Charltons: Cryptocurrency and ICO update 3 February 2018
Julia Charlton and Kim Larkin
JC: It’s Saturday 3rd February 2018 and I’m here with my colleague, Kim Larkin, to talk about what’s been happening in the cryptocurrency regulatory space over the last week or so. This week we’re going to not talk so much about Hong Kong and we’ll talk more about what’s been happening in other places. As we are only Hong Kong lawyers and are not qualified to comment on other jurisdictions, this is very much just in the way of a chat about what we can see from the media and hear from our clients about what has been happening. So Kim, I understand that Facebook and Tencent, the operator of Wechat the Chinese equivalent, have both come out this week to say that they will not support advertising of ICOs and crypto trading exchanges. Can you tell me a bit about that and the impact you think it’s likely to have.
KL:Yes well Facebook came out first on 30th of January with a post on their blog saying that they are changing their policy and will ban adverts relating to Bitcoin and ICOs among other things and then the following day, the 31st, one of the Tencent group companies, Tencent Internet Finance said that they are banning advertising of ICOs and cryptocurrency trading, and any other related services such as payment channels and other promotional services. I think what’s interesting in both of these cases is that they both talk about the fraudulent downside of cryptocurrencies and Tencent’s announcement is entitled “Putting an End to “Virtual Currencies” Illegal Financial Activities”. “Illegal” here is an obvious reference to the September 2017 government statement which actually declared all ICOs and cryptocurrency trading to be illegal in China. Because in China they have suffered a lot of fraudulent activity – there was a statement back in September 17 saying that some 90 per cent of Chinese ICOs were thought to be scams. And I think that’s probably why China cracked down so quickly and probably harshly, which has also led to criticism that in some ways the restrictions that have been placed on ICOs have really led to China losing its lead in this space, and also that the funding for blockchain applications which ICOs are used for has has been pretty much dampened by the very stringent regulation in China.
JC: Yes that’s interesting because I was actually hearing that India is trying to clamp down on ICOs but at the same time is trying to promote blockchain, and as you’ve just mentioned to some extent the two may go hand in hand because of the access to funding.
Of course there may be many motivations for Facebook and Tencent restricting promotion. They may be afraid of being prosecuted themselves perhaps for promoting these instruments that might be securities etc. and presumably they also may get advertising from banks and have other links with banks, so you do wonder about some of the motivation for this.
But the U.S. hasn’t banned CEOs has it, so what do you think the motivation for Facebook is in coming up with this restriction?
KL:That’s a good question. I mean you’re right, ICOs and cryptocurrencies have not been banned in the US. As long as they do not constitute securities and I think there are some other regulatory requirements that need to be complied with. But as long as a company complies with whatever the regulations are, there’s no actual ban on trading cryptocurrencies or issuing an ICO. The Facebook blog post actually talks about the promotion of financial products that are “frequently associated with misleading or deceptive promotional practices” and it lists a few, including binary options and also ICOs and cryptocurrencies. And yes, sure there have been some fraudulent ICOs in the US, a case in point there’s a big regulatory case this week where the U.S. has started proceedings against a cryptocurrency banking company called Arise Bank, but that is on the basis that it is alleged to be fraudulent. But I’m sure that for every fraudulent ICO, there are many more which are perfectly legitimate.
JC.: Yes, like some of the ones we see people come to us for advice on.
KL. Yes, exactly, ones either saying this is not a security, it’s basically crowd funding and is not a security under U.S. law, or other ones which maybe do fall within the security definition where the U.S. regulations such as for sales only to accredited investors are being complied with. So I think it’s in some ways it’s unfortunate that the emphasis seems to be tainting what in many cases is a perfectly legitimate fundraising source. The jurisdictions that you’re seeing clamp down on them tend to be the ones where there is a degree of fraud – places like Russia, China and even in South Korea, they have been tightening up the regulation. I think there there have been fraudulent ICOs as well and also a lot of problems with hacking, I think from North Korea. So in each jurisdiction there are particular dangers that the regulators are trying to contend with, but I don’t think that necessarily means that the underlying ICOs are problematic in themselves.
JC.: Yes absolutely. So the US has also I’ve heard made it difficult for people to list ETFs that invest in Bitcoin. Do you think that’s the case?
KL:Yes certainly. The US SEC issued a letter on the 18th of January saying that it does not intend to approve any retail ETFs which are going to invest in bitcoins and other cryptocurrencies. And here they are citing investor protection concerns and they set out a number of concerns that they have with investments in cryptocurrencies, the main risk that I think they are worried about are things like fraud and manipulation, things like the valuation and how you value an ETF which invests in bitcoin, and things like arbitrage as well as liquidity. So again the SEC is very much putting the emphasis on investor protection which may be valid given that these are retail ETFs being offered to members of the public. They’re not restricted just to professionals. But again I think it would be good if that was balanced with some kind of explanation that the investment in Bitcoin is not necessarily a bad thing. Yes, there are things to be ironed out, but maybe ETFs that are only being offered to those who are sophisticated enough to understand the risks could be allowed. I see that this week the Ontario Securities Commission has just approved their first bitcoin-invested ETF which is going to launch on the Toronto Stock Exchange next week.
