Bitcoin – Migration from China to Hong Kong – Part Nine

by Dorsey & Whitney LLP
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“Virtual currencies” in general, and bitcoin in particular, continue to attract frenzied media attention coupled with immense public and regulatory scrutiny as an ever increasing number of countries review and clarify their stance regarding its legality and overarching regulatory paradigm. The regulators seem to realize that the bitcoin genie is out of the bottle, with an intention to stay and whilst the currency may be virtual, the associated implications for the national and global economy are tangible and far reaching. A result of such realization is, as always, regulations.

Back in 2013, increasing interest from China’s investors and technology community pushed the bitcoin prices and popularity to their peak. Since December 2013, however, due to the efforts of the People’s Bank of China (PBOC) to curb the use of bitcoin in China, bitcoin prices were driven to fluctuate accompanied by a drop in overall activity in the global bitcoin market. If the PBOC continues to restrict bitcoin transactions, Hong Kong is likely to reach for the low hanging fruit and attract, absorb and assimilate chunks of the huge erstwhile Chinese market.

This eUpdate is the ninth part in a series of eUpdates on bitcoin-related topics. The first part of the series described what bitcoin is. The second part explained the legal status of bitcoin and how it is approached in different countries. The third part analyzed the effects of the Chinese demand on bitcoin, as well as how bitcoin is approached in China. The fourth part analyzed risks which virtual currency users may encounter. The fifth part discussed further steps taken by the Chinese government towards regulating virtual currencies and their impact on the bitcoin market. The sixth part discussed continuing concerns about bitcoin and updated on developments in the bitcoin market. The seventh part discussed Mt. Gox’s demise and its effect on the bitcoin market. The eighth part described intensified calls for government authorities around the world to start regulating virtual currencies and responses to such calls.

Restrictions in China

The bitcoin market remains both volatile and vulnerable. While the United States and some other countries took measures to investigate and regulate bitcoin, without restricting its use by trying to fit it into the existing regulatory frameworks, the approach of Chinese authorities towards bitcoin turned out to be more contentious,1 skeptical, and ultimately quasi-prohibitory.

Bitcoin’s surging rise in China came to an abrupt halt on December 5, 2013, when the PBOC issued a notice prohibiting financial institutions from dealing in bitcoin in order to “protect the status of the renminbi as the statutory currency, prevent risks of money laundering, and protect financial stability.”2 On December 16, 2013, the PBOC ordered its largest third-party payment processing companies, including Alibaba’s Alipay, to halt transactions in virtual currencies by January 31, 2014. Two days after, BTC China was forced to stop accepting renminbi-denominated deposits, thereby effectively prohibiting new purchases of bitcoins within China. The effects of BTC China’s closure devastated the market: bitcoin prices in China plunged by more than 50% from its peak on December 1, 2013.3

While a run-on-the-bank was feared and considered imminent, BTC China and other Chinese bitcoin exchanges were able to continue trading by exploiting a loophole, which enabled them to circumvent payment processing companies and accept payments directly in their corporate bank accounts.4 By March 27, 2014, however, the PBOC appeared to have found a way to close the loophole by “requiring banks and payment companies to close all the accounts opened by the operators of websites that trade in the virtual currency by April 15, 2014.”5 The PBOC’s proclamation reportedly listed fifteen trading websites whose accounts were to be closed.6 The PBOC’s restrictions were first published by Caixin, a Chinese financial publication, but could not be independently verified. In fact, none of China’s three largest bitcoin exchanges said they received any official notification from the PBOC, which reflects the tendency of Chinese authorities to issue “private verbal warnings” to parties involved with bitcoin without explicitly and publicly banning it, as noted in some reports.7 On April 10, 2014, however, some Chinese exchanges were informed by their local bank branches and financial partners, but not by the PBOC directly, that their business accounts would be frozen. Following the closures of these exchanges, bitcoin prices dropped 10% overnight.8

The PBOC’s March 27, 2014 restrictions were perceived by some as a death knell to the Chinese and global bitcoin market by extension. The restrictions forced virtual currency trading websites in China to close, or to seek moving their servers abroad, relying on foreign bank accounts and payment companies. Following the announcement of the restrictions, global bitcoin prices tumbled yet again, falling 7.77% by the end of the day.9

Despite the regulatory confusion, in mid-April 2014 BTC China managed to install China’s first bitcoin ATM in Shanghai, which allowed customers to buy bitcoin directly from the exchange with renminbi, as well as an online application, which allowed customers to buy and sell bitcoins using mobile phones, thereby skirting the PBOC’s restrictions.10

