Written by Babywhale, Techub News
This past weekend, issues related to the Hong Kong Virtual Asset Trading Platform (VATP) license once again sparked discussion.
More than a year ago, the Hong Kong Securities and Futures Commission announced that starting from June 1, 2023, cryptocurrency exchanges operating in Hong Kong will have one year to apply for a compliance license from the regulator. If they are still not approved after one year, they will not be allowed to operate in Hong Kong. In the following year, institutions in the Web3 industry including OKX, Huobi, Matrixport, and brokerages such as Victory Securities have joined the ranks of applicants.
Time flies. Today, some applicants who were considered "confident" have chosen to withdraw, while some new players in the exchange field have stayed, and doubts and speculations are rampant. Although Hong Kong has maintained a leading position in the world in the regulation of Web3 since the declaration, the actual implementation of exchanges and previously approved Bitcoin and Ethereum spot ETFs has always been unsatisfactory.
We can’t help but ask: What happened to Hong Kong, the “Web3 New Capital” that was once highly anticipated?
The “Trolley Problem” of Exchange Regulation
In 1967, Philippa Foot first proposed a thought experiment in the field of ethics. Its content is roughly as follows: A madman tied five innocent people to a tram track. An out-of-control tram is coming towards them and will run over them in a moment. Fortunately, you can pull a lever to make the tram go to another track. However, the problem is that the madman has also tied a person to the other tram track. Considering the above situation, should you pull the lever?
Simply put, sacrifice one person or five people? In my opinion, the current regulatory authorities in Hong Kong are facing a similar test.
Last week, Wu said blockchain exclusively disclosed the reasons why several well-known exchanges voluntarily withdrew their applications to operate compliant exchanges in Hong Kong. The main reason was that Hong Kong regulators required applicants to guarantee that there were no Chinese users on the offshore exchanges currently in operation. Obviously, these exchanges that openly said they would not accept registrations from Chinese users had no way to guarantee this. In fact, the market initially circulated explanations such as "too high costs, fierce competition, and limited market size", but this reason full of loopholes was difficult for everyone to accept: Didn't they do research on the low input-output ratio at the beginning of the application?
In fact, an anonymous person close to the Hong Kong regulatory authorities once revealed to Techub News that Hong Kong regulatory authorities will not allow exchanges with "original sin" to easily obtain compliance licenses. In other words, although Hong Kong supports the development of Web3, it will not do the "whitewashing" thing, which is basically consistent with what Wu said.
For the SFC, the dilemma now is: allowing so-called "sinful" exchanges to "go ashore" seems unfair to the early "leeks"; but a one-size-fits-all approach seems to have hindered the process of introducing industry giants into Hong Kong to some extent.
What is right and what is wrong, what is important and what is not, reality has already told us the regulatory decisions.
The logic behind this is not hard to understand: In theory, cryptocurrency exchanges are not allowed in mainland China, and offshore exchanges should not be open to mainland users. They should also take the initiative to clear out their users. But if you cannot promise that there are no users on the platform that do not comply with regulatory requirements, how can you guarantee that you will operate in compliance in Hong Kong? This is not a rule, but just a basic requirement.
The wild growth of early exchanges will inevitably sacrifice the interests of some innocent people, but we believe that the original accumulation of capital is bloody, and the survival of the fittest and the law of the jungle are natural laws that cannot be escaped even in a peaceful and stable society. However, objective laws cannot cover up mistakes forever. Even a big company like Binance admits that it had many problems in its early days. The boomerang of history will always make you pay a price at some point in the future, but it can be big or small.
The Hong Kong regulators have shown their determination to make a decisive move in this matter. Such an action will inevitably bring a certain degree of loss, after all, the appeal of the industry's leading exchanges is obvious to all. The decision to allow new players to open up new horizons is actually a very courageous one.
From another perspective, even in the last bull market when many big exchanges gathered, there were still disruptors like FTX; in this cycle when Solana is in full swing, Backpack, which focuses on the Solana ecosystem, has also taken its own path. Old exchanges certainly have mature models and technologies, but emerging exchanges may also be more innovative and dynamic.
