Bitcoin: China’s New Special Economic Zone
After the recent regulatory announcement on the part of the People's Bank of China, the Bitcoin markets and many in the Chinese Bitcoin community have been in a state of panic. Although the day after the event was relatively calm in the Western world, with Bitcoin markets dropping only by 10% and the Bitcoin reddit covered with threads reassuring readers that the announcement was a positive for BItcoin. In China, however, the price immediately crashed by 25%. The next day, however, Baidu Jiasule and China Telecom stopped accepting Bitcoin, and the mood rapidly began to turn sour. Bitcoin markets on both sides were in disarray, both crashing by about 50% from the pre-announcement highs over the course of twelve hours before making a partial recovery. Now that the initial shock of the news is over, what is going to happen next? Exactly how will the Chinese Bitcoin community react from here, and what are the consequences going to be in the medium to long term?
First, it is important to note what the immediate causes of the price crash were. Although no one has access to an alternate universe simulator, and so we can never truly know what would have happened had certain events gone differently, certain facts about the Bitcoin economy allow us to make solid educated guesses. First of all, the bulk of the rise from $125 to $1000 was backed by Chinese speculation. Evidence that China was "leading the rally" is plentiful, ranging from technical analysis on price movements around the time when Bitcoin broke through the 165 USD / 1000 CNY level, to BitcoinQt download statistics showing China climbing up to (and, as of the time of this writing, staying at) first place in the number of downloads, and the rapid growth of volume in Chinese exchanges, culminating in BTCChina taking over first place. The trigger that many felt was the true turning point that started the rapid rise, however, was Baidu Jiasule, a subsidiary of Baidu, accepting Bitcoin for its services. Soon after that, China Telecom, a state-owned telecommunications company that is the second largest in the industry in China, also started accepting Bitcoin for reservations of their latest Samsung phone. These two companies, the so-called "Chinese Google" on the one hand and a state-owned telecommunications company on the other, were seen as by far the largest endorsement of Bitcoin that has ever happened to date. And now, in the span of a few hours, they are both gone.
In reality, however, the influence of both companies has always been overhyped. The Baidu announcement was not "Baidu accepting Bitcoin" to anything close to the extent to which, say, Namecheap accepts Bitcoin for its entire array of products and services. Rather, Baidu Jiasule is only one small subsidiary of Baidu. In fact, the company received very few actual customers - the 1.37 BTC that the company did receive was the product of Western Bitcoin users sending Baidu donations to show support. Similarly, in the case of China Telecom, China Telecom was not accepting Bitcoin for its telecom services; it was only taking it for pre-orders of the latest Samsung phone. The Chinese economy is much more organizationally centralized on both a government and corporate level, but what many do not understand the system to some extent naturally compensates for this to a partial extent by giving individual corporate divisions and local governments considerably more independence. Although Baidu Jiasule almost certainly did get approval from Baidu's management before taking Bitcoin, neither Baidu mangement nor Baidu Jiasule ever intended for the announcement to be anything close to a company-wide endorsement. Now, the portion of the Bitcoin bubble that relied on this mistaken assumption can be officially considered to be popped.
What About the Regulations?
The public opinion on the first day after the news, when Baidu Jiasule and China Telecom had not yet stopped accepting Bitcoin and much of the reaction was still positive, was arguably the more correct viewpoint. Most Chinese Bitcoin users active on the forums and various semi-private channels interpreted the news in a cautiously positive manner, although the markets clearly acknowledged that the announcement is putting a brake on Bitcoin's prospects in the very short term. In order to understand why the news is positive, however, one must understand what is going on in more detail both by itself, and in the context of the Chinese regulatory strategy as a whole.
The regulatory announcement had five parts, of which the first two were the most important. First, Bitcoin is classified as a commodity, not a currency, meaning that Bitcoin exchanges do not need to register under currency trading regulations. Second, "financial institutions and payment institution" are forbidden from buying and selling bitcoins or offering Bitcoin-related products and services. The category of "financial institutions and payment institutions" is a restrictive one - essentially, it only includes banks and perhaps the Chinese equivelents of Visa, Mastercard and Paypal. Bitcoin exchanges are still free and clear to operate. This is made more clear by another section of the announcement, requiring exchanges to register with telecommunications authorities - why would the Chinese government require exchanges to register with anyone, if exchanges are not even allowed to exist?
Joseph Wang, who describes himself as an "Ex-VP Quant [at a] Big Investment Bank", writes the following opinion on Quora:
The PBC has basically given the green light for bitcoin trading and exchanges. They are trying to keep bitcoin trading "separate" from the other parts of the financial system so that if bitcoin blows up, then nothing bad will happen. The thing that I think they are worried about is a Lehman style situation in which something blowing up in derivatives brings down the rest of the economy.
Three months ago, the situation in China was simultaneously much more calm and unclear. Although it was evident that Chinese interest in Bitcoin was present, and growing, the Chinese government was remaining silent on the matter, and no one was certain whether the silence should be interpreted positively or negatively. Some believed that the Chinese government had basically quietly given the Bitcoin economy the green light; others argues that the government was simply "institutionally unaware" of Bitcoin's presence, and if Bitcoin were to grow to any significant extent they would eventually clamp down hard. I personally was in the former camp, and even argued that the Chinese government was moving to establish Bitcoin as a sort of "special economic zone".
China’s special economic zone (SEZ) program was first created in the early 1980s as part of China’s economic modernization initiative, creating specific locations with business-friendly policies in order to attract foreign investment, as well as experiment with different ways of increasing economic freedom so as to determine which policies would be best to expand to China as a whole. The idea would satisfy the more conservative elements of the Chinese government, which wanted to exercise the precautionary principle and keep the bulk of the country under tight control, but would also allow a high degree of freedom to those industries that needed it. The result has been an interesting one; although mainland China remains heavily controlled by the Chinese government, the various special economic zones, and especially semi-independent territories like Hong Kong, have come to be economically favorable jurisdictions even by the standards of the west. The idea has its parallels in Western thought, with the recent statement by Larry Page that he wanted to "set aside a part of the world" for unregulated experimentation, and to an even greater extent with the recently popular concept of seasteading.
And now, with the People's Bank of China's announcement, the establishment of Bitcoin as yet another one of these areas - the first ever that only exists in cyberspace, has essentially become official. The announcement specifically forbade the existing Chinese banking system from interacting with the Bitcoin economy, but otherwise created an environment for the Bitcoin economy that some have described as even more free than that of Europe. Although exchanges are required to follow know-your-customer guidelines and register with telecommunications authorities, aside from this they do not need any kind of financial license in order to operate. The Bitcoin economy will be allowed to grow, and businesses related to Bitcoin mining, trading and using Bitcoin as a payment mechanism - provided that prices are not set in BTC - will be allowed to continue to exist and prosper.
In fact, for those advocates of Bitcoin who appreciate it for its community aspects and because it has no connections to the existing financial system, this is even positive news, as the Bitcoin economy will be growing on its own without being rapidly "taken over" by the banking sector. In the short term, this may not be positive for Bitcoin's price, as multi-billion-dollar speculators and hedge funds inside of China will not be able to participate in the Bitcoin economy through instruments like the Exante Bitcoin fund or SecondMarket's offering in the United States. In the long term, however, if Bitcoin continues to grow, the Chinese government will undoubtedly allow Bitcoin to interface with the mainstream financial system in due time - that is, of course, if Bitcoin and other more powerful crypto-financial networks do not outright replace it.