Controversy over Payment Stablecoins: Currency, Security, or “Other”?
Payment Stablecoins: Currency, Security, or Something Else?
01 Recent Cryptocurrency Industry Developments
On June 5th and 6th, 2023, the US Securities and Exchange Commission (SEC) filed a lawsuit against two virtual asset trading platforms, Binance and Coinbase, stating that certain cryptocurrencies were deemed ‘securities’ due to meeting the Howey test and must be regulated by the SEC. Looking back to March of this year, the US Commodity Futures Trading Commission (CFTC) regarded virtual assets as ‘commodities’, thereby considering it to have jurisdiction, and accused Binance of conducting non-licensed transactions in the US. The jurisdictional dispute over cryptocurrencies between the SEC and CFTC will continue until a mutually acceptable draft is passed.
While US industry policy is uncertain, some Asian regions are embracing the Web 3.0 revolution with open arms.
Last Thursday (June 22nd), blockchain company Ripple obtained a principle-based approval to operate in Singapore, which is also good news for the global cryptocurrency industry. The license will allow Ripple to provide regulated digital Blockingyment token products and services and expand the cross-border transfer of XRP (a cryptocurrency closely related to the company) amongst its clients (banks and financial institutions). It should be noted that three years ago, the US SEC, using a similar lawsuit tactic as with Binance and Coinbase, found that some of the cryptocurrencies provided by Ripple met the definition of ‘securities’ and accused Ripple of providing unregistered securities trading services. Recently, SEC and Ripple are still in a long legal battle, and Judge Torres has repeatedly requested that SEC provide further legal clarification.
Singapore, as a leader in Web3.0 in Asia, has made a meticulous industry layout by enacting the Payment Services Act, the Digital Token Sale Guide, and the Financial Services and Markets Act since 2020. Hong Kong, China has followed suit, and the Securities and Futures Commission (SFC) of Hong Kong released the “Consultation Summary on Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by or Registered with the Securities and Futures Practice Supervision Commission” on May 23rd this year. After the amended legislation took effect on June 1st, many virtual asset exchanges rushed to apply for licenses in Hong Kong.
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02 Stablecoin Overview
The high volatility of the cryptocurrency market makes cryptocurrency investments unsuitable for ordinary transactions, and stablecoins provide an alternative to the high volatility of popular cryptocurrencies such as Bitcoin (BTC). Therefore, stablecoins are more useful as an exchange medium than cryptocurrencies with greater volatility. Stablecoins can be pegged to currencies such as the US dollar or to commodity prices such as gold. Depending on the stability mechanism, the stablecoins commonly seen in the market can be divided into:
(1) Centralized stablecoins pegged to fiat currencies (such as the US dollar and the British pound): Fiat-collateralized stablecoins hold reserves of fiat currency (or currency) as collateral to ensure the value of the stablecoin. These reserves are maintained by independent custodians and are audited regularly. Examples include Tether (USDT) and True (TUSD).
(2) Stablecoins over-collateralized with crypto assets: As the reserves of cryptocurrencies may also be subject to high volatility, this stablecoin is over-collateralized, meaning that the value of the reserve crypto assets exceeds the value of the stablecoin issued. For example, MakerDAO’s Dai (DAI) stablecoin is pegged to the US dollar, but is essentially supported by 150% collateral of Ethereum (ETH) and other cryptocurrencies whose value circulates as DAI stablecoin.
(3) Algorithmic stablecoins: Algorithmic stablecoins may or may not hold reserve assets. Their main difference is that they use algorithms to control the supply of stablecoins to maintain their value stability. Essentially, a computer program runs a pre-set formula. Unlike traditional currencies, this currency does not have the endorsement of a central bank.
Centralized stablecoins pegged to fiat currencies (such as the US dollar and the British pound) are the regulatory focus of major jurisdictions such as the United States, Singapore, and Hong Kong. In traditional fiat currencies, a 1% fluctuation in foreign exchange transactions is rare. Therefore, compared to other currencies, these centralized stablecoins pegged to fiat currencies are stable in price, have low market risk, and are widely used, making them the most promising to become a widely accepted payment method. This paper takes this type of stablecoin as a starting point to analyze its qualitative, regulatory, and future trends in payment-type stablecoins in the United States, Singapore, and Hong Kong, China.
