Journal of Investment Compliance

ISSN: 1528-5812

Article publication date: 17 May 2021

Purpose: To describe recent regulatory developments in China on digital renminbi (RMB), initial coin offerings (ICOs), cryptocurrency holdings, cryptocurrency exchanges and blockchain technology.

Design/Methodology/Approach: Describes a digital RMB pilot program, seven government agencies’ bans on ICOs and cryptocurrency exchanges, the legality of holding and trading cryptocurrencies in China and the government’s endorsement of blockchain technology.

Findings: No PRC law or regulation prohibits Chinese investors from holding or trading cryptocurrencies but Bitcoin is defined as a virtual commodity, not a currency.  Despite a ban on ICOs and cryptocurrency exchanges, the People’s Bank of China (PBOC) and other government agencies endorse blockchain technology as long as its goal is to service the real economy.

Originality/Value: Expert guidance from lawyer with experience in foreign investment, cross-border mergers and acquisitions, capital markets, fund formation and venture capital and private equity investments in China.

Keywords: People’s Bank of China (PBOC), Digital renminbi (RMB), Cryptocurrency, Cryptocurrency exchanges, Initial coin offering (ICO), Blockchain

Paper type: Technical paper

In October 2020, the People’s Bank of China (PBOC), the central bank of China, launched a pilot program in Shenzhen to test digital renminbi (RMB). Each of 47,573 participants received 200 digital RMB (equivalent to approximately US$ 30)) in his or her digital currency wallet, which may be used to make purchases at 3,389 designated retail stores in Shenzhen. Users may also transfer funds from their bank accounts to their digital currency wallets and use the digitalized currency to make purchases, similar to the use of Alipay or Wechat pay.

Immediately following the Shenzhen pilot program, PBOC published the revised PBOC Law (draft) to solicit comment from the public. Article 19 of the draft laws provides that RMB may take a physical form or a digital form. This draft law, if enacted, will pave the way for the formal launch of digital RMB.

Despite the positive developments in digital RMB, China remains hostile to non-government backed cryptocurrencies. Article 22 of the draft PBOC Law reiterates that no entity or individual should produce or offer coupon tokens or digital tokens to replace RMB for circulation in market. This has been the consistent position of the Chinese government since 2013.

Initial coin offerings (ICO) were banned in China in September 2017. Exchange platforms that traded cryptocurrencies or provided facilitation services were also ordered to be closed following the crackdown on ICO. Many exchanges chose to relocate to jurisdictions that are more favorable to cryptocurrencies than China. In recent years, the Chinese government has made unprecedented efforts in cracking down on money-laundering activities using cryptocurrencies (such as Bitcoin or Tether (USDT)) as intermediaries.

Interestingly, it is not illegal to hold Bitcoins and other digital assets or even to buy or sell them in China, as they have been categorized as “virtual property”. The Chinese government also encourages the development and application of blockchain technologies, but has made it clear that blockchain technologies must service the real economy.  

Ban on ICOs

On September 4, 2017, seven government agencies of China, i.e. PBOC, the Central Cybersecurity and Information Technology Lead Group of Communist Party of China, the Ministry of Industry and Information Technology, the State Administration for Industry and Commerce, China Banking Regulatory Commission, China Security Regulatory Commission and China Insurance Regulatory Commission, jointly issued the “Notice regarding Prevention of Risks of Token Offering and Financing” (the 9/4 Notice). The Notice banned all ICOs in China and ordered that any organizations or individuals who had previously completed ICOs to make arrangements such as return of token assets to investors to protect investor rights.

In the 9/4 Notice, ICO was described as a process by which fundraisers distribute digital tokens to investors who make financial contributions in the form of cryptocurrencies such as Bitcoin and Eethereum. The 9/4 Notice further pointed out: “By nature, it is an unauthorized and illegal public financing activity, which involves financial crimes such as illegal distribution of financial tokens, illegal issuance of securities and illegal fundraising, financial fraud and pyramid scheme.”

Among the crimes mentioned in the 9/4 Notice, “illegal fundraising”, which generally means raising funds without government approval, is the term for a crime that has been widely used in cracking down on undesirable financial activities as the scope of the crime can be interpreted very broadly.

To understand this harsh attitude, we have to look at the big picture of China’s economy and financial market. In the past 20 plus years, China has enjoyed high-speed economic development, which, many believe, came at the cost of high leverage in the financial system and the accumulation of financial risks. In the past few years, control of financial risks and stabilization of the financial system has become the top priority of PBOC. For example, thousands of internet platforms providing P2P loans and micro lending were ordered to close down. It is no surprise that ICOs, due to the sheer increase both in numbers and in the amount of funds raised, as well as some socially chaotic events caused by ICOs, received the death sentence from PBOC.

It should also be noted that even ICOs outside of China are not completely safe if they attract Chinese investors. According to Article 6 of the PRC Criminal Law, if any of the criminal activities or results of such activities have occurred in China, the crime is deemed to have occurred in the territory of China. If the ICO has involved financial crimes based on Chinese criminal law standards, the promotors or organizers of that ICO may potentially be subject to Chinese criminal liabilities if they are Chinese citizens. Even if they are not Chinese citizens, if overseas ICOs have attracted Chinese investors, they may still potentially be subject to Chinese criminal liabilities. 

