Author: Liu Xiaochun, Vice President of Shanghai New Finance Research Institute
Source: Caijing
On May 21, the Hong Kong Legislative Council passed the "Stablecoin Regulation Bill," nearly simultaneously, on May 20, U.S. time, the U.S. Senate passed the "Stablecoin Uniform Standards Protection Act" (GENIUS).
In no time, the crypto community was buzzing with various comments. However, most commentators did not conduct a specific study of the two legal documents, and some, for various reasons, confused concepts such as stablecoins, cryptocurrencies, and crypto assets, which misled people’s understanding of stablecoins. Therefore, it is necessary to provide a brief and specific analysis of the two legal documents and, based on this, analyze the demands of the relevant parties.
As a new type of financial product, stablecoins inevitably have their functions and roles, but the relevant parties involved in the innovation also inevitably have their economic demands. Whether these demands can be met is the key to the ultimate success of the financial product. Different issuance methods and regulatory approaches for stablecoins will also have varying impacts on the future development, currency circulation, and monetary policy of stablecoins.
I. Analysis of the Stablecoin Regulation Draft in Hong Kong, China
The "draft" provides a clear definition of stablecoins, consisting of five points.
The first point is relatively simple, which is the presentation form of stablecoins: "expressed in terms of valuation units or storage forms of economic value." For example, the Hong Kong dollar stablecoin must clearly indicate that it is a stablecoin of the Hong Kong dollar and the face value in Hong Kong dollars.
The second article clearly limits the applicable scope of stablecoins: payment for goods or services; debt settlement; investment and trading. In other words, the HKD stablecoin is a means of payment, not an asset for investment or speculation. The term "trading" here should consider that Hong Kong, as an open economy, will have exchanges between local currency and foreign currencies in its monetary circulation, and the HKD stablecoin can also be exchanged with foreign currencies in circulation.
The third article clarifies the storage and transfer methods of stablecoins: they can be done electronically.
Article 4 further clarifies that operations are to be conducted "on a distributed ledger or similar information storage repository." These two provisions can be said to limit the application field of stablecoins, meaning that stablecoins can only be digital and can only operate and circulate online.
Article 5 clarifies the value basis for stablecoins: a single asset; a group or a basket of assets. In the case of Hong Kong stablecoins, the anchored assets are primarily in Hong Kong dollars, and the reserve assets must be of high quality, highly liquid, and low-risk.
The "draft" has made some specific provisions regarding stablecoin regulation. Firstly, the issuers of stablecoins must be "companies", that is, profit-making commercial institutions. This time, Hong Kong has specifically stipulated that recognized institutions outside Hong Kong can also issue stablecoins pegged to the Hong Kong dollar, but they must be subject to the supervision of the Hong Kong Monetary Authority. Secondly, there are capital requirements, with a minimum of 25 million Hong Kong dollars or other approved equivalent amounts of currency, meaning that the capital must be sufficient monetary funds.
The third requirement for the underlying assets of stablecoins is: (1) The market value of the reserve assets must always be greater than or equal to the face value of the unreleased stablecoins; (2) The reserve assets must be isolated from the company's other funds, meaning that the reserve assets can only be used for the redemption of stablecoins and cannot be used for other business activities of the company; (3) The reserve assets must be high-quality, highly liquid, and low-risk assets; (4) The reserve assets must undergo regular risk management and asset audits; (5) Details of the reserve assets must be disclosed to the public, and the level of detail disclosed must meet audit requirements.
The fourth is the risk management requirements. (1) Stablecoin issuers must promptly meet the redemption requests of holders and may not impose excessively strict conditions, but reasonable fees can be charged; (2) Issuers must establish KYC and AML systems that comply with the Hong Kong government's requirements; (3) Establish information security management, anti-fraud, and other regulatory requirements that meet the Hong Kong government's standards; (4) Establish reasonable user complaint reporting channels and violation mechanisms. All these regulations indicate that even if the Hong Kong dollar stablecoin uses distributed accounts to conduct peer-to-peer cross-border payments on the blockchain, it cannot evade regulation.
The fifth point is the requirements for the positions of the CEO, directors, and stablecoin managers of the applicant issuing stablecoins, which are the same as the qualifications for senior executives of exchanges set by the Securities Regulatory Commission. The sixth point is that stablecoin issuers must publish a white paper to provide the public with comprehensive information about the stablecoin.
Finally, there are other conditions. (1) Licensees may not pay or allow the payment of interest on stablecoins. This is to prevent stablecoins from effectively becoming deposits or investment assets, and also to prevent licensees from deviating from the operational track of stablecoins as payment tools; (2) Licensees may only operate stablecoin businesses and may not engage in other businesses beyond their license. This further restricts the operational scope of stablecoin issuers (licensees), allowing them to only issue and redeem Hong Kong dollar stablecoins, and to ensure the smooth, safe, and compliant circulation of stablecoin payments.
In summary, Hong Kong hopes to provide an innovative payment tool for new economic fields such as WEB3 and cryptocurrency trading, without causing risk shocks to the existing system. This is a new type of payment tool, not an asset to be invested in; it is a regulated payment tool that emphasizes information security but does not allow for regulatory evasion.
II. Analysis of the U.S. Stablecoin Uniform Standards Protection Act
The regulatory logic of the "bill" in the United States and the "draft" in Hong Kong is generally not very different, but each has its own characteristics.
The similarities between the "Bill" and the "Draft": First, both are assets anchored to a fiat currency (the US dollar) for payment and settlement. Second, stablecoins must be 100% backed by US dollars or high-quality assets (such as US Treasury bonds). Third, issuers are required to disclose reserve asset reports monthly and undergo third-party audits. Fourth, they must comply with anti-money laundering and counter-terrorism financing requirements, with issuing institutions falling under the purview of the Bank Secrecy Act, requiring them to fulfill obligations such as KYC and reporting suspicious transactions. Fifth, it is prohibited to pay interest or returns on stablecoin. Sixth, the "Bill" grants the Secretary of the Treasury and the newly established "Stablecoin Certification Review Committee" regulatory powers to strengthen oversight of foreign stablecoin issuers.
