Where is Hong Kong’s OTC regulation heading?

Unraveling the Future of Hong Kong's OTC Regulation

Hong Kong’s regulation of OTC is imminent. Recently, Hong Kong customs and treasury officials have expressed their intention to strengthen regulation of OTC, and some industry insiders have also embraced regulation.

However, Techub News found during field visits that most offline OTC shops in Hong Kong are currently operating normally, with almost no pressure from impending regulation.

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 of the industry at the moment.

| Regulating OTC Approaches

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In President Commercial Centre in Mong Kok, Hong Kong, there are two virtual currency OTC shops and multiple cryptocurrency ATMs, which are frequented by a person named Ahua (alias).

Ahua is a “veteran” in the coin circle in Shenzhen. Due to the ease of withdrawing money from the mainland, he often uses offline OTCs and ATMs in Hong Kong to withdraw money.

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 in Shenzhen go to Hong Kong to withdraw money. Mong Kok, Tsim Sha Tsui, Causeway Bay, there are many OTC shops.”

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

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

Regarding OTC regulation, the Hong Kong Treasury also stated that the government and regulatory agencies will periodically review regulatory measures and consider introducing appropriate measures in response to market developments.

Since the eruption of the JPEX case in September, Linzuo, Coingaroo, CryptoLeopard, Dongji, and other OTC business executives have been arrested by the Hong Kong police for alleged conspiracy to commit fraud. The regulatory gap in OTC has also become a focus of public opinion, and many OTC businesses have suspended operations.

OTC physical stores provide a convenient channel for many retail investors to invest in virtual currency and withdraw money. According to industry estimates, there are over 100 OTCs in Hong Kong, processing billions of dollars in cash transactions each year.

Tang Yi, Co-Chairman of the Hong Kong Blockchain Association HKBA.club, said that OTC is widespread 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. The relevant government departments have expressed their intention to strengthen regulation, including KYC (Know Your Customer), CTF (Counter-Terrorist Financing), and AML (Anti-Money Laundering).

Many OTC managers have expressed their welcome for the Hong Kong government’s regulation of the industry.

According to media reports, Li Donghan, co-founder of OTC “One Bitcoin,” stated in an interview that they voluntarily set rules, requiring KYC for transactions above 120,000 RMB; they also plan to establish a database and continuous monitoring system to detect suspicious wallets. OTC shops will reject transactions involving suspicious wallets and report them to the Joint Wealth Intelligence Group.

Lin Yinhuan, the founder of another OTC called “Crypto HK,” has also stated that they have always hoped to obtain a license and are looking for clearer regulatory guidance. After studying multiple regulatory agency institutions, they found that the Money Service Operator (MSO) license from the Customs and Excise Department is not applicable, and the SFC’s virtual asset service provider framework has high automated system requirements. Since OTCs do not hold client assets, they have nowhere to be regulated.

| Most OTCs are operating normally

On one hand, there is the strengthening of regulation, and on the other hand, there is the calm OTC industry.

Techub News recently visited several OTC shops and cryptocurrency ATMs in Hong Kong and found that most of them are operating normally. A merchant with nearly 10 OTC branches confirmed to Techub News that all their branches are open for business and have not been affected by the JPEX case.

OTC promotional advertisement

Another OTC shop employee told Techub News that although their business is not affected, they have seen a significant decrease in customers, with most of them being mainland Chinese users.

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 set up many obstacles for cryptocurrency users. Transactions are not legally protected, frozen accounts are common, and investigations by the police may occur. The open attitude towards the cryptocurrency industry in Hong Kong and the convenient OTC services provide a good channel for mainland Chinese cryptocurrency users to deposit and withdraw funds.

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 customer base. However, by July of this year, the percentage of mainland Chinese customers had increased to around 50%.

The aforementioned shop employee said, “OTC is a market necessity. As long as banks cannot provide convenient cryptocurrency deposit and withdrawal services, OTC will continue to exist. If offline shops are not allowed, they can simply operate online, as it is a peer-to-peer transaction.”

“We have many stable clients, and our main business is conducted online,” the employee added.

OTC can be divided into two models: online and offline. Most OTC transactions are conducted online rather than in physical OTC shops. For many businesses, physical OTC shops serve as more of a facade, facilitating transactions with individual retail investors and, more importantly, expanding their user base online.

