Cryptocurrency Regulations
A Complete Summary
Last updated on - March 11, 2019
“There is no evidence that more regulation makes things better. The most highly regulated industry in America is commercial banking, and that didn’t save those institutions from making terrible decisions.” - Wilbur Ross
While the very reason of the existence of the first cryptocurrency (Bitcoin) was to create an economy that could not be manipulated or controlled by any trusted third party - the crowdfunding models (ICOs or STOs) based on one of the technologies behind Bitcoin - Blockchain (via Smart Contracts) has the government regulatory agencies ponder upon the regulatory landscape and redefine a security to safeguard the investors from potential frauds and impose taxes on it. According to a report published in July 2018 by an STO Advisory firm SATIS Group on Bloomberg, 78% of all ICOs are scam and that is terrifying.
The Securities Act of 1933 (and Securities Exchange Act of 1934) was put in place to remove information discrepancies between promoters and investors prescribing that the promoter is liable for material misstatements in the offering materials provided to the investors. The term security means any note, stock, bond, profit-sharing agreement, investment contract, option, transferable share, or voting-trust certificate; terms used to describe an investment contract which, to describe briefly is - (a) an investment of money, (b) a common enterprise, (c) having expectation of profits, (d) derived solely from efforts of others.[1] If the security regulations are applicable on a project, the issuers must publish and register a prospectus to avoid criminal and civil liabilities.
This is suffice to say most cryptocurrency tokens could be considered as security and hence, we should be aware of the laws surrounding them. Labeling a token as utility in a white paper will not make it such. To determine what constitutes a security - certain tests are employed whereby, for the US it is the infamous Howey Test.
This article summarizes the cryptocurrency regulations in various countries, in alphabetical order with the USA being an exception, since it is the largest economy & securities market of the world; what it does matters to everyone. The scope of having the necessity of regulations is broad, hence this article is kept precisely focused on the regulatory stances of the countries or regions.
- United States of America [SEC]
The Securities and Exchange Commission (SEC) is one of the most well known financial regulatory bodies in the world. The SEC provides clear and well established offering rules and often used exemptions for conducting offerings without having to get approval from the Commission. The Commodity Futures Trading Commission (CFTC) is also a regulatory body to be aware of in the United States.[2] In July 2017, the SEC released a report highlighting tokens to be subjected to full scope of US securities regulations following The DAO ICO.
“Cryptocurrencies that replace the dollar, the euro and the yen with
bitcoin, that type of currency is not a security. However, a token or a digital
asset, where I give you my money and you go off and make a venture,
and in return for giving you my money I say ‘you can get a return’ that
is a security and we regulate that. We regulate the offering of that security
and regulate the trading of that security.” - Jay Clayton (June 6, 2018)[4]
Meaning that Bitcoin and Ether are not securities. SEC repeated their stance by saying -
“Applying the disclosure regime of the federal securities laws to the
offer and resale of Bitcoin would seem to add little value. And putting
aside the fundraising that accompanied the creation of Ether, based on my
understanding of the present state of Ether, the Ethereum network and its
decentralized structure, current offers and sales of Ether are not securities
transactions” - William Hinman (June 14, 2018)[5]
The statement above means that if an asset distribution is sufficiently decentralized, it may not represent an investment contract as the ability to identify an issuer or promoter to make the required disclosures becomes difficult and less meaningful.[3]
The International Swaps and Derivatives Association [ISDA] published legal guidelines for Smart Derivatives Contracts in January 2019 - which should provide a common interface for interested organisations.
Projects raising funds in the US or the ones allowing US citizens to participate need to understand the following terms -
Accredited Investor, Regulation D (“Reg D”), Rule 504, Rule 506, Regulation Crowdfunding (“Reg CF”), Regulation A (“Reg A”), JOBS Act
[Recommended Read] - On US Securities laws from a retired lawyer here.
2. Australia [ASIC]
In September 28, 2017, the Australian Securities and Investments Commission (ASIC) issued a guidance for ICOs with a detailed information sheet (INFO 225) that covers the legal status of ICOs, when an ICO can be an offer of a financial product, financial products that reference ICO tokens, and how prospective ICO issuers can obtain informal assistance from ASIC.