The main difference between a "bill" and a "draft" is the regulatory framework. Hong Kong has a single-tier regulation, while the U.S. regulatory framework is divided into two tiers: issuers of stablecoins with a market capitalization exceeding $10 billion must comply with federal regulation; issuers with a market capitalization below $10 billion may choose state-level regulation but must meet federal minimum standards.
In addition, there are some differences in details, such as the United States having clearer requirements for the types of reserve assets for stablecoins, while Hong Kong only requires the nature of reserve assets, leaving some room for exploration.
Overall, both Hong Kong and the United States have legalized fiat-backed stablecoins and incorporated them into regulatory frameworks, providing new settlement tools for emerging economic sectors while preventing such innovative settlement tools from having a negative impact on sovereign currencies and financial markets. The key is to clarify the nature of stablecoins, that is, fiat-backed stablecoins are payment settlement tools, which should be strictly distinguished from securities tokens, and to strengthen the regulation of reserve assets and information disclosure, as well as to enhance requirements for anti-money laundering and counter-terrorism financing.
3. Bank Drafts and Stablecoins
From the legal documents regarding stablecoins in Hong Kong and the United States, the rules for the issuance and management of stablecoins are basically the same as those for bank promissory notes, and there are also some similarities with authorized currency issuance.
Three note-issuing banks in Hong Kong must deposit an equivalent amount of US dollars into the Monetary Authority to obtain a deposit certificate from the Monetary Authority before issuing Hong Kong dollars. This means that the note-issuing banks must have a 100% reserve of US dollars to ensure they can meet the demands of Hong Kong dollar holders for equivalent US dollars at any time.
The basic rules of a bank draft are as follows: A customer exchanges an equivalent amount of currency with the bank for a draft of the same amount. The holder of the draft can use it to pay for goods or services, repay debts, or exchange it for cash at other banks. When the final holder requests payment from the issuing bank, the bank pays the equivalent amount of currency equal to the face value of the draft upon presentation.
In fact, the original banknotes were created this way, and the notes from money shops also follow this rule. It can be said that fiat stablecoins are a type of currency under the conditions of fiat currency.
The emergence of promissory notes is due to the same reason as the emergence of paper currency and bonds, which is that carrying physical cash over long distances is heavy and unsafe. Now that electronic payments are widespread, the environment for using bank promissory notes has basically vanished, making them hard to find.
The invention and popularization of paper is a prerequisite for the emergence of banknotes, promissory notes, and bonds, but the fundamental issue of application demand is that physical currency is inconvenient and unsafe for long-distance carrying. Cryptographic code technology is the technological prerequisite for stablecoins and crypto-assets. So, what are the specific application demands for stablecoins as payment tools and currency-like instruments?
Years ago, JPMorgan Chase issued JPM Coin, with issuance rules similar to stablecoins and bank notes. As the most important US dollar clearing bank, JPMorgan Chase intended to strengthen its leading position in cross-border US dollar clearing, but over the years, it has not found applicable scenarios in interbank cross-border clearing. In recent years, JPMorgan Chase has begun to collaborate with other institutions to explore some alternative application scenarios, seemingly making progress. However, whether it can ultimately achieve commercial application remains to be seen.
In addition, the model of Western Union remittance is quite similar to that of a money order. Customers hand over the currency at any Western Union outlet, and the outlet provides the customer with a remittance receipt. The customer can keep the receipt or transfer it to someone else. The holder of the receipt can present it at any Western Union outlet in the world to obtain the remittance. A stablecoin is a certificate that can be redeemed for an equivalent amount of fiat currency.
The above are all historical payment tools. As payment tools, they share common characteristics. On one hand, the reasons and processes for the emergence of payment tools are quite similar; they all require a clear measure of value and stable value. Whether it is face-to-face payments or cross-space payments, instant payments or deferred payments, they must be safe, convenient, and fast. On the other hand, issuers have the impulse to overissue, which easily leads to risks such as mixed quality and counterfeiting. These risks are not imaginary, nor are they only present under traditional paper currency conditions.
Unfortunately, technology, including blockchain technology and encryption technology, cannot solve the problems of human greed and capital greed. For the United States, the risk of stablecoin runs is real and has already occurred. In May 2022, the dollar-pegged stablecoin TerraUSD experienced a severe run leading to its collapse, ringing alarm bells for regulators. As a result, both the Hong Kong and U.S. legislation have imposed strict and clear requirements on the quantity, quality, and management of stablecoin reserve assets.
4. The Demands of Relevant Parties in Stablecoins
The emergence of anything in human society is driven by demand, and behind that demand are the interests of various stakeholders. Only by meeting the different demands of different stakeholders can a payment tool truly be accepted.
Payment tools, on the surface, only involve the two parties in the transaction. As long as the demand for exchange is met, it is sufficient for the functionality to achieve convenient, safe, fast, and accurate value transfer. However, behind the smooth operation of payment tools lies a complete set of issuance, management, and operation systems, which itself requires significant cost investment. With investment, there will inevitably be a demand for returns. Therefore, stablecoin issuers or investors in stablecoin issuing institutions are the more important stakeholders.
The relevant parties of stablecoins primarily include the payer. First, for the payer, using stablecoins for payment in specific fields or scenarios is quicker, more convenient, and safer than using fiat currency; otherwise, there would be no need to go through the trouble of converting fiat currency on hand into stablecoins. Second, the conversion of fiat currency into stablecoins should be on a 1:1 basis, with no financial cost. Third, the cost of paying with stablecoins should generally be lower than paying with fiat currency, and at the very least, the benefits of transactions made with stablecoins should be greater than those made with fiat currency.
For recipients of stablecoins, first, accepting stablecoins makes transactions easier than accepting fiat currency. Secondly, the received stablecoins must be redeemable 1:1 for fiat currency, meaning there can be no loss of value. Lastly, stablecoins can be used for other payment scenarios that one may need.
