Hong Kong Set to Lift Retail Crypto Trading Ban, Observers Question Crypto Rules and City’s Priorities

Hong Kong is poised to allow retail trading of cryptocurrencies later this week as it attempts to reclaim its global blockchain hub status. The securities and futures markets regulator in the city-state, the Securities and Futures Commission, has worked out a regulatory framework in the last couple of months whose implementation will pave the way for licensed entities to provide their crypto services to retail investors. Starting in June, the retail-friendly regime will replace the outgoing system, with the local regulator already prepared to issue the first licenses to exchanges seeking to do business in the market. This change of tune from the previous skeptical stance is expected to meet the growing demand for digital assets in the jurisdiction.

Virtual asset service providers (VASPs) to be introduced to a new licensing system

In February, the SFC opened a consultation period on its proposed requirements requesting feedback from industry stakeholders. The commission said at the end of the window that it had received more than 150 written submissions. Its proposed regulations stipulated a 12-month grace period for existing centralized crypto trading platforms to obtain licensing. Crypto companies without established operations in Hong Kong must seek full compliance in the form of SFC licensing as a prerequisite. Last week, the commission published its consultation conclusion paper, noting that comments from industry associations, market participants, and other stakeholders were welcoming.

The new regime will override the previously proposed guidance, which limited exchanges based in the city to serve only professional investors – individuals managing portfolios worth more than 8 million HK dollars. Expected to take effect starting June 1, HK's proposed regulatory requirements will effectively reverse the existing restrictions on crypto retail trading. The new rules that will apply to Hong Kong's digital asset space also entail measures to protect traders, as highlighted in the official statement from the securities watchdog.

” The SFC will implement a number of robust measures to protect these investors, including ensuring suitability in the onboarding process, good governance, enhanced token due diligence, admission criteria and disclosures.”

A recent report evaluating the crypto readiness of various jurisdictions in the world ranked Hong Kong as the most appealing to investors, citing its friendly taxation guidance and fast-growing industry. Profits grossed from crypto trading activities are not subject to capital gains taxes in the region – also in Germany, Malaysia, Panama, Portugal, Switzerland and Turkey. Per the report findings, Hong Kong averages three blockchain startups per population of 100,000, only behind first-place Switzerland which has an average of at least a dozen startups per 100,000 people. Hong Kong's smaller geographical area also means it has an edge in crypto ATMs with respect to population size.

Token listing and stablecoin regulation

Still applicable to VASPs, the criteria for listing tokens will involve a thorough background check of developers and issuers. Eligible tokens will have to prove utility and justify legal risks. In addition to checks on the supply, demand, and liquidity of new tokens, the securities regulator would assess technical blockchain aspects. Notably, the SFC's new licensing regulations do not include non-fungible tokens (NFTs), considered securities.

Hong Kong is also preparing to regulate stablecoins with a spokesperson from Hong Kong’s central bank revealing in February that the discussions aimed at deriving a “risk-based, pragmatic and agile approach” which will incorporate feedback from further consultation it intends to conduct are underway. The Hong Kong Monetary Authority has thus far maintained a strict stance that requires the issuer of foreign stablecoins to be incorporated in Hong Kong. This policy has been met with backlash from observers who opine that requiring foreign entities that have already issued stablecoins to set up shop in Hong Kong is hectic.

DeFi projects are too required to toe the regulatory line.

Decentralized finance entities will be regulated under the Securities and Futures Ordinance and are expected to comply with the same guidelines as in the traditional finance context. Speaking during the Web3 Festival in Hong Kong, the Securities and Futures Commission (SFC) representative Keith Choy said automated trading services are subject to regulation under the SFO. Furthermore, he explained that a Type 7 license is mandatory for decentralized platforms and their operators if they offer trading of virtual assets categorized as securities or futures as per the SFO.

The challenge in regulating DeFi projects would be that they are not built to conform to traditional organizational structures. Their operating mechanism does not leave a single entity in charge; rather, they embrace collective responsibility. Nonetheless, SFC official Cai Zhonghui dispelled the thought that most DeFi projects are decentralized, arguing that it is usually only a small group in charge of most tokens and control over the project's decision-making process.

Hong Kong's renewed interest and commitment to pursue the digital economy hasn't been limited to virtual currencies. Last month, the Financial Secretary Paul Chan Mo-po noted that ‘this is the best time' for Hong Kong to explore Web3 despite the volatility in the cryptocurrency market and collapse of crypto companies being notable causes for concern. Hong Kong’s financial chief also highlighted proper regulation and development as factors that would create an innovative environment that supports Web3 adoption.

CyberDefender Metaverse: HK police unveil a platform to combat crypto crime

Last week, the Hong Kong Police Force introduced a cutting-edge platform called ‘Cyber Defender Metaverse' aimed at proactively combating cybercrime within the metaverse. This innovative Web3 platform will educate the public about the potential risks and challenges associated with Web3 and the metaverse.  The HK police organized an inaugural event titled ‘Exploring the Metaverse’ to engage participants in discussions on strategies to ensure safety in this virtual landscape, focusing on crime prevention.

A rise in digital asset crimes

Highlighting the urgency of the matter, Chief Inspector Ip Cheuk-yu from the Cyber Security and Technology Crime Bureau (CSTCB) addressed those in attendance, shedding light on various risks posed by the metaverse. Cheuk-yu emphasized that all types of crimes commonly witnessed in cyberspace, such as investment frauds, unauthorized access, theft, and sexual offenses, could also occur in the metaverse, sharing statistics that revealed Hong Kong saw 2,336 virtual asset-related crimes in 2022 alone, resulting in substantial losses of about $1.7 billion.  The situation has deteriorated this year, with 663 cases reported in the first quarter (a loss of $570 million), marking a 75% rise from a year ago.

