1. The continuous standardization of the market has further promoted the entry of Wall Street capital. After further clarification of regulations, whether in the United States or globally, a unified Web3 virtual asset market may be formed.

This article covers the regulatory dynamics of major Web3 virtual asset jurisdictions in Hong Kong, the European Union, the United Kingdom, the United Arab Emirates, Japan, South Korea, and the United States in the first half of 2023, as well as observations on hot events. We have seen that after the initial confusion and pain, global regulatory authorities tend to coordinate and gradually establish a regulatory framework for Web3 virtual assets to implement KYC/AML/CTF at the level of the Financial Action Task Force (FATF), while focusing on protecting investors and regulating the healthy development of the market.

On the other hand, in the lawsuit against Coinbase, the SEC in the United States directly targeted the bottom line of regulation, that is, "What kind of virtual assets are securities?" Once this issue is clarified, all the current regulatory uncertainties and opacity will be resolved, including the registration of Security Tokens, registration of exchanges, custody, brokerage, and clearing businesses, and the possibility of directly covering regulation to DEX and DeFi. The continuous standardization of the market has further promoted the entry of Wall Street capital. After further clarification of regulations, whether in the United States or globally, a unified Web3 virtual asset market may be formed. Of course, the inevitable division and pain from the executive, judicial, and legislative levels in the United States are likely to be resolved in the year of the 2024 election. Let's wait and see.

2. Hong Kong introduces a new Virtual Asset Service Provider (VASP) system

With the proposal of the "Policy Statement on the Regulation of Virtual Asset Activities in Hong Kong" in October last year, the new Virtual Asset VASP system in Hong Kong officially came into effect on June 1, 2023, marking a major boon for the virtual asset industry in Hong Kong.

As early as 2018, the Hong Kong Securities and Futures Commission gradually established a "voluntary licensing" system for security token virtual assets, clearly stipulating that the Hong Kong Securities and Futures Commission has no authority to regulate virtual asset trading platforms that only trade non-security token virtual assets. Under the "voluntary licensing" system, virtual asset trading platforms that engage in non-security token virtual asset trading do not need to be licensed.

Today, the virtual asset industry has undergone significant changes, and the original "voluntary licensing" system can no longer cover the market, which is now mainly focused on retail investors and non-security token trading. In order to comprehensively regulate all centralized virtual asset trading platforms in Hong Kong and implement the latest standards of the Financial Action Task Force (FATF), the Hong Kong government has revised the Anti-Money Laundering Ordinance and established a new mandatory licensing system for VASP, in order to achieve a more suitable balance between investor protection and market development.

After the VASP system is officially implemented, all centralized virtual asset exchanges operating in Hong Kong or actively promoting their services to Hong Kong investors, regardless of whether they provide security token trading services, will need to be licensed and regulated by the Hong Kong Securities and Futures Commission.

The Hong Kong Securities and Futures Commission will implement measures in the second half of the year to allow licensed virtual asset exchanges to provide services to retail investors, but only tokens that are non-securities and have high liquidity in one of the traditional financial indices can be provided to retail investors.

For stablecoins, regulatory arrangements for stablecoins will be implemented in 2023/24, and a licensing and permit system for stablecoin-related activities will be established. Before stablecoins are regulated, the Hong Kong Securities and Futures Commission believes that stablecoins should not be included for retail trading.

Web3 Xiao Lu Comments:

The VASP system guides compliant licensed exchanges to "channel water," and in this context, KYC and anti-money laundering compliance are of utmost importance. After the first step of "channeling water," we will see a series of detailed regulations on opening up investment to retail investors and how to protect investors in the second half of the year. Only by meeting regulatory requirements can exchanges participate in the distribution of this huge cake and promote the long-term development of the market. Whether Hong Kong can rely on its traditional financial foundation, perfect legal system, and solid resources backed by the mainland to regain its former glory as a "cryptocurrency center," remains to be seen.

3. The European Union issues the Markets in Crypto-assets Regulation (MiCA)

On May 31, the European Union issued the Markets in Crypto-assets Regulation (MiCA), which was published in the Official Journal of the European Union (OJEU) on June 9. This marks the first globally comprehensive and clear unified virtual asset regulatory framework, which will create a unified virtual asset market covering 500 million consumers and 27 EU member states. After an 18-month transition period, MiCA will officially come into effect on December 30, 2024.

