15 November 2023

SUMMARY OF LEGAL AND REGULATORY ANALYSIS

 

Neokingdom DAO OÜ, registry code 16638166 (Neokingdom DAO or you), approached Advokaadibüroo (we or us) and requested that we draft a summary (Summary) on the basis of the legal and regulatory analysis conducted by us (Analysis) relating to the legal classification of Neokingdom DAO and Neokingdom Tokens^[1].

For the purposes of the Analysis, you asked us to analyse the following questions (together, Questions):

1.          whether the Neokingdom Token is considered as a regulated instrument (e.g., a security) under current Estonian and EU laws and why;
2.         whether Neokingdom DAO is considered as a regulated entity (e.g., an obliged entity) under current Estonian and EU laws and why;
3.         whether the Neokingdom Token is considered as a regulated instrument (e.g., a security) under EU laws which have been adopted but not yet become applicable (e.g., MiCAR^[2]), and why;
4.         whether Neokingdom DAO is considered as a regulated entity (e.g., an obliged entity) under EU laws which have been adopted but not yet become applicable (e.g., MiCAR, the AML Package^[3]), and why;
5.         if any of the above answers is positive, what should be changed, with respect to the Neokingdom Token and/or Neokingdom DAO, to turn that answer into a negative one.

We have agreed that other than the Questions, the Analysis and the Summary will not cover any other aspects in connection with Neokingdom Tokens, Neokingdom DAO, its business, affiliates, any instruments issued by it, any shareholders of Neokingdom DAO (Shareholders) or any third parties or any other legal or regulatory matters relating to any other assets.^[4]

The views and opinions in the Analysis and the Summary have been given on the basis of the documents and information provided by you, and are subject to the assumptions, qualifications and disclaimers set out in the Analysis and the Summary and are strictly limited to the issues raised in the Questions.

1.               Characteristics, functions and rights related to Neokingdom Tokens

The AoA^[5] and the SHA^[6] of Neokingdom DAO provide that the Neokingdom Token is a cryptographical device used by the internal software of Neokingdom DAO, which is deployed to manage the Shareholder Register^[7] and the adoption of the resolutions of the Shareholders, to determine the scope of the special rights granted to each Shareholder in a machine-readable way.

The person is considered a Shareholder from the day that the person is entered in the Shareholder Register. Shareholders are divided into the following three categories:

1.        Regular Investors;
2.      Impact Investors; and
3.    Contributors.

The Shareholders have the following rights:

1.        Rights to profit distribution. The rights to profit of Neokingdom DAO are special rights granted only to the persons who have become a Shareholder. The scope of these rights is automatically calculated by means of Neokingdom Tokens.
2.      Voting rights. The voting rights attached to Neokingdom Tokens are granted only to the specific categories of Shareholders, i.e., to Impact Investors and Contributors. The scope of special rights granted to each Impact Investor or Contributor is taken into account while determining the distribution of voting power. Voting power is calculated automatically in a machine-readable way by using Neokingdom Tokens on the blockchain addresses of Contributors and Impact Investors entered in the Shareholder Register.
3.    Reward rights. Only Contributors of Neokingdom DAO may be rewarded with Neokingdom Tokens for their time spent for the benefit of Neokingdom DAO. We understand that Neokingdom DAO seeks to incentivise Shareholders to perform tasks for the benefit of Neokingdom DAO and increase engagement with Neokingdom DAO.

The Neokingdom Token does not itself grant any rights akin to the rights of Shareholders described above, i.e., where the relevant token holder is not at the same time a Shareholder. Exercising the rights of Shareholders is only possible by persons who (i) have the status of a Shareholder and (ii) hold Neokingdom Tokens on a blockchain address recorded in the Shareholder Register.

2.            Are Neokingdom Tokens regarded as tokens within the scope of the banking and financial services regime^[8]?

Neokingdom Tokens may, in principle, be deemed to satisfy two conditions required to be met in order for the tokens to be considered transferable securities^[9]. More specifically, Neokingdom Tokens are:

1.        technically capable of being transferred on the relevant blockchain network from one user of such network to another (subject to such users merely holding digital wallets on the network);
2.      standardised, i.e., they all belong to the same class of tokens, have certain common features resulting in their interchangeability, and give the same rights to the same group of token holders.

Therefore, the key question in the context of whether Neokingdom Tokens qualify as securities is, essentially, whether Neokingdom Tokens grant their holders that are not Shareholders a reasonable expectation to become a Shareholder and therefore a reasonable expectation for profit (e.g., a right to a part of the issuer’s profit, regular cash flows, or any other promise about future profit) or governance rights.

