The stablecoin regulatory system in Hong Kong not only promotes innovation but also provides security for the market.

Written by: TaxDAO

1. Background of Hong Kong's Stablecoin Regulatory Policy

1.1 Definition of Stablecoin

A stablecoin is a special asset in the cryptocurrency market, characterized by its value being pegged to fiat currencies or other assets, thereby maintaining a relatively stable value. The Bank for International Settlements (BIS) defines it as "a cryptocurrency whose value is pegged to fiat currencies or other assets." Unlike traditional cryptocurrencies (such as Bitcoin), stablecoins aim to avoid severe price fluctuations by anchoring to fiat currencies or other assets. The emergence of stablecoins provides a relatively stable value carrier for the cryptocurrency market, especially in the decentralized finance (DeFi) sector, where their widespread use brings liquidity and stability to on-chain transactions, lending, and other scenarios.

Stablecoins can be roughly divided into three types based on their pegging mechanisms:

• Fiat-collateralized stablecoins: such as USDT and USDC, which use fiat currencies like the US dollar as collateral to maintain a 1:1 exchange relationship with the dollar.
• Crypto-collateralized stablecoins: such as DAI, which ensure stability through over-collateralized crypto assets.
• Algorithmic stablecoins: such as Ampleforth, which maintain price stability by automatically adjusting supply.

The rapid development of stablecoins globally demonstrates their immense potential in payments, cross-border transactions, and financial instruments. By 2024, the market capitalization of stablecoins has surpassed $300 billion, with daily trading volumes reaching hundreds of billions of dollars. Among them, USDT (Tether) is the most popular stablecoin globally, accounting for nearly 70% of the total market capitalization of all stablecoins, making it the absolute leader in the stablecoin market.

1.2 International Stablecoin Regulatory Background

Internationally, regulation of stablecoins is becoming increasingly stringent. In 2021, the U.S. Treasury publicly called for strong regulation of stablecoins, emphasizing the systemic risks they pose in payment systems. Europe and the UK are also gradually advancing regulatory frameworks for stablecoins to ensure compliance and financial security. Meanwhile, many countries have begun researching the launch of central bank digital currencies (CBDCs), which, to some extent, compete with stablecoins, although their roles and use cases differ. In emerging markets such as Southeast Asia and the Middle East, stablecoins bring new opportunities for cross-border payments and financial inclusion, allowing many unbanked individuals to participate in the global financial market, thereby enhancing economic liquidity in these regions.

1.3 Stablecoin Regulatory Background in Mainland China and Hong Kong

The Chinese government has a relatively cautious attitude towards stablecoins. Since 2017, the People's Bank of China has emphasized a strict regulatory stance on virtual currencies and further intensified its crackdown on cryptocurrency trading and mining in 2021. While the People's Bank of China has been promoting the application of the digital yuan (e-CNY), its attitude towards foreign stablecoins remains strict, as stablecoins are seen as potentially affecting China's monetary sovereignty and financial security. Therefore, when considering cross-border payments, there is a greater inclination to promote the government-led digital yuan.

As a Special Administrative Region, Hong Kong has adopted a different regulatory strategy compared to mainland China, leaning towards providing a certain degree of innovation space for virtual assets. Its relatively relaxed virtual asset regulation has attracted numerous crypto enterprises and innovative projects. This year, a subsidiary of JD.com also joined Hong Kong's regulatory sandbox, indicating the interest and trust of mainland enterprises in Hong Kong's virtual asset policies. In fact, as early as 2018, Hong Kong began gradually introducing regulatory policies regarding virtual assets; in 2019, the Hong Kong Securities and Futures Commission (SFC) issued regulations for virtual asset trading platforms and fund management, clarifying compliance requirements for virtual assets, marking the beginning of a new era of virtual asset regulation in Hong Kong. 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. This system requires virtual asset service providers to obtain a license to operate legally in Hong Kong while setting strict compliance requirements such as KYC (Know Your Customer) and AML (Anti-Money Laundering). This article will focus on Hong Kong's stablecoins, analyzing and summarizing their regulatory system and policies.

