Many business ideas and infrastructure projects require a large amount of capital in order to become operational. Initial coin offerings (ICOs) have enjoyed much hype - and scepticism - as a means of generating capital. Drawing on experience from the energy sector, we present an overview of the pros and cons of ICOs as an alternative project finance mechanism to established approaches such as loans, bonds, and venture capital.

1. Andreas Gunst, Kenneth Wallace-Mueller
Initial Coin Offerings:
A viable alternative for project finance?
Experience from the energy sector
March 2019

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• This presentation does not constitute legal or investment advice
• This presentation is not focused on any specific jurisdiction, but provides a general overview of
regulatory and contractual questions raised
• Cryptocurrencies and tokens are risky investments with severe price fluctuations
• We recommend seeking legal advice before starting an ICO or similar form of project finance
• There are a broad range of legal issues which need to be considered (corporate, contracts,
capital markets, regulatory, tax, intellectual property, insolvency…)
• Tokens and ICOs are regulated differently in different jurisdictions. As such these should be
reviewed on a case-by-case basis
• Despite the innovative technology, ICOs, tokens and blockchains are not exempted from a
country's laws (or even those of other countries)
Disclaimer
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ICOs and token design
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• Blockchain technology has received a lot of media attention in the last few months, with promises
made that it will revolutionise many sectors
• Blockchain is the backbone technology of the cryptocurrency Bitcoin, and it has quickly been
developed into different structures, such as Ethereum
• Also known as Distributed Ledger Technology (DLT), it acts as a chronological record of
transactions, tracking the movement of value, such as Bitcoins, between participants
• The USP of blockchain is that the record is not stored on a central server or by a single entity.
Instead the entire record is stored on the computers of all participants on the blockchain network
• Transaction details are encoded, meaning that the parties to a transaction cannot easily be
identified, and the nature of the record prevents the retroactive amendment of transaction details
• This creates a robust peer-to-peer transaction system, potentially eliminating any third parties
from the transaction and reducing errors and transaction fees
What is blockchain?

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• Initial Coin Offerings (ICO), also known as Initial Token Offerings (ITO) are offshoot of blockchain
technology and have been recognised as an innovative project finance tool
• In an ICOs, virtual “coins” or “tokens” are created and then…
• Issuers will publicly sell these to investors in return for project capital
• Investors seek to make a profit on their investment
• An increasing number of ICOs have appeared over the last years, with approx. USD 7.8 billion
having been raised in 2018 (icodata.io)
• The large number and willingness of investors to join in and the limited scope of regulation has
meant that – whilst some ICOs are legitimate – a number have turned out to be fraudulent, with
culprits increasingly adopting professional approaches
• ICOs generally occupy a legal vacuum, with many countries holding back on actively regulating
ICOs and underlying tokens – an interesting development is the Security Token Offering (STO)
What are ICOs?

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ICO: 6 general steps
The ICO proper is then performed
Platform to advertise the ICO is selected
Date and duration for the ICO set, token price and a cap on amount to be raised
Fixed number of tokens are created
A white paper is published
The organisers announce the ICO to generate interest

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• In return for capital, investors buy a number of “tokens”. These can take a variety of forms,
depending on their intended purpose.
• There are several general options for tokens or token-alternatives:
• Usage tokens (e.g. Blockchain, Ether)
• These are in a literal sense cryptocurrencies, which carry value and can be exchanged with
other tokens, fiat currencies, or goods and services
• Work tokens (e.g. ClimateCoin)
• These grant certain rights within the framework of their issuance. These can be varied,
e.g. ownership rights, voting rights, or a tracking system for certain goods, or even simple
proof of investment. These can be sub-divided into:
• tokens mimicking equity instruments or debt instruments
• tokens serving as types of vouchers, the use of which is determined by the organiser
(utility tokens)
• utility tokens, which are locked on issue and are unlocked once the system is built
Token design

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• Simple Agreements for Future Token (SAFT) or Simple Agreement for Future Token or
Equity (SAFTE)
• Agreements between issuer and holder where the tokens are not immediately issued, but
give the holder the right to acquire tokens following launch
• SAFTs may be sold as securities, however after launch the tokens become Utility Tokens
• SAFTE have an equity conversion feature, if a priced equity round occurs prior to launch
• Security token
• A more recent approach, where a token is designed to replicate a regulated instrument, such
as a share or bond
• From a programming perspective, anything is possible – however the real question is what rights
(and obligations) does a holder have?
• This boils down to a (legal) contractual relationship between the issuer and holder
Continued
Token design

