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Regulatory Approaches to Bitcoin

The regulatory definition for bitcoin is unclear and varies across countries. We believe depending on the use-case for bitcoin, different regulations are likely to be applied. For instance in remittances and money transfer, bitcoins are likely to be categorized as a currency, and therefore subject to anti-money laundering (AML) laws. On the other hand, bitcoin as a commodity would be subject to tax laws.

Japan – Government recognized bitcoin as a valid payment method in Apr. 2017 and required crypto-currency exchanges to register with regulators. In Sep. 2017, the FSA officially licensed 11 new operators of crypto-currency exchanges. After the recent hack on Coincheck, the FSA has also stepped up on-site inspections on cryptocurrency exchange operators to check for vulnerability.

Switzerland – FINMA states that bitcoin operators and virtual currency platforms are subject to the AML Act and must therefore be a member of one of the selfregulating organizations or be regulated by FINMA. Regulators also introduced a regulatory sandbox to promote FinTechs including bitcoins.

US – The U.S. Commodity Futures Trading Commission (CFTC) ruling in 2015 defines crypto assets as commodities. In 2017, the CFTC also approved the first federally regulated digital currency options exchange / clearing house for cryptocurrencies. CFTC published a primer in Oct. 2017 on virtual currencies, explaining that the structure of the token will determine classification as security/commodity. CFTC also published a backgrounder in Jan. 2018 outlining the oversight and approach to the virtual currency futures market.

Elsewhere globally, bitcoins are still in a grey area, with some countries like China, South Korea and Russia banning them to varying degrees; whilst others are still working on possible regulations.

Australia – The govt. has proposed a set of reforms to bring digital currency exchanges under the remit of the Australian Transaction and Reporting Analysis Centre (AUSTRAC) as a way to regulate exchanges (link).

China – Regulators have termed ICOs as unauthorized and halted all fundraisings (link). In addition, regulators are also contemplating a ban on Bitcoin and other virtual currency trading on domestic exchanges (link).

European Union – Issued warnings on the risk of investing in virtual currencies and indicated that AML and anti-terrorist financing rules will apply. Recently, EU finance head Valdis Dombrovskis warned that EU will regulate cryptocurrencies if the risks associated are not tackled (link).

India – Reserve Bank of India currently working on policy for crypto-currencies including Bitcoins and is exploring a possibility of issuing its own fiat cryptocurrency (link). In a press release in Dec. 2017, RBI has cautioned users, holders and traders of virtual currencies including Bitcoins (link).

South Korea – FSC banned all forms of ICOs and the practice of loaning funds to trade cryptocurrencies (i.e. margin trading). In a recent move to curb speculation in cryptocurrencies trading, the FSC announced that it will ban virtual currencies traders from using anonymous bank accounts (link).

United Kingdom – Bitcoin is currently classified as a private currency. In Dec. 2017, FCA said in a press release that it is monitoring DLT-related market developments and keeping its rules and guidance under review.

© 2018 Citigroup

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Interview with King & Wood Mallesons: Urszula

McCormack

About King & Wood Mallesons

King & Wood Mallesons, founded in 1993, is an international law firm based in Hong Kong with a team of over 2000 lawyers in 27 locations. The firm’s practice areas include banking and finance, competition and antitrust, corporate and mergers and acquisitions, employment law and industrial relations amongst others.

About Urszula McCormack

Urszula McCormack is a Partner at King & Wood Mallesons. She is a financial regulatory specialist based in Hong Kong primarily focusing on financial technology and financial crime. Urszula’s key areas of expertise include financial services licensing, digital assets/stored value facilities, payments/remittance systems, digital banking platforms and AML/CFT sanctions; and she has played a significant role in developing the Hong Kong AML/CTF framework with the Hong Kong Association of Banks. Urszula is an ACAMS Certified Anti-Money Laundering specialist and is admitted to practice law in HK, England & Wales and New South Wales (Australia).

