Korea’s Largest Internet Firm Kakao Is Running a Crypto ICO That Is Not Subject to SEC Scrutiny

Kakao, South Korea’s largest internet conglomerate that operates applications and have nearly a 90 percent dominance in their respective markets, is running an Initial Coin Offering (ICO) to raise funds for its blockchain project called Clay.

In March, Kakao released its initial attempt to conduct a token sale by establishing an entity in Switzerland. But, with resistance from the Financial Services Commission (FSC), the corporation was not able to pursue its plans. With no changes made to the regulatory framework regarding ICOs in South Korea, how has Kakao been able to raise funds to create a blockchain project?

Private Sale

On Nov. 19, The Hankyoreh — a business-focused mainstream media outlet in South Korea — exclusively reported that Kakao is planning to raise around $300 million to develop its own token.

A source told the local publication that the majority of the funds have already been secured by Ground X, a subsidiary of Kakao that focuses on blockchain operations. The source added that a Chinese venture capital firm is said to be involved in the token sale.

“The target amount is $300 million and Kakao is very close to securing its target. A China-based venture capital executive held a meeting with Ground X in September and, even at the time, Ground X was planning to raise $300 million.”

As a private sale, only registered, accredited and approved institutional investors are allowed to invest in the token sale of Kakao. Considering that all of Kakao’s meetings with accredited investors were held confidentially — without any information provided to the media, unlike the Telegram ICO in May — the company planned a rigorous path to raise funds in a way that does not violate regulations in Japan, South Korea and even the United States.

On Nov. 27, U.S. Securities and Exchange Commission (SEC) Chairman Jay Clayton said that the vast majority of ICOs that are presently in the global cryptocurrency market are considered securities under existing U.S. laws and emphasized that if companies plan to raise funds through a token sale, firms either need to register with the SEC or conduct a private sale.

"We don't believe Bitcoin is a security. Many of the ICOs that you see and you talk about, they are securities. And if you're going to offer or sell securities, you have to do so in compliance with our laws. We've been clear about that, the recent actions further emphasized that our securities laws apply to the ICO space. And if people are going to raise money using Initial Coin Offerings, they either have to do so in private placement or register with the SEC.”

Companies prefer not to conduct private token sales unless they are absolutely certain that the product they offer will attract large investors, because a private sale is just as difficult and complex in a legal point of view as raising venture capital funding.

It can be argued, given the involvement of local financial authorities — and possibly the SEC — that conducting a private token sale is more resource-intensive than a traditional venture capital funding round.

For a company in the size of Kakao, it was of the utmost importance to be compliant with both local and international regulations, rather than completing the target amount of funding. This naturally led the conglomerate to conduct a private sale over a public sale, which could have been more lucrative.

Why Japan, not South Korea?

Ground X is based in Tokyo, Japan, and the decision to legally establish its blockchain initiative in Japan instead of South Korea by Kakao was likely a strategic move to circumvent various regulatory hurdles pertaining to cryptocurrencies that still exist in the country.

Throughout the past three months, South Korea has seen significant progress in cryptocurrency regulation. The government officially provided commercial banks permission to freely work with cryptocurrency exchanges and provide virtual bank accounts to digital asset businesses.

Blockchain technology has also been recognized as one of the core pillars of the Fourth Industrial Revolution, alongside big data and artificial intelligence (AI), and the government has established initiatives to bring young talent into the blockchain sector.

However, the stance of the government toward ICOs still remains uncertain and while local financial authorities were expected to provide an official announcement regarding the regulatory state of domestic ICOs by the end of November, given the time frame, the government is expected to delay the announcement once again.

Whether the ICO conducted by Kakao is a private sale or a public sale, because policies in South Korea remain undetermined, the firm cannot risk being in conflict with local regulations by prematurely conducting a private sale with institutional investors.

In December 2017, Chosun — another business-focused mainstream media outlet in South Korea — reported that the government was considering the possibility of allowing institutional investors to participate in private token sales. However, 11 months have passed and the government is yet to make a decision on the matter.

Legally, Kakao needed to conduct its private sale in Japan with an entity based in Japan. But, the implications of its blockchain initiative on its relationship with the Financial Services Commission (FSC) remain in question.

In July, Choi Jong-ku — the chairman of the FSC, South Korea’s main financial watchdog — disapproved of Kakao’s initial plans to run a public ICO and opposed the idea of Kakao completing a token sale in overseas markets. Commissioner Choi said, warning Kakao:

“Even if there is no prohibition on cryptocurrency or digital asset trading, there is a possibility that it [Kakao ICO] may be regarded as fraud or multi-level sales according to the issuance