Context for China’s Crypto Crackdown
In early September 2017 China banned the so called ICOs, or Initial Coin Offerings, a crypto-currency version of the IPO. Now a couple of weeks later, there is talk that the Chinese regulator (*) will shut down all cryptocurrency exchanges in China.
An ICO is in principle similar to a Kickstarter campaign, except that nobody’s in charge. Many have welcomed the ICO ban in China. Over the past year things in the ICO world have gotten a bit out of hand. It has become a joke that anyone can have their own ICO in about a day: pick an Internet application (say Medium), say that you are going to build a Medium-like distributed service on the Blockchain, issue a crypto coin for it that will be used to pay to read the articles (obviously), build a one page WordPress site, and off you go to an ICO to raise several million or more dollars.
Then? Well, hire one developer on Upwork for $10/hr to architect, code and market your product so you can’t be accused of being a complete fraud, and proceed to enjoy the rest of your life with your new found wealth since you have no legal obligation whatsoever to the people who bought the coin. Obviously, nothing will come out of your project, but that wasn’t the point. Start-ups fail, right?
Yeah, it was that bad. Kickstarter would kick you off their platform, and in an IPO situation, you would need to report all kinds of audited information about your operation, how you spend funds, etc. but there is nobody to force you to do that in the crypto world. People issued coins named after long-dead writers and sold them to their ideological fans like baseball cards. There is even a Trump Coin and you can trade it. Mostly they were pyramid schemes. Not all of them, surely, but picking out the ones which weren’t became virtually impossible.
ICO-like models may eventually have their place in the start-up fund-raising ecosystem, but as they were, they simply muddied the water and were not helping real start-ups at all. US Securities and Exchange Commission (SEC) issued their own warning, but China’s regulator proceeded to straight out ban ICOs, and acted swiftly to inspect and shut down all related operations within a week.
So far so good.
Then, however, rumors by anonymous sources started swirling this week that China will close down all bitcoin exchanges, some of which have been in business for several years and are world leaders in crypto-exchange services. Their combined daily volumes are several hundred million US dollars. That’s still tiny: Shanghai Stock Exchange does about $20 billion USD in volume every day, and NY Stock Exchange is closer to $200 billion, but the Chinese crypto exchange volumes at one point about a year ago represented almost half the world wide bitcoin daily trading. They had financial products such as margin and futures and sophisticated APIs allowing automated trading (some US and international exchanges do as well). On the other hand, the exchanges were operating in complete regulatory vacuum. This was true of most bitcoin exchanges world wide.
In January of 2017, the People’s Bank of China stepped in, mainly out of concern for capital control abuses. Beijing government has strict capital flow controls in part to maintain the stability of the Chinese yuan. In November 2016 Chinese yuan started sliding (losing value) a little faster than PBoC could stomach, and after several major monetary interventions failed to stop the slide, PBoC got increasingly nervous looking for leaks where money was leaving China (selling yuan for other currencies would cause Chinese yuan to drop). Must be bitcoin!
There is no doubt some money was leaving China via bitcoin, but most people in this business in China agree that based on common sense the volume would have to have been a drop in the bucket on the scale of China. If say several billion dollars left China in November 2016 via bitcoin (based on trading volumes on exchanges, essentially saying that all bitcoin buying in China was for capital flight and not speculation), it’s nothing compared to the daily amount of money that comes and leaves the second largest economy in the world. China’s annual trade (exports+imports) is $4 trillion USD, so if you divide that neatly into 12 months you get over $300B of cross-country payments every month. Several billion dollars are a small percentage of this number, unlikely to have caused a big drop in the Chinese yuan. And that’s just trade. There are many other legitimate currency flows beyond exports and imports — millions of Chinese and foreign tourist coming to China for example. So that bitcoin volume becomes even less relevant.
In any case, the Chinese regulator stepped into the bitcoin market, but did not shut down the exchanges. It temporarily suspended bitcoin withdrawals, while forcing Chinese exchanges to implement anti money laundering (AML) and so-called Know-Your-Customer (KYC) procedures. It also told the exchanges to stop providing margin (lending) and futures services. Overall, it was a good thing because it basically brought the exchanges out of regulatory vacuum into the mainstream. Note that none of these changes were enshrined in any sort of formal document, much less law. In fact, the exchanges claimed that they voluntarily implemented some of the changes based on suggestions and recommendations by the PBoC. Visionary!
