(FORTUNE Magazine) – SHI HENGXIA is neither brilliant nor exceptionally beautiful. And she is certainly no political activist. Since leaving her village in Shaanxi province for China's capital four years ago, she has failed to realize her dream of winning admission to a prestigious Beijing graduate school and is still looking for Mr. Right. But the 28-year-old can boast one undeniable achievement: She has become one of China's most celebrated cyberdivas. And that turned her into a thorn in the side of China's censors.

A few years ago she began posting personal essays--along with photos of herself fully clothed but in saucy, provocative poses--on electronic student bulletin boards, where she took the name Hibiscus Sister. The blithe boldness of her postings made them an overnight sensation. "My sexy appearance and ice-and-jade purity bring me a lot of attention wherever I go," she wrote in one. "People never tire of looking at my face. My physique gives men nosebleeds." Was she serious? Was it a put-on? As the debate spread, her blog became one of the most heavily trafficked in China. She began popping up on magazine covers and TV programs. By last summer Hibiscus Sister had blossomed into nationwide celebrity.

That's how Hibiscus Sister--one of a vast garden of curious flowers to bloom since China discovered the Internet--became an unlikely example of how the web nurtures free expression and how Chinese censors try to prune it back. In August a number of blog sites were ordered to move Hibiscus Sister's postings to less trafficked areas, enabling her to complain that she was the victim of a "crackdown." That China's Communist rulers would feel compelled to move against a harmless self-promoter, as lacking in political intent as in talent, is a telling measure of their vexation with the Information Age. And when it comes to bloggers who do have political intent, the censors are of course even less tolerant.

In recent months Western media have been filled with reports of Beijing's increasingly heavy-handed attempts to silence dissent and block references to politically sensitive topics like democracy and human rights. The debate is especially hot in the U.S., because some of America's most respected tech pioneers--many of which tout the web as a force for individual empowerment--have collaborated with the Communist Party's effort to keep the Internet under its boot. Cisco and Sun Microsystems sell Beijing hardware and filtering systems used to block access to forbidden sites--the so-called Great Firewall of China, managed by nine state-licensed Internet-access providers that use technology and an army of censors to patrol the gateway between China and the rest of the world. Yahoo surrendered information on at least two e-mail customers later jailed for disclosing state secrets. And Microsoft said it would block access within China to individual blogs at Beijing's behest.

The sharpest barbs have been hurled at Google. The company, famous for its "Don't be evil" motto, announced earlier this year that it has deployed a separate, politically correct site for users in China, which blocks access to content Beijing deems controversial. The result is a digital alternate universe in which users who type "Tiananmen Square" into the Chinese Google site are guided to pictures of tourists strolling around Mao's tomb under balmy skies, while users in the rest of the world are directed to links depicting tanks and bloodied demonstrators.

In Washington, D.C., at a Feb. 15 House subcommittee hearing, representatives from Google, Yahoo, Microsoft, and Cisco squirmed as chairman Christopher Smith (R-New Jersey) decried their acquiescence as the equivalent of turning Anne Frank over to Nazi agents. Microsoft counsel Jack Krumholtz seemed unable to decide on which horn of the dilemma he preferred to be impaled, pleading that individual companies "do not have the leverage" to defy orders of a sovereign within its own borders moments after entreating lawmakers not to tie the hands of U.S. firms with codes of conduct, as Smith's proposed bill would do. "Enacting legislation that effectively forces us to withdraw from China," Krumholtz said, "would be counterproductive."

Lost in the furor are important truths about the Chinese web. One is that Chinese citizens today enjoy greater freedom of thought and access to information from outside China than at any time in history. The Internet is a major reason for that and will continue to tip the scales in favor of openness, as the very nature of the web is to bring people together outside the ambit of the state. Despite the Great Firewall, there are an estimated 110 million Internet users--more than in any country except the U.S.--and 16 million bloggers, up from just 2,000 at the end of 2002. Bokee.com, one of China's largest blogging sites and host to Hibiscus Sister's blog, is registering 40,000 new users a day. "Yes, things get blocked, and nobody likes the filters," says Bokee founder Fang Xingdong, who employs a team of censors to weed out heresies and hews to the party line when he asks, "Why are the Western media so obsessed with that kind of stuff? Those things are only a tiny part of the industry."

