China's moves against bitcoin won't be fatal, but it's more than a flesh wound

By Michael Carney , written on December 16, 2013

From The News Desk

When I wrote three weeks ago that bitcoin has a China problem, I may have left out a word. At the time, bitcoin had a *looming* China problem, as in a problem that appeared ominous or threatening, but which had not yet been realized. Today, that extra word is no longer necessary.

News coming out of China that the country’s Central Bank banned third-party payment companies from doing business with bitcoin exchanges, makes China a full on problem for the bitcoin ecosystem. The news has not been confirmed through official statements from either the Central Bank or any payments companies in the country, but sources tell Coindesk that the message was delivered “in no uncertain terms,” while another added, “the writing’s on the wall.”

The immediate result of this news has been a nearly 23 percent drop in the global average value of bitcoin over the last 24 hours, from a value of $893 to begin the day to $699 currenlty. On BTCChina, which is China’s and the world’s largest exchange, the price has fallen more than 26 percent over the same time period, from more than 5,200 RNB to 3,842 RNB currently.

The reason this news is such a near-term blow to the bitcoin ecosystem is that much of the recent run-up in price and growth in global adoption has been due to a rapid rise in demand within China. Rising demand competing with mathematically fixed supply has led to an increase in the value of bitcion. Of course there are other bitcoin bulls elsewhere in the world that believe in the crypto-currency for its potential as a store of value (like gold) and a medium of exchange (like cash), but a non-trivial portion of the recent demand has been driven by China.

In China, this demand has been driven by a desire to transfer wealth out of the country, and out from under the government’s supervision. Secondarily, many outside observers have postulated that bitcoin is seen as a hedge against potential deflation in the value of the Chines Yuan should the government ever choose to let the currency’s value float freely.

According to sources speaking to Coindesk following today’s China Central Bank meeting, going forward, “people will still be able to withdraw their money from Chinese exchanges, they just won’t be able to deposit new funds.” If accurate this will mean a dramatic decline in bitcoin demand, and a near term increase in selling pressure from Chinese bitcoin holders trying to get out of their virtual currency positions before the market declines further.

Today’s news should come as little shock to anyone who has followed the Chinese government’s past behavior toward virtual currencies. When the Tencent-backed QQ in-game currency crossed over into use within physical commerce in 2009, the federal government passed new legislation outlawing the use of virtual currency in the “real” economy.

To date, China has remained tight lipped on its policy toward bitcoin, with the closest thing to an official statement being People’s Bank of China Deputy Governor Yi Gang remarking that Beijing will not recognize bitcoin as an official medium of exchange anytime soon, but that people are free to participate in the market. At best, this meant that bitcoin was a permissible speculative asset, but certainly not a currency. At worst it meant that the government is not thrilled about bitcoin but is not ready to regulate it out of existence quite yet. Gangs remarks came on November 21, less than one month ago. My how quickly things have changed.

By comparison, Norway, the richest country in Scandinavia, reached a its own conclusions regarding bitcoin this week, ruling that the virtual currency doesn’t qualify under the definition of “real money” and thus will be treated as an asset, like gold, and be taxed according to capital gains policy. This is not a death knell for bitcoin, and in fact may reduce the tax basis for many transactions, but it is not the vote of confidence in bitcion as the currency of the future that many in the marked hoped for. Germany recognized bitcoin as “private money” in August and the US government has not delivered an official stance on bitcoin despite holding congressional hearings on the matter in November.

It’s unclear what the longterm impact of the Central Bank of China’s move against bitcoin will be, but in the near-term its sure to introduce new uncertainty into the system. Bitcoin may hold true long term value, both in terms of appreciation from today’s opening average price of nearly $900 and in terms of its potential to act as a ubiquitous, worldwide, alternative economic protocol.

But bitcoin is still in its early stages and uncertainty and controversy are hardly good things. Watch for more volatility in the price of bitcoin over the coming days and weeks as the market looks to understand what this shift will mean for supply and demand.

The bitcoin ecosystem has proven before that it is strong enough to survive systemic shocks like theft, major exchange fraud, and government intervention against marketplaces and exchanges. The market will likely survive this change as well. But a bitcoin ecosystem without China is a very different beast than one with it. Just how different remains to be seen.