Director of Shanghai Academy of Social Sciences discusses Bitcoin and China's economic security

Dr. Alessandro Arduino is the Director of the Security and Crisis Management Program at the Shanghai Academy of Social Sciences (SASS) and an invited Senior Research Fellow in the China Program at the Rajaratnam School of International Studies (RSIS) at Nanyang Technological University, Singapore.

In this article, Arduino explains China’s role in the global digital currency market and how domestic investors and regulators may influence the market’s development.

China experienced two consecutive market crashes in early 2016, forcing regulators to intervene in the Shanghai and Shenzhen stock exchanges.

Chinese regulators did the same thing in 2015 when the stock market bubble collapsed, intervening to organize a recovery plan. The yuan has continued to depreciate despite a $20 billion injection by the People's Bank of China (PboC) after the January 5 market crash.

Gold is a reliable commodity for investors in uncertain times, so the price of gold rose during that period.

At the same time, virtual currencies that use heavy encryption and blockchain technology, such as Bitcoin, have also appreciated due to Chinese investment.

Cryptocurrency and Fund Control

In 2016, the vulnerability and uncertainty surrounding cryptocurrencies in the Chinese economy are likely to continue to grow.

For China, security is a large-scale threat, and the solution is related to capital outflow, relying on tools such as Bitcoin to circumvent China's strict capital controls.

Another thing worth noting is the possibility of the collapse of the virtual Ponzi scheme, which is based on the possibility of easy profit from virtual currency, thus attracting more and more Chinese people to use their savings to participate in investment.

This virtual pyramid scheme, which exploits the gray area of ​​China's financial regulations, can have a domino effect after it collapses, consuming the life savings of unsavvy Chinese investors in a few hours.

The collapse of these fraudulent schemes, or even the internal collapse of more legitimate funds associated with Bitcoin, could cause severe social unrest, perhaps even more severe than the stock market crash of October 2007.

Threats from the use of Bitcoin have long weighed on China’s security, including the lack of accountability in China’s growing shadow economy and the potential for Bitcoin to provide an additional tool for financial terrorism and illegal activities such as kidnapping.

For example, in the last month of 2015, in a high-profile kidnapping involving Hong Kong tycoon Wong Kun, the kidnappers made a high ransom demand in Bitcoin.

In 2015, the Chinese government's efforts to support securities markets ranged from restrictions on capital inflows to penalties for short sellers (traders who profit from declines in market value).

In 2016, the government’s options are more limited, as a dwindling foreign account surplus and a likely bursting of a bubble in bad loans to provincial governments and state-owned enterprises could absorb much of the remaining savings.

As the yuan depreciates, Chinese online bitcoin exchanges such as OKCoin, Huobi and BTCC are becoming more and more popular as the exchange rate between bitcoin and the dollar changes.

The depreciation of the RMB will attract more and more Chinese people to store assets in the form of Bitcoin.

The connection between the RMB and cryptocurrencies

To allay the concerns of some Western countries, China needs to do more to address the irregular use of digital currencies, especially money laundering and terrorist financing.

Anonymity is fundamental to cryptocurrencies, but it is prone to abuse and must be taken into account when developing new regulations and policies.

However, Bitcoin is merely a medium of value transfer and does not need to be stigmatized as a “terror currency.” In this regard, calling for Bitcoin to be made illegal is unrealistic, and is the equivalent of calling for the dollar to be discontinued because it is the currency of choice for global drug and arms trades.

Considering the role of the RMB and Bitcoin, it can be inferred that China’s future regulatory policies will have a greater impact on the global value of Bitcoin.

While the People’s Bank of China’s current priorities include managing the volatility of the yuan, curbing additional capital outflows and limiting pressure for currency depreciation, China is now in urgent need of finding a long-term approach to dealing with cryptocurrencies, especially their illegal use.

China now has significant influence over the global financial system due to the size of its economy, and its influence over the value and use of Bitcoin is growing rapidly.

The onus is therefore on China to provide practical solutions that can even regulate the legal uses of cryptocurrencies.

This chapter originally appeared as part of RSIS Commentary, a platform for policy-relevant commentary run by the S. Rajaratnam School of International Studies. It is republished with the author’s permission.