04 Oct 2017
On Monday 4th September at 3pm Beijing time, China’s central bank announced an immediate ban on initial coin offerings (ICOs). The fundraising practice had, according to the bank, “seriously disrupted the economic and financial order.” Businesses that had conducted ICOs were ordered to return the money they had raised, and a list was prepared of 60 exchanges that would be subject to individual inspection.
Ten days later, Chinese cryptocurrency exchanges were ordered to stop trading. No official timeframe was set—at least not publicly—but OkCoin and Huobi, two of the largest exchanges, have announced that they will cease renminbi denominated trading at the end of October. BTCChina, another major exchange, has set the even earlier date of September 30th—likely because it was involved in ICOs as well as currency trading. Over the counter (peer-to-peer) trading is currently still legal but faces an uncertain future, as does cryptocurrency mining in China. There are rumours that both may imminently be banned.
These abrupt changes in regulation followed a halt on withdrawals in January by several of the largest Chinese cryptocurrency exchanges, after the country’s central bank warned them of the need to enforce anti-money laundering and capital flight restrictions.
What is an ICO?
ICOs can take a few forms, but they are essentially a method of fundraising for a venture by issuing the coins of a new cryptocurrency rather than stock. Unlike IPOs and venture capital investment, they are more or less unregulated. Buyers do not get a stake in or control over the venture, although ‘token’ ICOs may include some form of royalties or rights of ownership. On the whole buyers are paying for the right to participate in a new economy, speculating that if the venture is successful their coins will rocket in value.
Unsurprisingly scammers have been quick to see the opportunity in this combination of investor hype and nonexistent regulation. A significant proportion—estimates range from 10% (Ethereum Scam Database) to 99% (Chamath Palihapitiya)—of ICOs are scams.
China is not the only place where ICOs are controversial. The US uses the Howey Test, which dates to the 1940s, to establish whether or not a transaction counts as an “investment contract”. If a transaction passes the test it is subject to SEC regulation, just as a traditional IPO would be. Commentators have been observing for a while that most ICOs pass Howey with flying colours, and as of July this year, the SEC has indicated that it is looking into the matter. In all likelihood China’s kneejerk crackdown will be followed by increasingly restrictive regulation, if not outright prohibition, of ICOs in the US.
Blatantly fraudulent ICOs aside, China has plenty of reasons to worry about cryptocurrencies. Former Bank of China president Li Lihui, as quoted by Reuters, described bitcoin, ethereum and others as “tokens” that “are stateless, do not have sovereign endorsement, a qualified issuing body or a country’s trust … and should not be spoken of as digital currencies”. Because blockchain based transactions are secure without the backing of a national legal system, transacting parties can remain anonymous. As such, as Li emphasised, they are an appealing tool for “illegal fund flows and investment deals.”
There’s no doubt that cryptocurrencies are indeed a useful tool for money laundering. But the predicate crime the Chinese government is most concerned about is probably not fraud or drug trafficking, but the circumvention of China’s tight capital controls. In practice it is actually unlikely that bitcoin and similar currencies are ever used to transfer large sums out of the country. But the government is unnerved by anything that could limit its ability to manage the value of its currency. Over the course of 2016, a surge in the renminbi cost of bitcoin correlated with a fall in the value of the renminbi against the US dollar. This may only reflect Chinese investors searching for a haven for their assets as the value of their currency plummeted. But it could also suggest a deflationary pressure on the price of the renminbi resulting from widespread renminbi to bitcoin transfers.
Another revealing aspect of Li’s comment is his emphasis on the statelessness of cryptocurrencies. In the second half of 2016, renminbi transactions accounted for 98 per cent of global bitcoin trading volume, and bitcoin was accepted as a payment method in a growing number of shops and restaurants in China. This rapid rise of a means of payment over which the government could exercise almost no control was clearly a cause for concern. As David Daokui Li, a leading professor of economics at Tsinghua University (the alma mater of China’s last two premiers) observed in a recent lecture: “the Chinese government is worried about bitcoin replacing the renminbi.”
China is not, in general, opposed to digital payments. Even small roadside kiosks in Beijing now accept WeChat Wallet, an electronic payment tool linked to the country’s ubiquitous homegrown social media platform. But WeChat wallets must be backed by a Chinese bank account, and transfers use traditional centralised server technology (in which money from User A goes to a central database, and from there to User B), rather than the distributed ledger technology (“DLT”) that underpins cryptocurrencies. Far from granting anonymity, WeChat payments allow the government even greater scrutiny of users’ whereabouts and financial affairs.
Crypto comes of age?
A couple of weeks ago, Beijing’s dim view on cryptocurrencies was echoed in a starkly different setting. In a speech mid-September, JPMorgan CEO Jamie Dimon described bitcoin as a “fraud” that would blow up more catastrophically than the infamous Dutch tulip mania of the 17th century. He said that any JPMorgan trader speculating in bitcoin would be fired on the spot—because “it’s against our rules and they are stupid.”
The Beijing ban and Dimon’s comments come at a time when august financial institutions around the world appear to be starting to take cryptocurrencies seriously. In a section of its Quarterly Review titled “Central bank cryptocurrencies“, the Bank of International Settlements (“BIS”) notes the meteoric rise of bitcoin’s brand recognition (from “an obscure curiosity to a household name” in “less than a decade”). It highlights the experiments run by several central banks with the distributed ledger technology on which bitcoin, and all other cryptocurrencies, are based.
The irony of this is surely lost on no one. DLT is remarkable because it facilitates free and fair transfers of property without the intrusion of a trusted central authority. Theoretically, cryptocurrencies pose an existential (and deliberate) threat to central banks. But only theoretically—ultimately it’s easier to believe in a piece of paper backed by the might of millions of US military personnel than an intangible token backed by not much.
The title ‘central bank cryptocurrencies’ will surely irk the committed libertarians who were bitcoin’s first and most evangelical users. But as the BIS Review observes:
what might [central bank cryptocurrencies (“CBCCs”)] offer that alternative forms of central bank money cannot? … If anonymity is not seen as important, then most of the alleged benefits of retail CBCCs can be achieved by giving the public access to accounts at the central bank.
The technology on which cryptocurrencies are based has the potential to be more efficient, reliable and secure than traditional systems, and may be valuable to central banks in numerous ways. But if anonymity is not something a central bank wishes to grant its public—and in China, it certainly is not—it’s hard to see what state backed cryptocurrencies could possibly have to offer.
Amos Wittenberg is a former editor of KYC360. He is currently living and studying in Beijing.
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