(By Caixin journalists Tang Ailin and Kelly Wang)
When police in East China’s Shandong province busted Li Bi at her office in July 2023 because they suspected she was involved in an underground banking operation, they found her in possession of ten bank cards linked to over 17 billion RMB (US$2.3 billion) in transactions.
The accountant at a small textile company, who was 41 at the time, was later identified as a key virtual currency trader behind a complex scheme to move money overseas using cryptocurrencies like Tether and Ethereum. The operation helped a variety of people, including Chinese students overseas and purchasing agents to circumvent China’s strict foreign exchange limits, which cap annual personal currency exchanges at US$50,000.
[Cryptocurrencies’] decentralised nature and degree of anonymity offered to users, combined with different regulatory environments in different countries, have further complicated supervision and law enforcement efforts.
Cryptocurrencies have lowered the barriers to running an underground currency exchange as they eliminate the need for large reserves of both local and foreign currencies. Their decentralised nature and degree of anonymity offered to users, combined with different regulatory environments in different countries, have further complicated supervision and law enforcement efforts.
When investigating Li’s case, the State Administration of Foreign Exchange’s (SAFE) branch in Qingdao and the local public security bureau also uncovered links to underground banks in 17 other provincial-level regions including Shanghai and Guangdong, where money laundering activities were suspected.
“This new method has completely overturned the traditional model of currency trading through underground exchange networks,” said Yang Yi, a Qingdao police case officer who followed the case.
Since 2021, China has banned all cryptocurrency transactions. This past January, a district court in Qingdao convicted Li of running an illegal business and sentenced her to seven months in prison. Local police later revealed more details to Caixin in interviews conducted during the second half of the year.
How it was uncovered
Qingdao police began their investigation after receiving tips from the Ministry of Public Security in November 2022 about suspicious bank transactions. Several hundred Chinese bank accounts showed an unusually high number of daily transactions at unusually high amounts with IP addresses of online banking operations in South Korea. This was especially suspicious because the registered names on the accounts were people who had never been abroad.
The police investigation determined that most of the people transferring money into these accounts were Chinese students studying in South Korea or shopping agents who frequently travel between the two countries. Shopping agents are people who travel abroad to buy goods that are either unavailable in China or are taxed heavily when imported.
“These [accounts] can be understood as small domestic underground banks, and were springing up everywhere. They don’t need a pool of reserves. They can operate with just a phone,” said Jia Fangqiang, a criminal investigator on the case.
Because of the vast number of accounts involved in the case and the unusual transaction patterns, it took a lot of time and effort to pin down who was actually in control of these accounts. Yang said Qingdao police had never dealt with an underground banking case involving virtual currencies, and that they had had to learn the methods for collecting evidence on the spot.
South Korean regulations require that foreign cryptocurrency exchange accounts and South Korean cryptocurrency exchange accounts must be registered to the same person if money is being transferred between the two. Thanks to anti-fraud measures like this, Qingdao police were able to put some of the funding chain together.
In one of the cases that law enforcement was able to nail down, Li received over 5.3 million RMB from one underground bank operator in South Korea, which she used to purchase virtual currencies to convert to South Korean won, according to a verdict from a district court in Qingdao.
How it works
Qingdao police found that one of Li’s trading counterparties was Dou Zhuang, a 27-year-old former student in South Korea who operated one of the underground banking accounts.
Dou… [offered] cheaper service fees than banks or other businesses that offer cross-border currency exchanges. His service was also faster and there was no limit on the amount of RMB that could be converted into other currencies.
At first, Dou used cryptocurrencies to move his own money across borders. After his friends, classmates and purchasing agents learned of the benefits, Dou started offering this service online, advertising it with daily exchange rates on his personal WeChat, police told Caixin.
Dou attracted customers looking to move money overseas because he offers cheaper service fees than banks or other businesses that offer cross-border currency exchanges. His service was also faster and there was no limit on the amount of RMB that could be converted into other currencies.
Dou charged a small fee and also made money exploiting price differences between domestic and South Korean exchanges. He would typically accept Tether and exchange it for the Ethereum cryptocurrency in China, which he would sell for a higher price on an exchange in South Korea. From there, he could convert it into won. The whole process took five to 30 minutes.
This method allowed his clients to get anywhere 0.7 to 1 more Korean won per Chinese RMB compared to official channels. Exchanging 50,000 RMB in this manner could yield about 200 RMB more in Korean won. In return, Dou would charge a fee of around 0.06% of the amount transferred.
Li’s part was to help get the client’s RMB, which came to her through intermediaries like Dou, into crypto in the first place. Her profits came from small price differences by buying cryptocurrencies low and selling high — earning 0.01 RMB to 0.05 RMB per Tether, a so-called “stablecoin” pegged to the dollar. The police found Li made over 8 million RMB trading cryptocurrencies.
Between 2020 and 2023, Dou exchanged more than 11 million RMB to South Korean won, about half of which was moved through Li’s crypto transactions, the court verdict showed. Dou was eventually convicted of running an illegal business and sentenced to ten months behind bars. “Virtual currencies are increasingly involved in illegal foreign exchange operations, blurring the line between virtual currency crimes and traditional fiat currency crimes,” Qingdao police said.
… virtual currency exchanges require no reserve funds. This makes it easier for illicit operators to engage in cross-border financial activities without the scrutiny traditionally associated with physical currency transactions.
Supervision difficulties
The key difference between traditional and cryptocurrency-based underground money exchanges is that the former typically rely on large reserve pools of the currencies being traded, with an infrastructure to manage the flow of funds in and out of the system. They also need to bear the risk of swings in the values of the currencies, Yang told Caixin.
In contrast, virtual currency exchanges require no reserve funds. This makes it easier for illicit operators to engage in cross-border financial activities without the scrutiny traditionally associated with physical currency transactions.
This shift in the operational model has raised alarms among regulators and law enforcement agencies in China. In a notice issued in November 2023, the Supreme People’s Procuratorate listed virtual currency exchanges as a “mainstream method” for money laundering,
“The difficulty in identifying, handling, and assessing virtual currencies has become a major obstacle to cracking down on fraud and money laundering,” it noted.
In recent years, certain cryptocurrencies have gained popularity among criminals including kidnappers because they are easy to convert, don’t suffer from wild swings in value and offer a degree of anonymity.
(Li Bi and Dou Zhuang are pseudonyms in the story.)
This article was first published by Caixin Global as “In Depth: Maternity Wards Are Latest Victim of China’s Falling Birthrate”. Caixin Global is one of the most respected sources for macroeconomic, financial and business news and information about China.
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