The recent tumble in bitcoin, driven by a stampede of Chinese sellers who until last week were willing buyers at any price, has exposed the weakest link in bitcoin's until recently exponential rise: the mood and social psychology of Chinese momentum and bubble chasers, who like clockwork rush into any one given asset, bid it up to ridiculous levels, watch the bubble burst, before moving on to the next bubble.

The good news is that courtesy of $25 trillion in local savings, or more than double the amount in the US, the bubble eventually returns to where it burst. The bad news is that in the meantime, those who chased the original bubble lose most if not all of their money.

Unfortunately, for most of China's bitcoin traders, the bad news may be just starting.

Take the story of Ding Wen, who by the age of 34 had built up a personal fortune of more than two million yuan after years of hard work at an internet company in Nanjing, in east China’s Jiangsu province. But, as SCMP recounts his tale, Wen saw most of that wealth go up in smoke on January 5, when China’s bitcoin market crashed, sending the price of the virtual currency plunging 40 per cent in just a few hours after lunch.

With the market in free fall, Ding was unable to log into his account with China’s biggest bitcoin trading platform, Huobi, meaning he could not sell off his holdings or top up his principal to meet the margin call. By the time he managed to log on in the evening, most of the bitcoins in his account had been compulsorily sold off by Huobi for 6,361 yuan each, lower than his purchase price of 8,101 yuan. This included the part of his investment he had bought using a loan he obtained from Huobi by pledging the bitcoins he owned originally.

“I have taken on big risks when making leveraged betting, but the collapse of the trading system made me unable to run stop-loss orders, so I think the platform should compensate for investors’ losses,” Ding said.

The platform disagrees.

Ahead of the market crash, Ding had borrowed 995 million yuan from Huobi by pledging a principal consisting of the 409 bitcoins he already owned. He then bought a further 1,228 bitcoins with the loan. Most of his holdings were compulsorily sold out by Huobi during the price collapse while he was unable to access his account.

Meanwhile, Wu Xing, head of marketing at Huobi, said the log-in delay was caused by a torrent of visits and selling orders, which exceeded the capacity of the website. “[The loss] was due to irresistible factors and not included in the compensation scope. We are sorry and understand the feelings of the investors,” she said.

So to recap... trading the extremely volatile bitcoin on massive, unregulated margin, in an exchange that arbitrarily locks out its clients?

What can possibly go wrong.

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According to SCMP, "many analysts and investors fear China’s bitcoin market is quickly turning into another time bomb like the scandal-hit peer-to-peer (P2P) lending sector. A series of P2P lending platform frauds rocked the country last year and washed away tens of billions of yuan of investment from small investors, creating a headache for local and central governments, which feared social unrest."

Now speculation, derivative products, leveraged betting and program trading appear to be spreading in the largely unregulated bitcoin market. Such practices are thought to be responsible for pushing up the price of bitcoin by more than 260 per cent since early 2016.

The market hit a historic high of 8,995 yuan on January 5... Just ahead of the crash.

Most of the transactions are happening on three privately owned platforms or through P2P trading.

Data provider Bitcoinity shows trading volume in China accounted for more than 98% of the global total during the past 30 days amid more pronounced price fluctuations. Until now, no regulator has overseen this market, which sees daily turnover worth tens of billions of yuan. However, things appear to be changing fast.

After the great bitcoin crash, the People’s Bank of China announced on Wednesday afternoon that it had sent inspection teams to the country’s top three bitcoin trading platforms to scrutinise their practices. It is the first regulatory move China’s central bank has made publicly involving the virtual currency.

The PBOC has been in talks with the platforms from time to time in private since 2013 and asked them for data and information, according to an executive from a major trading platform, who asked not to be named. But the authorities have not formally listed bitcoin under their regulatory framework. Nor have they issued any rules to govern the market.

