Future Web3 New Chapter: Triple Impact of VSAP on Exchanges, Financial Markets, and TradFiWeb3's Future: VSAP's Triple Impact on Exchanges, Financial Markets, and TradFi
With the rapid development of the virtual currency market, more and more people are investing in and trading virtual currencies. However, due to the unique nature and high risk of the virtual currency market, regulatory authorities are increasingly demanding stricter regulation of centralized virtual currency exchanges. In this context, the new Virtual Asset Service Provider (VASP) licensing system for centralized virtual currency exchanges has emerged in Hong Kong.
The VASP license is a new licensing system established by the Hong Kong Securities and Futures Commission (SFC) as of June 1, 2023, for regulating and managing institutions that provide virtual asset trading and related services, namely centralized virtual currency exchanges. The introduction of the VASP license aims to strengthen the regulation of virtual asset service providers, ensure their compliance, and protect the rights of investors.
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The VASP license requires virtual asset service providers to comply with a series of compliance requirements, including KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations, capital adequacy requirements, security measures, transparency, and reporting systems. By obtaining a VASP license, virtual asset service providers can demonstrate their compliance with regulatory requirements, enhance market confidence, attract more investors to trade, and promote the development of the virtual asset market.
(Image source: Beosin Blockchain Security Audit)
Key provisions of the Hong Kong VASP license system
The application process includes:
1. Recruit two suitable ROs (Responsible Officers) to supervise the operation of the VASP and ensure compliance with AML/CTF and other regulatory requirements.
2. Prepare relevant documents (shareholder information/business plan/company structure)
3. Complete the WINGS application form
4. Determine the application details/submit the application
5. Rent a specific location for decoration,
6. SFC approval/respond to SFC’s related questions
7. Arrange to open a bank account
8. The applicant will receive written notification regarding the approval
9. Hire follow-up compliance and audit personnel
In the article “Hong Kong Web3: 1 Year, 1 Card, 1 New Industry,” we can see that the RO position plays a crucial role in license applications. RO is a supervisory role, and the licensed company pays the salary but is accountable to the Hong Kong Securities and Futures Commission. The RO needs to pass the assessment and registration of the Securities and Futures Commission (the exam results are valid for three years) and can engage in related work for life. The RO qualification is related to personal qualifications, not to the licensed company, so the RO can freely change jobs among licensed companies. According to this system, if the RO violates the regulations of the Securities and Futures Commission, they may lose the qualification to engage in related work for life. Therefore, to maintain this professional qualification, the RO will supervise the daily operation of the licensed company from the perspective of the regulatory requirements to ensure compliance. They are the management personnel of the Securities and Futures Commission at the front line of licensed companies.
Regulatory Requirements and Compliance Measures
It is recommended that the trading platform use cold wallets to store 98% of customers’ virtual assets, and private keys and mnemonic phrases should be stored in Hong Kong to reduce the risk of the platform due to hacker intrusion or attack.
The platform operator shall not participate in self-operated transactions (except for offline back-to-back transactions) or self-operated dealer activities.
Refer to the FTX case. The platform shall not deposit, transfer, lend, pledge, re-pledge, or buy and sell customers’ virtual assets in any other way.
Customer assets can only be properly kept by wholly-owned subsidiaries holding trust or company service providers (TCSP) licenses.
The platform needs to purchase third-party insurance or allocate funds as reserves in a trust manner or by its affiliated companies to provide protection for users.
The relevant laws and regulations referred to are as follows:
Anti-Money Laundering and Counter-Terrorist Financing Ordinance 2022 (Revised Ordinance 2022)
Consultation Paper on Proposed Regulation of Virtual Asset Trading Platform Operators Accredited by the Securities and Futures Commission (VASP Consultation Paper)
Guideline on the Application of Regulatory Requirements for Virtual Asset Trading Platform Operators (VASP Guidelines)
Anti-Money Laundering Ordinance
Securities and Futures Ordinance
Impact on Centralized Cryptocurrency Exchanges
Compliant exchanges will benefit from Hong Kong’s virtual asset service provider (VASP) license. First, compliance and official recognition will enhance the exchange’s legitimacy and credibility, attracting more investors to choose to trade on the platform. As Kevin, the head of Gate Hong Kong, said, there are over 7.4 million local users in Hong Kong. By leveraging Hong Kong’s status as an international financial center, Gate aims to build a bridge for the flow of capital between the vast compliant capital and cryptocurrency exchanges worldwide.
Obtaining a license will enhance the exchange’s market reputation and industry recognition, further attracting more users and institutional investors’ attention. In addition, compliant exchanges can establish partnerships with banks, payment institutions, and other financial institutions, providing more trading pairs and financial tools, expanding users’ choices.
In terms of security, compliant exchanges need to comply with certain security standards and measures. The multi-protection measures will provide users with a more secure and reliable trading environment for asset and data security. At the same time, regulatory compliance can reduce the risk of illegal activities such as market manipulation, fraud, and money laundering, maintaining market order and stability.
