This article is written by Emiliano Cordoba, of counsel at Block Asset Management in Luxembourg. It originally appeared in the May 2018 issue of Citywire Switzerland.
Switzerland is emerging as a world leader in ecosystems for cryptocurrencies and blockchain technologies, and the canton of Zug is the epicentre of this trend.
Back in 2014, ethereum, the second-largest cryptocurrency by market capitalisation at around $62 billion, was created in Zug. Many others naturally followed. The government-supported Crypto Valley Association is now aiming to take full advantage of Switzerland’s strengths to build the world’s best blockchain ecosystem.
As well as Switzerland’s reputation for security and neutrality, there is a strong commitment to the industry from the Swiss government, and major market players appear to be throwing their weight behind the country.
The weight of the law
The legal framework must now be updated to fulfill the needs of the market. Despite a number of potentially applicable laws such as the Federal Constitution, the Banking Act, the Anti-Money Laundering Act, the Collective Investment Schemes Act, the Data Protection Act, and the Stock Exchanges and Securities Act, blockchain is still not adequately regulated.
Because of the novelty of this technology and the numerous ways it can be employed, there is no relevant case law or consistent legal doctrine.
Nevertheless, in February of this year, the Swiss Financial Market Supervisory Authority (Finma) took a very important step in the right direction by publishing guidelines on how it intends to apply financial market legislation to initial coin offerings (ICOs).
The document differentiates between three types of tokens, with hybrid forms also being possible. First, there are payment tokens and cryptocurrencies, which are intended to be used as a means of payment for acquiring goods or services. They have no further functions or links to other development projects. Next are utility tokens, which provide digital access to an application or service by means of a blockchain-based infrastructure. And finally, there are asset tokens, which represent assets such as debt or equity claims against the issuer. They promise, for example, a share in future company earnings or future capital flows. In terms of their economic function, these tokens are analogous to equities, bonds or derivatives.
With a focus on the economic function and purpose of the tokens, Finma will handle inquiries on a case-by-case basis. This approach and Switzerland’s openness to dealing with complex new products (particularly ICOs) will comfort investors, who will be reassured by its solid legal background – something that will probably not be available in many countries for a long time to come.
How to protect your clients
This type of investment is extremely volatile, so it’s essential to ensure you have the maximum legal certainty by analysing and carefully selecting the setup and regulation of crypto assets.
There are currently a number of options for ICOs (the US, the UK or Switzerland) and funds (the Cayman Islands, the US or Luxembourg). But beyond the jurisdiction, I believe due diligence on the legal structure and professional management is fundamental.
First, you need to review the selected partners, the bank, the fund administrator, the legal adviser and the auditor. When the track record is short or almost nonexistent, all other factors become more important. Also bear in mind that the lack of a proper regulatory framework in most countries creates a higher risk of scams and fraudulent or illegal schemes.
Last year Finma closed down three companies and it has now opened investigations into 11 other suspect cryptocurrency schemes. Some of these are Ponzi schemes, scammers exploiting expectations of quick profits. Among the infractions detected were a lack of a banking licence and failing to back cryptocurrencies with the tangible assets promised.
I strongly advise you to read the Finma guidelines for the cryptocurrency sector. Always start by checking whether the provider is regulated and has been authorised by Finma or the applicable foreign entity.
Whether the clients’ appetite is for cryptocurrencies, listed companies, mining companies, ICOs, ETFs or funds, go the extra mile in your due diligence. We are in the infancy of a technology that many are already calling the Fourth Revolution. The risks are as big as the potential returns.