The Chinese actions of banning ICOs and shutting down cryptocurrency exchanges may be with the intention of preventing ordinary Chinese citizens from incurring financial losses. They should, however, be wary of the Cobra Effect.
The Cobra Effect?
There is an interesting anecdote about the British rule of India. Worried about the large number of venomous cobras in the Indian city of Delhi, the British government had a brilliant idea: they offered a reward for every dead cobra. While this initially resulted in people killing cobras to claim the reward, it soon resulted in unforeseen problems for the British. People began to breed cobras to claim the reward. When the British realized this, they scrapped the reward program. The people then released the worthless snakes, resulting in an increase in the cobra population. The efforts taken by the British to solve the cobra problem had actually exacerbated the situation.
Ceteris Paribus – The Problem
Ceteris Paribus (Latin for all other things remaining unchanged) is a key underlying assumption when people debate solutions to problems. If they fail to consider the side effects or secondary effects of the solution that they propose, they could be in for surprises. The British thought offering a reward for dead cobras would result in people killing cobras and the cobra population decreasing. Similarly, since most cryptocurrency trades take place at exchanges, the Chinese government may have thought shutting down exchanges will decrease the number of people investing in cryptocurrencies. They might just be in for a surprise.
Driving Cryptocurrencies Underground – No Solution
What could be the motivation behind the Chinese government’s actions of banning ICOs and shutting down cryptocurrency exchanges? One reason could be that the Chinese government would like to make it more difficult for ordinary citizens to buy cryptocurrencies and therefore make it less popular. While there has been a temporary blip in trading volumes, resulting in Bitcoin trading it a discount, it is difficult to say how long it will last. Another reason might be that the Chinese government would like to ‘protect’ the retail investor by making it difficult for him to buy Bitcoins.
However, the decision to shut down cryptocurrency exchanges will likely just drive people who want to buy Bitcoins to enter into PTP trades. These are far riskier than buying Bitcoins through exchanges, with a high risk of fraud. The Chinese are, right now, creating their own version of the Cobra Effect!