26/04/2014

I've been fielding a lot of questions in IRC, twitter, email so I thought I would summarize my thinking about recent events. I'm posting this on the 26th but started writing it on the 25th.

On Friday morning, China fired the next black swan: well not so black for me because I expected this something like this, I just didn't know when.

Chinese authorities are angry at the bitcoin exchanges for flouting the spirit of their original December guidance on virtual currencies: that banks and financial institutions should distance themselves from virtual currency trade/derivatives/products/services. This was later strengthened to include not facilitating deposits to bitcoin exchanges.

Bitcoin exchanges responded by all manner of tricks, like using their own personal bank accounts, tradeable cash recharge codes and even their own ATMs.

I'm not hating on China in any way, nor siding with any particular political ideas, but I want to make some clear distinctions about how things work at government level. The government cares a lot about their image. This is partly a cultural thing, and partly because of how their political system is structured.

The government made the spirit of their wishes clearly known. They are publicly worried by how bitcoin exchanges have been inflating figures, zero trading fees and aggressive leverage to cause massive speculation and volatility. They view this as a menace and as detrimental to the well-being of ordinary people's finances – and frankly, they are probably right because the bitcoin trading space is more corrupt than anyone wants to admit. Most day-traders are like pigs to slaughter.

The motivation of the government of course could be multifaceted, but they definitely did seek to dampen the virtual currency space to help protect inexperienced traders and isolate bitcoin's potential effects on wider markets by insulating it from the main financial system (that is why they forbade bitcoin derivatives). It is questionable if they really worry about currency leakage because bitcoin's economy is soooo small and there are many easy ways to get large quantities of CNY out of the country without the risks that bitcoin carries (due to price volatility).

In response, bitcoin exchanges practically gave the government the middle finger. Something similar to when a parent tells a child to apologise and the kid apologises, but not sincerely. They comply with the letter but not the spirit of the law. In China, you should comply with the spirit and don't try to be a clever word-smith trying to find loopholes because being a smart-alec makes the other party look stupid. The Chinese political system does not want to appear weak, or stupid or to lack influence.

Now the government is angry and wants to put a stop to cash recharge codes and forbid institutions that service these from doing so (that would include businesses that need bank accounts to manage the cash), and one Chinese bank has already posted news to such effect: http://cmbchina.com/main/noticeinfo.aspx?guid=6c13744e-d0f2-4681-9009-2b81dfe04b91

If bitcoin exchanges continue on this path, the next thing you will see are raids on exchanges, seizure of servers and arrests. Bitcoin may not be banned, but the government very much wants to control the effects of bitcoin and other virtual currencies. Years before bitcoin, they made Tencent QQcoin completely illegal. You would be forgiven for thinking the Chinese are rebellious. They are not, and corruption aside, the laws are strictly imposed. If China stamps on something and it resists, they'll do it harder. Tienanmen Square is a good example.

So my opinion is, things look very bleak for bitcoin in China. It's not banned, but exchanges are getting squeezed out and I really don't have much hope for large volume trading in China for the forseeable future. Talk of Huobi moving offshore is all very well, but I don't see how the average Chinese investor will be able to wire their money out because of currency controls. My understanding is that just 50,000CNY per person per year may be converted to foreign currency. That's not a whole lot.

How much more Chinese exchanges will be willing to stretch their luck against a heavy handed government remains to be seen. In a country that executes people for financial crimes, tax evasion and corruption I can't see Bobby Lee and co pushing their luck much further.

Chinese investors have proven themselves to be easy to influence, and they “pump” or “dump” veraciously on news cues but as I explained before, eventually they will desensitize.

So what are the possibilities, where can we go from here. I do not believe we've heard the last of this. We may see new statement being released by exchanges and financial institutions. Exchanges will have to do so when their recharge code systems are turned off and their bank accounts closed entirely. Expect it.

News may be mixed, hot and cold. More leaks will come through the press. Don't expect a statement from the PBOC. Creating certainty is not what they want to do. Continued doubt and uncertainty dampen bitcoin trading. Clarifying things immediately creates certainty and the market can then price it in and move on. Game theory is important.

We cannot predict the reaction of the exchanges. They have already reframed their bad news to create (excuses for) market rallies. Bobby Lee of BTC China has lied outright and mislead the market (and may in fact be part of the conspiracy). Huobi has said they wont release statements to influence the market. Most exchanges have said they will open operations offshore.

Every news release from now on is going to move the market. There will likely be a mix of hopeful and negative. Exchanges may try not to paint a terrible picture but negative news will leak from other sources, like banks themselves. I do not see a quick resolution and it is not possible for the USD market to disconnect from Chinese influence until and unless arbitrage routes are closed. I am not sure that is possible given the way CNY can leak out of China by other means.

Be wary of trading analysis during this time. TA cannot predict the input of real world events. So while sub $300 is possible, it would not be possible without real world events to push it there. It just so happens that, on the balance of probabilities, we are going to get more bad news over the coming days and weeks. That being somewhat likely means we can guess the market direction.

Each news event will be priced in and may move the prices up or down depending. No-one can predict this without insider knowledge. We can only speculate. The levels that BTC will rise and fall to will be dictated by TA only in as much as people place their bets according to TA and thus are psychological trading levels. Events may smash past any of these levels in both directions depending on the market reaction to news events. Because I don't see any certainty coming soon in China, and the open arbitrage between China and BTC/USD I am not convinced there is anything to rally us out of this bear trend yet. Once we do change trend, the TA retrospectively will always be right, but that trend change will be event based.

So I don't believe we'll tank directly, more step down in response to news events and in the absence of further bad news, sideways. Remember a lot of market activity is the effect of margin positions being closed out and not real buying or selling. This time is ripe for manipulation because people are much more emotional, so watch out for unrealistic walls pushing the price up or down. There is a lot of overt manipulation going on already.

Since most people didnt expected this smack-down, but here we are. So don't apply the same logic again “oh well that must be the end of it”. It could get a lot worse before it gets better and each time it will knock the price out of whatever level it is at. I don't expect it, but Huobi/BTCChina/OKCoin may probably try another “ATM stunt” confidence trick, but on the other hand, they might be more cautious this time. The news I read specifically indicated the government was angry that exchanges were doing things that restored confidence and incited crazy trading volumes.

There is a view that there is a lot more money gunning for bitcoin this time round so a visit to sub $300 will be pretty unlikely. I agree, but smart money wants the smart price. Smart money will not fight the market and simply wait for a cheaper entry point.

On the positive side, there is a lot of investment in infrastructure so that's good for the long term. My own view is most traders who get burned now are just day traders. From a hedge fund perspective, even if we go back to $260 frankly, bitcoin has still performed extremely well on a 1 year graph and has a lot of potential when viewed as a 5 year investment. With that view, any price sub $500 is a bargain.

As I previously stated, $350-$450 (and lower) is a safe long term buy. I personally favour USD and trade on margin and I will wait and see what prices do and how this plays out. Based on a “rumour” we dropped from 510 to 440 and levelled out at ~450. The next news can surely drop us to 400 if it's even bad. And I'm sure that won't be be the only news either which is why I believe we can move to the lower price levels as stated in my previous opinion piece on 24/04/14.

Based on the current information, realistically sub $300 is unlikely but possible to $260ish. $300-$350 is a distinct possibility and I would surmise $380 to $400 is extremely likely (with some margin for error).

So play it by ear and don't get emotional, this could be a long process.

As it's the weekend now, I wouldn't expect any news movers Saturday or Sunday, but remember China is GMT+8 so things can happen early late night Sunday or early morning Monday US/EU time.

All the best, and happy trading.

BtcDrak

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