The issue of licensing for Hong Kong Virtual Asset Trading Platforms (VATP) has sparked renewed discussion. Since June 1, 2023, the Hong Kong Securities and Futures Commission (SFC) has required cryptocurrency exchanges operating in Hong Kong to apply for a compliance license. Some well-known exchanges have voluntarily withdrawn their applications because they cannot guarantee that offshore exchanges do not have Chinese users. Hong Kong regulators face a dilemma: allowing problematic exchanges to operate compliantly is unfair to early investors, but a blanket ban hinders the entry of industry giants. Hong Kong's innovation in the Web3 field is limited to the combination of infrastructure and traditional elements, lacking support for native Web3 applications. Although the launch of Bitcoin and Ethereum spot ETFs has advantages, trading volume and market liquidity are insufficient. Hong Kong needs more support for innovative projects, attracting talent and capital to drive the prosperity of the Web3 market.

Over the past weekend, the issue of the Hong Kong Virtual Asset Trading Platform (VATP) license once again sparked discussion. More than a year ago, the Hong Kong Securities and Futures Commission (SFC) announced that starting from June 1, 2023, cryptocurrency exchanges operating in Hong Kong would have one year to apply for a compliance license from the regulatory body. If they fail to obtain approval within a year, they will not be allowed to operate in Hong Kong. Over the past year, institutions in the Web3 industry, including OKX, Huobi, Matrixport, and brokers like Victory Securities, have joined the application process. Time flies, and today, some applicants who were considered to be First, the author believes that Hong Kong and the institutions launching cryptocurrency spot ETFs should first face the issues head-on and not try to temporarily cover them up with illogical explanations. For example, the trading volume and fund size of Hong Kong's spot ETFs are far inferior to those of cryptocurrency spot ETFs launched in the U.S. during the same period. Jupiter Zheng, a partner at HashKey Capital's secondary fund, believes that although there is a difference in absolute size, the gap in the proportion of cryptocurrency spot ETFs to the total ETF market in their respective markets is not significant. A $250M Bitcoin spot ETF accounts for 0.5% of Hong Kong's ETF market, while $57.3B accounts for 0.67% of the U.S. ETF market.

But what are the facts? The fact is that Hong Kong is vigorously developing Web3, while the Web3 industry in the U.S. is frequently hit by regulatory crackdowns. Hong Kong's cryptocurrency spot ETFs are launched almost unimpeded and include physical subscription of fund shares, whereas the launch of Bitcoin spot ETFs in the U.S. has been fraught with difficulties, initially being rejected, then not allowing physical subscriptions, and finally being officially launched after 10 years of back-and-forth. In addition, we are ahead of the U.S. in the progress of institutional products, have the highest insurance volume for cryptocurrency protection, can provide various arbitrage opportunities, and have many other advantages. Despite these overwhelming advantages, the proportion of Hong Kong's Bitcoin spot ETF size compared to the U.S. is not much different, and it is even unacceptable that there is a net outflow of funds compared to the launch day.

Institutions always emphasize that 'the future will be better,' but why, despite such significant advantages, do the current data not meet expectations but instead fall short?

First, the launch of the U.S. Bitcoin spot ETF provided an investment exposure for many institutions or funds that were unable to directly invest in Bitcoin spot due to regulations (although Coinbase is listed on the U.S. stock market, the SEC has never recognized any 'fully compliant' cryptocurrency exchange), and the fees are very low. Secondly, local institutions and even individual investors in the U.S. have a global leading awareness of Bitcoin and other cryptocurrencies. In contrast, in Hong Kong, there are already fully compliant cryptocurrency exchanges (HashKey Exchange and OSL), meaning that if institutions or funds are allowed to invest in cryptocurrencies, they can do so directly on the exchange without management fees and with the same level of security. So why invest in ETFs?

Clearly, Hong Kong has not fully thought through 'why launch cryptocurrency spot ETFs.'

Of course, the author does not think it is unnecessary to launch ETFs, but the value of Hong Kong's Bitcoin and Ethereum spot ETFs lies more in providing a direct investment window for foreign capital, which compliant exchanges cannot offer. Therefore, instead of finding untenable reasons to excuse the lack of preparation, it is better to face and acknowledge the current issues and study how to attract more foreign capital to participate in Hong Kong's cryptocurrency spot ETFs rather than the U.S. counterparts.