Educational initiatives and AML guidelines to remedy digital crime

To address these growing concerns, the Hong Kong Police Force plans to leverage the platform to intensify educational initiatives, mainly targeting the younger generation. The intention is to raise awareness among teenagers about the latest technological advancements, potential pitfalls, and the importance of preventing related crimes. The Hong Kong Securities Regulatory Commission (HKSRC) also shared updated anti-money laundering guidance to equip institutional investors with means to safeguard themselves when interacting with digital assets.

The enhanced Know Your Customer (KYC) and due diligence requirements will be applied to all firms dealing with virtual assets to ensure robust safeguards against money laundering activities. Recognizing that cybercrime isn't bound by borders, Hong Kong's adoption of heightened KYC rules will make it a less attractive destination for criminal actors seeking to exploit crypto to conceal their identities and channel their proceeds through the city.

Crypto exchanges and local firms actively seek presence in Hong Kong

Crypto exchanges looking to serve retail investors must seek approval under the Anti-Money Laundering Ordinance (AMLO) and the Securities and Futures Ordinance (SFO). Last week, the Hong Kong SFC revised its requirements, with exchanges now allowed to have two responsible officers if dually licensed as opposed to two ROs for each type of license held. The change came in view of a talent crunch as there aren’t many qualified ROs. The city-state’s securities watchdog said it would start considering applications from virtual asset providers when the new regime goes into effect.

In the meantime, several exchanges and financial services providers have already lined up to take a share in the market. HTX announced the launch of its Hong Kong entity, HTX HK, whose trading platform will provide crypto services to residents on May 26, two days after Gate Group introduced Gate.HK as part of its expansion strategy. HTX HK has since submitted its application to become a licensed operator to the SFC per a May 29 tweet.  Others with similar plans include OKX and virtual currency platform JPEX.

Early reports indicate that Hong Kong is poised to license multiple crypto firms in the second half of the year. Former SFC official Angelina Kwan, now the CEO of Stratford Finance, told the Wow Summit in Hong Kong that the city-state has appealed to many crypto firms, prompting the new regulatory framework. The former regulator told a neutral panel at the end of March that of numerous applications the authorities have received, she expects at least eight firms to land a crypto license during the year's second half. Earlier in March, Financial Secretary Christian Hui said more than 80 crypto companies, including those from mainland China, had shown interest in exploring Hong Kong's prospects since October 2022, when the city-state embarked on plans to regain its status.

ZA Bank to offer to launch virtual asset trading services

State-owned banks in the locality have also been keen on collaborating with crypto ventures. In a May 24 announcement, ZA Bank confirmed plans to offer retail virtual asset trading by partnering with locally licensed virtual asset exchanges to obtain regulatory approvals. ZA Bank backs the digital Hong Kong dollar pilot project overseen by the Hong Kong Monetary Authority. Last month, the bank was said to be preparing to act as a settlement institution for withdrawals of tokens by offering currency conversion services to crypto firms in Hong Kong. At the time, Bloomberg reported that the virtual bank intended to allow licensed crypto exchange partners to complete withdrawals in United States dollars, Hong Kong dollars, and Chinese yuan.

ZA Bank CEO Ronald Iu confirmed that licensed exchanges HashKey and OSL are already using the currency conversion service, with more exchanges expected to join up as their status is stamped. Iu explained that in serving as a settlement bank for these firms, ZA Bank is empowering companies, whether domestic or international, to develop a viable strategy for success. Even so, the bank said it completes the necessary AML checks to meet regulatory requirements, reporting no issues in recent months. ZA Bank supports web3 startups and similar nascent businesses through online account services, following a sandbox pilot that involved 100 companies. Alternate chief executive at the bank, Devon Sin, explained that linking up to the city's company registry data allowed minimal information input and made cross-checking possible.

Boost from the hostile US regulatory scene

Hong Kong's commitment to regaining its spot has received a boost from the intensified scrutiny in the US regulatory landscape, which has compelled many crypto companies to consider overseas operations. Enforcement actions from authorities have been detrimental that some industry key figures, including Gemini co-founder Cameron Winklevoss, believe they have quashed potential market catalysts in the US.

“It will be a humbling reminder that crypto is a global asset class and that the West, really the US, always only ever had two options: embrace it or be left behind,” the Gemini cofounder wrote in a February tweet.

BitMEX ex-CEO Arthur Hayes also noted in October that Greater China would be influential in inspiring the sector’s comeback. The former exchange executive narrowed his forecast to Hong Kong as the nucleus whose ‘reorientation as a pro-crypto location' would make it ‘a strong supporting pillar' of the bull run. Hayes pointed out that mainland China plans to use the special administrative region as a testbed for crypto while Beijing remains shielded.

“If the Chinese capital is there, the Western capital will meet it,” Hayes said at the time.

Mainland China in the past voiced its reservations, citing concerns that a flourishing Hong Kong economy may jeopardize financial stability in China. The region’s ambitions which started last October, have nonetheless scored a nod, albeit subtle, from Beijing officials. Though the mainland Chinese capital hasn’t taken an inimical stance on Hong Kong pursuing a digital economy, some warn that the renewed ambitions may not be sustainable in the long term.

“The fantasy for exchanges is thinking that if officials let us get a license, then maybe they’ll start a sort of crypto-connect trading link with mainland China,” crypto entrepreneur Bobby Lee said.