This content is from: Banking

PRIMER: China’s cryptography law

A closer look at the country's new law targeting blockchain development, how it relates to the country’s national digital currency, and the impact on the fintech community

China has passed a new law regulating cryptography, which will come into force on January 1 2020. Cryptography is an integral part of blockchain technology which has been strongly supported by the People’s Bank of China and at a high level, by President Xi Jinping.

IFLR’s latest primer looks at how it will impact blockchain development and the broader implications for the government’s desire to create a national digital currency.

What’s cryptography?

Cryptography is the method of protecting information by changing or encrypting it into an unreadable format so that only those with a secret key can decipher it into plain text. It’s used to secure data in transmission, data storage and user authentication.

What’s the cryptography law about?

Under the new law, organisations working on cryptography need to have management systems in place to ensure there is sufficient security of their encryption. While the law encourages the commercial development of encryption technology, its use cannot harm state security or public interest.

In the legislation, cryptography generally refers to technologies, products and services that apply specific transformations to information to effect encryption protection and security authentication.

The law stipulates that all state secrets have to be stored and transmitted using core and common encryption. Commercial encryption is the third type, which can be used by anyone to protect information that is not confidential.

At this stage the law remains quite vague, and further implementing guidelines can be expected in 2020. Many in the market are enthusiastic.

“I think it’s a net plus for the blockchain community since it will now be a mandate that they have high quality encryption built in,” says Richard Turrin, a Shanghai-based author and fintech consultant. “Strengthening the encryption or setting standards that guarantee the security of that encryption are both fundamentally good things.”

He continues: “There are hundreds of blockchain protocols out there being built by developers in China, but right now it’s unclear whether the encryption you're buying into is as advertised when you use the system. So it's certainly a form of insurance, in as much as the law can be enforced on a vast army of coders.” 

PRIMER: regulating cryptocurrency exchanges

However, some believe that the encryption law won’t have much of an impact. Samson Williams, adjunct professor at University of New Hampshire school of law, believes that blockchain laws are not needed.

“Laws pertaining to data privacy, data ownership and data sharing are needed,” he explains. “Blockchain is just the plumbing of data collection, maintenance, sharing and monetisation. We need laws that address how data is commercialised and who owns it, not necessarily the means of how the data is amassed.”

What concerns does the industry have with the new law?

More clarity is needed on the definitions of certain terms such as national security, and how much government interference is possible.

“I think we’ll see pilot projects first with domestic businesses,” says a Singapore-based in-house lawyer at an international bank. “Until we see these test cases, it’s hard to delve into the cross-border and data control aspects.”

Turrin says there may be a few points of contention for foreign developers. For instance, the government will require import licensing on commercial-grade encryption technology used by companies to protect networks and for information security.

“Whether this licensing is simply a formality or will be strictly enforced is not yet clear,” says Turrin. “The good news, though, is that the law explicitly forbids the government from demanding source codes and proprietary information.”

According to Sherry Gong, partner at Hogan Lovells, article 21 of the law provides that all commercial encryption operators, including domestic companies and foreign-invested enterprises, shall be treated equally.

But due to the general and somewhat ambiguous nature of the drafting, it is still unclear whether the equal treatment principle will mean that both domestic capital and foreign-invested enterprises, and foreign individuals will be permitted to import foreign-made commercial encryption products or services.

Another unanswered question is whether the products may be sold in the China market.

How does the law relate to China’s plan to develop a national digital currency?

Chinese officials have been studying the possible rollout of a national digital currency for some time now. Market participants believe it will happen, although no formal timeline has been set. The cryptography law is thought to provide an overarching framework for the further development of blockchain and digital currencies.

“It provides a broad-brush framework, including commercial uses, for digital currencies. It’s a good move, but more implementing guidelines are needed,” says the in-house counsel.

According to Turrin, the law will support the national digital currency by enshrining its high encryption standards in law.

Exactly what these standards are is unclear at the moment but observers believe that evolving standards are inevitable with the rapid changes in technology. With the passage of time, though, many believe there’s potential for the legislation’s mandated encryption standards to change – which would require the national digital currency encryption to change.

Takatoshi Shibayama, founder of Blockchain Centre Singapore, believes the law demonstrates China’s sustained interest in pushing for blockchain development, but it’s unclear where it could be headed.

“Blockchain technology, from its first manifestation of bitcoin to recent use cases in supply chain management, has a spectrum of usability for the exchange and storage of data. This can be fully encrypted and managed by a decentralised system, or be fully transparent and be centralised,” says Shibayama.

He continues: “The only commonality of the two is that the data is being exchanged without going through an intermediary, reducing human error and friction. But what gets recorded, where it gets stored and how that is governed are the ultimate questions, and it is a matter of where the technology’s direction is spearheaded towards.”

How ready is China for a national digital currency?

With the rapid advance of payment systems like Alipay, observers believe that it’s only a matter of time before China adopts a national digital currency. However, at a global level, central banks are still grappling with creating the appropriate governance structures.

“China has plans to launch a national digital currency that will be pegged to the renminbi,” says the in-house counsel. “With so much of China already cashless, I think it wants to set a benchmark to the rest of the world – and it will also help internationalise the renminbi.”

The in-house counsel adds: “Central banks around the world are exploring the new risks associated with digital currencies, and need to create the security, taxonomy and governance building blocks – no central bank can do it alone.”

A key lingering question for Chinese officials is how best to ensure oversight while providing space for innovation and commercial success. It’s a delicate balancing act that central banks and regulators around the world are struggling with.

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