It all boils down to whether the crypto asset or ICO is (or is not) a financial product. The guidelines are clear on how to operate within Australia’s regulatory framework, while encouraging innovation and the development of new financial business models.
Ultimately, it can be seen as a positive framework for ICOs but holds them in line with the existing legislative framework in order to protect citizens against scams or fraudulent ICOs.[3]
3. Canada [CSA]
On August 24, 2017, the Canadian Securities Administrators (CSA) issued a staff notice detailing what cryptocurrency exchanges and cryptocurrency investment funds are, what coin or token offerings are, and a four-prong test to determine if an investment contract exists, just like the Howey Test.
The CSA also found several factors as important considerations for whether a person or company is trading in securities for a business purpose. They are -
1. Soliciting a broad base of investors, including retail investors
2. Using the internet, including public websites, and discussion boards, to reach a large number of potential investors
3. Attending public events, including conferences and meetups, to actively advertise the sale of the coins/tokens
4. Raising a significant amount of capital from a large number of investors
The CSA does have a Regulatory Sandbox initiative allowing firms to register and/or obtain exemptive relief from securities law requirements, under a faster and more flexible process than through a standard application. The purpose is to test their products, services, and applications throughout the Canadian market on a time-limited basis. [3]
4. China [CSRC]
In September 2017, the Chinese government, via a public service announcement through the People’s Bank of China website, declared ICOs to be illegal in China and asked all related fundraising activities to be halted immediately[7]. Shortly thereafter, cryptocurrency exchange platforms were ordered to discontinue operations. More recently, China has decided to block access to any cryptocurrency and ICO-related website for anyone within the mainland’s borders.
There are rumors circulating that China will lift the ICO ban soon in favor of regulated and controlled ICOs.[3]
5. Cayman Islands [CIMA]
Due to a long history of companies setting up funds in the Cayman Islands there are many well established rules and processes for conducting private offerings from the Cayman Islands and many law firms that specialize in these types of offerings.[2]
6. Estonia [FSA]
Estonia’s Financial Supervision Authority (FSA) describes a legal framework of ICOs that echoes other authorities around the world -
The EFSA states that although a new technology is involved, and
what is being sold is referred to as a token instead of a share or equity,a token may still qualify as a security as set forth in the Estonian legislation. Businesses should complete an analysis on whether a security is involved. Professional advice may be useful in making this determination. [8]
Having said this, Estonia, named “the most advanced digital society in the world” by specialist tech magazine Wired, has grabbed attention by offering “e-residency” to anyone from anywhere and is looking into an estcoin that could be used within the government-backed e-residency ID program.
In December 2017, the Estonian Ministry of Finance and the FSA worked together, resulting in the Ministry of Finance applying for funding for a project called Opening Estonian Regulatory Framework for Innovative Technical Solutions, which is targeted at developing a favorable legal framework for crowdfunding and alternative infrastructure.[3]
7. Europe (The European Union)[ESMA]
On November 13, 2017, the European Securities and Markets Authority (ESMA) issued two statements on ICOs. One statement was on the risks of ICOs for investors and another on the rules applicable to firms involved in ICOs. To the firms, it was basically a reminder of their obligations under EU regulation.[3]
The European Commission - a body that shapes the EU’s overall strategy, proposes new EU laws, and policies, monitors their implementation, and manages the EU budget, recently published a 2018 Fintech Action Plan -
In the course of 2018, the Commission will continue monitoring the
developments of crypto-assets and Initial Coin Offerings (ICO) with the European Supervisory Authorities (ESAs), the European Central Bank (ECB), and the Financial Stability Board (FSB) as well as other international standard setters. Based on the assessment of risks, opportunities, and the suitability of the applicable regulatory framework, the Commission will assess whether regulatory action at EU level is required.
