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Bursting China’s Bitcoin Bubble

Monopoly money or the key to an international financial future?

10·23·2014

Bursting China’s Bitcoin Bubble

Monopoly money or the key to an international financial future?

10·23·2014

It’s difficult to believe that only a year ago, the Middle Kingdom was a paradise for virtual currency. Chinese markets made up over half of the world’s trade in Bitcoins, and companies such as Baidu accepted the coins as currency for transactions. With over 618 million Internet users reported this past January, China was an unparalleled market for the decentralized, online currency. Shanghai-based Bitcoin exchange company BTC China made its fortune as the main Chinese marketplace for Bitcoin, exchanging more than 100 million USD of Bitcoin every day, but on December 5, 2013, it all came crashing down.

After the value of Bitcoin skyrocketed  to 1,130 USD, the Chinese government, as ever, decided it was crackdown time. Implementing a series of strong restrictions, China effectively halved the world value of Bitcoin to around 500 USD–basically, the Chinese market, almost, was no more.

In China today, Bitcoin isn’t classified as a currency. It cannot be used to buy physical goods or services, nor can it be converted into RMB by Chinese banks, and Chinese companies no longer accept it as valid payment. As Forbes reported, with no way to convert Bitcoin into actual currency in China, it simply became “digital Monopoly money”.

Despite the lack of government support, Bitcoin exchange in China isn’t actually illegal, and it’s regaining lost ground. In fact, China remains one of the most active Bitcoin marketplaces in the world, topping daily dollar trades with Beijing-based exchange company OkCoin in late September. According to BTC China, since this last September, over 70 percent of Bitcoin trades were exchanged from RMB. “As the world becomes more digital, paying physically with bills, gold or credit cards will seem archaic,” said BTC China CEO Bobby Lee.

With or without Chinese support, the introduction of Bitcoin shook the foundations of what’s considered money in today’s economic system. Bitcoin is defined as a decentralized, virtual currency–a currency without a government or bank overseeing its use and stability, and without the security of backing up purchases and loss. Some call it magic internet money, others, the future of currency.  It’s peer-to-peer, so transactions are passed around by a global network of computers that track the transactions but not the parties involved. Its main claim to fame is cutting out the middleman in online transactions, so you don’t need a bank account, a specific native currency, or a membership to organizations like Paypal to transfer money online. Currently there are over 13 million Bitcoins in circulation, with 25 new coins made every ten minutes.

In traditional currencies, governments decide when and how much hard currency to create or print, which manipulates the value of the currency in the international market. But Bitcoin is purely virtual and completely decentralized. They expressly don’t have oversight. This is both a selling point and a huge problem with Bitcoin, since while it plays to our libertarian sensibilities, it’s also a huge financial risk. Bitcoin trades are tooted as anti-theft and anti-corruption, but once Bitcoin is spent, lost, or stolen, it cannot be recovered. So if you mismanage a transaction or, like the Japanese exchange company Mt. Gox, go bankrupt, you are liable to lose all your money. One Bitcoin owner threw away the private key to his accounts, and lost a total of 7.5 million USD in Bitcoin.

So how are Bitcoins made? There are two main ways. The first is the exchange of flat currency (like dollars or renminbi) for Bitcoins at a market exchange such as BTC China. In China, you can either go through an exchange company such as OkCoin or BTC China to change flat currency into Bitcoin, or you can go to one of the Bitcoin ATMs, leftover from the golden days, scattered around major Chinese cities. The current value of Bitcoin fluctuates around 380 USD, but it’s extremely volatile.

The second method is known as mining, where people work on the Bitcoin system in exchange and are paid for their services in Bitcoin. Mining is an essential aspect of Bitcoin because it approves the transactions made, keeping the system decentralized and, in theory, secure.  Individuals or groups use specialized software to solve the increasingly difficult math problems that make up the Bitcoin algorithms, and are given a specific amount of Bitcoin in exchange. However, mining has grown incredibly specialized. Specific processors were created for the purpose of mining Bitcoins, and miners now join groups called mining pools to split up the heavy workload and earn equal pay. Though as an individual, the amount of Bitcoin you earn probably won’t cover the cost of the electricity you use to mine.

These mines are China’s main involvement in the Bitcoin marketplace. The creation of massive warehouses filled with machines that all chip away at the math problems to earn coins is a reaction to the incredible complexity of the algorithms today. A few years ago, a couple of dozen units in a bedroom could mine a couple thousand coins in a day, according to the Coinsman. However, after the Bitcoin boom in 2013, it’s pretty much impossible to compete unless you have large-scale mining operations.

With the success of Chinese mining operations, there’s a new theory that the Chinese exchange of Bitcoins into dollars has been a main contributor to Bitcoin’s loss of value over the last few months. According to the Wall Street Journal, the summer-long fall in value coincided with an explosion in mining practices, in what was called an “arms race” between competing mining groups. Theorists believe that these groups are using Bitcoin to bypass foreign exchange capital controls, which limit exchanges to 50,000 USD per year. This rapid exchange may be a large contributor in the sudden loss of Bitcoin’s value.

Bitcoin’s reputation as the black market currency for sketchy online dealings isn’t unearned–from the bust of the illegal drug selling website Silk Road, to the many cases of money laundering discovered amongst Bitcoin users, it comes as no surprise that it’s viewed as a financially and morally gray zone. However, some advocates for Bitcoin argue that despite some shady use, Bitcoin should regain its place in the Chinese market.

Reddit user /u/robertsieg gave a strong case for the usefulness of Bitcoin in China, especially for foreigners. He argued that because of language barriers and the disgustingly high foreign transaction and currency exchange fees, using Bitcoin as a middleman for foreign transactions could reduce hassle and costs. To those of us who have felt the pain of fees from out native banks, he makes a good point. The transaction fee for Bitcoin is a mere 0.2 USD. So, instead of exchanging money or opening a Chinese bank account, you could buy Bitcoin using your native currency and then send it directly to the seller, who would cash them in their own currency. However, as this type of transaction is a strong gray area in Chinese monetary policy, you might just want to wait a bit before running to the nearest Bitcoin ATM and changing money.

OkCoin’s chief technology officer, Changpeng Zhao believes that Chinese citizens will increasingly invest in Bitcoin because of tightening controls in the real estate market. “There is not much else one can invest in. This, combined with the increase in buying power- people naturally look to Bitcoins,” he said.

However, as an unregulated currency, the restrictions on Bitcoin in China probably won’t be lifted any time soon. Foundations like Brussels-based CoinCenter are attempting to find a more secure way to trade in Bitcoin and create greater integration into the international market but, for now at least, we’ll just have to leave it to the enthusiasts, tech-obsessed, and libertarians.

 

Photo Courtesy of Flickr