The option to sell self-created crypto tokens to investors as a means to procure capital has grown ever more popular with companies at the latest since the end of 2017. There are different types of these so-called token sales. The probably best known type is the so-called Initial Coin Offering or ICO which also kicked off the hype concerning token sale events in late 2017. In this process, companies create their own crypto tokens via smart contracts on suitable blockchain infrastructures which they subsequently sell to interested investors. If tokens are connected to security-like rights, e.g. a claim on return or participation rights, the public offering of them may qualify as a so-called Security Token Offering (STO). About two years ago, various international crypto exchanges also began to expand their range of services to include so-called Initial Exchange Offerings (IEOs). In this process, the involved crypto exchange does not only offer the token issuer the technical programming of the subsequently offered tokens, but also a listing of the tokens on the exchange to enable interested investors to directly acquire and trade the tokens. Probably the newest type of token sale is the so-called Initial DEX Offering (IDO). Token issuers thereby utilize a Decentralized Exchange (DEX) as the connected trading venue for the initial public offering and possibly also for the secondary trading of the tokens instead of a centralized crypto exchange.

How Do IDOs Work?

The token issuer offers his tokens during an IDO to investors via a decentralized exchange platform.  These so-called DEX are autonomously, decentralized, on suitable blockchains via smart contracts functioning programs which are not directly operated by any specific entity. The last feature is the decisive difference to centrally designed crypto exchanges. The later are always operated by a specific and responsible operator which matches supply and demand through his services and which will facilitate the settlement of contracts in cases in which a contract is agreed upon. With DEX, the matching of offeror and investor as well as the settlement of crypto transactions is performed automatically via an accordingly programmed smart contract. Token offerors as well as investors may independently interact with the smart contract and may acquire or sell tokens via the DEX from or to other trading participants of the DEX. Trading participants of a DEX provide a blockchain address with which they intend to participate in the decentralized trading. Token issuers are therefore able to offer their tokens by listing a blockchain address on the DEX which contains the offered tokens as a credit balance. In order to acquire the crypto tokens, investors may then transfer other cryptocurrencies with an amount equivalent to the intended investment amount to a blockchain address provided by the issuer to the DEX. The DEX will then automatically transfer crypto tokens equivalent to the investment amount to the investor.

Which Regulatory Obligations May Be Triggered by an IDO?

Even though the actual trading on a DEX is performed in a decentralized way and without a clearly responsible operator, the participants may nevertheless be addressees of regulatory obligations. Should the offered tokens e.g. qualify as securities in the sense of the EU Prospectus Regulation, a security prospectus or other required documentation has to be provided by the issuer for the first public offering. Regarding the DEX itself, the initiators of the platform might be subject to authorization obligations, depending on their specific contribution to enable the DEX for operation. Should the initiator of the DEX for example reserve administrative rights that enable him to influence the trading on the DEX or should transactions on the DEX trigger transaction fees for the benefit of the initiator, a case for the regulatory responsibility of the initiator could well be made. In summary, there are therefore no real regulatory simplifications for the issuers of tokens via IDOs compared to other types of token sale events. For the initiators of the DEX, the question of profiting from regulatory simplifications depends on the actual autonomy of the DEX and on the connection of the initiator to the operation of the DEX, for example through the reception of transaction fees stemming from the trading activities on the platform.   

Attorney Lutz Auffenberg, LL.M. (London)