The International site of 8btc News, which describes itself as the oldest and most influential independent news source for bitcoin, blockchain and cryptocurrency in China, has a full text translation of an article written by Yao Qian, Director of the People’s Bank of China (PBOC) Digital Currency Research Institute, on ICOs and token sales (ICOs for short), and the regulation thereof.
The translation carries a disclaimer: “This article represents only the author’s personal academic viewpoint and shall not be regarded as that of the organization he works for.” However, it seems plausible that Yao Qian’s consideration could reflect key aspects of the current thinking of Chinese authorities on ICO regulation.
“ICO is becoming one of the important financing channels for blockchain startups,” reads the abstract of Yao Qian’s paper. “This article makes a comprehensive study on the connotation, categories and value assessment of ICO. The paper also compares ICO with IPO, equity crowdfunding and other financing methods and proposes specific framework and suggestions for ICO regulations with considerations upon the legislation practice of securities issuance and the current regulatory design. “Regulatory sandbox” is suggested as the practical patch to regulate ICO projects.”
ICO is defined as “the fundraising mechanism that a blockchain company or a decentralized organization issues cryptographic tokens and sells them to participants to get funds for project development.”
Yao Qian seems to think that the ICO funding mechanism is only suitable for the blockchain industry itself, but this seems a too restrictive definition: in principle, and with some flexibility, nothing prevents “real-world,” “brick-and-mortar” businesses to seek funding via ICO.
A very interesting section of the paper outlines criteria for ICO valuation, as well as similarities and differences with traditional stock valuation models. The core concept is the same – the value of ICO tokens is determined by potential future earnings (payoff). Traditional public stocks “generally can be assessed by price-to-earnings ratio and cash flow discount method,” but traditional stock valuation methods can only be applied to established traditional businesses.
“A viable idea is to use the option pricing method to consider the economic value of the token as a call option for the underlying value of the project,” says Yao Qian, and proceeds to establishing a mathematical valuation method for projects denominated in bitcoin.
ICO investing has many parallels with traditional IPO (Initial Public Offering) investing and, even more, with investing in pre-IPO private companies. An important difference is that, while only wealthy accredited investors meeting strict requirements issued by national regulators can invest in private companies, anyone can invest in an ICO, even anonymously. Unless, that is, the authorities step in with ICO regulations.
Existing restrictions on risky investments have been put in place to protect consumers. However, it can be argued that current regulations are too strict, and deny less wealthy people the chance to invest in promising ventures at an early stage. Also, too much regulation can stifle development by making access to funding too difficult for ambitious projects based on emerging, yet unproven technologies. Yao Qian is aware of this point. “[Significant] technological innovation has never been the result of government planning, design and dominance,” he acknowledges. “[Preemptive] and excessive intervention by regulator will damage the market’s automatic clearing mechanism.”
In the last part of the paper, Yao Qian elaborates on desirable global regulatory actions to “impose reasonable supervision to ICO as soon as possible.”
In the US, the JOBS Act launched in 2012 eases many US securities regulations and opens a regulated path to crowdfunding campaigns. China is taking similar steps with the “Private Equity Financing Management Approach (Trial).” These regulatory innovations could, according to Yao Qian, be adapted to ICO projects, which in turn should make a best effort to be forthcoming and transparent in communicating with the public.
“[It’s] suggested to be tolerant of ICO and give some inclusive immunity in terms of listing approval, investor restrictions, publicity and promotion of the project,” says Yao Qian, concluding with a recommendation to “implement regulatory sandbox policy for ICO” aimed at creating safe innovation spaces that allow ICO projects to conduct testing activities without worrying about regulatory consequences.
Picture from bfishadow/Flickr.