Bitcoin, the world’s first and most popular blockchain-based cryptocurrency, has seen a wild year. After investment fervour pushed prices past US$63,000 in April, its value then plummeted by more than 40 per cent.
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).
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?
The Chinese government has periodically cracked down on cryptocurrencies for years, often framing its actions as guarding against financial risks. The same reason was given for its harshest crackdown yet on bitcoin mining, which started in May.
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.
While Beijing has tacitly endorsed cryptocurrencies as investment vehicles, irrational exuberance can lead to some retail investors losing their savings.
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.
The network is currently consuming about 67 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 have 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.
In the early 2010s, bitcoin mining activity started to shoot up in China because of places where cheap electricity is available. Miners concentrated in the western region of Xinjiang, the northern region of Inner Mongolia, and the central province of Sichuan, which is known for its renewable hydropower.
Because of their reliance on coal-fired plants for electricity, Xinjiang and Inner Mongolia were the first to face the brunt of China’s bitcoin crackdown. By the end of June, not even abundant hydropower could save Sichuan’s bitcoin miners, who were ordered to halt operations on June 18.
During 2020, Xinjiang alone accounted for more than a third of the global bitcoin hash rate, and more than half of China’s mining activity, according to the CBECI. However, miners moved around China according to conditions on the ground, with Sichuan accounting for as much as 61 per cent of the country’s mining activity at the peak of the wet season.
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.
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.
Less computing power on the network means it is easier to add new blocks of transactions. So while the profitability of bitcoin mining initially fell during the crackdown because of falling prices, once enough people left the network, profitability returned to April levels, according to a July analysis by blockchain intelligence firm Glassnode.
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”.
In a 2018 paper, researchers from Princeton University and Florida International University detail “how China threatens the security, stability, and viability of bitcoin”. In addition to a possible 51 per cent attack, the paper explains how Chinese miners could exploit the network latency of international traffic coming in through the Great Firewall.
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.
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.
For many, this is the main appeal of the cryptocurrency, but that makes it a poor asset to use when buying an electric car from Tesla – you might find out tomorrow you spent a lot more for that car than you thought.