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SSRN Id3080098
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Discussion Paper
Abstract: I nitial Coin Offerings (ICOs) provide rapid access to capital for new ventures, but
suffer from drawbacks relating to non-regulation, considerable risk, and non-accountability,
which has created controversy and raised questions about the mechanisms for regulation
in an era of emergent cryptocurrencies. This discussion paper provides a timely review of
the regulatory and other risks that ICOs pose for participants, which thereby situates ICOs
in the underexplored domain of accountability.
capital through the emission of bitcoins to investors as a percentage of total newly issued
currency in exchange for capital that may be legal tender or another cryptocurrency. ICOs sell
cryptocurrencies or may sell a right of ownership or royalties to a project, in contrast to an Initial
Public Offering (IPO) which sells a share in the ownership of the company itself.
As such, it offers significant promise for new startups in the cryptocurrency space as means of
quicker and easier capital raise. Furthermore, as of this writing (November, 2017), there are more
than 50 ICOs taking place every month. However, there are various regulatory and other risks that
emerge from the ICO model, and they need to be situated within the accountability domain, as they
are at the cutting edge of technological progress but raise concerns that match those highlighted
in earlier periods, and therefore represent something of a revisitation of regulatory & accountability
with Ethereum (3700B = $2.3m) and Karmacoin following in 2014, and the more “mainstream” ICOs
occurring with Kik (messaging app developer), which emitted $50 million in tokens (“Kin”) to
institutional investors in September, 2017. Related to this emission, an unknown 3rd -party
conducted a phishing scam by circulating a false URL for the Kik offering via social media. In fact,
as this paper explores, there are significant regulatory and accountability issues within the ICO
space. However, this is not dissuading investors from leaping into the arena, as for example when
web browser Brave’s ICO generated $35 million in less than 30 seconds. Volumes are growing at
breakneck speed, even though the market share of emissions is dominated by a single entity: the
successful Ethereum project. To monitor ICO emission, there are more than 20 websites that offer
tracking data, and a cumulative analysis shows that ICO value in October 2017 year-to-date (YTD)
was $2.3 billion, ten times greater than calendar year 2016.
resulted in substantial scam-artistry, phishing, Ponzi schemes, and other shenanigans - which
cumulatively account for more than 10% of ICOs. The US Securities and Exchange Commission
(SEC) has issued explicit warnings to investors to be highly cautious against scammers using
ICOs, particularly in the colloquially termed “pump and dump” schemes, where capital is fleetingly
raised and then immediately dumped in exchange for other instruments at a profit, all within a very
brief interval. In July 2017, the SEC indicated that it could have the authority to apply federal
securities law to ICOs, and while it not state that all blockchain tokens (ICOs) would necessarily be
considered securities, its determinations would be made on a case-by-case basis. The SEC action
may encourage more institutionalized investors to invest in ICOs, but it should be noted that ICOs
typically prevent U.S. investor participation to remain out of the jurisdiction of the United States
government. For precedent, the SEC has charged Maksim Zaslavskiy for fraud in September, 2017
in connection with the ICOs for RECoin and DRC World. The SEC has ruled that celebrity ICO
endorsements must disclose the amount of any compensation paid for the endorsement.
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The UK Financial Conduct Authority has also warned that ICOs are very high risk and speculative
investments, are scams in some cases, and often offer no protections for investors. Even in cases
of legitimate ICOs, funded projects are typically in a high-risk early stage of development, with
considerable downside potential for investors. This is why, as this discussion paper insists,
Increased regulation of ICOs should encourage institutional investors to invest along more stable
horizons, and in larger volumes, over more instruments. With strong accountability, the ICO market
can thrive, and the SEC notes that ICOs can provide fair and lawful investment opportunities.
Australia’s regulator (ASIC) has issued guidance (September, 2017) stating that the legality of an
ICO is dependent on the specific circumstances, on a case-by-case basis.
A more cautious attitude has been taken by financial regulators in countries such as China, where
seven regulatory agencies officially banned all ICOs within the People’s Republic, and they
demanded that the proceeds from all past ICOs be refunded to investors or face being "severely
punished according to the law". A similarly strong line has been taken by regulators in South Korea,
where the Financial Services Commission prohibited ICOs in September 2017 and promised "stern
penalties" for violations. The Chinese context is important because ICOs has raised nearly $400
million from about 100,000 investors prior to the ban. However, more recent statements from
Chinese regulators have stated that the ICO ban is intermittent, pending a more systematic
regulatory framework. A similar situation, and a more surprising one, has emerged as of this
writing in Switzerland. Although Switzerland was previously viewed as a jurisdiction amenable and
friendly to ICOs, in September, 2017 the Swiss Financial Market Supervisory Authority announced
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an investigation of an unspecified number of coin offerings to examine whether they complied with
Swiss regulations.
Given the recency of the ICO phenomenon, many important jurisdictions such as Canada and
France, have yet to issue regulatory guidelines, of this writing. However, more comprehensive
guidance has been issued by Hong Kong, New Zealand, Australia, Gibraltar, and the UAE. In Hong
Kong, the Securities and Futures Commission released a statement (September 2017) explaining
that tokens may constitute securities for purposes of the legal framework (Securities and Futures
Ordinance), in which case dealing in such tokens would be a regulated activity under Hong Kong
law. In New Zealand, the Financial Markets Authority (FMA) released guidelines on the current
regulatory environment in regards to ICOs (October 2017). In Gibraltar, the government published
regulation establishing a framework for regulated DLT (Distributed Ledger Technology) companies,
which would encompass ICOs and subject them to financial controls and standards; to enter into
effect on January 1, 2018. In the UAE, the Abu Dhabi Global Market issued official guidance on
Conclusion
Given the incipient nature of ICOs, the regulatory response has been delayed, and as with Bitcoin,
the response has been favorable in some jurisdictions but less so in others (Chohan 2017b). There
is a much higher risk of fraudulent practices in ICOs than in established cryptocurrencies such as
Bitcoin, which operate in a trust-less s etting (Chohan 2017a), which does not require the sort of
oversight and accountability in the traditionally constructed sense (Chohan 2017d, 2017e, 2017f,
2017g, 2017h, 2017i). However, ICOs do require accountability and regulation in the traditional
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sense, and there is a strong case, as is being made by Australia, the United States, and some other
countries, that a case-by-case approach may be most appropriate. However, there is also merit in
the approach being posited by Hong Kong and New Zealand, which situates ICOs within regular
security ordinances and law. In any case, the recency of the ICO phenomenon necessitates both
academic and practitioner considerations of the risks, regulation and accountability mechanisms
that are self-reinforcing and dynamic, in the same way that the innovation of ICOs is. The period
2018-2020 is likely to be the most crucial in the ultimate international verdict on the workability of
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References
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https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3024330
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Legality Across National Jurisdictions. SSRN.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3042248
3. Chohan, U.W. (2017c). A History of Bitcoin. SSRN.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3047875
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