MiCA is part of the European Union's macro-level digital finance strategy and will unify the following rules of EU member states: transparency and disclosure requirements for the issuance and trading access of crypto-assets; authorization and regulation of crypto-asset service providers and issuers; operation, organization, and governance rules for asset-referenced tokens, electronic money tokens, and other crypto-asset service providers; consumer protection rules for crypto-assets; measures to prevent market abuse and ensure the integrity of the crypto-asset market.

MiCA fills the gaps in the current EU financial regulatory framework, establishing a regulatory framework for virtual assets that applies to all entities involved in the issuance of crypto-assets and the provision of virtual asset-related services in the EU. In general, MiCA mainly regulates:

(1) Various types of crypto-assets, including E-Money Tokens, Asset-Referenced Tokens, and other Tokens;

(2) Various types of crypto-asset services and service providers, including wallet custody services, deposit and withdrawal services, exchange services, asset management services, and investment advisory services.

4. The UK House of Lords passes the Virtual Currency and Stablecoin Regulation Bill

Following the issuance of the Markets in Crypto-assets Regulation (MiCA) by the European Union, the UK's virtual asset regulatory legislation is catching up. According to reports, the UK House of Lords voted to pass the Financial Services and Markets Bill (FSMB) on June 19, indicating that the bill is likely to enter the final stage before being signed into law, and the UK is likely to soon usher in formal regulation of virtual asset financial services and markets.

The bill considers virtual assets as a regulated activity, first treating certain stablecoins as a means of payment for regulation. The bill proposes to expand the scope of Part 5 of the Banking Act 2009 to include payment systems using digital settlement assets. This will bring certain stablecoin activities within the scope of the Financial Conduct Authority (FCA).

Secondly, the bill also grants new powers to government regulatory agencies, explicitly allowing them to create new regulated virtual assets and activities to be incorporated into the current framework of traditional financial regulation. Currently, the FCA only has the authority to ensure that virtual asset companies are registered and comply with their anti-money laundering rules. The bill also attempts to strengthen coordination among regulatory agencies in new technologies, data usage, and decentralized technologies such as virtual currencies, stablecoins, NFTs, tokenization, and blockchain.

Web3 Xiao Lu Comments:

As the UK accelerates the clarification of the legal framework for virtual asset regulation, we observe that institutions facing significant regulatory uncertainty in the United States are also beginning to establish a presence in the UK. For example, a16z recently announced the establishment of the world's first international office in London, and Coinbase, the largest virtual asset exchange in the United States, which was sued by the SEC this month, also plans to conduct compliant business in the UK. After Brexit and the loss of many EU financial businesses, the UK government is eager to rebuild London as a financial technology center. We look forward to seeing how Prime Minister Sunak's support for the virtual asset industry can break through the conservative political environment in the UK.

5. The United Arab Emirates issues the 2023 Virtual Assets and Related Activities Regulations (VARA Regulation)

On February 7, 2023, the Dubai Virtual Asset Regulatory Authority (VARA) issued the 2023 Virtual Assets and Related Activities Regulations, which came into effect immediately, requiring all market participants conducting virtual asset business or providing services in the UAE (excluding the two financial free zones ADGM and DIFC) to obtain approval and licensing from the Emirates Securities & Commodities Authority (SCA) or VARA.

[Attached images were not translated.]

1. The VARA Regulation was issued based on the Virtual Assets Regulation (No. 4) Law of the Emirate of Dubai in 2022, which established the Dubai Virtual Asset Regulatory Authority (VARA) as the world's first independent government virtual asset regulatory body. This has created a robust regulatory framework for the governance of virtual assets and blockchain technology in Dubai.