Chinese yuan stabilized in December 2016, but the price of bitcoin shot through the roof meaning possibly more people were buying it, apparently elsewhere in the world. It might have been the ICOs. Or it might have been a supply crunch since it was hard to buy bitcoin in China (so either demand surged or supply shrank or both). In any case, PBoC declared victory in February 2017 without specifically naming bitcoin exchanges and putting it in perspective of a larger crackdown on illegal forex trading, apparently much bigger than even all the bitcoin trading in China combined.
What is the reason for the latest rumors about bitcoin exchange shut downs seems to baffle most people now that there is actually a semi-legal framework for the operation of bitcoin exchanges and that the ICO coins have been delisted.
At the time of this writing the ax has not come down yet, so we do not know the extent, duration or the ways bitcoin exchanges in China will be affected. We know that BitKan and BTCC have already suspended or announced a trading suspension by the end of September. We know that China’s National Internet Finance Association (NIFA), “a self-regulatory organization and not a regulatory agency itself, initiated in 2015 by the People's Bank of China and approved by the State Council” (*) said a couple of days ago that:
“Any trading platform for any kind of so-called ‘coin’ has no legal base of foundation in China.”
While true, it’s stating a bit of the obvious. There might also be truth to their charge that crypto-currencies have “become a tool for speculation among investors, while also serving as a payment conduit for illegal fundraising and money laundering” but that is also true of stock trading and real estate purchases in China. Illegal drugs are purchased with cash, yet nobody is talking about banning cash. Besides, bitcoin is far less anonymous than cash! It seems our “self-regulatory organization” (NIFA) is admitting defeat in its apparent mission (?) to self-regulate. While the Japanese Financial Services Agency simply decided to do its job and create a legal framework for cryptocurrency exchanges, the Chinese regulator apparently needs this sort of “permission” from the “self-regulating organization” in order to act.
But why now? And why a ban on the exchanges instead of regulation. It seemed like cooperation with exchanges was going quite smoothly. Exchanges were happy to cooperate. AML and KYC procedures are in, shady and risky products out.
I’ll suggest that this apparently imminent move against exchanges has a bit to do with this bi-annual period of self-cleansing that we in China go through as the Communist Party holds its Congress (this year it starts on October 17). It happens every time, and it is a time for all kinds of crackdowns. Not to mention that a major theme of Xi Jingping’s presidency is “Rule of Law”.
While all your government colleagues are cracking down on everything around you, cleaning up their portfolio and preparing power points about their successes for the big meeting, you cannot sit there at the PBoC and have this elephant in the room that’s all over the news live in legal limbo. Worse, imagine something happened with bitcoin during the Congress, for example while the president was laying out his vision of China under Rule of Law, and it stole the headlines. Yet the thing “has no basis in law”. And you are the guy tasked with watching over it. I wouldn’t want to be that guy.
That’s why now.
Is this really that simple? Yes, it’s really that simple. The goal post is no longer GDP, goal post now is “rule of law”. This is the reality of China’s political process and it works like clockwork. It has its own timeline and ways of working. Other political processes elsewhere have their realities and problems too. The purpose here isn’t to judge it, but to provide context — a connection apparently few people have made.
What happens to crypto and exchanges in China after the Congress remains to be seen. I have no “anonymous sources” whispering in my ear and I doubt the script has already been written.
All I can say is I see Japan (and Korea) taking over the torch of growth and innovation in crypto/blockchain from China — they do go hand in hand — and mainly by providing a regulatory framework and bringing all the creative resources into the fold. China’s share in world wide crypto trading and fintech innovation has gone from about 50% a year ago, to 20% now, and is likely to drop to low single digits after the bans. These are my rough estimates based on trading/investment volumes: these numbers paint a similar picture. Unless the second largest economy is banking on crypto and blockchain going away into obscurity, it has managed to lower itself from a world leadership position into one way below its re-emerging neighbors. Not to mention the US.
(*) Note: For simplicity, I used the term PBoC (People’s Bank of China) to refer to the PBoC itself, as well as a range of affiliated and related financial regulatory agencies of the Chinese government.
UPDATE 2017–09–15 1PM UTC:
Latest from the rumor mill is that all Chinese crypto exchanges were told to cease trading by September 30, 2017. Further rumors are that the exchanges will be allowed to resume operations after they get a license.
This is not part of the licensing rumor, but in general these kinds of business licenses typically take a month or two to be granted from the day you file them (October 1–7 is a public holiday in China). Which means, if these rumors are correct at all, that Chinese exchanges must halt trading September 30, and might resume trading some time in November/December time frame, conveniently missing the time of the 19th Congress of the Chinese Communist Party (October 18–25). This is surely pure coincidence.