Hong Kong OTC Regulation, where does the road lead?

Navigating OTC Regulation in Hong Kong Charting the Course Ahead

Source: Carl

Editor: Techub News-Junge

Regulation of OTC in Hong Kong is imminent. Recently, the Hong Kong Customs and Treasury Department have both expressed their intention to strengthen regulation of OTC. Some industry professionals have also embraced regulation.

However, Techub News’ on-site visit found that most offline OTC shops in Hong Kong are currently operating normally, with little sign of the impending regulatory pressure.

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Is this the calm before the storm? How will OTC regulation be implemented and what impact will it have on the industry? These are the key concerns in the industry right now.

1. OTC Regulation is Coming

In the President Commercial Building in Mong Kok, Hong Kong, there are 2 OTC shops and multiple cryptocurrency ATMs, which a person named Ahua often visits.

Ahua is a “veteran” in the coin circle in Shenzhen. Due to difficulties in withdrawing money on the mainland, he often uses Hong Kong’s offline OTC shops and ATMs for cash withdrawals.

He said, “Hong Kong and Shenzhen are completely different. Buying and withdrawing coins is so convenient, and there is no risk at all. Many people from Shenzhen go to Hong Kong for cash withdrawals. Mong Kok, Tsim Sha Tsui, Causeway Bay, there are many OTC shops.”

However, a series of recent events in Hong Kong has made Ahua somewhat worried. He said, “OTC may be regulated by the Hong Kong government, and it won’t be so convenient anymore.”

Recently, the Commissioner of Hong Kong Customs, Hermes Tang, stated that after the JPEX incident exposed regulatory loopholes, Hong Kong must address the money laundering risks brought by cash-to-cryptocurrency stores. “Regulating these off-exchange trading stores involves two aspects: combating money laundering and terrorism financing, and protecting investors,” the Commissioner said.

The Hong Kong Treasury Department also stated that the government and regulatory agencies will regularly review regulatory measures and consider introducing appropriate measures in response to market developments.

Since the JPEX case erupted in September, several OTC merchants such as Linzuo, Coingaroo, Crypto Leopard, and Dongji, have been arrested by the Hong Kong police on suspicion of conspiracy to commit fraud, and the regulatory gap in OTC has also become a focus of public opinion, with several OTC businesses suspending operations.

OTC physical stores are a convenient channel for many retail investors to invest and cash out virtual currencies. According to industry estimates, there are over 100 OTCs in Hong Kong, with billions of dollars in cash transactions processed by OTCs each year.

The Co-Chairman of the Hong Kong Blockchain Association, Tang Yi, said that OTC is very common in Hong Kong, with many small shops and ATMs. OSL and HashKey, which have obtained licenses, also provide offline OTC services. After the JPEX incident, it is inevitable for the Hong Kong government to regulate the OTC industry. Relevant government departments have expressed their intention to strengthen regulation, including KYC (Know Your Customer), CTF (Counter-Terrorist Financing), and AML (Anti-Money Laundering).

Several OTC executives have expressed their support for government regulation of the industry.

According to media reports, Li Donghan, one of the co-founders of OTC “One Bitcoin,” stated in an interview that voluntary rules have been established, requiring KYC for transactions over 120,000 yuan. They have also established a database and a continuous monitoring system to detect suspicious wallets. Shops will refuse transactions involving suspicious wallets and report to the joint wealth intelligence group.

Lin Yinhuan, the founder of another OTC, “Crypto HK,” also expressed his hope to obtain a license and expects clearer enforcement guidelines. He has studied the regulatory systems of multiple regulatory agencies and learned that the Money Service Operator (MSO) license issued by the Customs does not apply. The Securities and Futures Commission’s framework for virtual asset service providers requires a high threshold for establishing automated systems. OTCs do not act as custodians of client assets and have nowhere to be regulated.

2. Most OTC businesses are operating normally

On one hand, there is a growing call for strengthened regulation, while on the other hand, the OTC industry remains calm.

Recently, Techub News visited several offline OTC shops and cryptocurrency ATMs in Hong Kong and found that the majority are operating normally. A shopkeeper who owns nearly 10 OTC branches also confirmed to Techub News that all of their branches are operating as usual and have not been affected by the JPEX case.

OTC advertisement

Another shopkeeper of an OTC shop told Techub News that although their business is not affected, they have seen a significant decrease in customers, with most of them coming from mainland China.

According to Chainalysis data, mainland China is still the fourth-largest cryptocurrency trading market in the world. However, the unfriendly cryptocurrency policies in mainland China have placed many obstacles for cryptocurrency users, with transactions lacking legal protection and incidents of frozen accounts or even investigations by the police. Hong Kong’s open attitude towards the cryptocurrency industry and convenient OTC services provide mainland Chinese users with a good channel for deposits and withdrawals.

According to media reports, the founder of Crypto HK previously stated that during the pandemic, mainland Chinese customers accounted for less than 5% of their total customers. However, by July of this year, the proportion of mainland Chinese customers had increased to around 50%.

