The 3 New Ideas You Need to Know This Week (Issue 62 - 26 September 2021): China's Crypto Ban, Australians & Crypto, and Ethereum Uncle Blocks

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1. What You Need to Know About China’s Cryptocurrency Ban

On the afternoon of Friday, September 24, ten Chinese government entities, including the People's Bank of China, issued a notice effectively banning all crypto-related activities in the country.?

It is essential to understand what this ban was about, how it is different from previous bans, and what its potential impact could look like.

Let’s start with what the ban covers.?

The notice released by China’s top regulatory bodies focuses on three core issues.

First, the declaration clarifies that virtual currencies are not legal in the country and that any crypto-related transactions are illegal.?

Not only does this announcement explicitly ban financial service providers like banks from opening accounts with crypto exchanges or crypto-related entities (which was already the case before), but this blanket ban also forbids the provision of other services, from marketing to IT, to such crypto firms.

Second, this ban also targets overseas crypto exchanges.?

The notice explicitly mentions that the provision of crypto services by overseas exchanges to Chinese residents is illegal.?

This was the first time that overseas exchanges were so explicitly targeted.

And finally, unlike previous announcements that were issued at most by a handful of government bodies or trade associations, this latest notice was the most coordinated yet, as the ban was issued jointly by ten separate government bodies, including the central bank, whilst explicitly mentioning the coordination on various enforcement aspects, from monitoring and information sharing to actual implementation.?

Now, how is this ban different from previous bans?

First, this ban should not come as a surprise.?

China has made its position on Bitcoin and cryptocurrency transactions quite evident in the past.?

In 2017, for example, China issued a ban on ICOs .?

And just this past summer, three industry bodies came out and warned the public against the risks of trading cryptocurrencies, with the PBOC stating that banks should not provide services to crypto companies.?

Then came the ban on crypto mining that saw a mass exodus of mining pools begin to relocate to more favorable jurisdictions.?

But this notice leaves no area for interpretation and makes it crystal clear that Bitcoin and cryptocurrencies are no longer welcome in China.

There are several areas that I’m paying close attention to following this announcement.?

First of all, whilst crypto transactions are now clearly outlawed, the question now becomes what happens with the existing ownership of crypto-assets.?

Two years ago, China confirmed that ownership of cryptocurrencies was legal, but a court ruling in 2021 took a slightly different approach.?

It will be very interesting to see if this latest ban will impact the mere act of holding cryptocurrencies and whether or not they will still be considered property.?

It will also be interesting to watch what happens to broader services in the space, specifically companies in Mainland China that provide marketing, IT, data, or hosting services to crypto companies and whether they will de facto stop servicing the industry.??

The second thing to watch will be the impact on overseas exchanges.?

This notification was quite clear that overseas exchanges’ provision of crypto services to Chinese residents is illegal.

This will directly impact the broader space, as whilst there are not that many exchanges officially based in Mainland China, many of the global crypto exchanges, especially those with Chinese links, still service clients from the Mainland for crypto to crypto or P2P trading, for example.

Whilst many of the large centralised and regulated exchanges will probably stop accepting Mainland Chinese clients (and potentially off-board them), it will be interesting to see what proportion of the overall exchange market does so.?

Ironically, these Chinese crypto traders may soon feel what American crypto traders have been experiencing for some time, as most non-U.S. crypto exchanges have been banning “U.S. Person” clients for quite some time.?

However, the bigger question this ban raises is whether it can work.?

Given that Bitcoin and its peers are decentralized currencies, it is, in practice, very difficult to completely ban them.?

In theory, anybody in China who has an Ethereum wallet could start trading on these permissionless decentralized exchanges where there is no KYC.?

Even if certain websites are banned, many crypto traders in China and the United States already use VPNs to easily get around these restrictions.?

Second, the decentralised nature of Bitcoin makes it impossible to stop old-school peer-to-peer transactions.?

Bitcoin, by design, allows individuals to transfer value to one another with no centralised intermediary.

So it will be challenging to stop two individuals who meet in person and conduct a peer-to-peer Bitcoin transaction like in the early days of Bitcoin when people used to buy the asset at physical meet-ups.?

And finally, it will be tough to stop PRC citizens who are traveling or even living abroad from buying cryptocurrencies.?

For example, a PRC national could travel anywhere outside Mainland China, buy some Bitcoin, put it on their hardware wallet, and come back to China.

Trying to prevent such activity is very difficult.?

The many retail-focused OTC Bitcoin brokers next to the high-end stores or tourist areas that already cater to this market today in Hong Kong are a great example.?

