ICO muzzle - stopping the unstoppable?

Initial coin offerings by startups are still seen as having enough steam to propel ahead despite a clampdown by regulators.

Cash-starved startups may have landed themselves in a real conundrum after financial watchdogs in Hong Kong and on the Chinese mainland cracked the whip, pulling the plug on initial coin offerings (ICOs) - the novel method for budding enterprises to raise funds through the issuance of token-based digital currencies.

The clampdown came amid growing nervousness over the proliferation of financial malpractices, including fraud and pyramid schemes, and with a potential bubble in the making, following the recent explosion of the increasingly popular application of blockchain technology on a global scale.

Experts, however, are sticking to their guns that the world's virtual currency trend is unabating and are convinced that the muffling regulations, while being indispensable, are just a stop-gap measure aimed at preserving economic stability and paving the way for healthier growth of the ICO, cryptocurrency and blockchain business.

David Tang, founder of a Hong Kong-based ICO advisory company, as well as a blockchain enthusiast himself, has helped companies with smart contracts to put together ICOs, having come up with more than 10 ICOs so far.

He explains that ICOs, which promise investors high returns using cryptocurrencies rather than stocks, represent a financing channel that issues tokens on blockchain and sell them to investors in exchange for other cryptocurrencies like ethereum or bitcoins.

Faster, cheaper way

It's thus a faster, cheaper and better way to raise money with low transaction costs and high liquidity. But, the quality of ICOs, pyramid selling of bad ICOs, and ICO's disruptive impact to traditional market remain key concerns for the moment.

The controversial fundraising scheme through which startups can issue their own virtual currencies in exchange for real money, has been around for several years, but went wild recently. It struck a raw nerve with financial regulators on the mainland and in Hong Kong and South Korea, which mounted a crackdown on the controversial mechanism, sparking a dramatic drop in the prices of virtual currencies.

In a recent report on China's fintech industry, ICBC International - the financial arm of one of the mainland's "Big Four" lenders, Industrial and Commercial Bank of China - threw its weight behind the ICO measures, saying they're a buffer aimed at creating a salubrious environment to ensure the stability of the financial system and the better development of cryptocurrencies.

To date, 65 ICOs have been done on the mainland, helping startups raise almost 2.6 billion yuan ($400 million), according to a report by the mainland's fintech risk analysis technology platform.

Statistics from the Autonomous Research Institute showed that $1.3 billion in token-based funds had been raised globally by virtual organizations or fundraising entities in the first half of this year, far exceeding the amount put up through traditional venture capital financing.

The China Securities Regulatory Commission banned ICOs as an "illegal way" of fundraising in early September, triggering a 20-percent plunge in the price of bitcoins from $5,000 to $4,000 three days after the ban took effect.

The People's Bank of China stressed the need to prevent fundraising risks through ICOs, calling such activities "unauthorized and illegal public fundraising". It warned that they are suspected of being involved in criminal activities, such as the illegal sale of tokens, issuance of securities and fundraising, as well as the possible spread of financial fraud and pyramid schemes and internet crimes, coupled with unwanted speculation.

The central bank said the relevant authorities will closely monitor related developments, strengthen coordination with the judicial departments and local governments, strictly enforce the law and work based on the current mechanism, and resolutely clamp down on market irregularities.

Licensing rule

Hong Kong's Securities and Futures Commission said all parties engaging in a regulated activity targeting the Hong Kong public are required to be licensed by, or registered with the commission, irrespective of where they are located.

Tang said as far as ICOs are concerned, there's still a long way to go because as long as the SAR government does not legitimize the status of bitcoin or ethereum, no laws or regulations can be imposed regarding ICOs.

But, he said the case is different on the mainland, believing that ICOs will resume there soon, possibly next month, with the new rules intact.

"The new regulations on ICOs hurt us quite badly as 60 percent of our clients and 80 percent of their investors are from the mainland."

Tang believes the virtual currency ecosystem is an unstoppable trend and cryptocurrencies will only grow in popularity. "In the long run, ICOs can replace IPOs (initial public offerings) and disrupt the traditional capital market."

Eric Piscini, Deloitte Global Blockchain leader, backed ICOs as a fantastic way to raise funds, saying they have successfully serviced 75 ICO projects worldwide to date.

He believes that future prospects are good. For the time being, it's too easy for enterprises to raise money, so regulations are definitely needed. He thinks the ICO clampdown on the mainland is temporary and regulators will come up with more detailed regulations on the activity when they're ready.

According to Piscini, the key factors they take into consideration when dealing with ICOs include corporate structure, the quality of the platform itself, and how a company will use the funds raised. He added that many ICO projects presented to them for consultation were not compliant.

Debut failure

The first global ICO, called Mastercoin, was launched in 2013. It was a digital currency and communications protocol built on the bitcoin blockchain, but it turned out to be a failure. According to experts, the most prominent failure was the DAO which got hacked and caused another ICO company Ethereum to split. Ethereum is a successful ICO project and a decentralized platform that runs smart contracts, including applications that are programmed without any possibility of downtime, censorship, fraud or third-party interference.

Joe Chan, managing partner of MindWorks - a budding venture capital enterprise with offices in Hong Kong and London - said ICOs are the spontaneous result of the development of cryptocurrencies as investors owning large amounts of cryptocurrencies have started to have wealth management demand.

He said he's not worried that ICOs, as a financing channel, would impact and disrupt the venture capital industry, as it has a mature ecosystem, and people working in venture capital are experienced professional investors.

tingduan@chinadailyhk.com