It’s Hong Kong FinTech Week, and although blockchain was the theme for day one (October 23), the only real topic was initial coin offerings.
So what did we learn? We already knew there’s huge interest in ICOs. Here are some takeaways.
Regulation is vital.
“Fintech is 90% about regulation and 10% about technology,” said Olga Feldmeier, CEO of Smart Valor, a Switzerland-based blockchain startup. She says regulation isn’t about issuing digital tokens to get funding, but instituting a robust practice for knowing your customer (KYC), keeping out dirty money and disclosing risks via a prospectus.
But regulation for startups needs to be tweaked, or countries risk stifling innovation. Government will benefit the token economy by supporting companies with real blockchain projects or developing useful protocols; those using ICOs just to get easy money are likely to fail.
“Companies that get licensed will get more money,” said Alexander Kohkhanovskyy, founder of DreamTeam, a company from the world of competitive computer gaming.
“Three years from now the majority of token sales will be in the form of securities,” said Volodymyr Panchenko, founder of DMarket, a marketplace for trading virtual items from games. Even though today issuers and investors are running from being deemed a security, and therefore having to be licensed, Panchenko says institutional investment – the real money – will make it worthwhile to be regulated.
Volatility is spooking regulators into action.
“We’d welcome blockchain and fintech ICOs, but how do I tell the scammers from the real service companies?” wondered James Lau, financial secretary of Hong Kong. It’s not enough that the Securities and Futures Commission has guidelines on defining when an ICO needs to be regulated, he said: the volatility in Bitcoin and other crypto-currencies is too sharp to be left alone.
Bart Chilton, former commissioner of the U.S. Commodities Futures Trading Commission, says regulators are spooked by crypto-currency volatility. They need to develop a rudimentary regime for digital money – going beyond KYC and AML to see if ideas like circuit breakers and position limits make sense in decentralized assets.
Lau says Hong Kong will consider following Canada’s move in setting up a regulatory sandbox for ICOs.
But the real action won’t be around ICOs as securities. “The tax authorities will be the smartest and the fastest” when it comes to regulation, said Bernard-Louis Roques, co-founder of Truffle Capital.
Decentralization is a problem for regulators.
“Regulators have the problem of being organized on jurisdictional lines,” said Duncan Fitzgerald, partner at PwC. By tradition, habit and resourcing, they can only supervise what’s in their geographic box. But digital tokens are expressions of decentralized applications.
To some extent, issuers have to have some place to exist, because there’s always a moment where fiat money is converted into digital assets. Some governments, accountants and lawyers feel the moment when ICO issuers threatened to be stateless anarchists has passed. But now ICOs are being issued by decentralized teams located in many countries.
But teams attempting a multi-jurisdictional ICO while claiming they belong to no taxable regime are putting themselves in danger of being found taxable in multiple countries.
“The challenge is in the secondary market.” Fitzgerald again. Companies might carry out professional, responsible ICOs, with full disclosure and shareholder rights spelled out. But once a network exists to trade tokens, who knows who’s on there or what they’re selling?
Decentralization might become the new regulator.
“Blockchain will become the KYC tool of choice; it can become the regulator itself,” said Ismail Malik, editor of ICO Crowd, a publication dedicated to the space. He says regulating ICOs means ultimately regulating the $250 billion global API economy. In other words, a heavy hand will stifle innovation.
This leads him to predict “Agile jurisdictions will become the new Silicon Valley,” such as Singapore, Switzerland and Gibraltar.
Gibraltar’s young stock exchange is launching a blockchain exchange in December, calling it an ‘ICO safe harbor’, says Nick Cowan, managing director.
Recognizing that regulators will struggle with decentralized entities, Gibraltar hopes to attract issuers, sponsors and investors by positioning a traditional, centralized exchange into servicing digital assets and blockchain projects. He adds, however, that the white papers behind these projects are not enough for disclosure and transparency purposes.
Whichever government figures it out, “Identity is fundamental,” said Urszula McCormack, partner at law firm KWM. For ICOs to go mainstream, the industry and regulators need to work out how to ensure tokenholders’ rights can be enforced across jurisdictions.
PwC partners added that ICO issuers are going to have to become very clear about governance, tokenholder rights, and issuer obligations – which will not only set best practices, but could also ensure favorable accounting and tax treatment.
Blockchain isn’t about Silicon Valley.
“Small countries are more nimble” than the U.S. or China when it comes to creating a legal framework to support ICOs while protecting investors, said Olga Feldmeier.
What will the hottest market for ICOs? Ismail Malik predicts it will be Japan: “They’re reshaping their economy to become digital.”
“It’s a sign of peace,” because ideas are now coming from all over the world.
He agreed that the legacy of U.S. regulation makes it hard to adjust to the new world of decentralized assets. Moreover, this is a challenge to Silicon Valley’s giant tech players and the business models they rely on, that is, attracting V.C. money to scale an idea.
“Tech companies are going to have to change that model rapidly, which I guess is similar to how banks are changing their models rapidly.”
Blockchain putting Big Tech in the same position as banks? Yikes.