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If you observe carefully, you can find numerous cryptocurrency exchange shops scattered across the streets of Hong Kong.
In these shops, users can freely exchange cash and cryptocurrencies without any Know Your Customer (KYC) identification—meaning, without being asked any questions. Based on on-site visits, it was found that last year, a single exchange shop could exchange up to 1 million Hong Kong dollars at once, and the exchanging party only needed to provide a phone number or email address. Compared to the high fees of Hong Kong digital exchanges, the exchange rates offered by these shops are undoubtedly more cost-effective and convenient. In a way, this reflects the characteristics of financial freedom in Hong Kong, but it has also raised concerns among some industry insiders about anti-money laundering.
However, recently, this freedom has been curtailed. Hong Kong has announced its intention to introduce new regulations to prohibit over-the-counter (OTC) exchanges, and the aforementioned companies are likely to face challenges in their operations or even closure due to imminent regulatory constraints.
The concept of OTC is not unfamiliar to industry insiders. As the name suggests, any place where transactions are autonomously matched outside of conventional exchanges can be considered an over-the-counter exchange. Generally, cryptocurrency OTC mainly covers three main channels: online platforms primarily matched through social media, offline physical exchange shops, and cryptocurrency ATMs.
According to preliminary observations by law enforcement agencies in Hong Kong, there are approximately 200 physical virtual asset OTC trading shops (including OTC trading shops operated by ATMs) operating across the territory, as well as about 250 active virtual asset trading service providers operating online. According to Chainalysis investigations, exchange shops are a significant part of off-exchange cryptocurrency trading, accounting for the majority of the $64 billion in digital assets flowing through Hong Kong as of June.
Upon closer examination, the main reasons leading to regulation are the inherent anti-money laundering flaws in OTC, market disorder, and lack of effective investor protection. Particularly, in the highly publicized JPEX and Hounax incidents last year, some cryptocurrency exchange shops played a role, with false advertising platforms obtaining compliance licenses. Data shows that investors lost $180 million in the JPEX incident, while in the Hounax scam, 145 victims lost a total of $18.9 million, and as of now, most investors' funds have not been recovered.
Against this backdrop, on February 2, 2024, Hong Kong Financial Secretary Christopher Hui announced that the government believes there is a need to regulate over-the-counter (OTC) virtual currency exchanges and will soon consult on the proposed regulatory framework, hoping that citizens and stakeholders will actively express their views. A few days later, on February 8, the Hong Kong government launched a public consultation on the legislative proposal to establish a licensing system for providers of virtual asset over-the-counter (OTC) trading services, with the consultation period ending on April 12.
According to the legislative proposal, Hong Kong plans to establish a licensing system under the Customs Department, covering online platforms including ATMs, physical entities, and anyone engaging in business related to any virtual asset spot trading service in Hong Kong must apply for a license from the Commissioner of Customs. Licensed virtual asset OTC operators must comply with anti-money laundering and counter-terrorist financing regulations stipulated in the Anti-Money Laundering Ordinance and other regulatory requirements. In short, providers of cryptocurrency over-the-counter trading services must collect customer records and increase personnel to monitor improper trading behavior, officially ending the era of no KYC.
Furthermore, the types of currencies available for trading will also be restricted. It is suggested that services provided by licensed virtual asset OTC traders may only cover tokens traded by retail investors on at least one virtual asset trading platform licensed by the Securities and Futures Commission and stablecoins issued by issuers licensed by the Hong Kong Monetary Authority (HKMA) after the proposed stablecoin issuer licensing system is implemented.
The legislative proposal also specifies penalties for violations of relevant regulations. Anyone engaging in regulated virtual asset over-the-counter trading services without a license, upon conviction following a public prosecution procedure, may be fined 1 million Hong Kong dollars and imprisoned for two years. In addition, licensed persons who engage in improper behavior (such as violating other regulatory requirements) may be subject to administrative penalties, including temporary suspension or revocation of licenses, condemnation, orders to rectify, and/or fines (not exceeding 500,000 Hong Kong dollars).
From a macro perspective, with over-the-counter virtual asset trading being brought into the regulatory framework, coupled with existing licenses such as the VATP, the Securities and Futures Commission's licensing system for securities-type virtual asset trading (upgrade of License No. 1), advisory licenses for securities-type virtual assets (upgrade of License No. 4), management of portfolios containing virtual assets (upgrade of License No. 9), guidelines for tokenized securities business by the SFC, and the upcoming stablecoin issuer licensing system, it undoubtedly signifies that Hong Kong's governance framework for the cryptocurrency sector is gradually maturing, forming a relatively comprehensive regulatory mechanism covering both on-exchange and off-exchange activities.
On the other hand, the deadline for applications from licensed entity exchanges is also approaching. According to rules set by the Securities and Futures Commission in the mid-2023 rulebook, licensed exchanges must obtain or apply for licenses by February 29.
However, focusing on individuals, considering the diversity of impacts caused by regulations, opinions vary among different entities.
Chengyi Ong, APAC Policy Manager at Chainalysis, which tracks digital asset transactions, says that as providers must manage crime, cybersecurity, and other operational risks, the proposed over-the-counter trading framework "will lead to integration and restructuring of existing institutions, enhancing the concentration effect, and reducing the frequency of OTC platforms as gateways for cryptocurrency entry."
Jason Chan, Partner at Howse Williams law firm in Hong Kong, specializing in financial regulatory advisory services, said that the proposed legislation would involve the Customs Department of Hong Kong with other agencies, potentially giving the public the impression of "overly fragmented" regulation.
In response, a spokesperson for the Financial Services and Treasury Bureau stated that given the Customs Department's own operational functions, it is the most suitable agency to regulate providers of cryptocurrency over-the-counter trading services. The spokesperson added that the rulebook of the proposal provides necessary risk controls and maximum investor protection.
For exchange shops caught in the regulatory whirlpool, the inevitable rise in compliance costs is on the horizon.
One Satoshi is one of the chain of OTC companies in Hong Kong. According to its co-founder Roger Li, the company mainly serves retail investors, usually conducting small transactions of HK$10,000 or less.
Li stated that although the company has already conducted some anti-money laundering and KYC checks, the new requirements related to compliance personnel and record keeping could increase costs. In this case, OTC trading companies "either have to stop cryptocurrency business or apply for new licenses," and he is currently waiting for clearer policy guidance to be issued.
This regulation does not affect the application for cryptocurrency exchanges. Currently, there are only two licensed digital asset exchanges in Hong Kong, HashKey Exchange and OSL Group. From information disclosed on their official websites, as of February 27, a total of 19 institutions, including OKX, Bybit, Crypto.com, and HKVAX associated with Binance, have submitted license applications. It is worth noting that HTX, under the guidance of Justin Sun, withdrew its application three days after submission without disclosing the reason for withdrawal. |
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Post time 9-3-2024 09:40:52