China and Crypto Currencies - Underground Mining, Surface Trading
The Asian Crime Century briefing 28
The Libyan authorities recently arrested 50 Chinese nationals who were involved in an illegal cryptocurrency mining in the city of Zliten in Libya. The action came several days after 10 Chinese were arrested for cryptocurrency mining in Misrata in Libya.
The Libyan authorities made the arrests because of the huge power used in cryptocurrency mining, which is a problem for the country as power outages are frequent. In 2021, Libya accounted for 0.6% of all Bitcoin mining globally. The Libyan government has previously blamed Bitcoin mining as one of the reasons for the power shortages. The cost of electricity in Libya is about 1/40th of the USA and 1/16th of China. However, mining one Bitcoin can use power equivalent to what a typical US household uses in nine years!
There are three things about cryptocurrency mining and China to consider:
1. The arrests in Libya.
2. The Chinese government ban on crypto mining.
3. The Hong Kong Government’s crypto trading drive.
The arrests in Libya relate to the Chinese government ban on crypto mining. In September 2021, the People’s Bank of China (PBOC) announced that cryptocurrencies do not hold the same status has fiat money and should not be used as currency and that it is illegal for overseas crypto exchanges to provide services to users in China. The National Development and Reform Commission the same month also announced that banning crypto mining is essential as the use of these severely impacts the development of the economy and society, and also threatens national security.
On 24 September 2021, the People’s Bank of China stated that “In recent years, bitcoin and other virtual currency transactions and hype activities have prevailed, disrupting the economic and financial order, breeding money laundering, illegal fund-raising, fraud, pyramid schemes and other illegal and criminal activities, and seriously endangering the property safety of the people.” Interestingly, the PBOC recognised the relationship between cryptocurrencies and crime, referring to money laundering, fraud, etc. The PBOC ban was affected by the regulator prohibiting financial institutions from taking any part in transactions involving crypto currencies. In addition, the authorities also instructed banks to not fund cryptocurrency transactions and blocked major crypto exchanges from major Chinese Internet search engines and social media platforms.
On the same date as the PBOC announcement, the National Development and Reform Commission issued a notice on rectifying cryptocurrency mining. The detailed notice was co-signed by the National Development and Reform Commission, the Central Propaganda Department, Central Network Information Office, Ministry of Industry and Information Technology, Ministry of Public Security, Ministry of Finance, The People's Bank, General Administration of Taxation, State Administration for Market Regulation, China Banking and Insurance Regulatory Commission, and the National Energy Board, indicating the coordinated central government approach to cryptocurrencies. The final lines of the notice required all national government departments to establish groups to evaluate the liquidation and withdrawal of crypto mining projects.
The business was dead inside China, and Chinese groups involved in crypto mining dispersed to other countries around the world seeking low cost power to continue crypto mining. Libya was one country where power costs were low enough to justify crypto mining operations. Iran was another. In 2021, power outages across Iran were partly blamed on Chinese Bitcoin miners who had established huge crypto mining farm in Rafsanjan in the southeast of the country. The Chinese farm reportedly employed 54,000 workers, trading under the name ‘Iran-China Investment Group’.
The power outages caused such concern that the Iranian authorities reportedly shut down 1,620 unregistered mining farms and confiscated 45,000 mining devices, despite wanting to use crypto mining as a means of generating revenue for the government. It seems likely that the rapid growth in unauthorised crypto mining that came as a result of the fast increasing price of Bitcoin led to pressure on authorised crypto mining activities in Iran. The Chinese investment in crypto mining developed as a result of the absence of investors from other countries due to US sanctions on Iran.
As well as Chinese crypto mining operations diversifying around the world, some seemed to have gone underground in China. The Cambridge University’s Cambridge Centre for Alternative Finance reported that China’s share of crypto mining was 34.3% in June 2021, 0.0% in July 2021 (following the crypto mining ban), but rebounded to 22.3% in September 2021. As usual with prohibited activities in China, it takes a little time for people to conclude who to bribe to ensure continuity of their business. The PBOC ban and the National Development and Reform Commission notice are likely to be ignored unless subject to harsh enforcement action.
