CRYPTOCURRENCY REGULATION - LEGALITY, TRENDS & ANALYSIS

The legality, risk & fraud activities of cryptocurrencies have become controversial in the global financial economy. Companies take different response to cryptocurrencies, where some are considering adopting it; some even establishing their own; some are planning to apply restriction on it and some are keeping a close eye on it.

This following article provides you more insight into the cryptocurrency regulation, and the foreseeable global market trend.

Raising Business, but also Fraud & Risk

Initial Coin Offering, or ICO, has become a fast growing way for startups to raise funds with cryptocurrency, which is backed by the distributed ledger technology (DLT) – or Blockchain – a more familiar terminology for the general public as one of the famousest example of DLT. The idea of ICO can be thought as a digital version of crowdfunding, where tokens are issued to the investors instead of shares, which is thenpaid back by cryptocurrency, most commonly by Bitcoin or Ethereum.

Fast Growing ICO– As the ICO is a relatively easy fundraising tool – compared to the traditional way, such as venture capitals or equities – the global financial world has experienced a dramatically bloom on the ICO in 2017. Fig 11 shows that ICO has raised over US $3 billion in 2017 and Fig 2 shows that ICO penetrating into different industries.

Fraudulent Activities– The new era of ICO can lead to new potential illegal fraud activities; unlike the traditional methods, ICO is currently not heavily regulated and does not have solid legalisation on the fundraising firm, for instances, currently the start-up companies are able to establish ICO without regulated standards on transparent disclosure, on financial statement evidences, on business operating model and organizational structure. This allows certain “shell” companies to raise funds without prudent record and be able to instantly withdraw all the funds (or even close the business in some cases), ultimately investors might become potential victims to invest their money in scams. The ICO might potentially provide new platform to undergo money laundering and terrorist activities.

In Sep 2017 China had announced a list of 60 major ICO platforms that would undergo a series of regulatory inspection and generated report for suspicious illegal activites2; in the same month, US SEC had charged 2 ICO platforms, “Recoin” & “DRC World”, for selling unregistered securities & coins to investors with frauds3.

High Investment Risk– Due to the blooming transaction volume and growing rate of cryptocurrency, market capitalization rate has dramatically surged in past 12 months. Bitcoin price value has recorded a historically more than USD$10K in Nov 2017, for example. However, the fluctuation and volatility of the price value is also extremely high; the demand & supply of a specific cryptocurrency fluctuated in minutes in a digital world. Under this circumstance, investors holding tokens or coins are exposed to extremely high investment risk --- especially, an investment not regulated by any regulatory bodies in many jurisdictions. The price volatility of cryptocurrency can be referenced from the public sources such as website of data provider Coin Market Cap4.

Legality Debate

While Bitcoin, Ethereum, Ripple and other common cryptocurrencies start impacting the global financial market in both positive (in terms of economy) and negative (in terms of stability) way, many government officials, bankers, investors or even traders may not even realise if they are trading on a legal currency. The answer to this question, surprisingly, is “Yet to know”, or “Yet to be defined”.

In the traditional financial world, “currency” is acting as a transaction medium and must be able to fulfil several behaviours such as liquidity, issuance by government or authorized financial institutions, immunity for counterfeit, etc. Obviously, cryptocurrency is disordering the traditional concept of “legal currency” and therefore it is hard to apply current monetary policies & regulations in a digital world.

On the other hand, the ICO activity involves the concept of an IPO while tokens just like digital “shares” that allocate to the investors. Therefore, there are debates around if cryptocurrency should be treated as “securities”, and regulated by territory’s Exchange rules; some debaters would try to treat the ICO as a virtual “asset”, which price may fluctuate according to the market news, and be able to convert back to any “real” assets according to an unregulated exchange market rate.

While there is yet to have a conclusion around the legality of cryptocurrency in the global market, the responses are different from one jurisdiction to another. In the coming section, we are going to list out and compare their approaches.

China– Active Monitoring / Restriction In-forced

On 4th Sep 2017, the People Bank of China announced that ICO is an illegal activity and has listed 60 ICO platforms for further investigation. All of the digital token financing and trading platforms are defined as illegal and must be stopped immediately5. This is the result for an increasing fraudulent and money laundering cases related to ICO, and for the fact that China has significant contribution in the ICO trading market. One report stated that in the first half of 2017 Chinese companies had raised US $383 million from 105,000 investors6. The prohibition of ICO and exchanges of cryptocurrencies indicate a signature step for China to apply active restriction in order to avoid potential financial “bubbles” that could direct impact on financial stability. Being one of the leading countries in digital currency development, other Asian countries will have high chance to follow.

