Can Bitcoin thrive without China?
Bitcoin started the month of September trading at an all-time high of $4,950. By implementing Segregated Witness, or SegWit, Bitcoin allowed more transactions to take place and signaled confidence that Bitcoin would scale. On September 4, the Chinese central bank banned trading in initial coin offerings (ICOs), leading to rumors that China was considering banning Bitcoin trading altogether. Those rumors were confirmed on September 14, and Bitcoin exchanges operating in China were told to cease trading for now. Prices fell to $3,226.
Before the ban, approximately 70 percent of Bitcoin mining activity occurred in China, the result of a profitable confluence between the manufacturers of the specialized hardware needed to mine Bitcoin quickly and subsidized electricity provided to businesses in China’s remote regions. The process of mining Bitcoin relies on a vast array of machines that continuously perform the same cryptographic computations and must be cooled to operate efficiently, meaning that the Bitcoin network as a whole consumes 332 megawatts, about half of the output of a typical power plant.
Though much of Bitcoin’s processing power is concentrated in China, only 10 to 20 percent of Bitcoin trading activity involved the yuan, prior to the crackdown. One potential explanation is that Chinese Bitcoin miners prefer to deal in currencies other than the yuan, and are trading their mined Bitcoin for other currencies. For example, the largest Bitcoin mining pool, Bitmain, accepts only Bitcoin, Litecoin, or the U.S. dollar to purchase its mining hardware. China has struggled on many fronts to stop its wealthy citizens from parking their capital overseas, and Chinese Bitcoin miners and investors are no different. China has expressed interest in launching its own central bank-issued cryptocurrency and may want to remove Bitcoin as a source of competition for this as-yet hypothetical eYuan.
As Chinese exchanges go dark, Japanese and South Korean Bitcoin trading volumes have increased. The market can easily route trading activity away from China as long as necessary. A more worrisome signal, though, is that mining executives in China have been prevented from leaving the country, indicating that one of China’s goals in banning Bitcoin trading is to also shut down mining operations. Without the ability to exchange mined coins for currency that can pay employees and operating costs, Chinese miners won’t be able to stay in business for long.
Even with SegWit’s increased capacity, the significant decrease in mining volume that would accompany the large-scale exit of Chinese miners would slow Bitcoin transaction processing. Prices of mining hardware could increase if manufacturers that operate mining pools, like Bitmain, shut down both sides of their business. If long-term confidence in Bitcoin is maintained, miners can rebuild or flourish anew in countries with slightly higher electricity costs, or in cold climates where the costs associated with cooling would be much lower. Bitcoin’s hash rate — the number of computations performed per second by the network — has remained relatively stable, indicating that Chinese miners have not shut down. But the sudden departure of most or all Chinese mining power would temporarily reduce the investment needed for a single block to gain a majority and essentially take control of the network.
In a sense, China’s deliberate action against Bitcoin serves to reinforce its value; if governments view Bitcoin as a threat to state-issued currencies, it must be because they predict Bitcoin’s persistence and stability. Big banks are also starting to criticize Bitcoin. On September 12, JP Morgan’s CEO Jamie Dimon called Bitcoin “a fraud” and threatened to fire any of his company’s employees who traded Bitcoin, despite previously attempting (and failing) to patent a bitcoin-style cryptocurrency platform. These seeming contradictions indicate that Dimon may see Bitcoin as a threat to be undermined, echoing his previous prediction that governments will not support cryptocurrencies that circumvent regulatory controls over cross-border capital flows. While China has borne out this prediction, other governments are not following their lead. Bitcoin can survive without China, and by redistributing its mining power, it could be even more robust than before.