And let’s not forget the millions of Chinese nationals living worldwide, from students to workers.

Stopping them from buying or bringing some Bitcoin back home will be extremely difficult.

Now, what will the potential impact of this ban be?

First, whilst the market fell slightly following the news, this should not have a significant impact in the long term.

There have been numerous “Bitcoin bans” from China in the past.

Such a development was already expected and baked into the price of Bitcoin and other crypto assets, especially following China’s actions against Bitcoin mining this past summer.

It will be interesting to see whether this will accelerate the implementation of the government-issued Chinese digital currency, the e-CNY, China’s central bank digital currency (CBDC).?

As we have covered in this newsletter in the past, China is lightyears ahead of other countries around the world when it comes to the development of CBDCs, with the government launching its research efforts in CBDCs back in 2014.?

And over the last couple of months , there have been over US$5 billion in e-CNY-based transactions, with over 1.3 million use cases and over 30 million retail and corporate wallets opened.??

And let’s not forget that the Winter Olympics are just around the corner and expected to begin on February 4th, when many believe the e-CNY will be made widely available.?

Now, who stands to benefit from this development?

?Many countries benefited from China’s ban on Bitcoin mining.?

Before China’s actions against Bitcoin mining earlier this year, China was responsible for roughly 65% of Bitcoin mining around the globe.

Now, much of that activity has moved out — some to Russia and Kazakhstan .

And even more to the United States , meaning that America could wind up accounting for the lion’s share of Bitcoin mining activity down the line.?

Whilst the mining migration out of China consisted mainly of mining machines that do not contribute much to local economies, there is now a possibility following this latest ban to attract real human capital, from R&D to operations.?

This can be a great opportunity for the likes of, say, Dubai or Miami, which are each trying to position themselves as global crypto hubs, especially when some of the natural landing spots of the crypto community in China, like Hong Kong or Singapore, are currently not as attractive due to unfavorable regulatory conditions, or simply due to very strict COVID arrival restrictions.??

It will be fascinating to see how this development unfolds over the coming months.?

Source: Henri Arslanian GIF page

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2. Why 1 in 6 Australians Now Own Crypto?

According to a recent survey , one out of every six Australians now owns some form of cryptocurrency, with the accumulated value of all of their holdings adding up to a whopping $8 billion!

The survey was conducted by Finder and is full of several interesting takeaways:

• The most commonly held cryptocurrency in Australia is, unsurprisingly, Bitcoin (9% of the surveyed population)
• Ethereum holdings come in at 5%, followed closely by Dogecoin and Bitcoin Cash (4%)
• 50% of all respondents believe that Bitcoin is a legitimate investment
• 1 in 3 think Bitcoin will eventually overtake fiat currency
• Cryptocurrency has particularly captivated the Gen Z cohort with 31% of them owning cryptocurrencies
• Men are twice as likely as women to own cryptocurrency (23% vs. 11%)

The survey later goes on to highlight the pressing need for crypto education in Australia, with 49% of respondents citing a lack of understanding of the space as a major deterrent to participation, whilst 56% think that Elon Musk invented Bitcoin.

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Want to learn more about the challenges that institutional investors are facing when entering the crypto ecosystem and how regulatory clarity around the industry could encourage more movement into the space?

I discussed the topic with Hugh Madden, the Group CEO of BC Group.

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Money Quote of the Week

“It frees you from doing things you dislike.

Since I dislike doing nearly everything, money is handy.”

Groucho Marx

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3. What Are Ethereum “Uncle Blocks”?

Despite the fact that Ethereum is gradually transitioning towards a proof-of-stake consensus mechanism with the continued rollout of Ethereum 2.0 (which we discussed in this newsletter following the network’s implementation of the London hard fork ), it remains very much worthwhile to look into how Ethereum blocks are mined in its current proof-of-work iteration, with the presence of what are known as “uncle blocks .”

Uncle blocks are created in Ethereum blockchains when two blocks are mined and submitted to the ledger at roughly the same time.

To better understand this, we need to go back to how a blockchain functions.?

A blockchain is formed as miners add new blocks to the chain, thus lengthening the blockchain.?

?The first miner to add a new block to the blockchain is rewarded with a block reward , and that is the case in both the Bitcoin and Ethereum blockchains.?

?However, it is possible for two blocks to be generated at the same time.

This phenomenon occurs more frequently on the Ethereum blockchain as, unlike the Bitcoin blockchain, a new block is added every 12-15 seconds .

This results in a temporary and unsettled state of the blockchain network, as the various nodes try to build a consensus about which of the newly identified blocks to continue with and which one to reject.