01 United States
In the SEC’s lawsuit against Binance, the SEC believes that the BUSD (a stablecoin that is pegged to the US dollar at a 1:1 ratio) issued by Binance is a “security.”
This week, on Thursday (June 22), Fed Chairman Powell released his views on privately issued stablecoins: “We do regard some of the stablecoin technologies as a form of money. What backs that up is central bank money.”
According to the definition of payment-type stablecoins in the US Congress’s draft bill (June 8, 2023 version) (g:\VHLD\060823\D060823.010.xml), payment-type stablecoins refer to digital assets that are used or designed to be used as a means of payment or settlement. Its issuer is obligated to convert, redeem, or repurchase a fixed amount of the currency value. It represents the expectation that it will maintain a stable value, relative to the currency value of a fixed amount. It is not a security issued by a national currency or investment company.
Although US regulators are still disputing the nature and jurisdiction of cryptocurrencies, the nature of payment-type stablecoins is relatively clear. Combining Powell’s remarks with the US Congress’s draft bill, payment-type stablecoins are likely to be recognized as a currency (but not a national currency), which will also affect the regulatory framework of other stablecoins in the future.
The Monetary Authority of Singapore (MAS) divides cryptocurrencies into three categories:
In Singapore, payment-type stablecoin DPT is regarded as a type of digital payment instrument, not a security or currency. This means that payment-type stablecoins are not considered currency or securities regulated by MAS, but are independently regulated as digital payment instruments.
DPT refers to digitized currencies issued and transmitted through encryption technology, including but not limited to cryptocurrencies, digital tokens, and digital stablecoins. DPT is typically used for payment and trading, and has relatively high liquidity and exchangeability. Among them, single-currency pegged stablecoins are a special type of DPT with payment and clearing functions. Therefore, single-currency pegged stablecoins need to comply with the regulatory requirements of DPT, including implementing anti-money laundering and anti-terrorism financing measures, protecting consumer rights, disclosing risks, etc.; at the same time, they also need to comply with the special requirements of single-currency pegged stablecoins, such as reserve ratio and price fluctuation limits.
03 Hong Kong, China
According to the Hong Kong Monetary Authority’s (HKMA) conclusions released in January this year, “stablecoins for payment purposes” are defined as stablecoins with the potential to become widely accepted payment methods.
HKMA stated that stablecoins that purport to reference one or more fiat currencies (a payment-type stablecoin) will be given priority in supervision. Regardless of whether they are anchored to fiat currency through algorithms or arbitrage mechanisms, or whether they are primarily used for retail, wholesale, or cryptocurrency transactions, stablecoins that purport to reference fiat currency will be included in the regulatory focus.
However, HKMA believes that it is necessary to exclude other cryptocurrencies regulated by other regulatory authorities, such as security tokens regulated by the HKSFC, to prevent regulatory arbitrage. The Hong Kong Monetary Authority has pushed forward the second round of public consultation in early June this year, and it is believed that we can expect that Hong Kong, China will also promote the issuance, circulation, and regulation of payment-type stablecoins as early as next year at the latest.
03 The Prospects and Future of Payment-Type Stablecoins
In recent years, stablecoins have gained great attention and adoption because they can combine the stability of fiat currency with the advantages of digital currency. Considering the various advantages that stablecoins provide in the financial ecosystem, the prospect of payment stablecoins is quite promising, including improving payment efficiency, increasing financial inclusion, decentralized finance (DeFi) applications, and more.
At the same time, the issuance and regulation of payment-type stablecoins still deserve attention:
1. Financial stability risk: The widespread use of payment-type stablecoins may have an impact on the stability of the financial system. As a popular payment tool, if payment-type stablecoins encounter credit risk, liquidity risk, and other issues, it may trigger panic and turmoil in the financial market.
2. Cross-border payment supervision: Payment-type stablecoins can facilitate cross-border payments, but this also poses challenges for regulatory authorities. Cross-border payments may involve issues such as money laundering and terrorist financing, which require strengthened international cooperation and supervision.
3. Data privacy and security: The issuer of payment-type stablecoins needs to ensure the privacy and security of user data to prevent data leakage and hacker attacks.
4. Competition and Antitrust Issues: If a certain payment-type stablecoin dominates the market, it may lead to a loss of balance in market competition, affecting the fairness and efficiency of the financial market.