2. Evolution of Hong Kong's Stablecoin Regulation

Since 2022, Hong Kong has gradually promoted a regulatory framework for stablecoin issuance, with the core goal of ensuring the transparency and security of stablecoin issuance and laying the foundation for the healthy development of the virtual asset market. The following is a timeline of the evolution of Hong Kong's stablecoin regulation:

2.1 2022: Initial Discussions and Consultation

In January 2022, the Hong Kong Monetary Authority (HKMA) released a discussion paper on "Cryptographic Assets and Stablecoins." The document pointed out that with the rapid development of cryptographic assets and stablecoins, the existing regulatory framework for payment systems and stored value payment tools (such as e-wallets) is insufficient to cover all types of stablecoins. Therefore, the HKMA proposed the necessity of prioritizing regulation for payment-type stablecoins pegged to fiat currencies (such as USDT and USDC) while excluding algorithmic stablecoins and other non-asset-collateralized types from regulatory priority. The document also invited relevant industries to provide feedback on the discussion paper by the end of March 2022, serving as an important basis for the design of future regulatory frameworks.

2.2 2023: Gradual Clarification of Regulatory Framework

In 2023, the HKMA accelerated the advancement of specific regulatory systems for stablecoins. In December, the HKMA and the Financial Services and the Treasury Bureau (FSTB) jointly released legislative proposals for the regulation of stablecoin issuers, presenting a draft of the specific regulatory framework. This framework comprehensively regulates the issuance and management of stablecoins and details requirements for the management of stablecoin reserve assets, corporate governance, risk control, information disclosure, as well as anti-money laundering and counter-terrorism financing.

Notably, the framework requires all stablecoin issuers to ensure that their circulating stablecoins have 100% reserve asset backing and to establish independent accounts to manage these reserve assets. Additionally, issuers must regularly disclose the reserve status of their stablecoins to the public.

2.3 2024: Legislative Promotion and Public Consultation

Entering 2024, Hong Kong further promoted the legislative process of the stablecoin regulatory framework. In January 2024, the HKMA published a consultation document proposing more detailed regulatory measures and, for the first time, clearly defined the concept of fiat-referenced stablecoins (FRS), which must peg their value to fiat currencies, commodities, or other financial assets, and issuers must be registered and obtain regulatory approval in Hong Kong.

The document also proposed specific requirements for licensing stablecoin issuers, including a minimum paid-up capital requirement (such as HKD 25 million), and issuers must establish a physical presence in Hong Kong, ensuring that the local management structure meets regulatory requirements. Furthermore, non-Hong Kong registered issuers wishing to market their stablecoins to the public in Hong Kong must also comply with Hong Kong's regulatory requirements. The implementation of this system is gradually making Hong Kong one of the global centers for virtual asset and stablecoin issuance activities.

To assist emerging stablecoin projects and enterprises in smoothly transitioning to the new regulatory framework, the HKMA also proposed a regulatory sandbox system for stablecoin issuers. This system allows enterprises to communicate regulatory requirements with the HKMA before actual issuance, obtaining preliminary guidance and supervision to ensure compliant operations. This measure not only encourages innovation but also provides flexibility for the compliant development of stablecoins.

3. Detailed Explanation of Hong Kong's Fiat-Referenced Stablecoin Regulatory System

Hong Kong's Fiat-Referenced Stablecoin (FRS) regulatory system is an important policy framework proposed to ensure the stability, transparency, and compliance of the virtual asset market. This regulatory system not only defines what constitutes an FRS but also sets clear applicable subjects, conditions, and a series of regulatory requirements for its issuance.

3.1 Regulatory Subjects and Concept Explanation

In Hong Kong, all entities issuing fiat-referenced stablecoins (such as those pegged to the Hong Kong dollar, US dollar, etc.) must apply to the HKMA for issuance licenses. This applies even to international issuers, as long as (1) their stablecoins are issued in Hong Kong, or (2) pegged to the Hong Kong dollar, or (3) their products are marketed to the public in Hong Kong, they must adhere to Hong Kong's regulatory requirements.

According to Hong Kong's proposal, the definition of FRS includes the following core elements:

• Digitally represented value protected by cryptography: FRS is a digitally represented value protected by distributed ledger or similar technology.
• Value stability: FRS must be pegged to a fiat currency (or a basket of assets) and maintain a relatively stable value. Products like algorithmic stablecoins that maintain value through supply and demand mechanisms may find it difficult to meet this requirement.
• Purpose: FRS must be used as a payment tool, investment tool, or debt settlement tool.

