1. Initial Coin Offerings in Estonia
The hype of Initial Coin Offerings (“ICOs”) and Token Generation Events (“TGEs”) has permeated Estonia, and requests for legal support on the matter have created challenges not only for the authorities but also for advisors to ICOs. The amount of money raised via ICOs in the first quarter of 2018 numbers has already surpassed 2017 entire-year numbers.
ICOs took Estonia by a storm from summer of 2017. The exact point in history can be traced to the U.S. Securities and Exchange Commission’s issuance of an investigative report on Decentralized Autonomous Organization (“DAO”) tokens and their qualification as securities.
The Chinese government’s ban of ICOs in early September 2017 also created a further influx of Asian ICO projects to Estonia.
The overall reaction to ICOs in Europe was comparatively much slower, and the European Securities and Markets Authority (“ESMA”) issued a statement only on November 13, 2017
The Estonian Financial Supervisory Authority (“FSA”) reacted more quickly, and by June 2017 it had already issued its first warning to Polybius Foundation OÜ, characterizing the company’s ICO as an initial public offering of securities. By that time Estonia had already been the site of its first Bitcoin & Blockchain Conference organized by the Russian company Smile Expo, where Polybius Foundation OÜ had actively promoted the credit institution planned with ICO-raised funds.
Following its first warning, the FSA quite surprisingly took a supportive stand and merely issued an explanation on ICOs on its website in August 2017
A second warning was issued by the FSA in January 2018 regarding an ICO by CryptoFinance OÜ, which the FSA had characterized as an initial public offering of securities.
Beyond national and regional laws, lawyers consulting businesses on ICO launches in Estonia have had to contend with a number of factors, including: (1) Estonia´s reputation as a blockchain country and its E-Residency Project; (2) the Otto Albert de Voogd case;
2.1.1 Estonia as a Blockchain Country
In March 2017, Wired UK named Estonia as the “most advanced digital society in the world,”
2.1.2 E-Residency Project
The E-Residency Project pre-phase started in 2014 as state officials Taavi Kotka, Ruth Annus and Siim Sikkut submitted a proposal to the Estonian Development Fund’s idea competition. The proposal was named “10 million e-Estonians by 2025” and won the competition prize, a monthly stipend for one year that enabled hiring towards the development of the concept of issuing identity cards to foreigners who were also non-residents.
As of May 2018, the statistics show that 33,438 individuals have applied to become e-residents of Estonia from 154 different countries.
According to a recent study by Deloitte: “The e-residency program has brought Estonia an estimated €14.4 million in income, including €1.4 million in net income and €13 million in net indirect socio-economic benefits.”
Next, Kaspar Korjus proposed the “Estcoin”:
... estcoins were proposed as a way to raise money and support for the development of our digital nation from more people around the world. We would also want to structure the tokens so that they help build our e-resident community and incentivise our own key objective, which is to increase the number of companies started in Estonia through e-Residency.22Kaspar Korjus. We’re planning to launch estcoin — and that’s only the start. December 19, 2017. Available at: https://medium.com/e-residency-blog/were-planning-to-launch-estcoin-and-that-s-only-the-start-310aba7f3790 [Accessed: 18 May 2018].
Estcoin remains in the conceptual phase. Its marketing hype re-triggered strong global interest in ICO launches in Estonia. The E-Residency Project has continued tying its marketing efforts to blockchain technology and building Estonia’s reputation not only as a digital nation, but a blockchain nation, stirring a further influx of related corporate activity.
2.2 Otto Albert de Voogd Case
Culminating in an Estonian Supreme Court decision
The case began on February 13, 2014
De Voogd lost the complaint at the highest court of Estonia on April 11, 2016 and on April 21, 2016 the FIU dropped the investigation and pursuit to obtain the KYC documentation for the following reasons: (i) de Voogd had suspended his activities, (ii) he had left Estonia permanently, and last but not least (iii) he had understood the content and effect of the MLPA.
