What’s behind China’s cryptocurrency ban?
- In late September 2021, the People’s Bank of China (PBOC) banned all cryptocurrency transactions. The PBOC cited the role of cryptocurrencies in facilitating financial crime as well as posing a growing risk to China’s financial system owing to their highly speculative nature. However, one other possible reason behind the cryptocurrency ban is an attempt to combat capital flight from China.
- According to the Chainalysis Blockchain data platform, more than $50 billion worth of cryptocurrency left East Asian accounts to areas outside the region between 2019 and 2020. As China has an outsized presence in East Asian cryptocurrency exchanges, Chainalysis staff believe that much of this net outflow of cryptocurrency was actually capital flight from China. Although Chainalysis does not have a definitive figure for how much capital fled China between 2019 and 2020, they estimate that it could be as high as $50 billion.
- Capital controls and cryptocurrency exchanges
China places an annual limit of $50,000 for the purchase of foreign currencies as part of its already strict capital controls. As such, the capital flight facilitated by cryptocurrency is especially notable.
- Previously, the rich in China got around capital controls by purchasing foreign real estate, creative invoicing for international trade and even coercing their employees to transfer money to foreign bank accounts. With Bitcoin, residents in China have been able to acquire foreign assets more easily, free from the scrutiny of Chinese authorities. Given the decentralized nature of Bitcoin and many other blockchain-based cryptocurrencies, they can be used to circumvent capital controls far more easily than a conventional currency exchange that uses the banking system.
- Despite the strict capital controls in place, Chinese authorities have always been wary of capital flight. The effectiveness of these capital controls is somewhat debatable, as some commentators argue that capital flight grew significantly between 2009 and 2018. Meanwhile, in 2017, the PBOC banned the operations of cryptocurrency exchanges within China. (The 2017 ban did not go so far as to forbid the ownership or mining of cryptocurrency, which the 2021 ban finally prohibits.) Although China did not cite capital flight as a reason for its cryptocurrency restrictions in 2017, Chinese authorities did place additional restrictions on overseas investments by Chinese companies that same year. In some ways, the 2017 restrictions on cryptocurrency exchanges in China can be seen as the harbinger of the subsequent tightening of outward investment of Chinese companies that year.
- Chainalysis also notes that much of the capital flight out of East Asia is facilitated by the stablecoin, Tether (USDT), a cryptocurrency notionally pegged to the value of the US dollar (USD). Tether became more popular in 2017 following the PBOC’s restrictions on crypto exchanges in China. Trading Bitcoin for Tether was already made illegal by the PBOC’s 2017 prohibition on cryptocurrency exchanges, but it was still possible for Chinese cryptocurrency traders to acquire Tether from discreet trade with over-the-counter brokers or through the use of foreign bank accounts. According to former Grayscale Director of Research Philip Bonello, Tether is especially popular in China because its value is stable from being hypothetically pegged to the US Dollar, making it easier to exchange to the fiat currency of a user’s choice.
- Common prosperity and capital controls
- The threat of capital flight remains a priority for the PBOC as the Chinese economy recovers from the COVID-19 pandemic, especially as China launches its “common prosperity” campaign. Former PBOC advisor Li Daokui has warned that the relatively fast economic recovery of the US could fuel greater capital flight, as Chinese residents may be inclined to purchase assets in the US for greater financial security.
- Moreover, the common prosperity drive emphasizes a heavier statist approach to managing China’s economy, as well as a more inward-looking economic strategy. Notably, the outlawing of cryptocurrency transactions happened only a month after the announcement of the common prosperity programme. This cryptocurrency ban may have also been brought in to curtail outward investments and instead encourage the rich in China to accept higher income taxes and to contribute their wealth domestically.
Altogether, there is strong evidence to suggest that the cryptocurrency prohibition was a response to the perennial problem of capital flight from China. Given that a huge amount of capital flight already occurred through cryptocurrency exchanges, the PBOC will have been aware that cryptocurrency was exacerbating China’s chronic issue of capital flight.
With the common prosperity programme, China aims to curb capital flight and encourage the domestic circulation of people’s wealth. China’s attempts at wealth redistribution would be far more difficult to accomplish if the rich circumvented China’s already strict capital controls through offshore cryptocurrency exchanges and acquired overseas assets.
Nevertheless, in spite of the political imperative, such a strict ban on cryptocurrency transactions will be very difficult to enforce. Capital flight, enabled by cryptocurrency transactions, is likely to continue. Time will tell how seriously the eventual economic impact will be.
- The Announcement
- China’s central bank, on 24th September 2021, announced a ban on all crypto-currency payments & services.
- This action by the Chinese regulators “strictly prohibits” exchanging Cryptocurrency for legal tender, providing information or pricing services, & trading in Cryptocurrency. It also applies to overseas exchanges that provide services online within the country’s borders.
- Virtual currencies had disrupted the economic & financial order & bred money laundering, illegal fundraising & fraud, read the statement signed by multiple authorities.
- The signatories included the People’s Bank of China, the Cyberspace Administration of China & the Supreme People’s Court.
- The price of bitcoin, the world’s leading virtual currency, fell by as much as 9% after the announcement to below $41,000 before paring its losses.
- China has long been crypto-skeptical. In recent years it has been instituting increasingly restrictive laws on crypto currencies.
- In 2013, the nation made it illegal for corporations to provide Cryptocurrency related services and to run cryptocurrency exchanges in the country.
- In 2017, China banned initial coin offerings; the country’s central bank designated them as an illegal form of fundraising.
- The country’s National Development and Reform Commission also announced that it was cutting power off for cryptocurrency mining operations, which expend large amounts of electricity to solve complex mathematical puzzles for which they’re rewarded with units of digital currency.
- China has in the past been a popular site for mining due to low electricity costs in areas like Inner Mongolia, but the country is currently experiencing an energy crisis and trying to become carbon neutral by 2050, a goal that cryptocurrency is making harder to meet.
- The Chinese government’s move to rein in cryptocurrency also has to do with its desire to exert more control over economic activity in the country.
- Bitcoin and its brethren were designed as a tool for facilitating transactions without institutional authorities like banks or governments, so allowing them to flourish in any country takes some power away from state actors.
- China is now trying to supplant bitcoin by creating its digital currency known as eCNY, which will be backed by the government.
- However, eCNY has only superficial similarities to bitcoin and doesn’t use Blockchain, the ledger technology at the heart of all cryptocurrencies.