China’s Bitcoin Ban: Bad for Bitcoin or Bad for Beijing?

By: Jeffrey Caviston

Introduction

One of the biggest news items in the financial world over the past year is the growing proliferation of Bitcoin in international markets. But while Western markets appear to be embracing the cryptocurrency boom, some countries are attempting to curb cryptocurrency in their economies. As the second largest economy on Earth, China’s recent efforts to stop the use of Bitcoin may hinder the development of the cryptocurrency market. On the other hand, by not allowing its markets to engage with and develop this emerging technology, China may be undermining its future economic growth.

Bitcoin and the Start of Cryptocurrency Regulations

In its simplest form, Bitcoin is digital currency.[1] Its underlying software is open-source, meaning that nobody owns it, everyone can use it, and anyone with the appropriate skill set can program with it.[2] In this sense, Bitcoin is like the internet or email.[3] What makes Bitcoin so interesting is its use of “triple entry bookkeeping.”[4] Essentially, this method of bookkeeping provides independent verification of transactions without the need and associated costs of a middleman—which in most cases is a bank or some other financial institution.[5]

In addition to completing transactions, cryptocurrency may be earned by “mining.”[6] Mining refers to processing transactions and securing and synchronizing the cryptocurrency network.[7] Miners who are able to code more efficient transactions may then be compensated in the form of transaction fees.[8] However, because the underlying cryptocurrency programming requires independent verification of transactions by other miners on the entire network, attempts at imputing fraudulent codes or transactions are rejected during that process.[9] And while mining may be lucrative for some programmers, it does require tremendous amounts of energy to process transactions.[10]

Thus, for transactions, cryptocurrencies have the potential to lower costs, provide greater security and control, and exponentially speed up processing times.[11] Furthermore, the transparency and accountability of triple entry bookkeeping technology has the potential to generally improve global financial markets.[12]

With cryptocurrency’s rapid rise, changing technology, and potential for abuse, countries across the world are beginning to update or implement new regulatory schemes.[13] But while even the Bitcoin Project acknowledges the apparent necessity of regulation similar to that in any currency market,[14] overregulation threatens to halt or regress the development of the technology underlying cryptocurrency.[15] Moreover, its open-source nature and inherent decentralized characteristics make regulation of cryptocurrency’s underlying programming challenging, if not impossible.[16] Thus, many of the countries that have implemented some form of cryptocurrency regulation have taken a cautious-yet-permissive approach.[17] Generally, these regulations represent attempts to target traditional illegal activity associated with any currency, such as fraud, money laundering, and tax evasion.[18] However, others have opted for far more restrictive regulatory regimes.[19]

China’s Legal Culture and Cryptocurrency Condemnation

Contrary to most economically developed countries, China is regarded as a “rule by law” government.[20] As opposed to the Western conception of the “rule of law,” whereby law reflects the norms of society and constrains government power,[21] “rule by law” in China is regarded as the use of law by the government “to control and regulate society.”[22] China’s method of rule is perhaps most apparent in the way the government regulates its technology sector.[23] Thus, with the Communist Party looking to remind the world of its control over China,[24] it should not come as a surprise that the Chinese government is taking a heavy-handed approach in dealing with cryptocurrency.

Despite being the largest hub for Bitcoin activity, China began implementing policies late last year to curb the use of cryptocurrencies.[25] First in September, Chinese authorities announced a ban on commercial cryptocurrency exchanges—the means by which cryptocurrencies are traded and converted into traditional currency.[26] More recently, local Chinese governments have become a conduit of the central bank’s crackdown on Bitcoin by imposing limits on power usage required for Bitcoin mining.[27] While these regulations do not render cryptocurrency illegal per se—direct person-to-person transactions are not yet affected (and likely cannot be controlled)—they may have the equivalent consequences, driving cryptocurrency users, investors, and developers away from the country.[28]

Ostensibly, China’s impetus for these new regulations is to protect its financial system.[29] However, Chinese officials are also concerned about the effects of capital outflow on the yuan, the value of which has been manipulated by the Chinese government for many years.[30]

