What Are ICOs and Why Are They Getting Banned in China?

China banned initial coin offerings and briefly paused the seemingly unstoppable price increase of bitcoin. But the cryptocurrency has already bounced back. With the likes of Paris Hilton, Kim Dotcom, and John McAfee all jumping into the ICO world in one way or another, it seems worth asking what this is about.
An ICO is a bit like the IPOs that come along when a company wants to offer ownership shares to the public. When a company like Snapchat wants to raise lots of investment capital to fund speedy growth, it offers shares to investors that are priced based on a number of factors, and the Securities and Exchange Commission (SEC) imposes regulations that help protect investors who buy in. With an ICO, a company offers a chance to invest in a “new” cryptocurrency that often has a business aspect related to it. Typically, the ICO will accept major cryptocurrencies like bitcoin or ether, and in some cases traditional currency in exchange for “crypto-tokens” that basically function as shares in the company.
The government-imposed regulations on IPOs along with standardised business practices give them a certain level of consistency. Your investment might be a foolish one and the product might not take off, but you can trust that a certain number of precautionary checkboxes have been marked as the IPO was prepared. With an ICO, almost all the rules function on a case-by-case basis. You can visit a repository like CoinSchedule that will show you current ICOs that are on offer and ones that will soon be available. Pick one that looks interesting and you’ll find a list of how many tokens will be offered, how to buy in, and usually, a whitepaper explaining how it works. The terms and conditions, business model, and legal framework are setup by the ICO itself.
In the case of newly minted crypto-superstar Ethereum, it started out as an ICO funded with bitcoin that’s become its own cryptocurrency (ether) that’s just as trusted as bitcoin by many people in the crypto community. Ethereum, broadly speaking, is positioning itself as a decentralised computing network specialising in smart contracts—a method of storing and verifying data in the blockchain. Many people believe that smart contracts will have a lot of uses, especially in the world of finance. But that’s a whole other subject. The most important thing to know is that there’s a hypothetical use for Ethereum beyond it just being another block-chain cryptocurrency.
On the other end of the spectrum, there are ICOs like Useless coin which started as a joke by someone who goes by “UET CEO” and was sold as transparently offering investors “no value, no security, and no product. Just me, spending your money.” It should have just been a satirical comment on the precarious nature of ICOs, but it still got some investors and currently has a market cap of about £48,500.
That probably sounds stupid, but it doesn’t change the fact that ICOs have raised around £1.5 billion this year. There’s a level of faith and a level of gambling involved. Just as the US dollar is backed by the “full faith and credit of the US government,” bitcoin is backed by the faith of the community that keeps putting money into it. Faith in the ICO market is almost entirely dependent on the faith that bitcoin will continue to increase in value. So far, people who are going long on the original cryptocurrency are doing great, and its value has more than quadrupled this year with its current price hovering around £3,500. Advocates like John McAfee tend to make insane predictions about how high it can go, and in July, he claimed he will “eat his own dick on national television” if the price doesn’t reach around £380,000 per bitcoin within three years.
In the last month or so, two big problems hit bitcoin and no one knew what would happen to its value. The first was a fork into a new cryptocurrency called Bitcoin Cash. Some people thought that the fork could cause a split in support for bitcoin, but the original currency’s price quickly recovered and has only gone higher. The second test came this week when China banned ICOs. Bitcoin lost about £380 per token in value over the course of two days, but it’s pretty much leveled back out.
The announcement by the Chinese government took a hard line requiring that all ICOs return money to investors in offerings that have already been completed. According to TechCrunch, “State media firm Xinhua reported in July that Chinese companies had raised £290 million from 105,000 investors during the first half of the year.” That’s a big problem, especially if the ICO is anything like the numerous American joke coins that always intended to just make off with foolish investors’ cash.
China’s central bank didn’t outline its full reasoning for the ban beyond the statement that ICO’s have “seriously disrupted the economic and financial order.” But experts have been quick to offer numerous explanations for the decision, chief among them being the rampant opportunities for fraud.
Another intriguing possibility for the Chinese ICO shutdown is that the government may have plans to offer its own cryptocurrency in the future. The fact is, China has been actively shutting down and reopening bitcoin exchanges for years. It clearly sees potential in this field and is very cautious about it growing too fast within its micro-managed economy. Stepping up with its own currency could be the solution it’s looking for.
Fred Wilson, an investor at Union Square Ventures and one of the biggest bitcoin boosters from the establishment, speculated that China is just looking to have a cooling off period. Returning everything to zero is a hell of a way to accomplish that. And other countries are showing signs that major changes that could disrupt the crypto market are on their way.
On Tuesday, September 5th, the Securities Exchange Commission’s co-director Steven Peikin spoke out against the growing trend of bad ICOs during a talk at New York University. “As with any kind of newsworthy event, roaches kind of crawl out of the woodwork and try to scam money off of investors,” he told the audience.
Peikin’s remarks follow a report from the SEC in July that tokens issued a German company called slock.it are officially securities under US law and are subject to all the regulations that designation entails. Slock.it raised £114 million in ether before $40 million worth was hacked in June 2016. While the SEC’s investigation was focused on this one organisation and its co-founders, the report clearly states, “U.S. federal securities law may apply to various activities, including distributed ledger technology, depending on the particular facts and circumstances, without regard to the form of the organization or technology used to effectuate a particular [cryptocurrency] offer or sale.” The investigation found that those involved with slock.it “may have violated the federal securities laws,” but it decided not to pursue enforcement actions at this time. It seems unlikely that the hyper-capitalistic US government would do anything as drastic as the Chinese government, but the writing’s on the wall that increased enforcement of regulations is likely just around the corner.