Question of the week: What is an Initial Coin Offering and is it a security?

Initial Coin Offerings (ICOs) using cryptocurrencies are a new way for businesses to raise capital.

Cryptocurrencies are online currencies that have their own monetary value but are not tied to a country or bank. They run on a distributed public ledger also called a blockchain which is a decentralized record of all transactions by currency holders. The most popular and known cryptocurrency is bit coin, but there many others including Ethereum and Ripple.

An ICO is most often used by start-up businesses to raise capital from investors. These investors are typically retail investors. Here’s how it works: During a specified period, an investor can visit a website to purchase coins in exchange for cryptocurrency or legal tender for the country they reside in. By purchasing the coins and taking part in the ICO, the buyer becomes an investor in the company. In some instances, investors may take part in an ICO by exchanging their cryptocurrency for tokens issued by the business known as a token offering. But is their investment considered a security, and does someone who develops an ICO need to comply with the Securities Act requirements?

There isn’t a firm yes or no answer to that question. It depends on the structure of the ICO or token offering and what the coins or tokens will be used for. There have been no rules or regulations specifically addressing ICOs or token offerings written in Nova Scotia, but anyone developing an ICO or token offering must abide by the Nova Scotia Securities Act if their ICO or token offering is deemed to involve a security or derivative. The automation of certain functions through technology or computer code does not remove conduct from the purview of NS securities laws. Not all ICOs or token offerings necessarily involve securities or derivatives and thus fall under the Nova Scotia Security Commission’s jurisdiction. Each ICO or token offering must be assessed based on its own merits to determine if it falls under the NS Securities Act.

For example, if by investing in an ICO or token offering you receive shares in the business you’re investing in, you’re most likely looking at an ICO or token offering involving a security. However, an ICO or token offering doesn’t have to provide an investor shares in the company to be considered a security. If an investor has an expectation of profit from their investment which is derived from the efforts of others, for example the developers of the blockchain, there’s a good chance this could fall within the realm of a securities regulation.

If an ICO or token offering is found to involve a security or derivative, unless an exemption is available, the issuer is required to file a prospectus and obtain a receipt from NSSC before any securities can be sold. Currently, the NSSC has not received any reports of exempt trades regarding ICOs or token offerings in Nova Scotia.

An ICO or token offering could also potentially fall under certain marketplace requirements if they facilitate the trading of the coins/tokens after the ICO or token offering. Those offering the coins/tokens may also have to be registered to do so in Nova Scotia, if they are deemed to be selling or advising on securities or derivatives.

If you’re thinking about investing in an ICO or token offering, we recommend you thoroughly do your homework. Be sure you know what and who you’re investing in. Is it a security? If so, is the person you’re investing with registered to sell and/or advise on securities in Nova Scotia? Can you resell your tokens, and is the medium for reselling tokens registered and regulated?

It’s always important to be cautious with any investment, but with ICOs and token offerings, which are still new and confusing to some investors, due diligence is key to making sure you make a smart, informed and safe investment.