OKG Research Dialogue with Academic Experts: Is the Hong Kong Banking Industry Moving Towards Web3 Out of Necessity or Dream Fulfillment?
There is a certain degree of isolation between the cryptocurrency market and the real world, but connecting the two requires addressing the challenge of how to integrate fully on-chain financial standards with off-chain virtual world industry rules.The OKG Research Institute launched the third episode of its podcast on November 2nd with the topic "One Year Anniversary of the Hong Kong Web3 Declaration: Is the Banking Sector's Move Towards Web3 a Forced Choice or a Dream Come True?" Unlike previous episodes, Dr. Gao Chengshi and Dr. Chen Yushi were guests on this podcast, sharing their experiences and insights on the topic with Jason Jiang from the OKG Research Institute.
Since the Hong Kong government issued a government declaration regarding virtual assets on October 31st last year, we have seen a steady and solid progress in the Web3 field over the past year.
Whether it is virtual asset service providers, stablecoins, or the current Wall Street ETFs, the integration of the traditional financial industry with Web3 has indeed become a theme this year. All of this cannot be separated from the participation of the banking sector. Bank accounts serve not only as the entry and exit points for funds but also as guardians against money laundering. What role has the banking sector played in the Web3 landscape? With this question in mind, the OKG Research Institute invited academic experts Dr. Gao Chengshi and Dr. Chen Yushi to discuss with us.
Introduction of Podcast Guests:
Dr. Chen Yushi, a distinguished expert in climate fintech at New Energy Nexus, an expert in the ISO Sustainable Fintech Working Group, and a member of the Carbon Peak and Carbon Neutrality Committee of the Chinese Society for Environmental Sciences. He is the author of "Transformation: The Metaverse and Digital Economy" and editor of "Breakthrough: Blockchain and Digital Economy."
Dr. Gao Chengshi, a PhD in cryptography, a senior member of CCF, an executive member of the Blockchain Committee, and an executive member of the Blockchain Committee of CSIAM. He is also an executive member of the Metaverse Industry Working Committee of the China Mobile Communications Association.
Jiang Zhaosheng, a researcher at the OKG Research Institute.
Here are the highlights from the third episode of the podcast:
Question 1: First of all, based on our recently released 2023 "Global Commercial Banks' Crypto Landscape" report, it is very clear that banks entering the blockchain and laying out in the crypto asset space has become a trend. From your perspectives, is this a forced situation, or are there other reasons?
Jiang:
First, let me briefly introduce the basic situation of our report. This report mainly dissects and analyzes the layout of about 70 banks globally in the crypto and Web3 fields over the past few years. We have drawn some interesting conclusions. For example, in terms of regional distribution, we found that Europe has further consolidated its leading position in the crypto and Web3 fields, while the United States may be more cautious due to regulatory reasons. In Asia and the Middle East, especially in Hong Kong and Singapore, some banks have become more competitive and influential in the crypto asset field.
From the layout perspective, we found that crypto custody services are currently the most important and competitive area for banks in the Web3 ecosystem, far exceeding services like account opening and deposits and loans. However, overall, the number of banks participating in Web3 is still relatively small, and most banks remain cautious about crypto assets. Compared to other technology innovation industries, the banking sector may be more conservative, often playing the role of a follower in terms of informatization and digitization. For banks, crypto assets are still a relatively new field. Although the entire crypto industry has made positive progress in compliance over the past two years, many risks still exist. If banks want to enter this field, they need to invest a lot of financial and human resources to cope with the complex situation. For many small and medium-sized banks, the cost-effectiveness of exploring crypto business may not be high, which is one of the key factors limiting their entry at this stage.
However, we also noticed that many large banks have been very active over the past two years, especially banking giants like JPMorgan, Citibank, and Crédit Agricole. According to the latest global banking rankings, almost all major global banks, excluding ten banks from China, are laying out in the crypto and Web3 fields. We believe that the main reason driving the banking sector's participation is the growing interest of institutional investors in this field. This also confirms a point in our report: as the global adoption rate of crypto increases and related technologies mature, crypto assets have become an area that banks cannot ignore or afford to miss.
Gao:
From two perspectives, one is about virtual crypto assets; the other is the concept of decentralization in blockchain and Web3, and how this technology transforms the traditional financial industry. Since virtual assets have already taken a significant share globally, they are even seen as a trend for the future. In this case, banks, especially major institutions, have to pay attention to this matter.
