Author: TaxDAO
1.1 Definition of Stablecoin
Stablecoin is a special asset in the cryptocurrency market. Its main feature is to link its value to legal tender or other assets, thereby maintaining its relatively stable value. The Bank for International Settlements (BIS) defines it as "a cryptocurrency whose value is linked to legal tender or other assets". Unlike traditional cryptocurrencies (such as Bitcoin), stablecoins aim to avoid drastic price fluctuations by anchoring to legal tender or other assets. The birth of stablecoins provides a relatively stable value carrier for the cryptocurrency market, especially in the field of decentralized finance (DeFi). Its wide application has brought liquidity and stability to scenarios such as on-chain transactions and lending.
Stablecoins can be roughly divided into three types according to their anchoring mechanism:
Fiat-collateralized stablecoins: such as USDT and USDC, which use fiat currencies such as the US dollar as collateral to maintain a 1:1 exchange relationship with the US dollar.
Crypto-collateralized stablecoins: such as DAI, which ensure stability through over-collateralized crypto assets.
Algorithmic stablecoins: such as Ampleforth, which automatically adjust the supply to maintain price stability.
The rapid development of stablecoins around the world has shown its huge potential in payment, cross-border transactions and financial instruments. As of 2024, the market value of stablecoins has exceeded 300 billion US dollars, and the trading volume has reached tens of billions of US dollars per day. Among them, USDT (Tether), as the world's most popular stablecoin, accounts for nearly 70% of all stablecoins in market value, becoming the absolute leader in the stablecoin market.
1.2 International Stablecoin Regulatory Background
Internationally, the regulation of stablecoins is becoming increasingly strict. In 2021, the US Treasury Department publicly called for strong regulation of stablecoins, emphasizing the systemic risks they pose in the payment system. Europe and the United Kingdom have also gradually promoted the regulatory framework of stablecoins to ensure their compliance and financial security. At the same time, many countries have also begun to study the launch of central bank digital currencies (CBDCs), which to a certain extent compete with stablecoins, but the roles and usage scenarios of the two are different. In emerging markets such as Southeast Asia and the Middle East, stablecoins have brought new opportunities for cross-border payments and financial inclusion. Many people without bank accounts participate in global financial markets through stablecoins, which has improved economic liquidity in these regions. 1.3 Regulatory Background of Stablecoins in Mainland China and Hong Kong, China The Chinese government is relatively cautious about stablecoins. The People's Bank of China has emphasized its strict regulatory attitude towards virtual currencies since 2017, and further strengthened its crackdown on cryptocurrency trading and mining in 2021. Although the People's Bank of China has been promoting the application of digital RMB (e-CNY), its attitude towards overseas stablecoins remains strict. Stablecoins are believed to be likely to affect China's monetary sovereignty and financial security. Therefore, when considering cross-border payments, it is more inclined to promote the government-led digital RMB.
As a special administrative region, Hong Kong has adopted a different regulatory strategy than the mainland, and is more inclined to provide a certain amount of innovation space for virtual assets. Its relatively loose virtual asset regulation has attracted a large number of crypto companies and innovative projects. This year, JD.com's subsidiary also joined Hong Kong's regulatory sandbox, which shows the interest and trust of mainland companies in Hong Kong's virtual asset policies. In fact, as early as 2018, Hong Kong began to gradually introduce regulatory policies on virtual assets; in 2019, the Hong Kong Securities and Futures Commission (SFC) issued regulations on virtual asset trading platforms and fund management, clarifying the compliance requirements for virtual assets, marking that Hong Kong has entered a new era of virtual asset regulation; in 2023, Hong Kong officially launched the Virtual Asset Service Provider (VASP) licensing system, further clarifying the regulatory framework for virtual asset trading platforms and service providers. The system requires virtual asset service providers to obtain a license to operate legally in Hong Kong, and at the same time sets strict KYC (know your customer) and AML (anti-money laundering) compliance requirements. This article will focus on Hong Kong stablecoins and sort out and analyze their regulatory systems and policies.
