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Could Hong Kong really become China’s proxy in crypto?

With its partial autonomy, the island city of Hong Kong has traditionally served as a gate to China, but with crypto, there is a catch.

With its partial autonomy, the island city of Hong Kong has traditionally served as “a gate to China” — the local trade center, backed by transparent English-style common law and an openly pro-business government strategy. Could the harbor, home to seven million inhabitants, inherit this role in relation to the crypto industry, becoming a proxy for mainland China’s experiments with crypto? 

An impulse to such questioning was given by Arthur Hayes, the former CEO of crypto derivatives giant BitMEX in his Oct. 26 blog post. Hayes believes the Hong Kong government’s announcement about introducing a bill to regulate crypto to be a sign that China is trying to ease its way back into the market. The opinion was immediately replicated in a range of industrial and mainstream media.

What happened

In late October, the head of the fintech unit at the Securities and Futures Commission (SFC) of Hong Kong, Elizabeth Wong, announced the liberalization of Hong Kong’s regulatory landscape by allowing retail investors to “directly invest into virtual assets.” 

Up until recently, only individuals with a portfolio worth at least $1 million (which marks about 7% of the city’s population) have been granted access to centralized crypto exchanges by the SFC. The regulator has also been reviewing whether to allow retail investors to invest in crypto-related exchange-traded funds, Wong noted.

Roughly a few days after, on Oct. 21, Hong Kong’s Secretary for Financial Services and the Treasury, Christopher Hu, shared his city’s fintech plans, among other efforts, directed at “transferring wealth to the next generation.” The key is establishing a regulatory regime for virtual asset service providers, and a certain bill was already introduced to the city’s lawmakers, as Hu specified.

Finally, on Oct. 31, during the city’s FinTech Week 2022, Hong Kong Financial Secretary Paul Chan assured attendees that the digital transformation of financial services is a key priority for his team. Chan’s colleague, the CEO of the Hong Kong Monetary Authority (HKMA), Eddie Yue, promised “radical open-mindedness” regarding the innovations. 

According to him, the HKMA is in the process of establishing a regulatory regime for stablecoins and has already issued guidelines to banks about cryptocurrency or decentralized finance-related services.

Crackdown on the Mainland, uncertainty on the island

Hong Kong’s intention to open up for crypto comes a year after a devastating crackdown on the industry in Mainland China. Until 2021, the People’s Republic Of China has been enjoying a status of a world leader in hash rate and cryptocurrency mining. 

Starting in May 2021, Chinese regulators began prohibiting involvement in crypto for financial institutions, then mining operations and, finally, the work of exchanges and trading for individuals. Although that didn’t effectively outlaw the crypto ownership as such, any potential for institutional development of the crypto industry in the country was frozen.

Back then, Hong Kong officials didn’t confirm (or deny) that the island city would comply with Beijing’s hardline policy on digital assets, but investors nevertheless started considering their options.

Recent: How are ‘lite’ versions of crypto apps helping adoption?

While today it may sound ironic, in 2021, relocating his headquarters to the Bahamas, Sam Bankman-Fried of FTX was highlighting the importance of long-term regulatory guidance and clarity, which Hong Kong laced in his opinion.

This uncertainty took its toll indeed — after attracting $60 billion in crypto between July 2020 and June 2021, Hong Kong started to witness the largest players opening up alternative offices in the Caribbean or neighboring Singapore. FTX was joined by the likes of Crypto.com, BitMEX and Bitfinex.

The Hayes narrative

Mixing two plot lines — one which traces all the most important crypto innovations to China, and the other which notes Hong Kong’s historical role as the entry point to communist China — Hayes argued:

“Hong Kong’s friendly reorientation towards crypto portends China reasserting itself in the crypto capital markets.” 

According to Hayes, Hong Kong authorities cannot diverge too far from Beijing in their decisions, so opening up the crypto market amid the crackdown in the Mainland couldn’t be an autonomous act. 

The reason behind Beijing’s benevolence to such a U-turn lies in the anxiety of Hong Kong losing its status as the principal Asian financial center. It has certainly faltered during the COVID-19 pandemic when the hardline lockdown policy, exercised in China and Hong Kong, caused an investment escape wave to the neighboring competitor, Singapore, which had eased its restrictions much earlier.

Another major factor behind China’s possible support of Hong Kong’s crypto liberalization, according to Hayes, is the former’s problem with a giant United States dollar trade proficit. Historically, like almost any nation in the world, China has been storing dollar income in assets like U.S. Treasury bonds.

But the example of Russia, whose foreign assets were blocked due to financial sanctions after an invasion of Ukraine, has worried Chinese officials. Hence, it is highly probable they would seek another type of asset in which to store their USD income. Cryptocurrencies and related financial products might be the option.

