Token Sales 2021 - Gibraltar

This post aims to provide a brief overview of token sales taking place today, provides updates of recent developments and also considerations as to how to proceed with a token sale in Gibraltar.

Content covered:

1. What are Token Sales?
2. Recent International Developments
3. Gibraltar Token Sales
4. International Comparative Guide

1. What are Token Sales? 

Token sales, also referred to as initial coin offerings (‘ICO’) and token generating events are effectively used to describe the same event. Token sales are effectively and most commonly known as the sale of crypto asset tokens (i.e. a virtual asset created using or on a distributed ledger) by an entity for a limited period of time to the public in exchange for other crypto assets and/or fiat currencies. 

Token sales have most commonly been used and referred to as a rather unregulated type of fundraising event as the objectives of the event typically and historically have sought to not fall within existing regulations for investments, securities or financial instruments, prospectus regulations or funds regulations. As a result, a number of entities have structured token sales in a number of jurisdictions so as to not be regulated by a number of existing regulations. This, of course, depends on a number of factors including but not limited to how the token sale event is taking place, where the entity or persons who are providing the sale are situated or carrying out the effective decisions for the event and where a number of the participants are participating in the token sale are situated.

Given that token sales can be structured in different ways and may indeed be regulated in different ways depending on the jurisdictions in which they may be implicated, there is no definitive definition or description. At this point it is effectively a fluid term to describe the sale of virtual asset tokens as described above.

The first Token Sales arguably took place in 2014 with the Ethereum token sale. Following this, there was a rush of token sales in 2017 and 2018 where it is estimated that approximately $10 billion and $11.4 billion respectively was raised by different entities in a number of jurisdictions for the sale of tokens. 

Token sales continue to take place today and have developed in a number of aspects. Recent developments include the ways that certain jurisdictions and intergovernmental bodies are increasingly regulating persons who may be concerned with the sale of tokens. Other developments include novel ways for entities to distribute tokens and market uptake, including by using exchanges (initial exchange offerings) to arrange the sale of tokens and ‘airdrops’. Airdrops are gifts by a particular entity or persons to other digital asset wallets as a result of an action they have taken. Typically airdrops are given to digital asset wallets that have interacted with a smart contract or protocol at a particular point in time (snapshot). Those wallets, at the snapshot, will be then transferred free tokens. The most successful airdrops are arguably Uniswap and Mirror Protocol, for example. 

Sometimes token sales can be a combination of an airdrop, a token sale and an initial exchange offering. However, not all airdrops may be token sales for example.

2. Recent Developments

Since the rush of token sales that took place in the 2017-2018 vintage, various distributed ledger technology (‘DLT’) related projects have continued to seek to raise capital using token sales. In particular, a number of solutions have been developed to improve best practices by the token sale issuer, improve accountability and also improve the experience for participants.

2.1 Different sides of the same token 

Since the initial frenzy of token sales in 2017 and 2018, a number of other token sales have sought to replicate these fundraising events and attempt to operate such token sales outside the remit of existing regulators. A number of projects have been successful, through diligent planning and cooperation in some jurisdictions to carry out token sales that are compliant and in accordance with the jurisdictions which they may be operating in or providing the sale to. However, on the other hand, a number of token sales have sought to replicate the fundraising model of other successful token sales but have not done so with best practices, done so diligently and have been met with regulatory intervention and uncertainty.

As a result, developments since the first token sales has shown that projects seeking to carry out a token sale need to do so in jurisdictions that appropriately support the objectives that they may be seeking in a compliant manner. Inevitably, projects that are looking to carry out large fundraising events with minimal best practices, regulatory considerations or due diligence on participants are likely to face considerable risks from regulators in a number of jurisdictions as well as token participants who are seeking accountability. 

The number of projects that have sought to carry out compliant token sales have helped increase best practices and regulatory certainty for other projects. Equally, a number of projects that may not have carried out compliant token sales have also shown how to improve on those practices and the importance of seeking regulatory certainty

2.2 Regulatory

Without looking to name particular projects or jurisdictions, a number of regulators in a number of jurisdictions have identified that they would not seek to support token sales. A number of jurisdictions have also taken the view that token sales may fall into existing regulatory oversight of securities regulations, fund regulations, payments regulations or similar.

Other jurisdictions on the other hand have identified that token sales may not indeed fall within existing regulatory scope and have sought to provide notices and warnings in relation to such activities. This leaves an opportunity for entities to seek to carry out compliant token sales in such jurisdictions with the assistance of experienced advisers who can help with legal, accounting, tax, compliance and operational aspects of the token sale. These jurisdictions include Singapore, Hong Kong and Gibraltar for example.

Separate to this, international intergovernmental bodies have identified the risks that token sales may pose to money laundering, terrorist financing and proliferation financing activities as some digital assets may be said to provide privacy features. As a result, the intergovernmental body for tackling money laundering and nefarious financial activity the Financial Action Task Force (‘FATF’) have developed guidance and recommendations over recent years for certain jurisdictions and virtual asset providers to take certain actions in managing the money laundering and financial crime risks that are most typically associated with digital assets and tokens.

The most recent of these recommendations includes the requirement for jurisdictions who are seeking to be compliant with the FATF’s standards and recommendations to have a registration or licensing regime for virtual asset service providers for Anti Money Laundering (AML) or Countering the Financing of Terrorism (CFT) purposes. At this stage, a number of jurisdictions are looking to implement these requirements and Gibraltar has for example already introduced a requirement for entities who effectively provide a token sale to be required to be registered with the Gibraltar Financial Services Commission (‘GFSC’) for the duration of the sale. Such a registration requires token sales to have adequate AML & CFT policies and controls, including appropriate due diligence, reporting mechanisms and responsible persons for such obligations within the entity.

