FCA warns on cryptocurrency initial coin offerings

After weeks of dragging its heels, the Financial Conduct Authority (FCA) today issued a ‘consumer warning’ on initial coin offerings (ICOs). ICOs are used by blockchain projects to sell the tokens used in their ecosystems to raise funds and are akin to a form of crowdfunding.

“ICOs are very high-risk, speculative investments,” says the UK financial regulator. “You should be conscious of the risks involved and fully research the specific project if you are thinking about buying digital tokens.

“You should only invest in an ICO project if you are an experienced investor, confident in the quality of the ICO project itself (e.g. business plan, technology, people involved) and prepared to lose your entire stake.”

The FCA has been fairly hands-off toward the cryptocurrency space, evidenced in its setting up of a sandbox environment in which blockchain projects are able to develop and test their business models without worrying about regulatory implications. Some of the projects involve “digitised/token-ised bonds and shares”, according to a spokesman at the regulator.

Interactive Investor contacted the FCA at the end of July, enquiring as to when the regulator might be issuing a warning to UK investors concerning ICOs. In reply, the FCA took an uncommitted approach: “We don’t regulate digital currencies and the DLT [distributed ledger technology] beneath them.”

In July, the US Securities and Exchange Commission issued a warning to investors about the risks associated with ICOs. On 4 September China’s regulatory authorities issued an outright ban.

Finally, in response to growing concern about the large sums of money being attracted to the unregulated ICO sector, the FCA has decided to act.

In its statement, similar in tone to that issued by the US SEC, the FCA said: “Whether an ICO falls within the FCA’s regulatory boundaries or not can only be decided case by case.

“Many ICOs will fall outside the regulated space. However, depending on how they are structured, some ICOs may involve regulated investments and firms involved in an ICO may be conducting regulated activities.”

ICOs have raised $1.7 billion globally this year and the pace of fundraising is accelerating, with $800 million raised in the second quarter alone.

Reacting to the FCA’s warning, Jakob Drzazga, the co-founder of blockchain fintech startup Brickblock, welcomed the regulator’s move. “It’s critical for the success of the whole area that regulators keep a careful eye on this” he said, urging investors to be “conscious of the risks and thoroughly research any project before considering buying tokens”. Brickblock, which is building a platform for trading exchange traded funds and other assets “without the middleman”, has a token sale taking place on 11 October.

As things stand it must be assumed that ICOs are not covered by the Financial Services Compensation Scheme and the Financial Ombudsman Service.

Some ICO promoters may seek to get around potential regulatory issues by declaring their tokens to be essentially worthless inside their ecosystem.

This was the case in the EOS token sale from blockchain startup Block.one, in which it stated: “The EOS Tokens do not have any rights, uses, purpose, attributes, functionalities or features, express or implied, including, without limitation, any uses, purpose, attributes, functionalities or features on the EOS Platform.” The token sale went on to raise $185 million.

The FCA consumer alert makes it clear that businesses promoting ICOs and digital exchanges must consider whether “their activities amount to regulated activities under the relevant law”. Specifically, exchanges dealing in “certain tokens” may “need to be authorised by the FCA”.

The regulator urges investors to report suspected ICO scammers on its scams alert page (https://www.fca.org.uk/consumers/report-scam-unauthorised-firm).

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.