A Stablecoin Pilot in China?

The Hong Kong Monetary Authority (HKMA) and Financial Services and the Treasury Bureau (FSTB) are working to establish a regulatory regime for stablecoin issuers in the territory as soon as possible. Asset managers and fintech firms are reportedly following the effort very closely. Other governments should do so as well.

Stablecoins are a type of cryptoasset that is supposed to maintain a value relative to a target currency. “Collateralized” stablecoins are backed by a pool of reserve assets, whether fiat currencies, other cryptoassets, or commodities. But not all stablecoins are backed by reserve assets: unbacked stablecoins seek to maintain a stable value by other means, such as through algorithms that limit their supply, creating a market value.

There is currently no universally agreed standard for stablecoins, let alone a regulatory framework governing them. But the market is large – and growing fast. Since the beginning of 2020, the estimated total market value of stablecoins skyrocketed from $5.9 billion to about $130 billion. Stablecoins pegged to the US dollar dominate the market, owing to the US dollar’s enduring global dominance as a means of payment, store of value, and unit of account, as well as the liquidity and convenience of the US dollar asset market.

Tether leads the way, with about 70% of the market, followed by USD coin, with 20%. Tether reports that, at the end of September 2023, it held $86.4 billion of assets – including some $56.6 billion in US Treasury bonds, $5.1 billion in secured loans, $3.1 billion in precious metals, $1.7 billion in Bitcoin, and $2.3 billion in other investments – against $83.2 billion in liabilities. In the first quarter of 2023, the firm reported a net profit of $1.4 billion.

The purpose of stablecoins is to offer a more reliable alternative to cryptocurrencies like Bitcoin, which are tethered to nothing and have proved highly volatile. According to the Bank for International Settlements, collateralized stablecoins have “generally been less volatile than traditional cryptoassets.” At the same time, “not one of them has been able to maintain parity with its peg at all times.”

Moreover, the BIS points out that “there is currently no guarantee that stablecoin issuers could redeem users’ stablecoins in full and on demand.” Ultimately, none of the more than 200 stablecoins in circulation today meets the “key criteria for being a safe store of value and a trustworthy means of payment in the real economy.”

But that could change. For the stablecoin market to succeed, four conditions need to be met. First, all stablecoins must be linked to a widely accepted legal tender or fiat currency. Second, they should operate within a globally accepted regulatory and licensing framework. Third, issuers should be able to innovate in areas such as distribution, market support, and infrastructure. And, lastly, stablecoins should be applied widely within the field of decentralized finance.

There is reason to think that Hong Kong could help drive progress. The territory’s own currency, the Hong Kong dollar, is pegged to the US dollar, making its “Digital HKD” essentially a stablecoin. (The HKMA’s September 2023 policy document essentially treated the Digital HKD as just that.) More important, Hong Kong’s monetary and regulatory authorities are well regarded, and its open, market-oriented, globally connected institutional environment is well-suited for pilot schemes.

One such project could involve the creation of a stablecoin pegged to the offshore renminbi for use in the Greater Bay Area – an economic zone comprising nine cities around the Pearl River Delta in Guangdong province, plus Hong Kong and Macau, with a combined GDP of $1.9 trillion. This “GBA stablecoin” could facilitate the issuance, trade, and settlement of new digital financial products in Hong Kong, and be exchanged readily with the offshore renminbi, the Hong Kong dollar, and the US dollar. Financial products issued outside mainland China could be priced in GBA stablecoin.

Under this scheme, the digital infrastructure, financial products, such as offshore bonds issued by local governments and enterprises in GBA, would be traded in Hong Kong, but their underlying physical assets would be largely in mainland China. This arrangement would be similar to H-shares, whereby stocks of essential mainland-based companies are traded in Hong Kong. The result would essentially be an operational offshore digital renminbi – a currency that benefits from the added market confidence brought about by HKMA oversight. This would bolster demand for offshore renminbi, thereby accelerating renminbi internationalization without risk to the stability of onshore renminbi.

The HKMA has already conducted a six-week central bank digital currency (CBDC) pilot with its counterparts in mainland China, Thailand, and the United Arab Emirates. Known as Project mBridge, it was among the first multi-CBDC projects to settle real-value, cross-border transactions on behalf of corporations.

Following the pilot’s success, the monetary authorities are now working to develop the mBridge platform to expedite cross-border retail or wholesale payments. This suggests that, with the right digital financial infrastructure – which takes advantage of distributed blockchain technology, including to enable “smart contracts” – GBA stablecoin could provide offshore financing for China’s ambitious multi-country Belt and Road Initiative (BRI) and facilitate international trade and investment more broadly.

Such a pilot’s success would depend not only on financial institutions’ willingness to issue the stablecoins, but also on the needs of banks, businesses, consumers, and investors. Within the current US dollar-based financial system, some might hesitate to use GBA stablecoin. But given America’s geopolitically-motivated weaponization of global finance, plenty of market participants – such as those engaging in BRI projects – are seeking a reliable alternative to the US dollar, including dollar-backed stablecoins.

Ultimately, the balance between the returns on equity and the risks associated with a given stablecoin will determine which coins gain a competitive edge. A long process of trial and error lies ahead.