Ban on Cryptocurrency Exchanges

The 9/4 Notice also targeted cryptocurrency exchanges and ordered that 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 buy or sell “virtual currencies” as a central counterparties (CCP); or
• Provide price determination or information intermediary services for tokens or “virtual currencies”.

In the several months after the 9/4 Notice, most of the cryptocurrency exchanges closed down their platforms in China but continued exchange business through platforms registered in foreign jurisdictions such as Japan, Hong Kong, Korea or other jurisdictions that have seemed to be more favorable to the exchange business than China.

They have also made adjustments to their business models. To avoid direct confrontation with Chinese monetary authorities, some exchanges no longer provide exchange services between fiat currency and cryptocurrencies. Some have chosen to introduce tokens (such as USDT, QC, etc.) to their platforms that have value equivalent to the value of fiat currency, as an intermediary between fiat currency and cryptocurrency. Investors may use fiat currency to buy this new token and then use that token to buy cryptocurrency.

Further, many exchanges have launched peer-to-peer trading platforms that support direct transactions between investors without the exchange acting as a CCP. On those platforms, one investor can buy cryptocurrencies from another investor and pay the seller via bank transfers, Alipay or Wechat pay.

Those modified business models are not entirely safe from the Chinese criminal law perspective. Although major exchanges have been relocated overseas, they may still be subject to Chinese criminal liabilities due to the long-arm jurisdiction of the Chinese criminal laws. If the founders or managers of the platforms are Chinese nationals, or they make decisions in China to operate overseas exchanges, or the investors are in China, if the exchanges have involved criminal activities, Chinese justice authorities would still have jurisdiction over those persons.

In October 2020, it was reported that the founder of OKEx, one of the major cryptocurrency exchanges in the world, was detained by the Chinese police for undisclosed reasons. This resulted in temporary freezing of withdrawals of cryptocurrencies from OKEx, which caused panic among users on the exchange.

To further protect Chinese investors from purchasing and trading cryptocurrencies on overseas exchanges, China has blocked internet access to the websites of some overseas exchanges from China. According to Chinese laws, nobody should use the internet to view information that violates Chinese laws and regulations.

Those who access overseas exchanges via virtual private networks (VPNs) may potentially face risks if the exchanges contain prohibited information. In January 2017, the Ministry of Industry and Information Technology ruled that only authorized VPNs could be used in China. The sale or provision of VPN services by companies or individuals without telecom licenses issued by Chinese telecom authorities became illegal.

Legality of Holding and Trading Cryptocurrencies in China

In view of China’s harsh attitude towards ICOs and cryptocurrency exchanges, some may assume that it would be illegal for Chinese to hold or trade Bitcoins or other cryptocurrencies. This is not correct. No PRC law or regulation prohibits Chinese investors from holding or trading cryptocurrencies.

This seems to be consistent with an early notice jointly issued by five Chinese government agencies led by PBOC back in 2013, which defined Bitcoin as a special virtual commodity, but not a currency. That notice also explicitly provides that Bitcoin does not have legal status as a currency and should not be circulated and used in the market as a currency. This should still be considered as the position taken by PBOC today. 

Article 127 of the General Rules of the Civil Law of China, which took effect on October 1, 2017, provides that: “In case laws have provisions on the protection of data and internet virtual properties, such laws should be complied with.” Some experts believe that this means that one of the basic laws in China recognizes the legal status of cryptocurrencies as virtual property.

In judicial practices, Chinese courts have long upheld the commodity nature of Bitcoins. In a recent case, Shanghai No. 1 Intermediate People’s Court ordered that the defendants return around 18.88 bitcoins to the plaintiffs, and if such return is impossible, the defendants shall pay compensation calculated on the basis of RMB 42,206.75 per bitcoin.

However, a recent ruling of Shenzhen Intermediate People’s Court seems to add uncertainty to the judicial practice in the area of cryptocurrencies. The court overturned an arbitration award which granted monetary damages to the arbitration applicant because the respondent failed to return the agreed amount of bitcoins and bitcoin cash to the applicant. The court ruled that the arbitration award violated “social public interests” as the monetary damage was based on exchange between bitcoins and renminbi and allowing such exchange would conflict with the spirit of the 9/4 Notice. Note, however, China is not a case law country, and court precedents do not have binding effect on new cases, even in the same court.

The Future of Blockchain in China

Despite the ban on ICOs and cryptocurrency exchanges, PBOC and other government agencies have consistently showed great enthusiasm towards the application of blockchain technology for the goal of modernizing China’s financial system and becoming a world leader in this new innovative technology. In recent years, various guidelines and papers issued by the government have endorsed blockchain technologies and even placed blockchain technologies in the same category of big data and artificial intelligence (AI).

However, the endorsement of blockchain technology is not without reservation. In the view of PBOC, blockchain technology and digital currency should be researched for the goal of better service to the real economy.