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Making an Initial Coin Offering in Hong Kong
1 May 2018

As the number of investors in cryptocurrencies such as “Bitcoin” continues to multiply in Hong Kong caused partly by a strong rally in the prices, regulators in Hong Kong are increasingly concerned about intermediaries’ activities in unauthorized promotional activities and unlicensed regulated activities of the products.

In Hong Kong, cryptocurrency is considered as a virtual commodity, and is not legal tender meaning that a cryptocurrency cannot be used as a medium of payment. It is therefore not regulated by the Hong Kong Monetary Authority or the Securities and Futures Commission (“SFC”). Trading activities are regulated by the Customs and Excise Department instead.

As a result, there have also been an increasing number of fundraising mechanisms by way of an initial coin offering (“ICO”) in Hong Kong whereby a project operator issues digital “tokens” or “coins” to fund a particular blockchain-related project (e.g. to develop a new blockchain business platform) in exchange for a widely-used cryptocurrency (such as Bitcoin or Ether) or cash. Usually, the project operator of the ICO will set out the business proposal including the token holder’s rights in a “white paper” published online. Some tokens or coins derived from ICO are very similar to a security under Hong Kong laws.

SFC Regulation Relating to Cryptocurrencies and ICOs

A key legal issue concerning cryptocurrencies is whether they are regarded as securities and thus subject to an extensive regulatory regime. “Securities” is defined in Schedule 1 of Securities and Futures Ordinance (Cap 571) (“SFO”) and includes inter alia :-

(a) shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a body;

(b) rights, options or interests (whether described as units or otherwise) in, or in respect of shares, stocks, debentures, etc.

(c) certificates of interest or participation in, temporary or interim certificates for, receipts for, or warrants to subscribe for or purchase, shares, stocks and debentures, etc.

(d) interests in any collective investment scheme.

On 5 September 2017, the SFC issued a statement on ICOs, and mentioned that whilst digital tokens offered in typical ICOs are usually characterized as a “virtual commodity”, digital tokens may also be a form of “securities” as defined in the SFO, and subject to the securities laws of Hong Kong, depending on the facts and circumstances of the ICO.

Under the SFO, digital tokens may constitute “securities” if the tokens are regarded as shares, debentures, or interests in a collective investment scheme (“CIS”). For example, digital tokens offered in an ICO may be regarded as “shares” where they represent equity or ownership interests in the corporation. Where digital tokens are used to create or acknowledge a debt or liability owed by the token issuer, the SFC may regard the tokens as “debentures”. As for whether digital tokens fall under the definition of a CIS, if the token proceeds are managed collectively by the ICO operator to invest in projects with an aim to obtain returns, and participants do not have “day to day control”, then the digital tokens may be regarded as interests in a CIS unless an exemption applies.

Further guidance was provided on 11 December 2017, where the SFC issued a circular to remind industry participants of the legal and regulatory requirements for providing any financial services in relation to bitcoin futures contracts (“Bitcoin Futures”) and other cryptocurrency related investment products to Hong Kong investors, as well as to warn investors of the risks of such investments (e.g. possible scams, money laundering risks, liquidity risks and platform risk).

In the 11 December 2017 statement, the SFC laid down the parameters for licensing requirements in Hong Kong, and noted that Bitcoin Futures are likely to be “futures contracts” as defined under the SFO. Accordingly, if an unlicensed intermediary engages in investment activity or provides investment service in relation to Bitcoin Futures which are targeted at Hong Kong investors without the proper SFC license or authorization, this activity may constitute a criminal offence under the SFO irrespective of whether the service provider is located in or outside of Hong Kong. It is thus possible that the SFC has taken a view that Bitcoin (as an underlying asset) should be viewed as a security rather than as a commodity.

Recent SFC regulatory action

In its 9 February 2018 statement, the SFC has mentioned that regulatory actions continue to be taken against cryptocurrency exchanges and issuers of ICOs, and has written to several cryptocurrency exchanges with connections to Hong Kong that they should not trade in cryptocurrencies which are considered as “securities” under the SFO without a proper license. Examples of SFC’s enforcement activities can be seen recently, where the SFC stopped the ICO activities of Black Cell Technology Limited to the Hong Kong public, and required Black Cell to unwind ICO transactions with Hong Kong investors and return the tokens. These actions followed SFC concerns that Black Cell had engaged in potential unauthorized promotional activities and unlicensed regulated activities, and that it may have constitute a CIS under the circumstances.

If you are an investor with a complaint regarding unlicensed or fraudulent activities, or seek to offer cryptocurrency related products, you should immediately seek legal advice about the applicable legal and regulatory requirements. Our Corporate and Litigation team have assisted clients in addressing issues on these topics. Please contact us if you have any such enquiry.

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