New Landscape of Virtual Asset Regulation: Hong Kong's Web3 Journey Has Just Begun

The Hong Kong virtual asset trading platform clearance policy officially took effect on May 31, and non-compliant exchanges will cease operations. As the deadline approaches, nearly half of the VATP applicants have chosen to withdraw, sparking market discussions. Some believe that "Hong Kong's status as a financial center is at risk" and that "the Web3 era in Hong Kong has ended before it even started," but is this really the case? How should regulation embrace the Web3 era?

In fact, Hong Kong, as a Web3 bastion connecting the East and the West, is just beginning to reveal its strategic significance.

The Next Decade of Web3: Comprehensive Compliance

Looking at the evolution of regulatory trends in major Web3 financial markets around the world.

Japan is a pioneer in the field of Web3 regulation. Since the Mt. Gox incident in 2014, Japan has gradually initiated regulation and introduced a licensing system for digital currency exchanges in 2017. Over the past decade, a total of 23 digital currency exchanges have been approved to operate in Japan, including some internationally renowned trading platforms, but primarily consisting of local companies.

Japan's regulatory experience is similar to that of Hong Kong, with regulations such as asset separation and the use of cold wallets. These strict measures played a positive role during the FTX incident, protecting users' asset safety. In addition, Japan's regulatory framework in areas such as ICOs, IEOs, STOs, and CBDCs is also relatively well-developed.

Singapore and the United States have strengthened regulatory measures after the Three Arrows Capital and FTX incidents in 2022.

Although the United States does not have any officially "compliant" exchanges, certain listed companies have achieved significant performance growth due to their relatively standardized operations. Meanwhile, some other international trading platforms are gradually facing regulatory challenges in the U.S. following the FTX incident.

These cases reflect a common trend: regulation is gradually deepening in various subfields and becoming more refined.

It is worth noting that Japan and Singapore also faced criticism for being "too strict" during the early stages of regulation, but as regulatory frameworks continue to improve, the Web3 ecosystems in these two regions are becoming increasingly vibrant.

The United States has recently adjusted its regulatory attitude. The latest released FIT21 (Financial Innovation and Technology Act of the 21st Century) regulatory framework proposes a method for defining digital assets (including DeFi and NFTs), as well as how to delineate the boundaries between commodities and securities, which may have a profound impact on the crypto industry.

Following the United States, regions such as Southeast Asia, the Middle East, and South Asia also plan to introduce Web3 regulatory policies in the coming years. Even some countries and regions that were previously not active in the cryptocurrency space, such as certain countries in Europe and Africa, have begun to engage in regulatory actions.

Global regulators are actively laying out their plans in the Web3 space. Whether starting with a positive embrace or responding to risks, jurisdictions will ultimately move towards precise regulation.

From the perspective of the number of licensed exchanges, local enterprises dominate in various regions, and the proportion of international trading platforms typically does not exceed 30%. This reflects that regulators tend to support the development of local enterprises.

For some international trading platforms, adapting to the new regulatory environment does pose challenges. Looking back, these platforms served nearly 200 million users in a relatively lenient regulatory environment. But that era has passed. Some large international trading platforms are actively positioning themselves to obtain licenses in multiple jurisdictions to meet new regulatory requirements.

It can be said that the era of "regulatory arbitrage" in the cryptocurrency market has come to an end, and a new era of compliance is on the horizon.

Compared to the "post-regulation" model in the United States, Hong Kong has adopted a "pre-licensing, post-operation" approach. Since the introduction of Web3 regulatory policies in Hong Kong in 2022, the clarion call for full compliance in the industry has been sounded. As of June 1, 2024, the AMLO license will be officially implemented, and non-compliant exchanges have completed their exit; currently, more than half of the applicants are still in the market. The trading volume of licensed platforms that have begun operations has surpassed 440 billion HKD, indicating a positive development trend.

Therefore, the exit of some exchanges should not be viewed too pessimistically. From a historical perspective, this is merely a necessary phase that Hong Kong, like other regulatory jurisdictions, is undergoing. More importantly, this marks that Hong Kong has addressed the most concentrated and complex "exchange" issue in the industry, laying the foundation for comprehensive regulation.

