Author: Jessy, Golden Finance
Since the release of the "Policy Declaration on the Development of Virtual Assets in Hong Kong" in November 2022, compliant Web3 has been developed for a year and a half in accordance with the requirements of the Hong Kong government.
During this year and a half, compliant exchanges have been opened to retail investors, and spot ETFs for Bitcoin and Ethereum have been approved for launch. Some native crypto projects have chosen to establish branches in Hong Kong. On July 18, the Hong Kong government officially announced the list of institutions entering the Hong Kong dollar stablecoin regulatory sandbox, and these institutions can now proceed with the issuance of the Hong Kong dollar stablecoin.
More subtle changes have been integrated into the daily lives of residents. Retail investors can now participate in compliant investments in Bitcoin and Ethereum at local securities firms, and numerous top events related to Web3 have emerged. Knowledge about blockchain has been incorporated into elementary school textbooks.
The development of Hong Kong's Web3 industry is steadily progressing according to plan, and Hong Kong citizens are gradually accepting Web3 in subtle ways. However, from the perspective of practitioners, overall, the development of Web3 in Hong Kong has shifted from the initial bold advancement to a more cautious approach.
Amid the tightening of Web3 policies by the Hong Kong government and the withdrawal of foreign capital, the primary challenge for Web3 enterprises compliantly operating in Hong Kong is how to establish a foothold in Hong Kong and then expand into larger markets.
Can the Hong Kong Dollar Stablecoin Improve the Position of the Hong Kong Dollar in the International Financial Market?
The Hong Kong dollar stablecoin is the centerpiece of the Hong Kong government's bet on Web3 development this year. In March of this year, the government issued a notice approving institutions interested in issuing the Hong Kong dollar stablecoin to apply to enter the sandbox. Four months later, on July 18, Hong Kong announced the first batch of institutions entering the sandbox: JD Coin Chain Technology (Hong Kong) Limited; Circle Coin Innovation Technology Limited; and Standard Chartered Bank (Hong Kong) Limited, ANX Group Limited, Hong Kong Telecommunications (HKT) Limited.
When the Hong Kong Monetary Authority consulted the public on the regulatory regime for issuers of the Hong Kong dollar stablecoin, 108 institutions submitted their opinions. Chen Weimin, Deputy Chief Executive of the Monetary Authority, stated that the authority received inquiries from ten institutions, and some well-prepared institutions formally submitted applications, ultimately approving three of them. He indicated that whether an issuer is approved to enter the sandbox depends on various factors, such as the business plan of the issuer after the legislation is implemented, and the need to test the stablecoin issuance process at the current stage and within a limited scope.
For Circle Coin Technology, which was selected to enter the sandbox, it submitted its application immediately after the notice was issued. Entering the sandbox means that it can now launch the Hong Kong dollar stablecoin under supervision and introduce specific use cases.
Stablecoins are undoubtedly a global business, and the market is currently dominated by USD-pegged stablecoins, with USDT being the dominant player. In the current environment where USD-pegged stablecoins hold an absolute market share, how much of the market can the Hong Kong dollar stablecoin capture? It is difficult for issuers of the Hong Kong dollar stablecoin to provide a definite answer.
Rita Liu, CEO of Circle Coin Technology, stated in an interview with Golden Finance that the stablecoin market is about expanding the pie rather than competing in a red ocean. After the launch of the Hong Kong dollar stablecoin, they will focus more on collaborating with compliant exchanges, institutional market makers, and traditional business merchants, or cooperating with traditional enterprise merchants to facilitate payment settlements in cross-border trade, thereby creating more use cases for the Hong Kong dollar stablecoin.
It can be seen that although the Hong Kong dollar stablecoin is pegged to the Hong Kong dollar, its actual influence does not solely depend on the position of the Hong Kong dollar in the international financial market, but rather on how each Hong Kong dollar stablecoin can open up the market in the crypto world. If the Hong Kong dollar stablecoin is widely used in Web3, it can actually enhance the position of the Hong Kong dollar in the international financial market.
Chen Weimin also stated that the implementation of the regulatory regime for issuers of stablecoin in Hong Kong is being vigorously promoted, and efforts are being made to submit the relevant draft legislation to the Legislative Council for review by the end of the year.
