Research: Which cryptocurrencies are included in the recognized token index in Hong Kong? An industrial analysis of the indexing economy.

Which cryptocurrencies are included in Hong Kong's token index? An analysis of the indexing industry.

Author | William

Wu said blockchain authorization release

I. Interpretation of Hong Kong Virtual Asset Index Policy

Since the Hong Kong government released the Web 3.0 vision last year, both traditional institutions and Web 3.0 companies have paid special attention to the market opportunities therein. Recently, with the formal finalization of regulatory documents on virtual asset trading by the Hong Kong Securities and Futures Commission, the future windfalls worth paying attention to have become clearer—virtual asset indices are one of them.

According to the policy document, digital virtual assets have an important strategic position in the future Hong Kong market: it is required by regulation that virtual assets available for retail trading must be included in at least two virtual asset indices from at least two accepted index providers. This means that virtual asset indices will become the main judges of “retail trading class assets”.

In order to further clarify which are qualified virtual asset indices and prevent interest transmission issues, the Hong Kong Securities and Futures Commission explicitly stated:

(1) Virtual asset indices issued by virtual asset issuers and exchanges are not qualified;

(2) At least one index should comply with the “Financial Benchmarking Principles” and be launched by a company with index experience on traditional securities markets.

From the above regulations, this actually gives traditional financial companies a “franchise-like operating right”—virtual assets that have not been included in traditional financial company-issued indices are not allowed to provide trading to retail investors.

So, as far as virtual asset indices currently on the market are concerned, which virtual assets are likely to be allowed to provide trading to retail investors? According to the collated market data, the institutions that currently provide virtual asset indices and are recognized by the market are mainly Galaxy, 21Shares, CF Benchmarks, Bitwise, Wisdomtree and Wilshire.

Among them, Galaxy cooperates with Bloomberg to issue virtual asset indices; CF Benchmarks’ indices have been widely used on CME and Nasdaq; Wilshire, as an old index issuer, currently cooperates with the Financial Times to issue virtual asset indices, so the above three companies can be considered “companies that comply with the ‘Financial Benchmarking Principles’ and have index experience on traditional securities markets'”.

After sorting, it can be found that, under the condition of meeting the requirements of the China Securities Regulatory Commission, there are currently 13 encrypted assets that can be used as alternative materials for retail trading, namely: BTC, ETH, ADA, SOL, MATIC, DOT, LTC, AVAX, UNI, LINK, AAVE, BCH, and CRV.

Of course, not all of the above currencies will be allowed to provide trading to retail investors. Because the assets available for retail trading need to meet three conditions: “due diligence of the exchange + qualified large virtual assets + approval in writing by the China Securities Regulatory Commission,” for example, the current operating situation of SOL and BCH is not very optimistic and may be excluded by the China Securities Regulatory Commission.

Table 1 Issuance Status of Virtual Asset Index

(Source: Meta Lab)

Table 2 Alternative Virtual Assets Available for Retail Trading

(Source: Meta Lab)

2. Feasibility Assessment of Virtual Asset Index Business

Until today, developing virtual asset index business is still a new topic for the Web 3.0 industry, mainly because index business is generally established in mature and compliant markets as a market indicator and performance benchmark. However, in the past decade, the virtual asset market has been in its early barbaric stage, there are not many high-quality assets with good liquidity, and the market lacks asset management institutions, and the index business lacks the soil for survival. Therefore, despite the large number of start-up companies doing virtual asset indices in the market over the past five years, only a few have survived. Today, with the compliance of the Hong Kong market, especially in the case where the regulatory authorities in Hong Kong have placed the index in an important position, the virtual asset index business has ushered in a new round of development opportunities.

1. Business Feasibility Analysis

As mentioned earlier, due to the immaturity of the virtual asset market, most of the index start-up companies that have appeared in the market over the past five years have almost disappeared, and the surviving companies are mainly divided into the following two categories:

One is to issue asset management products based on the preparation of virtual asset indices. Typical representatives, such as Galaxy and Bloomberg, issued Galaxy Crypto Index Funds after cooperation on the index; similarly, 12 Shares issued a large number of virtual asset ETP. Currently, most companies with index business operate in this way.

Secondly, combining virtual asset indices with news and information, such as the FT Wilshire Top 5 Digital Assets Index jointly issued by the veteran index issuer Wilshire and Financial Times, provides readers with market information in the Financial Times.

Of course, considering the trend of virtual assets gradually complying and being included in the traditional financial market, there is no need for many virtual asset indices in the future, and the commercial form will gradually approach the traditional market. Therefore, the index business model of the traditional securities market is worth referring to.

