An introductory study of China's Bitcoin boom in the period 2014 - 2016

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An introductory study of China’s Bitcoin boom in the period

2014 - 2016.

Bachelor thesis economics, 12 EC

Author: Marc Brouwers

UvAnetID : 10641017

Supervised by ms. Rui Zhuo

January 26, 2017

Carried out between 10-30-2016 and 01-31-2016 Faculty of Economics and Business, UvA

Abstract

Bitcoin has been rapidly gaining in popularity in China. Currently, over 98% of all trades between fiat currency and Bitcoin take place in China. The daily amount of Bitcoins traded on Chinese exchanges increased more than 20 times in the years 2014 - 2016. This research has been the first to describe the Chinese Bitcoin market and to identify the most probable reasons for its rise there. The findings show fundamental differences between the Chinese and American Bitcoin markets. Indications are found that Bitcoin is used in China as an investment asset as well as a speculative vehicle. Bitcoin’s exchange price and volume are significantly cross-correlated, exhibit negative correlations with the SSE composite index and the RMB/USD exchange rate and correlate positively with the price of gold. Bitcoin can be used as a channel for capital flight out of China, but this has been made difficult by consumer identification regulations by the People’s Bank of China. Bitcoin’s use as a currency in China is most likely negligible. The third party exchange infrastructure could make Bitcoin suseptible to possible future intervention from the Chinese government.

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1 Introduction

Bitcoin is a peer-to-peer cryptocurrency launched by a person or group under the pseudonym Satoshi Nakamoto in 2008 (Nakamoto 2008). It was created as a currency that does not rely on the use of a trusted third party like a bank. Instead, transactions take place on a separate peer-to-peer network that is operated by its users, following the Bitcoin protocol. Cryptography is used to secure the transactions. Bitcoin (in short BTC) is the first and by far the most widely used currency of its kind, with an average daily transaction volume exceeding 250 million USD by the end of 2016 (Blockchain.info 2016). The value of a single Bitcoin has seen a rapid and highly volatile increase since 2011. It has risen from less than 1 USD at the start of 2011 to a peak value of 1050 USD in December 2013, with a current exchange value of around 900 USD as of December 2016. Bitcoin’s history of rapid price increase paired with high volatility has lead to signifiant media coverage. Its benefits compared to fiat currency include increased anonymity for its users and less transaction costs (Reid and Harrigan 2013). Using Blockchain technology in transactions could also greatly accelerate the velocity of money. These aspects could possibly lead to a much more wide use of the Blockchain in the future (Capgemini 2015).

Trading Bitcoin for fiat currency is possible on designated Bitcoin exchanges. The exchange volume was dominated by US-based exchanges up to 2013. Combined Chinese and European ex-change volume never exceeded a share of 10% in this period (Bitcoinity.org 2017). One of the most important changes in the worldwide Bitcoin market has been the increase in trading on Chinese exchanges since then. This increase has been so large that 94.4 % of the trades between Bitcoin and any fiat currency took place in China over the last two years. China’s share has been even higher in 2016, averaging 98.3 % in the last six months.

The goal of this research is to provide an overview of the Chinese Bitcoin market in the pe-riod 12-7-2014 to 12-6-2016 and to identify possible reasons for its rise there. The methodology contains three parts: First a literature review is made of the factors that could drive a market for Bitcoin in general. Secondly, the events and regulations regarding Bitcoin’s rise in China are described, along with relevant details about China’s economic situation. Finally, correlations of Chinese Bitcoin exchange volume and price with stock prices, gold and the RMB/USD exchange rate are calculated. The timeframe for calculating the correlations was chosen between 12-7-2014 and 12-6-2016, the largest range where reliable daily exchange volume could be obtained. This research aims to be a first step in exploring the Chinese Bitcoin market and is therefore introduc-tory in nature.

