Financial Instruments concerning cryptocurrencies. Structuring of commercial companies operating with cryptocurrencies.




Cryptocurrencies are legally digital financial assets designed to work as a means of exchange by using the cryptographic method of securing transactions in order to control the creation of additional currency units. In this context, cryptocurrencies can be classified as a subset of digital currencies and / or as subspecies of alternative currencies, in particular virtual ones. In the present, the cryptocurrencies also serve to buy the so-called "tokens", which I think can be qualified as a type of electronic bonds serving to raise capital through the so-called "ICO" concept (Initial coin offering) is a type of electronic crediting of startup companies from third parties. This feature has turned cryptocurrencies into a particularly dynamic financial instrument, which are different from the different banking and stock exchange analogues, leads to incredible flexibility and speed in financial operations. The present statement aims to give a greater focus on all the mentioned processes - their positive, speculative nature, but also their role as an ever-increasing real financial instrument that literally blows the financial sector and places many legal issues. 

1.Historical development. The first cryptocurrency, created in 2009 it is the so-called “Bitcoin”, and for its security it’s used the SHA-256 crypto code. The idea is that a purely technical "SHA" (Secure Hash Algorithm) to be an unit of a number of cryptographic functions. Each cryptographic "hash" is a sort of signature that identifies the authorship of a given text (code of letters and numbers) or a data file. That's why the "SHA-256" algorithm generates an almost unique, 256-bit (32-byte) "hash" code with a fixed size. Hash is a one-way crypto function - it cannot be decrypted back. This makes the “Bitcoin” so stable in terms of its network security, which is of the utmost importance to ensure the interest of investors.

Since 2009 various cryptocurrencies have been created here as an alternative to “Bitcoin”, which in professional circles is therefore unrecognized by the "altcoins" logic. The concept of “Bitcoin” and its derivatives is to use decentralized control, unlike centralized electronic money, which is an old financial instrument in banking systems. Decentralized control is linked to the use of a strictly up-to-date technical electronic database, using the so-called "“Bitcoin” block chain" technology, a kind of redistributed electronic bookkeeping "ledger". In fact, the "block chain" is a computer file for recording and summarizing economic transactions, measured by currency and account type, with debits and credits in separate columns, initial cash balance and closing balance sheet for each account. Thus, each user in the "chain" has absolute (brief) information about his balance and how he is traded as the real-time value of the corresponding crypt.

Decentralized cryptocurrencies are created by the entire system of crypto-connectivity collectively, at a rate that is determined by the system itself from the date of its creation and is publicly known. In centralized banking and economic systems, such as the US Federal Reserve System, corporate boards or governments control currency supply by printing paper money units or by adding to digital banking registers. In the case of decentralized cryptocurrencies, companies or governments cannot imitate new shares that have not originally been brought to the attention of companies, banks or legal entities and which contain the value of the assets measured in these cryptographic records. The main technical system on which the decentralized cryptocurrencies are based was created on the basis of the "open source" concept by Japanese programmer Satoshi Nakamoto.

As of September 2017, there are over a thousand different cryptocurrencies, most of which are similar and actually related in fact to the first, fully applied to the principles of the financial market, the decentralized cryptocurrency - the "Bitcoin". Within the currency encryption systems, the safety, integrity and balance of financial statements is maintained by the community of interconnected countries and their computers, called "miners". Each member of the crypto community uses its computer to facilitate the validation and triggering of time transactions by adding them to the "ledger" (said electronic accounting book) according to a specific time schedule. "Miners" have a financial incentive to keep the "ledger" safe for the crypto-roll, as it gives stability to their own investment on the one hand, and on the other, two opportunities to "dig" (create) new cryptocurrency units.

Cryptocurrencies concept is based on the vision of gradually reducing the production of currency, setting a final cap on the total amount of currency you will ever be in circulation backed by precious metals. Compared to conventional currencies imitated by financial institutions or held as cash cryptocurrencies can be more difficult to seizure by law enforcement authorities. This is mainly due to the use of cryptographic technologies in maintaining the "block chain" system. Not accidentally globally cryptocurrencies used for business purposes and speculation of different types (“money laundering”, make speculative profits and financial crimes etc.). A typical example of this new challenge for law enforcement is the Silk Road case, in which Bitcoins were used to pay for an anonymous drug market in the US in 2013. The cumulative turnover detected by the FBI was 26,000 Bitcoins, which at the current price of the main cryptocurrency make a turnover of 15 million dollars.

