Companies and projects have increasingly relied on the sale of digital assets, or tokens, as a means of fundraising. These tokens generally do not grant the holders an ownership interest in the issuing company or project, but may provide governance rights, access rights or other utility. This has been conducted through public sales known as initial coin offerings (ICOs), proliferation through token generation events (TGEs) or private sales, among other mechanisms. While showing characteristics of traditional methods of fundraising, there are a range of unanswered questions related to the legal classifications of such products. As ICOs and TGEs will usually be distributed online and internationally, there is usually no single legal framework applying to such transaction, and the legal framework of each market in which the tokens may be offered or sold needs to be considered.
Attitude of the country towards ICOs/token sales
In autumn of 2021, the public was hit by a massive campaign of the XIXOIO project, offering a comprehensive solution for raising capital for companies that cannot or do not want to go the Venture Capital/Private Equity, IPO route, or ICO. The campaign was accepted with controversies, including massive criticism for targeting retail investors and offering them risky investments while not including e.g. a right to redeem the token back for money. The public is, however included and making investments in this project.
The drawback for ICO/token sales projects is the absence of specific regulations, which make some parts of the projects easier, but some actually more complex and challenging.
Presence of any explicit regulation on ICOs and the issuance of token/coins
As of February 2022, there is no explicit regulation on ICOs. As stated in the CNB’s opinion from 2018, called “Under which circumstances are initial coin offerings (ICOs) subject to the Act on Management Companies and Investment Funds?”, investments funds issuing ICOs, including AIF, should be regulated by Czech Act on Management Companies and Investment Funds - but this Act does not mention ICO and virtual assets itself.
Therefore, ICOs themselves are not directly regulated. But the banking supervision laws, as well as anti-money laundering provisions, may apply. The relevant legal provisions depend on how the ICO is structured and the token's legal nature. For example, the token can be deemed a financial instrument, a security, a capital investment, or neither of those things with the result that different regulatory provisions must be heeded.
Presence of any explicit restrictions on ICOs or the issuance, distribution and/or transfer of token/coins
There are no explicit restrictions on ICOs. Nevertheless, many supervisory and regulatory questions arise when setting up an ICO. Since the applicable regulation, as well as financial and investor protection rules, depending on the specific design of the coins or tokens issued in the context of an ICO, a company should adapt its business model or the functioning of the coins or tokens to the respective relevant laws.
Also, there is a CNB opinion from 2018, answering questions under which circumstances ICOs are subject to the Act on Management Companies and Investment Funds. The opinion says that without relevant authorisation from the CNB to manage a collective investment fund (or compliance with other conditions applying to foreign equivalents thereof), no collection of funds from the public for the purposes of collective investment is permitted, including through the issuance of tokens or ICOs. Moreover, a manager who collects funds for the purposes of joint investment for the benefit of investors other than the public via the issuance of tokens or ICOs is also obliged to register under Article 15 of the Czech Act as AIF.
Obligations and requirements to issue token/coins
The ICO itself, meaning the issuance of tokens for money, does not require a license.
Classification of token/coins in the jurisdiction
In its opinion, the CNB defined exchange tokens as equivalent to currency/payment tokens. The CNB's definition is partly followed in its consultation by the Ministry of Finance, which refers to payment tokens as virtual currencies and asset tokens as virtual assets. However, this division is problematic and inconsistent with the same CNB opinion. This is because CNB, like the UK FCA or the European Securities and Markets Authority, refers to payment tokens as "a subset of so-called crypto-assets".
Under the Czech law, the tokens cannot be securities under Section 514 of the Civil Code as it has two distinctive features for its conceptual definition. The first condition is the connection of the "value" of the security in the legal sense, i.e. the connection of the right with the instrument in such a way that it is impossible to exercise the right without the instrument. The second condition is the form of security, which, according to current legal doctrine, is inseparably linked to the physical substrate based on historical development. This condition is not met in the case of tokens.
As of a financial instrument (investment product) under MiFID II and Czech Capital Market Undertaking Act, it therefore seems legitimate to interpret the concept of financial instrument, in the light of the scheme and purpose of the legislation, in favor of asset tokens and their inclusion under financial instruments. This needs to be assessed on a case-by-case basis: currently, Czech legislators are waiting for MiCA and do not want to change the legislation itself.
Presence of a duty to publish a prospectus bevor offering token/coins to investors
Currently, there is no specific duty to publish a prospectus before tokens/coins offering (unless the tokens do qualify as financial instruments under the Czech Capital Market Undertaking Act).
Presence of AML/KYC requirements that are needed to be fulfilled regarding (i) the initial issuance of token/coins and (ii) any following transfer of token/coins to third parties
The issuance of an ICO constitutes a "service related to the virtual asset" within Section 4(8) of the AML Act. The person carrying out this activity becomes, therefore, an obliged person under Section 2(1)(l) of the AML Act, even though he carries out this issue only in the context of a single project since even such an engagement constitutes a continuous activity within the meaning of Section 420 of the Civil Code or Section 2 of the Trade Licensing Act.
As an obliged person, the issuer must comply with the Czech AML Act, including the requirement of identification pursuant to Sec. 7, identifying the customer wherever the transaction exceeds EUR 1,000, the transaction is considered suspicious (acc. to Sec. 6) or if it's an agreement to enter into a business relationship. The identification must be performed in one of the ways permitted by the AML Act.
Continuous monitoring of business relationships that may apply to the following transfers, are included in (enhanced) Customer Due Diligence pursuant to Sec. 9 and Sec. 9a. This Section was amended following the V. AML Directive coming into force while adopting the EU’s standards for Customer Due Diligence. Therefore, the CDD is performed (a) prior to the execution of a transaction outside the business relationship, where the conditions referred to in Section 7(1) are met, i.e. (1) no later than the time when it is apparent that it will reach a value of EUR 15,000 or more, (2) with a politically exposed person, (3) with a person established in a high-risk third country, a person identified in accordance with the procedure of Acceptance of Identification, referred to in Article 11(7), (4) in case of a transfer of funds of EUR 1,000 or more, (b) in situations to which the identification obligation regarding new business relationship and/or suspicious transaction applies, at the latest before the transaction takes place, and (c) during the course of the business relationship.
Additional comments regarding (i) the legal situation for ICOs/token/coins and (ii) any following transfer of token/coins to third parties
The key to successfully comply with Czech legislation and current regulation is to assess whether the issued token/coin qualifies as a financial instrument and, if so, what kind of financial instrument. The results of such assessment set the legislative framework that must be followed.
Market size for ICOs/token sales and existence of any previous regulated ICO/token sales in the jurisdiction
In 2021, the above-mentioned company XIXOIO allegedly sold tokens in a total volume of 300 million CZK to more than 2,800 users. In 2022, the company started tokenizing its first client, company Simplecell, with a target of lower hundreds of millions of Czech crowns raised to complete and sell an electricity meter connected to the Sigfox IoT network, which is operated in the Czech Republic; however, the project was postponed following the Russia’s invasion of Ukraine.
Thus, no other successful ICOs are currently publicly known.
Additional comments regarding the economic situation for ICOs/token sales or what companies must be aware of in this business area
With XIXOIO and its campaign bringing controversies both for the Czech business world and for the public, a trend of wider adoption between retail seems to be present.