but they won't stop being a market; this law only makes it harder for Chinese people to create new web companies, which will make it easier for other countries to dominate the market.
no it won't. If you want to operated a server in China, you need a Chinese company to do it. If you operate your server outside China, the bandwidth will be so bad you won't be able to retain many users and you might get blocked. For the most part local Chinese have an advantage over foreign companies trying to operate an Internet business within China.
This move by China's gov to only allow companies to register a domain is most certainly just something to ease the trouble of overseeing site ownership and regulation. You may not agree with the regulations, but they aren't draconian (yet).
