Gov­ern­ments around the world are ex­per­i­ment­ing with reg­u­la­tions that safe­guard in­vestors while al­low­ing in­no­va­tion

The Peak (Hong Kong) - - Contents - KIM LARKIN Kim Larkin is a cor­po­rate fi­nance lawyer with Charl­tons solic­i­tors.

“Ev­ery ICO I’ve seen is a se­cu­rity”, U.S. Se­cu­ri­ties and Ex­change Com­mis­sion (SEC) chair­man Jay Clay­ton told a US Se­nate hear­ing on Fe­bru­ary 6, 2018, be­fore con­ced­ing that not one ICO (ini­tial coin of­fer­ing) has been reg­is­tered with the SEC as a se­cu­ri­ties of­fer­ing. Ex­cept for China, which banned ICOS and cryp­tocur­rency trad­ing plat­forms in Septem­ber 2017, and Ja­pan which le­galised cryp­tocur­ren­cies and reg­u­lated crypto ex­changes from April 2017, plus a hand­ful of for­ward-think­ing emerg­ing mar­kets, the US po­si­tion is typ­i­cal of many ju­ris­dic­tions, Hong Kong in­cluded.

The dif­fi­culty of defin­ing an ICO leads to the chal­lenge of reg­u­lat­ing ICOS, and there­fore pro­vid­ing the sta­bil­ity needed for them – and the projects they sup­port – to suc­ceed. As in other ju­ris­dic­tions, ICOS in Hong Kong are typ­i­cally struc­tured as sales of util­ity to­kens that pro­vide ac­cess to a plat­form and/or a means of pay­ment for its ser­vices. Pro­vided that the hold­ers will not re­ceive a share of the re­turn of­fered by the plat­form, these ICOS aren’t con­sid­ered to con­sti­tute a se­cu­ri­ties of­fer, but given the range of ac­tiv­i­ties that are pos­si­ble with ICOS, there are plenty of grey ar­eas to sort out. Around the world, gov­ern­ments are ex­per­i­ment­ing with ways to deal with this phe­nom­e­non in the hope of re­al­is­ing the prom­ise of blockchain tech­nol­ogy, with­out squelch­ing it.

The wild fluc­tu­a­tions in the price of bit­coin and other cryp­tocur­ren­cies in re­cent months, along with cryp­tocur­rency thefts and ICO scams, have fo­cused at­ten­tion on reg­u­la­tory mat­ters. Sur­pris­ingly, per­haps, many of the calls for crypto reg­u­la­tion have come from the in­dus­try it­self. “If we want this whole as­set class to grow up and ma­ture, of course, there should be more reg­u­la­tion,” said Rip­ple CEO Brad Gar­ling­house.

He makes an im­por­tant point. In the US and the UK for ex­am­ple, bank par­tic­i­pa­tion in cryp­tocur­ren­cies is min­i­mal. The ad­van­tage of reg­u­la­tion would be to bring cryp­tocur­ren­cies into main­stream fi­nance and fa­cil­i­tate the real de­vel­op­ment of blockchain tech­nol­ogy and its ap­pli­ca­tions. Other is­sues re­lated to con­sumer pro­tec­tion and fa­cil­i­tat­ing ef­fi­cient cap­i­tal rais­ing for com­pa­nies.

In essence, ef­fec­tive reg­u­la­tion gives le­git­i­macy, and what is lack­ing now in cryp­tocur­rency mar­kets is le­gal cer­tainty and trust. Most of us would feel more con­fi­dent buy­ing cryp­tocur­ren­cies on­line know­ing that the plat­form is li­censed and meets ba­sic suit­abil­ity cri­te­ria. Reg­u­la­tion helps us dis­tin­guish le­git­i­mate ICOS from scams and Ponzi schemes, which would hope­fully dis­cour­age bad ac­tors from en­ter­ing the mar­ket. The cur­rent lack of reg­u­la­tion, there­fore, works to the detri­ment of le­git­i­mate ICO is­suers.

