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Hackernoon logoBrief Analysis of China’s Ban on ICOs by@lindsayxlin

Brief Analysis of China’s Ban on ICOs

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@lindsayxlinLindsay X. Lin

This morning, many in the U.S. woke up to the news that China has ordered a halt on all ICO financing, effective immediately. Moreover, token issuers who have completed ICOs are required to provide refunds to token buyers. Trading platforms have been restricted from providing price information and conducting any exchange between fiat and virtual currencies/

The statement explains that “people who refuse to cease ICO activities or refuse to refund investors will be investigated and severely punished according to the law.” Concurrently, China’s Remediation Office of Risks in Internet Finance has ordered that all ICOs in the country be investigated by local regulatory authorities.

The effect of this statement has lead to sharp plunges in crypto prices. But what does this ICO “ban” in China mean for the global crypto market in the short and long term?

Here are some of my off-the-cuff thoughts.

Backdrop

The background is that there has been a torrent of new ICOs in the Chinese market, collectively raising over 3 billion CNY (~$460 mil) from Chinese residents in the year to date. Some of them of were of dubious quality and could have potentially been fraudulent Ponzi schemes. Prior to the statement, there were several upcoming ICOs in the pipeline.

While the ICO market in China has been very lucrative, China has no qualms banning financially successful markets/organizations/industries that may hurt consumers or weaken its control on monetary or privacy policy. Many illustrious citizens have indeed been using ICOs as a mechanism for untraditional fundraising, bypassing money transfer restrictions, and potentially money laundering. Given China’s history of strict monetary controls and consumer protection actions, it’s not surprising that it’s acting to address these concerns. Recall that in 2013, China banned financial institutions from trading bitcoin and processing bitcoin transactions.

Despite the context, this ruling is a little surprising. There was news last week that industry leaders and authorities were working to create a ICO best practices framework. Instead of a framework on how to create a compliant ICO, we got a ban. It’s very likely that China wanted to act swiftly to prevent the advancement of further scams, and is instituting a blanket ban as a temporary measure as they figure out more fine-tuned details.

This statement sends a strong signal to the industry that fraudulent ICOs will not find a happy ending in China — they will be forced to refund contributions and many may be prosecuted and punished.

Questions for Consideration

  1. How is “ICO” is defined for the purpose of this regulation? Does “ICO” describe all events where premined tokens are distributed in exchange for value? Would it also cover thecase where the token is not completely premined and could be obtained through a presale OR through mining (e.g. ETH)? What if the token is distributed for free? The answer to this could determine whether cryptos like Ethereum, NEO, Ripple, and more may also be under scrutiny.
  2. Who does this order apply to? Will U.S./Europe/Australia/Israel/etc.-based ICOs have to blacklist Chinese customers, or does the ban only apply to Chinese-domiciled organizations? While the SEC could theoretically exercise its jurisdiction to anyone who sells to a U.S. resident, it’s unclear if China has the ability or desire to “punish” foreign token issuers beyond simply banning their tokens from being traded in Chinese exchanges/by financial institutions.
  3. What’s next? After ICO tokens, it wouldn’t be beyond China to put a blanket ban on transactions of privacy-focused cryptos (Monero, Zcash).

Short Term Ramifications

  1. There will be a drop in crypto prices due to lower anticipated and actual demand in the Chinese market. As expected, it’s an all-red day on CoinMarketCap (except for Tether, which is pegged to the U.S. dollar).
  2. Token issuers start to rethink their presence in China. Many organizations had originally thought that China would be a great source for token contributions, but that is no longer true (at least for now).
  3. In practice, authorities will likely only prosecute and punish the more fraudulent and visible token issuers. The enforcement of PCoB’s position will be discretionary, and activity that is technically prohibited could fly under the radar for awhile if the amount raised is trivial, the issuer has active cooperation with regulators, the issuer makes a bona fide effort to comply with regulations, and/or there’s no fraud.

Long Term Ramifications

  1. We will see significantly lower rates of innovation in blockchain/DLT from China if this ban continues. Organizations from other countries will take the lead in fostering innovation in this industry. Some organizations may be relieved that there will be lower competition from Chinese token issuers.
  2. Investors in China will get token-shy: they’ll be cautious towards future crypto developments for fear of potential bans
  3. If China lifts the ban and starts to regulate token sales, the higher cost of compliance will lead to fewer token issuers and possibly even a monopolistic/duopolistic landscape for certain token applications.

Next Steps

China will likely reinstate token sales, but will require licenses and/or approval processes for all organizations. Tokens will no longer be used as a technical layer that can enable regulatory arbitrage; an organization will likely have to abide by traditional regulations for the substantive use of the tokens.

It’s also possible that China will install a regulatory sandbox regime. In a regulatory sandbox, organizations under a certain size/transaction volume would join a government-sponsored program where they are monitored and guided (similar to the fintech sandboxes launched by the U.K. FCA and Singapore MAS).

Despite all the complaints that the crypto community has about U.S. regulators, it is unlikely that the SEC/CFTC/CFPB/FinCEN would outright ban an industry without opportunity for comment and a warning. The approach of US. regulators is to instate heavy regulatory burdens so less legitimate organizations are filtered out.

Overall, China’s statement on ICOs was a strong, decisive move towards greater consumer protection, greater monetary control, and more effective anti-money-laundering processes. The hope is that China will continue to investigate this issue and carve out a roadmap for legitimate blockchain and DLT innovations to thrive in the country.

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