Reality check

Speaking to Cointelegraph, David Lesperance, founder of Lesperance & Associates law firm, who has been dealing with Hong Kon and China-based clients for more than 30 years, doubted the possible interest of the Chinese government in opening up to crypto:

“Rather, they are interested in having complete control over their population, including those who reside in HK. This is demonstrated by such actions as social credit scoring, facial recognition, household registration, exit bans, zero COVID-19, etc.” 

Putting crypto aside, recent years have seen tightening political, cultural and economic control of China over Hong Kong with the national security law of 2020 sweeping the previous civil freedoms away, a change in school curricula to emphasize the Chinese history of the region and the ongoing integration of Mainland companies into the island’s juridical space. 

These signs of the shortening distance between the Mainland and Hong Kong might attract the attention of global regulators. As one banker said to CNN recently, “The worst scenario is that the West would treat Hong Kong as the same as the Mainland China, and then Hong Kong would suffer the kind of sanctions.”

The elephant in the room is China’s central bank digital currency (CBDC) project. The rapid development of the digital yuan (also known as e-CNY) and the ban on crypto is hardly a coincidence. As Ariel Zetlin-Jones, associate professor of economics at Carnegie Mellon University’s Tepper School of Business, told Cointelegraph back in 2021, in the aftermath of the crackdown:

“China clearly wants to promote the digital Yuan. Removing its competitors by banning crypto activities is one way to do this so it seems reasonable to consider this motivation as one rationale for their policies.”

The digital yuan became the most actively transacted currency in a recent six-week m-Bridge pilot of cross-border payments among the digital currencies issued by central banks of China, Hong Kong, Thailand and the United Arab Emirates. As state-owned Chinese media noted after the experiment, “Hong Kong [is] poised to be a vibrant center for e-CNY’s use in international trade.”

Recent: Breaking down FTX’s bankruptcy: How it differs from other Chapter 11 cases

Lesperance emphasized that the introduction of e-CNY and the continuing restrictions on the rest of the crypto, even when it comes to domestic miners, confirms Beijing’s drive to control the financial sphere in the first place:

“Control over the financial lives and assets of the Chinese citizens is the ultimate control. This will be achieved when all transactions are done in e-yuan. Facilitating other crypto-currencies would undermine this move toward complete control.”

Chinese Central Bank Governor: User Privacy and Financial Security Key Principles Guiding CBDC Design Process

According to Yi Gang, governor of China’s central bank, the process of designing the country’s digital currency is premised on two principles, the protection of user privacy as well as ensuring “financial security.” To achieve this, the central bank’s role will be limited to managing the digital currency’s “operating system” while the handling of personal […]

Chinese central bank exec says digital yuan will offer ‘controllable anonymity’

China’s digital yuan is one of the earliest CBDCs whose pilot phase has expanded to include millions of users and billions in transaction volume.

Chinese central bank governor Yi Gang, in a recent speech at Hong Kong Fintech Week, talked about the progress of their national digital currency called the digital yuan. He outlined the progress and the adoption of the national digital currency.

During his speech, Yi noted that the digital yuan is being positioned as an alternative to cash in China, a country with a robust digital payment infrastructure. He added that “privacy protection is one of the top of the issue on our agenda.”

He went on to describe the two-layer payment system that would offer controllable anonymity to the users. At tier one, the central bank supplies digital yuan to the authorized operators and processes inter-institutional transaction information only. At tier two, the authorized operators only collect the personal information necessary for their exchange and circulation services to the public.

Yi promised that data will be encrypted and stored and, personal sensitive information would be anonymized and not shared with third parties. Users can also make anonymous transactions up to a certain amount, and there will be specialized e-wallets to facilitate those transactions. The central bank governor noted that anonymity is a two-faced sword and thus must be dealt with carefully, especially in the financial ream and explained:

“We recognize that anonymity and transparency are not black and white, and there are many nuances that need to be carefully weighed. In particular, we need to strike a precise balance between protecting individual privacy and combating illegal activities.”

Yi’s comments are in line with the central bank digital currency (CBDC) program head Mu Changchun, who in July reiterated a similar stance saying CBDC doesn’t have to be as anonymous as cash. Mu had said that a completely anonymous CBDC would interfere with the prevention of crimes like money laundering, terrorism financing, tax evasion and others.

Related: Hong Kong could be key for China’s crypto comeback — Arthur Hayes

China started its CBDC program as early as 2014 and, after years of development, launched the pilot in 2019. Since then, the program has expanded to millions of retail customers across the country. In 2022, the CBDC testing has expanded to some of the most populous provinces. The extent of the CBDC trail can be estimated from the fact that the total digital yuan transaction volume crossed $14 billion by the third quarter of 2022.

