The year 2017 has seen a meteoric rise in the total market capitalization (“market cap”) of cryptocurrency assets such as Bitcoin and Ethereum. Since January 1, the market cap of cryptocurrencies has risen from $17.7 billion to $163.5 billion as of October 29, 2017. The rapid creation of new cryptocurrency assets has undoubtedly contributed to this surge in valuation, as dozens of new cryptocurrency tokens are being issued and traded on a weekly basis. Most newly created cryptocurrency assets raise funds through an Initial Coin Offering (“ICO”), a process similar in many respects to Initial Public Offerings but typically with few or no restrictions as to who can invest (vis-à-vis e.g. investor nationality, accreditation, etc.). The last six months in particular have seen a spectacular increase in the amount of money raised through ICOs, as some projects have raised as much as $257 million within only a few weeks. Astonishingly, the cumulative funds raised by ICOs more than tripled the amount raised through traditional Venture Capital fundraising in Q2 alone. This gulf appears to only be growing, as the expanse of ICO fundraising appears to be accelerating.
The ascendance of ICO fundraising has not been without incident. Indeed, false claims as to product viability and even outright scams have proliferated. Nonetheless, projects with dire prospects of success continue to raise immense sums, often leaving investors with rapidly depreciating assets and little in the way of legal recourse. Because the space has grown far more quickly than the body of law governing it, a number of fraudsters and money launderers have absconded with millions. Recently, however, a number of financial regulatory agencies worldwide have begun to carefully scrutinize ICOs in order to protect retail investors. Let us take a look at some of the regulatory responses to the ICO craze.
I. Blanket Ban: China
In early September, 2017, the People’s Bank of China (“PBOC”) unexpectedly announced that it would issue an outright ban on all ICO fundraising, implementing a plan which has since made it a financial crime for Chinese residents and citizens to invest in ICOs. Though deemed by many to be an unnecessarily severe measure, the reasoning behind this blanket ban is not without merit. As previously stated, there has been a surfeit of scams and thefts within the ICO space; this appears to have been doubly true within China, as “get rich quick” schemes seem to have plagued Chinese retail investors. Moreover, the PBOC’s ICO ban is very much in line with its regulatory responses to international financial technology more broadly. Indeed, China often enlists the strategy of “Ban First, Regulate Later,” as might have been the case with Google, Facebook, and even Bitcoin itself. Furthermore, special economic and political considerations exist related to the Chinese government’s determined effort to curtail capital outflows, which devalue the Chinese Yuan and weaken the Communist Party’s stronghold over national finances. There is much speculation that the PBOC ICO ban is only a temporary stopgap before a more permanent solution can be introduced. One potential such remedy is being implemented by Russia.
II. Registration and the “CryptoRuble”: Russia
Earlier this week, Russian President Vladimir Putin issued an order to the Russian Parliament to regulate ICOs by bringing them under the ambit of existing securities laws. Unlike the uncertain long-term stance adopted by the PBOC regarding ICOs, Russian regulators have explicitly vowed to “not kill” ICOs. Noting the immense potential of cryptocurrencies as an asset class, Russia appears to be aiming to strike a balance between laissez-faire regulation—which would leave retail investors at risk—and extreme scrutiny, which could lead to missed opportunities for innovation and development. A novel approach adopted by Russian regulators to combat the capital outflow problem—not to mention the rampant tax evasion typical of cryptocurrency investors—is the planned issuance of a national cryptocurrency: the “CryptoRuble.” This asset would function as an intermediary between fiat cash and other cryptocurrency assets. Whenever an investor opts to purchase Bitcoin, for example, he would first convert his Rubles to their CryptoRuble equivalent; doing so would incur a 13% tax, to be collected by the government. It remains to be seen what successes, if any, will result from this innovation. However, there is much cause for investor optimism in a major power choosing to work with, and not against, blockchain technology.
III. Cautiously Keeping Watch: The United States
Unlike the Russian and Chinese regulatory authorities, the U.S. Securities and Exchange Commission (“SEC”) has remained relatively quiet regarding general ICO regulation, providing little in the way of guidance as to how ICOs will be dealt with in the immediate future. One active measure undertaken by the SEC has been to target specific American-operated ICOs that are clearly fraudulent, thereby holding perpetrators accountable. Additionally, the SEC has stated its intention to be vigilant in pursuing regulation of ICO currencies that clearly fall under the scope of U.S. securities laws, and has otherwise opted to not go after those ICOs that do not issue securities. Still, the demarcation between ICOs that are securities and those that are not remains somewhat unclear. The test for determining whether an asset qualifies as a security under U.S. law—the Howey Test—is over 70 years old, and cannot possibly have been created with cryptocurrency assets in mind. Much remains to be seen within this space: whether, for instance, the U.S. government will promulgate an outright ban of ICOs, or instead create its own currency to combat capital outflows, or whether a new test for securities will be created with cryptocurrencies specifically in mind—or, perhaps, whether it will continue watching from afar, stepping in only when absolutely necessary.
Prior to enrolling at Columbia Law School, Arthur attended Columbia University (’16), where he studied economics, statistics, and philosophy. Arthur is an avid financial technology enthusiast.