The Breakdown - Is China Coming Back to Crypto?

Episode Date: May 31, 2023

China's crypto policies appear to be shifting. From bans on trading and mining in 2021 to this year encouraging state run banks to offer crypto companies in Hong Kong banking accounts, a change is in the air. On this episode, NLW looks at a recent Web 3 paper from Beijing and Hong Kong's new exchange rules.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big-picture power shifts remaking our world. What's going on, guys? It is Wednesday, May 31st, last day of the month. Today, we are talking about the rotation of China, Hong Kong, and the East into the mainstream of the crypto narrative, even as the U.S. recedes. Before we get into that, a quick note. If you are enjoying the breakdown, please go subscribe to it. give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.

ly slash breakdown pod. Hello, friends. As I said, today is the last day of May, and so we're going to get a sense of what the month was all about. We're going to talk about what I think was one of the biggest narratives. But we're going to start with some numbers because May has been a bit of a tumultuous month for Bitcoin. The month began with Bitcoin trading in a volatile range around 29,000, with the seizure of First Republic Bank, sparking fears that the banking crisis was not yet behind us. Over the first weekend of May trading, a deluge of negative headlines surrounding U.S. government investigations into Binance also crushed the Bitcoin price down, culminating

in a flush lower that saw Bitcoin collapse below $26,000 for the first time since March. Now, after remaining stuck at a lower range for the past few weeks, Bitcoin spiked above $28,000 over the weekend on news that the debt ceiling standoff had likely reached a resolution before then collapsing to a lower level. At the time of recording, it is trading around 27,000, and with this last day of trading remaining, it looks set to mark its first red months since September, dropping by around 6.5%. This month also marks a significant test of the theory that Bitcoin price is correlated to stocks. The correlation has been in a multi-month breakdown, but has shown faint signs of recovery at times. This month,

month saw the tech-heavy Nasdaq rally by more than 6.5% moving in entirely the opposite direction of Bitcoin. Over the course of the last month, the correlation between Bitcoin and the broader S&P 500 reached a low point not seen since before the October 2021 rally. Now that correlation has still not reached a negative range, however, which would indicate Bitcoin moving down while the broader stock market rallies. Bitcoin maintained that inverse correlation for much of 2019 during the depths of the previous bear market, perhaps indicative of its status as a discredited asset in the broader investment community during that time. During this bear market, we just haven't seen the dismissal of Bitcoin to the same level. Throughout the year, in fact, Bitcoin has performed in

response to macro risks like the banking crisis, indicating some level of belief that Bitcoin can function as a safe haven asset. Earlier this month, legendary investor Paul Tudor Jones even confirmed that Bitcoin still forms a part of his overall investment portfolio as a hedge against monetary calamity. Comments like that would have been frankly inconceivable during the previous bear market. Now, zooming into market structure, May trading has been dominated by a lack of liquidity. Exchange spot volumes across all pairs look set to close the month at their lowest levels since October 2020. That drops them below even the depressed volumes from December of last year. This low liquidity market regime has brought with it highly volatile liquidations.

Last weekend's news of debt ceiling relief brought with it a 3% move in Bitcoin that wiped out over $100 million in leveraged short positions and trimmed open interest by 3%. But with that, let's try to understand what I think was one of the biggest narrative realignments that happened this month. And that was the cycling in of China and Hong Kong in the East and the cycling out of the U.S. Now, this is something I've discussed pretty extensively. China obviously got more and more antagonistic to crypto over the course of the last bull market, and that seemed to extend to China's sphere of influence as well. Last fall, it looked like new Hong Kong crypto regulations were coming, and it looked like they'd be pretty

severe, even limiting the ability for retail investors to trade at all. However, over the course of this year, that has changed in pretty significant ways. We've heard reports of Chinese banks soliciting crypto companies to come open up accounts in Hong Kong. We've heard that Chinese officials are actually going to startup meetups in Hong Kong. And the big question has been whether the U.S. is growing antagonism towards Bitcoin and crypto have provoked a realignment and a rethinking of crypto policy as a new opportunity. While getting into some specifics, in general, January, the Hong Kong Monetary Authority concluded its consultation period for a discussion paper on crypto regulation. The paper primarily focused on stable coin regulations and went somewhat

under the radar. In March, proposal regulations were put forward including much more broad approvals than were previously considered. Included in the proposal was a set of guidelines under which exchanges could be registered to offer spot crypto trading to both retail and institutional customers. Again, especially that retail side was a big surprise. Later in March, news began to trickle out that this regulatory framework was intended to reopen Hong Kong to the crypto industry. As I said, reports were suggesting that banks were being encouraged to take on crypto firms as clients, and CCP officials were even attending local events. Earlier this month, the finalized regulations were released and they looked remarkably permissive all things considered. Retail traders would

