Why China Is Cracking Down on Cryptocurrencies, Again
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2017-09-14 06:11:21

At noon on Sept. 2, Wu Kunchao and his team arrived at the 3W Coffice building in Beijing to attend a conference on behalf of his newly established initial coin offering (ICO) startup. Before long, however, he found himself being shooed out of the meeting room. Staff at 3W Coffice, a salon where entrepreneurs meet and exchange ideas, informed Wu that recent official regulations barred them from offering space to ICOs — just as Wu had been preparing to hit the road in search of investors.

ICOs are essentially a form of fundraising. Companies issue a certain number of digital tokens, or “coins,” to investors in exchange for the capital needed to kick-start a new business. The idea is to create a model that only accepts the company’s proprietary digital currency, the supply of which is fixed and thus rises in value if the company is successful. This, theoretically, is what makes ICOs attractive to investors.

ICOs run on blockchain technology: a continuously growing list of records, or “blocks,” connected to each other via cryptography. In Asia, a prominent blockchain business council is the Digital Assets Coalition Asia (DACA). The night before Wu arrived at his shuttered conference room, organizers of the 2017 DACA Blockchain International Summit — billed as the “most anticipated financial technology summit of the year” and scheduled to take place the same day as Wu’s meeting — abruptly announced it had been canceled, citing public safety concerns that allegedly emerged after demand for tickets exceeded the capacity of the meeting space.

ICOs rely on cryptocurrencies, a form of decentralized international cash traded solely on the internet. Most cryptocurrencies record such transactions via a system of distributed ledgers, a set of replicated data spread globally across multiple servers. A consensus on how these ledgers work, combined with their vast geographic spread, should ensure that each cryptocurrency transaction is credible.

Wu, for his part, was unconvinced by DACA’s claim. “I’d heard some noise [about an impending ban] within the industry, but nothing was certain,” he says. “The summit’s cancellation by itself was not enough to say whether or not the government’s attitude toward regulation had changed.”

Wu’s concerns soon became reality, however, and the news was worse than he’d feared. On Sept. 4, the People’s Bank of China, in conjunction with six top government agencies in charge of internet security, industrial guidelines, business registration, banking, securities, and insurance, officially declared that ICOs were an unauthorized and illegal form of public financial activity. The announcement put an immediate end to all ICO-related financial activities.

Prior to Sept. 4, it was easy enough to run an ICO in China: All you needed was the right staff, digital tokens, a marketing strategy, and a white paper outlining your business model. Private placement companies like Wu’s offered their own tokens to investors in exchange for bitcoin, Ethereum, and other digital currencies. During the interval between issuing the coins and the official launch of the business, investors were allowed to trade tokens on secondary markets, including digital currency exchanges.

Cryptocurrencies are a source of concern for the Chinese government, as they allow money to be freely moved across borders and increasingly play a role in money laundering.

ICOs are similar to initial public offerings (IPOs), which allow established, profitable companies to sell shares to investors. ICOs are just another means of raising funds publicly, but unlike IPOs, they circumvent regulatory demands requiring companies to already be operating at a profit before seeking initial investment.

Following the global introduction of ICOs last year, they have caught on in China, with 65 made in the first half of 2017 pooling approximately 2.6 billion yuan ($398 million) from around 105,000 investors, according to the National Committee of Experts on Internet Financial Security Technology. The panel, launched last year as an outlet of the state-run National Internet Emergency Center, has warned of counterfeit coins, fraudulent fundraisers, and a lack of transparency.

Current trends in China, however, cast doubt on the efficacy of this system. In August, Wu Xiaoling, vice chairman of the National People’s Congress Financial and Economic Affairs Committee, told media outlets that although cryptocurrency ICOs have grown in popularity, they’ve drifted away from the norms for running ledgers, often in ways that could mislead the public and even encourage Ponzi schemes. And she has a point: Recently, the country’s media have published stories of scammers who used ICOs to crowdfund, only to run off with investors’ money.

