Why is Hong Kong regulating and licensing stablecoins?

The Hindu

a day ago

The story so far: Hong Kong is taking a decisive step forward in regulating certain types of cryptocurrencies, as it prepares to enforce the Stablecoins Ordinance from August 1. The new regulations come amidst an explosion of interest in stablecoins and their promising applications in both personal finance and international business. While crypto users who support official regulation are excited, the authorities have advised caution.
What is the new stablecoin licensing system in Hong Kong?
The Hong Kong Monetary Authority announced that the Stablecoins Ordinance will come into effect on 1 August this year. This means it will be illegal for people to 'offer any unlicensed fiat-referenced stablecoin (FRS) to a retail investor, or actively market the issue of unlicensed FRS to the public of Hong Kong,' according to Eddie Yue, Chief Executive of the HKMA.
Furthermore, companies that want to legally issue stablecoins to users in Hong Kong will have to obtain a licence from the Monetary Authority as well as meet set requirements when it comes to managing reserve assets and redemption, asset stabilisation, and processing user requests. In addition to this, they will have to comply with the applicable regulations that prevent money laundering and terrorist financing, thus making sure that their assets are properly disclosed and audited.
The HKMA warned that the regulations are not a red carpet for interested parties to begin issuing stablecoins, and that in the beginning it would 'at most grant a handful of stablecoin issuer licences. In other words, a large number of applicants will be disappointed,' per Mr. Yue in an official statement.
What are stablecoins?
Stablecoins are a class of cryptocurrencies, with their values linked to assets. Unlike better known cryptocurrency coins such as Bitcoin (BTC) and Ether (ETH) or even tokens such as Shiba Inu (SHIB), whose values can wildly rise and fall due to investor sentiments and other factors, stablecoins are designed to maintain relatively steady prices. Hence, their name.
This so-called stability is achieved through the process of 'pegging' the stablecoin to an asset such as fiat currency (like U.S. Dollars, EU Euros, Hong Kong Dollars, etc.), a commodity (like gold), other cryptocurrencies (such as Bitcoin), by regulating their value via computer algorithms, or by mixing multiple strategies. While the price of Bitcoin might rise or fall in the coming years, a USD-pegged stablecoin should ideally remain around $1.
Stablecoins are different from CBDCs, or Central Bank Digital Currencies, which are digital currencies officially issued and controlled by a government's central bank. Meanwhile, stablecoins can be privately issued and can also be pegged to foreign currencies.
Why do stablecoins require regulation?
Stablecoins play an important role both within and outside the crypto ecosystem, even if they might not balloon in price like Bitcoin. Crypto investors often use stablecoins to facilitate easy trading on crypto exchanges. Others around the world have used stablecoins to maintain the value of their savings when their native currencies are depreciating, or to save money on cross-border transactions. Argentina, Turkey, and even Taliban-occupied Afghanistan are some places where stablecoins are not just for trading, but a way to make daily life possible.
The numbers tell a compelling story as well. Tether (USDT), the fourth largest cryptocurrency by market capitalisation and the largest stablecoin, per CoinMarketCap, has a circulating supply of 163.75 billion USDT. Meanwhile, more than $250 billion worth of stablecoins are estimated to be in circulation worldwide.
Naturally, more governments are concerned about whether the highly engineered use of stablecoins could one day affect the value of the original fiat currencies or commodities backing them up. Furthermore, what is the guarantee that every stablecoin pegged to the dollar, euro, pound, or peso is actually backed up by its issuer? Currently, it is largely up to stablecoin users to audit their issuers' reserves and make sure that their stablecoins are adequately backed. When a stablecoin issuer suddenly adds millions of dollars in assets, it naturally raises questions about where the money to back this is coming from, or whether it really exists. This is where regulation comes in.
Do stablecoins exhibit volatility despite being pegged to currencies?
Despite their name and their backing, stablecoins can also exhibit volatility. In response to both technical factors and world events, stablecoins sometimes come unpegged and their prices may rise or fall beyond the usual range, with sudden drops triggering panic amongst investors. For example, USDT, which is pegged to the U.S. Dollar, has in the past fallen to prices as low as around $0.92.
Stablecoins have also collapsed entirely. In May 2022, Terra's cryptocurrency LUNA and its linked algorithmic stablecoin UST both lost most of their value in a matter of hours. Panicking investors who no longer trusted these assets quickly sold them off to minimise losses, and the prices fell close to zero. Billions of dollars were wiped from the crypto sector and the ensuing liquidity crunch triggered asset freezes across global crypto exchanges and fintech platforms.
Have other countries started to regulate stablecoins?
U.S. President Donald Trump in July signed the GENIUS Act that is designed to regulate stablecoins and protect the U.S. dollar, much to the joy of his pro-crypto supporters.
Per the White House, the GENIUS Act requires 100% reserve backing with liquid assets like U.S. dollars or short-term Treasuries for stablecoins. Those issuing this asset will also have to make monthly, public disclosures of the composition of their reserves, apart from complying with marketing rules.
Other countries that have started to regulate stablecoins include Japan and Singapore, per AFP, while multiple other jurisdictions have more generic regulations that cover stablecoins along with other cryptocurrencies.
Though the Chinese government heavily restricts crypto-related activities in its jurisdiction, some of the country's tech giants hope that Hong Kong's upcoming regulatory regime will provide an outlet for their own stablecoin ventures.