Cutting through the FUD series — China’s crypto crackdown
Disclaimer: Kelvin is the CIO at Spartan Capital. Spartan and/or its employees may or may not have exposure to assets discussed in the piece below.
Recently there has been a lot of fear, uncertainty and doubt (FUD) around the Chinese government’s crackdown on cryptocurrency speculation. The noise has been exacerbated by fake news and inaccurate reporting by various media sources. Map that with crypto volatility and the Western distrust of the Chinese government and you get some crazy price action.
President Xi’s speech on Oct 24 urging China to “seize the opportunity” afforded by blockchain technology was hailed by the crypto/blockchain community as the beacon call for a more progressive approach toward the industry. Hot on the heels of President Xi’s speech, the Standing Committee of the 13th National People’s Congress in China passed a cryptography law on Oct 26 that will come into force on January 1, 2020.
In addition, we learned recently the NDRC has quietly removed cryptocurrency mining from a black list of restricted industrial activities, reversing a decision they made during an earlier round of crackdown in late 2017. Our contacts in China also indicated a major uptick in inquiries from traditional corporates looking for guidance on how to leverage the technology to their benefit. This sudden enthusiasm feels more like corporate chieftains trying to ingratiate themselves with the great leader rather than a real belief in blockchain technology.
While the Chinese government is known to make a distinction between blockchain technology vs cryptocurrencies, we nonetheless believe that China’s top down approach means that the industry will benefit from more investment dollars and greater innovation. Reinforcing this view, officials in Guangzhou announced on Oct 31 that they are launching a 1 billion Yuan fund to invest in blockchain projects. Other cities such as Nanjing, Shenzhen, and Hangzhou have already launched their blockchain funds last year.
While these developments are welcome, they also quickly sparked a speculative fervor with many of the Chinese cryptoassets posting strong gains. Major projects such as Tron, Neo, Ontology, Bytom and Vechain rose 40–148% in the immediate aftermath of President’s Xi’s speech. Within days, the Chinese government called for a clampdown on all speculative cryptocurrency trading activity. Reports soon surfaced on social media that senior executives of various cryptocurrency exchanges had fled China while the offices of other exchanges were being raided by the public security bureau. These reports (some unsubstantiated) added to the uncertainty and doubt about the government’s intent.
Some observers have speculated that the latest crackdown has to do with the imminent launch of the DCEP, China’s national digital currency. While this may be a consideration, it is likely not the main reason. In our view, there are two more important reasons: 1) protecting retail investors from fraudulent schemes; 2) enforcing its capital controls as digital assets have the ability to circumvent existing restrictions.
Since the start of the 2017 ICO bubble Chinese retail investors have been the target of various crypto scams and ponzi schemes. At the height of the bubble, it is estimated that up to half of the crypto projects in China were scams. This situation is not isolated to China, but is particularly prevalent in China due to the lack of investment products in China and the ease with which money can be transmitted via Alipay and Wechat Pay.
The most egregious of these frauds is PlusToken. PlusToken debuted in June 2018 with a profit-sharing cryptocurrency wallet reportedly entitling users to monthly interest of 6–18 percent on all deposited cryptocurrency, with larger investments getting more rewards. PlusToken had a major following in Korea and China — especially among investors not familiar with cryptocurrencies. It is estimated that they amassed over $3 bn of BTC before the fraudsters initiated their exit strategy and fled China. Law enforcement were able to arrest 6 of the suspects involved with Plus Token in Vanatu on 29 June 2019. They have been detained and extradited back to China to face trial.
The government’s vigilant approach towards cryptocurrency speculation is understandable. In the past, China has faced similar speculative episodes with structured financial products and P2P lending that targeted retail investors. When retail investors invariably lost their hard-earned money, it resulted in social unrest and the government had to step in. Viewed in this light, there is nothing sinister or worrying about this round of crackdown, nor is this the first time it has happened to the cryptocurrency industry in China.
What about the exchanges? Amid the crackdown during the past week, most of the Tier 1–2 exchanges were operating normally and there were no issues with fund withdrawals in most cases. If you are wondering why these “raids” happen with regularity, here is a perspective for you. Even in the traditional regulated asset management industry, the CSRC conducts regular inspections. Only a few years ago, fund managers in China were regarded as crooks by the regulators (until proven innocent) due to their past transgressions of misappropriating client funds.
In my view, if crypto evolves into a real asset class (many signs point to that), China will eventually embrace it and crypto exchanges will be legitimized. It may take years but it will happen. Hong Kong will likely be the testing ground for it and this is already underway.
Thanks to Jason Choi and Dominika Nestarcova for suggestions & edits.
