The Current Situation of Web3 in Hong Kong - Compliance Challenges, Difficulty in Making Money, Globalization as the Only Direction

Author: Jessy, Golden Finance

Since the release of the "Policy Declaration on the Development of Virtual Assets in Hong Kong" in November 2022, compliant Web3 that meets the requirements of the Hong Kong government has developed for a year and a half.

During this year and a half, compliant exchanges have opened to retail investors, spot ETFs for Bitcoin and Ethereum have been approved for launch, and some crypto-native projects have chosen to establish branches in Hong Kong. On July 18, the Hong Kong government officially announced the list of institutions entering the Hong Kong dollar stablecoin regulatory sandbox, allowing these institutions to trial the issuance of Hong Kong dollar stablecoins.

More subtle changes have integrated into the daily lives of residents. Retail investors can participate in compliant investments in Bitcoin and Ethereum by entering street-side securities firms. More top-tier events related to Web3 are flourishing, and knowledge about blockchain has been incorporated into elementary school textbooks…

The development of Hong Kong's Web3 industry is steadily advancing as planned, and Hong Kong citizens are gradually accepting Web3 in subtle ways. However, from the perspective of practitioners, overall, the development of Web3 in Hong Kong has shifted from initially charging ahead boldly to a more cautious approach.

With the tightening of Web3 policies by the Hong Kong government and the withdrawal of foreign capital, the primary challenge for Web3 companies developing in compliance with Hong Kong regulations is how to establish a foothold in Hong Kong while opening up larger markets.

Can the Hong Kong Dollar Stablecoin Enhance the Status of the Hong Kong Dollar in the International Financial Market?

The Hong Kong dollar stablecoin is a key focus for the Hong Kong government in its Web3 development this year. In March, the government announced that institutions wishing to issue Hong Kong dollar stablecoins could begin applying to enter the sandbox. Four months later, on July 18, Hong Kong announced the first batch of institutions entering the sandbox: JD Coin Chain Technology (Hong Kong) Co., Ltd.; Yuan Coin Innovation Technology Co., Ltd.; Standard Chartered Bank (Hong Kong) Limited; Anni Group Limited; and Hong Kong Telecommunications (HKT) Limited.

When consulting the public on the regulatory framework for Hong Kong dollar stablecoin issuers, 108 institutions submitted opinions. The Deputy Chief Executive of the Monetary Authority, Chen Weimin, stated that the Monetary Authority received inquiries from ten institutions, and some well-prepared institutions formally submitted applications, ultimately approving three. He noted that whether an institution is approved to enter the "sandbox" depends on various factors, such as the issuer's business plan after the implementation of the regulations and whether there is a need to test the stablecoin issuance process in a limited scope at this stage.

Yuan Coin Technology, which was selected to enter the sandbox, submitted its application immediately after the announcement. Entering the sandbox means they can now trial the issuance of Hong Kong dollar stablecoins under regulation and launch specific use cases.

Stablecoins are undoubtedly a global business, and the market is largely dominated by US dollar stablecoins, with USDT being the most prominent. How much market share can the Hong Kong dollar stablecoin capture in an environment where dollar-pegged stablecoins hold absolute market share? It is difficult for issuers of Hong Kong dollar stablecoins to provide a definitive answer.

Rita Liu, CEO of Yuan Coin Technology, stated in an interview with Golden Finance that the current stablecoin market is about expanding the pie rather than competing in a red ocean. After the launch of the Hong Kong dollar stablecoin, they will focus more on collaborating with compliant exchanges and institutional market makers globally, or partnering with traditional enterprises for payment settlements in cross-border trade, thereby creating more use cases for the Hong Kong dollar stablecoin.

Thus, it can be seen that while the Hong Kong dollar stablecoin is pegged to the Hong Kong dollar, its actual influence does not solely depend on the status of the Hong Kong dollar in the international financial market, but rather on how each Hong Kong dollar stablecoin can carve out a market in the crypto world. The widespread use of the Hong Kong dollar stablecoin in Web3 could, in fact, enhance the status of the Hong Kong dollar in the international financial market.

Chen Weimin also stated that the Hong Kong Monetary Authority is implementing a regulatory framework for stablecoin issuers and is fully advancing the drafting of legislation, aiming to submit the relevant bill to the Legislative Council for review by the end of the year.

