Spend any amount of time explaining bitcoin to a lay audience, and before long you will be faced with a simple query: What happens if the government bans it?

The imagined government, in these hypotheticals, is often the Communist government of China, known for its strict capital controls and sweeping regulatory judgments. So fraught has been the Chinese government's relationship with bitcoin over the years—even as China became the world leader in bitcoin mining and, for a time, in bitcoin exchange operations—and so persistent has been the flow of negative rumors, that the idea of a Chinese "bitcoin ban" long ago became an inside joke for cryptocurrency enthusiasts.

No one, it seems safe to say, is laughing now. Chinese regulators have instructed all domestic cryptocurrency exchanges to shut down this month, effectively choking off one of the largest markets for the commercial buying and selling of bitcoin and other digital assets. Cryptocurrency exchanges in China must announce their imminent closure, stop allowing new user sign-ups and work closely with authorities as they wind down their operations, according to a leaked government document and insider reports. Four major Chinese exchanges—Huobi, ViaBTC, OKCoin and BTC China, at one time the world's largest by trading volume—have already given word of their shutdown.

The moment could be a pivotal one in the evolution of financial services, but it could easily be misread both by traditional bankers whose businesses the digital asset economy could disrupt and by proponents who champion its technologies. Bitcoin skeptics such as JPMorgan Chase's Jamie Dimon would be wise not to gloat over China's regulatory actions or write cryptocurrencies off, while bitcoin boosters should think hard about the possibility that digital assets may not continue to thrive without the Chinese government's blessing.

The authorities' order came as a coup de grâce to Chinese exchange operators following a crackdown that began earlier this month with a blanket ban on initial coin offerings, a newly popular funding method that has allowed blockchain startups and open-source software projects to raise nearly $2 billion from investors worldwide in 2017.

Stacks of bitcoins sit near green lights on a data cable terminal.
Turning point
Bitcoin skeptics such as JPMorgan Chase's Jamie Dimon would be wise not to write cryptocurrencies off after the Chinese crackdown, but their supporters —which include many bankers — have to take the political risk seriously. Bloomberg News

As the prices of bitcoin, ether and other cryptocoins went into freefall last week following the news, Dimon piled on. In widely publicized comments at an industry conference, the JPMorgan CEO called bitcoin a "fraud" that would soon "blow up."

"It's worse than tulip bulbs. It won't end well," he said.

One suspects Dimon, who last spoke out publicly against bitcoin in November 2015, when its price was about one-tenth of its current value, has grown annoyed at the cryptocurrency's staying power. Even his daughter, he said, has bought some bitcoin.

Yet bitcoin has weathered similar shocks in the past, from the meltdown of the Tokyo-based exchange Mt. Gox in 2014 to news of high-profile thefts and hacks of bitcoin businesses. Despite it all, bitcoin has continued to increase in value, soaring some 400% this year alone, from about $1,000 in January to about $5,000 in early September.

What's more, cryptocurrency may hold the key to the future of cross-border payments. Even JPMorgan is experimenting with blockchain technology—and filed a patent in late 2013 for a bitcoin-style digital payment system. ICOs, meanwhile, promise to displace venture capital as the chief means of funding cutting-edge startups and software projects—and possibly the very future of the internet.

Bitcoin, some of its proponents insist, is exiting China, not the other way around.

China's place at the table

China, as some observers have been quick to point out, has a long and ignoble history of banning or blocking Western innovations of the digital age, from Facebook to YouTube. In no case was China's censure the kiss of death.

Many cryptocurrency insiders are therefore cautiously optimistic, even downright sanguine. Erik Voorhees, founder and CEO of the cryptocurrency exchange service ShapeShift, points out that Chinese traders can simply go elsewhere if Chinese exchanges are shuttered.

"Some significant portion of the people who trade will just open up accounts on non-Chinese exchanges. I know that's the first thing I would do if it became illegal to trade [cryptocurrencies] in the U.S.—I would sign up with an exchange outside of the U.S," said Voorhees.

Voorhees' own company, which allows users to swap one digital token for another, has seen its monthly trading volume grow by 1,000,000%—from $25,000 to $250 million—in only three years.

"While it's easy to shut down some exchanges if you're the government, it's impossible to shut down every trader," Voorhees said.

But China seems intent on making the attempt. Early reports indicated that authorities didn't plan to outlaw person-to-person, or over-the-counter, trading. But insiders now say that Chinese officials are aiming for an all-out ban on bitcoin trading.

