Initial Coin Offerings (ICOs)
78. Many Initial Coin Offerings (ICOS) have failed in their fruition, resulting in financial
losses for those who had initially invested in the ICO. A crowdsourcing website that keeps
track of coins that have gone out of existence, www.deadcoins.com, has identified over 900
ICOs that have failed.113 The website lists whether the ICOs failed due to their inadequate
business proposals, through a successful hack of the coins or whether they were a fraud or scam to begin with. For example, CraftCoin was designed to be a crypto-asset that would
be used as an in-game currency for Minecraft114 users but failed to launch.
115 According to
CoinMarketCap, a website tracking the market capitalisation of crypto-assets, the value of
CraftCoin in September 2018 was $0.000738 and the market capitalisation, volume traded
in the last 24 hours and the circulation supply were unknown.116 Additionally according
to ICO Data, a website that lists the funds raised of ICOs, an ICO for a new crypto-asset
called Infinitum Coin was launched in January 2018 and ended in April 2018, having
raised $0.117 A study of 2,400 ICOs by a research team at Boston College, Massachusetts
found that 56 per cent failed within the first four months.118
79. Izabella Kaminska, Editor of the Financial Times Alphaville, told the Committee
that would-be investors in ICOs should be cautious:
You have to ask: why are these companies going to the ICO markets instead
of going to the conventional markets? If your product is good enough to
raise money in the markets, you should be able to raise it in the regulated
markets, not just go to the ICO issuance.119
80. As discussed earlier, most ICOs are not regulated in the UK, and investors are
extremely unlikely to have access to regulatory protections.120 David Geale, Director of
Policy at the FCA, explained that:
The bulk of this [ICO] activity seems to be in the unregulated space,
around things like the utility tokens, where you are buying, for example,
future rights to access a theme park or something that does not exist at the
moment. Is that the sort of thing we would regulate? It is certainly not the
sort of thing we regulate at the moment […]121
81. In its evidence to the Committee, MIT Media Lab argued that “ICOs are essentially a
new method of capital raising for a new enterprise [and] they should not be able to avoid
relevant securities regulations just by tweaking the form.”122 This view is reflected in the
approach taken by the US Securities and Exchange Commission, whose Chairman, Jay
Clayton, issued a public statement in December 2017 that:
A change in the structure of a securities offering does not change the
fundamental point that when a security is being offered, our securities
laws must be followed. Said another way, replacing a traditional corporate
interest recorded in a central ledger with an enterprise interest recorded
through a blockchain entry on a distributed ledger may change the form
of the transaction, but it does not change the substance. The Commission
applied longstanding securities law principles to demonstrate that a
particular token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that
the token offering represented an investment of money in a common
enterprise with a reasonable expectation of profits to be derived from the
entrepreneurial or managerial efforts of others.123
82. In particular, Mr Clayton highlighted that “utility” tokens would generally be treated
by the SEC as securities, and regulated accordingly:
Certain market professionals have attempted to highlight utility
characteristics of their proposed initial coin offerings in an effort to claim
that their proposed tokens or coins are not securities. Many of these
assertions appear to elevate form over substance. Merely calling a token a
‘utility’ token or structuring it to provide some utility does not prevent the
token from being a security. Tokens and offerings that incorporate features
and marketing efforts that emphasize the potential for profits based on
the entrepreneurial or managerial efforts of others continue to contain the
hallmarks of a security under U.S. law.124
83. Mr Geale explained how differences in the law gave rise to the different regulatory
approaches to ICOs in the UK and the US:
The tests [the SEC] applies are different [from the FCA]. It applies them
on the basis of case law, which is more like asking, ‘does it look and feel
like an investment, because you are investing for some form of speculative
return?’, whereas the definitions of a ‘financial instrument’ are laid down in
legislation here. It is different, but if it is a financial instrument that looks
like a form of security, or if there is a form of security […] it will be regulated.
