May Just Be a Setback: China’s Broadened Restrictions on Crypto Leave the Fundamentals Intact

KEY TAKEAWAYS

  • China bans resulted in short term crypto market crash and new offshore mining havens 
  • The ban is negative in the short term, but positive sentiments will follow in the long term.  
  • Q4 will become an important timing to observe whether the bear or bull will dominate the market

The Chinese government has recently reaffirmed its stance on Bitcoin mining and crypto trading activities after a meeting of the Central Financial and Economic Affairs Commission led by Liu He, the organization’s director and vice-premier of the State Council. This is, of course, not the first time that the highest-level Chinese government body has struck a blow against the broader crypto markets. In fact, China has banned cryptocurrency mining and trading numerous times since the inception of cryptocurrency. It is almost customary that regulators introduce a ban on cryptocurrency during each bull run — we’ve seen the 2013 crackdown of Bitcoin payment processors, the closure of local exchanges during the 2017 boom, and the stern warnings of 2019 against mining, citing noncompliance and environmental damage among other concerns. The pattern of the Chinese government reiterating its adversarial stance is almost too strong to ignore. 

So what’s different this time around? For a start, the timing is most inconvenient. Despite historically known as the month of high returns and relatively low volatility, the May of 2021 is a jarring anomaly. Since mid-May, Bitcoin has been battling heightened criticism stemmed from growing environmental concerns, and suffered a brief setback after Tesla revoked its decision to accept bitcoin as an alternative payment method, followed by several negative tweets on the leading cryptocurrency posted by none other than Elon Musk, the self-anointed Technoking himself. The crypto market inevitably responded with a brutal sell-off, posting an unprecedented volume of realized losses that almost wiped out new market entrants in its entirety. Despite being badly clawed by the bear, the crypto market sees a dose of optimism from broader institutional adoption, as internationally renowned asset management firms finally began to recognize crypto as investable assets. The market has gradually stabilized as the tumultuous month comes to an end. 

Another stark difference lies in the subtext of the ban reiteration. Unlike the crypto ban in 2017, China’s new regulations seek to question the real value of digital currency based on the premise that crypto mining and trading activities pose a threat to individual property and therefore, should be curbed to “resolutely prevent the transfer of individual risks to the society”. Hence, the ban inhibits companies from accepting or utilizing cryptocurrencies for payment, settlement and exchange with an iron fist. 

And of course, the environmentally-minded argument prevails, as always. Citing goals of carbon neutrality, China has intensified the stamping of crypto mining in Inner Mongolia by proposing punishments for companies and individuals involved in crypto mining. Other parts of China will likely follow suit. Despite repeated bans, mining operations in China still account for 65% of global hash rate. Tightening measures are pushing large mining companies to consider moving to North American or Central Asia, where the political climate tends to be more favorable. This will effectively accelerate the spike in new mining havens out of China, as it drives down hash rate to 150EH/s towards the end of May.  

In addition to substantial hash rate declines over a short time interval, Bitcoin’s mining difficulty saw a 16% decrease last Sunday from its recent all-time high. With plummeting hash rate and mining difficulty, miners’ profitability is expected to increase significantly, generating incentives to hedge their future mining. Mining economy is structured in a way that the hash rate moves in tandem with the price of Bitcoin, despite a slight lag arised from miners adjusting to changing market conditions. That said, as the price of Bitcoin establishes a stronger foothold above the 100 hourly SMA, hash rate will probably bounce back notwithstanding China’s mining FUD. 

On a macro level, the sharp rise in raw material costs has steadied Chinese yuan against unexpected inflationary spikes that plagued the U.S. financial markets in April. Soaring trading surplus and higher expectations of yuan also exerted some inflationary pressure on the dollar. As inflation rates rose in the U.S., the already low U.S. treasury yields plummeted further, prompting potential crypto dumping by the whales. In addition, the amount of stablecoin held on exchanges has decreased across major exchanges, indicating a cautious attitude towards investing in risky assets. 

The good news is that the crypto market has stabilized, more or less, as evidenced by Elon Musk’s tweet reassuring his involvement in crypto, which incited an immediate 19% bounce-back. With first-tier fund management firms jumping onto the crypto bandwagon, crypto traders have regained confidence in the crypto market. 

When will we recover from the short-term bear market? The market currently looks undecided, but the answer is highly correlated to the dilution of hash rates in China and impending Fed’s policies. Hence, Q4 is a good time to observe the overall trend of the crypto market.