Author: Virtual Asset Discussion by Jacqueline, Qiao Zheyuan, Zhou Jingbo, Cheng Xiaoyu, Chen Yushi, Shen Luwen, Zhang Lu, Liang Guoqiang, Liao Yuhui, Xiao Xinzhuang, Huang Kaijie, Chen Lu
As a subclass of encrypted assets, stablecoins are gradually gaining more attention. Compared to other encrypted assets, the most significant feature of stablecoins is that they are designed to be pegged to or supported by legal tender and/or other encrypted assets. It is based on this feature that market participants believe stablecoins may be more easily developed into widely accepted payment methods and/or stores of value, and therefore have a higher potential for acceptance by the global mainstream financial system. Consequently, they will have a more direct impact on currency and economic activities. In view of this, the FSB urges financial regulatory authorities to prepare for the regulation of stablecoins, especially global stablecoins that may be more widely used for cross-border payments.
Table of Contents
1. What are encrypted assets and stablecoins
2. Latest developments in the regulation of stablecoins in major countries and regions around the world
- One-minute overview of major events in the NFT field over the past week Google Play allows the use of NFTs in apps and games, and BAYC announces the ApeFest event in Hong Kong.
- Court ruling on XRP shakes the industry. Is it really a security? What will be the follow-up direction?
- XRP Court Ruling Shocks Industry: Is It Really a Security?
3. Conclusion
What are encrypted assets and stablecoins
What are encrypted assets
Since the birth of Bitcoin in 2009, various types of encrypted assets have emerged, such as stablecoins, utility tokens, and non-fungible tokens. The Financial Stability Board (FSB) defines encrypted assets as “private digital assets that primarily rely on cryptographic and distributed ledger technology or similar technologies.”
What are stablecoins
According to the FSB’s definition, stablecoins refer to “encrypted assets that attempt to maintain stable value by being associated with specific assets or asset pools.” The Bank of International Settlements considers stablecoins as “cryptocurrencies that are pegged to or backed by legal tender or other assets.”
As a subclass of encrypted assets, stablecoins are gradually gaining more attention. Compared to other encrypted assets, the most significant feature of stablecoins is that they are designed to be pegged to or supported by legal tender and/or other encrypted assets. It is based on this feature that market participants believe stablecoins may be more easily developed into widely accepted payment methods and/or stores of value, and therefore have a higher potential for acceptance by the global mainstream financial system. Consequently, they will have a more direct impact on currency and economic activities. In view of this, the FSB urges financial regulatory authorities to prepare for the regulation of stablecoins, especially global stablecoins that may be more widely used for cross-border payments.
According to different stabilization mechanisms, the commonly seen stablecoins in the market can be roughly divided into three categories: (1) centralized stablecoins pegged to fiat currencies; (2) collateralized stablecoins backed by over-collateralized cryptographic assets; and (3) algorithmic stablecoins.
1. Centralized Stablecoins Pegged to Fiat Currencies
Stablecoins pegged to fiat currencies (such as USD and GBP) are typically backed by a centralized issuer, who holds the supporting assets in custody or in bank accounts. There is a fixed correspondence between the supporting assets and the stablecoins (e.g., 1 stablecoin corresponds to 1 USD). Stablecoins are created when the supporting assets are sent to the issuer, and an equivalent amount of stablecoins is destroyed when the supporting assets are returned to the redeemers. To ensure the value of stablecoins remains pegged to the supporting assets, centralized issuers usually engage independent accounting firms or audit institutions to regularly verify the supporting assets held in custody. Representative examples of this type of stablecoin include USDT and USDC.
2. Collateralized Stablecoins Backed by Over-Collateralized Cryptographic Assets
The second type of stablecoin is backed by assets on the blockchain (i.e., other cryptographic assets), which are commonly referred to as “collateral.” In this case, the collateral is held by smart contracts, making it decentralized and more transparent. Users can review the code and view the total amount of collateral. Users can acquire these stablecoins by depositing collateral and can retrieve the collateral by depositing stablecoins again. Due to the significant volatility of cryptographic assets, smart contracts typically require users to over-collateralize at a ratio higher than 1:1 to maintain the relatively stable price of stablecoins. DAI is a representative example of this type of stablecoin.
