For years lawyers have warned of the risks associated with running a cryptocurrency business in the United States, especially when a token is involved. Regrettably, those risks are more apparent than ever.
As New York- and Austrian-licensed attorneys, we've talked countless clients out of publicly selling tokens in the U.S. or generally pursuing their businesses there. We've personally witnessed one of our European clients – a small fish by anyone's account – fall victim to U.S. regulators' zeal to shape the law through enforcement, presumably to establish precedent to go after bigger and badder actors in the distant future.
The saying "the gears of justice turn slowly" is particularly true for U.S. regulators, who just this year have secured important court rulings against companies that sold tokens in 2017 and 2018. One thing is clear: Token issuers in 2020 and beyond cannot ignore U.S. securities laws without risking severe fines and litigation many years down the road.
Fortunately, the U.S. is not the only market in the world where companies can raise capital by selling tokens. We agree with U.S. lawyer Preston J. Byrne, who remarked in a CoinDesk opinion piece:
"It is also true that there are, without a doubt, countries in the world that do countenance token offerings. Go there. U.S. securities laws are not meant to restrict the sale of tokens in those places." (emphasis added)
New token sales
The European Union is one of the hottest regions in the world in terms of raising capital through token offerings, according to ICO Watchlist. And, as more and more companies choose to put the United States on the list of banned jurisdictions alongside countries like Afghanistan, North Korea and Syria, the EU is bound to become even more popular.
In the last year, European-based projects like Polkadot (Switzerland) and Bitpanda (Austria) have sold tokens worth millions of euros through initial coin (ICO) or initial exchange (IEO) offerings. Leading blockchain projects such as Ethereum and MakerDAO are supported by Swiss foundations, and up-and-coming players like Bitpanda and Morpher (both of which are clients of the authors) are Austrian companies that have concluded financing rounds with prominent U.S. venture capital firms while maintaining their headquarters in Europe. On top of that, Bitpanda raised EUR 43.6 million in 2019 by selling BEST tokens. Morpher's public sale of its own MPH token is currently underway.
There are good legal reasons why companies are attracted to Europe. For starters, there is no Howey Test, which in 2018 led Securities and Exchange Commission Chairman Jay Clayton to declare that "every ICO [he's] seen is a security." Most European regulators, particularly those in the DACH region (Germany, Austria, Switzerland), distinguish security tokens and payment tokens from utility tokens and acknowledge that utility tokens, for the most part, are not subject to financial services or capital markets regulations.
Unlike in the U.S., European regulators simply do not have a history of cracking down on token issuers. And token issuers are far less likely to get bogged down in private litigation in Europe than in the U.S.
Differing regulatory approaches
These differing regulatory approaches to token offerings can be attributed to historical financing methods used by companies in Europe and the U.S. as well as their distinct legal systems. In the U.S., equity offerings are still much more common than in continental Europe, where debt financing remains to a large extent the prerogative of banks and large financial institutions.
Europe does not have as long a tradition of capital markets exposure as the U.S., and while European capital markets regulation was heavily influenced by the U.S., the need to harmonize the definition of “transferable securities” among the EU member states prevented the EU from employing the Howey Test outright when adopting the Markets in Financial Instruments Directive in 2004. In our personal experience, the constraints of the civil law tradition in continental Europe as opposed to the common law systems of the U.S. and the U.K. also prevent national regulators from introducing a Howey-like test via enforcement proceedings anytime soon, despite efforts to do so particularly with regard to token sales.
In contrast to the U.S., the EU has made significant progress in codifying regulations governing token sales. On Sept. 24, 2020, the European Commission published a draft Regulation on Markets in Crypto-assets (MiCA), which establishes a disclosure regime for token sales, and lays the foundation for stablecoin issuers and cryptocurrency service providers to securely operate within the EU. The regulation is expected to enter into force in all EU member states by the end of 2022.
Once adopted, the legal framework will provide legal certainty for token issuers and will help establish Europe as the go-to jurisdiction for crypto businesses. Time will tell how the divergent regulatory approaches in Europe and the U.S. will shape the crypto industry going forward. If the present is any indication, our bet is on Europe having the upper hand.