Virtual Assets

After a tumultuous 2022 for the virtual assets sector, the upheaval has continued into 2023 with the collapse of banks including Silvergate Bank and Signature Bank, key lenders to the crypto industry. At the same time, there have been some more positive signifiers, such as the recovery in value of some cryptocurrencies, and, in Hong Kong, proactive support from the government.

However, there is no doubt that the collapse Silvergate Bank and Signature Bank was a significant blow for the industry. One of the key services they provided was crypto on- and off-ramps – turning virtual assets into fiat money, and vice versa.

There is now a concern that if the major on- and off-ramps are closed and there are fewer providers, the costs of on- and off-ramps will continue to rise. There is also a risk that investors could get shut out from their investments if it becomes too difficult to exchange fiat and crypto. 

Although the industry has seen a lot of turmoil in the past year -- including the collapse of crypto exchange FTX and stablecoin Luna in 2022, and the US Securities and Exchange Commission suing Coinbase and Binance in June 2023 – in certain aspects it has bounced back recently. 

Some of the biggest cryptocurrencies have seen their values recover in 2023 after plunging last year. Ethereum has reached US$2,000, having dipped to below US$900 in 2022. Meanwhile, Bitcoin reached US$30,000 in mid-April for the first time since June last year, although it dropped back slightly to around US$26,000 by early June. 

There are a number of reasons why this is happening. There is a theory among some crypto investors that Bitcoin acts like hard money such as gold, in contrast to fiat currencies -- especially the US dollar where there are concerns about the US debt ceiling and printing money. 

The demise of Credit Suisse and a number of US banks has also played a role in the revival of crypto, as it plays into a broader lack of trust in institutions among some investors, which was one of the key drivers of interest in cryptocurrencies in the first place. 

A related trend has been towards alternatives to the US dollar. In particular, use of the RMB in international trade has grown in recent years, with Brazil and China’s deal to use the RMB rather than the US dollar being a recent example. So, Bitcoin is also attracting attention due to its role as another alternative currency.

Ethereum’s rising price is partly due to the recent transition to a full-featured proof-of-stake network. Investors are now able to withdraw their assets as and when they want, with limited liquidity risk and almost no execution risk, which had previously kept some investors at bay. It is anticipated that institutional investment will increase into ETH staking over time following these changes.

One of the biggest topics of discussion in the industry currently is the shifting and diverging global regulatory environment. In the US, for example, there has been a debate on whether to define a virtual asset as a security or a commodity, impacting who will be the regulator. 

Hong Kong is among the jurisdictions that has moved towards more regulation, including a new licencing regime for centralised virtual asset trading platforms that trade non-security tokens, which came into effect on 1 June. The introduction of more regulations in Hong Kong and some other jurisdictions are providing more stability to a market that had previously been seen as not having much certainty.

The VATP regime has so far attracted companies from both the start-up and more traditional finance realms, in addition to the exchanges already based in the city. What remains to be seen is how many of these applications will be approved by the SFC, which will prioritise maintaining Hong Kong’s reputation as a stable and reputable financial centre. 

Certain virtual assets players, including some in decentralised finance (defi), are less keen to be based in a regulated jurisdiction. However, many others welcome the increased security of a well-regulated environment and a number of companies in the sector have moved to the city recently and indicated their intention to apply for a licence. 

Besides crypto exchanges, other virtual assets businesses that have moved to Hong Kong recently include some that are interested in developing blockchain applications across the whole virtual assets ecosystem. Another benefit of Hong Kong being a well-regulated location for virtual assets is that global investors interested in the sector are likely to want to deploy their capital in a more stable jurisdiction.

Another good sign for the sector is that virtual asset companies in Hong Kong are continuing to attract investment. Start-ups that provide a link between digital assets and traditional finance are among those that have been successful in getting funding recently. One example is a platform that allows users to stake NFTs, which can then be collateralised against US dollars, Hong Kong dollars or cryptocurrencies. Another area attracting attention is payments, such as start-ups that are working with traditional credit cards to enable the use of digital currencies.

In contrast, virtual asset firms operating purely in the defi space are not getting as much traction at the minute.

Besides its efforts on the regulatory side, the Hong Kong government has been active in the market. Government officials including Financial Secretary Paul Chan, as well as senior executives from the SFC and HKMA, have spoken at industry events across the region about their plans to support Hong Kong as a hub for virtual assets.

Many traditional financial institutions are interested in the virtual assets space to varying degrees, including decentralised finance. Some frontrunners are participating in proof-of-concept projects, such as issuing tokenised securities as a proof of concept. Others are paying close attention to the market but not actively getting involved. Then some are disconnected from the conversation altogether, at least from a leadership perspective.

However, major banks are not ignoring the sector and many are using blockchain technology as part of their internal processes and in areas including trade finance solutions. For example, a number of major banks have been working with a cross-border payments network that uses blockchain technology. Broadly speaking, banks in Hong Kong are making sure that they understand the technology and that they will be in a position to adopt it in the future.