What is the value of Bitcoin and stablecoins? What are the risks? How to regulate them? This article explains your doubts!

From "virtual goods" in 2013 to "virtual currency" in 2017, and then to the recent characterization of Bitcoin and stablecoins as "crypto assets" by Li Bo, deputy governor of the People's Bank of China, it can be seen that the understanding and recognition of Bitcoin and stablecoins by Chinese regulators are constantly improving and becoming clearer.

In the view of the experts interviewed, as the global digital economy accelerates and inflation expectations continue to rise, Bitcoin's value storage function has gradually become a "global consensus." Stablecoins are one of the important applications of blockchain technology and a cutting-edge financial technology that is believed to have the potential to comprehensively transform the global payment system.

However, due to the anonymity and wide international circulation of crypto assets, they have exposed problems such as market manipulation, fraud, insufficient investor protection, and money laundering in their development. The Basel Committee on Banking Supervision issued the "Prudential Supervision Requirements for Virtual Assets (Draft for Comments)", proposing that the prudent regulatory framework for crypto assets should follow the principles of consistency, "technology neutrality", simplicity, and minimum standards.

Li Bo revealed that the regulatory rules for Bitcoin and stablecoins are being studied. In the future, if any stablecoin hopes to become a widely used payment tool, it must be subject to the same strict supervision as banks or quasi-bank financial institutions.

From "virtual goods" to "crypto assets"

The reporter noticed that with the global development of "digital currencies" such as Bitcoin and stablecoins, Chinese regulators' understanding of Bitcoin and stablecoins is also becoming clearer.

At the end of 2013, the People's Bank of China and five other ministries defined Bitcoin as a "specific virtual commodity" in the "Notice on Preventing Bitcoin Risks" (hereinafter referred to as the "Notice").

The Notice points out that Bitcoin has four main characteristics: no centralized issuer, limited total volume, no geographical restrictions on use, and anonymity. Although Bitcoin is called "currency", it is not a real currency because it is not issued by the monetary authorities and does not have monetary attributes such as legal tender and compulsion. In terms of nature, Bitcoin should be a specific virtual commodity that does not have the same legal status as currency and cannot and should not be circulated and used as currency in the market.

At that time, the "Notice" clearly stated that financial institutions and payment institutions shall not price products or services in Bitcoin, shall not buy or sell Bitcoin or act as a central counterparty to buy or sell Bitcoin, shall not underwrite Bitcoin-related insurance business or include Bitcoin in the scope of insurance liability, and shall not directly or indirectly provide customers with other Bitcoin-related services, including: providing customers with Bitcoin registration, trading, clearing, settlement and other services; accepting Bitcoin or using Bitcoin as a payment and settlement tool; conducting Bitcoin and RMB and foreign currency exchange services; conducting Bitcoin storage, custody, mortgage and other businesses; issuing Bitcoin-related financial products; using Bitcoin as an investment target for trusts, funds and other investments, etc.

In September 2017, the People's Bank of China and seven other departments issued the "Notice on Preventing Risks of Token Issuance and Financing" (hereinafter referred to as the "Notice"), emphasizing that the financing subject raises so-called "virtual currencies" such as Bitcoin and Ethereum from investors through the illegal sale and circulation of tokens, which is essentially an act of illegal public financing without approval. The tokens or "virtual currencies" used in token issuance and financing are not issued by monetary authorities, do not have monetary attributes such as legal compensation and compulsory nature, do not have the same legal status as currency, and cannot and should not be circulated and used as currency in the market.

Recently, Li Bo, deputy governor of the People's Bank of China, said at the Digital Payment and Digital Currency Forum of the Boao Forum for Asia 2021 Annual Meeting that Bitcoin and stablecoins are crypto assets. Crypto assets are investment options. They are not currencies themselves, but alternative investment products. The main role that crypto assets may play in the future is as an investment tool or alternative investment.

Yin Zhentao, director of the Financial Technology Research Office of the Institute of Finance of the Chinese Academy of Social Sciences, pointed out in an interview with a reporter from the International Financial News that "from virtual commodities in 2013, to virtual currencies in 2017, to today's encrypted assets," the People's Bank of China's understanding and recognition of "digital currencies" such as Bitcoin are constantly sublimating and clarifying, which is not only conducive to regulatory enforcement and judicial practice, but also in line with market laws and development trends.

The value of Bitcoin as an investment

As the global digital economy accelerates and inflation expectations continue to rise, Bitcoin's value storage function has gradually become a "global consensus." In the view of Yu Jianing, rotating chairman of the Blockchain Committee of the China Communications Industry Association and president of Huobi University, the key value of Bitcoin can be reflected in four aspects:

Yu Jianing told the International Financial News reporter that, first of all, the mining mechanism is the "basic foundation" of Bitcoin's value. The consumption of electricity and the depreciation of mining machines during the mining process continuously input value into the Bitcoin network, realizing the transformation of value from the physical world to the digital world, and constituting the basic foundation of Bitcoin's value.