be allowed to trade in spot markets for around 10 major cryptocurrencies, and exchanges would be brought under a licensing scheme that enforces generally accepted money laundering and investor protection standards. Now, when it comes to those 10 major cryptocurrencies, the basic idea was that any crypto that was going to be listed on an exchange for retail traders needed to appear in at least two major indices. And so based on that, there were about 10 that qualify. However, within that framework, once an exchange was licensed, the regulations gave them a lot of latitude to determine whether our crypto was suitable for retail trading or not. Still, in making their announcement of the new regulations, the Hong Kong Securities regulator was careful to note that no exchanges had been

granted licenses so far, and that unlicensed exchanges should plan an orderly exit from the region. Now, of course, the environment that we've been living in isn't just low liquidity. It's also been low narrative excitement, and so people immediately latched onto the idea that Hong Kong would be reopening for crypto trading and that China was going to pump our bags. Despite the clear guidance that retail traders would be limited to major tokens, a group of China-native meme coin spiked. Now, the big outstanding question surrounded how real this Hong Kong reopening would be, and whether or not local regulators truly had the blessing of the mainland government, which would represent a major U-turn in CCP policy.

Remember, in September 21, the People's Bank of China issued an order that banned all cryptocurrency trading and transactions, which itself followed a May 2021 ban on crypto mining in light of electricity shortages across multiple provinces in China. In retrospect, those bans had mixed effects. In the immediate aftermath of the mining ban, hash rate attributed to Chinese miners plummeted, and there were reports of raids on clandestine mining facilities. However, with two years now passed, it appears enforcement has been spotty at best and perhaps even collapsing under the near-impossible task of shutting down a decentralized network. In fact, according to the latest

mining distribution data from Cambridge University, which admittedly was gathered in January 2022, more than 20% of Bitcoin hash rate is still hosted in China. That is, of course, a meaningful drop from the 70% plus of global hash rate that was attributed to China in late 2019, but a long way from numbers consistent with an effective ban. The trading ban was similarly patchy in its effectiveness. According to chain aliasist data, Chinese nationals recorded 220 billion in on-chain crypto transactions between June 2021 and July 2022. That surpassed volumes recorded out of South Korea and Japan for the same period. Now, this volume did represent a 31% drop from the prior year, but again, that's far from an effective total ban. In that same time period, the special administrative regions of Hong Kong and

Macau, ranked as the fifth and seventh largest markets for crypto transactions in East Asia in their own right. So in the face of what seems like at best, a partially effective ban, questions remain over how sustainable this sort of policy is in a country like China. And over the weekend, we got our first glimpse at a potential route for softening policy not only in Hong Kong, but on the mainland. On Friday, a Chinese government department issued a white paper, singing the praises of Web 3 and the immersive internet, urging policymakers to consider a pivot to the Metaverse. The paper, published by Beijing's Municipal Science and Technology Commission, calls Web 3 a, quote, inevitable trend for future internet industry development.

According to local reports, the paper seeks to build a consensus among the industry and promote the development of the necessary technology, including AI, blockchains, extended reality, and even brain computer interfaces or BCI. According to the white paper, Beijing is well placed to facilitate the growth of the next generation internet tech and plans to spend at least 200 million yuan or $28 million over the next two years on the technology. The paper calls for Beijing to be established as a global innovation hub for the digital economy. Binance CEO, CZ, called the timing interesting ahead of a June 1st commencement date for Hong Kong's new crypto regulations. He said that the paper talks a lot about NFTs, VR, AI, Metaverse, etc. And that major Chinese tech firms

Bight Dance, JD, and Baidu are all specifically analyzed for their potential contributions in the sector. Now, while the paper is generally more focused on Metaverse technology for immersive internet-based experiences, the ideas of digital ownership and NFT technology are also mentioned throughout. One of the key ideas appears to be a focus on supporting tech workers and innovations in the sector, giving them the latitude to work on groundbreaking new products. The idea of competition with the West is also front and center, with the paper recognizing that the U.S. currently has the lead in Web3 technologies, with the EU focused on privacy concerns, and Japan and South Korea pushing forward on innovations of their own.

own. It's unclear whether the paper is more focused on hardware development or the implementation of new software designs, but something lacking within the Chinese tech ecosystem has clearly concerned policymakers enough to call for a revamp of the industry. Tron founder Justin Sun writes, it is indeed fascinating to witness the Beijing's government recent focus on Web3, particularly considering the imminent June 1st developments in Hong Kong. China's commitment to embracing Web3 technology reflects a significant step towards recognizing the transformative potential of decentralized systems and blockchain-based solutions. By prioritizing Web 3.0, China demonstrates its forward-thinking approach and understanding of the

