Chinese holdouts are testing the limits of Xi’s crackdown

(Bloomberg) — This summer, word began spreading on Chinese social media about a conference in Dali, a town nestled between 4,000-meter (13,100-foot) peaks in southwestern China. country.

Organizers expected less than 200 attendees, but ended up selling the 1,000-person venue only to see more than double that number finally show up for the August event. The topic of the rally: crypto, the sector the Chinese government declared largely illegal a year ago.

Prior to the crackdown, China was emerging as the epicenter of the crypto world, spawning giant exchanges like Binance Holdings Ltd. and top Bitcoin mining companies. Beijing’s decision to ban cryptocurrency trading and mining, announced in September 2021, seemed poised to stifle the entire domestic industry.

That’s not exactly how things happened. Instead, what has emerged is a mix of companies that conform to the Communist Party’s agenda promoting state-sanctioned blockchains and the digital yuan; some rogue bitcoin miners; and crypto entrepreneurs trying to grow their fledgling businesses without crossing any perceived red lines.

How China eventually deals with the remnants of the crypto sector will have big ramifications, as digital assets ranging from Bitcoin to non-fungible tokens are at the heart of what proponents like venture capitalist Marc Andreessen call web3, or the next iteration of today’s Internet.

Read more: Inside “Web3,” Crypto’s Plan to Revamp the Internet: QuickTake

China has “three red lines: crypto trading, OTC trading, and mining,” said Jason Kam, founder of Folius Ventures, an investment fund focused on Asian crypto startups. “Basically, the Chinese government will curb speculation and capital outflows, but for the rest of web3, like developers writing code, the government has a ‘one eye open, one eye closed’ approach.”

Find your way

China’s decision in the 1990s to erect the Great Firewall gave the CCP unprecedented power to restrict the free flow of information online and paved the way for an Internet industry whose Western companies like Google and Alphabet Inc.’s Twitter Inc. are largely excluded. . The fear of many remaining crypto entrepreneurs in China is that the government will take a similar approach to Web3, stifling innovation and keeping internet users isolated from the rest of the world.

Interviews with more than a dozen China-based industry participants, ranging from founders to programmers and operations specialists, paint a picture of an industry trying to find its way by experimenting with new products and services in the world. hope that regulators will not crack down. They all asked not to be identified for fear of government scrutiny.

Chainalysis Inc. researchers tracking global crypto adoption earlier this year noticed a startling phenomenon: China was actually gaining ground on other countries, so much so that it ranked 10th in Chainalysis’ latest Global Crypto Adoption Index, up from 13th in 2021. “Our data suggests the ban was either ineffective or loosely enforced,” they wrote.

Read more: The $8.6 billion startup helping governments trace crypto

“There are informal crypto markets operating in a kind of legal gray area,” said Kim Grauer, research director at Chainalysis. “We spoke with merchants who are in sub-Saharan Africa and Latin America who buy goods from China, using cryptocurrency in this informal market capacity. We can see that people in China still visit major centralized exchanges.

Home to ‘HBO’

For part of the industry’s brief history, China was a crypto powerhouse. As recently as 2017, it was home to the world’s three largest cryptocurrency exchanges – Huobi, Binance, and OKX, collectively known as HBO. At its peak, the country was estimated to have around three-quarters of the world’s Bitcoin mining capacity. Cheap labor and sophisticated supply chains have given mining rig giants Bitmain Technologies Ltd. and Canaan Inc. a step ahead of their Western rivals.

Such was China’s gravitational pull that crypto entrepreneurs ranging from Ethereum co-founder Vitalik Buterin to FTX’s Sam Bankman-Fried traveled there to seek funding for their fledgling ventures.

“China has always been one of the hot spots to stop for any project that wanted to grow and strive for adoption,” said Edith Yeung, general partner at Race Capital, an early investor. from FTX.

But China also has a difficult relationship with rampant speculation, with inevitable bankruptcies seen as a potential threat to the CCP’s grip on power. And few asset classes are as susceptible to speculative mania as cryptocurrencies. Officials were also concerned about money laundering and hard-to-track currency outflows.

In September 2017, the central bank and other regulators banned exchanges from facilitating exchanges between fiat currency and crypto and banned initial coin offerings, where issuers raise funds by selling new tokens. Authorities have also begun to discourage energy-consuming bitcoin mining as President Xi Jinping seeks to improve China’s environmental credentials.