Secondly, the total number of bitcoins is limited to 21 million, and 18.686 million have been "mined", which means that nearly 90% of bitcoins have entered circulation. The current nominal inflation rate is only 1.75%, which is lower than the general inflation target of 2% of central banks. However, due to the frequent loss of bitcoin private keys, the bitcoins in circulation will also decrease due to various reasons. Substantial deflation may occur in the future, further exacerbating the scarcity of bitcoins and fundamentally affecting the price trend.

Thirdly, Bitcoin has been recognized and participated by traditional financial institutions and listed companies, which has become a key link in capturing the value of Bitcoin. Since 2020, top financial institutions such as BlackRock, the world's largest asset management company, DBS Bank of Singapore, Sberbank of Russia, Bank of New York Mellon, and Goldman Sachs have launched encrypted asset trading and custody businesses. Well-known listed companies such as Tesla, PayPal, Square, MicroStrategy, and Meitu have included Bitcoin in their core asset allocation. Canada has also launched a number of Bitcoin ETF funds based on real assets, and a fund product 100% anchored to Bitcoin has also been launched in Hong Kong, China.

Finally, Yu Jianing believes that the position of Bitcoin in the digital world is similar to that of the US dollar in international trade. New applications based on blockchain are booming, and the changes in digital technology with blockchain as the core in the next decade will become the key driving force for the development of the entire world. The more scenarios in which blockchain is used, the greater the demand for Bitcoin reserves, which will undoubtedly have a huge impact on the value of Bitcoin.

As Bitcoin has become a new key area of ​​global technology and financial competition, governments around the world are increasing their regulatory attention and exploration in this area. From a global perspective, the United States and Japan are at the forefront of the world in regulating Bitcoin. Countries such as the United Kingdom, Canada, Australia, and Switzerland also recognize the positive significance of Bitcoin and are working on formulating relevant regulatory laws to regulate the development of the industry. Russia and Thailand have also shifted from prohibition to relaxation.

Singapore has also become more open and positive in the field of blockchain technology and crypto assets, encouraging financial innovation under the "regulatory sandbox" system. Singapore is at the forefront of the industry in the formulation of laws and regulations related to crypto assets.

In addition, in Hong Kong, China, the Hong Kong Securities and Futures Commission has issued new regulations on crypto assets, introducing specific terms and conditions for crypto assets, thereby balancing the protection of holders' interests, financial innovation and financial stability.

The development prospects of stablecoins

In addition to Bitcoin, stablecoins are believed to have the potential to revolutionize the global payment system. Stablecoins are collateralized by legal tender or assets when issued, and their value is anchored to a certain legal tender to achieve price stability. They have certain monetary attributes and the technical advantages of blockchain encrypted assets, so they can be used as one of the options for payment.

Since 2019, business giants such as IBM, JP Morgan, Facebook, Walmart, and Goldman Sachs have also announced their exploration of stablecoins. Among them, the more influential ones include the stablecoin project Diem (formerly Libra) announced by Facebook in June 2019 and JPM Coin launched by JP Morgan in February 2019. In January 2021, the U.S. Office of the Comptroller of the Currency issued an open letter stating that U.S. national banks and federal savings associations can use public blockchains and stablecoins for settlement. Visa also announced in March this year that it would allow customers to use the stablecoin "USD Coin" (abbreviated as "USDC") to settle transactions on its payment network.

After Facebook announced that it would lead the launch of Libra, many countries and international organizations began to pay attention to and study the regulatory issues of stablecoins, and formed a series of regulatory principles that can be used as reference.

For example, the Financial Stability Board (FSB), an international financial regulatory coordination organization established by the G20, issued the "Addressing the Regulatory Challenges Brought by Global Stablecoins (Draft for Comments)" on April 14, 2020. Based on the principles of consistency and technological neutrality, it proposed ten regulatory principles for addressing the challenges of global stablecoins.

The draft for comments suggests that global stablecoins can basically be included in the current regulatory framework, but specific issues need to be analyzed specifically. The specific rules that should be applied and the division of responsibilities between regulatory agencies should be clarified based on the operating mechanisms and economic functions of different stablecoins. If there are still regulatory gaps, then consider formulating supplementary regulations.

