THE ECONOMIST: China weighs stablecoin future as Hong Kong launches tough crypto regulations

Eric Trump has been called the top diplomat of the bitcoin nation. Last month the second son of Donald Trump spoke in Hong Kong at the Bitcoin Asia conference. What is it trading at today, he asked, while on stage: “112-113,000”. The answer — $US110,143 ($166,000) — was right behind him, continuously updated on a big screen.

Bitcoin’s volatility helps explain the appeal of stablecoins, digital tokens pegged to a more established currency. The hope is that stablecoins will retain the advantages of cryptocurrencies, such as cheaper, quicker, round-the-clock settlement, without the gut-wrenching gyrations in value.

More than 99 per cent of stablecoins, now collectively worth over $US280 billion ($422b), are pegged to America’s currency. In July Eric’s father signed the GENIUS Act which paves the way for regulated dollar stablecoins, widening their appeal to institutional investors and ordinary punters. The aim is to entrench dollar dominance in the new world of digital finance. America, Eric said, is winning the digital revolution. How might China respond?

With some disquiet. China has long sought to end its dollar dominance. At a summit of the Shanghai Co-operation Organisation in Tianjin on September 1, the organisation’s ten members, which include China, India and Russia, promised to settle a greater share of transactions in local currencies. China settled over 30 per cent of its current-account transactions (including trade in goods and services) in yuan in the first half of this year, up from 15 per cent in the whole of 2019.

China’s cabinet is considering a roadmap to boost its currency’s usage overseas. That may include yuan-backed stablecoins. But America’s enthusiastic embrace of the technology has put China in a bind, having banned cryptocurrency trading in 2021. It also puts tight controls on how much residents’ capital can leave the country, which stablecoins might weaken.

Hong Kong may offer a way out. Unlike the mainland, the territory permits capital to flow freely. And to keep up with rival financial centres it has encouraged experimentation in virtual assets. It also has a crypto-curious public. Tether, the world’s most popular stablecoin started life in Hong Kong. Even the city’s law firms are becoming crypto savvy. After scammers defrauded a Hong Kong company of $US2.7 million in Tether, lawyers served the miscreants a tokenised court order via a blockchain.

Hong Kong’s new stablecoin legislation came into effect on August 1. The rules try to ensure that regulated coins are indeed stable. They require issuers to have capital of at least HK$25 million ($4.9m) and to back their coins with safe, liquid assets worth at least as much as the face value of the coins. They also require issuers to collect customer information, submit to audits and comply with regulations against money laundering. All this will make the coins safer to hold but less profitable to operate.

Most stablecoins are held by speculators. Yet Hong Kong’s regulators seem keen to encourage other uses, such as supply-chain financing and cross-border payments. Last year the authorities allowed some firms to experiment with stablecoins inside a regulatory sandbox. They included a subsidiary of e-commerce giant JD.com and the Standard Chartered bank. None were crypto-trading platforms.

In principle, stablecoins issued in Hong Kong could be pegged to the offshore yuan, which trades separately from its onshore twin. That would allow China to test the international appeal of yuan stablecoins while holding them at arm’s length. However yuan stablecoins would have to be backed by yuan-denominated assets, which are scarce outside the mainland.

Hong Kong’s pool of such deposits amount to less than ¥1 trillion yuan ($220b) compared with over ¥300t on the mainland. Although China’s central bank has issued short-term borrowing instruments in Hong Kong, which could serve as backing, it sometimes buys them back when it wants to stop the offshore yuan strengthening. The supply of safe, liquid assets denominated in offshore yuan is unpredictable, says Morgan Stanley.

Yuan stablecoins might, therefore, prove impractical. If not, they would bring dangers. Despite the crypto ban the Chinese already trade more stablecoins than the authorities would like. A paper by Marco Reuter of the IMF uses AI to identify the location of crypto wallets. He estimates that in 2024 China bought $US18.6 billion ($28b) of stablecoins and sold $US3.6 billion ($5.4b). Binance, which cannot be accessed directly from China, was a big source. Mr Reuter’s figures are far higher than other estimates, which assume the Chinese do not hide their location.

The first firms to win stablecoin licences in Hong Kong will not peg to the yuan. Instead, they will almost certainly pick the Hong Kong Dollar. This has been called the original stablecoin. It has been tied to the American dollar since the 1980s. The peg is backed by a vast trove of dollar assets held by the Hong Kong Monetary Authority (HKMA).

Such a chain creates an intriguing geopolitical irony. If stablecoins take off, they will raise demand for assets to back them. That will put upward pressure on the HKD obliging the HKMA to sell its currency and buy American dollars to keep the exchange rate stable. The experiments, if successful, could raise demand not for the yuan but for dollar assets. Indeed, the HKMA might be obliged to buy a little more of the government debt issued by Mr Trump’s administration. At Bitcoin Asia, his second son enjoyed an incredible reception. He may soon have even more reason to thank Hong Kong.