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So far there has been surprisingly little academic research done on Bitcoin and none of it considers the situation of Bitcoin in China. Most of the early research, notably by Barber et al. (2012) and Grinberg (2012), has focused on the technical properties of Bitcoin and possible im-provements of the protocol. The emphasis has been on trying to understand and improve the security of cryptocurrencies. Other studies by i.e. Reid and Harrigan (2013) and Androulaki et al. (2013) have focused on the level anonymity and privacy on the Bitcoin network. Baur et al. (2015) and Yermack (2013) among others have studied correlations between Bitcoin prices on the Amer-ican exchanges and several assets and exchange rates. Their findings indicate that the Bitcoin price in America moves independently from these economic variables.

This research has been the first to identify the most probable factors concerning China’s Bit-coin boom. In contrast to existing literature on the American exchange market, this research has found siginificant correlations between Bitcoin exchange volume in China and stock prices as well as gold, an indication that Bitcoin is used as an investment asset in China. Bitcoin’s price and exchange volume are also found to correlate significantly with the RMB/USD exchange rate. This could be an indication that Bitcoin is used for capital flight out of China. However, the American Bitcoin exchange volume has not increased in the same period so the volume of capital flight is likely to be small. Another important factor in the Chinese Bitcoin market is the policy of the People’s Bank of China. By issuing consumer identification regulation for Chinese Bitcoin exchanges and by their statements warning about the use of Bitcoin as a currency, they have effectively stopped Bitcoin’s use as a currency in China. Their more recent statements have shown the real possibility of China intervening further in Bitcoin’s exchange market in the future.

This paper is structured as follows: First, a short technical review of Bitcoin is given in section 2. The possible drivers of a market for Bitcoins are then reviewed in section 3. Section 4 analyzes current situation and historic evolution of Bitcoin in China. Finally, correlations between Bitcoin price, exchange volume in China and several Chinese economic variables are evaluated in section 5. Then, section 6 concludes.

2 Technical review

Cryptocurrencies are still a novel concept in the field of economics and their characteristics are not yet widely understood. This section is used to explore Bitcoin’s characteristics from both a technical and an economical point of view.

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2.1 Context and origin of Bitcoin

The currencies that are commonly used in transactions worldwide like the US Dollar, Renminbi and the Euro share a set of characteristics. They are all state-issued fiat currencies, meaning they hold no intrinsic value but are instead based around a decree from a government or monetary union stating that they are legal tender. The use of them is based on a principle of general faith (White 1999). With the increase in internet banking and consumption over the last two decades, the digital aspect of money has gained in importance (Venkatesh et al. 2012). In this movement of digitalization, several attempts have been made to start entirely digital currencies such as Digi-Cash (Schoenmakers 1998) and Peppercoin (Rivest 2004). However, none of these attempts before Bitcoin succeeded in gaining siginificant market volume, largely due to problems with security and a lack of incentives for people to use them (Grinberg 2012). The first step to securing an entirely digital currency was proposed by Chaum, who developed the use of cryptography to send untrace-able payments (Chaum 1983). Other important developments include the method of Okamoto to be able to make cryptocurrency divisible (Okamoto 1995) and the work by Chaum et al. (1990), allowing trades to happen when the bank is offline Belenkiy (2011).

A second common characteristic of fiat currencies is that digital spending is only possible through the use of a trusted third party, typically a bank. Direct transactions between individuals can only be made using the currency in physical form. The use of a third party in transactions necessarily brings a cost in privacy with it. Bank accounts need to be registered and all transac-tions can be viewed by the banking institution. People who gain access to this information can find out entire financial histories of people linked to that bank. Bank accounts and transaction details have been hacked and leaked in the past, exposing the disadvantage of this system. One notable example is the cyberattack on JPMorgan Chase in October 2012 which compromised the accounts of 76 million households and seven million small businesses (Silver-Greenberg et al. 2012).

