultimately, help the issuer understand whether the token abides by the laws applicable to conventional exchanges that trade in securities.
A legal opinion is generally drafted by a competent professional of a specific area of law. For a cryptocurrency exchange, a qualitative legal opinion provides parties with clarity on their positions in various transactions and their validity as per the existing legislation. It helps draw reasonable conclusions. Further, such a legal consultation also helps token issuers to examine the customer’s activity and to ensure that the latter is a credible entity. In drafting a legal opinion on any financial assets or digital tokens legal professionals have the responsibility to ensure that they execute proper legal and factual examination, analysis, and verification.
Presently, there is no established structure of a legal opinion. Thus, these opinions are drafted based on a structure that has developed over time across the globe. This structure includes:
One important legal consideration for financial assets is its tax implications as per the jurisdiction within which the assets are introduced. All laws concerning ICOs and their tax liability depending on the nature of the tokens issued. Due to the inherent structure of an ICO, the tax liability sustained by various forms of tokens differs significantly.
In Europe, corporate tax is valid on the revenue at the rate of 12.5%. Certain Value-added Tax (VAT) exemptions are applicable under Article 135(1)(e) of the EU VAT Directive 2006/112/EC.
A utility token is a distinctive token that is used to finance projects for startups or companies. These tokens can be exempt from corporate taxes as they are prospective. The 12.5% rate of taxation applies to the profits when the prospective services are provided to the holder.
A legal opinion helps businesses understand the jurisdictional implications of their digital asset, as they vary substantially based on how welcoming the administration of a country is towards crypto-assets. The European Securities and Markets Authority (ESMA), for instance, emphasizes that firms involved in crypto-assets or ICOs must always consider whether their activities institute regulated activities, as then, they must fulfil the applicable legislation. Thus, even though ICOs may not fall within the purview of the existing laws, depending on how they are structured, where the assets are determined to be financial instruments it is probable that the firms involved in it must execute regulated investment activities.
Other administrative authorities like Germany’s Federal Financial Supervisory Authority introduced guidance regulations for the governing classification of digital assets or ICOs as financial tools. The authority has recognized the different types of token structures and established each ICO must be considered on a case-by-case basis. However, even though the guidance recognizes the existence of ICOs it does not offer any clarity as to under what circumstances can tokens be considered securities that mandate regulatory approval. The guidance has only established that approval is mandatory from the authorities in various cases. These cases can include when the token issuance or trading must be deemed as brokering, emission, or a financial asset that mandates permission or licenses under the existing financial regulation. Similarly, it has been seen from multiple instances that Germany has not fully embraced ICOs with open arms as there is a lack of statistical proof. However, while Germany’s crypto-asset laws are ambiguous on technical jurisdictional aspects of the assets, recently they faced considerable criticism for their classification of tokens as financial assets due to a recent decision of a higher regional court of Berlin. The court held that in providing this guidance and classification the Supervisory Authority had overstepped its authority.
In France, the Financial Markets Regulator (AMF) was less restrictive in adjudicating upon ICOs concerning the existing law regarding financial securities. However, subsequently, the AMF has sent multiple questionnaires to various French ICO project initiators to calculate the impact of these transactions on the finances and economy of the country, as it is drafting a suitable and dedicated ICO regulation. Similarly, the Swiss Financial Market Supervisory Authority (FINMA) issued guidelines in 2018 that effectively structured the financial market legislation that deals with inquiries of ICO organizers. These guidelines are very helpful in determining the data required by the authority to handle and solve such inquiries, by establishing certain principles for their responses. This creates clarity for the market participants and helps them have faith in the asset itself. Also, the authority has established that every case must be decided on its distinct merits. As per FINMA Guidance 04/2017, there are numerous regions in which ICOs are possibly influenced by financial market regulation, particularly anti-money laundering and securities directives.
Lastly, the Monetary Authority of Singapore (MAS) has explained that the proposal or subject of digital tokens in Singapore will be controlled by MAS if the digital assets or crypto tokens institute goods measured under the Securities and Futures Act (Cap. 289) (SFA). MAS’ explanation came after the recent upsurge in the amount of ICOs and crypto-tokens in Singapore as a way of raising funds in the times leading to the yearly financial statement.
Another important concept that Legal Opinions cover is if a token is considered security then what are the consequences they have on all parties concerned. These have been effectively defined by the European Union.
For all considerations regarding the validity of Crypto-assets within a certain jurisdiction, it has become increasingly important to ensure that all legal aspects are given due attention. Since Cryptocurrency itself is a fairly new concept in the present global market, multiple jurisdictions are still apprehensive about embracing the asset and thus all start-ups or companies aiming to work with ICOs must beforehand know the legal requirements for their asset. Even today, circumnavigating the regulations, statutes, and guidelines regarding the securities for token issuers, is a challenge. Here an effective legal opinion can actively indicate all legal aspects that take effect when such activities are introduced in the market.