Policy makers are unsure about how to proceed with the regulation of initial coin offerings, a new Treasury consultation paper concedes.
Under current arrangements, ICOs are subject to Australian Consumer Law where the tokens are not classed as financial producers.
If the tokens are classed as financial products, the ICO is subject to the Australian Securities and Investments Commission Act. In such cases, issuers are expected to comply with obligations that might apply in the case of an initial public offering of shares or the sale of units in a managed fund.
However, “the classification of an ICO is not straightforward”, the paper says. Treasury has put a number of questions and it is looking for feedback.
Classification is difficult because a digital token might perform multiple functions at different times during a venture’s life cycle. In other cases, there might be a lack of detail surrounding a clearly defined business plan and the rights and obligations attached to an issue of tokens.
Considerations include how the token is marketed and how it is described, and whether the token is exchangeable for an established good or service
“Growth in ICO issuance is testing regulatory frameworks around the world, compounded by the fact that arrangers of ICOs are choosing to issue from jurisdictions where regulatory settings are seen as most accommodating,” the paper says.
An ICO involves the creation of digital tokens by an issuer using distributed ledger technology. The tokens are acquired by investors through online auction or subscription.
Tokens then act as a medium of exchange, allowing holders to earn value or spend their tokens on services provided by the issuing venture.
The freedom to structure an offering to the preferences of the business makes ICOs an appealing fund raising mechanism. For example, entrepreneurs wanting to retain equity can structure ICOs that are not equity sales.
In other cases, tokens may have no rights attached to them, and so the money received is effectively a donation.
And companies can raise funds while remaining private, avoiding the costs associated with public companies reporting and compliance obligations.
Treasury says it is important to get regulatory settings right because a large number of ICOs have failed and many have turned out to be scams. Many investors do not or cannot undertake the due diligence required to have a full understanding of the risks involved. The proportion of successful ICOs in 2017 has been put as low as 7 per cent.
The paper reviews regulatory approaches in other jurisdictions, which vary a great deal. China and South Korea have actively discouraged cryptocurrency trading or ICO issuance.
The US Securities and Exchange Commission has deemed that tokens are securities if they represent an investment in a common enterprise with an expectation that profit will be derived from the efforts of others.
Switzerland defines three categories of digital tokens, including payment tokens, which are subject to anti-money laundering law but not securities law, utility tokens and asset tokens.