The End of the War or the Commencement of Battle?  

Cryptocurrency Regulation in China 

In September 2021, China’s central bank, its highest court and procuracy, as well as seven other national government departments and agencies jointly enacted a legally binding Notice on Further Preventing and Disposing of the Risks of Speculative Trading in Virtual Currencies (“Notice”), marking the culmination of China’s yearslong war against cryptocurrencies. The Notice, in effect, declares all cryptocurrency transactions illegal. In so doing, China became the first major economy to unreservedly embrace a blanket ban on cryptocurrencies.  

China’s Approach to Crypto Regulation  

Chinese law defines cryptocurrencies as currencies that “are issued by nonmonetary authorities, use encryption technologies and decentralized ledger or similar technologies, and exist in digital form,” and that “do not amount to legal tender.” The definition is not dissimilar to those adopted, for instance, in the recent International Monetary Fund (IMF) report and Financial Stability Board report. The Notice’s verdict that cryptocurrencies are not legal tender also echoes the Basel Committee on Banking Supervision’s (BCBS) position, as well as the IMF’s recent caution against granting cryptoassets legal tender status. What distinguishes China’s approach from the more permissive policy positions adopted by other national regulatory regimes and international standard setters is its categorical denial of any role for cryptocurrencies in the Chinese economy. It emphatically declares that cryptocurrencies “should not and cannot be used or circulated in the markets as currencies.” This view is in clear disagreement, for instance, with the positions taken by BCBS and the Financial Action Task Force.  

China outlaws cryptocurrency business transactions and related services by making the sweeping declaration that, as a matter of principle, “cryptocurrency-related business activities are illicit financial activities.” The Notice specifies a non-exhaustive list of cryptoasset businesses and services that are considered illegal. These include exchange services between fiat currencies and cryptocurrencies, exchange services between one or more forms of cryptocurrency, trading cryptocurrencies in the capacity of a central counterparty, the provision of information intermediation, and pricing services pertaining to trade in cryptocurrencies, fundraising via initial coin offerings, and trade in cryptocurrency derivatives. All these cryptoasset businesses and services are “strictly” prohibited and will be “resolutely cracked down on.” Perhaps more significantly, cryptoasset activities and services can constitute criminal offences, with those who conduct prohibited cryptocurrency activities or operations potentially being held criminally liable.   

Also of significance is China’s illegalization of access to offshore crypto exchanges. Domestic crypto exchanges have halted their operations within mainland China since late 2017. Internet access to crypto exchanges operating offshore has also been blocked within the country. However, until recently offshore crypto exchanges could still be accessed by Chinese residents using virtual private networks that bypass the country’s Internet restrictions. The Notice declares that it is illegal for overseas crypto exchanges to provide cryptoasset-related services to Chinese residents through the Internet. The question that arises is how this rule can be enforced against crypto exchanges that operate overseas. The Notice’s approach is to leverage on its jurisdiction over these exchanges’ mainland-based employees and the onshore providers of their services, including advertising and marketing, payment and settlement, and technological support. These employees and service providers will be investigated and held liable for any violations of the ban.  Offshore crypto exchanges had taken immediate steps to bring themselves into compliance with the new rule, with the operators of many reportedly closing their subsidiaries in mainland China. 

Uncertainty remains in Chinese law as to whether cryptocurrency transactions per se are valid and effective, particularly those carried out over the counter. The question had gone largely unaddressed under pre-existing Chinese crypto regulations. The Chinese judiciary had also been split on this critical issue, with some Chinese courts rejecting outright the legal validity of cryptoasset transactions and denying any legal recourse to the parties involved, and others taking a more permissive approach and recognizing legal interests in cryptoassets. The Notice provides, as a matter of principle, that an entity’s or person’s act of investing in cryptocurrencies and crypto-related derivatives shall be considered null and void where such act violates Chinese public policy or order. The entities and persons found in violation shall bear all losses resulting from their crypto investments. So, investments in cryptoassets are not categorically declared null and void. Rather, their legality and validity hinge on whether they are found to violate public order. The Notice’s general statement of principle removes some pre-Notice uncertainty, but still leaves considerable room for ambiguity. In particular, it falls short of providing much-needed bright line guidance on what types of investment in cryptoassets – and under what circumstances – constitute a violation of public policy. Shedding some light on the matter is the judgment handed down in 2020 by the appellate court in Shenzhen, a Southern city commonly dubbed China’s Silicon Valley. The rationale of the case appears to be that an exchange between a cryptocurrency and fiat currency, even if organized off the exchange, constitutes a violation of PRC public order, and is therefore null and void. What was left unaddressed was the more general questions of whether the possession of cryptocurrencies, the off-the-exchange and peer-to-peer purchase, and the sale of cryptoassets without exchanging cryptocurrencies into fiat currencies also violate public order. 