The final judgment came in 2021. In May of that year, a regulator headed by Vice Premier Liu He called for a large-scale crackdown on crypto mining and trading. Then, on September 24, authorities banned all cryptocurrency transactions and pledged to eliminate mining altogether.

“Crypto transactions and crypto services of any kind are prohibited in China. No room for discussion. No gray area,” Henri Arslanian, then a crypto leader and partner at PwC, tweeted.

By then, Binance had already moved its operations elsewhere. Two months later, Huobi would announce its intention to move to Singapore and pledge to sever ties with all China-based users (co-founder Leon Li recently sold his majority stake). A large number of small crypto outfits also decamped.

But even amid the carnage, the widespread enthusiasm for digital assets remained.

Dali Crypto Conference

As current and former entrepreneurs, students and employees of major Chinese tech firms descended on Dali in August for the crypto conference, Covid restrictions made a central location impractical. Participants therefore joined impromptu panels in bars and restaurants scattered around the city for three days.

Local officials were keen to host a conference on topics such as the Metaverse, said one of the organizers, who asked to be identified only by his first name Kai due to the sensitivity of the topic. Even so, organizers were careful to toe the line, avoiding soliciting sponsorships from crypto miners and centralized exchanges, Kai said.

At this conference, much like at a much smaller gathering in Beijing in September, discussions tended to focus on Web3, envisioned as a more decentralized version of today’s internet built around blockchains. – the digital ledgers underlying much of cryptography. And more specifically: which web3 domains can be safely prosecuted, given China’s restrictions?

Web3, as portrayed by the protagonists, involves things the CCP approves (blockchains) and disapproves of (cryptocurrencies like Bitcoin and Ether). It also includes NFTs, digital property certificates that the Chinese government has adopted, at least partially.

How China is embracing NFTs, with strings attached: QuickTake

The ambiguity towards NFTs – for example, it is fine to create and sell them, but trading them on secondary markets and using cryptocurrencies for settlement is prohibited – is partly what drove Frank Chen , 26, to leave his position as chief product officer at Tencent Holdings Ltd. and found a project called Strxngers.

In August, Strxngers released its first batch of NFTs resembling pixelated ’80s-style computer game avatars. They sold out in seconds, according to Chen.

“I chose NFT as an area to experiment with in China because I don’t think the country is completely against it,” Chen said. “Before any regulations on digital collectibles are released, there is currently a gray area that allows people to experiment.”

There are signs, however, that even NFTs are making authorities uncomfortable. In April, China’s Internet Banking, Securities and Finance Associations warned of the financial risks associated with these assets and banned industry members from providing or trading platforms to them. finance.

Even in areas that the government has unambiguously declared illegal, enforcement has sometimes proven difficult. The most recent data from the Cambridge Center for Alternative Finance shows that miners in China still accounted for 21% of global mining capacity in January, months after the ban. Cambridge said in May that the resurgence indicated “significant underground mining activity” in China.

The Chinese government has not yet adopted a global official position on the web3. But at a conference in Shanghai in early September, Zhang Ping, a member of the Chinese Academy of Engineering, said that as currently envisaged, web3 poses a threat to China’s strategic interests.

Instead, Zhang proposed a “permission-based” version of Web3 tailored to the country’s own needs, with yuan-pegged stablecoins issued by commercial banks.

If anyone could be considered the face of the CCP’s favorite Web3 version, it might be He Yifan, the managing director of Beijing-based Red Date Technology. The company operates a kind of hub allowing developers to build apps for everything from NFT transactions to tracking drug delivery, all running on state-supervised permission-based blockchains.

Unlike a traditional blockchain like Ethereum, transaction fees are denominated in fiat currency and set at 0.05 yuan per transaction. According to He, daily transactions on Red Date’s blockchain-based service network have reached over one million, which is comparable to volumes on Ethereum.

“Crypto is about commerce and applications, and we’re all about technology infrastructure,” he said. “Two totally different worlds.”

With the government seemingly poised to favor the latter of these worlds, the mood at Dali’s conference was mixed: optimism about the business opportunities web3 presents for Chinese developers and pessimism about China’s place in the latter, said said Kai, the organizer.

“China doesn’t know how the future of the internet will be structured,” said Yeung of Race Capital.

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