Hong Kong’s de facto central bank has released a discussion paper to collect public feedback on regulating crypto assets and stablecoins, in a move to embrace financial innovation while tackling potential systemic risks.

The Hong Kong Monetary Authority (HKMA) document, published Wednesday, focuses on addressing crypto-asset issues from three dimensions — stablecoins used in payments, investor protection and authorized institutions’ interface with crypto assets.

The regulator said stablecoins have the potential to “become a commonly acceptable means to make payment” but they “may not fall readily into the existing financial regulatory frameworks.”

Just like other major economies, Hong Kong regulators are looking at ways to increase scrutiny over the burgeoning crypto sector in the city, in a bid to contain risks surrounding financial stability and crimes.

Hong Kong has previously proposed legislation to require virtual asset service platforms (VASPs) to obtain licenses to operate. In May 2021, Hong Kong’s Financial Services and the Treasury Bureau published its Consultation Conclusions, with legislative proposals to introduce a licensing regime for VASPs, following a 2019 volunteer program that allowed exchanges to opt in and commit to compliance.

Read more: A look at how global stablecoin regulations are evolving

In the paper, the HKMA listed five regulatory policy options for crypto assets, ranging from no action to a general ban.

“That’s a wide spectrum of possible outcomes for the crypto firms in Hong Kong that are seeking regulatory clarification,” Winston Ma, managing partner of U.S.-based CloudTree Ventures, told Forkast. “It seems that the HKMA is keen on regulating stablecoins, into the same direction as China’s central bank and the U.S.’ financial regulators indicated during last few months.”

Benjamin Quinlan, CEO and managing partner of Hong Kong-based consultancy Quinlan and Associates, told Forkast that a blanket ban is unlikely but it’s clear that the market is not going to be unregulated completely.

“I think they want to balance what you would call consumer protection and broader financial stability, as well as the ability in particular with stablecoins to manage and effectively drive monetary policy but also not hamper innovation,” Quinlan said.

The consultation paper comes as Hong Kong is actively developing its own central bank digital currency (CBDC) — the e-HKD. In October, the HKMA released a whitepaper that proposes a dual infrastructure for both wholesale and retail CBDC.

“This signals that there’s space for stablecoins. The HKMA may probably recognize that there’s CBDC and stablecoin, and these two forms of new digital money will co-exist,” Charles d’Haussy, managing director for APAC at ConsenSys that helps Hong Kong authorities develop its CBDC, told Forkast.

“With the right regulation in place — being inclusive of the blockchain technology, its application and its potential — Hong Kong will thrive as a crypto hub,” d’Haussy added. “It’s really about enabling the existing players, which are already operating in Hong Kong for centuries, and helping them to safely enter the digital asset space.”

Read more: Regulators and the problem of unstable stablecoins

Eddie Yue, chief executive of the HKMA, said in a Wednesday statement it is crucial to ensure activities of payment-related stablecoins are safe and sound.

Yue said the HKMA has been reviewing the need to adjust the existing regulatory framework, such as that under the Payment Systems and Stored Value Facilities Ordinance, to “ensure that payment-related stablecoins are properly regulated in Hong Kong.”

In the document, the HKMA proposed that operators involving the creation, issuance, transaction validation, private key storage and redemption facilitation of stablecoins would need to be licensed.

The regulator said it intended to regulate stablecoin-related activities with a risk-based approach rather than in a one-size-fits-all manner.

For example, the HKMA proposed that if a foreign company wants to carry out stablecoin-related business in Hong Kong, it must incorporate a company under Hong Kong law and hold a license. “A mere Hong Kong branch or office of a foreign corporation is regarded as not meeting the requirement of ‘an entity incorporated in Hong Kong.’”

Additionally, the HKMA said it would draw reference from the city’s current approach and consider if stablecoin issuers should be regulated under the Banking Ordinance, as “stablecoins could be subject to run and become potential substitutes of bank deposits.”

“What the HKMA is trying to do here is to respond to both the market developments that have seen a tremendous rise in stablecoins in the digital economy, as well as to mounting pressure on regulators to make sure they’re doing something about it to deal with a systemic and investor protection at risks that are emerging,” Urszula McCormack, a financial regulatory lawyer at King & Wood Mallesons, an international law firm headquartered in Hong Kong, told Forkast.

McCormack said fiat needs to be a part of the digital economy, and stablecoins are serving that role. “The reality is that CBDCs are somewhat slow to be able to fulfill that role.”

Crypto firms in Hong Kong are starting to look into the document. A spokesperson of Babel Finance, a Hong Kong-based crypto financial services provider, told Forkast: “A robust discussion on charting the successful future of the crypto industry is welcomed in any form. The HKMA’s move is similar to other global regulators’ actions regarding stablecoins.”

The consultation is open until the end of March, and the HKMA is expected to formulate a plan by July this year for the new regime to be in place by 2023 or 2024, according to the document.