How To Operate In China's Blockchain 'Sandbox' Despite Recent Crackdown

Recently we have been bombarded with a flurry of alarming news coming out of China regarding regulatory crackdowns on bitcoin and cryptocurrency markets. Beijing's state government sent directives to the provinces to shut down bitcoin mining operations, and the People's Bank of China (PBOC) warned its banks and payment firms not to provide crypto-related services.

Crypto markets were rattled. And many in the West interpreted the signals as the end of bitcoin and cryptocurrencies in the world's second largest economy. Yet this interpretation would be incorrect, and the signals would be difficult to understand without putting them into a local Chinese context.

Happy 100 anniversary!

July 1, 2021 is the 100th anniversary of the Chinese Communist Party. Anyone who lives in Beijing, like me, knows that in the weeks before major government milestone dates, everyone has to be on their best behavior. They should brace for the occasional "Hard Strike" (Yan Da) campaign. Although the term is specifically for enforcement of criminal activities, it is also sometimes used to describe crackdowns that are executed for only a finite period of time, to ensure all citizens comply carefully with law and policy.

The past several weeks have been the precursor to one of the most important anniversaries of modern Chinese history, and there are crackdowns in multiple sectors ranging from the $120 billion private-tutoring industry to antitrust scrutiny for local technology mammoths, not just bitcoin mining.

China is the largest regulatory blockchain sandbox

While in the United States, the nascent technology has been burdened by over-regulation that makes even the most seasoned lawyer cringe, China has taken a very practical and long-term view of this burgeoning technology. In October 2019, President Xi Jinping announced that China would be a global leader in blockchain technology, and the government has taken a top-down approach to the development of the industry. This includes launching the BSN – China's national blockchain that is also international in scope by linking with some of the top international blockchains, and rolling out its own digital currency.

Yet its long-term wisdom and priority placed on technological advancement have also allowed for crypto-related startups to flourish, grow organically and become some of the largest in the world. In some respects, one might say China is the largest regulatory blockchain sandbox in the world, where there are no specific sets of regulations, yet there are certain principles required to be able to play in the sandbox. This is in stark contrast to the United States, which so far has failed to signal blockchain as a national priority on the world stage.

Don't cross the red line

What has happened recently in China is that the cryptocurrency market has grown in capitalization and volume so dramatically, that a number of activities related to cryptocurrencies are now crossing the "RedLine." These are the walls of this sandbox. So long as you quietly play within those confines, innovation and adoption continue to forge ahead, unofficially. Yet crossing red lines, such as engaging in fraud, is not permissible and can (and does), attract swift enforcement actions.

The PBOC warning was just a reiteration of old news. The crackdown on over-the-counter trading has been continuing for the past 18 months, primarily for situations involving money laundering or facilitation of capital flight, or engagement in other illegal activities. These are clear red lines. The recent warnings have resulted in the crypto exchanges shutting down their OTC trading desks. Those that engaged in crossing red lines have been met with investigations and detentions, yet individual over-the-counter traders who are not a part of these large platforms and stay within the confines of these red lines have largely continued business as usual.

Mining energy consumption

Beijing has recently made energy a national priority. The directive and execution to shut down mining operations in China was swift, as the Sichuan government required all miners to shut down by June 25, 2021. Any debate whether this is related to China's global commitments toward clean energy can be resolved with the signals from this action, as just about all of Sichuan's power is hydro.

Bitcoin mining, and high-energy mining of other cryptocurrencies such as Ethereum, are no longer welcome in China. Their energy consumption now crosses the "red line" of national policy objectives for directing energy consumption to national priorities. Specific directives from the highest level of central planning in China issued early in June require curbing energy consumption for the entire nation, not just the relatively small consumption of bitcoin mining. Just as Yan Da is happening in multiple sectors, such as education and tech, the prohibition on bitcoin mining energy consumption is but one, small part, of the China energy consumption story.

What's next?

As the cryptocurrency markets grow in their impact both globally and domestically in China, we can expect more regulatory scrutiny, and an increasing number of blockchain and crypto-related activities that potentially cross the "red lines" of the central government's policies.

In the future, you can expect to see this come where domestic retail investors are exposed to the high-risk speculative price fluctuations that are pervasive in cryptocurrencies. For example, the high leverage many secondary market traders take is a sensitive, potentially "systemic" risk. Yet at the same time, the Chinese government is the most powerful advocate of blockchain technology on the planet today, and although there is no official advocacy of bitcoin and cryptocurrencies, any industry expert knows that tokens are an integral and inalienable pillar of the technology.

Once Beijing's leadership decrees that something is to be a national focus, the results are swift and the plans are generational. And its top-down approach to making blockchain a national priority has produced what might be equated to the largest regulatory sandbox in the world for the technology. One where there is substantial domestic blockchain innovation, as today there are more blockchain patents filed in China than any other market, and where adoption surpasses just about any other market. It is this environment of early adoption that resulted, for example, in China years ago becoming the home to the majority of bitcoin hash power globally. Just remember to respect the red lines.

The leadership of China gets it: Blockchain is one of the most strategically impactful technologies in the world today. And that's important for leadership that thinks generationally.

(Omer Ozden is the CEO of RockTree Capital, a merchant bank that focuses on blockchain projects and mobile internet companies)