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What Might Happen if China Declared War on Bitcoin?

Juan M. Villaverde
Last updated: | 8 min read

Juan Villaverde is an econometrician and mathematician devoted to the analysis of cryptocurrencies since 2012. He leads the Weiss Ratings team of analysts and computer programmers who created Weiss cryptocurrency ratings.
Who would win a China-Bitcoin war? How would it impact Bitcoin’s price? Would it bring down the whole crypto world? Or would it give competing cryptos like EOS, NEO and Cardano more room to grow?

Source: iStock/konmesa

These are not breaking-news questions you need to act on immediately. Bitcoin is still a good staple for almost any cryptocurrency portfolio. But if you’re among those who like to buy and hold for the longer term, you do need the answers … and the best time to get them is right now.

Why Bitcoin is Fundamentally Flawed

Currently, the “inventory” of minted Bitcoin in the world is worth $113 billion. Like the stockpile of gold in Fort Knox …

• Its value goes up and down based largely on supply and demand in the marketplace. And …

• It is surrounded by a protective wall that wards off theft, cheating, larceny and corruption.

But there are also some critical differences. Unlike the gold bars in Fort Knox,

• Almost every detail about each Bitcoin is public information.

• Everyone in the world with a computer has access to the network.

• Most important, anyone can cheat the system provided they have the resources and the incentive to foot the bill. There is no law or punishment that prevents them from doing so.

Does it actually happen? No. But that’s only because it requires massive consumption of electric power; it would not be cost-effective; and everyone with knowledge of how Bitcoin works recognizes this reality.

“Even if we could scale the wall,” they reason, “the cost would be greater than the reward. So why bother?”

But when I say “everyone,” I exclude powerful sovereign governments like China.

Unlike individuals or private-sector corporations, they do have the resources to break in. The only thing they don’t have (yet!) is the incentive to do so.

Consider the facts:

Fact #1. As cryptocurrencies grow in value and importance, sovereign nations are naturally designing stronger and more aggressive strategies for dealing with them.

Fact #2. Anyone who controls more than 50% of Bitcoin’s hashrate (the power to solve the mathematical puzzles that unlock its value) could theoretically sabotage the network and effectively reverse history because no Bitcoin transactions are truly final.

This is very different from traditional transactions. For example, when you wire-transfer funds from Bank A to Bank B, or when you complete the settlement process on a stock trade, there’s no way to reverse the process unless you start a brand-new transaction. In Bitcoin, that final settlement never happens.

It’s a fundamental flaw that Bitcoin has never resolved.

Has anyone tried to systematically exploit it? No. But if a powerful entity, like the government of China, declares war on Bitcoin, it could!

Bottom line: If Bitcoin is deemed to be an imminent threat, a powerful sovereign nation could have a strong incentive to wreak havoc. And there is nothing the network itself could do to defend itself, unless radical changes are made in its structure

I repeat: This does not mean Bitcoin’s value is now going to crash further. Quite the contrary, for a whole set of other reasons we’ll tell you about in a future article, we see a major recovery for the entire crypto space now in the making.

But these fundamental flaws in Bitcoin help explain why we give it a rating of “C+”: Its technology, although trailblazing, is no longer robust enough for what might lie ahead.

The Inherent Downside of Proof-of-Work Mining

Most people assume that Bitcoin’s Proof-of-Work mining, while energy-intensive and slow, is THE best way to secure a distributed ledger network.

In practice, this has been true until now. But it is not an absolute truth.

In fact, the way Bitcoin implements Proof-of-Work is NOT the ideal way to secure a distributed ledger, especially one that holds people’s money. And it’s precisely for the reasons I cited earlier:

• Anyone can participate in the network; there are no barriers to entry.

• No payment is truly final.

This means that anyone with the will and the means can get in, reverse transactions and destroy history.

“Outrageous!” is the response we anticipate from Bitcoin lovers. “Blasphemy” will be the outcry from its worshipers. Their likely argument: “It’s precisely by allowing anyone to participate that we make Bitcoin the ultimate in decentralization!”

Our counter: There’s a critical difference between allowing anyone to compete in a system, and ensuring that system is decentralized. Bitcoin did the former very well. But actual experience demonstrates that Bitcoin has failed to achieve the latter.

