Hong Kong Web3 Regulation: The Inevitable Journey from "Embrace" to "Caution"

The Hong Kong virtual asset trading platform ( VATP ) exit 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 As the deadline approaches, nearly half of the VATP applicants have withdrawn, sparking market discussions. Some opinions suggest that "Hong Kong has become a relic of a financial center" and "Hong Kong's Web3 has ended before it even began", but is this really the case? How should regulation embrace the Web3 era?

In fact, Hong Kong, as the bridgehead of Web3 in the East, has only just begun its game with the West.

The Next Decade of Web3: Comprehensive Compliance

From a global perspective, what stage is Hong Kong currently in? We can compare several major Web3 financial markets.

Japan is a pioneer in the regulation of Web3. After the collapse of the Mt.Gox exchange in 2014, Japan gradually initiated regulation and introduced a licensing system for digital currency exchanges in 2017. Ten years later, Japan has a total of 23 approved digital currency exchanges, most of which are local companies. Japan's regulatory requirements are similar to those of Hong Kong, such as asset segregation, cold wallet usage, and regular audits. Thanks to strict regulations, Japanese exchanges were largely unaffected by the FTX incident. In addition, Japan's regulatory framework in multiple areas such as ICOs, IEOs, STOs, and CBDCs is relatively well-developed.

Singapore and the United States initiated strong regulations after the collapse of Three Arrows Capital and FTX Exchange in 2022. Although there is no officially "compliant" exchange in the U.S., the publicly listed company Coinbase has performed relatively well and has seen significant growth this year. Other offshore exchanges, such as certain platforms and trading platforms, have gradually faced regulatory challenges from the U.S. following the FTX incident.

It can be seen that regulatory measures in various countries are gradually delving into vertical fields, becoming a "meticulous task". Japan and Singapore were once considered to have overly strict regulations, but as policies have improved, the Web3 ecosystem in both regions has become increasingly active.

The recent U.S. regulations have also eased. The latest released FIT21(21 Century Financial Innovation and Technology Act ) framework proposes definitions of digital assets ( including DeFi and NFT ), as well as the delineation standards for commodities and securities, which could become one of the most far-reaching laws affecting Crypto.

Following the United States, Southeast Asia, Dubai, India, Iran, and other regions also plan to introduce Web3 regulatory policies in the coming years. Even countries like Europe and Nigeria, which were previously inactive in the cryptocurrency industry, have joined this round of regulation.

Global regulators do not want to miss out on Web3. Whether starting from embracing it or from risk events, jurisdictions will eventually move towards precise regulation. Judging by the number of licensed exchanges, offshore exchanges account for almost no more than 30%, and regulators prefer local companies.

This is not a regulatory challenge, but rather the challenges faced by offshore exchanges. Looking back to the early days, offshore exchanges served nearly 200 million users in a loose environment. But that is now a thing of the past. Apart from a well-known trading platform seeking compliance after paying hefty fines, other exchanges that have withdrawn their applications, such as a certain trading platform, have gradually laid out plans and obtained licenses in places like Singapore and Dubai, although some platforms have received fewer licenses.

Offshore exchanges face a rocky road to "land" in major financial regulatory jurisdictions. The "regulatory arbitrage" of the wild era of the crypto market is gone for good.

Compared to the "extension-based regulation" in the United States, which allows businesses to operate first and then be punished, Hong Kong adopts a "native regulation" approach, requiring licenses before businesses can operate, thus directly skipping the phase of unregulated growth. Since Hong Kong introduced Web3 regulatory policies in 2022, and with the AMLO license officially implemented on June 1, 2024, informal exchanges have completed their exit, and currently, more than half of the applicants are still active. Exchanges that have already commenced operations, such as a certain trading platform, have seen trading volumes exceed 440 billion HKD, showing a positive development trend.