Q: Let’s talk about ICOs. Your firm is involved in a couple of dozen ICOs in

Hong Kong. So, are ICOs a fad or the future of investing?

It is an interesting question, as there is a lot of debate out there about whether or not tokenization is a bubble or whether it is here to stay. I think what we are talking here is a much broader question of the digitization of value – capturing it, shaping it, sharing it and even regulating it in new ways.

Blockchain and smart contracts have created a perfect storm of sorts, because they enable you to capture and transact almost anything, in a really efficient way.

Many ICOs relate to digital software rights (like a voucher system); some effectively power large platforms (like Ethereum and other new protocols), while others just operate as a medium of exchange (like bitcoin). You can even use blockchain to represent regular things like loyalty points and certain rewards. What is fundamentally new, however, is the liquidity in these types of digital assets. This is adding a new dimension to the economy. It will undoubtedly stay, but the shape of it is certain to evolve.

Q: Do ICOs replace VC investing? Are they a threat or a complement to VC investing?

ICOs have become an extremely popular way to crowdfund very early stage projects. We know that they have overtaken venture capital funding in terms of quantum – for example, recent estimates suggest that they have delivered over three times more capital to blockchain startups than VCs.

However, there are genuine questions about the long-time sustainability of a crowdfunding-only model for two reasons. First, there is an element of token fatigue in the market, meaning that projects really need to ‘pop’ to attract attention. Second, as we move into the post-sale execution phase of many projects, failure risk is high. Certain reports suggest that over 45% of last year’s ICOs have already failed. Both of these issues link into one of the pivotal aspects of VC contribution – expertise. VCs typically have a longer investment time horizon and therefore the success of their investment is linked at least to the medium-term success of the project.

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Something interesting is emerging however. We hear many VCs are now participating in token sales. The upside for a token issuer is fast and early stage funding, sometimes without even having to go to public sale, coupled with at least some contribution of expertise. VCs tell us they like it because the time horizon is shorter. They don’t need to wait seven years to exit, but might be locked only for a year or so. They also expect to experience financial upside more quickly, if a token appreciates in value swiftly following sale, rather than waiting for shares to go public. But this isn’t always in the interests of the project and ICO dump schemes (buy at a discount, sell fast on public sale) are unfortunately highly prolific.

Q: How are regulators responding to ICOs? Are they legal in HK and other key jurisdictions? What do issuers and investors need to look out for?

The regulatory approach differs dramatically across jurisdictions. Some have cracked down heavily, particularly where capital flight and speculation have been a concern, such as Mainland China. Others are proactively supporting the nascent space – often in the form of creating smartly regulated markets (not necessarily allowing free-rein). For example, Japan has fostered a very sophisticated regulated market, with two of the leading banks even creating their own cryptocurrencies, which means you have a much richer and safer ecosystem. Gibraltar is also taking a strong lead.

Hong Kong and Singapore adopt a very balanced approach, but are watching the market and international developments. The most challenging jurisdictions are those where there is regulatory uncertainty – currently, and most publicly, the United States.

As an issuer or a purchaser, I would be following reliable news sources closely, but also reading the tea leaves at the transnational level. I am personally most interested in what bodies such as the IMF, Bank for International Settlements, IOSCO, the G20, and FATF are saying, because this will undoubtedly inform the next wave of regulation. There are very real and significant long-term monetary policy and systemic risk considerations that need to be balanced against the incredible innovation that ICOs have fostered.

Q: From a legal perspective, what's the best jurisdiction to do ICOs in and why?

This is the question everyone asks – and links back to your previous question. It is usually selected after several iterative discussions covering an overlay of regulatory, business conduct / opportunity, tax, IP and optic considerations. Never follow “market practice” alone, as it is regularly non-compliant. Suffice to say, you need to be well advised before issuing a token. This space is changing at break-neck pace.

© 2018 Citigroup