Risk and opportunities of the bitcoin - Mark Schaub

Chinese authorities have started to regulate the usage of the bitcoin. That is not necessarily a bad thing, writes Shanghai-based lawyer Mark Schaub at the website of his law firm. "Regulation should be seen as an opportunity, too. More stringent rules translate to lower investment risk and increased legitimacy."

Mark Schaub:

The opportunities with Bitcoin remain ample, as is demonstrated by its sustained growth. (Some of the most optimistic commentators have stated the value will rise above 6,000 USD.[18]) This is occurring alongside the continuous creation of new and derived cryptocurrencies, as was recently demonstrated by Bitcoin’s hard fork, which created ‘Bitcoin Cash’. Moreover, developers are continuing to find novel uses for blockchain technology as a whole. 

Regulation should be seen as an opportunity, too. More stringent rules translate to lower investment risk and increased legitimacy. Investors in cryptocurrencies, particularly ICO tokens, will likely be afforded some level of legal protection on their investment in certain jurisdictions. Start-ups, too, stand to gain from regulation as a means to build trust amongst an increasingly skeptical pool of investors. Indeed, the perceived legitimacy of the blockchain system as a whole seems to be on the rise, earning clout with institutions as large as the Bank of England, which signed up to participate in the Hyperledger project in March.[19] 

Regulation should also be seen as a way to stabilize the extreme volatility of the currency by making it harder for speculators to instantaneously purchase and liquidate Bitcoin on a whim. This will also open the door to more risk-averse investors. 

On top of these, there are opportunities specific to China, which looks poised to continue its role as a global hub for Bitcoin. Between Hong Kong and the mainland, it hosts some of the world’s most established Bitcoin exchanges[20] as well as significant infrastructure for Bitcoin mining, which generates 70% of the world’s Bitcoins.[21] Moreover, the trend of China-based cryptocurrency startups is only going to increase, as the government continues to incentivise a burgeoning ‘Silicon Valley in China’.[22] Recommendations have also been made by PBOC officials to foster a ‘regulatory sandbox’ for blockchain innovation. That is, an ICO-inclusive market with minimal intervention bounded by some basic regulations such as Singapore-style KYC rules.[23]

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Cryptocurrencies continue to bring a variety of risks to investors. The sheer variety of potential uses for blockchain technology is a double-edged sword. Increasingly, businesses are turning to blockchain as a panacea to a variety of database issues, or as a part of a marketing strategy to appear more modern. In reality, blockchain technology is a system with high energy costs and a narrow scope of uses.[24] Lacking the need for a single database with multiple writers and no trusted intermediary, many companies are better off employing a traditional relational database. Investors should beware of start-ups touting the use of blockchain where, in fact, it adds cost and does not increase efficiency. 

Furthermore, companies looking to maintain environmentally-friendly policies should also be aware of the significant energy costs of maintaining a blockchain system, as well as increasing public awareness of it. 

The volatility of Bitcoin and other, smaller cryptocurrencies continues to be a risk. Even with regulation, the digital nature of cryptocurrencies means they will also be more liquid than physical currencies or ‘real’ assets. 

Also, the new rules concerning Bitcoin stand to limit its uses. One focus of regulation, particularly in the Unites States, appears to be cryptocurrency products that seek to incorporate elements of traditional financial assets. These include the DAO token, which aimed to be a cryptocurrency venture capital fund, as well as the attempt by Winklevoss Capital to list an Exchange Traded Fund on the NYSE that tracked the price of Bitcoin, which was blocked by the SEC. Investors should be wary of these. 

Considering risks unique to China, some commentators have suggested that the newly-created ‘Bitcoin Cash’ is an attempt to create a Chinese version of Bitcoin. The larger block sizes of Bitcoin Cash pose a significant advantage to industrial-scale mining operations. Indeed, Jihan Wu, the creator of Bitcoin Cash is also the manufacturer of the ‘AntMiner’ mining device. At any rate, a pivot by the Chinese market to Bitcoin Cash may result in the loss of a significant driving factor for the growth of Bitcoin. 

Moreover, Bitcoin in China remains largely unregulated, at least for the time being. The nearly-catastrophic move by Huobi and OKCoin to invest idle client funds into wealth management products should be closely considered as an example of the potential losses to be incurred in the Chinese Bitcoin market. 

Regulation in China has started, however, and will continue. This poses risks for investors. For instance, Bitcoin was once seen as a potential “golden ticket” to bypass China’s increasingly harsh capital controls on getting money out of the country.[25] Following the PBOC investigation earlier this year, using Bitcoin as a means of repatriating funds will be throttled, at best. Users and investors in China must consider the very high possibility of the PBOC imposing further regulations on cryptocurrencies, both expected and otherwise. Financial laws in China are strict, and penalties are harsh. Another factor that may affect Bitcoin investors is further restriction on Bitcoin trading that may be imposed by the Chinese regulators. During the NPC & CPPCC in 2017, Mr. Zhou Xuedong, the Director of Business Administration of PBOC, proposed a bill for establishing a negative list with respect to the business activities that should not be conducted by a Bitcoin trading platform.[26] Furthermore, the Legal Affairs Office of the State Council issued the draft regulation on the penalty of illegal fund-raising activities, stating in its Article 15 that the department dealing with illegal fundraising shall conduct an illegal fundraising administrative investigation when any such acts are found and explicitly mentioning virtual currencies in this draft regulation. As such, there is the risk that issuing or trading in Bitcoins (particularly relevant to the ICO market) may be deemed and sanctioned as illegal fundraising.

More at the China Law Insight.

Mark Schaub is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers' request form.

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