In contrast, Bitcoin is a cryptocurrency that operates without the use of a third party. Trades happen directly on the Bitcoin network, which is based on a peer-to-peer system (see section 2.2). The process of securing transactions and its coupling to the production of Bitcoins through so called mining also aims to give Bitcoin an intrinsic value (Nakamoto 2008). These two character-istics set Bitcoin apart from fiat currencies. Bitcoin is the first cryptocurrency to be created but not the only one (Barber et al. 2012). As per December 2016 more than 700 different cryptocurren-cies are in circulation, almost all with their unique protocol and characteristics (CoinMarketCap 2016). However, so far Bitcoin has been the only one to gain any significant mainstream accep-tance.

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2.2 Bitcoin transaction network and production

Bitcoins are sent to and from Bitcoin addresses, much like transactions are made to and from ac-counts in the banking sector. Participants on the Bitcoin network store the required cryptographic identifiers of their addresses in so called Bitcoin wallets. These wallets contain a set of public keys and private keys for each address. The private key is the secured core of any address and is known only to the address’s owner. Without it no Bitcoin can be sent from the address, preventing theft. The sender of a transaction uses his private key to construct a digital signature, an analogue to traditional signatures, to mark the transaction. Any receiver can then use the public key of the sender to verify the signature. Individual coins are defined by the chain of digital signatures that marks their transaction history. This use of cryptography is the basis of the Bitcoin network.

The transaction details are stored on the Blockchain. The Blockchain is a a complete ledger of the Bitcoin network. It lists all previous transactions along with information such as on the fees attached to the transactions. Transactions are periodically lumped together in blocks before being added to the Blockchain. The entire Blockchain is publicly available and can be downloaded free of charge as part of a bitcoin wallet. The fact that all this data is publicly available makes Bitcoin’s unique from a privacy standpoint (Androulaki et al. 2013). The entire transaction history of any Bitcoin address can be viewed by anyone. However, it is usually unknown to whom any Bitcoin address belongs. As long as an address remains unconnected to the person behind it, the Bitcoin network can be used anonymously.

If anyone wants to exchange his Bitcoins for fiat currency, this can be done using Bitcoin ex-changes. In this paper, a distinction is made between transaction volume and exchange volume. The transaction volume is the total value of the transactions taking place on the Bitcoin network while the exchange volume is defined as the total trading volume on the Bitcoin exchanges. In order to purchace Bitcoins on an exchange, you need to open an account with fiat currency. Buyers and sellers post bids at their desired prices. There is no market maker involved. All trades happen directly between buyers and sellers. The exchange system is the only third-party aspect of the Bitcoin network. This is a very important point to make as in China, the government can still influence the Bitcoin network by applying regulations to the exchanges.

Bitcoin transactions are secured by Bitcoin nodes, computer units that use GPU output to solve cryptographic puzzles (Kroll et al. 2013). This process is calles mining and the people oper-ating these computers are often labeled as miners. All miners are working on the newest block and

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Figure 1: The projected amount of Bitcoins that will have been mined before the dates between 2009 and 2033 (Buchholz et al. 2012)

try to find a solution to the whole block, which is a probabilistic process (Courtois et al. 2014). The Bitcoin protocol incentivizes miners by providing rewards for every mined block. This reward is a combination of the voluntary transaction costs and the Bitcoin supply. Revenues of Bitcoin miners have been historically dominated by the Bitcoin supply. The share of transaction costs has never exceeded 2 % up to 2015 (M¨oser and B¨ohme 2015). Blocks are solved at an average rate of 6 blocks per hour. The bitcoin clients compare the actual number every time after 2016 blocks are mined. The difficulty of the puzzle is then adjusted accordingly. Graph 1 shows the amount of Bitcoins that will have been mined before the dates between 2009 and 2033. The difficulty of mining Bitcoin is adjusted to facilitate this pattern.