HashKey Exchange told Techub News that since its launch, HashKey Exchange has accumulated a total transaction volume of HK$440 billion and has more than 100,000 registered users. In the future, HashKey Exchange will play an indispensable role in RWA, STO and OTC businesses. If we only compare the tokens launched on HashKey Exchange, I believe that HashKey Exchange has surpassed quite a few second- and third-tier offshore exchanges in terms of transaction volume, which also confirms the author's point of view that emerging exchanges may not be worse than old exchanges, so there is no need to relax the bottom line.
Necessity of ETFs and the issue of liquidity
After talking about the Hong Kong government’s decision on exchange compliance issues, let’s talk about one of the most important developments in the Web3 field in Hong Kong in the past year: Bitcoin and Ethereum spot ETFs.
In essence, the launch of Bitcoin and Ethereum spot ETFs in Hong Kong is a good thing, providing many funds with safer and more convenient cryptocurrency investment exposure. However, I think that Hong Kong has acted too hastily in this matter and has not considered many issues thoroughly.
First of all, I think the first thing that Hong Kong and the institutions that launched the cryptocurrency spot ETF should do is to face the problem squarely and not try to cover it up temporarily with some explanations that lack logical thinking. For example, Hong Kong's spot ETFs are far inferior to the cryptocurrency spot ETFs launched in the United States in terms of trading volume and fund size during the same period. Jupiter Zheng, a partner of HashKey Capital's secondary fund, believes that although there is a difference in the absolute value of the volume, the volume of cryptocurrency spot ETFs accounts for a small proportion of the total volume of ETFs in the market. The $250 million Bitcoin spot ETF accounts for 0.5% of the Hong Kong ETF market, while the $57.3 billion accounts for 0.67% of the US ETF market.
But what is the truth? The fact is that Hong Kong is vigorously developing Web3, while the Web3 industry in the United States has frequently suffered regulatory crackdowns; Hong Kong's cryptocurrency spot ETF has been launched through an almost unimpeded and physical subscription of fund shares, while the US Bitcoin spot ETF has been launched with twists and turns, first rejected, then not allowed to subscribe in kind, and finally officially launched after 10 years of back and forth. In addition, we are ahead of the United States in the progress of institutional products, with the highest insurance volume for cryptocurrency protection, and can also provide a variety of arbitrage opportunities, as well as other advantages. Under the advantage of almost "comprehensive crushing", the volume share of Hong Kong's Bitcoin spot ETF is not much different from that of the United States, and even compared with the first day of launch, there is still a net outflow of funds, which is unacceptable.
Institutions always emphasize that "the future will be better", but with such a huge advantage, why is it that "at the moment" there is no data that even meets expectations, but is instead worse than expected?
First, the launch of the US Bitcoin spot ETF provides an investment exposure to many institutions or funds that cannot invest directly in Bitcoin spot due to regulations (although Coinbase has been listed on the US stock market, the US SEC has never recognized any "fully compliant" cryptocurrency exchange), and the fee rate is very low. Secondly, the awareness of local institutions and even individual investors in the United States about cryptocurrencies such as Bitcoin is among the best in the world. In contrast, Hong Kong already has fully compliant cryptocurrency exchanges (HashKey Exchange and OSL), which means that if institutions or funds are allowed to invest in cryptocurrencies, they can invest directly in exchanges without management fees and with the same level of security. Why do they still need to invest in ETFs?
Obviously, Hong Kong has not fully thought through the issue of "why to launch a cryptocurrency spot ETF".
Of course, I do not think it is unnecessary to launch an ETF, but the value of Hong Kong's Bitcoin and Ethereum spot ETFs is to provide a direct investment window for foreign capital, which is a role that compliant exchanges cannot provide. Therefore, instead of finding some untenable reasons to excuse the failure to do a good job, it is better to face up to and acknowledge the current problems and study how to attract more foreign capital to participate in Hong Kong's cryptocurrency spot ETFs instead of similar products in the United States.