2.Similarities and differences in the legal regime of the cryptocurrencies, the shares and the bonds. Shares are securities that certify that the holder holds a nominal value in the capital of a company. From this point of view, we come to the conclusion that the shares arefirst of all a document that individualizes certain bond rights (in most cases a right of receivable) and secondly - the shares are real trade instrument, i.e. they showing the property rights in respect of their holder. Unlike shares, cryptocurrencies are not a document, but they also create bond relationships (they can be a means of exchange in any type of bond deal). Cryptocurrencies are not legal object(most currencies are physically expressed through generic goods - paper money) but, like most traditional currencies, cryptocurrencies also serve as a financial instrument in civilian turnover. However, there is a huge resemblance between e-money and cryptocurrencies. According to some authors [1], electronic money, as a digital rendering tool, is "a currency issued by a bank or other institution containing a simple series of bits." On the other hand, cryptocurrencies are also a digital payment tool but decentralized because they are not imitated by a bank or other financial state or public institution.

The shares “de facto” and “de jure” are the same at par value and are indivisible. They have several values:

nominal value - the value written on the share itself.

issue value - the amount by which the shares are credited by the founders or by the persons subscribing to the shares when they are established by public ownership. Both values ​​may match but often differ.

For its part, the value of cryptocurrencies is a constant variable, and it may be said that they have a market value rather than a nominal value. Third parties acquire rights on the relevant cryptographic value of its current market value rather than its initial nominal value.

Shares may be offered for redemption of a value greater than or equal to the nominal. The difference between the nominal and the issue value is called “agio” and refers to the reserve funds. If the issue value is lower than the nominal value, the difference is called “disiagio” and is unacceptable in our legislation. The real value of the shares, on their part, can be considered as an economic category, determined by the optimal assets of the joint-stock company, that is, the share of the share capital of the respective shareholder. 

The market value of the shares is similar (at least theoretically) as a mechanism with that of the cryptocurrencies, representing the price at which the share can be sold to third parties or stock exchanges. This value varies closely around the real face of the share, unlike the market price of cryptocurrencies, which usually "plays" on the basis of various market mechanisms, affecting especially dynamically (daily, sometimes even hourly) on its size. 

2.1. In my view, commercial companies that operate with cryptocurrencies must be structured as a joint-stock company for several reasons.

First of all, a joint stock company makes it very easy, as a legal instrument, that the speculative effect of e-money trading be legally turned into shares, thus creating (capital) or increasing the capital of a joint-stock company. The capital increase I am seeking is the so-called "effective" capital increase, which is at the expense of importing new assets (converted in real money) into the company. Why is this necessary? Very often, in practice, the electronic currency as such is contained in an e-portfolio, with two main purposes for its owner:

- the first one is the actual legalization of the cryptocurrencies as a financial result by paying the taxes due (in Bulgaria this financial result is taxed only with corporate tax of 10%);

- secondly, there is a need to redistribute the risk of honey, the speculative effect of a constant rise of some cryptocurrencies as a value (as happened with the Bitcoin in recent years) and the actual operation with the financial expression of the corresponding cryptocurrencies for specific business purposes.

When properly structuring such a model for cryptographic operations through a joint-stock company (usually an open-end investment company - the subject is discussed below in the report), the two objectives can be achieved by effectively increasing its capital. It is noteworthy that, for this purpose, the old (initial) capital must be fully paid up, and then a decision to increase the capital is made. Such decisions are taken at the General Meeting of the joint-stock company, in most cases by a qualified majority of 2/3 of the votes of the shares represented at the meeting, and a larger majority can be envisaged in the statutes. Correctly structured public limited companies provide shares of different classes, in which case a decision is taken to increase the shares of the relevant class. The decision should specify the types of shares that increase the capital, as if this occurred at issue value, the difference ("agio") between it and the nominal value should also be referred to as the legal technique for increasing the capital, as well as the way to increase - in this case the cash contributions. The decision to increase is entered in the Commercial Register and has a constitutive effect. However, in order to be entered in the Commercial Register, the registered capital increase should present a list of shareholders who have registered new shares.