profound impact this technology can have on various sectors. Web3's decentralized nature and enhanced security features can empower individuals, foster innovation, and revolutionize industries such as finance, supply chain management, and data privacy. As the world moves towards an increasingly interconnected and digital future, China's dedication to Web 3 positions it as a significant player in shaping the global landscape of decentralized technologies. It's an exciting time to witness the unfolding of these developments and the potential they hold for empowering individuals and driving economic growth. Bill Hughes, a lawyer at Consensus writes, while U.S. regulators are hell-bent on hobbling Web3 development in the Western world, China appears ready to drive doggedly to be a defining force

behind this inevitable tech. Now, throwing just a little bit of cold water on this was Sam Reynolds, Asia Markets reporter at CoinDesk, who wrote, Beijing's Web3 white paper is more of China's blockchain-not-cryptop policy. Let's not get too excited. Now, that might be true, but it's still light ears from crypto is illegal and you're all going to jail, which is kind of where it seemed like we were a couple years ago. To be honest, I'm not totally sure yet what to make of this. On the one hand, this feels like it might be just a small report that's sort of broadly about frontier technologies, and that's broadly in line with China's desire to own and control a version of all these new technologies that is China-centric, that reinforces the system that they have,

that is prohibited from undermining social cohesion, and that basically reinforces the existing regime. To the extent, however, that this is not that, and this is an independent set of voices that are trying to make this argument that there should be more focus on this area, that would be something interesting. The big question, which we just don't know the answer to, is to what extent this is a test balloon for a broader policy shift versus just a small government body that feels emboldened enough to push back against the central party on this particular issue. Now, it seems as we leave May and head into June, we will be able to get more glimpses of some of the answers to this, as Hong Kong's new regulations come online. Crypto Insights tweeted

earlier this week, the race is on. Crypto firms are lining up for licenses in Hong Kong as the city prepares to open its retail trading regime on June 1st. Now, following this confirmation that Hong Kong was open for business, we saw a rash of exchanges announced that they planned to apply for a license to operate. Gate I.O., O KX, Amber Group, and Huobie were among the first firms looking to come into compliance with these new Hong Kong regulations. Huobie was one of the first firms to launch a local exchange and will commence trading tomorrow. Now, Huobi's license to operate in Hong Kong is still pending, with the exchange announcing its application had been made over the weekend. The Hong Kong-specific version of the exchange will be limited to offering Bitcoin Ethereum and other major cryptos,

but will not offer leverage trading or derivatives. In May, the exchange said, quote, regulation of Web3 in Hong Kong will contribute to the widespread adoption of cryptocurrencies on a global scale. Huobi will continue to collaborate with regulatory authorities in Hong Kong to support the development of a vibrant Web3 hub. So that is the story from here in the east, but what about over back in the U.S.? The biggest crypto narrative over the last month continued to be the ongoing regulatory crackdown, with a new twist that some major U.S. firms have finally had enough. Both Coinbase and Gemini have now launched offshore versions of their exchanges.

The Coinbase offering focuses solely on institutional traders with the exchange being accessible only via API with no graphical interface. The Gemini Exchange intends to offer an alternative platform for retail derivatives trading in jurisdictions where that's legal. In both cases, the concern was clear, a lack of certainty that U.S. crypto firms would be allowed to continue operating without ongoing threats from regulators. In an opinion article published on Tuesday, Coinbase CEO Brian Armstrong pointed out the issues with the current U.S. policy, arguing that, quote, China will benefit from enforcement of restrictive U.S. crypto policies. Armstrong pointed out that enforcement of these restrictive policies, quote,

risks America's time-honored role as the global financial leader and an innovation hub. The core of the argument is that the U.S. and other Western societies are pitted against a dystopic currency system rising in the east, embodied by the Chinese digital yuan payment system with its quote social credit system baked in. Armstrong argues that this currency and payments network is designed to challenge the U.S. dollar and its place at the center of global commerce. With China increasingly internationalizing the digital yuan through programs like the Belt and Road initiative, Armstrong says that given these moves to leverage financial technology to protect Chinese national interests, it's no wonder that Hong Kong is being positioned as a global crypto hub.

To counter this growing promotion of Chinese values abroad, Armstrong argues that fostering the U.S. crypto industry can, quote, play a significant part in stimulating the American economy and promoting democratic values worldwide. He claims that, quote, if we fall short today, the next generation of Americans will pay the price. And added that, quote, we're spending billions today to repatriate technologies like semiconductors and 5G infrastructure. We should learn from that mistake. He concludes, let's modernize our financial system and reaffirm our role as a global technology leader rather than abdicating it. And so I think that quite nicely wraps up what May was, at least from a narrative perspective when it comes to the crypto industry. Now, there are lots of

questions about whether there's any political will to make these sort of changes over the next however many months it is before the U.S. elections. But that's the state of the discourse right now. I think over the next few months we're going to learn a lot more about exactly what China and Hong Kong are trying to do. But the reality is that right now they're doing something that's not just cracking down on crypto. Weird times, friends, weird times. But that is it for today's breakdown. Thank you, as always for listening. And until tomorrow, be safe and take care of each other. Peace.