Will Hong Kong withdraw from the "Web3 Capital" battlefield?

Author: Compliance Researcher

The policy for the clearance of virtual asset trading platforms in Hong Kong officially took effect on May 31, after which non-compliant exchanges will cease operations. As the deadline approaches, nearly half of the VATP applicants, including OKX and Kucoin, have exited, sparking market discussions. Among them, there are voices of FUD regarding Hong Kong: "Hong Kong is already a relic of a financial center," "Hong Kong's Web3 has ended before it even began," but is that really the case? What stance should regulation take to welcome Web3?

The conclusion is presented upfront: Hong Kong, as the Eastern bridgehead of Web3, is just beginning its game against the West.

The Next Decade of Web3: Full Compliance

Comparing 2022 to now, Hong Kong's attitude seems to have indeed shifted from "embracing" to "relatively cautious." But from a historical perspective, what stage is Hong Kong currently in? We can take a global view and conduct a horizontal comparison of several major Web3 financial markets worldwide.

Japan was the earliest, a definite pioneer in Web3 regulation. After the famous Mt. Gox Bitcoin exchange collapse in 2014, Japan gradually initiated regulation and introduced a digital currency exchange licensing system in 2017, approved by the Financial Services Agency. A decade later, Japan has a total of 23 approved digital currency exchanges, including Binance, but most are local companies.

Operating an exchange in Japan has some similarities to Hong Kong. For example, there are requirements for asset segregation and cold wallets, as well as regular audits. However, it is precisely due to these relatively stringent regulations that Japanese exchanges were not affected during the FTX collapse—because a significant portion of users' funds were kept in cold wallets. Additionally, Japan's regulatory frameworks for ICOs, IEOs, STOs, and CBDCs have all progressed to relatively mature stages.

Singapore and the United States initiated strong regulation in 2022 following the collapses of Three Arrows and FTX exchanges.

Although the U.S. does not have a proper "compliant" exchange, the publicly listed company Coinbase appears more compliant than other exchanges, and it has achieved significant growth this year, successfully conducting business "by the book." Meanwhile, offshore exchanges like Binance and Kucoin have gradually faced regulatory challenges in the U.S. after the FTX incident in 2022.

The commonality observed is that regulation is gradually delving into vertical fields, becoming a "fine job."

During this period, there have been voices in Japan and Singapore claiming "too strict" and "pessimistic," but as regulatory rules continue to improve, the Web3 ecosystems in both regions are becoming increasingly vibrant.

The once "heavy-handed" U.S. regulation has shifted its approach. Recently, the U.S. released the FIT21 (Financial Innovation and Technology Act of the 21st Century) regulatory framework, which outlines how to define digital assets (including DeFi and NFTs) and delineate the boundaries between commodities and securities. This could become one of the most far-reaching pieces of legislation affecting crypto in the future.

Following the U.S., regions such as Southeast Asia, Dubai, India, and Iran plan to introduce Web3 regulatory policies within a few years. Even countries like Europe and Nigeria, which had previously not been active in the cryptocurrency industry and lacked clear regulatory stances, are now joining this round of cleanup and regulation.

Regulatory agencies worldwide do not want to miss out on Web3. A compliance trend has already formed; whether starting from embracing or from collapses, each jurisdiction will eventually move towards precise regulation.

From the perspective of the number of licensed exchanges, offshore exchanges account for almost no more than 30% of the total licenses, with regulators preferring local enterprises.

2023 to 2024 Legal Cryptocurrency Landscape (Illustrated by CoinGecko)

This is not a regulatory challenge but rather a challenge for offshore exchanges. Looking back at the wild west era, offshore exchanges could serve nearly 200 million users in a relaxed regulatory environment. But that is now a thing of the past. Aside from Binance, which is known for paying hefty fines to remain compliant, among the exchanges that have withdrawn their applications, OKX has gradually laid out plans and obtained licenses in places like Singapore and Dubai over the years, while Gate and Kucoin have relatively fewer licenses.

To put it in an inappropriate analogy, "it's hard to go from luxury to frugality." Offshore exchanges seeking to "come ashore" and enter major financial regulatory jurisdictions seem to face significant hurdles.

The cycle has changed; the "regulatory arbitrage" of the crypto market's wild era is gone forever.

Now let's take a look at Hong Kong. Compared to the U.S.'s "extend and then penalize" approach, Hong Kong adopts a "native regulation" model of licensing first and then operating. It has directly skipped the stage of barbaric growth.

Since Hong Kong introduced Web3 regulatory policies in 2022, it has begun to sound the horn for full compliance in the Web3 industry. By June 1, 2024, the AMLO license will officially take effect, and non-compliant exchanges will have completed their exit, with more than half of the applicants still in the field. Exchanges that have already begun operations, such as HashKey Exchange, have seen trading volumes exceed 440 billion Hong Kong dollars, showing a good development trend.

Therefore, the exit of some exchanges should not be viewed with excessive pessimism. Looking at the historical context, this is just an inevitable phase that Hong Kong, like other regulatory jurisdictions, is experiencing in its quest for compliance.

More importantly, the 531 policy also signifies that Hong Kong has tackled the "exchange" issue, completing comprehensive regulation in the industry where capital concentration is the highest and the most complex.

Hong Kong and the U.S.: The Bridgehead of East-West Competition

So, what comes after regulation? The initial momentum has passed; the competition has just begun.