But regardless of the reasons for it, China effectively outlawing Bitcoin does not appear to have dampened the interests of investors and financial institutions in digital currency in other parts of the world. In October, it was announced that Goldman Sachs—the second largest investment bank in the world in 2017—is establishing a digital currency trading operation.[31] Moreover, by the end of 2017 Bitcoin had surged in value to as high as nearly $20,000 per coin, with other cryptocurrencies seeing similar percentage gains.[32]

Perhaps more interestingly, Bitcoin seems to have adapted to China’s prohibition.[33] The cryptocurrency market was once seen as tightly correlated with the valuation of the Chinese yuan.[34] However, despite some adjustments after implementation of China’s regulations, Bitcoin no longer appears reliant on Chinese markets.[35]

Thus, by effectively banning Bitcoin, China is removing itself from the cryptocurrency market and may be forcing itself to play catch-up in the future or risk becoming economically and technologically obsolete in the global economy.[36] Moreover, as a form of capital control, China’s efforts may further hinder outward investment, move trading underground, or bolster criminal operations.[37] Similarly, as it becomes more difficult for Chinese investors to move their capital elsewhere in the world, the importance of the yuan in the international marketplace may be adversely affected.[38]

Conclusion

The future of cryptocurrency is undoubtedly uncertain, even if it seems to be rapidly becoming accepted and incorporated by orthodox financial institutions.[39] But while there are risks in embracing the volatile digital currency market, there is also danger to countries from failing to be involved in developing the regulatory and economic rules for cryptocurrency’s use.[40] Thus, China’s attempt to protect its financial system and the value of its currency from the perceived threats of cryptocurrency may come at the expense of driving away investment and stunting its economy.

[1] FAQ - General, Bitcoin Project, https://bitcoin.org/en/faq#general (last visited Jan. 4, 2017). As the first and most popular cryptocurrency, Bitcoin has sometimes been used to describe cryptocurrency in general. For the purposes of this article it is sufficient to note that other cryptocurrency functions essentially the same as Bitcoin.

[2] Id.

[3] Id.

[4] Id.

[5] Id.

[6] FAQ – Mining, Bitcoin Project, https://bitcoin.org/en/faq#mining (last visited Jan. 4, 2017).

[7] Id.

[8] Id.

[9] Id.

[10] Id.

[11] FAQ – General, supra note 1.

[12] See Is Bitcoin a Triple Entry System?, Fin. Cryptography (June 13, 2011), http://financialcryptography.com/mt/archives/001325.html.

[13] See Francine McKenna, Here’s How the U.S. and the World Are Regulating Bitcoin and Other Cryptocurrencies, Market Watch (Dec. 28, 2017), https://www.marketwatch.com/story/heres-how-the-us-and-the-world-are-regulating-bitcoin-and-cryptocurrency-2017-12-18.

[14] FAQ – Legal, Bitcoin Project, https://bitcoin.org/en/faq#legal (last visited Jan. 4, 2017). While Bitcoin is not exclusively owned by anyone, the Bitcoin Project exists as a figure head for disseminating information and software. See About Us, Bitcoin Project, https://bitcoin.org/en/about-us (last visited Jan. 4, 2017).

[15] FAQ – Legal, supra note 14.

[16] See id.

[17] See McKenna, supra note 13. Canada for instance is taking a “regulate-and-embrace” approach. Id. Likewise, Japan enacted laws this past spring that give digital currency the same legal status as traditional currency and subject it to the same laws. Id.

[18] See id.

[19] See id.

[20] ‘Rule of Law’ or ‘Rule by Law’? In China, a Preposition Makes All the Difference, Wall St. J.: China Real Time Blog (Oct. 20, 2014, 2:03 PM), https://blogs.wsj.com/chinarealtime/2014/10/20/rule-of-law-or-rule-by-law-in-china-a-preposition-makes-all-the-difference/.

[21] See American Bar Ass’n, Dialogue on the Rule of Law 4-6 (2008), https://www.americanbar.org/content/dam/aba/administrative/public_education/resources/FinalDialogueROLPDF.authcheckdam.pdf.

