Article reprinted from Knowledge@Wharton | April 23, 2019
By all counts, China is leading the world in the use and development of blockchain technology. It has far and away filed the most patents related to blockchain in the world and some of the biggest names in the blockchain and cryptocurrency community are Chinese firms. What’s more, blockchain is also a national priority: The Chinese State Council included its development in the nation’s 13th Five-Year Plan. And last year, President Xi Jinping said China seeks to lead in innovation worldwide, citing blockchain, AI, the Internet of Things and other technologies as the driving forces.
This national focus was confirmed by Chinese executives and entrepreneurs involved in blockchain endeavors at the recently held invitation-only roundtable discussion on blockchain hosted by the Penn Wharton China Center. Two-thirds of blockchain-related patents come from Chinese firms or entities, one participant said, adding that China also holds 72% of the mining power for bitcoin. “China is very pro-blockchain technology and the government has positioned itself to dominate the blockchain space in the world.
For the West, however, there is a bit of a conundrum about this focus. Blockchain, the underlying ledger technology of the bitcoin cryptocurrency, was created in 2009 by a mysterious entity called Satoshi Nakamoto to be a decentralized system. That means there is no central authority in control, which flies in the face of the current political system in China. But comments on China Central Television by Chinese official Xu Hao clarify the party’s stance: Blockchain in China is not about decentralization but “de-intermediarization. There is no way to get rid of the center.”
While the West looks at decentralization as a sort of libertarian haven — a principal attraction being the lack of central control — that’s not the goal in China. Blockchain can build trust and usher in greater prosperity for the Chinese, but it is not for undermining the state. To bring home this idea, the Cyberspace Administration of China (CAC) issued regulations in January governing blockchain companies. They include giving authorities access to stored data, requiring users to provide real identities, and mandating providers to oversee content and censor information that is prohibited by law.
This view of ‘blockchain with Chinese characteristics’ explains why the government can be so gung-ho with blockchain but crack down on the Chinese public’s speculation on cryptocurrencies as well as initial coin offerings. In China, curbing crypto speculation is seen as a social good. But a ban also gives government control over cryptos. With few investment options for the Chinese, and with a cap on how much money they can send abroad to invest, people get around the rules by buying bitcoin in-country and selling when they travel outside China, another participant said.
Chinese Blockchain Activity
China is attracted to the blockchain’s efficiency and ability to generate cost savings in transactions, among other benefits. As a digital ledger, the blockchain records transactions in a way that makes it impossible to change. Each user gets a copy of the transactions, ensuring all eyes on the records. It negates the need for a middleman to stand between two parties that don’t trust each other — and taking out intermediaries removes their fees. Recorded on the blockchain are things like bitcoin trades.
China’s central bank, the People’s Bank of China, reportedly is testing blockchain-based trade and finance platforms, such as in Shenzhen. On March 30, the CAC released a list of 197 registered blockchain firms, including units from Alibaba, Tencent and Baidu. In addition, China has blockchain ‘sandboxes’ — special economic zones designed to assist companies developing the technology. For example, one participant said, the Hainan sandbox offers government-sponsored incubators for startups, special deals for facilities, aid to entrepreneurs, official licenses and other perks.
Compare that to the U.S. where it was only in February that President Trump launched the country’s artificial intelligence initiative. “There’s no U.S. government strategy at all for blockchain,” according to an op-ed in The Washington Post. However, the Chamber of Digital Commerce sees the urgency and issued a National Action Plan for Blockchain, calling out the “need for a comprehensive, coordinated, pro-growth approach to developing blockchain technology in the United States.”
As the U.S. gets its act together, China is springing forward. “In China, it’s very tech friendly,” said Lin Pang, an attorney at the DLA Piper law firm in Washington. “They encourage innovation and creativity by providing the resources, including the incubator. For foreign companies [coming in] they want to make sure you work with the local companies and contribute to their economy.”
U.S. blockchain companies are looking to make it in China as well. But to be successful, they have to start with a China strategy, said Xiaochen Zhang, president of FinTech4Good, a global fintech and blockchain network. They have to understand the different components of doing business in China and adapt to the environment as efficiently as possible. “If they just go to China and find out it doesn’t work, it will be highly costly,” he said. Startups also need a Chinese corporate partner. “The corporate partner can help you get clients, or users,” as well as prevent the U.S. companies from making missteps in a foreign environment.
Zhang saw a mistake made by a U.S. startup when he was judging a green technology competition in China. “Some kids from Stanford developed a technology [to disrupt] the national [electrical] grid,” he said. (The State Grid Corporation of China is the largest utility company in the world.) But Zhang said no one on the team had any electrical grid experience nor industry contacts in China. As such, their solution “will never be used,” he said. Zhang’s advice: Get the China strategy right, acquire the relevant expertise and find the appropriate Chinese partner.
However, startups do have an advantage in China when it comes to disrupting financial services. In the U.S., it is tough to disrupt big financial institutions at scale because the industry is mature, incumbents are entrenched and regulations are well-developed. In China, the industry is not as developed and so it offers more opportunities for disruption, such as in crypto-banking, especially if the Chinese government supports the effort, according to Cao Huining, cofounder of Usechain, a blockchain built on real identities to create more transparency and accountability.
Hurdles to Mass Adoption
Globally, crypto-blockchain companies are realizing that they may have to play by existing rules to get scale. Indeed, a recurring problem in the industry is a dearth of big players due to regulatory constraints, said Adam Cole Jacobs, cofounder of Bitsdaq, a digital asset trading platform based in Asia. Cao added that big players want safety: “All these big mutual funds and hedge funds want to get in but they all want to know [what would happen to funds access] if I lost my private key.” What’s missing are custodians, they said. Today, banks are custodians that hold money in private accounts, standing between buyer and seller.
