China and the Shadow Crypto Market

In September 2021, China implemented a sweeping ban on all cryptocurrency activities, including exchange, trading, and any form of transactional use. This move was part of a broader strategy to control financial flows and mitigate economic risks. Yet, despite  these strict measures, reports in September 2024 revealed that over $75 billion in cryptocurrency transactions flowed through Chinese over-the-counter (OTC) brokers in the past year – a staggering amount for a supposedly prohibited market. 

Let's explore why China’s underground cryptocurrency business continues to thrive and where these funds are coming from.

China’s Crypto Journey

The history of cryptocurrency in China is an interesting tale. It was one of the earliest countries to recognize the potential of cryptocurrency, embracing it with relatively little fear or hesitation. Known for its rapid adoption of technological advances, China quickly took note of Bitcoin's inception in 2008. The country's first crypto exchange, BTC China, was launched just three years later in 2011. 

However, as the crypto market grew, the Chinese government began to see the risks associated with these currencies, including potential uses in money laundering. As a result, in 2017, China introduced its first set of crypto-related restrictions, targeting initial coin offerings (ICOs) and exchanges. Control measures increased year by year, culminating in the 2021 ban on all crypto transactions. Yet, this did little to curb the growth of an underground crypto market.

Many investors and traders continued to seek ways to bypass the ban, fueling the rise of OTC platforms and anonymous transactions. Ironically, these restrictions only deepened China's crypto market interest, with the ban unintentionally spurring the growth of a shadow economy that still impacts the national economy.

The Rise of Bitcoin Mining in China

In early 2021, China held a commanding 72% of the global average monthly Bitcoin hashrate. The country’s favorable business environment and low fees attracted many crypto miners, positioning China as a hub for cryptocurrency activities. However, in May 2021, the Chinese State Council announced a crackdown on Bitcoin mining, marking a turning point for the industry.

New restrictions in various regions disrupted business, and some companies ceased customer support altogether, creating additional hurdles for traders and investors. The Chinese central bank's official announcement on September 24, 2021, went further, declaring all cryptocurrency-related activities illegal. This extended the ban to mining, purchasing, selling, exchanging, storing, and even transferring crypto assets.

This action raises a critical question: why would China ban an industry that once bolstered its economy and strengthened its global influence? The answer lay in the government’s fear that the rising popularity of cryptocurrencies could destabilize China’s official currency during a crucial period of economic expansion. Officials worried that the growth of crypto assets could lead to capital flight and weaken financial controls.

While these reasons resonated with some, SimpleSwap analysts delved deeper into the government’s true motives, examining the economic and financial stability challenges posed by cryptocurrencies.

Why Did China Ban Cryptocurrencies?

The government’s decision stemmed from three primary concerns.

• Cryptocurrencies as a threat to the Digital Yuan

In 2021, China was actively promoting its own central bank digital currency, the digital yuan, which was in the experimental stage. Supporting this new official payment method and eliminating competitors made strategic sense. Officials argued that virtual currencies lacked intrinsic value, highlighting their intent to position the digital yuan as a secure, state-controlled alternative.

• Environmental concerns

The Chinese government also aimed to improve its environmental impact, particularly given global efforts to combat climate change. Cryptocurrency mining, especially for Bitcoin, consumes massive energy resources, often relying on coal-based power, which harms the environment. The crypto ban aligned with China’s broader environmental agenda, aimed at reducing the carbon footprint and promoting sustainable energy. 

President Xi Jinping had previously announced a target for China to reach peak carbon emissions by 2030 and achieve carbon neutrality by 2060. However, the energy-intensive nature of blockchain technology threatened these goals, as crypto mining alone could have contributed an additional 130 million tons of carbon emissions – an unacceptable amount for a nation striving to improve its environmental record.

• Cryptocurrencies undermining China’s financial system

Chinese authorities feared that crypto transactions could facilitate money outflows from the country, including illicit funds. Allowing cryptocurrencies to flourish could have emboldened fraudsters and enabled money laundering, undermining the state’s efforts to strengthen financial transparency and control. In the face of these challenges, cryptocurrencies posed significant risks to the stability and credibility of official financial institutions.

The Growth of China’s Underground Crypto Market

Despite the bans, many users continued to participate in cryptocurrency trading, fueling the growth of a shadow crypto market. This underground economy attracted unscrupulous players, adding to the government's security and control challenges. Consequently, the government recognized the need for stricter oversight and regulatory frameworks to safeguard its economy and citizens.

As China withdrew from the cryptocurrency scene, the U.S., Kazakhstan, and Russia emerged as leaders in crypto mining. However, there was also an uptick in “gray market” activity within China, with suspicions that OTC brokers were using regulatory loopholes to conduct transactions.

By 2024, Bloomberg reported that Chinese crypto brokers had handled over $75 billion in transactions, as per data from Chainalysis. Approximately 55% of these transfers involved amounts exceeding $1 million, signaling robust activity from large market players. Despite the government’s attempts to trace these transactions, it has not been able to curb crypto dealings, which are now facilitated by both individuals and international companies using cryptocurrencies for cross-border transfers. This has added complexities to government oversight and financial regulation.

Conclusion

China’s exit from the cryptocurrency market reshaped the global crypto landscape and created new challenges for regulators striving to control crypto-related risks. Although the crypto ban was based on valid concerns, it has not fully isolated China from this sector. Cryptocurrency mining and trading continue unofficially, contributing to environmental harm and gradually diminishing the government’s authority, as some entrepreneurs have found ways to bypass regulations. 

As Chinese regulators grapple with these evolving issues, the effectiveness of their measures remains in question. Stricter policies may yet emerge, mirroring aggressive approaches seen in places like the U.S. Securities and Exchange Commission (SEC). However, any such measures could drive further growth in the shadow economy and amplify unregulated activity, making financial oversight increasingly challenging. 

SimpleSwap reminds you that this article is provided for informational purposes only and does not provide investment advice. All purchases and cryptocurrency investments are your own responsibility.