Navigating Crypto Regulation: China

By Alex Paley

It’s the fourth installment in our crypto regulation mini-series and today we’re looking at crypto regulation and security offerings in China. Keep reading to find out which blockchain platform scored the highest on China’s Blockchain Assessment Index!

At the nation’s peak, China accounted for three quarters of the world’s bitcoin mining operations and over 95% of the bitcoin trading volume. On June 4, 2018, a broadcaster at China Central Television (CCTV) hosted an hour-long special about blockchain, featuring technology leaders and members of the Chinese government. During the special, the economic value of blockchain technology was touted as being “10 times more than that of the internet.” President Xi Jinping also mentioned blockchain as part of a technology revolution, along with artificial intelligence, quantum information, mobile communication, and IoT.

Although Blockchain tech is openly praised in China, the country has arguably the most restrictive regulation in the world. For this reason China is considered to take a “blockchain before bitcoin” stance. The main reason for their restrictive measures on cryptocurrency is likely geopolitical — Chinese economic initiatives including One Belt One Road are highly dependent upon them retaining and increasing their influence over the international flow of money. The United States already enjoys this power through the U.S. dollar and cryptocurrencies could do the same for China, assuming they have more control over the crypto money supply. In fact, the People’s Bank of China is actively working on a state-backed cryptocurrency and electronics payment system.

So if you are a Chinese individual or business with exposure to blockchain or cryptocurrency, it’s important you stay tuned for answers to some of the most important regulatory questions:

1. How has regulation in China progressed since 2013?
2. Can I trade cryptocurrency in China?
3. Can I issue tokens through an ICO in China?
4. Can I mine cryptocurrency in China?
5. How do I pay taxes on any crypto gains or income?

🇨🇳 A History of Crypto Regulation in China

A brief timeline of the development of Chinese crypto regulation:

• December 2013: The People’s Bank of China issues a warning notice on the risks of Bitcoin, and prohibits all crypto operations for financial institutions
• December 2016: The Chinese government adds blockchain technology to its five-year technology plan
• June 2017: The People’s Bank of China begins testing a prototype state-backed digital currency — the Bank sends several transactions between it and some of the country’s commercial banks.
• September 2017: The Chinese government imposes regulation banning all Initial Coin Offerings (ICOs) and crypto-to-fiat exchanges
• January 2018: The Chinese government imposes regulation banning P2P sales and over-the-counter markets
• February 2018: The Chinese government blocks access to foreign crypto exchanges and ICO websites
• May 2018: President Xi Jinping makes a speech about the importance of pursuing technological research and mentions blockchain amongst revolutionary technologies such as artificial intelligence and the Internet of Things.
• May 2018: China Center for Information Industry Development (CCID) Research Institute of the Ministry of Information and Technology releases the world’s first technology-focused public blockchain assessment index placing Ethereum as the number one contender.
• May 2018: CCID Research Institute of the Ministry of Information and Technology announces that a committee is being setup to establish a national standard for blockchain, with an expected completion date at the end of 2019.
• June 2018: China Central Television hosts a one hour special on blockchain technology with participants from the Chinese government; broadcaster touts blockchain as having economic value “10 times that of the internet.”
• June 2018: China Center for Information Industry Development (CCID) Research Institute of the Ministry of Information and Technology releases an updated public blockchain assessment index placing EOS in front, knocking Ethereum off the top spot.

👹 Can I trade cryptocurrency in China?

Can I trade through crypto exchanges?

On February 5, 2018, the People’s Bank of China issued a public notice of its plans to use the almighty Great Firewall of China to block access to all domestic and foreign cryptocurrency exchange websites. This action was taken after a failed attempt to ban crypto exchanges in late 2017. The South China Morning Post reported that after banning domestic crypto exchanges, many traders turned to overseas platforms to continue participating in crypto transactions. The People’s Bank stated that the risk of trading is still too high in the sector, and the tougher stance aims to put brakes on the ICO and crypto exchange mania that has been sweeping through China. It was also reported in February 2018 that the crypto market had lost $340 billion in value since the start of January, which many speculate was caused by the regulatory crackdown in China.