Reg­u­la­tors world­wide are grap­pling with the ques­tion of whether and how to reg­u­late cryp­tocur­rency trans­ac­tions, ICOS and cryp­tocur­rency trad­ing on on­line ex­changes. In­vestor pro­tec­tion con­cerns are para­mount, lead­ing reg­u­la­tors to warn po­ten­tial in­vestors of cryp­tocur­ren­cyre­lated risks in­clud­ing fraud, theft through hack­ing, price volatil­ity and po­ten­tial lack of liq­uid­ity. An­other ma­jor con­cern is that the anony­mous na­ture of cryp­tocur­rency trans­ac­tions fa­cil­i­tates money laun­der­ing and ter­ror­ist fi­nanc­ing – risks shared by na­tional cur­ren­cies and even stocks.

China and Ja­pan, two coun­tries at the cen­tre of the cryp­tocur­rency rev­o­lu­tion, are at op­po­site ex­tremes when it comes to reg­u­la­tion.

So far, China is alone in im­pos­ing a com­plete ban on ICOS and cryp­tocur­rency trad­ing ex­changes. The ban im­posed in Septem­ber 2017 de­clared ICOS an “unau­tho­rised il­le­gal fundrais­ing ac­tiv­ity” and put an im­me­di­ate stop to ICOS in the coun­try. An an­nounce­ment by the Peo­ple’s Bank of China at the time es­ti­mated that some 90 per cent of Chi­nese ICOS were scams, pro­vid­ing a very real in­cen­tive to clamp down on the ac­tiv­ity.

Ten­cent (like Face­book) banned ad­ver­tis­ing re­lated to ICOS or cryp­tocur­rency trad­ing, and the Chi­nese reg­u­la­tors have also sought to block ac­cess to off­shore cryp­tocur­rency trad­ing plat­forms and ICOS.

While China’s sharp crack­down on ICOS and crypto trad­ing amid wide­spread fraud is un­der­stand­able, it has also been crit­i­cised for di­min­ish­ing China’s once dom­i­nant role in the cryp­tocur­rency busi­ness. Yet China is not against the idea of a cryp­tocur­rency and is re­port­edly re­search­ing the de­vel­op­ment of a sov­er­eign cryp­tocur­rency.

On the other hand, Ja­pan be­came the first ju­ris­dic­tion to le­galise bit­coin as a means of pay­ment in April 2017. Ja­pan treats cryp­tocur­ren­cies as as­sets that can con­sti­tute a le­gal means of pay­ment – rather than as money or cur­ren­cies. Some 10,000 Ja­panese com­pa­nies now ac­cept pay­ment in bit­coin, in­clud­ing its largest bud­get air­line.

The Fi­nan­cial Ser­vices Au­thor­ity, Ja­pan’s reg­u­la­tory au­thor­ity, re­sponded to the 2014 theft of US$437 mil­lion worth of bit­coin from Ja­panese ex­change Mt Gox by im­ple­ment­ing clear reg­u­la­tions to gov­ern cryp­tocur­rency trad­ing ex­changes, rather than try­ing to clamp down com­pletely. The Pay­ment Ser­vices Act was amended to in­clude vir­tual cur­ren­cies as a means of pay­ment and to re­quire the li­cens­ing of cryp­tocur­rency trad­ing ex­changes and their im­ple­men­ta­tion of anti-money laun­der­ing (AML) con­trols.

Ja­pan taxes cryp­tocur­ren­cies and es­ti­mates put tax rev­enue from cryp­tocur­rency busi­nesses, in­clud­ing taxes on cap­i­tal gains from cryp­tocur­ren­cies made by in­di­vid­u­als and cor­po­ra­tions, in the re­gion of JP¥1 tril­lion (HK$ 72 bil­lion). Cryp­tocur­ren­cies now con­trib­ute roughly 0.3 per cent to Ja­pan’s GDP and that fig­ure is grow­ing, so Ja­pan’s proac­tive stance makes sense.


The most com­mon ap­proach to reg­u­la­tion in ju­ris­dic­tions that have not suf­fered wide­spread fraud and hack­ing is to reg­u­late cryp­tocur­ren­cies and ICOS with ex­ist­ing laws and reg­u­la­tions. This is the ap­proach in Hong Kong, as with the United States, the UK and Sin­ga­pore, although Sin­ga­pore’s MAS is con­sult­ing on a new Pay­ment Ser­vices Bill which would im­pose li­cens­ing re­quire­ments and AML and CTF obli­ga­tions on cryp­tocur­rency trad­ing plat­forms.

