Controversy over Payment Stablecoins: Currency, Security, or "Other"?

Original Author: Xiaosafa Legal Team

Recent Developments in the Cryptocurrency Industry

On June 5th and June 6th, 2023, the U.S. Securities and Exchange Commission (SEC) filed lawsuits against Binance and Coinbase, two virtual asset trading platforms. The SEC believes that certain cryptocurrencies meet the Howey Test and are considered "securities." As a result, they should be regulated by the SEC. Going back to March of this year, the U.S. Commodity Futures Trading Commission (CFTC) deemed virtual assets as "commodities," asserting jurisdiction and accusing Binance of unauthorized trading in the United States. The dispute over jurisdiction between the SEC and CFTC regarding cryptocurrencies will continue until an agreement that both parties can accept is reached.

While the industry policies in the United States remain uncertain, some Asian regions are embracing the Web 3.0 revolution.

Last Thursday, June 22nd, Ripple, a blockchain company, obtained provisional approval to operate in Singapore. This is also good news for the global cryptocurrency industry. This license will allow Ripple to provide regulated digital payment token products and services, and expand the cross-border transfer of XRP (a closely related cryptocurrency) among its customers (banks and financial institutions). It should be noted that three years ago, the U.S. SEC used similar legal means to accuse Ripple of providing certain cryptocurrencies that meet the definition of "securities" and offering unregistered securities trading services. Currently, the SEC and Ripple are locked in a lengthy court battle, and Judge Torres has requested further legal clarification from the SEC on multiple occasions.

Singapore, as a leader in Web 3.0 in Asia, has implemented meticulous industry regulations since 2020, including the Payment Services Act, Digital Token Offering Guidelines, and the Securities and Futures Act. Building on this, the Hong Kong region in China has followed suit. The Securities and Futures Commission (SFC) of Hong Kong published the "Consultation Conclusions on Proposed Regulation of Virtual Asset Trading Platform Operators Applying for a SFC License" on May 23rd this year. After the amended legislation formally took effect on June 1st, many virtual asset exchanges have applied for licenses in Hong Kong.

Overview of Stablecoins

The high volatility of the cryptocurrency market makes it less suitable for ordinary transactions. Stablecoins provide an alternative solution to the high volatility of popular cryptocurrencies, including Bitcoin (BTC). Therefore, stablecoins are more useful as a medium of exchange compared to highly volatile cryptocurrencies. Stablecoins can be pegged to currencies such as the U.S. dollar or prices of commodities like gold. Depending on the stability mechanism, common types of stablecoins in the market can be categorized as:

(1) Centralized stablecoins pegged to fiat currencies (e.g., the U.S. dollar, British pound): Fiat-backed stablecoins maintain reserves of the fiat currency (or currencies) as collateral to ensure the stability of their value. These reserves are maintained by independent custodians and undergo regular audits. Examples include Tether (USDT) and TrueUSD (TUSD).

(2) Over-collateralized stablecoins: As the reserve cryptocurrency can also be prone to high volatility, this type of stablecoin is over-collateralized - meaning that the value of the reserve cryptocurrency exceeds the value of the issued stablecoin. For example, MakerDAO's Dai (DAI) stablecoin is pegged to the US dollar but is essentially backed by 150% collateral support in the form of Ethereum (ETH) and other cryptocurrency values circulating as DAI stablecoins.

(3) Algorithmic stablecoins: Algorithmic stablecoins may or may not hold reserve assets. The main difference is that they use algorithms to control the supply of stablecoins to maintain their value stability, essentially operating a computer program based on a predefined formula. Unlike traditional currencies, this type of currency does not have the backing of a central bank.

Recently, centralized stablecoins pegged to fiat currencies (such as the US dollar, British pound) have been a regulatory focus in major jurisdictions like the United States, Singapore, and Hong Kong. In traditional fiat currencies, a 1% fluctuation in foreign exchange trading is rare. Therefore, compared to other currencies, these centralized stablecoins pegged to fiat currencies offer price stability, low market risk, and wide usability, making them a potential widely accepted means of payment. The following sections will analyze the qualitative aspects, regulation, and future trends of these payment-type stablecoins in the United States, Singapore, and China's Hong Kong, using these stablecoins as a starting point.

United States

In the SEC's complaint against Binance, the SEC considers Binance's issuance of BUSD (a stablecoin pegged to and anchored to the US dollar in a 1:1 manner) as a "security".

