LONDON (Reuters) - Bitcoin plunged by as much as 12 percent on Friday after China’s central bank urged investors to take a rational and cautious approach to investing in the digital currency, which is on track for its heaviest two-day drop in two years.

A customer feeds cash currency in to a Bitcoin ATM located in Flat 128, a boutique in New York's West Village, U.S. on August 22, 2014. REUTERS/Brendan McDermid/File Photo

Bitcoin had been on a tear until Wednesday, gaining more than 40 percent in two weeks to hit around $1,139 on the Europe-based Bitstamp exchange, just shy of its all-time record of $1,163.

But the web-based digital currency, which has shown an intriguing inverse correlation to the Chinese yuan in recent months, plunged as the yuan soared on Thursday, falling as much as 20 percent at one point.

It continued that fall on Friday, with its losses accelerating after the central bank’s warning.

It fell as low as $871, down almost a quarter from its peak on Wednesday, before recovering to about $900 by 1455 GMT (9:55 a.m. ET). That still left it down 10 percent on the day and on track for its worst two-day performance since January 2015.

The Shanghai head office of the People’s Bank of China (PBOC) noted in a statement that bitcoin prices had shown abnormal fluctuations in recent days, and said those investing in it should do so carefully, with awareness of the currency’s volatility.

The PBOC’s words carried echoes of its 2013 warning that financial institutions should steer clear of the digital currency, which sparked a $300 slide in bitcoin.

The PBOC also repeated on Friday its 2013 view that bitcoin is not a currency and could therefore not be circulated as a real currency in the market.

For full statement click: here

“This is the Chinese authorities saying: we’re watching,” said Charles Hayter, CEO of digital currency data analysis website Cryptocompare. “The relative size of the bitcoin market is minor, but trading has reached up to $10 billion a day on the bitcoin-yuan pairs.”

“The full meaning of the government’s comments aren’t 100 percent clear, but restrictions and regulation of trading is one avenue that could affect volumes and therefore price.”

Hayter said trading between the yuan and bitcoin had made up about 98 percent of the market for the past six months, according to his analysis. Because there are no trading fees on Chinese exchanges, it is much easier to get in and out of trades and therefore creates a higher trading volume, he said.

Bitcoin can be used for moving money across the globe quickly and anonymously, and operates outside the control of any central authority.

That makes it attractive to those wanting to get around capital controls, such as in China, and also to investors who are worried about a devaluation in their currency - one of the reasons often cited for bitcoin’s surge in 2016. While the yuan fell 7 percent, its worst year since 1994, bitcoin outperformed all other currencies, with a 125 percent climb.

But many bitcoin experts say Chinese trading volumes are overstated and attribute sharp moves to speculation by, for example, U.S.-based hedge funds.

“VOLATILE MARKETS”

The volatile trading prompted officials from the PBOC’s Shanghai branch on Friday to meet representatives of a major bitcoin trading platform in China, BTCC.

“On January 6 the People’s Bank of China Business Management Department and the Beijing Municipal Bureau of Financial Affairs jointly met with the relevant regulatory authorities of the ‘currency network’,” the PBOC said in the statement.

BTCC said in a post on Twitter: “BTCC regularly meets with (the) PBOC and we work closely with them to ensure we are operating in accordance with the laws and regulations of China.”

“All of our users should be aware of the current policies on virtual goods as well as the risks involved in trading in volatile markets,” another Tweet read.

Eric Gu, a blockchain expert and founder of ViewFin, a Chinese blockchain start-up, said the PBOC meets the country’s major bitcoin exchanges regularly but had previously never made such meetings public.

But recent volatility has increased risks and has triggered fears that the market could be used as a channel for money laundering, he said.

“Previously, bitcoin trading volume was small, and money laundering was not possible in such a market,” said Gu. “Now, the volume is up ... everyday, there are tens of billions of yuan worth of bitcoin changing hands. Volume is still (comparatively)small, but big enough to make the central bank worry.”

For a graphic on bitcoin price, click here

For a graphic on bitcoin economy, click