WHAT CHINESE INTERNET entrepreneurs like Fang are obsessed about is competition with Western companies. While Beijing has worked tirelessly to restrict what travels across the web, it has encouraged substantial foreign ownership in the businesses that run it, in part to gain access to network technology. Google, Yahoo, and Microsoft are major players in China, while eBay and Amazon have secured footholds there with local acquisitions. China's dysfunctional stock markets and backward venture capital rules have hobbled development of homegrown web firms and forced even the most promising to go abroad for startup cash and to list on stock exchanges. Thus, the flip side of the censorship controversy is a pitched and often emotional battle by Chinese operators to wrest control of China's web from the non-Chinese they looked to for capital and technological know-how. "I have to deal with a bunch of investors who don't live in China, can't speak the language, and don't even look at my site," fumes Charles Zhang, the founder of Sohu.com, a leading web portal. "All they want to talk about is the next quarterly earnings statement or how to replicate some business model from the U.S."

For now, earnings of Internet companies in China are small. BDA China, a Beijing consultancy, estimates that the market for online ads, games, search, instant messaging, and wireless services in China came to just over $5 billion in 2004, with wireless accounting for more than 90% of the total. But foreign firms and investors are betting that will change quickly as incomes rise and hundreds of millions of China's low-income farmers migrate to jobs in cities.

One sign of renewed interest by overseas investors: In September, Morgan Stanley tech maven Mary Meeker initiated coverage of China's Internet sector. Goldman Sachs and UBS quickly followed suit, and big venture funds are piling in too. Last year a record $4 billion was raised for China tech companies, according to Beijing research firm Zero2IPO. Betting on Chinese dot-coms isn't for the timid, but many take heart from the success of a group of investors, led by Draper Fisher Jurvetson, that backed Baidu. The Chinese search firm debuted Aug. 5 on Nasdaq at $27 a share and shot to $122 by the end of the day, the biggest first-day gain of any Nasdaq offering in five years.

Baidu's share price has since drifted back to $49, but its strong start put foreign tech companies on notice. After all, if there's one thing the founders of Google, Yahoo, and Microsoft appreciate, it's the importance of locking up market leadership. By that measure, China's Internet realm remains wide open. Rankings by sales, profit, and market cap can swing wildly with each quarter and within each sector. In the go-go days before 2000, portals like Sohu, Sina, and Netease were China's hot tech plays. Then the buzz shifted to wireless service providers such as Tom Online and online game providers like Shanda. Now those firms have fallen from favor, and search is all the rage.

Baidu has emerged as the clear leader in that segment. Last year it handled an estimated 47% of all Chinese search queries, according to iResearch, a Beijing consulting firm. Alexa.com, which monitors web traffic, ranks Baidu the fourth-most-visited site in the world. Founder Robin Li, 37, is a Chinese native who studied computer science at the State University of New York at Buffalo and cut his teeth in the search business at Infoseek during the height of the dot-com boom. "It was a great ride and taught me how the Internet can really transform people's lives," he recalls. But Li left Infoseek in 1999, disillusioned after the company's acquisition by Disney, and returned to China to raise money for a search firm of his own.

Baidu's success has made him a national hero. But Google is coming on strong. Last year it upped its share of the search market to 27% from 22%, and it's rolling out its new site in an effort to narrow Baidu's lead. Google expects the new Google.cn site will see higher traffic because it will run from servers within the Great Firewall, enabling it to return results faster and with fewer interruptions than searches routed through the filters to servers in the U.S. Li seems unfazed by the prospect of slugging it out with a company whose market capitalization is about 60 times larger than Baidu's. "The Internet is about language and culture, not just technology," he says, sitting in his office in Beijing. "As a Chinese company, we have a better understanding of Chinese users. To win in search, you have to sweat the details. We're better because of the thousands of tiny things we get right every day."