JC: Yes, I’ve heard about this Ontario Securities Commission approving the blockchain ETF which is really interesting. Apparently, it is set to launch on the Toronto Stock Exchange next week. What I heard was that Harvest Portfolios, a Canadian investment management company, filed the preliminary paperwork for a blockchain technologu ETF in January which is really interesting because this is actually an officially approved product and apparently it will invest in equity securities of issuers exposed directly or indirectly to the development and implementation of block chain and distributed ledger technologies. So that sort of brings us back to the point you were talking about earlier which is where does the money come from to actually invest in the potentially hugely beneficial blockchain technology which may well move economies forward. I think it is extremely welcome that the Canadians are actually seeing an official way forward with this instead of more of a knee-jerk reaction of seeking to ban various areas in the attempt to stamp out fraud, which of course happens in all areas of investment. It just happens to be much more clearly and historically regulated in areas which are not in the crypto space. Just to move on though, I’ve heard that there are rumours that South Korea is going to follow China by banning crypto trading exchanges. I’ve also heard that they’ve stepped back from that ban. What have you heard about that and what’s the latest on that?
KL:Yes there were rumors for several weeks mainly from the end of December about South Korea putting a ban on the trading of cryptocurrencies and I think the financial regulator actually came out with a statement saying that they were actually working on it. Then they do seem to have stepped back probably because Bitcoins are so widely held in South Korea. I think after Japan, it’s the second biggest trading market for cryptocurrencies. So, what they did instead and I think this is quite sensible, is that rather than actually ban the trading of cryptocurrencies, they have tightened up the banking account system. I think previously a cryptocurrency exchange would have an account with a bank and then the bank would then allow people who wanted to trade on the relevant exchange to have virtual accounts which were anonymous. And this is where there was a big concern around fraud and money laundering etc. So what they have now done is they have banned that system from the beginning of last week and so now anyone who wants to trade has to open their own named bank account with the same bank that the exchange they’re trading on has an account.
JC: So it’s going the sort of KYC / AML route to dealing with this rather than a total ban which would seem to make a lot of sense in that they are just making it more transparent.
KL:Yes exactly. But the thing is of course that this will then slow down trading on the exchanges because if you want to trade, you can’t just go along and put your money in a virtual account.
JC: So now this is huge barrier to entry into the market.
KL:So I think there are also only six banks in South Korea which are actually authorized to do this.
JC: That’s interesting isn’t it. Well they must be happy.
KL:And I think there’s also a ban on foreigners opening trading accounts with the banks.
JC: I can understand that. I mean I did hear there were a lot of arbitrage opportunities going on of people actually going back and forth to Korea and actually collecting currency because of the arbitrage of the price of crypto in Korea compared with the price in other places.
KL:Yes, I think bitcoin is trading at least at a 40 per cent premium in Korea. I wish I had thought about getting a ticket to Korea. Also they put in place new anti-money laundering guidelines for all banks to comply with, really beefing up the amount of KYC that banks have to conduct on anyone who wants to trade Bitcoin or any other cryptocurrency on an exchange. So that seems to be a far more sensible way of regulating these things.
JC: It does and it’s interesting that both Japan and Korea are sort of finding a way through this to actually allow it to happen and find some type of equilibrium on regulation. So what about other jurisdictions are they looking at regulating ICOs and Cryptocurrencies?
KL:Yes. Russia is going a similar way. Rather than ban it, they want to legalize it and they are also going to bring in regulation. They are going to bring in requirements for any exchange that’s trading cryptocurrencies that they will have to be licensed and then there will be capital requirements and they are going to impose limits on how much unqualified investors can buy in terms of digital coins and tokens. So again, there will be AML/KYC procedures carried out on anyone who wants to buy into cryptocurrencies through an exchange. And Russia interestingly also is talking about having their own national cryptocurrency which is going to be called the Cryptoruble which will be legal tender in Russia. At the moment, I think the only country that has a legal means of payment in terms of cryptocurrency is Japan where they legalised Bitcoin at least a year ago and were well ahead of the pack.
JC: Well that’s so interesting isn’t it. Yes and how about Hong Kong’s great rival, Singapore. What are they doing at the moment?
KL:You hear a lot about Singapore supposedly being ahead of Hong Kong in this space, but I think that is not actually true. What they have done is that they recently issued a consultation paper which is still out for responses which well basically require anyone who is trading virtual currencies or e-currencies through a digital wallet – those entities will have to be licensed and then they will also have to comply with certain requirements, capital requirements, AML and also various requirements around the technology and how it is protected, how they protect data that kind of thing.
JC:Yes, I have heard that some people actually like the idea that there is a licence because it makes them feel OK that what they are doing is what is allowed there. Where they are licensed and nothing is going to change dramatically, whereas in Hong Kong it just isn’t really regulated unless it happens to fall into existing legislation.
I think for some people that’s an enormous opportunity for others it creates much uncertainty for them as to what might happen next so that they don’t want to make the same level of investment that they might be willing to make in Singapore, although of course it remains to be seen whether this goes ahead.
KL:But in reality, any cryptocurrency exchange in Hong Kong is obtaining an MSO license – not because the cryptocurrencies are regarded as money or currency because they’re not, the FSTB an the Monetary Authority have both said that. But still if they are actually receiving real money or they’re exchanging it for cryptocurrencies, most of these exchanges to be cautious are getting the licence and most of them are also carrying out KYC.
So Hong Kong is really self-regulating. It hasn’t got that official stamp from a regulator which in some ways might be a good idea, and especially if it would help people opening a bank account which is where the real problems start.
JC: Yes, you’re right. Because you can have all the freedom in the world, but if you can’t ever open a fiat currency account then it becomes much less attractive, doesn’t it.
KL:Yes. So then you are forced to open a bank account in jurisdictions which are regarded as maybe sheltering shady activities which then makes cryptocurrencies look shady, when they actually are not.
JC: Yes, well let’s see what’s happening in the coming week. There certainly seems to be a lot happening at the moment. Thanks Kim.