In our last post, we delved into an alternative way to raise funds by way of cryptocurrency. We illustrated the legal framework applicable in the process of issuing digital tokens and the subscription of such tokens by investors as security for their investment. You can find this article here.
In this post, we highlight an important component of an IEO, namely 'Smart Contracts'. We explain the legality of such contracts and the purposes such contracts serve in an Initial Exchange Offering (IEO).
What is a 'Smart Contract'?
Smart contracts are programs stored on a blockchain that execute when specific predetermined conditions are fulfilled. They act as user-defined rules for transactions and are enforced by a network of peers, eliminating the need for intermediaries. Smart contracts use an automated ledger and recorded transactions. They operate on blockchain networks, where the contract code is replicated and recorded on multiple computers, ensuring transparency and security. Smart contracts are typically based on simple "if-this-then-that" logic. For instance, they can be integrated into vending machines to release goods upon cryptocurrency payment. Once the predefined criteria are met, the smart contract executes automatically, requiring no further action from the parties involved.
The legal status of 'Smart Contracts' in Malaysia
In common law, a valid and enforceable contract requires four main elements: offer, acceptance, consideration, and the intention to create legal relations. If these elements are met, and there are no vitiating factors such as misrepresentation, fraud, illegality, or duress, the law will enforce the promises made, concluding the contract formation and establishing rights and obligations for the parties involved.
In Malaysia, the formation, performance, and enforceability of contracts are governed by the Contracts Act 1950 (CA). Although historically applied to traditional contracts, a smart contract could potentially be recognized as valid and legal under Malaysian law if it fulfills the basic elements of a contract and meets the requirements under the CA.
The Electronic Commerce Act 2006 (ECA) also supports the enforceability of smart contracts. The ECA recognizes electronic contracts and signatures, applying to commercial transactions conducted electronically. It states that information in electronic form shall not be denied legal effect, validity, or enforceability. The broad interpretation of the ECA may cover smart contracts, given their electronic nature.
The ECA also recognizes the use of electronic signatures for contract formation, defining it as any electronic form adopted by a person as a signature. The transparency and reliability of blockchain-based transactions, with identifiable parties and digital indicators of acceptance, align with the ECA's definition of electronic signatures.
Furthermore, the ECA specifies that a document in the form of an electronic message, bearing an electronic signature associated with the message, will be validly executed if it adequately identifies the signer's intention and is "as reliable as is appropriate." This provision further supports the validity and enforceability of smart contracts in Malaysia, given the transparency and reliability of blockchain transactions.
Hence, while there are indications that smart contracts can be legally enforceable in Malaysia, the specific circumstances, requirements, and potential regulatory developments should be carefully considered, as the law continues to adapt to these technological advancements.
What role do 'Smart Contracts' play in an IEO?
In an IEO of digital tokens, smart contracts serve several important purposes:
Token Sale and Distribution
Smart contracts facilitate the sale and distribution of digital tokens during the IEO process. They define the rules and mechanisms for participants to purchase tokens, specify the token price, and handle the allocation and distribution of tokens to buyers. Smart contracts can also enforce any applicable restrictions or requirements, such as know-your-customer (KYC) verification processes or investment limits.
Transparency and Security
Smart contracts provide transparency and security in the token sale process. The code of the smart contract is publicly available on the blockchain, ensuring that the terms and conditions of the IEO are transparent and accessible to all participants. Additionally, smart contracts eliminate the need for trust in a central authority, as they automatically execute the sale and distribution of tokens according to the predefined rules, minimizing the risk of human error or manipulation.
Investor Protection
Smart contracts can incorporate certain investor protection mechanisms in the IEO. For example, they can include lock-up periods for tokens, where investors are restricted from transferring or selling their tokens for a specific duration after the IEO. This helps prevent immediate dumping of tokens and encourages long-term commitment and stability.
Fund Management
Smart contracts can handle the management of funds raised during the IEO. They can define how and when funds are released to the project or team behind the digital tokens, ensuring transparency and accountability. Smart contracts can also implement multi-signature wallets, where multiple parties must provide their approval for fund transfers, adding an extra layer of security.
Compliance and Regulation
Smart contracts can integrate compliance and regulatory requirements into the IEO process. They can enforce rules related to investor accreditation, geographic restrictions, or any other regulatory obligations. This helps ensure that the token sale is conducted in compliance with applicable laws and regulations.
The take away
By utilizing smart contracts in an IEO, participants can have increased trust, transparency, and security throughout the token sale process. Smart contracts automate and enforce the rules of the IEO, reducing the need for intermediaries and providing a streamlined and efficient mechanism for token issuance and distribution.
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