China crackdown reshapes cryptocurrency landscape
The government has cracked down hard on the production and use of cryptocurrencies
A crackdown by Chinese authorities on the production and use of cryptocurrencies contributed to the halving of the value of bitcoin -- the largest cryptocurrency by far. Chinese provinces have banned cryptocurrency 'mining' (the creation of new units of cryptocurrency using complex computer calculations), affecting over 90% of global capacity.
What next
The imperatives of political control, financial stability and environmental protection point to a long-term crackdown on cryptocurrencies. Some of the businesses involved will find ways around new restrictions as they are introduced, but now that the direction of policy is clear, regulators will move more quickly to catch up. China is unlikely ever to regain its pre-eminent place in the global bitcoin system.
Subsidiary Impacts
- Falling demand for bitcoin mining equipment may help relieve the global shortage of semiconductors.
- Relocation of mining to other countries will reduce or increase bitcoin's environmental footprint depending on the country's energy mix.
- While cracking down on private cryptocurrency activity, China's government will enhance its own blockchain and digital currency programmes.
Analysis
In April of this year, the value of the cryptocurrency bitcoin hit an all-time high, surging to over USD63,000. By early July, over half of that value was lost.
This volatility is ascribed to multiple sources, including Tesla founder Elon Musk's prevarication about its use as a payment method and its use in ransomware attacks and other forms of online crime.
One major reason for this fall in value of bitcoin and many other cryptocurrencies is the crackdown against them by Chinese authorities that has deepened since May.
Motives
The crackdown probably has political, financial and environmental motives simultaneously.
Financial stability
The cryptocurrency crackdown comes in the context of a broader offensive against volatility and abuse in the financial system. The possibility of a financial crash is an enduring fear for Chinese policymakers.
Political considerations
The Party worries about the unrest that tends to arise when domestic investors accumulate unstable assets and then blame the authorities when prices collapse. The government has been warning cryptocurrency investors to divest for several years. Those who have held on are risk-takers less likely to protest.
Another political consideration is the priority the Xi leadership has put on enforcing Party discipline as a way of improving the Party's effectiveness and legitimacy. Cryptocurrencies have been an easy method for corrupt officials and wealthy individuals to export capital unlawfully or avoid taxes.
More fundamentally, perhaps, the Communist Party leadership cannot as a matter of principle comfortably coexist with sources of power or influence over which it has little control. It sooner or later develops ways to control, co-opt or neutralise them.
China is developing its own Central Bank Digital Currency (the 'Digital Yuan'), which shares aspects of its technological functioning with cryptocurrencies, but unlike the latter is backed by China's central bank and can be monitored and controlled by the government, which cryptocurrencies, by design, cannot (see CHINA: Digital yuan’s impact may go beyond China - February 23, 2021).
Environmental protection
Mining bitcoin is energy-intensive. The bitcoin system worldwide now reportedly uses more electricity than the entire country of Argentina, and nearly two-thirds of bitcoin mines are located in China.
This conflicts with one of Beijing's most pressing objectives: the greening of its economy.
Bitcoin mines may be profitable as businesses -- at least as long as bitcoin prices remain high -- but they contribute little to Beijing's wider economic objectives relative to the amount of power they consume and the environmental footprint they therefore leave. They are neither major employers nor a strategic 'industry of the future' that Beijing wants to develop (despite their superficially high-tech nature).
Crackdown
In May, three business associations -- the China Banking Association, the National Internet Finance Association of China, and the Payment and Clearing Association of China -- issued a statement prohibiting banking and payment companies from conducting cryptocurrency-related business activities, including registration, trading, clearing and settlement.
These points largely reiterate a previous notification from 2017, but expand on it by explicitly barring the acceptance or use of cryptocurrencies in payments and settlements and the launch of currency exchange services. They mainly cite financial risks and concerns associated with cryptocurrencies to justify these measures, claiming that cryptocurrencies have "no real support value" (ie, they are a speculative asset without fundamental value) and are highly manipulatable.
Financial associations, provincial governments and police have all cracked down
The measures are binding on financial firms, but not on consumers; they do not constitute a prohibition on individuals holding cryptocurrencies.
In June -- though this went unannounced -- China's most-used search engine, Baidu, began blocking several cryptocurrency-related search terms.
The Ministry of Public Security around the same time announced that it had arrested over 1,100 suspects belonging to over 170 criminal groups involved in cryptocurrency-related money laundering.
Most importantly, the same month, provincial-level governments in China's largest bitcoin-mining regions -- Xinjiang, Inner Mongolia, Yunnan and Sichuan -- announced policies to curb mining, cutting off miners' electricity supplies and ordering them to close. This affected 90% of nationwide capacity. The governments of Anhui, Henan and Gansu provinces followed with bans this month.
Consequences
Some miners have shut down and sold their equipment. The price of the processing hardware used in bitcoin mining -- mainly multi-use graphics cards and other chipsets -- has dropped significantly.
Other miners have moved operations to other countries, including the United States and Kazakhstan (see KAZAKHSTAN: Law targets cryptocurrency miners - June 25, 2021).
China's crackdown on cryptocurrencies is the most significant because of the country's outsized role in the bitcoin system, but it is part of a broader trend. In May, Iran issued a provisional ban on mining to avoid brownouts. India is considering outlawing possession of cryptocurrencies (see INDIA: Chinese moves to fuel worry over cryptocurrency - June 9, 2021). Exceptions run against the trend, such as El Salvador -- the first country to make bitcoin a legal tender (see EL SALVADOR: Bitcoin experiment comes with risks - July 12, 2021).
The departure of cryptocurrency mining from China potentially gives Beijing less influence over how it develops globally. It appears willing to pay this price.
Blockchain
Beijing does see utility in the blockchain technology underpinning bitcoin, which ensures the verifiability and reliability of the digital token. It is accelerating efforts to construct a 'Blockchain Service Network' (BSN), both at home and internationally, where it is intended to support the digital side of the Belt and Road Initiative.
The BSN facilitates the spread of digital currencies and other blockchain-enabled applications such as smart contracting and supply chain management.
Beijing still supports blockchain technology and its own national digital currency
Outlook
The current crackdown against bitcoin seems like the beginning of a new normal. The State Council's Financial Stability and Development Committee indicated in May that it would continue to crack down on bitcoin mining and trading. A complete ban on the holding and trading of cryptocurrencies is not out of the question but is an extreme scenario. Even short of that, holding them will become less attractive.
