China enacted a draconian measure this weekend. Its regulators outlawed initial coin offerings or ICOs, a new way of financing startups based on blockchains, the technology that underpins cryptocurrencies. (For more on blockchain tech, read this recent Fortune magazine cover story.)
In a joint decree from seven financial regulators—including the People's Bank of China, the Ministry of Industry and Information Technology, and the China Banking Regulatory Commission—state officials laid out their reasoning. The group said they consider crypto token sales to be "an unauthorized and illegal public financing activity, which involves financial crimes such as the illegal distribution of financial tokens, the illegal issuance of securities and illegal fundraising, financial fraud and pyramid scheme."
In other words: don't even think about getting involved with an ICO.
We dug into the regulators' text and applied our own expertise to provide some context for the news. Below are seven reasons why China likely instituted the ban.
1. ICOs are out of control
The ICO craze has gotten out of hand. In the first half of the year, ICOs raised more than $1 billion for blockchain-based projects—many of which consist of little more than a white paper and some marketing spiel about disrupting various industries with new kind of Internet money. Celebrities ranging from pro boxer Floyd Mayweather to hotel heiress Paris Hilton have been endorsing the stuff. Without a counterbalance, the sector would continue to grow unchecked; China decided to put the kibosh on the funding mechanism before the space could get any more bonkers.
2. Many ICOs are scams
It doesn't take a financial whiz to understand that many ICOs operate like classic pump and dump scams or pyramid schemes. Get people to throw money behind an asset or opportunity they don't understand all that well; hope the price of the mostly worthless junk inflates; cash out. There are too many hucksters out there simply looking to make a quick buck.
3. The mania poses a danger to retail investors.
When the crypto bubble bursts who is going to get hurt? Joe investor, that's who. By clamping down on the ICO sector, China may be warding off bigger financial troubles for consumers down the line. There are securities laws for a reason.
China is an epicenter for cryptocurrency mania. In the first half of the year, China-based ICOs raised about $400 million through 65 offerings with more than 100,000 investors, according to a report from the National Internet Finance Association of China. That puts the country in a particularly precarious position if and when the crypto boom comes crashing down.
5. China wants its own coin
We've heard rumors that China is looking to mint its own national cryptocurrency. If the country succeeds it will have greater control over that platform than the present options (Bitcoin, Ethereum, etc.). Regulators may be clearing the way for this this eventual debut.
6. ICOs threaten incumbents
China likes to pick its business winners. In general, ventures originating outside the country tend to fail for lack of state support. In their very conception, ICOs are designed to threaten or circumvent traditional power players—to get around regulatory obstacles, to provide a new way to access venture capital, to build projects or protocols that might one day compete with incumbent businesses and provide censorship-resistant alternatives. A lack of state control means that government views the whole lot of ICOs warily.
7. China wants a cool-off period
By considering all ICOs illegal rather than differentiating ones that trade in unregistered securities from ones that act more like tokens to use certain decentralized apps, China is taking a heavy-handed approach. (In the United States, the SEC appears to be gearing up for a distinction between the two types.) China may simply be trying to cool off the crypto mania with a strict, if temporary, edict. There's no knowing whether this ban is forever, or whether it has been prompted by the present craze.
Fred Wilson, an investor at Union Square Ventures who is bullish on cryptocurrencies, penned a take on the move. He observed that "many have speculated that this Chinese ban is temporary to give the Chinese authorities time to come up with sensible regulations. I suspect that is right."