Why are exchanges in China still allowed to operate?

I am asked this question frequently and currently I cannot give you a non-speculative answer.

My guesses are thusly:

1) That policy makers, despite knowing Bitcoin/Litecoin has the ability to bypass capital controls would still like to see if there are other potential “legitimate” uses for it.  Remember, this is a developing country that is trying to turn Shanghai into a real international financial center (pdf) through initiatives like the new Free Trade Zone.   So for example, maybe they have been briefed on the ‘smart property’ features of the crypto protocols (e.g.,  secure time-stampingproving ownership of tangible propertydecentralized DNS and new ways to sign contracts).  I doubt this is the case though.

Or:

2) Instead of being relegated to a paltry few options such as owning multiple apartments and/or sometimes sketchy wealth management products (WMPs) perhaps they would like to permit residents to diversify and try out new financial instruments.  And as happenstance cryptocurrencies are seen as a new alternative asset class.  While the PBOC officially stated that private ownership and public participation are okay for now, they do not seem to view cryptos as meeting their criteria as a “legitimate” asset class, withholding their stamp of approval.12

Remember, because of strict capital controls [pdf], PRC nationals cannot transfer more than $50,000 in foreign currency abroad each year, the domestic banking system has a very large captive consumer base from which to essentially extract rents from (e.g., no need to innovate as the market is essentially walled off from outside competition).  Again, these limitations are expected to change over the next decade, though officials and analysts have been saying that since at least 2008 when I first arrived in China.3

Or:

3) Perhaps I am an incorrect in my assessment of the PBOC which has been based on the stern comments from Sheng Songcheng, head official of investigation and statistics at the PBOC (see his recent essay “虚拟货币本质上不是货币” as well as my commentary here).  In contrast, my friend over at Aha Moments wrote this past week:

Of course, to a certain extent this merely reflects the general laissez-faire approach which characterizes the Chinese government’s approach to private wealth, an aspect of Chinese reality which understandably attracts little coverage in countries with more voracious governments. The reality on the ground is in fact almost unimaginable to younger inhabitants of, say, the United States or Western Europe. Not only is there is no capital gains tax in China, but C2C bank transfers are for the most part instantaneous and unlimited. I can send 50000 yuan to my buddy in Xinjiang and he will have it in seconds, all for a token transmission fee. You can also walk into any bank in China with the equivalent of one million euro in cash and deposit it with no questions asked. Simply put, the government’s policy is to leave people and their money alone. While they do endeavor to tax some income at the source, for the most part that’s about as far as they go.

Aha does have a valid point in terms of the C2C transfers, it was always easy for me to transmit this specific type of transaction nearly instantaneously (assuming you are using ebanking or an ATM — face-to-face service is still quite slow and tedious).  So perhaps there is a liberalizing strain within the PBOC policy making that has remained in the background regarding cryptocurrencies.  I don’t buy that though either.4

Or:

4) That policy makers are biding their time to see what, if any, international consensus is built around the regulation and management of exchanges.  There is no global standard yet, Singapore’s government is taking a hands off approach towards cryptocurrency right now whereas Denmark plans to regulate and oversee its use.  In the US, all fiat exchanges have shut down with the exception of Coinbase and that is because its founders had previous business relationships with Silicon Valley Bank (the partner bank).5 And even with this exception, Coinbase technically is not an exchange per se, but rather receives its coins through other sources like Bitstamp.net.

I think this is the most likely, as regulators can put a squeeze on the industry as a whole, forcing artificial consolidation and/or bankruptcies quickly.6 Then the PBOC and other peer organs will only have to worry about a handful or participants instead of 20+.  We already see the verification process being rolled out as customers at large exchanges such as BTCChina and OKCoin require national ID names and numbers in order to register and conduct transactions.  This will likely allow the PBOC and other departments to track capital flows to specific individuals.

A sell signal?

