Could Hong Kong really become China’s proxy in crypto?

With its partial autonomy, the island city of Hong Kong has traditionally served as “a gate to China” — the local trade center, backed by transparent English-style common law and an openly pro-business government strategy. Could the harbor, home to seven million inhabitants, inherit this role in relation to the crypto industry, becoming a proxy for mainland China’s experiments with crypto? 

An impulse to such questioning was given by Arthur Hayes, the former CEO of crypto derivatives giant BitMEX in his Oct. 26 blog post. Hayes believes the Hong Kong government’s announcement about introducing a bill to regulate crypto to be a sign that China is trying to ease its way back into the market. The opinion was immediately replicated in a range of industrial and mainstream media.

What happened

In late October, the head of the fintech unit at the Securities and Futures Commission (SFC) of Hong Kong, Elizabeth Wong, announced the liberalization of Hong Kong’s regulatory landscape by allowing retail investors to “directly invest into virtual assets.” 

Up until recently, only individuals with a portfolio worth at least $1 million (which marks about 7% of the city’s population) have been granted access to centralized crypto exchanges by the SFC. The regulator has also been reviewing whether to allow retail investors to invest in crypto-related exchange-traded funds, Wong noted.

Roughly a few days after, on Oct. 21, Hong Kong’s Secretary for Financial Services and the Treasury, Christopher Hu, shared his city’s fintech plans, among other efforts, directed at “transferring wealth to the next generation.” The key is establishing a regulatory regime for virtual asset service providers, and a certain bill was already introduced to the city’s lawmakers, as Hu specified.

Finally, on Oct. 31, during the city’s FinTech Week 2022, Hong Kong Financial Secretary Paul Chan assured attendees that the digital transformation of financial services is a key priority for his team. Chan’s colleague, the CEO of the Hong Kong Monetary Authority (HKMA), Eddie Yue, promised “radical open-mindedness” regarding the innovations. 

According to him, the HKMA is in the process of establishing a regulatory regime for stablecoins and has already issued guidelines to banks about cryptocurrency or decentralized finance-related services.

Crackdown on the Mainland, uncertainty on the island

Hong Kong’s intention to open up for crypto comes a year after a devastating crackdown on the industry in Mainland China. Until 2021, the People’s Republic Of China has been enjoying a status of a world leader in hash rate and cryptocurrency mining. 

Starting in May 2021, Chinese regulators began prohibiting involvement in crypto for financial institutions, then mining operations and, finally, the work of exchanges and trading for individuals. Although that didn’t effectively outlaw the crypto ownership as such, any potential for institutional development of the crypto industry in the country was frozen.

Back then, Hong Kong officials didn’t confirm (or deny) that the island city would comply with Beijing’s hardline policy on digital assets, but investors nevertheless started considering their options.

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While today it may sound ironic, in 2021, relocating his headquarters to the Bahamas, Sam Bankman-Fried of FTX was highlighting the importance of long-term regulatory guidance and clarity, which Hong Kong laced in his opinion.

This uncertainty took its toll indeed — after attracting $60 billion in crypto between July 2020 and June 2021, Hong Kong started to witness the largest players opening up alternative offices in the Caribbean or neighboring Singapore. FTX was joined by the likes of Crypto.com, BitMEX and Bitfinex.

The Hayes narrative

Mixing two plot lines — one which traces all the most important crypto innovations to China, and the other which notes Hong Kong’s historical role as the entry point to communist China — Hayes argued:

“Hong Kong’s friendly reorientation towards crypto portends China reasserting itself in the crypto capital markets.” 

According to Hayes, Hong Kong authorities cannot diverge too far from Beijing in their decisions, so opening up the crypto market amid the crackdown in the Mainland couldn’t be an autonomous act. 

The reason behind Beijing’s benevolence to such a U-turn lies in the anxiety of Hong Kong losing its status as the principal Asian financial center. It has certainly faltered during the COVID-19 pandemic when the hardline lockdown policy, exercised in China and Hong Kong, caused an investment escape wave to the neighboring competitor, Singapore, which had eased its restrictions much earlier.

Another major factor behind China’s possible support of Hong Kong’s crypto liberalization, according to Hayes, is the former’s problem with a giant United States dollar trade proficit. Historically, like almost any nation in the world, China has been storing dollar income in assets like U.S. Treasury bonds.

But the example of Russia, whose foreign assets were blocked due to financial sanctions after an invasion of Ukraine, has worried Chinese officials. Hence, it is highly probable they would seek another type of asset in which to store their USD income. Cryptocurrencies and related financial products might be the option.

Reality check

Speaking to Cointelegraph, David Lesperance, founder of Lesperance & Associates law firm, who has been dealing with Hong Kon and China-based clients for more than 30 years, doubted the possible interest of the Chinese government in opening up to crypto:

“Rather, they are interested in having complete control over their population, including those who reside in HK. This is demonstrated by such actions as social credit scoring, facial recognition, household registration, exit bans, zero COVID-19, etc.” 

Putting crypto aside, recent years have seen tightening political, cultural and economic control of China over Hong Kong with the national security law of 2020 sweeping the previous civil freedoms away, a change in school curricula to emphasize the Chinese history of the region and the ongoing integration of Mainland companies into the island’s juridical space. 

These signs of the shortening distance between the Mainland and Hong Kong might attract the attention of global regulators. As one banker said to CNN recently, “The worst scenario is that the West would treat Hong Kong as the same as the Mainland China, and then Hong Kong would suffer the kind of sanctions.”

The elephant in the room is China’s central bank digital currency (CBDC) project. The rapid development of the digital yuan (also known as e-CNY) and the ban on crypto is hardly a coincidence. As Ariel Zetlin-Jones, associate professor of economics at Carnegie Mellon University’s Tepper School of Business, told Cointelegraph back in 2021, in the aftermath of the crackdown:

“China clearly wants to promote the digital Yuan. Removing its competitors by banning crypto activities is one way to do this so it seems reasonable to consider this motivation as one rationale for their policies.”

The digital yuan became the most actively transacted currency in a recent six-week m-Bridge pilot of cross-border payments among the digital currencies issued by central banks of China, Hong Kong, Thailand and the United Arab Emirates. As state-owned Chinese media noted after the experiment, “Hong Kong [is] poised to be a vibrant center for e-CNY’s use in international trade.”

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Lesperance emphasized that the introduction of e-CNY and the continuing restrictions on the rest of the crypto, even when it comes to domestic miners, confirms Beijing’s drive to control the financial sphere in the first place:

“Control over the financial lives and assets of the Chinese citizens is the ultimate control. This will be achieved when all transactions are done in e-yuan. Facilitating other crypto-currencies would undermine this move toward complete control.”