The transactions mentioned above that are easier to execute with stablecoins than with fiat currency, or specific trading scenarios, may fall into two categories: first, the digital economy sector supported by emerging digital technologies, where due to technical reasons, fiat currencies are currently difficult to support payments in this area, or even if payments can be made, the efficiency and cost are not economical; second, transactions that are currently prohibited or restricted by law. Therefore, the legislation in Hong Kong and the United States has regulatory requirements for anti-money laundering, anti-terrorism financing, and so on.
The issuer of stablecoins incurs huge costs in the issuance, management, and operation of stablecoins, and without reasonable returns, there is no need for investment. For the issuers, the most direct and crude profit is the direct issuance of stablecoins or even currency without reserves, followed by the issuance of stablecoins with over-reserves. Such phenomena have always existed in the history of currency and payment, leading to crises of varying magnitudes.
Secondly, there are fees for stablecoin exchanges, which include fees charged for cashing out stablecoins issued by oneself, as well as fees charged for exchanging other stablecoins. This is a very conventional fee under the conditions of metallic currency, paper money, and paper bank notes, as different metallic currencies have different purities and values, and there is a certain physical distance between the final holder of the notes and the issuer. During the process of cashing out the value from the issuer, certain costs are incurred, and there is even a risk of being unable to cash out.
However, under online conditions such as blockchain, whether stablecoin holders are willing to pay exchange transaction fees still depends on market dynamics. The "draft" in Hong Kong takes this issue into account and allows for reasonable fees to be charged during the redemption process.
The third possible source of income is to utilize the funds obtained from issuing stablecoins for various investments to generate returns. Historically, there have been countless painful lessons in this regard. The lighter cases involve liquidity crises caused by large investment scales and long durations affecting the redemption of stablecoins, while the more severe cases result from investment failures leading to an inability to redeem stablecoins. Therefore, the "bills" in Hong Kong and the United States impose strict regulations on the types of reserve assets and require that stablecoin operations and reserve assets be strictly isolated from the issuer's other businesses and assets, essentially limiting the issuer's investments.
Under such constraints, the issuer's main source of income may be the investment in high-quality, highly liquid assets such as government bonds. Since the yield on such assets is relatively low, the issuer will inevitably pursue economies of scale. However, although government bonds are liquid, they are ultimately not the legal currency itself, and excessive investment will also affect the liquidity of stablecoin redemption. Further, it remains to be seen what specific regulations the regulators will impose on the structure of stablecoin reserve assets.
Unlike physical payment tools such as paper money, stablecoins and other cryptocurrencies require a series of technologies to support uninterrupted network operations. While physical payment tools may not be very efficient, they do not have such conditional constraints. Therefore, technology companies related to these technological supports are also stakeholders in stablecoins. These technology support institutions may be the same as the stablecoin issuing institutions or they may be different entities, and they also need to share in the benefits during the issuance and operation of stablecoins.
In addition, governments and regulatory agencies are also stakeholders in stablecoins, and their demands are: to promote economic growth, maintain the stability of fiat currencies, and ensure the safety of financial operations.
The ability to satisfactorily meet the demands of all relevant stakeholders is a fundamental factor in the success of stablecoins, while the advantages offered by technology in the payment process are of secondary importance. The outcome of the various parties' negotiations may result in stablecoins being widely used, or it may lead to different stablecoins being used within their respective limited domains, thus becoming specialized stablecoins. There is also the possibility of being replaced by central bank digital currencies. Unless the current national structures change, stablecoins can never fully replace fiat currencies.
At present, stablecoins as payment tools mainly play a role in certain specific areas of the digital economy, but their application scope is constantly expanding. On one hand, the digital economy is the future direction of development; on the other hand, the scale of stablecoin applications has become large enough to impact the stability of the financial system. Therefore, from both the perspective of inclusive innovation and the perspective of maintaining financial stability, it is time to implement regulatory management.
5. Stablecoins and Monetary Policy and Currency Circulation Management
As a payment tool, stablecoins pegged to fiat currency are a type of currency that effectively circulates as money. If the issuer uses all the fiat currency obtained from issuing stablecoins to provide loans, it is equivalent to injecting an equivalent amount of currency into the market.
If, according to the requirements of the laws in Hong Kong and the United States, part of the fiat currency obtained from issuing stablecoins can be used to purchase high-quality assets such as government bonds, then it would mean an increase in the supply of money in the market. If all the obtained fiat currency is used as reserve assets without any investments, it will not increase the money supply.
However, if the reserve assets of stablecoins must be held by a third party, it will depend on the regulatory requirements for third-party custodians. If the custodians are required to guarantee that 100% of the reserve assets can be redeemed at any time, it will not increase the money supply; otherwise, it will also increase the money supply.
An effective payment tool will inject vitality into economic operations and also have a significant impact on the money supply. Therefore, the issuance scale and regulatory model of stablecoins must become factors to consider in the formulation of monetary policy.
Stablecoins are based on distributed ledger systems and represent a disintermediated payment method that may have completely different circulation rules compared to cash in traditional circulation. In today’s era of electronic, networked, and digitized bank account systems, cash in circulation is more about personal offline payments, with small single transaction amounts, low frequency, and dispersed usage. Stablecoins are mainly applied in virtual economic fields such as WEB3 and DeFi, where both institutions and individual investors coexist, with large single transaction amounts and high trading frequencies. Although they are distributed and can be used for peer-to-peer payments, most of the transactions are still for trading virtual assets or cryptocurrency assets on exchanges or platforms, aside from payments aimed at value transfer.
As a stablecoin issuer, it remains to be seen whether anti-money laundering, anti-terrorism financing, and KYC measures are implemented only during the issuance and redemption of stablecoins, or whether they must also be applied to the trading behavior of stablecoin holders. Currently, neither the "bill" in Hong Kong nor that in the United States has provided clear guidance.
Cross-border payments are currently a hotspot and selling point in the exploration of stablecoins. Direct payments between the payer and payee are certainly more straightforward and efficient than remittances through intermediaries like banks. However, payment is just one part of the operations of market entities; ultimately, it is to obtain returns that are denominated in and reflected by fiat currency. Therefore, stablecoins must eventually be converted back to fiat currency and deposited into bank accounts to earn interest income. Moreover, the exchange of different currencies in cross-border payments cannot be resolved by stablecoins; it still needs to be achieved through the banking clearing system.
