China’s crypto mining industry is facing the biggest regulatory threat of the last three years.
On May 21, China’s cabinet of ministers, the State Council, explicitly discussed cracking down on cryptocurrency mining. It was the first time the government body explicitly targeted the industry.
Just four days later, Inner Mongolia proposed a set of eight measures that will likely stifle crypto mining in the province.
The crypto world is waiting with bated breath for regional authorities in China’s other crypto mining hubs—Sichuan, Xinjiang, and Yunnan—to write rules.
Many crypto mining companies are already packing their bags, filling them with their most precious productive asset; mining rigs. Crypto exchanges and other crypto companies are holding out.
So is crypto in China over?
Bottom line: It’s too soon to say, but things are not going to be the same. Many crypto mining companies are already moving their rigs out of the country. Crypto exchanges and other crypto-linked companies are still holding out. But blockchain isn’t all crypto, and the wider ecosystem is still in good shape, perhaps the best shape it’s ever been in.
The status quo
A legal grey zone: Beijing has been suspicious of cryptocurrencies for a long time, but much crypto activity is tolerated. The Chinese government banned companies from issuing new tokens back in 2017. They also banned fiat to crypto conversion services, which led to the exchanges being kicked out of China, they stopped trading for Chinese mainland users, and moved their headquarters to other countries.
- This hasn’t stopped companies from issuing tokens, or exchanges from operating in China. At most, it has impeded China crypto people from shamelessly marketing tokens to Chinese consumers.
- It’s all about knowing how to navigate local laws and knowing the right people.
- But as many in the industry euphemistically say, “the trend is regulation.”
Vibrant community: China’s crypto industry may operate in a grey zone, but nobody is in hiding. Some parts of the industry are pretty swish, complete with fancy offices in central Beijing and lavish five-course dinners at private clubs. But the crypto industry is a lot more diverse than stereotypical tech.
- Some players are after a crypto-utopian dream, others are looking to line their pockets, some are simply ultra nerds, others old-school entrepreneurs. Of course, plenty of people are just there to earn a paycheck.
- The mining scene in particular is a great example of this. Many miners are (or were) down to earth people from the provinces, more comfortable in dialect than standard Mandarin.
- I’ve heard many in the industry describing Chongqing-born Wu Jihan, one of the founders of Bitmain, as a passionate genius who hates the spotlight. Wu reportedly hates interviews, and rarely speaks in public.
- This rag-to-riches spirit is true for other tech industries as well. But crypto is far newer—post-2008 and mostly post-2011—and a lot more centered around China, so the vibe is especially strong here.
- New hires in crypto companies increasingly herald from more affluent parts of China. Two internationally educated workers I know in their late 20s in Shanghai tell me they have a hard time understanding what their company is doing.
- Founders of many newer companies came from traditional finance. Former JP Morgan and Goldman Sachs traders, analysts, and executives, abound in crypto.
The crackdown
Change in tone: The China crypto scene has been facing increased regulatory pressure in the last year. By all accounts, there’s two motivations behind the talk at the highest levels of the Chinese government against mining: environmental and financial.
Why the crackdown? It’s one part green: In the last year, China has accelerated its move towards a greener future. In the 14th Five Year Plan, it pledged big reductions in carbon emissions.
- Unfortunately for China’s crypto industry, the type of mining Bitcoin network uses, known as proof-of-work, burns a lot of electricity. In regions like Inner Mongolia and Xinjiang, where electricity primarily comes from coal plants, mining is a big contributor to carbon emissions.
- It’s a little trickier to determine whether mining in other regions, like Sichuan and Yunnan, where electricity comes from hydropower plants, will suffer from the environmental guillotine.
One part financial stability: At the same time, finance authorities have their own beef with Bitcoin. The May 21 statement that got crypto peeps worried didn’t come from China’s environmental authorities. It came from the State Council’s Financial Stability Committee, which said that “it’s looking to control financial risk.”
- Regulators likely fear that Chinese retail investors, en masse, are putting themselves at risk with bets on cryptocurrencies.
- If crypto markets were to crash, not only miners, but mom and pop investors would lose their money.
- Chinese regulators have a history of protecting retail investors with costly bailouts when things go wrong in the market.
Not everybody likes the bull market: State bodies and media have been bashing cryptocurrency “speculation” in the last few months, as the bull market was raging, even as some officials have recognized Bitcoin as an asset.
- Just on May 15, Xinhua republished the story of a certain “auntie Meng,” who lost her life’s savings (RMB 600,000, or about $94,000, according to the article), and a large bank loan she took out to invest in what turned out to be a Ponzi scheme. The article said that the “chaos” of the bull market is dangerous to ordinary investors.
