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Reining in cypherpunks and the wild token ride

Some regulators are stepping in with advisories and warnings as cryptoanarchy leads to a rash of newfangled Kickstarter-esque funding

FaceMask, made from 10,770 Lego bricks by American brick artist Nathan Sawaya. Blockchain could create a new face for commerce, and speculative fever is high on newfangled digital tokens now tied to the technology.


THE rise of cypherpunks came amid the wash of anger over the financial crisis. Renegades sought a fresh brand of civil liberty through the Internet, by creating a new medium of exchange that was built and encrypted via layers of code. The first was called bitcoin.

Nearly a decade later, cryptoanarchy has translated to a rash of newfangled public crowdfunding that has regulators concerned. This fundraising, known as initial coin offerings (ICOs), has brought on another medium of exchange. Instead of selling company equity to investors, ICO issuers are raising public funds by taking in well-known cryptocurrencies or fiat money in exchange for their own brand of currencies, known broadly today as digital tokens.

What are the ordinary men and women getting through such Kickstarter-esque deals for these digital tokens?

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That such a basic question can pull a thick fog over the answers from the get-go has prompted regulators such as the Securities and Exchange Commission (SEC) and the Monetary Authority of Singapore (MAS) to step in. They have clarified that many digital tokens that promise a form of return, are in effect securities. This means they generally need to follow rules that govern shares, units of real estate investment trusts, and bonds.

In defining the purpose of these ICOs, they can broadly be split into two categories. The first are ICOs that sell tradable digital tokens - that is, a part - of an ongoing blockchain project that, if successful, should increase in value as per the network effect. ICOs run by application developers such as Thailand's Omise and Singapore-based start-ups Qtum and TenX have raised funds through an issue of their own brand of digital tokens. In exchange, they take bitcoins or ethers - a digital currency of the Ethereum platform that many developers are using to develop their blockchain technology.

A successful blockchain, so named because it can digitally authenticate and secure "blocks" of information for a distributed ledger, can allow businesses to work off a digital ledger of information that updates on sales and asset ownerships - a record that is distributed to other associated businesses. The hope is that blockchain technology can slash painful backend processing.

The second type of ICOs are those that are selling a fraction of a tangible asset, such as a piece of property, through digital tokens.

For example, Singapore's FundPlaces launched its digital token called Tiles, selling Tiles for Singapore dollars. Token holders are entitled to the cashflow of the underlying property investment, with high returns projected at more than 10 per cent. FundPlaces said it uses the Singdollar funds to then finance the building of properties.

As a brief from law firm Colin Ng & Partners pointed out, many investors participating in ICOs may be people with little or no expertise in blockchain, cryptocurrencies or in how ICOs operate.

Given the volatile jump in prices of digital tokens, many investors are simply jumping on the bandwagon, "hoping to make good investment returns, and quite often make decisions to participate in an ICO based on inadequate and possibly inaccurate information".

MAS stepped in to address problems with that information asymmetry that works against investors. If issuers of digital tokens are in effect offering securities, they have to issue a prospectus. There are exceptions; one way to skip the prospectus is in effect to limit ICOs to sophisticated investors.

The statement also addresses a misinterpretation by many token issuers that MAS had no desire to regulate token offerings, said law firm Morrison Foerster. "Perhaps, as a result, Singapore has attracted several high-profile token offerings."

Indeed, Matt Chwierut, research director at US-based Smith + Crown - which tracks cryptocurrencies - told The Business Times that the biggest ICO hubs are Singapore and Switzerland, with some smaller hubs emerging in Gibraltar, Vancouver, and the United States. Globally, ICOs have raised roughly more than US$300 million.

The nature of these digital tokens in having no central authority makes them quite unlikely to become fiat currency, for the basic reason that such legal tender is backed by the central bank. Token investors must expect little recourse in the event of a collapse.

Stephen Banfield, special counsel at Withers KhattarWong, said that apart from vendor acceptance, the biggest obstacle to overcome with the mainstream usage of digital currencies for everyday transactions is price volatility. He added that more countries are likely to follow the footsteps of the US and Singapore in regarding ICOs as an offer of securities, and higher scrutiny is certain to curb growth in this form of capital raising.

"This increase in regulation will provide an important level of investor protection and is a key part of the maturing of this sector. The costs and complexity of meeting with regulatory requirements for the issue of a new coin will provide a useful barrier to entry. This should help to weed out the more speculative or opaque of the offerings, and should also help to put in place controls around the disposal of coins by a project sponsor which is sorely needed."

For those who are trying to package the old financial system as an ICO - regulations today are a signal that they are not unwelcome, but would have to abide by existing rules, said David Lee, a professor of fintech in SIM University. This may separate token issuers that are improving the financial system with new innovation, said Prof Lee, who advises and invests in cryptocurrency platforms.

Where digital tokens' potential lies is not just in becoming a currency, but in the "immense amount of creativity" that they can fit into a company's product, user experience, and business model, said Mr Chwierut.

Still, creativity comes in many forms. MAS issued a separate warning on investing in digital tokens, noting that "the valuation of digital tokens are usually not transparent, and highly speculative".

Responding to BT queries through a YouTube video, TenX founder Julian Hosp said that he "personally, totally, welcomes this advisory from the MAS". "What it's going to do is that it'll make sure that fewer and fewer - let's call (them) borderline ICOs - manage to scam people."

Mr Chwierut said that broadly, regulatory ambiguity is holding great ideas back. "Governments could crack down aggressively, but many signals from SECs (of the world) seem to indicate that they are open to learning more about this technology before introducing new regulations," he told BT via e-mail.

"No one wants fraud - entrepreneurs, token purchasers, and regulators alike - so more guidance from relevant jurisdictions would be helpful. Ideally, regulators would provide guidance for the good actors while taking a case-by-case harder line for projects that seem to flout basic principles of public market regulation."

But even as more regulations come through, and in Singapore's case, alongside a proposed overhaul of the current regulatory regime for payments in Singapore, there are concerns that the old and the new will come into conflict, and create inconsistent global regulations.

"What global regulators have are existing 'old world' laws and regulations to apply to this new technology," said Lena Ng, head of financial regulatory practice at the Singapore office of Clifford Chance. "There is a risk that what we will see is a patchwork approach, with some regulators treating digital tokens as securities or collective investment arrangements or funds, and others as a currency or commodity."

What is consistent for regulators is in keeping a clean financial centre. ICO issuers in Singapore will be on the hook if they channel illicit flows. "Funds invested into investment schemes involving digital tokens are prone to being misused for illegal activities due to the anonymity of transactions, and the ease with which large sums of monies may be raised in a short period of time," said MAS.

Mr Banfield noted that this reflected the paradox of the blockchain: public, but anonymous.

"There is no simple way of linking a public key to a particular individual or organisation electronically. Regulators have sought to address this concern by requiring exchanges to meet with higher standards of know-your-customer and anti-money laundering, and this trend will surely continue," he said. "Capturing peer-to-peer transactions in digital currencies is where this becomes really very difficult, if not impossible. This is the modern day equivalent of the black economy problem."