The Initial Coin Offering (ICO) in China was sentenced to death on 4 September 2017, less than a year after its appearance.
The “10 Things You Need to Know about Initial Coin Offerings (ICOs)” published on our WeChat in July lists 10 key points about ICO for market players. However, on 4 September, seven ministries jointly issued an Announcement on Preventing Risks from Token Financing (the “Announcement”). All token financing activities were called off - a sudden death sentence for ICOs in China.
There were several early warning signs that this was going to happen. Along with the boom of virtual and digital currency transactions in recent years, ICO, as an emerging finance tool, gained lots of attention and attracted many investors. There was a surge of ICOs in China in the second half of 2016, accompanied with a number of risks due to a lack of legal guidance and regulation. Since 2013, Chinese regulators have studied digital currencies like bitcoin as well as related regulatory measures in other jurisdictions. In this article, we give an introduction to the development of regulation on digital currency transactions and finance activities, and prospective trends.
Over the last few months, a growing number of ICOs have moved to jurisdictions with lighter-touch regulation such as Hong Kong and Singapore. To cope with this, the Securities and Futures Commission (SFC) of Hong Kong issued a statement regarding ICO regulations on September 5. We will discuss new regulatory trends in Hong Kong and cross-border ICO in future articles.
Click on the image to view a timeline of ICOs in China.
The current Announcement has stopped almost all ICOs in China. However, it is still worth exploring the regulatory trends in this area.
Is token financing a crime?
According to the Announcement, token financing is a form of unapproved public financing which violates regulations. Despite that, it does not necessarily constitute a crime. Instead, it is an activity - the illegal sale of tokens/tickets, the illegal issuance of securities, illegal fundraising, financial fraud, pyramid schemes and other criminal acts.
The possible criminality of token financing can be looked at from the following two aspects:
- Token financing activities should be examined on a case-by-case basis to determine whether they constitute crimes and if so, the type of crime.
- Under Chinese Criminal Law, it is unclear whether certain acts of ICO constitute a crime. For example, in the criminal act of absorbing public deposits, the object of the crime is generally the raising of funds. If virtual currencies are defined as commodities (not monetary funds), would raising virtual currencies constitute the crime of absorbing funds?
Do tokens and other virtual currencies fit the legal definition of goods?
The Circular on Preventing Risks from Bitcoin (2013) (the “Circular No. 289”) states that “by nature, bitcoins are specific virtual goods”. Tokens and other virtual currencies are not explicitly categorized in the new regulation.
In the Announcement, regulators have pointed out that the raising of bitcoin, ether and other virtual currencies through token issuance is an illegal fundraising activity. Some believe under the current regulatory regime, regulators may no longer consider virtual currencies (including bitcoin) as goods. This conflicts with the above definition in Circular No. 289.
This inconsistency may represent evolving attitudes of regulators towards virtual currencies with advances in technology and changing times. On one hand, regulators have overturned the “goods” nature of digital currencies; on the other hand, they cannot ignore that market players treat digital currencies as “goods” in relation to token investment, trading and fundraising activities. However, we believe that the Announcement has not changed the nature of digital currencies substantially. It clarifies that virtual currencies such as bitcoin are not currencies, and thus cannot circulate in the market as currencies. In token financing activities, fundraisers often regard virtual currencies (including bitcoin) as currencies so may easily commit illegal fundraising. In that way, regulations preventing activities that use bitcoin as a currency is inconsistent with the defined nature of bitcoin and other virtual currencies.
Whilst virtual currencies continue to be considered goods (rather than non-monetary or financial products), how current regulations over illegal financial activities (such as illegal fundraising and illegal security issuance) will apply is a question that remains unanswered. In this regard, Hong Kong’s SFC statement may serve as a point of reference.
Token financing trading platform ≠ bitcoin trading information intermediary ≠ internet virtual currency platform
The Announcement prohibits “token financing trading platforms” from conducting business relating to virtual currencies, but does not define such platforms. The Announcement is about cracking down on illegal public fundraising. Its purpose is to prevent people from using the special nature of virtual currencies to circumvent regulations. Simply put, not all virtual currency deals are regulated. We believe that as long as the platforms are not clearly defined, we should not view all trading platforms relating to virtual currencies as “token financing trading platforms”
For instance, according to the Interim Measures for the Administration of Bitcoin Trading Activities (Draft for Comments) (the “Interim Measures”), the People’s Bank of China (“PBOC”) will implement filing management of bitcoin trading information intermediaries to achieve regulation-compliant operation. If the scope of token financing trading platforms covered all trading platforms relating to virtual currencies, the bitcoin trading information intermediaries would be banned from providing services. However, that conclusion is inconsistent with the proposed filing management of bitcoin platforms in the Interim Measures mentioned above.
Currently, platforms providing ICO services in China use several business models, primarily third-party specialized service providing platforms (providing ICO services for various projects) and virtual currency trading plus ICO model (as user payment, token payment and online trading of tokens are convenient, this sort of platform will provide virtual currency trading and ICO services as well). Does “token financing trading platforms” refer solely to specialized third-party service providing platforms? In terms of the virtual currency trading plus ICO model, is it enough to discontinue ICO-related business, or are such platforms not “token financing trading platforms”?
The scope of “token financing trading platforms” will affect how regulatory activities are rolled out, and authorities should give clear instructions as soon as possible. The final version of the Interim Measures should be officially released shortly to give clear direction on the regulation of bitcoin and bitcoin trading information intermediaries and to guide public investment.
Illegal ICOs, “regulation-compliant” ICOs and digital asset trading platforms
Judging from the wording of the Announcement and Notification No.99, we believe regulators primary concerns are illegal issuance to the public and related illegal activities. The Announcement emphasizes that token fundraising “involving violation of laws and regulations” will be punished.
Over the years, domestic regulators have been encouraging the development of block chain technology. The intention to include bitcoin trading information intermediaries in the regulatory system by implementing filing and after-event regulation mechanisms is reflected in the Interim Measures. Therefore, we believe that in the future, regulators will establish regulations around digital asset trading activities.
Technical issue: how to regulate?
Earlier this year, the PBOC led regulators to rectify the operation of three major domestic bitcoin trading platforms. They required financial institutions and non-financial payment service providers to follow Circular No. 289. In fundraising projects by token or virtual currencies, the provision of the following products and services were banned:
- account opening
It worked, to some extent.
But in some token fundraising projects, if the subject is virtual, the transfer of virtual currency can be independent from financial institutions. Non-financial payment service providers and such activities are free from regulation by the State Administration of Foreign Exchange. As a result, technically, these activities are not illegal.
The Announcement does not give a clear view on cross-border ICO activities. Instead, it focuses on domestic ICO activities. As discussed above, ICO activities are difficult to ban, especially cross-border ones. If foreign issuers only use foreign websites and social networks, and do not market or fundraise in China, they cannot be regulated in China. We believe that such activities may not be regulated at all. Although what will be regulated is:
- domestic fundraising
- sale agency
- cross-border payments.