The mining supply was set at 50 coins per block at the start of Bitcoin. This reward is halved automatically every 4 years. The supply of bitcoin will eventually be halted completely when 21 million bitcoins have been mined. This set supply of Bitcoin is fundamentally different from the dynamic policies that central banks use in issuing fiat currency. Bitcoin mining is comparable to how gold and other minerals are extracted, with the yield decreasing as the recource becomes more scarce. The idea behind this inbuilt scarcity is to grant Bitcoin an intrinsic value like gold, stemming from its use in combination with rarity. Another important aspect of the Bitcoin network is that because of the lack of an intervening third party, all transactions are irreversible (Nakamoto 2008). There are also no mandatory transaction costs involved. The Bitcoin protocol

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only allows for a voluntary transaction fee to be attached to a transaction.

3 Literary review: Bitcoin market drivers

A growing body of literature aims to describe the ways in which the Bitcoin price and exchange volume are driven. The aim of this section is to provide an overview. In addition, some other pos-sible market drivers are identified. Most previous research has focused around America’s Bitcoin rise in the period 2010-2014. It is possible that the Chinese Bitcoin exchange market has very different characteristics from the American market in this period.

While Bitcoin has been created as a currency and is viewed that way in much of the existing literature, the dominating drivers of the Bitcoin exchange market may be from people using Bit-coin as an alternative investment vehicle. The original paper of Nakamoto (2008) clearly states the creator’s intention for Bitcoin to function as a currency. This is also how Bitcoin is interpreted in research focused on technical aspects of the Protocol, i.e. anonymity (Reid and Harrigan 2013), privacy (Androulaki et al. 2013), or regulation (Kaplanov 2012). However, this view is contra-dicted by the work of Yermack (2013), who argues that Bitcoin’s characteristics fail to sufficiently satisfy the functions of a currency and that Bitcoin should be looked at as an investment vehicle rather than a currency. The results by Glaser et al. (2014) also indicate that users were more interested in using Bitcoin as an investment vehicle rather than a currency.

3.1 Bitcoin as an investment vehicle

The rapid growth of Bitcoin coupled with a sizeable volatility in price might make Bitcoin inter-esting as a speculative asset. There are indeed several papers that show indications of speculative Bitcoin trading on the American exchanges. Baek and Elbeck (2015) have made regressions of monthly Bitcoin returns with a list of fundamental economic factors: the consumer price index, industrial production, real personal consumption expenditures and the change in national average unemployment rate, spanning the period up to February 2014. They found that Bitcoin revenue is not significantly affected by these major economic indicators and argue that this is an indication of the American Bitcoin exchange volume being driven by speculation. Matta et al. (2015) have found that market sentiment measured by tweets and Google trends had a significant effect on future Bitcoin prices on the American Bitcoin exchange market in a period of 60 days between January 2015 and March 2015. This is again an indiaction of the speculative nature of America’s Bitcoin exchange market.

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Another possible driver of Bitcoin investors are its theoretical properties as a hedge against inflation. The issuance of more currency is typically linked positively to inflation, just like a de-crease in the money supply is linked to deflation (Barro and Grilli 1994). The predetermined and diminishing supply of Bitcoin means that the system has an inbuilt systematic deflation (Grinberg (2012), Kaskaloglu (2014)). Investors could therefore include Bitcoin in their investment portifolio to hedge against inflation risk. Bri`ere et al. (2013) have found some indication that this has in-deed been happening in the American Bitcoin exchange market. He examined the period between 23 July 2010 to 12 July 2013 and found a significant correlation of 16 % between Bitcoin and Inflation-linked bonds.

Finally, it is possible that Bitcoin is used as a hedge against various types of market risk. Bitcoin has different characteristics from other investments like stocks, real estate or natural re-cources. This might lead to Bitcoin having a very low correlation with these typical assets. If the correlations are low enough, Bitcoin can be used as a diversification to hedge against the risk carried by owning these assets. Bitcoin investors might also be attracted by its theoretical inde-pendence from governments and central banks. Like gold, Bitcoin is created with the idea that it has an intrinsical value. Baur et al. (2015) have looked at Bitcoin’s correlation with a range of exchange rates including RMB/USD as well as stocks, bonds, gold, oil and precious metals. Their data contained only American exchanges in the period 16 July 2010 to 28th December 2013 and they found no significant correlation of Bitcoin with any asset nor any exchange rate. Research by Yermack (2013), who analyzed the American Bitcoin exchange market in the period from July 19, 2010 up to March 21, 2014 found similar results. Bri`ere et al. (2013) also found no significant correlations between Bitcoin and other assets, except for a 17% correlation of Bitcoin with gold. The fact that no correlation has been found beteen the American Bitcoin market and any stocks or exchange rates indicates that while using Bitcoin as a hedge has been a viable option in America, this has likely not been happening on a large scale.

