HK’s new crypto license could be expensive for exchanges.

HK's new crypto license could be expensive for exchanges.

The High Costs and Tough Requirements of Operating a Crypto Exchange in Hong Kong

Introduction

The world of cryptocurrencies continues to evolve, with new regulations and licensing requirements being introduced to ensure a safe and secure environment for digital asset trading. One such example is the new regulatory regime for virtual asset trading platforms in Hong Kong, which came into effect in June. Under this regime, crypto exchanges are faced with high costs and tough requirements in order to obtain an operating license. This article explores the implications of these requirements and the impact they may have on the blockchain industry.

The Costly License Application Process

Obtaining a new license under the new regulatory regime in Hong Kong could cost crypto exchanges between $12 million and $20 million. This estimate includes operating costs leading up to the license application, as well as payments for necessary vendors such as consultants, lawyers, and insurance providers. The cost of license consideration is likely to be prohibitive for many smaller firms, potentially leading to a natural selection of players in the market.

To navigate the complex application process, companies often seek the assistance of licensing consultants, who can charge up to $1 million for their services. Additionally, exchanges are required to maintain a paid-up share capital of 5 million Hong Kong dollars ($640,000) and have liquid capital of at least $380,000. They must also hold liquid assets equivalent to at least a year of operating expenses, excluding virtual assets.

Comprehensive Capabilities and Local Presence

In order to meet regulatory requirements, crypto exchanges will need to invest in capabilities that ensure segregation of client funds, safe custody of assets, and smart contract audits. They must also demonstrate overall corporate governance and assess the knowledge of virtual assets possessed by potential investors. Furthermore, the new regulations require companies to have a local presence in Hong Kong, with seed phrases and private keys (along with backups) stored in the city.

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To meet these requirements, exchanges must hire compliance officers known as licensed responsible officers (ROs) to ensure adherence to regulatory standards. Each applicant is required to have at least two ROs, who often charge a premium due to high demand. These stringent requirements aim to enhance the security and reliability of crypto exchanges operating in Hong Kong.

The High Benchmark for Approval

The announcement of the licensing regime has spurred a rush for applications, but not all platforms will meet the regulator’s benchmark. Small exchanges that lack large trading volumes or a track record of regulatory compliance may face significant challenges in obtaining a license. Only eight banks were able to acquire virtual bank licenses despite a significant number of interested parties. Applicants not only need to meet the minimum criteria set by the Securities and Futures Commission but also present a strong case to support their application.

China’s Regulatory Sandbox

Interestingly, while China has banned its own population from trading virtual assets, Hong Kong’s residents are permitted to engage in such activities. As a result, Hong Kong functions as a testing ground for other forbidden activities on mainland China. It is worth noting that the Hong Kong government has actively promoted the blockchain industry, mentioning Web3 in the budget and forming a Web3 task force. This regulatory sandbox allows investors to have exposure to virtual assets, with the hope that licensed platforms will inspire confidence in both retail and institutional traders.

Allowing Retail Investors

One significant change under the new licensing regime is the permission granted to platforms to serve retail investors. Previously, retail trading of virtual assets was conducted in a regulatory gray area, with investors utilizing offshore exchanges. Now, licensed platforms can facilitate fiat currency transfers from banks to trading platforms, creating a more liquid market. The inclusion of retail traders on licensed platforms may also boost confidence among institutional investors who typically face stricter regulatory barriers.

Limitations and Surrounding Infrastructure

While the new regime opens up opportunities for crypto exchanges to serve retail investors, it still imposes limitations. Derivatives trading, one of the most lucrative aspects of crypto exchanges, remains off-limits. Only large-cap coins are permitted for trading, and tokens must meet specific criteria, including being listed in two acceptable indices and having a one-year track record.

Another requirement is that platforms must handle custody of virtual assets themselves and cannot rely on external custodians. This places a heavy burden on platforms to ensure the security and safekeeping of client assets. It also highlights the need for credible institutions specializing in custody to bear the insurance costs associated with potential losses.

Additionally, establishing reliable banking relationships and finding suitable insurance providers has proven challenging for crypto exchanges. Ensuring the appropriate surrounding infrastructure is in place is crucial for the success and sustainability of licensed platforms in Hong Kong.

Conclusion

The new regulatory regime for virtual asset trading platforms in Hong Kong has raised the bar for crypto exchanges, with high costs and tough requirements to obtain an operating license. While these requirements may weed out smaller firms, they aim to ensure the safety and reliability of the blockchain industry. Institutional investors are more likely to enter crypto markets when platforms can serve retail customers, and the involvement of a globally respected financial regulator provides market participants with confidence. As the industry continues to evolve, meeting regulatory standards will be essential for crypto exchanges to thrive in Hong Kong and beyond.

References: – CoinDesk: Tough Hong Kong regulations force crypto exchanges to upgrade – CoinDesk: Meet the Hong Kong Lawmaker Who Invited Coinbase to Town