In early September, China’s central bank declared that initial coin offerings (“ICOs”) are illegal, sending shockwaves throughout the virtual currency industry. The People’s Bank of China (“PBOC”), along with six other regulatory agencies, called ICOs “essentially a form of unapproved illegal public financing behavior,” and evaluated these transactions as “financial fraud and pyramid schemes”.
Despite the market’s reaction to China’s outright ban (with Bitcoin’s value dropping around 15 percent immediately after the ban), the crackdown is hardly surprising. The Chinese government has always demonstrated mixed feelings towards ICOs and virtual currency, particularly given its tight capital controls on physical currency. Its intolerance seemed to peak when 90 percent of the ICOs are reported as fraudulent, flawed, or get-rich-quick schemes.
The implications of China’s blanket ban can be multifold for Hong Kong and mainland China-based virtual currency businesses, especially for those who have invested in ICOs and the virtual currency exchanges that facilitate the sales. Legal advisors should be fully aware of, and well prepared for, the ramifications.
An immediate issue of concern could be from regulator’s demand to return funds already raised through ICOs to investors. A list of 60 major ICO exchanges that have held ICOs was prepared by the Chinese government for local financial regulatory bodies to inspect and report on. Those exchanges, along with token issuers, will be exposed to heightened scrutiny from regulators on the execution of the government’s instructions. The exchanges may even attract the attention of regulators outside of China, such as those in the US and UK, who have a track record of conducting parallel probes triggered by local government investigations.
In addition, China’s outright ban sets the stage for a global regulatory crackdown on ICOs. The US Securities and Exchange Commission (“SEC”), for instance, said in July that ICO issuers must adhere to federal securities laws, and, just this month, an SEC co-director criticised illicit ICOs, comparing those seeking to improperly leverage the offerings to “roaches”. Singapore, Korea and Japan also laid out new rules this summer, highlighting the risk of money laundering and fraud that investors face when buying into a digital token sale. Notably, the Hong Kong Securities and Futures Commission, in a statement, appears to be following in the footsteps of other regulators by underscoring the need for any digital token sales to adhere to securities laws.
Many things are still unclear about the ban. It is unclear, for example, whether it only applies to Chinese-domiciled organisations, or if it would also include non-China-based ICOs that sell to Chinese investors. While the US SEC could theoretically exercise its long-arm jurisdiction, it is unclear if China has the ability or desire to “punish” foreign token issuers beyond simply banning their tokens from being traded on Chinese exchanges or by Chinese financial institutions.
Overall, China’s statement on ICOs was a strong, decisive move towards greater consumer protection, greater monetary control, and more effective anti-money-laundering measures. As the virtual currency-based crowdsale model matures, increasing regulatory action worldwide seems inevitable. It is crucial for Hong Kong lawyers with clients in the virtual currency space to keep a watchful eye on the budding regulatory landscape.