3.2 Bitcoin as a currency

If Bitcoin behaves as a currency, its price compared to fiat currency will depend on its usefulness as a unit of exchange (Kristoufek 2015). In order to be able to spend Bitcoins, others should participate on the Bitcoin market so trades can take place. Therefore Bitcoin’s value should de-pend positively on factors measuring the participation this platform. Examples of such indicators are the number of unique users on the Bitcoin network, the transaction volume and the number of merchants accepting Bitcoin. No studies on the effect of such indicators has been performed yet. Due to its inceased anonymity, a sizeable share of trading on the Bitcoin network could be

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in illicit goods. A study by Christin (2013) estimated that a fraction of 4.5 % to 9 % of Bitcoin trades in the last eight months of 2012 were happening illicitly. There are also a number of large online gambling sites active that exclusively use Bitcoin, Satoshicoin being the most popular one (B¨ohme et al. 2015). Many of these websites are hard for governments to monitor or close down as they are hosted on the dark web.

Another possible driver of the Bitcoin network is its potential use to escape capital controls. Governments are able to control the in- and outflow of fiat currencies through regulation on the fiat exchanges. Bitcoin exchanges outside China have not been subject to such government con-trols so far. People can exchange local currency to Bitcoin on an exchange in their home country, send the Bitcoin to a foreign exchange and transfer it into foreign currency. A study by Mcleod (2013) has found that Bitcoin trading increased in Argentina when the government incorporated stricter capital controls. Indications of the use of Bitcoin to excape capital controls in China have also been found (Ju et al. 2015). However, regulations by the People’s bank of China have made this much harder to do anonymously (see section 4.2).

While the level of activity on the Bitcoin network remains relatively small, substitution effects and non-dynamic pricing could also be a driver of Bitcoin price and exchange volume. As Yermack (2013) has argued, Bitcoin’s transaction volume has remained negligible compared to worldwide transaction volume in fiat currency. Because of the limited number of Bitcoin-accepting mer-chants, not all types of goods can yet be bought with Bitcoin. Therefore any Bitcoin owner still makes a sizeable portion of his purchases with local fiat currency. He thus has to consider the exchange rate of Bitcoin relative to this currency. Besides that it is possible in most purchases to substitute Bitcoin by local fiat currency. Consumers may do so in order to get a lower price. This makes it possible that the short term exchange volume of Bitcoin is driven by its price relative to the local fiat currency.

4 Bitcoin in China

4.1 Bitcoin’s start and rise in popularity

The first Bitcoin exchange to be founded in China was BTCChina in June 2011, 11 months after the first US-based exchange was started (Bitcoincharts.com 2017). Exchange volume in China remained small compared to American trading during the subsequent two years (Bitcoinity.org 2017). However, while the average American exchange volume has remained close to constant

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over the last five years, Chinese Bitcoin exchange volume has been increasing rapidly since Octo-ber 2013. In that month, the Chinese internet company Baidu started allowing for payments to be made with Bitcoins (Kapur 2013). Chinese Bitcoin exchange volume first exceeded American exchange volume on November 12, 2013 and has remained higher until now (Bitcoinity.org 2017). The rise in Chinese Bitcoin exchange volume coincided with a rapid increase in Bitcoin’s exchange rate associated with the second Bitcoin bubble. It is not clear whether the Chinese trading lead to the increase in price or whether causal relation ran inversely (Kristoufek 2015).