The shop employee mentioned that only a small portion of OTCs are affected by the JPEX case. “We only engage in simple OTC trades and do not engage in promotions with high returns like JPEX. This way, we avoid fraud and ensure safety.”

Cryptocurrency ATM Machine

Techub News has experienced several OTCs and ATMs, all of which are very convenient. Generally, KYC is not required, and transactions can be completed in just a few minutes. OTC shops often offer favorable exchange rates, while ATMs charge varying fees, usually in the range of tens of Hong Kong dollars.

A certain ATM, with a fixed fee of 16 HKD

Since the virtual asset declaration was issued in Hong Kong in October of last year, the number of local cryptocurrency users has grown rapidly.

A clerk at a certain OTC shop told Techub News that another important client group for OTC physical stores is users who are not very familiar with cryptocurrency transactions, mainly from Hong Kong and often older in age.

Tang Yi, Co-President of Hong Kong Blockchain Association HKBA.club, noted that many people in Hong Kong are now conducting trades using USDT, and they often need to convert USDT into Hong Kong dollars, US dollars, and other fiat currencies. Hong Kong’s OTCs provide them with convenient services, allowing them to easily exchange cryptocurrencies for fiat currencies from Dubai, South Korea, Japan, and other countries.

However, the emergence of OTCs in Hong Kong also brings high profits but also multiple risks.

Tang Yi stated that the biggest risk for OTCs is third-party fraud, which is common in Hong Kong’s OTC trading industry. It is estimated that over 20% of OTC businesses are affected by third-party fraud, and many OTC operators frequently assist law enforcement agencies in handling such cases.

In addition, many OTC merchants are involved in money laundering cases. Recently, Bitrace conducted an analysis of Tron addresses with obvious OTC business features and found that nearly 3.5 billion risky USDT flowed into these addresses over the past 2 years.

| Regulation is not difficult, but caution is needed

Regulating OTCs in Hong Kong is inevitable, and how to regulate them is being closely watched.

Wu Wenqian, founder of Mura and a lawyer, suggested that Hong Kong should refer to the regulatory policies of the United States, Dubai, and other places and implement a licensing system for the OTC industry. For example, OTC shops should be required to apply for exchange licenses and undergo KYC verification of users to reduce the risk of money laundering.

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

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 exceeding 8,000 yuan should require real-name registration. At the same time, the person in charge should undergo AML training, and mechanisms should be established to report suspicious transactions.

Li Donghan, co-founder of “One Bitcoin,” expressed his hope to start with industry self-regulation. 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 he also hopes to share a suspicious wallet database with the industry to block the source and establish two-way data communication with law enforcement agencies.

However, there are also many industry professionals who hold a conservative attitude towards the regulation of OTC.

An industry analyst told Techub News that the demand in mainland China and the relatively flexible regulation in Hong Kong have created a unique OTC ecosystem in Hong Kong. If strict OTC regulation is implemented in Hong Kong, only allowing local Hong Kong residents to register and use it, Chinese mainland users will be excluded, and the industry will suffer a serious blow.

In fact, overly strict regulation cannot truly be implemented because OTC is essentially a peer-to-peer primitive trading method.

“The difference lies only in whether OTC is successfully included in the scope of legal regulation or excluded to the gray area by regulation,” the industry analyst said.

Wu Wenqian also believes that the formulation of OTC regulatory rules in Hong Kong should be cautious: “Regulating OTC is actually very easy to achieve technically, but OTC plays an important role in ensuring industry liquidity. If compliance regulation is carried out in the traditional way, it may greatly reduce industry liquidity. The most difficult thing is often to find a balance between regulation and the market.”

What the future development of Web3 in Hong Kong will look like, the words of Kong Jianping, director of Cyberport, may be worth learning from.

He said that Hong Kong has two contradictions in the development of Web3: the government has launched encouraging policies, but there have been many phenomena of “speculation” and “platform collapses”; the government hopes to attract more excellent developers and entrepreneurs, but often many illegal institutions such as pyramid schemes cause losses to investors through promotion and publicity.

“But we also see that the technology that is exploited by illegal activities is often trendy, which reflects that Web3 will get better and better from one side. As long as the Hong Kong government continues to promote and support Web3, the rest will be left to the entrepreneurs,” Kong Jianping said.

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