How Chinese exchanges influence bitcoin
By Mary Anne Callahan, journalist and bitcoin specialist
Satoshi Nakamoto originally imagined bitcoin as a truly decentralized currency, a store of value owned equally by each of its users, without any single point of failure, and uncontrollable by any regulating body. But is that how bitcoin is turning out?
Over the last decade, China has emerged as the biggest market for bitcoin. This has given large Chinese bitcoin exchanges such as BTC China, Huobi, and OKCoin, and international exchanges such as CEX.IO, a huge influence over bitcoin's price, volatility and perception around the world.
Let's take a look at each of these factors and how they will guide bitcoin in the future.
Influence on bitcoin price
The price of bitcoin is determined mainly by the same two factors as every other asset — supply and demand. Right now, both supply and demand of bitcoin are highest in China. To understand why, it's handy to know a little about how cryptocurrencies work.
Bitcoin supply — mining
Mining is fundamental to how cryptocurrencies work. It is the mechanism that keeps bitcoin secure, while also introducing new bitcoins to the world. Bitcoin miners offer their computers to solve the complex cryptographic problems that keep all bitcoin transactions working and safe. New bitcoins are given as a reward for this work.
The original intention was that everyone would do this with their spare computing power on their personal computer. But, after bitcoin's price soared, many began buying specialist equipment to mine these new bitcoins for profit. Now, miners all over the world compete fiercely for the new bitcoins released every 10 minutes. It's become so competitive that only those with access to cheap, specialist mining hardware and ultra-cheap electricity can compete.
So where is the best place in the world to get cheap hardware and electricity? China. It's estimated that 70 percent of bitcoin mining power is located there.
There are many different reasons why people want to buy bitcoins. Two important reasons are:
- to own something untraceable and free from government regulation; and
- to invest or to speculate on the price going up or down.
Both of these factors are massive in China. Tight government regulation of financial markets means that many Chinese investors are looking for assets that are independent of these controls. Also, there are limited investment options in China, and bitcoin is seen as an alternative to the declining Yuan. Online gambling is massive in China, and speculating on the volatility of bitcoin is seen by many as an exciting way to bet.
Put those supply and demand factors together, and it's no surprise that the price of bitcoin is guided by what happens in China. Hungry investors are buying up bitcoins as fast as they can be mined. Most bitcoin trading is done on bitcoin exchanges — and the biggest bitcoin exchanges are based in China. Coindesk estimates that Chinese bitcoin exchanges dominate over 85 percent of the global bitcoin market.
Impact on price volatility
Currencies on the Forex market generally have low volatility. The U.S. dollar declining 1 percent in a day is a huge deal. Bitcoin is a different story — 10–20 percent declines in just a few hours are very common. So how much of this volatility is due to China's influence?
China has one of the most tightly regulated financial markets in the world. One decision by the government can change things instantly, and there is little anyone can do about it. Investors from around world know this, and keep a constant eye on what's going on with bitcoin in China.
This was demonstrated recently, as the global price of bitcoin plummeted 9 percent overnight, as the Chinese exchanges stopped withdrawals. A decision by just a handful of companies had a sudden and devastating impact on the bitcoin price worldwide.
The debate about increasing the block size of the bitcoin blockchain (i.e., increasing the number of bitcoin transactions per second) is also starting to become more important. Some say that increasing the block size is the only way to scale bitcoin further, while others say this goes against the basic principles of decentralization. Whatever your opinion, decisions to change the way bitcoin works will be decided by the bitcoin miners. With the majority of mining power — the decision on the future of bitcoin will be decided mainly in China.
The Chinese government is currently making some big decisions on bitcoin regulation. For the moment, regulation is low and the People's bank of China doesn't even consider bitcoin a real currency. This may change soon, though, as they are taking a close look at the actions of bitcoin exchanges operating in China to determine what measures they need to take. The outcome of these decisions will determine the price of bitcoin.
This level of influence is not seen anywhere else in the world. The size of the bitcoin market in China — along with government's control over it — means that 85 percent of bitcoin trade volume is constantly at risk. If any of the large Chinese exchanges like BTCC, OKCoin, or Huobi were to be found guilty of breaking any rules, they could be shut down. This would send the bitcoin price into a tailspin.
Even large international exchanges like CEX.IO and Coinmama that operate in China don't have this much power.
Bitcoin was designed to be a currency free from control by any single institution. Influence and control are concentrating more in China, and many are worried this could undermine its value. It's hard to argue that bitcoin is decentralized and borderless if a single government has so much power over it.
Future of bitcoin
Some argue that that centralization in China isn't that bad. Paul Sztorc explains that the extreme efficiency of bitcoin mining in China helps to secure the bitcoin network as a whole. Also, some very tough decisions need to be made soon regarding the bitcoin block size. Reaching a consensus will be a lot easier with some level of centralization.
The outcome of all these factors is that right now, bitcoin's price, volatility, and reputation all hinge largely on what happens in China. For now, the future of bitcoin is tied to the future of China.