Moreover, banks are not monolithic; there is fierce competition among banks. To gain a first-mover advantage and not lose their initiative during this paradigm shift, many banks, even if they are not currently generating various profits, will invest corresponding human and material resources to make relevant attempts.
Another point is that, as Zhaosheng just mentioned, custody services may be the most significant type. After all, banks still need to do some compliance-related work. However, both blockchain and Web3 inherently involve decentralization and anonymity, which creates a natural conflict with traditional regulatory compliance. Therefore, in terms of feasible compliance, they may look for some points of integration, and they might be doing more work in the area of crypto asset custody. But I believe there are still many efforts being made beneath the surface that have not yet surfaced.
The second aspect is that, besides virtual assets, the entire Web3 decentralization, including NFTs and more financial innovations, is transforming the traditional banking industry. This is something we currently see as relatively scarce, or due to compliance factors, various concepts, academic research, and the supporting degree of results are still insufficient. Therefore, we have not seen much content in this regard. For instance, we mentioned that Hong Kong has already passed a whole year since last year, and the only thing that has emerged is an increase in financial trading targets, which is virtual assets.
Moreover, under legal and compliant circumstances, how to conduct KYC and AML, etc., but truly using the Web3 set of ideas and methods to transform traditional business is still relatively rare.
Chen:
Overall, banks are relatively cautious, with risk control being the top priority. However, they do not want to miss the new opportunities brought by Web3 and virtual assets. So the overarching tone, at least from my experience since 2017, has generally been to understand and embrace this possibility. One situation is that regardless of whether they are ready, they are actually doing some POCs internally, collaborating with some external startups, and providing relevant knowledge training for employees. These are things that banks have been continuously doing.
The reality is that, as Zhaosheng mentioned earlier, relatively large banks have already adopted blockchain for cross-border clearing and settlement, including RWA. The tokenization of real-world assets is not a new thing; it is merely using new technology to optimize existing banking business modules. Especially, as mentioned earlier, the compliance technology aspect, the multi-departmental data governance has always been a challenging process, particularly constrained by the inherent limitations of the bank's IT architecture. Another point worth noting is how to introduce stablecoins, some of which are entirely based on crypto assets, while others are based on stablecoins issued by the banks themselves, such as JPMorgan, which may adopt a structure of a settlement stablecoin. Additionally, we are seeing more and more banks exploring CBDCs, or central bank digital currencies.
Furthermore, as Zhaosheng mentioned, regulation is indeed a concern due to the SEC's lawsuits against market participants, which aims to classify more cryptocurrencies as securities. This merely raises the macro threshold for the market. In contrast, the European MiCA regulation clearly defines three types of assets. If legislation regulates the issuance and trading, as well as the management of the underlying assets, it will benefit the liquidity of assets, including redemption and custody, and provide significant institutional guarantees. Therefore, overall, I believe banks will enter this field with a relatively cautious attitude, and a compliant environment will certainly accelerate this process.
Question 2: Regarding the integration of the banking industry with external entities, what directions are worth looking forward to? Are there any differences in the layout of domestic and foreign banks and financial institutions in the blockchain and crypto fields?
Chen:
There exists a certain degree of isolation between the crypto market and the real world, which may hinder the further development of Web3 in the real world. However, the challenge of connecting the crypto market with the real world lies in how to integrate completely on-chain financial standards with off-chain virtual world industry rules. This is a path I have been exploring. This process is relatively challenging, especially when discussing the concept of regenerative finance in Web3, considering how to align the industry rules of the physical world with virtual rules.
For domestic banks and financial institutions, supply chain finance and cross-border finance are the main scenarios. Due to compliance restrictions, the financial attributes of domestic blockchain have been significantly weakened. Therefore, domestically, blockchain plays more of a role in information symmetry, especially as an extension of the core enterprise credit subject and credit targets. Technologically, what is currently advocated in China is an open permissioned chain technology system, including new architectural designs that cover hardware (such as secure computing chips), transmission (such as high-speed optical transmission networks), and software (such as cryptographic zero-knowledge proofs and encrypted quantum passwords).