On the other hand, the liquidity problem of the Hong Kong stock market is still one of the cruxes that affect the current vitality of financial asset transactions. We will not discuss the deep-seated reasons for this phenomenon here, but it is worth noting that the current cryptocurrencies are actually high-risk financial assets that are very dependent on liquidity, because in the early days of the industry, these so-called "projects" have no fundamentals to speak of, or the effect of popularity on the price of tokens has largely exceeded the fundamentals. As for Bitcoin and Ethereum, they have a stronger correlation with the macro liquidity of the US dollar. On the first day of the listing of the Bitcoin spot ETF in the United States, although the overall volume was not large, the trading volume in the secondary market exceeded US$1 billion in a short period of time. For a market with sufficient liquidity, even a small amount of capital overflow is enough to support the overall liquidity of a new form of financial assets.
For Hong Kong's cryptocurrency ETFs, while the size is not satisfactory, the trading volume can be said to be "terrible". For investors who invest in ETFs, if the secondary market does not have sufficient liquidity, then exiting will be relatively troublesome, and arbitrage and other operations are out of the question. Based on this, how to activate the liquidity of the overall market, or second best, how to at least activate the liquidity of the Hong Kong cryptocurrency market, is also one of the key issues at present.
Innovation doesn’t have to be limited to infrastructure
Currently, Hong Kong has limited Web3 innovation to infrastructure (transaction-related) and the combination of Web3 and tradition. Perhaps because there is not enough understanding and preparation for Web3 native application areas and development speed, Hong Kong has not had a good starting point in promoting application innovation.
Starting with DeFi, the latest concepts and tracks of Web3 were basically born in Western countries. Except for Terra, which has disappeared, there have been almost no Web3 projects that have become popular and ecological in Asia. Although we have great advantages in exchanges, asset management, hardware wallets, etc., there is almost no innovation in the actual application field.
It is far from enough for Hong Kong to hope to legalize exchanges and even businesses including STO and seek some innovation in these areas. If you want the Web3 market to prosper, you must support innovative projects that are at the forefront of the industry. For example, the current popular Bitcoin ecosystem, Ethereum re-staking, etc., can all gather "Hong Kong power" to select and launch several projects that can become the leaders of the track. When there are good enough projects born in Hong Kong, they will gradually attract talents, funds, and attract more ecosystems around high-quality projects to land in Hong Kong.
In terms of finance, even if Hong Kong is the best in Asia, it is difficult to compete head-on with the United States, so it can gradually catch up in the fields of finance and cryptocurrency trading, but these are definitely not the areas where funds and resources should be invested at the moment. Providing more subsidies and talent policies to potential Web3 native projects, or continuing to dig deeper in areas where Asia currently has a small advantage, such as RWA tokenization and Bitcoin ecology, is a good strategy to achieve overtaking.
“True innovation cannot be regulated”
The development speed of the Web3 industry has exceeded most people's imagination, and it can even be said to be literally "changing with each passing day". Facing a brand new field, I believe that Hong Kong is fully prepared, but I still underestimate the particularity of this industry. In any case, I still highly appreciate the Hong Kong regulator's style of strictly adhering to the bottom line when facing exchanges, but the supervision has always been around mature tracks, ignoring the innovation of the native field of Web3 and its driving effect on the industry and even the entire Hong Kong Web3 atmosphere is at least the most fatal problem so far from the perspective of public actions.
To innovation or to regulation? This has never been a question. The current regulation essentially does not "restrict" innovation at all, because it does not "touch" innovation, but only regulates certain irregular behaviors. Real innovation cannot be regulated in advance, just like the United States could not have thought of how to regulate a decentralized asset before 2008. Therefore, for mature tracks, exchanges, asset tokenization, and cryptocurrency ETFs, strong regulation is understandable, and real "innovation", innovation in the Web3 field must be the whimsical ideas of a small number of geniuses, and no one can regulate in advance, so it is only necessary to provide support for the development of good projects as much as possible and prevent structural risks within the known range.
To truly understand the industry, what are the most promising concepts in the Web3 native field, how RWA tokenization and DePIN can better empower the real industry with the help of the government, and mobilize resources and talents to jointly create high-quality Web3 projects that were born, raised and established in Hong Kong, may be able to resolve the difficulties currently encountered in the implementation process in various fields.
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