Next on the chopping block could be bitcoin miners, who devote tremendous amounts of computing power to verifying and recording transactions on the bitcoin network. In return, they receive new bitcoins which are minted at a predetermined rate. Some 80% of the world's bitcoin mining takes place in China, but the bottom could fall out of the business if miners have no way to turn their digital gains into fiat currency.

It may not come to that. Oleg Seydak, CEO of the marketplace lender Blackmoon Financial, which recently completed an ICO, thinks even the shutdown of commercial exchanges won't be permanent.

China is doing this "just to show their power," he said. "They will temporarily close all of these companies, introduce strong regulations and keep the industry and the sector under their control."

Arguing for this approach is the reluctance Chinese leaders must surely feel at the prospect of letting themselves be eclipsed in a new and growing market. In 2016, China accounted for the majority of global bitcoin trading activity. But with the government clamping down, China's share has dropped to less than 15% of global volume. Japan now holds the top spot, with the U.S. and South Korea close behind.

"In the U.S., which has the most highly regulated financial markets, bitcoin doesn't look like it's going anywhere," said Alex Waters, the former co-founder of CoinApex, a blockchain research group, and the chief technology officer of the stealth startup GetKelvin.

And if it can thrive in the U.S., then it will thrive in plenty of other countries that have no desire to [outlaw it], he added.

"A trustworthy international market for bitcoin will continue to exist," said Waters, "whether or not China has a place at the table."

'Cryptocurrency cannot be killed'

And what of other, newer digital tokens, which are distributed through ICOs? Sasha Ivanov, CEO of Waves, a blockchain platform that serves, like Ethereum, to launch new tokens, believes the Chinese ICO ban is a positive development for the industry.

Most ICOs were nothing but scams, said Ivanov, and Chinese regulators "finally lost patience, as more and more companies tried to raise millions for nothing."

China, he said, "has a reputation of being a harsh regulator that makes abrupt decisions," but he feels confident that ICOs will be allowed by Chinese authorities once they have put in place an adequate regulatory framework.

Erik Voorhees, founder and CEO of ShapeShift.
New world
"States can't control this stuff,” Erik Voorhees, founder of cryptocurrency exchange service ShapeShift, says in pointing out that Chinese traders can simply go elsewhere if Chinese exchanges are shuttered.

Other countries, including the U.S., Canada and Singapore, are currently dealing with the question of how to regulate the exploding market for digital assets, which has been valued as highly as $175 billion this year. Insiders disagree over what percentage of the money that has poured into cryptocurrencies in recent months was attributable to Chinese investors. Some say it was significant.

But the loss of Chinese capital has not brought token offerings to a halt. When Blackmoon launched its own token sale on Sept. 12, it took the precaution of blocking any Chinese investors from participating. It reached its funding goal of $30 million in less than 24 hours, raising capital from nearly 9,500 investors across 135 countries.

Whatever China decides, the introduction of clear regulatory guidelines for token sales may ultimately yield a healthier market.

"The trend very well may benefit token issuers that are committed to launching legally compliant token sales, in addition to protecting investors," Morrison & Foerster lawyer Joshua Ashley Klayman Kuzar wrote in a recent client alert. "As nations around the globe weigh in and provide legal guidance concerning token sales, a more legitimate, responsible and sustainable token sale market may emerge."

Some cryptocurrency diehards have expressed relief at China's "exit" from bitcoin. Better for China to stop all commercial trading activity, their thinking goes, than for the country's regulators to continue manipulating the market with rumors of bans and enforcement actions.

"This is a good thing," tweeted Charlie Lee, the creator of the digital currency litecoin and the former director of engineering at Coinbase, a cryptocurrency startup valued at more than $1 billion. "China can no longer play with the markets by banning bitcoin. Cryptocurrency cannot be killed by any country."

By Tuesday afternoon, cryptocurrency prices were on the rebound. Bitcoin was trading just below $4,000, a roughly 33% increase from its recent low of about $3,000, though still well off its all-time high of about $5,000—set in early September, before the China news broke. The overall market had recovered to $136 billion in total value.

For Voorhees and other longtime bitcoin bulls, the bounce was just one more sign of the resilience of this new asset class, which could unlock the future of remittances, e-commerce, peer-to-peer lending and more.

"States can't control this stuff. They can influence it, they can hamper it, but they can't control it," said Voorhees. "It remains to be seen how much time and money governments waste trying to prevent people from having voluntary interactions with each other."