Stablecoins – Regulating issuers to accord protection to users

1. Today, the Financial Services and the Treasury Bureau (“FSTB”) and the HKMA jointly issued a public consultation paper on the legislative proposal for implementing the regulatory regime for stablecoin issuers in Hong Kong, inviting feedback from the public and stakeholders. This represents our latest efforts in facilitating the healthy and sustainable development of the virtual asset ecosystem in Hong Kong.  You may refer to the consultation paper for details of the legislative proposal.  In the meantime, I would like to take this opportunity to talk about what stablecoins are, as well as why and how we plan to regulate stablecoin issuers.

Virtual assets and stablecoins

2. Virtual assets, often referred to as crypto-assets, are digital representations of value that are cryptographically secured, typically through the use of distributed ledger technology (DLT), like blockchain. The clear growth potential of virtual assets as an innovative technology has mostly been overshadowed by their price volatility, notably its rapid growth during the Covid-19 pandemic and subsequent collapse after a series of market events since early 2022, which hampered market confidence.
3. While price volatility is not uncommon for less mature markets, excessive price volatility would inevitably stall the otherwise healthy growth in the longer run. In fact, the extreme volatility had led to market frictions and fragmentation during the early days of virtual asset development.  Imagine the almost impossible challenge to agree on a trading price between two volatile virtual assets in the absence of a stable settlement asset, and more importantly, to develop a market with sufficient liquidity.  The lack of liquidity would in turn further distort the price discovery process.
4. The emergence of stablecoins is in part an attempt to solve these problems. Over time, stablecoins have gradually become one of the major settlement assets for transactions on blockchain.  Simply put, stablecoins can generally be seen as a virtual asset that aims to maintain a stable value with reference to certain asset(s), typically fiat currencies.  One can exchange fiat currency with a stablecoin issuer in return for stablecoins of the same value, or redeem the stablecoins for fiat currency of the same value.  These tokens with stable value on blockchain could help mitigate the abovementioned issues, which could in turn improve the overall efficiency of “on-chain” transactions.
5. As a type of private medium of exchange, stablecoins are not an entirely new concept. Prior to the enactment of the Currency Ordinance¹ by the Hong Kong Government in 1935, banknotes were issued by the then note-issuing banks to the public in exchange for deposited silver.  The banks were obliged to redeem the banknotes upon demand by paying the bearer the corresponding amount of silver.  These “silver tokens” served as a form of “private money” at that time.

Potential use cases and risks of stablecoins

6. Among the different possible use cases, there have been explorations on the potential use of stablecoins as a medium of exchange in the real economy, for instance, cross-border payments. With the use of DLT, payment and settlement via stablecoins could become more efficient and transparent, and with enhanced certainty due to the immutability of transactional data.  When used in conjunction with smart contracts, i.e. programmes that are stored on blockchain, stablecoins could also function as “programmable money” and be used to execute complex transactions.  For example, the transfer of stablecoins from the buyer to the seller could be made conditional upon the delivery of goods or services according to the relevant business contract.
7. In Hong Kong, there are multiple mediums of exchange that have been used extensively over time and proven effective, such as traditional bank deposits and stored value facilities. The HKMA and the banking industry have also been actively exploring the potential use cases of central bank digital currency and tokenised deposits.  An obvious question would be, with all these options, is there really a need for yet another alternative?  We believe the answer lies in the hands of the end users who would ultimately decide which options work best for them.
8. The virtual asset market is still far from maturity and will likely continue to evolve, notwithstanding the multiple cycles it has been through in the past few years. With that, stablecoins could become the interface between traditional finance and the virtual asset market.  In a scenario where stablecoins become one of the preferred payment options by the general public, we should reasonably expect further integration between the digital payment ecosystem and the real economy, and whether the stablecoin is indeed “stable” will then become ever more important.  In the absence of regulation, users may not be adequately protected, and the stability of our financial system could also be adversely affected. 
9. From the users’ perspective, they could suffer financial losses and disruption in their supposedly smooth daily payment routines if stablecoin issuers fail to maintain adequate reserve assets to uphold the stable value of the stablecoin, or redeem the stablecoin at par value within a reasonable timeframe, which would then cause undue disturbance to economic activities. Furthermore, there could potentially be financial stability risks if stablecoin issuers have to liquidate reserve assets at scale in order to fulfill redemption demands.

Formulation of a regulatory regime

10. In response to the potential risks of stablecoins, international bodies, including the Financial Stability Board under the G20, have already set out clear recommendations requiring member jurisdictions to formulate and implement a regulatory regime for crypto asset activities, including stablecoin issuance. In line with the international standards and practices, Hong Kong should put in place a regulatory regime, taking into account local circumstances, to ensure that stablecoins can live up to its name. 
11. Under our proposed regime, an issuer would be required to obtain a licence from the HKMA if it issues a stablecoin that references the value of one or more fiat currencies (“fiat-referenced stablecoin”) in Hong Kong. A licensee has to be locally incorporated with management presence, and fulfil certain financial resources requirements.  It would be required to put in place an effective stabilisation mechanism, such as maintaining a pool of high-quality and highly-liquid reserve assets (e.g. bank deposit in matching currencies, short-term debt securities) with proper custody arrangement, with a view to ensuring that users would be able to redeem the stablecoins for fiat currency at par should they wish to.  The licensee would also need to comply with relevant governance, risk management and AML/CFT measures.  We also intend to put in place necessary guardrails for entities other than the stablecoin issuers who would like to offer or distribute stablecoins.  In particular, only stablecoins issued by licensed issuers could be offered to retail investors. 
12. In an ever-changing market, it would be important to keep abreast of the latest developments, as well as to put in place a regulatory regime that strikes a good balance between safeguarding financial stability and embracing innovation. With this in mind, the HKMA plans to roll out a “sandbox” to facilitate the communication of our supervisory expectations with entities that are interested in issuing stablecoins in Hong Kong.  The details of the sandbox arrangement will soon be announced separately.
13. In the meantime, we welcome feedback from the public and stakeholders on the proposed regulatory regime. We will duly consider the feedback received, continue engaging different stakeholders, and monitor market development as well as international discussion when formulating the regulatory regime.

Eddie Yue
Chief Executive
Hong Kong Monetary Authority

27 December 2023