The year 2022 was a catastrophic one for the global crypto industry, with the collapses of the FTX Group and the Terra Luna ecosystem, as well as the bankruptcies of crypto lenders Celsius Network and Blockfi, and crypto hedge fund Three Arrows Capital, among the factors that wiped out some $2 trillion from the market. However, Asian jurisdictions like Singapore, Hong Kong and Japan have been realistic in acknowledging that crypto isn’t going away any time soon. Instead, they seek to strengthen cryptocurrency regulations and maintain their balancing act in attempting to minimise speculative and compliance risks.
Despite a series of high-profile collapses of crypto exchanges, multiple Asian jurisdictions are now working to clear away regulatory uncertainties for market participants and tap into a growing asset class.
Some jurisdictions have taken aggressive steps and opened channels for retail investors, while others have been more cautious.
The developments come with risks, however, both for traders and regulators. And the risks are multiple. The recent collapse of FTX Trading was a reminder of the multiple risks for the crypto market. It was hardly the first exchange to go bust, nor will it be the last.
Perhaps the first giant and high-profile crypto failure was that of Mt. Gox, a Tokyo-based cryptocurrency exchange considered, at its peak, the world’s largest Bitcoin exchange in terms of trading volume. Mt. Gox declared bankruptcy after being hacked and losing “hundreds of thousands of bitcoins” in 2014. After years of lawsuits and speculation, Mt. Gox started repayments to creditors in March 2023, a little relief for some of the earliest bitcoin believers.
Moving forward, market participants expect crackdowns in the U.S. on banks that served crypto customers to lead more crypto companies to shift to Asia. The crackdowns are set to cut the cryptocurrency industry off from its banking services.
To better regulate an emerging but growing industry, jurisdictions in the Asia Pacific have adopted growth and development mindsets towards virtual assets (VAs), with some being more mature in their regulatory regimes than others, says Karen Man, a partner in Baker McKenzie’s Financial Services group in Hong Kong.
JAPAN TAKES THE PROACTIVE ROUTE
Japan has developed comprehensive regulations around crypto, from decentralised autonomous organisations (DAO) to non-fungible tokens (NFT), as promoting Web3 remains part of Japan’s national strategy. The market in Japan is set to be dynamic, with vibrant competition.
Japan was among the first places to recognise the potential of a decentralised digital ecosystem and cryptocurrency mining, starting with Bitcoin. The Payment Services Act (PSA) recognised Bitcoin and other VAs as legitimate property in April 2017. Companies like Mt. Gox were established early and broke new ground globally.
As of April 30, 2023, Japan was home to 30 crypto-asset exchange service providers, according to Japan’s Financial Services Agency (FSA).
The PSA recognises crypto asset payments as methods that are not denominated in fiat currency and are used for paying unspecified persons. It mandates crypto asset exchange services to register with the FSA and comply with strict know-your-customer (KYC) and anti-money laundering (AML) regulations. This legislation aims to ensure that crypto exchanges in Japan operate transparently and securely, and protect investors. There are no restrictions on owning and investing in cryptocurrencies.
On the other hand, “security tokens”, which represent shares, bonds or fund interests in tokens, are regulated under the Financial Instruments and Exchange Act (FIEA) as electronically recorded transferrable rights.
In May 2020, the PSA and the FIEA made amendments and replaced the term “virtual currency” with “crypto-asset” which brought clarity to the regulation of cryptocurrency exchanges and trading platforms.
Based on the market's current state of development, Japan is trying to align itself with global standards, and even move further.
The Japanese authorities are now planning to revise the Act on Prevention of Transfer of Criminal Proceeds to require exchanges to provide user data when sending cryptocurrencies to another exchange, according to multiple reports.
In May, Japan signalled its support for suggestions by the Financial Action Task Force (FATF), the world’s money laundering and terrorist financing watchdog, for jurisdictions to implement a cryptocurrency “travel rule,” which requires digital asset firms to share and screen customer data for transfers above a certain threshold. Japan had not yet implemented the travel rule.
Japanese politicians have also been encouraging the emerging industry and aim to make it safer.
In an October 2022 speech, Japan’s Prime Minister Fumio Kishida said the government will further invest in digital transformation and expand the use of Web3 services. Web3 refers to the next evolution of the World Wide Web, which incorporates concepts such as decentralisation, blockchain technologies, and token-based economics.