The dif­fi­culty, how­ever, is that ex­ist­ing laws were writ­ten for a very dif­fer­ent time, and

try­ing to shoe­horn cryp­tocur­ren­cies into ex­ist­ing def­i­ni­tions may not work.

In Hong Kong, the prin­ci­pal reg­u­la­tors, the Hong Kong Mone­tary Au­thor­ity and the Se­cu­ri­ties and Fu­tures Com­mis­sion (the SFC), re­gard cryp­tocur­ren­cies not as le­gal ten­der, money or cur­ren­cies, but as “vir­tual com­modi­ties”, which are not sub­ject to reg­u­la­tion. That is pro­vided that the cryp­tocur­rency in ques­tion does not have the char­ac­ter­is­tics of a “se­cu­rity”.

In Septem­ber 2017, the SFC is­sued a state­ment out­lin­ing pos­si­ble cir­cum­stances in which a cryp­tocur­rency could be con­sid­ered a se­cu­rity, such as when to­kens carry rights of own­er­ship or to a share of the rev­enues of the projects funded. In that case, an ICO may re­quire SFC au­tho­ri­sa­tion as a se­cu­rity of­fer­ing.

The SFC has also stated that while bit­coin is not reg­u­lated, bit­coin fu­tures con­tracts traded on cer­tain fu­tures ex­changes, in­clud­ing the bit­coin fu­tures con­tracts launched on the U.S. CME and Cboe ex­changes in De­cem­ber 2017, are fu­tures con­tracts reg­u­lated by the SFC.

None­the­less, the SFC’S re­cent warn­ing state­ment ap­peared to con­firm that util­ity to­kens are not se­cu­ri­ties. That said, the sta­tus of a to­ken where the plat­form has not been de­vel­oped at the date of the ICO, or whose only po­ten­tial re­turn is a hy­po­thet­i­cal profit on a hy­po­thet­i­cal fu­ture sale of the to­ken if it be­comes trad­able, re­mains a le­gal grey area. Ul­ti­mately, it may be up to Hong Kong courts to set­tle such ques­tions, leav­ing in­vestors in a po­ten­tially dif­fi­cult tan­gle.

De­spite their warn­ing state­ments, Hong Kong reg­u­la­tors have not in­di­cated an in­ten­tion to ban ICOS or tighten reg­u­la­tion. This ret­i­cence is wel­come, given that ICOS are pro­vid­ing the fund­ing vi­tal to the revo­lu­tion­ary blockchain tech­nol­ogy with its trans­for­ma­tive po­ten­tial for economies.

Hong Kong does not pro­vide a spe­cific reg­u­la­tory regime to al­low crowd­fund­ing, such as was im­ple­mented by the Jobs Act in the US. ICOS are fill­ing that gap by pro­vid­ing a much-needed le­gal means of crowd­sourced fundrais­ing, par­tic­u­larly for start-ups in tech and dis­rup­tive in­dus­tries where bank and ven­ture cap­i­tal fi­nanc­ing may not be an op­tion.

Gov­ern­ments around the world are grap­pling with this tech­nol­ogy, and the up­dates are com­ing in on a daily ba­sis.


South Korea – the third largest cryp­tocur­rency trad­ing na­tion af­ter Ja­pan and the United States – fol­lowed China in ban­ning ICOS in Septem­ber 2017 amid fraud and hack­ing by North Korea. How­ever, South Korea’s Fi­nan­cial Ser­vices Com­mis­sion did not out­law cryp­tocur­ren­cy­trad­ing ex­changes as had been ru­moured. In­stead, it im­ple­mented guide­lines to reg­u­late trad­ing ex­changes in Jan­uary 2018, halt­ing anony­mous trad­ing.

A “real-name ac­count sys­tem” took ef­fect from Jan­uary 30, 2018, which re­quires cus­tomers to open named ac­counts with the bank ser­vic­ing the cryp­tocur­rency ex­change they use. New AML guide­lines were im­posed on banks deal­ing with cryp­tocur­ren­cies set­ting re­port­ing re­quire­ments for daily with­drawals of US$9,400 and weekly with­drawals of US$18,800.

Most re­cently, the South Korean gov­ern­ment has said that it sup­ports “nor­mal trans­ac­tions” on cryp­tocur­rency ex­changes.

