Virtual currency trading requires flexible approach
Virtual currency trading, notably fundraising through initial coin offerings (ICOs), has been hit this month by a powerful regulatory storm in China. However, some industry watchers have argued that the authorities should allow for flexibility when it comes to blockchain innovation.
Since the start of the year, so-called IPOs in the blockchain sector, namely ICOs – token sales in which investors trade established cryptocurrencies such as Bitcoin and Ether for a proprietary coin from ICO issuers – have exploded. A report on Chinese ICOs by the National Committee of Experts on Internet Financial Security Technology showed that 65 ICOs were completed in the country in the first half of this year, involving 2.62 billion yuan ($399.2 million) in funds raised from 105,000 investors.
In a sign of the untamed growth of ICO fundraising, many coin sale projects were able to raise 100 million yuan within only 15 minutes, even without a team of blockchain staffers or technology white papers. Huge market risks are thought to have derived from the ICO craze.
A few questions have arisen: whether ICOs are good or evil, whether ICO fundraising with minimal regulation offers an unparalleled advantage or comes with high risks, whether ICOs involve illegal fundraising, and how financial regulators in different countries cope with risks associated with ICOs.
Addressing these questions will be of importance, both realistically and theoretically, for China’s financial industry, which is moving toward being underpinned by big data, blockchain and securitization.
ICOs are in essence the asset securitization of blockchain projects and the coinage sales boom is mainly due to certain edges that ICOs have over traditional financing routes such as IPOs and venture capital.
First, the required threshold to invest in ICOs is low, including but not limited to professional investment agencies or individuals. It’s easier for blockchain start-ups to get financed via crowdfunding that seeks open cryptocurrency exchange.
Blockchain start-ups that are not qualified to conduct an IPO, or have insufficient access to venture capital resources and cannot obtain bank loans, thus have a new financing conduit.
Second, cryptocurrencies such as Bitcoin are accepted by ICO issuers for their proprietary tokens. This allows them to avoid giving away stakes and risking share dilution.
Third, the procedures for ICO financing are fairly simple given that token sales are weakly scrutinized, enabling efficient yet low-cost fundraising.
ICOs, as such, have become a significant fundraising route for the blockchain sector and have vigorously pushed for the application of blockchain technologies. Nevertheless, the explosive growth of coin fundraising has yielded cases of successful financing projects as well as examples of investment scams. It’s fair to say that the ICO boom presents various risks. There have yet to be laws and regulations specifically for overseeing ICO activities and a risk prevention framework has yet to be created in case of problems with ICOs. This legal vacuum increases the likelihood of ICO financing platforms being utilized for unlawful activities such as fraud, money laundering and illegal fundraising. Without any rules that cryptocurrency flows must be registered, ICOs accepting the likes of Bitcoin could easily be used as enablers of tax evasion and avoidance. In addition, cryptocurrency prices fluctuate too widely, subjecting ICO investment to big speculative risks. Also, severe information asymmetry exists in ICO trading, exposing investors to varied risks, including that of issuers absconding with the funds raised, unrealistic promises on returns, excessive valuations, and the possibility of Ponzi schemes. All these factors mean that ICOs are neither good nor evil. But they also mean that legal efforts must be made to maximize the benefits of ICO fundraising while minimizing the potential risks. The US Securities and Exchange Commission said in July that digital token offerings and sales “are subject to the requirements of the federal securities law” and soon after, the commission imposed trading halts on four over-the-counter-based companies on concerns over the accuracy of their ICOs.
Also, the Hong Kong Securities and Futures Commission said earlier this month that ICO tokens may be subject to local securities laws.
Separately, Russia has taken an increasingly tough stance on ICO oversight. Countries including the UK, the Netherlands, Germany, South Korea and Japan plan to grant digital currencies legal tender status. But they have taken an open attitude toward cryptocurrency trading and have yet to impose any restrictions targeting ICOs.
China, for its part, began to turn the regulatory screws on virtual currency trading since mid-year. The annual China Financial Stability Report released by the central bank in July mentioned the risk associated with speculative investment in specific virtual goods such as Bitcoin. The guidelines for handling illegal fundraising drafted by the China Banking Regulatory Commission in August also enumerated a raft of cases that merit a probe by relevant departments to look for possible illegal fundraising. Illegal fundraising under the guise of virtual currencies is one such problem.
The most recent ban on ICO practices jointly announced by China’s top regulators including the central bank is apparently the toughest part of the country’s ICO oversight. The regulatory storm that has swept through various ICO platforms and virtual currency exchanges is surely a timely action to establish safety nets against major financial risks.
That being the case, it is still hoped that there can be certain levels of tolerance for future ICO projects, so as to promote the type of blockchain innovation exemplified by Bitcoin platforms.
The authorities should allow for flexibility when it comes to blockchain innovation.