Asia-Pacific Insights: Antoine Martin comments on recent moves against Bitcoins, Initial Coin Offerings (ICOs) and crypto exchanges by China’s financial authorities.
[ By Dr Antoine Martin ]
The past weeks have witnessed significant developments in the relationship between China and digital currencies such as the Bitcoin. In particular, the prohibition of Initial Coin Offerings (ICOs) and the ban of several crypto-currency exchange platforms from Mainland China by Beijing had an important impact on the value of the Bitcoin in the fourth quarter of 2017. So, what is going on?
Explaining the trend.
There are various reasons to explain this evolution in policies on Beijing’s side of things.
Speculation and bubble control is one important aspect of the shift, but other elements also need to be brought into the balance, including internal politics and very ambitious projects developed by the Chinese People’s Bank of China (PBoC) in relation to the development of a sovereign digital currency.
ICOs & Exchange platforms banned
The Chinese authorities recently implemented a ban on the so-called Initial Coin Offerings (ICOs). ICOs are the digital equivalent of Initial Public Offerings (IPOs) which allow companies to obtain cash in exchange for equity. In ICOs, however, investors receive tokens – digital currencies – in exchange for their funds, at their launch value. Those tokens can be used to make encrypted transactions with financial partners who recognize and accept the new currency, but in many cases the trading of the currencies increases their values. Hence, they become a matter of speculation.
While some sources suggest that 65 ICOs reaching 2.6 billion yuan (US$398 million) were completed in China in the first seven months of 2017, the People’s Bank of China however called 90% of the Mainland ICOs deceitful in early September 2017 in an official communiqué (here) where it called all investor to terminate such activities immediately and to refund investors. In sum, one channel for digital currencies has been severely tampered with.
Tensions have also appeared in relation to crypto-currency trading platforms.
Beyond the increase in ICOs, recent (and less recent) currency developments also had impacts in terms of monetary policy. For the past years China faced significant capital outflows as a result of an economic slowdown and has put significant capital controls into place in order to limit capital evasion and currency devaluations (See The Asia-Pacific Circle – China, Capital Controls, Lagarde and Kuroda here).
Given the difficulty for many Chinese investors to take their capitals out of China, digital currencies such as the Bitcoin have over the past months become an efficient intermediary and a powerful way to exchange RMBs for US dollars whilst potentially making a profit.
In addition, Chinese capital markets have long been known for their volatility. The Shanghai stock exchange turbulences of 2016 were a consequence of the tendency of Chinese investors to conduct short-term speculation and Beijing was at the time largely criticized for the way it handled the situation on financial markets.
Hence, with digital currencies markets being perceived as a speculative bubble risk by the authorities, Beijing ordered a ban on Chinese digital currency trading platforms such as BTCC, OKCoin, or Huobi (98 percent of all bitcoin trading according to the Financial Times) to prevent a déjà vu scenario (see SCMP 04/09/2017 and FT 11/09/2017).
Mixed results, to say the least
Having said that, the results of Beijing’s policies are being questioned.
First, the ban on crypto-currency exchanges has had one unwanted consequence. Beyond reducing the value of bitcoins from $5000 to $3000 in a very short period of time, it pushed investors to trade their currencies in exchange for Bitcoins on alternative peer-to-peer Over-The-Counter (OTC) trading platforms.
WeChat transactions are one alternative channel, but so is the encrypted Telegram app for instance. In Hong Kong, also, two companies (OKEx and Huobi Pro) communicated on the modification of their crypto-currency-based system into RMB-to-crypto peer-to-peer platforms capable of allowing similar trading and announced receiving about 8,000 registration applications in a couple of days.
Second, because it led to pushing capitals away, Beijing’s policy is being questioned for reducing Beijing’s actual ability to oversee RMB – Bitcoin transactions, which when operated under domestic markets were said to at least be bound by domestic AML and KYC rules.
From Party motives to ambitious projects
Beijing’s policy can be explained by additional factors, however. Two perspectives are particularly worth mentioning.
