[Global Payment in Web 3 Keynote Speech] Fangda Partners Partner Laurence Yuan: Regulating Stablecoins
Recently, at Global Payment in Web3, a sub-forum of the Hong Kong Web3 Festival 2023, Fangda Partners Partner Laurence Yuan delivered a keynote speech titled Regulating Stablecoins.
In his speech, Mr. Yuan proposed the following core views:
- Stablecoins reduce transaction costs, improve financial inclusion, and facilitate cross-border payments. However, they also present liquidity risks, credit risks, operational risks, and legal/regulatory risks.
- The adoption of stablecoins in financial markets is growing more extensive. They are expected to evolve into a widely accepted store of value or payment method and are more likely to be incorporated into the mainstream global financial system.
- Thanks to stablecoins, tokens have become increasingly integrated with real-life scenarios and banking systems, and stablecoins will become the next legislative focus.
Here’s the full speech by Mr. Laurence Yuan:
Hello everyone, my speech today will focus on two perspectives: stablecoins and regulation.
Stablecoins came out several years ago and have kept evolving in the token space. Some consider stablecoins to be the most successful token application, in addition to Bitcoin and Ethereum. When tokens first appeared, BTC and ETH captured all our attention, but along with the emergence of stablecoins, we have noticed that in this fast-changing world, investors have shifted their focus from the US Dollar to USDT and USDC. It is surprising that both stablecoins and the US dollar are acceptable payment options in the contracts we audit, which include investments and other applications. To me, this is a very interesting development.
We are all familiar with stablecoins, which come in two categories: asset-backed stablecoins and algorithmic stablecoins. In particular, fiat-collateralized stablecoins are the most typical asset-backed stablecoins whose value depends on the price fluctuation of the underlying asset.
The relationship between tokens and real-life scenarios is a topic that often comes up, and I’ve also dabbled in this field. Real-life transactions usually involve three kinds of streams: information stream, logistics stream, and payment stream. Stablecoins resemble payment streams, while NFTs, also a trending topic, are more like products. Web1 and Web2 boast substantial information streams, but when it comes to blockchain applications, information streams are unidirectional; overall, they are a chain-like database that’s hard to alter or delete.
The advantages of stablecoins are obvious. For instance, stablecoins make cross-border payments easier because tokens are global and universal. To be more specific, international payments can be very slow even if you’re using the US dollar, but with stablecoins, the cross-border transfer of funds becomes much faster. Moreover, stablecoins and other token applications can reach out to a larger user base, as many people don’t have access to credit cards and bank cards.
Furthermore, value reference should also be considered. Stablecoins Consultation Paper issued by Hong Kong specifically discusses the issue of value reference. What is the value system behind stablecoins? Typically, the answer is the US dollar, but here the Hong Kong dollar is given priority.
The third issue I’d like to address is globalization. Globalization is not simply the globalization of trade as imagined by many. Instead, it is more about the globalization of payments. Now, if time freezes, the world’s dominant currency would always be the US dollar, but we would also have the expensive version of the dollar, which are stablecoins pegged to the dollar as the value reference. This is a very interesting phenomenon. We often picture the robust development of stablecoins, especially those pegged to the US dollar. In fact, as USD-pegged stablecoins make progress, the dollar will become stronger and witness new use cases. By the same token, Hong Kong has proposed that the Hong Kong dollar could also become a value reference for stablecoins.
Of course, stablecoins also present risks. For example, stablecoins are associated with prominent legal risks because they represent an emerging technology and are not subjected to strict regulations. From the perspective of lawyers or business owners, in addition to legal and regulatory risks, countries differ in terms of the legislation on stablecoins. Tokens come with extremely flexible business models, with great liquidity and the ability to constantly seek opportunities. Such a flexible, ever-changing industry is inherently associated with prominent legal and regulatory risks.
There are two types of international legislative approaches. One is to apply the laws of a particular country based on the specific transactions and points of connection, which is the common legislative approach on tokens; the second approach aims to facilitate the adoption of tokens in international trade, which is less common. In my view, the regulation of tokens should be based on payment streams, and tokens can only be regulated by introducing substantive laws through international legislative collaboration.
When studying the legal issues of token transactions, private and public interests are major considerations. Specifically, when considering the interests involved in a transaction, we have to distinguish between the individual interest and the public interest of the parties. For example, if both parties to a transaction are individuals or entities, the risks involved are primarily contract risks or customer protection risks. If public interest, such as monetary policy, is involved, however, the government may regulate the relevant tokens. Additionally, in cases where private and public interests are mixed, such as areas of economic and administrative laws, licensing issues are often involved. This is the general legal logic in the analysis of token transactions.
Just to be clear, the legislative aspects I mentioned are about tokens in general, and not specific to stablecoins. Typically, token legislation falls into five categories:
1. No action — market driven. Here, the most typical example is ICO, which sparked a craze back in 2017 and then just disappeared. In this case, the market showed us that ICO doesn’t work, which led to its demise. Many countries also share this attitude, especially in the early days.
