Bringing Swiss order to initial coin offerings

Finma is the Swiss body overseeing regulations for financial markets. Keystone

Switzerland, as a financial centre, has a double reputation. On the one hand, clockwork: practical, competent, reliable. On the other, chocolate: indulgent and dark.

The country’s private banks are still living down their reputations as facilitators of tax evasion. It is natural, then, that there should be knowing smiles at the news that Switzerland is keen to become a hub for cryptocurrency finance, and initial coin offerings in particular.

The Swiss have broken ranks with the many countries keen to curtail the proliferation of ICOs, in which digital or fiat currency is exchanged for digital “tokens” exchangeable for services or assets, or held for speculative purposes. ICO funds are typically used to fund the creation of a business.

The Financial Market Supervisory Authority (Finma) has introduced a set of guidelines designed to facilitate an orderly, legitimate and growing market for ICO funds. The same question should be asked of the Swiss approach as should be asked of an ICO itself, or of a cryptocurrency, or any use of the underlying blockchain ledger technology. If it is not there to facilitate tax avoidance, money laundering, or fraud, what is it there for?

The answers always come back to the same things. The ownership of every unit of value in a blockchain network is cryptographically verified, so that it is impossible for a user to spend or exchange what they do not own. Therefore there is no counterparty risk, no clearing of trades and no intermediaries. This means less friction, greater transparency and lower cost. Or so the story goes.

Regulating in the dark

In this context, the Swiss guidelines make broad sense, by making it clearer when money laundering and securities laws apply. The system will put ICOs into at least one of three categories: payment, asset or utility. 

Tokens from payment ICO are transferable and can be used as a means of payment, and will have to comply with money laundering regulations. Asset tokens promise returns, such as dividends, interest or rights to earnings. These will be regulated as securities. Utility tokens are only exchangeable for an application or service – which must be available at the time the token is issued, so as not to make the asset/utility distinction blurry.

A token that can be used like fiat money or a security should indeed be regulated like them. And, of course, any innovation that limits counterparty risks and transaction costs is welcome. Finance, and in particular capital raising, is an industry in desperate need of stronger, cost-cutting competition. A new technology with the potential to introduce some of that competition should not be rejected out of hand. So – in principle – there is much to be said for the Swiss approach.

The devil, of course, will be in the details of implementation and enforcement. Cryptocurrency, in virtue of its very newness and the anonymity that potentially offers to owners, is ripe for abuse – fraud and theft are already a problem. It also remains unclear whether, in the end, blockchain technology will take intermediaries and their fees out, or simply introduce a new class of middlemen. And the speculative and irrational bubbles in individual cryptocurrencies could introduce fatal instability to the system as a whole. One can hardly blame other regulators for opting for a ban.

As a basic structure, though, the Swiss approach is not mad. Some national experimentation can be ventured since there does not seem to be enough money at stake in ICOs to present a systemic threat. If that changes, the Swiss may have to adjust, and quickly.

Copyright The Financial Times Limited 2018