Deng Jianpeng: How Bitcoin trading platforms can transform into compliant platforms

1. The basis for stopping the trading platform

In recent years, China's Bitcoin trading market has been extremely hot, accounting for more than 70% of the global trading volume at one point. However, due to concerns about some negative factors, Chinese regulators require all Bitcoin (and other virtual currencies) trading platforms to stop exchanging legal tender for Bitcoin and other virtual currencies before October 31, 2017. The regulators' intentions for virtual currencies have been clear: no call auction transactions are allowed. Since then, the call auction transactions of domestic Bitcoin trading platforms for exchanging RMB have been completely stopped.

Previously, the business model of domestic Bitcoin trading platforms was no different from that of exchanges. Such Bitcoin trading venues are highly social and public, and require strict legal and standardized management to ensure safe operation. Therefore, unlike general commercial institutions, the establishment of an exchange in China requires special approval and the corresponding qualifications. According to the regulatory rules previously issued by the Chinese government, such as the "Decision of the State Council on Cleaning Up and Rectifying Various Types of Trading Venues to Effectively Prevent Financial Risks" (Guofa [2011] No. 38), it is stipulated that no trading venue shall adopt centralized trading methods such as centralized bidding and market makers for trading; any trading venue using the word "exchange" must be approved by the provincial people's government, except for those approved by the State Council or the financial management department of the State Council; before the provincial people's government approves it, it should seek the opinions of the joint meeting.

According to the "Implementation Opinions of the General Office of the State Council on Cleaning Up and Rectifying Various Trading Venues" (Guobanfa [2012] No. 37), without approval, commercial institutions shall not conduct transactions in a centralized trading manner. The so-called "centralized trading method" includes collective bidding, continuous bidding, electronic matching, anonymous trading, market makers and other trading methods, but agreement transfers and auctions conducted in accordance with the law are not included. The provincial people's governments (the specific responsible agency is the provincial financial office) shall formulate the planning and review standards for the product structure of trading venues and prudently approve the establishment of trading venues.

In addition, due to the "Notice on Preventing Bitcoin Risks" (commonly known as Document No. 289) issued by the People's Bank of China and other institutions in 2013 and the subsequent regulatory spirit of regulatory agencies, all Bitcoin trading platforms in mainland China have not obtained approval from provincial financial offices. Therefore, according to the aforementioned relevant measures, the regulatory authorities have legal basis to stop the corresponding business of Bitcoin trading platforms.

2. The legality of peer-to-peer transactions

However, the regulator’s suspension has caused misunderstanding among some investors and the media. Some members of the public have viewed the regulator’s suspension of Bitcoin business under the “centralized trading method” as not allowing the original trading platform to do any Bitcoin-related business. This is obviously wrong!

Previously, Bitcoin trading platform accounts stored a large amount of customer funds and a variety of virtual currencies. They adopted collective bidding, continuous bidding or electronic matching models without corresponding qualifications. The transactions had financial attributes and involved the public but were not strictly regulated, which contained huge risks. The regulatory authorities stopped such businesses. Based on the above two rules, the essence was mainly to stop the "centralized trading method" and prevent the spread of financial risks. However, this does not mean that all types of Bitcoin transactions are stopped in a one-size-fits-all manner. In other words, not all forms of Bitcoin transactions are prohibited.

In this regard, we should first clarify the legal status and legal characterization of Bitcoin. According to Article 115 of the 2017 General Provisions of the Civil Law, property includes real estate and movable property. If the law stipulates that rights are the objects of property rights, they shall be governed by such provisions. Article 127 of the General Provisions of the Civil Law stipulates that if the law has provisions on the protection of data and network virtual property, such provisions shall be followed. Bitcoin is a type of network virtual property. The specific civil and criminal law protection methods for network virtual property will be further legislated in the future. In the Notice on Preventing Bitcoin Risks, Bitcoin is regarded as a virtual commodity that individuals can legally hold. This is the basic characterization of Bitcoin in China at present.

According to the "Notice on Preventing Bitcoin Risks" and "Notice on Cleaning Up and Rectifying Token Issuance and Financing" (commonly known as Document No. 99), regulatory agencies strongly support technological innovation, treat blockchain, Bitcoin, Bitcoin trading, and Bitcoin centralized trading platforms differently, and actively promote the development of blockchain technology. On the other hand, they emphasize the risks of centralized trading platforms.

This means that as a legal online virtual commodity (property), people can legitimately hold Bitcoin, and can also trade it legitimately according to personal needs. According to the relevant provisions of the Legislation Law, the collection and requisition of non-state-owned property, the basic economic system, and the basic systems of finance, customs, finance and foreign trade, etc. can only be formulated by the National People's Congress and the Standing Committee of the National People's Congress. At present, the National People's Congress and its Standing Committee have not made prohibitive provisions on the collection, requisition and other uses of property held by individuals such as Bitcoin, and there is no explicit prohibition on the private buying and selling of Bitcoin. In addition to the centralized trading method, other related Bitcoin trading methods, such as individual-to-individual transfers reached by common agreement, are not prohibited. In addition, according to the spirit of "what is not prohibited by law in the field of civil behavior, it is legal for private individuals to spontaneously trade Bitcoin without infringing on the legitimate rights and interests of others and society."

3. The road to transformation of trading platforms

Furthermore, for this type of virtual goods, its Taobao-like commodity trading model is very different from the restricted "centralized trading method" (specific forms include collective bidding, continuous bidding, electronic matching, anonymous trading, market makers, etc.) in terms of legal nature, and is currently not prohibited by law. Therefore, the transformation of the original Bitcoin trading platform into a "Taobao-style information intermediary" that facilitates private peer-to-peer Bitcoin transactions is the way for the trading platform to survive in compliance transformation.