On December 5th 2013, the People’s Bank of China issued a decree that Bitcoin is not a cur-rency and that institutions are not allowed to keep Bitcoin or to convert Bitcoin into RMB (see section 4.2). Following this statement, Baidu retracted their Bitcoin payment feature indefinitely (Rose 2013). Two weeks later, BTCChina announced it had stopped its RMB deposits in response (Hill 2014). The Chinese Bitcoin exchange FXBTC stopped operations entirely, citing the new regulation as the main reason (Higgins 2014). Bitcoin’s price crashed to half its peak value in the two months following the announcement by the People’s Bank of China. However, not all exchange markets have ceased operations since then. BTCChina started accepting Bitcoin deposits again in January 2014, stating that that they had determined operating the exchange remained legal under the new decree (Chen 2013).

The increase in Chinese Bitcoin exchange volume has been the largest during the last two years. This has resulted in Chinese exchanges having a market share of 98.3 % in the last six months of 2016. Figure 2 shows a graph depicting the daily Chinese Bitcoin exchange volume between 2012 and 2016.

Figure 2: Daily (weekly averaged) Chinese Bitcoin exchange volume in the period between 2012 and 2016. (data: Bitcoinity.org (2017))

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The Chinese Bitcoin exchange market is currently dominated by three exchanges, reporting a market share of 98.95% over the last two years (Bitcoinity.org 2017). BTCChina, the oldest exchange and OKcoin, currently the largest are both based in Shanghai. Huobi is the second-largest exchange based on volume as per January 2017 and based in Bejing.

4.2 Current Bitcoin regulations

The general current stance of the Chinese government on Bitcoin is formulated in the statement by the People’s Bank of China from 2013, titled Prevention of Risks Associated with Bitcoin (Peo-ple’s Bank of China 2013). The notice is threefold: First they state that ”Bitcoin is not issued by a central authority, does not possess the characteristics of legal tender and does not have real meaning as a currency”. They further state that Bitcoin does not have legal currency status in China and that it cannot be used as such. However, ordinary people remain free to use Bitcoin to buy and sell items online. The second part of the anouncement states that financial institu-tions may not buy or sell Bitcoins or use them for a range of funcinstitu-tions including the pricing of products and services, providing Bitcoin-related services or exchanging Bitcoin for fiat currency. In essence, it bans all use of Bitcoin for finiancial institutions. Finally, the notice declares that Chinese Bitcoin exchanges must be legally registered with the Telecommunications Bureau. Fur-thermore, exchanges must ”comply with relevant authorities and with the Peoples Republic of China Anti-Money Laundering Law, and fulfill requirements related to customer identification, submit suspicious transaction reports and fulfill other statutory anti-money laundering obliga-tions”. The requirement of providing user information means that the Chinese government has an effective way to prevent anonymous trading, since all Bitcoin transactions are publicly available on the Blockchain and the address’s owners are identifiable. By preventing anonymous trading, China has taken away one of Bitcoin’s main benefits as a currency.

In their response to press questions on Bitcoin, the People’s Bank of China has further elab-orated their stance on two issues: Bitcoin risk and future policy. They state that Bitcoin has three risks; speculative risk, a risk of money laundering and the risk of Bitcoin being exploited by criminals in transactions of illigal goods and services. However, they argue that ”At present, Bitcoin does not bring systemic risks to China’s financial system, as the number of Bitcoins in circulation is comparatively small and the market scope is limited. Also, financial institutions are not directly involved in Bitcoin trading and investment activities.” This statement hints at the possibility of more government restrictions on Bitcoin trading in case the Bitcoin market becomes sufficiently large to be harmful. Such a possible intervention is more explicitly stated in People’s Bank of China’s response to a direct question regarding future Bitcoin policy. ”We [People’s Bank of China] will work with the relevant ministries to supervise the financial institutions, payment

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institutions and websites that provide Bitcoin registration, trading and other services to assist in implementing the ”Notice” provisions. Meanwhile, the Peoples Bank will continue to pay close attention to the movements of Bitcoin and associated risks; to further increase publics knowledge on currency; and to guide people towards a correct understanding of the concept of a currency and concepts of investment.” With the large increase in Bitcoin activity observed over the last three years, such increased intervention has become increasingly likely. Baidu decided in August 2016 to stop showing all Bitcoin-related advertisements, an action speculated to have been under pressure from the Chinese government (Tai 2016).

