China and the soaring price of bitcoin

As China emerges as a leading global player in the bitcoin market, here is one clue as to what is going on:

To what does he [Zennon Kapron] attribute bitcoin’s popularity in China, and how could others benefit from it?

“There’s BTC China’s no-fee trading for starters. You can leave your money on the platform, your coins on the platform, and trade in and out for free,”  he said.

The entry and exit points aren’t free, with a 0.5% Tenpay (China’s PayPal equivalent) cash in/out fee, and a 1% bank transfer fee.

Capital controls in China are strict. It’s easy to bring money into the country, but getting it out (to invest or spend) is more difficult. That means there are are plenty of wealthy Chinese citizens and residents looking to move their money around the world with greater freedom.

There is more here. And here is a map of bitcoin flows. In other words, more entrepreneurs in China are holding bitcoin and accepting the volatility of its value, in order to sell the asset to those looking to get money out of China.

Those using bitcoin may wish to diversify their portfolios, they may need to make payments abroad, or they may think the Chinese currency is currently overvalued, or some mix of the above. Bitcoin has become increasingly popular in China, and the largest bitcoin exchange is in China, yet the currency has hardly any retail use in the country. Still, the number of yuan-based bitcoin trades has risen thirty-fold in the last two months, according to Bloomberg.

Right now, you can think of the value of bitcoin being set in the same way that the value of an export license might be set through bids. If/when China fully liberalizes capital flows, the value of bitcoin likely will fall. A lot. To the extent the shadow market value of the yuan rises, and approaches the level of the current quasi-peg, the value of bitcoin will fall, by how much is not clear. Or maybe getting money out through Hong Kong (or Shanghai) will become easier and again the value of bitcoin would fall. If Beijing shuts down BTC China, the main broker, which by the way accounts for about 1/3 of all bitcoin transactions in the world, the value of bitcoin very likely will fall. A lot. You will recall that the Chinese government shut down the virtual currency QQ in 2009; admittedly stopping bitcoin could prove harder but still they could thwart or limit it.

If you are long bitcoin for any appreciable amount of time, it seems you are betting that the Chinese economy will do poorly and capital controls will remain. Then more people will be increasingly desperate to get more money out of the country. Or you may be betting that the Chinese use of bitcoin to launder money will increase due to the mere spread of the idea, through social contagion. According to this source, the value of bitcoin is up by a factor of 66 this year in China.

To the extent the price of bitcoin incorporates expectations about the future strength of the social contagion effect in China, the price of bitcoin may become more volatile. Expectations about the future strength of social contagion effects are probably not so stable.

In theory these points might give you a way to hedge the value of bitcoin. Or hedge the value of China. Here is an interesting post about how bitcoin prices in yuan do not so closely mirror bitcoin prices in dollars. If you are a resident of China and have a BTC account there are numerous interesting possibilities, none of which I recommend for the faint-hearted. (Justin Wolfers doesn’t have to like this, but how can he think it is not interesting?)

I do not recommend that you go either long or short in bitcoin, unless it is a small amount of money and done “for kicks.”

By the way, Ben Bernanke, by “talking up” the price of bitcoin, is placing an implicit tax on the Chinese Johnny-come-latelys to this market, whether he intends it or not. He also is raising the price for circumventing Chinese capital controls and perhaps thus delaying a fall in the actual market value of the yuan.

For related ideas behind this post, I am indebted to a series of tweets by Izabella Kaminska.

This article first appeared on marginalrevolution.com.

Author: Tyler Cowen is Professor of Economics at George Mason University.

Image: Signs on a window advertise a bitcoin ATM machine that has been installed inVancouver, British Columbia October 28, 2013. REUTERS/Andy Clark