Hong Kong Dollar stablecoin issuance: On-chain reconstruction based on the linked exchange rate system and the essential differences of CBDC

Written by: Zhu Weisha

After the introduction of the "Stablecoin Regulation" in Hong Kong, I pointed out in articles such as "The Current Methods for Issuing Hong Kong Dollar Stablecoins Need to be Reconstructed" that the existing issuance mechanism has potential flaws, and I systematically outlined the solutions. Some believe that the method I proposed is merely a "blockchainization" of the Hong Kong dollar pegged exchange rate system, which is very similar to the issuance method of Central Bank Digital Currency (CBDC). This article aims to respond to this question and clarify the essential differences between the two.

Core viewpoint: The central bank issues base currency M0, while the Hong Kong dollar stablecoin belongs to broad money M2. The issuer of CBDC is the central bank, whereas the Hong Kong dollar is issued by commercial banks. There are fundamental differences between the two in terms of credit basis, circulation mechanisms, and value stabilization methods.

1. The difference between Hong Kong Dollar and CBDC

Different issuing entities

CBDC is directly issued by the central bank (for example, the People's Bank of China), is a liability of the central bank, and is a form of legal digital currency.

The Hong Kong dollar is issued by three commercial banks: HSBC, Standard Chartered, and Bank of China (Hong Kong) (BOCHK). The Hong Kong Monetary Authority (HKMA) only issues coins and commemorative notes of 10 dollars and below.

Credit endorsement and support mechanisms are different.

CBDC is backed by national credit and has the same legal status as cash (M0), requiring no asset collateral.

The Hong Kong dollar is based on the linked exchange rate system, where every 7.8 Hong Kong dollars issued by the note-issuing banks must be backed by 1 US dollar paid to the Monetary Authority as reserves. Its credibility is supported by a triple backing of US dollar reserves, the credit of the Monetary Authority, and the credit of the note-issuing banks.

The path of currency creation is different.

CBDC follows a two-tier operating system of "central bank → commercial bank → public".

Hong Kong dollars are generated through the process of "commercial banks collateralizing US dollars → creating deposit currency → subsequently amplifying the money supply through credit," which is essentially market-driven currency creation.

The form of currency differs from the technological foundation.

CBDC is based on blockchain or distributed ledger technology (DLT), belonging to centralized systems, supporting controllable anonymity, programmability, and offline transactions.

The Hong Kong dollar exists in both cash and deposit forms, with cash issued by commercial banks and deposits accounting for over 90% of the supply, circulated through the banking system via electronic bookkeeping.

II. Similarities and Differences between Hong Kong Dollar Stablecoins and CBDCs

Although both may use blockchain as the underlying technology, their issuance mechanisms are fundamentally different:

Hong Kong dollar stablecoins are issued by licensed commercial banks or institutions, based on a reserve of equivalent US dollars and a linked exchange rate system. The issuance process is market-oriented, and credit relies on reserve assets.

CBDC is directly issued and backed by the central bank, and is a digital form of the national legal currency.

3. The issuance model of the Hong Kong dollar is the "ancestor" of fiat stablecoins.

The original concept of cryptocurrency was proposed by David Chaum in 1982, and he invented digital cash (DigiCash) in 1989. The term "cash" in Satoshi Nakamoto's Bitcoin system comes from this.

At that time, cryptocurrency was still in its infancy. The fixed exchange rate system has been operating as a mature system since 1983 for 42 years, and its market-oriented, decentralized design embodies the blockchain spirit of "not relying on a single authority." Stablecoins like USDT only emerged in 2014, and its founder Brock Pierce) publicly stated that it "drew inspiration from the Hong Kong note-issuing bank model." It can be said that the Hong Kong dollar issuance mechanism is a pioneer in the institutional framework of stablecoins, and its success stems from institutional design rather than technology, which has not been surpassed to this day. The centralized regulation and management of the Hong Kong dollar have been adopted by USDT, while the blockchain spirit of "not relying on a single authority" is not reflected in USDT. In essence, USDT can be seen as a diluted version of the Hong Kong dollar issuance method, which is not suitable for the issuance of the vast majority of sovereign stablecoins.

4. The Reasonable Issuance Method of Hong Kong Dollar Stablecoins

If the underlying technology for issuing Hong Kong dollars is replaced with blockchain, it will form a "Hong Kong Dollar Stablecoin". This model can effectively address the three core issues of stablecoin issuance: the lack of rescue, lack of transparency in credit, and naming confusion, thus avoiding the "over-leverage" risk of repeatedly issuing stablecoins based on the anchor currency.

In this model, Hong Kong dollars and Hong Kong dollar stablecoins circulate in parallel, without the worry of leverage. Even if the exchange rate of the Hong Kong dollar or stablecoin deviates from the range of 1 USD to 7.75–7.85 HKD, it can be independently adjusted through the mechanism.

Nobel Prize-winning economist Bengt Holmström pointed out in "Collateral and Liquidity" (2023) that "the collateral-arbitrage dual-track mechanism of Hong Kong's linked exchange rate system is the Pareto optimal solution to cope with currency crises." Adopting a linked exchange rate system and implementing a Hong Kong dollar stablecoin through blockchain is the optimal solution for the current Hong Kong dollar stablecoin.

V. The timely response of the Monetary Authority and outstanding matters

On July 21, I published an article titled "Will the Introduction of the Stablecoin Bill Trigger a Financial Tsunami?" pointing out the three major risks associated with the issuance of stablecoins. I didn't elaborate fully; it was meant for those who are insightful. It implies that the Hong Kong dollar stablecoin is at the eye of the financial tsunami.

On August 1, the Monetary Authority launched the "Real-name penetration + Data retention + T+1 redemption" policy, which, although sparked market controversy, effectively plugged most loopholes in systemic risk, significantly reducing the possibility of a financial tsunami. They excel in detailed execution, but there is still room for improvement at the strategic level. For example, the Hong Kong dollar mechanism is a notch above the USDT mechanism, so why does the Hong Kong Monetary Authority settle for less? Does it really need to follow the United States? Don't they know that Sir Paul Chan is the pioneer?

Sir John Henry Bremridge, the excellent designer of Hong Kong's linked exchange rate.

If the Monetary Authority does not respond in a timely manner, I originally planned to write an article titled "Bessent Harvests Hong Kong: The Complete Collapse of the Hong Kong Dollar," analyzing the potential crisis in depth. This shows that the design of financial systems and mechanisms is far more important than the technology itself.

Readers interested in "Beisente Harvesting Hong Kong: The Complete Collapse of the Hong Kong Dollar" can log onto the WuChain website and download the WuChain platform within ten days starting from August 20 if it reaches 3000 people, and I will write this article. Although some loopholes have been closed, it is still full of practical insights and creativity, which will be very inspiring. Beisente cannot do this, but it's uncertain for people in cryptocurrency. Of course, it's not easy to cause the collapse of the Hong Kong dollar.