South Korea’s re­fusal to ban ICOS is rooted in its pos­i­tive as­sess­ment of the po­ten­tial of

blockchain tech­nol­ogy. South Korean Fi­nance Min­is­ter, Kim Dong-yeon, on Fe­bru­ary 5 noted that fur­ther re­stric­tions on crypto-trad­ing ex­changes are un­likely (ex­cept to counter neg­a­tive uses) given the per­ceived need for cryp­tocur­ren­cies to en­cour­age in­di­vid­u­als to par­tic­i­pate in blockchain.


Rus­sia aims to reg­u­late rather than ban cryp­tocur­rency ac­tiv­i­ties. The Min­istry of Fi­nance pub­lished a draft of fed­eral law on Jan­uary 25 that would le­galise cryp­tocur­ren­cies and al­low their trad­ing on li­censed ex­changes. How­ever, Rus­sia will not recog­nise cryp­tocur­ren­cies as a le­gal means of pay­ment – only the ru­ble con­sti­tutes le­gal ten­der.

Rus­sia plans to al­low reg­u­lated ICOS, where only reg­is­tered busi­nesses and reg­is­tered en­trepreneurs will be per­mit­ted to con­duct an ICO. Un­qual­i­fied in­vestors will be sub­ject to a limit of RUR 50,000 (HK$6,800) on their in­vest­ment in dig­i­tal coins/to­kens. Rus­sia has also pub­lished pro­pos­als for ac­cred­it­ing is­suers of ICOS that are reg­is­tered as le­gal en­ti­ties in Rus­sia and have au­tho­rised cap­i­tal of at least RUR100 mil­lion.

Like China, Rus­sia is re­ported to be con­sid­er­ing the in­tro­duc­tion of its own na­tional cryp­tocur­rency – dubbed the “Cryp­toru­ble” – which would be le­gal ten­der in Rus­sia.


While de­vel­oped economies are slower to act, a raft of smaller and emerg­ing economies are fash­ion­ing them­selves as crypto-friendly hubs. Be­larus has le­galised cryp­tocur­ren­cies and ICOS and de­clared ac­tiv­i­ties re­lated to the cre­ation and sale of dig­i­tal to­kens and cryp­tocur­rency min­ing to be tax-free un­til 2023. The moves are part of a drive to boost pri­vate sec­tor growth and at­tract for­eign in­vest­ment.

Cam­bo­dia is an­other coun­try look­ing to le­galise and reg­u­late cryp­tocur­rency trans­ac­tions as a way to pro­mote growth. It is in these emerg­ing economies that gov­ern­ments are suc­cess­fully im­ple­ment­ing new reg­u­la­tory regimes un­hin­dered by the kick­back from the es­tab­lished fi­nance sec­tor seen in some de­vel­oped economies. Malta, too, has set out pro­pos­als for a new agency to cer­tify blockchain plat­forms and ver­ify cryp­tocur­rency trans­ac­tions with the aim of cre­at­ing “le­gal cer­tainty and trust”.

In some ways, a prin­ci­ples-based model such as the Gi­bral­tan model may be the most suit­able. The Gi­bral­tar Fi­nan­cial Ser­vices Com­mis­sion said re­cently that it might re­sort to a sys­tem of “au­tho­rised spon­sors” to han­dle reg­u­la­tory is­sues re­lated to ICOS.

In the ab­sence of reg­u­la­tion in Hong Kong, ICO is­suers and crypto trad­ing ex­changes may be best ad­vised to self-reg­u­late by con­duct­ing anti-money laun­der­ing and counter-ter­ror­ist fi­nanc­ing pro­ce­dures, en­sur­ing trans­parency of in­for­ma­tion and proof­ing their plat­forms against hack­ers. In prac­tice, Hong Kong cryp­tocur­rency ex­changes are vol­un­tar­ily con­duct­ing anti-money laun­der­ing and counter-ter­ror­ism fi­nanc­ing pro­ce­dures, as are most ICO to­ken is­suers.

A vol­un­tar­ily adopted code of con­duct, such as that adopted by Cryp­touk, a sel­f­reg­u­la­tory body for crypto ex­change, may be a use­ful model for other ju­ris­dic­tions, and help give ICO is­suers and crypto ex­changes the le­git­i­macy they need.

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