It can be seen that the true success of stablecoins does not lie in separating from the banking system, but rather in efficiently and seamlessly integrating with it. Moreover, the issuance of stablecoins by the issuing organizations, the acceptance of fiat currency, the investment in bonds and other reserve assets with fiat currency, and the redemption of stablecoins with fiat currency must all be realized through bank accounts. This is also a concern for currency circulation management and stablecoin regulation, and currently, there is no clear arrangement in the "bills" in Hong Kong and the United States regarding this.
Historically, there have been instances where banks could issue currency. In the United States during the 1840s and 1850s, there were over 8,370 different currencies circulating in the market simultaneously, which can only be imagined as inefficient and chaotic. If stablecoin issuing institutions only issue and apply stablecoins in limited specific areas, with a slight overlap in application among various stablecoins in the market, then it is not a problem for multiple institutions to issue stablecoins; however, if all stablecoins circulate throughout the entire market, it will inevitably lead to some chaos and inefficiency. If such a phenomenon occurs, both the market and regulation will choose moderate centralization. Therefore, the development model and scale of stablecoins after legalization still need to be tested by the market and regulation.
Six Suggestions for China
First, adhere to the principle of technological neutrality and encourage the innovative application of various technologies in the financial sector. Blockchain and cryptographic technology have already seen some successful applications in finance, such as the green bonds issued in Hong Kong. In areas like virtual asset trading and DeFi, various cryptocurrencies have demonstrated excellent applications in payment and settlement. Although many transactions in these fields are gray market transactions or even illegal transactions that are not recognized by existing laws, this does not negate the feasibility of cryptocurrency technology in payment and settlement functions. Cryptocurrency technology can certainly play a role in legitimate trading.
Secondly, stablecoins are a product of real demand. From the existing applications of stablecoins, demand comes from two categories. First, emerging economic sectors, such as virtual asset trading and on-chain transactions, where the current fiat currency payment and settlement methods cannot meet the payment and settlement needs of these types of transactions; second, some gray and illegal transactions, such as illegal asset transfers, which use stablecoins and other cryptocurrencies to evade regulation. Emerging sectors may also include legitimate transactions as well as gray or illegal transactions. As long as illegal transactions can be effectively identified, corresponding regulatory methods can be found.
Thirdly, the legislation on stablecoins is not only a necessity for innovation but also for financial security. The "bills" in Hong Kong and the United States are a response to innovation and a precaution against the risks it brings. The innovation of stablecoins as a payment tool aims to promote the development of emerging economic forms, such as virtual asset trading, and the issuance of stablecoins is not the end goal in itself. At the same time, due to the dual nature of payment tools, legislative regulation is necessary to prevent risks.
What is particularly noteworthy in this regard is that both Hong Kong and the United States have included foreign currency-pegged stablecoins within their regulatory scope. The reason is that foreign currency-pegged stablecoins, if not effectively regulated, could similarly pose a risk to the domestic currency system.
With the internationalization of the Renminbi, as long as there is demand, stablecoins pegged to the Renminbi will inevitably emerge abroad, and the Chinese financial system will inevitably face the risk shocks they may bring. It is necessary to formulate regulations to prevent this. As equivalents, stablecoins do not differentiate between offshore and onshore, but from a regulatory perspective, the scope of use for different issuers or different stablecoins can be limited.
Fourth, there are no substantial regulatory obstacles to China's issuance of RMB stablecoins. Stripped of the technical coat, stablecoins have the same rules as cashier's checks. Paper cash can be digitized, paper bills can be electronic, paper cashier's checks are also bills, and of course they can also be on-chain. Two options can be considered: one is to incorporate RMB stablecoins into the current bank bill management system; Second, considering that the current application field of stablecoins has certain particularities, refer to Hong Kong and the United States to formulate separate regulations for stablecoins. For the sake of prudence, the scope of application of stablecoins can be limited initially.
Fifth, the issuance of the renminbi stablecoin can create more suitable application scenarios for the digital renminbi. Technically, stablecoins and central bank digital currencies are the same, so why do stablecoins still exist? One reason is that some participants internationally seek to evade regulation, but more critically, the mechanisms are different, and the motivation for exploring and innovating application scenarios varies.
Central bank digital currency is issued by the central bank and leads the expansion of application scenarios, while commercial banks have a lower motivation to actively expand application scenarios due to the lack of a sustainable commercialization return mechanism. Stablecoins are issued by commercial entities, and there are commercial interests in issuing stablecoins, so they will inevitably do their best to explore application scenarios.
At the same time, due to the high compatibility between application scenarios and the characteristics of stablecoins, the trading frequency in application scenarios will increase on one hand, while system maintenance will also be relatively easy and low-cost on the other hand. The scenarios where stablecoins can be successfully applied are inevitably the scenarios applicable to central bank digital currencies. Therefore, the issuance of the RMB stablecoin actually helps promote the application of the digital RMB.
Sixth, to innovate and build a payment system for the RMB stablecoin that seamlessly integrates with the banking account system. The tech community often looks at the speed of payment in isolation during innovation, neglecting the connection to economic operations behind payments, leading to a separation between the virtual and real worlds. The emergence of stablecoins aims to bridge this gap between the virtual world and the real world, with the purpose of issuing stablecoins to gain benefits in the form of fiat currency. If the RMB stablecoin can resolve its connection with the banking account system from the outset through institutional arrangements, it will not only be more competitive but also easier to regulate.
Seventh, the competition of international currencies is a competition of national comprehensive strength and credibility. A certain payment settlement method or technological application of a currency may facilitate the use of that currency, but will not play a decisive role in its competition. Once the credibility of the U.S. dollar collapses, stablecoins pegged to the dollar will not save it. However, as long as the dollar remains the main international reserve currency and transaction currency, the widespread use of dollar stablecoins for payment settlements in an internationalized emerging economic field is a normal phenomenon. If China issues a stablecoin pegged to the renminbi, its primary purpose should not be to compete with dollar stablecoins, but to serve the development of emerging economies and the internationalization of the renminbi.
