Qiu Dagen: Many exchanges withdraw their license applications. What will happen to Hong Kong Web3?

Author: David Chiu, Legislative Councillor, Hong Kong Economic Journal

The new licensing regime for virtual asset trading platforms (VATPs) set up by the Hong Kong Securities and Futures Commission came into effect on June 1, 2023. The transitional arrangement of the new regime allows operators to apply for a license before February 29 this year, and comply with the new regulatory requirements from June 1, and continue to provide virtual asset services in Hong Kong until the authorities make a final decision on their license applications.

However, as the transition period approaches the end of May 31, more and more operators have decided to abandon the Hong Kong market. At the time of writing, 11 have withdrawn or returned their license applications. When the SFC introduced the licensing conditions, it failed to attract large exchanges such as Coinbase to apply to Hong Kong. Since February, several internationally renowned exchanges such as Gate and Huobi have withdrawn one after another. In May, the situation worsened, with a total of 6 operators announcing their withdrawal, including OKX, which ranks among the top three in global trading volume. Most of the remaining 18 applicants are small. Some lack industry experience, while others are traditional financial institutions trying to get involved in VATP business but not deeply involved in Web3.

OKX's exit has sparked a lot of discussion in the industry, questioning whether Hong Kong is truly determined to develop and embrace Web3. A large number of related comments have appeared in the author's WeChat circle, such as some with titles such as "Is Hong Kong's Web3 over just at the beginning?" and "The arrogance of Hong Kong people has broken OKX's heart." They accuse the authorities of being timid and cautious when actually implementing the new system, and of taking a conservative and risk-averse approach, which weakens the competitiveness and flexibility of the licenses from the perspective of traditional finance. Some operators decided to return their applications at the last stage even though they had invested a lot of resources and upfront costs.

Many industry insiders are worried that the new licensing system will turn into a replica of the "food truck incident", or even like the government's promotion of virtual banks, with a lot of thunder but little rain. They are worried that the authorities will repeat the same mistakes, and even if operators are approved for licenses, it will be difficult to develop a profit model.

Based on the opinions of the industry, the author believes that the new licensing system shows several areas of concern. First, several policies and measures related to the development of Hong Kong's virtual asset market (such as VATP, stablecoin issuance, virtual asset over-the-counter trading, etc.) were designed by different departments, lacking overall strategic considerations for industry development. The relevant policies entered the consultation stage or were put on the legislative process at different times, which made the entire Web3 layout completed in stages, taking too long and unable to keep up with the rapid pace of technological evolution.

Second, the SFC requires operators to meet standards in terms of asset custody, conflict of interest avoidance, network security, accounting and auditing, risk management, combating money laundering and terrorist financing. Many of the approval conditions borrowed the operating concepts and conditions of traditional finance, which seemed too strict when implemented in Web3 finance. Some applicants told the author that the authorities lacked a forward-looking vision for the development of the next generation of financial technology, and that the traditional financial thinking to promote Web3 "financial innovation" lacked flexibility.

Third, many industry insiders believe that the government and regulatory agencies lack the DNA of innovation. At present, the authorities require the management of licensed operators to have many years of experience in virtual asset business. On the other hand, the board and management of officials and regulatory agencies lack personnel with actual experience in operating Web3 business. The two sides have different technical backgrounds, market experience and innovative spirit, and it is difficult to communicate.

The withdrawal of the licensing system this time has shaken the confidence of market participants in Hong Kong's promotion of Web3 development. In order to restore market confidence, the author hopes that the SFC will make a decision on the license application as soon as possible so that investors can have long-term confidence in virtual asset trading platforms. Secondly, the products provided by the trading platform must be breakthroughs that can balance the need to maintain a sound legal system, protect investors, and financial innovation. When approving new products in the future, the authorities must show new thinking and determination to encourage Web3 finance.

In the final analysis, innovation is a thought and an action. If you are passionate when promoting innovation, but afraid of losing and making mistakes when taking action, how can you innovate? The essence of innovation is to try and allow failure to happen. The most important thing is how to review mistakes and accumulate experience from failure, rather than retreating to the "safety line" from the beginning and trying to promote the so-called "innovation" with zero risk!