The VARA Regulation confirms VARA's authority to issue rules, directives, or guidance on virtual asset activities. Entities planning to conduct virtual asset activities in Dubai need to obtain a license from VARA before engaging in such activities. The scope of virtual asset activities includes advisory services, brokerage services, custody services, trading services, lending services, payment and remittance services, and virtual asset management and investment services. Additionally, the VARA Regulation also provides provisions for (1) the classification and licensing of virtual assets, (2) mandatory registration of large-scale trading firms, (3) rules for virtual asset service provider activities, (4) anti-money laundering, (5) marketing and promotion, (6) market misconduct, and (7) fines and penalties.

Furthermore, the Central Bank of the UAE issued new Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) guidelines for licensed financial institutions on May 31, with the main purpose of helping relevant institutions understand the risks associated with virtual assets and their service providers. The new guidelines are based on the standards of the Financial Action Task Force (FATF) and will come into effect within one month. They apply to banks, financial companies, exchanges, payment service providers, remittance service providers, insurance companies, agents, and brokers, among others.

According to reports, the Middle East branch of the virtual asset exchange OKX has obtained a provisional license (MVP) from the Dubai Virtual Asset Regulatory Authority (VARA). OKX stated that once the Minimum Viable Product (MVP) license is fully operational, OKX Middle East will offer spot, derivative, and fiat services, including USD and UAE Dirham (AED) deposits, withdrawals, and spot trading.

5. South Korea passes the Virtual Asset Investor Protection Act

According to reports, the South Korean National Assembly passed the first phase of the virtual asset legislation, the "Virtual Asset Investor Protection Act," on May 11. The core of the first phase of virtual asset legislation is to introduce legal rules to protect customer assets and eliminate unfair trading to protect users. When international standards for virtual assets are established, the second phase of legislation in the country will promote supplementary regulations for virtual asset issuance and disclosure, among other market order provisions.

The law regulates the virtual asset market, unifying terms such as cryptocurrencies, crypto assets, and digital assets under the term "virtual assets." Virtual assets are defined as "electronic tokens with economic value that can be traded or transferred," excluding central bank digital currencies (CBDC) from the definition of virtual assets. According to the law, requests for damages due to unfair trading of virtual assets will also be based on the law, allowing users to claim compensation. Additionally, unfair trading using undisclosed information, market manipulation, and illegal trading methods will be subject to fines. Unfair trading practices will be subject to a basic penalty of more than 1 year of imprisonment or fines up to 5 times the unjust gains, with penalties potentially increased based on the amount of profit or loss.

Through this law, the Financial Services Commission (FSC) of South Korea has the authority to supervise and review virtual asset operators, and the South Korean National Assembly can also establish a virtual asset committee responsible for advising on virtual asset matters. Furthermore, the second phase of legislation to promote virtual asset issuance and disclosure of market information will be formulated later. Baek Hui-yeon, the chairperson of the National Assembly's Political Affairs Committee, stated, "Virtual assets have finally entered the realm of law."

6. Japan's largest bank is negotiating the issuance of a global stablecoin

It is reported that Japan's largest bank, Mitsubishi UFJ Financial Group, is in negotiations with global stablecoin issuers and other companies to issue its stablecoin. Tatsuya Saito, Deputy President of Mitsubishi UFJ, stated that the bank is discussing the issuance of a stablecoin pegged to foreign currencies, including the US dollar, using its blockchain platform Progmat for global use. He mentioned that with Japan's legislation in effect, both issuers and users will have a sense of security when using stablecoins. However, he declined to disclose the stablecoin issuers with whom they are negotiating.

In June 2022, Japan passed the world's first stablecoin law, the Amendment to the Fund Settlement Act, which categorizes stablecoins as virtual currencies and allows licensed banks, registered transfer agents, and trust companies to act as stablecoin issuers. In December 2022, Japan's financial regulatory authority removed restrictions on the trading of overseas stablecoins in Japan. Stablecoins, to some extent, bridge the gap between fiat and virtual currencies and are considered a key element in the development of Web3. Stablecoins can be pegged to the Japanese yen, allowing domestic residents to purchase various tokens using stablecoins.

7. Crypto-friendly banks Silvergate Bank and Signature Bank taken over by FDIC

On March 1, 2023, Silvergate Bank announced that it was unable to submit its annual 10-K report to the SEC on time and indicated that it may face a "capital deficiency" situation. Silvergate Bank is a community retail bank based in California, positioning itself as a gateway to the virtual asset industry, accepting deposits from virtual asset exchanges and institutions, and establishing its own virtual currency settlement payment network, the "Silvergate Exchange Network" (SEN) real-time payment system. This system enables virtual asset exchanges, institutions, and customers to exchange virtual currencies for fiat currencies.