Driving Forces Behind China’s Blanket Ban on Cryptocurrencies  

China’s intensified hostility towards cryptocurrencies is plausibly attributable, at least in part, to its concerns over the illicit use of these virtual currencies, a challenge commonly faced by national regulators and financial supervisors, as well as international standard setters. Chinese authorities seem to be particularly concerned with two categories of illicit use, as identified in a US Attorney General’s Cyber Digital Task Force report: engagement in financial transactions with the commission of crimes; and engagement in money laundering or shielding an otherwise legitimate activity from tax, reporting or other legal requirements.  

China’s policy decision to ban cryptocurrencies altogether appears to have also been driven by two unique factors. The first is the risk of capital flight. China maintains an extensive capital control legal regime. A recent IMF report suggests that the country “still has one of the world’s highest levels of de jure capital account restrictiveness.” Chinese regulators have remained concerned about the use of cryptocurrencies to evade the country’s strict capital control. The Notice thus appears to be the latest attempt by the Chinese authorities to completely close a known capital flight loophole – cryptocurrencies.  

The second unique factor is cryptocurrency’s potential rivalry with the digital yuan, China’s central bank digital currency (CBDC). China has taken the lead among the world’s major economies in respect of CBDCs. In competition with the Chinese CBDC are decentralized cryptocurrencies. In general, “[d]igital currencies were created to compete with central banks,” as a notable research declares. While cryptocurrencies and CBDCs can coexist, privately issued cryptocurrencies have gained “first mover” advantage in the long-term competition for pre-eminence in future global financial infrastructure. Seen in this light, the Notice can be seen as an attempt by the Chinese authorities to regain monopolized control over money and to give its fledging CBDC the upper hand in that competition.  

Implications for the Global Quest for Optional Crypto Regulation  

China has become the first major economy to impose a blanket cryptocurrency ban. The impact of this development is likely to be far-reaching given the size of China’s economy, its economic interconnectivity with the global economy, and its transformation into a global leader in technology and innovation.  

China’s policy stance is driven by both global and domestic concerns. In terms of global concerns, the decentralized, anonymous, and cross-border nature of cryptoassets facilitates their use for illicit purposes, presenting a common set of regulatory challenges that national authorities and international standard setters are scrambling to understand and address. China’s policy reactions to these common challenges must also be understood in light of certain attributes of its national conditions, such as China’s capital controls regime and its ambitions to centralize digital currency. It is in this context that the debate over the proportionality and regulatory cost (in terms of innovation) of China’s approach should be placed.  

The case of China offers two useful points of reference for other national regulators and international standard setters on the design of a cryptocurrency regulatory framework. First, the Chinese approach exemplifies an institutional arrangement that is “comprehensive and involve[s] all financial sector regulators and other relevant authorities,” according to this IMF report. The Notice counts ten PRC national authorities as its rulemaking bodies, with the country’s central bank as the coordinating agency, which highlights the need for intra-agency coordination and cooperation to effectively respond to crypto challenges. Second, paradoxically, despite the Notice’s hard-line approach, it demonstrates China’s flexibility with, if not pragmatism, towards crypto regulation. Rather than codifying the cryptocurrency ban in national legislation, which entails a less flexible process, China treats crypto regulation as a matter appropriate for departmental rulemaking. This approach leaves room for future legal and regulatory responses in a field where new technological innovations and applications are constantly emerging to bring fresh opportunities and pose new challenges for the economy and the financial system.   

Dr Chao Xi is Professor of Law and Associate Dean (Research) of the Faculty of Law, The Chinese University of Hong Kong.  

This post is adapted from his paper, “The End of the War or the Commencement of Battle?  Cryptocurrency Regulation in China,” published in the Banking & Finance Law Review and available on SSRN

The views expressed in this post are those of the author and do not represent the views of the Global Financial Markets Center or Duke Law.  

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