There is a new trend appearing in the regulation of virtual currencies. Countries such as the United States, Japan, and South Korea are strengthening their regulation of ICOs. This article will focus on current supervision of ICO and related legal risks.
What is an ICO?
- The Basic Concept of an ICO
Initial Coin Offering or Initial Crypto-Token Offering (“ICO”) refers to the issuance of crypto-currencies. The concept stems from Initial Public Offering (“IPO”) on the stock market.
In an ICO, general investors exchange Ether, Bitcoin, or other virtual currencies for a new token offered by the issuer. A small number of ICO projects allow investors to pay in conventional currencies.
- Main Types of ICO
The three main types of ICO’s in the market are:
(1) Product Project ICO
This is the most common type of ICO. Investors can use this newly-issued token for a product project.
(2) Earnings Project ICO
This token represents a promise to deliver earnings.
(3) Equity Project ICO
This token corresponds to shares in the company it was obtained from.
- The Nature of ICO
China and the United States agree that the substance of an ICO (not its concept and form) is what should be used to determine its legal nature.
The U.S. Securities and Exchange Commission (“SEC”) and the U.S. Commodity Futures Trading Commission (“CFTC”) have issued a “Joint Statement from CFTC and SEC Enforcement Directors Regarding Virtual Currency Enforcement Actions”. “When market participants engage in fraud under the guise of offering digital instruments – whether characterized as virtual currencies, coins, tokens, or the like – the SEC and the CFTC will look beyond form, examine the substance of the activity and prosecute violations of the federal securities and commodities laws.”
ICOs issue new tokens by absorbing Bitcoin or other virtual currencies. In China, there is no legislation around virtual currencies, although the property attributes of tokens have been recognized in judicial practice. In this sense, an ICO may constitute a form of financing, similar to advancing an IPO.
The Current Status of ICO Regulation
There are three main regulatory models of ICO worldwide.
- A Comprehensive Ban on ICO
The People’s Bank of China, the Cyberspace Administration of China, the Ministry of Industry and Information Technology, the former State Administration for Industry and Commerce, the former China Banking Regulatory Commission, the China Securities Regulatory Commission, and the former China Insurance Regulatory Commission jointly issued the “Announcement on Preventing Financing Risks of Token Issuance” on 4 September 2017, officially calling off ICOs. The IMO model (Initial Miner Offerings) of issuing virtual digital assets represented by Xunlei’s LinkToken was criticized by the National Internet Finance Association of China for its intrinsic similarities to an ICO. 
(2) South Korea
On 12 January 2018, South Korea’s Justice Minister Park Sang-ki made a public declaration, stating “Virtual currencies are of great concern. The judiciary is formulating a bill that prohibits transactions of virtual currencies at exchanges in Korea.” 
- “Penetrating Regulation” on ICO
(1) The United States and Canada
The United States and Canada agree that an ICO falls under the jurisdiction of securities regulations.  On 25 July 2017, the SEC issued a report on an ICO project, the DAO. It concluded that ICO tokens were securities and therefore subject to regulation by the SEC. Companies must comply with federal securities laws when issuing an ICO. 
On 1 April 2017, Japan’s Cabinet Order on Virtual Token Exchange Firms came into force.  It states that companies that engage in the buying, selling, and exchange of virtual currencies must file with relevant government agencies.  ICO companies now need to meet stricter regulatory requirements around information disclosure.
- Loose Regulation on ICO
Switzerland and Singapore
Both countries view virtual currencies as assets rather than securities. Therefore, the issuance of virtual currencies does not require approval from financial market regulators.
However, a joint statement from the Monetary Authority of Singapore (MAS) and the Commercial Affairs Department (CAD) in August 2017 warned the public of the risks of ICO and virtual currency investment. This suggests Singapore may tighten regulatory policy for ICOs.
ICO-related Legal Risks
ICO issuers are usually entities registered outside of China. This can create jurisdictional issues. When relevant departments in China do have jurisdiction over an ICO issuer, a number of legal risks may arise.
- ICO-Stage Legal Risks
(1) Product Project ICO
Exaggeration and false advertising are thought to be common in the white papers and promotions of certain Product Project ICOs. Some coins on offer simply do not exist. If a project proponent fabricates or omits facts to swindle virtual or conventional currencies, they may be subject to investigation for activities such as fraud, contract fraud or fund-raising fraud.
(2) Earnings Project ICO
Earnings Project ICO may promise investors a ratio of earnings in order to raise virtual or conventional currencies. The ICO process usually employs publicity and public offering approaches including white papers. An unauthorized Earnings Project ICO could be suspected of illegally receiving deposits from the public .
(3) Equity Project ICO
In an Equity Project ICO, the token is closely linked to the issuer’s equity. This creates a risk of the token being viewed as a disguised offering of company shares. Unauthorized issuance of shares may be suspected.
- Post-ICO Legal Risks
Similar to securities or futures, newly issued tokens are traded on trading platforms after an ICO. Therefore, illegal trading behavior now commonly seen in the securities and futures sectors may also occur in ICOs.
In practice, some ICO issuers retain a relatively large proportion of tokens for themselves, private placement investors, and technical teams. As a result, they hold more tokens than ordinary investors in the secondary market.
In the absence of specific regulations, ICO issuers may use their advantages in holding a large proportion of tokens and information access to drive up or push down the token price, raking in huge profits in the process.
This type of market manipulation seriously affects the development of the token trading market. It infringes on the legitimate rights and interests of ordinary investors. Defining ICO as a form of securities trading by law and regulations will address this issue.
In the meantime, parties need to be aware that the judiciary could rule this type of market manipulation as an illegal business operation.
- The Legal Risks for Other Participants
An ICO project usually involves three parties: the issuer, the technical team that provides blockchain crypto-currency technology, and private placement investors. Some issuers invite “celebrities” to endorse their tokens. It is worth noting that once an ICO project runs into legal risks, all relevant participants may be held legally accountable.