- When a bull market sent Bitcoin soaring to $60,000, it attracted the interest of Chinese social media and retail investors. But in the last year, Chinese police have continued to uncover scams and heists related to crypto.
Crypto financial services: More than the miners, in the last year, we’ve seen crypto financial services providers have been targeted.
- Over-the-counter traders, which help people and especially miners quickly exchange fiat to crypto and vice versa, were the target of a crackdown starting in September 2020.
- Crypto exchanges also took some heat: Huobi COO Leon Li, disappeared in November 2020 as he was assisting police with an investigation.
- Such events and crackdowns are not unheard of in the crypto world. They are part of a cat and mouse game that has lasted for years.
- But it is entirely possible that such financial services providers will face increased pressure as the Financial Stability Committee tries to limit risks to auntie Meng.
Blockchain boom: Meanwhile, the non-crypto blockchain ecosystem has seen unprecedented support from the central and local governments. In 2019, the technology was endorsed by President Xi Jinping, and in 2021 the technology was mentioned by name in the national five year plan.
- The government-backed Blockchain Services Network is forging ahead with its plan to build a global “internet of blockchains.”
- Local governments started to throw money at blockchain in the last year. The city of Beijing announced plans to use blockchain in governance in July. In January 2021, Shanghai invested $5 million in Conflux, a blockchain startup.
Blockchain vs. crypto; what’s the difference?
For regulators, crypto is out of favor in China, but blockchain is still in. But it’s often hard to figure out what that means. When I ask people “what is blockchain good for?” I often get a garbled response that includes something like “efficiency” and “transparency.”
That hasn’t convinced me. The very decentralized version of blockchain, known as a public chain, is not at all efficient (I’m looking at you, Bitcoin). The simple reason; it takes more work to coordinate a network of computers to do your bookkeeping than it does to keep a single book.
Blockchain isn’t all crypto: Companies are applying the basic ideas of Bitcoin to managing all kinds of data, often for very mainstream players. Blockchain is a good way to automate trust, particularly as you integrate data.
- Even state-owned enterprises like State Grid are experimenting with the use of blockchain for data integration.
- Other companies are implementing supply chain traceability applications, such as the VeChain blockchain, used by Walmart China.
The supply chain application: Walmart works with a long supply chain of food producers, processing facilities, and logistics companies to put food on its shelves. Tracing a single item’s journey through this supply chain is a hefty task, not just because the chain is long, but because those suppliers keep their own ledgers of product information, invoices, orders, that aren’t necessarily compatible. Blockchain provides a relatively simple way to keep standardized and secure records across this entire chain.
- Blockchain is pretty good at solving this problem: It can create a ledger that is updated in real time by different agents, define multi-party relationships such that some parties can only view the ledger whereas others can edit it, and do all of this in a pretty secure way that is hard to tamper with.
Greasing the wheels: Corporate applications—and many of the blockchain the Chinese government is looking to implement—are typically “consortium” chains, running on computers controlled by a set of defined agents. In these cases, if you trust these agents, you trust the system.
- But blockchain can also come in the form of trustless “public” chains. Rather like carving the terms of a deal in stone in the town square, these rely on immutability and public-ness to establish trust.
Through tokens we trust: Public chains need to run on strangers’ computers—and if you’re going to make them trustworthy, you need a lot of strangers running a lot of computers to check each others’ work.
- That’s where cryptocurrencies, and mining, come in; in return for providing resources to running the chain, miners are paid in the network’s native currency, such as Ethereum.
- This way, miners have both an incentive to run the computations, and not to behave maliciously. Because they own the chain’s native cryptocurrency they have an incentive for the network to grow and do well.
- If you’re running a public chain, tokens are an inevitable part of the design: Not only are they the economic incentive that keeps people doing the unglamorous work, but they incentivize good behavior.
- Plenty of Chinese companies are working on public chains—and that means they’re working on and offering their own cryptocurrencies.
What’s to come? Crypto mining firms will increasingly face pressure from authorities, following the State Council committee’s meeting. It is also likely that authorities will crack down on companies bringing crypto trading to Auntie Meng—piling onto their moves on crypto financial services from last year.
But the rest of China’s blockchain ecosystem will keep going. Authorities have shown tolerance and even support for companies working on fundamental blockchain technology, be it public or consortium chains. These same firms issue cryptocurrencies to keep their public chain protocols going. As long as they don’t encourage Auntie Meng to take on too much risk by investing in crypto, they will likely be fine.