On 12 December 2018, the European Banking Federation (EBF), an association representing 32 national banking associations in Europe, released a position paper on crypto-assets and Initial Coin Offerings (ICOs). This article summarizes the EBF's key findings and recommendations and offers a brief analysis of the position paper at the end of the article.
Crypto-tokens as an emerging asset class
The EBF identifies crypto-tokens, i.e., security and utility tokens, as an emerging asset class. The position paper highlights several advantages of crypto-tokens, such as increasing efficiencies in the settlement of securities, allowing of greater customization of asset classes, and enabling access to distributed platforms. The EBF generally seems optimistic about the use of crypto-tokens, and expects that greater tokenization of assets will occur in the near future, including tokenization and trade of commercial real estate, baskets of securities and personal data.
Bullish on ICOs, bearish on STOs
The position paper touts ICOs that offer utility tokens as "a new way to raise funds publicly" that may "surpass crowdfunding in terms of speed, reach and presence of a secondary market". The paper also claims that ICOs present lower barriers to entry than traditional IPOs or venture capital. Key shortcomings, however, include fraud, scams, hacks and cyber incidents targeting ICOs. Despite these challenges, the EBF views ICOs as having the "potential to be a method of raising capital [in] an area where Europe is currently struggling to compete with the US and its deeper pools of capital".
In contrast, the EBF takes a less optimistic view of STOs. Although the position paper concedes that STOs are gaining popularity, the EBF views STOs as a short term phenomenon. The paper cites limited adoption and capacity of STOs worldwide as well as skepticism from the cryptocurrency community, which the EBF claims "criticized securitization as a mean of centralization and identification".
Current Risks and Threats
The EBF identifies common risks typically associated with crypto-assets, including the risk of money laundering and terrorist financing, extreme volatility and speculation, and lack of consumer protections. Despite these risks, however, the EBF concludes that crypto-assets do not pose an imminent threat to global financial stability, but could one day as crypto-assets continue to evolve.
State of Regulation
The position paper offers several suggestions for regulating crypto-assets from a banking perspective. As a general matter, the EBF suggests identifying risks analogous to those found in traditional markets and financial industries and applying the same regulatory structure to crypto-assets, as applicable. For example, the EBF cites the Prospectus Directive, MiFID Regulations and AIFM Regulations as laws that aim to increase investor protection and reduce fraud. The EBF argues that the same or similar principles could apply to ICOs, particularly where tokens fall within the definition of "security".
The EBF also advocates for a technology neutral approach to future regulation, which should "focus on the impact on financial activity rather than on the technology". The position paper concludes that further research on distributed ledger technology is needed to ensure the best regulatory approach moving forward.
We generally agree with the EBF on many of the key points of the position paper. We share the view that crypto-assets have the potential to reshape industries and drive innovation. Exploding consumer interest in crypto-assets over the last year and a half underscores the need to have adequate safeguards in place to protect consumers. Many of the laws and regulations applicable in the EU already mentioned by the EBF were drafted explicitly with this purpose in mind. We welcome the EBF's position that we must first look to the current regulatory framework to see which of the same principles can adequately address the risks related to crypto-assets.
In that same vein, we view STOs as a viable option for companies large and small to raise the capital needed to fund projects and to grow. In contrast to ICOs, STOs are just as regulated as public offerings in the traditional capital markets; extensive disclosure requirements and other regulations have served to protect consumers for years. STOs combine the advantages of regulation with the efficiencies of blockchain technology, which should encourage institutional players such as regulated exchanges, broker-dealers, and even banks to embrace them as a legitimate alternative to the traditional capital markets. For these reasons, we are excited about the potential of STOs and believe they will develop to be a key part of the capital markets over the long term.