Four years ago, PayPal's founder predicted that significant political conflicts in the future would revolve around artificial intelligence from communism and cryptographic technology from liberalism.

Now, both AI and Web3 are gaining momentum, with the U.S. and Hong Kong seen as the bridgeheads of the Web3 industry between East and West. The regulatory competition between the two regions will lead the global direction of Web3 development.

Why compete? Unlike AI, in Web3, monopolistic regulation is no longer feasible. The Web3 era has built more business entities based on the network economy, easily crossing physical boundaries to provide services to customers.

The Web3 bible that inspired Satoshi Nakamoto to invent Bitcoin, "The Sovereign Individual," depicted this scenario: "Due to the development of information technology, you will soon be able to create wealth in cyberspace, completely free from the plunder of nation-states. This will form a de facto meta-constitutional requirement, meaning that before the government can demand you pay your bills, it must genuinely provide satisfactory services."

In the future, political leadership may increasingly resemble entrepreneurial spirit; only by being sufficiently friendly can it attract capital and talent. It is not Web3 that needs to be regulated, but rather regulators that need Web3.

The recent attitude of the U.S. has been very clear. This year, the topic of cryptocurrency has been placed at the center of the U.S. political stage for the first time. According to CoinDesk, about one-third of American voters will consider a political candidate's stance on cryptocurrency before making their voting decision. 77% of voters believe that U.S. presidential candidates should at least understand cryptocurrency. 44% of voters believe that "cryptocurrency and blockchain technology are the future of finance." Trump even exclaimed: "Ensure that the future of cryptocurrency happens in the U.S.!"

The East-West competition landscape has taken shape, with a notable battleground being ETFs. The recent abrupt shift in the U.S. stance on ETH ETFs may be influenced not only by domestic factors but also by Hong Kong's relatively pioneering launch of ETH ETFs in April.

Although there is currently a significant scale gap between Hong Kong and U.S. ETFs, Hong Kong, as one of the world's largest offshore financial centers, is expected to attract more institutions as the ecosystem matures, leading to a new institutional bull market.

Next, the ETH ETF, as a stakable income-generating asset, is expected to become the next focal point of competition.

Since Ethereum transitioned from POS to POW, it has generated passive income similar to interest after staking, with the current market annual interest rate around 4.5%. If Hong Kong takes the lead in launching a staking-enabled Ethereum spot ETF, obtaining staking rewards will transform ETF subscriptions from a cost into a profit-generating activity. It could also, to some extent, become a "digital U.S. Treasury bond," with its appeal potentially surpassing that of Bitcoin ETFs.

The development of the Web3 industry is also related to its local cultural heritage. Although Easterners appear more reserved and cautious compared to the relatively outgoing and diverse West, it does not mean they have fallen behind.

Hong Kong has currently released several regulatory documents, including the "Guidelines for Virtual Asset Trading Platform Operators," "Guidelines for Combating Money Laundering and Terrorist Financing (Applicable to Licensed Corporations and Licensed Virtual Asset Service Providers)," "Guidelines for Preventing Money Laundering and Terrorist Financing for Related Entities Issued by the Securities and Futures Commission Applicable to Licensed Corporations and Licensed Virtual Asset Service Providers," and "Guidelines for Disciplinary Actions and Fines by the Securities and Futures Commission."

The regulatory policies are clearer and more mature compared to the U.S.'s previous reliance on the "Commodity Futures Trading Commission Regulations," and there is no need to debate whether cryptocurrencies are "securities" or "commodities."

As the bull market gradually peaks, the wealth creation effect in the industry will become apparent, and a new batch of wealthy individuals is about to emerge. Hong Kong, a region that inherently possesses the advantage of "Eastern mysterious power," will also see more capital and core forces from the mainland and overseas Chinese Web3 flow in with the market.

The next cycle will be the multidimensional integration of Web3 and traditional finance, revitalizing the Hong Kong financial market. Currently, the Hong Kong Securities and Futures Commission has indicated that it may open STO and RWA investments to retail investors, further broadening the virtual asset market. Additionally, the regulatory framework for Hong Kong's Hong Kong dollar stablecoin and over-the-counter (OTC) virtual asset stores is also being advanced. Once the entire chain is connected, Web3 will inject new vitality into the entire Hong Kong market.

As historical tides roll forward, which enterprises will remain at the table? Exchanges are the most crucial cornerstone of Hong Kong's Web3 ecosystem.

In the foreseeable future, licensed exchanges like Hashkey Exchange, in addition to their trading businesses, will also become key players in connecting various financial industries in Hong Kong's Web3. For example, in this ETF issuance, Hashkey Exchange also played the role of custodian, providing underlying infrastructure support for the issuer. In the future, in businesses such as RWA, STO, and OTC, they will play an indispensable role.

It is precisely for this reason that some offshore exchanges have been pushed off Hong Kong's table. This is also known as, "If you come out to mix, you will eventually have to pay it back."

HashKey has actually made a very smart move. For offshore exchanges, transitioning from luxury to frugality in compliance is difficult, but for a native compliant exchange, expanding from a jurisdiction to an offshore exchange, "compliance" can even become a shortcut. HashKey has also obtained a license from Bermuda, an offshore center, and launched the international platform HashKey Global a month ago, targeting overseas users. It is hoped that in the future, powerful exchanges like HashKey will break more physical boundaries, providing individuals with safer and more convenient Web3 business support.

Development has its ups and downs; perhaps we should take a broader historical view during Hong Kong's clearance phase and make rational judgments.