Since its return to China in 1997, Hong Kong has become the country’s indispensable offshore financial center, with considerable international links. It has engaged in financial innovation, such as the cultivation of the world’s premier offshore renminbi trading hub. However, Hong Kong also faces much more competition from Singapore than it did in the late 1990s, and other Asian cities like Tokyo.
Meanwhile, when it comes to capital markets, it is the mainland that is arguably Hong Kong’s greatest competition as Beijing is encouraging more listings in Shanghai, Shenzhen and even Beijing. Strategic industries like semiconductors, aeronautics, quantum computing and new-energy vehicles linked to long-term policy objectives are more likely to list on the mainland than in Hong Kong given specific incentives as well as political considerations.
For these reasons, Hong Kong has decided to make a big bet on cryptocurrency. The city aims to become the paramount Asian digital asset hub, and is moving aggressively to capture related opportunities. Its regulators seem to believe that digital assets are here to stay and can help secure the city’s future as a financial center, but it is not yet clear if they fully understand the risks of this endeavor.
Accelerated Regulatory Framework
Barely a month goes by without a new regulatory development in Hong Kong’s digital asset sector. We would not say regulations are being rushed, but the speed at which they are being rolled out exceeds that of most other jurisdictions. On February 21, the HKSAR government repeated its intention to implement legislation for virtual asset over-the-counter (OTC) services. In a written statement, Financial Secretary Christopher Hui said that the government plans to submit bills on virtual assets to the Legislative Council “as soon as practicable,” adding that the “government and regulators are committed to enhancing the VA regulatory framework.”
Just one day earlier on February 20, the Hong Kong Monetary Authority (HKMA) issued guidance for authorized institutions that aim to provide crypto custody services, enhancing the license regime established in 2023 designed to allow digital asset exchanges to ultimately operate under a comprehensive regulatory framework. The HKMA wants the industry to ensure strong investor protection. To that end, the guidance mandates that authorized digital asset custodians carry out independent systems audits, put a substantial part of their client’s digital assets in cold storage, and perform a full risk assessment as well as manage any identified risks carefully.
The guidance appears to be directly influenced by the massive scandals that have rocked the industry in recent years – not just FTX’s implosion but also the collapse of South Korea’s Terra Luna and Singapore-based Three Arrows. For instance, the guidance requires providers of custodial services to separate their assets from those of clients and forbids misuse of client assets. While this is a step in the right direction, questions of enforcement still remain.
Risk Management
The biggest downside to Hong Kong’s embrace of digital assets is that the nascent industry remains highly susceptible to malfeasance. No matter how much Hong Kong officials reassure us that the city has things under control, becoming Asia’s premier digital assets hub is going to be a bumpy ride that will test theirs and investors’ mettle.
This is especially true for the retail segment. There is a reason that Singapore has more or less drawn a red line in the sand with regards to retail trading of digital assets. Yes, there are many market opportunities, but you have to stay several steps ahead of the cybercriminals. Not every jurisdiction wants to take on the high level of associated risk.
Hong Kong learned this lesson the hard way last year when the local JPEX platform defrauded investors out more than $200 million. Should retail investors have been suspicious of a platform that promised yields up to 20%? Yes, but now it is too late for them to recover their losses, in some cases life savings. Meanwhile, HKUST surveys taken in 2023 found that about 70% of respondents did not understand digital assets “very well” or “at all.”
Overall, we can see a clear association between Hong Kong’s embrace of crypto and a surge in digital asset related crime. There were 3,415 documented cases of such crimes involved involving $600 million in 2023, compared to 2,336 in 2022 and 1,397 in 2021.
Future Prospects
Looking ahead, we expect Hong Kong will double down on its crypto push – despite the mounting risks – because it faces significant pressure to revive its fortunes and lacks other attractive options. Compared to other industry segments the city is cultivating, such as wealth management, crypto has an undeniably global orientation. A larger wealth management sector in Hong Kong might ultimately encompass the Greater Bay Area in southern China, but if the erstwhile British Crown Colony becomes a digital asset hub, it could be at heart of a much more geographically diverse ecosystem.
That said, to achieve its crypto dream, Hong Kong will need the continued support of Beijing. With digital assets still severely restricted on the mainland, and Hong Kong continuing to face tenacious crypto crime, it is possible that the central government will have second thoughts about permitting Hong Kong’s crypto experiment.
To be sure, the experiment is possible under the one country, two systems framework, but Hong Kong has to show that it can manage all related risk effectively. If a large scam occurs that adversely affects a significant number of mainland investors, doubts could emerge about the wisdom of allowing the city to become a digital assets hub.
Finally, the ultimate size of the market opportunity will also be affected by how major economies such as the U.S., EU, India decide to proceed with digital assets. While Europe seems to be gradually moving towards acceptance, the same cannot be yet said of the U.S. and India. Hong Kong should carefully consider these factors as it continues to develop its regulatory framework for digital assets.