3. Algorithmic Stablecoins
Algorithmic stablecoins usually do not have 100% asset backing but instead attempt to maintain a fixed correspondence through other means (e.g., 1 stablecoin corresponds to 1 USD). When the price of stablecoins rises, the algorithm generates more stablecoins to expand supply and lower prices. When the price of stablecoins drops, the algorithm reduces the quantity of stablecoins to decrease supply and raise prices, thereby maintaining the relative stability of stablecoin prices. Algorithmic stablecoins are inherently decentralized: algorithms, currency issuance and circulation quantities, and transaction information are publicly available on the blockchain, making it difficult to tamper with information on the blockchain. Representative examples of this type of stablecoin are UST, FEI, and Basis.
Latest Developments in the Regulation of Stablecoins in Major Countries and Regions Worldwide
Currently, major countries and regions worldwide have different regulatory positions on cryptocurrencies (including stablecoins), and corresponding regulatory frameworks and legislation are at different stages. The following section briefly introduces the latest developments in China’s Hong Kong, Mainland China, the United States, Singapore, and the European Union. This article aims to provide readers with a summary reference and guidance on the regulations in these countries and regions.
1 Hong Kong, China
On January 12, 2022, the Hong Kong Monetary Authority (HKMA) issued a discussion paper on extending the regulatory framework in Hong Kong to stablecoins, inviting industry and the public to provide feedback on the regulatory model for cryptocurrencies and stablecoins. The discussion paper outlines the HKMA’s conceptual thinking on the regulatory model for cryptocurrencies, particularly stablecoins used for payment purposes. The HKMA expects to develop a plan by July next year to issue new regulatory measures before the 2023/24 fiscal year.
The HKMA believes that stablecoins are increasingly being seen as widely accepted means of payment, and their growing usage increases the potential for stablecoins to integrate into the mainstream financial system. This, in the HKMA’s view, would have broader implications for monetary and financial stability, making stablecoins a regulatory focus for the HKMA.
The discussion paper further analyzes seven major risks associated with the use of stablecoins, including financial stability risk, currency stability risk, settlement risk, user protection, financial crimes and cyber risks, international compliance and regulatory arbitrage. The HKMA presents eight specific discussion questions related to stablecoins for industry consideration, outlined as follows.
1. Do we need to regulate all types of stablecoin activities, or should we prioritize regulating stablecoins that are associated with payment functions and pose greater risks to the monetary and financial system, while providing flexibility in the mechanism to adjust the scope of stablecoins that may need to be regulated in the future?
The HKMA points out that it is appropriate to initially expand the regulatory scope to cover stablecoins associated with payments, while not ruling out the possibility of regulating other forms of stablecoins. The HKMA hopes that any new regime introduced will have sufficient flexibility to potentially expand to other types of stablecoins in the future.
2. What types of activities related to stablecoins should be within the regulatory scope, such as issuance and redemption, custody and management, reserve management?
The HKMA suggests a broad scope of activities related to stablecoins that should be regulated, including issuance, creation or destruction of stablecoins; management of reserve assets to ensure stability of stablecoin value; verification of transactions and record-keeping; storage of private keys for accessing stablecoins; facilitating redemption of stablecoins; funds transfer for settlement of transactions; and executing transactions using stablecoins.
3. What approval and regulatory requirements will apply to entities subject to the proposed new stablecoin licensing regime?
The HKMA’s proposed requirements mainly cover four categories: (1) authorization and prudential requirements, including adequate financial resources and liquidity requirements, etc.; (2) eligibility requirements regarding management and ownership; (3) maintenance, management, and system requirements related to supporting asset reserves; and (4) control, governance, and risk management requirements.
4. Under the proposed regulatory mechanism, which institutions need to apply for a license?
In its discussion paper, the Hong Kong Monetary Authority (HKMA) states that foreign companies engaged in regulated activities or actively promoting these activities in Hong Kong under the new regulatory mechanism should register and establish a company in Hong Kong and apply for a license from the HKMA.
If this regulatory mechanism is implemented, it will have a significant impact on global cryptocurrency exchanges that currently provide stablecoin trading to Hong Kong users from offshore. These companies will face the choice of either registering and establishing in Hong Kong and applying for a license or ceasing to provide services to Hong Kong users.
5. When will this risk-based regulatory mechanism for stablecoins be implemented, and does it overlap with other financial regulatory regimes in Hong Kong, including the Securities and Futures Commission’s licensing regime for virtual asset service providers and the Stored Value Facilities (SVF) licensing regime under the Payment Systems and Stored Value Facilities Ordinance?
