Investment management consultant MATTHEW FEARGRIEVE asks if we should heed the warning issued by technology billionaire Peter Thiel that the world’s most popular cryptocurrency could be used by the Chinese as a "financial weapon against the US" - and, indeed, against the rest of the world.
Just as Bitcoin was hovering around US$56,000 over 6-8 April, before climbing back to over US$64,000 a week later, Trump loyalist and crypto investor Peter Thiel was addressing the members of the Richard Nixon Foundation at a virtual event.
Thiel was joined by former US Secretary of State Mike Pompeo and former US National Security Advisor Robert O’Brien. The conversation between Thiel, who has frequently criticized American companies that do business with Beijing, and these former members of the Trump administration, was largely focused on US-China relations.
It emerged during the course of remarks made at the event that billionaire Thiel, who is a major investor in virtual currency ventures as well as in cryptocurrencies themselves, now considers Bitcoin to have the potential, in Chinese hands, to undermine America’s security and its place in the world order.
Thiel explained why the Chinese dislike the US Dollar because of its status as a reserve currency. “From China’s point of view, they don’t like the US having this reserve currency because it gives the US a lot of leverage over Iranian oil supplies and all sorts of things like that. [Bitcoin] threatens fiat money, but it especially threatens the US Dollar, and China wants to do things to weaken [the Dollar].”
He added: “[If] China is long on Bitcoin, perhaps from a geopolitical perspective, the US should be asking some tougher questions about exactly how that works.”
The audience at the event then held its breath as Thiel concluded: “I do wonder whether at this point, Bitcoin should be thought [of] in part as a Chinese financial weapon against the US.”
If we take Thiel’s remarks at face value, they represent something of a departure from his previous publicly-made statements about Bitcoin’s qualities and attractiveness as an investment asset. But we need to add some qualifications to the substance of what he said, before we decide what weight to give his apparently new position on Bitcoin.
Thiel described himself at the event as being “pro-Bitcoin”, and he still holds significant positions in virtual currency ventures as well as in cryptocurrencies themselves. It seems unlikely that Thiel will shed his crypto investments anytime soon, although his views on the sustainability of the current Bitcoin surge are unknown. And PayPal, which he co-founded, has onboarded Bitcoin (and other cryptocurrencies) as accepted currency on some of its payment platforms.
Perhaps the remarks he made at the Nixon event signal something of a crypto-rethink on Thiel’s part. Perhaps he was just being philosophical. Perhaps he was just being deliberately provocative.
Whatever the truth of the matter, whatever his motivation for saying what he said, we need to ask: does his argument hold water? Could Bitcoin be used by China to undermine the US Dollar and US interests? Could China utilise Bitcoin as a "financial weapon"?
It is important to keep in mind the context in which Thiel was speaking. The Richard Nixon Foundation and its members are, unsurprisingly, Right-leaning. The panel members with whom he was having this discussion were Mike Pompeo and former National Security Advisor Robert O’Brien, both hawkish members of the Trump administration. And Thiel’s own loyalty to Trump is well known.
Against this backdrop, Thiel may well have imbued his comments about China’s use of Bitcoin with a little extra political clout. Would he have spoken about crypto in so openly geo-political terms at, say, an investors conference? Maybe not.
Having established the context in which Thiel was speaking about Bitcoin, we need next to examine the three premises that appear to underpin his comments:
first, that Bitcoin could threaten fiat currencies;
secondly, that Bitcoin could challenge the US Dollar as a major reserve currency;
thirdly, that China is, as Thiel put it, “long on Bitcoin”, in other words, holding it in significant amounts.
Let’s examine these three propositions in turn.
Does Bitcoin have the potential to threaten fiat currency?
Thiel asserted that Bitcoin "threatens fiat money". Is this true?
Fiat money is government-issued money that is not backed by a commodity like gold. Fiat money gives central banks greater control over the economy because they can control how much money is printed.
Bitcoin, like other cryptocurrencies, is like fiat money because it is not backed by any commodity or precious metal. It differs from fiat money in being a digital asset that derives its intrinsic value from blockchain (and the technological integrity thereof).
Read Are Bitcoin and Gold the Safe Haven Assets of 2021? by clicking here.
Fiat money on the other hand is a physical currency (paper notes and metal coins) that derives its intrinsic value from the stability and creditworthiness of the government that issues it.
If Bitcoin is a fiat currency, what are its advantages over the US Dollar? Thiel did not elaborate on this at the Nixon event. But there is a degree of consensus about what are the notional advantages that crypto enjoys over traditional (or should that be mainstream?) currency. We say notional because there is far less agreement about whether they truly constitute real advantages in the real world.
