China is facing a serious currency crisis as the threat of a deflationary economic spiral and a property market collapse looms over the world’s second-largest economy. The Chinese government has taken some measures to stabilize the yuan, but these could have negative implications for bitcoin and other risky assets.
The Chinese yuan (CNY) has lost 1.39% of its value against the U.S. dollar since the start of the year, while its offshore counterpart (CNH) has dropped 1.25%. The currency is tightly controlled by the People’s Bank of China (PBOC), which sets a daily reference rate and allows the yuan to fluctuate within a 2% band.
The yuan’s weakness is partly driven by the capital outflows from China, as foreign investors are losing confidence in the country’s economic prospects. China’s stock market has plunged over 7% to its lowest level since March 2020, amid fears of a hard landing for the economy and a debt crisis in the property sector. The default of Evergrande, China’s largest property developer, has triggered a wave of panic selling and contagion risks in the financial system.
PBOC intervenes to support the yuan
To prevent the yuan from falling further, the PBOC has intervened in the foreign exchange market by selling U.S. dollars and buying yuan. The central bank has also tightened the liquidity conditions in the offshore market, making it more expensive for traders to bet against the yuan. The offshore yuan one-week interbank rate rose to 4.95%, the highest since September 2021.
However, these measures could have unintended consequences for the global financial markets and bitcoin. When the PBOC sells U.S. dollars, it also buys other currencies to maintain the proportion of its foreign exchange reserves. This could boost the value of the dollar index (DXY), which measures the greenback against a basket of major currencies.
Bitcoin inversely correlated to the dollar
Bitcoin is known to have an inverse correlation with the dollar, meaning that when the dollar rises, bitcoin tends to fall, and vice versa. This is because a stronger dollar makes bitcoin less attractive as an alternative store of value and reduces the purchasing power of bitcoin holders in other countries.
Bitcoin’s rally in the fourth quarter of 2023, which saw the cryptocurrency surge by 50%, was partly fueled by the dollar’s weakness. The dollar index fell by 4.5% in the same period, as investors anticipated the approval of a spot bitcoin ETF and increased their exposure to the crypto market.
However, the situation has reversed in 2024, as the dollar index has gained 2.5% and bitcoin has dropped by 15%. The PBOC’s intervention could add more pressure to bitcoin, as it could strengthen the dollar and dampen the risk appetite of investors.
Other factors affecting bitcoin
Of course, the PBOC’s intervention is not the only factor affecting bitcoin’s price. There are also other developments in the crypto space that could influence the market sentiment and demand for bitcoin.
For instance, the regulatory scrutiny on Binance, the world’s largest crypto exchange, could have a negative impact on bitcoin. According to a report by the Wall Street Journal, Binance’s CEO Changpeng Zhao allegedly admitted in a private conversation that the exchange had engaged in wash trading, a practice of artificially inflating the trading volume, several years ago.
Another factor that could affect bitcoin is the innovation and competition in the crypto industry. Bitcoin faces challenges from other cryptocurrencies that offer faster, cheaper, and more scalable transactions, as well as more advanced features such as smart contracts and decentralized applications. Bitcoin also has to contend with the emergence of central bank digital currencies (CBDCs), which could offer a more regulated and convenient alternative to cash and crypto.
China’s currency crisis could have a significant impact on bitcoin’s price, as it could boost the dollar and reduce the risk appetite of investors. However, bitcoin’s price is also influenced by other factors, such as the regulatory environment, the innovation and competition in the crypto industry, and the supply and demand dynamics of the market. Therefore, bitcoin investors should be aware of the various risks and opportunities that could affect the cryptocurrency in the future.