Hong Kong is positioning itself as a hub for virtual assets by installing a regulatory environment that clears away uncertainties for market participants. The Special Administrative Region has been an international finance hub for decades and has plenty of experience providing fast and efficient financial services. It is now looking to replicate all these advantages in the crypto space.
‘With a high-standard licensing regime, traditional financial institutions can join the game’
Momentum is building. In April, a Hong Kong court declared cryptocurrencies to be ‘property’. And local regulators have proposed a new licensing regime for virtual asset platforms that will allow retail investors to trade in crypto products.
Future of finance
‘With the development of technology, we are now embracing an era where people make investments and earn their income online. The virtual asset is just a representation of values that can be traded and transferred,’ says Kavi Harilela, business director of electronic payment solutions provider Payment Asia.
Harilela would like to narrow the gap between traditional finance and tech-based finance. He calls the development of virtual assets ‘revolutionary’ for the finance industry, arguing that they will cut costs, increase efficiency, and lower fraud rates though greater transaction traceability.
‘For a financial hub like Hong Kong, developing the virtual asset industry advances the future of finance,’ he says.
‘If we want wider acceptance, regulators need to get involved in educating the market’
New regime
The current environment in Hong Kong is very friendly for Web3 (ie blockchain-based) start-ups. Hong Kong has unveiled several initiatives, including a new licensing regime for virtual asset service providers that took effect on 1 June. The regime centralises Securities and Futures Commission-licensed/regulated virtual asset trading platforms doing business in Hong Kong or actively marketing services to Hong Kong investors.
The new regime will require virtual asset platforms to meet a range of capital and investor protection measures. Retail access to the platforms has been proposed.
Harilela considers this an essential step for the education of the mass market. ‘Currently not many retail investors participate in the virtual asset industry. If we want wider acceptance of it, regulators need to get involved in educating the market as well as providing credibility to the participants.’
Mainstream
The new regime is also an important step in providing a healthy environment and preventing fraud. Under the new regime, licensed firms will have higher compliance costs, which could impact profitability. But licensing creates a healthier market that would attract more institutions.
Paul Li, co-director of the PolyU and Cybaverse Academy Joint Lab on Law and Web3, says: ‘With a high-standard virtual asset licensing regime, traditional financial institutions can join the game, and the volume is 100 times more than the current US$1 trillion market. This is the era of regulation: the faster one can adapt, the higher the chances of capturing this new market.’
Li says Hong Kong is a virtual asset licensing pioneer. Europe has only just passed its regulation of markets in crypto assets, which won’t be implemented until 2024. In the US, it is still unclear whether the sector will be regulated by the Securities and Exchange Commission or the Commodity Futures Trading Commission.
‘There are other new species in the crypto world where we also need new regulations’
Crypto property
In a recent case involving a now defunct crypto exchange, a Hong Kong court ruled that cryptocurrencies are property that can be held on trust.
‘Before this decision, there was no Hong Kong legislation defining cryptocurrencies as property or not,’ says Li. His Joint Lab is building a real-time monitoring system for crypto exchange reserves, to offer regulators and other stakeholders tools to ensure capital safety and protect the public’s investments.
Many other jurisdictions have already defined crypto as property, including England and Wales, the British Virgin Islands, Singapore, Canada, the US, Australia and New Zealand. The recent ruling aligns Hong Kong with other common law jurisdictions and provides some legal certainty.
Looking ahead, Li thinks more regulation in the offing will provide further clarity. ‘The virtual asset service provider licence only addresses virtual asset exchanges. There are other new species in the crypto world where we need new regulations.’
Challenges ahead
Legal issues still to be resolved include how a decentralised autonomous organisation can be registered as a legal entity, the intellectual property rights of non-fungible tokens, and how to resolve commercial disputes when there is no legal contract in decentralised finance.
Harilela believes the virtual asset business is going to thrive after a period of disorderly development. ‘The tightening of regulation in the US after the FTX implosion presents a great opportunity for Hong Kong to step up. With a robust regulatory framework and bank support, Hong Kong will become a centre for crypto and virtual asset investment.’
‘The survivor firms will be those with true technology advantages and compliant businesses’
FTX, once the third largest cryptocurrency exchange by volume, collapsed in November 2022 after its token failed to weather a liquidity crisis.
Harilela also thinks traders are waiting for the Hong Kong Monetary Authority (HKMA) to give clearer guidance. ‘HKMA recently released a circular urging banks to support legitimate cryptocurrency businesses. The document emphasises the necessity for banks to provide access to financial services for these firms while maintaining a risk-based approach to anti-money laundering initiatives.’
It will take time for more financial products to be developed and more institutions to get involved in crypto, but the writing may be on the wall.
Harilela says: ‘In time we will see those without actual business and innovation get eliminated. The survivors will be those with true technology advantages and compliant businesses.’
More information
Read the AB articles ‘Regulating the crypto markets’ and ‘Building a virtual asset hub’
