This article describes the classification of tokens issued in an initial coin offering (ICO) and their regulatory regimes in Lithuania. The classification will be mainly based on the guidelines provided by the Bank of Lithuania (BoL)
What is a token?
BoL has defined “token” as a digital assets that are recorded /distributed/acted upon or trigger other associated activity on a distributed ledger (via smart contracts). Similarly, the Securities Market Stakeholders Group (SMSG), whose aim is to facilitate European Securities and Markets Authority’s (ESMA) consultation on its work with relevant securities markets stakeholders from around the European Union (EU), has noted that token is a broad term that encompasses many virtual assets and can be defined by opposing it to account-based assets; additionally, that the term’s definition may vary depending of the specific network.
The tokens are initially created in a blockchain process, aka mined, and issued in a publicly held bidding process to subscribers. The creation process of tokens by the initiator is called Initial Coin Offering (ICO). The term ICO is used for the initial offering of any crypto assets – it is an innovative way for raising funding for a project from early backers.
What type of tokens are there?
The characteristics and purpose of tokens may vary across ICOs. Some coins or tokens serve give to access to or purchase a service or product that the issuer develops using the proceeds of the ICO; and others provide voting rights or a share in the future revenues of the issuing venture. Some coins or tokens are traded and/or may be exchanged against fiat or virtual currencies – however, some tokens may have no tangible value.
The tokens issued in an ICO may broadly be divided into four categories according to the BoL as follows:
Payment-type tokens
This category covers tokens which may serve as a means of exchange or payment for goods or services (transfer value).
Utility tokens
These tokens provide some ‘utility’ or consumption rights, e.g., the ability to use them to access or buy some services/products. The tokens falling under these two categories do not grant profit or governance rights. These types of tokens are covered by the same regulatory regime and are often both referred to as utility tokens. This kind of tokens derive their value from how it is used and its issuer may use the tokens to gather funds for their project. However when payment-type tokens are exclusively used for payment purposes, utility-type tokens are often treated as coupons, meaning that in the future they could be exchanged to access the products or services of the issuer.
Investment-type tokens
Tokens with specific characteristics denoting they meet the definition of transferable securities or other financial instruments like a share or a debt instrument of MiFID II – also, often referred to security tokens. The tokens falling under this category grant its owner reasonable expectations for profits or governance rights. This kind of tokens derive their value from an external, tradeable asset (e.g., stocks, precious metals, real estate) and represent an investment. Investment-type tokens grant its owner a reasonable expectation for profit or governance rights.
Hybrids
They are tokens that are a mixture of ‘investment-type’ and/or ‘utility-type’ and/or ‘payment-type’ tokens, therefore, confer the mixture of the rights typical to ‘investment-type’ and/or ‘utility-type’ and/or ‘payment-type’ tokens. It is not rare for a token to fall under this category – most tokens hold the characteristics of several previous tokens, therefore must be thoroughly assessed to determine the applicable regulatory environment.
The regulatory environment and licensing requirements differ substantially, depending on the token’s classification.
Authorization requirements for entities engaging with ICOs
If a token classifies as a payment-type or utility-type token, it will be regulated under the Lithuanian Law on the Prevention of Money Laundering and Terrorist Financing (LPMLTF). The definition of a such tokens correspond to the one of virtual currency under the Lithuanian legislation and the entities acting as virtual currency operators, meaning exchange and deposit operators, must register themselves as such to have an authorization to operate – the supervision over virtual currency operators registered in Lithuania is done by the Financial Crime Investigation Unit (FCIS). FCIS is the financial intelligence unit of Lithuania and their mission is to protect the state financial system by disclosing criminal actions and other violations of law by providing methodological assistance and supervision over financial institutions and other obliged entities under LPMLTF.
However, if the token classifies as an investment-type token, it will be regulated under the Law on Securities of the Republic of Lithuania (LoS) and the Prospectus Regulation of the European Union (EU) may also apply among other EU regulations. The provision of investment services may be provided only by financial brokerage firms holding a license of a financial brokerage firm, credit institutions provided the license of a credit institution authorises the provision of investment services, and licensed financial advisor company holding a financial advisory company license. The Bank of Lithuania is responsible of approving of and the supervision over such financial institutions.
BoL has provided guidelines especially for issuers whose token classifies as an investment-type token – is regulated as a security. However BoL notes that the legal qualifications of tokens may be subject to change due to the novelty of the sector and the regulatory obligations EU law may impose.