Rumors and unofficial announcements of the PBOC’s restrictions on bitcoin continued to circulate through the end of April 2014, partially in anticipation of China’s Global Bitcoin Summit (the “Summit”) held from May 10 to 11, 2014 in Beijing.11 On April 25, 2014 Caixin reported that the PBOC’s officials “specifically criticized various commercial banks for continuing to do business with BTC China” and other bitcoin businesses during a closed-door meeting, prompting China Merchants Bank to issue a notice requiring all customers engaged in bitcoin transactions to close their accounts.12 The announcement forced BTC China to suspend renminbi crediting of customer accounts, causing the international bitcoin price to drop by US$40 overnight.13 Most Chinese exchanges have subsequently closed their bank accounts in the face of “unprecedented pressure” from the central bank.14

On May 6, 2014 China’s three largest exchanges (BTC China, OKCoin, and Huobi.com) collectively decided to pull out of the Summit “in light of the perceived clampdown of the central bank.”15 At the same time, paying homage to the popularity of this virtual currency, several hundred people defied China’s central government’s bitcoin crackdown by attending the Summit.

The attitude of China’s regulators towards bitcoin appeared to be rather ambiguous.16 While the PBOC seemed to pressure banks and bitcoin companies behind closed doors, its officials claimed that China cannot ban bitcoin.17 The closures of several bitcoin exchanges in late April 2014 may suggest that Chinese banks and bitcoin exchanges are beginning to heed the PBOC’s orders. Others within the bitcoin community still believe that “attempts by Chinese authorities to steer bitcoin legitimacy” cannot succeed because “bitcoin’s legitimacy derives from its market adoption and continued usage among its participants,” not political institutions.18 Until the PBOC adopts an official policy towards bitcoin, ongoing rumors of regulation may continue to affect the global bitcoin market.

Growth in Hong Kong

Many Chinese bitcoin entrepreneurs escaping regulatory restrictions in China landed in Hong Kong, where a clearer and less restrictive operating environment led to the adoption of bitcoin vending machines and ATMs, offering growing opportunities to potential investors. Whereas the PBOC acted to thwart bitcoin use in China, Hong Kong is well positioned to become a global hub for bitcoin entrepreneurs and businesses. According to the Hong Kong Monetary Authority, bitcoin is a virtual commodity, not a currency. As such, while Hong Kong can punish illegal acts such as theft, fraud, and money laundering involving bitcoin, it does not regulate the “virtual commodity” as it “doesn’t meet the criteria of a means of payment or an electronic currency.”19

Hong Kong’s “hands-off” regulatory approach fostered a user-friendly environment for bitcoin. In late February 2014, Asia Nexgen (ANXBTC), Hong Kong’s largest bitcoin exchange, opened the world’s first over-the-counter bitcoin store in Hong Kong.20 Both ANXBTC and the Bitcoin Group Hong Kong set up bitcoin ATMs, which function like vending machines. A third company, Alitobit, announced its plans to open three additional bitcoin ATMs in Hong Kong in April 2014. Not only can Hong Kong’s nearly 10,000 investors easily buy, sell, and deposit bitcoins, but they also have access to more than 20 merchants who accept bitcoin.21

With Chinese regulators threatening to eradicate, eliminate and penalize the use of virtual currencies, the general perception in the Hong Kong business community is that “Hong Kong has the potential to absorb part of China’s bitcoin market.”22 In fact, after the PBOC ordered banks and financial institutions to stop dealing in bitcoin in December 2013, the number of Chinese customers of Hong Kong-based exchange BitCashOut doubled.23 China’s large bitcoin exchange, Huobi, is reportedly considering shifting its operations abroad to protect its customers. “We are trying to create an offshore account and to go international,” said Leon Li, founder and chief executive of the Beijing-based trading platform, and added “We don’t want to touch the customers’ money in China, because maybe [regulation] is going to get worse.”24

At present, however, Hong Kong’s trade volume is miniscule compared to that of BTC China and BTC-e, the top bitcoin exchanges by volume. On average, China’s two largest bitcoin exchanges, Huobi and BTC China, saw 120 times more trade volume than ANXBTC in April 2014.25 Moreover, as the Chinese market remained relatively unfazed following the PBOC’s latest restrictions, it is not yet evident that Chinese users have started shifting to Hong Kong.26

Hong Kong’s bitcoin market may see a huge bump in volume if China’s bitcoin millionaires decide to move their funds to Hong Kong’s exchanges. Li Xiaolai, regarded as the most well-known figure in the Chinese bitcoin world, admitted that his bitcoin holdings numbered six figures.27 At bitcoin’s peak pricing in November 2013,28 Li Xiaolai would have held at least US$116.7 million worth of bitcoin.

