Talking about Global Stablecoin Regulation

Author: Jacqueline's Virtual Asset Talk, Qiao Zheyuan, Zhou Jingbo, Cheng Xiaoyu, Chen Yu's Poetry, Shen Luwen, Zhang Lu, Liang Guoqiang, Liao Yuhui, Xiao Xinzhuang, Huang Kaijie, and Chen Lu

As a subcategory of cryptoassets, stablecoins are gradually gaining traction. The most distinctive feature of stablecoins compared to other cryptoassets is that they are designed to be pegged to or backed by fiat currencies and/or other cryptoassets. Based on this feature, market participants believe that stablecoins may be easier to develop into a widely accepted payment method and/or value storage method, and therefore have a higher potential to be accepted by the global mainstream financial system. In turn, they have a more direct impact on money and economic activity. In view of this, the FSB urges financial regulators to prepare for the regulation of stablecoins, especially global stablecoins that may be more widely used in cross-regional payments.

Table of contents

1. What are encrypted assets and stable coins

2. The latest developments in the regulation of stablecoins in major countries and regions around the world

3. Conclusion

What are encrypted assets and stable coins

What is Crypto Assets

Since the birth of Bitcoin (Bitcoin) in 2009, various types of encrypted assets have emerged, such as stablecoins, utility tokens and non-fungible tokens, etc. . The Financial Stability Board (FSB) defines a crypto asset as "a private digital asset that relies primarily on cryptography and distributed ledger technology or similar technologies."

What is a **** stable coin

According to the FSB's definition, a stablecoin refers to "a cryptographic asset that attempts to maintain a stable value by being linked to a specific asset or asset pool." The Bank of International Settlements considers stablecoins to be "cryptocurrencies whose value is pegged to fiat currency or other assets."

As a subcategory of cryptoassets, stablecoins are gradually gaining traction. The most distinctive feature of stablecoins compared to other cryptoassets is that they are designed to be pegged to or backed by fiat currencies and/or other cryptoassets. Based on this feature, market participants believe that stablecoins may be easier to develop into a widely accepted payment method and/or value storage method, and therefore have a higher potential to be accepted by the global mainstream financial system. In turn, they have a more direct impact on money and economic activity. In view of this, the FSB urges financial regulators to prepare for the regulation of stablecoins, especially global stablecoins that may be more widely used in cross-regional payments.

According to different stabilization mechanisms, the common stablecoins in the market can be roughly divided into three categories: (1) centralized stablecoins linked to legal tender; (2) stablecoins with over-collateralized encrypted assets; and (3) algorithm-based stablecoins of stablecoins.

1 Centralized stablecoins pegged to fiat currencies (e.g. USD, GBP)

The backing asset for a stablecoin pegged to a fiat currency (e.g. USD, GBP) is typically held by a centralized issuer, either with a custodian or in a bank account. There is a fixed correspondence between backing assets and stablecoins (e.g. 1 USD to 1 stablecoin). Stablecoins are created when the backing assets are sent to the issuer. When the backing asset is returned by the issuer to the redeemer, the corresponding amount of stablecoins is destroyed. In order to link the value of stablecoins to the number of supporting assets, centralized issuers usually hire independent accounting firms or audit institutions to regularly verify the supporting assets in the escrow account. Representatives of such stablecoins are USDT and USDC.

2 Stable currency for over-collateralized crypto assets

The second type of stablecoin is a stablecoin based on assets on the blockchain (that is, other encrypted assets) (also known as providing "collateral" in the market). At this point, the collateral is held by the smart contract, so it is decentralized and transparent in nature. Users can audit the code and view the total amount of collateral. Users can obtain these stablecoins by depositing collateral, and can also deposit stablecoins again to get back the collateral. Because the value of encrypted assets tends to fluctuate greatly, in order for smart contracts to maintain stable currency prices, users usually need to over-deposit collateral at a ratio higher than 1:1. The representative of this type of stable currency is DAI.

3 Algorithm-Based Stablecoin

Algorithm-based stablecoins are usually not backed by 100% assets, but use other methods to try to maintain the stability of a fixed correspondence (eg 1 USD to 1 stablecoin). When the price of stable coins rises, the algorithm creates more stable coins, expands the supply, and lowers the price; when the price of stable coins falls, the algorithm reduces the number of stable coins, reduces the supply, and increases the price, so that the price of stable coins is relatively stable . The essence of algorithmic stablecoins is decentralization: algorithms, currency issuance and circulation, and transaction information are disclosed on the blockchain, and the information on the blockchain is difficult to be tampered with. Representatives of such stablecoins are UST, FEI, and Basis.