The legal dispute centered around Section 6 subparagraph 4 of the MLPA, which defines an alternative means of payment service provider as:
a person who in its economic or professional activities through communications, transfer or clearing system buys, sells or mediates means of monetary value by which financial obligations can be performed or which can be exchanged for an official currency who is not a [credit institution] or a financial institution for the purposes of the Credit Institutions Act.28Money Laundering and Terrorist Financing Prevention Act of Estonia (MLPA) regulating both the range of subjects obligated to comply with the law and the obligations of the obligated persons.
Under the MLPA, in case a person was identified under the law as an alternative means of payment service provider, and if the value of the transactions of the customer of the obligated person exceeded 1,000 euros per calendar month, the obligated person needed to identify and verify each customer while being present at the same place as the customer (face-to-face identification).
Yet under section 12 (2) and 15 (1) of the MLPA, the foreign currency exchange service providers were also obliged to comply with enhanced due diligence measures on the basis of face-to-face meetings, but only starting from 15,000 euros for cash transactions. This meant that foreign currency exchange services and virtual currency exchange service providers were treated differently, and virtual currency operators faced discrimination. However, this issue received little attention during the dispute.
Interestingly the final ruling in de Voogd case came on April 11, 2016, while on July 16, 2016
(i) providing services of exchanging a virtual currency against a fiat currency;
(ii) providing “virtual currency wallet service,” which means the service in the framework of which keys are generated for customers or customers’ encrypted keys are kept, which can be used for the purpose of keeping, storing and transferring virtual currencies.
The norms on virtual currency were based on the European Commission´s proposal
Virtual currency transfers are currently not monitored in any way by public authorities within the EU, as no specific binding rules have been laid down, neither at Union level nor by the individual Member States, to set out conditions for such monitoring.
The Proposal confirms that virtual currency exchange platforms and custodial wallet providers were previously not under the scope of the AML Directive
2.3 Initiatives from the E-Residency Project and Estonian Ministry of Finance
Prior to the Global Festival, the E-Residency Project, the Ministry of Finance (“MOF”) and FinanceEstonia had separately organized a few meetings to discuss what applies to ICOs and possible ICO regulation. FinanceEstonia had invited among its member organizations interested companies, and the MOF had handpicked a few law firms, NASDAQ and FSA representatives, along with one fintech startup representative from Funderbeam
Along with these initiatives, the MOF applied for funding from the Structural Reform Supportive Service (“SRSS”) of the European Commission and the EBRD to organize public procurements on related topics. One procurement launched on the first week of March 2018 by the MOF was related to the Estonian capital market diagnostics. According to a MOF press release, the procurement winners “will conduct an overall Estonian capital market diagnostic covering all aspects of capital markets including debt, equity, money markets, derivatives, capital market infrastructure, investor base, and financial intermediaries as well as the general legal and regulatory environment.”
The second procurement was not yet published prior to the Global Festival, but an invitation to the Discuss Track stated:
On 6th of December 2017 the Ministry of Finance and Financial Supervisory Authority (FSA) brainstormed on ICOs on the basis of European Commission Structural Reform Support the Ministry of Finance applied for funding of a project, “Opening Estonian Regulatory Framework for Innovative Technical Solutions,” which is targeted to developing a favorable legal framework for crowdfunding and alternative infrastructure. The Commission granted the funds for the project appointing EBRD as the main service provider. EBRD will procure publicly for the required financial technology experts and legal experts. The aim of the procurement will be to analyze and submit ideas, suggestions and proposals to amend the legal acts.
Topics covered in the above mentioned project have a potential overlap with the need to bring legal certainty to ICOs, and consequently, these initiatives should be coordinated. As the next step it is foreseen that relevant stakeholders should take the lead in drafting Best Practices for ICOs based on international standards. This could be followed by FSA’s guidelines and the Ministry of Finance leading the process of amending the relevant legal acts.38See https://www.meetup.com/Estonia-Legal-Hackers/events/248462971 [Accessed: 10 June 2018].
The second procurement was published on June 5, 2018 and is very fintech-oriented, stating:
Estonia has been focused on promoting innovation for many years through its “e-Estonia” movement, growing from the public sector and now into the private sector. The country is now trying to improve the efficiency and accessibility of its financial markets through the implementation of innovative technological solutions or FinTech.39See https://www.ebrd.com/work-with-us/procurement/pn-73585.html [Accessed: 10 June 2018].
