ICOs, centrally-issued cryptocurrencies and dispute resolution: key issues for investors in cryptocurrencies

As cryptocurrencies rise in both prominence and use it is important for market players to keep aware of the legal and regulatory frameworks applicable to them. In this post, we consider some key developments that investors in cryptocurrencies will need to be aware of – in particular, signs that national regulators are becoming increasingly proactive in monitoring cryptocurrency activity – and raise a number of issues that investors will need to consider in assessing if their investments are suitably protected.

Much of the debate around cryptocurrencies stems from uncertainty around their classification, and in particular whether they can be considered ‘investments’. Some clarity in this regard may be on the horizon as regulators across various jurisdictions have recently started looking into initial coin offerings (“ICOs”) as securities offerings, with the consequence that ICOs may be subject to domestic securities laws and regulation. As Jeremy Barr noted in a recent blog post, the Chairman of the SEC commented at the end of last year that tokens issued in ICOs “contain the hallmarks of a security under US law” and, more recently, a US court indicated (albeit not conclusively) that such tokens may constitute securities. Several other jurisdictions, such as Canada, Switzerland and Mexico, have begun to regulate cryptocurrency exchanges and ICOs. The position is less clear in the UK, China and Singapore, but these countries are also expected to introduce legislation in due course to deal with cryptocurrencies. A Freshfields survey in November 2018 found that most regulators around the world are either beginning to apply existing regulations to ICOs or taking a watching brief for the time being, but few are establishing bespoke regulatory regimes.

There are signs of increased regulatory consensus in Europe. In January 2019, the European Securities and Markets Authority and the European Banking Authority published reports urging the European Commission to establish harmonised regulation of cryptocurrencies in the EU. The EU has already taken steps in this direction: the Fifth Money Laundering Directive, which is required to be implemented by 10 January 2020, brings cryptocurrency exchanges within the scope of the AML regime.

At the same time that regulatory vigilance in relation to cryptocurrencies seems to be increasing, some governments have begun to look into centrally-issued cryptocurrencies. In fact, a January 2019 Bank for International Settlements survey of 63 central banks found that “[s]ome 70% of respondents are currently (or will soon be) engaged in [central bank digital currency] work”. For example:

• In December 2017, President Maduro of Venezuela announced a new Venezuelan crypto-currency that would be backed by commodity reserves, including oil, with a view to avoiding the pitfalls (inflation and sanctions) that the bolivar is currently facing. Maduro has claimed that the petro-presale (launched in February 2018) has garnered more than US$5 billion to date.
• The Russian Association of Cryptocurrency and Blockchain has announced that the CryptoRuble will be launched in the middle of 2019, at a 1:1 ratio with the ruble.
• Turkey has indicated that it is considering the “Turkcoin”, a cryptocurrency that would aim to tokenise asset-backed securities. The asset basket would include large public companies in the country’s wealth fund such as Turkish Airlines, the Istanbul Stock Exchange and Turk Telecom.
• The Reserve Bank of India has set up an ‘inter-departmental group’ tasked with examining the “feasibility to introduce a central bank digital currency”, following its decision last year that blockchain technology had “matured enough” to permit digitisation of the rupee.

For many investors, the opportunity to purchase centrally-issued cryptocurrencies may be an attractive one. It does not, however, come without risks. For instance, the Bank for International Settlements recently issued a warning against central bank cryptocurrencies, arguing that they could lead to “digital runs” on central banks. Additionally, there appears to be little uniformity as regards the purpose of, or the approach to, government-issued cryptocurrencies, which means that investors will need to ensure they subject each of their investment decisions to even greater scrutiny.

Investors in cryptocurrencies will need to follow regulatory developments carefully, not only to ensure continued compliance but also because these developments may affect their rights under investment treaties if cryptocurrencies are considered ‘investments’ for the purposes of an applicable treaty. Investors will want to make sure they understand precisely what they are buying into and whether (and, if so, how) their asset will be protected. For now, it remains to be seen how increasing regulation of cryptocurrencies will interact with investor-state protections, and we are unaware of any treaty claims having been brought against states in relation to cryptocurrencies.

Related to this, investors in cryptocurrencies, or parties who conduct cryptocurrency-related business, should carefully consider the dispute resolution mechanisms they include in their agreements. As always, governing law provisions should be given due regard. With respect to forum, arbitration agreements may be particularly well-suited to transactions involving cryptocurrencies, given that, as discussed above, they are inherently borderless and currently undefined in nature. The borderless nature of cryptocurrencies makes arbitration particularly attractive given that arbitral awards are enforceable across borders under the New York Convention.

Furthermore, investors may gain some certainty by specifying arbitration as it offers neutrality vis-à-vis national regulatory systems and permits parties the opportunity to appoint arbitrators who are well-versed in the relevant technical subjects. Arbitration also offers parties greater procedural flexibility, for example in relation to document discovery and protecting the confidentiality of commercial information and/or intellectual property during the course of the proceedings. Arbitration also provides scope for institutional rules to develop and adapt to the unique nature of cryptocurrency disputes.

Cryptocurrencies may offer major investment opportunities. But these opportunities need to be balanced against an uncertain regulatory position and the unclear consequences for investors’ rights under applicable investment treaties.