Beijing sees opportunity, but concerns linger

NANSHA, China — As investors and technologists worry that the U.S. is falling behind in the race for dominance in blockchain, Beijing is trying to get ahead.

“In a bear market for crypto we make friends; in a bull market we make money,” said Rae Deng, founding partner of Du Capital, a crypto investment firm based in Singapore.

Deng said at CNBC’s East Tech West conference in the Nansha district of Guangzhou, China she sees another flourishing crypto scene coming, with more Chinese investment striding to the market after Beijing suddenly announced plans to embrace blockchain technology.

“China is eyeing for a thorough digital migration,” she said. “The policy signal will definitely bring a lot of incremental capital into the market.”

She argued that Beijing’s public support will drive “traditional money” – corporate investment in Chinese traditional sectors — to become a big player. These investors previously shied away from the crypto market due to its sensitive status. Initial coin offerings (ICO) have been banned in China since 2017.

“The magnitude and appetite of the traditional money will definitely change the status quo of the crypto community,” she added. “That’s a total game changer.”

In late October, the global crypto market surged after Chinese President Xi Jinping said the country should “seize the opportunity” blockchain technology presents.

The price of bitcoin briefly soared above $10,000 following Xi’s remarks. That pop was mirrored by similar spikes in the prices of more than a hundred Chinese stocks with blockchain exposure as well as a bunch of other cryptocurrencies.

While Beijing’s unexpected move came after Facebook announced its Libra cryptocurrency project in June, the policy change did not happen overnight, according Edith Yeung, managing partner at Proof of Capital, a blockchain-focused venture capital fund.

“They have been working on and studying this for the last 5 years so this is not just ‘because of Libra therefore we do this’,” Yeung told CNBC.

China is moving full speed ahead while Facebook defends the cryptocurrency project against skeptical regulators. The social media giant has also seen many key payment partners, including Mastercard, Stripe, Visa, PayPal and eBay, pull out of the project.

Industry experts predict that China could start rolling out its state-backed digital currency as early as the next two to three months. Government grants have been set up to help blockchain projects. For example, Guangzhou’s city government launched a 1 billion yuan (about $140 million) subsidy fund to support development of the blockchain industry.

China’s crypto initiatives are strategically significant, according to Xiao Wunan, executive vice-chairman of the China-backed Asia Pacific Exchange and Co-operation Foundation (APECF).

“Blockchain is the technology field that China started to develop almost at the same time as other countries in the world,” said Xiao, who used to work in the Chinese government. “It’s hard for China to claim technological supremacy on fields like Internet Plus [China’s initiative on information technology] or artificial intelligence, but the blockchain technology would be a perfect fit for China’s technological dominance.”

“It’s called ‘corner overtaking’ strategy in Chinese,” Xiao told CNBC in Mandarin, indicating that the practice could be risky yet effective.

To be sure, China’s digital currency might be very different from bitcoin or other tokens, which emphasize anonymity and decentralization. A state-issued digital currency would help the Chinese government fight issues like counterfeiting and product safety, but it also raises privacy concerns.

First, a state-backed digital coin could “further facilitate the internationalization of yuan,” Du Capital’s Deng said.

“It could run in parallel with the SWIFT [Society for Worldwide Interbank Financial Telecommunications] system and also the One Belt One Road initiative could be a carrier of that,” said Deng.

A digital currency would also be able to tap into China’s massive, and largely cashless, payments system.

“WeChat Pay has one billion transactions a day and footprints in 60 countries,” Deng told CNBC. “China has the digital payment infrastructure of that scale and also domestically as China is moving towards a cashless society. It only makes sense for the central bank to adapt to that digital revolution reality.”

China is the world’s largest e-commerce market, accounting for more than 50% of global transactions, according to a July report from the U.S. Department of Commerce’s International Trade Administration. In 2018, third-party mobile payment transaction volume hit 190.5 trillion yuan, according to China-based analytics firm iResearch. That figure amounts to about $28.78 trillion, based off the 2018 average exchange rate from the U.S. Internal Revenue Service.

A state-backed digital currency could give regulators greater abilities to track money flows and product logistics within that massive e-commerce market. That would better equip them to tackle issues like counterfeit goods and product safety concerns, APECF’s Xiao explained.

“The prime application would be in the agriculture sector because food security is one of the most crucial issues in China,” said Xiao. “Regulators would be able to track and identify origins of products. Also, if we apply the blockchain technology to Chinese e-commerce site, it would be much easier to address fake goods issues.”

His comments come as China grapples with skyrocketing pork prices as African swine fever kills millions of hogs.

“Similarly, it would be important to the healthcare sector too, as China may soon allow entry of Indian generic medicines in the country,” he added. “Traceability is best cure for fake medicine.”

Experts also see potential for a state-backed digital currency in China’s business-to-business (B2B) market. Currently, the country’s payment leaders – WeChat Pay and Alipay – focus on person-to-person or small payments, with little B2B exposure.

“Blockchains have a huge potential to reduce cycle time in business transactions,” said Paul Brody, head of blockchain at Ernst & Young.

That B2B e-commerce market totaled 20.5 trillion yuan ($3.07 trillion) in 2017, according to statistics site China Internet Watch.

“Adding B2B payment into the blockchain transaction in a strong global currency would have a big impact in accelerating B2B [activities],” Brody told CNBC. “You could have the first Chinese B2B payment infrastructure that could be very, very large.”

But as cash floods into the latest crypto boom, concerns about fast-rising valuations and potential fraud also crop up.

“I hope we will avoid repeating some of the mistakes here in China that happened in the rest of the world,” said Brody.

Cryptocurrencies hit staggering highs toward the end of 2017 and the beginning of 2018, only to plunge to a fraction of those levels. Bitcoin has recently been seen trading around $8,000, far below its all-time high of nearly $20,000 in late 2017.

“Seventy-five percent of the companies in the [previous] ICO boom never produced any product. Most of them never got auditors and that’s why we got a lot of the fraud,” he told CNBC.

Valuations of Chinese crypto start-ups and projects are surging, making it harder for potential investors to negotiate.

“Some of the companies we spoke to immediately raised their valuations by more than 50% shortly after Xi’s speech,” Du Capital’s Deng said. “It has become harder for us to get deals at reasonable valuations because competition is heated.”

“I think there will be bubbles for sure,” she added.