In September 2022, the government of Japan awarded non-fungible tokens (NFTs) to seven mayors for their achievements in their respective municipalities. This placed Japan as one of the first national governments to use digital technology to issue NFTs as supplementary rewards for good performance.
HONG KONG MOVES TOWARDS REGULATION
Hong Kong has been an international finance hub for decades and has plenty of experience providing fast and efficient financial services. It is looking to replicate all that in the crypto space.
Thanks to a relatively loose regulatory environment, the city was once home to some big names in the crypto space, including Bitmex and the controversial failed exchange FTX.
Hong Kong started later than Japan and only recently confirmed the nature of cryptocurrencies in its regulations. In an April case involving the now-defunct crypto exchange Gatecoin, a Hong Kong court ruled that cryptocurrencies are “property” that can form the subject of trust.
Before the Gatecoin decision, some case law confirmed that the familiar legal principles of trusts and injunctions could apply equally to cryptocurrency as a novel asset class, though the issue of whether they were property had not been ruled upon directly, according to Karen Man of Baker McKenzie.
Man notes that the Gatecoin decision has significant implications for players in the cryptocurrency market by offering greater certainty concerning their legal status and the rights and obligations under the law.
“This may positively impact the ability, for example, for banks and other financial institutions to accept (virtual assets) as collateral and take security over these assets,” says Man.
“The decision also confirms, for cryptocurrency exchanges and their investors, that the terms and conditions of use of the exchange are a key factor in determining whether the cryptocurrencies deposited are held in trust for an investor and will be returned to users if the exchange is wound up or made available for distribution to unsecured creditors.”
Man says VAs are challenging to regulate because blockchain and smart contracts offer almost limitless scope for issuers to determine the nature of a virtual asset and its rights and obligations. This means each VA needs to be considered on a case-by-case basis against the relevant regulations, and its treatment determined in light of the current regulatory regime.
However, Hong Kong has ramped up efforts to develop the industry with some regulations in place.
“Hong Kong has been very fortunate to have seen an ongoing willingness across key stakeholders and industry participants to contribute to the development of the crypto industry,” says Man.
The current environment in Hong Kong is very friendly for Web3 startups, especially those focusing on tech or infrastructure development. Hong Kong has unveiled several initiatives, including a new licensing regime for virtual asset service providers (VASP) that took effect on June 1.
The licensing regime centralises virtual asset trading platforms doing business in Hong Kong or actively marketing services to Hong Kong investors, which are licensed and regulated by the Securities and Futures Commission (SFC). Man thinks the changes to the regulatory regime represent an important milestone, and believes Hong Kong is now set for significant development and has the opportunity for healthy growth going forward.
“Virtual asset trading platforms (which provide trading services in non-security tokens only) that are currently operating in Hong Kong without a license, or propose to operate in Hong Kong in the future, will be brought within the regulatory remit of the SFC,” Man adds.
The new licensing regime will require VA platforms to meet a range of capital and investor protection measures and proposes retail access to licensed platforms.
“In addition to regulating from an AML perspective, Hong Kong’s proposed regime imposes both licensing and conduct requirements on platform operators. This includes robust onboarding requirements to conduct investor knowledge and suitability assessments, rules regulating token admission and trading, safeguards on VA custody, and fitness and properness requirements for the individuals and companies that are licensed.”
Karen Man, Baker McKenzie
“In addition to regulating from an AML perspective, Hong Kong’s proposed regime imposes both licensing and conduct requirements on platform operators. This includes robust onboarding requirements to conduct investor knowledge and suitability assessments, rules regulating token admission and trading, safeguards on VA custody, and fitness and properness requirements for the individuals and companies that are licensed,” says Man.
Man thinks the new regime heralds the next chapter and underscores a renewed and consolidated commitment by the SFC to continue to promote innovation and growth of the VA industry in Hong Kong to all investors.
“The SFC’s previous opt-in licensing regime for VA trading platforms which offer at least one security token was one of the first of its kind, and provided a mechanism to foster innovation and investment potential,” says Man.
Man believes the revised measures provide an important opportunity to enable the industry's stable growth and facilitate safer access by a wider group of investors, including the retail segment.
Looking ahead, experts think more regulations in the offing will provide even more clarity.
Rocky Mui, a partner at Clifford Chance, tells ALB that the SFC published on May 23 the results of its consultation on the proposed regulatory requirements for Virtual Asset Trading Platform (VATP) operators licensed by the SFC.
The consultation has received some comments from market participants.
