We have been writing about the legal issues surrounding tokens and ICOs/token sales for quite some time now. However, there’s still a lack of clarity regarding many legal and tax issues regarding the sale and exchange of tokens. The subject is not directly regulated by either EU or Polish laws. While the European Securities and Markets Authority and numerous national regulators (including the Polish Financial Supervision Authority) have issued statements on the subject, numerous issues remain unresolved creating uncertainty for blockchain entrepreneurs and their lawyers.
Of course, the rapid development of blockchain technologies and their token-related applications makes it even more difficult to regulate the area. Unique tokens and decentralised exchanges (DEX-es) are just two popular recent examples of such blockchain innovations.
Airdrops as an ICO alternative
Airdrops (the free distribution of new tokens to particular blockchain wallets) are yet another new development that has recently gained popularity.
There are several reasons why blockchain projects use airdrops. Usually, an airdrop is used to promote a new project and attempt to achieve a network effect by expanding the number of holders of a new token – creating an initial group of customers and stakeholders. Generally, there are two distribution methods for airdrops: tokens are either distributed for free to wallets without their owners’ knowledge or they require that users register their interest or sign up to the project’s social media channels.
It should also be clear that airdrops are sometimes used to avoid the regulatory consequences (or minimise regulatory uncertainty) related to more traditional token distributions such as ICOs. This is why it is so important to understand the potential legal implications of an airdrop.
Airdrops and the law
The fundamental legal question related to airdrops is identical to the one surrounding ICOs: what is the legal status of tokens? In light of the above-referenced statements by ESMA and the Polish Financial Supervision Authority it is clear that, in some circumstances, a token can be considered a security. This decision will then determine the applicability of laws such as: the Act on Trading in Financial Instruments and the Act on Public Offerings and Conditions for the Introduction of Financial Instruments to Organised Trading, and on Public Companies.
As we have noted on several prior occasions there are no clear guidelines as to which tokens constitute securities and which do not. For now, this question has not been clarified by regulatory authorities (regulatory bodies in some EU member states have issued guidance statements) and the valid interpretation of regulations will have to be develop in practice. Thus, the question of legal status remains the universal challenge for all token-related activities including traditional ICOs as well as airdrops.
Another question is whether the unique characteristics of airdrops affect the way they should be treated by regulations. The most obvious question involves the fundamentally free transfer of tokens used in airdrops. Some guidance in this area can be obtained from the ESMA Questions and Answers related to the regulation of prospectuses.
In 2012, ESMA and the Commission were confronted with a question regarding free offers of shares (free public offerings). Two of the issues discussed in the document appear to be particularly relevant:
- In situations of allocations of securities where there is no element of choice on the part of the recipient (including no right to repudiate the allocation), there is no “offer of securities to the public” within the meaning of the Prospectus Directive (which forms the basis for the Act on Public Offerings). In the context of airdrops, this would mean that token distributions conducted without the knowledge of the tokens’ recipients do not constitute offers of securities to the public – even if the allocated tokens are found to be securities.
- On the other hand, if the recipient of the free securities decides to “accept the offer” the public offering can be properly regarded as an offer for zero consideration which is entitled to qualify for exclusions established by the Prospectus Directive (in terms of the Act on Public Offerings, the exclusion primarily refers to the absence of a requirement to issue a prospectus and make it available to the public if the total value of the securities on the basis of the issue price or selling price does not exceed EUR 1,000,000). This exclusion also appears to work in favour of airdrop organisers. However, it should be kept in mind that various “hidden” considerations which take a form other than a transfer of funds to the ICO organisers may lead to a finding that the offer does not constitute a bona-fide “offer of free shares.”
Thus, it is possible that in at least some circumstances, airdrop organisers will not be subject to public offering regulations even if the allocated tokens constitute securities. However, we must keep in mind that these conclusions are based on regulatory bodies’ interpretations from several years ago, ones which were developed in different technological circumstances and were primarily related to employee share schemes.
This discussion only addresses the public offerings of tokens. Questions related to the public exchange of tokens allocated through airdrops must also be analysed in light of regulations on trading in financial instruments and Anti Money Laundering (AML) laws.
Additionally, the tax law implications of airdrops must also be considered but the subject falls outside the scope of this article.
The question of how will the laws apply to airdrops remains unanswered. While there are many legal arguments regarding the application of regulations to this new means of distributing tokens – the way in which they will be applied is unclear. We are hopeful that the Polish Financial Supervision Authority’s blockchain workgroup (in which we are active participants) will assist in finding this clarity.