In 2017, blockchain, cryptocurrencies and initial coin offerings (ICOs) took the world by storm. The figures are staggering. The combined market capitalisation of cryptocurrencies surged to over US$590 billion from US$17.7 billion at the start of 2017, according to Coinmarketcap, while the price of bitcoin soared 1,500%. 

Bitcoin reached a record high of US$19,511 on 18 December 2017, but has since more than halved in value.

There are now 1,515 cryptocurrencies with an aggregate market capitalisation of approximately US$345 billion. 

Cryptocurrencies and ICOs

So what are cryptocurrencies? Bitcoin, the original cryptocurrency, operates as a digital payment system without the middlemen – banks or other intermediaries. Instead, transactions are recorded on blockchain in a digital format. As a decentralised technology, blockchain has created a new means of verifying transactions and is used by governments, healthcare providers and companies to store records as well as for payment.

ICOs are a form of crowdfunding in which companies issue digital “coins” or “tokens” in return for payment. ICOs raised more than US$4 billion in 2017. Most coins allow holders access to the company’s platform where they can be exchanged for services or products. But with the levels of interest seen for some ICOs, they are undoubtedly also attracting speculators. 

To regulate or not?

Financial regulators worldwide are grappling with the question of whether to regulate cryptocurrency transactions. Investor protection issues are paramount. Another key concern is that the anonymous nature of cryptocurrency transactions can be exploited for money laundering and terrorist financing. Yet all these risks are shared by fiat currencies and traditional investments such as stocks. 

Vastly different approaches to regulation are being adopted by different regulators around the world, with the Chinese Mainland and Japan at opposite extremes.

Mainland China

To date, Mainland China is alone in imposing a complete ban both on ICOs and cryptocurrency trading exchanges. The ban imposed in September 2017 declared ICOs an “unauthorized illegal fundraising activity.” The People’s Bank of China at the time estimated that some 90% of Chinese ICOs were scams, providing an incentive to clamp down. 

Yet China is not against cryptocurrency itself and is reportedly researching the development of a sovereign cryptocurrency. 

Japan

Japan was the first and so far only jurisdiction to legalise bitcoin as a means of payment, which it did in April 2017. Cryptocurrencies are treated as assets which can constitute a legal means of payment, rather than as money or legal currencies. Some 10,000 Japanese companies now accept payment in bitcoin. 

Japan’s regulatory authority, the Financial Services Authority, implemented clear regulations to govern cryptocurrency trading exchanges. Japan amended its Payment Services Act to include virtual currencies and to require all cryptocurrency trading exchanges to be licensed and to implement anti-money laundering controls. 

Hong Kong 

Probably the most common approach adopted by regulators is to regulate cryptocurrencies and ICOs only to the extent that they fall within the scope of the existing laws and regulatory framework. This is the case in Hong Kong, the U.S. and the United Kingdom.

In Hong Kong, the Hong Kong Monetary Authority and the Securities and Futures Commission (SFC), regard cryptocurrencies typically 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 giving clarification on situations where cryptocurrencies are likely to constitute securities. 

There has been no indication that Hong Kong regulators intend to tighten ICO regulation, and a recent article by the Hong Kong Fintech Association suggested Hong Kong is emerging as something of an ICO hub.

In Hong Kong, and other jurisdictions like it, ICOs are filling a very real need for legal crowdsourced fundraising, particularly for start-ups where bank lending and venture capital finance may not be available. 

South Korea

South Korea – the third largest cryptocurrency trading nation after Japan and the U.S. – followed China in banning ICOs in September 2017. The country’s Financial Services Commission did not, however, outlaw cryptocurrency trading exchanges. Instead, the commission introduced guidelines in January which put a stop to anonymous trading. 

South Korea has been positive in its assessment of the potential of blockchain technology and a statement by Finance Minister Kim Dong-yeon on 5 February noted that further restrictions on cryptocurrency trading exchanges are unlikely. 

Russia and Belarus

Russia’s Ministry of Finance published a draft federal law on 25 January which would legalise cryptocurrencies and allow them to be traded on licensed exchanges. 

Russia is also proposing to allow and regulate ICOs. Only registered businesses and entrepreneurs will be allowed to conduct an ICO, and a limit of 50,000 roubles (around US$900) will be imposed on unqualified investors. 

Belarus has also legalised cryptocurrencies and ICOs, and declared that related activities will be tax-free until 2023. The moves are part of a drive to boost private sector growth and to attract foreign investment. The legalisation and light-touch regulation in emerging nations such as Belarus, other former Soviet countries, and in Asian countries such as Cambodia, is seen as a way to boost growth. 

Advantages of Regulation

There is certainly an argument that some form of light-touch regulation might be welcome:

1) it might help distinguish the legitimate ICOs from the scams and discourage bad actors from entering the market;

2) it would give legitimacy to the majority of ICOs which are already voluntarily adopting best regulatory practices;

3) it would help dispel the image of ICOs as a kind of “get-rich-quick” money grab – in reality huge amounts of work go into the development of the underlying technology; and

4) it might assist coin issuers and cryptocurrency trading exchanges with opening a fiat currency bank account.

Gibraltar

One of the most interesting regulatory approaches is that introduced in Gibraltar on 1 January. The framework applies to any business which uses distributed ledger technology (DLT) for storing or transmitting value belonging to others. (Blockchain is a type of DLT.) All firms carrying on a business in DLT activities need to be authorised as DLT Providers by Gibraltar’s Financial Services Commission (FSC). 

Gibraltar’s regulatory approach is outcome-focused, so rather than impose rigid rules, the FSC requires DLT Providers to comply with a set of principles, such as conducting business with integrity and protecting client assets.

In practice, these principles are employed by the vast majority of cryptocurrency-related businesses. With the advantages of providing legitimacy and flexibility, the Gibraltan model is possibly one for serious consideration.

This article is intended for educational purposes only: its contents do not constitute legal advice and Hong Kong legal advice must be sought in relation to any particular transaction.