All types of stablecoins, regardless of whether their stability 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

Issuing stablecoins in Hong Kong requires meeting strict regulatory conditions, primarily including the following aspects:

• Financial resource requirements: FRS issuers need to have sufficient capital, with a minimum paid-up capital requirement of HKD 25 million, ensuring that issuers have enough capital buffer to cope with market fluctuations. Additionally, issuers must ensure that the circulating stablecoins have reserve assets corresponding to their face value, and these assets must be highly liquid and low-risk, stored independently in regulated financial institutions.
• Governance and risk management: Issuers must have a sound corporate governance structure to ensure effective internal controls and risk management mechanisms. Issuers need to conduct annual risk assessments, including technical risks, security controls, anti-fraud measures, etc. Furthermore, FRS issuers must comply with the Anti-Money Laundering and Counter-Terrorism Financing Ordinance, ensuring their systems can monitor transactions and prevent financial crimes.
• Reserve asset management: Issuers must ensure that all issued stablecoins have sufficient reserve asset backing, which must correspond to the fiat currency to which the stablecoin is pegged, and reserve assets must be regularly disclosed to the public, including the total amount of circulating stablecoins and the market value and composition of the reserve assets. This measure aims to ensure transparency and market trust.
• Prohibition of interest payments: Hong Kong's FRS regulatory system prohibits issuers from paying interest to stablecoin holders. This regulation is intended to prevent stablecoins from becoming deposit-like products and to avoid their impact on the banking industry.
• Localization requirements: All FRS issuers must register a company in Hong Kong and ensure that their executives and management team are based in Hong Kong, capable of effectively managing their issued stablecoins.

3.3 Specific Process for Issuing Stablecoins in Hong Kong

To issue stablecoins in Hong Kong, issuers must first apply for a license from the HKMA and meet a series of strict standards, including but not limited to sufficient financial resources, sound corporate governance structures, and professional reserve management mechanisms. This process requires issuers to submit a detailed business plan to the HKMA, which should not only outline the stablecoin issuance plan, including target markets, issuance scale, and expected uses, but also include a specific reserve management plan detailing how to ensure that each unit of stablecoin has corresponding reserve assets backing it, as well as a comprehensive risk management framework to ensure the stability of the stablecoin's value and the security of the system under various market conditions.

In addition to submitting the business plan, issuers must also ensure that their reserve asset management systems and information disclosure systems meet the high standards set by the HKMA. This means that the systems must not only have a high level of security and transparency but also be able to disclose key information to the public in a timely and accurate manner regarding the issuance volume of stablecoins, the status of reserve assets, etc., so that investors and other stakeholders can make informed decisions. Once a license is obtained, issuers must also comply with ongoing compliance requirements, including regularly submitting detailed operational reports to the HKMA. 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 legal and regulatory requirements to maintain market fairness and protect investors' interests.

Issuing stablecoins in Hong Kong faces numerous challenges. Capital requirements pose a high barrier for many startups, as issuers not only need to hold sufficient funds to support the initial issuance but also need to ensure that reserve assets consistently match the face value of the issued stablecoins, which may require a significant amount of liquid capital as support. Additionally, compliance costs cannot be overlooked; FRS issuers must adhere to multiple strict regulations, including anti-money laundering, information disclosure, and risk management, which often means that companies need to invest additional human and material resources to establish dedicated compliance teams and systems to ensure the legality and transparency of their operations. For some international issuers, localized management is also a considerable challenge, as companies issuing stablecoins in Hong Kong must establish a local entity to ensure that management and key functional teams can operate effectively in Hong Kong. This not only increases the operational costs for companies but may also bring challenges related to cultural integration and management.

3.4 Stablecoin Regulatory Sandbox System

On March 12, 2024, the HKMA launched an innovative measure called the "Sandbox Program," aimed at providing a pilot environment for entities intending 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 the opportunity to observe and assess the operation of these new financial instruments. This not only facilitates 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 did not limit the specific number of participants but set strict standards for applicants. Applicants must demonstrate a genuine intention and reasonable planning to issue fiat currency-pegged stablecoins in Hong Kong and have developed specific strategies for participating in the sandbox program. Additionally, they need to prove their ability to meet the regulatory requirements outlined in the consultation document, which includes having a detailed business plan, a professional team based in Hong Kong, and sufficient startup capital to cover initial operating costs.

For companies wishing to join the sandbox program, the application process is relatively straightforward. Applicants can submit the necessary documentation to the HKMA via a designated email address, and the HKMA may request additional information to assist in the evaluation. During the review process, regulators will consider multiple factors, such as the uniqueness of the stablecoin application scenarios proposed by the applicant, the effectiveness of the price stability mechanism, the management of reserve assets, and user protection measures. Even if successfully admitted to the sandbox arrangement, it does not mean that the project has received formal recognition or regulation from the HKMA or other financial regulatory bodies. Once the licensing system for stablecoin issuers is officially implemented, all sandbox participants must reapply to obtain formal operating licenses. Furthermore, the sandbox arrangement itself has certain limitations, such as potentially controlling the user base and issuance limits of stablecoins to ensure that risks remain at acceptable levels. The HKMA also reserves the right to adjust sandbox rules based on specific circumstances to adapt to the ever-changing market and technological environment.

