On May 19, 2021, China’s ‘State Council’s Financial Stability and Development’ Committee announced that it would be cracking down on bitcoin mining and exchange in an effort to maintain stability and fend off financial risks to the Chinese economy. The announcement resulted in a sharp decline in the value of the popular cryptocurrency, to the tune of 10%, and wiped nearly $1 trillion off the bitcoin market.
China’s choice to restrict the flow of cryptocurrencies within its sovereign territory is not unusual. Though a small number have banned cryptocurrencies altogether, many countries across the world including Russia and Canada have adopted conservative policies which seek to restrict the proliferation of cryptocurrencies. The violation of monetary sovereignty, which is a government’s power to exercise exclusive legal control over its currency, is almost always cited as the primary reason for such strict regulations. However, China’s regulation of cryptocurrencies and its underlying blockchain technology presents an interesting case. Alongside placing a variety of restrictions on the exchange and mining of cryptocurrencies, the Chinese government has encouraged the development of blockchain, the technology which forms the basis of cryptocurrencies. This article argues that a ‘strategic’ pattern of regulation of cryptocurrencies such as Bitcoin has allowed the Chinese state to assume a position of dominance in blockchain technology, the backbone of modern cryptocurrencies. It specifically examines China’s intentions to use its domestic blockchain to promote its own digital currency, the Digital Yuan, and the impact it would have on the current world order.
A brief history of cryptocurrencies in China
Between 2011 and late 2013, interest in bitcoin, consistently the world’s most popular and widely used cryptocurrency, grew considerably in China and led to the establishment of several firms dealing in it. BTCChina, briefly the world’s largest by volume and China’s first Bitcoin exchange, was launched in June 2011. Its establishment contributed to a sudden and sustained surge in interest in bitcoin in China. More crypto exchanges followed as an increasing number of entities in China like technology firms, charities and e-commerce sites began accepting bitcoin for transactions over the next two years.
Interest for bitcoin in China grew steadily during this period, to the point that the cryptocurrency saw an 800% price increase in just about two months and was trading at $800. However in December 2013, the Chinese central bank banned financial institutions and payment processors from servicing cryptocurrency exchanges. Just as it was beginning to be established in China, bitcoin could suddenly not be used to pay for any products or services across the country. The sudden crackdown led to an immediate 35% drop in the cryptocurrencies’ value to $450.
Interestingly, however, the restrictions placed by the Chinese central bank did not impact the mining of bitcoin, and still allowed Chinese citizens to trade it as citizens were not barred from possessing or exchanging the currency. This, along with a combination of subsidised electricity, abundance of coal and hydropower energy, and availability of low cost hardware helped create perfect conditions for bitcoin mining operations in China which continue to thrive to this day. Much of this mining takes place in the autonomous Inner Mongolia region of China, where temperatures are colder and machines are easier to protect from overheating. Today, some of the largest bitcoin farms in the world are located in China and have produced nearly 65% of the world’s currently circulating bitcoin.
But in 2017, the Chinese government moved restrictions on bitcoin yet again, in an effort to thwart the currency’s spread. In September, seven government agencies including the Chinese central bank and the Central Cybersecurity and Information Technology Lead Group of the Chinese Communist Party (CCP) issued a joint notice which banned all ‘Initial Coin Offerings’ (ICOs), fundraisers to create new cryptocurrencies, in China. In its aftermath, a new business model emerged. Instead of offering ICOs, businesses now began to offer ‘Initial Miner Offerings’ (IMOs), arrangements where organisers sold mining equipment to investors who in turn were awarded points for their mining activity. However, this practice too did not last. A month after the ban on ICOs, China’s National Internet Finance Association (NIFA) identified IMOs as ICOs in disguise and proceeded to ban them. Further restrictions included a ban on trading cryptocurrencies for fiat money. This still left Chinese nationals with the option to trade crypto to crypto with foreign exchanges. However, that option too was soon foreclosed after the government blocked access to foreign crypto exchanges through its Great Firewall.
Having already barred the use and trading of cryptocurrencies, the Chinese government now appears to be targeting cryptocurrency mining. On May 25th 2021, the Inner Mongolia Autonomous Region issued draft guidelines highlighting plans to ban cryptocurrency mining. Facing an impending halt in operations, many firms located in the region, considered China’s crypto mining hub, are now seeking relocation to other countries.
A pattern in regulation and the concurrent rise of blockchain
When observed in retrospect, the Chinese government’s regulation of cryptocurrencies appears as a carefully constructed strategy. Instead of seeking outright bans on the mining, exchange and usage of cryptocurrencies like bitcoin, the Chinese government proceeded to safeguard its highly-controlled economy through incremental regulations which have made bitcoin an unviable option of exchange within China.
