How could bitcoin be impacted by China’s measures to shield Yuan?

Due to the persistent threat of a deflationary economic downturn and the concerns of the real estate market, foreign investors are seen withdrawing their cash from China, which has resulted in continued currency devaluation. The most recent steps Beijing has taken to address the problem pose a downside risk to Bitcoin via the foreign currency channel.

China’s strictly regulated Yuan has dropped 1.39% versus the US dollar, while its offshore Hong Kong equivalent, CNH, has dropped 1.25%. The Shanghai Composite, China’s benchmark market index, has fallen more than 7% to its lowest level since March 2020.

The People’s Bank of China loosely pegs CNY’s value to a basket of 24 currencies through a managed-float system, allowing the home currency to fluctuate 2% on either side of the daily fix or the reference point.

China’s state-owned banks sold US dollars onshore while tightening liquidity in the offshore foreign exchange market to support the Yuan. Hong Kong’s offshore Yuan one-week CNH Hong Kong Interbank Offered Rate – a gauge of offshore Yuan liquidity conditions -rose to 4.95045%, the highest since Sept. 26.

Such measures could lead to broad-based USD strength, tighter financial conditions worldwide, and investors scaling back exposure to risky assets like bitcoin and technology stocks.

That’s because when the PBOC sells U.S. dollars onshore to support the Yuan, it purchases the dollar against other currencies to keep the American currency’s proportion in its foreign exchange reserves stable. Other things being equal, the intervention has the potential to lift the dollar index (DXY), which tracks its value against major rivals.
Bitcoin is known to be inversely correlated to the dollar. The cryptocurrency Q4 2023 surge of 50%, widely attributed to the spot ETF optimism, came as the dollar index fell by 4.5%.

Major state banks were seen selling dollars today to prop up the Yuan and curtailed lending in order to tighten Yuan liquidity and make it more expensive to short the currency. This typically feeds back into broader dollar strength as dollars are bought back against other currencies to maintain currency reserve ratios.

China is incentivized to keep a lid on Bitcoin to maintain a relative veil of currency stability and discourage capital flight. Past episodes when the Yuan has come under pressure have coincided with Bitcoin underperformance.

The dollar index has already gained 1.8% this month. Bitcoin, meanwhile, has dropped to $39,129, after having tapped highs near $49,000 early this month.