However, the transferability of Neokingdom Tokens is restricted by rules and restrictions that Shareholders are bound by when transferring Neokingdom Tokens.^[10] In addition, third persons are not able to qualify as Shareholders by virtue of receiving a right to Neokingdom Tokens from outside the Neokingdom DAO ‘eco-system’, i.e., by exchange of Neokingdom Tokens between Shareholders, the transfer of Neokingdom Tokens to third persons is strictly limited akin to how Estonian private limited companies^[11] restrict the rights of shareholders to transfer shares to third persons.

We are of the opinion that the restrictions on the transferability of the Neokingdom Token are broad enough as to ensure that even if transfers of Neokingdom Tokens occur, the transferee is not able to receive the same rights as Shareholders by virtue of merely obtaining the Neokingdom Tokens. Thereby, Neokingdom Tokens cannot be considered as transferable securities due to Neokingdom Tokens not being freely negotiable within the meaning of Article 1(2) of Regulation 2017/568.

More specifically, taking into account that the Neokingdom Token, on a stand-alone basis (i.e., where the relevant token holder is not a Shareholder), does not grant its holder a reasonable expectation for profit or governance rights in Neokingdom DAO and, further, it is not freely negotiable within the meaning of Article 1(2) of Regulation 2017/568, we are of the view that the Neokingdom Token does not qualify as any of the securities specified in § 2(1) of the SMA^[12] or “another similar tradable right” within the meaning of § 2(1)1) of the SMA.

Further, it is our opinion that the Neokingdom Token, due to its characteristics described above, does not, in substance, qualify as any of the following tokens within the scope of the banking and financial services regime:

1)  ‘alternative investment fund’ tokens, i.e., where Neokingdom DAO would invest the raised funds in accordance with the determined investment policy for the benefit of the investors; or

2) ‘deposit’ tokens, i.e., where Neokingdom DAO would grant loans in its own name and account, and this activity would be financed through gathering repayable funds from the public.

3.        Considerations relating to Neokingdom Tokens in the context of the AML Act

As we have discussed above, the Neokingdom Token does not, in our view, appear to meet the requirements for classification as a transferable security or a token that grants their holder a reasonable expectation for profit or governance rights as specified in the EFSRA Guidelines^[13]. However, this conclusion does not automatically exclude that it may, potentially, be classified as a virtual asset within the meaning of the relevant FATF Guidance^[14] and virtual currency within the meaning of the Estonian AML Act^[15], provided that the Neokingdom Token satisfies the scope of the relevant definitions.

In our view, the Neokingdom Token, as currently described to us, (i) is not used for payment purposes in the meaning of the FATF Guidance/the AML Act, but (ii) is used in connection with investment purposes. Since the role of the Neokingdom Token seems to be mostly of technical nature, it should not, in our view, be considered to be caught by the virtual currency definition in that respect^[16]. Therefore, it is our view that the specific functions and characteristics of Neokingdom Tokens do not cause them to be qualified as a virtual currency within the meaning of the AML Act.

Based on the above and also considering that, according to the information provided by you, Neokingdom Tokens are issued (or caused to be issued) by Shareholders rather than Neokingdom DAO itself, it is our opinion that the activity of Neokingdom DAO does not constitute the activity of an obliged entity within the meaning of the AML Act.  We are of the view that Neokingdom DAO is not to be considered as an obliged entity also under the relevant EU AML/CFT regulation.

4.         Considerations relating to Neokingdom Tokens in the context of the Digital Finance Package and the AML Package

According to the Analysis, Neokingdom Token is a utility token in line with Article 3(1)(5) of MiCAR. While our opinion is that the classification of the Neokingdom Token as a utility token should not change under MiCAR, the issuer of such a token needs to take into consideration the fact that when making an offer to the public, additional obligations are imposed on issuers of utility tokens from the time that the relevant provisions of MiCAR become applicable.

The AML Package, although of high importance in relation to the operation of a crypto-asset service provider, does not, in our view, have an impact, within the scope of the Questions, on how the Neokingdom Token should be classified or whether Neokingdom DAO would be an obliged entity, instead the changes brought about with the AML Package will impact the scope of obligations imposed on such obliged entities.

5.             Specific answers to the Questions

Within the scope of the Analysis, we are of the view that:

1.          Neokingdom Token is not to be considered a token within the scope of the banking and financial services regime under the current Estonian or EU laws;
2.         Neokingdom DAO is not to be considered as an obliged entity under the current Estonian or EU AML/CFT laws;
3.         the classification of the Neokingdom Token as specified in section (V) 1) above should not change as a result of the adoption of the Digital Finance Package and the AML Package;
4.         Neokingdom DAO should not be considered as an obliged entity under the AML Act, and its classification would not change as a result of the adoption of the Digital Finance Package and the AML Package.