This ‘strategic’ regulation of cryptocurrencies has allowed the Chinese government to build its domestic blockchain capacities. While tacit for a long time, the Chinese government’s support for blockchain technology has turned vocal in the past couple of years. In an October 2019 speech, Chinese President Xi Jinping called for intensified development of blockchain technology in China, and detailed how the Chinese government would support blockchain, research, development, and standardization. The speech triggered a 30% surge in the price of bitcoin, which is built on blockchain technology, and a jump in value for more than 85 Chinese companies which deal in blockchain technology.
This enthusiasm has been actualised through concrete progress in blockchain technologies in the country. According to Beijing-based data services firm ‘Blockdata’, China led the world in the number of blockchain projects initiated, at 263, by the end of 2019. Blockchain technologies are being adopted at a faster rate by firms in China than anywhere else, and Chinese companies currently lead the world in blockchain research, holding more than 68% of all blockchain patents filed. Seven Chinese companies, including the likes of Ant Group, Baidu and Tencent also made it to the 2021 Forbes Blockchain 50 List.
But these are still far from the most important development in blockchain in China. In April 2020, the Chinese government launched its Blockchain-based Services Network (BSN). BSN is a national blockchain network which will form the backbone of China’s digital communications – transactions, cloud computing, development and other communications – facilitated through apps run on the blockchain called ‘dapps’ (short for decentralised apps). Already spread across 80 Chinese cities, the network promises to significantly lower costs of access to digital services currently offered by leading technology giants such as Amazon, Google and Microsoft at steep prices, giving Chinese tech companies an advantage in the market. The network is expected to expand to over 200 Chinese cities by the end of 2021, and possibly also spread internationally to countries friendly with China.
China’s dark horse: the Digital Yuan
China’s rapid adoption of blockchain technology in its domestic economic fold has significant consequences for the global economy. The creation of the digital Yuan is perhaps the most consequential goal of China’s efforts to develop a domestic blockchain, the need for which stems from China’s perceived threat to sovereignty and autonomy in the international order. Currently being tested in a live beta project, China’s new Digital Currency Electronic Payment (DC/EP) is unlike traditional cryptocurrencies issued and regulated by a central authority – the People’s Bank of China. However, like cryptocurrencies, the new digital currency is expected to be built on and distributed domestically and internationally via the BSN, China’s national blockchain.
Despite its similarity to existing cryptocurrencies, the new digital currency vastly differs from cryptocurrencies in operation. Above all else, the digital Yuan allows the Chinese government to exert previously unimaginable levels of control over the Chinese economy. Although it is currently being circulated alongside paper currency, China’s government intends to distribute the digital Yuan through traditional banks and eventually replace physical notes and coins. The new digital currency is even expected to be pegged to the paper Yuan and offered for use offline with the help of Near-field Communication (NFC) technology. Most significantly, the blockchain ledger which records all digital Yuan transactions will be centrally controlled by the Chinese government. This gives Chinese authorities greater control over managing foreign capital flows and the ability to intensely monitor the transactions of all citizens. In essence, with the development of a domestic blockchain and a national digital currency to go with it, the Chinese government has operationalised the technology behind cryptocurrencies while discarding their defining feature: their ‘decentralised’ nature which prevented any single central authority from exerting control over their flow.
The digital Yuan, if it is widely accepted internationally, could also offer China significant strategic gains over the current global hegemon, the United States. Adoption of China’s national blockchain in foreign countries provides it the opportunity to increase global circulation of the digital Yuan and rival the economic influence that the United States currently enjoys due to the primacy of the US Dollar. This widespread adoption could in turn help China craft new norms and regulations for global currency exchange, replacing current institutional arrangements such as SWIFT, which were set up by and favour the interests of the United States and its allies. Finally, global acceptance of the digital Yuan would greatly strengthen the Chinese surveillance state by providing its centrally controlled blockchain access to the digital records of billions of global citizens.
The Chinese government’s development of the digital Yuan is an interesting and potentially disruptive event which must continue to be closely studied. While it shares close similarities with existing cryptocurrencies by virtue of being built on the same blockchain technology, it is ultimately a mechanism for much greater control over the national economy and much closer surveillance of citizens. For its rivals, a concerted effort to keep pace with China’s blockchain developments is the need of the hour.
Kartikeya Reddy is a rising first year student at Ashoka University majoring in Political Science with minors in International Relations and Computer Science.