The HKMA states that it will collaborate and coordinate with other financial regulatory authorities in defining the scope of its regulatory jurisdiction and will strive to avoid regulatory arbitrage, including areas that may be subject to regulation by multiple local financial institutions.
6. Stablecoins could be subject to runs and potentially serve as alternatives to bank deposits. In light of the recommendations in the Stablecoin Report by the President’s Working Group on Financial Markets in the United States, will the HKMA require stablecoin issuers to be “recognized institutions” under the Banking Ordinance?
Although the HKMA does not explicitly state that it will require stablecoin issuers to be regulated as “recognized institutions” under the Banking Ordinance, it indicates that the requirements applicable to stablecoin issuers are expected to draw reference from the existing regulatory framework for stored value facilities in Hong Kong. The HKMA further notes that certain stablecoin issuers may be subject to more stringent prudential requirements due to their systemic implications.
7. Considering that asset-backed cryptocurrencies increasingly connect with the mainstream financial system and pose higher risks to financial stability, does the HKMA plan to regulate these asset-backed cryptocurrencies?
The HKMA does not explicitly exclude the regulation of asset-backed cryptocurrencies and states that it is necessary to continue monitoring the risks associated with such cryptocurrencies.
8. Prior to the HKMA’s publication of the regulatory mechanism, what should existing and future participants in the stablecoin ecosystem do?
The HKMA recommends that existing and potential participants in the stablecoin ecosystem provide feedback on the proposals outlined in the discussion paper. It also notes that during this period, it will continue to oversee activities related to regulated institutions and cryptocurrencies and implement the licensing regime for stored value facilities.
In addition, under the Securities and Futures Ordinance in Hong Kong, unless there are specific exemptions, engaging in regulated activities related to “securities” (such as securities trading, providing services in relation to securities trading, providing advice on securities, etc.) requires obtaining a license issued by the Securities and Futures Commission. Therefore, before engaging in stablecoin-related businesses, a specific analysis and judgment should be made regarding whether the stablecoin in question falls within the definition of “securities” under the Ordinance. If the stablecoin in question falls within the definition of “securities” under the Securities and Futures Ordinance, conducting business related to that stablecoin will be considered a regulated activity and a corresponding license from the Securities and Futures Commission will need to be obtained in advance.
It is worth noting that if stablecoins have traditional payment functions, the current regulations on stored value payment tools and payment system supervision in Hong Kong should also be considered by stablecoin operating institutions.
2 Mainland China
Mainland China’s regulatory policy on cryptocurrencies began with the “Notice on the Prevention of Bitcoin Risks” issued by the People’s Bank of China and five other ministries on December 5, 2013. On September 4, 2017, the People’s Bank of China and seven other ministries issued the “Announcement on Preventing the Risks of Token Issuance and Financing,” also known as the 94 ban. The announcement clearly stipulates that no organization or individual may engage in illegal exchange between legal currency and tokens or “virtual currency,” and may not buy or sell tokens or “virtual currency” as a counterparty, nor provide pricing, information intermediary, and other services for tokens or “virtual currency.”
In June 2021, the People’s Bank of China interviewed some banks and payment institutions regarding speculation in “virtual currency” transactions, requiring them to effectively fulfill their customer identification obligations and not provide account opening, registration, transaction, clearing, settlement, and other products or services for related activities, and not engage in or participate in “virtual currency” related business activities.
On July 8, 2021, Fan Yifei, Deputy Governor of the People’s Bank of China, pointed out in a press conference of the State Council’s regular policy briefing that private digital currencies (including various so-called stablecoins) pose potential risks to financial security and social stability, and have become payment tools for money laundering and illegal economic activities. Stablecoins issued by some commercial institutions, especially global stablecoins, may bring risks and challenges to the international monetary system, payment and settlement system, etc. After expressing concerns about this issue, the central bank also stated that it would take certain measures.