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What is the key to the success of stablecoins?
Author: Liu Xiaochun, Vice President of Shanghai New Finance Research Institute
Source: Caijing
On May 21, the Hong Kong Legislative Council passed the "Stablecoin Regulation Bill," nearly simultaneously, on May 20, U.S. time, the U.S. Senate passed the "Stablecoin Uniform Standards Protection Act" (GENIUS).
In no time, the crypto community was buzzing with various comments. However, most commentators did not conduct a specific study of the two legal documents, and some, for various reasons, confused concepts such as stablecoins, cryptocurrencies, and crypto assets, which misled people’s understanding of stablecoins. Therefore, it is necessary to provide a brief and specific analysis of the two legal documents and, based on this, analyze the demands of the relevant parties.
As a new type of financial product, stablecoins inevitably have their functions and roles, but the relevant parties involved in the innovation also inevitably have their economic demands. Whether these demands can be met is the key to the ultimate success of the financial product. Different issuance methods and regulatory approaches for stablecoins will also have varying impacts on the future development, currency circulation, and monetary policy of stablecoins.
I. Analysis of the Stablecoin Regulation Draft in Hong Kong, China
The "draft" provides a clear definition of stablecoins, consisting of five points.
The first point is relatively simple, which is the presentation form of stablecoins: "expressed in terms of valuation units or storage forms of economic value." For example, the Hong Kong dollar stablecoin must clearly indicate that it is a stablecoin of the Hong Kong dollar and the face value in Hong Kong dollars.
The second article clearly limits the applicable scope of stablecoins: payment for goods or services; debt settlement; investment and trading. In other words, the HKD stablecoin is a means of payment, not an asset for investment or speculation. The term "trading" here should consider that Hong Kong, as an open economy, will have exchanges between local currency and foreign currencies in its monetary circulation, and the HKD stablecoin can also be exchanged with foreign currencies in circulation.
The third article clarifies the storage and transfer methods of stablecoins: they can be done electronically.
Article 4 further clarifies that operations are to be conducted "on a distributed ledger or similar information storage repository." These two provisions can be said to limit the application field of stablecoins, meaning that stablecoins can only be digital and can only operate and circulate online.
Article 5 clarifies the value basis for stablecoins: a single asset; a group or a basket of assets. In the case of Hong Kong stablecoins, the anchored assets are primarily in Hong Kong dollars, and the reserve assets must be of high quality, highly liquid, and low-risk.
The "draft" has made some specific provisions regarding stablecoin regulation. Firstly, the issuers of stablecoins must be "companies", that is, profit-making commercial institutions. This time, Hong Kong has specifically stipulated that recognized institutions outside Hong Kong can also issue stablecoins pegged to the Hong Kong dollar, but they must be subject to the supervision of the Hong Kong Monetary Authority. Secondly, there are capital requirements, with a minimum of 25 million Hong Kong dollars or other approved equivalent amounts of currency, meaning that the capital must be sufficient monetary funds.
The third requirement for the underlying assets of stablecoins is: (1) The market value of the reserve assets must always be greater than or equal to the face value of the unreleased stablecoins; (2) The reserve assets must be isolated from the company's other funds, meaning that the reserve assets can only be used for the redemption of stablecoins and cannot be used for other business activities of the company; (3) The reserve assets must be high-quality, highly liquid, and low-risk assets; (4) The reserve assets must undergo regular risk management and asset audits; (5) Details of the reserve assets must be disclosed to the public, and the level of detail disclosed must meet audit requirements.
The fourth is the risk management requirements. (1) Stablecoin issuers must promptly meet the redemption requests of holders and may not impose excessively strict conditions, but reasonable fees can be charged; (2) Issuers must establish KYC and AML systems that comply with the Hong Kong government's requirements; (3) Establish information security management, anti-fraud, and other regulatory requirements that meet the Hong Kong government's standards; (4) Establish reasonable user complaint reporting channels and violation mechanisms. All these regulations indicate that even if the Hong Kong dollar stablecoin uses distributed accounts to conduct peer-to-peer cross-border payments on the blockchain, it cannot evade regulation.
The fifth point is the requirements for the positions of the CEO, directors, and stablecoin managers of the applicant issuing stablecoins, which are the same as the qualifications for senior executives of exchanges set by the Securities Regulatory Commission. The sixth point is that stablecoin issuers must publish a white paper to provide the public with comprehensive information about the stablecoin.
Finally, there are other conditions. (1) Licensees may not pay or allow the payment of interest on stablecoins. This is to prevent stablecoins from effectively becoming deposits or investment assets, and also to prevent licensees from deviating from the operational track of stablecoins as payment tools; (2) Licensees may only operate stablecoin businesses and may not engage in other businesses beyond their license. This further restricts the operational scope of stablecoin issuers (licensees), allowing them to only issue and redeem Hong Kong dollar stablecoins, and to ensure the smooth, safe, and compliant circulation of stablecoin payments.
In summary, Hong Kong hopes to provide an innovative payment tool for new economic fields such as WEB3 and cryptocurrency trading, without causing risk shocks to the existing system. This is a new type of payment tool, not an asset to be invested in; it is a regulated payment tool that emphasizes information security but does not allow for regulatory evasion.
II. Analysis of the U.S. Stablecoin Uniform Standards Protection Act
The regulatory logic of the "bill" in the United States and the "draft" in Hong Kong is generally not very different, but each has its own characteristics.
The similarities between the "Bill" and the "Draft": First, both are assets anchored to a fiat currency (the US dollar) for payment and settlement. Second, stablecoins must be 100% backed by US dollars or high-quality assets (such as US Treasury bonds). Third, issuers are required to disclose reserve asset reports monthly and undergo third-party audits. Fourth, they must comply with anti-money laundering and counter-terrorism financing requirements, with issuing institutions falling under the purview of the Bank Secrecy Act, requiring them to fulfill obligations such as KYC and reporting suspicious transactions. Fifth, it is prohibited to pay interest or returns on stablecoin. Sixth, the "Bill" grants the Secretary of the Treasury and the newly established "Stablecoin Certification Review Committee" regulatory powers to strengthen oversight of foreign stablecoin issuers.
