Blockchain unchained

Germany's 'Wild West' laws lure cryptocurrency IPOs

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German ICO investor, unencumbered by regulation. Source: Imago

As authorities in the US tighten their regulations for cryptocurrencies like Bitcoin, upstart financiers are turning to countries in Europe to raise funds from Initial Coin Offerings, or ICOs. Paradoxically, Germany – widely regarded as a digital laggard whose society is stuck in the hard-cash era – is drawing more ICO projects than ever before, thanks to startling laxness in its financial laws.

Experts point to Germany’s stable economy, burgeoning startup scene and oddly relaxed attitude towards initial coin offerings, which makes it similar to that of Switzerland and tax havens like Gibraltar and the Cayman Islands. Alarmed at the potential for dubious dealings, German politicians have called for a crackdown on the “Wild West” of lawless ICOs, and for greater clarity from financial regulators.

ICOs are similar to initial public offerings, or IPOs, in which companies float on the stock exchange. Rather than receive shares, investors get crypto “tokens” or coins that are ostensibly linked to the company’s future value and are cryptocurrencies in their own right. They tend to be a purely speculative investment and their buyers, who often pay in Bitcoin, usually have no voting rights in the company. Bitcoin and other cryptocurrencies run on blockchain or their own version thereof – a digital ledger that records transactions, called blocks, and validates each new transfer from several, independent sources.

As the value of cryptocurrencies soared last year, ICOs also flourished. In 2017, companies are thought to have raised around $5 billion (€4.1 billion) through ICOs, according to Coindesk, a cryptocurrency news service.

In January, the SEC shut down a $600 million ICO for Arise Bank, a Dallas-based financial startup.

But exploding prices and patchy information have left investors vulnerable and regulators concerned. In recent weeks, the Securities and Exchange Commission, the main US regulator of stock and bond markets, has issued subpoenas and information requests to around 80 companies involved in recent ICOs.

In January, the SEC shut down a $600 million ICO for Arise Bank, a Dallas-based financial startup, citing serious irregularities. Digital crooks have been having a heyday. Consultants at EY estimate that $400 million of the $3.7 billion raised through ICOs so far has been stolen by hackers.

In order to curb fraud, US regulators have decided that crypto tokens will be defined as a form of equity, akin to an ownership share. ICOs will be regulated accordingly, with strict rules on information and responsibilities.

The American crackdown has prompted some firms to look elsewhere. “Many international companies planning ICOs are avoiding the United States entirely. It’s just too complicated,” says Jonathan Ching of Linklaters, a multinational law firm.

Germany’s financial regulator Bafin has taken a more relaxed approach. According to details seen by Handelsblatt, the agency investigated 23 suspicious ICOs in 2017. In 13 cases, the agency took steps against improper financial trading; on four occasions, Bafin imposed a formal ban and handed the file to criminal prosecutors. But Bafin, chronically understaffed, has yet to fine a single violator. Nor, crucially, has it formally defined ICO coins and tokens as a form of equity.

Observers say this is not enough to protect investors from sketchy ICOs. “Germany is not well-positioned on this, either in terms of regulation or taxation,” Frank Schäffler, a parliamentarian and finance expert for the pro-business Free Democratic Party, told Handelsblatt. Ingo Fiedler, a leading academic expert on ICOs, said Germany must establish a sensible regulatory framework, enabling genuine ICOs while putting an end to shady practices.

“The crypto world is a new sphere, beyond the reach of state authorities. It ultimately cannot be regulated.”

Austin Alexander, account manager at Kraken.com

Authorities face a tricky balancing act, trying to protect investors while not putting off innovators. “The crypto world is a new sphere, beyond the reach of state authorities,” said Austin Alexander, an account manager at Kraken.com, a US-based cryptocurrency trading platform, at a recent “crypto assets” conference in Frankfurt. “It ultimately cannot be regulated.”

Switzerland has embraced a low-regulation approach, enticing many cryptocurrency firms to set up in the country. The canton of Zug, an active supporter of startups seeking ICO capital, has become known as “Crypto Valley.” Consultants PwC report that four of the 10 largest ICOs in 2017 took place in Switzerland.

Some in the crypto sector say self-regulation, backed up with new technology, will ultimately solve the ICO problems. A new ICO model, known as DAICO, has been proposed. In a DAICO, money raised goes to a kind of trust fund, with investors voting on whether to release new tranches of funding or to pull the plug on the startup. The model will soon be used for the first time, in an ICO for The Abyss, a Swiss digital games platform.

In the meantime, investors are growing cautious. In November, just 23 percent of ICOs reached their target amount, according to EY, suggesting that the rough-and-tumble of the Wild West isn’t so appealing to investors after all.

Michael Brächer is a financial editor in Handelsblatt’s investment team in Frankfurt. Astrid Dörner is an editor for Handelsblatt. Brían Hanrahan and Jeremy Gray adapted this article into English for Handelsblatt Global. To contact the authors: braecher@handelsblatt.com, adoerner@handelsblatt.com.

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