Canadian regulators take on ‘wild west’ world of initial coin offerings

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Canada's securities regulators are wading into the murky world of initial coin offerings.

An ICO is an emerging form of fundraising, in some cases similar to crowdfunding, in which companies sell digital "coins" or "tokens" to finance a new venture. Some early-stage companies have raised millions of dollars quickly using this method. But it is not clear how ICOs fit into securities laws that are designed to protect investors; in a staff notice scheduled to be published on Thursday, the Canadian Securities Administrators says it will determine on a case-by-case basis whether an ICO constitutes a security.

The move responds to numerous queries that the CSA, which is comprised of provincial securities regulators, has received from fintech companies seeking clarity on whether securities laws cover ICOs. After reviewing several of those offerings, the CSA found "many instances" where the coins or tokens being issued are actually investment contracts.

Regulators are eager to clarify the rules because ICOs are gaining popularity as tech entrepreneurs look for alternatives to venture capital. The digital tokens, which are issued using blockchain, or distributed ledger technology, typically promise future access to a platform that has not yet been built. Examples include a global marketplace that would allow people to sell their idle computing power or an internet browser that restricts ads.

Although early investors stand to profit from any appreciation in a coin's value by reselling it in the secondary market, experts caution the investments can be risky. Still, money has been flooding into the space amid soaring prices for Bitcoin and other cryptocurrencies. Some companies have managed to raise tens of millions of dollars in minutes through coin offerings. As of the end of July, 102 projects have raised about $1.3-billion (U.S.) via ICOs, according to research firm Smith and Crown.

"A lot of this right now is done very anonymously, and intentionally anonymously," said Pat Chaukos, who heads an Ontario Securities Commission initiative aimed at helping fintech startups.

"So what we're trying to do is raise awareness that just because you've called something a coin or token doesn't mean it's now a loophole and you can go and promise your investors great returns, not provide any sort of documentation and not ensure that what you're selling to them is actually suitable to them."

In its notice, the CSA says each ICO is unique and will be assessed based on its individual characteristics. Any coin or token whose value is tied to the future profits or successes of a business will likely be considered a security, according to the regulators. Businesses considering an ICO are advised to complete an analysis, possibly with the help of a lawyer, to determine whether securities laws would apply.

Canadian regulators are not the first to take a stab at the issue. Last month, the U.S. Securities and Exchange Commission weighed in, ruling that the tokens sold by a group called The DAO (for decentralized autonomous organization) in May, 2016, are securities and therefore subject to federal laws. But the securities regulator opted not to take any action against the organizers of the DAO ICO, which raised about $150-million.

But it is unclear whether the DAO ruling would apply to all coin offerings, and experts say the lack of regulatory clarity has led to a rampant explosion of new business and funding models.

"It has kind of created a wild west mentality, where you have a bunch of coders who want to build really cool products, and a whole bunch of people from Wall Street who see a great opportunity to make some returns that are greater than what they can make in the equity market," said Moe Adham, the co-founder of Bitaccess. The Ottawa-based company produces Bitcoin ATMs and other digital currency products.

In crafting their policy, Canadian securities regulators were aiming to balance two competing needs – innovation and investor protection.

"The reality is this is imminent. This is the way investors want to be investing going forward and we want to be part of that," Ms. Chaukos said.

"We've got to make sure that we're doing what we need to do and that's being open and flexible in terms of how do we regulate these new types of businesses. But at the same time, we need to be there to protect investors and make sure that investors are getting what they need – knowing what they're investing in and who are the people behind it, because ultimately it's their savings that they're putting into these coin and token offerings," she added.

Companies will have to determine if a token they want to issue is in fact a security. If so, they will likely be required to provide a prospectus and register as a dealer unless it would fall under any of the available exemptions to these rules. Platforms that trade securities, such as digital currency exchanges, may be subject to marketplace requirements set out in securities laws.

Some coin offerings may also be considered derivatives and be subject to trade reporting rules and other derivatives laws, the CSA notice states.