IN A GLEAMING new office tower a few blocks away, Sohu.com's Zhang is throwing money and manpower into Sogou.com, a new search site that's taking aim at Baidu. He expresses admiration for Li's success but advises him to "enjoy it while it lasts." Zhang, a returned MIT graduate, launched the firm that became Sohu in 1996. When it floated shares on the Nasdaq in 2000, Sohu was the darling of global investors, and Zhang was the It Boy of Chinese IT. But after the U.S. tech wreck, everything went wrong. In 2001 his once adoring foreign backers scorned his plea for more servers and increased bandwidth, leaving Sohu short of capacity as traffic soared. A year later, Zhang says, they badgered him into expanding wireless services to capitalize on China's mobile-phone boom. For a time Sohu was getting half its revenue from wireless. But there were too many competitors, and then the government slapped tighter restrictions on providers after a series of billing controversies. In the end, Zhang complains, he wasted more than a year chasing a futile business model. Now, he says, he's stopped listening to foreign know-it-alls: "I've been through this a couple of cycles. I know how wrong Wall Street can be." Then again, he's not ignoring the Street entirely. Sohu just forked out millions for rights to be an official sponsor of the Beijing Olympics and to host its website. The expense will build brand awareness at home, but Zhang says the primary goal is to "demonstrate to foreign investors Sohu's position as China's market leader."

Jack Ma, an elfin 42-year-old former English teacher often called "the father of China's Internet," has his own ideas about market leadership. He launched China's first commercial Internet site in 1995, briefly worked at China's foreign-trade ministry, then returned in 1999 to Hangzhou, his hometown, to set up Alibaba.com, an online clearinghouse for Chinese suppliers seeking buyers overseas. He followed in 2003 with Taobao, an online auction site for consumers similar to eBay's. The notion that Chinese firms like Alibaba will ultimately prevail over foreign rivals in their home market is a favorite Ma theme. He contends that resisting invitations to list Alibaba on foreign exchanges has been a key to his success, and he relishes boasting to foreign visitors that Taobao handles more transactions than eBay's China subsidiary, Eachnet, because it has a better sales force and a site design that makes more sense to Chinese users. (eBay says it's ahead of Taobao in attracting paying users. But after dismissing Taobao's strategy of allowing its site to be used free, eBay last year eliminated some China fees to bolster traffic.) Giants like eBay may be "sharks from the Pacific Ocean," says Ma, but small companies like Alibaba are "Yangtze River crocodiles," sure to dominate in their home waters.

That argument seems to make sense to executives at Yahoo. In August the U.S. web giant agreed to fold its China operations into Alibaba. As part of the deal, Yahoo put up $1 billion--a staggering sum in the fledgling Chinese market--in exchange for a 40% stake in the combined venture. Ma, who now has complete operational control, has given Yahoo's China site a radical makeover, clearing away news and entertainment directories to highlight its search box. He promises to make Yahoo China the country's top search engine within three years and to use the Yahoo site to draw users to Alibaba and Taobao.

But to win their battle with the U.S. tech giants, China's Internet insurgents know they must also win the hearts and minds of China's programmers. At a recruiting meeting for more than 600 engineering students in the banquet hall of Hangzhou's Yellow Dragon Hotel last November, Ma and his lieutenants served a potent rhetorical cocktail of national pride and individual ambition. Sure, the big foreign companies have more cash and better technology, went the pitch. But do they really care about improving China's economy? Will they really develop your career skills? Chinese executives from Alibaba and Yahoo assured students that working for foreign companies in China would prove stultifying and bureaucratic. Warned one: "You'll have to go all the way to some middle manager in California just to get approval for the shape of a click button." Ma told his listeners they had "the chance to put 1.3 billion people on the Internet. They can't do that in America. We're already competing with eBay and Google. In five years' time, we could be strong enough to take on Microsoft."

