On February 2024, 2, another application from a licensed exchange in Hong Kong was withdrawn.
Huobi, a long-established exchange, has been struggling on the road of "how to comply with regulations" for many years, and finally waited for the perfect opportunity for Hong Kong to enter Web2023 in 3. After completing the compliance implementation in Hong Kong, Huobi will be able to successfully "go ashore", which is not only an opportunity to reverse its image, but also an opportunity to restart its business.
However, the result is obvious: the road to compliance in Hong Kong is not easy.
On January 1, Greenland Hong Kong failed to enter; on February 29, Kaisa Group failed; a few days later, on February 2, Huobi was not spared. In total, 7 applicants were withdrawn in less than a month, which poured cold water on the applicants still waiting in line.
What is the difficulty in applying for a licensed virtual asset exchange in Hong Kong? Who will be left standing in the future?
In this article, Bailu Living Room deeply explores the operation of licensed virtual asset exchanges in Hong Kong.
(I) Three key points of application: capital injection, technical assessment requirements, and appropriate personnel regulations
Throughout 2023, the Hong Kong government's propaganda and actions were very loud, and the market and practitioners felt that this would be a powerful medicine to save Hong Kong's financial system. The frenzy also gave rise to an illusion that anyone could take this powerful medicine.
But the truth will not favor those who "take advantage of the trend". The 331-page "Anti-Money Laundering and Terrorist Financing (Amendment) Bill 2022" and the 99-page "Guidelines for Virtual Asset Trading Platform Operators" provide an extremely complex framework for the supervision of licensed virtual asset trading platforms in Hong Kong. Only applicants who have all the legal, technical and capital strengths are eligible to complete the road to approval.
Generally speaking, all applicants must be prepared in three major aspects: capital injection, external assessment requirements, and staffing that meets the appropriate personnel requirements.
Capital injection
According to the "Guidelines for Virtual Asset Trading Platform Operators" issued by the Hong Kong Securities and Futures Commission, applicants must meet two basic requirements in terms of capital preparation:
(i) The Platform Operator should at all times beneficially own in Hong Kong sufficiently liquid assets such as cash, deposits, treasury bills and certificates of deposit (but not virtual assets) in an amount equal to the Platform Operator’s actual operating expenses calculated on an ongoing basis for at least 12 months.
(ii) A Platform Operator must at all times maintain a paid-up share capital of not less than HK$5,000,000.
Capital preparation before application is not a difficult hurdle. For those who dare to step into the exchange track, they must have already prepared the required financial and material resources, otherwise they would not dare to get involved. The real test of capital comes more from the cost of continuing to operate the exchange in Hong Kong, which we will mention later.
External evaluation requirements
The second thing I put in second place is various external assessment requirements, including but not limited to private key management, investor protection measures, anti-money laundering, monitoring and protection, network security and other aspects.
In terms of solutions, the path to meet the relevant conditions is actually quite mature; different types of applicants have their own advantages, and they can pass if they play their best. For applicants with senior backgrounds in large leading firms, they already have mature development capabilities and rich operational experience, and what they need is to fill the gaps in legal and compliance; while for applicants who are transforming from traditional finance, their situation is exactly the opposite. Years of hard work in the Hong Kong financial market have made their capabilities in corporate management and compliance very sound, and they need to reconfigure a development team with sufficient industry background and strength.
Pure entrepreneurs may encounter some difficulties, but generally speaking, the appropriate person requirement is a hurdle that all applicants must face.
Fit and proper person and competence requirements
Pursuant to the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Regulations 2022, the SFC can only approve a license if the applicant meets the following requirements:
(i) a company incorporated in Hong Kong and having a fixed place of business, or a company incorporated elsewhere but registered in Hong Kong under the Companies Ordinance;
(ii) Applicants who have passed the SFC’s Fit and Proper Test.
Passing the fit and proper person test is not easy and the conditions include:
(i) The applicant must have at least two responsible officers (ROs) approved by the SFC to oversee the business and ensure that the applicant complies with anti-money laundering and counter-terrorist asset raising regulations and other regulatory requirements; and only ROs can serve as executive directors of VASPs.
(ii) The ultimate beneficiary of the applicant should be a person who can provide virtual asset services;
Focusing on each RO, they need to have a basic academic background and more than 3 years of working experience in the relevant industry. There are not many candidates who can meet the requirements, which makes the service fees of qualified ROs also rise sharply. If there are disagreements in cooperation, personnel changes may directly ruin the entire application process.
In addition to senior executives, relevant personnel must also meet competency requirements and continuous training requirements. From management to grassroots employees, the Hong Kong government's supervision ensures that every practitioner can maintain sufficient professional ethics, but it also increases the difficulty of each applicant in forming a team and the burden of continuous operation.