The main such notional advantage, that Thiel will no doubt have had in mind, is that cryptocurrency cannot be controlled by any central authority of any country, unlike traditional fiat currency, which can be controlled to some extent by the reserve bank of its issuing country.
Another notional advantage is that, unlike banking services that are required to support the flow of traditional fiat money, cryptocurrency like Bitcoin has no storage cost. This characteristic must seem very appealing to retail banks worldwide, which have hated cash deposits for some years now, necessitating as they do a vast and costly infrastructure of buildings, machinery and manpower.
The final key advantage that is relevant to Thiel’s remarks is, perhaps, the decentralized nature of crypto. Traditional fiat currencies are limited to the borders of their respective countries, hence the clunky and costly business of foreign exchange (FX). Bitcoin on the other hand, being decentralized, enables cross border transactioning of uniform value at no additional cost.
Here, then, are three key notional advantages of Bitcoin over traditional fiat money that support the proposition that Bitcoin has the potential to rival (and, to take this argument to its logical conclusion, to replace) fiat money.
Given that the US Dollar is a traditional fiat currency, the next question is:
Could Bitcoin challenge the US Dollar as a major reserve currency?
Thiel opined, when discussing China's dislike of the greenback as the reserve currency, that Bitcoin "especially threatens the US Dollar". Is this the case?
A reserve currency is a large quantity of currency maintained by the central banks of different countries and major financial institutions, to invest, transact, meet international debt obligations and influence domestic exchange rates. A large percentage of commodities, such as gold and oil, are denominated in the reserve currency, which means that other countries have to hold that currency in order to pay for those commodities. The price of gold is a key example, which is always expressed in US Dollars.
With these characteristics, it is obvious that any country that issues a currency that acts as a reserve currency for the rest of the world will enjoy a lot of influence and power, as will the currency itself. As a result of the Bretton Woods Agreement, the US Dollar was officially crowned the world’s reserve currency and was backed by the world’s largest gold reserves.
So does Peter Thiel have a credible point when he suggests that Bitcoin could challenge the US Dollar as a reserve currency?
Most economists are doubtful. The Bank for International Settlements said in January that the “dollar is the world’s premier reserve currency because it has a stable value (low inflation), a large supply of safe assets and the credibility of the US economic and legal system […] investors can also easily access the US’s deep and efficient capital markets, without worrying about capital controls […] These factors are likely to remain the primary drivers of global reserve currency status“.
Bitcoin does not share any of the qualities identified here by the Bank for International Settlements. Bitcoin does not (notoriously) maintain a stable value, and the finite number of bitcoins means that it cannot keep up with global demand for safe assets, like the US debt market can. Indeed, investor willingness to buy US government public debt, often at negative real interest rates, shows that the US Dollar continues to have mass investor appeal, even as cryptocurrencies begin to show signs of going mainstream.
The recent rise in US Treasury yields, the spectre of inflation and the investor rush into inflation-linked TIPS will all have an interesting impact on Bitcoin prices; for more on this, and the trajectory of Bond Yields in general, read our blog Why Bond Yields will Climb Further.
More fundamentally, there is a political element to the potential attractiveness of cryptocurrency to the Chinese Communist Party (CCP). We mentioned above that a key notional advantage that Bitcoin enjoys over traditional fiat money is that it cannot be controlled by any central authority of any country. This unique quality is something that, for the CCP, makes Bitcoin an interesting alternative to old fiat currency and the dominance of the greenback; this same quality is what also makes Bitcoin a deeply troubling proposition for the CCP.
China’s actions over the past decade show that it is deeply sceptical of Bitcoin and likely sees crypto as a threat to the power of the CCP. In 2017, the People’s Bank of China and five other ministries banned financings using cryptocurrency, and banned the exchange of fiat money for cryptocurrency.
Read about how Bitcoin is Becoming a Lifestyle Investment for Indian Consumers.
Behind these state-imposed prohibitions (something to which many Bitcoin apologists claim crypto is immune) we can see China’s strict capital controls at work, preventing wealth from leaving China for other countries. To maintain these controls while allowing cryptocurrency transactions, Chinese banks would have been required to undertake what for them would have been a technologically impossible mission of tracking and imposing limitations upon each encrypted, anonymous cryptocurrency transaction from every Chinese user.
We may well speculate that Chinese banks are now receiving State funding to help them develop the technology to help them achieve this in the future. But the official view in China right now is - probably - that Bitcoin is a commodity, not a currency.
