Digital currencies: Cryptos, CBDCs and the future of payments

November 22, 2021 08:56

Cryptocurrencies are grabbing headlines across the globe daily, and it is not just about Bitcoin. According to data from CoinMarketCap, a cryptocurrency data aggregator, there are over 13,000 cryptocurrencies in existence with Ethereum, Solana and Cardano being some of the coins with the highest market capitalization after Bitcoin. It is noteworthy that the total crypto market cap has increased nearly ten-fold since the start of the Covid-19 pandemic, to a staggering US$2.9 trillion now (as of November 11th).

The growing popularity of cryptocurrencies, coupled with the rapidly declining use of cash globally, is also putting pressure on central banks to accelerate their digital currencies efforts. 87 countries (accounting for over 90 percent of global GDP) are now exploring the development of their central bank digital currency (CBDC), which is the digital form of fiat money.

Crypto adoption in Hong Kong

In the past few years, Hong Kong has witnessed the establishment of several homegrown crypto exchanges such as, some of the world’s largest crypto custodians such as HEX Trust and have welcomed the expansion of foreign companies such as BlockFi, a borrow and lend crypto platform.

In addition, crypto has been steadily gaining acceptance as a new asset class both for retail and institutional investors. However, interest in using cryptocurrencies to pay for goods and services is still relatively nascent in Hong Kong, in line with global trends. This is on account of two things. On the one hand, crypto holders have traditionally seen crypto as a store of value or as a speculative asset. On the other hands, the institutional framework needed for crypto to be widely accepted by merchants is still being set up.

Nonetheless, the usage of digital currencies as a form of payment is promising. In fact, a recent FIS-commissioned survey of 1000 Hong Kongers found that more than one-third (35 percent) plan to use either cryptocurrencies or CBDCs to make purchases in the next five years.

Consumer demand is only one piece of the puzzle, with merchants being the other side of the coin. Non-crypto merchants may want to accept crypto payments and hold them on their balance sheet or alternatively be able to seamlessly convert crypto back into fiat currencies. Merchants may also want to receive fiat currencies, further to a transaction made in crypto, such as the announced partnership between Amber AI and Mastercard for a pay with crypto project.

The regulatory landscape for crypto

For crypto payments to become mainstream, payment providers, financial institutions and regulators are coming together to address key challenges in the ecosystem. For instance, in APAC, crypto exchanges (a major segment of crypto merchants) might struggle to navigate regulations or find a partner bank in the region. Some settlement banks are also not willing to process transactions for crypto merchants.

To accommodate this innovation, the regulatory framework around crypto has evolved in Hong Kong and is currently being refined. In 2019, the SFC issued a Position Paper on the “Regulation of virtual asset trading platforms.” This outlined an opt-in for exchanges wishing to obtain licensing for platforms trading at least one tokenized security. Stricter regulation of cryptocurrency exchanges operating in Hong Kong is now underway. If government proposals are passed by the Legislative Council crypto businesses will require a licence from the Securities and Futures Commission and will only be allowed to provide services to professional investors.

While these rules point to the fact that a tougher stance towards crypto is coming, with regulatory guardrails, institutions will be able to get into the space, giving consumers comfort and enabling crypto to become more mainstream.

CBDC development

Proponents of crypto find its decentralized features appealing. FIS’ survey showed 41 percent of Hong Kongers who preferred cryptocurrencies to CBDCs wanted to make transactions without the involvement of a central authority. However, others want the stability of a government-backed digital currency.

CBDCs can be powered by the same distributed ledger technology that provide the rails of cryptocurrencies. Yet, they are different from cryptocurrencies because the latter are decentralized and lack legal tender status (at least in Hong Kong). CBDCs bring together the conveniency of cryptocurrencies and the regulated, reserve-backed money circulation of the traditional banking system.

CBDCs can also bring social benefits, such as the enablement of easier transfer of money across borders. One use case is for migrants to transfer money back to their home countries. CBDCs can also broaden financial inclusion for more people around the world, particularly in emerging economies.

Although a CBDC is yet to be formally developed in Hong Kong, it is gaining pace with the Hong Kong Monetary Authority. In fact, the HKMA has released a whitepaper on an electronic Hong Kong Dollar, i.e. 'e-HKD' just last month. If it came to fruition, it would have the potential to be a game-changer and play a key role in the financial services ecosystem.

In conclusion, digital currencies – whether crypto or CBDCS – are here to stay. With its longstanding reputation as an international financial hub, Hong Kong’s approach to digital currencies will be closely followed.

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Senior Legal Counsel (Blockchain & Digital Assets), Worldpay from FIS