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China’s tolerance for financial experimentation reaches limit

Last month Kevin Guo, co-founder of Dianrong, a fintech company in Shanghai, began to invest in Chinese “initial coin offerings” that sell investors digital tokens in exchange for virtual currency such as bitcoin.

Mr Guo scanned WeChat groups, attended forums in Shanghai and exchanged ideas with others who shared his interest. He read white papers and other documents from dozens of issuers and eliminated those he thought would be vulnerable to manipulation or whose technology was particularly iffy before he selected a few to invest in.

Then earlier this week, after an unexpectedly tough regulatory clampdown in China, Mr Guo received an inquiry from one of the ICOs he had selected. The founder was shutting down on the mainland and was offering him two choices. He could have his money back or hang on until the entrepreneur re-launched the offer from another jurisdiction.

“Initial coin offers have a lot of support from tech people who believe it is the future,” Mr Guo said. Well known international investors such as Sequoia Capital China and local private equity firms have invested. At the same time though, he warned, many of the ICOs are “flawed . . . get-rich-quick schemes, not serious projects. Many of the founders collect the money and then invest in other ICOs.”

The debate about virtual cryptocurrencies and the blockchain technology behind them is, in many ways, the ultimate tug of war. It pits powerful vested interests of the financial world — including governments and the big state-owned banks such as Industrial & Commercial Bank of China — against those who are seeking to use technology to challenge them.

That debate and a continuing cat-and-mouse game between regulators and the financial markets has merged with a more general effort from Beijing to stamp out all kinds of financial risks.

These include excess corporate debt, speculative wealth management products and bad loans in the banking system. Regulators have put special emphasis on stemming capital flight at a time when one of the big drivers of bitcoin and other cryptocurrency trading is people seeking ways to move their money out of China. For people who combine a distrust of government with an equal distrust of gold, bitcoin is a preferable alternative to state-backed currencies.

It is hardly surprising then that China, where speculation and betting have always been national sports, is embracing ICOs and virtual currencies with ardour, particularly given the country’s tight capital controls on physical currency.

More than 100,000 mainland investors spent $385m on virtual currencies through ICOs in first half of this year, a government-backed study found, according to Caixin Global. “The problem here is that people are so extreme,” said the founder of one merchant bank that specialises in technology deals. “There is no pacing. They want to take 100 steps in one go.”

China this week halted new ICO offerings — in a statement seven regulatory agencies called them “essentially a form of unapproved illegal public financing behaviour”. Hong Kong followed up with an announcement that ICOs would be treated as a regulated activity.

Regulators seem aware of the two faces of financial innovation in China. While they see cryptocurrencies as a problem, the blockchain technology has the potential to make industries from finance to shipping more efficient. That is why even retired mainland regulators are taking part in some of the non-profits that have been established to understand these trends.

The growth of bitcoin comes at a time when other technology-based finance — specifically the growth of e-payments from the likes of Alipay and Tenpay — is already posing challenges to the Chinese central bank. It is having a harder time controlling or even understanding money supply these days. That makes it “more challenging for the central bank to predict and stabilise liquidity and leverage,” said a recent report from Bank of America Merrill Lynch. “The rapid rise of e-payment (with 500m users) requires financial regulatory upgrades to catch up with the cashless trend.”

There will be bigger challenges to come. But the lead up to the 19th Party Congress next month is no time to expect tolerance for more financial experimentation in China.

henny.sender@ft.com