Investors in Hong Kong can easily separate the wheat from the chaff, as crypto exchanges now have the option to get regulated or not.
While many diss the regulators, one of the biggest bullish signs this month [apart from Bitcoin maintaining its support levels] is the SFC’s approach towards regulating cryptocurrency marketplaces.
This article is a deep dive into SFC’s regulations around cryptocurrency exchanges, the dissecting of its position paper and an analysis of this framework.
To start with, let’s clear out a couple of misconceptions and a TL;DR of the 60 pager position paper.
- No cryptocurrency is considered to be a legal tender in Hong Kong.
- It is not compulsory to become a regulated crypto exchange. Exchanges have the option to opt-in or not.
- Any crypto exchange that complies with the guidelines provided by SFC is eligible for a license.
- The regulated crypto exchanges can ONLY provide their services to professional investors.
- Regulated exchanges need 100% covered insurance on hot wallets and 95% or more on cold wallets.
- It’s mandatory for every SFC regulated exchange to take preventive measures for ML/TF.
Dissecting and Analysing SFC’s position paper
The Licensing T&C for Virtual Asset Trading Platform Operators consists of multiple checklists, including financial soundness, custody of assets, record-keeping, auditing and much more. Here we analyse a few points that stood out the most.
Due diligence conducted on virtual assets before their listing on the exchange.
The considerations mentioned are such as:-
-Knowing the background of developers and management team of the digital asset
-The supply, demand, maturity and liquidity of a virtual asset, including its market capitalisation, and average daily trading volume.
-The level of activity within the development community
-The marketing materials of a virtual asset provided by the issuer, which should be accurate and not misleading etc.
That said, Bitcoin [BTC] will never be able to check this due diligence off the list due to the lack of background checks available for its team, stability of its financial ratios, no registered “issuer” and more.
This could open doors for centralized cryptocurrencies to have a better chance of higher adoption than the decentralized ones. And could also bring in many hurdles in terms of crypto-to-crypto conversions as most of the investors store their holdings in Bitcoin.
On the other side, the grass seems more green as unregulated crypto exchanges based out of Hong Kong would still be in a position to let its users trade any cryptocurrency listed amongst the 3000 recorded on CoinMarketCap.
As mentioned in the TLDR section, the regulated crypto exchanges can only allow “professional” traders to trade which means only institutional investors and HNI with a portfolio of 1million USD and above are eligible to trade.
Additionally, the position paper even states that:
“Where a Platform Operator provides its trading platform to other companies (ie, white labelling), which may in turn provide such services to their clients, the Platform Operator should take all reasonable steps to ensure that all such clients and end users of its platform are professional investors if the ultimate client’s transactions are to be routed to and executed on the same platform as those of the Platform Operator’s direct clients.”
Which indicates that even when a regulated crypto exchange shares it orderbook [“platform”] with another crypto exchange [non-regulated] its mandatory that the clients trading on the third party platform are also professional investors.
If this was implemented on Binance [Largest crypto exchange by volume] it would automatically lose over 80% of its volume as many smaller exchanges use its orderbooks and Binance has more retail investor volume than institutional [Source].
When it comes to monitoring AML/CFT there are 9 pointers on the document, one of the pointers indicate that measures have to be taken against, “transactions involving virtual assets with a higher risk or greater anonymity (for example, virtual assets which mask users’ identities or transaction details);”
This basically means that private blockchain based cryptocurrencies such as Monero [XMR], ZCash [ZEC] etc will not be listed on the regulated crypto exchanges as well as clients dealing with these currencies may be monitored under AML/CFT regulations.
To prevent money laundering and terror funding, regulated exchanges can also apply security measures and preventive techniques by choosing third party forensic tools.
Last year, the SFC published a license that permissioned fund managers of virtual assets to sell digital products to potential investors. While the thought may seem like a step towards higher adoption it actually gave almost zero outcome as far as the guidelines were concerned. According to the intel provided very few managers were actually licensed by SFC.
However, SFC’s this regulatory framework was released right after China’s first-ever crypto law announcement. The coming year, the asian cryptospace can expect an improvement in the regulatory framework of dealing with/in cryptocurrencies.