Hong Kong Web3 Regulatory Path: Compliance is the Trend, the East-West Game Has Just Begun

Recently, the withdrawal policy of virtual asset trading platforms in Hong Kong has been officially implemented, and non-compliant exchanges will cease operations. As the deadline approaches, nearly half of the VATP applicants, including some well-known trading platforms, have exited, sparking heated discussions in the market. Some pessimistic voices believe that "Hong Kong's status as a financial center is at risk" and "the prospects for Hong Kong's Web3 development are bleak," but is this really the case? How should regulatory agencies respond to the challenges of Web3?

In fact, Hong Kong's strategic value as a Web3 bridge connecting the East and West is just beginning to emerge.

The Next Decade of Web3: Comprehensive Compliance

Compared to 2022, Hong Kong's attitude seems to have shifted from actively embracing to being cautious. But from a broader historical perspective, what stage is Hong Kong currently in? We might as well make a horizontal comparison of several major Web3 financial markets around the world.

Japan is undoubtedly a pioneer in the Web3 regulatory field. After the infamous Bitcoin exchange collapse in 2014, Japan gradually initiated regulation and introduced a licensing system for digital currency exchanges in 2017. A decade later, Japan has a total of 23 approved digital currency exchanges, including a well-known international trading platform, but most are local enterprises.

Operating an exchange in Japan has similarities with Hong Kong, such as the need to comply with asset segregation and cold wallet regulations, and to conduct regular audits. It is precisely these relatively strict regulations that allowed Japanese exchanges to avoid a chain reaction when a certain well-known trading platform collapsed—because most user funds were stored in cold wallets. In addition, Japan's regulatory framework in various fields such as ICOs, IEOs, STOs, and CBDCs is also relatively mature.

Singapore and the United States began to strengthen regulation in 2022 after some well-known institutions faced crises.

Although the United States does not have strictly defined "Compliance" exchanges, a certain listed trading platform appears to be more compliant than others and has seen significant growth in recent performance. Meanwhile, other offshore exchanges have gradually faced regulatory challenges from the U.S. following events in 2022.

It can be seen that regulation is gradually deepening into various subfields, becoming a meticulous task.

During this period, Japan and Singapore have also faced criticisms for having "overly strict" regulations, but as policies continue to improve, the Web3 ecosystem in these two regions is becoming increasingly vibrant.

The regulatory attitude in the United States has shifted from a tough stance to a more flexible one. Recently, the U.S. released the regulatory framework for the 21st Century Financial Innovation and Technology Act, which outlines how to define digital assets (including DeFi and NFTs) and delineates the boundaries between commodities and securities. This could become one of the most impactful pieces of legislation for the crypto industry.

Following the United States, regions such as Southeast Asia, the Middle East, and South Asia plan to introduce Web3 regulatory policies in the coming years. Even countries in Europe and Africa, which were not previously active in the cryptocurrency industry, are beginning to join this wave of regulation.

Global regulators do not want to miss the opportunities of Web3. Whether starting with a proactive embrace or risk prevention, jurisdictions will ultimately move towards precise regulation.

From the perspective of the number of licensed exchanges, offshore exchanges in various regions account for almost no more than 30% of the total licenses, and regulators tend to support local enterprises.

This is actually not a regulatory challenge, but rather a challenge faced by offshore exchanges. Looking back at the early development of the industry, offshore exchanges were able to serve nearly 200 million users in a loose environment. But that era has passed. Apart from a certain well-known exchange that is willing to pay hefty fines to ensure Compliance, among the exchanges that withdrew their applications, a certain platform has gradually laid out its plans and has obtained multiple regional licenses in recent years, while some other platforms are relatively lagging behind.

Using an inappropriate metaphor, "it's difficult to go from luxury to frugality." Offshore exchanges wanting to "come ashore" and enter major financial regulatory areas still seem to have many obstacles to overcome.

With the changing cycles, the early era of "regulatory arbitrage" in the crypto market is long gone.

Back to Hong Kong. Unlike the "extended regulation" approach of the United States, which allows development first and then imposes strict penalties, Hong Kong has adopted a "native regulation" model that requires licensing before operations, directly skipping the stage of unregulated growth.

Since the implementation of Web3 regulatory policies in Hong Kong in 2022, the industry has begun to promote comprehensive Compliance. By June 1, 2024, the AMLO license will officially take effect, and informal exchanges will complete their exit; currently, more than half of the applicants are still present. Licensed exchanges have seen their trading volume exceed 440 billion HKD, showing a positive development trend.

