May 26, 2021

Asia

CHINA: Crypto crackdown – is this time different?

BY Gabriel Wildau

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Report Contents

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( 4 mins)
  • Three government-backed industry associations ordered financial institutions not to facilitate virtual currency transactions or provide any related services.
  • But the impact is likely to be modest, as the latest crackdown does not go substantially beyond a previous ban in 2017 that resulted in the shutdown of mainland crypto exchanges.
  • The impact on bitcoin mining may be more severe, however, as local governments push ahead with the shutdown of large-scale mining operations.

The joint statement on 18 May by the National Internet Finance Association of China, the China Banking Association, and the Payment and Clearing Association of China instructed financial institutions not to provide trading, registration, or clearing and settlement services related to virtual currencies.

More of the same

In 2013, a group of Chinese regulators declared that bitcoin is “not a true currency” and banned financial institutions from facilitating bitcoin trading. In 2017, regulators banned initial coin offerings and prohibited financial institutions from facilitating transactions involving all “virtual currencies.” The language of the latest statement closely echoes the 2017 ban, which also explicitly prohibited the services listed above. But the latest statement adds prohibitions on providing storage, custody, and collateral services; accepting virtual currencies as a payment instrument; the issuance of virtual currency-linked investment funds and trust products; and offering conversion between renminbi and virtual currencies. This latter set of products and services are not commonly offered, however, so the practical impact will be modest.

Following the 2017 action, China-based crypto exchanges like Huobi and OKEx moved offshore, largely to Singapore and Hong Kong. While these platforms are unable to process renminbi payments to facilitate crypto trades, they enable such trading indirectly by guiding investors to online chat rooms where they can trade over the counter using renminbi. Payments for these over-the-counter trades can still occur through Chinese commercial banks and commonly-used digital payment platforms like Alipay and WeChat, since domestic payments between individuals do not require disclosure about the purpose of the transaction.

The latest announcement may cause financial institutions to monitor transactions more closely to detect crypto-related payments. Still, it is not clear how they could reliably distinguish such transactions from anodyne payments between friends and family or from commercial payments linked to the sale of legal goods and services. The impact is therefore likely to be marginal. Another potential method to curb virtual currency transactions would be for China’s internet regulator to block access to foreign cryptocurrency websites. But while such action would create an additional hurdle for mainland crypto investors, most are probably tech savvy enough to to circumvent China’s internet controls by using a VPN.

Capital flight worries

Though China’s currency is currently stable and capital flight is not a short-term problem, concern about capital flight is likely one motivation for the latest crackdown. Chinese individuals can purchase USD 50,000 worth of foreign exchange per year for foreign consumption purposes (e.g., tourism, tuition, and medical care), some are reportedly using their forex quotas to invest in crypto assets. Before virtual currencies were popular, households used the same technique to obtain foreign currency for the purchase of overseas stocks, bonds, and real estate.

During China’s last bout of sustained capital flight and renminbi depreciation in 2015-2016, regulators and banks tightened enforcement of existing rules requiring individuals to declare how they intend to use the foreign currency they buy. Banks began requiring more specific disclosures and warning customers of penalties if they used their forex for an unapproved purpose. Nevertheless, as with domestic payments, financial institutions mostly lack the capability to verify how forex is used once it is disbursed to clients and remitted abroad.

Mining crackdown

In terms of bitcoin mining – which has thrived in areas like Xinjiang, Sichuan, and Inner Mongolia with cheap and plentiful solar energy – the latest crackdown may be more impactful. Though the joint statement by industry associations did not mention mining, Inner Mongolia’s regional government launched a dedicated hotline on 18 May for residents to report illegal crypto mining. The hotline follows on an announcement in March that local authorities in March intended to curb bitcoin mining over concerns about high energy use.