6.         Recommended liaison with EFSRA^[17] and FIU^[18]

We recommend establishing liaison with both the EFSRA and the FIU with a view to discussing the regulatory implications relating to Neokingdom Tokens and Neokingdom DAO and seeking their non-binding views as to the issues highlighted in the Analysis.

 

Appendix 1. Examined documents, assumptions, qualifications and disclaimers

1.               For the purposes of the Analysis, we have examined only the documents and information specified below:

1.1.               Articles of Association of Neokingdom DAO OÜ (version as of 12 September 2023);

1.2.              Shareholders’ Agreement entered into by and between all shareholders of Neokingdom DAO OÜ (version as of 14 September 2023).

2.              The Analysis is subject to the following assumptions and qualifications:

1.          Where a document has been examined by us in draft, it will or has been executed in the form of the same draft as examined.
2.         There is no other fact, matter or document which would, or might, affect the Analysis and which was not revealed by the documents examined.
3.         Only issues expressly stated in the Analysis have been analysed to the extent described herein.
4.         No opinion is expressed on matters of fact.
5.         The Analysis relates only to and shall be construed in accordance with Estonian law as applied and interpreted by the Estonian courts at the date of this analysis. We express no opinion in the Analysis on the laws of any jurisdiction other than Estonia. To the extent that the laws of any other jurisdiction may be relevant, we have made no independent investigation thereof.
6.         By providing the Analysis, we do not assume any obligation to notify you of future changes in Estonian law which may affect the views or opinions expressed herein or otherwise to update this analysis in any respect.

Please note that the Analysis and the Summary (together, the Analysis Documents) relate only to the Questions, and that the Analysis Documents do not cover any other aspects in connection with Neokingdom Tokens, Neokingdom DAO, its business, affiliates, any instruments issued by it, any shareholders of Neokingdom DAO or any third parties or any other legal or regulatory matters relating to any other assets. This means that the Analysis Documents do not, inter alia, include analysis of the treatment of Neokingdom DAO from the perspective of commercial law applicable in Estonia or elsewhere, including without limitation the Estonian Commercial Code or any other provisions applicable to operations of Estonian companies.

The opinion of competent authorities or regulators, including without limitation the EFSRA and the FIU, in regard to the subject matter of the Analysis Documents may differ from the opinion provided by us in the Analysis Documents. Therefore, we strongly recommend establishing liaison with both the EFSRA and the FIU with a view to discussing the regulatory implications relating to Neokingdom Tokens and Neokingdom DAO and seeking their non-binding views as to the issues highlighted in the Analysis Documents. Furthermore, the opinions of the EFSRA and the FIU as to the subject matter may change from time to time; accordingly, this may affect the views or opinions expressed in the Analysis Documents.

The Analysis Documents have been prepared specifically for the particular use of Neokingdom DAO  and not for the purpose of addressing possible inquiries made by any other party, or indeed for any other purpose. Consequently, the Analysis Documents, including any views, opinions or other information contained in the Analysis Documents, may neither be partly nor fully suitable for the use for any purpose by any other party. Regardless of the form of action, whether in contract, tort or otherwise, and to the extent permitted by applicable laws, we accept no liability of any kind and disclaim all responsibility to any person other than Neokingdom DAO subject to the terms of the relevant client agreement in place between Neokingdom DAO and us.

The Analysis Documents are confidential and intended solely for Neokingdom DAO OÜ (the addressee) and may not be disclosed nor copies thereof provided to any third party without our prior written consent.

Where the Analysis Documents are nevertheless disclosed to a third party or a third party otherwise gets access to the Analysis Documents, such third party acknowledges, accepts and agrees for and on behalf of themselves and any person or entity such third party represents that:

1. The Analysis Documents were prepared on Neokingdom DAO OÜ’s instructions and was based on information regarding Neokingdom DAO OÜ’s legal position. Therefore, Advokaadibüroo, while preparing the Analysis Documents, was acting solely with Neokingdom DAO OÜ’s interests in mind and prepared the Analysis Documents solely with regard to Neokingdom DAO OÜ’s specific circumstances.
2. The Analysis Documents were not planned in contemplation of the purpose of being disclosed to any third parties or providing information to any third parties. Consequently, the Analysis Documents cannot in any way serve as a substitute for enquiries or procedures or any other necessary steps which the third party will or should be undertaking for the purposes of satisfying themselves regarding the purpose of receiving information as a third party.
3. Advokaadibüroo and/or other Advokaadibüroo firms, their partners, employees and agents neither owe nor accept any duty, responsibility or liability for or in connection with the Analysis Documents towards any third party, whether in contract or howsoever otherwise arising, and shall not be liable for any loss, damage or expense of whatsoever nature which is caused by any direct or indirect use that the third party may choose to make of the Analysis Documents, or which is otherwise consequent upon the third party getting access to the Analysis Documents.
4. If Advokaadibüroo is requested to provide explanations or further information in relation to the Analysis Documents or Neokingdom DAO OÜ, Advokaadibüroo shall not be obligated to do so. However, should any Advokaadibüroo partner, employee or agent provide the third party with any explanations or further information, you acknowledge that they are given subject to the same terms and conditions as those specified herein in relation to the Analysis Documents.

