The Wall Street Journal: Laundromats and VPNs are key to China's underground crypto trading

Author: The Wall Street Journal

Compiled by: Ning, Tuo Luo Finance

According to The Wall Street Journal, some small and medium-sized investors from China are using an underground network of brokers and intermediaries to circumvent strict regulations on cryptocurrency trading in their country.

China is one of the countries with the strictest regulations on cryptocurrencies in the world. Since 2021, the Chinese government has comprehensively banned cryptocurrency trading, with regulatory measures continuously escalating, including a series of actions against some industry giants, involving detentions and fines. Against this backdrop, major Chinese cryptocurrency exchanges, including Binance, have turned to overseas operations before the trading ban, marking the culmination of years of crackdowns.

However, cryptocurrency trading remains prevalent in mainland China, with traders employing techniques such as location masking, lax exchange regulations, and secret meetings in cafes and other public places to attempt to bypass relevant regulations.

Data from blockchain analysis firm Chainalysis shows that between July 2022 and June 2023, Chinese traders generated a net cash flow of $86 billion from cryptocurrency activities. In just one month last year, they conducted approximately $90 billion in transactions on Binance, the world's largest cryptocurrency exchange. The fact that cryptocurrency traders in the country have successfully circumvented regulations indicates that global regulators, including those in the United States, will find it difficult to regulate the industry.

"The regulatory challenge is significant. China has over a billion people, and the large population makes it hard for regulators to know what they are buying," said Bobby Lee, founder of cryptocurrency storage service Ballet.

Many users in China still have accounts with overseas cryptocurrency exchanges, which are often created and used by traders before the trading ban. According to insiders, they can access their accounts through virtual private networks (VPNs), which allow internet users to mask their locations. Some have also stated that even without using a VPN, a significant portion of cryptocurrency traders in China can access wallet accounts.

In response to the policy, many exchanges, including Bybit, KuCoin, and Gate.io, currently do not allow users from mainland China to open accounts. However, some exchanges are flouting the rules; although they publicly claim to have closed accounts for mainland China, they are secretly seeking other ways to connect. For example, the exchange HTX has created a nationality program called Digital Citizen, allowing users to select other nationalities when opening accounts.

According to insiders, traders with demand for Bitcoin, Tether, or other cryptocurrencies often use social media apps like WeChat and Telegram to connect buyers and sellers in dedicated groups after being introduced by friends, thus facilitating trades without the need for an exchange.

Additionally, Chinese cryptocurrency traders also employ some traditional methods to bypass restrictions and rules. Insiders say these methods are more direct P2P transactions, primarily involving in-person meetings in public places to exchange cryptocurrency wallet addresses. Traders can choose from three methods for transactions: exchanging cryptocurrencies, cash payments, or arranging bank transfers.

Insiders indicate that physical transactions are particularly popular in inland China, such as Chengdu and Yunnan. Local governments in cities away from the coast focus more on people's livelihoods or other social issues, resulting in relatively lax enforcement in the cryptocurrency sector. Some areas were once hotspots for cryptocurrency mining operations.

Cryptocurrency traders in these cities can go to laundromats, cafes, snack shops, or restaurants to conduct transactions with shop owners or other customers. Some traders find crypto merchants through peer-to-peer services on cryptocurrency exchanges, while others rely on referrals from acquaintances, spreading the word through word of mouth.

"In the past, users would look for intermediaries in back alleys and then hand cash to traders in exchange for goods that they wanted but were not used for legitimate purposes. Now, with the backing of cryptocurrency, you just need to go to a café and exchange details of a USB drive or wallet. It's much more convenient and simpler than carrying a bag of cash," said Ben Charoenwong, an assistant professor of finance at the National University of Singapore.

In fact, the Chinese government has implemented strict capital controls on foreign exchange transactions due to concerns about currency stability and financial security, and cryptocurrencies, as non-sovereign currencies, have had some impact on sovereign currencies. Banks stipulate that, without special needs, Chinese citizens can exchange no more than $50,000 in foreign currency per year. Cryptocurrency executive Lee believes that foreign exchange control measures have, to some extent, increased the demand for cryptocurrency assets.

At the end of December, Chinese authorities announced detailed information on cracking down on illegal cross-border capital flows, with a focus on the use of cryptocurrencies. China's top prosecutorial agency and foreign exchange regulators outlined eight typical cases of such crimes, two of which involved exchanges between the renminbi, Tether, and foreign currencies.

"Speculating on virtual currencies like Bitcoin disrupts economic and financial order and seriously endangers public property safety. There is a broad consensus across society on its harmfulness," a spokesperson stated, noting that the number of crypto transactions is showing a significant downward trend.

According to industry insiders, when Chinese police track bank accounts suspected of money laundering or financial crimes, if the funds in those accounts trace back to cryptocurrencies, they often take freezing actions. The Ministry of Finance stated in October that it had discovered a crime network based in China that supplied chemicals used to manufacture fentanyl and other drugs. It emphasized that these chemical suppliers typically use virtual currencies for payments to evade tracking.

Chinese investors were once a dominant force in cryptocurrency trading. According to a study by scholars Conghui Chen and Lanlan Liu, before the Chinese government ordered the closure of exchanges in 2017, the renminbi was the most popular fiat currency in Bitcoin trading.

Despite maintaining a high level of vigilance towards cryptocurrencies, China still allows the use of blockchain and the sale of digital collectibles, which is similar to NFTs. Additionally, central bank digital currency is developing rapidly in China.

However, the blockchain allowed by the Chinese government is a private blockchain, not a public, decentralized ledger that supports cryptocurrencies. Chinese companies are using consortium blockchains for purposes such as food traceability and luxury goods authentication, and consortium blockchains are also used outside of China. A spokesperson for the People's Bank of China stated that regulators encourage the use of blockchain technology in the financial sector, including supply chain payments, trade financing, and credit reporting.

In 2021, the Chinese government intensified its crackdown on cryptocurrency mining. Data from the Cambridge Centre for Alternative Finance shows that in 2019, China's Bitcoin mining accounted for about three-quarters of the global total, but by early 2022, this proportion had dropped to around one-fifth. Alexander Neumüller, chief researcher on the climate impact of digital assets at the center, stated that this proportion has significantly decreased again.

In addition to using VPNs and secret locations, Chinese cryptocurrency companies and traders have also begun to turn to Hong Kong for trading. However, overseas experts believe that Hong Kong, as an offshore market, will not have an impact on mainland China.

Justin d'Anethan, the director of institutional sales at Amber Group, stated in a March interview, "Although there have always been rumors in the market that China might relax its stance on cryptocurrencies, so far, we have not seen any signs of that."

Even before China officially banned cryptocurrency trading, government officials had sounded the alarm. Senior Communist Party official Pan Gongsheng has been a staunch opponent of cryptocurrencies. In 2017, he warned attendees at a public event by quoting French economist Éric Pichet's analysis: "The time of market irrationality can be long enough to bankrupt you, so just sitting by the river, one day the corpse of Bitcoin will float by you."

Last year, Pan Gongsheng was appointed as the head of the People's Bank of China, which is one of the most important regulatory bodies for cryptocurrencies in China.