Explaining China’s ICO Ban

EXCLUSIVE – China just jumped on the bandwagon of governments regulating ICOs… by banning them. The question that experts can’t seem to agree on is: why?

Joshua Klayman, an expert in the legal aspects of blockchain technology, confirms that new regulations are already changing the global cryptocurrency ecosystem.

Klayman, a founding partner and head of Morrison & Foerster’s Blockchain + Smart Contracts Group who has written extensively on this issue, participated in an interview with Bank Innovation on September 5th.  She pointed out that, although China has taken the efforts to regulate cryptocurrency markets “a step further” than others by banning ICOs completely, and by forcing ICOs to return money to investors, the sentiment of caution it has expressed with respect to the dangers of ICOs is consistent with those of the governments of Israel, Russia, Hong Kong, and the United States.

ICOs are a means of crowdfunding with the use of cryptocurrencies. Cryptocurrencies are digital currencies that use blockchain technology.

Chinese regulators announced on Monday that they have banned initial coin offerings (ICOs) in the People’s Republic of China, ordering that all fundraising activities “cease immediately.”

Several Chinese government entities have announced that ICOs are being used, in large part, as a cover for scams within the country, and the PBoC reported that ICO funding “disrupted economic and financial order.”

Some see China’s ban as an extreme measure, but the tone of its announcement echoes that of the United States’ own Securities and Exchange Commission: a certain percentage of ICOs are, in a word, scams. Thus, the SEC has recently issued warnings about the risks of ICOs, along with other national governments.

In this regard, the Chinese government is following suit with many other governing bodies throughout the world.

However, it is important to note that some, including Klayman, have expressed a skeptical view that concern for investor safety may not be the only motivator for state governments to crack down on cryptocurrencies. With regard to the Chinese ICO ban, in particular, Klayman remarked, “I don’t know if the shutdown was motivated by a concern for the investors, or if they just want to control the market.”

Control for the rapidly expanding and relatively unregulated cryptocurrency is on everyone’s mind. Outside of China, where ICOs remain legal, governments are swiftly erecting regulatory and legal infrastructures to help govern those in the cryptocurrency space.

There are multiple thoughts on why this trend has developed. Some skeptics go so far as to suggest that these governing bodies are attempting to regulate the expanding cryptocurrency market in order to maintain their once-unchallenged, possibly-fading monopolies on printed and digital currency.

In a nutshell, this perspective suggests that cryptocurrencies like bitcoin represent an alternative to, and possibly competition for, government-backed fiat currency. In a recent article for Forbes, Panos Mourdoukoutas expressed his conclusion that “big government” may be cryptocurrency’s natural enemy.

Mourtoukoutas’ tone in his opening sentences is particularly revealing of stance on the cryptocurrency, or rather, Bitcoin, issue: “Big governments cannot tolerate Bitcoin, the digital currency that threatens to break their monopoly on printing money, and to manipulate the economy to accommodate the interests of powerful elites. Sooner or later, they will crush it.”

From this perspective, taken to the extreme, the attempted regulation of cryptocurrencies can be seen as an attempt to control a free, unregulated market that challenges government dominance over currencies.

On the other hand, professionals like Klayman see new regulations, and possibly even China’s out-right ban on ICOs, as a potential positive. They point out that new regulations may be an opportunity to elevate the importance of legitimate ICOs. Klayman states that, on a global scale, “The net result of China’s actions are that it is, in some ways, clearing the way for responsible [emphasis mine] token issuers… and to add legitimacy to this form of fundraising.”

No one seems to argue against the point that, regardless of whatever regulations may be put in place, a certain percentage of ICOs are going to be scams. The question seems to be how to — and whether or not to — go about regulating cryptocurrencies in light of this fact.

For example, institutions may be able regulate ICO activity by regulating the cryptocurrencies they use, and by filing these cryptocurrencies under a broader term: “securities,” as the SEC calls them. Here in the United States, for example, Klayman points out that some tokens are already legally classified as “securities,” and as such, must comply to their jurisdictional regulations governing securities.

This fact raises yet another issue: investors and cryptocurrency enthusiasts may think that the cryptocurrency they are investing in constitutes an unregulated token, but it very well may be a security in the eyes of the law of whatever legal jurisdiction they are operating in.

How exactly does an investor tell whether a particular token is or is not classified as a security?

The answer is that no one really has a definitive answer to that question at this juncture.

As Klayman explains, blockchain technology regulation is an emerging field of law, and the line that separates tokens from securities is still blurry. We may have laws that clearly define what is a security, but “the challenge is that we don’t have guidance as to what is not a security.”

The future of this quickly expanding market, and of this emerging field of law, is up in the air, as governments around the world and at every level struggle to make sense of what blockchain technology means for their constituents. Perhaps these governing bodies will take the Chinese route and outright ban ICOs, and perhaps they will take a more moderate approach and attempt to regulate them.

It is also uncertain whether or not the Chinese ban on ICOs will damage the global ICO market beyond repair. Of the $1 billion USD that has been raised globally this year from ICOs, $400 million USD has originated from China. That’s 40% of the global ICO market that, essentially, just disappeared.  Yes, cryptocurrencies can be used even without ICOs, but their popularity and their ability to yield high returns in a short amount of time likely didn’t hurt investors’ eagerness to invest in cryptocurrency and blockchain technology, either.

Now, with the effective freezing of ICO activity in mainland China, the global cryptocurrency market braces for the impact of the Chinese government’s momentous decision.