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 method. Since the risk is very high in terms of investor protection, the government has a negative stance on the ICO.”

Speaking to Hankyoreh, a Kakao representative said that while the fundraising could be considered as a private sale, the company does not consider it as one:

“Kakao has been securing strategic partners to help improve and grow the global blockchain ecosystem by obtaining new capital. It could be recognized as a private sale, but it’s not open to individual investors and is participated by institutions that are partnering with Kakao. Currently, it is not possible to finalize exact numbers regarding the funding round, and the company is not in the position to openly share which companies are involved in the initiative. Kakao needs to communicate with its partner companies first.”

Japan’s newly created ICO regulatory framework

On Nov. 27, Nikkei — a mainstream publication in Japan — reported that the Financial Services Agency (FSA) held a meeting on the Nov.26 to discuss the state of ICO regulation in the country.

During the meeting, the FSA and other local financial authorities discussed policies surrounding cryptocurrency exchanges and the possibility of allowing accredited investors access to domestic ICOs.

According to local reports, the FSA still restrict public token sales.

The token sale conducted by Kakao and Ground X falls under the newly created category by the FSA as a private sale aimed at institutional investors. Legally, the token sale of Clay is fully compliant with the regulations of Japan, South Korea, the U.S. and every other major market.

Japan and the U.S. both allow private token sales if approved by local authorities, and South Korea enables both corporations and investors to invest in foreign ICOs.

Problem with South Korea’s cryptocurrency market

The cryptocurrency market of South Korea has been able to demonstrate signs of improvement in terms of infrastructure and regulation.

Most recently, Upbit — the country’s largest cryptocurrency exchange based on daily trading volume provided by CoinMarketCap — successfully obtained an information security management system (ISMS) license from the Korea Internet and Security Agency (KISA) after passing an evaluation phase conducted by the government agency using a criteria with over 253 subsections.

Lee Seok-wu, the CEO of Dunamu — a company invested in by Kakao and the parent company of Upbit — said:

“Since early 2018, Upbit has been working tirelessly to improve the platform’s internal management system and security measures to obtain the ISMS license. With top class security experts and tested security systems, the company will continue to create a safe trading environment and protect the data of its investors.”

The local cryptocurrency and blockchain space has seen progress, but multi-billion dollar companies like Kakao are leaving South Korea to establish blockchain initiatives that well surpass the $100 million mark — which, in Silicon Valley, is acknowledged as a mega round.

In October, Min Byung-doo — the chairman of Korea's National Policy Committee — warned the government about an inevitable scenario in which companies move out of the country to kickstart operations that could be worth billions of dollars in the long term.

Referencing the $4 billion ICO of Block.one and EOS, chairman Min heavily emphasized that the government could no longer dismiss ICOs, given the positive impact token sales could have on the economy of South Korea.

“The government cannot dismiss ICOs. It needs to allow companies to conduct an ICO. [ICOs have] become a new trend in the global market, and it is the responsibility and ability of the government to embrace new technologies. We can see that the flow of investment is clearly changing compared to ICOs and angel fundraising. The ICO has raised $1.7 billion for Telegram and $4 billion for block.one. It is getting bigger and bigger.”

Japan’s ICO market is flourishing as a result

Line, a direct competitor to Kakao as the dominant messaging application based in Japan, has also recently released a new token called LINK.

The cryptocurrency and blockchain initiatives of Kakao and Line are structurally very similar. Both companies finance cryptocurrency exchanges — with Kakao’s Dunamu operating Upbit and Line directly overseeing the operations of BitBox. The two firms have also created their own unique cryptocurrencies to support their long-term vision in blockchain development.

The Japanese government’s forward-thinking approach toward regulating the cryptocurrency market has led two internet conglomerates from South Korea (Line is owned by Naver, the largest search engine in South Korea) to develop and release their own tokens in Japan, with funding from domestic and international companies.

Kakao’s Clay is said to have raised $300 million, and the market valuation of Link remains uncertain. However, the two cryptocurrencies have the potential worth billions of dollars collectively in the long run, purely based on the amount of funding the two projects have raised.

Line’s Link, for instance, can be used at 94,000 locations in Japan when converted to Line points on the BitBox exchange, demonstrating a level of merchant adoption which most major cryptocurrencies are still yet to see.

“In addition to using LINK Points for other DApp services in the LINK Ecosystem, residents in Japan can exchange LINK Points with LINE Points before converting them into JPY at par to make payments at over 94 thousand locations across Japan with LINE Pay, or make purchases in various LINE services,” the Line team explained.

The scenario which Korea's National Policy Committee chairman Min Byung-doo feared in October has come to realization faster than expected. Kakao’s abrupt private token sale could potentially lead to the government of South Korea speeding up the process of regulating the local ICO market to facilitate the growth of the local cryptocurrency sector.