Building trust in the ecosystem is key, said Dan Doney, CEO of Securrency, which provides decentralized investment banking services. “Custodianship matters,” he said. “The old financial system was very much about scaling out trust. [But] they happened to do it very poorly with mechanisms that were largely about an old boys club. That can be displaced.”
People will always want security. “How can you be sure that this exchange isn’t going to lose [say,] $160 million of value? What mechanisms are there to assure someone that the right things are in place [to keep the assets safe]?” Doney said. “The world is the way it was for a good reason. We need to understand and incorporate those reasons and then move beyond into a new world where this scales.”
But this pragmatic argument is not convincing to industry experts with a more purist viewpoint, such as Vanessa Grellet, executive director of blockchain solutions provider Consensys. She believes blockchain should blaze a new path. “We should stop replicating the existing structure. True innovation will come from new companies — and not by replicating the existing [infrastructure] or trying to improve the efficiencies in the existing systems…. That’s not where innovation is going to be in the future.”
As this pragmatic vs. purist debate rages on, governments are beginning to act. FinTech4Good’s Zhang said the Organization for Economic Co-operation and Development (OECD) has created the Blockchain Policy Centre, which is a global platform for countries to address challenges and opportunities raised by this distributed ledger technology. Last month, it held a “Tech for Trust” conference in Paris where blockchain was the top topic and many countries showed interest in it, Zhang said. He noted that, for example, he has advised the government of Kazahkstan about crypto regulations, which has resulted in two new policies.
Regulations have a purpose. “Governments have to protect their people,” Doney said. “Instead of rejecting or attempting to get around regulations, [learn to] incorporate it into the transactions themselves at scale, respecting that different governments have different viewpoints in what it means to protect their populace. You need to be able to react to all those different viewpoints — and that’s where we’re beginning to progress.”
But it’s a different picture among central banks. There’s still a big divide where they typically fall into two opposite camps. “Some are very innovative and more agile,” on one hand, while others are resistant such that “they tried to defeat … [the idea of having a] digital currency or cryptocurrency,” said Zhang, who recently presented a paper on digital currencies to several central banks. “They say a non-tangible is not an asset.”
The key to wider adoption has to be education. “Everyone [at the roundtable] knows what a bitcoin is. But outside of this room, if I go to my Uber driver, he [probably] doesn’t know anything about bitcoin,” said Wilfred Daye, head of financial markets for OKcoin, a digital asset trading platform. “It’s also a cultural and generational thing. Younger folks understand bitcoin but older folks may not.” Culturally, countries with developed financial systems may be more resistant than developing economies, which can leapfrog more easily to the latest technologies.
‘A Modern Internet’
Blockchain is actually at a tipping point, said DLA Piper’s Pang. While big firms are interested in the technology, they’re also “very skeptical because they don’t have a lot of incentives to really change” their existing system, she said. “It’s … human nature. We just don’t want to change unless we have to.” That’s why she believes financial institutions are at the frontier of pushing blockchain adoption. “They’re Wall Street. They’re very sensitive to new technology because they don’t want to be replaced by their competitors or some new [type of commerce].”
Other industries are not so motivated. Pang said her real estate clients don’t see an imminent need to adopt the blockchain. So they stick to the tried-and-true approach. “They feel comfortable working with their traditional service providers,” she said. If they want to invest in a certain market, they will call their brokers to find them a project and then consult with investment bankers they know and trust, she said.
“It’s very hard to build a new trust system without the existing trust system,” Pang continued. “The middleman is there for a reason — to prevent market manipulation or maybe some violation of the rules, and to protect investors and protect the interests of others.” On the other hand, companies must also be open to change because refusing could lead to their downfall. Once one company changes, it could force other players in the ecosystem to pivot as well. “But it’s going to take time,” she said.
Another hurdle to mass adoption is knowing how to categorize never-before-seen products like bitcoin. “Right now, the debate around cryptocurrency is, what is its core concept?” said Adam Cai, CEO of VirgoCX, a fiat currency-to-cryptocurrency exchange based in Canada. “Is bitcoin a cryptocurrency? A commodity? An asset?” The industry needs “proper custodianship, needs a proper legal framework” to make it work, he added.
But Securrency’s Doney believes that people eventually will adopt a technology if they can “participate in the value of their own upside.” He cites the example of ‘usage rights’ in real estate. Currently, the interests of the landlord and tenant are misaligned. The owner profits if the property appreciates in value. The tenant does not, and in fact it typically doesn’t hurt him to degrade the property. “But you can have a middle ground where you combine these two and pay for only what you use, and if you improve [the asset] then you participate in the equity upside.”
Doney pointed out that some companies already are deploying this concept, such as WeWork, which provides shared office spaces and business services. “It’s that component where you own your own upside for the space that you use,” he said. “That framework could become pervasive and would then move to other industries, like … being able to participate in the upside of your own data, in your own intellectual property.” Added Consensys’ Grellet: “The entire fractionalization of value and things is the use case that is really going to grow the industry.”
Over the long run, however, bigger changes are needed. It’s time to design a new internet, contends Sunny Feng Han, founder of the MIT IDE Blockchain Pillar and Foundation, and cofounder of Elastos, which is building what it calls a ‘Modern Internet’ that is open source, encrypted end-to-end and powered by the blockchain. “Why do we need a modern internet? Because the internet now can’t protect everyone’s data and privacy,” he said.
“We need a new internet — a modern internet [to serve as the new] infrastructure, to have peer-to-peer commerce and a trusted environment and, certainly, blockchain to protect everyone’s data rights in the future,” he continued. “We need a decentralized internet; [then] we will have a new infrastructure to support decentralized applications — you eliminate the middle point and we can control our data. … We need new infrastructure to support a decentralized new internet in the future. That is the most important.”