Bitcoin, you have a China problem
By all metrics and accounts, bitcoin's popularity is exploding across the People’s Republic of China. It now boasts the world’s most active bitcoin exchange, BTC China, the greatest number of bitcoin mining nodes, the highest number of bitcoin wallet downloads, and set the record for the highest price ever paid for a bitcoin (7,000 yuan or approximately $1,120 on November 19) while trading at just $900 on Mt. Gox. A map of global bitcoin trading activity further illustrates China’s dominance.
Bitcoin bulls are eager to see the currency spread and gain broader global adoption, and thus may not view this as a problem. But for a currency touted for its independence from government interference, the growing concentration of Chinese influence over this crypto-currency wealth creates a single point of failure for the system. The same would be true if you replaced China with any other country (assuming it could generate similar trading volumes), but the fact that it is the notoriously unpredictable China doesn’t inspire confidence.
The rapid rise in popularity has attracted both investors and fraudsters. In late October, Lightspeed China (an international arm of Lightspeed Venture Partners) made a $5 million investment into BTC China, adding legitimacy to the already formidable company. Around the same time, GBL a supposed Hong Kong-based bitcoin exchange that was actually based in Beijing, shut down unexpectedly, taking $4.1 million worth of client deposits along with it. Despite red flags in the run-up to this disappearance, the bitcoin market barely noticed, either in China or elsewhere.
A number of possible explanations exist for bitcoin's popularity in China, each of which raises its own red flag. One factor is that BTC China, the world’s largest bitcoin exchange and one that trades only in yuan (aka CNY or Renminbi), currently offers no-fee trading – a rarity among major global exchanges. Users pay nominal exchange entry and exit fees – 0.5 percent when using Chinese PayPal equivalent Tenpay and 1 percent by bank transfer.
But beyond fee advantages, China’s bitcoin obsession primarily traces back to two central factors: the difficulty of getting wealth out of China, and the fact that Beijing does not allow the yuan’s value to float freely. Should either of these change, bitcoin’s value could plummet.
Today, many wealthy Chinese who want to invest in international assets or send their children to school abroad are turning to bitcoin to move money across borders with greater freedom. The same can be said of Chinese looking for a hedge against the artificially stable yuan, which is widely considered to be overvalued. Should China eventually decide to float its currency, much of its purchasing power could evaporate overnight. Therefore, Chinese bitcoin adoption is less a vote of confidence in an alternative digital currency and more a vote of no confidence in the yuan, as evidenced by the premium – often as much as 20 percent – that Chinese must pay to purchase bitcoin with yuan.
In each of these drivers lays a potential land mine. Should Beijing change its currency policies, bitcoin's value could also suffer. The rest of the world better take note.
The Chinese bitcoin market is also expanding rapidly on an unstable foundation of unspoken federal approval. This runs counter to prior history. China previously passed legislation outlawing the use of virtual currency in the “real” economy and used these laws in 2009 to curb the explosion of Tencent-backed QQ, an in-game currency that was crossing over into physical commerce.
This time around, while the government has not explicitly targeted or endorsed bitcoin, a combination of state actions seems to reflect at least tacit approval. The first was a May 2013 bitcoin documentary that aired on the state-owned broadcaster, CCTV2. Subsequently, the network aired a segment in late October on the world’s first bitcoin ATM launching in Vancouver. Following both events, bitcoin wallet downloads and trading activity spiked in China. Similarly, the decision by Baidu-owned firewall service Jiasule to begin accepting bitcoins implies a measure of governmental approval.
Days before this latest broadcast, People’s Bank of China Deputy Governor Yi Gang offered a similarly lukewarm endorsement of bitcoin while speaking at an economic forum. In his remarks, made in Chinese, he said that Beijing would not recognize bitcoin as an official medium of exchange anytime soon, but people were free to participate in the market. For many, this alleviated fears of a response similar to that taken with QQ, the in-game currency it banned.
BTC China founder and CEO Bobby Lee told Coindesk at the time: “The fact he made any comment at all is significant. It means, in the near term anyway, China’s central bank won’t give bitcoin any official legal status. But the key point here is ‘near-term.’ Given his position, of course his statements need to be conservative. Anything else would be too much of an official statement.”
While Gang’s remarks may represent the strongest governmental endorsement of bitcoin, they’re anything but conclusive. As such, they’re subject to change at any time without notice. If the world has learned anything over the last half century, it’s that modern China can be a manic and unforgiving patriarch, making rapid and unilateral policy decisions that often fly in the face of logic or the perceived greater good. It would be foolish to assume we can predict its future actions around bitcoin.
There are reasons why China may ultimately act in favor or bitcoin. Given the above described explosion of bitcoin activity within its borders, China controls a large portion of the global bitcoin market and infrastructure, including exchanges, mining nodes, and assets. Should this trend continue, and should bitcoin emerge as a sustainable and meaningful piece of the global economy, Beijing could view this as an opportunity to grab power and influence. This is a fact that many US bitcoin enthusiasts and influencers have raised in recent congressional hearings, urging lawmakers to relax regulations and allow the US to regain its influence in the bitcoin market.
The second such motivation, although seemingly less plausible, is the notion that bitcoin could one day replace the US dollar as the global reserve currency. This is unlikely, but to the extent that Beijing thinks it can even drive discussion of around that possibility, it may influence policy within the country.A bet on bitcoin is increasingly a bet on the predictability of the Chinese government and its highly unstable economy. It is a bet that the Chinese economy will perform poorly, capital controls will continue, and Beijing will remain tolerant of bitcoin.
In other words, it's a sucker's bet.