Bitcoin and the China effect: There is no business as usual

By Michael Carney , written on December 19, 2013

From The News Desk

A series of anti-bitcoin actions by the People’s Bank of China (PBOC) over the past two weeks sent bitcoin’s price on a wild ride, with the most violent swings coming over the last 48 hours. It reached a 30-day-low of $422 yesterday, down 43 percent from its Tuesday high of $746 preceding the PBOC news and 63 percent from its all-time high of $1,147 just 12 days prior, according to the CoinDesk Bitcoin Price Index. The currency has rebounded to $681 at the time of writing, up nearly 31 percent for the day. It’s easy to get vertigo from all that bouncing around.

But it’s not just the price of the crypto-currency that has been out of sorts this week. A number of trading dynamics within the market have deviated from their norm. At the same time, the price of a number of other altcoins have followed bitcoin for this wild ride. Litecoin, which many have called the silver to bitcoin’s gold, fell 36 percent in its own right, before gaining 39 percent a day later.

On December 5, the PBOC stated that bitcoin was not a legal currency -- although was acceptable for use as a commodity -- and thus prohibited financial institutions from transacting in it. At the time, the news had only limited impact on the price of bitcoin, but it was foreshadowed things to come. Earlier this week, news began to leak out of a private meeting between PBOC and several of the country’s largest payment processors, that these service providers would no longer be able to serve virtual currency exchanges.

The effect was an immediate freeze on new Chinese Yuan (CNY) deposits and, a resulting spike in motivation for Chinese citizens to sell any existing bitcoin holdings while the price was still high – a motivation that quickly spread across the world. Bitcoin prices dropped by more than 20 percent worldwide over a 24 hour period.

It’s not just the price that’s different today compared to a week ago. Throughout much of the runup in price over the last 60 days, buyers on CNY exchanges – the largest of which are BTCChina and OKCoin – have paid a premium of 10 to 20 percent to those on US dollar exchanges. CNY trading volume has also outpaced US dollar volume at most time, a condition that was supported in part by the no-fee trading policies of China’s top exchanges.

Following this week’s PBOC news, each of these conditions flipped on their head. Dollar exchange rate premiums reached an all time high relative earlier today at 30 percent above CNY rates. At the same time, the last two days have been the first in six weeks when US dollar trading volume outpaced that in CNY – thanks in no small part due to decisions by BTC China and OKCoin’s to end no-fee trading following the PBOC actions. The Chinese bitcoin market is paralyzed, and with it, a major portion of global demand for the crypto-currency.

It’s not just Bitcoin that’s feeling the brunt of these Chinese market disruptions. Litecoin fell 36 percent yesterday from a high of $21.49 to a low of $13.55 immediately following the PBOC news. Like bitcoin, it has has regained a portion of those losses today, reaching 18.78 as of 2:30 p.m. PST today, an increase of nearly 39 percent. Peercoin, too, followed a similar pattern in the wake of the China news, dropping more than 10 percent, but has more than doubled since.

There are three critical takeaways worth recognizing with regards to the crypto-currency markets over the last 72 hours. The first is that the bitcoin market is still subject to wild swings in value. With 12.15 million bitcoin in circulation, the total value of the currency system has fluctuated from a high of $12.9 billion to a low of $5.1 billion during this brief period, and currently sits at $8.3 billion.

Second, as much as bitcoin bulls like to downplay the influence of Chinese market demand, recent evidence illustrates that this demand represents a significant portion global trading activity. This begs the question, are the nosebleed prices seen two weeks ago viable without an active and liquid Chinese trading ecosystem?

Finally, while bitcoin is the undisputed king among crypto-currencies today, the entire altcoin system is heavily interdependent. Global regulatory actions and macroeconomic conditions are likely to affect each of these virtual currencies similarly, and thus they can be expected to move in concert. For those who have considered holding multiple virtual currencies as a diversification strategy, this may not be a viable an option.

The fact that bitcoin found trading support at $422, rather than racing all the way to zero should be viewed as a good sign. This is more than a flash in the pan. There are a number of metrics beyond price that support bitcoin’s high levels of adoption in the US, and its use as more than a speculative instrument. Coinbase has 650,000 users and 16,000 merchants signed up, while BitPay’s has grown its merchant list to 15,000 merchants, up 50 percent in the last two months, and Coinmap list 1,963 locations that accept bitcoin, up 150 percent in the last month.

The virtual currency regulatory environment in China remains uncertain, and the same can be said for a number of the world’s largest economies. Only once  this regulatory landscape shakes out, can these crypto-currency prices stabilize. Near term, Bitcoin’s future is likely to be as volatile as its past.