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The multiple faces of ICO regulation

BIScom Subsection: 
Nigel Morris-Cotterill

The ICO, or initial coin offering, is causing furrowed brows at regulators. It's a fascinating concept and governments are split: should they regulate it on the hoof or, as China has done, ban it until they can work out what do to about it? Or should they pretend it's not happening?

All three approaches are being adopted.

China's decision to ban Initial Coin Offerings (ICOs) was seen by some as a knee-jerk reaction as explained here, in World Money Laundering Report. As that article says "China first announced that it would ban the Initial Coin Offering (ICO) from its markets. The reasoning was simple and accurate: there is nothing except sentiment backing a cryptocurrency and each one is, almost by definition, it's a bubble in the making. Essentially, the regulators argued that an ICO is gambling and worse it's open to easy manipulation and, therefore corruption. The risk of unsophisticated people buying into a market that no one truly understands was likely to lead to many people losing a lot of money and, because many people were likely to borrow (legally or illegally) to fund what they thought was an investment, there was a serious risk of a significant increase in debt."

The ICO is the mechanism by which cryptocurrencies "go live." And China is right: it's a gambler's charter, a fraudster's open door and a money launderer's opportunity.

These days, to create a new Bitcoin clone, or something very similar, does not require major technical know-how. Even banks have announced their own cryptocurrencies. When a new variety is released, it is sold via what is often termed a market, at a discount. That, of course, encourages what in the world of shares is called "stagging." But, unlike companies (at least honest companies that produce a verifiable prospectus, companies behind an ICO have nothing, absolutely nothing, to show to investors. It is arguable that it is not an investment, per se, but a currency exchange. If it's a currency exchange, then the "markets" are regulated. But they deny this and so operate outside the legal framework that currency exchanges function in.

Essentially, a company seeking to raise capital issues an ICO which it sells. But, and here's the big reason it's a problem, it is not selling shares in itself. The purchaser of the cryptocurrency gets nothing except a cryptocurrency. Imagine for a moment a company that designs what amount to tokens, mass produces them at close to zero cost, then sells them to raise operating funds. If a market develops in those tokens and those tokens become traded at a higher value, the seller makes money when he sells his remaining stock and the purchaser makes money if he sells them.

An Initial Coin Offering, also commonly referred to as an ICO, is a fundraising mechanism in which new projects sell their underlying crypto tokens in exchange for bitcoin and ether. It's somewhat similar to an Initial Public Offering ( IPO ) in which investors purchase shares of a company.


Not only are the markets close to unregulated in many countries (due, largely, to a failure to properly define terms to take account of non-state issued currency as "money") but there are in most market no, or nearly no, restrictions on who may join in. Therefore the unsophisticated who imagine that Bitcoin-like tokens are a secure investment are likely to find themselves in desperate circumstances, especially if they have borrowed to make the purchase. Readers can look up the history of Bitcoin for themselves to see how wildly its value has fluctuated. Yet, Bitcoin has the benefit that anyone who has heard of Cryptocurrencies has heard of Bitcoin: it is, one might say, the American Dollar of the virtual currency world. But the others aren't even the Euro or the Yen or the Yuan. No, as they proliferate, as their servers get hacked and their credibility falls, their profile will be more like the Zloty which, many are surprised to learn, still exists because Poland is in the EU but outside the Euro.

The idea of creating and using digital currency to raise funds for companies is not new: the first known instance was in 2013 when a company called RIpple "mined" 1,000 million tokens called XRP which it then sold to "investors" in return for - wait for this - Bitcoin or even actually US dollars.

Shortly afterwards, a platform called Ethereum was launched. According to NASDAQ " It promised to create a decentralized organization that would fund other blockchain projects, but it was unique in that governance decisions would be made by the token holders themselves." But the system was compromised by security flaws and large amounts of coins were "stolen."

Why put inverted commas around "stolen." It's because the legal status of a virtual currency is not often defined. It is not a chose in action (i.e. a debt - which is what moneys in bank accounts are) and it is not a thing (which is what notes and coin are). If it neither of those things, then there has to be questions over whether theft laws cover it. However, it is widely accepted that fraud laws which relate to " a benefit" and are therefore far more nebulous include it and so do computer intrusion / data theft laws.

The problem that regulators are having to deal with is that the markets are simply incomprehensible. Companies have raised many millions of dollars in, literally, seconds and, because they are not issuing via a recognised stock exchange, the transactions are not properly protected.

The USA's SEC has ruled that "In some cases, the token is simply a utility token, meaning it gives the owner access to a specific protocol or network; thus it may not be classified as a financial security. On the other hand, if the token is an equity token, meaning that it's only purpose is to appreciate in value, then it looks a lot more like a security." NASDAQ says that's cleared up some things. We say it's still as clear as mud and just as claggy.

Today, ASIC, the Australian regulator, said "ICOs are highly speculative investments, are mostly unregulated and the chance of losing your investment is high. Consumers should understand the risks involved, including the potential for these products to be scams, before investing." Then it issued guidance for "issuers of initial coin offerings" under the Corporations Act 2001.

Amongst the ASIC notes are that if the coin comes with rights attached, it may be regarded as a share. If digital assets are used to purchase an interest in a managed scheme, that would be regulated (sounds obvious when it's phrased like that). The legal status of the ICO will depend: on whether it is regarded a share, etc or simply the sale of services or products (it is not, of course, a "good" but whether it is a "service" or "product" is also open to debate).

ASIC also considers whether the ICO could be considered to be an offer of a derivative. The complex explanation can be reduced to this: if the performance of the coin depends on the performance of an underlying asset (e.g. the company's shares) then it is a derivative but if the performance of the coin depends entirely on its traded value then it is not a derivative.

ASIC is clear: an ICO is only a financial product it it's a share, managed fund or derivative. If it's a financial product then its market must be regulated. If it's not a financial product, then its market is not regulated. In short, think of it as a coin and it's regulated; think of it as a washing machine and it's not.

There is one further matter: a "non-cash payment facility." This is " is an arrangement through which a person makes payments, or causes payments to be made, other than by physical delivery of currency." Think of this as hawala type systems, if they were registered. An Australian Financial Services Licence is needed for money transfer services that fall into this category. However, we agree with ASIC's view that "coins offered under an ICO are unlikely to be NCP facilities." And that's where the biggest problem arises because this is the hole which money laundering and the financing of future crime, including money laundering can readily exploit.

Once the coins are issued, while they can be traced, they can only be traced if anyone other than the holder knows about them. The layering (for once that term makes sense) of transactions between multiple digital currencies will make audit trails impossible, on a practical basis, to follow. What it does, in practical terms, is to create a virtual world in which the old fashioned secrecy bank havens are supplanted by computerised money transfer system. Moreover, there is nothing to prevent virtual currencies operating undetected in the so-called Dark Web.

This is why regulators need to stop, take a deep breath and perhaps follow China's lead is saying "you can't do that here until we understand it and we understand the risks."


Nigel Morris-Cotterill, Head, The Anti Money Laundering Network, ultimate owner of PleaseBeInformed.com has studied the use of and risks presenteb by virtual currencies and alternative payment methods for more than 20 years.

So: here's the question - how is this, in principle, different from pump and dump in penny stocks in companies that list on e.g. the USA's Pink Sheets OTC markets yet have no or no significant assets?

The pragmatic answer is that it is not and therefore the ICO route to floations using or of cryptocurrencies is, indeed appealing to the casino atmosphere of barely regulated markets and to automated trading platforms.

Here is the next problem: almost all cryptocurrency trading platforms are automated.