China’s Bitcoin Entrepreneurs Bet the House

Chinese investors, always eager to literally bet the house on the latest investment idea, are starting to come around to bitcoin, the 21st century’s most sensational and mysterious currency – or used to be until the Chinese government cooled them off by stepping in to prohibit institutional investors from putting in money and, as hoped, forestalling a bubble.

Pessimists say bitcoin could be the next Tulip Mania ,which will collapse when the bubble bursts. But government skepticism and investor warnings haven’t deterred investors willing to countenance the dramatically fluctuating price on the hope of making a fortune. Some have.

Lu Bin, the co-founder of a digital assets management company BTB Asset, started studying the phenomenon when doing his PhD in the US. “I came across this term, bitcoin, when I was Googling ‘alternative investment’ in 2010,” he said, “and the price was five cents each, unbelievable, right?” Now each bitcoin is worth around US$600.

Bitcoin supposedly was invented by a Japanese named “Satoshi Nakamoto,” although behind that name probably stands a group of people. In 2008, Nakamoto proposed a digital currency based on peer-to-peer authentication. He came up the concept of bitcoin with an algorithm which determines the rules of “mining” them and the limit on the number of bitcoins that could ever be mined out. It was introduced as an open-source software currency in 2009.

People can contribute to mining by running the open-source bitcoin software. The bitcoin algorithm produces a new bitcoin block every 10 minutes, which contains 25 bitcoins. But instead of distributing the minerals in the block evenly to every miner in the field, the system works like a lottery: the one who got lucky gets all the new bitcoins. There is no limit on the number of blocks to be mined, bitcoins be mined from every block fall by half every four years. Thus only 21 million bitcoins could ever be mined.

Bitcoin wasn’t worth much at first. No market, no exchanges, more a game played by cryptocurrency fans. The first real transaction in bitcoin was made by a user who bought two pizzas for 10,000 bitcoins in 2010.

But by December 2011, the price of bitcoin kept rising – slowly for a year from US$2 to US$13. After that, it skyrocketed by 5-10 percent daily, hitting its second peak of $266 on April 11 2013. The most impressive boom happened at the end of the year when the price hit the US$1, 000 threshold on November 27.

However, when the Chinese government issued regulations and waged a crack-down on bitcoin the following month, the price crashed to US$500 in the last few days of the year.

In February 2014, the bankruptcy of what had been the biggest bitcoin exchange platform Mt. Gox again panicked the market. Mt. Gox suspended trading and closed its website claiming that 850,000 bitcoins valued at US$450 million by then were lost to hackers, driving the price down dramatically. But the price has also weathered the Chinese crackdown and the Cypriot financial crisis. The current price has stabilized at US$560~$640.

“If you define risk as short-term volatility, then its risk is significantly high,” Lu said, “But if you diversify your investments and hold them long term, the value of digital currency is on a unilateral rise. The potential revenue is very promising.”

Many see bitcoin as a great opportunity to make money. Zhao Dong, the co-founder and former CTO of Chinese weather application MoWeather, is now a partner in China’s joint mining project Hashration. Zhao spent RMB1 million buying 2,000 Bitcoins before the price rocketed dramatically in October last year.

“I bought them when others sold them anxiously because of the depreciation. But I believed there must be a turning point,” he said. His prediction came true.

Why would people still have faith in bitcoin after such fluctuations and frustrations? According to Hung Hongyuan, the CTO of bitcoin exchange platform BTC China, technically bitcoin has an almost perfect algorithm, which determines the amount of bitcoins that could ever be mined and thus scarcity is ensured.

“There were attempts to challenge the algorithm, but they all failed - that’s basically why people are still using it,” said Huang. As confidence grows, fluctuations in value tend to smooth out. The supply-demand mechanism of bitcoin reaches equilibrium, which means the sellers and the buyers have reached a general agreement on its value.

But there is another layer to the story: government regulations. Dr. Jerry Dwyer, once worked at the Federal Reserve Bank of Atlanta, holds that some of bitcoin’s characteristics threaten government control on economy. “Governments with capital controls, significant inflation or both will try to suppress bitcoin because it reduces the demand for the government’s money and makes it harder for the government to direct people to do whatever the government wants them to do,” said Dwyer.

Another problem is illegal transactions in bitcoin. Dwyer mentioned that there is a possibility for people to hold their assets more in bitcoin and less in domestic currency, evade capital controls and transfer funds outside of the country into a foreign currency. There are chances that bitcoin could be used as a medium of money laundering.

Despite all the risks, cyclical value booms in bitcoin still motivate people to bet on its future. As the value of bitcoin keeps swelling, mining bitcoin has turned into an arms race, which demands better hardware and chips. Nowadays, microchips particularly designed for bitcoin mining are developed. These chips are called “miners.”

Zhao Dong spent around US$6,600 on a miner last year. He got 40 bitcoins before his miner died. “It’s a wrong investment – US$6,600 could buy 100 bitcoins at that time,” the 32-year-old multimillionaire said. “Still, it’s a monetary revolution rather than new speculative products.”

Zhao’s mining project Hashratio offers miners and the revenue would-be bitcoins to be generated. E-Bay now features more than 1,000 listings for Bitcoin miners, many of them used.

But Dwyer sees bitcoin in a more meaningful way. “Bitcoin may become increasingly important in transactions in economies with high inflation,” he said, “in general, it has many possibilities in terms of future development. I think it has the potential to disrupt and dramatically change the payments system around the world.”

Wu Hanqi and Chen Yajiao are Asia Sentinel interns.