A Capital Idea: What’s Behind China’s Bitcoin Craze?
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2017-01-24 02:57:36

Earlier this month, in a move that drew the attention of the country’s financial media, the People’s Bank of China (PBOC) summoned China’s three major bitcoin trading platforms for talks aimed at explaining the virtual currency’s huge price swings, which had destabilized normal currency trading in the nation.

About a week prior to the meeting, and almost eight years to the day that bitcoin was created, the virtual, global currency recorded its highest midday trading price in three years, at one point hitting $1,250. Since the beginning of 2016, bitcoin’s value has risen by around 260 percent, far more than China’s much-maligned real estate and commodity prices.

Bitcoin’s growth in the past 12 months has been remarkable, especially in the context of Donald Trump’s victory in the American presidential election and the Federal Reserve’s imminent raise of interest rates. Some analysts believe that the currency’s soaring value has its roots in the geopolitical uncertainties of the last year, which include the greatest depreciation of the yuan in two decades, the U.K. vote to leave the European Union, former Italian Prime Minister Matteo Renzi’s failure to secure support for his constitutional referendum, and — of course — Trump entering the White House. All of these events caused investors to lose confidence in various currencies and drove them into the online bitcoin market.

While there is much to say from a global perspective, in reality, the soaring value of bitcoin is chiefly driven by Chinese buyers. There are three major bitcoin trading platforms in China that process 90 percent of all global transactions in the currency. These three websites — Huobi, Bihang, and BTC Trade — were the ones brought in for talks at the PBOC. News of the discussions caused bitcoin prices to fall by around 1,000 yuan ($146) in midday trading on Jan. 6th.

Through efforts to clamp down on dwindling foreign reserves, the government may be essentially urging investors to smuggle more yuan out of China.

Chinese investors have come around to bitcoin as a buffer against the impact of a spiraling yuan, which fell 7 percent against the dollar in 2016. Keen to move capital held in yuan out of the country, investors often purchase bitcoin with yuan on a domestic bitcoin trading platform, before selling the virtual currency through a foreign exchange provider and cashing out.

Another motivation behind the bitcoin rush in China is the desire to bypass the country’s newly reinforced capital controls. Back in December 2013, the PBOC issued a notice banning all domestic financial institutions from trading in bitcoin on account of “excessive speculation” from investors — a move that triggered a drastic drop in bitcoin prices, which fell from $1,100 to $400 before bottoming out in late 2014. 

But in the last year, newfound hype from Chinese speculators has allowed bitcoin to make a comeback. Even Baidu, China’s largest online search engine, has recently begun accepting bitcoin as a form of payment. The most optimistic speculators predict that bitcoin’s value may rise as high as $2,000 this year.

It is clear that bitcoin’s fate is tightly bound up with the value of the yuan. While some claim that Chinese investors have monopolized the bitcoin market, the fact that bitcoins are traded mostly as a means to overcome a lack of trust in the national currency is hardly looked upon favorably by the Chinese government.

Beginning this year, the government will implement new guidelines requiring private citizens to fill out a so-called foreign currency purchase form in order to move money out of the country. This will combat the continued depletion of China’s foreign exchange reserves, which — as of November 2016 — had fallen by $940 billion down to $3.05 trillion in less than two years.  

The forms will help track the flight of capital from the country and will raise the threshold required for private citizens to acquire foreign currency. Those who do not comply with the new rules will be put on a watch list, will lose access to foreign exchanges for three years, and may face fines of approximately 30 percent of the unlawfully transferred funds plus an additional penalty of up to 50,000 yuan.

Despite its formidable trading power, China has not yet made the yuan a freely convertible currency, and official consent must be given before significant sums of money are moved abroad. The rapid depreciation of the yuan has made more companies and individuals willing to purchase foreign exchange, causing the prolonged reduction of China’s reserves since July 2015. There are worries that China may strengthen its foreign exchange controls, as reserves consistently come under attack.

Yet a move to tighten currency controls will only accelerate what is already a vicious circle. Restrictions on foreign currency, implemented to halt the depreciation of the yuan, will only cause speculators to sink more and more money into bitcoin. These actions are inextricably interlinked: Through efforts to clamp down on dwindling foreign reserves, the government may be essentially urging investors to smuggle more yuan out of China under the guise of bitcoin transactions.

Instead of solving the problem, such a move will only encourage underground money laundering and tax evasion. Bitcoin is only one conduit for such maneuvers. The success of official currency watchdogs in 2017 will depend on how well the government manages to detect and close these loopholes.

(Header image: A citizen uses a specially modified ATM to process bitcoins in Shanghai, April 16, 2014. Sun Zhan/Sixth Tone)