The second procurement also is aimed at analyzing the Estonian legal and regulatory framework, but for the purpose of identifying the barriers to implementing innovative technology, and is much more focused on creating a “live testing environment or ‘sandbox’ to test the technology and FinTech companies against regulation.”
3. Discuss Track Discussion
The following private sector initiatives for managing risks related to ICOs were discussed at the Legal Hackers Computational Law and Blockchain Global Festival on March 15, 2018 in Tallinn, Estonia.
3.1 Smart Contracts and Protocol
One proposed idea involved leaving the domain of the ICOs to be merely regulated by distributed ledger technology-based smart contracts or private regulatory framework of the network, which is built into the protocol. This idea builds on the lex cryptographica concept
3.2 ICO Best Practices and SRO
The least intrusive alternative and maintaining the most flexibility in the approach would be to let to industry self-regulate.
One option for Estonia is to follow the same example as was adopted in crowdfunding. FinanceEstonia was active in drafting Best Practice Guidelines for Crowdfunding, with the context of crowdfunding as a sort of self-regulating organization on the market, issuing annual Best Practice Guidelines adherence badges.
Consequently, an alternative is to develop ICO best practice guidelines within the private sector and see to their adoption as a market standard by the government body of FinanceEstonia. FinanceEstonia then would act as a self-regulating organization, issuing adherence badges to ICOs meeting the requirements stated in the ICO Best Practices. This idea requires further development and resource planning.
As an aside, the FSA referenced the Crowdfunding Best Practice Guideline to develop a draft law for crowdfunding, but this draft has not yet made it to Parliament and probably will not be pursued further.
3.3 FSA Guidelines (similar to FINMA in Switzerland and MFSA in Malta)
Despite its hesitancy to market its approachability and facilitate market development, the FSA has already shown initiative in issuing general guidelines in relation to ICOs and securities market regulation, there exists the possibility of taking a few more steps to produce guidelines similar to those issued by FINMA
There are multiple alternatives the FSA could consider, such as:
(i) the FSA most likely will not be interested in creating a favourable tool for facilitating the market of ICOs, but would most likely merely introduce a guideline similar to Good Corporate Governance Rules
(ii) alternatively or additionally, the FSA could introduce a Good Communication Rules, attempting to streamline market contacts and the expected responses from the FSA, similar to the FINMA guidelines;
(iii) alternatively or additionally, the FSA could continue down the path already selected by it—issuing general guidelines for identifying when tokens are securities, similar to MFSA in Malta.
3.4 Regulatory Convergence, Standardisation and Regulating the Protocol
Regulatory convergence refers to a process that is not the harmonisation of laws, but an alignment of regulatory requirements across jurisdictions through standards, technical guidance documents, and similar practices, principles, and mechanisms.
The International Organization for Standardization (“ISO”) is currently working on blockchain and distributed ledger technology standards.
3.5 Dynamic Information Sharing
These alternative means to mitigate and manage risks require a thorough risk analysis prior to their development, but as can be seen from the experience of Northern Trust,
3.6 Introducing a Safe Harbour Clause
In the case of recent amendments to the Investment Funds Act, Estonia used the option to adopt an innovative concept of safe harbour from U.S. law into Estonian law. This option is best achievable through FSA’s adoption of guidelines (possibly similar to the MFSA guidelines with respect to the token-as-a-security test), or a lengthier process would resemble the process behind the Investment Funds Act—introducing relevant regulation.
3.7 Modifying Relevant National Legal Acts
Quite possibly the highest level of legal certainty can be achieved either by amending existing legal acts or introducing new ex post regulation. Yet this is also most likely the longest alternative process other than introducing regional legislation and will most likely from start to end take years to complete. Considering that the Ministry of Finance has initiated public procurements to research how to proceed with innovation of the regulatory framework, it can be reasonably expected that the process of introducing respective regulation will most likely last a few years.
3.8 Waiting for EU Legislation
As can be seen in many legislative drafting processes in Estonia, the given regulation is transposed to the Estonian legal system only after it has been tested within the EU, and on the basis (usually of the most conservative approach)
The Author’s footnoting style is retained for this Discussion Report.