HKMA publishes findings of e-HKD pilot

Experts share insights around the value potential of a digital currency, following the HKMA’s publication of an initial report on the pilot.

Yesterday (October 30), the Hong Kong Monetary Authority (HKMA) published a report outlining key findings from its recent e-HKD pilot initiative. The regulator launched the pilot programme in May to explore the use cases, implementation and design issues associated with the hypothetical introduction of a retail central bank digital currency (CBDC) – the e-HKD – in the special administrative region (SAR).

The programme comprised 14 different project streams and involving leadership by 16 firms active across Hong Kong’s financial, payment and technology sectors. The projects set out to investigate application of a potential digital currency across six key areas: fully-fledged payments; programmable payments; offline payments; tokenised deposits; settlement of Web3 transactions; and settlement of tokenised assets.

“Mandating a cross-industry consortium and public-private partnership was paramount to exploring the value potential offered by the e-HKD to the full breadth of Hong Kong’s economy,” participant, David Chan, managing director and partner at Boston Consulting Group (BCG), told FinanceAsia.

“This helped to interrogate the key components required in driving the adoption and success of potential e-HKD implementation and provides practical input for HKMA to consider across its overall digital currency strategy through an informed approach. For example, the areas of regulatory development required to unleash the full value of e-HKD, or other forms of HK dollar-pegged digital currency.”

BCG participated in the “Settlement of Tokenised Assets” strand of the first e-HKD pilot programme to evaluate the value-add of a hypothetical e-HKD, alongside local payment solutions provider, HKT Payment which operates Tap&Go; virtual bank, ZA Bank; UK-based digital financial market infrastructure provider,; and Venture Smart Financial Group (VSFG) – the first Securities and Futures Commission (SFC)-approved virtual asset manager in Hong Kong.

Value creation

While yesterday, the HKMA acknowledged that the pilot programme was conducted on a small scale under a controlled environment and thus the regulator remains unable to confirm a decision around the introduction of an e-HKD, it recognises that implementation could “add unique value” to Hong Kong’s financial ecosystem. In particular, the HKMA sees opportunity in the payment space, with potential benefits across programmability, tokenisation and atomic settlement.

“Before the pilot commenced, there were questions around what benefits the potential e-HKD could offer to Hong Kong – given that current payment rails, such as the faster payment system (FPS) for example, already offer efficiency and the ability to transfer near-instantly,” Chan explained. “But our pilot successfully identified additional value creation.”

The cross-industry consortium was formed to investigate whether a digital currency chain could help “unlock” the liquidity trapped in real assets due to operational inefficiency. The group had to deliver an end-to-end pilot solution involving tokenisation of real-world assets, loan applications, spending and refund.

The pilot was based on a hypothetical e-HKD created by the group using its own technology. The unit provided programmability and carried all other typical features of digital currency, including instant settlement, atomic settlement with tokenised assets, and materiality for smart contract usage.

“The pilot’s transaction demonstrated the possibility of bringing new features to financial products, and improved efficiency, compared to current processes.”

He offered the example of credit assessment, which he explained could offer loan usage as a new assessment parameter.

“This was very challenging because, at the moment, lenders rarely manage the usage of loans once they have been disbursed to users. Digital currency’s programmability will fundamentally allow banks to have better risk control, and offer more competitive products to clients. This is particularly important for lenders and consumers in the current high interest rate environment.”

One key factor involved being able to programme the currency’s usage. “This usage is effective across platforms, meaning it can be instructed to be used for specific application purposes, as defined.”

“Then the end-to-end process tested the ‘open banking’ concept – the ability to enable users to mandate multiple solution providers to achieve their objectives. This is where envision a future where banks and different financial institutions can come together to better service consumers and society. The can do what they are best at doing: enabling the growth of real economy through the power of finance.”

The full process proved to be seamless, Chan explained, and demonstrated potential efficiency improvement in loan processing – overall end-to-end loan application time was reduced, and the proof of concept was fast; while the transaction also diminished key risk factors for lending, such as the use of the funds disbursed to clients.

Meanwhile, HSBC participated in the scheme by developing an e-HKD payment ecosystem for use on the campus of the Hong Kong University of Science and Technology (HKUST).

Three hypotheses were appointed for testing, a spokesperson for the bank previously told FA, including use of an e-HKD to lower transaction cost for merchants, enhance fraud prevention, and provide targeted spending offers and discounts.

“The insights gained from this closed-loop pilot provide an initial picture of the benefits that a CBDC ecosystem could potentially provide in everyday payments,” said Luanne Lim, chief executive for the bank in Hong Kong, via a note to media.

“Our distributed ledger technology (DLT) enabled near instant transfer of value from customer to merchant wallets, as well as provided automated rewards and discounts using smart contract programmability.”

Programmability was a “highly rated feature by merchants and consumers alike”, she added.

Uncertainty versus opportunity

However, in spite of pilot programme progress, key uncertainties remain around the implementation of a potential e-HKD.

Paul Tang, chief operating officer at Payment Asia and director of the Hong Kong Money Service Operators Association (HKMOA) told CT, “The emergence of virtual assets can address some inefficiencies in traditional finance. However, due to their borderless and 24/7 trading nature, regulating them poses certain challenges.”

It is understood that current thought favours an intermediary or central bank-backed model, where the wholesale layer of the CBDC would be governed by the central bank, while the licensed private intermediaries could handle the distribution and management of client data.

