The legal classification of tokens is a crucial step that must be tackled prior to issuing or listing a token in a regulated jurisdiction. While the crypto industry has heavily relied on the tripartite classification of tokens into payment, security and utility tokens, the growing complexity of tokens in circulation necessitates a thorough analysis of the characteristics of a token, both from a technical and legal perspective, to ensure legal certainty.
The Importance of Token Legal Opinions
The purpose of token legal opinions is to determine the legal classification of a token under the law of a particular jurisdiction where the token will be issued or listed on the platform of a service provider, such as an exchange. The firm tasked with preparing a legal opinion must thus determine the laws of which jurisdiction must be taken into account and must also have a thorough understanding of such legal framework. Jurisdictions which have chosen to regulate cryptoassets have done so in varying ways, hence the importance of obtaining a legal opinion specific to the jurisdiction in which such token shall be listed or issued.
For instance, under Maltese law, a Virtual Financial Asset (VFA) is defined as “any form of digital medium recordation that is used as a digital medium of exchange, unit of account, or store of value and that is not (a) electronic money; (b) a financial instrument; or (c) a virtual token”. Thus, a token to be listed or issued in Malta would fall within the ambit of the Virtual Financial Asset framework if it is not electronic money, a financial instrument or a virtual token.
On the other hand, Liechtenstein law provides a generic definition of tokens as information on a Trusted Technology (TT) system which represents rights, such as rights to membership or property, and which are assigned to one or more TT identifiers. The law does not classify tokens, with such classification depending entirely on the characteristics of the tokens themselves. This lack of legal certainty further highlights the importance of obtaining a legal opinion on the classification of the token, as should the tokens constitute financial instruments, financial market laws potentially become applicable.
Singapore’s regulatory framework provides a detailed definition of digital payment tokens as “any digital representation of value (other than an excluded digital representation of value) that –
- is expressed as a unit;
- is not denominated in any currency, and is not pegged by the issuer to any currency;
- is, or is intended to be, a medium of exchange accepted by the public, or a section of the public, as payment for goods or services or for the discharge of a debt;
- can be transferred, stored or traded electronically; and
- satisfied such other characteristics as the Authority may prescribe”.
The above definition excludes securities and even most stablecoins, and mainly captures cryptocurrencies consisting of payment tokens and utility tokens. The definitions provided in such legal frameworks highlight the importance of ensuring an accurate classification of a token within a particular legal ecosystem, as the classification of a token as a regulated instrument could have serious ramifications, including licensing requirements under securities regulations, which would make the entity seeking listing or issuing tokens subject to onerous obligations.
Token legal opinion requirements across jurisdictions
Under the Maltese VFA framework, the Financial Instrument Test must be carried out prior to offering DLT Assets to the public in or from within Malta or offering VFA services in relation to a DLT asset, unless it was already carried out by an Issuer. The financial instrument test involves an analysis of whether a DLT asset is electronic money, a financial instrument, a VFA or a virtual token, and the scope of the test is to determine the classification of a token. For a VFA Service Provider to list a token on its platform, the classification of a token must be that of a virtual financial asset or e-money; classification as a financial instrument would require the VFA Service Provider to obtain a separate license, while classification as a virtual token is generally reserved for those crypto-assets that cannot be freely publicly traded. The Financial Instrument Test should ideally be conducted by VFA Agents licensed by the Malta Financial Services Authority, due to its specialized and technical nature.
In order to obtain a payment services license in Singapore to provide a digital payment token service, the applicant must conduct a risk assessment of all the digital tokens and digital token services which they intend to support or provide. Such risk assessment must provide a list of all the digital tokens which it will support and also include an assessment of the nature of the token under the Monetary Authority of Singapore’s regulatory framework, i.e. whether it is classified as a security token or a payment token. A supporting legal opinion must also be provided which includes an assessment of all tokens, except for Bitcoin, Bitcoin Cash, Bitcoin Gold, Bitcoin SV, Ethereum, Ethereum Classic, Litecoin and Ripple.
The Monetary Authority of Singapore encourages those seeking to offer digital tokens to seek professional advice to ensure compliance with financial laws. Where digital tokens are classified as securities, units in a collective investment scheme or derivative contracts, such tokens would be subject to traditional financial regulation under Singapore’s Securities and Futures Act. Thus, it is advised to obtain a legal opinion to ensure that tokens do not fall within the remit of such regulations. Where applicants seek further clarification from the Monetary Authority of Singapore to determine the regulation of the proposed business activity, the submission of a legal opinion from a Singapore-qualified lawyer analyzing the structure of the proposed digital token is required.
Under Liechtenstein’s regulatory framework, persons seeking to provide Trustworthy Technology (TT) Services and token issuers must prove that their business model is not subject to any other licensing requirements. This would depend on the classification of the tokens being issued or supported by the service. In the case of ICOs, in particular, the Financial Market Authority might request a legally-founded self-assessment, usually in the form of a legal opinion, that the token does not fall within the remit of traditional financial instruments and thus does not require the publication of a prospectus and does not bring about due diligence obligations.
Furthermore, TT Service Providers seeking to list crypto-assets on their platform should obtain a legal opinion on such crypto-assets to ensure that they are not financial instruments, as otherwise such TT Service Providers would be required to obtain a separate license under the EU’s MiFID framework to list such crypto-assets.
The Technical Aspect
Although the above analysis of the applicable regulatory requirements with regard to token legal opinions highlights the importance of thorough knowledge of the law, the importance of employing a firm with sound technical knowledge and expertise when drafting a token legal opinion cannot be overlooked. The cryptoasset industry is an ever-evolving space where new tokens, protocols and technologies emerge at a fast pace. One such development has been the rise in popularity of De-FI tokens which are often complex tokens combining different features, such as tokens which initially grant governing rights and subsequently provide a right to receive fees. Thus, a legal opinion must also provide an analysis of the technical aspects of a token, such as the platform on which it operates, the digital wallet it is stored in, the token protocol, and the ecosystem in which the token operates as a whole.