Why China's sudden crackdown on crypto? Follow the Money

4 October, 2020

In one of our previous posts, we discussed the fact that China recently began cracking down on online gambling more aggressively than they have in the past. They are going specifically after payment processors, knowing that if they can prevent citizens from making cryptocurrency deposits, they can reduce the amount of gambling activity.

Most gambling in China has been illegal for decades. So why the sudden aggression? Follow the money. It turns out that upwards of ¥1 trillion (US$145.5 billion) leaves China every year by way of online gambling. That is money the ruling Chinese Communist Party wants to keep in the country. Moreover, they want anyone in China looking to gamble to do so in Macau, a semi-autonomous region controlled by China but very much open to casino gambling and tourism.

Government officials are very aware of the large volume of offshore websites offering gambling opportunities to Chinese citizens. They are also wary of emerging cryptocurrency exchanges and payment processors that make it easier than ever before for Chinese citizens to buy and use cryptocurrency. In their mind, the only way to keep the trillions lost to gambling every year in the country is to crack down on gambling.

A gambling underworld

Giving Chinese nationals access to online gambling opportunities requires the existence of an entire underworld organization. For right or wrong, that is the way things are in China. Ministry of Public Security director Liao Jinrong says that online gambling in that country is facilitated by gambling gangs. The gangs specialize in illegal gambling operations and digital currencies.1

Liao says that the big concern is how such a large outflow of fiat could jeopardize China's long-term economic future. Speaking at a live event in Beijing recently, Liao said that online gambling threatens China's economic security due to collusion between "foreign powers" and gambling operators.

It is not clear exactly what Liao meant by that statement. Could he be implying that foreign countries - particularly in the West - are working with gambling operators to undermine China's economy? Such accusations would not be surprising coming from the Chinese Communist Party.

Nonetheless, it is clear that government officials are unhappy with their citizens frequenting online gambling sites outside of China. It is also clear they do not want domestic entrepreneurs aiding and abetting the gambling industry by providing cryptocurrency exchanges, payment processing services, banking services, and so forth.

Too many loopholes

Liao also made known in his recent comments that there are far too many loopholes in Chinese law, loopholes that allow cryptocurrency exchanges and payment processors to circumvent restrictions against online gambling. That explains Beijing's recent crackdown on payment processors.

If you read our previous post, you know that a number of creative entrepreneurs have established e-commerce operations that act as fronts for making cryptocurrency payments. Runners sign up to open accounts through which they can make purchases that appear to look like standard purchases of goods and services. In reality though, they are using those accounts to make cryptocurrency deposits for their gambling clients. The clients then reimburse them by adding Tether back into their accounts.

It is a rather elaborate scheme that can involve quite a bit of subterfuge. Some operators generate fake receipts and QVC codes to make it look as though legitimate purchases are taking place. Others have gone so far as to actually ship empty boxes to customers to give the appearance of regular commerce.

To the delight of the gambling public, the government hasn't made much headway in stopping this sort of thing. They also have not been very successful in clamping down on exchanges. The problems they are having are no different than the problems experienced by governments elsewhere.

Simply put, cryptocurrency exchanges are software projects first and foremost. Unlike traditional fiat exchanges that require a physical presence to deal in physical bills and coins, everything in the digital arena can be done online. Moreover, exchanges are based on the decentralized finance principle. There isn't a single entity that Chinese officials can go after to crack down on exchanges.

This allows the exchanges to operate pretty independently in most cases. Chinese government officials are very cognizant of this, which is why some suspect they may eventually go after decentralized finance and blockchain across the board.

Meanwhile, in Macau

The other thing that has Chinese officials riled up is the struggling gambling industry in Macau. At the start of the coronavirus crisis, Macau was effectively shut down. All the land-based casinos in the city were closed for weeks on end. They lost tens of millions. Even after they began reopening, traffic was scant. Six months later and the casinos are still not back to full throttle.

Despite Macau being semi-autonomous, their gambling revenues still support the Chinese Communist Party. Of course government officials would be unhappy that Macau casinos still aren't generating significant revenues while online gambling is going through the roof. It is in the government's best interest to crack down on online gambling and funnel all of those gamblers back to Macau.

Unfortunately, Macau is an expensive city to visit. It is a tourist trap and one that is built almost exclusively on gambling. Not only that, but it also caters to high rollers. Your average Chinese citizen who simply wants to play the slots for a few minutes doesn't have the financial resources to take a holiday in Macau.

Cracking down on online gambling is not likely to solve Macau's problems. Getting gamblers back into the city is a matter of easing travel restrictions, getting rid of social distancing mandates, ending mask mandates, etc. But that is a different discussion for a different post.

Crypto works as advertised

We can see what is happening in China and learn a few lessons from it. First and foremost, cryptocurrency does what it's supposed to do for gamblers. It works as advertised. Cryptocurrency allows people who do not have any other access to casino gambling to still play slot machines, table games, etc.

Picture an illegal gambling ring operating in Beijing. Imagine scores of people meeting in a dark storefront to play cards and throw the dice. They gamble with fiat until the early hours of the morning. Such an operation would always be at risk of discovery. Those who run it would risk stiff prison sentences and other penalties.

The obvious solution is to take the operation online. But if gamblers only have fiat to work with, going online is not going to help. Banks can always block the transfer of funds. Yet cryptocurrency solves that problem. Chinese citizens can buy crypto by way of a local or international exchange. That crypto gives them access to online casinos.

An added bonus is that their identities are protected. There are no banking records to track. There are no electronic paper trails left behind. Average citizens can gamble to their hearts content knowing that the likelihood of their financial records revealing their activities is slim.

Tight rein on the Internet

Online gambling via cryptocurrency also explains why the Chinese government attempts to keep the reins on the internet. They not only want to prevent outside information from creeping in, they also do not want their people using the internet to reach beyond China's borders. Restrictions are meant to stop the flow of information in both directions.

The question is how Chinese gamblers are accessing online sites under such a restrictive environment. In all likelihood, they are using virtual private networks (VPNs). A VPN would allow a person to logon to a network located within China, a network that then provides a secure tunnel to get traffic outside of the country. However, this is just speculation.

It would seem that China's efforts to prevent online gambling involves cracking down on internet technology as well. Maybe it does and the rest of the world just hasn't heard about it yet. In the meantime, it is clear the government is going after payment processors and exchanges. Expect to see more aggressive action taken against the latter in coming months.

Follow the money

At the end of the day, the evidence suggests that Chinese officials do not object to gambling on moral grounds. Nor do they object to it out of fear that it increases crime or leads to other sorts of unacceptable behavior. If that were the case, Macau's gambling industry would not exist. No, China's Communist Party objects to mainland gambling and its online cousin because it doesn't want to lose money to foreign operators.

They can keep foreign operators out of the land-based arena simply by not allowing casinos in China. That they have done. But they cannot prevent foreign operators from setting up websites on servers located outside China. That is a problem because China is losing trillions of yuan every year.

Their losses are largely the result of cryptocurrency. Coins like BTC and LTC have made it possible for Chinese citizens to gamble at a host of sites around the world. Their government is doing everything they can to stop online gambling, but it is clear operators and gamblers are winning the war. As for whether or not that is a good thing, we will leave that for you to decide.

1) Yahoo. Cryptocurrency helps ship 1 trillion yuan out of China to casinos, gambling every year