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The situation of cryptocurrencies in China

Until last September, China was the largest virtual currency market in the world, accounting for 90 percent of global transactions. However, Beijing’s government decided to ban fundraising through ICOs (Initial Coin Offerings) and cryptocurrency exchanges. At this time, Jeff Chen was working at a small digital currency exchange in Shanghai. He said that investors and entrepreneurs went crazy after the announcement of the ban. Indeed, all the investors want their money back. Jeff Chen is not working with digital currency anymore, he is now working as a business intelligence analyst at fintech firm ViewFinn. After the ban, the digital currency trading volume in China fall to only 1 percent of global transactions. Nevertheless, there are a few hopes that the Chinese government will change its mind.

The PBOC (People’s Bank of China) Vice Governor Pan Gongsheng said in a January memo: “Pseudo-financial innovations that have no relationship with the real economy should not be supported”. He advocated for the government to ban centralized trading of digital currency and prevent individuals and businesses from providing services related to digital currency. The Vice Governor also explained that he wants to slow down cryptocurrency mining, which is the process in which transactions for various forms of cryptocurrency are verifier and added to the blockchain digital ledger.

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According to the government, the crackdown on cryptocurrency was essential in order to control systemic financial risk. Last September, cryptocurrencies were called “tools for criminal activities of money laundering, drug deals, smuggling and illegal fundraising” by the industry group China’s National Internet Finance Association.

Why did the digital currency business flourish in China?

Because of ideal market conditions in the country. Indeed, China benefits from a wide power supply and space for large warehouse facilities. Consequently, remote provinces were attractive to crypto miners. Moreover, it was easy for crypto miners to get mining equipment from domestic suppliers based in Shenzhen.

Miners use software to confirm valid transactions or blocks to create new bitcoins. They can add these new transactions to the blockchain every 10 minutes. So, the more transactions they confirm, the more bitcoin they earn. On a regular basis, they can receive 12.5 bitcoins for every block they create. A problem of cryptocurrency mining is the huge amount of power used. Indeed, according to the research firm Digiconomist, the global digital currency mining industry consumes almost 0.20 percent of the world’s electricity, which is more than 161 individual nations. Consequently, mining infrastructures have to be based in a country where the electricity prices are low in order to be profitable. In exchange of a part of profits, governments are willing to furnish electricity subsidies and they are even eager of profits that can be made with cryptocurrencies.

The top coal-producing region in China was Inner Mongolia where currency mining companies partnered with the local government to give the firms access to electricity from China’s State Grid for just 5 cents per kilowatt-hour. In exchange, the government received tax revenue from the profits. However, even if up until last September China mined about 75 percent of the world’s bitcoins, mining in the country is not attractive anymore. Jeff Chen said: “Since this will also impact the local officials who were getting kickbacks from the miners, it strikes me that this has as much to do with local corruption and the current state of central-local relations as it does the need to get bitcoin out of China.”

Lee Cheng-Hwa, A senior analyst at the Taipei-based research firm MIC (Market Intelligence & Consulting Institute) explains that before the ban China was also the world’s largest market for trading digital currencies. He said: “Cryptocurrency became big because China’s hot money did not have many investment targets and speculation prevailed.

The other reason is that some people who wanted to bypass foreign exchange controls moved their money out of the country through cryptocurrency transactions.” Indeed, the Chinese government limits overseas remittances of $50,000 a year, which is not sufficient for some investments like real estate. Consequently, some investors found a solution with cryptocurrency to convert RMB to foreign currency. They bought bitcoin with RMB, then sold their bitcoin for foreign currency.

For some Chinese investors, it is also a solution to be independent of the Chinese economy. But, the worry of the Chinese government was the decentralization of cryptocurrencies and this was precisely the main factor for Beijing to ban cryptocurrencies and digital currency trading in China.

Will the ban last in China?

According to a research fellow at the Washington DC-based Peterson Institute for International Economics named Martin Chorzempa, the ban is only temporary. Indeed, it “is necessary to protect investors from fraud and maintain financial stability in the short term and should not become permanent.” And Chinese finance experts agree with this point of view and many of them think that the ban could be lifted once China had implemented regulations for cryptocurrencies. One of the current problems is that the Chinese government does not know the number of domestic funds being transferred overseas.

Other countries are following Beijing’s example in cracking down on cryptocurrency, such as South Korea that also banned ICOs last September.  However, the country partially reversed the ban in December to allow institutional investors to participate in cryptocurrency fundraising. China is more and more isolated on the cryptocurrency market even is its ban does not appear to be having a major impact on the overall market. Bitcoin minors delocalized and are now heading to Russia where the government appears to be embracing this. The Chairman of State Duma’s financial markets committee, Anatoly Aksakov said that Russia should “give people the opportunity to work legally with it, to protect them as much as possible”.

Blockchain may be the solution

Blockchain technology can have wide applications in supply-chain management. Indeed, “counterfeiting is a serious problem in China, it endangers consumer safety and erodes trademark owners’” profitability,” said the Managing Director of Shanghai-based intellectual property consultancy O2O Brand Protection, Dean Arnold. This technology could reduce counterfeiting thanks to the creation of a secure and auditable record of a product’s journey in the supply chain. Many Chinese companies decided to use blockchain to safeguard a supply chain. For example, JD.com is using it to safeguard its meat supply chain and allow customers to check how the meat was raised, butchered, and transported.

Will China take advantage of cryptocurrency with its own sovereign digital currency?

China decided to maintain a strong grip on the financial system, but the government also wants to take advantage of the benefits of a digital currency by creating its own sovereign digital currency. The PBOC’s digital currency research chief, Yao Qian, recommenced the government to create its sovereign digital currency in order to use it as cash and in digital wallets. Sovereign digital currency and bitcoin are different because a sovereign digital currency must have the backing of a central bank while a cryptocurrency like bitcoin is decentralized.

The Director of Asia Business Development for New York-based blockchain firm R3, Carl Weger, said: “A central bank digital currency provides an opportunity for a national government to build an ecosystem of banks that understands the potential of blockchain technology. It also allows the government to give input into the standards that are being considered for cross-border central bank digital currency transactions, which will begin this year.” China is one of the largest economies experimenting with digital currency and the country may soon join North Korea, Iran, and Venezuela thinking about create their own cryptocurrencies in order to evade international financial sanctions. However, Beijing has to manage the risk of the digital currency being hacked because current defenses against digital-currency hacking are not sufficiently robust.

Japan is leading the world’s cryptocurrency transactions, the country event accounts for more than 56 percent of bitcoin transactions. Japan is leading the sector in terms of adopting regulations for cryptocurrencies. Isaac Mao, a Chinese entrepreneur, and blogger answered: “It remains to be seen if Beijing someday will regret the crackdown for having undermined the potential to lead the world in this sector.”

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