How are Bitcoin ETFs doing in Hong Kong?

1. The Hong Kong Blockchain Market

As discussed in the "Hong Kong: The Rising Digital Finance Hub (again)" report, Hong Kong was once a leading financial hub in Asia. However, recent years have seen a significant exodus of financial firms, driven by China's tightening control and the associated 'China Risk'. In response to its diminishing stature as a financial hub, Hong Kong has pivoted towards blockchain and web3 technologies. The government has adopted an aggressive strategy to attract blockchain companies, including issuing licenses for virtual asset exchanges and allocating funds for the web3 sector.

This revitalization of the web3 market can deliver two key benefits. Firstly, it aims to restore Hong Kong’s reputation as a center for digital finance. Secondly, it positions the city as a potential gateway for cryptocurrency trading in China. Nonetheless, persistent "China Risk" and political instability could impede the growth of the blockchain sector in Hong Kong. It remains to be seen how many local users, who currently trade cryptocurrencies through other channels, will switch to VATP-licensed exchanges.

Despite these challenges, the Hong Kong blockchain market has continued to attract global attention in 2024, highlighted by significant advancements such as VATP license applications and ETF approvals. This report examines the trends from Q1 2024 to gauge the evolution of Hong Kong’s blockchain market.

2. Key Changes in Hong Kong from Q1 2024 forward

2.1. Introduction of VATP Licensing

In June 2023, Hong Kong established a licensing regime for Virtual Asset Trading Platform (VATP), under the broader Virtual Asset Service Provider (VASP) framework. VATP is the license regulated under the VASP framework, requiring compliance with the Securities and Futures Ordinance and the Anti-Money Laundering and Countering the Financing of Terrorism Ordinance for VASP.

As of February 5th, the Securities and Futures Commission (SFC) mandated that all exchanges apply for a VATP license by the end of February or terminate operations by May 31st. To date, only OSL and Hashkey acquired VATP license approval, while major players like Bybit, OKX, and Crypto.com are among the 23 awaiting review. Huobi (HTX) withdrew its application just three days post-submission and exited the Hong Kong market, alongside five other firms that were either rejected or withdrew voluntarily. The SFC has recently escalated enforcement, issuing a warning to the unlicensed exchange, SureX.

With the SFC’s stringent approach, Hong Kong exchanges are prioritizing regulatory compliance, investor protection, and security enhancements while awaiting the review outcomes. This heightened regulation is a trend not only in Hong Kong but across Southeast Asia. Some countries block access to crypto exchanges, but traders often use VPNs to bypass these restrictions. However, there's growing talk of stricter measures, like banning investors from certain countries through global KYC rules, making it harder to trade even with a VPN. This underscores the critical importance of securing appropriate licenses to maintain market presence.

2.2. nbsp;Approval and Trading of Bitcoin and Ethereum Spot ETFs

On April 15th, the Hong Kong Securities and Futures Commission (SFC) granted conditional approval to three asset managers to launch Bitcoin and Ethereum spot ETFs. Trading commenced on the Hong Kong Stock Exchange on April 30th, the first in Asia.

On its debut, Bitcoin ETF attracted approximately $250 million, while Ethereum ETF drew around $43 million in inflows. Since their launch, both ETFs have experienced modest net inflows. However, these figures have disappointed investors compared to the larger inflows seen in similar ETF approvals in the US.

Additionally, with commercial crypto trading prohibited in China, significant fund inflows from Chinese sources into the Hong Kong ETF market remain unlikely. This situation is expected to persist, particularly as Yao Qian, ex-head of China's Digital Yuan project, is currently under investigation by China's Central Committee.

Despite these challenges, the approval of Bitcoin and Ethereum spot ETFs is significant progress. Since 2022, the SFC has consistently proposed regulations for crypto-related products. Following this ETF approval, a turnaround in regulatory tightening through either permissions or deregulations of crypto-related financial products can be anticipated.

2.3. Regulatory sandbox for issuing stablecoins

On March 12th, the Hong Kong Monetary Authority (HKMA), Hong Kong's central bank, announced plans to implement a regulatory sandbox for stablecoin issuers. The HKMA, in collaboration with the Financial Services and the Treasury Bureau (FSTB), published a paper on legislative proposals for the regulation of stablecoin issuers in December last year, during which it also revealed plans to introduce a sandbox regime for stablecoin issuers.

Authorities believe it is urgent to establish a clear regulatory framework to ensure the healthy development of stablecoins and control potential risks, with a focus on the capital soundness of issuers, the stability of asset management, and user safeguards. With many global stablecoin projects considering Hong Kong as their main base, it will be interesting to see if the city can emerge as a stablecoin hub.

Hong Kong's ZA Bank is considering offering cash reserve accounts for stablecoin issuers to back their tokens. Devon Sin, deputy general manager of ZA Bank, said that 5~8 corporate clients are considering stablecoin issuance. The bank will provide them with fiat reserve accounts once they are officially approved by the HKMA's regulatory sandbox. The bank will also look into the custody of virtual assets, including stablecoins, and establish the necessary infrastructure.

The HKMA also called attention to the risk of crypto fraud, urging sandbox participants to refrain from disclosing their application status before approval and the public to be wary of fraudulent investment advertisements.

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