Sandbox ------ Legislation ------ Licensing, the Hong Kong dollar stablecoin is gradually being realized. The core role of the Hong Kong dollar stablecoin is to serve as a bridge that seamlessly connects traditional finance to the blockchain world. Just moving the exchange of fiat currencies onto the blockchain presents a vast market, indicating that the imagination for fiat stablecoins is sufficiently large.

Globalization as the Focus for the Development of Compliant Exchanges in Hong Kong

Running a compliant exchange in Hong Kong is not easy to profit from.

In one week this year, an institutional client business at a Hong Kong exchange made only over $100 in profit. This profit includes all revenue from services provided to institutional clients, such as fees and custody fees.

Market insiders close to this exchange told Golden Finance that institutional clients are generally reluctant to use compliant exchanges; they prefer over-the-counter trading. One main reason is that the money of institutional clients is often not "clean."

With only over 7 million local residents in Hong Kong, the ceiling for user conversion for a licensed exchange in Hong Kong is quite low. For example, Hashkey Exchange has accumulated nearly 100,000 users on its Hong Kong platform after nearly a year of retail trading. In contrast, the Hashkey Exchange international platform, launched in April this year, accumulated nearly 100,000 users within a month.

It is reported that Hashkey Global obtained a compliance license in Bermuda and is currently primarily targeting the Asia-Pacific and Southeast Asian regions. Japan, South Korea, and Taiwan are key markets for Hashkey Global. The focus of Hashkey Group's exchange business has shifted to Hashkey Global.

Establishing a foothold in Hong Kong and then expanding globally may be the only way out for compliant exchanges in Hong Kong. It is both difficult to obtain licenses and to make profits while operating a compliant exchange locally.

At the beginning of 2023, news emerged that the licensed exchange OSL in Hong Kong was seeking to acquire for 1 billion Hong Kong dollars, and six months later, it finally succeeded, with Bitget's parent company investing 700 million Hong Kong dollars.

At that time, obtaining a license would cost several tens of millions of Hong Kong dollars, and Bitget undoubtedly spent a significant amount.

However, it now seems that Bitget was smart in pursuing the Hong Kong compliance license. Hong Kong is very strict in granting licenses to crypto-native exchanges, and most native exchanges in the crypto space find it difficult to get approved. By the end of May, as the second licensing date approached, traditional crypto-native exchanges like OKX and Huobi announced their exit from the Hong Kong market before the second round of license approvals was announced. It is rumored that to obtain a license in Hong Kong, they would need to sign a commitment to ensure the withdrawal of mainland users.

Summarizing the second batch of 11 institutions announced by the Hong Kong government in June as being considered for licensing, it can be observed that these institutions are local and have resources from mainland China, with traditional financial backgrounds.

Regardless of the reasons behind the traditional crypto exchanges' exit from the Hong Kong market, the outcome indicates that Hong Kong is not welcoming traditional institutions from the crypto space. The Web3 market in Hong Kong resembles a game of traditional finance. What Hong Kong hopes for is to leverage Web3 to complete the transformation of traditional finance or to empower traditional industries with Web3.

However, whether it is traditional finance transforming into Web3 or native Web3 trying to establish a foothold in Hong Kong, both are challenging.

Looking at OSL, its parent company BC Technology has been in a state of loss for several consecutive years. The actual controlling shareholder of BC Technology is the "shell king" of Hong Kong, Gao Zhenshun. Unlike Hashkey, OSL does not focus on retail trading; they invest more energy into institutional business. For instance, on September 12, 2023, OSL announced a strategic cooperation with Harvest International Asset Management in the area of security token offerings (STO) and has established liquidity partnerships with multiple exchanges, becoming the custodian for Harvest International and Huaxia Fund in the virtual currency spot ETF.

Like Hashkey Exchange, OSL has also focused on expanding into global markets this year, announcing the launch of its 2024 globalization strategy at the beginning of the year. Moreover, since last year, OSL has actively been laying out overseas licenses, having already submitted a license application in Singapore.

Not only exchanges but virtual banks also struggle to make profits. In 2023, ZA Bank reported a net loss of 399 million Hong Kong dollars, although this was a 20% reduction compared to the previous year. Not only ZA Bank is in the red; eight virtual banks in Hong Kong, including Ant Group and Tianxing, are also operating at a loss.