Following the collapse of FTX in November 2022, Silvergate Bank had over $10 billion in risk exposure to FTX. More significantly, the collapse of FTX resulted in a severe "bank run" on Silvergate Bank, with over $8.1 billion in withdrawals processed. To meet the large volume of withdrawals, Silvergate Bank was forced to endure significant losses and urgently sell approximately $5.2 billion in assets, and obtained a $4.3 billion loan from the Federal Home Loan Bank. On March 8, 2023, Silvergate Bank submitted a filing to the SEC stating that it would voluntarily wind down its operations and undergo voluntary liquidation. "The bank's liquidation plan includes full repayment of all deposits and consideration of the best way to settle claims and preserve the remaining value of its assets, including its proprietary technology and tax assets." Subsequently, Silvergate Bank was taken over by the Federal Deposit Insurance Corporation (FDIC).

On March 10, 2023, against the backdrop of the Fed's interest rate hike, a brief 48-hour bank run caused severe liquidity issues for Silicon Valley Bank (SVB), the 16th largest bank in the United States with a 40-year history, and it was taken over by the FDIC. This was the second-largest bank collapse event in US history after the collapse of Washington Mutual in 2008. On March 12, the Treasury Department, the Fed, and the FDIC issued a joint statement, agreeing to complete the rescue of Silicon Valley Bank through the FDIC in a manner that fully protects all depositors, and from Monday, March 13, depositors will be able to use and retrieve all their money, with any losses related to the resolution of Silicon Valley Bank not borne by taxpayers.

Due to the impact of Silicon Valley Bank, on March 12, 2023, the US Treasury Department, the Federal Reserve, and the FDIC issued a joint statement, citing "systemic risk" as the reason for announcing the closure of the crypto-friendly bank Signature Bank to prevent the ongoing banking crisis. At the same time, NYDFS appointed the FDIC as the receiver to handle the assets of Signature Bank. Despite the bank's recovery from the impact of Silicon Valley Bank, Signature Bank held a strong balance sheet.

8. US regulatory enforcement against Binance and its founder CZ

8.1 New York financial regulatory agency orders Paxos to stop minting its stablecoin BUSD

On February 13, 2023, Binance CZ issued a statement: The New York State Department of Financial Services (NYDFS) directed stablecoin issuer Paxos to stop minting new BUSD (BUSD is a stablecoin fully owned and managed by Paxos). At the same time, Paxos confirmed that it had received a notice from the SEC regarding potential charges related to its BUSD product.

Paxos is a stablecoin issuer registered in the state of New York, holding a BitLicense virtual asset operating license from New York State, directly regulated by NYDFS. Its BUSD product is built on the Ethereum blockchain and is required to have full reserves of 1:1 USD assets according to the USD stablecoin issuance guidelines issued by NYDFS in June 2022. NYDFS has the authority to require Paxos to stop issuing BUSD or directly suspend Paxos's BitLicense due to uncompleted user periodic risk assessments and due diligence commitments to prevent the occurrence of misconduct (such as money laundering) and other compliance matters. NYDFS stated that this regulatory measure is to clarify the unresolved complex issues between Paxos and Binance.

Paxos responded to NYDFS's regulatory measure on its official website, stating that as of February 21, Paxos will stop issuing new BUSD tokens in accordance with NYDFS's instructions and will terminate its partnership with Binance regarding BUSD. Subsequently, Pax Dollar (USDP) will be introduced to replace the previous BUSD. NYDFS further explained the issues in a report with Bloomberg. The reason for the request to stop issuing BUSD seems unrelated to the securities classification of stablecoins, and the real reason may be related to Circle's complaint about Binance-Peg BUSD's poor reserve management.