While it is illegal to trade crypto in China, the ban certainly isn’t stopping serious investors. Trading from China is at a low, but is not completely nonexistent. Many Chinese traders are simply using VPNs to circumvent website bans. On March 31, 2018, a regulatory ban on unauthorized VPNs came into effect. Despite this, VPN providers and users are still claiming that they have access to the services. Other investors are also moving offshore to Hong Kong and Japan.

While official sources have cited caution as the key reason for the early crackdown on crypto, foreign spectators are generally under the belief that the move is more geo-political than it seems. Notably, the underlying reason for the ban may be concerns that capital flight could devalue the yuan currency and undermine the economic stability that depends on a strong foreign exchange reserve.

Can I hold on to my crypto?

While crypto trading is illegal, it is legal for Chinese individuals to hodl 🙃 cryptocurrencies. Financial institutions on the other hand, cannot. In January 2018, the People’s Bank of China ordered financial institutions to stop providing banking or funding to any activity related to cryptocurrency. The document was circulated among banks internally, providing requirements for financial institutions to enhance their daily transaction monitoring to ensure that any suspected payments relating to cryptocurrencies are shutdown. 💀

When will I be able to trade again in China?

While the Chinese government has not indicated that crypto trading will be legal again anytime soon, various research projects and investments coming out of China indicate that once speculation has leveled out, trading will be both legal and encouraged in China. In particular, the China Center for Information Industry Development (CCID) Research Institute of the Ministry of Information and Technology has now officially released the world’s first technology-focused public chain assessment index. The purpose of the index is to help “grasp the status quo of global public-chain technology development, to timely track the direction of public-chain technology innovation, and to help promote the innovation and application of blockchain technology.” So, while trading is currently illegal, the fact that this index has been created indicates that the Chinese government indeed does want to educate people on blockchain technology while they wait for the volatility to die down.

According to the CCID, here are the Top 15 Public Blockchains of May 2018:

Global Public Chain Technology Assessment Index (Phase 1)

May 2018 Global Public Chain Technology Assessment Index

Since publishing Phase 1 of the assessment index, the CCID has also provided an updated Top 15 Public Blockchains of June 2018:

June 2018 Global Public Chain Technology Assessment Index

The successful integration of EOS’ proof-of-stake consensus algorithm likely helped the blockchain knock Ethereum off the top spot this month. Ethereum has yet to succeed in implementing a proof-of-stake consensus despite the fact they have been talking about it for quite some time.

☠️ Can I issue tokens through an ICO in China?

In September 2017, the People’s Bank of China declared that all Initial Coin Offerings constitute illegal fundraising and must be ceased immediately. As a consequence, any companies already issuing tokens through an ICO were legally required to buy back their tokens and cease all fundraising. The People’s Bank of China took this severe action because the Chinese government is concerned that too many ICO’s are fraudulent, and they also have stated concerns that of the 80,000 blockchain projects launched globally, only 8% are still being actively maintained.

At the Southeast Asia Blockchain Summit in January, the director of the Chinese Center for Financial Technology denied that the blanket ban on trading and ICOs would continue indefinitely. The director added that the hostile regulatory climate in China was ostensibly meant to weed out fraudulent ICO projects to allow bonafide offerings to flourish.

⛏️ Can I mine cryptocurrency in China?

In January 2018, mining operations faced serious crackdowns due to “excessive electricity consumption.” Bitcoin mining in China is estimated to use up to 4 gigawatts of electricity, which is equivalent to the power of three nuclear reactors. While the reason for the crackdown was cited as excessive electricity usage, interestingly the statement came from the People’s Bank of China instead of an energy commission. For this reason, many speculate that the decision was just one of many used by the Chinese government to curb cryptocurrency use and hype in China.

So despite the crackdowns, why is China the world leader in crypto mining?