The main difference between a "bill" and a "draft" is the regulatory framework. Hong Kong has a single-tier regulation, while the U.S. regulatory framework is divided into two tiers: issuers of stablecoins with a market capitalization exceeding $10 billion must comply with federal regulation; issuers with a market capitalization below $10 billion may choose state-level regulation but must meet federal minimum standards.
In addition, there are some differences in details, such as the United States having clearer requirements for the types of reserve assets for stablecoins, while Hong Kong only requires the nature of reserve assets, leaving some room for exploration.
Overall, both Hong Kong and the United States have legalized fiat-backed stablecoins and incorporated them into regulatory frameworks, providing new settlement tools for emerging economic sectors while preventing such innovative settlement tools from having a negative impact on sovereign currencies and financial markets. The key is to clarify the nature of stablecoins, that is, fiat-backed stablecoins are payment settlement tools, which should be strictly distinguished from securities tokens, and to strengthen the regulation of reserve assets and information disclosure, as well as to enhance requirements for anti-money laundering and counter-terrorism financing.
3. Bank Drafts and Stablecoins
From the legal documents regarding stablecoins in Hong Kong and the United States, the rules for the issuance and management of stablecoins are basically the same as those for bank promissory notes, and there are also some similarities with authorized currency issuance.
Three note-issuing banks in Hong Kong must deposit an equivalent amount of US dollars into the Monetary Authority to obtain a deposit certificate from the Monetary Authority before issuing Hong Kong dollars. This means that the note-issuing banks must have a 100% reserve of US dollars to ensure they can meet the demands of Hong Kong dollar holders for equivalent US dollars at any time.
The basic rules of a bank draft are as follows: A customer exchanges an equivalent amount of currency with the bank for a draft of the same amount. The holder of the draft can use it to pay for goods or services, repay debts, or exchange it for cash at other banks. When the final holder requests payment from the issuing bank, the bank pays the equivalent amount of currency equal to the face value of the draft upon presentation.
In fact, the original banknotes were created this way, and the notes from money shops also follow this rule. It can be said that fiat stablecoins are a type of currency under the conditions of fiat currency.
The emergence of promissory notes is due to the same reason as the emergence of paper currency and bonds, which is that carrying physical cash over long distances is heavy and unsafe. Now that electronic payments are widespread, the environment for using bank promissory notes has basically vanished, making them hard to find.
The invention and popularization of paper is a prerequisite for the emergence of banknotes, promissory notes, and bonds, but the fundamental issue of application demand is that physical currency is inconvenient and unsafe for long-distance carrying. Cryptographic code technology is the technological prerequisite for stablecoins and crypto-assets. So, what are the specific application demands for stablecoins as payment tools and currency-like instruments?
Years ago, JPMorgan Chase issued JPM Coin, with issuance rules similar to stablecoins and bank notes. As the most important US dollar clearing bank, JPMorgan Chase intended to strengthen its leading position in cross-border US dollar clearing, but over the years, it has not found applicable scenarios in interbank cross-border clearing. In recent years, JPMorgan Chase has begun to collaborate with other institutions to explore some alternative application scenarios, seemingly making progress. However, whether it can ultimately achieve commercial application remains to be seen.
In addition, the model of Western Union remittance is quite similar to that of a money order. Customers hand over the currency at any Western Union outlet, and the outlet provides the customer with a remittance receipt. The customer can keep the receipt or transfer it to someone else. The holder of the receipt can present it at any Western Union outlet in the world to obtain the remittance. A stablecoin is a certificate that can be redeemed for an equivalent amount of fiat currency.
The above are all historical payment tools. As payment tools, they share common characteristics. On one hand, the reasons and processes for the emergence of payment tools are quite similar; they all require a clear measure of value and stable value. Whether it is face-to-face payments or cross-space payments, instant payments or deferred payments, they must be safe, convenient, and fast. On the other hand, issuers have the impulse to overissue, which easily leads to risks such as mixed quality and counterfeiting. These risks are not imaginary, nor are they only present under traditional paper currency conditions.
Unfortunately, technology, including blockchain technology and encryption technology, cannot solve the problems of human greed and capital greed. For the United States, the risk of stablecoin runs is real and has already occurred. In May 2022, the dollar-pegged stablecoin TerraUSD experienced a severe run leading to its collapse, ringing alarm bells for regulators. As a result, both the Hong Kong and U.S. legislation have imposed strict and clear requirements on the quantity, quality, and management of stablecoin reserve assets.
4. The Demands of Relevant Parties in Stablecoins
The emergence of anything in human society is driven by demand, and behind that demand are the interests of various stakeholders. Only by meeting the different demands of different stakeholders can a payment tool truly be accepted.
Payment tools, on the surface, only involve the two parties in the transaction. As long as the demand for exchange is met, it is sufficient for the functionality to achieve convenient, safe, fast, and accurate value transfer. However, behind the smooth operation of payment tools lies a complete set of issuance, management, and operation systems, which itself requires significant cost investment. With investment, there will inevitably be a demand for returns. Therefore, stablecoin issuers or investors in stablecoin issuing institutions are the more important stakeholders.
The relevant parties of stablecoins primarily include the payer. First, for the payer, using stablecoins for payment in specific fields or scenarios is quicker, more convenient, and safer than using fiat currency; otherwise, there would be no need to go through the trouble of converting fiat currency on hand into stablecoins. Second, the conversion of fiat currency into stablecoins should be on a 1:1 basis, with no financial cost. Third, the cost of paying with stablecoins should generally be lower than paying with fiat currency, and at the very least, the benefits of transactions made with stablecoins should be greater than those made with fiat currency.
For recipients of stablecoins, first, accepting stablecoins makes transactions easier than accepting fiat currency. Secondly, the received stablecoins must be redeemable 1:1 for fiat currency, meaning there can be no loss of value. Lastly, stablecoins can be used for other payment scenarios that one may need.
