The first experience of the ICO ban in China: causes, legal features, risks and consequences
Most recently, an important event took place in the ICO market – the Chinese authorities banned krauseylov in their jurisdiction, and all companies that had already conducted the ICO, were urged to return the funds to depositors. His opinion about how this ban can affect the future of the crypto-currency ecosystem, in the exclusive material for ForkLog, said Dr.Sci., Lawyer Ruslan Chernolutsky.
The main reason for the global success of bitcoin and other crypto-currencies is the entry of large financial and investment players into a new market. As you know, big money for different “pyramids”, “nonsense and fairy tales” will not provide money. Investment funds, international corporations, financial monopolies and even some states are already beginning to declare their support and the beginning of the use of a number of crypto-assets and blocking technology as a whole-all this inspires confidence in investors and holders of crypto-currencies.
The market seriously regards bitcoin as a financial digital asset, rather complicated, but real, and most importantly – having monetary value and its uniqueness, both in creation and investment, and in use.
However, large international regulators are afraid and distrust of such a process of raising funds for new investment projects, like ICO (Initial Coin Offering, the primary deployment of cryptonet-tokens). Still, there are suspicions that all this is the old school of Ponzi (the financial pyramid). We must understand that the main goal of the financial pyramid is to enrich its creators at the expense of the personal investments of new participants. The assets of such pyramids are not needed by anyone on the external market, they do not have any advantages in use, they do not solve any problems.
In the case of crypto-currencies and some types of tokens, the situation is different: they solve a big problem of the financial market, their turnover is convenient and profitable for its numerous participants, which creates a real demand for their purchase.
But the nature and the process of conducting the ICO pushes the various suspicions of regulators. State financial managers do not want to put up with the fact that they are not actually engaged in the issue of tokens and can not totally regulate through the tools of licenses and permits a new market. It is enough to see how complex and regulated the securities market is in the US, where the SEC (Security and Exchange Commission) is the king and god of this market. Therefore, 2017 was the year of loud statements by the SEC, MAS (Monetary Authority of Singapore), which warned their citizens about the risks of ICO and severely limited the possibility of attracting their funds at the crowdsdale.
Significant in this issue was on September 4, 2017, when the People’s Bank of China declared illegal operations related to the ICO. The financial regulator ordered not only to stop all ICO-campaigns, but also to return the funds collected earlier, as well as to prohibit the operations of exchanging crypto-currency for fiat money. China expressed concern that many ICOs are financial fraud or a pyramid scheme. The main logic of claims for regulators is the following: ICO is vulnerable to the risks of money laundering and terrorist financing because of the anonymous nature of transactions and the ease with which large amounts of money can be transferred from one source to another in a short period of time.
I note that the attitude of official China to all branches of the finteh industry is rather cautious. China has one of the fastest growing markets in the world. In addition, it is here that most of the mining farms are located. At the same time, the legislative approach to the legal regulation of crypto-currency relations in China has not yet been worked out. At the same time, the crypto currency is considered by the regulator as a virtual commodity, and crypto-exchange exchanges must be registered with the Telecommunications Bureau, which is progress.
Taxation in China is carried out in accordance with the standard rules for goods: operations with crypto currency are subject to income tax, income tax and capital gains tax, and its sale can be taxed with value added tax.
Back in 2013, the Central Bank of China said that in the near future it would not be possible to recognize bitcoin as a legitimate financial instrument. At the same time, the Central Bank noted that there is no ban on the implementation of crypto-currency transactions, since these are commodity relations.
In 2014, the People’s Bank recommended that Chinese banks and payment systems close the accounts of Chinese web resources that trade bitcoin, and in the same year said that they did not consider the possibility of prohibiting bitcoin. In this bitcoin, he defined as a kind of asset, not currency.
In addition, in 2015 it became known that such virtual property could soon be recognized as the “basic human right” in China, as the relevant definitions are contained in a new draft of the main provisions of the Civil Code of the country. It was a kind of curtsey towards liberalism.
Risk number 1. Possible recognition by ICO of the procedure for the sale of securities
This is one of the first risks that are remembered when it comes to ICO. The problem is that the attraction of possible investors with promises of profit has already drawn the attention of securities market regulators – and this carries the risks of possible subsequent prosecution.
Hence the conclusion: ICO-tokens need to move away from associations with securities, with the sale of a stake in the company and generally avoid mentioning the receipt of profit (dividends) for their owners. In this connection, it is worth remembering the so-called Howie rule (worked out by American judicial practice), because American law does not contain a clearly formulated approach to the notion of a security. The English word securities in US legal documents has a much broader interpretation than just a security. At the heart of the American concept of securities lies, first of all, a detailed analysis of the content of a particular legal relationship between the issuer and the holder of securities. In this connection, the American notion of securities can include not only a specific security in its classical sense, for example, an equity, a bond, but also any other legal relationship of two or more persons, which creates for one of them an investment interest in the enterprise of the other. This, in turn, makes the concept of “issuer” and “holder” somewhat arbitrary.
Therefore, at one time in the SEC case against W. J. Howey Co, the US Supreme Court applied a method called the Howie test. He distinguishes four main components, the presence of which in the legal relationship allows us to say that the legal relationship is security:
investing money or other property;
general holder and issuer security company;
expectation of profit from the enterprise;
the expectation of such profits exclusively from the issuer or a third party, but not from the holder.
Risk number 2. Lack of legislative regulation and legal protection
To begin with, there is currently no legal and regulatory framework in the world that establishes standard rules governing the conduct of the ICO. From this it follows that there are no legal protection mechanisms for both investors and persons who issue tokens.
Now in some countries there are already attempts to include crypto-invests in the legal field and giving the crypto-currencies official status. It is possible to consider these attempts in creating conditions for the regulation of a new financing instrument. For example, in Switzerland in late 2016, the development of rules was announced that would allow raising up to 1 million Swiss francs within the ICO without obligation to report to the securities market regulator, which may attract relevant companies.
Singapore is at the stage of developing its own legislative regulations. However, the myth that Singapore is a “paradise” for the ICO, is no longer confirmed after the statement about ICO risks for investors by MAS. Singapore, like China, for a long time did not pay attention to what was happening until it touched on its citizens and the requirements of the Financial Action Task Force (The Financial Action Task Force, FATF).
An indicative example is Japan, which was the first country to equate digital money with real money, legalize crypto-exchanges by developing rules for their activities and, as a result, created a basis, but not a system standard for procedures like ICO.
The example of these countries showed that the definition of the legal status of crypto-currencies and the processes of initial placement of coins creates guarantees for participants and players of the market itself, and therefore prerequisites arise for the emergence of centers for crypto-investment. Of course, the lack of legal regulation provides freedom, nevertheless attracting serious players will require certain legislative and legal guarantees.