Looking Forward: A Legal Perspective on Blockchain

Ross McKee, Partner at Blakes

For better or worse, the cryptocurrency industry has a history of positioning itself as outside the establishment, promising the means to transact and invest without the oversight of governments or reliance on traditional financial networks. Unfortunately, this attitude also led hundreds of ambitious entrepreneurs to assume that existing securities law didn’t apply to their exotic ‘initial coin offering’ businesses, which collectively raised well over $10B from late 2017 to early 2018.

As we roll into 2019 many ICO’s are coming to the painful realization (including Canadian startup Kik, which raised around $100M last year for it’s ‘Kin’ token), that securities law is a harsh master, and that the absence of ICO-specific regulations doesn’t mean you won’t be retroactively subject to them once regulators come up with new rules.

Which brings us to Ross McKee. Ross is a senior partner in the securities group at Blake’s, a Toronto law firm where he leads the blockchain and cryptocurrency practice. He’s also highly respected within the blockchain community for his expertise in navigating the evolving regulatory landscape as it pertains to crypto, and for having a thorough understanding of the broad applications of blockchain technology.

“My particular focus has been more on the regulatory side and in the blockchain and cryptocurrency space” says McKee. “We look at it both from the point of view of issuers, intermediaries, investors, and people trying to get a handle on the products themselves as to how they’re affected by the securities laws. And then we give advice on how people can carry out those actions under the existing regimes.”

As McKee notes, much of the ambiguity in the crypto space has to do with a lack of definition around the crypto products coming on to the market. “It’s really the token aspect of it, where people are acquiring an item that can be recorded through blockchain technology. That is where the securities regulators look at this and say, ‘Well, why are people buying this? Are they buying it so they can use it, or are they buying it because they hope it’s going to rise in value and they can cash out and make some money?’”

This difference between ‘utility’ tokens and ‘security’ tokens is a critical distinction that dictates whether or not the company is subject to securities regulations. “The concept would be that a utility token would be something that is primarily useful, and therefore it’s not being bought for investment purposes”, McKee explains. “The problem is that there have been many things called utility tokens [that] may have utility as a side use, but the real reason people are acquiring them is [as] an investment. They may have utility in the future, but the future hasn’t actually arrived because the network hasn’t been built out. And because the focus is on investment, then the securities regulators say that means it’s an investment contract.”

Despite the added scrutiny of regulation, McKee sees ‘smart’ security tokens, which incorporate trading rules into the token itself, as a promising development.
“One of the most interesting things for me is the development of security tokens that have regulatory rules built into them. So they will not allow themselves, for example, to be resold to someone who is not allowed to buy them and rather than just having an inert token that can be bought and sold by anybody, it would be a smart token that says ‘is the purchaser allowed to purchase this? Am I allowed to sell this in this particular country?’ and so on. And so it gives a regulator much more comfort and the sellers much more comfort that this is a legal transaction taking place.”

“Current transactions of utility tokens that have been characterized as securities don’t have any restrictions on them built in, they rely on the goodwill of the parties who are buying and selling to comply with the law. That’s frankly how the way it works today with shares and bonds – people rely on shares and bonds being sold properly, the shares and the bonds themselves don’t enforce their own rules. So a security token is actually a step beyond. It’s going to be a token that actually enforces its own rules and won’t allow itself to be misused, which is a huge step. “

Beyond tokens, McKee is quite bullish on the global applications of blockchain. “I think the thing that interests me most about the expansion of blockchain technology is the simplification of quite complicated processes on an international basis”, says McKee. “Currently, international trade is really complicated and slow, and transferring between different currencies is complicated and slow. And [blockchain] is essentially a global trading system that is uniform. It could be a great application for systems that are currently labor intensive, paper intensive and so on. And I think the next area is going to be the ‘battle of the standards’, so you don’t have proprietary systems for one particular area. There is a shipping company that developed a really good blockchain mechanism for shipping and it hasn’t had a lot of buyers for it from other companies because its proprietary to that one particular shipping company. So I think developing global standards for this is going to be a part of the adoption, and once it gets going, then I think it will spread very rapidly from there.”