JPEX saga: Are DAO tokens regulated in Hong Kong?
The Securities and Futures Commission (“SFC”) has recently published various statements in relation to JPEX, a virtual asset trading platform (the “Platform”), which according to the SFC, has been operating without a license. This was followed by actions from the Hong Kong Police Force in arresting various persons suspected of helping promotion of the unlicensed Platform. Some investors claimed that they have since then been unable to realise their investments from the Platform.
Much to everybody’s surprise, the Platform has responded swiftly, by offering to investors that they will be allowed to exchange their investments into DAO tokens. The Platform claimed that they will then repurchase the DAO tokens from the investors in two years’ time, thereby paying the investments back to the investors in full.
Putting the disagreements between the SFC and the Platform aside, this proposal by the Platform brings DAO back in the spotlight, which was a heated topic a few years ago. That gives rise to the question – is the issue and use of DAO tokens subject to the regulatory regime of the SFC, or at all?
What are DAOs?
Decentralized autonomous organization, or DAO, is a type of structure developed by using blockchain technology. DAO is not a strictly defined term, and it broadly refers to a community-led organization with no central authority, and hence it is “decentralized”. People joins a DAO usually share a common goal, and hence would poll their money for that goal. One of the advantages of using a DAO (as opposed to the traditional limited company) is that persons joining the DAO by subscribing to its tokens can remain anonymous yet at the same time be able to raise funds for their common goal.
Sometimes a DAO is incorporated such that there is a genuine “legal person” created as the DAO, but at other times the DAO can be a fictional legal person that potentially exists in perpetuity. Also, as limited companies do, DAO token holders’ liabilities are limited to their investments (if any) into the DAO, and will not be held personally responsible for the liabilities of the DAO. However, unlike limited companies, some DAOs may be just a set of predefined computer programmes running on the Internet without any physical location (i.e. the registered physical address). Therefore, practically the DAOs which are not actually incorporated might have difficulties in owning properties or executing contracts etc. in a way that legal persons could. In other words, a DAO might have difficulties to interact and form contracts with parties outside of the DAO, or to open bank accounts to effect money transactions. Some unincorporated DAOs are, legally speaking, asking to be treated as a general partnership, in which its token holders are partners.
Further, DAOs are “autonomous” in that there are built-in smart contracts lay the ground rules and execute the decisions agreed from time to time by its members through voting. So the DAO is governed by its individual members (i.e. holders of various digital tokens) who make collective decisions. Any member may make any proposal as regards the running of the DAO including commercial decisions and treasury allocations. Proposals that are accepted by a sufficient and pre-set number of members will be enforced through the use of the smart contract (i.e. the programme).
Regulatory framework for DAOs in Hong Kong
An often-asked question is whether the activities of DAO including the issue and use of its tokens in Hong Kong are subject to the regulatory or licensing regime at all. In so far as the Securities and Futures Ordinance (Cap 571) (“SFO”) is concerned, the answer to this question would partly depend on whether the DAO tokens would be caught by the term “securities”, which is defined in the SFO to cover various categories of investment products, including shares, stocks, debentures, funds, collective investment schemes etc. These terms are in turn widely defined, for instance, the definition of “shares” cover “any share in the share capital of a corporation” and hence do not cover unincorporated DAOs, but other terms like “collective investment schemes” may cover “arrangements in respect of any property” in which “arrangements” appear to include schemes carried out through an incorporated body or otherwise.
The SFC has warned on multiple occasions that if the tokens are in fact digital representation of ownership of assets such as real estate, economic rights such as a share of revenue, or depository portfolios of underlying overseas listed stocks, then these tokens may be treated as “Stock Tokens” and are likely to be treated as “securities” under the SFO.
In any event, whether under the SFO or the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), centralised virtual asset trading platforms carrying on their businesses in Hong Kong, or actively marketing their services to Hong Kong investors, are required to be licensed and regulated by the SFC. Back to the issue relating to JPEX’s recent announcement to issue DAO tokens to its customers or investors, it appears that such activities may also be subject to the regulatory and licensing requirements if JPEX is considered as a “centralised virtual asset trading platform” carrying on its business, or actively marketing its services to investors, in Hong Kong.
Experience from the US
The experience in the US is worth noting, although the regulatory regime is not entirely the same. On 25 July 2017, the Securities and Exchange Commission of US (“SEC”) published a report in relation to various tokens issued by a DAO founded by Slock.it UG. This DAO is an unincorporated body which would invest in various projects with the aim to distribute profits to token holders of the DAO. The founders of Slock.it UG were responsible for the management and to put forward investment project proposals to the DAO. The DAO was intended to be autonomous in that the projects were in the form of smart contracts that exist on the Ethereum Blockchain and the votes were administered by the code of the DAO. Upon investigation, the SEC ruled that the DAO tokens are securities. The SEC’s analysis was based on: First, that the potential for a return on investment through earnings from the projects created a reasonable expectation of profit in the DAO token holders, which is a hallmark of a security; and second, that any profit so received would be derived from the managerial efforts of others, principally the Slock.it co-founders and the “curators” who act as gatekeepers in respect of the projects, another such hallmark.
Both the regulators and regulations are trying to cope with the fast changing and ever developing blockchain technology. Under the current regulatory framework in Hong Kong, there can hardly be any “one size fits all” test to determine whether a DAO token is caught by the definition of “securities” under the SFO. Each case has to be considered on its own facts and circumstances, and in some cases there may be no readily available answer. Those who intend to operate a business in Hong Kong in relation to DAO tokens should therefore seek professional advice before engaging in such business.
For enquiries, please feel free to contact us at:
E: firstname.lastname@example.org T: (852) 2810 1212
19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong
Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.
Published by ONC Lawyers © 2022
 Speech of Mr. Ashley Alder, Chief Executive Officer of the SFC “Fintech: the regulatory response to evolving challenges - Keynote address at Hong Kong FinTech Week”, dated 3 November 2020. See also Warning statement on unregulated virtual asset platforms, published by the SFC on 16 July 2021.
 See the Circular on implementation of new licensing regime for virtual asset trading dated 31 May 2023.
 Applying the test in SEC v W.J. Howey (1946).