On September 24, 2021, the People’s Bank of China and ten other ministries issued the “Notice on Further Preventing and Dealing with the Risks of Speculation in Virtual Currency Transactions,” also known as the 924 notice. Compared with the 94 ban, the 924 notice specifically identifies the following five types of “related business activities” of virtual currencies as “illegal financial activities”: (1) conducting the exchange of legal currency and virtual currency, and the exchange of virtual currencies; (2) buying and selling virtual currencies as a counterparty; (3) providing information intermediary and pricing services for virtual currency transactions; (4) token issuance and financing; and (5) virtual currency derivative trading, etc. Considering that some stablecoins issued by commercial institutions discussed in this article belong to the type of virtual currency defined in the 924 notice, engaging in “related business activities” related to stablecoins falls within the scope of “illegal financial activities” prohibited by the 924 notice.
3 United States
On June 18, 2019, Facebook released the Libra whitepaper, which quickly drew regulatory attention. Regulators have expressed concerns about a range of issues, including how to prevent Libra from being used by criminals for money laundering and how to prevent Libra from posing financial stability risks.
In November 2021, the U.S. President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency jointly released a report on stablecoins. To address the risks posed by payment stablecoins, the report recommends that the U.S. Congress quickly legislate to ensure that payment stablecoins and their related arrangements are subject to unified and comprehensive federal regulation, in order to fill the legislative gaps in market integrity, investor protection, and illicit financing currently associated with stablecoins. The report also aims to address the following important concerns: (1) to prevent stablecoin runs, legislation should require all stablecoin issuers to be insured depository institutions and subject to appropriate regulation at the depository institution and holding company levels; (2) to mitigate payment system risks, legislation should subject custodial wallet providers to appropriate federal regulation; and (3) to address systemic risk and the risk of concentration of economic power, legislation should require stablecoins to comply with restrictions on activities related to limitations on business entity affiliations. Regulators should have the authority to enforce these standards to promote interoperability among different stablecoins. In addition, the U.S. Congress may also consider other standards for custodial wallet providers, such as restrictions on business entity affiliations or user transaction data.
On March 31, 2022, Senator Bill Hagerty introduced the Stablecoin Transparency Act in the Senate. The bill aims to improve transparency in the stablecoin market and set reserve standards for reserve assets. The bill requires stablecoin issuers to hold (1) government securities with a maturity of less than 12 months; (2) fully collateralized repurchase agreements; and (3) reserves backed by U.S. dollars or other non-digital currency, and requires monthly publication of a report on the reserve assets held by stablecoin issuers, audited by a third party, on their websites.
On April 6, 2022, Senator Pat Toomey, a member of the Senate Banking Committee, released a discussion draft of the Stablecoin Reserve Transparency and Unified Safeguards and Trading (TRUST) Act. The draft bill proposes to limit the issuers of payment stablecoins to the following three types of entities: (1) nationally registered money transmitters; (2) entities holding new federal licenses specifically designed for stablecoin issuers; and (3) insured depository institutions. It also requires payment stablecoin issuers to disclose their reserve assets, establish redemption policies, and undergo regular certification by registered public accounting firms.
In May 2022, U.S. Treasury Secretary Janet Yellen stated during a Senate hearing that stablecoins are a rapidly growing product and carry risks associated with rapid growth. She emphasized the importance of Congress passing legislation on stablecoins and believed it would be “very appropriate” for Congress to do so by the end of 2022.
On the other hand, Gary Gensler, Chairman of the U.S. Securities and Exchange Commission (SEC), recently stated to the House Appropriations Subcommittee on Financial Services that, according to the SEC’s definition, many cryptocurrency trading platforms are trading securities rather than commodities. Based on this, he requested lawmakers to increase the SEC’s enforcement budget to require cryptocurrency trading platforms to register with the SEC. Therefore, cryptocurrency trading platforms should also pay attention to whether stablecoins will be considered “securities”.
4 Singapore
Singapore’s Payment Services Act, enacted in 2019 and implemented on January 28, 2020, regulates digital payment tokens (DPT) and electronic money (e-money). According to the Act, DPT services and electronic money issuance services are regulated activities under the Payment Services Act and require a license from the payment service provider.
What is DPT
According to Section 2 of the Payment Services Act, digital tokens that meet the following criteria are considered DPT under the Act: (1) represented as a unit; (2) not denominated in any currency and not pegged to any currency by the issuer; (3) used or intended to be used as a medium of exchange for goods or services or for the discharge of a debt to the public or a specific group; (4) capable of being transferred, stored or traded electronically; and (5) satisfying any other criteria specified by the Monetary Authority of Singapore.