[…] For utilities, where it is not conferring rights to future returns but there
might be a future reward of some description, it is outside the perimeter.125
84. On 12 September 2017 the FCA published a consumer warning about the risks of Initial
Coin Offerings (ICOs), stating that ICOs are “very high risk, speculative investments”126
and highlighting the absence of regulatory protections.127 The consumer warning went
on to highlight the risks faced by consumers from price volatility, potential for fraud
and inadequate documentation that are typically associated with ICOs. It cautioned that
investors should be “prepared to lose [their] entire stake.”128
85. The FCA’s power to issue consumer warnings extends to products that fall within
its remit. Mr Geale conceded that the FCA’s warning on ICOs may “have gone a little bit
outside of our remit.”1
86. It is not known how many current or prospective ICO investors have read the FCA’s
warning. When asked whether it had been useful, Ms Kaminska stated that “personally, I
do not think they have gone far enough, and they have been very late to the game as well.
We were all waiting to see action much earlier than it happened.”130
87. The FCA’s stark consumer warning on ICOs is evidence that they present
significant risks to investors. But apart from drawing attention to the risks, there
is little the FCA can do to protect individuals from being defrauded or losing their
money. This is because most ICOs do not promise financial returns, but instead offer
future access to a service or utility, meaning they fall outside the regulatory perimeter.
88. While there may be no explicit promise of financial returns, investors in ICOs
clearly expect them: they are not buying tokens to gain access to as-yet unbuilt theme
parks, or to obtain dental services in years to come, but in the hope of selling them
at a profit. The development of ICOs has exposed a regulatory loophole that is being
exploited to the detriment of ordinary investors. The Regulated Activities Order
should be updated to bring ICOs within the FCA’s perimeter as a matter of urgency,
and bring investor protections into line with those in the United States.
89. Crypto assets and ICOs are extremely risky, and the Committee agrees with the
FCA that investors should be prepared to lose all their money
Money laundering and terrorist financing
90. Although they will fall within the scope of the Fifth Anti-Money Laundering (AML)
Directive and will have to comply with anti-money laundering and counter-terrorist
financing rules, crypto-asset exchanges are not included in Anti-Money Laundering
(AML) regulations that are currently in force. As the FCA notes:
The activities that require firms to comply with anti-money laundering
(AML) obligations are set out in the Money Laundering, Terrorist Financing
and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR).
Crypto-asset exchange activities are not included in the MLR, which means
that such firms are not currently subject to AML requirements.131
91. It is suspected that crypto-assets and crypto-asset exchanges appeal to money
launderers and are being used to facilitate money laundering and terrorist financing. The
Solicitors Regulation Authority noted that given the current lack of regulation, “crypto-
[assets], and any similar technologies […] facilitate anonymity […].”132
92. When asked about crypto-assets’ role in facilitating money laundering, David
Raw, Deputy Director of Banking and Credit at HM Treasury, stated that “the latest
risk assessment from the National Crime Agency is that [crypto-assets’] use for money
laundering and terrorist financing is currently low. They are seeing cases of it, but it is not
widespread.”1
93. In evidence to the Committee’s Economic Crime inquiry, Donald Toon, Prosperity
Command at the National Crime Agency, explained that even though there is a growing
risk that crypto-assets are facilitating money laundering and terrorist financing, “it is
important that we place virtual currencies in the context of the whole money laundering
problem.”134 There are “other large-scale areas of the problem.”135 Nevertheless, he stated
that “we are not relaxed about this. We see it as a problem.”136
94. Mr Raw, HM Treasury, explained that, although they provide a degree of anonymity,
some characteristics of crypto-assets disincentivise criminals and terrorists from using
them to launder money:
[While crypto-assets are] an anonymous way of paying for illicit activity,
there is the fact that you are potentially creating a more transparent record
of the transaction, which is potentially auditable. There is a question over
whether terrorists would want to use this method. There are other methods
available to them, many of which are easier, such as cash couriers.137
95. However, the FCA stated that the role of crypto-assets in money laundering could be
more significant than previously assessed:
In 2017, the UK’s National Risk Assessment of money laundering and
terrorist financing risk (NRA), assessed the risk of crypto-asset use for
money laundering to be relatively low. This was because of a lack of evidence
