Bitcoin and the Yuan

This is a guest post by Cole Frank, a research associate at the Council on Foreign Relations.

China watchers are always looking for new ways to gauge capital flows and pressure on the yuan. The most reliable indicators—FX settlement data and the PBOC’s balance sheet—are monthly and thus don’t shed light on today’s dynamics so much as yesterday’s. BoP data is even worse, only coming out quarterly. So, the suggestion late last year that the daily price gyrations of bitcoin might work as a high-frequency-hot-money proxy certainly raised eyebrows. The simultaneous weakening of the yuan and rapid rise of bitcoin (and cryptocurrencies more generally) between mid-2015 and May of this year sparked wide speculation about the relationship between the two. The apparent inverse correlation led observers to posit that as the PBOC tightened capital controls and the yuan continued to weaken, bitcoin became an increasingly attractive way for Chinese residents to get their money out of the country. An examination of daily bitcoin trading volumes provides prima facie evidence that this may have been the case between late 2015 and late 2016.

However, any correlation between the price of yuan and the price of bitcoin collapsed early this year. Bitcoin continued to surge through the first half of 2017 despite a consistently strengthening yuan. This alone though is not proof that there was never any causation between the two. The coincident clamp down on cryptocurrencies by China (just as the correlation was breaking down), and subsequent rise in bitcoin trading outside of China show that the dynamics driving the price of bitcoin changed fundamentally in the first few months of 2017.

In 2015 and 2016 the overwhelming majority of bitcoin trading was conducted through China-based exchanges and with yuan. According to data from Bitcoinity, over 90 percent of trading volumes throughout 2016 were in exchange for yuan.* And plotting the dollar price of bitcoin against the dollar price of CNY (or CNH) during this period is, at the very least, an intriguing exercise:

(Source: Paul Mylchreest of ADMSI as cited in the FT )

The above graph takes some liberties with its use of truncated/separate axes and the fit is far from perfect (particularly the decline in the price of bitcoin that followed the big August 2015 devaluation). But the late 2015 and mid-2016 surges in bitcoin concurrent with opposite moves in the yuan-dollar exchange rate warrant some attention given the context of the PBOC closing other avenues for capital outflows.

Graphing daily CNYBTC trading volumes against the dollar-yuan exchange rate pretty clearly shows that, during the period in question (late 2015 through February of this year), CNYBTC trading spiked in the days following yuan weakness.

So, it seems conceivable that the roughly 250 percent rise in the dollar price of bitcoin between January of 2015 and January of 2017 was due at least in part to Chinese capital outflows. However, any causation between the two was very much one-sided. Bitcoin may have been a proxy for downward pressure on the yuan, but bitcoin outflows likely only ever made up a small amount of Chinese capital outflows. Bitcoin trading volumes were fairly large in late 2016 and early 2017, but they're now trivial compared to, say, USDCNY trading volumes.

Is it fair to compare bitcoin trading volumes to the 6th most traded currency pair in the world? Not really, unless you’re trying to make the point that there’s no endogeneity problem when it comes to bitcoin and the yuan.

But any relationship that may or may not have existed between the price of bitcoin and the yuan is very much a thing of the past. In January of 2017 the PBOC publically announced they had met with the three largest China-based bitcoin exchanges in order to “remind them to ‘strictly’ follow relevant regulations on risk control and to ‘clean up’ any irregular practices” (FT article). This announcement was followed by increased scrutiny of the exchanges and rumors of coming cryptocurrency regulations. In early February, the two largest Chinese bitcoin exchanges, OKCoin and Huobi.com, halted bitcoin withdrawals.

The price of bitcoin fell on the news, but the larger and more lasting effect was a huge decline in the share of bitcoin trading done in China or in exchange for yuan. In January, 96 percent of bitcoin trading volume was in exchange for yuan, in February the yuan share of bitcoin trading fell to 25 percent, then a paltry 14 percent in March. The vacuum left by the PBOC’s crackdown was partially filled by trading in other currencies (mostly USD), and the price of bitcoin more than recovered.

Which is all to say that bitcoin is no longer a China story, and hasn’t been since early this year. The yuan’s swift appreciation beginning in late May of this year laid this fact very bare. The “Chinese-outflows-are-driving-the-price-of-bitcoin” narrative would predict that sustained appreciation in the yuan would depress the price of bitcoin as more Chinese would be willing to hold on to their yuan. Instead bitcoin soared: gaining some 90 percent over the same period that the yuan appreciated almost 6 percent against the dollar.

And while bitcoin tumbled earlier this month on reports that China was shutting down exchanges, its rapid rebound, despite confirmation of those reports, seems to point to investors’ recognition that China is no longer as central to bitcoin’s expansion.

*The bitcoin trading volume data presented here covers any trading that occurs over an exchange, but excludes over-the-counter (OTC) bitcoin trading. OTC trading—reportedly a preferred method for large transactions—is peer-to-peer and, by its nature, difficult to track. China's recent efforts to curb bitcoin trading were aimed both at the commercial exchanges and some of the popular platforms used for OTC trading.

[Edit: Due to a spreadsheet error some of the graphs in the original post understated the magnitude of bitcoin trading volumes. They have been updated and the post has been edited to reflect these changes.]