Hong Kong’s Unique History with Currency May Be Valuable for Crypto


Even official money is almost private in Hong Kong, with people interchangeably using IOUs from its three note-issuing banks. But as central banks around the world plan to digitize cash, can this arrangement hold up? Or will the city’s 7.5 million residents have to transact in a brand new currency, the direct responsibility of the Hong Kong Monetary Authority?

The answer may be of global interest as governments around the world are under pressure to adapt to new technology.

Stables, pegged at 1: 1 to the dollar or euro, are emerging as a haven of value for those trading volatile cryptocurrencies. Synthetic private money could become mainstream when social media giants put the power of their networks behind stablecoins. For example, Meta Platforms Inc. (formerly Facebook Inc.) supports Diem, a yet to launch token that can be sent instantly to anyone, anywhere with an entry-level smartphone and data connection.

To anticipate the financial stability risk of stablecoins that are too big to fail, central banks are considering their own versions of official digital currency. But they are reluctant to open their registers to the entire population and know in real time if someone is trying to spend the same money twice. Regulators who have historically only worked with a limited number of banks are simply not equipped to take on the extra work that comes with being consumer-oriented institutions.

The way Hong Kong navigates the digital money world might offer some useful advice.

Three years after it officially became a British colony in 1843, notes issued by designated commercial lenders began to circulate as a medium of exchange in local Hong Kong transactions. The tradition has continued. Shortly before the city’s transfer to the People’s Republic in 1997, the Bank of China (Hong Kong) Ltd. joined the two UK-based institutions, HSBC Holdings PLC and Standard Chartered PLC, as the island’s third-largest banknote printer. Since all of their pieces of paper are fully backed by assets deposited with the Hong Kong Monetary Authority (HKMA), no one except first-time tourists even notices the name of the issuer of the banknotes. .

Can a similar public-private partnership work with an electronic retail Hong Kong dollar (e-HKD)?

The city’s monetary authority is currently only investigating the feasibility of retail digital cash, but one of the design options presented in a technical white paper looks promising. The proposal is to create two blockchain-based layers: wholesale and retail. The central bank will only operate in the wholesale business and here too will only issue new currency or buy it back. The banking intermediaries will decide by consensus whether any of them are entitled to receive wholesale digital money from HKMA based on the return of a 1: 1 value in the supporting assets.

The central bank will have no presence in the retail layer. Intermediaries will convert their wholesale digital money to e-HKD and deliver it to customers in single-use envelopes, known to the crypto world as unspent transaction output, or UTXO. When a customer spends, they tear up one or more envelopes and store any change in a new one. By tracing these cryptographically marked packets, transactions could be traced back to the original source: the wholesale money that entered the retail system.

The advantage of this traceability feature is that if a retail layer intermediary goes bankrupt, payment disputes do not need to go to court. Code can sort them out, with the blockchain forging a consensus that the stranded holder of e-HKD has a good faith claim to the supporting assets parked with the central bank.

On the other hand, the anonymity of physical money will be lost forever. The public key in a blockchain-based payment system is like a mailbox address. People can use new ones to prevent their identities from being revealed by intruders. But banks, which will need to perform know-your-customer checks to guard against money laundering, must register all of their customers’ public keys. They will know.

However, for transactions where absolute anonymity is not crucial and where a payer would voluntarily use a debit card – or digital wallet – instead of having to fork out cash, e-money will be a welcome addition. as a convenient smartphone payment option. . Such a version of digital money will nominally be a private sector responsibility, but due to rock-solid backing it will be indistinguishable from government-printed currency.

Separating the wholesale and retail layers will reduce the “attack surface” for hackers. It is therefore conceivable that even the new-age Hong Kong virtual banks, such as Mox Bank Ltd. and ZA Bank Ltd. competitive.

No large country can emulate Hong Kong’s fixed exchange rate currency board system. But when it comes to tokenization of money, the Asian financial center can have a valuable message to the rest of the world: rather than opposing the private sector, the public sector should try to co-opt it as much as possible. . It may be a less burdensome route to digital money than taking each individual depositor as a central bank customer.

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About Ruben V. Albin

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