China Crashes Bitcoin

Today bitcoin crashed again. The lows of the day were $752.11 which represents a 16.9% decline from the open. That represents a 33% fall from the closing high about a week ago. Bitcoin has now recovered to the $780s after the sharp decline in the morning. It had stabilized for a few days at around $900, but the news today ended hopes that the correction was over. The lower bitcoin goes, the better buy it is. Using caution is logical given the volatile price swings. However, the time to be worried was when it was about $1,000.

The reason bitcoin was knocked down was because more news came from the Chinese government over its investigation of bitcoin exchanges. The government doesn’t like bitcoin because it’s used to get around capital restrictions as money flees the yuan. It also doesn’t want Chinese people to use bitcoin in place of the yuan because it would inhibit its power. If I was in the government and witnessed the price decline it caused last week by simply paying bitcoin negative lip service, I would try to do it again. The government doesn’t want to crack down on it overtly because it wants to appear like it’s becoming more capitalistic. Lip service doesn’t inhibit the goal to appear like the government supports free markets, but it was effective at tanking the price which limits bitcoin’s appeal to speculators. It’s the sweet spot of government action, which is why we saw the latest report today which I will describe now.

Today, according to Reuters, the People’s Bank of China probed the exchanges BTCC, Huobi, and OKCoin for a few potential regulation violations such as market manipulation, money laundering, and unauthorized financing. China launched spot checks on the top bitcoin exchanges in Beijing and Shanghai. The spot checks on Huobi and OKCoin were about how the exchanges implement forex management and anti-money laundering policies. The spot checks on BTCC were on similar issues such as if the firm is operating outside its scope, if there is unauthorized financing, payments, or forex, and if the exchange is involved in market manipulation, anti-money laundering, or carried fund security risks. Spot checks is code word for pressure. It’s like a teacher who sees a student doing well on tests and brings her in for questioning even though there’s no evidence of cheating. The Chinese government can’t shut down bitcoin itself, so the exchanges are the next closest thing.

The PBOC didn’t say if any violations were found. This is code word for there weren’t any violations. If there was a problem, the PBOC would be happy to shut the exchanges down. Being that the exchanges know they will be heavily scrutinized, I expect them to go out of their way to be sure there isn’t even the appearance of illegality.

I’m surprised the Chinese government has reacted so quickly to bitcoin’s price increase given its relatively small size. There is $50-$60 billion in outflows from China per month and the entire market cap of bitcoin is only $12.56 billion. I think this says more about the dire straits the government is in than anything about bitcoin. Instead of solving the reason for the capital outflows, the government is focusing its efforts to tighten the capital controls. It’s typical government action to not fight the tough battles and instead focus on symptoms of the problem. I wouldn’t be surprised if the government blamed the fall in bitcoin for its economic problems.

As with what happened last time, those involved with bitcoin want to calm the market, so they claim this action was good news. It would be like if the FDA was launching a probe into a firm’s drug and the firm said it’s happy the FDA is doing its job. The bitcoin exchanges cannot criticize the government because there could be retribution and it could cause bitcoin prices to fall further. Bitcoin exchanges don’t make money from price increases, but their volumes will fall if the price crashes and everyone wants out. This is why Bobby Lee, the CEO of BTCC, told Reuters the following: "I wouldn't call it an investigation. I think they are working closely with us to learn more about our business model and the bitcoin exchange industry. We had a very fruitful meeting today," Whether it is or isn’t an investigation is a matter of semantics. It’s still a negative for the price of the currency.

The way I foresee the price action of bitcoin in the next few months, I can’t see an avenue for it to go higher. While I don’t expect a real crackdown by China, the Chinese government knows it can simply knock the price down whenever it wants. Therefore, we will see knee jerk selloffs as a response to Chinese government actions followed by moderate price increases when the market realizes there’s no tangible changes. If the price increases too much, there will be another round of ‘investigations.’

The long-term future of bitcoin must not rely only on China for it to grow. There are a few important aspects which need to happen for bitcoin to become more widely used. The first step is innovation. Developers need to maintain their dedication to the currency to help it become more user friendly. I expect this to happen unless there’s a hard fork which results from disagreement among them. The second is a broader acceptance from retail. There are end-arounds to using bitcoin at retailers such as using Gyft cards, but if a company like Amazon started accepting bitcoin, it would make usage easier and bring instant legitimacy to the currency. Amazon should want to accept bitcoin because it would help its margins as credit card fees take a large chunk out of them. I was wrong in predicting Amazon would accept bitcoin a few years ago, so it’s tough to tell when/if it will ever happen.

There’s two more things bitcoin needs to be successful. The first is for the U.S. government to continue to rack up trillions in debt which hurts the confidence in the dollar. There’s nothing governments like to do more than to spend money they don’t have, so I expect this to occur. The final issue is time. I think younger generations are more open to bitcoin than older ones. It’s tough for someone over the age of 70 to grasp the concept of bitcoin. As younger people start earning more money, the adoption rate of bitcoin should grow.

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