2. Opt-in/pilot regime.
3. Risk-based regime (address risks in a targeted manner) (e.g. HK).
4. Catch-all regime (address risks in a broad manner).
5. Ban (e.g. China’s mainland).
The risk-based regime and catch-all regime are less forward-looking. The UK, for instance, prefers the catch-all regime. However, there are subtle distinctions between the two, which stem from our understanding of law. Yesterday, a speaker mentioned that the crypto and Web3 space lack specific legislation, which might be a misunderstanding. In continental law, all legislative powers and regulations come from the constitution, under which there are laws, and under the laws there are regulations. Therefore, it might seem that there isn’t specific legislation, but there’s bound to be abstract legislation because when we cannot find the applicable subordinate laws, we’d always consult superior laws. This is another legal characteristic we should consider: the lack of legislation does not mean the absence of laws.
Furthermore, there’s also the summary of existence, which is a new approach between the risk-based regime and the catch-all regime. This approach, combined with feature regulation, offers the following benefits: It introduces people to existing laws, rather than thinking that no laws exist. The summary of existence provides us with more effective guidelines. When you account for the cost of law, rectification and compliance become less expensive. Here, URS is a good example. Although URS only issues a small amount of money, it is subject to extensive contemporary regulation under the US Securities Act.
Finally, we come to China’s mainland, where tokens are basically banned. The most memorable Chinese regulation on crypto is that the country banned ICO on September 4, 2017, and banned token charges in November 2021. However, the earliest crypto restriction in this region was introduced back in 2013 when the government announced that Bitcoin and other cryptos could not be used as currency. In China’s legal system, issuing securities that replace RMB calls for criminal charges, rather than civil liabilities.
Now, let’s turn to regulation, which falls into different contexts in continental law and common law. In continental law, regulation involves a three-tiered legislative system, while regulation operates through parallel legislative structures in the common law. When I was studying in the US, there was a question about the source of regulation, and the answer is Law. Back then, I was confused. Later on, I learned that regulations were previously summaries of laws in the common law system. However, in contemporary legislation, especially since the adoption of the US Securities Act in 1933 and 1934, regulation has become more forward-looking, aiming to prevent risks. Therefore, in today’s legal discussions, regulation is about addressing problems in advance, rather than reacting to them upon occurrence.
In the US, stablecoin issuers are required to follow banking regulations, but such regulations do not yet exist in China; in China, the central bank issues digital currencies, while the US has no such official digital currencies. Hong Kong’s regulatory framework oversees the entire financial system using four types of licenses (1/4/7/9). However, there are currently no specific rules for managing stablecoins, only consultation documents. If stablecoins are considered a type of future commodity, then they will be subject to futures regulation.
That said, Hong Kong has other laws and regulations for stablecoins, such as the Securities and Futures Ordinance and the Payment Systems and Stored Value Facilities Ordinance. These laws and regulations might change over time. Additionally, Hong Kong has also introduced regulations regarding issuing banks. This tells us that if we expect stablecoins to be regulated by the Payment Systems and Stored Value Facilities Ordinance, the same rules might also apply to the issuance of stablecoins. Although the city has adopted specific regulations on asset-backed stablecoins in the relevant documents, there are no rules for algorithm-generated stablecoins. This is the case because the latter poses greater risks and requires more stringent regulations.
Hong Kong may regulate stablecoins through “Regulated Activities” and “Actively Marketing”. What this means is that you will be regulated by Hong Kong if your stablecoin marketing efforts affected the region, whether you are marketing the stablecoin in Hong Kong or not. Today, Hong Kong regulators mainly focus on asset-backed stablecoins.
Another interesting thing is that China often criticizes the US for its long-arm jurisdiction. The typical example is that US courts state that the US will assert its jurisdiction if you use the US dollar. But what about stablecoins? Are they also subject to US jurisdiction? What about Hong Kong dollars or HKD-pegged stablecoins? Additionally, with licensing, only a few market players could engage in the relevant activities. The legal trend that I noticed is that we are getting constant feedback by issuing licenses, which allows legislators to introduce specific rules and explore the relevant legal matters during that process.
Let’s turn to the legislative system, which may introduce new legislation or amend existing legislation to better cover stablecoins. When reviewing the content of Regulated Activities, you will find that the no-action approach, the risk-based regime, and the catch-all regime have all been adopted. In particular, Reserve and Stabilize represents a unique legislative trend that will affect new regulations.
Lastly, from late October 2022 to early 2023, a large number of research papers on stablecoins have been published. Now, thanks to stablecoins, tokens have become increasingly integrated with real-life scenarios and banking systems, which creates two major trends:
First, banks and central banks are already starting to provide banking services for tokens.
Second, the adoption of stablecoins might be the next legislative focus. In comparison, NFTs have not been subject to much regulation because, as a product, they are more of an “object”, meaning that their product value can be explained.
Stablecoins will become the next legislative focus, so please stay tuned. With stablecoin license and token charge, basic Web3 regulations will slowly take shape, which will foster more interesting ecosystems, and I hope we can all have fun in the future world of Web3. Thanks!