Why China’s Central Bank Took the Regulatory Lead on Bitcoin

The hype surrounding bitcoins continues. After hitting a high following the unprecedented bailout of Cyprus’ banks this year, the price of a bitcoin soared again in November. Within one month, the popular virtual currency surged from US$ 200 per unit to a high of US$ 1,200. Less than one year ago the figure was US$ 13.

Such zeal aroused concerns of a bubble. The research team at Anbound pointed out as early as April that the Bitcoin bubble is no different from the tulip bubble in 1632 or the most recent credit bubble, and will end the same way. The argument is gaining more and more acceptance as bitcoins continue to appreciate.

Bitcoins are on the radar of regulators around the world. The European Central Bank issued a notice in October 2012 that said bitcoins could contribute to financial innovation, but could also expose investors to risks. Fed chief Ben Bernanke told Congress in November that the Fed “does not necessarily have authority to directly supervise or regulate these innovations or the entities that provide them to the market.” But he also said that virtual currencies “may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system.” Bernanke also pointed out the potential risks bitcoins entail in terms of regulation and law enforcement. In December, the Dutch Central Bank warned of the volatility of bitcoins, and said they lacked a central issuer who could be held liable.

‘Trade at Your Own Risk’

China joined the discussion around the same time Bernanke made his statements. A deputy governor of China’s central bank, Yi Gang, said it will not confirm the legitimacy of bitcoins any time soon but would not prohibit citizens from trading them. Moreover, the People’s Bank of China and four other ministries and agencies surprised the market with a notice on Bitcoin regulation on December 5, making the Chinese central bank the first financial regulatory agency in the world to issue regulations on bitcoins and their online trading platforms.

In line with Yi’s statement, the notice denied bitcoins are a currency and prohibited them from circulating in the currency market. The notice restricted banks and financial agencies from providing services related to bitcoins or using them in transactions. In addition, online trading platforms will be subject to stricter management. But on the other hand, the central bank allowed people to freely trade bitcoins online at their own risk. Apparently, what really concerns the central bank is bitcoins replacing the yuan.

Having closely followed and studied bitcoins, Anbound approves the regulatory move by the central bank. In fact, as a peer-to-peer online product, bitcoins do not fall under the jurisdiction of existing currency regulatory system. The central bank has no authority to prevent people from trading bitcoins. However, the central bank can control all the channels through which bitcoins might enter the real economy – financial agencies, payment agencies and websites. Judging from the wording of the notice, the central bank clearly realizes this may be the only measure it can take. Because of the lack of effective methods to regulate Bitcoin online trading, the central bank took a laissez-faire approach instead of overstepping its authority.

It is worth noticing that whether the central bank approves of Bitcoin as a true currency has little real effect on it because the development of bitcoins does not rely on approval from a sovereign bank. Bitcoins have not been approved by any sovereign bank since their birth, but that has not stopped investors. Therefore, the notice by the central bank does not cause real harm to bitcoins as a popular online financial product. Even if all the central banks in the world join forces to show their disapproval of bitcoins, they would continue to grow as long as people still talk about them and investors believe in them. When the bubble bursts is not up to central bank regulators but market forces.

However, the central bank’s regulation can achieve short-term effects. Due to limited supply, the price of a bitcoin is completely determined by investor confidence. The central bank’s notice has thrown some cold water on Bitcoin by warning investors about the risk. If some investors then choose to exit, that will trigger a tumble in short-term prices. But how long the effect lasts is hard to know due to a group of overzealous adherents and the public’s growing attention to the virtual currency. Perhaps right at this moment some Bitcoin followers are “buying on the dips” while pointing at the notice and saying: “Look, the central bank doesn’t prohibit us from trading Bitcoin!”

That the central bank took the lead in strengthening supervision of Bitcoin shows how much it fears the threat from bitcoins to the yuan. Its move to regulate bitcoins may not all of a sudden burst the bubble, but it will increase the volatility of the virtual currency’s prices. Bitcoin could be a good speculative instrument, but it cannot have any further breakthrough. This is the message coming from the central bank.

*The author is a macroeconomics researcher at public policy think tank Anbound Consulting.
**Read the original article at Caixin.