(II) Two operational problems: burning money and being too competitive
Even if you get a license, you can’t rest easy. The two major dilemmas of “getting killed if you hold a license” and “too many wolves and too little meat” are equally thorny in the continued operation of a licensed exchange in Hong Kong.
The dilemma of being killed by a license holder
Wang Yang, vice president of the Hong Kong University of Science and Technology, once said that "licensing is killing" is the best summary of the operating difficulties of licensed exchanges in Hong Kong. The apparent 500 million Hong Kong dollars is only the baseline for registration, and the accumulation of various operating costs is the challenge for operators.
Some costs can be reasonably estimated: legal and compliance team, investment in security and technical resources, implementation of fund isolation and risk management mechanisms, establishment of audit and reporting systems, employee compliance training and education, and the cost of setting up a local branch in Hong Kong to store mnemonics and private keys.
Each of the above is a type of cost expenditure; in addition, there are many other costs that are difficult to estimate. For example, due to the high demand for the two licensed responsible officers (ROs) that each institution must employ, ROs usually charge additional fees for their services. For another example, on January 2024, 1, the Hong Kong Securities and Futures Commission required licensed virtual asset exchanges to provide at least 30% insurance for customer assets to ensure the safety of investor funds. On April 50, 2024, the OTC licensing system has begun public consultation. After implementation, application and management fees will continue to increase. With the increasing number of similar clauses, the capital accumulation required to maintain compliance will become higher and higher.
High costs are the positive side of “being killed by a license”, and on the other side, the inability to expand business becomes another shackle.
First of all, virtual assets must be approved by the Securities and Futures Commission before they can be listed, and each exchange that wants to list must also submit an application to the Hong Kong Securities and Futures Commission. As a result, licensed exchanges can only trade a few currencies, and their ability to attract new users is naturally greatly reduced.
On the other hand, compared with the common non-compliant large exchanges, the innovation direction of Hong Kong licensed exchanges is also very limited. The exchanges do not have the big contracts that make them profitable, and the compliant exchanges that are almost "casino-like" in nature, once the overall market conditions decline, the difficulties they face can be imagined.
OSL has provided the best example. In 2022, OSL Group's financial report showed a loss of HK$3 million; in the first half of 2023, the group still recorded a net loss of about HK$9500 million. In June 2021, OSL Group (then still BC Technology Group) hit a record high in the stock market during the bull market; in 6, the company's stock price fell by nearly 2023%. The virtual asset market is still a win-win situation. Whenever a bear market comes, the requirements and costs of supervision will only make things worse.
The involutionary pattern is hard to avoid
"License holders are killed" is just a result of strict supervision. However, even without the pressure from the regulatory authorities, the competition among applicants will continue to squeeze each other's living space.
So far, including the two licensed exchanges that have been successfully approved and HKVAX that has been approved in principle, a total of 2 institutions have applied for Hong Kong virtual asset trading platforms. In February 1, six different applicants have joined the competition in just one month.
Hashkey has begun to show the head effect and is desperately trying to grab market share. Once more exchanges are approved, roll-in fees, roll-in product promotion, roll-in insurance, and even roll-in airdrops may all appear immediately. In a situation where there are too many wolves and little meat, will the dominant institutions stand out with their strength, or will they hurt each other and go into a death spiral together?
Hong Kong licensed exchanges should no longer repeat the bank run farce of Binance and FTX.
3. Facing competition: Only by clarifying strategies and leveraging advantages can we gain a firm foothold
The Hong Kong government's original intention to raise the industry threshold is not wrong. The ubiquitous risks in the Web3 industry have always been the biggest obstacle to the expansion of the industry. Under competition, the winner who can hold on to the end and gain a foothold must be the best choice for the market.
Today, when the infrastructure of the Hong Kong market is still imperfect, the core competitiveness of institutions with different backgrounds is different. Institutions with traditional financial backgrounds rely on the huge funds in the market to do a good job in investor education and guidance, and bring funds into the market; at the same time, institutions with mature Web3 backgrounds will do a good job in innovation, communicate with regulators to promote the successful implementation of more diversified products. Only when each finds its own position and builds the entire virtual asset ecosystem can it help form a prosperous market with healthy competition.
As for who will have the last laugh, although no one can predict the future, some institutions have already taken the lead and their future performance is more worthy of attention.
Traditional background: HKVAX, VDX
HKVAX has the advantage of being the first mover. On August 2023, 8, HKVAX received the approval-in-principle notice from the Hong Kong Securities and Futures Commission, allowing it to conduct Category 11 and Category 1 regulated activities (Virtual Asset Licenses 7 & XNUMX), and will become the third licensed virtual asset trading platform in Hong Kong. In terms of application, HKVAX no longer needs to be questioned; and in terms of continued operation, the first-mover advantage accumulated by HKVAX in being the first to be approved will definitely be a great boost to its business development.
