New model of crypto-assets offering, no escape from securities regulations. Risks related to Initial Exchange Offerings

Initial Exchange Offerings (hereinafter “IEOs”) basically are Initial Coin Offerings (hereinafter “ICOs”) launched through the IEO platform (dubbed “launchpad”) of a crypto-assets exchange.

In a typical ICO, a company (generally the issuing entity) receives fiat currencies, such as US dollars or Euro, or crypto-assets, such as Bitcoin or Ether, in exchange for certain rights embodied in crypto-assets. IEOs are based, instead, on agreements between project developers and crypto-assets exchanges for initial placement of the crypto-assets on the exchange. Crypto-assets exchanges serve as underwriters, review the projects and offer crypto-assets to vetted customers.

IEOs bring on the table: (i) easy access to a large potential purchaser base; (ii) help with crypto-assets distribution; (iii) a marketing boost from being promoted on the exchange’s social media; (iv) an immediate listing on the crypto-assets exchange post-IEO. From the perspective of a purchaser, instead of sending Ether, Bitcoin or other crypto-assets to a smart contract governing the ICO, each IEO participant has to create an account with the crypto-assets exchange and send Ether, Bitcoin or other crypto-assets to this account. When the IEO starts, the participant can purchase the launched crypto-asset directly from the exchange. IEOs have potentially some advantages, including eliminating scam and dubious projects from raising funds.

IEOs has not yet fully caught the attention of regulators and financial market authorities. By and large, existing laws do not appear to allow IEOs, or the issued crypto-assets, to escape regulation as securities or compliance with the securities laws. Potentially, indeed, some of the characteristics of IEOs (the easy access to a large potential purchaser base marketing; the marketing boost from being promoted on the exchange’s social media; immediate listing on the crypto-assets exchange post-IEO) could lead them to fall even more unquestionably within the (US) category of (in application of the Howey Test pattern) investment contracts (and therefore within the securities perimeter) or the (European) definition of participation right in an investment scheme or  transferable security (by EU definitions, a blockchain-derived crypto-assets is a security if it is transferable, negotiable, and standardized) offered to the public or admitted to trading in secondary markets (hybrid crypto-assets that can be used for payment but have some investment functions are securities, unless their sole purpose is as a payment instrument).

Crypto-assets exchanges work similarly to a stock exchange (but with some differences: traditional exchanges usually only carry out swaps between securities, stay out of the broker/dealer role and do not touch custody) and appear to be acting as broker-dealers operating alternative trading systems (they should then register for regulatory oversight).

IEOs are currently operating in a way that grants substantially less investor protection than that of traditional equities and fixed income markets (while pushing the underlying crypto corporate financial transactions closer to the traditional ones).

This article is an extract taken from Crypto-assets global corporate finance transactions | A comparative and functional analysis of crypto offerings and securities laws. SINGULANCE’s book about crypto-assets offerings.