A State-led crackdown like this on decentralized, “ownerless” cryptocurrency systems can hardly be seen as a move by China to promote Bitcoin as a competitor currency for the US Dollar. Thiel did not address this in his debate at the Nixon Foundation, nor did he acknowledge China’s homegrown digital currency, a digitalized yuan which has been developed over the past three years as a counterweight to popular digital payment platforms like AliPay and WeChat Pay, that have gained a toehold in China's retail consumer markets.
This digitalized yuan is issued by the country’s central bank (natch) and is undoubtedly designed in part to give the CCP more control over fiat currency changing hands in China.
Whilst Thiel’s remarks about China disliking the geopolitical power bestowed on the US via the greenback were entirely uncontroversial, it is harder to agree with his suggestion that a decentralized, borderless cryptocurrency could ever be embraced by a Chinese Communist Party that is bent on holding on to power and preventing foreign influence in China.
This brings us to the final question.
Is China Long on Bitcoin?
Thiel openly speculated whether "China is long on Bitcoin [...] perhaps from a geopolitical perspective, the US should be asking some tougher questions about exactly how that works".
The proper question, we suggest, is not so much whether China is financially long Bitcoin, but rather whether the CCP is ideologically long Bitcoin. Ideology is the beginning and the end of everything in China.
It may be true that in 2020 China "acquired" a South Korean based cryptocurrency exchange called PlusToken and in so doing seized a large volume of cryptocurrencies, including some US$3.3 billion worth of Bitcoin.
In January 2021, data reports revealed that Chinese currency, out of all the G10 currencies, had the strongest statistical correlation to Bitcoin over the previous year, at around 84%. That means that any strengthening of the RMB against the US Dollar would translate into a similar gain for Bitcoin, 84% of the time. When the Renminbi rises, so does Bitcoin. By comparison, the same report showed that the Euro and the Rouble each had lower correlations with Bitcoin, at 74% and 25% respectively.
Of course, China’s role in setting Bitcoin prices is already well known. This may have been the central plank on which Thiel was building his remarks about China’s long positions in Bitcoin threatening the US Dollar - which argument supposes that crypto can ultimately come to rival traditional fiat currency which, as we have just argued, is doubtful.
Another thing to which Thiel may have been alluding is the fact that there are four miners in China that control over 50% of issued Bitcoin. This confers on China (or, more precisely, the CCP) the power to control the supply of coins in the Bitcoin market and to raise transaction fees based on supposed mining difficulty.
China is also home to some of the biggest cryptocurrency exchanges for trading Bitcoin, like Binance. These exchanges have achieved high trading volumes and attract international retail investors by being cheaper to use than their foreign competitors.
Read about My Coinbase Woes here.
So Thiel’s warning about China being long Bitcoin, and his suggestion that US foreign and economic policy should sit up and take more note of this, is probably best understood in the context of China’s dominant share of worldwide Bitcoin production, as opposed to how many Bitcoins the CCP currently holds.
How could China use Bitcoin as a Weapon against the US?
As we posited earlier in this piece, it may well be the case that Thiel was using a Right-wing political platform as the springboard for making some suitably Right-leaning and somewhat mischievous comments about Sino-US relations in various spheres, Bitcoin being an interesting and a topical one.
Having stated, entirely uncontroversially, that the CCP does not like the power that the US Dollar, as the world’s reserve currency, confers upon the US, Thiel went on to state that Bitcoin threatens traditional fiat currencies like the US Dollar. We have argued in this piece that this is not the case – for the moment, at least.
We have also argued here that China, whilst undoubtedly holding significant amounts of Bitcoin, is ideologically opposed to the whole decentralized, self-regulating nature of cryptocurrencies, and that the CCP is therefore unlikely to be plotting world domination by promoting Bitcoin with a view to its overtaking the US Dollar as a new reserve currency. Indeed, any such suggestion is absurd.
So just how could China use Bitcoin as a financial weapon against US interests, as Peter Thiel would have us believe is possible?
There is a potential threat stemming not from the value of Bitcoin that the CCP owns, but from China’s dominance of Bitcoin mining and production. It could in principle intervene in harmful ways in the costs of mining and – ultimately – challenge the basic principle of Bitcoins being finite in nature.
To what end? Well, the mindset of the CCP is, has always been, and will remain, a mystery. But it would not be inconceivable that it could try by covert means to derail Bitcoin, if for no other reason than to ensure the wholesale uptake by its population of a digitalized yuan.
Maybe Mr. Thiel has a point…
MATTHEW FEARGRIEVE is an investment management consultant. You can read his investing blog here and see his Twitter feed here.
