Hong Kong's crypto hub dream mired in high costs, other barriers one year on, with JPEX but one stumbling block
South China Morning Post
9 min read
On Halloween last year, the giant virtual head of Sam Bankman-Fried displayed on a monitor sat on stage for Hong Kong's FinTech Week, where he was asked about the city's plans to become a "global crypto hub".
"I think [Hong Kong] could regain that status," he told the crowd gathered in the hall to see the then-billionaire dial in remotely from the Bahamas, where he had moved his crypto exchange and related trading house Alameda Research from the city he was addressing. "When you look at the East, it's not obvious ... It could be Hong Kong, it could be Singapore, it could be one of the other places."
One year on, it is still not obvious. After bankrupting his companies, Bankman-Fried is in custody in the US and facing trial for embezzlement, among other charges. Several other exchanges with ties to Hong Kong have either gone under or faced extreme financial difficulties. Most recently, the JPEX scandal has seen more than HK$1.5 billion (US$192 million) go missing after more than 2,500 complaints against the ostensibly Hong Kong-based exchange, run by people who have still not been identified, leading to at least 28 arrests.
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Ahead of last FinTech Week, Hong Kong announced to great fanfare an effort to become a virtual asset hub. FTX was bankrupt less than two-weeks later. The JPEX event - possibly the largest financial fraud in the city's history - and the high costs of the licensing process have cast doubt on the financial centre's ability to attract big industry players while catering the broader industry.
In many ways, Hong Kong's efforts to legitimise the cryptocurrency industry through regulation reflect what has been happening globally, from Singapore to Dubai to Europe. But while other markets have tried to rein in unruly players, hype in Hong Kong reached a fever pitch as crypto companies sought to capitalise on what they saw as new momentum in China's semi-autonomous financial hub, just outside the clutches of Beijing's cryptocurrency ban.
"It was almost two years ago when a similar narrative took hold for Dubai, with global exchanges flocking to the city - the same ones which were bullish on Hong Kong," said Tung Li Lim, Asia-Pacific senior policy adviser at blockchain analytics firm Elliptic. "This seems like a game of musical chairs, given that recent media reports suggest that Dubai is increasing its scrutiny of licence applicants ... The global nature of crypto means that it is easy for firms to uproot themselves from a host country."
This is precisely what happened in 2021, when exchanges like FTX and Crypto.com moved their base of operations away from Hong Kong amid concerns that the then-voluntary licence, which limited trading to professional investors, would become mandatory and harm business. Hong Kong-based OSL and HashKey were the only exchanges to get the voluntary licence.
Plans to ban retail crypto investing in Hong Kong never materialised. The new regulation, which took effect in June, allows exchanges to sell cryptocurrencies with large market capitalisations - such as bitcoin and ether - to retail traders. Yet there are few signs that trading activity is returning to the city relative to other markets.
Hong Kong fell one spot in this year's Chainalysis crypto adoption index to No 47. The blockchain research firm said Hong Kong is still a very active market, but its US$64 billion in crypto transactions from July 2022 to June 2023 lower than the previous year's roughly US$70 billion.
"Hong Kong is certainly well positioned for establishing itself as a crypto hub, but while the industry can swing on a dime, a lot of the real growth is long and hard-won over time," said Kim Grauer, head of research at Chainalysis in New York. "You weather the storm and wait for the growth periods. But from what I've gathered from talking to the [over-the-counter traders], there's little feeling of pessimism and there's still the excitement that Hong Kong has a really bright crypto future and is continuing to attract new types of customer profiles, both international and domestic."
This continued optimism for Hong Kong within the industry has so far not resulted in a wave of new businesses moving to the city. One major hurdle is expense.
The entire process of securing a virtual asset trading platform (VATP) licence is likely to cost a company at least HK$60 million, according to Robert Lui, partner and Hong Kong digital asset leader at Deloitte. Firms are required to hire Responsible Officers (RO) to liaise with the Securities and Futures Commission (SFC). These specialists are already hard to find, according to Liu, and few specialise in crypto-related matters. Monthly salaries can range from HK$200,000 to HK$300,000, Liu said, and companies will also "burn money" on required IT staff, lawyers and professional services such as consultancies.
