The Chinese Blockchain Paradox

The Chinese government and Public Bank of China (PBoC) can easily baffle onlookers by what can be perceived as mixed messages when it comes to crypto regulation. Does it imply some complex strategy or a lack thereof? Let’s take a closer look at the issue.

The government in China talks at length about the dangers of cryptocurrencies and ICOs, yet it shows a lot of support for the national trio of tech giants — Alibaba, Tencent, Baidu — when it comes to investing in blockchain technology. PBoC bans all organized crypto trading in the country, but still discusses plans for government-issued cryptocurrency and registers more than 40 blockchain-related patents.

It actually seems that the Chinese regulators have conducted a much more thorough analysis of the new technology and its economic repercussions than their peers in other countries. They realize that a fast-track implementation of blockchain could prove to be a crucial advantage for the country. Yet a number of traits peculiar to the Chinese economic model make it especially susceptible to the destabilizing effects of cryptocurrency and ICO markets. Thus, supporting blockchain and banning crypto trading are not necessarily contradicting policies.

In its first-ever official statement regarding the crypto market made back in 2013, PBoC warned about potential risks associated with investing in these assets but did not show any intention to somehow limit access to them. Yet in September 2017 crypto trading and ICOs were summarily banned in China. So what was the reason for this regulatory U-turn? It looks like Chinese authorities were worried about the growth of BTC transactions in yuan — in January 2017, those made up 96,3% of total BTC trading volume. This implied widespread popularity of crypto investments among the Chinese population. This phenomenon was in its turn explained by several macroeconomic factors: slower GDP growth, plummeting yuan exchange rates, and the real estate bubble. Banning ICOs and crypto trading, limiting access to foreign crypto exchanges, closing down certain WeChat groups dedicated to crypto — all these measures were in fact meant to prevent the Chinese middle class from investing in high-risk volatile assets.

The middle class in China is still an emerging social layer that makes up to a third of the general population (around 400 million people). The Chinese government has high hopes for the increased middle-class consumption that will provide a much-needed momentum for the slowing economy. Yet the position of this group is still precarious — we shouldn’t forget that people with the annual income of 3600 dollars are already considered middle-class by the government statistics agency in China. Their consumption growth is further hindered by falling yuan and skyrocketing rent prices. Under these already dire conditions, widespread involvement of middle-income Chinese in crypto investing could jeopardize their stability in case of a market crash — and this could have catastrophic repercussions for the Chinese economy in general. State authorities realize this and solve the problem in a paternalistic manner — by altogether denying the general population access to digital assets.

There is yet another inherent risk posed by cryptocurrencies to the Chinese economy — due to their decentralized nature they serve as the perfect tool for circumventing the government’s rigorous foreign exchange controls. These measures are used to stem the capital outflow — a particularly pressing issue in recent years due to yuan devaluation and trade wars with the US. According to the Institute of International Finance (IIF), capital outflow from China has reached a record 725 billion dollars in 2017. Banning crypto and ICOs can be seen as an extension of the government’s foreign exchange control.

Considering all of the above, it becomes evident that Chinese blockchain and crypto policy, despite a number of restrictions, is different from cryptoscepticism of certain other jurisdictions. It is a rather pragmatic approach, concentrated on mitigating a number of systemic risks inherent to the Chinese economic model. We shouldn’t expect to see the crypto trading and ICO ban lifted in the foreseeable future. Yet the government will continue to support tech companies and venture capital funds investing in blockchain-based projects as it realizes the technology’s economic potential for the future of China.