The transactions mentioned above that are easier to execute with stablecoins than with fiat currency, or specific trading scenarios, may fall into two categories: first, the digital economy sector supported by emerging digital technologies, where due to technical reasons, fiat currencies are currently difficult to support payments in this area, or even if payments can be made, the efficiency and cost are not economical; second, transactions that are currently prohibited or restricted by law. Therefore, the legislation in Hong Kong and the United States has regulatory requirements for anti-money laundering, anti-terrorism financing, and so on.
The issuer of stablecoins incurs huge costs in the issuance, management, and operation of stablecoins, and without reasonable returns, there is no need for investment. For the issuers, the most direct and crude profit is the direct issuance of stablecoins or even currency without reserves, followed by the issuance of stablecoins with over-reserves. Such phenomena have always existed in the history of currency and payment, leading to crises of varying magnitudes.
Secondly, there are fees for stablecoin exchanges, which include fees charged for cashing out stablecoins issued by oneself, as well as fees charged for exchanging other stablecoins. This is a very conventional fee under the conditions of metallic currency, paper money, and paper bank notes, as different metallic currencies have different purities and values, and there is a certain physical distance between the final holder of the notes and the issuer. During the process of cashing out the value from the issuer, certain costs are incurred, and there is even a risk of being unable to cash out.
However, under online conditions such as blockchain, whether stablecoin holders are willing to pay exchange transaction fees still depends on market dynamics. The "draft" in Hong Kong takes this issue into account and allows for reasonable fees to be charged during the redemption process.
The third possible source of income is to utilize the funds obtained from issuing stablecoins for various investments to generate returns. Historically, there have been countless painful lessons in this regard. The lighter cases involve liquidity crises caused by large investment scales and long durations affecting the redemption of stablecoins, while the more severe cases result from investment failures leading to an inability to redeem stablecoins. Therefore, the "bills" in Hong Kong and the United States impose strict regulations on the types of reserve assets and require that stablecoin operations and reserve assets be strictly isolated from the issuer's other businesses and assets, essentially limiting the issuer's investments.
Under such constraints, the issuer's main source of income may be the investment in high-quality, highly liquid assets such as government bonds. Since the yield on such assets is relatively low, the issuer will inevitably pursue economies of scale. However, although government bonds are liquid, they are ultimately not the legal currency itself, and excessive investment will also affect the liquidity of stablecoin redemption. Further, it remains to be seen what specific regulations the regulators will impose on the structure of stablecoin reserve assets.
Unlike physical payment tools such as paper money, stablecoins and other cryptocurrencies require a series of technologies to support uninterrupted network operations. While physical payment tools may not be very efficient, they do not have such conditional constraints. Therefore, technology companies related to these technological supports are also stakeholders in stablecoins. These technology support institutions may be the same as the stablecoin issuing institutions or they may be different entities, and they also need to share in the benefits during the issuance and operation of stablecoins.
In addition, governments and regulatory agencies are also stakeholders in stablecoins, and their demands are: to promote economic growth, maintain the stability of fiat currencies, and ensure the safety of financial operations.
The ability to satisfactorily meet the demands of all relevant stakeholders is a fundamental factor in the success of stablecoins, while the advantages offered by technology in the payment process are of secondary importance. The outcome of the various parties' negotiations may result in stablecoins being widely used, or it may lead to different stablecoins being used within their respective limited domains, thus becoming specialized stablecoins. There is also the possibility of being replaced by central bank digital currencies. Unless the current national structures change, stablecoins can never fully replace fiat currencies.
At present, stablecoins as payment tools mainly play a role in certain specific areas of the digital economy, but their application scope is constantly expanding. On one hand, the digital economy is the future direction of development; on the other hand, the scale of stablecoin applications has become large enough to impact the stability of the financial system. Therefore, from both the perspective of inclusive innovation and the perspective of maintaining financial stability, it is time to implement regulatory management.
5. Stablecoins and Monetary Policy and Currency Circulation Management
As a payment tool, stablecoins pegged to fiat currency are a type of currency that effectively circulates as money. If the issuer uses all the fiat currency obtained from issuing stablecoins to provide loans, it is equivalent to injecting an equivalent amount of currency into the market.
If, according to the requirements of the laws in Hong Kong and the United States, part of the fiat currency obtained from issuing stablecoins can be used to purchase high-quality assets such as government bonds, then it would mean an increase in the supply of money in the market. If all the obtained fiat currency is used as reserve assets without any investments, it will not increase the money supply.
However, if the reserve assets of stablecoins must be held by a third party, it will depend on the regulatory requirements for third-party custodians. If the custodians are required to guarantee that 100% of the reserve assets can be redeemed at any time, it will not increase the money supply; otherwise, it will also increase the money supply.
An effective payment tool will inject vitality into economic operations and also have a significant impact on the money supply. Therefore, the issuance scale and regulatory model of stablecoins must become factors to consider in the formulation of monetary policy.
Stablecoins are based on distributed ledger systems and represent a disintermediated payment method that may have completely different circulation rules compared to cash in traditional circulation. In today’s era of electronic, networked, and digitized bank account systems, cash in circulation is more about personal offline payments, with small single transaction amounts, low frequency, and dispersed usage. Stablecoins are mainly applied in virtual economic fields such as WEB3 and DeFi, where both institutions and individual investors coexist, with large single transaction amounts and high trading frequencies. Although they are distributed and can be used for peer-to-peer payments, most of the transactions are still for trading virtual assets or cryptocurrency assets on exchanges or platforms, aside from payments aimed at value transfer.
As a stablecoin issuer, it remains to be seen whether anti-money laundering, anti-terrorism financing, and KYC measures are implemented only during the issuance and redemption of stablecoins, or whether they must also be applied to the trading behavior of stablecoin holders. Currently, neither the "bill" in Hong Kong nor that in the United States has provided clear guidance.
Cross-border payments are currently a hotspot and selling point in the exploration of stablecoins. Direct payments between the payer and payee are certainly more straightforward and efficient than remittances through intermediaries like banks. However, payment is just one part of the operations of market entities; ultimately, it is to obtain returns that are denominated in and reflected by fiat currency. Therefore, stablecoins must eventually be converted back to fiat currency and deposited into bank accounts to earn interest income. Moreover, the exchange of different currencies in cross-border payments cannot be resolved by stablecoins; it still needs to be achieved through the banking clearing system.
