- The diversity of blockchain projects makes investments difficult and creates legal uncertainties.
- The SEC proceedings against Ripple clarify whether XRP is an investment or a digital asset.
- The Howey test assesses whether objects of sale are unregistered securities; this does not officially exist in Europe.
- Problems arise with utility tokens when they are used for corporate financing.
- Missing prospectuses lead to legal consequences and possible claims for repayment.
- Inadequate general terms and conditions and a lack of information can cause financial damage for providers.
- It is important to review sales processes and clearly define the legal basis.
Currently, there are very many projects in the field of blockchain, tokens and coins and the potential “investment opportunities” are as diverse as they are confusing. It is often unclear which company (if any) is behind it, what exactly the whitepaper looks like, or even how the token is to be legally classified.
The options are as confusing as the legal assessments (whether it’s a utility token, a security token, or whatever). However, it is often the case that providers try to give tokens a different actual and/or legal qualification than they would have upon closer inspection. The requirement for security, bonds or actual investment object are high, often too high for startups. The risk of misclassifying a blockchain instrument, however, is also not to be sneezed at.
Ripple vs. SEC?
Probably one of the most prominent disputes currently, which could also decide a lot for the industry, is the SEC’s case against Ripple in the USA. I don’t want to shed light on the process in detail, because other blockchain portals do that better, but essentially this is also about the question of whether the purchase of the blockchain content called XRP (I’ll name it very neutrally for once) was now an investment in the company Ripple Labs or whether it was just a purchase of digital assets. The hanger in the USA is the so-called Howey test. This test is designed to evaluate whether or not a sale item is an unregistered security. The three points are that 1.) someone invests money in 2.) a public company, because it is 3.) Profits expected solely from its efforts. The Howey test does not officially exist in Europe. However, the audit points that arise, for example, in the context of an audit of a possible violation of the German Investment Act or other standards in Germany are at least similar.
And in Europe?
Often companies try to sell utility tokens, for example, but in reality they are more for corporate financing, in part because there was no company or even product at the time the digital asset was sold. The details here are highly debatable, but the problem, especially for providers, remains. Without a clean audit, one runs great risks that BaFin might be of the opinion that blockchain instruments could be unauthorized banking transactions or that one violates other standards in the Federal Republic of Germany.
One of these other laws could well be the Asset Investment Act. If a blockchain instrument that one sells as a provider in large quantities and a large number of buyers is in fact an investment, because it may also be directly or indirectly advertised as such, the sale could include the obligation to prepare (or usually have prepared) a so-called prospectus. If a prospectus has not been prepared or is inadequate, the consequences for the provider can be disastrous and the buyer could demand his money back because the “investment” is not a success. The acquirer of assets may then demand from the issuer of the assets and the offeror as joint and several debtors the takeover of the assets against reimbursement of the acquisition price, insofar as this does not exceed the first acquisition price, and the usual costs associated with the acquisition, provided that the acquisition transaction was concluded prior to the publication of a sales prospectus and within two years of the first public offering of the assets in Germany.
This could lead to numerous court proceedings for the provider and may even have criminal consequences.
Details are complicated, but the risks are quite high
The details are complicated and potential legal proceedings can be lengthy and complicated. But this is a risk for both sides. In addition, a review of the legality of a token/digital asset/NFT sale often reveals other gateways for buyers. In my experience in the blockchain sector, for example, the general terms and conditions are often not formulated with sufficient certainty, no thought is given to the possible clarification of a right of withdrawal, regulations such as the button solution in Section 312g of the German Civil Code (BGB) are unknown to the providers, or generally not all the necessary information on consumer protection is provided during the sale, so that in the event of, for example, delayed completion of pre-financed projects, not only warning letters from competitors, but above all thousands of claims for restitution from buyers can be threatened.
These problems, which are often disregarded because blockchain providers often have the attitude that laws only apply to them to a limited extent, can quickly pose such a financial threat to the company AND the founders/shareholders that one then wishes one only had to deal with the somewhat sluggish BaFin or other European supervisory authorities.
As a provider, you would be well advised to review your sales process and make sure the legalities are clean. As a buyer of tokens (which may not meet one’s expectations), on the other hand, you might be well advised to check carefully, or have it checked, whether you can reclaim your “invested” money after all.
You are welcome to contact me via my contact form for the appropriate consultations. Again, I offer a free brief consultation.