The exit of some exchanges should not be viewed with excessive pessimism. From a historical perspective, this is just an inevitable cleansing phase that Hong Kong, like other regulatory jurisdictions, has to go through. More importantly, the 531 policy marks that Hong Kong has tackled the "exchanges," which is the sector with the highest concentration of capital and the most complexity, completing comprehensive regulation.

Hong Kong and the United States: The Battleground of East-West Web3

After regulation, what is the next step? The initial phase has passed, and the phase of competition has just begun.

Four years ago, the founder of PayPal predicted that future political conflicts would fall between communist artificial intelligence and liberal cryptocurrency technology. Now, both AI and Web3 have risen, with the United States and Hong Kong seen as the East-West bastions of the Web3 industry. The regulatory game between the two places will guide the global direction of Web3 development.

Why gamble? Unlike AI, monopolistic regulation does not work in the Web3 era. Web3 has built more business entities based on the network economy, easily crossing physical boundaries to serve customers.

The "Sovereign Individual" that inspired Satoshi Nakamoto's invention of Bitcoin depicts this scenario: "After the development of information technology, you can create wealth in cyberspace without being plundered by nation-states. This will form a de facto requirement for constitutional governance, where the government must provide satisfactory services to you before collecting taxes."

In the future, political leadership may increasingly resemble entrepreneurship; only by being sufficiently friendly can it attract funding and talent. It is not that Web3 needs regulation, but rather that regulators 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 focus in American politics. According to a certain data platform, about one-third of American voters will consider candidates' positions on cryptocurrency before voting. 77% of voters believe that presidential candidates should at least understand cryptocurrency. 44% of voters believe to some extent 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 West has taken shape, and ETFs are a clear battleground. The recent abrupt change in the United States' attitude towards the approval of ETH ETFs may be due to local factors, but it could also be influenced by Hong Kong's relatively pioneering launch of the ETH ETF in April.

Although there is currently a significant gap in the scale of ETFs between 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 in the future, Hong Kong will attract more institutions to enter the market, forming an institutional bull market.

As a stakable income-generating asset, the development expectations of ETH ETF will become a key point of contention in the future. After Ethereum switched from POS to POW, staking has created passive income similar to interest, with the current market annual interest rate at approximately 4.5%. If Hong Kong takes the lead in launching a Staking-enabled Ethereum spot ETF, the act of subscribing to the ETF will transform from a cost into a profit-generating activity after receiving staking rewards. To some extent, this could become a "digital U.S. Treasury bond," attracting interest even more than Bitcoin ETF.

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

Hong Kong has released multiple regulatory documents, including the "Guidelines for Virtual Asset Trading Platform Operators" and the "Guidelines for Combating Money Laundering and Terrorist Financing." These policies are clearer and more mature than the previously used "Commodity Futures Trading Commission Regulations" in the United States, and there is no need to waste words on whether cryptocurrencies are "securities" or "commodities."

As the bull market gradually reaches its peak, the wealth creation effect in the industry will become evident, and a new batch of billionaires is about to be born. Hong Kong, leveraging its "mystical Eastern power" advantage, will attract more mainland and overseas Chinese Web3 backbone forces and their capital.

The next cycle will be a multidimensional integration of Web3 and traditional finance, revitalizing the Hong Kong financial market. Currently, the Hong Kong Securities and Futures Commission has indicated that it may open 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 virtual asset store (OTC) is also being advanced. Once the full chain is connected, Web3 will inject new vitality into the entire Hong Kong market.

In the foreseeable future, licensed exchanges that remain operational will not only engage in their own trading activities but will also become key players in connecting various financial industries within Hong Kong's Web3 ecosystem. For example, in ETF issuance, a certain trading platform also acts as a custodian, providing underlying infrastructure support for the issuer. In the future, these exchanges will play an indispensable role in RWA, STO, and OTC businesses.

This is exactly why some offshore exchanges have been forced off the Hong Kong stage. This is also a reminder that "what goes around comes around."

Development has its ups and downs. We should take a broader view of history and make rational judgments during the moment of clearance we experience in Hong Kong.