More:
1. March 8 report on German Finance Ministry calling for regulated blockchain securities market.
2. A Research Paper on Crypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial Law
8. Gibraltar [GFSC]
The Gibraltar Financial Services Commission (GBFC) have taken a mindful approach to the various fintech sectors; they are supportive of innovation while recognizing the need for suitable regulation in many key areas to -
1. encourage good operators (that are looking for a suitable regulatory framework);
2. deter bad operators and practices;
3. protect consumers and the clients of fintech firms;
4. and mitigate the risks of money laundering and crime.[13]
Gibraltar is willing to tackle regulation at the cutting edge of technological developments in order to ensure that it remains a leading fintech jurisdiction as witnessed by the DLT provider regime. It has also advanced proposals for a new regulatory regime for the promotion and sale of crypto-tokens.[14]
9. Hong Kong [SFC]
On September 5, 2017, the Hong Kong Securities and Futures Commission (SFC) provided a statement on ICOs -
Where the digital tokens involved in an ICO fall under the definition
of ‘securities’, dealing in or advising on the digital tokens, or managing or marketing a fund investing in such digital tokens, may constitute a ‘regulated activity’. Parties engaging in a ‘regulated activity’ are required to be licensed by or registered with the SFC irrespective of whether the parties involved are located in Hong Kong, so long as such business activities target the Hong Kong public.
The general summary is that as the terms and features of ICOs may differ in each case, those engaging in ICO activities should seek legal professional advice if they are in doubt about the applicable legal and regulatory requirements.[2]
10. India [SEBI]
The Government of India has been a vocal supporter of the blockchain technology but at the same time has banned ICOs in the country for the moment. The Reserve Bank of India termed the cryptocurrencies as illegal and forbid the banks from providing services to the cryptocurrency startups. The Honorable Supreme Court of India however, has asked the Government to set up the regulations which are expected to be released by April.[16]
11. Japan [FSA]
Japan has the world’s most progressive regulatory climate for cryptocurrencies and as of April 2017, recognizes Bitcoin and other digital currencies as legal property under the Payment Services Act.
Japan remains a friendly environment for cryptocurrencies, but growing AML concerns are drawing the FSA’s attention to further regulatory steps. Following talks between exchanges and the FSA, an agreement to form a self-regulatory body, the Japanese Virtual Currency Exchange Association (JVCEA) was put in place. The JVCEA will provide advice to as yet unlicensed exchanges and promote regulatory compliance.
12. Liechtenstein [FMA]
The Financial Market Authority (MFA) is developing new laws in the hope of attracting more blockchain business to Liechtenstein. They are discussing exemptions for STOs that could be among the mostly friendly to issuers in the world.[2]
13. Luxembourg [CSSF]
The Commission de Surveillance du Secteur Financier is the primary financial regulator body in Luxembourg and they provide fairly clear regulations that have attracted many hedge funds to the region. In terms of number of hedge funds accounted for, Luxembourg is second only to the USA.[2]
14. Malaysia [SC]
The regulations which came in effect starting January 15, 2019 has classified cryptocurrencies, tokens and crypto assets as securities, which means they are now under the jurisdiction of the Malaysian Securities Commission.[15] The regulations are rather harsh as any unauthorized cryptocurrency exchanges or ICO could face a 10-year jail sentence and fines to the tune of $2.4 million. Finance Minister Lim Guan Eng quoted saying:
The Ministry of Finance views digital assets, as well as its underlying blockchain technologies, as having the potential to bring about innovation in both old and new industries. In particular, we believe digital assets have a role to play as an alternative fundraising avenue for entrepreneurs and new businesses, and an alternate asset class for investors.
15. Malta [MFSA]
The Malta Financial Services Authority has been proactive in trying to provide clear and less burdensome rules for token offerings. The MFSA is constructing new rules and exemptions to attract companies in the blockchain space and could provide an ideal jurisdiction for issuance, although at this time the new rules primarily involve utility token offerings.[2]
16. New Zealand [FMA]
In May 2018, New Zealand’s Financial Market Authority (FMA) outlined statements regarding ICOs and cryptocurrency services. There are four factors determining how an ICO is regulated. These are if the token is classified as a financial product, if a financial service is being provided, if the token purchaser is a retail (general public) or wholesale (experienced) investor, and if the investor is based in New Zealand or overseas.
The FMA outlines the four types of financial products: debt securities, equity securities, managed investment products, and derivatives[10]. The FMA is open to discussions, stating -
Given the bespoke nature of ICOs we encourage you to approach us early in the development phase if you’re considering making an offer. We can provide guidance around whether your ICO involves a financial product or a financial service, and whether fair dealing requirements are met. We expect you to refrain from seeking to raise funds while discussions with us are ongoing.
