Will China Disrupt Bitcoin?

According to a recently published research paper, China is capable of disrupting or even destroying Bitcoin.

Bitcoin advances peer-to-peer transfers in a secure and fast manner, with the blockchain technology using a distributed network validated by the miners. The protocol is meant to be decentralized and, as such, uncontrollable by authorities.

This is where China steps in. Over the course of the last few years, Chinese businesses have made a habit of monetizing the enhancements in chip design by deploying the ASIC chips for mining.

Namely, Asics are predominantly produced in China, with the leading manufacturer, BitMain, stating to have produced 70% of the chips used globally in 2017.

Unrestricted Control

Chinese companies own the biggest mining farms, with the total of their miners standing at a stunning 74% hashrate on the Bitcoin network. In addition, world’s largest exchanges are also run by Chinese companies, most of which relocated after the introduction of the 2017 trading ban.

“Mining pools managed by individuals in China have constituted over half of the total network hash power since 2015”, reads the paper. “As of June 2018, over 80% of Bitcoin mining is performed by six mining pools, and five of those (…) are managed by individuals or organizations located in China.”

The businesses in charge of the mining operations are not directly controlled by the state, but… Chinese government still controls the country’s financial and economic activity.

The miners are not controlled by China, but the managers are located there, meaning they are subject to local authorities. Since managers assign mining jobs, they are in control of the miners’ inputs/outputs, which means those are also indirectly controlled by Chinese authorities. China has more direct control over the hashrate than any other country (the precise quantity is unknown).

Governmental Incentives for Miners

The rise of Chinese mining was initially encouraged by the state. E.g., provincial governments offered tax incentives and energy- and land discounts. The practice ended in early 2018, when local regulators were directed to cease the preferential treatment program and cut down Bitcoin mining by regulating power usage, taxes, land use, and environmental protection.

To illustrate, in April 2018, Tianjin police confiscated 600 computers used to mine Bitcoin after the power grid operator had reported “abnormal electricity usage.” The police said it was “the largest power theft case in recent years.”

Large-Scale Surveillance

It is a well-known fact that China exerts large-scale censorship over the internet. To that end, the government deploys large-scale surveillance tools, such as the Great Canon and the Great Firewall. These (and some other ones) can tamper with traffic, launching cyber-attacks (like, e.g., DDoS). Both systems primarily operate on traffic transiting between China and the rest of the world. However, regulators also control all ISPs in China, which allows for collection and analysis of domestic traffic.

Potential Network Disruption

Control of 51% hashrate can empower the miners to perform a 51% attack, which would enable them to deny confirmations leading to network disruptions. On top of that, the miners can also choose to cause a double-spend by reversing transactions.

Would China Attack Bitcoin?

The paper labels potential China attacks “unlikely,” but doesn’t rule out the “theoretical possibility.” It is suggested that the country may have four reasons for wishing to undermine Bitcoin, as follows:

Making an ideological statement: Bitcoin is directly opposed to China’s centralized governance policy.

Law enforcement: preventing illegal activity. Launching de-anonymization attacks against specific users.

Strengthening the control over Bitcoin, reinforced by the country’s distrust in the cryptocurrency.

Economic risk prevention: the uses of Bitcoin are progressing rapidly. As the cryptocurency is getting increasingly integrated into global finance, it may become a tool capable of bringing foreign economies down.

A Brief Overview of Bitcoin in China

Bitcoin entered China in 2013. In years to follow, country’s exchanges have grown to dominate the global market. In 2018, “more hash power is located in China than in any other country.”

The country’s official standpoint on Bitcoin remains ambiguous. Regulators haven’t done a thing to institute tight controls, in spite of them citing concerns over “criminal activity, subversion of capital controls, and speculative risk.” They have, however, introduced a set of regulations, which we will examine briefly hereby.

The first regulation emerged in December 2013. It banned financial institutions from buying/selling Bitcoin, but the cryptocurrency was not made illegal. As a result, exchanges were not vetoed from facilitating trades – as long as they were keeping in line with the anti-money laundering regulations.

It didn’t take long for country’s Bitcoin exchanges to find loopholes. The most common case saw domestic businesses close their accounts with Chinese commercial banks and use alternative financial systems.

After a couple of confusing months, the Chinese exchange market managed to stabilize. Operations continued to shoot up, with little or no interference during the two subsequent years. In December 2016, CNY exchange comprised 98% of the overall Bitcoin exchange activity.

In 2017, a series of warnings was issued to exchanges: they were to remain in compliance with the 2013 policy or face the consequences. Following the warnings was a ban on initial coin offerings (ICO), with ICOs being dubbed “disruptive to economic and financial stability.”

In the following months, exchanges did make some improvements to their anti-money laundering practices, but that didn’t prove to be enough. In September 2017, regulators ordered the exchanges to shut down.

The remaining loopholes (peer-to-peer trading, over-the-counter sales, and foreign listings) were banned in early 2018. That final straw saw domestic exchanges relocate, leaving Chinese exchanges accounting for less than 1% of the global market.

Source:

“The Looming Threat of China: an Analysis of Chinese Influence on Bitcoin”, Mireya Jurado, Ben Kaiser & Alex Ledger, arxiv.org, October 5, 2018.