?In the Bitcoin blockchain, the rejected block is called an orphan , and is simply disregarded. The miner does not get any type of reward for that block.

However, in the Ethereum blockchain, these are called “uncle blocks” and are still rewarded, although with a lower reward amount.?

?This uncle block receives 87.5% of its base reward, and the “nephew” that includes the stale block receives the remaining 12.5%.

Transaction fees, however, are not awarded to uncles.

This was a design choice in the Ethereum blockchain and was put in place to ensure the security of the network despite having short intervals for new blocks.?

For most readers, that should be enough, and you should now understand what an “uncle block” is.?

But if you really want to geek out, keep reading.

Uncle blocks are achieved by implementing a protocol called GHOST ("Greedy Heaviest Observed Subtree"), which is an innovation first introduced by Yonatan Sompolinsky and Aviv Zohar in December 2013 .?

The motivation behind GHOST is that blockchains with fast confirmation times suffer from reduced security due to a high stale rate - because blocks take a certain time to propagate through the network.

For example, if miner A mines a block and then miner B happens to mine another block before miner A's block propagates to B, miner B's block will end up wasted and will not contribute to network security.?

Furthermore, there is a centralisation issue: if miner A is a mining pool with 30% hashpower and B has 10% hashpower, A will have a risk of producing a stale block 70% of the time (since the other 30% of the time A produced the last block and so will get mining data immediately), whereas B will have a risk of producing a stale block 90% of the time.?

Source: GitHub

Thus, if the block interval is short enough for the stale rate to be high, A will be substantially more efficient simply by virtue of its size.

With these two effects combined, blockchains that produce blocks quickly are very likely to lead to one mining pool having a large enough percentage of the network hashpower to have de facto control over the mining process.

Ethereum implements a simplified version of GHOST that only goes down seven levels. There are two main reasons for this.??

First, unlimited GHOST would include too many complications into the calculation of which uncles for a given block are valid.?

Second, unlimited GHOST with compensation, as used in Ethereum, removes the incentive for a miner to mine on the main chain, and not the chain of a public attacker.

Ultimately, whilst Ethereum currently still uses proof-of-work, the network features a somewhat different approach to mining and miner compensation.

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Henri Arslanian

*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with.

Who is Henri?

Passionate and focused on the future of finance and money, Henri Arslanian is the PwC Crypto Leader and Partner, the former Chairman of the FinTech Association of Hong Kong, and an Adjunct Professor at the University of Hong Kong where he teaches the first FinTech university course.

Henri advises many of the world’s leading crypto exchanges, investors, financial institutions, and tech firms on their FinTech and crypto initiatives as well numerous governments, regulators, and central banks on Fintech and crypto regulatory and policy matters.

With over 500,000 LinkedIn followers and 40,000 newsletter subscribers, Henri is a TEDx and global keynote speaker, a best-selling published author, and is regularly featured in global media including Bloomberg, CNBC, BBC, CNN, The Wall Street Journal, The Economist and the Financial Times.

Henri was named by LinkedIn as one of the global Top Voices in Economy & Finance and is the host of the FinTechCapsules? and CryptoCapsules? social media series.

Henri was recently named by Onalytica as the #1 most influential individual on Finance globally on LinkedIn out of 50k+ individuals working at the top professional services and management consulting firms in the world.

Chambers Global named Henri the “highest-profile FinTech consultant in Hong Kong”, Blockchain Asset Review named him the “Most Influential Crypto and Blockchain Thought Leader in Asia”, and Asian Private Banker awarded him the “FinTech Changemaker of the Year” award.

Henri’s latest book “The Future of Finance: The Impact of FinTech, AI and Crypto on Financial Services” published by Palgrave Macmillan, was ranked as one of Amazon’s global top 10 best-sellers in financial services and was recognized as one of the “Best FinTech Books of All Time” by Bookauthority.

Before joining PwC, Henri was with a FinTech start-up and previously spent many years with UBS Investment Bank in Hong Kong. Henri started his career as a financial markets and funds lawyer in Canada and Hong Kong.

Henri speaks five languages including English, French, Armenian, Spanish, and Mandarin Chinese.

He holds a Masters in Chinese Law from Tsinghua University; a joint Global Executive MBA from Columbia Business School, London Business School, and Hong Kong University; a Bachelor of Law from the University of Montreal (Dean’s List of Excellence) and a Masters in Transnational Law from the University of Sherbrooke, where he was awarded the Governor General of Canada Gold Medal for Academic Excellence for having graduated with the highest grades of the university.

You can learn more about Henri on his website (www.henriarslanian.com ) and you can reach him at [email protected]