Roadblock for ICOs?

Increased regulation in key markets could dampen growth of digital coins

THE growth of cryptocurrencies may have just hit a wall, as governments around the world are increasing their scrutiny of initial coin offerings, or ICOs.

China, for one, has over the week issued an all-out ban on ICOs, declaring these digital coins illegal, while South Korea is now considering a possible ban on ICOs and stricter regulation on other digital currencies such as bitcoin and ethereum.

Other countries that have in recent months increased scrutiny on ICOs, potentially subjecting the industry to regulatory purview, include the United States, Canada, Russia, Hong Kong and Singapore.

As for Malaysia, while there are no indications that the authorities will clamp down on ICOs and other cryptocurrencies, the public has been warned about the risks associated with these schemes.

The most explicit warning on ICOs came from the Securities Commission (SC) over the week, advising investors to fully understand the features of an ICO scheme, and carefully weigh the risks before “parting with their monies”.

The onus, therefore, is on the investors to safeguard themselves from the risks associated with ICO investments.

Such warnings, as well as increasing regulatory scrutiny in several key markets, will likely put a brake on the growth of ICOs, according to one analyst, as companies may now give a second thought about raising funds through ICOs because increased regulation and scrutiny will only make the process cumbersome.

“What contributes to the significant growth of ICOs in recent years in the first place is the absence or lack of regulation on the industry ... it is so easy to raise funds that so many groups – be it those with genuine business models or those with dodgy backgrounds – rush to this means of raising funds; now, things will change,” he says.

New craze

In the world of cryptocurrencies, which are digital assets that have been designed to work as a medium of exchange using cryptography, ICOs are the latest rage.

Largely unregulated, ICOs have in recent years become an increasingly popular method used by start-up companies to raise funds to finance projects built on blockchain technology.

This is because fundraising via new digital currency offerings allow these startups to bypass the conventional – and oftentimes, rigorous – process of raising funds via venture capital or banks.

ICO investors, in return, will receive tokens or digital coins, which are akin to shares in a company or project.

Investors are sometimes promised big returns, but mostly, they are encouraged to read what the project is all about and participate if they think it’s going to be a great innovation.

No doubt, there are some dubious offerings out there.

In its statement, the SC says: “Investors should be mindful of the potential risks involved in ICO schemes, and take note that scheme operators may not have presence in Malaysia and it would be difficult to verify the authenticity of the scheme and the recovery of invested monies may be subject to foreign laws or regulations”.

It points out that some ICO schemes and the parties involved operate online and may not be regulated, hence, investors may be exposed to heightened risks of fraud, money laundering and terrorism financing.

In addition, it says, digital tokens traded on a secondary market may give rise to risks of insufficient liquidity or volatile and opaque pricing, and that the structure of some ICO schemes might limit the legal protection and recourse for investors against scheme operators.

“As the terms and features of ICO schemes may differ in each case, investors who wish to engage or invest in ICO schemes are reminded to seek legal or other professional advice if there are doubts on the legitimacy of these schemes,” the SC says.

ICOs rise

The growth of ICOs has been exponential.

According to Coinschedule, a website that tracks ICO fundraising, the number of ICOs this year to date has already tripled from last year, while the amount raised has increased by almost 20-fold.

As it stands this year, there have been 138 ICOs, collectively raising a total of US $2.11bil (RM8.85bil) globally.

This compared with the 46 ICOs, which collectively raised US $96.4mil, in 2016.

In Malaysia, ICO issuers are few and far between.

A notable one is Ecobit, which reportedly raised more than US $4.5mil after completing its ICO in June this year.

The company is reportedly seeking to team up with the Kelantan government to manage and maintain one million acres of rainforest for 30 years and build a market for carbon credits.

Ecobit, however, has been placed on Bank Negara’s financial consumer alert service since June 23, as “companies and websites which are neither authorised nor approved under the relevant laws and regulations administered by Bank Negara”.

