[Note: I posted an earlier draft at reddit, below is a revised and expanded edition]

For those unfamiliar with Huobi, it is now the largest BTC exchange in China doing roughly 40,000-80,000 in volume a day (versus 4,000 at OKCoin) – though these numbers could be suspect (see the last section below).  Earlier today I spoke with my friend who is building an exchange in Shanghai who explained the volume discrepancy.

The way the current exchanges in China are nearly all set up is that all of the trading is actually conducted using the CEO’s personal bank account.  That is to say, none of the exchanges (at first) utilized a corporate account.  At some point this past year the big exchanges managed to switch to corporate accounts in some form or fashion.  So on top of the 3rd party payment provider ban issues last week, the CEOs at the big exchanges (probably) expect some kind of crackdown on personal accounts so they are trying to go completely legitimate and avoid the risks associated with personal liability.1

Thus Li Lin (CEO of Huobi) is shouldering a great deal of risk that neither Bobby Lee (BTCChina) nor Xu Mingxing (OKCoin) no longer are willing to do any longer (see below for several reasons why).

The other reason for Lin’s success is that he has an individual account with each bank (ICBC, BoC, ABC, CCB, SPD, etc.) so his system does not utilize an interbank transfer (other exchanges may have used that same method as well, I do not know). Again this is largely due to the current legal policy (which has existed for as long as I lived there) in which you cannot just move money from a corporate account to a personal account without a fapiao.2

Note: if you are a big trader, right now you would want to use Huobi to buy BTC (as it is the easiest/fastest way to do so) but use BTCChina for actual trading (due to its API/bot functionality and features).  Why?  Because ceteris parebus as the big exchanges get closer to zero liquidity then there will likely be larger arbitrage spread opportunities.3

Personal and commercial accounts

A reddit user asked, “so the government restriction doesn’t apply to deposits sent through a CEO’s personal bank account?”

As of right now, it does not. But the CEO part is not necessarily the linchpin as outlined by some specific bank policy. The exchanges use the CEOs personal account due to liability issues, how bank transactions take place (personal versus corporate) and how corporate structures work in China (e.g., you do not ask the intern to use their personal account even though it is roughly the same as the one the CEO uses). The People’s Bank of China (PBOC) could restrict that directly if it chose to irrespective of whether or not you have a fapiao (invoice).

Which brings up another overlooked issue entirely, why is a fapiao necessary? Basically if you want to move money from a corporate account to your personal account, you need to have a “chopped” (印章) invoice for each transaction.4 Even if you own the corporate account, in China you have to present this fapiao for each exchange. You can imagine the logistical and paperwork burden that would place on say a bitcoin exchange that processes tens of thousands of transactions a day.  China Briefing has a good a explanation of how a fapiao works.

And as mentioned earlier, one of the speculations right now is that Bobby Lee and others believe that there will be a crackdown on personal accounts and that is the reason why they stopped doing it (you would have to ask them though).

I personally would never allow my account to be used like that as it really puts you in a bad legal liability position if someone you sent/received money from ends up doing something illegal. You could be held liable as accessory to whatever crime or even more directly, enabled money laundering to take place (depending on jurisdiction).5  But again, this is a personal preference and there are obvious huge financial rewards for taking that risk right now.

Outright banning

Another reddit user asked, “why would the government not try to close personal accounts used for BTC exchanges?”

The answers are completely speculative (unless the person you talk to works for the PBOC).

Ultimately the PBOC has the authority to ban cryptocurrency exchanges on the mainland and even ban the commercial use of it. But they have (so far) chosen not to. This is not an accident and again let there be no doubt that they can ban nearly the entire ecosystem within China immediately (e.g., exchanges, merchants, POS, even large ASIC facilities).

Why haven’t they?  Perhaps they want to control it which is significantly easier if there are just a couple of big exchanges and not many small ones (there were ~20 about 2 months ago, it is unclear how many there are today).

Perhaps connected members in the PBOC and its peer organs in the Party appartus are indeed making money off of BTC as some have speculated, but this is impossible to tell unless an address is verified.  For example, on a small, distributed 1-1 scale, bitcoin exchanges are essentially untraceable (e.g., act as massive “tumblers“) and the Chinese personal banking system makes 1-1 transfers very easy.

Obviously Chinese policy makers cannot afford to undermine their dollar assets, but they more than likely want a multi-currency world and by creating this additional uncertainty in the FOREX market it encourages currency plurality. That is to say if you are unsure about the USD, you will also hold Euro and RMB.  However, the RMB cannot replace USD now because of capital controls and if that is their goal, the road to adoption is extremely long as RMB settlements account for ~2% globally.6

Padded numbers

According to some news accounts, OKCoin (and likely others) may have been fudging its volume numbers which could explain part of the large drop in recent volume.  This of course is disconcerting in that it hurts the credibility of all exchanges and only adds ammo for critics who claim that exchange operators can do a lot of front running since there is currently little transparency (e.g., who is to say anyone besides the exchange itself is actually trading on exchange X or Y?).

As a consequence, this same friend recently told me how Xu Mingxing may have brought unwanted attention to his own account because of those huge posted volume numbers.

And again, my point about the CEO account link above was to illustrate the operational risks involved with creating financial startups on the mainland.  Prior to the Bobby Lee inauguration, all of BTCChina’s deposits purportedly went to the co-founder Yang Linke.  Perhaps there will be another personal account method used there in the future.  We will find out shortly.  And as long as the customers are fine with it, it is/was apparently much easier in terms of accounting to try this method.  Thus it will be interesting to see how the industry hedges those risks/liabilities in the future and to see what areas the Chinese policy makers restrict next.

1. The PBOC issued guidelines prohibiting 3^rd party intermediaries and payment processors such as Alipay and Tenpay from transferring CNY (renminbi) to and from cryptocurrency exchanges.  This effectively put an end to all mainland based CNY deposits for BTC exchanges.  See Bitcoin Value Sinks After Chinese Exchange Move from The New York Times and Doubling down, China bans transactions between Bitcoin exchanges and 3rd-party payment companies from Tech In Asia [↩]
2. Again while speculative, the “new” exchange system implemented at Huobi and others may be very low tech and simply involve a person using internet banking to manually transfer and approve all funds.  This is much slower than the automation previously used. [↩]
3. If you want to cut your teeth programming HFT bot software, you can use the open source cryptrade libraries at git and join the community at Cryptotrader.org [↩]
4. See Chinese Chops Or Seals from About.com and What is a Chinese “Chop” or Seal? from Yahoo! [↩]
5. There is no global standard yet, Singapore’s government is taking a hands off approach towards cryptocurrency right now whereas Denmark plans to regulate and oversee its use. [↩]
6. For an explanation as to why the RMB will not replace the USD anytime soon see this overview with Patrick Chovanec from earlier this year.  I also recommend reading the Debt and Reserves section from Michael Pettis’ note in October.  In addition readers are encouraged to read the highlights of this Bloomberg report on the hypothetical issue of Chinese institutions “dumping” the USD en masse. [↩]