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China Has Good Reason to Fear Bitcoin

China’s massive crackdown on cryptocurrency has caused chaos. China was a key participant in the new financial ecosystem. Beijing’s actions may be the beginning of a wider regulatory crackdown against cryptocurrencies and crypto assets worldwide. This would be a shame. Although cryptocurrencies are not without faults, the technology behind them holds great promise.

China had previously banned initial coin offerings. This is the cryptocurrency equivalent to initial public offerings of stock shares by companies. The Chinese government then took steps towards limiting the use of crypto assets and cryptocurrencies by financial institutions. This latest move is even more expansive. All domestic cryptocurrency transactions are now banned. These transactions are possible in principle without the government’s knowledge. However, few Chinese citizens and financial institutions will be willing to take the government’s ire.

Beijing’s actions show how central banks and national governments are increasingly worried about cryptocurrencies destabilizing financial systems and other adverse consequences. They have every reason to be concerned.

Bitcoin, the original cryptocurrency, was once used to fuel illicit transactions on the dark internet and is now used to facilitate ransomware attacks payoffs. In the meantime, it has been revealed that Bitcoin is not a good medium for daily transactions. It is volatile and the Bitcoin network can’t process large volumes of transactions quickly or cheaply.

Instead, Bitcoin has become a speculative digital asset that is of no intrinsic value. Its scarcity is its entire value proposition. Bitcoin is issued by a computer algorithm that has a hard limit on the number of digital coins that can be issued. This is in contrast to fiat currencies, which central banks can print at will.

Governments are concerned by the possibility that households will channel their savings into crypto assets. This could make them more vulnerable to a burst of the speculative boom. China’s government is clearly against this. This is especially true given the fact that it is currently facing criticism for trying to reduce the housing market speculative bubble, which it once supported.

Beijing was also concerned about the impact of cryptocurrencies on its control over domestic payment systems. It has taken steps to crack down on Ant Financial and other tech companies that have dominated domestic retail payments. This has made central bank money less relevant. China is also wary of stablecoins, a new cryptocurrency that maintains stable value and is backed by fiat currency stores. These stablecoins could be used to make payments in addition to the fiat currencies.

Another concern was that stablecoins and cryptocurrencies could be used to bypass restrictions on cross-border financial flows. These controls have been relaxed in recent years. The government is concerned that unregulated flows could make it more difficult to control the renminbi’s exchange rate. China attempted to curb capital outflows in 2015-16 to stop a sharp depreciation of its currency. However, Bitcoin demand from China soared during this time, as people used the cryptocurrency to escape the government’s control and take money out of China. Beijing sees cryptocurrency as a conduit for capital control evasion.

China has also taken aim at Bitcoin mining. This is a process in which huge amounts of computing power are used to validate transactions on the cryptocurrency network in return for Bitcoins. Because of its easy access to cheap energy and high-quality hardware, such mining has been a growing trend in China. This makes it the world’s largest center for this type of activity. Both the environmental impact of such mining in terms energy consumption and computer debris have been huge. The country is currently experiencing a power crisis as it attempts to reduce its dependence on nonrenewable energies. Bitcoin mining was clearly not going to be tolerated.

Despite all these flaws, blockchain technology which underpins Bitcoin may actually have many benefits. This technology has already been used in finance. The technology will soon allow for a wide range of transactions, including the purchase of a house or car without traditional intermediariessuch lawyers and real-estate brokers. The emergence of cryptocurrency has also prompted central banks to design digital variants of their fiat currencies. China has already started such trials. Japan, Sweden, and many other countries have already started such trials.

It is uncertain what the future holds for cryptocurrencies as financial assets. However, the revolution they started will make it possible to make low-cost digital payment easily accessible. If these new technologies are allowed to evolve further, they will also help expand access to basic banking services and financial services for all income levels, including those with low incomes and those who are not served by existing financial institutions.

The Chinese crackdown on cryptocurrency advocates is a lesson for them to learn. Instead of resisting regulation and oversight or claiming technology will allow the industry’s police to take control, advocates for cryptocurrency should work with regulators and governments in creating effective regulation. The industry will then benefit from increased legitimacy and stability.