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In Short

The Situation: Authorities in China have
cracked down on privately developed cryptocurrency, yet have
heavily invested in and encouraged the development of other
blockchain applications and services.

The Result: The rapidly rising number of
blockchain projects in China is accompanied by increased
regulation, including a requirement that blockchain-related
projects be registered with the Cyberspace Administration of
China.

Looking Ahead: As China’s central bank
continues to develop a government-backed digital currency, there
will likely be no lifting of the crackdown on other types of
cryptocurrency in China. However, blockchain technology will
continue to expand, and foreign companies doing business in China
should closely monitor related legal developments.

Cracking Down on Cryptocurrency

It was said that China is controlling around 70% of the
cryptocurrency mining operations around the world. Since 2014, the
People’s Bank of China has been working on developing a fully
backed digital fiat currency, and is expected to become the first
national central bank in the world to launch an official currency
in digital form. In the lead-up to its introduction, Chinese
financial regulators have cracked down on other
cryptocurrency-related firms and activities. As early as 2013,
China’s central bank and other authorities jointly issued the
Notice on Prevention of Risks imposed by Bitcoins to
prohibit financial institutions from transacting bitcoins,
denominating products and services in bitcoins, or providing
bitcoin-related services. These restrictions were expanded in
September 2017 when Chinese authorities published the
Announcement Preventing the Financing Risks of Initial Coin
Offerings
(“Announcement”), essentially banning
initial coin offerings (“ICOs”) and ICO-related financing
activities (an ICO is the introduction of a new cryptocurrency in
order to raise capital, similar to an initial public offering of
stock).

The Announcement declared ICO financing to be an unauthorized
illegal public financing, akin to the illegal issuance of
securities or even financial fraud. It further required authorities
to close down trading platforms that provide an exchange service
between legal tender and cryptocurrency and other services related
to cryptocurrency, such as pricing and intermediary services, and
prohibited financial institutions and payment institutions from
providing these services. The Announcement has led to a nationwide
crackdown of cryptocurrency, including bitcoin.

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In late 2019, Chinese President Xi Jinping declared his support
and encouragement of the development of blockchain technology in
China. With blockchain being the key technology behind
cryptocurrency and cryptoassets, many investors and entrepreneurs
mistakenly interpreted this endorsement as an endorsement of
privately developed cryptocurrency as well, temporarily reigniting
China’s cryptocurrency sector and crypto trading activities.
Chinese authorities put a swift end to this, however, closing down
all platforms that traded or provided services related to foreign
cryptocurrency, including five China-based cryptocurrency exchanges
that allow cryptocurrency to cryptocurrency exchange
transactions.

Blockchain Technology in Public and Private Sectors

Despite this strict crackdown on privately developed
cryptocurrency, blockchain technology is gaining rapid acceptance
in China. In cracking down on cryptocurrency applications, the
Chinese government has emphasized the distinction it sees between
cryptocurrency and blockchain users. Users are warned not to
conflate the two and reminded that the development of blockchain
applications, as opposed to cryptocurrency, is widely encouraged.
Organizations using blockchain technology in China or on a global
basis should pay close attention to the distinction and seek
detailed legal and regulatory advice where necessary.

There has been an explosion of blockchain-based solutions in the
public and private sectors. One major project launched by the
Chinese government is the blockchain-based cross-border financing
platform implemented by the State Administration of Foreign
Exchange (“SAFE”) in March 2019. Similar to the Greater
Bay Area Trade Finance Blockchain Platform, which was launched in
2018, the platform facilitates receivables financing and
information verification for cross-border businesses and is now
used by commercial banks and SAFE bureaus in 19 provinces and
cities across China.

Other Chinese governmental projects include a smart contract
application introduced by the Hangzhou Internet Court that assists
the automation of contract execution and smart adjudication of
cases, an identification platform in Shenzhen that automates
identity verification of users of government services, and a
logistic platform introduced by the Customs of Tianjin Province
that facilitates cross-border transactions and payment.

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Experts predict that blockchain has the potential to be applied
in China in fields such as anticorruption, public security, public
transportation, and crime investigation, and of course, as the
backbone of the central bank’s digital currency in the near
future. Many companies are also exploring the use of blockchain
technology in the private sector, some with financial investment
from local technology giants. Such applications range from product
certification and verification, to invoicing and e-billing system,
recording of intellectual property rights, and tracing and tracking
of drug identity in pharmaceutical supply chains.

As blockchain applications grow in popularity, the performance
of blockchain companies performance has taken on greater
significance in the broader Chinese financial markets. In Shenzhen,
an exchange-traded fund (“ETF”) based on the performance
of publicly listed blockchain companies was recently proposed.
While this proposal is pending the China Securities Regulatory
Commission’s approval, the Shenzhen Stock Exchange launched in
December 2019 a blockchain index reflecting the performance of the
top companies with blockchain ventures. These developments signal
new opportunities in the stock exchange, as well as optimism in the
continued growth of the blockchain industry.

In the Catalogue for Guiding Industry Restructuring, which was
issued by China’s National Development and Reform Commission in
October 2019 and took effect on the first day of 2020, blockchain
information services approved by the Chinese government is labelled
as encouraged industry.

Regulations

With the expansion of blockchain activities naturally comes the
expansion of the corresponding rules and regulations. The
Provisions on the Administration of Blockchain
Information Services (“Provisions”) implemented
by the Cyberspace Administration of China (“CAC”), a
governmental agency that regulates, oversees, and controls the
internet of China, specifically governs issues relating to
blockchain and blockchain information services. For example, the
Provisions grant the CAC the power to supervise and regulate all
blockchain information services in China.

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Companies seeking to provide blockchain information services in
China, including websites or applications that utilize blockchain
technology to provide information to the public, must register with
CAC their blockchain information services, as well as any
subsequent modifications to the services. Additionally, identity
verification is required of all users, and service providers must
not provide services to a user who refuses to comply with this
requirement. Service providers must also retain records of
contents, logs, and other information for at least six months and
make them available to law enforcement upon request. The Provisions
apply to both local and foreign companies that seek to provide
blockchain information services in China.

Another new regulation that may be relevant to those looking to
establish blockchain-related services in China is the new
Encryption Law of the People’s Republic of
China
(“Encryption Law”), which went into effect at
the turn of this year. The law requires encryption products to
adhere to technical and security standards to be set by the
relevant Chinese regulatory authorities. As encryption is a core
component underpinning cryptocurrency and blockchain, service
providers and developers should adhere to the rules under the
Encryption Law. Maintaining encryption standards is critical to the
long-term success of blockchain technology as advances in quantum
computing threaten to make existing encryption technology less
secure. Encryption products with protection functionality relating
to national security or the public interest are additionally
subject to import licensing and export controls.

Three Key Takeaways

  1. Chinese authorities have cracked down
    on firms involved in cryptocurrency and related activities.

  2. Chinese authorities are encouraging
    the development of other blockchain applications, and there has
    been heavy investment in the industry from both the public and
    private sector.

  3. Developers and providers of
    blockchain services must closely monitor Chinese legal developments
    relating to blockchain services.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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