> Does the government turn a blind eye to most of it?

Sort of. It's difficult to track private transactions on WeChat between friends to actual goods being sold. From what I've seen, most illegal goods/services sold just have you add them as a "friend" and send the agreed upon amount. Somewhat informal but neither side tends to scam since the consequences of escalating (e.g. getting a WeChat account banned) essentially makes it impossible to live. I've also seen Taobao being used where they place an overpriced real product that you buy and the margin is what you pay for the illegal good.

I'm not sure if it's truly turning a blind eye or whether the scale is just too large for the government to do anything about it.

Do you think most bigger drug dealers and prostitutes pay tax on their income?

I'd think it would be hard to have $100k+ flowing into your account with no explanation.

I've been curious what most countries will do for these situations as they go cashless. Non-KYC'd crypto seems like a natural solution, but I haven't seen it used much outside larger organizations.

Don't know how it works for large drug dealers but I would assume they use the same channels as money launderers: overseas accounts.

You get in contact with a connections guy and they give you a list of accounts to pay in yuan (usually business owners that makes profit overseas), they pay you in USD from their legitimate businesses for some made up invoice. Each transaction is under the limit for being scrutinized. Once money is out of the country, you can pay people off however you want.

Prostitutes would probably just take cash if close to limits.