On 4 September 2017 the Chinese central bank, the People’s Bank of China, announced a ban on Initial Coin Offerings (ICOs) with immediate effect. However, only a few days later during a television interview a spokesman for the Institute of Finance and Banking, an academic organisation that works closely with the Chinese government, told interviewers that the ban is “only temporary” and suggested licensing regulations could follow.
The spokesman explained that declaring ICOs an illegal method of fundraising is just to allow the relevant government bodies to construct the required regulatory framework to support and protect both investors and the companies looking to generate funds. According to some translations, he also added that ICOs had only been “paused” rather than “forbidden”, something observers have taken as another sign that ICOs will resume in China in the near future.
What was evident is that if ICOs are reinstated as a going concern, they will be closely monitored and will have to be licensed by the Chinese government and operated within a highly controlled environment.
As this stage a lot of the commentary surrounding the Chinese government’s eventual conclusion is based upon nothing more than assumption, opinion and conjecture but even with that accepted, there is concern the resulting regulatory system may put people off pursuing potential ICOs.
The Chinese also need to stay awake to the possibility that many of their near neighbours may be poised to exploit their hesitancy and their perceived opposition to new technologies including, as recently as 2013, Bitcoin. The enthusiasm and flexibility being shown by countries like Japan, Hong Kong and Singapore towards the ICO market could end up costing China dear.
ICOs are a form of investment funding. In ICOs, start-ups offer new types of cryptocurrency in exchange for cash or other types of cryptocurrency. At the moment, they are unregulated in most of the world. Investopedia states they are designed to “bypass the rigorous and regulated capital-raising process required by venture capitalists or banks”.
Unlike traditional share offerings, companies using ICOs don’t always offer investors anything in return for their investment. With an Initial Public Offering (IPO), investors are given a stake or equity in the company in exchange for their money. This isn’t always the case with ICOs.
Instead, the investor is given a digital token that should increase in value as others invest in the currency. China’s worry is that this resembles a Ponzi or pyramid scheme. That said, while there are risks, there are also potential rewards. The difficulty for investors lies in discerning between genuine organisations and scams. This is made all the more difficult by the fact that there is currently no regulatory framework around the issuing of ICOs.
There are a number of reasons for this crackdown:
With more than $1bn raised in six months, the market is extremely lucrative – which can attract fraudsters. In many cases, these currencies are backed by little more than marketing spiel and vague promises. It’s easy to see that the combination of a technology many people don’t understand, the promise of riches and the ‘social proof’ of similar currencies doing well is a recipe for fraud. There may be (financial) trouble ahead.
As we know from previous bubbles and crashes, it’s the investor who gets hurt and the rest of us who pay the price. By clamping down on ICOs, China is hoping to ward off greater financial trouble further down the line.
China is at the epicentre of the cryptocurrency boom. This gives it increased exposure if (or when) the bubble bursts.
There are rumours that China wants to mint its own cryptocurrency. If it succeeds, it will have complete control over that currency, rather than being beholden to platforms such as Bitcoin or Ethereum. It may be that regulators are clearing the decks for this eventuality.
China likes to pick its winners. In most cases, Chinese businesses win out over foreign ventures for lack of state support. By their nature, cryptocurrencies are designed to circumvent centralised power by getting round regulation. They provide new flows of capital and help build modern businesses that threaten traditional establishments. With the lack of state control over ICOs, China understandably felt uncomfortable.
China is extremely risk averse so it comes as no surprise that it is taking a strict approach to this type of fundraising. The People’s Bank Of China feared it may “severely disrupt the social and economic order”. While China is so far the only nation to have acted, it isn’t the only nation to warn of the potential risks. Singapore’s monetary authority warned of the potential risk of scams and even terrorist funding that ICOs represent. Singapore itself is a hotbed of FinTech activity, which means its input is also likely to have far-reaching ramifications. In the US, the Securities and Exchange Commission has determined ICOs must be held in accordance with federal securities law, although there has been no Chinese-style crackdown as yet.
After the ban was announced in China, two leading cryptocurrencies saw sharp falls in their prices. Bitcoin, possibly the best-known cryptocurrency, dropped €200.
The People’s Bank of China issued a list of 60 major ICO platforms that financial regulatory bodies are to investigate and report on, and at least two major Chinese cryptocurrency exchanges have ceased their ICO operations. A conference on blockchain technology was also cancelled.
Perhaps most worryingly for FinTech companies, the Chinese authorities have called on investors to be refunded. The rationale behind the ban is to protect investors from the risks associated with investment in cryptocurrency.
As lawyers who are working to help clients resolve disputes involving not only fraudulent ICOs but also almost every other type of digital fraud, we know how quickly this threat is increasing and understand exactly why China – like so many other countries around the world – are working so hard and so quickly to tighten up the regulations around digital trading.
If you have lost money to a digital fraud and want to know what you should do next, call us today on 020 7792 5649 or email us at email@example.com.
We will help.