5. The third party agrees to hold harmless Advokaadibüroo, its partners, employees and agents, against all actions, proceedings and claims (except any by Neokingdom DAO OÜ) brought or threatened against Advokaadibüroo, its partners, employees and agents, and all loss damage and expense (including legal expenses) relating thereto, in any way arising out of or in connection with the provision of the Analysis Documents, or any explanations or further information, to such third party.
6. The Analysis Documents, or information obtained from it, must not be made available or copied, in whole or in part to any other party without our prior written permission which we may, at our absolute discretion, grant, withhold or grant subject to conditions (including conditions as to legal responsibility or absence thereof)

^[1] Cryptographic ERC-20 tokens issued or caused to be issued by one or more shareholders of Neokingdom DAO OÜ.

^[2] Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets, and amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and (EU) 2019/1937.

^[3] A package of legislative proposals by the European Commission which relate to the AML/CFT rules of the EU with the aim to provide more stringent rules to combat money-laundering and terrorist financing, including a new regulation on AML/CFT, the plans to adopt the 6th Directive on AML/CFT (AMLD 6) and to revise the 2015 Regulation on Transfers of Funds. Please note that, as of the date of this document, the AML Package has not yet been adopted.

^[4] We specifically note that as part of the Analysis or the Summary, we have not analysed any matters relating to the legal setup of Neokingdom DAO from a commercial law perspective. Nor have we analysed whether any mandatory provisions of the Estonian Commercial Code (in Estonian, äriseadustik) or any other provisions of other applicable laws could influence the operation of Neokingdom DAO as a private limited company (in Estonian, osaühing) registered in Estonia.

^[5] Articles of Association of Neokingdom DAO.

^[6] Shareholders’ Agreement entered into by and between all Shareholders of Neokingdom DAO.

^[7] A register of Shareholders kept by Neokingdom DAO in accordance with applicable law.

^[8] According to the EFSRA Guidelines, digital tokens are divided into two major categories:

1.         Tokens that grant their holder a reasonable expectation for profit or governance rights (i.e., tokens that fall within the scope of the banking and financial services regime – regulated tokens); and
2.       Tokens that do not promise any profits or monetary claims (i.e., tokens falling outside the perimeter of the banking and financial services regime – unregulated tokens).

See further the EFSRA Guidelines for entities engaging with virtual currencies and ICOs, available at: https://www.fi.ee/en/finantsinspektsioon/financial-innovation/virtual-currencies-and-ico/information-entities-engaging-virtual-currencies-and-icos.

^[9] Typical transferable securities are set out in an open list in Article 4(1)(44) of Directive 2014/65/EU.

^[10] For example, section 10.2.2 of the SHA provides that before transferring Neokingdom Tokens that are on blockchain address which is entered into the Shareholder Register out of that address, a Contributor must offer them for sale to other Contributors with a fixed price of one euro per one Neokingdom Token.

^[11] In Estonian, osaühing.

^[12] Estonian Securities Market Act (in Estonian, väärtpaberituru seadus).

^[13] EFSRA Guidelines for entities engaging with virtual currencies and ICOs, available at: https://www.fi.ee/en/finantsinspektsioon/financial-innovation/virtual-currencies-and-ico/information-entities-engaging-virtual-currencies-and-icos.

^[14] Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers, FATF (2021).

^[15] Estonian Anti-Money Laundering and Terrorist Financing Prevention Act (in Estonian, rahapesu ja terrorismi rahastamise tõkestamise seadus) (the AML Act).

^[16] However, subject to our recommendation to establish liaison with the Estonian Financial Intelligence Unit (in Estonian, Rahapesu andmebüroo) with a view to discussing and clarifying the treatment of the Neokingdom Token with regard to the investment related component involved.

^[17] Estonian Financial Supervision and Resolution Authority (in Estonian, Finantsinspektsioon).

^[18] Estonian Financial Intelligence Unit (in Estonian, Rahapesu Andmebüroo).