Therefore, the exit of some exchanges is not worth being overly pessimistic about. From a historical perspective, this is just a necessary cleaning phase that Hong Kong and other regulatory regions are experiencing.

More importantly, the policy on May 31 also marks that Hong Kong has solved the most concentrated and complex issue in the "exchange" industry, completing a comprehensive regulatory framework.

Hong Kong vs USA: The Strategic Game Between East and West

What is the next step after the regulation is completed? The initial phase has passed, and the strategic game has just begun.

Four years ago, the founder of a certain payment giant predicted that major political conflicts in the future would occur between communist artificial intelligence and liberal cryptocurrency technology.

Today, both AI and Web3 are gaining momentum, with the United States and Hong Kong seen as the forefront of the Web3 industry in the East and West. The game of regulatory attitudes in both places will lead the global direction of Web3 development.

Why gamble? Unlike AI, monopolistic regulation is no longer feasible in the Web3 space. The Web3 era has built more commercial entities based on the network economy, which can easily cross physical boundaries to provide services to customers.

The book "Sovereign Individual," which inspired the invention of Bitcoin, depicted a scenario like this: "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 establish a de facto meta-constitutional requirement that the government must genuinely provide satisfactory services before demanding payment of bills from you."

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

The recent attitude of the United States has become very clear. This year, the topic of cryptocurrency has first become a focal point in American politics. According to a certain data platform, about one-third of American voters would consider candidates' positions on cryptocurrency before voting. 77% of voters believe that presidential candidates should at least understand cryptocurrency. 44% of voters somewhat agree that "cryptocurrency and blockchain technology are the future of finance." A certain political figure even called for: "Ensure that the future of cryptocurrency happens in the United States!"

The game pattern between the East and the West has taken shape, and ETFs have become a clear battleground. The sudden shift in the U.S. stance on ETH ETF approvals may be related not only to local factors but also to Hong Kong's early launch of the ETH ETF in April.

Although there is currently a significant gap between the scale of ETFs in Hong Kong and the United States, as one of the largest offshore financial centers in the world, it is expected that with the improvement of the ecosystem, Hong Kong will attract more institutions in the future, forming a new round of institutional bull market.

Next, the ETH ETF, as a pledgeable income-generating asset, will become the next focus of the game.

After Ethereum transitioned from PoW to PoS, staking can generate passive income similar to interest, with the current market annual interest rate around 4.5%. If Hong Kong is the first to launch a spot ETF for Ethereum with staking functionality, subscribing to the ETF will no longer be a paid action but a profitable one after receiving staking rewards. This could, to some extent, become a "digital US Treasury bond," and its appeal may even surpass that of a Bitcoin ETF.

The development of the Web3 industry is closely related to the local cultural heritage. Although Easterners appear more reserved and cautious compared to the outgoing and diverse Westerners, it does not mean they are lagging behind.

Hong Kong has currently issued multiple regulatory documents, including guidelines for virtual asset trading platforms, anti-money laundering, and counter-terrorist financing.

These policies are clearer and more mature compared to the Commodity Futures Trading Commission regulations previously used in the United States, and there is no need to endlessly debate whether cryptocurrencies are "securities" or "commodities."

As the bull market gradually reaches its peak, 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 inherently endowed with the "mystical power of the East," will also attract more mainland and overseas Chinese Web3 talents and their capital inflow as the market progresses.

In the next cycle, the integration of Web3 and traditional finance will occur across multiple dimensions, revitalizing the Hong Kong financial market. Currently, the Hong Kong Securities and Futures Commission has indicated the possibility of opening up STO and RWA investments to retail investors, further expanding the virtual asset market. In addition, the regulatory framework for Hong Kong's HKD stablecoin and over-the-counter (OTC) virtual asset trading is also being advanced. Once the full chain is connected, Web3 will inject new vitality into the entire Hong Kong market.

The historical tide rolls forward, what kind of enterprises can stay at the table? Exchanges are the most important cornerstone of the Hong Kong Web3 ecosystem.

In the foreseeable future, licensed exchanges that are still present will not only engage in their trading business but also become key connections for Hong Kong's Web3 across various financial industries. For example, in this ETF issuance, a certain trading platform also acted as a custodian, providing underlying infrastructure support for the issuer. In the future, they will play an indispensable role in RWA, STO, and OTC businesses.

For this reason, some offshore exchanges have been forced to leave the Hong Kong market. This also confirms an old saying: "What goes around comes around."

Development always has its ups and downs. We should take a broader view of history and make rational judgments, especially during the moment of withdrawal in Hong Kong.