On November 24, 2020, the Bank for International Settlements (BIS) released a working report entitled "Stablecoins: Risks, Opportunities and Regulation", arguing that the regulation of stablecoins should be based on the many conveniences they may provide, rather than being limited to the existing regulatory framework. It can consider implementing "embedded regulation", that is, directly embedding regulatory requirements into the implementation of the "global stablecoin" system.

In addition to the regulatory proposals of international regulatory organizations, the United States, as the country with the largest scale of stablecoins anchored to fiat currencies, has also put forward a series of regulatory requirements for the operation of stablecoins. In September 2020, the Office of the Comptroller of the Currency (OCC) of the United States issued a guide stating that federally chartered banks and federal savings associations in the United States can store reserves for stablecoin issuers. However, banks are only allowed to provide storage services for stablecoin issuers that issue 1:1 anchored to a single fiat currency. In addition, banks must verify at least every day that the balance of the reserve account is always equal to or greater than the number of outstanding stablecoins of the issuer.

Yu Jianing pointed out that stablecoins under the US regulatory framework only apply to stablecoins that have been reviewed and approved by regulatory authorities and are subject to continuous supervision, namely, USDC, GUSD, PAX, etc. that have obtained operating licenses. If we want to promote compliant stablecoins for global payments, we still need to reach a consensus in the international community and form international rules that are commonly followed. Therefore, we need the participation of international organizations and coordination and cooperation among countries.

Risks and regulation of crypto assets

Crypto assets have brought a new business model that combines new technologies, new finance, new industries, and new organizations. This deeper model innovation is different from past technological innovations and has also posed great challenges to regulatory models and risk management. At present, crypto assets have not yet had a substantial impact on the stability of the financial system, but the problems exposed in the development of market manipulation, fraud, insufficient investor protection, money laundering, etc. have attracted the extreme attention of regulators in various countries.

Yu Jianing introduced that the market risk, credit risk, and operational risk of the crypto asset industry represented by Bitcoin still exist, and the technical risk is prominent. The recently popular DeFi (distributed financial technology) faces more complex technical issues such as smart contract execution risk, operational security, liquidation risk, and hacker attack risk.

In addition, due to the anonymity and wide international circulation of crypto assets, in recent years criminals have used crypto assets for cross-border exchange to convert criminal proceeds and profits into foreign legal currency or property, which has to some extent become a new means of money laundering.

In China, although the regulatory authorities have explicitly prohibited token issuance financing and exchange activities, due to differences in regulatory policies adopted by various countries and regions on crypto assets such as Bitcoin, transactions between Bitcoin and legal currency can be freely traded through overseas crypto asset service providers, exchanges and Bitcoin ATMs.

According to the 2020 Annual Digital Currency Anti-Money Laundering Report released by PeckShield, the value of unregulated outbound crypto assets reached $17.5 billion in 2020, up 51% from 2019, and is still growing rapidly. Fraud cases involving crypto assets continued to occur, reaching 151, and extortion cases also grew rapidly. China implemented the "card cutting" operation, and traditional money laundering channels suffered a heavy blow, and then turned to crypto assets, and the form of crypto asset money laundering was severe.

With the rapid rise and iteration of crypto assets and distributed financial technology DeFi around the world, it has also attracted widespread attention from international organizations, central banks and regulators. At present, the main idea of ​​various countries in regulating financial activities related to crypto assets is to classify them according to the nature of the business corresponding to crypto assets, incorporate them into the current regulatory framework, and clarify the applicable regulatory standards.

On August 7, 2020, the China Banking and Insurance Regulatory Commission released a working paper titled "International Regulatory Ideas for Virtual Assets and Their Implications for Establishing a Long-term Mechanism for Preventing Internet Financial Risks". The paper stated that we can draw on the international regulatory ideas and trends of crypto assets to establish a long-term mechanism for preventing Internet financial risks in my country and avoid repeating the mistakes of online lending platforms.

According to the "Draft for Comments on Prudent Regulatory Requirements for Virtual Assets" issued by the Basel Committee on Banking Supervision in December 2019, the following principles are proposed for the prudent regulatory framework for crypto assets:

The first is the principle of consistency. Because crypto assets do not create a new financial business model, as long as the economic functions and risks of the financial business are essentially the same, the same regulatory standards should apply.

The second is the principle of "technology neutrality". The design of the regulatory framework should not reflect the orientation of supporting or opposing a specific technical solution, but it should consider the additional risks that may be brought about by the relevant technical solutions adopted and other special attributes.

The third is the principle of simplicity. Banks’ current risk exposure to crypto assets is still relatively small, and they should try to use a relatively simple “standard method” based on their economic functions and business nature.

Fourth, the principle of minimum standards. The prudent regulatory framework for crypto assets proposed by the Basel Committee is only a minimum standard or regulatory bottom line. Countries can put forward more stringent regulatory requirements.