The key comments received have been related to retail access to licensed VATPs, token admission criteria, insurance/compensation arrangements, AML, and counter-financing of terrorism (CFT) matters, and transitional arrangements.
“The SFC will carry out further consultation regarding virtual asset derivatives and will publish further guidance on the dual-licensing regime,” adds Mui.
Paul Li, Co-Director of PolyU and Cybaverse Academy Joint Lab on Law and Web3, tells ALB that the VASP licensing regime only addresses VA exchanges, and there are still quite some other new species in the crypto world where “we need new regulations.”
Man anticipates further regulatory moves to implement a stablecoin-specific regulatory regime. The Hong Kong Monetary Authority (HKMA) has issued a discussion paper, saying that only license-holding companies will be able to issue stablecoins and offer cross-border payments.
And there are many other legal issues to resolve, including the registration issue for a DAO to be a legal entity, the intellectual property (IP) rights of NFTs, and commercial disputes issues when there is no legal contract in decentralised finance, Li notes.
Kavi Harilela, business director of Payment Asia, an electronic payment solutions provider in Hong Kong, also thinks traders are still waiting for the HKMA to give clearer guidance.
“The HKMA recently released a circular urging banks to support legitimate cryptocurrency businesses. The document emphasises the necessity for banks to provide access to financial services for these firms while maintaining a risk-based approach to anti-money laundering initiatives.”
Kavi Harilela, Payment Asia
“The HKMA recently released a circular urging banks to support legitimate cryptocurrency businesses. The document emphasises the necessity for banks to provide access to financial services for these firms while maintaining a risk-based approach to anti-money laundering initiatives,” says Harilela.
Still, it will take time for more financial products to be developed and more institutions to get involved in crypto.
Singapore’s approach to cryptocurrency regulation is supportive, but also includes aggressive measures to protect consumers and prevent illegal activities.
Singapore has been known for being one of the most crypto-friendly countries in the world, with a regulatory approach that is generally seen as balanced and supportive of innovation in the industry.
In Singapore, cryptocurrencies are not considered legal tender, but they are recognised as a form of payment and are subject to regulation by the Monetary Authority of Singapore (MAS). The MAS has taken a progressive approach to regulating cryptocurrencies, recognising their potential benefits while also seeking to mitigate their associated risks.
The MAS’s managing director Ravi Menon says the authority’s strategies aim to promote innovative and responsible digital asset activities.
“If a crypto hub is about experimenting with programmable money, applying digital assets for use cases, or tokenising financial assets to increase efficiency and reduce risk in financial transactions, yes, we want to be a crypto hub,” Menon said in his opening address at the Singapore Fintech Festival 2022.
However, the city-state does not want to be a “hub” for trading and embrace retail investors, probably to avoid risks. “If it (a hub) is about trading and speculating in cryptocurrencies, that is not the kind of crypto hub we want to be,” said Menon.
Therefore, Singapore tries to avoid excessive risk for retail investors. As a result, Binance, the world’s largest digital assets exchange, withdrew its licensing application to operate an exchange in Singapore after failing to gain regulatory approval in December 2021.
Singapore authorities do not ban retail access to cryptocurrency, but they have been discouraging the public from investing in the space. For example, earlier in 2022, Singapore banned promoting cryptocurrency activities in public services, including train stations.
“Innovation and regulation are not incapable of coexisting. We do not split the difference by being less stringent in our regulation or being less facilitative of innovation,” Menon said in a speech at a fintech conference in August 2022.
For VASPs, Singapore’s approach is similar to both Hong Kong and Japan. Under the Payment Services Act (PSA), crypto businesses that conduct activities such as buying, selling or facilitating the exchange of cryptocurrencies are required to be licensed by the MAS and comply with AML and CFT requirements.
Further, the Financial Services and Markets (FSM) Bill passed in April 2022 regulates VASPs created in Singapore but only offers overseas services for AML/CFT purposes.
In addition to the regulatory framework for payment services, Singapore has established a FinTech Regulatory Sandbox for fintech startups, including those working on blockchain and cryptocurrency solutions. The sandbox allows companies to test their products and services in a controlled environment with regulatory oversight, which can help them to refine their offerings and navigate the regulatory landscape.
Crypto-relative regulations are expected to be stringent in Singapore.
“The regulatory approach is always market specific. The differences in regulatory approach can make it more difficult for a crypto business to scale up an offering in Asia, as there is not always a one-size-fits-all solution that can be offered in all of the potential markets without any change,” Man of Baker McKenzie says.