Hong Kong's crypto competitiveness challenge

The US SEC has approved applications for Ether ETFs, neutralising Hong Kong’s brief regulatory advantage, prompting the financial hub to seek new strategies as 11 exchange platforms await regulatory approval.

The US Securities and Exchange Commission (SEC) approved rule changes on May 23 that paves the way for spot Ether ETFs, in a development which reflects expanding institutional acceptance and regulatory clarity for the world’s second-largest cryptocurrency after Bitcoin.

While the move is expected to lift crypto demand, the endorsement’s timing came as a surprise, according to industry and market experts. Ether was not initially included when the SEC approved cryptocurrency backed ETFs in January, clearing the road for Hong Kong’s Securities and Futures Commission (SFC) to take a brief regulatory lead after they approved both Bitcoin and Ether funds in May.

The SEC’s announcement effectively places Hong Kong’s regulator on equal footing to Washington, meaning the the Asian financial centre will grow its product and service offering to reclaim its competitive advantage, said Rania Gule, market Analyst at XS.com, to FinanceAsia.

Gule suggested a range of options, proposing that the most feasible response would be approving less popular cryptocurrency tokens. “By diversifying its portfolio of supported cryptocurrencies, Hong Kong can attract a wider range of investors and strengthen its position as a global crypto hub,” she said, underscoring that Hong Kong’s openness to emerging trends and flexibility in adapting to evolving market conditions are the essential components investors are seeking at this time.

The sentiment is echoed by Yang Xu, partner at Tiger Brokers who said: “Hong Kong is actively working to establish clear regulations and guidelines around cryptocurrency trading and investment activities, promoting transparency and accountability among market participants while reducing risks associated with holding and managing cryptocurrencies."

Xu added: "Hong Kong’s regulator could adopt an ‘in-kind’ transaction mechanism, allowing investors to buy and sell ETF shares using relevant crypto tokens." 

Ether staking

Another idea worth considering is enabling Ether staking, which was specifically prohibited during the SEC’s approval process. Staking, which involves locking up cryptocurrency as collateral to support the network, incentivises investors to use idle cryptocurrencies to validate transactions by accruing extra yield on their holdings.

While investors would likely welcome the passive income on an otherwise idle digital asset, Gule explained that from the SEC’s perspective, enabling Ether staking could potentially increase inherent risks by exposing a regulatory arbitrage outside their jurisdiction.

Precedence already exists. Back in 2022, the SEC charged Payward Ventures and Payward Trading Ltd, better known as Kraken, with failing to register their crypto asset staking as a service program, when it was offering double digit yields on select accounts.

For crypto enthusiasts, Ether staking offers technological benefits beyond the finance realm. Because existing digital tokens are utilised to validate transactions, staking is less energy intensive when compared to proof of work validations for tokens like Bitcoin, where digital mining, when measured in terawatt hours, consumes more energy than either the Netherlands or Pakistan. Using additional Ether tokens as collateral would also boost investor confidence to hold it as an asset class, possibly positioning it as an alternative to Bitcoin.

However, crypto sceptics counter that the SEC maintains a vague stance on whether Ether is categorised as a security or as a commodity, identifying it as the former in the Kraken lawsuit. This is where proactive dialogue between the US and Hong Kong can establish mutual understanding and cooperation to evolve the crypto landscape rather than becoming one that just cuts red tape to be competitive, Gule says.

Establishing a competitive framework becomes more crucial to Hong Kong’s crypto ambitions. In early June, the SFC unveiled a list of 11 cryptocurrency exchange platforms with licenses nearing approval. Industry experts see cryptocurrency integration within established regulatory frameworks as the main component to mitigate volatility and enhance market integrity, instilling the credibility that draws traditional financial entities into the digital space.

As the US SEC and Hong Kong SFC strive to establish the right balance to promote virtual assets within an established framework, so too do other jurisdictions such as Dubai and Singapore, that have reflected aspirations to become digital currency leaders as well. That competition is unlikely to abate, ultimately benefiting cryptocurrencies, analysts predict.

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