One point must be noted is that while China is banning all the ICOs and cryptocurrency exchange platform, this does not seem to stop the “existence” of cryptocurrencies. This is no surprise after considering the economic benefits that have been brought in by Bitcoin or Ethereum to China in 2017 (Fig 3 illustrating Bitcoin price raising for 13 times over 2017) and the underpin Blockchain technology is continuously attracting the market focus in the FinTech development. Market reporter stated that China is aiming to develop a centralised and well regulated digital currency platform/ mechanism to fully exploit the potentials of cryptocurrencies7. 

India, Malaysia, Singapore – Coming Regulatory Actions / Legal Clarification

India, the world largest remittance market, as well as the Asia’s major economy, has undergone hot debates on the legality of cryptocurrency. Indian Supreme Court – the highest court in India – has asked the country centralised government to set up a legal clarity on cryptocurrency as well as regulation. Recently, Bitcoin in India is considered not recognised as a legal transaction media, but neither illegal too9. Due to the ambiguity, the ‘big four’ Bitcoin exchanges in India (Zebpay, Unocoin, Coinsecure and SearchTrade) has set up a self-regulated body in Feb 201710.  The legal position of cryptocurrency will be in the agenda of India’s government meeting; with the prudent regulation of Bitcoin for integration for the remittance market could be a deterministic step for digital economy development9.

Malaysia, according to the head of Central Bank, has already setup a timeline to introduce a regulatory framework on cryptocurrency, targeting to be effective in early 2018. It will focus on anti-money laundering and anti-terrorism financing, and all the platforms that converting cryptocurrency into fiat currency would also be considered as “Reporting Institution” and will be required to follow the regulatory measures9.

Singapore, on 22nd Nov 2017, a consultation of retail payment service regulation was launched, with payment transaction using virtual currencies is also included in it. Hence, a sign of an upcoming legal formality of cryptocurrency and the transaction payment involving it will be regulated under transaction monitoring.

US, EU, Hong Kong– High Degree of Awareness from Regulatory Bodies 

The majority of the global economies, however, are keeping high degree of awareness on it, rather than setting up a concrete time table for a governance model at this moment.

In the US, while SEC has kept combating illegal ICOs, as stated earlier, the Treasury stated that they yet to have a specific time table to confirm the legal position of the cryptocurrency. The implication is that, cryptocurrency is recently being treated like other investment products, and therefore illegal activities are prohibited just like any other products9.

Hong Kong has also reacted similarly towards cryptocurrency– while there is yet to be a legal formality and regulation on it. On 5th September 2017, the SFC in Hong Kong has raised concern on ICO, after the announcement from China about banning ICO on 4th September 2017, emphasising that ICO may falls on the definition of “securities” and will be regulated by the existing SFC guidelines11.

The EU evaluated the cryptocurrency as a “speculative financial instrument”, which the amounts involved are still marginal to generate monetary risks. While close awareness is necessary, it is still not yet being regulated.

Cryptocurrency trading activities as well as ICO have experienced a dramatic surge in 2017, and the underpin technology -- Blockchain is one of the key eye-catching items in the development of FinTech. There is no doubt that the concept of cryptocurrency together with Blockchain is beneficial in terms of lower transaction cost, secure digital transaction & execution efficiency.

On the other hand, more and more illegal cryptocurrency related activities occur, utilising the feature of the anonymous transaction and distributed ledger. The risk building up in the financial ecosystem is rapidly emerging and appropriate governmental response is necessary.

It can be foreseen that the global financial market will have a direction to setup an international standard on ICO & cryptocurrency payment transaction. Each of the global economy entity will define the legal position of cryptocurrency as well as setting up a governance model to achieve regulation and risk control mechanism.

The year of 2018 would be a critical year for economy entities to achieve this. There is no doubt that cryptocurrency can continue as a driving force in developing the future financial market, when it is well-governed.

Sources:  

1. The SEC has charged two initial coin offerings with defrauding investors: Tech Crunch 
2. Coin Market Cap

3. Bitcoin Tumbles as PBOC Declares Initial Coin Offerings Illegal: Bloomberg

4. China has banned ICOs: Tech Crunch 

5. China’s central bank is developing its own digital currency, even as it bans bitcoin and private cryptos: SCMP

6. Bitcoin Regulation: Abu Dhabi Financial Regulator Considers Cryptocurrency Framework: CCN

7. Indian Bitcoin Startups Join to Launch Self-Regulatory Body: CCN

8. Statement on initial coin offerings: SFC

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