Regulation of Cryptocurrency and Initial Coin Offerings (ICOs) in Hong Kong and other Jurisdictions

Introduction

In Hong Kong, as elsewhere, cryptocurrencies, blockchain – the technology which underlies them, and initial coin or token offerings (ICOs), are changing just about everything, from banking, payments and capital raising, to commerce, healthcare and education.

In 2017, the combined market capitalisation of cryptocurrencies surged to over US$60 billion from US15 billion, while the price of Bitcoin, the first cryptocurrency, soared 1,500%. ICOs in the first 8 months of 2018 raised US$ 6.8 billion [1], more than the US$6.1 billion raised in 2017. There has been exponential growth in cryptocurrencies, also known as “altcoins”, over the past two years and there are now over 1,900 cryptocurrencies, with a combined market capitalisation of US$233 billion [2].

Bitcoin, like other cryptocurrencies, depends on blockchain technology – an “open distributed ledger” which records transactions between parties in a verifiable and permanent way. Its key advantage is that it allows transactions to be recorded in a digital format which are “stored in transparent, shared databases, where they are protected from deletion, tampering, and revision” [3].

The value of Bitcoin grew at a phenomenal rate in 2017 suggesting huge speculative appetite for cryptocurrencies. However, since reaching a record high of US19,511 in December 2017, the price of Bitcoin has more than halved. Bitcoins are also still not widely accepted as a medium of exchange, making it unlikely that they will replace fiat currencies in the near term.

What is an ICO?

ICOs are a method of crowdfunding for a blockchain-based technology, in which investors are offered newly-issued cryptocurrency coins in exchange for fiat currencies or other cryptocurrencies, typically Ether. However, as The Economist [4] has noted, ICOs should not be confused with Initial Public Offerings (IPOs) which are very different in that ICO investors do not normally receive ownership rights or a share of the platform’s profits. Instead, an ICO coin or token typically gives the holder rights to use the technology once it is developed, and in some cases, is exchangeable for fiat currency if the cryptocurrency is accepted for trading by a cryptocurrency trading exchange.

Further, in contrast to IPOs which typically require the publication of a detailed prospectus which includes the company’s audited financial statements and has been subjected to due diligence, there are no regulatory requirements governing information disclosure for ICOs in most jurisdictions. ICO issuers are typically start-ups and information describing the technology and details of the coin offer is set out in a relatively short white paper.

ICO Regulation

Over the past year to eighteen months, regulators around the world have warned consumers of the risks of investing in cryptocurrencies including price volatility, fraud, theft and hacking of cryptocurrency exchanges. Other key concerns are the use of cryptocurrencies for money laundering and terrorist financing. Yet the technology underlying cryptocurrencies – including blockchain – offers tremendous benefits both in the financial industry and many other spheres. The challenge facing regulators is thus how to protect consumers and stamp out illegal uses of cryptocurrencies without stifling the development of distributed ledger technology (DLT). Indeed, as noted by IMF Managing Director, Christine Lagarde, developments in technology, particularly in regulatory and supervisory technology, offer tools to counter criminal involvement in cryptocurrencies [5]. Artificial intelligence, cryptography and biometrics should improve digital security and facilitate the identification of suspicious transactions while DLT can be used to implement know-your-client and anti-money laundering procedures.

There is currently no unified approach to the regulation of cryptocurrencies. Nor is there any internationally agreed terminology: the terms cryptocurrency, virtual currency, digital tokens, and crypto assets have different meanings when used by different regulators. As discussed below, it was only in June 2018 that a senior official of the US SEC declared that current sales of Ether are not securities transactions, suggesting that initial sales of Ether during the fundraising phase may have been securities transactions. For the purposes of this note, the term “cryptocurrencies” includes digital tokens issued in an ICO.

At the time of writing, China and South Korea are the principal jurisdictions to have declared ICOs to be illegal [6]. China also prohibits trading of cryptocurrencies on crypto exchanges. Japan is currently the only jurisdiction to have legalised cryptocurrencies as a legal means of payment and Bitcoin is widely accepted by Japanese retailers and also for payment of utilities bills. Financial intermediaries licensed to deal in cryptocurrencies are subject to capital and anti-money laundering requirements. Cryptocurrencies are also subject to Japan’s tax regime. Other jurisdictions, notably Gibraltar, Malta and Switzerland, have implemented or proposed to implement specific ICO regulation aimed at fostering ICOs and their development as ICO hubs.

Most other jurisdictions have not issued cryptocurrency-specific regulation and the trend has been for regulators to state that irrespective of the name given to a cryptocurrency, if it bears the features of a regulated instrument, it will be regulated under the existing laws applicable to that instrument. In 2017, a number of regulators issued statements that cryptocurrencies which have the characteristics typical of securities (e.g. shares, debt and other investment products) will be regulated as such irrespective of the name ascribed to them. Given that cryptocurrencies vary widely, regulators have stressed the need to conduct the legal analysis on a case-by-case basis. In some jurisdictions, such as the US, ICOs may also be regulated under commodities laws.

Note: The above represents Charltons’ current understanding of the regulation of ICOs in different jurisdictions. Charltons advises only on Hong Kong law and while the above represents our understanding of the legal position in certain other jurisdictions, legal advice from qualified lawyers in the relevant jurisdictions should be sought in relation to any particular transaction or situation. Further, this note is intended for educational purposes and it does not constitute Hong Kong legal advice. Specific advice must be sought in relation to any particular situation. 

August 2018

Notes

  1. Data from ICODATA.IO as at 1 September 2018
  2. CoinMarketCap at 1 September, 2018.
  3. Harvard Business Review, “The Truth About Blockchain”,
  4. Ibid
  5. IMFBlog. Christine Lagarde. “Addressing the Dark Side of the Crypto World”. 13 March 2018. <https://blogs.imf.org/2018/03/13/addressing-the-dark-side-of-the-crypto-world>
  6. Others include Bolivia and Ecuador

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