The latest developments in the regulation of stablecoins in major countries and regions around the world

At present, major countries and regions around the world have different regulatory stances on encrypted assets (including stablecoins), and the corresponding regulatory frameworks and legislation are at different stages. The following is a brief introduction to the latest developments in Hong Kong, China, Mainland China, the United States, Singapore and the European Union. This article hopes to provide readers with some general reference and guidance on the supervision of the following countries and regions.

1 Hong Kong, China

On January 12, 2022, the Hong Kong Monetary Authority issued a discussion paper on extending the Hong Kong regulatory framework to stablecoins, inviting the industry and the public to provide opinions on the regulatory model for encrypted assets and stablecoins. The discussion paper sets out the Hong Kong Monetary Authority's thinking on the regulatory model for encrypted assets, especially stablecoins used for payment purposes. The Hong Kong Monetary Authority is expected to draw up plans by July next year to enact the new regulatory regime by 2023/24.

The Hong Kong Monetary Authority believes that stablecoins are increasingly seen as a widely accepted payment method, and the fact that their usage has grown increases the potential for stablecoins to integrate into the mainstream financial system. In the view of the Hong Kong Monetary Authority, this will trigger broader monetary and financial stability implications, making stablecoins a supervisory focus of the Monetary Authority.

The discussion paper further analyzes seven major categories of risks associated with the use of stablecoins, including financial stability risks, currency stability risks, settlement risks, user protection, financial crime and cyber risks, international compliance, and regulatory arbitrage. The HKMA proposes eight specific stablecoin-related discussion questions for industry consideration, outlined below.

1. Do we need to regulate all types of stablecoin activities, or should we prioritize the regulation of stablecoins related to payment functions and pose greater risks to the currency and financial system, and provide flexibility in the mechanism to Might the regulated stability range be adjusted in the future?

The Hong Kong Monetary Authority pointed out that it is appropriate to first expand the scope of supervision to cover payment-related stablecoins, while not ruling out the possibility of regulating other forms of stablecoins. The HKMA hopes that any new regime introduced will be flexible enough that it can be extended to other types of stablecoins in the future.

2. What types of stablecoin-related activities should fall within the scope of regulation, such as issuance and redemption, custody and management, reserve management?

The Hong Kong Monetary Authority proposes to regulate a wide range of stablecoin-related activities, including issuing, creating or destroying stablecoins; managing reserve assets to ensure the stability of stablecoin values; verifying transactions and records; storing private keys used to access stablecoins; Redemption of stablecoins; transfer of funds for settlement of transactions; and execution of transactions in stablecoins.

3. What approval and regulatory requirements will there be for entities that intend to be subject to the new stablecoin licensing regime?

The Hong Kong Monetary Authority's proposal mainly covers four types of requirements: (1) authorization and prudential requirements, including sufficient financial resources and liquidity requirements, etc.; (2) eligibility requirements for management and ownership; maintenance, management and system requirements; and (4) control, governance and risk management requirements.

4. Under the proposed supervisory mechanism, which institutions need to apply for licenses?

In the discussion paper, the Hong Kong Monetary Authority said that foreign companies offering regulated activities under the new regulatory regime in Hong Kong or actively promoting these activities in Hong Kong should incorporate companies in Hong Kong and apply for a license from the Hong Kong Monetary Authority.

If the regulatory mechanism is implemented, it will have a significant impact on global cryptocurrency exchanges that currently offer stablecoin trading from offshore to users in Hong Kong. These companies will face the choice of either being incorporated in Hong Kong and applying for a license or stopping trading for Hong Kong users.

5. When will this risk-oriented regulatory mechanism for stablecoins be implemented? It will be compatible with other financial regulatory systems in Hong Kong, including the Hong Kong Securities Regulatory Commission’s licensing system for virtual asset service providers, the Payment System and Stored Value Instruments Ordinance "Stored Value Facility (SVF) Licensing System, etc., are there overlaps?

The Hong Kong Monetary Authority stated that it will cooperate and coordinate with other financial regulators in defining the scope of supervision of the Hong Kong Monetary Authority, and will also try to avoid regulatory arbitrage, including areas that may be regulated by multiple local financial institutions.