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Project finance
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• Before they can become operational, many projects need a large amount of up-front capital
• e.g. wind or solar plants, premises and interior fittings for restaurants, fleets of vehicles
• One way is for the developer to invest his/her own money (through savings or profits made)
• Alternatively, the developer can get capital from another person – there are two categories:
• Debt – gets capital, but the borrower has to pay back money owed
• Equity – gets capital, but the lender becomes part-owner of the project
• There are many drivers to this choice, such as:
• Do I want to give away part of my business?
• Do I want to on-board additional experience or reputation?
• How much does it cost (money or other resources, e.g. time)?
• What is the impact on my liquidity?
• Tax? (an exciting topic, but for another time!)
What is project finance?
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Debt Equity
Pros:
• Developer's ownership interest not diluted
• Only principal and interest repaid (not future profits)
• Can easily forecast future repayments
• Limited regulation (if not financial instrument)
• Support of e.g. a large bank adds credibility
Pros:
• No obligation to repay money
• No regular payments
• Can on-board additional experience
• Well-known shareholders may give project additional
credibility
Cons:
• Total interest amount can be relatively expensive
• Regular payments may cause liquidity issues
• If loan, may need to grant security over assets
• If bond, prospectus obligation?
• If repayment default, legal problems (penalty,
termination, claim on security?)
• Restrictions on ability to take out further loans or change
corporate structure (change in control)
Cons:
• Have to give away part of the business (lower dividends)
• Have to share decision making – investors expect
success of the business
• Need to invest time in investor relations
• May fall under financial instruments / securities
regulation
• Buy-out might be more expensive than original capital
Debt or equity?
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• The main difference between each of these options is:
what rights and obligations do the lenders / investors have?
• Through token design, ICOs can replicate existing financing models, such as:
• Shares in a company (i.e. ownership rights)
• Bond / loan (i.e. developer promises to pay back the token holder at a set "maturity" date)
• Whilst ICOs previously sought to avoid being regulated, together with financial market authorities
token issuers can seek to create a token which replicates a regulated instrument
• A new model can be created, such as:
• Investment trackers – who invested how much, when? Link to profit pay-outs?
• Large-scale co-ownership of an object?
• "Sponsorship" of an object, in effect similar to sponsoring an animal at a zoo (e.g. updates on
status, health, profitability, other variables)
Where do ICOs fit in?
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• Over the last century, private individuals have been increasingly able (and willing) to make risky
investments – this often led to losses of savings and bankruptcy (e.g. 1929 Wall Street crash)
• After the 2008 financial crisis, the EU sought to further increase regulation of financial services
• A key takeaway is – private investors must be informed about their investment itself, their rights,
the associated risks, and potential to make both gains and losses – can they make an informed
decision? Professional investors are treated differently
• Certain EU laws aim to regulate the trade of "financial instruments" – a similar concept are
"securities" in the USA
• Also worth considering, a prospectus must generally be published where either an offer of
securities is made to the public or securities are admitted to trading on a regulated market –
i.e. information on the potential investment (there are however exceptions)
• The concept of ICOs in general, the ease of which private investors can invest, the nature of
rights and obligations granted by the token, and a potential secondary market for tokens –
explain why ICOs have been viewed with unease and skepticism by regulators
Quick breakout – why all the regulation?
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(a non-exclusive list)
ICOs vs other finance mechanisms
Mechanism ICO (not regulated) ICO (regulated STO) Crowd Funding Loan (debt) Bonds (debt) Venture Capital
(equity)
IPO (equity)
Source of finance Multiple online
investors
Multiple online
investors
Multiple online
investors
Bank, other financial
institution
Exchange Directly through
investors
Exchange
Regulation Currently generally
unregulated
In principle regulated,
subject to regulatory
authority
Varied, depending on
jurisdiction
Highly regulated Highly regulated Highly regulated Highly regulated
Rights of investors Diverse, depending
on nature of token
Diverse, depending
on nature of token
and regulation
Often comparable to
donation – organiser
can ascribe any
rights (equity/debt?)
Generally none,
possible security
required
Depends on
jurisdiction and
agreed terms
Ownership rights Ownership rights
Repayment
structure
Diverse, depending
on organiser
Diverse, depending
on organiser
Generally none, often
comparable to
donation
Principal and interest
to be repaid over
time
Payment on maturity
date, interest
payments (coupon)
Through sale of
shares
Through sale of
shares
Relative direct
costs of finance
Low Low-Medium (due to
possible regulation)
Low High Medium Medium High
Comments in
comparison to ICO
--- --- Similar, but less
flexible than ICO as
no tokens or similar
tracking system
involved. Less hype
than ICOs?
Secure source of
funding and formal
legal relationship with
bank with negotiable
terms, however
expensive
Limited control by
bondholder, however
highly regulated, and
principal to be repaid
with coupon and/or
discount,
prospectus?
Equity given away,
but investors may
contribute business
advice and network
Equity given away,
but investors may
contribute business
advice and network,
prospectus?

