In recent years, Initial Coin Offerings (ICOs) have gained in popularity as a way for companies to raise capital to fuel expansion and future growth.
Sometimes compared to a “kickstarter” or crowdfunding campaign, ICOs involve companies offering tokens or “coins” that can confer different types of value and benefits to their owners.
Tokens are typically divided into two categories:
- Utility tokens, which allow whoever holds them to access and use the company’s features and services, or to exercise voting rights on a company or project’s decisions, and
- Security tokens, which confer equity ownership of a company or project
For example, in order to use our partner network SelfKey’s Marketplace, you would need to buy KEY tokens, which are then used to pay the fees for services such as opening a bank account or incorporating an offshore company through safe transactions on the blockchain. KEY is therefore considered a Utility token. It does not confer ownership of anything; it is a coupon that is bought and then used for a service.
Security tokens are different to utility tokens in a number of ways. First, they are usually tied to an existing asset, such as a company. They also confer ownership, through some kind of pre-established contractual agreement between the buyer and the seller. While their value may fluctuate according to the laws of supply and demand, their value should also in theory increase or decrease according to the underlying value of the asset they confer ownership over.
Most importantly for the scope of this article, many regulators around the world are now beginning to treat all tokens offered through ICOs as securities. This is critical from a regulatory standpoint, as dealing in securities involves complying with complex regulations designed to minimize the risk of fraud and money laundering that is all too common in securities trading.
Therefore, any company that seeks to issue a security token will need to ensure they are complying with the regulations governing this type of asset class in the jurisdictions whose laws they are subject to. And it’s also important to remember that although you may consider your token to be a utility and not a security, that doesn’t mean that regulators will take the same view.
Is KYC Compliance that Important for an ICO?
We regularly discuss the impact of expanding regulatory frameworks, such as the FATF Travel Rule, on Virtual Asset Service Providers (VASPs) and how they will need to conduct business in the future.
When it comes to ICOs, the need for compliance – and the forms it has to take – is hard to generalize, as they can vary significantly from one jurisdiction to the next.
Indeed, the U.S. Securities and Exchange Commission (SEC) ruled in 2018 that although Bitcoin and Ethereum were not securities (principally due to their lack of a centralized, controlling organization), tokens offered in ICOs were most likely to fall under the definition of a security, and its own guidelines on ICOs also leave a lot of room for interpretation on what will be treated as a security under U.S. law.
As a result of the legal ambiguity surrounding ICOs – and the likelihood that regulations will become tighter and more coherent in the future – the general and widely-recommended option is to err on the side of caution and to voluntarily ensure that diligent Know Your Customer (KYC) processes are in place and part of a robust Anti-Money Laundering (AML) protocol.
However, employing teams of legal and compliance professionals to manually vet every potential investor or purchaser of a coin in an ICO is not really an option for any company, let alone a startup seeking funding to get off the ground.
This is where automated KYC software like KYC-Chain can make all the difference. Here’s how it can help:
- Stay ahead of the Regulatory Axe
Financial regulators are constantly expanding and evolving the laws VASPs are subject to, and many in the world’s larger markets are leaning towards classifying all tokens offered in ICOs as securities. As such, it makes sense to have the right KYC/AML measures in place, even if they are not yet definitively required.
- Comply with KYC regulations for future tracking and regulatory audits
Understanding who purchases a token is important for being able to track what happens to the token in the future. Some countries, such as the U.S., have rules governing the amount of time required for a security to be held before it can be sold again, so knowing who your customers are and where they are located is critical for remaining compliant.
- Create a verified track record to ease access to banks and the broader financial network
Most banks will want to have clear and verified information on sources of funds. By implementing a robust KYC procedure during your ICO, you’ll be better equipped to prove your funds were generated from legitimate sources, and that they have not been used for money laundering or other illicit activities.
- Quickly and safely screen all token customers for presence on sanctions lists or risk
Using a risk-based approach, you can use KYC-Chain to segregate low risk from high risk customers, funneling the latter into more rigorous screening processes and Enhanced Due Diligence techniques.
While there is a common misconception that KYC processes can have the effect of discouraging certain potential customers from finalizing their purchase, the reality is that most people and institutions feel safer doing business with companies that demonstrate they take security and compliance seriously.
- Expand your potential pool of investors
As KYC-Chain is built to factor in a wide variety of different jurisdictional regulatory frameworks, integrating the technology as your KYC tool will provide expanded access to potential customers and investors across the world while ensuring compliance with each jurisdiction’s legal regimes.
Choosing the Right ID Verification Provider for your KYC
When selecting a KYC provider for your token sale, there are some key points to take into consideration for ensuring that the technology and services they offer are what you need. Asking the following questions will help you build a clearer picture of the quality and scope of the KYC technology on offer, and whether it will suit the specific requirements and dynamics of your ICO:
- Spread: Is it an end-to-end solution? Does the KYC technology cover a full suite of KYC, AML and anti-fraud measures? Can it integrate a risk-based approach that escalates screening based on a user’s risk rating?
- Scope: How many jurisdictions does it cover? Can the provider demonstrate specialized legal expertise for all the regulatory frameworks that you may be subject to, including where your customers are based?
- Sources: What sanctions lists does the KYC provider screen your customers against? Make sure your provider isn’t limited to just the obvious ones.
- Scalability: ICO life cycles tend to be short, which means your KYC provider must be able to ensure that their technical infrastructure can handle processing a sudden, large influx of checks simultaneously. The last thing you want is your system to crash during the ICO.
- Security: What measures does the provider have in place to ensure data, privacy and identity security?
- Usability: How complex is integration? Is their UX / UI simple and attractive enough to ensure you don’t lose conversions?
Have any questions on how to use KYC-Chain for your upcoming ICO? Get in touch and we’ll be happy to arrange a demo.