6. Stablecoins could be run on and become a potential substitute for bank deposits. As suggested by the U.S. President’s Working Group on Financial Markets in the Stablecoin Report, will the Hong Kong Monetary Authority require stablecoin issuers to be “authorized institutions” under the Banking Ordinance?

While the Hong Kong Monetary Authority did not expressly state that it would not require stablecoin issuers to be regulated as authorized institutions under the Banking Ordinance, it said it expected that the requirements applicable to stablecoin issuers would draw on Hong Kong’s existing SVF regulatory framework. The Hong Kong Monetary Authority further stated that certain stablecoin issuers may be subject to stricter prudential requirements due to their systemic impact.

7. Considering that non-asset-backed crypto-assets are increasingly connected to the mainstream financial system and pose higher risks to financial stability, does the Hong Kong Monetary Authority plan to regulate these non-asset-backed crypto-assets?

The Hong Kong Monetary Authority did not explicitly rule out the regulation of crypto assets that are not backed by assets, and stated that it is necessary to continue to monitor the risks posed by such crypto assets.

8. Before the Hong Kong Monetary Authority announces the regulatory mechanism, what should existing and future entities in the stablecoin ecosystem do?

The Hong Kong Monetary Authority recommends that existing and potential participants in the stablecoin ecosystem provide feedback on the proposals set out in the discussion paper, noting that in the interim, it will continue to monitor the activities of authorized institutions related to crypto assets, implement the development of stored value licensing system.

In addition, according to Hong Kong's "Securities and Futures Ordinance", unless there are specific exemptions, conducting regulated activities related to "securities" (such as securities transactions, providing services for securities transactions, providing advice on securities, etc.) requires prior Hong Kong License issued by the Securities Regulatory Commission. Therefore, before conducting stablecoin-related businesses, specific analysis and judgment should be made on whether the involved stablecoins fall within the scope of “securities” under the regulations. If the stable currency involved constitutes the scope of "securities" under the Securities and Futures Ordinance, the business related to the stable currency will be deemed to be regulated activities, and it is necessary to obtain the corresponding license issued by the Hong Kong Securities Regulatory Commission in advance.

It is worth noting that if the stable currency has traditional payment functions, Hong Kong's current stored value payment tools and payment system supervision methods should also be considered by stable currency operators.

2 Mainland China

Mainland China's regulatory policy on encrypted assets began on December 5, 2013 with the "Notice on Preventing Bitcoin Risks" issued by the People's Bank of China and other five ministries and commissions. On September 4, 2017, seven ministries and commissions including the People's Bank of China issued the "Announcement on Preventing Financing Risks of Token Issuance", namely the 94 ban. The announcement clearly stipulates that any organization or individual shall not illegally engage in the exchange business between legal tender and tokens, "virtual currency", shall not buy or sell tokens or "virtual currency" as a central counterparty, and shall not be a token or "virtual currency" "Virtual currency" provides pricing, information intermediary and other services.

In June 2021, the People's Bank of China interviewed some banks and payment institutions on the issue of "virtual currency" transaction speculation, requiring them to effectively fulfill their customer identification obligations and not to provide account opening, registration, trading, clearing, settlement and other products for related activities or services, and shall not carry out or participate in business activities related to "virtual currency".

On July 8, 2021, Fan Yifei, deputy governor of the People's Bank of China, pointed out when answering the national level's plan to take "virtual currency"-related activity service providers at the regular policy briefing of the State Council on July 8, 2021. , private digital currencies (including the various so-called stablecoins launched) have the potential risk of threatening financial security and social stability; at the same time, they have also become payment tools for some money laundering and illegal economic activities. The stablecoins of some commercial organizations, especially global Stablecoins may bring risks and challenges to the international monetary system, payment and settlement system, etc. After expressing its concern about this issue, the central bank also made it clear that it would take some measures.

On September 24, 2021, ten ministries and commissions including the People's Bank of China issued the "Notice on Further Preventing and Dealing with the Risk of Hype in Virtual Currency Transactions", that is, the 924 Notice. Compared with the 94 ban, the 924 notice clearly stated that the "related business activities" of the following five types of virtual currency are "illegal financial activities": (1) carrying out the legal currency and virtual currency exchange business, and the exchange business between virtual currencies; (2) Act as a central counterparty to buy and sell virtual currency; (3) provide information intermediary and pricing services for virtual currency transactions; (4) token issuance financing; and (5) virtual currency derivatives transactions, etc. In view of the fact that the stablecoins issued by some commercial institutions discussed in this article are one of the virtual currencies defined in the 924 Notice, the "related business activities" related to stablecoins fall within the scope of "illegal financial activities" and are prohibited by the 924 Notice.

