By Giulio Prisco

On the first day of 2017, the U.S. dollar exchange rate of bitcoin passed the threshold of $1,000. Bitcoin, the value of which more than doubled in 2016, was one of the best investments of the year and the best-performing currency, which can be explained by fear of capital controls in China. However, the price of bitcoin plunged quickly back into the $800 range. Analyzing the likely causes of this rapid rise and fall gives insight into the dominant role that Chinese power-users play in the Bitcoin ecosystem.

Bitcoin, the currency, and Bitcoin, the system and underlying technology, are two separate things, as shown by the current emphasis to separate the technology that underlies the Bitcoin blockchain from the currency. What is good for the currency is not necessarily good for the system, and vice versa.

Fortunenotes that the price of bitcoin, which had surged to almost unprecedented highs, went quickly down after China's central bank cautioned investors to take a rational and careful approach to investing in the digital currency. Converting funds to bitcoin was becoming an attractive way for concerned Chinese citizens to protect themselves from the depreciation of the yuan, and circumvent rules that limit individuals to $50,000 of foreign exchange per year. But now the Chinese government is making efforts to slow down the depreciation of the yuan.

The Shanghai office of the People's Bank of China (PBOC) met representatives of leading Chinese bitcoin exchanges and operators, including BTCC, OKCoin and Huobi, to secure their collaboration and keep capital outflows in check. Though the PBOC is only asking nicely at this moment, its attitude could harden in the future.

BTCC, which claims to be the world's longest-running bitcoin exchange, said it is working closely with the PBOC “to ensure that we are operating in accordance with the laws and regulations of China.” But, of course, the government can change rules and regulations.

The attention on China’s attitude toward bitcoin is explained by a simple fact: exchanges in China account for 90 percent of global bitcoin trading. This figure comes from the exchanges themselves, but the real figure can’t be too far behind. Therefore, the price of bitcoin is largely defined by the attitude of Chinese buyers and sellers. By slowing down the depreciation of the yuan and easing capital controls, the Chinese government could persuade its people to stop buying bitcoin, which would have a negative impact on the price. But of course, not everyone will believe the government.

Chinese financial news service Caixin, as reported by Quartz, said the government wants to bar exchanges from mentioning the yuan’s depreciation in marketing bitcoin as an asset class. OKCoin CEO Star Xu revealed that the PBOC will convene experts to discuss how to manage bitcoin services, or to set up an escrow platform for the exchanges, which would represent a significant increase in government oversight for Chinese exchanges.

On the other hand, government oversight would further legitimize bitcoin as an asset class worth regulating. In summary, according to Quartz, “bitcoin’s price, at least in the short term, is at the mercy of officials in Beijing.”

To understand the growing role of China in the Bitcoin economy, it’s worth listening to an authoritative voice. The former director of the Massachusetts Institute of Technology (MIT) Media Lab’s Digital Currency Initiative (DCI), Brian Forde, qualifies as such an authority.

In a video interview with Bloomberg's Tom Mackenzie on "Bloomberg Markets,” recorded at the recent UBS Greater China Conference in Shanghai, Forde discussed the price of bitcoin, mining and the future of blockchain technology. Forde noted that the price of bitcoin is an important factor not only for speculative investors but also as it incentivizes the “miners” to protect the blockchain.

A technical explanation is in order here: Bitcoin “miners” are those users who keep a copy of the blockchain — the distributed ledger that records all bitcoin transactions that are made — and run the official Bitcoin software to validate transactions, which protects the blockchain and safeguards its security. In exchange, miners are compensated with bitcoin. Today, mining is a very computing- and power-intensive operation. Some home users with expensive equipment can mine bitcoin at a profit, but most of bitcoin mining is done at huge mining server farms.

Forde noted that more that 50 percent of global bitcoin mining is done in China, especially in areas where power is cheap. It’s also worth noting that relatively low labor costs in China permit mass-producing specialized hardware for mining farms. As a result, Chinese power users dominate not only bitcoin trading and mining, but also mining hardware production.

It’s important to emphasize that decentralized bitcoin mining adds to the security of the blockchain. In fact, if malicious agents could acquire control of more than 50 percent of the global mining pool, they could control and compromise the blockchain. Therefore, says Forde, “as governments and large corporations start to adopt the Bitcoin blockchain infrastructure around the world, they will have to think through the concentration of bitcoin mining that is happening in China, and maybe they will have to put up speed in doing bitcoin mining in their countries, to start to decentralize even further and increase the security.

Forde elaborated on the basics and applications of blockchain technology, and the active interest of governments and corporations. In view of the growing importance of blockchain technology, allowing a single country to gain control of the Bitcoin system could be catastrophic.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.