8.2 CFTC accuses Binance and its founder CZ of deliberately evading US law and operating an illegal virtual asset derivatives exchange

On March 27, 2023, the Commodity Futures Trading Commission (CFTC) announced that it had filed a civil lawsuit in US court, accusing CZ and three entities operating the Binance platform of multiple violations of the Commodity Exchange Act (CEA) and CFTC regulations. According to the complaint, from July 2019 to the present, Binance provided and executed virtual asset derivatives trading to US persons (despite blocking US IP addresses), and under CZ's guidance, Binance instructed its employees and customers to deliberately evade US law through opaque business operations, bypassing CEA and CFTC regulations, and engaging in planned regulatory arbitrage for commercial gain.

CFTC accuses entities providing virtual asset derivatives services in the US, such as Binance, of failing to register with the CFTC as Futures Commission Merchants (FCMs) to assume similar compliance obligations such as KYC, and failing to enforce basic compliance requirements aimed at preventing and investigating terrorist financing and money laundering activities. Entities engaged in derivative trading operations should also register with the CFTC as a Designated Contract Market (DCM) or Swap Execution Facility (SEF), which Binance has never done.

Therefore, through civil litigation, the CFTC accuses CZ and affiliated entities of violating laws and regulations related to futures trading, illegal off-exchange commodity options, failure to register as FCMs or DCMs, and failure to implement KYC or anti-money laundering processes, as well as formulating inadequate compliance plans, seeking civil penalties and permanent trading and registration bans against CZ and affiliated entities.

CFTC Chairman Rostin Behnam stated, "Today's enforcement action demonstrates that no region, or claimed non-jurisdictional region, can prevent the CFTC from protecting US investors. I have made it clear that the CFTC will continue to use all its powers to discover and stop improper behavior in the volatile and high-risk virtual asset industry… For years, Binance has knowingly violated CFTC regulations but continued to work actively to maintain liquidity and avoid compliance. This should serve as a warning to everyone in the virtual asset world that the CFTC will not tolerate intentional evasion of US law."

8.3 SEC charges Binance and its founder CZ with 13 counts

On June 5, 2023, the SEC filed 13 charges against Binance, its founder CZ, and multiple entities, including operating unregistered exchanges, proprietary traders, and clearing agencies; engaging in fraudulent trading and ineffective regulation of Binance US; and issuing and selling unregistered securities.

This enforcement action follows a similar lawsuit filed by the CFTC against Binance in March. In a lengthy 136-page complaint, the SEC charged CZ and multiple entities, including Binance, on multiple fronts: Binance unlawfully solicited US investors to buy, sell, and trade virtual currencies, failed to restrict US investors' access to Binance.com; issued and sold unregistered securities, including BNB, BUSD, and loan products known as "Simple Earn" and "BNB Vault," as well as offering so-called staking investment plans on Binance. The SEC also pointed out that Binance secretly controlled assets pledged by US customers in the BAM staking plan; multiple entities, including Binance, should have registered as securities exchanges, proprietary traders, and clearing agencies but did not; Binance.US lied about preventing market manipulation and allowed an undisclosed "market-making" trading company, Sigma Chain, to engage in wash trading, which is also controlled by CZ.

SEC Chairman Gary Gensler criticized CZ and multiple entities, stating that they "have built a network of extensive deception, conflicts of interest, lack of disclosure, and intentional evasion of the law." "As alleged, CZ and multiple entities misled investors in their risk controls and false trading volumes, actively concealed platform operators, manipulated their affiliated market makers to trade, and even used investor-held funds," Gensler said in a press release. "They attempted to evade US securities laws through false control to keep high-value US customers on their platform. The public should be wary of investing their hard-earned assets on these illegal platforms or investing in them."

In addition to the charges against Binance, the lawsuit mentioned virtual currencies listed as securities, including but not limited to BNB, BUSD, SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, COTI. The SEC emphasized that the listed tokens are "including but not limited to." It is worth noting that tokens with significant trading volume such as ETH, USDC, USDT, and LTC were not included. Previously, the former chairman of the SEC stated that any virtual currency other than Bitcoin may have securities attributes.

