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China's attempt to control the domestic encryption industry through a ban may have a similar impact on the use of digital currencies in the country-Photo: Shutterstock
The global Bitcoin mining industry has recovered from the ban imposed by the Chinese authorities in May, when this East Asian country accounted for about half of global output.
Data released by Blockchain.com on Friday showed that since the Chinese authorities imposed the ban, the hash rate used to measure Bitcoin's total computing power has increased by 113%.
It seems that the Chinese authorities tried to control the domestic cryptocurrency industry by banning the use of cryptocurrencies in September, which may have a similar impact on the use of digital currencies in their borders.
Instead, activities are shifting to the DeFi field.
The term "DeFi" refers to decentralized applications that do not rely on centralized intermediaries to provide financial services, most of which are built on the Ethereum blockchain.
So-called smart contracts (a binding commercial agreement between two parties created in autonomous code) automatically execute transactions when certain conditions are met.
Anshu Siripurapu, an economics expert at the U.S. Council on Foreign Relations, explained that the rapid rise of DeFi companies means that billions of dollars of transactions are now taking place in a relatively unregulated area, raising concerns about fraud, tax evasion, and cybersecurity, and Broader financial stability.
This has forced regulators to begin to formulate rules for emerging industries, but it is challenging to formulate rules that limit traditional financial risks without stifling innovation.
Maps showing markets where cryptocurrencies are restricted or banned are almost entirely dominated by Asia, such as Russia, Bangladesh, and China. China has also severely cracked down on public decentralized chains because they used initial coin offerings.
However, the Shanghai government invested in the blockchain company Conflux in January, which some observers interpreted as China's attempt to build its own version of DeFi and limit the amount of capital flowing out of the country.
Conflux, which claims to be the only public blockchain in China that meets regulations, has received more than US$5 million in research funding from the Shanghai Municipal Science and Technology Commission and the Xuhui District Government.
In September, Shanghai Digital Map Blockchain Research Institute (a joint venture between Conflux and Shanghai Maritime University) announced that it will test offshore RMB stablecoins in the Lingang Special Zone of the China (Shanghai) Pilot Free Trade Zone.
Chinese banks are also seeking to participate. A subsidiary of China Merchants Bank launched a US$50 million fund that will invest in the development of DeFi and blockchain-related products in cooperation with public blockchain developer Nervos in the early and growth stages Startups.
According to Chainalysis's 2021 Global DeFi Adoption Index, China ranks fourth, second only to the United States, Vietnam, and Thailand. It is one of the markets with the largest DeFi transaction volume, receiving 256 billion RMB from July 2020 to June 2021. Almost half (49%) of U.S. dollar cryptocurrencies have switched to the DeFi protocol.
At this point, many Chinese users seem to be waiting for what will happen after Huobi reaches the end of December, when it says it will close the accounts of Chinese users.
Many of these users are being dispersed to secondary exchanges that do not enforce rules, although larger exchanges also benefit from this migration.
Vice President Ben Yorke said that because the regulations for Chinese users living abroad are not particularly clear, some centralized financial (CeFi) platforms use this loophole to allow Chinese people to customize, even though they stated that users from mainland China are not allowed to DeFi platform liquidity network WOO Network.
“Wallets like Tokenpocket, ONTO Wallet, and Math Wallet provide part of decentralized applications that allow Chinese users to have a closed DeFi experience, which undoubtedly brings people into this field,” he said.
“Currently, only true advanced users are using mainstream protocols, but as people become more experienced and CeFi regulations tighten, this situation may change in 2022. Some of the wealthiest exchanges, venture capitalists, Both the project and the miners are Chinese, so it is impossible to ignore these communities when shaping the future of DeFi."
Zennon Kapron, managing director of Kapronasia, an Asian financial technology strategy consulting company, said that China's cryptocurrencies, including Bitcoin, have largely solved non-existent problems.
"Although China's financial industry is not as mature as many other countries in the world, it has rapidly modernized.
"Digital payments are ubiquitous, and financial services are also turning to online to a large extent. However, DeFi has the potential to solve some of the gaps in China's financial industry, especially in terms of loans and financial inclusion."
Zhong Anqi, a senior lecturer in finance at the RMIT School of Economics, agrees and believes that China's suppression of centralized exchanges has intensified the explosive growth of DeFi.
"This can also be seen from the increase in transaction value in the DeFi ecosystem," she added.
Robert Le, a senior emerging technology analyst at financial data provider PitchBook, warned that Chinese citizens continue to use DeFi services at risk.
"The government can find a way to cut off access, which will result in a loss of funds/assets," he said.
As previously reported by Capital.com, China's level of centralized control makes it a reality for the country's government to exercise control over the use of its domestic decentralized financial platforms.
Le believes that any DeFi regulatory framework in China may address issues such as developer responsibility, KYC (know your customer) and anti-money laundering legislation compliance requirements, and intergovernmental cooperation.
If they believe that these requirements have not been met, he suggested that the Chinese authorities can block access to DeFi by using a firewall to restrict access to domestic wallets.
But this does not mean that regulators will find it easy to supervise Chinese DeFi companies. Due to the nature of the decentralized platform it runs, it has always been challenging to regulate cryptocurrency and DeFi.
Governments and regulators tend to focus on the parts they can control, such as restricting the services that banks can provide to cryptocurrency exchanges.
"However, as more and more value is transferred to the DeFi platform, it will be more difficult for regulators to control this industry because everything will happen in a decentralized network," Kapron said.
"Once the digital renminbi is fully launched, China may have a slight advantage in regulating DeFi, but it will face many of the same challenges," he added.
Yorke observed that regulation can only be done at the exchange level, and stated that the goal is not to completely eradicate the industry, but only to prevent it from disrupting society through fraud, money laundering and rampant speculation.
"This goal has basically been achieved. With the appointment of the 2022 Olympic Games and the Politburo, I doubt whether the elimination of DeFi will occupy an important place on China's priority list," he said.
The question remains how likely it is for the Chinese government to build its own decentralized financial network.
The challenge for DeFi regulators and the government is the ability to track transactions and intervene when necessary. In theory, the controllability of the digital renminbi will enable the Chinese government to have a deeper understanding of DeFi transactions.
"Based on the digital renminbi, people can see a potentially very powerful DeFi infrastructure in China, which not only allows the government to understand what is happening, but also allows third-party participants to solve many of the shortcomings of the current financial market. The system, For example, individuals and SMEs (small and medium enterprises) lack credit," Kapron said.
Yorke said that China will launch something similar to a decentralized network in the next ten years, possibly in the form of an automated layer using licensed smart contracts, although this is very different from what we usually refer to as mainstream crypto assets.
But Zhong still needs to be convinced. "I don't think this will happen," she said. "The Chinese government is highly centralized in all aspects. Even if it has its own digital currency, it is unlikely to have anything decentralized."
Le is also skeptical, referring to the Chinese authorities' preference for centralization.
"For this reason, we can expect the government to build more financial infrastructure so that it can better control and understand its financial system," he concluded. "China's ambition to establish a central bank digital currency is proof."
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