BANKING AND FINANCE

What is an ICO, and why is China’s central bank banning it?

PUBLISHED : Monday, 04 September, 2017, 10:33pm
UPDATED : Tuesday, 05 September, 2017, 12:12pm

What is an ICO?

An initial coin offering (ICO) is a form of crowd-sourced fundraising that uses cryptocurrencies. Also known as digital currencies, or virtual currencies, cryptocurrencies work as a medium of exchange using encryption to secure transactions and for creating (known as mining) additional units.

Cryptocurrencies, the best known of which is the bitcoin, use distributed ledgers known as block chains to track transactions. There are now hundreds in existence, as the currencies’ independence make them attractive to some users.

Cryptocurrencies can be designed to be widely used, as with bitcoin, or to operate within an online network like the Ethereum network that uses ethers to make payments.

When a new cryptocurrency is launched, the creators, as with any other project, need funds to make it work. ICOs have evolved to fill this need.

How does an ICO work?

In initial public offerings (IPOs), companies sell their equity, in the form of shares, for cash. Rules that govern IPOs usually require the companies selling equity to be backed by tangible assets.

During ICOs, companies exchange their newly created cryptocurrencies -- called tokens -- for payment in an existing currency, which can be old-fashioned cash, or an established cryptocurrency, often bitcoin.

Read: China bans initial coin offerings over concern about financial and social stability

ICO investors profit when their tokens gain in value at a faster rate than the currency they used to pay for them. The value, or “capital gains” of these appreciating tokens can only be realised if they are exchangeable for legal tender, or for goods or services.

These fundraising ICOs are conducted online, and are usually announced on a cryptocurrency forum. Most projects have a white paper, a website, and active online forums as a way of building confidence.

An ICO has an additional benefit for the founders of the cryptocurrency, as it provides a way of distributing the new tokens.

Are they successful?

Karmacoin held the first ICO in the annals of cryptocurrencies, with its April 2014 sale of karmashares.

Ethereum sold US$18 million of ether units in July-August of 2014, valuing each ether at less than US$1. As of June this year, each ether unit was valued at US$378.

This is not always the case. Historically, ICOs have been unregulated and so offered an opportunity for the unscrupulous to exploit others hoping make some quick cash.

As many as 65 ICO transactions were completed in China in the first seven months of 2017, raising a combined 2.6 billion yuan (US$398 million), according to the Beijing Internet Finance Association.

According to the People’s Bank of China, China’s central bank, 90 per cent of the ICOs that have been launched on the mainland were fraudulent.

How are they regulated?

Regulators are now starting to look into ICOs.

In July, the US Securities & Exchanges Commission reported on its investigation of the DAO, a virtual organisation, and its use of distributed ledger or block chain technology to facilitate the offer and sale of DAO Tokens to raise capital.

The SEC determined that DAO Tokens were securities, and said that those who offer and sell securities in the US were required to comply with federal securities laws, regardless of whether those securities were bought with virtual currencies or distributed with block chain technology.

Are cryptocurrencies legal tender?

The People’s Bank of China has banned ICOs outright, calling them illegal and fraudulent.

The legality of cryptocurrency is best described as “evolving” or “undefined” in most countries. Hundreds of cryptocurrency mines exist, although their creations are best described as “barter” if a willing buyer wants to exchange a product or service for them, rather than commonly accepted legal tender.

Bitcoins and other cryptocurrencies have been legally accepted as money in Japan since 2014, owing to a government decision that acknowledged that there are no existing laws that can unconditionally ban individuals or companies from receiving cryptocurrencies as payment.

The People’s Bank of China doesn’t make it illegal for private parties to hold cryptocurrencies, but bans financial institutions from holding or transacting in them.

In Hong Kong, cryptocurrencies are considered virtual commodities. There are no laws that directly regulate the use of cryptocurrencies in the city, although the Organised and Serious Crimes Ordinance and other legislation provide legal sanctions against unlawful acts such as fraud or money laundering through the use of cryptocurrencies.

In Taiwan, bitcoins can be purchased through convenient stores, some of which accept them in exchange for products.

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