ICOs remain a relatively new form of capitalization and every nation has generally stated that ICOs will fall into existing regulatory framework. This is of no surprise because it is the easiest form of action to apply.[3]
The Philippines has announced new regulations to govern crypto assets. According to the Cagayan Economic Zone Authority (CEZA) - the new regulations cover areas around the acquisition of cryptocurrencies, including utility and security tokens. The aim is to effectively regulate the crypto industry while safeguarding investor interests and promoting innovation.[17] CEZA has distributed 19 licences to companies so far to operate cryptocurrency exchanges. Raul Lambino, CEO of CEZA quoted saying -
We aim to provide a clear set of rules and guidelines that will boost innovation while also ensuring proper compliance by actors in the ecosystem.
We hope that these set of regulatory innovations will promote blockchain and crypto adoption by institutional investors and the financial system.
The safeguards built into CEZA’s rules and system will lead to greater investor protection and transparency. The involvement of DA agents and experts bring in competent and neutral third parties into the process to help ensure issuers are truthful and accurate.
18. Russia [FCSM]
Russian President Vladimir Putin has issued another deadline for the government to adopt regulations for the digital assets industry, according to instructions for the Federal Assembly. The document was published on the official website of the President of Russia, Kremlin.ru, on Feb. 27.
According to the document, Pres. Putin has ordered the government to enforce crypto-related regulation by July 1, 2019. The President has required the Council of the Federation of Russia and the lower house the Federal Assembly of Russia (Russian State Duma) to adopt the regulation during the spring session of 2019. [18]
The Russian State Duma plans to review and adopt new cryptocurrency regulations in March, while the former Energy Minister Igor Yusufov is also proposing an oil-backed crypto. Yusufov reportedly said that the introduction of a crypto settlement system on the energy market could reduce costs associated with the use of unbacked currencies and the fluctuations of their exchange rates.
The Monetary Authority of Singapore (MAS) is the main regulatory body. The Securities and Futures Act (SFA) is the regulation that provides clear rules for conducting offerings and also provides some exemptions to standard registration requirements that can be advantageous to a company targeting high wealth investors.[2]
In August 2017, MAS clarified the regulatory position on the offer of digital tokens; they will be regulated by MAS if the digital tokens constitute products regulated under the Securities and Futures Act.[11] In November 2017, MAS then published a 13-page guide to digital token offerings providing general guidance on the application of the securities laws administered by MAS in relation to offers or issues of digital tokens in Singapore. It states -
MAS will examine the structure and characteristics of, including the rights attached to, a digital token in determining if the digital token is a type of capital markets products under the SFA.
20. South Korea [FSC]
In late September 2017, the South Korean Financial Services Commission (FSC) announced that ICOs would be prohibited.[12]
South Korea followed the Chinese model and formally introduced legislation regarding the ban. However, South Korea is preparing a policy plan for ICOs, opening the door for Korean companies to raise funds despite prior reservations. The thinking is that if the likes of Kakao and Bithumb decided to launch ICOs abroad, the blockchain sector of South Korea would lose out on multi-billion-dollar opportunities, solely due to the country’s ban on domestic ICOs. [3]
21. Switzerland [FINMA]
The Swiss Financial Market Supervisory Authority (FINMA) has shown themselves and the region to be crypto-friendly. They have provided clear exemptions to standard security registration requirements including Qualified Investor exemptions and self-issuance exemptions.[2]
FINMA published market guidance in September 2017 and more recently in February 2018. Depending on the structure of an ICO, the Swiss regulator will determine, among others things, whether supervisory regulations, collective investment scheme legislation, and banking law provisions may be applicable to specific ICOs. The key is that each case will be decided on its merits and the principle focus around the function and transferability of the tokens. Accordingly, the issuers should carefully assess regulatory status when structuring and marketing ICOs.[3]
22. United Kingdom [FCA]
The Financial Conduct Authority (FCA) issued a statement in December 2017, which said -
Whether an ICO falls within the FCA’s regulatory boundaries or not can only be decided case by case. Many ICOs will fall outside the regulated space. However, depending on how they are structured, some ICOs may involve regulated investments & firms involved in an ICO may be conducting regulated activities.
