THE BIG BANG BITCOIN – BLOCKCHAIN, TULIPS, CRYPTOCURRENCIES AND REGULATORY SANDBOXES

THE BIG BANG BITCOIN – BLOCKCHAIN, TULIPS, CRYPTOCURRENCIES AND REGULATORY SANDBOXES

Bitcoin and other cryptocurrencies have had an astronomic rise in 2017 (“to the moon” as crypto fans like to refer to the rise in value) – with some cryptocurrencies even increasing more than 20 times in value this year alone. It certainly has been the year of cryptocurrencies, with mass media attention and new user wallet registrations reaching an all-time high almost every week (even The Big Bang Theory, one of the most popular comedic sitcoms in the US, dedicating a whole episode to Bitcoin).

With this new euphoria of interest in blockchain, Bitcoin and other cryptocurrencies, we have been extremely busy this year researching distributed ledger technology, providing commercial and regulatory advice on coin offerings and helping our clients navigate their way through the regulatory wilderness in which, not just South Africa, but the world finds itself.

What is Bitcoin and Blockchain technology?

Blockchain or distributed ledger technology, emerged as the technology underlying Bitcoin. Bitcoin was the first significant cryptocurrency to be used and was created in 2009 by a mysterious figure using the alias “Satoshi Nakamoto”. Essentially, blockchain is the operating model that allows Bitcoin transactions to be processed and recorded.

Blockchain introduces a form of collective bookkeeping, or a publicly available digital ledger, via the internet. More specifically, it is a completely decentralised record of ownership which is shared across a network of computers. This shared public digital ledger contains a record of all the transactions that have taken place in each specific cryptocurrency (or potentially any other asset) that have ever been processed by the blockchain. Indirectly, this allows verification at any moment in time of who owns how much of it. Each of the computers connected to the network hosts a complete copy of these records.

The so-called “mining of Bitcoin” process allows new transactions to be verified and added to the digital ledger in a consensual, fully decentralised way. Unlike with conventional payment systems, in the blockchain there is no need for a trusted central bank or central authority to do this job. Distributed ledger technology “decentralises” trust, this being one of the key features of the innovation. It is a distributed, decentralised, immutable, public, digital ledger.

Bubbles and Tulips

Bitcoin and “bubble” have become synonymous during this year’s sky-high rally. According to www.coinmarketcap.com, the total market capitalisation of more than 1000 different cryptocurrencies and tokens are about US$300 billion, of which Bitcoin makes up approximately 56% (as at the time of writing – this could all change in the blink of an eye)!

JP Morgan boss Jamie Dimon recently labelled Bitcoin a fraud and said its astronomic rise is a textbook financial bubble comparable to the Dutch “tulip mania”, wherein 17th century Holland, the price of tulip bulbs initially soared before collapsing in the aftermath. Hundreds of articles conversely have been written over the past few months speculating on how high Bitcoin could possibly go. US hedge fund manager, Mike Novogratz, believes the world will see a Bitcoin price of more than US$40 000 by the end of 2018 and cybersecurity computer programmer and businessman, John McAfee, believes Bitcoin will hit US$1 million by 2020.

While Bitcoin itself is uncertain and could be a “bubble”, cryptocurrencies are gaining traction without many people realizing how much society has already begun to adopt these models. Bitcoin or any other current cryptocurrency might not go the length, but they have opened peoples’ eyes to the endless possibilities that blockchain technology holds for the future.

South African regulators and “regulatory sandboxes”

Whether or not blockchain technology, or rather cryptocurrencies, would pass the legal and regulatory hurdles which exist in South Africa is yet to be determined. In South Africa, cryptocurrencies, to a certain degree, are still unregulated, and crypto-entrepreneurs need to ensure they fit themselves into existing legislation when launching these types of businesses.

A thorough legal investigation needs to be undertaken by any crypto-entrepreneur in South Africa to understand whether their planned blockchain business and/or cryptocurrency system falls within the scope of the Banks Act, 1998, its regulations, the South African Reserve Bank Act, 1990, the National Payment System Act, 1998, and of course for offshore transactions, the Exchange Control Regulations.

Regulators and regulatory bodies across the globe are keeping a close eye on the growing impact of blockchain. Many are also creating “regulatory sandboxes” as controlled environments within which innovation can be stimulated. A “regulatory sandbox” is a regulatory haven, that allows fintech innovators, such as blockchain and crypto-entrepreneurs, to test their products and business models in a live environment whilst being exempt from having to adhere to some of the existing regulatory legislation and requirements. Although regulation may not always move as fast as innovation, it is positive to see the Financial Services Board and the South African Reserve Bank also adopting this “regulatory sandbox” approach in South Africa, which has been most notably lead by the UK.

Whether or not you understand blockchain technology, believe cryptocurrencies is in a “bubble”, a fad or that the world is on the cusp of a technological revolution, one thing is clear – Bitcoin, cryptocurrencies and blockchain have made a massive statement this year and 2018 is certainly going to be interesting!

