Explainer | China’s bitcoin crackdown: why is it happening and what’s next for the original cryptocurrency?
- China’s widespread crackdown on bitcoin has sent the hash rate plummeting, but miners leaving the network have also pushed up profitability
- Bitcoin was designed to be the world’s first decentralised currency, outside the reach of any central bank, but it now more closely resembles a commodity
Beijing, concerned by the volatility, announced another crackdown on the cryptocurrency. This time, it went after a practice previously assumed to be safe: bitcoin mining.
Local governments across mainland China have responded by pushing out cryptocurrency miners, forcing some of these enterprises to seek a new home overseas.
Experts previously raised concerns about China’s influence over the bitcoin market, since it accounted for 65 per cent of the decentralised network last year, but a declining share of mining is changing that situation.
Here is everything you need to know about bitcoin and what China’s crackdown means for the future of the cryptocurrency that started it all.
What is bitcoin?
Born in the wake of the 2008 financial crisis, bitcoin was designed by an anonymous person or group, known only as Satoshi Nakamoto, as a peer-to-peer digital currency free from any central authority.
Rather than being widely adopted as a full-fledged currency outside the domain of political influence as some had hoped, bitcoin’s design instead has become its most lauded technical contribution.
Blockchain, a clever open-source solution to a very difficult problem, is what makes the world’s first cryptocurrency viable. It is a distributed ledger technology that is collectively maintained by all those taking part, rather than by one central authority or clearing house.
The principal innovation of blockchain was to introduce scarcity to digital goods and has since been put to other uses such as non-fungible tokens (NFTs).
Why China is investing heavily in blockchain
What is bitcoin mining?
Unlike a traditional fiat currency, typically managed by a central bank, the blockchain has set rules governing how long it takes to create a new unit of digital currency.
This is done by hashing or solving hash functions, requiring large amounts of computing power.
For large, mature blockchains, like those of bitcoin and Ethereum, the hash rate is usually given in terahashes, or trillions of hashes, per second (TH/s). Before Beijing’s crackdown, the hash rate peaked on May 14 at more than 180 million TH/s, according to blockchain.com. Seven weeks later, the rate had halved.
Hash functions are effectively complex math problems that turn variable data into a fixed size, and the bitcoin network requires the constant solving of these problems to create more of the digital currency and verify transactions on the network. This is called “proof of work”.
The reward for adding a new block of bitcoin transactions, currently at 6.25 BTC, halves about every four years with the total supply eventually plateauing at 21 million bitcoins in the year 2140.
Until then, the incremental increase in the bitcoin supply has been likened to a form of monetarism espoused by free-market economist Milton Friedman, who promoted the idea that the money supply should be held steady and only increase slightly each year to account for economic expansion.
This tight control on the supply has turned bitcoin into an investment vehicle that behaves less like money and more like a commodity, such as gold.
Why did China crack down on bitcoin mining?
There are a couple of long-standing financial concerns for Beijing. One is price volatility, which appears to have been the impetus behind the current crackdown. Beijing started rooting out bitcoin mining after the price soared past US$60,000 and then started to drop. Over the following two months, it plummeted by more than 40 per cent.
China intensifies cryptocurrency crackdown as bitcoin miners flee
Another concern inherent in decentralised cryptocurrencies is that they make it easy to circumvent China’s capital controls, which restrict people from converting more than US$50,000 worth of yuan into foreign currencies each year.
Without restrictions on bitcoin trading, it is easy to buy large values of the digital token and quickly convert it into other currencies. Still, the fees associated with that are typically much higher than what people would pay through bank transfers.
There are also growing concerns around the world about the environmental impact of cryptocurrencies. As a large, proof-of-work blockchain, bitcoin has an especially large carbon footprint.
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Is cryptocurrency too risky for China?
The network is currently consuming nearly 70 terawatt-hours (TWh) of power on an annualised basis, according to an estimate from the Cambridge Bitcoin Electricity Consumption Index (CBECI), more than the entire country of Venezuela. This has more than halved from its peak of 141.28 TWh on May 10.
Only local governments so far have mentioned concerns about bitcoin’s power consumption, but they have been tasked with helping meet national emissions goals. The country has pledged to reach peak emissions by 2030 and be carbon neutral by 2060.
Why was so much bitcoin mining done in China?
The short answer: cheap power.
China’s share of global bitcoin mining has been declining for a couple years, falling from 75 per cent in September 2019 to 46 per cent by April 2021, according to the CBECI. But one reason it became so high in the first place is that the cheap electricity incentivised companies to set up mining pools. As the name implies, these involve pooling resources from many different users to mine cryptocurrency.
The world’s largest mining pools today are either based in China or have Chinese founders. F2Pool, BitMain’s AntPool and Binance Pool all have Chinese founders. Some cryptocurrency companies changed where they were incorporated during previous crackdowns – Bitmain, for example, is now incorporated in the Cayman Islands – but maintained servers in China.
The advantage of joining a pool is that people with relatively little computing power can share in the spoils of a mining operation. Rewards are doled out proportionally, so that someone who provides 1 per cent of a pool’s computational power, for example, gets 1 per cent of the reward for each new block added to the blockchain.
While this means individuals taking part in larger pools get less money per block added to the blockchain, more computational power means the pool is more likely to add more blocks, bringing in more money. This has helped make China’s mining pools the best-known in the world.
This concentration of mining power has caused alarm in some circles, though, because of Beijing’s grip over activity within its borders. Most of the criticism about China’s concentration of hashing power has centred around the idea of a 51 per cent attack, which is the idea that a party could prevent the confirmation of certain transactions if they control most of the network’s hashing power.
China’s first bitcoin exchange ditches crypto following Beijing crackdown
This can allow for double-spending – the spending of the same coin twice – as the party with control over the network can prevent the authentication of certain spending, stealing the money from other users. This has happened before on some other cryptocurrency networks.
The original bitcoin network, though, has never suffered such an attack. With all the disparate mining operations across China, rallying the collective hash power for malign ends might have proven challenging, even for Beijing. Instead, the government headed in the other direction with its nationwide crackdown.
What does China’s crackdown mean for bitcoin?
The most immediate effect of China’s bitcoin crackdown was making the cryptocurrency a lot more affordable. In addition to sending market prices plummeting, the global hash rate also more than halved over a seven-week period from mid-May to early July, according to data from Blockchain.com.
Some people also see China’s war on bitcoin mining as a good thing for the network in the long term. Despite the logistical difficulty of Beijing pulling off a 51 per cent attack or otherwise controlling the network, some have continued to raise questions about the country’s influence.
In April, PayPal co-founder Peter Thiel, an outspoken supporter of former US president Donald Trump who has repeatedly criticised China, said he wondered whether bitcoin could be used as a “Chinese financial weapon against the US”.
The researchers posit that Beijing might attack the bitcoin network for political reasons, such as undermining certain types of transactions, censoring specific bitcoin addresses or deanonymising users and tracking their behaviour.
Bitcoin miners look overseas amid crackdown in China
For reasons like these, Beijing’s continued distrust of cryptocurrencies is offering some relief to the bitcoin faithful.
Despite this, realising the lofty dreams of bitcoin becoming the currency of the future remains distant. Given the way the blockchain manages bitcoin’s supply, it is a poor substitute for fiat currency, which typically has its value actively managed by a central bank responding to demand.