The FCA also provided yet another statement in April 2018, on cryptocurrency derivatives stating -
Cryptocurrencies are not currently regulated by the FCA provided they are not part of other regulated products or services. Cryptocurrency derivatives are, however, capable of being financial instruments under the Markets in Financial Instruments Directive II (MIFID II), although we do not consider cryptocurrencies to be currencies or commodities for regulatory purposes under MIFID II. Firms conducting regulated activities in cryptocurrency derivatives must, therefore, comply with all applicable rules in the FCA’s Handbook and any relevant provisions in directly applicable European Union regulations.
In conclusion
The crowdfunding models (ICOs, IEOs and STOs) will generally be incorporated within existing regulatory framework. The ICO mechanism was supposed to disrupt the traditional VC space, but more recently they are the ones pouring more and more investments into projects rather than donations from general public. A speculation of increase in value of any digital token will term it as security in the eyes of SEC which will hinder the pace at which ICOs raise capital and may stifle innovation. Companies to compliantly access the capital markets will need to work their through frameworks present today.
There are existing exemptions that ICO projects should look at and work with the regulatory agencies to be compliant. Most regulators are open to work together with businesses and the future looks inclusive. Efforts from blockchain startups to “embed” KYC/AML features within a blockchain based token have shown great success and limiting token transfer ability will open new frontiers of fundraising.
[Disclaimer] - This article is not a legal advice. The views are personal and the ones that refer to external sources belong to them.
Sources
- The 1933 Act - https://en.wikipedia.org/wiki/Securities_Act_of_1933]
- Tokenized Securities - https://tokeny.com/wp-content/uploads/2019/01/TOKENIZED-SECURITIES.pdf
- Tokenomics (Sean Au, Thomas Power) - https://www.packtpub.com/big-data-and-business-intelligence/tokenomics
- Jay Clayton, SEC Chairman - https://www.youtube.com/watch?v=wFr1ooaVPjY
- William Hinman, Director, DCF (SEC) - https://www.sec.gov/news/speech/speech-hinman-061418
- Cryptocurrency regulatory resources (Australia) - https://asic.gov.au/regulatory-resources/digital-transformation/initial-coin-offerings-and-crypto-currency/
- China ICO ban public announcement - http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3374222/index.html
- Estonia FSA - https://www.fi.ee/et?id=12466
- Hong Kong [SFC] statement on ICOs - https://www.sfc.hk/web/EN/news-and-announcements/policy-statements-and-announcements/statement-on-initial-coin-offerings.html
- New Zealand [FMA] statement on ICOs - https://www.fma.govt.nz/compliance/cryptocurrencies/initial-coin-offers/
- Monetary Authority of Singapore, press release - http://www.mas.gov.sg/News-and-Publications/Media-Releases/2017/MAS-clarifies-regulatory-position-on-the-offer-of-digital-tokens-in-Singapore.aspx
- South Korea FSC press release on ICO - http://www.fsc.go.kr/info/ntc_news_view.jsp?bbsid=BBS0030&page=1&sch1=&sword=&r_url=&menu=7210100&no=32085
- Gibraltar Finance: Token Regulation - http://gibraltarfinance.gi/20180309-token-regulation---policy-document-v2.1-final.pdf
- Fintech regulation in Gibraltar - https://www.lexology.com/library/detail.aspx?g=eb554fac-9c8c-4059-8483-a03bf2d875a7
- Malaysia Regulation Update - https://cointelegraph.com/news/malaysia-develops-harsh-regulation-alongside-with-positives-attitudes-toward-crypto
- Indian Supreme Court’s directive to the Government - https://www.ccn.com/indias-supreme-court-sets-4-week-deadline-for-government-to-regulate-cryptocurrency
- CEZA Cryptocurrency regulations - https://news.bitcoin.com/philippines-announces-new-cryptoccurency-regulations/
- Cointelegraph’s Update on Russian regulations - https://cointelegraph.com/news/russian-president-putin-orders-government-to-adopt-crypto-regulation-by-july-2019
