The world of cryptocurrencies is in the midst of a tornado just now. Since the beginning of September, total cryptocurrency market capitalisation is down by US$60 billion to around US$109 billion. That’s a fall of 40 percent.
I spoke to a colleague this morning based in the U.S. and he was in a total panic about “what’s happening in China”.
First of all, let me give a quick overview of what’s been happening over the past few weeks with regard to cryptocurrencies in China, what’s happening right now, and more importantly, what I think will play out over the next couple of months.
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ICOs go first…
At the end of August and early September, we saw the first signs of imminent changes in China’s attitude towards cryptocurrencies with the larger ICO (initial coin offerings) broker platforms ICOINFO and ICOAGE suspending their ICO services.
(ICO platforms in China aggregate global initial coin offerings into a single access point for Chinese investors. So instead of investors having to open lots of different cryptocurrency wallets and familiarise themselves with lots of different ICOs, they can simply allocate whatever money they want to put to a range of ICOs through a single platform).
We then saw Caixin, a mainland China media outlet, publish an “exclusive” that ICOs would imminently be labelled as “illegal fund raising” and banned. Cryptocurrencies sold off across the board.
Two days later, the People’s Bank of China (PBOC), along with half a dozen other regulators, released a joint regulatory notice banning ICOs.
…and now the exchanges…
Last night, one of the largest mainland China exchanges, BTCC, announced that it would be suspending operations by the end of the month.
Earlier this afternoon (approximately half an hour ago as I’m writing this), ViaBTC, another exchange, also announced closure of its exchange.
One by one the others, like Huobi and OKcoin will follow.
The process will be as orderly as possible. If there are any exchanges that have been running fractional reserves, and badly (i.e. lending fiat or cryptocurrencies for crypto margin trading, and not running their trading risk properly), then the last thing the regulators want is to trigger a ‘bank run’ on an exchange which ends up not being able to pay back its customers.
After last night’s BTCC announcement, we saw another heavy round of selling, with bitcoin falling another 15 percent, and second largest cryptocurrency ethereum fall by around 17 percent.
What’s going on?
Anyone who’s familiar with how the Chinese government works will understand – first of all – that the ICO ban was long overdue. Speculation was indeed getting out of control, with hundreds of millions of renminbi being funnelled into projects with little or no viability.
ICOs represented a clear threat to financial stability. Remember, when a lot of those renminbi start to evaporate on the back of shoddy ICO companies looking for a quick-buck round of speculative financing, you can be sure that punters nursing losses will go straight to the government to complain.
That’s a threat to stability. Enough upset speculators who lose their cash can cause a lot of problems very quickly for a government that prizes keeping the peace above everything else.
With regard to the exchanges, I’d note a few things…
Firstly, despite BTCC announcing plans to suspend trading, there has not been any official announcement from the PBOC (similar to what we saw with ICOs) regarding the exchanges.
Both BTCC and ViaBTC cite the public statement from the PBOC as cause for closing their exchanges. I’m told that the regulators are visiting the major exchanges one by one. And this is the result.
Secondly, bear in mind that the National People’s Congress (NPC) is being held in Beijing on the 16th of October. It’s not unusual to see the Chinese government flex its muscles in the run up to this event, whether it’s political (i.e., sharply reminding Hong Kong that it belongs to China), cracking down on potentially overleveraged (and overambitious) Chinese conglomerates, or social media – this week the government announced that the administrators of any WeChat messaging groups would be liable for whatever people said on their chats, coinciding with the crackdown on cryptocurrencies which use social media for the majority of communication.
What happens next?
If you’ve been following any of the China regulatory crackdown over the past few weeks in China, you’ll realise that there has been no mention at all of bitcoin “mining”.
A huge amount of the total computational hashpower underpinning bitcoin contributed by miners comes from China. These miners in effect run huge server farms, and are rewarded with bitcoin for their efforts.
It’s tremendously lucrative. Bitmain, run by Jihan Wu, is the main company behind the production of bitcoin mining chips, and a major miner itself. It’s considered to be one of the most profitable and wealthy bitcoin-related companies there is.
For China, bitcoin mining generates millions of dollars a day in bitcoin that can be sold offshore – i.e., it’s a potential source of foreign exchange income. What’s more, the more bitcoin rises in price, the higher the dollar-equivalent value of those mining rewards (i.e. currently 12.5 bitcoin every 10 minutes approximately).
And take a look at this statement from the exchange ViaBTC from earlier this afternoon (announcing its closure). Its mining pool is unaffected.
Putting this all together suggests to me two possibilities over the next couple of months:
- The exchanges will all announce their closure, mining will continue unaffected, and then later in the year (after the NPC), select exchanges will be issued licenses to operate regulated cryptocurrency exchanges. Regulators will put together a framework to ensure they have full transparency and oversight of which individuals are trading, how much they can trade, and which cryptocurrencies they are allowed to trade.
- All exchanges will close, permanently, and the government will look to open its own centralised national cryptocurrency exchange, likely early next year. (I think this is a much lower probability event).
In either of these circumstances, ICOs will still potentially be possible, but will require substantial regulatory oversight prior to listing – similar if you will to a framework used by regulators for traditional equity issuance.
This isn’t “the end of cryptocurrencies in China”. Rather I think it’s the beginning of a more highly regulated market… one that favours domestic blockchain related companies in particular (I will cover this in a separate note).
However, in the short term we are going to see plenty of selling pressure across the board in cryptocurrencies.
If you do not own bitcoin or cryptocurrencies yet, then it’s a good opportunity to start nibbling, and averaging in over the next few months.
If you are already long, then just sit tight – as you well know by now, this is one of the most volatile asset classes in existence, but nothing that’s happening in China right now affects the long-term potential of bitcoin whatsoever.
It’s worth noting that there is plenty of liquidity in non-China exchanges taking up the slack. Of the top 10 largest bitcoin exchanges by volume over the past 24-hours (which account for 52 percent of global volume), only two are Chinese… accounting for around 9 percent of total global volume.
Prices will continue to fall over the next few days as more exchanges are closed, but the next few weeks should represent an excellent buying opportunity.