Aside from all discussions regarding the regulatory aspects of cryptocurrencies and whether they are indeed a practical alternative investments, there has been substantial recent debate about the possible future involvement of governments and legislators in this area.
This is particularly relevant when issues related to trust, transparency and the financial backing of cryptocurrencies are all under review.
Bitcoin, for example uses blockchain to create a highly secure peer-to-peer (P2P) payment system. Blockchain then becomes a sort of “master file”, a digital registry where every single operation payment and currency trade can be recorded through a digital signature. In such way the amount of digital currency linked to every single component of the “blockchain transaction”, can be verified, without mistake and this can all be done in real time.
Having a clear, transparent, and enforceable legal basis is a key element of financial payments, and all clearing and settlement arrangements.
People often use the terms “Blockchain” and “Distributed Ledger” (DLT) interchangeably. Blockchains are one type of distributed ledger technology. A blockchain is distributed across and managed by peer-to-peer networks. As it is a distributed ledger, it can exist without a centralized authority or server managing it, and its data quality can be maintained by database replication and computational trust. Yet, the structure of the blockchain is different from other kinds of distributed ledgers.
Distributed Ledger Technology can increase legal risks if there is ambiguity or lack of certainty about an arrangement’s legal basis. Due to the fact that the application of this technology to payment, clearing and settlement activity is new, the legal underpinning for certain activities may not be as well established as that for traditional systems (for example, in terms of identifying the applicable jurisdiction or relevant laws). Conversely, DLT can be used to help reduce certain legal risks. For example, automating certain terms and conditions of legally binding agreements (such as automating interest payments as outlined in a contractual agreement) may reduce the risk that contract terms are not enforced as specified in the agreement within the agreed time period. An arrangement’s legal basis consists of a legal framework that includes general laws and regulations governing property, contracts and liability, among other things. It also includes the arrangement’s rules, procedures and contracts.
There are certain legal issues, such as proprietary rights and settlement scope, that should be articulated clearly by the arrangement, understood by participants and supported by applicable law. For example, the legal basis regarding the ownership or transfer of assets or the rights and obligations of the relevant parties may not always be clear. An arrangement typically attempts to use standardised rules or contracts to define rights, obligations and processes. In such cases, it is important to consider the soundness of these legal arrangements and their enforceability. This can be further complicated by transactions that take place across borders or in multiple jurisdictions, in which case the law underpinning the activity would need to be confirmed or adopted in multiple jurisdictions in ways that are mutually compatible.
The current situation in Hong Kong
In Hong Kong there have been numerous complaints about misappropriated assets and market manipulation linked in part to the technical breakdown of several cryptocurrency exchanges. Whatever the exact reason, regulators from the Securities and Futures Commission and Police have now both intervened to clamp down on any potential fraud, which is often associated with cryptocurrencies.
This puts market professionals – e.g. traders, accountants and lawyers – in the position to control the prevention of fraud and uncertain fundraising activities, while complying with the law.
Hong Kong aims to become an important international blockchain hub, and according to the Fintech lead at InvestHK, “Blockchain is a very high priority for us. There is hype, and there is the fast grab of money with Initial Coin Offerings in some cases. But what we are looking at building here in Hong Kong is an infrastructure for new businesses and existing businesses, to make sure the technology and innovations remain a key enabler for financial sector growth.”
As of 2017, 48 of the world’s leading 100 Fintech companies are reaping rewards from the city’s technologically advanced ecosystem. A trade finance platform based on Blockchain technology was recently developed by the Hong Kong Monetary Authority, showing the city’s commitment to the future of Fintech.
The situation in Mainland China
The Cyberspace Administration of China (CAC 国家互联网信息办公室) recently issued a public consultation document, the Administrative Rule on Blockchain Information Services (the “Blockchain Rule”).
The Blockchain Rule does not override the ban on the issuance and trading of coins in China, which was already effective under the Announcement on Preventing Token Fundraising Risks (the “Risks Announcement”) issued by the People’s Bank of China (中国人民银行) in 2017.
Still, the Blockchain Rule does now provide a clear legal framework, which cryptocurrency service providers need to follow.
The Blockchain Rule implements a territorial based jurisdiction and may therefore regulate all cryptocurrency service providers; in most cases an overseas entity is formed to operate the block chain business then using a Chinese entity to provide technical support to blockchain operations. The Blockchain Rule only currently regulates the way all entities and organizations providing technical support to block chain businesses actually operate.
Filing requirements – including disclosure of real name registration, content censorship, formulation of emergency plans, reporting obligations, security protection, cyberlogs retention, prohibition of illegal information – and approval by PRC authorities become crucial, but as a result defying the core character of anonymity.
The submission of information relating its shareholders, its operation of business and the address of servers, etc. are mandatory, so is strict compliance with specific regulations, e.g. the yearly update of its filing renewal and the pre-approval requirement in restricted industries.
The public consultation for Blockchain Rule may indicate that Central Government of PRC holds a contradictory view on the use of such technology.
On the one hand, the PRC government has a material concern on the issuance and trading of coins through blockchain services which may impact the financial markets, avoid foreign exchange controls and amplify financial risks.
On the other hand, the PRC government recognizes that the blockchain technology has unique merits and any overzealous intervention may curb its application and development.
Another proposed article in the draft also requires blockchain information service providers to enforce “know your customer” (KYC) measures by gathering users’ national identification numbers or mobile phone numbers.
In recent years, blockchain technology had been utilized to bypass China’s heavy-handed internet censorship – more widely known as “The Great Firewall”. For example, as part of the #Metoo movement and a high-profile pharmaceutical scandal in the country, individuals have posted information on the Ethereum blockchain where it cannot be censored.
From a legal aspect, although the Risk Announcement has imposed a ban on the initial coin offerings, the application of blockchain technology itself is not prohibited in China, in fact PRC courts have often reiterated that cryptocurrencies are to be considered as a type of asset protected by local laws, which somewhat seems to encourage the development of such technology, while – at the same time – Initial Coin Offerings is formally banned.
Most of the requirements however are already embedded in existing laws and regulations and should not present a surprise to businesses interested in using blockchain to provide business solutions in China.
Our team at Hugill & Ip has extensive experience in dealing with regulatory, financial and risk management issues – so if you need further advice on these subject and other topics discussed, get in touch with us to find out how we can help.
This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.