Yesterday the Financial Times published a report detailing the Chinese regulatory environment for cryptocurrencies.  It reconfirmed what I discussed a couple weeks ago, that fiat deposits at several exchanges, notably Huobi, are being transmitted through the CEOs personal account.

What struck me however was how several entrepreneurs went on record with FT, using their own identities to explain how they were bypassing regulations and/or finding loopholes.  Of course the inner libertarian in me cheers for a liberalized, self-organized world but a couple of their viewpoints seemed naive, short-sighted and wishful thinking.  And will likely end bad for them.  In fact, yesterday I was corresponding with Vijay Boyapati (who incidentally is the same person who convinced me of the long-term merits of cryptocurrencies and their protocols) and he asked me about the recent rise in price levels and if had to do with liquidity from China.

Here was my response:

I do think that the added liquidity (or at least the appearance of liquidity, who knows how deep it is on the Chinese exchanges) is helping buoy the price levels.  I don’t think it will last on the Chinese side, especially with articles like that from the FT.  PBOC staff read that newspaper, those comments are just going to make the officials want to close all the loopholes even more — at least that’s my guess.

24 hours later and the price for BTC token has dropped from ~5800 RMB to 4900 RMB and LTC token from 180 RMB to 145 RMB.  Who knows why, perhaps it will jump back up to those heights again tomorrow.  Self-reported volume on OKCoin and Huobi are still roughly the same as they have been the last few days.  Perhaps it is just the typical volatility.7

Yet the longer term issue still remains unresolved for several of these exchanges named in the FT piece: how to legally keep fiat liquidity flowing in both directions.  Are investors at exchanges prepared for the possibility of yet another December panic sale or hedged against a possible lower liquidity environment?  What about the personal liability issues that someone like Li Lin is now potentially facing in the event that a future audit takes place?  Perhaps now is the time to contact a risk management attorney to see if there other upsides (or downsides) to this nebulous guidance.8

  1. Getting an official seal, or chop, is very important for tax purposes in China.  See Chinese Chops Or Seals from About.com and What is a Chinese “Chop” or Seal? from Yahoo! []
  2. For more specifics and commentary about the PBOC notice on December 5th readers are encouraged to view: China’s Statement on Bitcoin is Open to Interpretation from CoinDesk and Despite panic, China’s regulation of Bitcoin leaves room for optimism from Tech In Asia []
  3. HNWI and financially savvy individuals can bypass some of these regulations by sending RMB-denominated funds through Hong Kong.  See This issue was directly discussed in Getting Money Out Of China. That’s Illegal. from ChinaLawBlog and In Reversal, Cash Leaks Out of China from The Wall Street Journal []
  4. This current stance by the PBOC seems to have taken many by surprise.  For example, back in October 2013 Bobby Lee was interviewed on a local station called International Channel Shanghai (video).  At the 12:38 minute mark Bobby says: “I hope personally to see more government regulation on bitcoin to clarify what businesses can and cannot do with bitcoin, to clarify how individuals can and cannot buy and sell bitcoins.”  Again, I have not spoken with him, but I doubt what he had in mind was what the PBOC and other organs announced/enforced last month regarding banning 3rd party payment processors. []
  5. See Regulatory risks, challenges and opportunities of cryptocurrencies in China and elsewhere []
  6. This is all speculative but there may still be time for new market entrants to enter the industry and merge/acquire with competitors. []
  7. One new story that came out today is that Taobao has a new rule (Chinese) that will ban the buying and selling of crypto coins.  Thus it will purportedly impact vouchers such as those being offered by BTCChina. []
  8. I do not know if law firm Harris & Moure has any particular advice on these issues at this time, but Dan Harris publishes a popular site: China Law Blog that discusses many legal issues regarding the mainland. []
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One thought on “Why are exchanges in China still allowed to operate?

  1. Truly hope you keep posting updates on the subject. Just wanted to really say thank you for sharing all this and for great reads. I am very happy that I found your page.

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