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[On the Bar] Cryptocurrency and ‘proper’ regulations for ICO

On the Bar is a regular column written by attorneys at Yoon & Yang LLC on various laws and regulations that affect running a business in Korea. -- Ed.

Initial coin offering refers to the fundraising activities for entrepreneurial purposes by issuing the cryptocurrencies and/or tokens based on the blockchain technology.

In other words, an ICO has a similar function with an initial public offering in the crypto world.

Ever since the ICO in 2013, in which Mastercoin raised 5,000 Bitcoin, equivalent to $230,000, the ICO market has rapidly expanded with total value of $250 million raised in 2016. However, after almost half of the Ethereum coins raised through the “Dao project” -- one of the most successful ICOs in 2016 -- was stolen due to security vulnerabilities, the need for the heightened regulation on ICO has been increased. 

 Lee Ji-min (left) and Cho Jae-ryun
 Lee Ji-min (left) and Cho Jae-ryun
Accordingly, US Securities and Exchange Commission announced that the Securities Exchange Act of 1934 would apply to the tokens found as securities under “Howey Test.”

In response to the stringent regulations on ICOs in US, a significant number of ICO projects skipped the US and instead chose another jurisdiction for executing ICOs. And accordingly, the number of ICOs conducted in US significantly declined.

Along with the US, Britain and Germany also expanded the scrutiny to the companies conducting ICOs.

As the US and other EU countries lost their edge in the ICO business, Switzerland with its favorable environment for ICO projects emerged as a new ICO destination. In response to a sharp increase in the number of ICOs executed in Switzerland, the Financial Market Supervisory Authority published the “Guideline for enquiries regarding the regulatory framework for initial coin offerings (ICOs)” in February 2018.

According to the FINMA’s Guideline, depending on the function and transferability of tokens issued by the ICO organizer, FINMA categorizes tokens into three types: (i) payment tokens; (ii) utility tokens; and (iii) asset tokens, and applies the different regulations, respectively. Due to its lenient regulations and transparency, Switzerland notched up $640 million out of $3.5 billion global ICO proceeds in the first three quarters of 2017 and dominated the league tables for ICO projects.

While most Asian countries previously had no special regulations on ICOs, the governments realized the need for regulatory schemes on ICOs as the cryptocurrency market grew explosively.

China, one of the largest mining countries in the world, announced a total ban on ICOs in September 2017 and made all fundraising activities through ICOs illegal. Upon the surge in cryptocurrency transactions in mid-2017, the Financial Supervisory Service of South Korea ultimately banned raising money through ICOs for all types of cryptocurrencies, but without any valid legal basis.

On the contrary, Singapore had virtually no regulation on ICOs until 2016, but, at the end of 2017, the Monetary Authority of Singapore established a regulatory sandbox and allowed the ICOs with certain features. Specifically, MAS resolved the uncertainties in its regulations on ICOs by allowing an ICO where the issuing company does not distribute its financial performance without any financial regulations applied. It alsoo allowed an ICO where the issuing company distributes its economic performance only if said issuing company complies with the any relevant regulations as conducting an IPO.

As MAS has clarified the target of its ICO regulations, the cryptocurrency developers and venture capitalists interested in ICOs have gathered in Singapore, which is geographically, culturally and linguistically convenient and has relatively lenient financial regulations.

Accordingly, Singapore has become the leading offshore jurisdiction for ICO projects, together with Cayman Island and British Virgin Island.

Along with the cryptocurrency developments, the legal, accounting, and tax consulting industries for ICOs have also expanded in Singapore. Singapore has seen a cluster effect as a new hub for fintech through expansion of ICOs by creating fintech-related jobs and diversifying the economy.

As Singapore has become a new center of ICOs, a number of cryptocurrency developers in Korea have also moved to Singapore and currently carry out various cryptocurrency projects.

Indeed, major IT companies in Korea have established companies engaged in cryptocurrency- or blockchain-related business and more than 100 venture companies related to cryptocurrencies are currently active in Singapore as of today. As a result, the Korean government is facing criticism that its ban on ICOs and overreach regulations have caused national wealth to flow out of the country and hindered the development of blockchain technology in Korea.

Of course, the clear, proper regulations are necessary as various social problems have arisen in related to ICOs, shown as (i) 10 percent of total funds raised through ICOs in 2017 (equivalent to $400 million) was stolen by hacking; (ii) the success rate of ICOs remained only 25 percent; and (iii) ICOs have been abused in various fraudulent schemes.

Still, the strict regulation of or total ban on ICOs are not the only solutions.

Taking a lesson from how Singapore has become one of the world’s top blockchain and fintech hubs by allowing healthy ICOs while regulating Ponzi-type ICOs through the regulatory sandbox, Korean government also needs to be proactive in attracting a number of promising ICO projects.

Korean financial regulatory authorities must allow healthy ICOs that are firmly based on blockchain technology and, under such a policy, South Korea, an IT powerhouse in Asia, will serve as a new hub for blockchain and fintech. 

By Cho Jae-ryun and Lee Ji-min

Cho Jae-ryun is a senior associate attorney at Yoon & Yang LLC and he is a legal expert in the areas of finance, securities regulation, M&A and private equity matters. Lee Ji-min is an associate attorney (US qualified) at Yoon & Yang LLC and she is a legal expert in general corporate matters, banking and finance.