“This would not be so different from the current two-tier approach employed in banknote operations, where note-issuing banks [HSBC, Bank of China (BOC) and Standard Chartered (SC)] issue notes to the public, backed by the assets governed by the HKMA,” Chan explained.

But comprehension is lacking outside of specialist circles, Tang noted. “The general public's understanding of virtual assets remains largely limited to viewing them as ‘investment products’, which indicates that there is still some distance to go before virtual assets achieve wide adoption.”

In addition to the pilot implementation, the BCG-involved consortium, also conducted a survey with more than 1,800 locals for their view on the perceived benefits of digital currency and secured lending, such as home mortgages and car park loans.

“Roughly 70% stated that documentation was a key pain point for secured lending applications today, and out of those who have applied for home mortgages and car park loans, ~80% said that it takes more than 2 weeks (~40% said more than 4 weeks) to complete the secured lending process.”

“With a digital currency that can be settled with tokenised assets, users can enjoy much more efficiency. For example, a user can front-load most of the paperwork during the tokenisation process, and then use the tokenised assets as collateral to secure funding at better rate, whenever they need to.”

Chan is optimistic about the capacity for a viable digital currency to bring with it broader benefits for Hong Kong. Based on the pilot, he feels it is possible that such a development could unlock an additional 0.5% in GDP growth over the next decade.

Chan takes note of four specific opportunities, to:

  • Unlock liquidity: Much liquidity sits in assets that cannot be redirected to a more productive environment, or cannot be utilised effectively. A digital currency could help to increase liquidity for a specific asset – as collateral to provide liquidity to owners at an affordable financing rate, enabling the value of the asset to be redirected for use in the real economy.
  • Foster financial inclusion: If digital currencies were programmed for specific purposes, investors and governments could deliver funding support to specific sectors or groups that need help, while reducing administrative processes. For example, SMEs or Covid-hit F&B businesses could potentially obtain better access to government funding for certain permitted purposes. The programmability feature of digital currency could enable the government to roll out targeted policies to support specific areas of the economy.
  • Support the new economy: Hong Kong aims to be a Web3 hub in the Asian region. HK dollar-pegged digital currency is fundamentally needed for Web3 use cases, as currently its participants only have access to other denominations. If Hong Kong were to launch a widely accepted and regulated digital currency as a means of settlement, this could help increase society’s confidence in Web3 developments, bringing talent, capital and corporate imports into its ecosystem.
  • Facilitate cross-border connectivity: A variety of pain points mean that cross-border collaboration can incur high costs and be slow. If cross-border payment settlement were achieved through an HK dollar-pegged digital currency, Hong Kong could better fulfil its role as an international financial gateway.

“CBDCs is one thing, but we also need the backend infrastructure system – and this is a crucial aspect being explored in the mBridge project,” explained Rocky Mui, partner at Clifford Chance in Hong Kong.

Project mBridge specifically looks at the wholesale side of CBDC application, which is likely to bring benefits for a potential retail e-HKD.

“It aims to make cross-border foreign exchange settlement more efficient. This is one of the more obvious areas where we can achieve efficiencies to enhance Hong Kong’s roles as a financial and trading hub, its unique position as a renminbi (RMB) pool and role in the internationalisation of the RMB.”

“I do agree that the development of e-HKD could prompt new economic growth in the region,” Tang said.... More importantly, it could help the de-dollarisation in the current Web3 world.”

Tang agreed that issuance of e-HKD would provide an alternative for transactions in the Web3 ecosystem. Additionally, its baking by a government organisation, would mean it inherently had more credit than a currency issued by a private company.

“Currently most of the settlement in Web3 world, or between fiat and cryptocurrencies, is done in Tether’s USDt or USD Coin (USDC), as their prices are more stable compared to Bitcoin or Ether. However, this is also heavily dependent on US dollar. Currently about 90% of stablecoin… on or off ramp... is pegged with US dollar and issued by a private company.”

He proposed that digitally enabled cross-border settlement of e-HKD, could “reduce reliance on the US dollar as the dominant reserve and transaction currency”.

“We are in urgent need of a regulated bridge between traditional finance and the Web3 world – as can be seen from the recent JPEX case. With regulation in place, we can really build a Web3 ecosystem rather than use digital assets as another way for investment, or even speculation. Hence the importance of the e-HKD.”

Next steps

The pilot initiative constitutes part of the HKMA’s “Fintech 2025” strategy and forms the second of the regulator’s “three-railed approach” to investigating CBDC viability, as outlined in the regulator’s September 2022 whitepaper, e-HKD: Charting the Next Steps.

The first rail – which ran alongside the pilot and continues to progress – aims to lay the technological and legal foundations to support implementation; while the third will commence once results of the first two schemes have been consolidated and reviewed. This final stage will involve full analysis of progress to date, as well as more thorough planning around any proposed implementation and launch of a digital currency.

It is understood that the BCG-involved cross-industry consortium plans to publish an additional whitepaper in review of the pilot initiative in the coming months.

“In the long run, the true value of developing e-HKD lies in its role in security, transparency, and longevity. It is crucial for improving the efficiency, trust, confidence, safety, and stability of the financial market,” Tang concluded.

He commended the efforts of the HKMA to facilitate progress and discourse. “Although it may take years to achieve, I think it is a good first step."

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