Overview

In October 2022, the Hong Kong government announced its plan to promote the city as an international blockchain hub, stating that it will establish favorable policies for companies to set up businesses in the region.

At the same time, Hong Kong’s Securities and Futures Commission (SFC) announced a regime for crypto futures ETFs, giving retail investors indirect access to digital assets trading.¹

Re-emphasizing the city’s desire to set their mark as a premier digital assets destination, the SFC announced proposed legislation requiring all centralized digital assets trading platforms to be licensed with a regulatory body, which would allow all types of investors, including retail investors, to participate.²

These announcements have started a ripple effect in the industry, causing both incumbents and newcomers to take advantage of these new opportunities.

Shortly after the proposed regulation was announced, OKX quickly announced that it has set up an HK entity and will apply for an HK Virtual Assets Service Provider (VASP license).³

The new VASP licensing regime took place on June 1st.

While some have been eagerly awaiting to explore the opportunities that come with the new regulation, others have been skeptical, opting to take a ‘wait-and-see’ approach before planning their next steps.

Local Institutional Support

Hong Kong established the Web3 Institute last month to supplement its regulatory efforts in the space.

The Institute is led by Norman Chan, who previously served as the Head of the Hong Kong Monetary Authority (HKMA), who brings experience from the traditional finance sector.

He will translate this knowledge into guiding the institute towards robust standards and frameworks for the city’s seamless transition into adopting digital assets.

Although China had previously imposed a stringent ban on digital currencies in 2021, it has appointed Li Feng, the CEO of China Mobile International, as the Institute’s honorary chairperson.

This is seen as a positive sign towards China’s view on Hong Kong’s positioning as Asia’s digital assets hub, and is definitely a first step for China to re-open the door to the industry.

Given our strong history and network in Hong Kong, Cadenza has reached out to the Web3 Institute and are actively exploring potential avenues for collaboration.

Additionally, the Hong Kong government has also allocated approximately $6.4MM USD to develop its Web3 ecosystem.⁶  

Hong Kong Cyberport, a startup incubator and ecosystem wholly owned by the HKSAR government, has also been a strong supporter of fostering blockchain technology in the region for years.

Although they seek to invest in many different technology verticals, they have identified blockchain as ‘one of [their] key technology clusters.⁷

Animoca Brands, a leading Web3 gaming company advancing digital property rights for the open metaverse, is perhaps one of the biggest success stories to come out of the Cyberport’s community.

Founded in 2014, Animoca had reached Unicorn status in 2021 after a $88MM USD capital raise.

Cyberport actively promotes digital entertainment ventures, attracting potential startups in the industry to join the community, which creates synergy for all the companies here.⁸  

For companies that plan to set up or relocate to Hong Kong after this regulatory change, Cyberport presents an attractive ecosystem for development and growth.

One of the big motivations behind Hong Kong’s aggressive regulatory push is to regain its position as Asia’s premier financial hub.

In recent years, amidst China’s digital assets clampdown and rigorous COVID policies, many founders had relocated and fled to Singapore to set up their businesses.

Looking from a wider macro perspective, Singapore’s assets under management ‘grew 16% to $4tn, while Hong Kong’s grew by only 2% to $4.6tn.⁹

Therefore, the establishment of institutions to support the industry’s development could serve as a dealbreaker for many Singaporean-based companies to consider relocating to Hong Kong.

Additionally, the Hong Kong Monetary Authority announced in mid-May that a trial run for a digital Hong Kong Dollar (e-HKD) is in the works.

This move is timely and is reflective of recent trends. According to the 2022 Global Payments Report published by the FIS, ‘digital wallets will account for 40% of the city’s online transaction value by 2025, overtaking credit cards.¹⁰

Alongside other institutions that are playing a role in fostering Web3 adoption in the region, the e-HKD trial run will involve ‘around 16 handpicked banks and payment companies, including industry heavyweights HSBC and Standard Chartered, [whom] will undertake tests involving six potential use cases for the digital asset.¹¹

Startup Opportunities

The regime is set to bring forth a whole new wave of companies that specifically operate within one set of regulations.

Specifically, the aforementioned regime plans to ‘supervise the governance, issuance and stabilization of stablecoins’, starting with fiat-backed ones.

Founded in 2021, CNHC is registered in the Cayman Islands as a cross-border payment service provider; with the latest announcement, they are now in the process of moving its headquarters to Hong Kong, which is also home to the largest offshore center historically.

Other established players are also looking to tap into the space.

In December of last year, the Tron blockchain launched TCNH.

A stablecoin pegged to Offshore Chinese Yuan.¹³

With both the Hong Kong and Chinese government looking for ways to push digital currency adoption in their jurisdictions, companies can benefit by building solutions that complement these political agendas with increasingly visible regulatory guidelines.

As mentioned above, other internationally-based exchanges such as OKX have expressed their desire to move into the region as well.

However, these transitions might prove more tedious than it seems.

Another digital assets exchange, Bitget, announced that Hong Kong users will be required to move to www.BitgetX.hk and ‘close any open perpetual contract or margin trading positions and withdraw their virtual assets from Savings products at Bitget.com.¹⁴

This presents an opportunity for new exchange players to enter the space and provide a product that is both compliant and user-friendly.

Innovative products are continuously being developed in line with the region’s shifting regulatory landscape.

Conflux Network, a Layer 1 protocol that claims to be the only regulatory compliant, public and permissionless blockchain in China, announced that it has partnered with China Telecom to build blockchain-based SIM cards.¹⁵

These BSIM cards will allow users to ‘store digital assets safely, transfer their digital assets conveniently, and display their assets in a variety of applications’.

