The People’s Bank of China (PBOC) announced in early September that virtual currencies such as Bitcoin were suspected of supporting criminal activities such as illegal fund-raising, financial fraud and pyramid schemes, and implemented an immediate halt to their use. In response, the three biggest Bitcoin exchange platforms in China, BTC China, Huobi.com and OKCoin, have announced that they will stop all trading by the end of September.

The prices of several virtual currencies have plunged since the announcement. Of these, the price of Bitcoin plummeted from 4,550USD (30,000 RMB) to 2,578USD (17,000 RMB).

This strict regulation of the virtual currency trade market imposed by China’s authorities is unprecedented. So what has happened to arouse the concern of the Chinese government and trigger such an uncompromising action?

The Financial Crisis Lurking Behind the Virtual Currency Trade

The fundamental reason for banning virtual currency exchanges is very simple and clear: Virtual currency is not currency at all, but a tool for fraud and speculation. All currencies are legal tenders issued only by the national governments. Virtual currencies are not issued by any government monetary authorities and thus are illegal. They represent no value of actual goods and services, but stealing money from real economy, without any government supervision.

ICO is the acronym of Initial Coin Offering, which originated from the concept of IPO (Initial Public Offering). But in contrast to IPO, ICOs are not stocks but electronic currency tokens, offered on a digital platform called blockchain. ICO projects create virtual currencies such as Bitcoin and Ethereum for investors to exchange for legal currencies like the RMB or USD on virtual currency exchange platforms. At the same time, investors can also buy legal currencies in exchange for ICO tokens on the platforms.

Virtual currency transactions simplify the transaction procedure between individuals and companies, but they also make it much more difficult for supervisory authorities to track the transaction information. This prevents the government and the banks from exerting proper control over capital flows.

ICO projects first began to spread in 2013. At the very beginning, they were only of interest to a small number of digital currency enthusiasts. However, almost 5 years down the line, their coverage has extended to a much larger scale. The rampant growth of the ICO market has been propelled by the surging price of various virtual currencies in recent years, such as Bitcoin, ETH, GXS (Gongxin shares) and ANS (Ant shares).

This year in particular, the transaction price of ETH rocketed from 50USD to nearly 400USD in only 3 months, which ignited a boom in the ICO market. The estimated value of Stratis soared from 1million USD in August last year to over 1billion USD in June this year, giving maximum yield rates of 1,500 times and more.

Fortunes were made overnight, and this kind of staggering profit quickly attracted a swarm of opportunists, which soon dragged the whole business down a dark alley. Most investors in ICO projects cared only about speculation and fast returns, which created enormous financial bubbles in the market, disrupted the normal financial order, and led to a huge hidden financial risk.

All kinds of different ICO investment agencies are now emerging. According to an insider, websites containing “ICO” in their domain names are being squatted, and it is becoming increasingly difficult to register a domain name with ICO in it.

Among these virtual currencies, Bitcoin is the most influential. According to data from the National Committee of Experts on Internet financial Security Technology, the “market value” of Bitcoin now exceeds 50% of the total value of the world’s main virtual currencies.

But as the main instrument of payment for the “black” economy, Bitcoin is now sheltering – and even breeding – a number of criminal activities such as black markets, money laundering and circumventing foreign exchange controls. The biggest digital black market in the world, which had millions of clients, conducted all its transactions in Bitcoin. It was commandeered by the US law enforcement department in 2013. The WannaCry network virus which proliferated in May this year also demanded ransoms in Bitcoin to unlock infected files. Bitcoin is also widely used in illegal asset transfers.

China’s Crazy Bitcoin Gamblers

Bitcoin trade has gradually gained popularity in China in recent years, and Chinese players are becoming an important force driving the Bitcoin market. The trade volume of Bitcoin in China reached 4.58 billion USD (30.17 billion RMB) in July this year, which was 30% of the world volume.

There are now an enormous number of ICO investors in China. They harbor a great passion for speculating in virtual currencies in the hope of making big money. They can even profit by drawing people into Wechat groups to engage in speculation, and earning money from the headcount.

A lot of initiators of ICO projects are no longer using the blockchain platform to tackle real problems in real industries.

Instead operators are flashing the term around their ICO road shows to gain the trust of investors and dupe them with fancy technical jargon. The ultimate aim is simply to defraud their targets out of large sums of money.

This operating model of “swindle people out of their money first, operate projects later” has become commonplace. Overseas ICO projects are shifting their target to Chinese investors too – money from Chinese investors is currently the biggest source of ICO projects in Silicon Valley. It is hardly surprising that this blind and feverish stampede of private Chinese capital has aroused the attention of the Chinese government.

The Chinese Government Is Clamping Down Hard on Virtual Currency Crime

Confronted with the chaos of the ICO market, the Chinese government has made a series of announcements and issued regulations to address the risk. On 4^th?September seven ministries and commissions under the State Council of China classified ICO projects as criminal activities that involve illegal token sales, illegal stock issuance, illegal fund-raising, financial fraud, and pyramid schemes. On 13^th?September the National Internet Finance Association of China issued a risk warning that virtual currencies like Bitcoin are gradually becoming tools for criminal activities like money laundering, drug trafficking, smuggling, and illegal fund-raising, and that all investors should beware of them. On 14^th?September, one of China’s biggest Bitcoin exchange platforms, BTC China, became the first company to announce that it would close its registration window and stop all trading by 30^th?September.

Strengthening Regulation and Oversight on Virtual Currency

Although different countries have different oversight methods and mechanisms, there is a universal trend towards enhancing controls over virtual currencies. Korea, as one of the world’s biggest sources of digital currency transactions, has stated that it will reinforce scrutiny over digital currencies such as Bitcoin and carry out investigations into money laundering, illegal financing and other illegal trades involving digital currencies.

The self-regulatory organization for the financial industry in the US has set up a panel of financial technology experts to assess the credibility of ICO projects and to issue certification. In the future, only certified bodies will be authorized to participate in token sales. Japan revised the Act on Prevention of Transfer of Proceeds from Crimes?in April this year, increasing the level of oversight on Bitcoin account holders, their sources of capital, and their transaction details.

The Chinese government will study the trends and regulation experiences in other countries, so as to strengthen and consummate the complete supervision regime on currency exchanges, to help control all the financial risks and secure a safe, sound environment for the sustainable economic growth over time.

（Liu Dian Assistant Research Fellow, Chongyang Institute for Financial Studies, Renmin University of China

Chen Xinran Intern, Chongyang Institute for Financial Studies, Renmin University of China）