"The difficulty now is that while you're trying to push for something new, the public still can't differentiate clearly between digital assets and scams using digital assets," Lui said. "This will create a lot of doubt and concern for the public, and leads to a lot more education work from the government."
Joseph Wang, a former quantitative analyst who has been helping companies with the licensing process, said the process has no formal checklist and is prohibitively expensive for small companies that have to go through "risk averse" intermediaries.
"They want you to talk to the SFC first, and there's a back-and-forth," he said. "You only apply for the licence once the SFC tells you that you should ... No small company from outside Hong Kong will go through what I've gone through."
Wang said he is setting up an experimental crypto trading platform and has been going through the licensing process to see how it is done. He is still "bullish on Hong Kong", he said, but has been disappointed by the lack of clarity for companies that may not have the resources of larger firms to complete this process.
Under pressure after the JPEX scandal, the SFC published an official list of VATP licence applicants last month. There were only four names: Hong Kong Virtual Asset Exchange, Hong Kong Digital Asset Exchange, Hong Kong BGE and Victory Fintech, all based in Hong Kong.
Hong Kong's initial announcement of its virtual asset push drew some interest from exchanges with ties to China. OKX and HTX, formerly Huobi, both said they were pursuing a licence. Many more companies other than the four official applicants have said they are seeking to get licensed in the city. OKX CEO Lennix Lai said on X, formerly Twitter, last month that the company was making "steady progress" on its application and expected to submit it this month.
To date, OSL and HashKey remain the only licensed exchanges in the city, as they had their voluntary licences upgraded in August to be able to serve retail customers.
As Hong Kong prepares for its latest FinTech Week, which kicks off on October 30, the city finds itself treading a path others have tried before, with no unqualified successes to serve as a blueprint.
In the 15 years since the original bitcoin whitepaper was released in October 2008, a number of locations have sought to make crypto happen on a grand scale. El Salvador adopted bitcoin as legal tender. Miami courted industry investors, put on an annual bitcoin conference and minted its own cryptocurrency. Malta was known for a time as "blockchain island" because of its early crypto-friendly legislation.
All these locations have been burned by the boom-and-bust crypto cycle, major insolvencies, and prolonged "crypto winter" that began in 2022 after a pair of linked algorithmic stablecoins - Terra and Luna - collapsed. This set off a chain of reactions that eventually forced FTX to declare bankruptcy last November.
Even Singapore, where many Hong Kong crypto firms moved, has sought tighter regulations on the industry. Recently proposed rules would require retail traders to pass a test, seemingly heading in the opposite direction of Hong Kong.
After a string of bankruptcies and legal troubles in the industry, Hong Kong officials have remained committed to the new vision for virtual assets. Local industry players have also voiced confidence in the new regulations, even after the SFC was criticised for not acting quickly enough against JPEX.
"The proactive regulatory measures have exposed pre-existing industry risks," HashKey chief operating officer Livio Weng said. "While some may criticise or question the regulation, objectively speaking, these risks existed before the SFC's regulatory policies were put in place. If the SFC had not taken the initiative to expose this criminal activity, the consequences could have been even more significant."
Donald Day, chief operating officer of VDX, the owner of Victory Fintech, said the JPEX scandal has shown how essential Hong Kong's new regulations are.
"While a year ago some market participants still questioned the value of being licensed and regulated, the challenges now centre around how fast the market can scale up, how quickly additional service providers can get operational in Hong Kong, and to what degree there is a pool of available, experienced and well-trained resources," he said.
The booth of HashKey Group, one of only two crypto exchange operators licensed in Hong Kong, seen during FinTech Week 2021 at the Convention and Exhibition Centre in Wan Chai. Photo: Shutterstock alt=The booth of HashKey Group, one of only two crypto exchange operators licensed in Hong Kong, seen during FinTech Week 2021 at the Convention and Exhibition Centre in Wan Chai. Photo: Shutterstock>
Future growth in the digital asset market will come from providing "clear value-add over traditional, and alternative, solutions", Day added, offering tokenisation of real-world assets as one example.
Exchanges like OSL, HashKey and others based in the city have little choice but to remain committed to the vision. And like so many crypto enthusiasts in years past, some are confident that more boom times are right around the corner.
"A bull market is expected to arrive in 2024 to 2025," HashKey's Weng said. "Bull markets typically see a surge in retail users, with registration numbers being 10 times higher than during bear markets."
