Recently, Bloomberg cited insiders reporting that Hong Kong-based BC Technology Group is considering selling its crypto trading platform, OSL. However, OSL insiders told DeThings that the Bloomberg report does not fully align with the facts.
Previously, Wang Yang, Vice President of the Hong Kong University of Science and Technology, commented on the regulation of virtual assets in Hong Kong, stating that the existing licensing regime is not only burdensome but also counterproductive. He used the term “licensed to death” to describe the predicament faced by licensed exchanges in Hong Kong—institutions that have obtained virtual asset trading platform licenses in Hong Kong struggle to compete with other unlicensed or overseas exchanges due to strict regulatory requirements and high operating costs, leading to sluggish business performance or even losses.
As two virtual asset exchanges licensed by the Securities and Futures Commission (SFC) in Hong Kong, OSL and HashKey face internal pressure from high compliance costs and increasingly stringent regulations, while externally confronting competition from offshore exchanges. In this dynamic game, can licensed crypto exchanges continue to maintain their footing in Hong Kong?
Compliance: “An Endless Process”
Since Hong Kong announced its new policy on virtual assets, the cost of applying for crypto exchange licenses has been a hot topic.
According to CoinDesk, under Hong Kong’s new regulatory framework, crypto exchanges may need to pay up to USD 20 million in licensing fees. Beyond application fees, the cost of compliant operations is also extremely high. Lily Z King, Chief Operating Officer of Cobo, previously told Interface News that the cost of applying for a Hong Kong license and maintaining compliant operations is very expensive, “with annual operating costs potentially around HKD 20 million, and initial costs possibly ranging from HKD 30 million to HKD 40 million.”
These high compliance costs have also brought about side effects.Attorney Liu Honglin of Mankun Law Firm told DeThings that the current compliance costs for licensed crypto exchanges in Hong Kong have “deterred” many enterprises wishing to enter this field. Many domestic clients with substantial capital and strong backgrounds showed interest in June but subsequently hesitated due to compliance costs.
The compliance costs for licensed crypto exchanges do not only require sufficient reserve capital; other stringent requirements also impose a burden on crypto institutions.
An insider at HashKey Exchange, one of the only two licensed crypto exchanges in Hong Kong, told DeThings that the preparation and operation of a compliant exchange involve establishing a legal compliance team, investing in security and technical resources, implementing fund segregation and risk management mechanisms, establishing audit and reporting systems, and conducting compliance training and education, each of which incurs costs.
CoinDesk cited an individual familiar with the Hong Kong licensing application process, stating that licensed exchanges must maintain paid-up share capital of HKD 5 million and liquid capital of at least USD 380,000. The liquid assets they hold must be equivalent to at least one year’s operating expenses, excluding virtual assets.
In addition, applicant companies must establish local branches and store seed phrases and private keys (with backups) in Hong Kong. They must hire compliance officers, known as Responsible Officers (ROs), to ensure business compliance with regulatory requirements, and each applicant must have at least two ROs. Due to high demand, ROs often charge additional fees for their services.
“From the perspective of industry entrepreneurs, compliance is an endless process.Pursuing 100% security means infinite investment. Compliance is not just about obtaining a license; it also involves data, assets, taxation, and other aspects. When funds are limited, entrepreneurs should first focus on the primary criminal compliance risks and then gradually improve compliance in other areas, with the sequence determined by progress,” Liu Honglin told DeThings.
The aforementioned HashKey Exchange insider told DeThings that the core profits of crypto exchanges mainly come from user transaction fees. Additionally, some exchanges generate extra income through various channels such as market liquidity rewards, listing fees, deposit and withdrawal fees, and providing futures and leveraged trading.
However, Attorney Liu Honglin stated that licensed exchanges can only trade a very limited number of tokens, with various transactions and financial innovations restricted,making it difficult to generate revenue through common business practices: “While compliance is achieved, whether the profits generated by the restricted business model can support the healthy development of a commercial company remains a question.”
The financial reports of the parent company of OSL, Hong Kong’s first licensed crypto exchange, reflect this. According to Bloomberg, based on the financial reports released by its parent company, BC Technology Group, the group recorded a net loss of approximately HKD 95 million in the first half of 2023, a significant improvement from the HKD 300 million loss in the same period the previous year, but still failing to meet profitability targets. BC Technology Group’s interim report showed that OSL’s crypto trading volume in the first half of 2023 decreased by nearly 50% compared to the previous year.
Meanwhile, BC Technology’s market capitalization more than doubled from its low point in August this year to nearly HKD 1.9 billion. However, compared to the historic high reached in June 2021, the company’s stock price has still fallen by 80%, a period that coincided with the previous bull market in crypto.
Coinbase, the world’s largest compliant exchange, faces similar challenges. As the first listed crypto exchange in the United States, Coinbase obtained registration as a Money Services Business (MSB) with the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) as early as September 2013 and subsequently obtained relevant licenses in 41 U.S. states.
However, its profitability cannot match that of offshore exchanges with fewer regulatory constraints. Coinbase officially listed in April 2021, during a period of significant crypto price increases, reporting a profit of approximately USD 800 million for the first quarter. Based on the rule that Binance, its largest competitor, burns 20% of BNB quarterly based on profits, the market inferred that Binance’s first-quarter profit was close to USD 3 billion, several times that of Coinbase.
With the arrival of the crypto bear market, Coinbase began to incur significant losses, particularly in the second quarter of 2022. According to Coinbase’s official financial report, the exchange recorded a net loss of approximately USD 1.1 billion for that quarter. Its stock price also fell from USD 251.05 at the beginning of 2022 to USD 35.39 by the end of the year, a drop of over 85.90%.
Under existing conditions, licensed crypto exchanges find it difficult to “increase revenue and reduce expenditures,” leading to the phenomenon described by Wang Yang, Vice President of the Hong Kong University of Science and Technology, as “licensed to death,” and rumors of OSL’s desire to sell its business. The aforementioned HashKey Exchange insider also told DeThings, “It is difficult for exchanges to generate sufficient revenue through existing businesses, making long-term sustainability challenging.”
“It is reasonable for regulatory authorities to attempt to raise industry thresholds.” Attorney Liu Honglin stated that the difficulties faced by crypto exchanges are likely to persist for some time, and whether high thresholds will promote the healthy development of the industry remains to be seen.
Original DeThings article link:https://m.dethings.com/app/h5/#/pages/common/topicDetail/topicDetail?id=8706
{loadmoduleid 245}
To submit articles or request reprint permissions, please add WeChat ID: MankunLawFirm