A number of other jurisdictions have not yet introduced this requirement and such registrations and requirements to carry out token sales compliantly are increasingly a requirement in a number of jurisdictions. Above all, entities looking to carry out an effective and compliant token sale may choose to register in jurisdictions that have these requirements, such as Gibraltar, to show participants, investors and even other authorities or institutions that the token sale has undergone a particular level of AML and CFT controls and monitoring on assets received. Furthermore, carrying out the token sale in a jurisdiction which is overall supportive of DLT activity and/or digital asset investment may be in the long term ambitions of a project as they may wish to be regulated under a specific regulatory regime that exclusively covers distributed ledger technologies.

Separate to the above considerations are also the increasing pace of development of regulators who may look to regulate token sales specifically, or activity relating thereto. The European Union's proposed draft for the Markets in Crypto Assets regulations ('MiCA') may be a relevant consideration in future.

3. Gibraltar Token Sales

Token sales in Gibraltar are not void of regulatory considerations and may be described as one of the more favourable jurisdictions for token sales due to its proven track record for appropriately navigating existing regulations. This has resulted in a large number of token sales taking place in or from Gibraltar.

Token sale projects have chosen Gibraltar as the jurisdiction to incorporate and issue their token sales as a result of a number of considerations such as having adequate AML & CFT requirements, experienced advisers and a supportive operational environment. Gibraltar also has purpose built distributed ledger technology regulations (that are not necessarily relevant for token sales, but evidence the jurisdiction’s knowledge for related matters) and above all being able to suitably navigate existing regulatory regimes.

3.1 Considerations

Token sales in Gibraltar should consider a number of existing regulatory frameworks before proceeding with a launch. These include existing financial services regulations (electronic money, payment services, prospectus regulations, collective investment schemes), Gibraltar’s distributed ledger technology provider regulations, data protection, online gaming, anti-money laundering, taxation and general company law considerations. 

3.2 Assistance

Experienced advisers will be able to help projects navigate these regulations and help projects put in place adequate processes and policies to ensure relevant compliance. Experienced advisers can also assist projects with other operational aspects such as looking to assist the token sale issuer with obtaining operational resources such as compliance support, fiat and banking solutions as well as other insights on tokenomics and private sale of tokens. 

Once a number of key risks have been identified, advisers will typically assist with the set up of a suitable and appropriate entity, provide input and reviews on relevant documents and formulate an appropriate approach to messaging and marketing of the token sale. This is above all of the other relevant considerations already mentioned. Legal advisers will also provide you with a suitable legal opinion setting out the key regulatory considerations and how the issuer's token sale would be affected by those regulations.

In respect of accounting and tax advice, experienced advisers will be able to identify whether the token sale activity or the intended activity of the project, once developed and launched, will incur any Gibraltar tax liabilities. Gibraltar operates a territorial basis of taxation and there is no capital gains tax, wealth tax or withholding taxes in Gibraltar. Token sales may not incur a Gibraltar tax liability but this will largely depend on the structuring of the token sale and appropriate advice can be provided. Similarly, individuals may also not incur a tax liability in Gibraltar subject to their personal tax residency and accruing of income.

Experienced accountants will also be able to assist with preparing accounts, filing financial and tax returns as well as providing audits should they be required by the entity or as a result of company legislation. 

3.3 Other considerations

Token sale projects, if successful, will also need to consider a number of other considerations such as safe management of treasury assets, ongoing accounting obligations, potential tax considerations, commercial agreements with third parties, intellectual property and licensing considerations and litigation or disputes from third parties. Projects with longevity and ambitions to develop projects in Gibraltar may also wish to consider the benefit of Gibraltar’s purpose built principles based Distributed Ledger Technology framework that has been in effect since 2018. Alternatively, projects may wish to develop their own digital asset investment funds in Gibraltar, using appropriate fund structures and assistance, to choose to invest digital assets in a particular manner whilst projects are being developed. 

Further more recent developments include considerations of decentralised apps (DAPP), distributed or decentralised autonomous organisations (DAOs) and decentralised finance (DeFI) applications. These are all unique developments and any projects looking to take on any such a form should closely consider how they may wish to develop their fund raising event and project development thereafter in the most appropriate environment.

Other considerations are whether token sale issuers wish to be in the European Union or not. Gibraltar is no longer a member of the European Union as a result of the United Kingdom's departure from the EU as a result of the Brexit vote and decision to withdraw. The result of this may be Gibraltar holding equivalent standards in certain regulatory regimes and also may see a protracted adoption of upcoming regulations such as the EU's proposed MiCA regulations that may not be directly applicable in the EU for another few years or have equivalence provisions for a further period of time.

4. International Comparative Guide

Using information obtained from PWC’s ‘Introduction to Token Sales (ICO) Best Practices’ that provides the following information on Hong Kong and Singapore, Gibraltar’s position has been included below by way of comparison:

* Companies that are classified as a small company under the Companies Act 2014, depending on a number of factors, may not require an audit.

** Persons will only need to pay income tax in Gibraltar if they personally incur an income tax liability in Gibraltar. Gibraltar has an effective rate of income tax of only 25% of tax on income up to ￡50,000. However, professionals possessing specialist skills may be able to benefit from what is known as the HEPS certification and only the first ￡120,000 will be taxed.

*** A token sale, depending on how it is structured, may not incur a Gibraltar tax liability.

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This information sheet was produced on the 30 June 2021 and is intended as general guidance on your rights and responsibilities. Nothing in this information sheet constitutes legal advice or gives rise to a solicitor/client relationship. Specialist legal advice should be taken in relation to specific circumstances.

In the circumstances no warranty, express or implied, is given as to the accuracy of this information sheet and we do not accept any liability for error or omission.