Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Fri, 28 Oct 2016

Could China fork Bitcoin?

Ever since Ethereum forked into two competing cryptocurrencies, I have been thinking about China orchestrating a fork of the leading cryptocurrency Bitcoin. Izabella’s post at FT Alphaville on Bitcoin as a Chinese capital outflow proxy has finally pushed me to write up my wild speculation on this possibility. I do not have as much practice as Lewis Carroll’s Red Queen who claimed to have “believed as many as six impossible things before breakfast.”, but I am willing to indulge myself with some wild speculation once a quarter. (And, it is more than three months since I posted my wild speculation on the 1000 Swiss franc note.)

The starting point of all my speculation is that China is experiencing significant capital flight and Bitcoin is a sufficiently important medium of this flight for the Bitcoin price to serve as a proxy for this capital flight as explained in Izabella’s post. The Chinese financial system is also experiencing severe stress and if this stress goes beyond the tipping point towards a rapid erosion of confidence in the renminbi, it is not inconceivable that Bitcoin becomes a significant parallel currency in China. Instead of getting dollarized, China could get Bitcoinized.

In such a scenario, the Chinese government would of course want to gain control over Bitcoin. There are three factors that make it possible for the Chinese government to succeed:

  1. Chinese miners control a large part of the hashing power of the Bitcoin network. A Chinese fork of Bitcoin will have no shortage of mining capacity.

  2. The Great Firewall of China would allow China to isolate Chinese Bitcoin from Classic Bitcoin, making it impossible for Chinese nodes to connect to any nodes outside China.

  3. The government could prod the Chinese internet trinity (Alibaba, Baidu and Tencent) to accept Chinese Bitcoin, thereby making it the de facto currency of China.

The translucence of the Bitcoin blockchain would allow the Chinese government to monitor Bitcoin transactions to a far greater extent than it can monitor cash transactions. It could thus become another instrumentality of government control. A process that starts out as a form of rebellion against the government could thus end up strengthening its grip on the society.

What would this do to Bitcoin itself? Chinese Bitcoin could probably reach a market capitalization of several hundred billion dollars (may be even a trillion dollars) very quickly. Through a rub on effect, Classic Bitcoin itself could reach a hundred billion dollars of valuation compared to its current value of ten billion dollars. But that would also provide the motive for powerful nation states to attack Bitcoin. The US would be tempted to use its entire cyber war capabilities to disrupt Chinese Bitcoin, and China would probably throw everything it has to try and destroy Classic Bitcoin. Given Bitcoin’s vulnerability to the 51% attack, it is quite likely that neither of the two Bitcoins would survive such a concerted attack. But if one or both do survive, cryptocurrencies would probably go mainstream very quickly.

Posted at 10:38 on Fri, 28 Oct 2016     0 comments     permanent link

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