Most outside observers stop here, assuming the matter is done and dusted, case closed. “Bitcoin is a speculative toy for Chinese traders”. But all is not as it appears. Let’s start from the top.

Chinese bitcoin exchanges charge zero trade fees

Due to the fierce competitive forces that reign in China’s cut-throat bitcoin industry, Chinese bitcoin exchanges offer 100% fee-free trades [2]. This is quite unlike Bitcoin exchanges in any other market, which all charge a fee per trade (for example Bitfinex charges up to 0.2%).

So why do zero fees matter when it comes to bitcoin trade volume? Because without a fee, there is zero cost to making any trade — it’s completely frictionless. Comparing US and Chinese trading volumes is like comparing apples 🍎 and oranges 🍊. Keep this in mind next time you read an article from Bloomberg, Financial Times, or The Economist [3].

An actual close-up of a bitcoin’s path on a zero-fee exchange

Incentivised trade volume

Chinese exchanges generate most of their revenue from CNY withdrawal fees [4]. And these CNY withdrawal fees are tiered based on each trader’s trade volume, encouraging traders to trade as much as possible to lower the cost of withdrawing their profits.

As described in Brian Armstrong’s (Coinbase CEO) recent tweetstorm, this creates pressure for traders to make as many trades as possible, even if they are not generating any profit. Put another way, it encourages what I’m going to call trading spam (or in lieu of “fake news”: fake trades).

Wash trades

A more malign form of this behaviour is wash trading. Put simply, a trader could set up two separate accounts and — using his trading software — trade his bitcoin back and forth rapidly.

If his account only has one bitcoin, and he trades it one thousand times in the space of a day, he’s suddenly generated 1,000BTC in trade volume…without moving the price, at little to no cost (zero fees remember!), and an account balance of only 1BTC. No “real” trading has taken place.

Aside from private traders suspected of engaging in this practice, there are also suggestions that Chinese bitcoin exchanges perform wash trading on their own platforms to inflate their volume figures [5].

A couple of cheery wash traders racking up some volume

More volume, more customers, more funding

The main driving force for incentivising trade volume (both real or fake) is that traders want to trade on the most liquid exchanges. More liquidity means:

There’s a smaller spread, allowing buyers and sellers to transact closer to the mid-market rate It’s easier to get in and out of position without any slippage

Trade spam and wash trading do nothing directly to improve either these. They increase volume, not liquidity [6]. But with little to separate the various platforms on functionality, improving the appearance of volume can be the best route to attracting more users.

Exaggerating trade volume also has the added benefit of impressing investors, helping exchanges achieve their next round of funding. However, all indications are that exchanges are highly profitable, and for the most part, self-sustaining.

It’s not the volume but the liquidity that counts

So is there any way to assess how much trading activity actually occurs in China? Even without any trading spam or wash trades, China’s fee-free exchanges mean it is pointless to compare volume with foreign exchanges.

One potential method would be to compare the total number of bitcoins held by traders on Chinese exchanges vs. the rest of the world. But this data is not shared publicly by the exchanges.

Observers could assess the depth of the order book (how many buy and sell offers either side of last trade), but for all the reasons above, there is no reliable way of finding out whether these orders are real without testing.

The best way to assess the level of trading activity on an exchange is to test the liquidity. To do this, we would need to see how much the price moves when placing a large order, say $100,000. Sadly, traders that make large enough trades are usually in no hurry to publicise these valuable figures because they can be used to their competitive advantage!

Just give me a number!

Okay, okay 🙌🏻 . The best I can do here is to give an indication from anecdotal discussions with serious traders in the industry — not scientific at all. I’ve personally heard that the total “real” trading volume at Chinese exchanges is around 40–50% of the global exchange market. Still massive, but nowhere near 90%.

A rare sighting indeed. The fearsome bearwhale. (billymabrey.com)

“Chinese” is not just Chinese

What is also missing from the equation is that a portion of traders on Chinese exchanges are not even Chinese. Foreign traders — some of them “whales” — are able to trade here too [7]. We’re entering a global marketplace (see part three).

Furthermore, on-exchange trade volume is rumoured to pale in comparison to over-the-counter (OTC) bitcoin trading in USD. Exchange volume, Chinese or otherwise, may only be the tip of the iceberg.

OTC volume cannot be measured. (original image from IHMT)

Keep things in context

There is no doubt that Chinese trading activity is hugely influential on bitcoin’s price. If demand for bitcoin were to dry up in China, the price would take a significant hit (see my comments on the 2017 PBOC announcement here).

But overplaying China’s trade volume leads to the wrong conclusion that bitcoin’s value is purely derived from its role as a speculative plaything for Chinese investors. It leads people to make the mistake that there is existential risk to bitcoin in the Chinese government’s treatment of bitcoin trading, or just Chinese traders’ whimsy.

What’s really at work is that China is increasingly leading the world in internet technology. It’s not an accident that the most profitable bitcoin companies are almost all based in China. Startups and investors here have recognised bitcoin’s unique utility and historic importance. Bitcoin’s speculative potential is secondary to this.

Bitcoin is more than just a price

Don’t confuse influence with ownership

In the worst-case scenario: if Chinese exchanges were closed down, or Chinese traders got bored and moved onto another hyped asset, bitcoin would not just disappear. Its value proposition is too great. Until either of these highly unlikely scenarios play out, the bitcoin industry will continue to grow in China.

Chinese interest in bitcoin will always be a key factor behind the bitcoin price. But given China’s increasing influence on the world, the same could be said for any asset, any commodity, any currency.