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Considerations
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• Currently (March 2019) these are generally unregulated in Europe
• One exception are STOs, however this is under tight control of financial regulators
• Access to a large group of investors
• Potential to raise significant capital
• Relatively low cost (but more legwork)
• Still a good time to benefit from the “hype”?
• However, it is important to:
• Ensure transparency, legitimacy and trustworthiness of the project
• Ensure that the technical aspects of the ICO and tokens are in order
• Ensure that the ICO does not unintentionally fall under a regulated regime
• Ensure that the proper contractual framework is in place for investors
• Ensure the ICO and token rights can survive change in law
Advantages of an ICO

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• Programming gives tokens their characteristics in the blockchain environment
• How do tokens get their characteristics in the "real world"?
• Subject to regulation, this can be done by contracts – these set out the legal relationship between
the issuer and individual investors
• Individual contracts? General terms and conditions?
• Debt characteristics?
• Bond? Issuer promises to pay the investor (or bearer?) the principle and interest by a set date.
Right to trade on secondary market?
• Loan? Generally issued by credit institution, but may be a personal loan. Again, promise to pay
principle and interest by a set date
• Equity characteristics?
• Shares: Voting rights? Issuer promises to pay dividends (fixed or variable?) on regular basis.
How does this fit with "regular" shareholders (if any)?
• Other? e.g. right to see usage statistics, financial status of assets, property rights on assets
(enforceable?), only limit is the imagination… (and the law!)
You mentioned contracts…
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• Other clauses… (non-exhaustive)
• Obligations on issuer – e.g. investment only for ethical purposes, AML, anti-bribery, GDPR
compliance, termination / liquidated damages on breach
• Audit right of investor – worth considering, but to what extent?
• Change in law – what if a new law makes the investment illegal – can the investor/issuer
amend or terminate the agreement?
• Confidentiality – can investors share business information? Can this be enforced?
• Compliance with national consumer protection law – e.g. termination right within 14 days,
transparency of terms and conditions, no excessively unfavourable clauses
• Lock-out of certain investors / investor types – certain countries prohibit participation in
ICOs or holding tokens, this should be clarified to prevent problems down the road
• Governing law / dispute resolution (courts or arbitration, other?)
• Governing law is key, as it will determine what contractual provisions apply
• Need to set out forum and location of dispute resolution. Cost of disputes?
Continued
You mentioned contracts…
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• The contract should aim to establish trust between investor and issuer
• Dispute resolution is always a factor to consider in contracts
• Disputes can be expensive and long
• Its better to have a good contract (with minimal implied terms) and have clarity…
• …rather than an poor contract which is confusing and ambiguous
• Don't forget, with a lot of investors, you will have a lot of contracts!
• Advantage of general terms and conditions
• Needs to draft with thought as to future amendments as your business grows and as new
regulations come into force
Continued
You mentioned contracts…
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• What do I want to achieve?
• I need tokens on a blockchain to run my business
• I need a large capital boost
• I want to try something new
• Is there an easier way?
• Blockchain might be a "cheap" way to get capital, but it is labour intensive
• Token value relies on investor goodwill – this has to be established and maintained (throughout the life of
the tokens) – bad reputation might mean business failure
• Investors are likely private individuals, and respond to different triggers than professional investors (i.e.
uncertainty with price fluctuations, shorter term, emphasis on certain values)
• Integrity of system requires robust contractual framework
• Blockchain is largely unregulated… what happens if / when this changes?
• Does the blockchain "hype" help?
• Does speculation in your tokens help you or harm you?
• There are always other alternatives to consider
So, do I want to run an ICO?
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Any questions?
Andreas Gunst
Partner
T: +43 676 8888 1232
T: +44 7802 719 480
andreas.gunst@dlapiper.com
Kenneth Wallace-Müller
Associate
T: +43 676 8888 1844
Kenneth.wallace-mueller@dlapiper.com