In summary, there exists a certain degree of isolation between the crypto market and the real world, but connecting the two requires addressing the challenge of integrating completely on-chain financial standards with off-chain virtual world industry rules. Domestically, supply chain finance and cross-border finance are the main focus areas. Due to compliance restrictions, the financial attributes of domestic blockchain have been weakened, thus playing more of a role in information symmetry. Technologically, there is an advocacy for an open permissioned chain technology system that encompasses innovations in hardware, transmission, and software.
Gao:
In fact, in this area, as Yushi just mentioned, we are limited by some policies. To be honest, there do not seem to be many innovative points in domestic progress, such as traceability and proof of existence.
In the view of many traditional cryptography experts, blockchain may not be necessary compared to traditional pure cryptographic technology, as traditional technology can also handle these two issues well. There are significant differences between domestic and foreign practices in this field. Blockchain faces difficulties in integrating with the real world because it is seen as an early-stage technology system. Blockchain can only handle content in a completely digital form, such as Bitcoin, Ethereum, and NFTs, which are all based on completely digital content.
Once it is associated with the real physical world, many offline legal and regulatory systems are needed to provide guarantees. If these safeguards are not in place, many things may not be able to advance.
Additionally, regarding RWA (Real World Assets), it is not a new concept. For example, in traditional futures exchanges, what is traded is warehouse receipts, which can be used to extract physical goods after delivery, which is itself a form of RWA. Bringing real-world assets on-chain requires more legal and regulatory safeguards. For instance, when buying stocks on the Shanghai Stock Exchange, how to ensure that the stocks you purchase, whether physical stocks or digital electronic equity, are guaranteed, requires support from many legal and regulatory systems in the real world.
Therefore, these issues cannot be fully resolved relying solely on blockchain and external technologies. Blockchain and external technologies can facilitate transactions, delivery, settlement, and clearing in a completely digital form, but it becomes complex when involving the real world.
Future development requires the support of traditional legal and regulatory systems, while traditional centralized applications also have their applicable scenarios. Web2 is centralized applications, while Web3 is decentralized. They are two different branches of technological development, and I believe Web3 will not replace Web2, but rather the two will integrate with each other.
Jiang:
The discussions by both of you have covered a lot of content. In fact, back in 2020, I also participated in research work on blockchain in domestic banks and published related research results. At that time, we communicated with many banks, and they chose to exclude financial attributes when laying out blockchain technology due to regulatory reasons, focusing more on intermediary businesses like supply chain finance and trade financing, while involving less in asset and liability business.
Additionally, domestic banks in recent years have been more inclined to build their own blockchain platforms or alliances, with fewer attempts to delve into external innovation fields. However, some well-known international banks and financial institutions are more open and proactive in this regard. They establish their own digital asset trading platforms, support or incubate independent crypto companies, and pilot in areas such as payment stablecoins, digital deposits, and institutional-level DeFi. These banks may be participating more deeply in blockchain ecological innovation.
Returning to the first question, regarding the integration of the banking industry with external entities, what directions are worth looking forward to? I believe, in addition to what the two of you mentioned, we should focus on banks in places like Hong Kong. They are more eager to develop virtual assets and expand related businesses to serve institutional clients while reaching more young customer groups.
We know that virtual assets, Web3, and the metaverse attract more of the Gen Z customer base, and banks are motivated to increase their investment efforts through financial product and service innovations to serve the previously hard-to-reach long-tail customer groups. This is also the capability we believe blockchain technology or virtual assets possess. On the business level, I think banks may focus more on strategic custody and virtual asset derivatives in the future, as there is a market demand that exists and will continue to grow. Additionally, I personally also pay attention to areas like stablecoins and tokenized deposits, as these areas will have greater imagination.
Question 3: When laying out blockchain and crypto assets, what are the biggest concerns or difficulties for financial institutions?
Gao:
First is the challenge of compliance, as banks are institutions rather than individuals, so compliance is the primary consideration. Secondly, risk control is crucial, as virtual asset trading involves a paradigm shift that differs from the traditional financial system. Traditional financial institutions are built on a mature monetary financial system theory, such as the two-tier banking system of central banks and commercial banks, and the concept of the money multiplier. In Web3.0, virtual asset trading is more about spot trading, with no concept of credit loans. Moreover, the emergence of virtual assets has also brought about a paradigm shift; Bitcoin's creator, Satoshi Nakamoto, believed that traditional banks are centralized and can do harm, hence proposing the concept of decentralization. However, currently, in the virtual asset field, banks' decentralized businesses are still relatively shallow, merely adding a financial trading target.