Chinese agents used Bitcoin transactions through Wasabi to allegedly bribe US government employee

According to an analysis by crypto risk management firm Elliptic, two Chinese intelligence agents used Wasabi Wallet to conceal BTC transactions allegedly used for bribes.

The United States Department of Justice has announced charges against two Chinese intelligence officers who allegedly bribed a double agent with Bitcoin.

In an Oct. 24 announcement, the Justice Department said Guochun He and Zheng Wang attempted to obstruct the prosecution of an unnamed global telecommunications company based in China, which allegedly involved paying a U.S. government employee roughly $61,000 in bribes using Bitcoin (BTC). However, the individual was a double agent working on behalf of the Federal Bureau of Investigation and did not move against authorities in the Eastern District of New York in the case against the China-based company.

According to an analysis by cryptocurrency risk management firm Elliptic, He and Wang used Wasabi Wallet to conceal the BTC transactions allegedly used for bribes. The firm reported that the privacy wallet had previously been used in an attempt to launder BTC from the July 2020 Twitter hack and the attacks on crypto exchanges Bitfinex in 2016 and KuCoin in 2020.

“The same properties of digital assets that make them attractive to criminals — such as censorship resistance, pseudonymity and the ease with which they can be transferred across borders — also make them valuable tools for all intelligence agencies looking to fund clandestine operations,” said Elliptic.

Source: Elliptic

According to the Justice Department, the two Chinese intelligence officers began the scheme in 2019 by directing the double agent to steal confidential information related to the prosecution of the company — which Elliptic suggested may be Huawei. He allegedly made separate bribes of $41,000 and $20,000 in BTC to the agent for providing “secret” documents and rewarding the release of information, respectively.

Related: No crypto for criminals: Coinjoin BTC mixing tool to block illicit transactions

Following the creation of the Justice Department’s National Cryptocurrency Enforcement Team in October 2021, the government department has taken many enforcement actions against individuals and entities using crypto for illicit actions including money laundering and related to cybercrimes. In 2022, the Department of Justice seized roughly $500,000 in fiat and crypto from a hacking group tied to the North Korean government, and it has taken steps to move forward on a criminal prosecution case against a U.S. citizen who allegedly violated sanctions through crypto.

Not like China: Hong Kong reportedly wants to legalize crypto trading

Hong Kong’s securities regulator wants to allow retail investors to invest directly in virtual assets and to reconsider current crypto trading requirements.

Hong Kong is taking action to regain its status as a global cryptocurrency hub by launching several legal initiatives related to the crypto industry.

A city and special administrative region of China, Hong Kong is willing to distinguish its crypto regulation approach from the blanket crypto ban in mainland China.

The government of Hong Kong is considering introducing its own bill to regulate crypto in its own China-free way, according to Elizabeth Wong, head of the fintech unit at the Securities and Futures Commission (SFC).

One of the SFC’s initiatives is allowing retail investors to “directly invest into virtual assets,” Wong said during a panel held by InvestHK, the South China Morning Post reported on Oct. 17.

Such an initiative would mark a significant shift from the SFC’s stance over the past four years, which restricts crypto trading on centralized exchanges to professional investors, Wong noted. Eligible investors include individuals with a portfolio worth at least $1 million, or about 7% of the city’s population, as of September 2021.

Wong emphasized that the crypto industry has become more compliant over the past four years, suggesting that it’s time to change the city’s stance on crypto, stating:

“We think that this may be actually a good time to really think carefully about whether we will continue with this professional investor-only requirement.”

The SFC official also mentioned a few other legal initiatives targeting the development of the crypto ecosystem in Hong Kong, including a policy introduced in January to allow service providers to sell certain crypto-related derivatives. The regulator has also been reviewing whether to allow retail investors to invest in crypto-related exchange-traded funds, Wong noted.

The latest news comes amid Hong Kong, on Oct. 19, launching a $3.8 billion fund to attract foreign businesses back to the city after a massive talent exodus prompted by strict lockdowns and tense political climate.

Related: Bank of China: Digital yuan transactions volume crossed $14B mark

According to an official statement by the government of the Hong Kong special administrative region, the local government has introduced a bill to propose establishing a regulatory regime for virtual asset service providers. The city authorities also plan to embrace emerging technologies like nonfungible tokens and metaverse and develop Hong Kong into an “international virtual assets center.”

According to some reports, Hong Kong has already been succeeding in terms of crypto adoption so far. Considering a number of factors like crypto ATM installations, pro-crypto regulations and startup culture, Hong Kong was ranked the best-prepared country for widespread crypto adoption in a study by Forex Suggest published in July 2022.

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