Apollo Capital is a multi-strategy crypto fund based in Melbourne, Australia. Apollo Capital invests in the crypto assets that are powering the next generation of computing infrastructure. Our investment process includes a regulatory review of compliance to relevant regulatory frameworks.
Definitions and Token Categories
1.1. What is the clearest way to define ICOs and different categories of tokens?
There is an increased industry understanding in categorising crypto assets. Note that we will use the term crypto assets as a broad term for all assets that are secured on an open blockchain network. Apollo Capital suggests the following categories:
Cryptocurrencies. These are crypto assets whose main purpose are ‘money-like’. This include crypto assets like Bitcoin and Zcash.
Tokenised securities. These are crypto assets that represent ownership and rights and would fall under the regulatory framework of a Financial Product. An example of this are tokenised shares with voting rights in a company.
Utility tokens. These tokens have a specific utility but doesn’t offer rights that reach the threshold of being categorised as a Financial Product under Australian regulatory framework. We believe examples of this include Augur and Maker.
We refer Treasury to the FCA recent ‘Guidance on Cryptoassets’ for a similar categorisation as above.
Drivers of the ICO Market
2.1. What is the effect and importance of secondary trading in the ICO market?
Crypto assets are often similar to early stage venture investing. One key differential factor is the early liquidity as crypto assets trade on exchanges. This increases price transparency and lowers liquidity risk compared to venture capital investing.
2.2. What will be the key drivers of the ICO market going forward?
The big boom in ICOs in H2 of 2017 was prompted by a market fuelled by speculation. ICOs have been around for around 5 years and will continue to play a role in launching new blockchain network independently of where in the market cycle we are.
Opportunities and Risks
3.1. How can ICOs contribute to innovation that is socially and economically valuable?
ICOs offer a way to bootstrap new networks by making early users stakeholders in a new network. This is a flatter and more democratic versus traditional venture capital investing. See this blog post by Chris Dixon (a16z) for further thoughts on this. Economically, as blockchain networks predominately are a new computing platforms for trust, massive savings can be made. See RMIT Prof. Jason Potts article ‘The $29 trillion cost of trust’.
3.2. How important are ICOs to Australia’s capability to being a global leader in FinTech?
Crypto networks are a new computing platform for trust. It heralds a new design space for entrepreneurs, investors and computer scientists to build global software applications that utilise this primitive of trust. This has, and will continue to, lead to an explosion of innovation, particularly in the finance vertical. ICOs are a way for crypto startups to raise working capital without such a heavy reliance of venture capital funding, itself centred in Silicon Valley. On a high level, ICOs are a new source of innovation funding - this should be taken seriously.
Specific to Fintech, Decentralised Finance, or #DEFI, is arguably the most promising emergent vertical in crypto.
There are projects that enable the borrowing and lending of assets peer to peer, i.e. without a bank or lending institution in between. Dharma and Compound are key examples here.
Other projects enable the creation of credit through a collateralised debt position. Similar to how people leverage their house as collateral to secure a mortgage, MakerDao allow users to collateralise ether, the native token to Ethereum, to draw out a debt position denominated in their USD-pegged token, Dai. Soon other assets will be able to be used as the underlying collateral.
Binance, the world’s largest exchange, is developing a decentralised exchange that will enable the peer to peer trading of assets. This exchange will allow users to retain custody of their assets throughout the trading process. And Binance have the resources to deliver - they made more in profit than Deutsche Bank in Q1 of 2017.
Crypto is both a patent threat to incumbent financial institutions and perhaps the biggest innovation opportunity of a generation. Australia should support, and incentivise, projects to be based in this country. Having clear ICO guidelines is a critical first step. As with any enterprise, certainty is highly valued.
3.5. Are there other risks associated with ICOs that policymakers and regulators should be aware of?
ICOs have been very polarising. Most are not worthy of the money they raised through their ICOs. Hype, no doubt, drove much of the ICO boom in H2 2017. Conversely, some ICOs have funded extremely innovative projects that are provided substantial value to investors.
Key risks associated with ICOs include:
Fraudulent promises and claims
Some bad actors targeting unsophisticated investors
The token sold in the ICO having little or no current or future value.
ICOs do not represent an equity stake in the enterprise. They offer few rights, particularly in the early stage of a network.
Regulatory Frameworks in Australia
4.1. Is there ICO activity that may be outside the current regulatory framework for financial products and services that should be brought inside?
It’s Apollo Capital’s view that crypto assets that are representative of a high enough level of rights in centralised projects are considered Financial Products under Australian regulation. All other crypto assets are either too decentralised or do not meet a sufficiently rights threshold to be considered a Financial Product.
4.2. Do current regulatory frameworks enable ICOs and the creation of a legitimate ICO market? If not, why and how could the regulatory framework be changed to support the ICO market?
More clarity is needed.
We believe increased regulatory clarity of what constitute a Financial Product would benefit innovation in Australia. We would like to emphasis the global nature of the crypto landscape.
Specifically we believe the relevant regulator needs to clarify what ‘rights’ a crypto assets need in order to be categorised as a Tokenised Security (our proposed categorisation above). We believe that the rights associated with a token to fall under this category should be similar to traditional shares or debt instruments. We further note that section 9 of Corporations Act (Managed Investment Scheme) refers to a ‘common enterprise’. Apollo Capital believes crypto assets that are sufficiently decentralised cannot be categories as a common enterprise. Therefore we recommend the regulators evaluate the categorisation of crypto assets both along the lines of rights and decentralisation. As an example, in our view, a crypto asset with ‘shareholder like’ rights that are not sufficiently decentralised should be categories as a Tokenised Security regulated under existing framework of a Financial Product. If a crypto asset is either sufficiently decentralised or does not reach the threshold of rights it cannot be categories as a Tokenised Security and it should fall outside the perimeter of regulation of Financial Products. Apollo Capital believes that categorising crypto assets that are either sufficiently decentralised or do not have shareholder like rights as Financial Products would significantly impede the innovative landscape in Australia.
Henrik Andersson is the Chief Investment Officer of Apollo Capital — Australia’s Premier Crypto Fund. The Apollo Capital Fund is a professionally managed portfolio of crypto assets, offering investors exposure to the fast growing crypto market. For more information, please see apollocap.io.