In January 2024, HKVAX CEO Wu Weiliang attended the "1 Qingdao Hong Kong and Macao Financial Night Event" and said at the meeting: "Domestic'exclusive' blockchains, such as Wenchang Chain, Wuhan Chain and Ant Chain, are very different from the Ethereum blockchain used overseas. Therefore, from a technical point of view, Hong Kong is the preferred platform for companies to develop virtual assets. Hong Kong supports all 'chains'. If we 'link' some domestic digital assets to Hong Kong through some domestic 'chains', such as Ant Chain, and then change the relevant underlying layer to Ethereum in Hong Kong and sell it to overseas companies, we can solve all problems, whether they are technical or legal issues. We can use Hong Kong as a bridge to connect some domestic businesses as products with overseas." It can be inferred that HKVAX may have found all the entrances to promote domestic business overseas, and has started linkage with domestic companies, especially mainland companies, in advance to give play to the advantages of the bridge.
As for VDX, as a subsidiary of Victory Securities, its successful experience in introducing traditional finance into the Web3 industry is a powerful weapon for VDX. On November 2023, 11, Victory Securities became the first local brokerage firm in Hong Kong to be approved to conduct virtual asset retail business. In 24 months, the average monthly turnover reached 2 million US dollars, and its virtual asset business was profitable, showing that Victory Securities has the necessary capabilities and experience in investor education and the introduction of traditional funds. It has laid a good foundation for VDX to carry out 1000B business with more institutions in Hong Kong in the future.
According to reliable sources, VDX CEO comes from the traditional financial circle, with more than ten years of high-frequency trading experience and seven years of experience in the virtual asset industry; COO has worked for Deutsche Bank and Accenture, and was previously an expert in virtual assets at the Hong Kong Securities Regulatory Commission. Many team members are from Tencent, Futu and Tiger Securities. Although VDX's license application has not yet been finalized, its most critical team building has stabilized, and capital preparation has the support of the parent company and will not become a key issue. In terms of cooperation with traditional financial institutions, VDX is one of the most anticipated licensed exchanges in the future.
Background of big firms: Hashkey, OKX
未来一段时间，Hashkey依旧会是香港Web3市场的领军人物。用户量超15万，日均交易量6.3亿美元；支持18种虚拟资产在平台交易；超过10家券商基金综合账户开户；与超过20家机构展开合作；6家港股上市公司选择在Hashkey开户。Hashkey在香港的积淀已开始逐步发挥出来，香港Web3的生态也需要Hashkey冲锋在前充分做好创新，扩大市场、推行稳定币、做好RWA创新。
The most eye-catching is still the issuance and promotion of the Hong Kong dollar stablecoin. On February 2024, 2, RD Technologies announced that it had reached a cooperation intention with HashKey Exchange and Allinpay International on the stablecoin business. The cooperation will cover online and offline transaction scenarios of stablecoins, digital currency trading services, offline physical merchant acceptance networks, and stablecoin research and development technology, as well as joint research and issuance of the Hong Kong dollar stablecoin HKDR.
The United States' approval of the issuance of a Bitcoin spot ETF also reflects, to some extent, its intention to extend the dollar's hegemony to the virtual asset industry. Whether the Hong Kong dollar stablecoin can succeed is crucial to Hong Kong's future global position in the industry.
Another exchange that has attracted much attention is OKX, which has the largest number of Chinese users. Although traditional trading giants such as Bybit, Kucoin, and Bixin also have layouts in Hong Kong, OKX's reputation and brand influence accumulated among the Chinese community in Hong Kong, which is backed by the mainland, will undoubtedly make its development smoother. The market's expectations for traditional large exchanges are generally the same: Is the compliance of the top large exchanges just for "legality" or can it promote more innovation? Many people are waiting for the answer.
In recent years, OKX has made great efforts in financial products and its own exchange products; and the innovation of financial products also coincides with the route of Hong Kong's development of the virtual asset industry. Can OKX make a breakthrough in regulation and make more products and functions compliant to promote market development? This is not only the market's expectation for OKX, but also the expectation of all applicants with big backgrounds.
Conclusion
Ultimately, it is difficult to apply for and operate a licensed exchange in Hong Kong, and the difficulty lies in the unpredictable changes.
Changing regulations, changing markets, changing risks. The Web3 industry has many uncertainties, including extreme price fluctuations, new hacker attack methods, and even whether AI will suddenly explode and cause drastic changes to the entire industry. No one can say for sure.
Who will have the last laugh? It depends on who always maintains a serious attitude, constantly improves their professional strength, maintains innovation and progress, and constantly adapts to the still evolving Web3 finance.
Source: Bailu Living Room
Author: Bowen