The PBOC popped the 2013 Bitcoin bubble by instructing banks to close accounts of the exchanges. This spooked the market and lead to the initial drop. Then MtGox failed and the party was over for 2 years.

When Bitcoin flirted with 9,000 CNY in early January of this year, the PBOC sprung into action again. This time after jawboning the price lower, they brought the hammer down upon the Chinese exchanges. Over the past few weeks the following things have been implicitly banned by the PBOC, margin trading, zero fee trading, and Bitcoin withdrawals.

It is obvious that the PBOC feels threatened by the relentless rise of Bitcoin. However in this instance the marginal effectiveness of their actions is diminishing rapidly. After the initial standard warning from the PBOC that Bitcoin is volatile and not a nationally recognised currency, the price dropped 30%.

Undeterred, bullish traders bid the price back above $1,000 and it appeared that a full retrace would occur. Then the PBOC removed the Chinese secret success sauce of leverage and zero fees. The price went below $1,000, only to rally back in less than a week.

The PBOC continued with on-site “inspections” of all Chinese exchanges. They believed that KYC and AML regulations were not being followed correctly. Why all of a sudden is the PBOC interested in how exchanges conduct compliance? Surely it would have been appropriate to conduct similar site checks in 2014. However in 2014 the price went down and stayed down.

The inspections failed to produce enough fear needed to cause a serious correction. The ultimate bombshell was then dropped late last week: in order to comply with more stringent KYC and AML requirements, Chinese exchanges began halting Bitcoin withdrawals.

KYC and AML violations are used by governments worldwide to harass companies. CNY withdrawals were unaffected. If there really were lax KYC and AML controls at the exchanges, all withdrawal functions should have been ceased. It is obvious the PBOC intended for spooked traders to dump Bitcoin and withdraw CNY to the safety of national banks.

The big three exchanges (BTCC, Huobi, and OKCoin) have all shut Bitcoin withdrawals until mid-March. It appears that exchanges will be required to integrate systems that pass client information to the police and other relevant agencies.

This integration takes time and development resources. Smaller exchanges threw in the towel. HaoBTC was one exchange that decided to close its exchange business rather than completing the upgrade. Expect more second and third tier exchanges to shutter. Regulation always favours the incumbents.

If Bitcoin still creeps higher as the fear subsides, what else can the PBOC do to curtail the trading of Bitcoin in China and how will it affect the market structure?

Close All Exchanges

The PBOC could close all the known Bitcoin exchanges in China. Given that they have been unwilling to do that since 2013, I don’t think they will choose that nuclear option in this instance.

By threatening large exchange owners with the closure of their business and possible civil and criminal charges, the PBOC can effectively control the trading of Bitcoin. If they were to close the large exchanges, Bitcoin trading would move underground and would become uncontrollable.

In China, people build illegal power plants. Given the right financial incentives, underground Bitcoin exchanges will proliferate. The PBOC will be powerless to stop them. Chinese people will be able to fully use the pseudonymous features of Bitcoin.

Currently, moving large amounts of RMB offshore via Bitcoin for clients unwilling to go through KYC is impossible. If less scrupulous operators are given a business opportunity, black money will gush through Bitcoin.

The PBOC can barely control state owned banks, they won’t risk opening a gaping hole in their capital account by relinquishing leverage over the large Bitcoin exchange operators. Bitcoin withdrawals will be re-enabled in time with caveats.

Add Bitcoin to the FX Quota

Some traders speculate that Bitcoin purchases will be subtracted from each comrade’s $50,000 annual FX quota. That would mean that the PBOC re-classifies Bitcoin as a real currency. This is very unlikely.

If Bitcoin is re-classified as a real currency, it would give it legitimacy. Normal investors who shied away from Bitcoin due to the constant pronouncements from government agencies about its inherent risk and price volatility, might decide to place small amount of their investable assets in the cryptocurrency. The price would skyrocket.

In order for Bitcoin purchases to be properly debited against each citizen’s quota, all exchanges would need to interface direcly with the State Administration of Foreign Exchange (SAFE). There is a small possibility that the current KYC/AML upgrades are a step in that direction.

Bitcoin Birdcage

During a recent CCTV report about Bitcoin, commentators expressed a view that Bitcoin should not be banned but properly regulated. They used the metaphor of a birdcage. Bitcoin can still move, but its range of motion is restricted. Any views aired by CCTV come directly from the Party.

China like all other governments since the industrial revolution believe that through science, resources can be allocated effectively by government diktat. The command and control economy is sexy to bureaucrats. I fully expect China to attempt to create a Bitcoin walled-garden.

Withdrawals will be permitted to certain white-labelled addresses. Bitcoin may not leave these approved platforms. That effectively destroys the fungibility of Bitcoin.

If Bitcoin isn’t fungible, why would someone buy or trade it? Chinese traders may still trade on approved platforms if they believe one day the walled-garden will be removed. That may happen once the PBOC drastically devalues the Yuan.

OTC Trading

Bitcoin over-the-counter (OTC) platforms are the biggest beneficiaries. Bitcoin / CNY volumes on LocalBitcoins, the largest OTC Bitcoin trading exchange, spiked. The merits of owning unencumbered Bitcoin grow with each desperate action of the PBOC. Traders are willing to pay a significant premium to acquire coins they can actually use.

Some Chinese exchanges recognising the shift away from on-exchange trading, are even allowing OTC brokers to advertise openly in their WeChat and QQ groups. They want more deposits, so it is advantageous if clients are able to acquire Bitcoin and then deposit on the exchange. Why anyone would do that in the face of a withdrawal freeze is beyond me.

Price Implications

Chinese people will find a way to trade Bitcoin even if it is not officially permitted. Chinese people do not trust the government. Throughout history the ability for the central government, whether that was the Emperor or the Communist Party, to effectively govern outside of the capital is tenuous.

The financial incentives are too great for entrepreneurs not to offer the ability for comrades to trade Bitcoin. The transaction costs may rise, but Bitcoin in China is here to stay.