Like all other central banks, the PBOC defines bitcoin as a commodity rather than a currency, which ruled it out of their existing regulatory coverage in late 2013. Aurélien Menant, founder and chief executive of Gatecoin, a cryptocurrency and blockchain assets trading platform based in Hong Kong, said: “Given the dominant role of Chinese exchanges, which represent 95 per cent of global bitcoin trading activity, at more than 50 billion yuan every day, it’s likely that the PBOC recognises the growing significance of this new and so far unregulated alternative financial market.

“The PBOC has been engaging with the major cryptocurrency exchanges in China for several years, but given the sudden price movements and high volumes traded over the past few weeks, it’s very clear that now it just wanted to step up their checks on market manipulation and money laundering.”



In an announcement issued on Wednesday, the central bank said it was joining forces with the Beijing Financial Bureau to probe trading platforms including Huobi and OKCoin to check if they were running in accordance with foreign-exchange management, anti-money-laundering and trading exchange rules.

Mainland media reported in recent months that bitcoins had become a popular tool for investors to export money out of China, circumventing capital controls that had been tightened by the regulators amid the yuan’s sharp depreciation. Cheung Chun-yin, a PwC China fintech partner, said it was possible for bitcoin holders in China to circumvent domestic capital control limits by selling bitcoin to an overseas buyer in exchange for foreign currency.

“In theory, the bitcoin market is borderless, and as long as you could find a buyer overseas, you would be able to get US dollars, and the trade could happen without leaving a trace, with no record in the traditional banking system,” he said, adding that the volume of capital flow through this channel was likely to be quite limited.

Feeling attacked, the local industry quickly rose up in defense. Zhao Dong, owner of Jiandong Tech, a company that buys and sells bitcoin, agreed that the actual amount of capital leaving the country through bitcoin was not likely to be very high.

“Among the 16 million bitcoins already dug out across the world by now, there are around four to five million held by the Chinese. That already caps the total value, while most of the owners are more interested in short-term speculation on the mainland market than exporting them for foreign currencies,” he said. Cheung said that although neither the mainland nor Hong Kong financial regulators had included bitcoin in the existing regulatory framework, bitcoin-related activities were “evolving and bearing the features of traditional financial market activities” and overlapping with the traditional financial system. That makes it more important than ever that the regulators start to take notice.

The biggest problem for the Chinese bitcoin market, according to Zhao, is that “the trading platforms are facing the challenge of having to prove themselves innocent” because many investors accuse them of inside trading or market manipulation. The market boom and the quick build-up of leverage had left the market in urgent need of official regulation, he said. Chen Yunfeng, a senior partner with Zhonglun W&D law firm, based in Shanghai, said he was dealing with an increasing number of bitcoin-related disputes. These included cases of bitcoin theft and scams in which investors have been unable to verify their trading partners.



“The bitcoin market is facing great risks, with turnover and leverage climbing quickly, and mixed up with unregulated foreign-currency trading and money laundering. I think it is time that the PBOC prepared new policies,” he added.

Industry players said the PBOC was mulling the idea of introducing third-party custodian services to govern the market by taking care of the account records, cash or bitcoins on behalf of the platforms. In early August, investor confidence in bitcoin took another knock when Bitfinex, a prominent Hong Kong-based digital currency exchange, reported the theft of about US$65.8 million worth of bitcoins. About 119,756 bitcoins were lost in a security breach, the company said.

In early 2014, Japan-based bitcoin exchange MtGox collapsed over the loss of nearly US$390 million worth of the virtual currency. Police later arrested its chief executive, Mark Karpeles, who was suspected of having accessed the computer system of the exchange and falsifying data on its outstanding balance.

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Meanwhile, overnight BTCChina announced (and other exchanges allegedly followed) that it had suspended its margin loan service indefinitely. The move came after the exchange received "informal guidance" from the PBoC, which has been more actively engaged with domestic bitcoin exchanges amid the run-up in bitcoin prices seen at the start of the year. While the move may flush out much of the bubbly euphoria, it may also lead to a far more stable market.

Alternatively, it may just accelerate the blow up of China's "bitcoin time bomb."