Take the US Standard & Poor’s as an example. Currently, the company’s index business (Standard & Poor’s Dow Jones Indices) accounts for about 11% of its total revenue, and index revenue has three main sources: asset-linked fees, subscription fees, and sales royalties.

From the actual operation of S&P, the index business has three major characteristics:

First of all, the gross profit margin and operating profit margin of the index business are very high. Taking S&P as an example, in the past ten years, S&P’s index business has maintained an average gross profit margin of about 83% and an operating net profit margin of about 65%, which is higher than the total comparable indicators of S&P. The main reason is that if inflation factors are deducted, the cost of the index business is relatively fixed. With the increase of customers, scale effects will be formed, leading to a decrease in cost ratio and a high profit margin.

Figure 1: S&P’s gross profit margin in the past decade

(Data source: Wind, Meta Lab)

Figure 2: S&P’s operating net profit margin in the past decade

(Data source: Wind, Meta Lab)

Secondly, the income increment of the index business is high. In the past ten years, Standard & Poor’s index business revenue has increased from USD 490 million in 2013 to USD 1.34 billion in 2022, and the increment is not small. The main reason is that in the past decade, the global index fund and ETF scale have grown from USD 1 trillion in 2008 to about USD 10 trillion by the end of 2022, accompanied by the growth of index-linked fees.

Figure 3 S&P Company Revenue in the Past Decade (in USD 10,000s)

(Data source: Wind, Meta Lab)

Lastly, the revenue scale of index business is limited. According to industry estimates, the size of index business in traditional securities market is no more than 10 billion US dollars. It is worth noting that even for top companies in the index business like S&P, their main source of revenue is not index business. Based on the revenue composition in 2022, market intelligence and rating business accounted for over 60%, while index only accounted for 11.8%.

Figure 4 Revenue Composition of S&P Company in 2022

(Data source: Wind, Meta Lab)

2. Assessment of Future Development of Virtual Asset Index Business

From the historical development of traditional index business, market indices were born in the second half of the 19th century (Dow Jones Index in 1884), mainly providing market information as financial indicators, and their profitability has always been a problem. It was not until the 1960s that the business model of index business gradually became clear: the appearance of ETF and mutual fund products that track indices in the 1970s marked the official transformation of indices from investment benchmarks to investment targets, making asset-linked fees possible; In 1993, the U.S. SEC issued the “Final Rules for Disclosure of Mutual Fund Performance and Portfolio Managers”, which for the first time required mutual funds to provide investors with specific performance benchmarks and required funds to compare returns with appropriate securities market indices in the form of trend charts. Indices have become a necessary benchmark for evaluating fund performance, and major asset management companies began to pay subscription fees to index companies.

It can be seen that the maturity of the profit model for indices in the traditional securities market is mainly due to the rise of index-based asset management products and regulatory requirements from the SEC to provide performance benchmarks. In the current field of virtual asset index business, institutional customers are not yet mature, and the number of institutions is relatively small compared to index customers; index-based products are relatively scarce, mainly Bitcoin and Ethereum ETFs.

Based on the above realities, the author believes that the main characteristics of virtual asset index business in Hong Kong in the future are as follows:

(1) Currently engaged in virtual asset index business, we need to be prepared for the business not being profitable for the next 3-5 years. The key to its profitability in the future lies in whether the virtual asset derivatives market will be opened up. If the derivatives market is open to the public, the index will most likely serve as a reference price for derivatives and royalties can be charged to exchanges or issuers. Alternatively, after the derivatives market is opened up, professional asset management institutions in the virtual asset field may increase further, and more index-like products may be issued.

(2) Virtual asset index business should be treated as a subsidiary business rather than a main business. As mentioned earlier, companies that historically had index businesses did not have index businesses as their main business, but rather rating and intelligence businesses.

(3) Virtual asset index business is suitable for traditional financial institutions rather than Web3.0 start-ups. The main reasons, in addition to the qualification requirements for index providers by SFC mentioned earlier, are market competitiveness – corporate brand and reputation have a significant impact on index businesses. For example, the credibility and dissemination of virtual asset indices released by Bloomberg and start-ups speak for themselves.

Of course, index-like businesses are a “long-termism” business. As can be seen from the analysis of Standard & Poor’s Company in the previous section, although index businesses are difficult to be profitable in the early stages, with the further maturity of the virtual asset market, scale advantages and low-cost, high-profit margins can easily emerge under the first-mover advantage.

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