Galaxy Digital Research Report: Bitcoin’s Correction Benefits the Market in the Long Run

China’s cryptocurrency ecosystem will survive, but it will become smaller, with stricter regulations and a government looking for a new balance.

Galaxy Digital Research Report: Bitcoin's Correction Benefits the Market in the Long Run

| Galaxy Digital Research

On May 21, a high-level committee of the Chinese government outlined its goal to “crack down on bitcoin mining and trading,” creating additional uncertainty in the cryptocurrency market after a major adjustment.

The core elements

  1. the Chinese government’s Financial Supervisory Commission said in a notice issued after a recent policy meeting that a “crackdown on bitcoin mining and trading” is coming.
  2. miners are taking this news seriously, and we have already seen various reactions from miners accelerating their migration to full surrender.
  3. hash rates will drop in the short term as miners migrate to areas with cheap utilities every year.
  4. China’s cryptocurrency ecosystem will continue to survive, but it will become smaller and more tightly regulated as the government searches for a new balance.
  5. Hash rates will shift primarily to Kazakhstan, Russia and Pakistan as the government imposes more restrictions, but North America will also benefit from the migration.
  6. An outright ban on bitcoin is unlikely, but restrictions and government censorship are imminent.
  7. As hash rates become more decentralized, the Bitcoin network actually becomes more robust, which benefits Bitcoin in the long run.
  8. What’s happening in China?

On May 21, a new government policy to restrict bitcoin mining and trading was announced at a meeting of the Financial Stability and Development Commission of the Chinese State Council (“FSDC” or “Finance Commission”), chaired by China’s Vice Premier. At 10 p.m. Beijing time on Friday, the committee released a statement detailing several goals for the financial system. The second part outlines the country’s need to “prevent and control financial risks” and includes “combating bitcoin mining and trading” as a specific item on its list of priorities.

The second is to resolutely prevent and control financial risks. Adhere to the bottom-line thinking, strengthen the comprehensive scanning and early warning of financial risks, promote the reform of small and medium-sized financial institutions, focus on reducing credit risks, strengthen the supervision of financial activities of platform enterprises, crack down on bitcoin mining and trading, and resolutely prevent the transmission of individual risks to the social sector. To maintain the smooth operation of the stock, bond and exchange markets, crack down on illegal securities activities, and severely punish illegal financial activities. We should strictly prevent external risk shocks, effectively deal with imported inflation, strengthen expectation management, enhance market supervision, and make good response plans and policy reserves.
Established in November 2017, the FDC is a high-level government body that coordinates financial regulation and includes Liu He (vice premier), Yi Gang (governor of the People’s Bank of China) and Ding Xuedong (deputy secretary-general of the State Council), as well as chairs of securities, foreign exchange, economic affairs and national development regulators.

Indeed, this is not the first time the Chinese government has imposed restrictions on Bitcoin. in 2013, the Chinese central bank banned financial institutions from working with cryptocurrencies, and since this ban, over-the-counter transactions have been the main fiat currency gateway into cryptocurrencies. In addition, ICOs and exchanges were restricted by Chinese policy in 2017, with Huobi and OKEx suspending trading and establishing offshore entities in response, while the Coinan exchange exited the Chinese market, prior to the ban.

In 2020, executives from both Huobi and OKEx were interviewed and OTC counters were temporarily shut down. OKEx bore the brunt of the scrutiny and the exchange was forced to suspend withdrawals.

As things progress towards normalization, the cryptocurrency ecosystem in China is in a precarious equilibrium, but still an equilibrium. Fiat and cryptocurrency trading remains banned, but OTC trading remains the gateway to the asset class. Exchanges typically trade in USDT denominations, avoiding interaction with the banking system, but are able to provide referral services for OTC transactions for a relatively smooth user experience. Exchanges continue to operate and some even maintain close ties with the government. China remains the primary location for most hardware manufacturers and mining pools, and the geographic center of the mining industry.

These aforementioned policies have both commonalities and differences when compared to the government’s latest announcement. The differences are twofold: this policy was introduced to target miners more than traders, and it is shared by a senior government committee with significant influence. While the impact of the policy is still festering, conversations with local sources tell us that the latest announcement could lead local governments to follow central government policy and take regulatory action.

China is not a single entity: the central government operates separately from the provincial governments, which in turn are different from companies registered in China. Provincial restrictions will remain in place until 2021, with China’s Inner Mongolia province recently banning bitcoin mining, a series of restrictions imposed on the energy-intensive sector. As central government policies are announced, other provinces are likely to follow suit. Central government policies are typically slow to be enacted; state restrictions on cryptocurrency trading and mining are almost certainly coming, but an outright ban on both practices seems unlikely.

Due to policy restrictions, we will see an exodus of Chinese miners, especially those who rely on coal power. The decline in hash rates will initially be due to seasonal migration, but will later be permanent migration abroad. Hash rates will move primarily to Kazakhstan, Russia and Pakistan, but also to North America and other regions. The continued volatility will likely continue as the dynamics develop. China’s cryptocurrency ecosystem will survive, but it will become smaller, more tightly regulated, and the government is looking for a new balance.