The Game Between East and West: The Roles of Hong Kong and the United States

After the regulatory framework is established, what will be the next step? In fact, the game has just begun.

Four years ago, someone predicted that future political conflicts would occur between artificial intelligence and encryption technology. Today, both AI and Web3 have shown strong momentum, with the US and Hong Kong regarded as important battlefields for the Web3 industry in the East and West. The competition between the regulatory attitudes of the two places will influence the global direction of Web3 development.

Why does a game emerge? Unlike AI, the Web3 era has established more business models based on the network economy, which can easily cross geographical boundaries to provide services. This means that traditional monopolistic regulation may no longer be applicable.

In the future, political leadership may be closer to entrepreneurial spirit, and only a sufficiently friendly policy environment can attract funds and talent. Therefore, it is not only Web3 that needs regulation, but regulators also need Web3.

The recent attitude of the United States has become very clear. This year, the topic of cryptocurrency has for the first time become a focal point in American politics. Reports indicate that about one-third of American voters will consider a candidate's position on cryptocurrency when voting. 77% of voters believe that presidential candidates should at least understand cryptocurrency. 44% of voters somewhat believe that "cryptocurrency and blockchain technology are the future of finance."

The game pattern between the East and the West has already taken shape, and ETFs have become a clear competitive field. The sudden shift in the U.S. attitude towards ETH ETFs may be related not only to domestic factors but also to Hong Kong's launch of ETH ETFs in April.

Although there is currently a gap in scale between Hong Kong and US ETFs, as one of the world's largest offshore financial centers, it is expected that Hong Kong will attract more institutions in the future as the ecosystem improves, potentially triggering a new wave of institutional investment enthusiasm.

In the future, ETH ETFs as stakeable income-generating assets may become the next competitive focus. After Ethereum transitioned to PoS, staking can generate passive income similar to interest, with the current market annual interest rate around 4.5%. If Hong Kong takes the lead in launching an Ethereum spot ETF with Staking functionality, it will no longer be merely a paid product, but a profit-generating tool. It could even become, to some extent, a "digital U.S. Treasury bond," with an appeal that may surpass that of Bitcoin ETFs.

The development of the Web3 industry is closely related to local culture. Although Eastern culture appears more reserved and cautious compared to the outgoing and diverse nature of the West, it does not mean it is behind.

Hong Kong has released a series of detailed regulatory guidelines covering various aspects such as the operation of virtual asset trading platforms, anti-money laundering, and counter-terrorism financing. These policies are clearer and more mature than the Commodity Futures Trading Commission regulations previously adopted in the United States, and they also avoid controversies regarding the classification of cryptocurrencies.

As the bull market gradually approaches, the wealth creation effect in the industry will become apparent, and a new batch of millionaires is about to emerge. Hong Kong, with its unique geographical and cultural advantages, is expected to attract more Web3 talents and funds from the mainland and overseas Chinese.

The future development cycle will be the integration of Web3 and traditional finance across multiple dimensions, which will inject new vitality into the Hong Kong financial market. Currently, Hong Kong regulators are considering opening up STO and RWA investments to retail investors, further expanding the virtual asset market. In addition, the regulatory framework for Hong Kong dollar stablecoins and over-the-counter (OTC) virtual asset trading is also being advanced. Once the full chain is connected, Web3 will bring new development opportunities to the entire Hong Kong market.

In this new era, those that will remain in the market are enterprises that can adapt to the regulatory environment and possess innovative capabilities. Exchanges, as the cornerstone of the Hong Kong Web3 ecosystem, will play a key role.

In the foreseeable future, licensed exchanges will not only conduct trading activities but will also become key nodes connecting Hong Kong's Web3 with various financial industries. For example, during the ETF issuance process, certain trading platforms also play the role of custodians, providing infrastructure support for issuers. In the future, these platforms will play an indispensable role in RWA, STO, and OTC businesses.

It is precisely for this reason that some international trading platforms have failed to obtain licenses in Hong Kong. This also reflects a reality: "Compliance is the trend of the times."

In the process of development, there are bound to be ups and downs. We should view the development of the Hong Kong Web3 industry from a more macro perspective and make rational judgments about its future prospects. The road for Web3 in Hong Kong has just begun, and the future is still full of opportunities and challenges.