CLAMPING DOWN

China’s biggest bitcoin exchanges are facing scrutiny over how idle client funds are put to use

For a long time up until recently, Chinese bitcoin exchanges didn’t charge users transaction fees—a major revenue source for other exchanges in the crypto market. How did they make a profit? At least part of the mystery might have been solved.

China’s two biggest bitcoin exchanges, Huobi and OKCoin, collectively invested around 1 billion yuan ($150 million) of idle client funds into “wealth-management products,” state newswire Xinhua wrote in an Aug. 17 report (link in Chinese), citing an investigation by the People’s Bank of China. As has been noted elsewhere, such products in China are often high-yielding and risky. On the same day that the investigation was reported, bitcoin hit an all-time high of $4,500.

Yesterday (Aug. 21) Xinhua also published a rare commentary (link in Chinese) warning against bitcoin’s recent price surge. “New things are developing so fast that regulations must keep pace,” the article said, calling on the government to shut down dubious bitcoin exchanges and to “never be soft” on them.

Xinhua provided no further details about the financial products Huobi and OKCoin reportedly invested in using such client funds. Quartz could not access the PBOC report it cited. While bitcoin exchanges in the US and Europe typically hold client funds rather than use them, the same doesn’t apply to their Chinese counterparts.

Huobi declined to comment. In a statement to Quartz, OKCoin said, “We are, of course, prohibited from using our client’s fund for our own gain, and do not do so.” CEO Star Xu added:

“We at OKCoin have a strict policy of placing idle client funds into lower-risk banking products. This policy is in keeping with general practices in the banking and securities industry, for both the purpose of safeguarding clients funds, as well as assuring proper record keeping and segregation of funds. We refute allegations to the contrary as patently false.”

China’s central bank, fearing capital flight and money laundering, has tightened its grip on bitcoin trading in recent months. At the start of this year, the People’s Bank of China launched an investigation into major bitcoin exchanges including Huobi and OKCoin, and issued warnings about possible risks on their platforms. In response, Huobi and OKCoin ended zero-fee trading and margin-trading services, which lets customers borrow yuan or bitcoin from the exchanges to boost their bets. The exchanges also suspended bitcoin withdrawals, and only reactivated them about two months ago. These moves ended China’s dominance of the global bitcoin market, as measured by trading volume.

 

Employees of Beijing-based bitcoin exchanges and wallet apps, through which users send and receive bitcoin, told Quartz that their companies are now required to report to the central bank weekly about suspicious trading activities on their platforms. They are also anticipating that authorities will release new rules on bitcoin trading in China—a draft is now reportedly in the making. A 2013 central bank document contains some vague rules, such as requiring bitcoin exchanges to implement “know your customer” procedures, and abide by China’s anti-money-laundering laws. The 2013 document also banned financial institutions and payment services from bitcoin-related businesses. That means Chinese banks are not allowed to serve as custodians and hold client money for bitcoin exchanges, a practice that is commonplace for Chinese stock brokers.

This article was updated after receiving OKCoin’s comments on Aug. 23.

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