4.3 Bitcoin and capital controls

It is currently not allowed for Chinese citizens to exchange in indefinite amount of RMB into foreign currency. To counter excessive capital flight from China, a yearly foreign exchange quota of 50.000 USD has in place for Chinese nationals (Lee 2017). Still, the Chinese foreign exchange reserves have shrunk from 3.99 trillion USD in June 2014 to 3.05 trillion USD in November 2016 (Xie 2016). As explained in section 3, Bitcoin can be used to obtain foreign currency through the use of Bitcoin exchanges in the two relevant countries. In principle these amounts can exceed the government’s limit. However, this has become harder with the controls on the exchanges since December 2013.

In response to Bitcoin’s possible use in evading capital controls, China’s regulatory institution of foreign exchanges has announced that it is currently investigating whether this is indeed hap-pening in China (Higgins 2017). The People’s Bank of China has also issued a new statement on January 6th 2017, reconfirming their previous statements on Bitcoin (People’s Bank of China 2017). Their statement could be interpreted as a public warning to the exchanges. They also state to have met with the owners of the major Bitcoin exchanges to discuss their compliance with the relevant laws and regulations.

5 Empirical data analysis

The daily exchange trading volume (volBTC) and volume-weighed price of Bitcoin on it’s three major exchanges (exBTC) are correlated on each other, on the Shanghai composite stock in-dex (SSEcomp), the price of gold in China, the number of unique addresses on the Blockchain (N unique) and on the RMB/USD exchange rate (exUSD). The period spans 12-7-2014 to 12-6-2016, the longest timeframe for which reliable daily Bitcoin data could be obtained. In addition to calculating correlations, the daily Bitcoin exchange volume in the US and China are compared

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visually. All prices are given in RMB and the volumes in Bitcoin. The data for the Bitcoin price and daily Chinese Bitcoin exchange volume are taken from the Bitcoinity.org database (Bitcoin-ity.org 2017). The Shainghai composite index data is taken from Yahoo Finance (Yahoo Finance 2017), the price of gold in China from the database of the World Gold Council (Quandl 2017a) and the RMB/USD spot exchange from the Bank of England database (Quandl 2017b). The daily number of unique users on the Blockchain network is taken from Blockchain.info (Blockchain.info 2017). A graphical overview of the data is given by figure 3 at the end of section 5.1.

5.1 Correlation calculations

Table 1 shows the different correlations that have been calculated.

volBTC exBTC N unique exUSD SSE comp gold

volBTC 1.0000*** 0.6205*** 0.6570*** 0.6548*** -0.3777*** 0.3620*** exBTC 0.6205*** 1.0000*** 0.8482*** 0.9311*** -0.5184*** 0.7637***

Table 1: Correlation coefficients between daily Bitcoin exchange trading volume, volume-weighed price and a range of economic variables in the period 12-7-2014 to 12-6-2016. (*** for p ≤ 0.01)

These correlations suggest that Bitcoin can be used as a hedge against stock market and currency risk and that it has been used as such in China. Exchange price and volume exhibit significant negative correlations with the Shanghai Stock Exchange index (-0.52 ; -0.38) and a significant positive correlation with the RMB/USD exchange rate (0.93 ; 0.65). Bitcoin in China appears to be similar to gold in several ways. Their prices correlate significantly (0.76), they are both based on ideas of intrinsic value and move against the direction of stock prices. Previous research has shown that data from American Bitcoin exchanges had no significant correlation with exchange rates and American stock prices (Baur et al. (2015), Yermack (2013), Bri`ere et al. (2013)). Bitcoin’s correlation with gold in China is also found to be greater than in America. As such the results presented here show fundamental differences between the American and Chinese Bitcoin market for the first time.

