Israel on Track to Become a Crypto-Powerhouse, Says Attorney

In April 2017, Tel Aviv-based law firm Herzog, Fox & Ne'eman established a cryptocurrency unit under its ecommerce department. Today, the department has 30 concurrent projects under its wing, said partner Roni Cohen-Pavon in an interview with Calcalist. The unit’s team and has already met with over 200 entrepreneurs looking to enter the industry.

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“Israel is on the way to becoming a crypto powerhouse,” Mr. Cohen-Pavon said, “but the first and most important thing is to create a certainty for the industry.”

Since blockchain technology was invented and used in 2009 as a public ledger for the first cryptocurrency, bitcoin, the popularity of such decentralized coins has skyrocketed and over a thousand digital coins are in circulation today, leading many to caution against a dot.com bubble-like crash. The popularity of crypto-coins also created an alternative funding route for technology companies: initial coin offering, or ICO.

More and more startups are using ICOs to raise money, bypassing gatekeepers like venture capital funds and banks. These companies issue tokens to early backers in exchange for some form of legal tender or another more popular cryptocurrency like bitcoin. Such ICOs don’t require a prospectus like securities offerings, only a white paper stating the project’s terms.

A January report by financial consulting and advising firm Ernst & Young put the global number of funds raised by ICOs in 2017 at $3.7 billion. The authors of the report though estimated 10% of the funds raised were lost or stolen by hackers.

In Israel, ICOs are spreading fast. A January report by Israel-based market research firm IVC Research Center Ltd. and law firm Zysman Aharoni Gayer & Co. (ZAG/S&W) counted 10 Israel-based companies that raised funds via ICOs in 2017, for a total sum of $480.2 million. At the lead was Sirin Labs, a luxury phone manufacturer that raised $157.8 million in December to fund a pivot to a blockchain technology-based phone.

“The ease with which the public can participate in these offerings, and the large capital they manage to raise so quickly are severely worrying regulators,” Mr. Cohen-Pavon said. Though comprehensive laws have yet to be established, he explained, regulators are already weighing in. “Once I can transfer money straight to you, from one end of the world to another, with no mediators, there’s a big risk of money laundering, That’s what regulators are so afraid of,” he said.

One of the duties of the regulators is to defend investors. “To put it simply, if a token gives you any rights in a company, it’s a financial asset and therefore an investment. But it's more complicated when a company is issuing a currency to use for its services, especially when some or most of these services don’t exist yet.”

According to Mr. Cohen-Pavon, there’s a difference between an early stage company issuing a token for future services, when the coin’s value is speculative and therefore an investment, and a stable and mature company issuing a token for existing services. “That’s the point regulators are deliberating,” he explained.

China banned ICOs in September, saying the offerings are disruptive to economic and financial stability. South Korea soon followed suit.

In January, Israel’s central bank said it would not recognize cryptocurrencies such as bitcoin as actual currency, as it will be difficult to amend existing regulations to monitor the risks such activities pose to both banks and clients. The bank’s position is that virtual currencies should be viewed “as a financial asset,” said the bank’s Deputy Governor Nadine Baudot-Trajtenberg at the time.

In September the U.S. Securities and Exchange Commision established a cyber unit to increase its enforcement against cyber-based threats, including ICOs. In January the commission stepped up its regulatory battle against ICOs, with head Jay Clayton announcing he had instructed staff to be on the lookout for ICOs that violated federal securities laws.

The uncertainty that exists today is what’s creating obstacles for regulated entities like banks, Mr. Cohen-Pavon said. There are many entrepreneurs that made significant amounts of capital from the industry, but their money is stuck overseas and they can’t transfer it to banks in Israel.

Israel’s Prohibition on Money Laundering Law requires Israeli banks to automatically report suspicious deposits and all deposits exceeding NIS 50,000 (around $14,700) to the Israeli Ministry of Justice, and people wishing to deposit such sums must produce documents that verify the legitimacy of the deposit’s origin. However, the nature of the cryptocurrency industry means Israeli banks refuse to accept deposits that originate from cryptocurrency, fearing their origin is illegal.

The current uncertainty might also chase away companies operating in the market, Mr. Cohen-Pavon added, causing Israel to lose out on an industry that makes billions a year.

“I believe ICOs and their issuers need to be clearly regulated,” Mr. Cohen-Pavon stated, “but unseasoned investors must also be allowed to participate, so they can profit from the benefits blockchain offers.”