The sandbox-legislation-licensing process for the Hong Kong dollar stablecoin is gradually taking shape. The core role of the Hong Kong dollar stablecoin is to serve as a bridge that seamlessly connects traditional finance to the blockchain world. Even simply moving foreign exchange between fiat currencies onto the blockchain has a massive market. From this perspective, the potential for fiat-pegged stablecoins is substantial.
Globalization as the Focus of Development for Compliant Exchanges in Hong Kong
It's not easy to make money as a compliant exchange in Hong Kong.
During a certain week this year, the institutional client business of a Hong Kong exchange only made a profit of just over $100. This profit includes all the revenue from services provided to institutional clients, including fees and custody fees. Market sources close to this exchange told Golden Finance reporters that institutional clients are generally reluctant to use compliant exchanges and prefer over-the-counter trading. One major reason is that the money of institutional clients is not considered clean.
With only over 7 million local residents in Hong Kong, the ceiling for converting users for a licensed exchange in Hong Kong is very low. For example, Hashkey Exchange's Hong Kong site accumulated nearly 100,000 users within a year of launching retail trading. In contrast, Hashkey Exchange's international site, launched in April this year, accumulated nearly 100,000 users in just one month.
It is reported that Hashkey Global has obtained a compliant license in Bermuda and is mainly targeting the Asia-Pacific and Southeast Asian regions. Japan, South Korea, and Taiwan are the key markets for Hashkey Global. The exchange business of the Hashkey Group has shifted its focus to Hashkey Global.
Establishing a presence in Hong Kong and then expanding globally may be the only way out for compliant exchanges in Hong Kong. It is difficult to obtain a license and be profitable as a compliant exchange in Hong Kong.
In early 2023, there were reports that the Hong Kong licensed exchange OSL was seeking a buyout for HK$1 billion, and six months later, it finally succeeded as the parent company of Bitget invested HK$700 million.
At that time, it probably cost several tens of millions of Hong Kong dollars to apply for a license. But now, it seems that Bitget was wise in pursuing a Hong Kong compliant license. Hong Kong is very strict with native crypto exchanges, and most native crypto exchanges find it difficult to obtain approval. Near the end of the second licensing date, traditional native crypto exchanges such as OKX and Huobi announced their withdrawal from the Hong Kong market. It is rumored that if they want to be licensed in Hong Kong, they need to sign a commitment to ensure the withdrawal of mainland Chinese users.
Summarizing the second batch of 11 institutions announced by the Hong Kong government in June, it can be seen that these institutions are local institutions and companies with resources in mainland China, with a traditional financial background.
Regardless of the reasons for the withdrawal of traditional crypto exchanges from the Hong Kong market, the result is that Hong Kong does not welcome traditional crypto institutions. The Web3 market in Hong Kong is more like a traditional financial game. Hong Kong hopes to use Web3 to complete the transformation of traditional finance or to empower traditional industries with Web3.
However, whether it is the transformation of traditional finance into Web3 or the desire for native Web3 to establish a foothold in Hong Kong, both are challenging.
Looking at OSL, backed by BC Technology, it has been in a loss-making state for several years. The actual controlling shareholder of BC Technology is the "shell king" Gao Zhenshun of the Hong Kong stock market. Unlike Hashkey, the trading business for retail investors is not the core business of OSL. They have focused more on institutional business, such as announcing a strategic cooperation in security token offerings (STOs) with JPMorgan International Asset Management Limited on September 12, 2023, and reaching liquidity cooperation with multiple exchanges, becoming the custodian for spot ETFs for JPMorgan International and Huaxia Fund.
Like HashkeyExchange, OSL has also focused on expanding into the global market. Earlier this year, the company announced the launch of its 2024 global strategy. Since last year, OSL has actively pursued overseas licenses, such as submitting a license application to Singapore.
It's not just exchanges that struggle to make money; virtual banks also face challenges. In 2023, ZA Bank reported a net loss of HK$399 million, a 20% reduction from the previous year. Not only ZA Bank, but also 8 virtual banks in Hong Kong, including Ant Group and WeLab, are operating at a loss.