It can be seen that the true success of stablecoins does not lie in separating from the banking system, but rather in efficiently and seamlessly integrating with it. Moreover, the issuance of stablecoins by the issuing organizations, the acceptance of fiat currency, the investment in bonds and other reserve assets with fiat currency, and the redemption of stablecoins with fiat currency must all be realized through bank accounts. This is also a concern for currency circulation management and stablecoin regulation, and currently, there is no clear arrangement in the "bills" in Hong Kong and the United States regarding this.
Historically, there have been instances where banks could issue currency. In the United States during the 1840s and 1850s, there were over 8,370 different currencies circulating in the market simultaneously, which can only be imagined as inefficient and chaotic. If stablecoin issuing institutions only issue and apply stablecoins in limited specific areas, with a slight overlap in application among various stablecoins in the market, then it is not a problem for multiple institutions to issue stablecoins; however, if all stablecoins circulate throughout the entire market, it will inevitably lead to some chaos and inefficiency. If such a phenomenon occurs, both the market and regulation will choose moderate centralization. Therefore, the development model and scale of stablecoins after legalization still need to be tested by the market and regulation.
Six Suggestions for China
First, adhere to the principle of technological neutrality and encourage the innovative application of various technologies in the financial sector. Blockchain and cryptographic technology have already seen some successful applications in finance, such as the green bonds issued in Hong Kong. In areas like virtual asset trading and DeFi, various cryptocurrencies have demonstrated excellent applications in payment and settlement. Although many transactions in these fields are gray market transactions or even illegal transactions that are not recognized by existing laws, this does not negate the feasibility of cryptocurrency technology in payment and settlement functions. Cryptocurrency technology can certainly play a role in legitimate trading.
Secondly, stablecoins are a product of real demand. From the existing applications of stablecoins, demand comes from two categories. First, emerging economic sectors, such as virtual asset trading and on-chain transactions, where the current fiat currency payment and settlement methods cannot meet the payment and settlement needs of these types of transactions; second, some gray and illegal transactions, such as illegal asset transfers, which use stablecoins and other cryptocurrencies to evade regulation. Emerging sectors may also include legitimate transactions as well as gray or illegal transactions. As long as illegal transactions can be effectively identified, corresponding regulatory methods can be found.
Thirdly, the legislation on stablecoins is not only a necessity for innovation but also for financial security. The "bills" in Hong Kong and the United States are a response to innovation and a precaution against the risks it brings. The innovation of stablecoins as a payment tool aims to promote the development of emerging economic forms, such as virtual asset trading, and the issuance of stablecoins is not the end goal in itself. At the same time, due to the dual nature of payment tools, legislative regulation is necessary to prevent risks.
What is particularly noteworthy in this regard is that both Hong Kong and the United States have included foreign currency-pegged stablecoins within their regulatory scope. The reason is that foreign currency-pegged stablecoins, if not effectively regulated, could similarly pose a risk to the domestic currency system.
With the internationalization of the Renminbi, as long as there is demand, stablecoins pegged to the Renminbi will inevitably emerge abroad, and the Chinese financial system will inevitably face the risk shocks they may bring. It is necessary to formulate regulations to prevent this. As equivalents, stablecoins do not differentiate between offshore and onshore, but from a regulatory perspective, the scope of use for different issuers or different stablecoins can be limited.
Fourth, there are no substantial regulatory obstacles to China's issuance of RMB stablecoins. Stripped of the technical coat, stablecoins have the same rules as cashier's checks. Paper cash can be digitized, paper bills can be electronic, paper cashier's checks are also bills, and of course they can also be on-chain. Two options can be considered: one is to incorporate RMB stablecoins into the current bank bill management system; Second, considering that the current application field of stablecoins has certain particularities, refer to Hong Kong and the United States to formulate separate regulations for stablecoins. For the sake of prudence, the scope of application of stablecoins can be limited initially.
Fifth, the issuance of the renminbi stablecoin can create more suitable application scenarios for the digital renminbi. Technically, stablecoins and central bank digital currencies are the same, so why do stablecoins still exist? One reason is that some participants internationally seek to evade regulation, but more critically, the mechanisms are different, and the motivation for exploring and innovating application scenarios varies.
Central bank digital currency is issued by the central bank and leads the expansion of application scenarios, while commercial banks have a lower motivation to actively expand application scenarios due to the lack of a sustainable commercialization return mechanism. Stablecoins are issued by commercial entities, and there are commercial interests in issuing stablecoins, so they will inevitably do their best to explore application scenarios.
At the same time, due to the high compatibility between application scenarios and the characteristics of stablecoins, the trading frequency in application scenarios will increase on one hand, while system maintenance will also be relatively easy and low-cost on the other hand. The scenarios where stablecoins can be successfully applied are inevitably the scenarios applicable to central bank digital currencies. Therefore, the issuance of the RMB stablecoin actually helps promote the application of the digital RMB.
Sixth, to innovate and build a payment system for the RMB stablecoin that seamlessly integrates with the banking account system. The tech community often looks at the speed of payment in isolation during innovation, neglecting the connection to economic operations behind payments, leading to a separation between the virtual and real worlds. The emergence of stablecoins aims to bridge this gap between the virtual world and the real world, with the purpose of issuing stablecoins to gain benefits in the form of fiat currency. If the RMB stablecoin can resolve its connection with the banking account system from the outset through institutional arrangements, it will not only be more competitive but also easier to regulate.
Seventh, the competition of international currencies is a competition of national comprehensive strength and credibility. A certain payment settlement method or technological application of a currency may facilitate the use of that currency, but will not play a decisive role in its competition. Once the credibility of the U.S. dollar collapses, stablecoins pegged to the dollar will not save it. However, as long as the dollar remains the main international reserve currency and transaction currency, the widespread use of dollar stablecoins for payment settlements in an internationalized emerging economic field is a normal phenomenon. If China issues a stablecoin pegged to the renminbi, its primary purpose should not be to compete with dollar stablecoins, but to serve the development of emerging economies and the internationalization of the renminbi.