1. Cheap Electricity — electricity is far cheaper in China than in most other countries. In industrial regions, electricity is either supplied by hydro-electric facilities or can be subsidized by the state. The cheap electricity allows miners to operate at peak efficiency and outlast foreign competitors. Furthermore, environmental policies in China are more lax than in other countries. Coal is the cheapest power source and Chinese energy producers can freely burn it and use the energy for mining. It is more cost-effective to establish a bitcoin mining operation near a source of coal to convert the carbon directly to crypto, a tactic which some of the biggest miners in China are using.
2. Leading Bitcoin Mining Pools — many miners outside of China often join Chinese mining pools because they are attracted to their size. The bigger the pool, the more predictable and steady the member’s earnings.
3. Top ASIC Hardware Manufacturers — top hardware manufacturers such as Bitmain (recently valued at $12 Billion) are based in China which allows for easier and more reliable access to mining hardware.

What are miners doing in response to the crackdown?

While mining companies in China are still operational, they are severely struggling to control keeping their electricity usage under the limits imposed by the People’s Bank. Many mining companies are moving overseas to take advantage of less restrictive climates. Recently, Bitmain Technologies set up a subsidiary in Switzerland in addition to its current branches in Amsterdam, Hong Kong, Tel Aviv, Qingdao, Chengdu, Shanghai and Shenzhen. While moving abroad will likely result in higher energy costs and lower profits, lower profits are better than no profits at all.

💰 How do I pay tax on any gains or income?

Do I have to pay income tax on crypto?

In most countries, such as the United States, profits on cryptocurrency transactions are generally taxed as income. This is because cryptocurrency is recognized as property or a commodity. A lot of countries have taken a similar stance on the taxation of crypto, while failing to provide any concrete guidance. China has yet to take any stance on the status of crypto for the purpose of taxation, and the government has been largely silent on the matter.

Presuming that crypto would be recognized as property or a commodity in China, it would be subject to personal income tax. In China, personal income tax is divided into 11 categories, each with its own rate and allowable deductions:

1. Employment income (i.e. wages and salaries)
2. Income from the operation of a sole proprietorship
3. Income from the operation of a business on a contract or lease basis
4. Payment for labour services
5. Author’s remuneration
6. Royalties
7. Interest, dividends, and profit distribution
8. Rental income
9. Income from the transfer of property
10. Incidental income
11. Other taxable income as determined by the Ministry of Finance of the State Council

Since 2013, the Chinese government has been outspoken on many facets of crypto regulation, more so than any other country; yet despite the country’s massive trading volume and profits, the Ministry of Finance has not released any cryptocurrency taxation guidance. One thing is clear, however: gains from cryptocurrency would not fall strictly under any of the 11 categories, other than perhaps “incidental income”.

Of course, income and gains on crypto only occur when a coin or token has been sold for a profit, and in China, trading cryptocurrency is illegal. As such, a lot of crypto holders in China will not be participating in crypto transactions and consequently will not be exposed to tax liability. And of course, any holders in China that are illegally trading crypto will obviously not want to expose their illicit activity by declaring gains on their tax returns. So, a lack of tax guidance from the Chinese government is not entirely surprising.

Once trading is permitted, crypto holders should expect that they may need to file crypto gains under the “incidental income” category on their personal income tax return, unless the Chinese government provides otherwise.

Blockchain before Bitcoin

Following their pattern of “blockchain before bitcoin”, even though tax guidance is lacking, the Chinese government is leveraging blockchain technology to help prevent tax evasion. The National Taxation Bureau of the city of Shenzhen has partnered with Tencent to curb fraudulent and misleading tax behavior through an “Intelligent Tax” project. In a statement, Shenzhen officials stated that the project will use Tencent’s technological advantages — including its in-house blockchain technology and expertise. The blockchain will be used to track and trace tax documentation such as receipts and invoices, preventing people from forging inaccurate information. So, while cryptocurrencies are being somewhat oppressed in China, the country is very much so investing in blockchain research and real world use cases.

This article is legal information and should not be seen as legal advice. You should consult with an attorney before you rely on this information.