Since 2022, Hong Kong has gradually promoted the regulatory framework for the issuance of stablecoins, with the core goal of ensuring the transparency and security of the issuance of stablecoins and laying the foundation for the healthy development of the virtual asset market. The following is a chronological review of the evolution of stablecoin regulation in Hong Kong:
2.1 2022: Preliminary discussion and solicitation of opinions
In January 2022, the Hong Kong Monetary Authority (HKMA) issued the "Discussion Paper on Cryptoassets and Stablecoins". The document points out that with the rapid development of cryptoassets and stablecoins, the existing regulatory framework for payment systems and stored-value payment instruments (such as e-wallets) is no longer sufficient to cover all types of stablecoins. To this end, HKMA proposed the necessity of giving priority to the regulation of payment stablecoins (such as USDT and USDC) pegged to fiat currencies, and excluded the regulatory priority of non-asset collateral types such as algorithmic stablecoins. In the document, HKMA also invited relevant industries to express their opinions and provide feedback on the discussion document before the end of March 2022 as an important basis for the design of the future regulatory framework. 2.2 2023: Gradually clarify the regulatory framework In 2023, HKMA accelerated the promotion of the specific regulatory system for stablecoins. In December, HKMA and the Financial Services and Treasury Bureau (FSTB) jointly issued legislative proposals for the regulation of stablecoin issuers and proposed a specific draft regulatory framework. This framework not only comprehensively regulates the issuance and management of stablecoins, but also refines the requirements for the management of stablecoin reserve assets, corporate governance, risk control, information disclosure, and anti-money laundering and counter-terrorist financing.
Among them, it is particularly noteworthy that the framework regulates reserve assets, requiring all stablecoin issuers to ensure that their stablecoins in circulation are 100% backed by reserve assets and to set up independent accounts to manage these reserve assets. In addition, issuers are required to disclose the reserve status of stablecoins to the public on a regular basis.
2.3 2024: Legislative promotion and public consultation
In 2024, Hong Kong further promoted the legislative process of the stablecoin regulatory framework. In January 2024, HKMA issued a consultation document, proposing more detailed regulatory measures, and for the first time clarified the definition of fiat-referenced stablecoins (FRS) in the document. The value of such stablecoins must be linked to fiat currencies, commodities or other financial assets, and the issuers must be registered in Hong Kong and obtain regulatory licenses.
The document also proposes specific requirements for the licensing of stablecoin issuers, including minimum paid-up capital requirements (such as HK$25 million), and that issuers must establish entities in Hong Kong and ensure that the local management structure meets regulatory requirements. In addition, issuers not registered in Hong Kong must also comply with Hong Kong's regulatory requirements if they want to market their stablecoins to the Hong Kong public. The implementation of this system has gradually made Hong Kong one of the global centers for virtual asset and stablecoin issuance activities.
In order to help emerging stablecoin projects and companies smoothly transition to the new regulatory framework, HKMA has also proposed a regulatory sandbox system for stablecoin issuers. The system allows companies to communicate with HKMA on regulatory requirements before actual issuance, obtain initial guidance and supervision, and thus ensure compliance operations. This measure not only encourages innovation, but also provides flexibility for the compliant development of stablecoins.
Hong Kong's regulatory system for fiat-referenced stablecoins (FRS) is an important policy framework proposed by Hong Kong to ensure the stability, transparency and compliance of the virtual asset market. This regulatory system not only defines what FRS is, but also sets clear applicable objects, applicable conditions and a series of regulatory requirements for its issuance.
3.1 Regulatory Objects and Concepts
In Hong Kong, all entities that issue stablecoins pegged to fiat currencies (such as stablecoins pegged to fiat currencies such as the Hong Kong dollar and the US dollar) need to apply to the HKMA for an issuance license. Even international issuers need to comply with Hong Kong's regulatory requirements as long as (1) their stablecoins are issued in Hong Kong, or (2) are pegged to the Hong Kong dollar, or (3) their products are marketed to the Hong Kong public.
According to Hong Kong's proposal, the definition of FRS includes the following core elements:
Digital value protected by encryption: FRS is a digital value protected by encryption through a distributed ledger or similar technology.
Value stability: FRS needs to be pegged to a fiat currency (or a basket of assets) and maintain a relatively stable value. Products that maintain value through supply and demand mechanisms, such as algorithmic stablecoins, may find it difficult to meet this requirement.
Purpose: FRS needs to be used as a payment tool, investment tool or debt settlement tool.
All types of stablecoins, regardless of whether their stabilization mechanism is based on fiat currency reserves, must comply with this regulatory system as long as they claim to maintain value stability.
3.2 Conditions and regulatory requirements for issuing stablecoins in Hong Kong
The issuance of stablecoins in Hong Kong needs to meet strict regulatory conditions, mainly including the following aspects:
Financial resource requirements: FRS issuers need to have sufficient capital, with a minimum paid-up capital requirement of HK$25 million, which ensures that issuers have sufficient capital buffers when dealing with market fluctuations. In addition, issuers must ensure that the stablecoins in circulation have reserve assets corresponding to their face value, and these assets must be highly liquid and low-risk, and the reserve assets must be independently stored in regulated financial institutions.
Governance and risk management: Issuers must have a sound corporate governance structure to ensure that their internal control and risk management mechanisms are effective. Issuers need to implement annual risk assessments, including technical risks, security controls, anti-fraud measures, etc. In addition, FRS issuers must comply with the requirements of the Anti-Money Laundering and Anti-Terrorism Financing Ordinance to ensure that their systems are able to monitor transactions and prevent financial crimes.
