Although a large number of initial coin offerings (ICOs) have either skirted laws to illegally raise funds or, in some cases, been outright scams, with the right regulatory settings they may offer a range of opportunities for Australian businesses, consumers and investors, according to a new government consultation paper.
A Satis Group paper from mid-2018 concluded that 78 per cent of the ICOs it examined were scams. Around 4 per cent failed, and 3 per cent had gone dead, while 15 per cent went on to trade, the analyst firm concluded.
However, an issues paper released today by the Treasury argues that the ICO fundraising model can allow individual investors to “gain exposure to a startup or small business in the early stages of growth” or allow consumers “to earn bonuses and discounts on a product or service, or function like a loyalty rewards program”.
For businesses, the ICO model offers a number of potential advantages as an alternative to more common capital-raising approaches such as IPOs, seeking VC and crowdfunding.
“An ICO may allow businesses to raise funds by, in effect, issuing equity, accepting funds for management, or bringing forward sales revenue,” states the paper. “The money raised can then be spent on early-stage platform and product development.”
The paper is part of a government effort to gauge whether ICOs are subject to appropriate regulatory settings: It notes that the rapid growth of ICOs is “testing regulatory frameworks around the world”.
ICOs involve issuing digital tokens based on blockchain-style distributed ledger technology (DLT).
The paper notes that some jurisdictions are “are actively competing to attract ICO activity and establish themselves as a hub for innovative technologies that favour ICO fundraising”. The growth in ICOs can potentially open up a new source of fundraising for startups, it adds.
“So long as the incentives faced by fundraisers and investors are sufficiently aligned, ICOs could help to improve the efficiency of capital allocation and contribute to economic growth.”
However it also cautions that reports of “fraud and investor loss are numerous and there is also anecdotal evidence that many ICOs have been conducted based on an often incorrect assumption that existing financial regulations do not apply.”
The Treasury is seeking input on a range of issues relating to ICOs, including their definition, their economic and social contribution, and whether Australia’s current regulatory frameworks facilitate ICOs and a legitimate ICO market — and if not, what changes should be considered.
The tax treatment of ICOs is also within the scope of the consultation. The government in 2017 made good on a promise to change the way Bitcoin and similar digital currencies were treated for the purposes of taxation. Prior to the changes, Bitcoin was treated by the Australian Taxation Office as more akin to a commodity than a currency for the purposes of GST.
Currently, the tax treatment of an ICO depends on the nature of the associated token, according to the Treasury.
“This tax treatment is consistent with taxation of other commercial transactions, financial instruments and capital raising mechanisms, where the tax implications flow from the underlying nature of the rights and obligations attached to the instrument, and not the form in which the instrument is issued,” the consultation paper notes.
The Treasury is seeking input on the appropriateness of the current approach, including whether there should be any changes to the tax implications for token holders.
Regulatory framework
The Australian Securities and Investments Commission (ASIC) in September 2017 initially released guidance on ICOs that recognised they “have the potential to make an important contribution to the options available to businesses to raise funds and to investment options available to investors”. In May last year the regulator released an updated guide on the issue that noted the laws applicable to an ICO or “crypto-asset” may differ depending whether it “is (or is not) a financial product”. Bitcoin, for example, is not a crypto-asset in the view of ASIC.
ICOs and crypto-assets that are financial products as set out in the Corporations Act are subject to that legislation, as well as the general law, ASIC said.
“For ICOs and crypto-assets that are not financial products, these are subject to the general law and the Australian consumer laws,” the current ASIC guidance states.
Depending on the specifics, an ICO may be a managed investment scheme, an offer of shares, or a derivative, or may involve a non-cash payment facility.
In September, ASIC revealed that it had kyboshed five ICOs in a six month period because they were proceeding “without the necessary investor protections”
“If you raise money from the public, you have important legal obligations. It is the legal substance of your offer — not what it is called — that matters,” ASIC Commissioner John Price said at the time. “You should not simply assume that using an ICO structure allows you to ignore key protections there for the investing public and you should always ensure disclosure about your offer is complete and accurate.”
DLT
Separately to ICO mania and the now-significantly-abated frenzy of cryptocurrency trading, the interest of a number of major Australian businesses has been piqued by DLT. The Commonwealth Bank of Australia has released details of a number of its experiments with DLT, and last year CBA was chosen by the World Bank to be sole arranger of its first bond that employed blockchain technology. Other Australian banks have also been investigating DLT.
One of the most significant DLT developments, from a local perspective but also internationally, has been the ASX decision to employ DLT to deliver post-trade services. ASX plans to go live with the new system, which will replace its existing CHESS system, in 2021.
The Treasury is accepting submissions on ICOs until 28 February.