What is e-money
Regarding e-money, Section 2 of the Payment Services Act defines it as any monetary value stored electronically that (1) is denominated in any currency or pegged to any currency by the issuer; (2) is prepaid in order to make payment transactions through a payment account; (3) is accepted by a person other than the issuer; (4) represents a claim on the issuer; but does not include any deposit accepted in Singapore by a person resident in Singapore.
The Monetary Authority of Singapore believes that stablecoins, due to their fluctuating exchange rates with fiat currencies and the fact that stablecoin holders do not need to enter into contractual relationships with stablecoin issuers or open accounts with issuers, do not meet the characteristics of e-money and therefore are not considered e-money under the Payment Services Act.
The Monetary Authority of Singapore further states that it will examine the specific characteristics of individual stablecoins on a case-by-case basis from a technology-neutral standpoint to determine appropriate regulatory measures. Based on the current features, the USDC and USDT should be considered DPT, and the provision of DPT services related to these two types of stablecoins should be subject to the restrictions of the Payment Services Act and require the corresponding license.
In addition, the Monetary Authority of Singapore issued a public consultation in December 2019 to seek public opinion on the interaction between fiat currency, e-money, and cryptocurrencies (including stablecoins), as well as the appropriate regulatory measures for cryptocurrencies (especially stablecoins).
In recent times, Ravi Menon, the President of the Monetary Authority of Singapore, has expressed his views on the regulation of stablecoins on multiple occasions. Ravi Menon emphasized the urgency of addressing the issues surrounding stablecoins and questioned the stability of stablecoins pegged to fiat currencies. Without sufficient support, it is difficult to imagine stablecoins being able to function as a currency. Therefore, he believes that the key to regulating stablecoins lies in ensuring that they have sufficient backing, which should be in the form of liquidity and be available for use when needed.
It is worth noting that if the issuance or issuance of stablecoins constitutes capital market products under the Securities and Futures Act (such as shares in securities or collective investment schemes), such activities will be regulated under the Securities and Futures Act. Intermediaries involved in facilitating the issuance or issuance of stablecoins (including platform operators providing platforms for the issuance, issuance, and/or trading of the stablecoin, as well as intermediaries providing financial advice related to the stablecoin) will be subject to licensing requirements and other compliance requirements under the Securities and Futures Act and/or the Financial Advisers Act.
5 EU
In September 2020, the European Commission proposed the Markets in Crypto-Assets Regulation (MiCA) draft, which aims to establish a broad and comprehensive regulatory framework for all crypto-assets, including stablecoins, in order to protect consumer and investor interests and maintain market integrity and financial stability.
For “electronic money tokens,” which are stablecoins pegged to a single fiat currency and used for payments, the current regulatory provisions for e-money apply. If an issuer issues electronic money tokens, MiCA stipulates that the issuer must be one of two authorized entities: either a “credit institution” authorized under the Capital Requirements Directive or an “electronic money institution” authorized under the EU Electronic Money Directive. The issuer must comply with the operational requirements of the EU Electronic Money Directive and publish a white paper and notify it to their competent authority. Token holders should be granted the right to seek redress from the issuer and be able to redeem the tokens at any time for an equivalent amount in the fiat currency against which the tokens are backed, as stated in the white paper. The white paper for the tokens must specify: (1) the procedures and conditions for exercising the redemption right mentioned above; (2) the relevant technologies and corresponding standards for the holding, storage, and transfer of the tokens; (3) all relevant information relating to the issuer’s issuance of the tokens or allowing them to be traded on crypto-asset trading platforms; and (4) operational risks associated with the issuer. The issuer also needs to invest the funds received in safe, low-risk assets, and the valuation currency of the invested assets should be the same as the fiat currency supporting the tokens to avoid currency risks.
In March 2022, the European Parliament’s Committee on Economic and Monetary Affairs voted in favor of the MiCA regulatory draft. Currently, the MiCA regulatory draft will be discussed in the European Parliament, European Commission, and European Council.
Conclusion
Looking at the global landscape, different countries have varying regulations and legislative stages regarding stablecoins. Regulatory agencies around the world are closely monitoring stablecoins, and regulations are continuously evolving. Institutions engaged in related business should constantly assess risks and applicable laws and regulations, adjust their business models promptly to comply with stablecoin-related requirements, and avoid potential compliance risks.
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