Reserve Asset Management: Issuers need to ensure that all issued stablecoins are backed by sufficient reserve assets, which must correspond to the fiat currency to which the stablecoin is linked, and that reserve assets must be disclosed to the public regularly, including the total amount of stablecoins in circulation and the market value and composition of reserve assets. This measure is intended to ensure transparency and market trust.
Prohibition of interest payments: Hong Kong's FRS regulatory regime prohibits issuers from paying interest to stablecoin holders. This provision is intended to prevent stablecoins from becoming deposit-like products and prevent them from causing an impact on the banking industry.
Localization requirements: All FRS issuers must register their companies in Hong Kong and ensure that their executives and management teams are based in Hong Kong and have the ability to effectively control the stablecoins they issue.
3.3 Specific process for issuing stablecoins in Hong Kong
To issue stablecoins in Hong Kong, the issuer must first apply to the HKMA for a license and meet a series of strict standards, including but not limited to sufficient financial resources, a sound corporate governance structure, and a professional reserve management mechanism. This process requires the issuer to submit a detailed business plan to the HKMA, which should not only outline the issuance plan of the stablecoin, including the target market, issuance scale, expected use, etc., but also include a specific reserve management plan, that is, how to ensure that each unit of stablecoin is backed by corresponding reserve assets, as well as a comprehensive risk management framework to ensure that the value stability of the stablecoin and the security of the system can be maintained under various market conditions.
In addition to submitting a business plan, issuers must ensure that their reserve asset management system and information disclosure system meet the high standards set by the HKMA, which means that the system must not only have a high degree of security and transparency, but also be able to disclose to the public in a timely and accurate manner key information such as the issuance volume of stablecoins and the status of reserve assets, so that investors and other stakeholders can make informed decisions. Once licensed, issuers must also follow ongoing compliance requirements, including submitting detailed operational reports to the HKMA on a regular basis. These reports should cover all aspects of business operations, such as financial performance, the effectiveness of risk management measures, customer protection measures, etc., while ensuring that all operations comply with the requirements of laws and regulations to maintain market fairness and the interests of investors.
There are many challenges in issuing stablecoins in Hong Kong. Capital requirements pose a high threshold for many start-ups. Issuers not only need to hold sufficient funds to support the initial issuance, but also need to ensure that the reserve assets are always consistent with the par value of the issued stablecoins, which may require a large amount of liquidity as support. Secondly, compliance costs cannot be ignored. FRS issuers must comply with a number of strict regulations including anti-money laundering, information disclosure and risk management, which usually means that companies need to invest additional manpower and material resources to establish dedicated compliance teams and systems to ensure the legality and transparency of various operations. For some international issuers, local management is also a big challenge, because companies issuing stablecoins in Hong Kong must set up local entities to ensure that management and key functional teams can operate effectively in Hong Kong, which not only increases the operating costs of the company, but may also bring cultural integration and management difficulties. 3.4 Stablecoin Regulatory Sandbox System On March 12, 2024, HKMA launched an innovative measure called the "Sandbox Program" to provide a pilot environment for entities that intend to issue stablecoins in the Hong Kong market before the relevant legislation officially takes effect. The sandbox program allows participants to test their products and services in a controlled risk environment, while providing regulators with an opportunity to observe and evaluate the operation of these new financial instruments. It not only promotes communication between regulators and the industry, but also lays a solid foundation for the future regulatory framework for stablecoin issuance. To ensure the effectiveness and fairness of the sandbox program, the HKMA does not limit the specific number of participants, but sets strict standards for applicants. Applicants must demonstrate their true intention and reasonable planning to issue legal currency-linked stablecoins in Hong Kong, and have developed specific strategies for participating in the sandbox program. At the same time, they also need to prove their ability to meet the regulatory requirements set out in the consultation document, that is, they need to have a detailed business plan, a professional team based in Hong Kong, and sufficient start-up funds to cover initial operating costs. For companies that wish to join the sandbox program, the application process is relatively straightforward. Applicants can submit the necessary documents to the HKMA through a designated email address, and the HKMA may require additional information to assist in the evaluation. During the review process, the regulator will consider a number of factors, such as the uniqueness of the stablecoin application scenarios proposed by the applicant, the effectiveness of the price stabilization mechanism, the management of reserve assets, and the protection measures for users. Even if the project successfully enters the sandbox arrangement, it does not mean that the project has been officially recognized or regulated by the HKMA or other financial regulators. Once the licensing system for stablecoin issuers is officially implemented, all sandbox participants must resubmit their applications to obtain formal operating licenses. In addition, the sandbox arrangement itself has certain restrictions, such as the user base of participants and the amount of stablecoin issuance may be controlled to ensure that the risk is at an acceptable level. The HKMA also reserves the right to adjust the sandbox rules according to specific circumstances to adapt to the changing market and technological environment. All sandbox participants must obtain the approval of the HKMA before publishing any information about their sandbox status to the public to prevent misleading publicity and protect potential investors from unnecessary risks. On July 18 this year, HKMA announced the list of participants in the "Sandbox" for stablecoin issuers, namely JD CoinChain Technology (Hong Kong) Co., Ltd.; Yuanbi Innovation Technology Co., Ltd.; Standard Chartered Bank (Hong Kong) Co., Ltd., Anni Group Co., Ltd., and Hong Kong Telecom Co., Ltd.