  1. How will the market react?

As we wrote in our May 20 report “Assessing the Cryptocurrency Correction”, the market is trading in a nervous state after a major correction over the past two weeks. This has further depressed the market due to uncertainty over Chinese policy news.

The Financial Stability Development Board announcement was made on Friday, May 21 at 10 p.m. CST (GMT+8), or 10 a.m. Eastern Standard Time (GMT-5), and BTC fell 12.5% in the first hour and was down 20% by 2 p.m. ET. Bitcoin prices continued to slide over the weekend, bottoming out at around $31,100.

Due to the late announcement and little information from regulators, more clarifying news is expected next week. According to our sources, some miners are liquidating their machine inventories and selling their bitcoins in a panic. This is confirmed by an increase in outflows from miners’ wallets according to on-chain data, suggesting that miners’ selling is playing a role in the volatility.

  1. China Mining Dynamics

(1) Distribution of hash rate

Bitcoin is permissionless, and anyone can join as a user, verifier, or miner. Because of this, Bitcoin is a global industry. Since anyone can join and there is no centralized catalog of participants, estimating the breakdown of the hash rate distribution is very difficult.

Miners tend to operate in areas where electricity is cheap. Because of this, mining is clustering in areas with low-cost electricity such as China, Russia, and North America, but it is difficult to estimate where miners are located.

The heavy representation of Chinese miners in bitcoin hash rates is often a point of contention. Traditionally, Chinese companies have been leaders in the mining industry, not only in terms of their ingenuity, but also because of cheap electricity and the network effect created by the presence of ASIC manufacturers and mining pools.

(2) Cheap Electricity

China’s power grid is hydroelectricity centered around the Three Gorges Dam in Sichuan. From May to October, the Sichuan region is in the rainy season, reducing the cost of hydroelectricity.

In northern and western China, electricity generation is economically competitive by global standards throughout the year; and the price of electricity in the Sichuan basin is highly economical during the rainy season. To take advantage of this, Chinese miners practice seasonal excavation, shifting machines between Inner Mongolia/Xinjiang and the Sichuan Valley each year to optimize the lowest cost of electric energy. The great migration of miners usually manifests itself as a decrease in the hash rate of machines during transportation.

The rainy season has started this year and we will continue to see hash rates drop in the coming weeks. Due to the impact of how hash rates are estimated, there is a lag of about seven days to accurately observe and real-time estimates are less reliable and accurate. Miners are paid in advance for electricity on a monthly basis, so we expect the drop in hash rate to be most severe near the end of the month, and this data will be accurately observed early next month.

The hash rate decline may partially recover as Sichuan Basin miners come back online. However, it will take some time for miners who have been temporarily eliminated from the industry due to government regulation to come back online in other jurisdictions, so the hash rate may continue to decline. Given the scale of China’s mining industry compared to other countries, carrying capacity has become a significant bottleneck. Contrary to the past year or so, the factor limiting growth in hash rates is the severe shortage of machines.

(3) ASIC Market

Almost all competitive Application Specific Integrated Circuit (ASIC) manufacturers are located in China, which provides Chinese miners with faster access to machines. There is little public data on the size of manufacturers’ machines, in large part because the opaqueness of the market makes price discrimination even worse.

The traces left by miners on the blockchain provide some clues. Based on data analysis, we can estimate the proportion of hash rates offered by some types of hardware. Today, the technique is most notably applied in the Ant Miner S9, the first two generations of Bitmain’s flagship product.

At the peak of its dominance in June 2018, the Ant Miner S9s and related hardware were responsible for about 75% of the network’s computing power. Even today, two generations of hardware later, the S9s and related hardware contribute about 31% of the network’s computing power.

The data derived from nonce analysis has been confirmed at point in time by CoinShares and Cambridge. In the future, the technique may be used to identify other types of hardware, including newer models of miners from Bitmain and other manufacturers, to better estimate network health and decentralization at the hardware level.

ASIC resellers are leaving China in light of last week’s policy impact. Reseller, which is associated with mining pool, announced that it will stop providing services to Chinese customers, as did Huobi Mining Pool’s machines. We expect a large number of machines to be sold on the secondary market, which could lead to a dislocation between the Chinese and overseas mining platform markets as Chinese miners clear out their inventory.

  1. What does this mean for Bitcoin?

Bitcoin is resilient and unaffected by any individual country regulation. In the short term, we will see hash rates continue to decline as miners continue to migrate their mining machines, or even shut them down.

Government bans on the storage of value have a long history. in 1933, President Roosevelt signed Executive Order 6102, which banned private entities from owning gold in the U.S. This ban did not last and private ownership of gold has not stopped. As of 2021, gold continues to hold its value. Bitcoin’s resistance to censorship makes it more impossible for the government to effectively suppress ownership of the asset on a global scale.

In the long run, this benefits Bitcoin. In essence, the Bitcoin network will emerge from these events stronger and more decentralized. The ban should also be a huge boon from a PR perspective: while Bitcoin survives the policy restrictions, the notion that it is controlled by China will be dispelled.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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