This brings us to the third part of the China cryptocurrency mining map, the approach taken by the government in Hong Kong (a Special Administrative Region of China). In January 2023, the Monetary Authority announced that after a consultation process “An appropriate regulatory environment will help address financial stability risks possibly posed by stablecoins, and promote the orderly and sustainable development of the industry.” In June 2023, the Monetary Authority announced that licensed banks should support the business needs of licensed crypto exchanges.
The Hong Kong government seems to be aiming for the city to become a global crypto hub. But as reported in the FT recently the Monetary Authority has pressed banks to open accounts for crypto exchanges, despite bank concerns regarding financial crime risks (money laundering, fraud, etc). Crypto trading and marketing in Hong Kong has been licensed since 2023, defined in law under the Securities and Futures Ordinance and the Anti-Money Laundering and Counter-Terrorist Financing Ordinance, regulated by the Securities and Futures Commission (SFC). The new licensing regime in Hong Kong will allow retail as well as institutional investors in crypto trading, with the SFC aiming to protect investors with a regulatory framework.
Failed crypto exchange FTX was based in Hong Kong before it moved to the Bahamas in September 2021. The SFC as well as the Monetary Authority were named as creditors to FTX in the bankruptcy documents filed by lawyers for the company. Sam Bankman-Fried, the founder of FTX, has been charged with 13 criminal counts in the US, including wire fraud, money laundering, securities and commodities fraud, allegations of campaign finance violations and conspiracy to commit bank fraud. To recap, FTX collapsed in 2022 after it was publicly revealed that Alameda Research, a quantitative trading firm also operated by Sam Bankman-Fried, held US$5 billion of the FTT token created by FTX (i.e. they were insolvent).
The creation of the crypto trading regulatory regime in Hong Kong could not happen without the approval of the central government in Beijing, which indicates that Hong Kong is being positioned as a ‘near-shore’ hub for crypto currency trading that the Chinese government can more easily monitor and control. In the same way that Macau is allowed to be a hub for casino gambling (illegal elsewhere in China), Hong Kong will become a crypto trading hub. This approach has not worked well in Macau, which has developed into a conduit for money laundering from mainland China and in particular a channel for corrupt officials to move money.
Hong Kong is certainly likely to attract Chinese companies to apply for licenses, but given the availability of licenses in Bahrain, the Bahamas, Dubai, Singapore, South Korea and the US (and an increasing number of other locations), reputable international investors may prefer more established jurisdictions. If Hong Kong becomes a centre for Chinese companies engaged in crypto trading, this may lead to another conduit for capital flow out of mainland China.
The growth of licensed crypto trading opportunities seems likely to continue to boost the price of established crypto currencies such as Bitcoin. Bitcoin is today trading at US$ 30,245. Standard Chartered forecast recently that the value could reach US$ 50,000 this year and US$ 120,000 by the end of 2024. This brings us back to crypto mining. The source code for Bitcoin sets an upper limit of 21 million Bitcoins that can ever be mined, hence with around 19 million Bitcoins already mined there are only another 2 millions of supply to enter the market. The scarcity of Bitcoin indicates that the value will continue to increase as demand drives price upwards.
This raises the question of how far the price can go without too many of the holders of such a costly asset only being able to buy by leveraging themselves with debt. It brings to mind the tulip price in Holland in the mid-1600s which was driven to impossibly high levels by investors using credit to buy the flowers. The fate of failed crypto firm FTX is a warning for investors, and indeed any government that seeks to capitalise on the growth of crypto trading by establishing a licensing regime. Assets should exist and have some tangible basis, otherwise they are likely to become subject to the same fraud and money laundering that Sam Bankman-Fried was sucked into with FTX.