Overall, Hong Kong's FRS regulatory system is forward-looking globally, and its strict reserve requirements and transparency regulations ensure market stability and trust, but for issuers who want to enter the Hong Kong market, they also need to deal with higher capital and compliance costs. Through the sandbox system, companies can get the necessary support and guidance to ensure that their operations meet regulatory requirements.
As an important international financial center, Hong Kong's stablecoin regulatory system provides a robust legal framework for the global cryptocurrency market. Hong Kong's regulatory system emphasizes the management of reserve assets. Through strong supervision, it ensures that all issued stablecoins are 100% backed by reserve assets and that these assets are deposited in regulated financial institutions. For international companies, this means that the issuance of stablecoins in Hong Kong needs to meet high regulatory requirements. For example, all non-Hong Kong issuers who want to bring stablecoins pegged to the Hong Kong dollar to the market or market them in Hong Kong must obtain permission from the HKMA. Non-asset-backed stablecoins such as algorithmic stablecoins may not be issued in Hong Kong because they are difficult to meet regulatory requirements. In addition, Hong Kong's regulatory sandbox system provides companies with a "controlled" environment to help them test their business models and compliance before entering the market, reducing the risks of initial operations. It also provides Hong Kong regulators with the opportunity to establish a closer working relationship with companies, thereby continuously improving their regulatory framework. As a special administrative region of China, Hong Kong's regulatory policies are in sharp contrast to mainland China's cryptocurrency policies. Mainland China has a relatively conservative attitude towards cryptocurrencies, while Hong Kong, with its status as an international financial center and flexible regulatory approach, has become a bridgehead for mainland Chinese companies to experiment with virtual asset businesses. For example, a subsidiary of JD.com has joined Hong Kong's regulatory sandbox to explore innovative applications of stablecoins and other virtual assets. This trend shows that mainland companies are increasingly paying attention to expanding global markets through Hong Kong, and it may also suggest that mainland China may adjust its attitude towards cryptocurrencies in the future. Hong Kong's regulatory system is also expected to provide reference for mainland virtual asset policies. Its transparency, reserve management and risk control requirements in the regulatory framework provide a practical reference for the mainland's future virtual asset regulatory system. For global cryptocurrency companies and investors, Hong Kong's stablecoin regulatory system has created a relatively stable and transparent market environment. Companies issuing stablecoins in Hong Kong must meet high standards of reserve management and compliance requirements, which provides investors with more trust. At the same time, Hong Kong's anti-money laundering (AML) and counter-terrorism financing (CFT) regulations have also made the stablecoin market safer and more reliable, reducing the risks of money laundering and illegal transactions, and helping to enhance the reputation of the entire cryptocurrency market. Hong Kong also provides companies with a flexible market entry route and sandbox system, where companies can test their business models within a limited scope and obtain guidance from regulators, thereby reducing compliance risks. This provides start-ups and small and medium-sized companies with opportunities to enter the market and enhance their competitiveness. Hong Kong's stablecoin regulatory system not only promotes innovation, but also provides security for the market. The implementation of this system will contribute to the long-term healthy development of the stablecoin market and enhance Hong Kong's position in the global crypto asset field. Because stablecoins have strong monetary attributes, other jurisdictions will also increasingly tighten their supervision of stablecoins in the future. The stablecoin regulatory system explored by Hong Kong also provides valuable experience for other jurisdictions.
References
[1]. Overview of Crypto Compliance Licenses: Hong Kong. Web3caff
[2]. Consultation Conclusions on Legislative Proposals for Implementing a Regulatory Regime for Stablecoin Issuers in Hong Kong. HKMA
[3]. Understanding Hong Kong’s Stablecoin Issuer Licensing Regime in One Article. Junfa Legal Review
[4]. HKMA Announces Participants in the Stablecoin Issuer “Sandbox”. HKMA
[5]. Hong Kong Monetary Authority introduces plans to regulate stablecoins. Reed Smith In-depth
[6]. Summary of Discussion Papers on Crypto Assets and Stablecoins. HKMA
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