If we were to introduce the entire Web3.0 concept, including the technological system behind virtual assets and the decentralized architecture, into traditional finance, it could have a disruptive impact on traditional financial concepts. For example, in traditional currency, there are classifications of M0, M1, and M2, but it is still unclear whether similar classifications will appear in the digital currency field. Additionally, the regulatory rules and monetary theories in the virtual asset field are still immature. For central banks and commercial banks, entering this field requires more caution, as it could be a matter that affects the entire system.
Chen:
I believe Gao's points are quite comprehensive. First, compliance and risk control are challenges banks face when engaging in virtual asset businesses. Additionally, I agree with the viewpoint on paradigm shifts, as blockchain and decentralized architecture may impact the existing financial system. We can look back at previous examples, such as Facebook's proposed Libra, which was ultimately blocked by central banks uniting to prevent the development of private currencies, as the dollar is issued by central banks and has developed into a global reserve currency based on the gold system.
Currency is a comprehensive reflection of both soft and hard power, so private currencies will impact central banks and the entire financial system, including interbank stability. However, to fully realize this paradigm shift, I believe there is still a long way to go.
Moreover, Gao mentioned the transition from M0 to M2. Decentralized technology may, to some extent, exacerbate centralization and concentration. If central bank digital currencies can cover all forms of currency from M0 to M2, the role of commercial banks may be correspondingly weakened. For central banks, all forms of currency become transparent, which has a tremendous impact on implementing monetary policy and reshaping previous gray areas.
In summary, I believe financial institutions are most concerned about policy uncertainty and the challenges posed by regulation. Additionally, in the current environment, what opportunities and challenges blockchain can bring to the economy, including consumer trust in crypto assets, cost reduction, efficiency increase, and reaching customer groups, are all matters of opportunity cost measurement.
Question 4: What kind of sparks do you think will be generated between the banking industry and RWA?
Chen:
I am very interested in the dual-track transformation, specifically how sustainable and digital transformations intertwine. In fact, RWA still faces many issues. Previously, Sandt mentioned in 2015 that it could increase banks' revenues and reduce costs, but last week Forbes published an article about the gradual decline of the RWA trend on Wall Street.
In reality, if investors do not trust the cryptocurrency market, this situation will not occur. This is related to compliance, including recent exchange fraud cases in Hong Kong and money laundering issues in Singapore. Virtual assets need more high-quality and long-term asset projects to attract a broader range of investors. This is due to infrastructure issues; the interoperability between different blockchains affects the liquidity of tokens, which is also one of the challenges RWA faces.
Another issue is how to connect real-world systems with virtual systems. Personally, I am focused on the financing aspect of new energy assets. From a fundamental perspective, I see this as a huge opportunity: how to replace traditional entity financing with asset financing. This will fundamentally impact the underlying logic of the financial system. As we mentioned earlier, RWA lacks subject credit; it is based on spot trading.
Because of this characteristic, it has a high demand for trust in assets. For new energy assets, they are essentially a collection of data flows. To some extent, how to prove the high value of this data depends on whether the combination of data points and data can substantiate this. I believe there is significant potential in this area. I also agree that Web3 and Web2 may represent the concept of Web2.5, meaning that in the short term, there will not be a complete realization of centralization or complete decentralization, but rather an interweaving of different scenarios.
Jiang:
Regarding RWA, I personally have a very optimistic view of this track and am looking forward to its development in Hong Kong. Back in April this year, I wrote an article forecasting the development potential of RWA in Hong Kong. Now we can see many RWA-themed projects in the market, but we find that there is a serious homogenization of projects. First, there is not much innovation on the technical level, as the restrictive factors for asset tokenization are not technical in nature, but rather on the asset side. Currently, the variety of assets that can be tokenized is still not rich enough. Therefore, I previously proposed that the key to RWA tokenization at this stage lies not in the technical aspect but in the asset aspect, as technical issues are relatively easier to solve, while the richness of underlying assets and compliance issues after asset tokenization may be more challenging to address.