According to the norm of Art. 164 of the ZPPCK the investment company is a joint-stock company whose business is focused on investing in securities and other liquid financial assets ("crowdfunding" electronic bonds in the form of so-called "tokens" - these will be discussed below in the discussion of the issue of imitation of bonds) raised through public offering of shares (or bonds converted into shares), which company strictly follows the principle of risk distribution. The recently popular ICO modeling model, by structuring for the purpose of an investment company offering public shares and / or bonds, completely exhausted the hypothesis of Article 164 of the ZPPCK. Such a model (so-called "crowdfunding" or "incremental fundraising") may also be in the very initial formation of the capital of an open-end investment company,

In this line of thought, the capital of the open-end investment company is always equal to the net asset value (the sold "tokens" valued in non-convertible bonds converted into shares, with which the capital has increased accordingly). Similarly, an open-ended investment company constantly offers its shares to investors at issuance value based on the net asset value and at the request of its shareholders to buy back them at a price also based on the net asset value. The issue price per share may exceed the net asset value per share by the amount of the issue costs and the redemption price may be lower than the net asset value per share with redemption costs. The open-end investment company may provide in its statutes for a closed period during which it is not obliged to buy back its shares. It may not be longer than two years from the date of the establishment of the company. A closed-ended investment company may not, in principle, buy back its shares. They are traded freely on the stock exchange. 

2.2. Speaking of cryptocurrencies and joint stock companies, it is worth mentioning the particularly important option of the latter to imitate (issue) bonds. Issuance of bonds is a legal means of financing (external debenture loan) of the joint-stock company with funds arising from third parties to the company. Bond issuance actually corresponds to the ICO model, which is the electronic crediting of a project through the so-called "token" purchased in a certain cryptocurrency (usually owned by " start-up "company) through the formation of an electronic wallet of strategic investors. In my opinion, ICO funding is precisely the issue of electronic bonds, and this funding model can be structured ICO of open and closed type. Here, it is particularly important to note that in Bulgarian legislation there are investment joint-stock companies of open and closed type which, 100% as a legal structure, meet the ICO concept.   

The huge legal problem in practice is how to effectively protect the investment interest of an external investor in an electronic project by ensuring the value of his investment through real legal instruments to exclude speculation in the acquisition of an electronic investment portfolio. The answer to this question is - issuing bonds for the benefit of the external creditors of the joint stock company, the owner of the electronic wallet, realized through the ICO model of "funding".

The imposition of bonds in order to protect a company's external creditors can be achieved as a legal effect by a joint stock company, operating in electronic money as an investment company, only in the presence of a precise factual composition:

- The joint stock company has been legally operational for at least two years;

- The joint stock company has received at least two annual accounts;

- decision of the General Meeting of Shareholders to issue bonds;

The amount of the issued real bond loan must be less than or equal to half the paid-in capital (not the subscribed) if the bond loan is guaranteed by a bank or by the state. There are two ways to raise the bond loan: 

- a public subscription, which, as a legal instrument, is analogous to the concept of shares;

Closed subscription - the bonds are subscribed by the shareholders. 
An investment joint stock company may issue several bond loans as appropriate, whereby the bonds of each individual issue form an appropriate meeting of the bondholders. Each of them elects no more than three representatives, who form a group to protect the interests of the bondholders. They have the right to participate in the General Meeting of Shareholders in a deliberative voice, which also effectively guarantees the rights of external creditors in an electronic "start-up" project.

Types of bonds that may be issued by an investment joint stock company are several. Here are the most basic ones as follows: 

"convertible bonds" - they may, under certain conditions, be converted into shares. Their issue value is greater than or equal to the issue value of the shares of an investment joint stock company. These bonds are also the most interesting from a practical point of view as they give the buyers of "token" investors a real tool to guarantee their interest. These bonds really represent the value of the "token" (electronic bonds) and the company imitates them only to create an objective legal instrument that is analogous to the actual investment made in cryptocurrency. The legal action to convert these bonds into shares guarantees 100% investor interest in the "token". The decision to convert convertible bonds into shares is only effective if approved by the General Meeting of bondholders who have acquired the right to convert their bonds into shares. The Board of Directors shall set the term for the conversion of the bonds into shares, which may not be longer than 3 months. The legal interest in converting the bonds into shares for an investment joint stock company is that the liabilities of the company are reduced and its capital is increased accordingly. From the point of view of investors - the new shareholders (former bondholders), with this step, they acquire the right to a liquidation share and not just to the nominal value of the bond as a loan.

"non-convertible bonds " they are a pure form of a bond loan.

The rights of the bondholders granted to them by an investment joint stock company are as follows: 

- they can dispose of the convertible bonds through any legal transaction (embedding, betting, selling, gyro transfer, etc.);

- if we look at bondholders as lenders through unconventional bonds, they have two types of rights: 

1.Individual - right to repay the principal and right to interest. Bondholders who have subscribed an equal number of shares of the same denomination have equal right of claim.

2.colective. Bondholders are satisfied when liquidated before the shareholders, and in this context, they have the right to manage their investment.


Author: Mr.Atanas Kostov – attorney at law


[1] See Winston Calacotta, "E-Commerce Boundaries," page 284