Since the first issuance of ICO in the US in 2014, there have always been concerns about the risks of this cryptocurrency.

It has been noted that the absence or lack of regulatory oversight could make the instrument a breeding ground for fraud and money laundering, as well as put many investors at a vulnerable position.

Red flags raised

Essentially, it is the rapid growth of ICOs that has prompted regulators to take notice of the potential abuse of the system.

Last month, Singapore regulators issued a consumer advisory document, urging consumers to exercise due diligence before investing in digital tokens, with particular emphasis on the emergence of ICOs.

According to the Monetary Authority of Singapore (MAS), ICOs are “vulnerable to money laundering and terrorist financing risks due to the anonymous nature of the transactions, and the ease with which large sums of monies may be raise in a short period of time”.

It says some ICOs and token sales in Singapore may be subject to securities laws depending on their underlying purpose and context.

The MAS’ comments last month followed the move by the US’ Securities and Exchange Commission (SEC), which in July issued a note declaring that the issuance of digital tokens could trigger US securities laws.

Hot on the heels of China’s clampdown on ICOs, Hong Kong on Tuesday warned that some ICOs could face regulatory scrutiny.

The territory’s Securities and Futures Commission (SFC) said some ICOs could be classified as securities, and hence subject to securities regulations.

Citing the anonymous nature of the transactions, the SFC warned that the sales of digital currencies could “pose inherent and significant money laundering and terrorist financing risks”.

Undeniably, there are some bad apples in the ICO sector, but that does not mean the whole barrel is rotten, as some analysts put it.

Speaking to the Financial Times (FT), Henri Arslanian, PwC fintech and regtech head for China and Hong Kong, says:

“There are many entities doing ICOs that are working with reputable professional advisers and looking at building useful ecosystems for the long term.

“However, there are some bad apples that are simply looking at making a quick buck,” he concedes, adding that he hopes regulatory statement will deter many of those “bad apples”.

Positive thing

Some ICO issuers remain positive on the prospects of the sector.

While growth may slow under a tighter regulatory environment, they believe increased scrutiny or regulation on the industry is a positive development for ICOs over the longer term, as genuine schemes may continue to survive and thrive, while the dodgy ones get weeded out.

Hello Gold Sdn Bhd founder and CEO Robin Lee, for one, says: “I think it is good for the industry, as increased scrutiny can help improve investor confidence on ICOs and this gives a lot of support for (genuine) issuers,” Lee tells StarBizWeek.

He points out that increased regulation will minimise the risks of people being negatively impacted by investments that are questionable.

Hello Gold has embarked on its own ICO of what it calls HelloGold tokens in Singapore.

The group is currently in the fourth of its five tranches of ICO process, which could raise up to US$9mil upon completion.

Lee says Hello Gold’s ICO remains unaffected by Singapore’s recent ruling on the industry.

Separately, he expects China’s ban on ICO to be “temporary” measure, which will likely ease off in the future.

“I think it is a right move by the Chinese government, as it puts an end to those that should not be using token sales to raise funds in the first place,” Lee explains.

Meanwhile, Mriganka Pattnaik, countries associate at Luno – a bitcoin startup headquartered in Singapore – says a blanket ban may not necessarily be the best solution to avoid the risks of ICOs.

“While the ban of ICOs by China had caused some volatility in the cryptocurrency markets, it is still unclear as to what the long-term effects would be.

“Countries like Singapore and Hong Kong have taken a more measured approach to ICOs by referring to securities’ laws... initiatives like these would actually boost the industry and usher in mainstream adoption,” Mriganka tells StarBizweek.

He argues that for companies going the ICO route, it is important to obtain the right legal counsel and if necessary, even approach regulators for clarity before launching an ICO.

“A majority of ICOs out there that have been successful have built their reputation within their community over several years, so it is definitely not an easy way to raise money quickly,” Mriganka says.

As for investors, he points out that they should also be fully aware and recognise the risks associated with ICOs before investing in these schemes.