The aforementioned shopkeeper said, “OTC is a market necessity. As long as banks cannot provide convenient cryptocurrency deposits and withdrawals, OTC will definitely exist and cannot be completely banned. If offline shops are not allowed, they can simply operate online, as both are peer-to-peer transactions.”

“We have many stable customers, and our main business is online,” the store clerk said.

OTC is divided into two modes: online and offline. Most OTC transactions are conducted online rather than in physical OTC stores. For many merchants, physical OTC stores serve more as a facade. On one hand, they facilitate transactions with some retail investors, and on the other hand, they are more important in expanding a larger base of stable online users.

The aforementioned store clerk mentioned that only a small portion of OTC is affected by JPEX. “We only engage in pure OTC transactions and do not engage in the kind of promotion that promises high returns like JPEX. This way, we avoid scams and ensure safety.”

Cryptocurrency ATM

Techub News has experienced several OTC and ATM services, and they are very convenient. Generally, there is no need for Know Your Customer (KYC) procedures, and transactions can be completed in just a few minutes. OTC stores often offer favorable exchange rates, while ATMs may charge various fees ranging from tens of Hong Kong dollars.

A certain ATM machine with a fixed fee of 16 HKD

Since Hong Kong released its virtual asset declaration in October last year, the number of local cryptocurrency users has rapidly increased.

A store clerk from a certain OTC store told Techub News that another important customer group for physical OTC stores is users who are not very familiar with cryptocurrency trading, mainly from Hong Kong and usually of older age.

Tang Yi, Co-Chairman of the Hong Kong Blockchain Association HKBA.club, stated that many people in Hong Kong now conduct trading using USDT. They often need to convert USDT to Hong Kong dollars, US dollars, and other fiat currencies. OTC stores in Hong Kong provide them with convenient services, and it is also easy in Hong Kong to convert cryptocurrency into fiat currencies from Dubai, South Korea, Japan, and other countries.

However, behind the surge of Hong Kong’s OTC industry lies high profits and multiple risks.

Tang Yi mentioned that the biggest risk in OTC transactions is third-party fraud, which is quite common in the Hong Kong OTC trading industry. It is estimated that over 20% of OTC businesses are affected by third-party fraud, and many OTC operators often assist the police in handling such cases.

In addition, many OTC businesses are involved in money laundering cases. Recently, Bitrace analyzed Tron addresses with obvious OTC business characteristics and found that nearly 3.5 billion risky USDT flowed into these addresses over the past two years.

3. Regulation is not difficult, but caution is required

Regulating OTC in Hong Kong is inevitable, and how to regulate it has attracted much attention.

Wu Wenqian, Founder of Mura and lawyer, suggests that Hong Kong should refer to the regulatory policies of the United States and Dubai and implement a licensing system for the OTC industry. For example, OTC stores should apply for exchange licenses, and it should also require KYC verification for users to reduce the risk of money laundering.

“In addition, OTC regulation will be more favorable for compliant exchanges with licenses, helping to promote the healthy development of compliant exchanges,” said Wu Wenqian.

Chen Lexi, founder of Zhongzhu Global Group, suggested that OTC should be regulated by customs, and the existing MSO license should be extended to virtual assets. Transactions over 8,000 yuan should be registered with real names, and there should also be a responsible person who undergoes AML training, as well as mechanisms to report suspicious transactions, etc.

“One Bitcoin” co-founder Li Donghan expressed hope that regulation should start within the industry. The plan is to establish an association with major stakeholders to jointly develop KYC and AML standards. OTCs that meet the standards can join, and they also hope to share suspicious wallet databases with the industry to block the source and establish two-way information sharing with law enforcement agencies.

However, many industry insiders hold a conservative attitude towards OTC regulation.

An industry analyst told Techub News that the market demand in mainland China, coupled with the relatively flexible regulation in Hong Kong, has created a unique OTC ecosystem in Hong Kong. If Hong Kong implements strict OTC regulation, only allowing local residents to register and use it, while excluding mainland Chinese users, the industry will suffer a severe blow.

In fact, overly strict regulation cannot truly be implemented because OTC transactions are essentially peer-to-peer primitive transactions.

“The only difference is that OTC is either successfully incorporated into the legal regulatory framework or excluded from regulation into the gray area,” the industry analyst said.

Wu Wenqian also believes that the formulation of OTC regulatory rules in Hong Kong should be cautious: “In terms of technology, OTC regulation is actually very easy to implement, but OTC plays a crucial role in ensuring industry liquidity. If compliance regulation is carried out in a traditional manner, it may greatly reduce industry liquidity. The most difficult part is usually finding a balance between regulation and the market.”

What lies ahead for Hong Kong Web3 development may be worth learning from Kong Jianping, director of Cyberport.

He said that there are two contradictions in Hong Kong’s Web3 development: the government has launched supportive policies, but there have been many phenomena of “speculating on coins” and “platform collapses”. The government hopes to attract more excellent developers and entrepreneurs, but often many fraudulent organizations such as pyramid schemes cause investor losses through promotion and advertising.

“But we also see that technologies exploited by illegal activities are often cutting-edge, which reflects that Web3 will continue to improve. As long as the Hong Kong government continues to promote Web3 and leave the rest to entrepreneurs,” said Kong Jianping.

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