Exchanges and virtual banks face similar challenges in Hong Kong. For institutions, the main issue is how to market and promote new products to capture market share. The local market in Hong Kong is quite limited, and how to effectively utilize Hong Kong's position as an international financial center to bridge domestic and foreign capital is also a crucial consideration for these institutions.

These challenges are largely due to the withdrawal of foreign capital from Hong Kong. When money becomes scarce, efforts yield diminishing returns. For institutions in Hong Kong, the current task is to seek more opportunities abroad.

The two earliest licensed exchanges in Hong Kong are now focusing on global markets. For exchanges, Hong Kong can only serve as a compliance base. The broader opportunities lie overseas.

High Fees and Complex Subscription Processes Discourage Users from Virtual Currency Spot ETFs

Another significant initiative by the Hong Kong government this year is the launch of virtual currency spot ETFs. The Bitcoin and Ethereum spot ETFs in Hong Kong have been online for two months, and according to SoSo Value data, as of July 5, the total trading volume of the six spot ETFs exceeded 26 million USD.

During the subscription phase, the performance of Hong Kong ETFs was impressive. According to SoSo Value data, the three Bitcoin ETFs had a subscription scale of 248 million USD on their first day, while the total net value of the first day for US Bitcoin spot ETF products, excluding the grayscale (GBTC) that transitioned from trust to ETF, was only 130 million USD.

A market insider close to several major ETF issuers in Hong Kong told Golden Finance that the significant discrepancy between the subscription volume and actual trading volume is due to the fact that during the initial subscription, these ETF issuers found large clients and encouraged them to purchase ETFs through resource exchanges, resulting in high subscription volumes on the first day.

The subsequent trading volume reflects the true scale of ETFs in Hong Kong. The independent capital volume in Hong Kong is already quite small, with over 7 million people, and the current market capitalization of Hong Kong stocks is only about 3.2 billion Hong Kong dollars. The reason why fund companies prefer to invest in US ETFs is simple: the virtual currency spot ETF is a globally competitive market, and capital will choose the products that are the lowest cost, most efficient, and safest.

In comparison, Hong Kong's virtual currency spot ETFs lack competitiveness. The compliance costs in Hong Kong are relatively high. The aforementioned market insider mentioned that the timeline is tight, and everyone is rushing to meet deadlines. For example, in terms of custodians, both Huaxia and Harvest chose to sign agreements with OSL, as both issuers of virtual currency spot ETFs selected OSL as their custodian, which incurs high custody fees.

This undoubtedly raises the cost of spot ETFs. Comparing the Bitcoin spot ETFs in Hong Kong and the US reveals that, aside from the ETFs issued by Grayscale and Hashdex, the fees for the remaining products range from 0.2% to 0.49% in the US. In contrast, Huaxia's fee is 1.99%, Harvest's fee is 1%, and Bosera's fee is 0.85%, all of which are higher than those in the US.

In terms of user experience, Hong Kong's virtual currency spot ETFs are also lacking. Taking Victory Securities as an example, the only securities firm that allows for both deposits and withdrawals, users still need to use email and phone calls for subscriptions and redemptions.

All these issues require issuers to further optimize their processes.

A more fundamental and evident problem is that the issuers of Hong Kong's virtual currency spot ETFs are still approaching the market with traditional financial thinking, focusing on marketing and channels rather than striving to improve product quality.

Some practices by Huaxia Fund can illustrate this point. Comparing the three virtual currency spot ETF products, Huaxia Fund has the largest trading volume, which is largely related to its channels and marketing efforts. For instance, at the Bitcoin Asia Conference held in early May this year, where the focus was on discussing the development of the BTC ecosystem, Huaxia Fund's marketing personnel took the main stage to introduce the situation of their spot ETFs and set up a booth at the conference. This clearly demonstrates the effort Huaxia Fund has put into marketing and market presence.

For Hong Kong's virtual currency spot ETFs, the next steps should focus on how to reduce fees and simplify the subscription process to secure a foothold in the global competitive landscape.

Whether it is virtual currency exchanges, virtual currency spot ETFs, or Hong Kong dollar stablecoins, they all face challenges beyond just the Hong Kong market; the key is how to expand globally after achieving compliance in Hong Kong and participate in the global Web3 competition.