19 October 2017

(Crypto)tokens and Initial Coin Offerings – Croatian Legal Framework

An ICO or Initial Coin Offering is a new disruptive crowdfunding mechanism where a backer of a project founded on a blockchain technology receives an underlying token as opposed to "regular" crowdfunding or an IPO where the backer receives a product or a security. Funding is mostly made in the form of other tokens (eg bitcoin or ether).

Thus far in 2017, ICOs have raised more than USD 2 billion worldwide, whilst in June 2017 they had surpassed angel and early venture capital funding for internet companies. Such a rise is mostly due to lack of regulatory constraints, which allows for easy access to worldwide capital as well as avoidance of high initial costs. In addition, tokens are highly liquid, which makes them appealing for speculators.

Compared to Croatian start-ups, which in 2016 managed to collect only HRK 2.3 million via crowdfunding as against HRK 5.3 million in 2015, and whereby only 12 of 49 initiated projects have been able to collect the envisaged amount, ICOs may provide a way for necessary capital injections to Croatian start-ups which cannot access venture capital.

ICOs currently work in a grey area and most jurisdictions have no specially implemented regulation. Until such regulations are adopted, the existing law may apply to them. In this regard, the US Securities and Exchange Commission found that tokens offered and sold by a "virtual" organisation known as The DAO (digital decentralised autonomous organisation and a form of investor-directed venture capital fund) were securities and therefore subject to the federal securities laws.

Accordingly, certain ICOs as well trading with certain tokens may fall under the provisions of the Croatian Capital Markets Act (Zakon o tržištu kapitala; "CMA"). This would primarily depend on the structure of an ICO or token, ie whether the token would represent certain types of assets or rights (eg equity, securitised debt, etc), and hence be a financial instrument. Accordingly, entities trading or intermediating with such tokens would need to obtain a necessary licence from the Croatian Financial Services Supervisory Agency (HANFA) or the Croatian National Bank ("CNB").

Moreover, pursuant to the CMA (which transposes the Prospectus directive), issuers of securities, as risky assets, are usually obliged to issue a prospectus in order to protect inexperienced investors. The prospectus must be approved by HANFA. Therefore, legal entity issuing tokens – which would represent a security – via ICO would have to issue prospectus, unless one of the exemptions prescribed by the CMA applies. In this regard, there is no prospectus obligation when the value of the offered securities is less than EUR 5 million in HRK, which considering the amount of funds usually collected by Croatian start-ups via crowdfunding, seems like a sizeable threshold. 


What are (crypto)tokens? They are basically entries in a ledger, ie blockchain (blocks of digitally stored information that are cryptographically secured and linked in a chain), which may be accessed via a private key and reassigned to someone else by making a new entry in a ledger. Depending on the type of blockchain project, their underlying functionality may be to represent assets or rights, either on-chain (eg rights to use blockchain, rights to vote on blockchain, etc) or off-chain (eg proprietary ownership, equity rights, etc).

These tokens may thus be viewed as a commodity or an asset (basically IOUs), or as a security or financial instrument, provided there is legal acknowledgement. Each of these tokens may also become (crypto)currency if the social circle that accepts it as a (contractual) means of payment becomes large enough.

Besides a couple of opinions of the CNB on the status of bitcoin, the Croatian Government and regulators have no official position on the status of tokens or ICOs. Nevertheless, in 2013 the CNB announced that it will follow EU regulations regarding bitcoin, according to which the use of bitcoin does not violate any EU regulation. Then in June 2014, the CNB stated in a letter to the Croatian Tax Administration that bitcoin does not fall within any regulated category of means of payment, because according to the Croatian National Bank Act (Zakon o hrvatskoj narodnoj banci) and Foreign Exchange Act (Zakon o deviznom poslovanju) it does not constitute money, means of payment, foreign currency or foreign means of payment. It also stated that as the value of bitcoin does not reflect the value of (fiat) money which was received for it (ie it is not backed), it cannot be considered electronic money.

There are also several opinions of the Croatian Tax Administration regarding the treatment of bitcoin. The most recent of these refers to the conclusions from the ECJ's judgment in case C-264/14 regarding the VAT treatment of bitcoin, according to which bitcoin, being accepted by parties to a transaction, is considered a contractual means of payment as an alternative to legal tender. It was also concluded that bitcoin may not be considered tangible property, as its sole purpose is to serve as a means of payment, and that it neither represents security conferring a property right nor a security of a comparable nature.

On the basis of the ECJ's judgment and for the purpose of tax collection, the Croatian Tax Administration concluded that bitcoin is equivalent to a money-market instrument (type of financial asset) and that tax should be paid on revenues stemming from bitcoin trading. It is safe to assume, however, that this conclusion is a result of the Tax Administration wanting to forcefully subsume bitcoin under one of the expressly stipulated types of financial assets, which is both unnecessary and mistaken. In any case, the Tax Administration's conclusion should not be used for future interpretations of the legal status of bitcoin or any other token.  

A brief overview of the Croatian legal framework for tokens and ICOs is provided below. 

Payment services and electronic money

The Croatian Payment System Act (Zakon o platnom prometu), which transposes the Payment Service Directive – PSD I, should not apply to undertakings providing certain cryptocurrency services (eg cryptocurrency exchanges, such as bitcoin exchanges). Namely, the Payment System Act defines a payment transaction as an act of placing, transferring or withdrawing funds, whereas funds are deemed banknotes and coins, monetary claim against the payment service provider and electronic money. With this in mind, cryptocurrencies should not fall under any of the mentioned categories, primarily because they do not satisfy legal tender characteristics as there is no issuer (eg central or commercial bank), but are created directly within blockchain in line with the underlying code. In addition, the CNB expressly stated that bitcoin is not money.

As it does not differentiate the definition of "funds" from PSD I, the Payment System Act should not change following the implementation of PSD II. However, the Payment System Act will apply if the token is backed by or linked to funds (eg HRK, EUR, etc). In such a case, the token would represent monetary value issued by its issuer after receipt of funds for the purpose of making payment transactions. Undertakings issuing such tokens should register with the CNB as an electronic money institution and would also fall under its supervision in accordance with the Electronic Money Act (Zakon o elektroničkom novcu). The minimum share capital of an electronic money institution amounts to HRK 2,600,000 (approx. EUR 346,000), which is also the minimum of the electronic money institution's own funds (capital adequacy). The entire share capital must be paid in cash.

Anti-money laundering and Know Your Customer obligations

Although there are money laundering concerns linked to tokens, according to the Croatian Money Laundering and Terrorist Financing Prevention Act in force (Zakon o sprječavanju pranja novca i finacniranja terorizma; "AMLA"), its provisions should not apply to cryptocurrency exchanges, for example, as such services are not regulated thereby. However, the provisions of the AMLA apply to the electronic money institution, and thus if tokens are backed or linked to funds, the issuer would need to comply with the provisions of the AMLA.

Regardless of the above, considering the obligations of entities falling under the anti-money laundering provisions (eg depth analysis of customers) and that the AMLA defines assets very widely, being all means (including any means of payment), tangible or intangible, moveable or real, documents or instruments in any form, including electronic or digital, which prove ownership or right of ownership over assets, cryptocurrency exchanges still may face difficulties doing business with the credit institutions in which they plan or have opened transaction accounts.

In any case, the new proposal of the Money Laundering and Terrorist Financing Prevention Act, which transposes the 5th AML Directive, expressly prescribes anti-money laundering obligations to entities engaged in exchanging virtual currencies for fiat currencies and vice versa, as well as providers offering custodial services linked to virtual currencies.