Risks and challenges for non-compliant exchanges. Exchanges that operate without regulatory approval may violate local financial laws and regulations and face the risk of fines, suspension, or other legal risks. Without compliance, investor trust in the exchange may decrease, affecting trading volume. Under market competitive pressure, user loss may occur.
Impact on the Market
Market makers are the most sensitive group of professionals to trading. After interviewing several local market makers in Hong Kong, I chose to look at this impact from the perspective of market makers. Hong Kong’s cryptocurrency market makers currently hold a positive outlook on the new VASP licensing system because compliant operations help enhance the trustworthiness and transparency of the entire cryptocurrency market. Licensed exchanges comply with stricter regulatory requirements, which is beneficial for reducing trading risks and protecting the interests of both retail and institutional investors.
However, this is not absolute, as market makers also consider other factors such as trading volume, transaction costs, and the technical and operational capabilities of the exchange when choosing which exchanges to operate on. Higher liquidity provides a guarantee for faster and more stable trading opportunities. Transaction costs determine the relevant trading costs, and a reasonable fee structure will help market makers’ profit margins. If a licensed exchange can provide competitive services in these areas, market makers are more likely to choose to trade on these exchanges.
Impact on Traditional Finance
After obtaining a license for compliant operations, the impact of cryptocurrency exchanges on traditional finance is multifaceted. Compliant cryptocurrency exchanges will introduce a large number of new financial products and services, enhance the competitiveness of the entire Hong Kong financial market, and pose a challenge to traditional financial institutions. At the same time, this may also drive traditional financial institutions to innovate in order to meet new market demand.
The emergence of compliant cryptocurrency exchanges will change investors’ investment behavior and strategies. The high volatility of cryptocurrency investments is more attractive and may attract some “hot money” from traditional financial markets. This will affect the flow of funds in traditional financial markets.
In addition, the services provided by cryptocurrency exchanges are usually more convenient, user-friendly, and can provide services around the clock. This may drive traditional financial institutions to improve their services to meet customer needs and promote the integration of financial technology and traditional finance.
It is worth noting that compliant cryptocurrency exchanges may also bring new risks, such as cryptocurrency price volatility and security issues. This may affect the strategies and policies of financial regulators.
Overall, the compliant operation of cryptocurrency exchanges can not only have a profound impact on the traditional financial industry, but also promote further integration and development of financial technology and traditional finance. The future financial market may become more diverse, open, and flexible as a result.
Comparison and Enlightenment of International Regulations
The regulatory models for virtual asset service providers (VASPs) vary significantly in different regions. The regulatory model in each place usually depends on its attitude towards virtual assets, legal system, and the characteristics of its financial market. In many regions, such as the United States, the regulation of virtual asset service providers is handled by multiple agencies. For example, exchanges may need to obtain a license from the Financial Crimes Enforcement Network (FinCEN) while also meeting the requirements of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). This decentralized regulatory model can provide more comprehensive regulation but may increase compliance costs.
While the United States has taken a more decentralized approach to regulating virtual asset service providers, the European Union (EU) has adopted a more centralized regulatory model. Europe has incorporated the regulation of virtual asset service providers into its anti-money laundering and counter-terrorism financing (AML/CFT) regulations, which all member states are required to comply with. The advantage of this model is that it provides a unified regulatory framework and simplifies the compliance process.
Hong Kong’s regulatory model has its own uniqueness. In 2020, the Financial Services and Treasury Bureau (FSTB) of Hong Kong proposed new regulations for virtual asset trading, requiring all virtual asset trading platforms to obtain a license from the Securities and Futures Commission (SFC) of Hong Kong in order to operate. Unlike many regions that only regulate services provided to retail customers, Hong Kong’s regulatory scope includes all cryptocurrency transactions, whether they are retail or institutional clients.
In addition, Hong Kong has also achieved regulatory alignment with traditional financial markets. For example, SFC’s regulatory requirements for virtual asset trading platforms are similar to those for traditional securities trading platforms. This model helps ensure the stability of the virtual asset market and provides a compliant path for the further development of virtual assets.
Hong Kong’s regulatory model has certain reference value. First, it provides a comprehensive regulatory framework that includes all types of virtual asset trading. This helps prevent regulatory loopholes and eliminates potential investment risks. Second, by aligning the regulation of virtual asset trading platforms with that of traditional financial markets, market fairness and transparency will be ensured, while providing a compliant path for the further development of virtual assets. This provides valuable reference for other regions on how to balance innovation and regulation.
Finally, as an international financial center and innovation and technology hub, Hong Kong will usher in broader development prospects after the compliance of virtual assets. With the rapid development of the global digital economy, virtual assets will become an important part of financial transactions and investment. The Hong Kong government actively promotes the compliance of virtual assets and has established corresponding regulatory frameworks and supervision schemes, which will surely lead the way in global financial innovation.
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