Cryptocurrencies are a source of concern for the Chinese government, as they allow money to be freely moved across borders and increasingly play a role in money laundering. The capital exodus that comes with large-scale use of cryptocurrencies is intolerable to a state that seeks to keep tight control over the value of the yuan in order to avoid financial instability.

In the wake of this week’s unprecedented announcement to ban ICOs, many companies have already declared that they will be buying back their ICO tokens, with some going so far as to announce they will erase them and give up ICOs altogether. On Sept. 10, VeChain — a cloud-based commodity verification service — announced that it would seal all the tokens it had already exchanged in a secure, publicly known location. Under the supervision of a third-party expert, the company said it would then destroy all of its tokens.

Xue Manzi, a prominent investor in ICOs, quickly let it be known that he was in favor of a government crackdown on pyramid schemers and so-called air coins — tokens not yet backed by concrete projects. However, he also expressed hope that entrepreneurs making genuine use of blockchain technology would be given a second chance.

Xue directly addressed the existence of a bubble in the industry, saying: “Blockchain technology is something that deserves [investors’] attention in the long term, much like how we invested in big data companies previously. The rise of any new technology will always bring with it a massive bubble; this is unavoidable.”

When it comes to the wider Chinese digital currency market, however, the reported ban on ICOs was only the first wave of a much larger tsunami. Last Friday, business news outlet Caixin published a report based on information from a source close to the government working group that oversees the internet finance sector. According to the report, regulatory authorities have decided to shut down all domestic digital currency exchanges.

The motivation for this round of shock therapy comes from the Chinese government’s desire to manage the risk digital currencies pose to the nation’s broader financial stability.

This means that as soon as the 60 ICO financial platforms initially targeted by the People’s Bank of China are shut down, all major bitcoin exchanges will be closed, including OKCoin, Huobi, and BTCChina. Of the 48 digital currency exchanges currently operating in China, these three are by far the largest, together controlling around 60 percent of the domestic market.

In the first half of this year, the market value of the world’s three leading digital currencies — bitcoin, Litecoin, and Ethereum — increased from $17.7 billion to $100 billion, with the market value of bitcoin alone jumping by 270 percent. In July, bitcoin transactions within China amounted to 30 billion yuan, accounting for about 30 percent of the global total, and enthusiasm for digital currencies within China has played a major role in propelling their rise.

On Sept. 8, the China Securities Journal, the country’s top trade publication on securities and capital markets, quoted a source saying bitcoin exchange platforms have long been havens for illegal price manipulation, money laundering, and extortion schemes, and should be shut down as soon as possible. It is worth noting, however, that this decision will only apply to transactions occurring through digital currency exchanges located within China — it does not constitute a ban on bitcoin, nor does it constitute a complete ban on all transactions between digital and paper currency within China’s borders.

In the aftermath of the ban on ICOs and the feared upcoming closure of secondary markets, many entrepreneurs and platforms unwilling to give up have started searching for regulatory loopholes, with a few ICO projects exploring ways to attract investment abroad. Japan, the United Kingdom, and Singapore are all potential destinations, as these countries have adopted more tolerant approaches to digital currency and ICO regulation than China. Wu Kunchao, for one, has already decided to go to Singapore to issue his tokens.

The sudden storm brought on by ICO regulations has had an undeniable impact on the digital currency world. The motivation for this round of shock therapy comes from the Chinese government’s desire to manage the risk digital currencies pose to the nation’s broader financial stability.

It does not mean the end of blockchain technology and innovation, however. After all, laws aren’t always written in stone, if the spread of QR codes is any indication: In 2014, the People’s Bank of China temporarily halted the use of QR codes and digital credit cards as payment methods, but the technology soon made a resurgence, and today it has become one of the Chinese financial industry’s most influential innovations.

Translator: Kilian O’Donnell; editor: Matthew Walsh.

(Header image: An employer examines equipment at a so-called bitcoin mine in Aba, Sichuan province, Sept. 6, 2016. Liu Xingzhe for Sixth Tone)