On the other hand, the liquidity issue of the Hong Kong stock market remains one of the main problems affecting the current vitality of financial asset trading. We will not discuss the deep-seated reasons for this phenomenon here, but it is worth noting that current cryptocurrencies are highly dependent on liquidity as high-risk financial assets. In the early stages of the industry, these so-called 'projects' have no fundamentals to speak of, or the impact of hype on token prices greatly exceeds the fundamentals. As for Bitcoin and Ethereum, they have a stronger correlation with the macro liquidity of the U.S. dollar. On the first day of the U.S. listed Bitcoin spot ETF, although the overall size was not large, the trading volume in the secondary market exceeded $1B in a short period. For a market with sufficient liquidity, even a small outflow of funds is enough to support the overall liquidity of a new form of financial asset.

For Hong Kong's cryptocurrency ETFs, if the size is still barely satisfactory, the trading volume can be described as 'dismal.' For investors in ETFs, if there is not enough liquidity in the secondary market, exiting becomes relatively troublesome, and arbitrage operations are out of the question. Therefore, how to activate the overall market liquidity, or at least activate the liquidity of Hong Kong's cryptocurrency market, is one of the key issues at present.

Currently, Hong Kong limits Web3 innovation to infrastructure (related to trading) and the combination of Web3 and traditional sectors, perhaps because it does not have enough understanding and preparation for the Web3 native application field and development speed. Hong Kong has not had a good focus on promoting application innovation.

Starting from DeFi, the latest concepts and tracks of Web3 have basically originated in Western countries. Apart from the now-defunct Terra, there have been almost no Web3 projects in Asia that have become significant or formed an ecosystem. Although we have significant advantages in exchanges, asset management, hardware wallets, etc., there is almost zero innovation in practical application fields.

Hong Kong's hope to seek some innovation in the compliance of exchanges, including STOs, is far from enough. To make the Web3 market prosperous, it is necessary to support innovative projects that are at the forefront of the industry. For example, the current hot topics of the Bitcoin ecosystem, Ethereum re-staking, etc., can gather 'Hong Kong power' to select and launch several projects that can become leaders in their tracks. When enough excellent projects are born in Hong Kong, it will gradually attract talent, capital, and more ecosystems around quality projects to settle in Hong Kong.

In terms of finance, even if Hong Kong is the best in Asia, it is difficult to compete head-on with the U.S. Therefore, in the field of finance and cryptocurrency trading, we can gradually catch up, but these are definitely not the areas where we should focus our funds and resources at present. Providing more subsidies and talent policies to potential Web3 native projects, or continuing to delve into areas where Asia currently has a small advantage, such as RWA tokenization and the Bitcoin ecosystem, is a good strategy for achieving a breakthrough.The speed of development in the Web3 industry surpasses most people's expectations, and it can even be said to be literally 'changing with each passing day.' Facing this new field, I believe Hong Kong is well-prepared, but it still underestimates the uniqueness of this industry. Nevertheless, I highly appreciate the Hong Kong regulators' firm stance when dealing with exchanges, but the focus on mature tracks while ignoring the innovative power of the native Web3 field and its impact on the industry and the overall Web3 atmosphere in Hong Kong is, at least from public actions so far, the most fatal issue.

To innovate or to regulate? This has never been a question. The current regulation essentially does not 'restrict' innovation because it has not 'touched' innovation, only regulating certain non-compliant behaviors. True innovation cannot be pre-regulated, just as the U.S. could not have thought of how to regulate a decentralized asset before 2008. Therefore, for mature tracks like exchanges, asset tokenization, and cryptocurrency ETFs, strong regulation is understandable. However, true 'innovation' in the Web3 field is the brainchild of a small number of geniuses, and no one can pre-regulate it. So, it is only necessary to support the development of good projects as much as possible and prevent structural risks within the known scope.

Truly understanding the industry, understanding what the most promising concepts in the native Web3 field are, how RWA tokenization and DePIN can better empower the real economy with the help of the government, and mobilizing resources and talent to jointly create high-quality Web3 projects born, grown, and succeeded in Hong Kong, may resolve the difficulties encountered in the implementation process across various fields.

The Dilemma of Web3 Regulation and Innovation in Hong Kong