There is currently no formal law or ordinance to qualify tokens either in Switzerland or internationally. Backed in 2018, resp. 2019, FINMA has therefore established guidelines for ICOs and stablecoins in which it is explained how tokens shall legally be classified.
In assessing Token Generation Events (TGE), FINMA will focus on the economic function and purpose of the tokens issued by the TGE organizer. The key factors are the underlying purpose of the tokens and whether they are already tradeable or transferable. Basically, FINMA has established a tripartite distribution of tokens (payment, utility, asset).
Payment tokens are tokens which are intended to be used, now or in the future, as a means of payment for acquiring goods or services or as a means of money or value transfer. This includes "cryptocurrencies" in the strict sense of the term, such as Bitcoin, and numerous cryptocurrencies resulting from forks or variations of BTC, such as BCH or LTC. Other tokens may also be designed and used as a means of payment, e.g. tokens that are "secured" with assets such as gold or fiat currencies and are primarily intended for the transfer of money or value. They also often take the form of digital rights values which, depending on their distribution and the infrastructure available, can be used as a means of payment.
Payment tokens have no further functions or links to other development projects. Tokens may in some cases only develop the necessary functionality and become accepted as a means of payment over a period of time.
In principle, cryptocurrencies give rise to no claims on their issuer. In particular, the issuer has no obligation to make a particular payment or to provide a service to the investor. From a regulatory point of view, payment tokens have many similarities with foreign currencies.
Given that payment tokens are designed to act as a means of payment and are not analogous in their function to traditional securities, FINMA does not treat payment tokens as securities in the case of a TGE. However, the AML & CTF provisions usually apply.
Utility tokens give the investor the right to use digital services, available in most cases on a (decentralized) platform. These services are usually provided using a blockchain infrastructure, and the investor's right to access digital usage through the tokens is limited to the relevant platform and service. Depending on their form, they are comparable to vouchers, chips or keys that can be redeemed for contractually owed services. Similar to asset tokens, utility tokens are based on a contractual relationship (in the form of a claim).
The main function of a utility token is therefore to provide access digitally to an application or service by means of a blockchain-based infrastructure.
Utility tokens are not considered securities if their sole purpose is to confer digital access rights to an application or service and if the utility token can actually be used in this way at the point of issue. In these cases, the underlying function is to grant the access rights and there is no connection to the capital markets, which is a typical feature of securities.
On the other hand, if a utility token functions solely or partially as an investment in economic terms, they will be treated as securities (i.e. in the same way asset tokens are). This is, for example. the case if a token is issued to collect funds to start or develop a company or a platform that will not provide services until a later date (pre-operating stage). From an economic point of view, the focus for the issuer is on borrowing and for the buyer on the investment or speculation opportunity, therefore the token is regarded as a security.
If a utility token has a payment function as well but the payment functionality remains of lower importance, the token is classified as utility only (accessory payment function). In case the payment function is at least of equal importance to the utility function, the token shall be classified as a hybrid token.
From an economic point of view, asset tokens present a predominantly investment-related or speculative aspect (for the buyer). Unlike pure payment tokens, they represent real economic assets "outside" the blockchain. In particular, an asset token may consist of a claim/right against the issuer under contract law or a membership right according to corporate law. These rights consist of a fixed fee or a pre-determined share of the investor in a reference value (e.g. performance data) of the issuer's business. For example, asset tokens promise a share of future company earnings or future capital flows.
As the main function of asset tokens is usually to represent assets such as a debt or equity claim on the issuer, in terms of their economic function, these tokens are analogous to equities, bonds or derivatives and are therefore treated as securities by FINMA provided that they are standardized and suitable for mass trading.
The category of asset tokens also includes tokens that allow for the trading of standardized claims for the delivery of physical objects on the blockchain, especially if such claims are normally traded in the capital markets (e.g. trade in commodities, DLT-securities, tokenized shares).
2. Different stages
The qualification of a token can vary in time. FINMA Guideline regarding ICOs also sets out four stages:
- Pre-financing stage: Investors are offered only the prospect that they will receive tokens at some point in the future and the tokens or the underlying blockchain remains to be developed.
- Pre-sale stage: Investors receive tokens which entitle them to acquire different tokens at a later date. The pre-sale tokens will need to be swapped or converted into the final token in the future.
According to FINMA Guidelines regarding ICOs and the Financial Market Infrastructure Act (FinMIA), the claims to acquire tokens in the future (during the TGE) received during a pre-financing, respectively the initial tokens during a pre-sale shall be treated as securities (i.e. as asset tokens) if they are standardized and suitable for mass standardized trading.
Securities are deemed suitable for mass standardized trading when they are publicly offered for sale in the same structure and denomination or are placed with more than 20 clients, insofar as they have not been created especially for individual counterparties.
- Pre-Operational stage: The main functionality of the tokens is available, but it cannot be used at the point of issue because the application, platform or the underlying blockchain remains to be developed or requires completion.
In this case, FINMA considers the tokens to be asset tokens, respectively securities if they are standardized and suitable for mass trading.
- Operational stage: Tokens are already put into circulation at the point of issue. This takes place on a pre-existing blockchain and the main functionalities of the tokens are available. The tokens can actually be used in the intended way on a functional blockchain, application, or platform.
In this case, the qualification of the token depends on the aforementioned classification criteria.
Eventually, it is mentioned that in order to ensure compliance with the applicable laws, issuers may seek interpretative guidance in the form of “no-action letters” from FINMA prior to launching a token. Enquiries can be submitted to FINMA’s FinTech Desk and are subject to a fee. Although recommended in some cases, obtaining a non-action letter is not a mandatory requirement.
In conclusion, it is important to carefully assess the classification of a token before launching the project in order to define whether a license or an affiliation to an SRO (Self-Regulatory Organization) is required.
Moreover, in the case of a utility token, it is crucial to ensure that at the time of the TGE, the functionalities to which the token will give access are effectively implemented and operational. If this is not the case, the utility token risks being considered as an asset token, respectively a security.
As a trusted partner of genius X, JayBee AG can support you in establishing a token assessment. Based on the conclusion of the report, we will recommend whether or not to obtain a no-action letter from FINMA. This approach is usually time saving in most cases.
The considerations in this article are limited to Swiss financial market laws and the practices of the Swiss Financial Market Supervisory Authority (FINMA) at the date hereof to the extent such practices have been publicly communicated. Swiss legal concepts are not expressed in a Swiss official language. Thus, the translated terms may differ from similar terms in laws of other jurisdictions.
Finally, although drafted with great care, this article does not constitute legal advice and is not a substitute for consulting a lawyer. JayBee AG disclaims any liability for the use of this article or for any decisions made based on this article. Finally, JayBee AG shall not be liable for any damages arising from the use of this article.