BITCOIN, BLOCKCHAIN, CRYPTOCURRENCIES AND ICO’S: LEGAL ENIGMAS FOR START-UP’S OPERATING ON THE FUTURE FRONTIER

BITCOIN, BLOCKCHAIN, CRYPTOCURRENCIES AND ICO’S: LEGAL ENIGMAS FOR START-UP’S OPERATING ON THE FUTURE FRONTIER

The latest buzz words shaking up the technology, business, financial and legal establishments are not to be treated lightly. These terms are uniting (hard as it might be) all the major role players in their quest to evaluate the potential far-reaching effects it might hold for the future of commerce globally. It is difficult to ignore the fast-paced development of the latest technological advances, as we find ourselves amid the fascinating transition phases nestled between the Third and Fourth Industrial Revolutions. More importantly, as the universal compatibilities envisioned for this technology have now progressed from hypothetical online discussions between “tech-developers” and futurists to functioning real-life applications, passionate debates have erupted across a variety of diverse forums. Ranging from the corridors of legislators and financial regulators to the living rooms of the Stokvel run by Joe Soap, as people are curious (and watchful) about the industries based on the Future Frontier – and rightly so.

As the terminology is complex, we will not aim to explain what the Blockchain, Cryptocurrencies (which include BitCoin) or Initial Coin Offerings (“ICO”) are. We will also not attempt to define or address the application possibilities of these initiatives in this post, as the possibilities are vast and beyond the scope of this post. (For more information on the technical aspects relating to these terms, please see the links below explaining this in more detail.[1]) We will only briefly aim to highlight some aspects start-ups and potential investors should bear in mind when investigating the opportunities created by the technology found on this Future Frontier.

For Start-Up’s

Start-ups looking to venture into the industries of the Future Frontier are advised to note that there is still a lot of uncertainty as to the regulations governing and enforcing the practical application thereof. As such, carefully considering the current legislative frameworks in existence (and more importantly, the purpose behind it) might provide a helpful understanding of the things entrepreneurs should consider when developing their business models for the market. In a South African context, start-ups should consider the following legislative and regulatory concerns which might be applicable to them:

  • FICA, Money-Laundering and Know-Your-Client (KYC) legislation: due to cryptocurrencies trading far more anonymously over various encrypted platforms entrepreneurs are encouraged to familiarise themselves with the relevant FICA, Money laundering and KYC processes. Especially in industries where payments are being made by potential payment or payment systems operators;
  • Business of a Bank and Collective Investment Schemes: Business models based around the collecting and pooling of fees and/or accepting deposits for investments into cryptocurrencies and ICO’s might be considered to be Collective Schemes or structures conducting the business of a bank, both of which are strictly regulated by the SARB and FSB, respectively;
  • Financial Advisory and Intermediary Services Act (Twin Peaks Financial Sector Regulation Bill): any current or potential services aimed at the financial advisory or intermediary industries are strictly regulated by the Financial Services Board (and will soon fall under the Twin Peak Provisions);
  • Exchange Control Regulations: Strict requirements regarding the outflow of capital and funds exist in South Africa. As a result, certain apps or services designed to facilitate transfers of this kind without prior SARB approval, tax clearance from SARS or adherence to existing policies may pose some concern to regulators;
  • Companies Act: A very popular means to raise funds for start-ups focusing on Future Frontier industries is by way of an ICO. During an ICO the start-ups issue their own crypto- tokens to participants at a discount and often raise vast amounts of capital. However, an ICO might, depending on the rights attached to these crypto-tokens, in some cases be regarded as a thinly veiled offer of securities to the public. If that is the case, the Companies Act and accordingly, the strict laws relating to the issue of securities by way of an offerings to the public will be applicable. Since the Securities Exchange Commission of the USA recently declared this position (not without criticism), other jurisdictions may follow suit; and
  • Consumer Protection Laws: The loss of virtual cryptocurrencies value, tokens issued to paying participants without any underlying value and other types of blockchain transaction issues such as erroneous payments and systems breaches, hacks or Ponzi schemes are things to consider. If not adequately managed, this may create serious liabilities, not to mention reputational damage, to any start-up involved in these types of commercial venture.

These are merely some of the myriad questions start-ups are urged to consider as a starting point into the regulatory and compliance frameworks regulating the industries on the Future Frontier.

Investors

Warren Buffet once said the following: “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know”.

In keeping with this thought, we would therefore urge any investors considering investing into start-ups which focus on the Future Frontier industries to not stray too far from established investment principals. Especially in determining what the Investor does not know, conducting an adequate due diligence investigation (or “DD“) into the envisioned Start-up’s proof of concept, management of regulatory and compliance issues and the viability of their intended financial and business models should be considered a minimum requirement. Further to this, investors would do well to consider special escrow arrangements for any transfer of investment funds irrespective of whether these funds are done by way of crypto-funds/tokens and/or fiat currency. Also using respected and knowledgeable service providers may mitigate against any risks involved in these investments.

Conclusion

There are various levels of uncertainty regarding the practical and legal implications of these Future Frontier industries. This accordingly provides ample grey area for entrepreneurs and investors alike to either flower or flounder through. As such, we would recommend that any Start-Ups or investors contemplating to venture into these Future Frontier Industries to make sure that they have a clear view of the legal nature of the transaction at hand. If the legal nature of the transaction is clear, it enables the parties to take a measured approach to control the relative risk associated and build in the protective mechanisms that the law requires.

We hope to see legislators work with other industry experts to create a legislative framework that promotes certainty, without smothering the revolutionary initiatives and staggering opportunities presented by Future Frontier technology.

[1] For further detailed information regarding how Cryptocurrencies and the Blockchain function and operate please make use of the following recommend sources: