Trading in tokens is currently in the spotlight of the public’s and the regulator’s attention. Based on distributed ledgers-technology, blockchain technology is used to issue tokens as tradable digital units and to record ownership and transactions of the issued tokens. At present, there are no specific laws and little regulation applying to trading in tokens in Switzerland. With a view to improve market confidence as well as to ensure proper functioning and transparency of token trading, a variety of legal issues have yet to be resolved. In particular, the question of insider trading and market manipulation needs to be clarified.

By Thomas U. Reutter / Daniel Raun (Reference: CapLaw-2018-43)

1) Introduction

Coinbase, a cryptocurrency exchange platform, is currently facing a class action lawsuit in connection with the announcement of the listing of Bitcoin Cash (BCH) on its cryptocurrency trading platform Coinbase Pro (formerly GDAX). The claimants accuse Coinbase of tipping off insiders ahead of the launch of BCH trading.

This case and others show that fraudulent behavior, such as exploitation of insider information and market manipulation, is a real risk also in token markets. This risk is arguably further increased by the distinct shortage of information in connection with trading in tokens on trading platforms and Initial Coin Offerings (ICOs) and the lack of specific rules and regulations in many jurisdictions. In order to prevent such behavior, the question arises whether existing regulations in Switzerland can be applied to token trading or whether new rule-making is required.

There is a great variety of tokens with very different features. In February 2018, the Swiss Financial Market Supervisory Authority (FINMA) issued (non-binding) guidelines regarding ICOs categorizing tokens into three types:

• Payment tokes are synonymous with cryptocurrencies and are designed as a means of payment. They have no further functions or links to any asset development project or the like. They do not grant the holder any specific right other than to hold and act on the token itself.
• Utility tokens are tokens which grant the holder the right to use certain services or provide access to an application.
• Asset tokens represent assets such as a debt or equity claim against an issuer, e.g. participations in real physical underlyings or an entitlement to dividends or interest payments. Due to their economic function such tokens have characteristics similar to equity, bonds or derivatives.

Using the above classification of FINMA, this article provides a brief analysis as to whether the existing regulation on insider trading and market manipulation are applicable to and suitable to govern also the trading in tokens.

2) Existing Regulation on Insider Trading and Market Manipulation

a) Insider Trading

Under Swiss law, the use of insider information may constitute both a criminal offence (article 154 Financial Market Infrastructure Act (FMIA)) and a violation of public administrative law (article 142 FMIA). Swiss law defines insider information as confidential information whose disclosure would significantly affect the prices of securities admitted to trading on a Swiss trading venue (article 2 lit. j FMIA). Information is considered price-sensitive if an investor would typically deem the information important in deciding whether to buy or sell securities. Examples include material acquisitions, financial results, significant product developments and other circumstances of similar importance. Persons who come into possession of insider information are prohibited from (i) exploiting insider information to acquire or dispose of securities admitted to trading on a trading venue in Switzerland or to use financial instruments derived from such securities, (ii) disclosing it to a third party, or (iii) exploiting it to recommend to a third party to acquire or dispose of securities admitted to trading on a trading venue in Switzerland or to use financial instruments derived from such securities.

b) Market Manipulation

Market or price manipulation may also constitute a criminal offence (article 155 FMIA) and/or a violation of public administrative law (article 143 FMIA) under Swiss law. According to article 143 FMIA, a person violates these rules if he or she (i) publicly disseminates information or (ii) effects transactions or acquisitions or disposal orders that he or she knows or should know give false or misleading signals regarding the supply, demand or price of securities admitted to trading on a trading venue in Switzerland. The object of article 143 FMIA are securities (Effekten) within the meaning of article 2 lit. b FMIA (see definition further below).

c) Applicability on Trading with Tokens

Whether the aforementioned provisions are applicable on token trading hinges on the following questions:

• whether tokens can be considered securities within the meaning of article 2 lit. b FMIA; and
• whether tokens can be regarded as being admitted to trading on a Swiss trading venue, i.e. an exchange (article 26 lit. b FMIA) or multilateral trading facility (MTF) (article 26 lit. c FMIA).

i. Qualification of Tokens as Securities

According to article 2 lit. b FMIA, the definition of securities (Effekten) comprises standardized certificated and uncertificated securities (Wertpapiere, Wertrechte), derivatives and intermediated securities that are suitable for mass trading. With regard to tokens, a distinction needs to be made between the different types of tokens described above. According to FINMA’s guidelines on ICOs, asset tokens are deemed securities within the meaning of article 2 lit. b FMIA. Utility tokens can only be regarded as securities if the tokens embody, at least partially, an investment purpose, while payment tokens (cryptocurrencies) fall outside the scope of the definition altogether. Therefore, utility tokens without an investment purpose and payment tokens are, in principle, not considered securities under the FMIA and the rules on insider trading and market manipulation thus do not apply to these categories of tokens. In contrast, based on FINMA’s guidance it stands to reason that asset tokens are subject to the restrictions of the FMIA regarding the use of insider information and market manipulation.

ii. Qualification of Token Trading Platforms as Trading Venues

Pursuant to article 26 lit. a FMIA, a trading venue means either a stock exchange or an MTF. Both are institutions for multilateral securities trading whose purpose is the simultaneous exchange of bids between several participants and the conclusion of contracts based on non-discretionary rules.

According to article 23 of the Financial Market Infrastructure Ordinance (FMIO), rules are deemed to be non-discretionary if they grant the trading venue or the operation of an organized trading facility no discretion in the amalgamation of offers. The difference between stock exchanges and MTFs is that on a stock exchange securities are listed, i.e., they are admitted to trading pursuant to a standardized procedure in which requirements regarding the issuer and the securities specified by the stock exchange are examined. Absent such a standardized admission process it can be excluded that trading platforms for tokens are stock exchanges in the sense of article 26 lit. b FMIA. However, token trading platforms could qualify as MTFs (and in Switzerland would thus be subject to FINMA’s authorization and supervision) because they typically operate a simultaneous exchange of offers among several participants as well as the conclusion of contracts according to non-discretionary rules.

3) Conclusion and Outlook

Tokens have given rise to debate whether existing laws are suitable to govern these new technological applications or whether new legislation needs to be adopted.

The trading of asset tokens and utility tokens may fall under the administrative provisions regarding insider trading and market manipulation of the FMIA (articles 142 and 143 FMIA) if such trading takes place on an MTF. For reasons of investor protection and to further the credibility of token markets and the crypto world, in general, these provisions can and should be applied on payment and utility tokens that have an investment purpose – at least as a preliminary measure – at this stage of development. Based on the fundamental principle of nulla poena sine lege of the Swiss Criminal Code (article 1), the criminal provisions (articles 154 and 155 FMIA) may in our view not be applied by analogy.

Despite FINMA having issued its guidelines, significant legal uncertainty still exists. The current legislation needs to be adapted to provide a suitable means to address the issue of insider trading and similar behavior in blockchain technology based instruments.

Thomas U. Reutter (thomas.reutter@baerkarrer.ch)
Daniel Raun (daniel.raun@baerkarrer.ch)