Consequences of China’s Ban on Local Cryptocurrency Exchanges

Bitcoin couldn’t have asked for a better start to this month. The price of Bitcoin reached a much anticipated all time high of $5000 on Sept 2, but since then the cryptocurrency has been hit by news from China – bringing the price down to as low as $3850.

It all started with China banning ICOs in the country two days after it hit an all time high. It made sense to a lot of analysts because too many startups were raising unexpected amount of money through token sales without even having a prototype. In theory, Bitcoin price shouldn’t have been affected by this event since it had nothing to do with Bitcoin per se, but it did. Investors started to panic sell leading the price to slump below $4500.

Few days later, rumours started to come in from China suggesting that the People’s Bank of China (PBoC) is looking to shut down all the local cryptocurrency exchanges. These rumours were confirmed by major media outlets like WSJ, Bloomberg and people ‘in the know’. It wasn’t surprising to see Bitcoin price finding support at $3800 range following the news.

Although, at the time of writing there has been no official response from China on outlawing Bitcoin exchanges. That being said, if China does go ahead with the ban, let’s take a look at how it would affect $150 billion cryptocurrency market.

China’s role in Bitcoin ecosystem is huge partly because of country’s major Bitcoin mining operations. Chinese mining pools control more than 70% of the Bitcoin network’s collective hashrate. It is safe to say China’s ban will be limited to exchanges and not on every Bitcoin operation in the country.

Interestingly, according to unnamed sources cited by Bloomberg, the ban on exchange-based cryptocurrency trades will not extend to over-the-counter (OTC) transactions. What this essentially means is that the broker-based OTC trades which are typically high-volume in nature, will not be a part of the ban.

The OTC market for Bitcoin is bigger than the exchange market. OTC trades lets buyer and sellers negotiate a price directly through a broker, who connects both parties in a chat group. So the rumoured ban will shut down regular Chinese Bitcoin users by making it impossible for them to buy or sell the digital currency.

Old users will definitely still trade, but the entry threshold for new users is now very high,” Zhou Shuoji, a partner at cryptocurrency investor FBG Capital, told Bloomberg.

One of the reasons why China may ban exchanges is because Chinese people started using Bitcoin to move money outside the country – a move that could devalue Yuan in the long run and create disorder in the financial system.

Here is the bright side though: A ban on crypto exchanges won’t mean the end of digital currency trading. Whether it be exchanges or OTC brokers in China, they’re prepared with a contingency plan. The OTC trades have already started moving from WeChat to non-Chinese companies like Telegram in order to keep the trades going without any government interruptions.

One way for exchanges would be to shut down their centralized exchange services and focus only on peer-to-peer trading instead. Two of the biggest exchanges in China; Huobi and OKCoin, made similar statements saying their plan is to shut down the exchange portion of their business if required, and facilitate peer-to-peer trades between individuals instead.

Another way for exchanges is to simply move out of China. Although, overseas exchanges would not accept Chinese yuan, so they would have to focus solely on cryptocurrency trading much like Bittrex and Poloniex.

Most of the analysts are very optimistic that a crackdown on exchanges, even if it happens, will only damage the cryptocurrency market short term. Long term investors stay unaffected.

Exchanges are not what give value to blockchain assets like bitcoin. It is the intrinsic technology and numerous applications who play decisive roles,” says Eric Zhao, an engineer at the Chinese Academy of Sciences.

Price wise, Bitcoin still had a good year. At the end of 2016, it was trading just above $1000. Now comfortably sitting at just below $4000. Andreas Antonopoulos tweeted something very interesting just after China banning Bitcoin exchanges rumours:

What novel economic theory says that reducing (banning) trading of bitcoin in China will drop price? Demand stable, supply reduced. Huh…

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