The specific connotation of this "Taobao-style information intermediary" model in the field of Bitcoin transactions is that users publish information on buying or selling Bitcoin on the Bitcoin transaction information service platform, which is actually a C2C (trading customer to trading customer) trading business model. From the perspective of the model, the transformed commercial institutions provide users with information on the supply and demand of Bitcoin for both buyers and sellers. In this business model, users freely decide the price of buying and selling Bitcoin, and both parties independently choose to reach an agreement and transfer, and the information service platform assumes part of the transaction guarantee function.

However, institutions avoiding "centralized trading methods" does not mean that market risks and legal risks are eliminated. According to the "Bitcoin OTC Trading Detection Report" issued by the National Internet Financial Security Technology Expert Committee on October 27, there are currently three types of OTC trading in mainland China, as follows: First, online P2P trading, generally through OTC trading platforms such as LocalBitcoins and CoinCola. This type of platform provides a place for Bitcoin buyers and sellers to publish information. The transaction is similar to the "Taobao" model, and buyers and sellers conduct one-to-one transactions based on the published information. Second, online B2C transactions, users (C-end) can directly buy or sell Bitcoin to the platform, and the price is specified by the platform. After receiving the user's payment, the platform will directly pay Bitcoin to the buyer user, or after receiving Bitcoin, pay the funds to the seller user. The platform (B-end) funds or Bitcoin are owned by the platform or come from cooperative merchants. Third, offline transactions, buyers and sellers conduct transactions online or offline through online chat tools such as QQ groups, WeChat groups, Telegram groups, Slack groups, or face-to-face pure offline methods.

For the first transaction method, the servers of Taobao-style information intermediary platforms such as LocalBitcoins are mostly located overseas, and the core business team is usually also located overseas. When they provide information services to Chinese customers, it is difficult for Chinese regulators to effectively supervise them, such as requiring the platform to do a good job of identity recognition, etc. For the third transaction method, this offline private group owner guarantee transaction model is not conducive to the implementation of KYC (customer identification) and hides fraud risks, such as the group owner running away with the money (currency), etc. The threshold for KYC and the implementation of anti-money laundering and other compliance requirements is high, and only platforms with certain strength and development norms can complete it. The private trading groups that set up group transactions have neither the willingness nor the strength to meet the above requirements.

Compared with the previous transaction model, the original Bitcoin trading platform in mainland China has transformed into a "Taobao-style information intermediary" model, realizing the transformation from "value transfer intermediary" to "information release intermediary". The transformation of the trading platform to provide information services for peer-to-peer transactions must comply with existing national laws and policies and reduce regulatory costs. The Bitcoin transaction information service platform must actively connect with the regulatory agency for corresponding transaction information and strictly implement KYC and other related regulations, such as strengthening the review of account holders, understanding the legitimacy of the source of funds of traders, requiring users to provide detailed identity proof, etc.

4. Balance between encouraging innovation and risk control

For new things like Bitcoin, I believe that regulators should maintain a stance of encouraging innovation while controlling risks. Before effectively and deeply evaluating the prospects and future of new things, we should avoid the inherent practice of simply killing them with one stick, and prevent new things from causing systemic risks in the financial field.

On September 15, 2017, the day when Chinese regulators called for the suspension of Bitcoin trading platforms, Japan issued more than a dozen official licenses for virtual currency exchanges. After Chinese Bitcoin trading platforms officially stopped the Bitcoin exchange for legal currency on October 31, 2017, the historic Chicago Mercantile Exchange in the United States planned to launch Bitcoin futures trading at the end of 2017. As Bitcoin gradually entered traditional commodity exchanges, some traditional financial institutions around the world also began to enter the market. Although some senior financial professionals denounced Bitcoin as a "tulip bubble" based on outdated financial theories and practices, other authoritative figures, such as Christine Lagarde, Managing Director of the International Monetary Fund (IMF), suggested that refusing to accept virtual currencies may not be a wise move. While effectively operating monetary policy, central bank decision-makers should be open to new ideas and demands. Therefore, from the perspective of the mainstream trend of Bitcoin in the international community, although the almost one-size-fits-all suspension of Chinese regulators is legally justified, whether it is conducive to encouraging innovation is still a question.

Trading institutions and regulators in some developed countries, based on the positive value of Bitcoin, such as the huge investment demand and payment convenience of the society, mainly consider how to regulate Bitcoin under the legal trading mode and put the corresponding risks under control through supervision and regulation. Based on excessive concerns about risks, Chinese regulators pay more attention to the negative factors of Bitcoin and consider how to de-financialize Bitcoin and try to weaken the financial attributes of Bitcoin, such as initially defining it as a "virtual commodity" and finally directly stopping the business of all trading platforms. But the reality is that the financial attributes of Bitcoin have been significantly enhanced in recent years. On the one hand, the ICO, which has been in full swing in recent years, uses mainstream virtual currencies such as Bitcoin as fundraising targets. Bitcoin has become the main source of funds or "social funds" for the launch, research and development or promotion of blockchain entrepreneurial projects. Bitcoin has essentially become a substitute for money in some areas. On the other hand, in some developed countries, such as Japan, it is directly recognized as a means of payment through legislation. Therefore, based on the general trend and international experience, Chinese regulators recognize the quasi-financial attributes of Bitcoin, strengthen the supervision and legislation of Bitcoin in the financial field, and break through the old rules in the trading model, which may be another healthy way.