In the long run, I believe that banks and other financial institutions have significant advantages and potential in the RWA track, primarily because they hold sufficient high-quality financial assets. As the RWA market matures and regulations improve, they may be more motivated to make relevant attempts. Currently, we have already seen many banking giants conducting research and practice in tokenization, especially in deposit tokenization, which may be an important area for us to focus on in the future. Tokenized deposits are essentially a digital representation of deposits held by financial institutions, backed by bank deposits, and can be seen as an intermediate product between CBDCs and private stablecoins. Personally, I believe that tokenized deposits can address some of the shortcomings in the current stablecoin model and serve as a new bridge connecting virtual assets with traditional financial markets, replacing roles such as stablecoins in relevant transaction and transfer activities.
Question 5: How do you evaluate the development of virtual assets and Web3 in Hong Kong over the past year? The industry has seen many doubts regarding the government's stance. How can these doubts be addressed from a technical perspective?
Gao:
Regarding the situation in Hong Kong this year, I previously mentioned that it has mostly added a financial trading target. Regarding RWA, I can explain that in traditional businesses, such as securities, futures, options, and other derivatives, these can all be seen as RWA. However, we need to observe RWA cautiously, as it may pose risks and stability uncertainties.
Traditional banks and exchanges are also exploring related areas, but they adopt centralized or not fully digitalized approaches. However, completely transforming it into a digital form and utilizing decentralized methods may lead to increased risks and stability uncertainties. Additionally, if various physical assets are brought on-chain, we need to consider which underlying supply chain to use.
The stability of the consensus mechanism of the underlying blockchain supply chain is also an issue. Although the Ethereum ecosystem is relatively rich in chains and the underlying security measures are relatively stable, many changes are expected in the future, as this industry evolves rapidly. Returning to what you mentioned about Hong Kong, I believe it currently involves more asset aspects. If it merely adds virtual assets as financial trading targets without more innovation, whether Hong Kong can rise in this field remains to be seen.
From a technical perspective, I am not particularly optimistic, as technology can only solve technical issues and cannot address problems beyond technology, such as privacy and investor protection. These issues may need to be viewed in a broader context, such as the concept of investor protection. If all rules are transparent and public, with no potential misconduct, is there still a need for investor protection? In the economics community, there are differing views on usury. Some economists believe that people's rational judgment is sometimes insufficient, thus requiring protection for investors and limiting usury.
However, other economists argue that usury provides a form of relief in special circumstances. Therefore, for these issues, government positions may also need to be considered. Technology can solve some problems, but it also brings new challenges.
Thus, I believe we need to continuously pay attention to these issues. Returning to the topic of Hong Kong, if it merely remains at the current stage of development, I think this development is still a cause for concern. To achieve a future connection with Web3, Hong Kong needs to step out of the local market and develop globally. This involves some core issues, such as how a region can lead global decentralized development. This may be a deeper issue.
Jiang:
Dr. Gao's remarks are very practical. Although Hong Kong has been releasing friendly signals in the Web3 field over the past two years, most business explorations are still concentrated in the issuance and trading of virtual assets, which have strong financial attributes. There is still relatively little genuine empowerment of the real economy using Web3 technology and concepts, or connections with real industries. However, the overall situation remains optimistic. Of course, in this process, we have also seen some risk events occur. But I always believe that we must learn to accept the various problems that may arise during the development of Web3 in Hong Kong. Since we hope to keep Hong Kong's Web3 innovative and vibrant, we need to keep the "window" open to attract more fresh "sunlight" and "air," and we cannot close this window just because of some existing problems.
So how can we address these potential issues? In the future, we should primarily start with on-chain data. Because risk management in the traditional financial system is also based on data, in the virtual asset and Web3 market, we also need to rely more on data for product design and risk management.
Taking anti-money laundering as an example. In the Web3 ecosystem, the most common data we encounter is address and transaction data, rather than identity information. This means that traditional KYC and KYB techniques based on identity are not entirely applicable to Web3. Therefore, the Onchain AML we launched upgrades KYC and AML monitoring based on on-chain data, analyzing KYT in real-time through on-chain transactions and providing address risk warning (KYA) to help financial institutions identify whether there is risk in each on-chain transaction, customizing services for financial institutions to achieve 24/7 panoramic monitoring.
However, currently, due to the information gap and time lag between innovation and regulation, many institutions may not yet see the value of on-chain monitoring and compliance tools in Web3. Nevertheless, Web3 enterprises should actively embrace global compliance trends and proactively adopt various on-chain compliance solutions to ensure that their products and services can operate in a safer environment.
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