When Hong Kong was established as a free trading port in 1841, there was no local currency in circulation. Trading in Hong Kong was done using foreign currencies such as Spanish and Mexican Reales, Indian Rupees and Chinese coins. In the 1860s, banknotes of the new British colonial banks, HSBC and the Chartered Bank of India, Australia and China, denominated in dollars, began to circulate in Hong Kong.
The currency notes were silver-backed and as a result the value dropped immensely compared to the gold-backed US dollar during the international silver crisis. In 1935, Hong Kong abandoned silver and introduced a crawling peg to sterling of HK$16 to £1. It was from this year on that the Hong Kong dollar as a distinct unit of currency came into existence and in 1937 it became the unified legal tender of Hong Kong.
In 1972, the Hong Kong dollar was pegged to the US dollar as the dominant currency in the global economy. The peg was first set at a rate of US$1 to HK$5.56 and in 2005 it was modified to range between the lower guaranteed limit of HK$7.75 and upper guaranteed limit of HK$7.85.
Today, Hong Kong’s position in the global economy as a financial center is based largely on the decades old USD peg. It is considered an anchor for financial stability and the economy at large, attracting investors to park their wealth in Hong Kong with faith in a currency peg that is safe and easily convertible.
About the USD peg
The Hong Kong Monetary Authority (HKMA) is the de-facto central bank of Hong Kong, charged with the mandate to uphold the currency peg. Via the currency board mechanism, the HKMA keeps HKD trading close to 7.80 following two main strategies:
- Stock rule: At all times, the monetary base must be fully backed by US dollars at the rate of 7.80
- Flow rule: Increases and decreases in the monetary base need to be matched by transactions against US dollars with he Exchange Fund at intervention rates within the 7.75 – 7.85 trading band.
This is what keeps HKD trading at HK$7.75 to HK $7.85 per US dollar. The reason for keeping HKD pegged to USD as opposed to another currency is that US dollar is simply the most appropriate anchor-currency to create financial stability. It is fully convertible and traded freely in large amounts on forex markets. The US dollar is also used as an international reserve currency and the Fed – the US authority in charge of monetary policy – has a reputation for fostering price stability effectively.
As a side note, Hong Kong dollar is joined by other currencies that have pegged their value to the US dollar including Aruban Florin, Bahraini Dinar, Qatari Rial and many more.
When the HKMA needs to step in
The USD peg has never been close to breaking, but the HKD rate has reached its lower and upper limits in the past requiring the HKMA to step in and uphold the currency peg. Usually what moves the exchange rate is interest rates, particularly when local HK interest rates don’t move in lockstep with interest rates in the US. For example, when interbank rates on the Hong Kong dollar (Hibor) remain high when the Fed in the US lowers borrowing costs, it is more attractive for investors to buy HKD against USD.
In 2018, the HKMA stepped in as the Hong Kong dollar hit the weaker side of the trading band. In order to keep the HKD closely pegged to USD, the HKMA bought HK$9.66 billion over the course of 3 trading sessions on the foreign exchange market.
In 2020, the reverse took place when the HKMA was required to defend the peg as the Hong Kong dollar touched the strong end of the trading band at 7.75. The currency strength was driven in large by traders exploiting widening interest rate differentials when higher local interest rates in relation to the US dollar made buying HKD an appealing trade. Over several trading sessions, the HKMA sold HK$3.37 billion to defend the peg.
In 2019, Hong Kong got its first stablecoin dedicated to the local currency when Bitspark launched the Sparkdex.HKD stablecoin. Until then, US dollar stablecoins had always dominated the crypto markets in Hong Kong and the local crypto start-up saw the need to diversify the currency offerings in the stablecoin sector.
That same year, TrustToken, the company behind TrueUSD, launched its own HKD stablecoin TrueHKD, marking the company’s first step outside of the US. They have partnered with Legacy Trust as their digital asset custodian, holding the HKD fiat that is used to collateralize TrueHKD.
However, both of those HKD stablecoins are no longer operational. While Sparkdex.HKD did hold its currency peg in a reliable fashion with a 1:1 ratio held in fiat reserves, the start-up has since closed down. TrustToken has also pulled its stablecoin from the markets, leaving the local Hong Kong stablecoin market underserved currently.
As a trader, having access to a stablecoin related to your local currency makes it easier to move in and out of crypto at lower cost, across any exchange. Most stablecoins are ERC20 meaning you can take crypto denominated in your local currency to any exchange and trade the markets from a familiar starting point. Both depositing and withdrawing become easier when you have stablecoins that serve your market, making crypto markets all the more available to everyone.