Exchanges and virtual banks face similar challenges in Hong Kong. For institutions, the main challenge is how to market and promote new products to capture the market. The local market in Hong Kong is very limited, and these institutions need to consider how to effectively leverage Hong Kong's position as an international financial center to bridge domestic and foreign capital.
These challenges are largely due to the withdrawal of foreign capital from Hong Kong. When money becomes scarce, efforts yield half the results. For institutions in Hong Kong, the current common goal is to seek more opportunities abroad.
Two of Hong Kong's earliest licensed exchanges are focusing on the global market this year. For exchanges, Hong Kong can only serve as a compliant base. The broader world lies overseas.
High Fees and Complex Subscription and Redemption Processes Deter Users from Virtual Currency Spot ETFs
Another important measure by the Hong Kong government this year is the launch of virtual currency spot ETFs. Bitcoin and Ethereum spot ETFs in Hong Kong have been online for two months. According to SoSoValue data, as of July 5, the total trading volume of six spot ETFs exceeded $26 million.
The performance of Hong Kong ETFs during the initial subscription phase was impressive. According to SoSo Value data, the scale of the first-day subscription for three Bitcoin ETFs was $248 million, while the total net value on the first day for U.S. Bitcoin spot ETF products, excluding Grayscale's (GBTC) conversion from trust to ETF, was only $130 million.
A market source close to several major ETF issuers in Hong Kong told Golden Finance that the significant difference between the subscription volume and actual trading volume is because during the initial subscription, these ETF issuers actually found large clients and allowed them to purchase ETFs through resource exchange, resulting in a large volume on the first day of subscription.
The subsequent trading volume is the true ETF volume in Hong Kong. Hong Kong's independent capital volume is relatively small, with just over 7 million people, and the market capitalization of Hong Kong stocks is only HK$32 billion. The reason why fund companies choose to purchase U.S. ETFs is simple: the virtual currency spot ETF market is a global competition, and capital will choose the products with the lowest cost, highest efficiency, and highest safety.
In comparison, Hong Kong's virtual currency spot ETFs are not competitive. The compliance costs in Hong Kong are high. According to the market source mentioned above, time is tight, and everyone is rushing to launch the products. For example, in terms of custodianship, both Huaxia and JPMorgan have chosen to sign agreements with OSL. Both issuers of virtual currency spot ETFs have chosen OSL as the custodian, and the custodian fees are very high.
This undoubtedly increases the cost of spot ETFs. Compared to Bitcoin spot ETFs in Hong Kong and the United States, the fees in the United States, except for ETFs issued by Grayscale and Hashdex, range from 0.2% to 0.49%. In contrast, Huaxia's fee is 1.99%, JPMorgan's fee is 1%, and BOCI's fee is 0.85%, all of which are higher than those in the United States.
In terms of user experience, the current virtual currency spot ETFs in Hong Kong are not performing well. Taking Victory Securities as an example, the only securities firm that allows users to buy and sell coins, users still need to use email and phone calls for subscription and redemption.
All of these issues require further optimization by the issuers.
A more fundamental issue is that the issuers of virtual currency spot ETFs in Hong Kong are still using the mindset of traditional finance to operate virtual currency spot ETFs, focusing on marketing and channels rather than striving to improve product quality.
Some practices by Huaxia Fund can illustrate this point. Compared to the spot ETF products of three funds, Huaxia Fund has the largest trading volume, which is closely related to its channels and marketing efforts. For example, at the Bitcoin Asia conference held in early May this year, which focused on the development of the BTC ecosystem, Huaxia Fund's marketing staff also took the main stage to introduce the situation of Huaxia Fund's spot ETF and set up a booth at the conference. This demonstrates the effort that Huaxia Fund has put into marketing and the market.
For virtual currency spot ETFs in Hong Kong, the next step should be to focus on reducing fees, simplifying the subscription and redemption processes, and thus gaining a foothold in the global competition.
Whether it's virtual currency exchanges, virtual currency spot ETFs, or Hong Kong dollar stablecoins, the challenge is not just the Hong Kong market, but how to expand to the global market and participate in the global Web3 competition after achieving compliance in Hong Kong.
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