One relates to the 19th National Congress of the Communist Party of China and to the necessity for Beijing to send a message in terms of corruption-curbing. Simply put, crypto-currencies have long represented a means for corrupted officials to illegally transfer important funds outside of Mainland China despite the capital controls in place. Hence, the anti-Bitcoin policy was about signaling the end of a practice at a very political level.
Second, and perhaps more relevantly, China is currently working on an ambitious digital currency-related project which directly competes with Bitcoins and other foreign crypto-currencies.
The information has been released by the financial press for some months now, but there were not many comments on the whys and hows. In light of the recent Bitcoin developments, however, more comments have appeared, pointing to the creation of a “sovereign digital currency” aimed –according to the People’s Bank of China– at increasing the efficiency of monetary policies.
A significant change
In other words, the goal is to create a financial alternative to Bitcoins that would give Beijing control over a proprietary form of digital currency.
This represents a significant change because beyond the idea of creating a sovereign digital currency is the idea of tweaking the system at the very basis of digital currencies, to bring them back under state control.
One of the fundamentals of Bitcoins and other crypto-currencies is the use of blockchains, a chain of actions aimed at validating the authenticity of numerous data blocks by multiple servers and computers. In other words, digital currencies rely on a “decentralized” process which makes transactions verified and reliable for the users, without any state interference or control.
Here, however, the goal is to create a sovereign digital currency, without the decentralization process. To the contrary, Beijing would centralize controls over the currency – most likely through the Chinese central bank – and would thus gain a major influence over the trading of the new digital currency, as already done with the RMB.
In sum, controlling digital money in the same way paper money is already controlled.
Whilst at first reading this would make it easy for everyone to blame it on China, the reality is that digital currencies are creating concerns on a global scale.
The concern is not to build domestic digital currencies, that’s for sure. The concern, nonetheless, is the inability of governments and monetary authorities to control the up and downs of currencies that were deliberately created to escape normal monetary logic and regulations. Problematically, whilst the primary goal of a currency is to permit the storing and the exchange of value in a stable and reliable way over time, cryptocurrencies have become a matter of speculation and hardly play the traditional role of a currency.
In most places, in fact, those currencies do not have a legal status. The United States considers them as securities and requires compliance with securities regulations when it comes to ICOs, but in Hong Kong (so far) crypto-currencies are considered virtual commodities and are not regulated.
The recent developments point to two major directions.
One is obvious and deals with China’s standing on the issue. On the one hand, Beijing is making its best to control the negative impacts of cryptocurrencies on its monetary stability. On the other hand, these will continue to strive and therefore China is moving forward with the idea of creating an alternative currency to the alternative currency, but with a control tweak. But let me ask a silly question here… what would be the impact if China became the first country equipped with an official digital currency?
The other conclusion is, unsurprisingly, that the digital currency market is becoming an increasingly grey area which, more and more, will create concerns. Concerns to the regulators obviously, both at the domestic and international levels. But also concerns for financial actors.
Somehow, interestingly, digital currencies are increasingly perceived as a risk by banks. In late September, the Hong Kong-based exchange platform GateCoin released a communiqué explaining that their Hong Kong bank had frozen their USD accounts, and that “the actions of [their] past banking partners reflects a global trend among banks to cease relationships with crypto-token exchanges in spite of the efforts among many members of our industry, including ourselves, to work with them to ensure strict compliance policies and procedures”.
Even more interestingly, in fact, Gatecoin’s competitors in other jurisdictions have reported similar developments, with other financial services providers (Paypal) similarly closing accounts held by cryptocurrency traders. But let’s remember, though, that while Paypal is nowadays an established financial intermediary, it once used to be a disruptive actor in the market!
So, between states blocking digital currencies and creating their alternative own, and former disruptive players starting to question the legitimacy of newer disruptive players, it would seem that the topic is becoming schizophrenically complex. Could this be a sign?
Insights by Dr Antoine Martin
Dr Antoine Martin is the Head of Insights of The Asia-Pacific Circle, which he co-founded in Hong Kong in 2016. Antoine follows analyzes and comments on developments in international trade, investment, and finance, with a particular focus on Asia-Pacific relations. He is also a scholar at The Chinese University of Hong Kong, Faculty of Law, a leading academic institution in Asia.
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