CHINA'S NET BARONS say they have no qualms about operating within the censorship restrictions laid down by Beijing. Indeed, Robin Li stresses that Baidu employs a large team of editors to monitor the site and communicate with official censors. Jack Ma says that although he wasn't in charge when Yahoo turned over the e-mail records of Shi Tao, a journalist later jailed on charges of subversion, he probably would have done the same. "Any company that wants to do business in China," he says, "has to operate according to Chinese laws."

It would be foolish for Chinese entrepreneurs to say anything else. But it's also true that their willingness to offer such professions of loyalty gives them a competitive edge, making it all the more difficult for foreign sharks to maneuver in Chinese waters. A day before U.S. tech executives were excoriated on Capitol Hill, Liu Zhengrong, who oversees Internet affairs at China's State Council Information Office, held a rare press briefing in which he described China's restrictions on the Internet as "basically in compliance with the international norm."

That one is a whopper, even by the standards of Chinese propagandists. A recent survey by OpenNet Initiative, a research consortium staffed by Harvard, Cambridge, and the University of Toronto, deemed China's filtering regime "the most sophisticated effort in the world." The list of what is forbidden passage through that firewall is long and constantly updated. The ban includes such taboo subjects as the 1989 demonstrations in Tiananmen Square, Falun Gong, Tibet, and human rights. But it's unevenly enforced, and access to controversial material can ebb and flow. Even with an army of censors, thought to number in the tens of thousands, monitoring computers in every home and 113,000 Internet cafés in China, it's difficult to control a medium as vast and mutable as the web.

Indeed, the surge in traffic suggests Beijing's effort to control the Internet is a cat-and-mouse game in which long-run odds favor the mouse clickers. Chinese users grow savvier by the day, and a growing army of "hacktivists" outside China is working to help them slip past the blocks. A software program called Freegate allows Chinese users to circumvent the filters by connecting them to U.S. servers. A network named Tor, based in Boston, helps Chinese users send messages anonymously. And it's not just the mounting cost of suppressing and snooping. The web fosters the development of civil society--clubs, discussion groups--and celebrates the very un-communist ethos of individual choice.

Consider the case of Yang Chengang, who toiled in obscurity crooning pop songs on Yangtze River cruise boats until a friend helped him post one of his ditties, "Mice Love Rice," on a popular music portal. Suddenly the song was everywhere--on computers, radio, mobile phones. "Mice Love Rice" has been downloaded more than 100 million times, bringing Yang fame, record deals, and enough income to finance his own recording studio. Okay, it's only pop music, but that's 100 million people in the world's largest dictatorship rendering collective judgment without meddling by the state.

UNTIL RECENTLY the liveliest exchanges in China could be found on bulletin boards and in chatrooms run by major portals. The problem with such forums, though, is that they are moderated by editors, who can easily scrub away controversial postings. Blogs are harder to monitor because they're easy to set up and can be shifted cheaply from server to server. As recently as 2003, China had no more than 2,000 active bloggers, according to Xiao Qiang, director of Berkeley's China Internet Project. But then a young Guangzhou journalist writing under the name of Mu Zimei began posting a diary about her favorite hobby: sex. The entries were so steamy they drew thousands of visitors a day and ignited a debate in the media that popularized the idea of blogs.

These days Mu Zimei, like Hibiscus Sister, can still be found on Bokee.com, where they seem to be grudgingly tolerated by China's Net Nannies. And China's blogosphere is thriving--on servers within the Great Firewall. In recent months it has helped spread word about a host of embarrassing incidents that were censored in the mainstream press, including a toxic chemical spill in China's northeast and a police crackdown on protesters in rural Guangdong province that left 20 farmers dead. How long it will take for China's digital wall to go the way of its stone counterpart, now the country's most famous tourist attraction, is anyone's guess. What is clear, though, is that it has already begun to crumble.

REPORTER ASSOCIATES Zhang Dan, Eugenia Levenson, and Joan L. Levinstein

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REPORTER ASSOCIATES Zhang Dan, Eugenia Levenson and Joan L. Levinstein contributed to this article.