China's cryptocurrency clampdown: what next for digital-first businesses?

We take a look at the Chinese governmental move on cryptocurrencies

China appears to be getting tough on cryptocurrencies – really tough. Reports suggest regulators have decided on a “comprehensive ban” which includes shuttering commercial exchanges and prohibiting any buying or selling of digital currency, as well as access to foreign exchanges. It’s been a long-time coming but is not a total surprise, given Beijing’s willingness to step in when it sees a threat to financial and social stability.

The question is, what does this mean for the future prospects of cryptocurrency and the businesses which use or have built products around it?


Taking a tumble

The cryptocurrency market cap fell by a staggering $60 billion to around US$109 billion in the first two weeks of September – a drop of around 40% following the news from China. That’s sent alarm bells ringing among investors and some tech firms heavily reliant on such platforms.

The move initially seemed focused on closing individual Bitcoin exchanges, and on banning Initial Coin Offerings (ICOs), a funding mechanism for crypto-currency startups. However, that has morphed – in a typically opaque Chinese way – into an outright ban on all activity, aside from international-facing exchanges in the country and cryptocurrency mining, which brings in significant sums of foreign exchange income into the Middle Kingdom.

Major players like BTCC, ViaBTC, Yunbi, OKCoin and Huobi have all closed their doors, leaving Japan as the biggest global market for digital currency.

So, what happens next?


Maintaining order

The good news is that those investing in ICOs have by and large got their money back – about 90% as of 22 September, according to Xinhua. The ban also doesn’t affect Hong Kong, offering an alternative for many.

The question is whether the ban will become permanent. To answer that, we must first know why it was issued in the first place. Most analysts agree that Beijing issued the edict for a couple of main reasons.

“This highlights the concerns from Chinese regulators that virtual currency would disrupt the financial system and money supply in China, as investors are heavily investing in Bitcoin and betting against the Chinese yuan,” IHS Markit senior research analyst, Ruomeng Wang, told me.

The Communist Party has always had one primary impulse; to stay in power. That means minimising the chances of its authority being questioned, which requires then maintenance of social stability. Digital currency represents a huge potential challenge to that stability. With a major stock market crash of summer 2015 still fresh in the memory, Beijing wanted to avoid the potential for another bubble bursting, whilst continuing a general tightening of capital flight and clamp down on fraud and Ponzi schemes – especially ahead of the 19th Communist Party National Congress (NPC) in October.

This twice-a-decade meeting is hugely symbolic in presenting a change of leadership at the upper echelons of the Party. VPNs are banned during the week-long event, and traffic grinds to a standstill in Beijing. This is more than likely to have influenced the timing of the ban.


The path to regulation

IDC APAC analyst, Simon Piff, told me it may also be viewed as coming “in preparation for a more formal approach to cryptocurrency by the Chinese government which may (or may not) be decided after the upcoming Congress”. In fact, the analyst house doesn’t believe the ban will be permanent.

“This is simply putting the brakes on an area that is running and changing very quickly, and one which we believe the government has plans to leverage in its own unique style in the future. I would expect to have a clearer picture once the National Congress begins, or shortly afterwards,” he concluded.

“Also remember Bitcoin is only one part of where the whole blockchain and distributed ledger technology is going, and we think that whilst crypto-currency is grabbing headlines, there are some huge impacts in the underlying technology that will emerge over time.”

Tama Churchouse, of financial analysts Stansberry Churchouse, believes the next couple of months will see one of two outcomes:

“1) The exchanges will all announce their closure, mining will continue unaffected, and then later in the year (after the NPC), select exchanges will be issued licenses to operate regulated cryptocurrency exchanges. Regulators will put together a framework to ensure they have full transparency and oversight of which individuals are trading, how much they can trade, and which cryptocurrencies they are allowed to trade.

2) All exchanges will close, permanently, and the government will look to open its own centralised national cryptocurrency exchange, likely early next year. (I think this is a much lower probability event).”

So, we will most likely see the Chinese government revisit the ban after the NPC, potentially looking to allow only highly regulated entities onto the market – a similar situation to that US and Japanese regulators are working towards. In the meantime, according to Westminster Business School lecturer David Coker, “capital always finds a way”.

“Anyone in China with a valid public key – a large numerical value that is used to encrypt data and is generated by a software program or provided by a designated authority – can still receive and sell Bitcoin. Keys are freely available for the asking. The Great Firewall of China won’t be able to block Bitcoin traffic originating on Blockchain's decentralised network,” he explained in an email.

“Second, it is well known foreign travel by Chinese citizens has surged in response to the crackdowns on capital flight. Any Chinese citizen traveling to the United States or Western Europe can easily purchase Bitcoin at any one of several thousand public ATMs selling the cryptocurrency.”

In fact, reports are already emerging that the crypto-currency market is recovering as Chinese money flows to other areas.

What the market looks like in a few months’ time, of course, will depend a great deal on the plans currently being formulated by the Chinese government.