Initial Coin Offerings, Digital Tokens and Virtual Currencies

What have Initial Coin Offerings, Digital Tokens and Virtual Currencies got to do with investments?

If you have been puzzling over terms like digital and virtual currencies, cryptocurrencies, digital tokens, or initial coin offerings and wondered what these terms mean, you may like to find out more here.

What are digital, virtual or cryptocurrencies?

A virtual currency is sometimes referred to as a digital currency or a cryptocurrency if it’s a digital currency secured by cryptography.

A virtual currency is a form of digital token that typically functions as a medium of exchange, a unit of account or a store of value. For instance, a virtual currency may be used as a means to pay for goods or services.

Virtual currencies first emerged about 10 years ago and may not have a physical form, unlike coins or notes. Examples of virtual currencies are Bitcoin and Ethereum’s Ether.

Virtual currencies are not issued by any government, and are not legal tender. This means that you may only use them to pay for goods or services if you are dealing with someone who is willing to accept them as a mode of payment. Typically, payments with virtual currencies are made online, although some shops are able to accept them as payments in-store.

Virtual currencies operate on a peer to peer system. Users of a virtual currency transact directly with each other, and each transaction is typically recorded in a blockchain for that virtual currency. The blockchain for a virtual currency operates as a distributed ledger or database of all transactions entered into by all users of the virtual currency.

Users of a virtual currency usually maintain anonymity with respect to their transactions entered into the blockchain. The blockchain may nevertheless be publicly available. You may buy, sell or transfer virtual currencies through an online platform, virtual currency exchange, or dedicated self-service kiosks.

Virtual currency exchanges allow users to buy or sell a virtual currency, for example, a Bitcoin for a fiat currency like USD or another virtual currency such as Ether. The exchanges may be centralised or decentralised. In a centralised exchange, the exchange provides liquidity and undertakes counterparty risk (i.e. is a party to the trade). Decentralised exchanges on the other hand may act just as bulletin or information platforms where buyers and sellers are matched or may locate each other.

There are also applications that allow you to store your virtual currencies in a digital "wallet," and you may spend your virtual currencies at physical shops where they are accepted.

What risks should you look out for in relation to virtual currencies?

As interest in virtual currencies grows, please be aware of the risks involved if you are buying a virtual currency.

Virtual currencies have seen extreme price volatility. Transparency has been limited as there might be little publicly available information that could help you gauge the fair value of the virtual currency. The surges in the prices of virtual currencies appear to be driven by speculation. If you plan to buy virtual currencies, you should carefully consider the claims being made about you are being offered – if the touted ease of making significant profits sounds too good to be true, it probably is. You should carefully assess whether buying virtual currencies is suitable for your investment objectives and risk appetite. Buyers of virtual currencies should be aware that they run the risk of losing all their capital.

The platforms or persons you deal with may not have taken enough security precautions and this could lead to theft through hacking. For example, as in the case of Bitcoin exchange Mt. Gox, which had 850,000 Bitcoins stolen in February 2014 (valued at more than US$450 million at the time), leading to its subsequent bankruptcy and closure. In January 2018, Coincheck, another virtual currency exchange based in Japan, also reported being hacked into and losing an estimated USD 400 million to theft.

Fraud has also occurred in relation to companies that claim to offer virtual currency payment platforms and other virtual currency related products and services. For example, in December 2015, the US Securities and Exchange Commission charged two Bitcoin mining companies with conducting a Ponzi scheme.

The anonymity of transactions involving virtual currencies means they can be an attractive means for money laundering and other illegal activities. In the event a platform or person is discovered to have used virtual currencies for purposes of money laundering or other illegal activities, it is likely that you could find your activities adversely affected if a law enforcement agency limits or even shuts down the platform’s or person’s operations.

You could lose your digital wallet or it could be hacked into and the contents stolen.

Does MAS regulate virtual currencies and intermediaries which deal in virtual currencies?

MAS does not regulate virtual currencies and their derivatives. Virtual currencies in Singapore are not regulated by MAS as they are not considered securities or legal tender. Members of the public who lose money from transacting in virtual currencies and related investments may not be able to rely on any protection afforded under legislation administered by MAS. Financial institutions that offer products that are not regulated or approved by the MAS are expected to disclose this, as well as the associated risks of the products in a clear and easily understood manner to investors.

If you wish to buy any investment product, you are strongly encouraged to deal only with persons regulated by MAS to offer that specific investment product, as such persons must disclose information on investment products being offered to you. They are also required to deal with you fairly. If you deal with an unregulated entity or invest in an unregulated product you give up the protection afforded under laws administered by MAS.

Virtual currency intermediaries, such as “cryptocurrency exchanges” that facilitate the buying or selling of virtual currencies, or provide a platform to allow persons to exchange virtual currencies, will be regulated by MAS for money laundering and terrorist financing risks. You can find out more here. You should continue to be cautious when dealing with virtual currencies as MAS’ regulation of intermediaries will not extend to the safety and soundness of virtual currency intermediaries or the proper functioning of virtual currency transactions.

What is a digital token?

A digital token is a cryptographically-secured representation of a token-holder’s rights to receive a benefit or perform specified functions. One particular type of digital token is virtual currency. Virtual currencies are typically used as a means to purchase goods or services. Examples of virtual currencies include Bitcoin and Ether.

