Bitcoin Market Update 4/11

Hi Everyone,

It's been a rough week for bitcoin as Chinese exchanges (with the exception of BTC China) can no longer accept deposits through their banking partners driving the price down from the $450/BTC to $460/BTC to around $340/BTC before rebounding to $420/BTC where it sits right now.  Fiat withdrawals from Chinese exchanges are not affected.

Altogether, I'm not worried in the least.  This crash event reminds me of when Silk Road closed down, causing a brief panic selloff before rebounding very quickly.  It seems to be happening in the same way which suggests that Chinese regulatory policy may not have much influence anymore on the bitcoin price given that most trembling-handed speculators were already pushed out of the market in the earlier fall from over $1000/BTC to $800/BTC during the first Chinese crackdown.  In other words, most of those left holding are strong believers of bitcoin since they didn't sell off during the earlier panic.  Very similar to those who held during the crash from $260/BTC to below $100/BTC except now those true believers are greater in number and have more capital invested.   

I also suspect that market participants outside of China had bigger part to play in the selling pressure we saw yesterday than initially apparent.  It's possible that the crash was more of a reaction by the rest of the world to the news coming out of China in anticipation of how the Chinese would react rather than the Chinese actually reacting to it themselves and selling large quantities of BTC.  Like I mentioned before, most of the trembling-handed speculators in China had already been shed off by the earlier crash. Also a freeze on deposits is very different from a freeze on withdrawals in the sense that since neither BTC withdrawals nor CNY withdrawals have been affected, exchange users can at anytime pull out their assets through either of the two funnels and get out of exchange counterparty risk.  One of the reasons gox BTC traded so much higher than the rest of the market before they halted BTC withdrawals is because it was the only funnel to get your assets out and neutralize counterparty risk.  Users would trade their immobile gox fiat for BTC which they would then sell on other exchanges.  The cost for getting out of gox was the premium paid in the trade price.  As gox got more "risky", the premium increased.  Since a freeze on deposits does not affect a user's ability to exit out of counterparty risk, panic selling as a Chinese user on a Chinese exchange does not make much sense.  To sell, a user would have to believe that this latest crackdown foretells another crackdown in the future whereby withdrawals might be halted AND he/she would have to not believe in the long-term value of bitcoin otherwise he/she would just hold bitcoin instead of sell it.  The second contingency seems unlikely since most of the shaky speculators have already left the market, leaving mostly strong believers still in the game.  The first contingency also seems unlikely given that the stance of the Chinese government has always been to put a ring fence around bitcoin to prevent it from affecting the financial sector should it implode.  It would be counterproductive to halt withdrawals since it would lock capital in with the potential implosion.  In fact, a halt on deposits is very much in line with a "keep the bomb from getting any bigger" policy.  Ironically, this could have an unintended effect whereby a black market for BTC or peer-to-peer marketplace like localbitcoins could grow and thrive in China, allowing people to convert CNY to BTC freely.  Also, by making it difficult for the Chinese to buy bitcoin, it will only increase the incentive for them to subvert capital controls and buy those bitcoins overseas.  The government loses out on tax revenue, faces more money laundering problems, and could push their exchanges out of the country.  Regulatory arbitrage is real; one needs to look no further than the many offshore jurisdictions so many companies use for incorporation and banking.

In other news, there has been some buzz in the bitcoin community about sidechains.  Sidechains would effectively replace altcoins and bitcoin-2.0-esque creations like mastercoin/ethereum.  Sidechains involve something called proof-of-burn which Counterparty XCP helped popularize.  These sidechains would also benefit from the hash rate and difficulty of the bitcoin network.  Proof-of-burn is where bitcoins are be sent out to an address which no one controls and an alternative coin is produced based on some fixed peg to the amount of BTC burned (e.g. one to one or one to two).  Then transactions can happen on the altchain and eventually those alt coins can be redeemed for bitcoins based on the set peg.  The logistics of this get tricky if redemption (burn plus redemption for a two-way process) is desired since it would require changing some parts of the core bitcoin protocol.  The burning part (one way process) is easy and can already be done.  Some drawbacks of sidechains include a reorganization of the sidechain should the blockchain reorganize (due to the orphaning of previous main chain blocks).  Also theft would be possible on a sidechain if there was a 51% attack within the sidechain as opposed to how blockchains currently work where a 51% attack would enable double-spend attacks but not outright theft of held coins. More on this as I learn more.

Kevin & Team Buttercoin
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