ICO and DAO tokens under the EU financial regulatory framework

Ken Becher

Sep 14, 2021

Virtual currencies are typically issued through the so-called "initial coin offering" (ICO) or as part of decentralized autonomous entities, which must be evaluated from the perspective of securities act rather than payment law.

The issuance of virtual currency is mainly used as a means of investment, not as a means of payment. After summarizing the core principles of the frameworkof EU MiFID (Markets in Financial Instruments Directive), this paper analyzes whether thisframework can be applied to virtual currency.As for whether traditional payment virtual currencies (such as Bitcoin) may have investment purposes—it can be concluded that they themselves can not be regarded as financial instruments. However, derivative instruments can use these virtual currencies as the fundamental value to constitute financial instruments under MiFID. For some new types of virtual currencies which are mainly used as a means of investment, if they are transferable and can transfer their rights to the issuer, then they can be regarded as transferable securities in the sense of the MiFID framework. German legislators have added financial instruments that can be applied to virtual currency which are not found in EU directives. Although this obviously deviates from EU law, it does put forward a current method to extend the scope of application of this legal framework.

So far, most of the EU regulatory agencies have adopted a wait-and-see attitude, while there have been also some agencies taking some proactive regulatory actions already. First of all, almost all EU market regulators have issued warnings to potential investors of ICO, introducing them to relevant risks and potential deficiencies in EU financial law regarding consumer protection.Some regulatory agencies have further established the "sandbox regulation."

"Sandbox regulation" can indeed help promote innovation without imposing direct regulatory burdens, and can easily regulate innovators when needed, instead of imposing all regulatory rules on them from the beginning. However, this may lead to equality issues, that’s because only a few innovators will receive such preferential treatment, while other innovators may have to comply with the regulations immediately.

A more powerful policy option is to introduce new legislation, but this will increase the pressure on regulators, diversify the existing legal framework, and create the risk of its legislation becoming obsolete due to the market development. Therefore, the first step in legislation should be to understand whether and how the existing framework applies, and where it needs to be revised. For the investment in virtual currencies, the existing MiFID framework may have been partially applied. And in some cases, only explanatory guidance may be required, rather than legislative amendment or entirely new legislation.

Looking forward to the future, these schemes can be integrated and a hybrid scheme will be proposed. If the existing legal framework is found to be applicable, then only explanatory guidance is needed, or at most only some minor changes are needed, and there is no need for new legislation. If the existing legal framework is not inadequate, and some small changes can not solve this problem, regulators and legislators need to take a cautious wait-and-see attitude and a clear regulatory sandbox scheme before deciding whether a larger-scale regulatory reform is needed or whether an entirely new legal framework must be drafted. In addition, the close cooperation between market innovators and regulators and the prediction of market development can help determine the correct strategy for the future.

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