Regulating a virtual threat

Explaining the nitty-gritty behind Germany’s warning on digital “initial coin offerings,” and why the financial regulator waited so long to issue it.

Germany’s financial regulator sees no need for a ban on digital currency offerings, or ICOs, despite issuing a stern warning about the dangers of potential fraud from these new financial instruments. BaFin, the federal agency that splits its supervisory duties with the Bundesbank, has come under fire for being tight-lipped on ICOs even as supervisory bodies in other countries took action.

In an interview with Handelsblatt, BaFin official Christoph Kreiterling defended the agency’s reticence, saying it was simply observing developments before issuing its warning. “A clear warning requires a clear examination of the phenomenon and its risks,” said Mr. Kreiterling, who runs BaFin‘s new department of Innovations in Financial Technology. In the past, Bafin had occasionally banned the use of individual financial products or restricted their circulation. Last Thursday’s announcement was unusual as it applies to an entire class of potential assets. In its warning, BaFin said information brochures on ICOs were often insufficient or even misleading, and that these tokens were liable to fraud, money laundering and terrorism financing. “Each token sale submitted to BaFin has to undergo an individual examination of its material content.” – Christoph Kreiterling, head of BaFin‘s financial innovations section The popularity of ICOs has skyrocketed. Last year, there were 46 of them worldwide, with 200 so far in 2017. In one highly-publicized case, investors last year poured more than $160 million (EURO 135 million) of Ethers, a Bitcoin-like currency, into a crowdfunded platform called DAO, only to see a hacker siphon off nearly one-third of the kitty. And last spring, authorities in Mumbai, India, raided offices of OneCoin, a pyramid scheme believed to have spirited $350 million in swindled funds through a payment processor in Germany.

Currently, six German companies are planning to launch an ICO. Asked how the regulator checks the seriousness of these offerings, Mr. Kreiterling said BaFin first checks whether it is a capital-raising activity, which would require the organizers to obtain a license or registration, or comply with other securities regulations. “Each token sale submitted to BaFin has to undergo an individual examination of its material content,” said Mr. Kreiterling, a onetime IT corporate consultant at KPMG. All ICO providers are obliged to publish an information leaflet, according to Mr. Kreiterling. “This ensures a uniform standard of transparency and makes it easier to compare offers,” the German official said.

However, he added that BaFin would need to clarify on a case-by-case basis whether a given token offer amounts to crowdfunding. Some ICO offerings, for example, are based on donations, repayments of capital with interest, or coupons for future goods or services, rather than giving investors equity in the company. While Mr. Kreiterling reiterated the need for investors to exercise caution, he stopped short of recommending new German laws to regulate them. “Given how diverse token sales are, it’s not always clear from an investor’s point of view whether supervisory law would apply,” Mr. Kreiterling said. Nor would Germany seek a flat ban on ICOs, as South Korea and China have done. “There is no legal basis for a flat ban,” Mr. Kreiterling said. “Bafin observes the market very closely and will promptly intervene wherever regulatory requirements are broken.”


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