Regulation Of Cryptocurrency In China – Technology – China – Mondaq News Alerts

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Cryptocurrency-related activities have received little tolerancefrom the Chinese government. Initial coin offerings (ICO) werebanned in China in September 2017. Exchange platforms that tradedcryptocurrencies or provided facilitation services were alsoordered to be closed following the crackdown on ICO. Many exchangeschose to relocate to jurisdictions that are more favorable tocryptocurrencies than China. However, due to the long-armjurisdiction of the Chinese criminal laws, organizers and promotersof overseas ICO and exchanges may not be free from the jurisdictionof Chinese criminal laws, if those persons are Chinese citizens orif Chinese investors invested in overseas ICO or tradedcryptocurrencies on overseas exchanges.

Interestingly, it is not illegal to hold Bitcoins and othercryptocurrencies or even to buy or sell them in China. The Chinesegovernment also encourages the development and application ofblockchain technology, but made it clear that blockchain technologymust service the real economy.

1. ICO

China's Policy:

On September 4, 2017, seven government agencies of China, i.e.the People's Bank of China ("PBOC"), the CentralCybersecurity and Information Technology Lead Group of CommunistParty of China, the Ministry of Industry and InformationTechnology, the State Administration for Industry and Commerce,China Banking Regulatory Commission, China Security RegulatoryCommission and China Insurance Regulatory Commission, jointlyissued the "Notice regarding Prevention of Risks of TokenOffering and Financing" (the "Notice"). The Noticebanned all ICO in China and ordered that any organizations orindividuals who had previously completed ICO to make arrangementssuch as return of token assets to investors to protect investorrights.

Background:

To understand the harsh attitude of the Chinese governmenttowards ICO, we have to look at the big picture of China'seconomy and financial market. In the past 20 plus years, China hasenjoyed high speed economic development, which, many believe, cameat the cost of high leverage in the financial system andaccumulation of financial risks. In the past two years, control offinancial risks and stabilization of the financial system hasbecome the top priority of PBOC. Before ICO, internet platformsproviding P2P loans and micro lending had been targeted by PBOC andother financial regulators and are still in the process ofcleansing and rectification. It is no surprise that ICO, due to thesheer increase both in numbers and in the amount of funds raised,as well as some socially chaotic events caused by ICO, received thedeath sentence from PBOC.

Nature of ICO in the Eyes of PBOC:

In the Notice, ICO was described as a process by whichfundraisers distribute digital tokens to investors who makefinancial contributions in the form of cryptocurrencies such asBitcoin and Eethereum. The Notice further pointed out: "Bynature, it is an unauthorized and illegal public financingactivity, which involves financial crimes such as illegaldistribution of financial tokens, illegal issuance of securitiesand illegal fundraising, financial fraud and pyramidscheme."

Among the crimes mentioned in the Notice, "illegalfundraising", which generally means raising funds withoutgovernment approval, is a crime that has been widely used incracking down on undesirable financial activities as the scope ofthe crime can be interpreted very broadly.

Overseas ICO:

It should be noted that even ICO outside of China are notcompletely safe if they attracted Chinese investors. According toArticle 6 of the PRC Criminal Law, if any of the criminalactivities or results of such activities occurred in China, thecrime is deemed to have occurred in the territory of China. If theICO involved financial crimes based on Chinese criminal lawstandards, the promotors or organizers of those ICO may potentiallybe subject to Chinese criminal liabilities if they are Chinesecitizens. Even if they are not Chinese citizens, if overseas ICOattracted Chinese investors, they may still potentially be subjectto Chinese criminal liabilities.

Initial Miner Offerings (IMO):

After ICO was banned by the Chinese government in September2017, a new business model quickly became popular, which was called"Initial Miner Offerings" (IMOs). In contrast to ICO, theorganizers sell mining equipment to investors initially, and theinvestors are awarded with tokens or points for their miningactivities using the equipment. On January 12, 2018, the NationalInternet Finance Association of China ("NIFA")[1] issuedthe "Risk Alert concerning Prevention of Disguised ICOActivities", in which NIFA pointed out that an IMO involvesfundraising activities and is a disguised form of ICO. Followingthe NIFA alert, the IMO market in China also went down.

2.Exchanges

China's Policy:

The Notice also targeted cryptocurrency exchanges and orderedthat any so-called "fundraising and trading platforms"shall not:

- Offer exchange services between fiat currency, tokens and"virtual currencies";

- Buy or sell tokens or "virtual currencies", or buyor sell "virtual currencies" as a central counterparties(CCP); or

- Provide price determination or information intermediaryservices for tokens or "virtual currencies".

Adjustments of Market Players:

In the several months after the Notice, most of thecryptocurrency exchanges closed down their platforms in China butcontinued exchange business through platforms registered in foreignjurisdictions such as Japan, Hong Kong, Korea or otherjurisdictions which seemed to be more favorable to the exchangebusiness than China.

