Why is Hong Kong pushing crypto and web3?

In early 2022, the Hong Kong financial community was buzzing again after three difficult years that included mass protests, the passing of a National Security Law that chilled civil society, and citywide lockdowns due to COVID-19: Advertisements promoting cryptocurrencies cropped up in MTR subway stations, and social media feeds became saturated with stories of the coming “web3 revolution,” an idea for a new phase of the internet that incorporates virtual reality (the “metaverse”), unique digital representations of goods (“non-fungible tokens,” or NFTs), and the use of decentralized financial tokens like Bitcoin and Ethereum.

Eighteen months and several interest rate hikes later, talk of cryptocurrency and the transformative power of web3 has died down. In particular, the collapse of FTX and Three Arrows Capital highlighted the speculative nature of the sector. The United States and China are tightening their oversight: Beijing began restrictions on crypto in 2013 and renewed its crackdown in 2021, while in June 2023 the SEC charged exchanges such as Coinbase and Binance with various violations related to being unlicensed issuers of securities. While Bitcoin, Ethereum, and USDT (a token tied to the value of the U.S. dollar) remain tradable assets on global exchanges and continue to retain value, much of the froth has subsided.

Bold or foolish?

In spite of the decline in hype over cryptocurrencies and web3-related products, in October 2022, the Hong Kong Special Administrative Region (HKSAR) government released a policy document outlining its ambitions for the city to become a “vibrant” space for virtual assets. Then in April of this year, Hong Kong Financial Secretary Paul Chan (陳茂波 Chén Màobō) wrote on his blog that “the digital economy and the application of the third-generation internet (web3) indeed present great development potential.” On August 4, Hashkey and OSL became the first cryptocurrency exchanges in Hong Kong open to retail trading services in Bitcoin, Ethereum, and USDT — the three tokens the SEC explicitly does not consider to be securities. Previously, while it was possible to trade cryptocurrency in Hong Kong, transactions occurred through unlicensed exchanges.

In an email to The China Project, Brian Wong (黃裕舜 Huáng Yùshùn), an assistant professor at Hong Kong University and an established public commentator, noted that officials in Hong Kong are both interested in fostering financial innovation and signaling “the city’s desire to emerge from the shadows of geopolitical competition and stake out a seemingly distinct niche on the world map.” With its relatively robust legal system and established role as a capital market connecting mainland China with the rest of the world, Hong Kong has some natural advantages in the fintech-web3 space.

But given that China and the U.S. are Hong Kong’s main sources of economic and financial backing, it remains to be seen if Hong Kong’s web3 push is a bold move to reclaim its status as “Asia’s freewheeling financial hub” or a policy out of step with the times.

Hugh Harsono, who researches central bank digital currencies, believes it’s positive that regulators are establishing baseline procedures and accountability for digital assets. “Hong Kong’s future as a fintech hub is sustainable in the short term,” he said. Moreover, the city’s relatively loose regulatory framework will make licensing faster than in jurisdictions such as Singapore.

But longer-term uncertainties over the city’s legal relationship with China remain.

There are concerns that tightening regulations in either China or the U.S. could hurt the industry. “Hong Kong is a second-tier place as a crypto hub because of ties to China and the U.S.,” said Angus Buttar, an employee at a Vancouver-based web3 startup.

Other regions, such as Dubai and Switzerland, offer lower corporate tax rates and greater regulatory certainty.

And despite Singapore’s relatively strict regulation, Jessica Chiang (江雨伦 Jiāng Yǔlún), the director of business development for crypto quant trading at Combo Research, said the city-state is more attractive than Hong Kong for cryptocurrency businesses: “For planning 5 to 10 years [into the future], Singapore is a much better choice.” As for the larger web3 industry, she believes the U.S. remains the center of innovation, and that Singapore is the best place for later-stage fundraising.

Bitcoin and other digital tokens have demonstrated their resilience against sell-offs and government regulation. China, where cryptocurrency trading is illegal, ranked 10th globally in crypto adoption for 2022. Chainalysis, the company responsible for the index, responded to a request from The China Project by saying, “Users in China are most likely accessing these services through a VPN.”

Chiang and most others in the space feel bullish for the long-term prospects of mainstream cryptocurrencies. She believes tokens such as Bitcoin “definitely will be a new currency for the financial industry. There’s no sense they will come to zero in the long term.”

Given the difficulty of an outright ban on digital assets, some think Hong Kong would rather take part in crafting rules around their use, while also benefiting from hosting exchanges where trading occurs.

Buttar, the startup employee, notes that regulation is good for the industry in the long term. “Crypto is very hard to control…government hands are being forced,” he noted.

Whether transparent regulations will be enough to create a dynamic new sector of the economy is less clear. A Hong Kong–based employee at an established cryptocurrency company who spoke to The China Project on the condition of anonymity is pessimistic on the prospects of the industry in the city. “Lots of people ask if they should join the industry. My answer is no.”

Others believe that China and the U.S. turning away from cryptocurrencies has created an opportunity for markets such as Hong Kong. Jonathan Mui, the co-founder of Moongate, a NFT-based ticketing startup in Hong Kong, said, “The crypto exchanges in Hong Kong will definitely do very well.”

And of course, web3 involves more than cryptocurrency. Mui is not worried about products such as Moongate’s virtual tickets being classified as securities by the SEC or targeted by regulators in Beijing.

In the long term, such companies could drive economic growth in the city. “It’s about the flow of talent, the flow of money,” Mui said of Hong Kong’s web3 ambitions.

Moreover, Hong Kong has long served as both a doorway and an escape valve for capital flowing into and out of China. Multiple sources speaking on background to The China Project mentioned that Beijing may have given Hong Kong the green light to help facilitate certain forms of capital flight.

The other explanation is that Beijing is using Hong Kong to experiment with new policies for emerging industries. “The P.R.C. is trying to create web3 under its own conditions,” Harsono said. Hong Kong is a useful place to “test what they can control, what they can’t control.” Of the push, Harsono said, “Looking back at this in 20 years, folks will either call these decisions extremely innovative or extremely reckless.”

As for the longer-term prospects of success, Brian Wong wrote the government will need to demonstrate that not only is Hong Kong an ideal place for web3 businesses, but also that “web3 technology and innovation can in fact serve the public, and the wider community at large. It’s only understandable that there are web3 skeptics out there given the debacle[s of] recent years.”

In Hong Kong in 2023, MTR transit stations are once again filled with advertising for beauty products and upcoming films — a reminder that the physical world has reasserted itself. Whether the city will realize its web3 ambitions remains to be seen. But it’s apparent the government would rather risk getting caught holding the bag than being left behind.