This week, the world of digital currencies was shocked by the news that Chinese regulators declared initial coin offerings(ICOs) illegal. The news sent the prices of Ether and Bitcoin(the two cryptocurrencies most used as exchange for ICO tokens) tumbling 8% and 20% respectively before some recovery in the last few days.
The move by Chinese financial regulators followed warnings from financial market authorities in countries such as Singapore, Canada and The US expressing that some ICOs could be treated as securities and subjected to the corresponding regulation. However, China went far beyond warnings and declared that all fundraising activities through ICOs should cease immediately. The move was obviously extreme but shouldn’t be surprising to anybody familiar with China’s financial markets. After seeing some of the initial overreaction in the market, I decided to write down a few thoughts that might help to put the decision of Chinese regulators into perspective.
The Things that Makes Chinese Financial Regulators Tick
One word: stability! That’s essentially the main thing that moves the regulatory arms of China’s financial markets. In China, the government and regulators will to to extreme extends to enforce the stability of the Yuan, the stock exchanges and even the fintech startup ecosystem. Let’s go back to a recent example from early 2016 when Chinese equitities trading all over the world experienced a sharp decline. During those months not a week went by in which we didn’t hear of yet another measure adopted by the government in order to stabilize the trading of equities. From passing “overnight laws” that controlled the volume of shares allowed to be sold per stock, bypassing trading halts triggered by market’s circuit breakers( ironically implemented for that purpose) to injecting ridiculous amounts of money into equities, the Chinese government did everything possible to preserve the image of a stable market.
When comes to ICOs, Chinese financial regulators see the fundraising mechanisms as a potential sign of instability. Those fears have been accelerated by the growing number of Chinese citizens who are digital currency holders and have been actively participating in ICOs. Another factor influencing the fear of the regulators in the questionable performance of some recent token offerings. Declaring ICOs illegal is definitely an extreme measure but it can be entirely surprising if you understand the DNA of the Chinese financial market.
Fear the Numbers
The fear by Chinese regulators is partially due to the underperformance of recent ICOs. Just this year, ICOs have raised about $1.5 billion vastly passing the amount of capital raised by blockchain startups. While most ICOs have performed decently, there have been some very high profile token offerings that have disappointed casting a shadow over the entire market. Among the underperformers, we have Bancor which tokens have lost about 12% after raising over $143 million to build a crypto-token exchange. Similarly, Estonia-based Polybius is down 24 % after raising 32%, Encryptel’s token are down 50% and BitcoinGrowthFund is down 59%. Overall, 10% of the ICOs are trading downwards from their original price and 30% have not traded at all.
Seeing those numbers, we can understand the reaction of Chinese regulators but I think that perspective can be very misleading. By the previous numbers, we can infer that 60% of the ICOs are performing above their initial price. That beats the majority of market indices. In terms of numbers, the overall value of ICO tokens have raised an astonishing 28 times since their initial offering overperforming some of the top Index-Funds in the market. On any stable market there are always underperformers; just look at the recent debacle of Snap and BlueApron or the inexplicable raise and fall of the mysterious DryShips stock and suddenly the ICO numbers don’t seen that scary at all.
Regulators are Coming
China is not the only country (although is certainly the most extreme) to try to take a regulatory stand on ICOs. Last month, the Canadian Securities Administrators(CSA) declared that ICOs are likely to be considered securities and warned about some behaviors in ICOs that could hurt investors. Similarly, the US Securities and Exchange Commission(SEC) recently ruled that one high profile ICO which have raised over $150 million for an automated investment model was in fact a securities offering. To its credit, the SEC published guidelines to help companies pursuing an ICO, understand the circumstances under which their token offering could be considered a security. Singapore is another country that has issued regulatory guidelines about ICOs.
Generally speaking, ICOs are likely to experience some level of regulation in the near future and I think that should be welcomed by the ICO community. While classifying all ICOs are security offerings might be oversimplistis, we should keep in mind that many times regulators react first and think later :)