They also made adjustments to their business models. To avoiddirect confrontation with Chinese monetary authorities, someexchanges no longer provided exchange services between fiatcurrency and cryptocurrencies. Some chose to introduce a new token(such as USDT, QC, etc.) to their platforms which has valueequivalent to the value of fiat currency, as an intermediarybetween fiat currency and cryptocurrency. Investors may use fiatcurrency to buy this new token and then use this new token to buycryptocurrency.

Further, many exchanges launched peer-to-peer trading platformsthat support direct transactions between investors without theexchange acting as a CCP. On those platforms, one investor can buycryptocurrencies from another investor and pay the seller via banktransfers, Alipay or Wechat pay[1].

Legality of Adjusted BusinessModels:

Those modified business models are not entirely safe from theChinese criminal law perspective. Although major exchanges havebeen relocated overseas, they may still be subject to Chinesecriminal liabilities due to the long-arm jurisdiction of theChinese criminal laws. If the founders or managers of an exchangeare Chinese nationals, or they make decisions in China to operatethe overseas exchange, or the investors are in China, if theexchange performs prohibited functions, Chinese justice authoritieswould still have jurisdiction over those persons.

Access to Overseas Exchanges:

To further prevent Chinese investors from purchasing and tradingcryptocurrencies on overseas exchanges, China has blocked internetaccess to the websites of some overseas exchanges from China.According to Chinese laws, no person should use the internet toview information that violates Chinese laws and regulations. Thosewho access overseas exchanges via virtual private networks(VPN's) may potentially face risks if the exchanges containprohibited information. In January 2017, the Ministry of Industryand Information Technology ruled that only authorized VPN'scould be used in China. The sale or provision of VPN services bycompanies or individuals without telecom licenses issued by Chinesetelecom authorities became illegal.

3. Mining Activities

It was reported that on January 2, 2018, the Working TeamLeading Risk Control and Rectification concerning Internet Finance,a special task force established under the State Council, issuednotices to local governments requesting them to take measures to"guide" Bitcoin mining operators to exit from theirrespective regions. Since then, major miners reportedly decreasedor ceased their operations in China, once the largest mining basein the world, and moved to more favorable countries, similar to themove of the cryptocurrency exchanges.

4. Legality of Holding and TradingCryptocurrencies

In view of China's harsh attitude towards ICO,cryptocurrency exchanges and mining activities, some may assumethat it would be illegal for Chinese to hold or trade Bitcoins orother cryptocurrencies. This is not correct. No PRC law orregulation prohibits Chinese investors from holdingcryptocurrencies or trading cryptocurrencies . This seems to beconsistent with an early notice jointly issued by five Chinesegovernment agencies led by PBOC back in 2013, which defined Bitcoinas a special virtual commodity, but not a currency. That noticealso explicitly provides that Bitcoin does not have legal status asa currency and should not be circulated and used in the market as acurrency. This should still be the position taken by PBOC as oftoday.

Article 127 of the General Rules of the Civil Law of China,which took effect on October 1, 2017, provides that: "In caselaws have provisions on the protection of data and internet virtualproperties, such laws should be complied with." Some Expertsbelieve that this means that one of the basic laws in Chinarecognizes the legal status of cryptocurrencies as virtualproperty.

5. Transfer of Payments Using BlockchainTechnology

Senior officials of PBOC have publicly encouraged the use ofblockchain technology to improve the convenience, promptness andlow cost of retail payments. In fact, PBOC established its ownDigital Currency Research Institute for the goal of issuing digitalmoney. It should be noted, however, that China's digital moneywould still be fully controlled by the central government, incontrast to the nongovernmental nature of Bitcoin.

According to news reports, in December 2017, China MerchantsBank, Wing Lung Bank of Hong Kong and Wing Lung Bank, ShenzhenBranch have successfully completed cross-border transfers ofRenminbi[4] payments using blockchain technology. Many other bankshave reportedly made experiments and even progress on the use ofblockchain technology to improve their transaction systems.

6. The Future of Blockchain in China

Despite the ban on ICO and cryptocurrency exchanges, PBOC andother government agencies have consistently showed great enthusiasmtowards the application of blockchain technology for the goal ofmodernizing China's financial systems and becoming a worldleader in this new innovative technology. In recent years, variousguidelines and papers issued by the government have endorsedblockchain technology and even placed blockchain technology in thesame category of big data and artificial intelligence (AI). In thepast twelve months, many local governments sponsored the formationof sizable investment funds to make investment in startups ofblockchain technology and applications.

However, the endorsement of blockchain technology is not withoutreservation. In the view of PBOC, blockchain technology and digitalcurrency should be researched for the goal of better service to thereal economy. PBOC believes that blockchain technology can bedeveloped without the use of tokens, which are believed to havebeen the roots of various social problems such as illegalfundraising and fraud.

Footnotes

1. The current leaders of NIFA are former seniorofficials of PBOC, and alerts issued by NIFA often predict the nextmoves of PBOC.

2. Both of which are popular third party payment APPs inChina.

3. Given that cryptocurrency exchanges were banned inChina, cryptocurrencies may only be traded in a peer-to-peermanner.

4. Official currency of China.

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circumstances.

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Regulation Of Cryptocurrency In China - Technology - China - Mondaq News Alerts