3 USA

On June 18, 2019, Facebook released the Libra white paper, but the project quickly attracted regulatory attention. Regulators are concerned about a series of issues, including how to prevent Libra from being used by criminals for money laundering purposes and how to prevent Libra from posing financial stability risks.

In November 2021, the U.S. President’s Working Group on Financial Markets, the FDIC, and the U.S. Office of the General Review of the Currency jointly released a report on stablecoins. To address the risks of payment-based stablecoins, the report recommends that the U.S. Congress expeditiously legislate to ensure that payment-based stablecoins and their related arrangements are regulated under a unified and comprehensive federal framework to fill the current gap between stablecoins in terms of market integrity, investor protection and Legislative gaps in illegal financing, etc., and will work to address the following important concerns: (1) In order to prevent the problem of stable currency runs, legislation should stipulate that all stable currency issuers must be insured depository institutions, and the depository institutions and holding companies (2) to mitigate payment system risks, legislation should be made to subject custodial wallet providers to appropriate federal regulation; and (3) to address systemic risks and risks of concentration of economic power, legislation should require stablecoins to comply with Activity restrictions limiting affiliation with business entities. Regulators should have the power to enforce standards to facilitate interoperability between different stablecoins. Additionally, Congress could consider other standards for custodial wallet providers, such as limiting their affiliations with commercial entities or users’ transaction data.

On March 31, 2022, Senator Bill Hagerty submitted "The Stablecoin Transparency Act" in the Senate; the bill aims to improve the transparency of the stablecoin market and set reserve standards for reserve assets. The bill requires stablecoin issuers to (1) hold government securities with a maturity of less than 12 months; (2) have fully collateralized securities repurchase agreements; and (3) have reserves backed by U.S. dollars or other non-digital currencies, And it needs to publish a monthly report on its website on the third-party audited reserve assets held by stablecoin issuers.

On April 6, 2022, Pat Toomey, a member of the U.S. Senate Banking Committee, announced the discussion draft of the "Stablecoin Reserve Transparency and Uniform Security Transactions Act" (The Stablecoin TRUST Act). The discussion draft of the bill proposes to limit issuers of payment stablecoins to the following three types of institutions: (1) state-registered money transmitters; (2) holders of new federal licenses designed specifically for stablecoin issuers; and (3) Insured depository institutions, and require payment of stable currency issuers to disclose their reserve assets, formulate redemption policies, and accept periodic certification from certified public accountants.

In May 2022, U.S. Treasury Secretary Janet Yellen stated at a Senate hearing that stablecoins are fast-growing products and there are risks associated with rapid growth. She also emphasized that it is very important for the US Congress to pass legislation on stablecoins, and believes that it is "very appropriate" for Congress to pass legislation by the end of 2022.

On the other hand, Gary Gensler, chairman of the U.S. Securities and Exchange Commission (SEC), recently told the House Appropriations Financial Services Subcommittee that, according to the SEC's definition, many cryptocurrency trading platforms are trading securities, not commodities, requiring lawmakers to increase SEC executive budget to require cryptocurrency trading platforms to register with the SEC. Therefore, cryptocurrency trading platforms should also pay attention to reviewing whether stablecoins will be identified as "securities".

4 SINGAPORE

Singapore's "Payment Services Act" promulgated in 2019 and implemented on January 28, 2020, includes digital payment tokens (Digital Payment Token, referred to as DPT) and electronic money (e-money) into regulation; according to the Act, DPT services and e-money issuance services are regulated activities under the Payment Services Act, and need to apply for a payment service provider license.

What is DPT

According to the definition in Section 2 of the "Payment Services Act", digital tokens with digital value that meet the following characteristics belong to the DPT under the Act: (1) expressed in units; (2) not denominated in any currency, issuer Nor does it link it to any currency; (3) is or is intended to be a medium of exchange for the public or a specific group of the public to pay for goods or services or to settle debts; (4) can be transferred, stored or traded electronically; and ( 5) Satisfy other characteristics specified by the Monetary Authority of Singapore.

