Cryptocurrencies have grabbed investor attention ever since Bitcoin, the first and now the most traded cryptocurrency today, was launched in 2008. Blockchain, the technology underpinning Bitcoin, became a buzzword. Soon, many others caught on to the act and created blockchain platforms, with Ethereum, Ripple, Hyperledger, IBM, and R3 just some of them. Many start-ups are now building entire businesses on the blockchain technology, a process that calls for significant funding. However, instead of turning to public stock markets or venture funds to fund their initiatives, these businesses are turning to cryptocurrencies through an Initial Coin Offering (ICO), a process of tokenization that entails issuance of new digital tokens or coins to fund their projects.
ICOs have now become a part of the international financial mainstream and funds raised via ICOs recently breached the $4 billion mark. Although most countries barring China seem to have accepted ICOs, regulation of ICOs and cryptocurrencies is still something that is evolving. Opinions on ICOs are diverse. There are evangelists who regard ICOs as the Next Big Thing — the key component in the digital revolution. Conversely, there are sceptics that believe they are the next big bubble that will inevitably burst. The scale of funding, nevertheless, suggests that not just evangelists and speculators are putting their money and faith into blockchain-related products. All this leads us to the crucial issue of regulation on ICOs. The official stance of most nations towards ICOs ranges from tacit acceptance to official recognition. However, the problems regulators have with ICOs are that, technically, they are a workaround. The design or plan behind ICOs is that businesses can avoid making an initial public offering and instead seek low amount seed funding that can bypass the due diligence, regulatory requirements and other fiduciary approvals a traditional Initial Public Offering (IPO) would need. Thus, small businesses with untested or lesser-known technologies that would otherwise be ineligible for traditional funding opportunities would be the beneficiaries of funding opportunities such as ICOs. Such opportunities, according to some, could be rife with frauds and the fear is that scammers could use ICOs to defraud investors. Even countries that otherwise support cryptocurrencies have taken a very stringent position on fraudulent or malicious ICOs, especially if they are originating from foreign soil.
How the regulations have panned out globally
In the US, William Hinman, director of the SEC’s corporation finance division, clearly outlined his observations on ICOs: the promoters tout their ability to create an innovative application of blockchain technology and typically the business model and viability of the application are quite uncertain. He argued that, at this stage, the purchase of a token is a bet on the success of the enterprise and not the purchase of something used to exchange goods or services on the network. Although he stated that this did not reflect SEC’s views, he hinted that a cryptocurrency initially offered as a security through an ICO could evolve into a different structure, perhaps akin to a commodity. In the UK, the FCA recently highlighted the increasing need to bring ICOs into the regulatory perimeter given that the design and role of cryptocurrencies as investments could present considerable risks. In the EU too, regulators are making efforts to gauge whether cryptocurrencies and tokens come within the description of traditional financial instruments and whether they should be come under the purview of existing regulatory framework. The EU is also evaluating the risks that these activities present as they become more ‘mainstream’. Australia has new regulations in place that would allow the questioning and prosecution of malicious ICO operators. Many countries are looking at changes to their regulatory policies to classify adherence to anti-money laundering and know-your-customer practices into laws for ICOs. Moreover, in case an ICO relates to property transfers or to fiat currencies, it may be involved with securities and could have repurcussions on taxation and securities integrity. Countries such as India are studying the regulatory scenario pertaining to ICOs in other countries.
What all this means for investors
The upshot of all these developments is that the regulatory scenario is still unfolding. In addition to the upcoming anti-money laundering requirements at the EU level, it is likely that regulatory oversight will turn more stringent globally, although the pace at which this will happen is uncertain. Keeping an eye on regulatory trends and understanding the ever-changing nature of regulation pertaining to cryptocurrencies and ICOs should be one of the most important risk-mitigating practices followed by investors.