of crystallised risk. However, FCA work on this issue using information that
postdates the intelligence the NRA relied on shows evidence supporting
wider-scale criminal use and we now view the potential harm in this space
to be greater than previously assessed.138
96. The Committee received written evidence from Crypto UK arguing that “lack of
regulation around the ‘on’ and ‘off’ ramps, where fiat is converted into a cryptocurrency
and vice versa, [i.e. crypto-asset exchanges], means that these points are currently
vulnerable to criminal activity.”139
97. Obi Nwosu, Chief Executive Officer of Coinfloor, argued that there is an important
role for exchanges in mitigating the risk of money laundering:
If exchanges put efforts into knowing their customer, track the source
and destination of funds on the crypto side as well as the fiat side, have
strong policies around monitoring behaviour on the site and have a policy
of submitting suspicious activity to the National Crime Agency […] they
[would] have very low rates of issues in [money laundering]
98. However, Izabella Kaminska, Editor of the Financial Times Alphaville, argued that
the current policies and practices of crypto-asset exchanges are often ineffective:
There is a difference between asserting that you are pre-emptively compliant
and the reality of that compliance. In my day job as a journalist, I often
test a lot of these platforms for exactly that. I have often been privy to
situations where I can open accounts without providing the full spectrum
of information that is usually needed to fulfil KYC [Know Your Customer]
requirements. […] It is very easy to say that you are compliant, but who is
testing that compliance?141
99. Mr Raw highlighted to the Committee that the Government is already considering
how to apply AML regulation to the crypto-asset landscape. He said the “key thing […] in
terms of tackling money laundering and terrorist financing, is […] to bring the exchanges,
which is the point at which fiat currency exchanges for cryptocurrencies, into the money
laundering directive regulations”.142
100. Mr Raw told the Committee that the next step was for the UK to transpose the
European Directive into UK regulation:
Transposing the Fifth AML Directive is certainly a matter of urgency.143
[…] We will be consulting on how to transpose that over the remainder
of this year and the course of next year. The precise timings are still being
worked out, but by the end of next year it will be transposed so we will know
precisely what that new money laundering framework looks like in relation
to crypto assets and exchanges, including who the responsible regulator is.
We will know precisely how we are going to deal with it.144
101. The Committee also heard in evidence from David Geale, Director of Policy at the
FCA, that the FCA has reminded firms of their own AML responsibilities whilst the Fifth
AML Directive is being transposed:
In the interim, we have […] written to the chief executives of the banks,
asking them to think about the use of crypto assets in terms of whom they
are dealing with, the due diligence they do on the customers they have and
who those people are dealing with, the jurisdictions they are dealing in, the
underlying technology and the governance that is being put around that.
There are interim steps that we can take and are taking to remind the banks
of their own responsibilities under existing antimoney laundering laws. The
new ones will help in terms of what actually comes through the exchanges.145
102. The Committee also heard from Iqbal Gandham, Chair of Crypto UK and Managing
Director of eToro, that some crypto-asset exchanges are preparing for the implementation
of the Fifth AML Directive, but also require further guidance from the Government and
regulators:
[Some exchanges] are also aligning themselves with the Fifth Anti-Money
Laundering Directive. [But]we still need clarity from the UK Government
to say, ‘these are the checks that we want you to do.’146
103. Owing to their anonymity and absence of regulation, crypto-assets can facilitate
the sale and purchase of illicit goods and services, and can be used to launder the
proceeds of serious crime and terrorism.
104. The absence of regulation of crypto-asset exchanges—through which individuals
convert crypto-assets into conventional currency—is particularly problematic.
105. The adoption of the Fifth Anti-Money Laundering (AML) Directive represents a
step forward in this respect. Under the Fifth AML Directive, crypto-asset exchanges
will have to comply with anti-money laundering and counter-terrorist financing rules.
The Committee urges the Government to treat the transposition of the Directive as
a priority, and to expedite the consultation process, which is currently not planned
to finish until the end of 2019. If the UK leaves the EU without a transition period
in March 2019, the Committee would nonetheless expect the Government to seek to
replicate the relevant provisions of the AML Directive in UK law as quickly as possible.
106. The Committee believes that the FCA should be the relevant regulator for
supervising anti-money laundering