Chinese cryptocurrency traders are looking for ways to circumvent the ban

Ray thinks he's a loner. While many Chinese are closing their digital wallets after Beijing banned cryptocurrency investments, he is determined to keep going.

Ray has already received a notice from his cryptocurrency exchange that his account will be closed by the end of the year. But he said: “I am now considering opening an account on a decentralized exchange.”

China's campaign against cryptocurrencies led authorities to shut down Bitcoin mining operations in May. This coincided with the emergence of decentralized finance, or DeFi, which allows users to trade with each other without an intermediary like a bank or broker and makes it harder to block.

“I still trade crypto regularly,” said a Chinese investor with a bank account abroad. “How can authorities stop me when the industry has evolved to evade central control?”

While the strictest enforcement against cryptocurrencies occurred in September, China first banned crypto exchanges in 2017 and Chinese users are gradually moving towards DeFi.

According to Chainalysis, a research firm, China's share of global Bitcoin transactions peaked at 15 percent in November 2019 and had fallen to 5 percent in June 2021.

In the 12 months to June, mainland China saw $256 billion in cryptocurrency activity, the highest in Asia, and 49 percent of the total volume was traded on DeFi platforms. Uniswap, one of the leading DeFi exchanges, is now the second largest exchange in East Asia by transaction volume, Chainalysis said.

While recent restrictions discourage new blood from entering crypto markets, some existing cryptocurrency holders are turning to DeFi to continue trading, according to experts.

“Most trading is halted because of the ban,” said Deng Jianpeng, director of the Finance, Science and Technology Research Center at the Central University of Finance and Economics in Beijing. “But there will always be some people who will try to find new ways to invest, for example through a foreign platform or through decentralized exchanges.”

DeFi protocols do not have the same “know your customer” obligations as the more regulated conventional exchanges. Henri Arslanian, PwC crypto leader and partner, said that the use of DeFi “may be banned in China, but in practice it is very difficult to monitor” because it offers users anonymity.

Miha Grčar, head of global business development at Kraken, a major exchange, said DeFi is a “bit of a Wild West in crypto.” He added that governments are thinking about how to regulate this, for example by requiring some form of user identification.

In an interview with the Financial Times, US Securities and Exchange Commission Chairman Gary Gensler warned that regulators want more authority over DeFi platforms.

“Many Chinese people are now studying how to use DeFi, but there is uncertainty here too as the US government tries to tighten controls,” said Colin Wu, an independent journalist who runs the popular Twitter channel Wu Blockchain.

In an interview with the Financial Times, US Securities and Exchange Commission Chairman Gary Gensler warned that regulators want more authority over DeFi platforms.

“Many Chinese people are now studying how to use DeFi, but there is uncertainty here too as the US government tries to tighten controls,” said Colin Wu, an independent journalist who runs the popular Twitter channel Wu Blockchain.

Chainanlysis found that countries like the US, China, Vietnam and the UK are playing an outsized role in DeFi with historically large institutional investors armed with large crypto wallets.

Large crypto asset owners are attracted to DeFi because it allows them to earn income from their coins. Users lend their crypto to DeFi protocols to provide liquidity pools for peer-to-peer lending. In return, investors receive a portion of the transaction fee or token rewards.

However, Chinese investors cannot transfer profits from DeFi protocols to Chinese bank accounts. “The government is cutting the connection between cryptocurrency and fiat currency,” said Zee Zheng, founder and CEO of SpaceChain, a company focused on space applications for blockchain technology. Zheng, a Chinese entrepreneur, moved to crypto-friendly Singapore four years ago.

This is not a problem for wealthy Chinese as long as they can transfer crypto profits to foreign bank accounts and bypass capital control limits.

Several posts on the 51 Bitcoin Forum — one of the informal crypto blogs that have popped up since Chinese social media sites began censoring content about cryptocurrencies — recommend investors register a foreign company and apply for a corporate trading account. Another user provided a list of UK and US financial institutions that allow China residents to open bank accounts to transfer profits from crypto investments into fiat currency.

But for many, the extra steps required to invest in digital currencies aren't worth the hassle. Zheng said: "The government is not going after the 1 percent who trade on the sidelines. For them, it is enough that the restrictions are strict enough to stop the 99 percent trading."