Bitcoin is on a tear.
The price of bitcoin has jumped 42 percent since the beginning of June. It hasn’t been this high since early 2014. It’s moved from a total market capitalization of US$8.3 billion, to nearly US$12 billion. It’s unheard of for a currency – digital or otherwise – to skyrocket this quickly.
China has played a big part in this rally. As The Wall Street Journalrecently reported, two Chinese exchanges, Huobi and OKCoin, now collectively account for 92 percent of global trading in bitcoin.
In February, we explained that bitcoin is “cryptocurreny,” or a form of digital money. It’s created and stored electronically through a blockchain database.
Like dollars or yen, you can use bitcoin to buy goods and services. But, unlike paper currencies, which governments can create and print at will, no single entity controls the bitcoin network. Its mathematical rules limit the maximum number of bitcoin units to 21 million.
A network of “miners” digitally secures bitcoin transactions. When a miner completes the complex process of mining a block, he’s paid a fee – in bitcoin.
Every time 210,000 bitcoin blocks are mined, the value of mining new bitcoins is cut in half. There’s only been one “halving” since bitcoin was created eight years ago. It happened in November 2012.
Miners expect the next halving to happen in July. This is one explanation for the recent price surge. Some investors see the imminent halving – which will cut the mining fee from 25 to 12.5 bitcoins – as a reduction in supply. That’s why they’re bullish on bitcoin.
Another explanation is that blockchain, the technology at the heart of bitcoin, is gaining traction in a growing number of commercial applications, stoking investor interest.
Also, concerns over “Brexit” are adding to bitcoin demand. Some investors are worried about the financial fallout if the U.K. leaves the European Union. So they’re turning to bitcoin as a safe haven asset – treating it like a digital alternative to gold.
That said, the yuan is a much bigger player in this bitcoin rally.
China’s currency has been weak in recent months. It’s down 6.1 percent against the dollar since August.
Investors in China are selling yuan-denominated assets in favour of other currencies, particularly the U.S. dollar. In 2015, Chinese citizens and corporations moved an estimated US$1 trillion in capital out of China. The capital flight has slowed this year. But renewed weakness in the yuan may reaccelerate it.
China’s government wants this to stop. This is part of the reason why it prohibits individual citizens from moving more than US$50,000 per year out of the country. Even so, Chinese citizens have a variety of ways to bypass these capital controls – including bitcoin.
Bitcoin is gaining popularity as a method to quietly and anonymously move money out of China. Basically, a Chinese investor can deposit yuan in a bitcoin account and exchange the bitcoin overseas for some other currency. Fees range from one to two percent.
The price of bitcoin is volatile. So there’s a risk it might change while the transaction is being processed, causing the investor to lose money. Otherwise, it’s a relatively simple way to skirt the rules.
Still, the main reason for bitcoin’s price surge is even simpler: Good old-fashioned speculation.
In recent months, speculation driven by Chinese money has resulted in short-lived bubbles in assets as diverse as iron ore, steel rebar, cotton, and eggs – as well as in bitcoin.
All of these Chinese-driven speculations have the same basic lifeline. Whatever the explanation – lack of alternative investments, a deep-rooted gambling culture, investing naiveté, easy-money loans – each of these market booms played out the same way. Prices shot up in a speculative frenzy, and crashed once the mania faded.
Bitcoin shows all the signs of another Chinese-driven financial bubble.
That’s not to say the price of bitcoin won’t go higher. Bitcoin’s 2013 price surge, as shown above, is the stuff of legend. At the start of 2013, you could purchase a single bitcoin for around US$12. On November 29, you could sell that same single bitcoin for US$1,100.
That’s more than a 9,000 percent gain.
If the yuan starts to freefall, it’s certainly plausible that bitcoin could blast as high as it did in 2013, which would be about a 50 percent gain from current levels.
Keep in mind that China’s economy dwarfs the bitcoin market. Chinese financial deposits total over US$22 trillion. The country experienced capital outflows of US$45 billion in April alone, according to RBS (Royal Bank of Scotland). And by recent standards that’s considered moderate.
If the yuan starts a correction in earnest, and just a portion of the fleeing capital flows into bitcoin, it’s anyone’s guess how high the price of bitcoin might fly.
Nevertheless, buyer beware. When this bubble pops (as they all do), many speculators will wish they had never heard of bitcoin.