How Free Markets Lose Their Freedom

In the perfect world, Proof-of-Work mining creates a free, competitive marketplace. Free from censorship. Free from centralized control. Free from dominance by any one group.

But the history of markets proves that the world is far from perfect. Almost all so-called “free markets” that are open to everyone without proper governance devolve into not-so-free markets controlled by a few dominant players.

We saw that happen among big railroads of the 19th century and Big Oil in the 20th.

Plus, in modern times, we’ve seen it in:

• Amazon’s dominance of ecommerce (nearly 50%) …

• Facebook’s undisputed leadership of social media (66%) …

• And Google’s near-total control of the search engine world — a whopping 86%, despite Microsoft’s doubling of Bing’s share over the past six years.

And, alas, we also see it happening in the world of Bitcoin, with China or the Chinese playing the central role along three different dimensions:

1. Mining pools: According to a recent report by Princeton University and Florida International University, 74% of all mining is done by mining pools located in China.

While it’s true that pools don’t control the miners themselves, it cannot be ignored that these pools have a Chinese manager, and these managers determine what blocks are added to Bitcoin’s ledger.

2. Geographic concentration: As mining becomes more difficult, we’re witnessing more concentration of mining in geographical locations where energy is cheap and abundant. Once again, China comes out on top here.

3. Hardware: Most is manufactured in China.

All this adds up to a huge geopolitical risk to the Bitcoin network.

It all comes together in China. Check off the boxes …

1. In terms of the technology and infrastructure, what country has the biggest levers of power over the Bitcoin network? China.

2. Politically speaking, which country has the least skin the game if Bitcoin goes south? Again, the answer is China; Chinese citizens are already banned from trading cryptocurrencies.

3. In terms of ownership by individuals, which country has the least to lose? China! The owners of Bitcoin are mostly citizens of Japan, South Korea and Western countries. Their Bitcoins were created in the early days when the network was small. Few of these early adopters were in China.

4. Finally, when it comes to large institutional players, which ones will have the least commitment to Bitcoin? Chinese institutions! New Bitcoin financial derivatives, such as ETFs and futures contracts, are being developed primarily by Western and other non-Chinese companies. These products, as they launch, will lead to an ever-larger non-Chinese ownership share of the Bitcoin supply.

The end result is a unique, vexing dilemma:

Most Bitcoins are owned outside of China, but the Bitcoin network is secured and controlled inside China.

Suppose trade relations continue to sour? Suppose the much-feared trade war breaks out in full force? Will China then have a new, heretofore unthinkable “nuclear option”?

Would China come to the conclusion that the Western-dominated global financial system has enough exposure to Bitcoin to warrant subverting the network? That the benefit of dominating the new world of digital assets justifies the costs of sabotaging the competition?

In sum, would China have the power to use Bitcoin as another lever to destabilize the West’s financial system?

Yes. All they’d need to do is force or pay their miners to rewrite the Bitcoin ledger, and voila — you’d no longer be certain whether your Bitcoin was spent, or even who owns what.

Will they have the incentive to do so? That remains to be seen.

I want to be clear here: This risk is limited to Proof-of-Work cryptocurrencies ONLY.

So this story is mostly about Bitcoin.

I also want to repeat this key point: The fatal flaw of Proof-of-Work is that it allows anyone to participate in its consensus decision-making. And experience has shown that a few dominant players can control most of the mining power. Once they effectively take over, the network ceases to be “trustless” and we must instead TRUST that those who dominate the network will always follow the rules, never exploiting those rules for their own personal gain.

These types of risks are why our ratings model has always favored consensus algorithms where such risks are reduced or eliminated.

The Inherent Strength of Proof-of-Stake

Proof-of-Stake (PoS) coins like EOS, NEO and Cardano would be among the main beneficiaries.

Reason: They use PoS mining, which mostly addresses these issues:

First, PoS ledgers make “miners” and “token-holders” one and the same. As a result, you will never see a situation in which one side owns the currency while an opposing side secures it.

Second, transactions are final and cannot be reversed. This is achieved with what’s called “Byzantine Fault Tolerance.” Thus, even if a malicious actor could acquire the computing power to attack the network, they would still not be able to rewrite the history of the ledger. Yes, they could break in. But to no avail because they would be unable to steal a darn thing.

So Proof-of-Stake cryptos could be among the beneficiaries of any sovereign-nation threat to Bitcoin.