Why has China cracked down on token exchanges and ICOs so suddenly?

I am heroic and still in charge!

China has been on an anti-cryptocurrency tirade these past few months. In January the government required the nation’s Bitcoin exchanges halt withdrawals of Bitcoin and Litecoin until the exchanges passed inspections. Then last month the government made it clear that ICOs would be banned, supposedly for the protection of investors. Soon after that, the word came down from on high that all the exchanges had to shutter China-facing operations by the end of the month.

Now there are even rumors that OTC exchanges, like localbitcoins.com, will be blocked. Bitkan has already halted its P2P exchange. Additionally, a document published on Sina Weibo suggests that the Great Firewall of China will be programmed to block access not just to localbitcoins.com, but several other international exchanges, including Coinbase and Bitfinex. Mining operations might even have their access to international nodes blocked, effectively killing their businesses, and removing 51% of the world’s hashing power from the Bitcoin and Litecoin systems.

So, what the hell is going on?

It’s all about timing, politics and the Chinese economy.

The 19th National Party Congress (NPC) meets next month in Beijing. This body meets every five years to discuss, and rubber stamp, policies proposed by the Politburo — the top leaders of the Communist Party of China (CPC), which include President Xi JinPing.

More importantly, the congress elects the president of China, and nominates (in a sense) his successor. At the last party congress in 2012, Xi was “elected” to a five-year term. Typically, Chinese presidents serve two consecutive terms, contingent on the approval of the party congress. So, all of this sturm-und-drang about Bitcoin and ICOs may just be political theater — bread and circuses — to show the congress who’s the boss.

President Xi JinPing (right) greets soldiers at the 90th anniversary of the PLA
There have been rumors that Xi may attempt to nominate his own successor, to retain his influence on the CPC, rather than accede to recommendations by the other members of the Politburo and the NPC. Such an attempt would break with decades of tradition and policy, so Xi may be trying to convince (or coerce) the congress to go along with his nominee.

Critics of Xi within China have accused him of promoting a “cult of personality,” to become in effect a second Chairman Mao. For the 90th anniversary celebration of the People’s Liberation Army earlier this summer, Xi chose to wear military camouflage instead of the usual business suit and tie of previous presidents, probably to emphasize his additional role as commander-in-chief of the armed forces.

Since Xi took power in 2012, he has gone after corruption within the party in a big way, though mostly against those who do not openly support him. Dissenters have been imprisoned more often, or at least more openly than before. The nation’s social media platforms have also been more censored and more closely regulated than before. Everyone is now required to provide their real name and identification number upon registration, for example.

But Xi’s political maneuvering is all speculation. The Chinese political system is opaque to outsiders, no matter if you’re Chinese or an expat living in China. Actions by the CPC may come suddenly, without warning or explanation. Or they may be hinted at, by letting the nation’s tightly controlled media “leak” upcoming policies in advance of any official action. Nor are victims of government policy changes allowed to comment publicly on those actions. The exchanges may say they are voluntarily shutting down yuan trading, but more than likely they were told to do so, or face dire consequences.

Note the third quarter downtrends here

Besides political maneuvering, economics is another possible explanation for the sudden crackdown on exchanges, ICOs and digital assets in general. China’s economy is on a precarious footing, and party leaders may see cryptocurrencies as a threat to economic stability. They worry about capital flight a lot — cryptocurrencies certainly offer a convenient means to move one’s Chinese yuan offshore — and about “alternative investments” that siphon funds away from more traditional vehicles, like savings accounts.

Cryptocurrencies are seen as a threat to the established order, as can be seen in this translated excerpt from a Chinese financial blog, which was tweeted today by Joseph Young.

One observer has suggested that the government plans to devalue the yuan next month, and that the War on Bitcoin may be intended to forestall capital flight.

Till now, Chinese regulators have tolerated Bitcoin and other cryptos as commodities that can be traded for Chinese yuan. They are not recognized as legal tender currencies, so you cannot spend Bitcoin at a restaurant in China, though it’s perfectly fine to use the homegrown mobile payment apps offered by WeChat (part of Tencent) and Alipay (part of Alibaba).

The first time China interfered with Bitcoin was in early December 2013, right about the time Bitcoin values — largely driven by Chinese trading — surged above $1,300. The People’s Bank of China (PBOC), the central reserve bank, declared that Bitcoin was not a currency, and prohibited banks from dealing directly with Bitcoin trading and Bitcoin exchanges. Bitcoin markets dropped precipitously, as traders in China (myself included) suddenly lost easy access to Bitcoin.

After a few months, things were more or less back to normal, as the exchanges worked out funding arrangements amenable to the authorities. Bitcoin prices once again rose, and by January this year were topping the $1,000 mark.

Then the government stepped in once again, requiring the exchanges to block withdrawals of Bitcoin and Litecoin (but not Ethereum or other tokens) while the regulators examined the exchanges’ compliance with Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements. By June the larger exchanges were back to business as usual, though they now required customers to provide identification and to pin one specific bank account to their exchange account. Smaller exchanges just closed up shop.

The ICO craze was the next big target, as hundreds of projects — some legitimate and many not — appeared out of nowhere, offering fast profits to would-be investors. Those were shut down earlier this month. ICOs which were still in progress or which had recently closed were required to refund their investors’ contributions. Project developers are still scrambling to comply with the refund requirement.

The markets fell again, recovered slightly, then came more bad news. Like dominoes, one exchange after another announced it was either closing for good, or closing its China-facing operations by Sept. 20. Customers were required to withdraw all their fiat and crypto holdings. For all intents and purposes, trading within China will soon grind to a halt.

Major Chinese actions seem to follow peaks in values

Note the pattern. Bitcoin peaks in value. Government passes some new regulation. Prices fall, then recover as regulations ease. Lather, rinse, repeat as necessary.

Will the restrictions ease after the close of the National Party Congress? It’s hard to say, but given my experience as a Chinese resident of nine years, I’d say the government will probably permit crypto trading and ICOs to resume, but under heavy regulation. Given China’s mining power, which attracts millions of dollars into its economy, the government would be foolish to abandon Bitcoin and other crypto currencies completely. I’m not the only one who thinks so. Writing for Medium, Jon Creasy reminds us that Xi likes free markets, and once he is re-elected Oct. 18, we’ll probably be back to business as usual soon afterward.

We’ll see if past performance indicates future returns.

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