People buying Bitcoin on exchanges to use as a currency online is unlikely to be a significant part of Chinese exchange volume. While the significant cross-correlation between Bitcoin exchange price and volume (0.62) could be seen as a sign of short-term dynamic pricing driving Bitcoin, it is more likely that it should be interpreted as an indication of speculative trading. As explained in section 4.2, China’s regulations and statements on Bitcoin have efficiently reduced its use as a currency.

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(a) Daily Chinese Bitcoin exchange volume (BTC) (b) Volume-weighed Bitcoin exchange value (RMB/BTC)

(c) Daily number of unique used Bitcoin addresses (d) RMB/USD exchange rate

(e) Shanghai Composite index value (f) Price of an ounce of gold in China (RMB/oz)

Figure 3: Data used in this research. It covers the period 12-7-2014 to 12-6-2016. (data: Bitcoin-ity.org (2017)), Yahoo Finance (2017), Quandl (2017a), Quandl (2017b), Blockchain.info (2017)

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5.2 Comparision Chinese and American trading volume

Figure 4 shows a comparison between the Bitcoin exchange volume on the Chinese and Ameri-can exchanges. Exchange volume in China started increasing rapidly at the start of 2014 while American exchange volume has remained relatively constant.

Figure 4: Comparison between the (weekly averaged) daily Bitcoin exchange volume on the Chi-nese and American exchanges during the period 12-7-2014 to 12-6-2016. (data: Bitcoinity.org (2017))

The significant negative correlation between the Bitcoin price and RMB/USD exchange rate could suggest that Bitcoin is used as a channel for capital flight out of China to the US. How-ever, while Bitcoin exchange volume in China has increased rapidly since 2014, it has remained approximately constant in America. Because swapping currency using Bitcoin requires a trade both in the home and the foreign country, the uneven increase in exchange volume indicates that capital flight has not contributed a large share of total trades on the Chinese exchanges. Using Bitcoin to get RMB with foreign currency has also become harder with the exchange’s consumer identification regulations.

6 Conclusion

Bitcoin in China has seen a rapid increase in popularity over the last few years. The aim of this research has been to describe the Chinese Bitcoin exchange market for the first time and to identify the most probable reasons for Bitcoin’s rise there. Existing literature has only focussed on the American Bitcoin exchange market, where Bitcoin is observed to move independently with assets, stocks and exchange rates.

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In contrast, this research has found that the Bitcoin exchange volume and price in China ex-hibit significant correlations with the SSE composite index, the RMB/USD exchange rate and with gold. Investment and speculative activity, possibly in combination with capital evasion are the most likely causes of Bitcoin’s rise in China. In addition, the Chinese government is found to play a major role in the Bitcoin exchange market. By issuing regulations they have effectively reduced Bitcoin’s use as a currency and made it more difficult to use Bitcoin for capital flight. Possible future intervention could restrict the market further.

This work is introductory in nature and invites further research. In order to investigate how various variables and regulations have influenced Bitcoin trading in China quantitatively, regres-sions on exchange volume have to be run. The possibility of Bitcoin’s use to hedge against inflation is also not investigated here. In addition, the cultural aspect of Bitcoin in China could be subject of future research. It is possible that China’s recent history of a more controlled society has in-creased its attraction to Bitcoin’s theoretical freedom from governments. Regarding the results of this work, the impact that the newly found correlations of the Bitcoin network have on Bitcoin’s use as an asset could be investigated further. Another interesting aspect that was not considered in this research is the effect of China’s Bitcoin boom on trading in other parts of the world.

Acknowledgements

I want to thank Rui Zhuo for supervising this research and for her many useful contributions to this work. My brother Thomas is thanked for introducing me to Bitcoin back in 2011.

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An introductory study of China's Bitcoin boom in the period 2014 - 2016