All sandbox participants must obtain prior approval from the HKMA before releasing any information regarding their sandbox status to the public to prevent misleading promotions and protect potential investors from unnecessary risks. On July 18 of this year, the HKMA announced the list of stablecoin issuer "sandbox" participants, which includes JD Coin Chain Technology (Hong Kong) Limited; Yuan Coin Innovation Technology Limited; Standard Chartered Bank (Hong Kong) Limited; Anni Group Limited; and Hong Kong Telecommunications Limited.

Overall, Hong Kong's FRS regulatory system is forward-looking on a global scale, with its strict reserve requirements and transparency regulations ensuring market stability and trust. However, for issuers wishing to enter the Hong Kong market, they must also contend with high capital and compliance costs. Through the sandbox system, companies can receive the necessary support and guidance to ensure their operations comply with regulatory requirements.

4. Impact of Hong Kong's Stablecoin Regulatory System

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, ensuring that all issued stablecoins have 100% reserve asset backing, and that these assets are held in regulated financial institutions. For international companies, this means that issuing stablecoins in Hong Kong requires meeting high regulatory standards. For example, all non-Hong Kong issuers wishing to market or promote Hong Kong dollar-pegged stablecoins must obtain permission from the HKMA. Non-asset-backed stablecoins, such as algorithmic stablecoins, may find it difficult to meet regulatory requirements and may not be able to issue in Hong Kong. Additionally, Hong Kong's regulatory sandbox system provides companies with a "controlled" environment to test their business models and compliance before entering the market, reducing initial operational risks while also providing Hong Kong regulators with opportunities to establish closer cooperative relationships with companies, thereby continuously improving their regulatory framework.

As a Special Administrative Region of China, Hong Kong's regulatory policies stand in stark contrast to the cryptocurrency policies of mainland China. Mainland China's attitude towards cryptocurrencies is relatively conservative, while Hong Kong, leveraging its status as an international financial center and flexible regulatory approach, has become a testing ground for mainland Chinese companies to experiment with virtual asset businesses. For instance, a subsidiary of JD.com has joined Hong Kong's regulatory sandbox to explore innovative applications of stablecoins and other virtual assets. This trend indicates that mainland enterprises are increasingly looking to expand into global markets through Hong Kong, which may also suggest that mainland China could adjust its attitude towards cryptocurrencies in the future. Hong Kong's regulatory system is also expected to provide valuable insights for mainland virtual asset policies, as its transparency, reserve management, and risk control requirements in the regulatory framework offer practical references for future virtual asset regulatory systems in mainland China.

For global cryptocurrency companies and investors, Hong Kong's stablecoin regulatory system creates a relatively stable and transparent market environment. Companies issuing stablecoins in Hong Kong must meet high standards for reserve management and compliance, which provides investors with greater confidence. At the same time, Hong Kong's anti-money laundering (AML) and counter-terrorism financing (CFT) regulations also make the stablecoin market safer and more reliable, reducing the risks of money laundering and illegal transactions, which helps enhance the overall reputation of the cryptocurrency market. Hong Kong also offers companies flexible market entry pathways and a sandbox system, allowing businesses to test their business models within a limited scope and receive guidance from regulators, thereby reducing compliance risks. This provides opportunities for startups and small to medium-sized companies to enter the market and enhances their competitiveness.

5. Conclusion

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. Given the strong monetary attributes of stablecoins, future regulations on stablecoins in other jurisdictions are likely to become increasingly stringent. The stablecoin regulatory system explored by Hong Kong also provides valuable experience for other jurisdictions.

References

[1]. Overview of Crypto Compliance Licenses: Hong Kong Edition. Web3caff

[2]. Summary of Consultation on Legislative Proposals for Stablecoin Issuer Regulation in Hong Kong. HKMA

[3]. Understanding Hong Kong's Stablecoin Issuer Licensing System. Junhe Legal Review

[4]. HKMA Announces Participants in Stablecoin Issuer "Sandbox." HKMA

[5]. Hong Kong Monetary Authority Introduces Plans to Regulate Stablecoins. Reed Smith In-depth

[6]. Summary of the Discussion Paper on Cryptographic Assets and Stablecoins. HKMA

[7]. A Comprehensive Analysis of the Stablecoin Sector: Models, Operating Principles, Trends, and Reflections on Hong Kong Stablecoins. AiYing Compliance

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