Virtual currency Bitcoin made a reversal of its recent rise and dropped 20 percent against the dollar on Thursday, Jan. 5, after only two hours of trading, as buyers became wary that China will introduce new measures to restrict movement of money out of the country.
An article published by Fortune said that 90 percent of bitcoin trade and 70 percent of bitcoin "mining" are conducted in the country, which means the recent instability most likely lies in China.
Although the source and motivation for the bitcoin rally cannot be exactly determined, signs indicate that the bitcoin's decline was related to movement in the yuan.
In November, the yuan (renminbi) fell sharply but in the last two days, it rallied, caused by China's central bank new restriction which pressured speculators.
The Chinese currency rose 2.5 percent on Thursday, Jan. 5, reaching about 6.81 to the dollar in the offshore Hong Kong market. This was magnified several times in the bitcoin market but unlike in the official currencies market, it does not have the same liquidity or transparency.
Bitcoin, which analysts said was "due a correction," had risen 45 percent against the dollar since Dec. 21 and an astounding 521 percent since Sept. 2015. The moves are remarkable since the dollar has strengthened against all other currencies but the bitcoin.
China's introduction of new capital controls to prevent the yuan's decline could trigger the "correction," the report said.
Starting Jan. 1, the People's Bank of China (PBOC) required banks to notify them of all cash transactions worth more than 50,000 yuan ($7,100), from a current ceiling of 200,000 yuan. The central bank said this was aimed at improving the monitoring of money-laundering and tax fraud.
On the other hand, the State Administration for Foreign Exchange (SAFE) also imposed new reporting requirements which require individuals to explain why, where and how they intend to use their annual quota of foreign currency, which is limited to $50,000 per person.
According to the report, China let the yuan weakened in the last 18 months as it does not to cause panic in the domestic market and get accused again of currency manipulation by the new U.S. president.
However, this manipulation was really aimed at supporting the yuan, rather than weaken it. In the first ten months of 2016, capital outflows from the country rose to about $530 billion while China's foreign reserves sank to nearly 25 percent from under $4 trillion in early 2014.
Analysts estimated that in November, more than $34 billion was spent by the PBOC to strengthen the yuan; while next week, they expect figures from SAFE to show that the reserves would drop below $3 trillion for the first time since 2011.
Since the government allowed the yuan to fall 2 percent against the dollar in Aug. 2015, Chinese bets against the yuan have also increased. This shows how the yuan the bitcoin rates to the dollar are closely related.
If the government decides to crackdown on bitcoin exchanges as a way of capital control, the outcome could be tremendous, the report said.