Canada: Crypto Update: January Crash, Securitized Tokens And Threats To Traditional VC

Bloodbath in the CyrptoMarket

For the past three years in January, Bitcoin experienced significant price corrections. This year is no different – except for its magnitude. Likely exacerbated by an influx of new investors and a spike in actively traded altcoins, Bitcoin depreciated by almost 50% from its all-time high in mid-December.

According to CoinMarketCap, the total market value of cryptocurrencies nosedived from USD $832 billion on January 7, 2018 to USD $450 billion on January 17, 2018, erasing USD $360 billion in value.

The price of the two other largest cryptocurrencies, namely, Ethereum and Ripple, dipped as much as 38% and 65% respectively from their January highs.

Whether this is an isolated correction or whether the markets have crossed into a bear market remains to be seen. As of  today's date, the market has only started to recover from its January 17 low.

Regulatory headwinds growing stronger

This downturn is popularly attributed to regulatory pressures from the Chinese, South Korean and Indian governments to crack down on cryptocurrency trading and exchanges.

The regulators in South Korea, home to the third largest cryptocurrency markets in the world by traded volume, may be contemplating a ban on cryptocurrency trading. South Korean regulators hinted at the possibility of an outright ban on cryptocurrency trading. Though the regulators subsequently softened their message, they maintained the possibility of a complete ban on crypto trading remained a "live option".

The regulators in China have similarly expressed that they would clampdown on online exchange platforms and mining operations. China hosts the largest number of Bitcoin mines in the world. Any move to decisively disrupt Chinese investors may adversely affect cryptocurrency prices.

The regulators in India froze major cryptocurrency exchange accounts and tax authorities sent notices to cryptocurrency investors warning that they must pay capital gains on their income from the virtual currency.

Tokenized securities making a debut in trepid market conditions

Blockchain technology now has its crosshairs on traditional forms financing.

Polymath Inc., a Toronto based blockchain firm, is seeking to build a "securities network platform". It seeks to gives issuers of financial products access to the blockchain, smart contracts and token creation technology through the Ethereum network. Polymath incentivizes the creation of a compliant ecosystem by rewarding both lawyers and software developers who contribute to the development of regulatory contracts built on the POLY.

The promise of on-chain securities is enticing: better functionality and liquidity, instant settlements, very low fees and 24/7 trading. However, the challenges of regulatory compliance remain very real. Whether Poly participants will get the regulation right will depend on the quality and extent of the users it attracts as well as the general sentiment of the regulators.

Regulators' response to Polymath remains a question mark. The requirement to correctly abide by onerous disclosure obligations associated with issuing securities is one thing; abiding by rules and regulations associated with exchanges and clearing houses is another. And Polymath will need to get it all right.

What does any of this mean for the VC market?

The advent of crypto-securities may very well mean a decline in venture activity. The VC market was already  under stress by startups raising funds through initial coin offerings (ICOs) rather than traditional forms of financing. According to a Bloomberg article written in May 2017, twice as many funds were raised by way of ICOs than VC seed rounds.1 According to Coindesk's ICO tracking tool, startups have raised well over USD 3.7 billion in digital coin sales as of the end of November 2017. Instead of giving equity away, startups increasingly issue tokens and grant users a right to participate in their network.

Going forward, more startups may adopt a hybrid model of VC financing and ICO such as Kin, Filecoin, Unikrn, benefitting from the professional participation of VCs while maintaining low cost of capital.

A lot will depend on the CryptoMarket's recovery and whether investors, after a correction of this magnitude, will still have the appetite for high-risk, high-volatility coins or tokens – now, with the added variable of regulatory uncertainty.

The author would like to thank Saam Pousht-Mashhad, Articling Student, for his assistance in preparing this legal update.


About Norton Rose Fulbright Canada LLP

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