9. SEC's regulatory enforcement against Coinbase, the largest publicly traded compliance exchange in the US

Less than a day after the SEC sued Binance and CZ, on June 6, 2023, the SEC filed a lawsuit against Coinbase, the largest virtual asset compliance exchange in the US. This lawsuit, unlike the SEC's lawsuit against Binance and CZ, reflects more of the regulatory challenges and legal compliance framework that virtual asset exchanges need to face.

Coinbase became the first comprehensive financial services provider for virtual assets to be listed in the US in April 2021. Coinbase is known for its compliance, holding a BitLicense from New York and a trust license, MTL licenses in various states in the US, as well as electronic money service licenses from the UK FCA and the Central Bank of Ireland, enabling it to provide services such as fiat currency deposits and withdrawals and spot trading.

According to the SEC's charges, Coinbase integrates traditional financial services of exchanges, brokers, and clearing agencies. Since the trading assets include security-type tokens (Crypto Asset Securities), registration with the SEC is required by law. Therefore, Coinbase's violations include:

(1) Unregistered broker-dealer, including soliciting potential investors, handling customer funds and assets, and collecting trading fees; (2) Unregistered exchange, including providing a market for the aggregation of orders from multiple virtual asset buyers and sellers; (3) Unregistered clearing agency, including holding customer assets in wallets controlled by Coinbase and settling customer trades through debits.

SEC also accuses Coinbase of issuing and selling unregistered securities to customers through its staking products (Staking-as-a-Service Program). This staking product provides users with token staking products with returns by holding users' assets. Such products violate securities laws, constituting unregistered securities issuance and sales, and Coinbase has never registered this product with the SEC. In February of this year, the SEC took similar regulatory enforcement actions against the San Francisco-based virtual asset exchange Kraken. Ultimately, Kraken agreed to pay $30 million to the SEC and stop offering its staking products to US customers to settle the SEC's charges of selling unregistered securities.

In addition, the SEC has classified 13 tokens on the Coinbase platform as security tokens. These tokens include SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, Dash, NEXO. It is worth noting that the SEC stated that this is a non-exhaustive list.

The US Treasury Department released the 2023 DeFi Illegal Financial Activity Assessment Report on April 6, 2023, in response to the virtual asset regulatory framework issued by the White House in March 2022. The report outlines the market structure of the DeFi ecosystem and identifies how criminals exploit DeFi services for illegal financial activities, including ransomware attacks, theft, fraud, drug trafficking, and terrorist financing. The report also identifies vulnerabilities in criminals' use of DeFi services for illegal financial activities, including non-compliance with anti-money laundering/counter-terrorism financing (AML/CFT) and sanctions obligations, decentralized risks, and a lack of international AML/CFT standards in overseas jurisdictions. The report recommends strengthening AML/CFT regulation and enforcement of virtual asset activities, including DeFi services, to improve compliance with BSA obligations.

The SEC's custody regulations will encourage investors to entrust their virtual assets to institutions or mainstream banks that hold custody licenses. This will also enable banking regulatory authorities to review virtual asset activities. Entities with custody businesses have obtained trust charters at the state level and are subject to supervision by state financial regulatory authorities. Anchorage Digital Bank has gone further to obtain approval from the Office of the Comptroller of the Currency, the federal agency responsible for supervising US banking institutions, making it a truly federally chartered virtual asset bank.

EDX Markets, a new virtual asset trading platform supported by Wall Street forces such as Citadel Securities, Fidelity Investments, and Charles Schwab, announced its upcoming launch. It has also received financing from Sequoia Capital, Paradigm, and Virtu Financial and plans to provide spot trading for BTC, ETH, LTC, and BCH, none of which are classified as securities by the SEC. EDX Markets CEO Jamil Nazarali stated that they will work with third-party custodians and plan to launch EDX Clearing, a clearing agency for the EDX Markets platform, later this year.

SEC Chairman Gary Gensler has emphasized the need to separate the functions of virtual asset exchanges to avoid conflicts of interest and self-dealing. He believes that the current exchanges are too large, combining trading, market-making, and custody. This has led to the SEC's proposed new regulations on virtual asset custody, which can be compared to the 1933 Glass-Steagall Act and the 2010 Dodd-Frank Act, both of which were enacted in response to financial crises to mitigate systemic financial risks. These regulations are seen as cautionary lessons.

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