This Thursday (June 22), Fed Chairman Powell expressed his opinion on privately issued stablecoins: "We do view stablecoins as a form of money. And in all of the developed economies, the central bank is where the ultimate credibility comes from."

According to the definition in the US Congress' draft legislation on payment-type stablecoins (June 8, 2023 version) (g: \ VHLD \  060823   \ D  060823.010.xml), a payment-type stablecoin refers to a digital asset that is used or designed to be used as a means of payment or settlement. Its issuer has an obligation to convert, redeem, or repurchase a fixed amount of currency value. It is expected to maintain a stable value relative to the fixed amount of currency value. It is not a security issued by a national currency or investment company.

Although relevant US agencies are still debating the classification and jurisdiction of cryptocurrencies, the classification of payment-type stablecoins is relatively clear. Based on Powell's statements and the US Congress draft legislation, payment-type stablecoins are recognized as money (but not national currency), which will likely impact the regulatory framework for other stablecoins in the future.

Singapore

The Monetary Authority of Singapore (MAS) classifies cryptocurrencies into three categories:

In Singapore, payment-type stablecoins, referred to as DPT (Digital Payment Tokens), are considered as a form of digital payment instrument rather than securities or currency. This means that payment-type stablecoins are not regulated by MAS as currency or securities but are independently regulated as digital payment instruments.

Among them, DPT refers to digital currencies issued and transmitted through encryption technology, including but not limited to cryptocurrencies, digital tokens, and stablecoins. DPT is usually used for payment and transactions, with relatively high liquidity and interchangeability. Among them, single-currency pegged stablecoins are a special type of DPT that has payment and settlement functions. Therefore, single-currency pegged stablecoins need to comply with the regulatory requirements of DPT, including implementing anti-money laundering and counter-terrorism financing measures, protecting consumer rights, and disclosing risks; they also need to comply with the special requirements of single-currency pegged stablecoins, such as reserve ratios and price fluctuation limits.

Hong Kong, China

According to the conclusion published by the Hong Kong Monetary Authority (HKMA) in January of this year, "payment-related stablecoins" are defined as stablecoins with the potential to become widely accepted payment methods.

The HKMA stated that it will prioritize regulating stablecoins that purport to reference one or more fiat currencies (a type of payment-based stablecoin). Whether anchored to fiat currencies through algorithms or arbitrage mechanisms, and regardless of whether they are primarily used for retail, wholesale, or cryptocurrency asset transactions, stablecoins that claim to reference fiat currencies will be subject to regulatory focus.

However, in terms of specific definitions, the HKMA believes it is necessary to exclude cryptocurrencies regulated by other regulatory bodies, such as security tokens regulated by the Hong Kong Securities and Futures Commission (HKSFC), to prevent regulatory arbitrage. The Hong Kong Monetary Authority has launched the second round of public consultation in early June this year, and it is believed that by next year at the latest, we can expect that the issuance, circulation, and regulation of payment-based stablecoins will also be promoted in the Hong Kong, China region.

The Prospects and Future of Payment-Based Stablecoins

In recent years, stablecoins have received great attention and adoption due to their ability to combine the stability of fiat currencies with the advantages of digital currencies. Considering the various advantages that stablecoins provide in the financial ecosystem, the future of payment-based stablecoins is quite promising, including improving payment efficiency, increasing financial inclusion, and decentralized financial (DeFi) applications, and so on.

At the same time, the issuance and regulation of payment-based stablecoins still deserve attention:

1. Financial stability risks: The widespread use of payment-based stablecoins may have an impact on the stability of the financial system. As a popular payment tool, if payment-based stablecoins encounter credit risks, liquidity risks, and other problems, it may trigger panic and turmoil in the financial market.

2. Cross-border payment regulation: Payment-based stablecoins facilitate cross-border payments, but they also pose challenges for regulatory authorities. Cross-border payments may involve issues such as money laundering and terrorist financing, requiring enhanced international cooperation and regulation.

3. Data privacy and security: The issuers of payment-based stablecoins need to ensure the privacy and security of user data, preventing data breaches and hacker attacks.

4. Competition and anti-monopoly issues: If a certain payment-based stablecoin dominates the market, it may lead to an imbalance in market competition, affecting the fairness and efficiency of the financial market.