On May 18th, Conflux unveiled their BSIM card, as well as announcing that they will be piloting the product in Hong Kong before introducing it to Mainland China and overseas.

This shows that companies have identified an existing market large enough in Hong Kong to test their products, hinting at the potential of the startup ecosystem that is yet to be unlocked.

In recent years, Hong Kong has become home to a budding blockchain startup ecosystem.

In 2022, FinTech News identified approximately 400 FinTech-related startups in the city, and found that blockchain represents the largest FinTech segment (24%).¹⁶

Venture Ecosystem

Looking Ahead

On May 23rd, the Hong Kong SFC concluded its consultation on regulation of digital assets trading platforms.

Including these key points:

Additionally, the SFC has said that they have not approved any virtual asset trading platforms to provide their services to retail investors.

However, there now exists a very concrete and actionable framework for companies to follow.

There have been mixed reactions from the community regarding these new rules.

Some think that they are too restrictive, and that they are not enough to enact any sort of significant change in the ecosystem.

However…

Others welcome the change, stating that clear-cut boundaries are a positive sign showing the city is ready to properly embrace wider digital assets adoption.

Ultimately, the regulatory landscape for digital assets and Web3 is shifting every day, and there remains a lot to be seen on how Hong Kong’s Web3 ecosystem takes shape.

For now, the new regulatory frameworks supported by institutional involvement will definitely propel Hong Kong’s position as a digital assets destination.

At Cadenza, we plan to actively monitor deal flow for new and exciting investment opportunities, and build out a robust investor network in the region to stay updated with the latest activities.

Inflationary Fiat Currencies

Although inflation has recently been a hot topic globally, countries such as Argentina and Turkey have been dealing with extremely high inflation (in some cases reaching hyperinflationary levels¹) on their local currencies for decades.

Inflation is caused by a number of factors but two of the primary forces are:

1. An increase to a country’s money supply (which takes place at the direction of local government through a combination of fiscal and monetary policy)

2. Relaxed banking regulations whereby banks can lower their lending standards effectively increasing the amount outstanding debt.

The negative impact inflation has on society is higher prices for everyday goods and depleted savings value which can be significantly amplified if inflation is untamed ultimately resulting in hardship for citizens of that country.

Our view has been that alternative and globalized solutions to local currencies in countries and regions with uncertainties as described above would lend themselves well from a demand perspective.

Restrictive Monetary Policy

Capital controls are a form of monetary policy that certain countries use to limit the inflows and outflows of foreign capital within a domestic economy.

There has historically been a lot of debate amongst economists as to the pros and cons of capital controls and their effectiveness as a form of monetary policy.

“One effect that’s undeniable is that capital controls limit the investment options for non-affluent citizens to invest globally”.

In the case of India, the Reserve Bank of India (“RBI”) has implemented specific limitations on how much Indian citizens can invest outside of India through a program called the Liberalised Remittance Scheme (“LRS”).

Currently, the LRS allows Indian citizens to invest up to $250K USD globally per year with prior written approval from the RBI (it should be noted that in 2004, the LRS had a limit of $25K USD).

With a population of 1.4B, India represents nearly 20% of the world’s population.

Our view is that globalization will continue to accelerate in the coming decades and citizens in countries with strict capital controls will actively seek the ability to invest globally without limitations.

Inefficient Cross-Border Payment Rails

Per the World Bank, remittances to low and middle income countries grew to over $625B USD in 2022.

Remittances have become a significant source of private financial resources for households in emerging markets.

These transfers have been extremely beneficial to economic growth in these countries helping to curb poverty, promote household formation, and technological advancement.

The remittance industry is known for high fees and slow processing times which has been a main focus of the United Nations (“UN”) in recent years.

One of the UN’s goals by 2030 is to reduce the cost of remittances to less than 3% and eliminate any remittance corridors with costs in excess of 5%.

In 2022,

• The Philippines had the fourth largest amount of remittance inflows in the world with over $30B USD coming into the country.

• Nigeria was not far behind with over $20B USD in remittance inflows, making it the ninth highest in the world³ .

In the Philippines, overseas foreign workers are a main part of the country’s economic development plans.

The current government continues to expand their labor exportation with plans to send over 500K Filipinos abroad in 2023.

These workers will contribute significantly to the remittance inflow over the coming years.

In 2021, the Central Bank of Nigeria (“CBN”) rolled out its ‘Naira 4 dollar scheme’ to further incentivize remittances throughout the region by offering 5 Naira for every $1 USD.

This program was originally only supposed to last three months.

But was extended indefinitely by the CBN given its overwhelming success.

Per Grand View Research, the global digital remittance market is expected to expand at a 15.6% CAGR between 2023-2030.

Summary

The most recent banking crisis and some of the repeated mistakes from 2008 have caused many to reflect on the principles that led to the adoption of Bitcoin and other cryptocurrencies.

While we have long avoided taking the extremist view that Bitcoin will displace fiat currencies and that banks will become extinct,

Here’s what we do think…

1. Please reference a recent article by the BBC speaking to Argentina’s inflation rate surpassing 100% for the first time since the end of their hyperinflation cycle in the 1990s.

2. Although Rain Financial services multiple countries in the MENA region, one of their key markets is Turkey.

3. Please reference a recent article by the World Economic Forum speaking to the role that remittances play around the world as well as the level of remittances by country in recent years.

4. Please reference an overview industry analysis by Grand View Research speaking to the global digital remittance market in recent years and the prospects in future years.