If the Chinese government’s clampdown continues as expected, major bitcoin investors in China are likely to “naturally look at Hong Kong—not Singapore, not Korea—for substitution,” says David Shin, a Hong Kong investment banker and bitcoin advocate.29

Undoubtedly, bitcoin’s unique status as a virtual currency and an effective peer-to-peer payment system that is completely decentralized and free from regulation or back up by any central banking institution, makes it both controversial and attractive at the same time.

We, as always, will keep tracking the major developments in the bitcoin regulatory landscape and bitcoin market.

1   http://origin.www.uscc.gov/sites/default/files/Research/USCC%20Economic%20Issue%20Brief%20-%20Bitcoin%20-%2005%2012%2014.pdf
2   http://www.nytimes.com/2013/12/06/business/international/china-bars-banks-from-using-bitcoin.html
3   http://www.nytimes.com/2013/12/19/business/international/china-bitcoin-exchange-ends-renminbi-deposits.html
4   http://origin.www.uscc.gov/sites/default/files/Research/USCC%20Economic%20Issue%20Brief%20-%20Bitcoin%20-%2005%2012%2014.pdf
5   http://english.caixin.com/2014-03-27/100657518.html
6   http://english.caixin.com/2014-03-27/100657518.html
7   http://online.wsj.com/news/articles/SB10001424052702304688104579465291947128528; http://www.coindesk.com/bitcoin-price-drops-40-following-reports-new-pboc-warnings/  
8   http://blogs.wsj.com/moneybeat/2014/04/10/bitcoin-prices-down-10-after-chinese-banks-cut-off-local-exchanges/
9   http://online.wsj.com/news/articles/SB10001424052702304688104579465291947128528
10  http://www.reuters.com/article/2014/04/16/china-bitcoin-idUSL3N0N80HP20140416; http://english.people.com.cn/business/8600577.html  
11  http://www.coindesk.com/chinas-bitcoin-ecosystem-undeterred-by-fxbtc-exchange-closure/
12  http://blogs.wsj.com/moneybeat/2014/04/25/bitbeat-china-dings-bitcoin-again/; http://www.coindesk.com/btc-china-halts-rmb-withdrawals/  
13  http://www.coindesk.com/btc-china-halts-rmb-withdrawals/
14  http://www.coindesk.com/chinas-bitcoin-ecosystem-undeterred-by-fxbtc-exchange-closure/; https://coinreport.net/bank-of-china-warns-bitcoin-reacts/  
15  Bobby Lee, CEO of BTC China; see http://www.bloomberg.com/news/2014-05-06/china-s-bitcoin-exchanges-pull-out-of-summit-after-pboc.html  
16  http://origin.www.uscc.gov/sites/default/files/Research/USCC%20Economic%20Issue%20Brief%20-%20Bitcoin%20-%2005%2012%2014.pdf
17  The PBOC has not released an official statement on bitcoin since December 3, 2013, https://vip.btcchina.com/page/bocnotice2013  
18  http://www.coindesk.com/bitcoin-adoption-chinas-central-bank-underlies-legitimacy/
19  http://www.bloomberg.com/news/2014-01-06/robocoin-s-bitcoin-teller-machine-won-t-need-hong-kong-approval.html; http://www.info.gov.hk/gia/general/201403/14/P201403140751_print.htm  
20  http://dealbook.nytimes.com/2014/03/19/in-hong-kong-betting-big-on-bitcoin/
21  http://www.scmp.com/news/hong-kong/article/1448009/three-companies-set-launch-bitcoin-atms-hong-kong-within-days
22  Michael Chau, business professor of the University of Hong Kong; see http://dealbook.nytimes.com/2014/03/19/in-hong-kong-betting-big-on-bitcoin/  
23  http://dealbook.nytimes.com/2014/03/19/in-hong-kong-betting-big-on-bitcoin/
24  http://www.scmp.com/news/hong-kong/article/1510452/china-bitcoin-businesses-plot-escape-beijing-crackdown-PBOC
25  http://data.bitcoinity.org/markets/volume/30d?c=e&t=a&volume_unit=btc
26  http://origin.www.uscc.gov/sites/default/files/Research/USCC%20Economic%20Issue%20Brief%20-%20Bitcoin%20-%2005%2012%2014.pdf
27  http://www.danwei.com/li-xiaolai-bitcoin-millionaire/
28  According to BitcoinCharts.org, the price of renminbi-denominated bitcoin peaked on November 29, 2013 at US$1,167.95.
29  http://dealbook.nytimes.com/2014/03/19/in-hong-kong-betting-big-on-bitcoin/

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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