[22] Paul Gewirtz, Opinion, What China Means by ‘Rule of Law’, N.Y. Times (Oct. 19, 2014), https://www.nytimes.com/2014/10/20/opinion/what-china-means-by-rule-of-law.html.

[23] See Li Yuan, Facebook, Take Note: In China’s New Era, the Communist Part Comes First, Wall St. J. (Nov. 2, 2017), https://www.wsj.com/articles/facebook-take-note-in-chinas-new-era-the-communist-party-comes-first-1509615006.

[24] Id.

[25] Chao Deng & Paul Vigna, China Cracks Down on Bitcoin, Wall St. J., Sept. 12, 2017, at A1, A8.

[26] Id.

[27] China’s Central Bank Can Tell Local Governments to Regulate the Power Usage of Bitcoin Miners, CNBC (Jan. 3, 2018), https://www.cnbc.com/2018/01/03/bitcoin-mining-power-usage-comes-under-government-regulation-in-china.html.

[28] China Cracks Down on Bitcoin, supra note 25.

[29] Id.

[30] Angelo Yong, Bitcoin is Devaluing China’s Currency but the Country Won’t Do Much About It, Salon (Feb. 25, 2017), https://www.salon.com/2017/02/25/bitcoin-is-devaluing-chinas-currency-but-the-country-wont-do-much-about-it/; see Eduardo Porter, Trump Isn’t Wrong on China Currency Manipulation, Just Late, N.Y. Times (Apr. 11, 2017), https://www.nytimes.com/2017/04/11/business/economy/trump-china-currency-manipulation-trade.html.

[31] Paul Vigna et al., Goldman Sachs Explores a New World: Trading Bitcoin, Wall St. J. (Oct. 2, 2017), https://www.wsj.com/articles/goldman-sachs-explores-a-new-world-trading-bitcoin-1506959128.

[32] Kieran Corcoran, Bitcoin is Climbing on the Last Day of 2017, Business Insider (Dec. 31, 2017), http://www.businessinsider.com/bitcoin-price-value-increasing-on-final-day-of-2017-2017-12?r=UK&IR=T; see Lucinda Shen, Ethereum Rises Above $1,000 for the First Time as Ripple Soars, Fortune (Jan. 4, 2017), http://fortune.com/2018/01/04/ethereum-price-1000-ripple-bitcoin-buy/.

[33] See sources cited supra note 32; Cole Frank, Bitcoin and the Yuan, Council on Foreign Relations: Follow the Money Blog (Oct. 17, 2017), https://www.cfr.org/blog/bitcoin-and-yuan.

[34] Frank, supra note 33.

[35] Id.

[36] See FAQ – Legal, supra note 14. This of course depends on whether cryptocurrency eventually lives up to its potential.

[37] Ye Xie, Capital Controls, Bloomberg (Aug. 18, 2015, 12:20 PM), https://www.bloomberg.com/quicktake/capital-controls.  

[38] See Christopher Balding, China Finally Halts Outflows. Now What?, Bloomberg (Apr. 10, 2017), https://www.bloomberg.com/view/articles/2017-04-10/china-finally-stems-capital-outflows-now-what; see also Ye Xie, supra note 37.  

[39] See Lauren deLisa Coleman, Why the Massive Fears Around Cryptocurrency Will Rise and What’s Next for 2018, Forbes (Dec. 17, 2017, 9:15 PM), https://www.forbes.com/sites/laurencoleman/2017/12/17/why-the-massive-fears-around-cryptocurrency-will-rise-and-whats-next-for-2018/#3faa398c742d.

[40] See Jamie Hopkins, Opinion, Bitcoin Might Be a ‘Bubble’ but Digital Currencies Are Not, Forbes (Nov. 29, 2017, 1:01 PM), https://www.forbes.com/sites/jamiehopkins/2017/11/29/bitcoin-might-be-a-bubble-but-digital-currencies-are-not/#53b0225d5d02.