However, the function of digital tokens has evolved beyond a virtual currency. For example, these digital tokens may represent ownership or a security interest over the token seller’s assets or property, or a debt owed by the seller. Such digital tokens have been marketed as investment opportunities.

How do ICOs and investment schemes involving digital tokens work?

Digital tokens may be offered through an ICO or other investment schemes.

Digital tokens offered through an ICO are usually specific to the seller, and such tokens are typically sold to consumers in exchange for a widely-used virtual currency (such as Bitcoin or Ether) or cash. These sellers often set out their business proposal in a “whitepaper” which is published online. ICOs may relate to different business propositions, for example to develop a new blockchain platform. Others may offer an opportunity to invest in a property, business, and assets, or promise certain benefits or monetary returns.

Offerors of digital tokens usually claim that their tokens have the potential to appreciate in value as they will issue these in limited quantities. The price appreciation of virtual currencies like Bitcoin is often cited as an enticement to investors. (See also ‘Risks relating to insufficient secondary market liquidity’ below).

Digital tokens may also be sold indirectly through the sale of electronic credits which are convertible into tokens. Yet other schemes may bundle credits or tokens with conventional products or services such as educational courses or jewellery. The marketing efforts often focus on the potential returns from the token with little or no information on the bundled products or services.

What could go wrong with investment schemes involving digital tokens?

Here are some risks you should be aware of. The risks highlighted below are worth considering but they are not exhaustive.

Risks relating to foreign and online operators

You would be exposed to heightened risk of fraud when investing in schemes that operate online or outside Singapore. As these operators do not have a presence in Singapore, it would be difficult to verify their authenticity. Should the scheme collapse, it would also be difficult to trace the scheme’s operators. The recovery of invested monies may also be subject to foreign laws or regulations, which may not be the same as Singapore’s.

Risks relating to sellers without a proven track record

The seller of digital tokens may not have a proven track record, making it hard for you to establish its credibility. As with all start-ups, the failure rate tends to be high.

Risks relating to insufficient secondary market liquidity

Even if digital tokens are tradable in a secondary market, in practice, there may not be enough active buyers and sellers or the bid-ask spreads may be too wide. You may not be able to exit their token investments easily. In the worst case scenario where no secondary market develops, you may not be able to liquidate his token holdings at all. The exchanges or platforms that facilitates secondary trading of digital tokens may not be regulated by MAS.

Risks relating to highly speculative investments

The valuation of digital tokens are usually not transparent, and highly speculative. Where digital tokens do not hold any ownership rights to the seller’s assets, the digital tokens would not be backed by any tangible asset. Such tokens would be merely speculative investments and their traded price can fluctuate greatly within a short period of time. There is a high risk that you could lose his entire investment amount. In the worst case scenario, the digital tokens could be rendered worthless.

Risks relating to investments promising high returns

You should be wary of investment schemes involving digital tokens that promise high returns. Usually, the higher the promised returns, the higher the risks. While these might also appear to be in the form of traditional investment profits, increasingly, they may also be in non-traditional forms such as high referral commissions i.e. promising consumers benefit for referring new participants.

The payment of such referral commissions may also be in breach of the Multi-Level Marketing and Pyramid Selling (Prohibition) Act. Further, such commissions would increase operating costs, which could lower the chances of achieving the returns.

Risks of money laundering and terrorist financing

Funds invested into investment schemes involving digital tokens are prone to being misused for illegal activities due to the anonymity of transactions, and the ease with which large sums of monies may be raised in a short period of time. You would be adversely affected if law enforcement agencies investigate any alleged illicit activities related to the token investment scheme.

What consumers should know…

You should seek to understand the nature of the digital tokens before dealing with digital tokens, and should exercise caution. You can also refer to the press release on MAS’ regulatory position on the offer of digital tokens for more information.

How do I check if the person or entity I am dealing with is regulated by the Monetary Authority of Singapore (MAS)?

You are strongly encouraged to seek financial services only from persons regulated by MAS as only professional persons are allowed to provide such services to you. They must also disclose information on investment products being recommended to you and deal fairly with you. If you deal with an unregulated entity, you will forgo the protection afforded under MAS’s laws.

To find out whether an entity is regulated by MAS, you can check the Financial Institutions Directory on the MAS website. You can also look up the MAS Investor Alert List for a non-exhaustive list of entities that may have been wrongly perceived to be regulated by MAS. Consumer Alerts on the MoneySENSE website also has tips on avoiding scams.

If you suspect that an investment scheme involving digital tokens could be fraudulent, you should report such cases to the Police.

Virtual currencies in the news

Checklist for consumers:

1.  Make sure you fully understand the benefits and risks of the product or service before committing. The potential returns from digital tokens is uncertain and depends on various factors: the underlying business or assets (if any), whether the project is successfully developed, and general economic, political or market conditions. Before investing in such tokens, you should ensure that you understand the risks that the underlying project, business or assets carry. In the worst case scenario, the digital tokens you hold could end up worthless.

2.  Assess whether the features of the product or service offered meets your needs. Would you have bought them anyway?

3.  Before committing to an investment, consumers should ASK, CHECK and CONFIRM

     a. ASK the seller as many questions as you need to fully understand the investment opportunity

     b. CHECK if the information provided by the seller on itself or its scheme is true.

     c. CONFIRM before investing, the seller or its representative’s credentials by using resources such as

         i)   MAS Financial Institutions Directory

         ii)  MAS Register of Representatives

         iii) Investor Alert List