What is e-money

With respect to electronic money, section 2 of the Payment Services Act defines it as any electronically stored monetary value that is (1) denominated in any currency or pegged to it by its issuer; (2) has (3) is accepted by a person other than the issuer; (4) represents a claim on the issuer; but does not include any person originating from and held in Singapore Accepted deposits.

The Monetary Authority of Singapore believes that because the exchange rate between stable currency and legal tender cannot be fixed, stable currency holders do not need to have a contractual relationship with the stable currency issuer or open an account with the issuer, and do not meet the requirements of electronic currency. characteristics and therefore do not qualify as electronic money under the Payment Services Act.

The Monetary Authority of Singapore further stated that it will examine the characteristics of specific stablecoins on a case-by-case basis from a technology-neutral standpoint to determine appropriate regulatory measures. In the view of the Monetary Authority of Singapore, USDC and USDT should be recognized as DPT based on the current characteristics, so the provision of DPT services related to these two types of stablecoins should be regulated by the Payment Services Act and corresponding licenses should be applied for .

In addition, the Monetary Authority of Singapore issued a public consultation in December 2019 to consult the public on the interaction between fiat currencies, electronic currencies and cryptocurrencies (including stablecoins) and the appropriate regulatory means for cryptocurrencies (especially stablecoins) Opinion.

Recently, Ravi Menon, President of the Monetary Authority of Singapore, expressed his views on the regulation of stablecoins on different occasions. Ravi Menon expressed the urgency to solve the problem of stable currency, questioning the stability of stable currency linked to legal tender, and if stable currency does not get enough support, it will be difficult to imagine that it can play the role of currency. Therefore, he believes that the key to regulating stablecoins is to ensure that stablecoins can have support, which should be liquid and can be used when needed.

It is worth noting that if the stable currency offered or issued constitutes a capital markets product (capital markets product) (such as a security or a share in a collective investment scheme) under the Securities and Futures Act, such offering or issuance will be subject to Regulation of the Securities and Futures Act; intermediaries assisting such offerings or issuances (including platform operators providing platforms for the offering, issuance and/or trading of the stablecoin and providing financial advice related to the stablecoin Intermediaries) will be subject to licensing requirements and other compliance requirements under the Securities and Futures Act and/or the Financial Advisers Act accordingly.

5 EU

The European Executive Committee proposed a draft Markets in Crypto-Assets Regulation (MiCA) in September 2020, aiming to establish a broad and comprehensive regulatory framework for all encrypted assets, including stablecoins. To protect the interests of consumers and investors, and maintain market integrity and financial stability.

For "e-money tokens" (e-money tokens), that is, stablecoins linked to a single legal currency and used for payment, the current regulatory requirements for e-money apply. If an issuer issues electronic currency tokens, MiCA stipulates that the issuer must be one of two types of authorized entities, namely, either a "credit institution" authorized under the Capital Requirements Directive for the Financial Services Industry, or a "credit institution" authorized under the European Union Electronic "Electronic Money Institutions" authorized under the Currency Directive. The issuer shall comply with the relevant operational requirements of the EU Electronic Money Directive, and shall issue a white paper and notify its competent authorities of the white paper. For token holders, they should be given the right to claim compensation from the issuer, and at any time can request redemption equal to the face value of the legal currency supported by the token, and this redemption right should be stated in the white paper. For the white paper of the token, MiCA requires that it should specify: (1) the procedure and conditions for exercising the aforementioned redemption right; (2) the relevant technologies and corresponding standards on which the holding, storage and transfer of the token are based; ( 3) All relevant information related to the issuance of tokens by the issuer or allowing them to be traded on encrypted asset trading platforms; and (4) Operational risks related to the issuer, etc. The issuer also needs to invest the received funds in safe, low-risk assets, and the denominated currency of the invested property should be the same currency as the legal currency supporting the token to avoid cross-currency risks.

In March 2022, the Economic and Monetary Affairs Committee of the European Parliament voted to approve the draft MiCA specification. At present, the draft MiCA specification will be discussed in the European Parliament, the European Executive Committee, and the European Council.

Conclusion

Throughout the world, countries have different regulations on stablecoins, and legislation is at different stages. Regulatory agencies in various countries are paying close attention to stablecoins, and their regulations are also constantly evolving. For institutions engaged in related businesses, they should assess risks and applicable laws and regulations at any time, and quickly adjust their business models to comply with relevant regulations on stablecoins and avoid potential compliance risks.