The Breakdown - Hong Kong Opens For Crypto Business

Episode Date: May 24, 2023

One of the surprising twists of this crypto cycle is the US closing down to crypto and Hong Kong (and the Chinese powers behind it) opening back up. In this episode, NLW looks at Hong Kongs new crypto exchange rules as well as Coinbase's response to the SEC's response to its lawsuit.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Wednesday, May 24th, and today we are talking about Hong Kong and how shockingly they are open for crypto business. Before we get into that, a quick note. The breakdown, as you know, has become the breakdown network. Yes, we have two new shows that have joined the family. Bitcoin Builders is the story of all the interesting, creative, entrepreneurial energy going into Bitcoin

and the Bitcoin Community, and the AI breakdown is, well, the breakdown for AI. Bitcoin Builders comes out two to three times a week, and the AI breakdown is also daily. If you're enjoying either of them and you want to dive into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly.L.Y slash breakdown pod. All right, guys, well, today we are focusing on one of the most interesting and frankly unexpected shifts of this cycle. From top to bottom, we have seen China first ban crypto and push Hong Kong on a similar path to now being in a position where Hong Kong and China behind the scenes seem to be recognizing the opportunity in the U.S.'s aggressive anti-crypto turn post-FTX collapse.

So today we're going to discuss Hong Kong's new rules, which we've gotten much more detail about in the last few days, but we're going to start with the latest in the U.S. being inhospitable. Coinbase has responded in its case against the SEC. They have accused the regulator of hypocrisy in their presentation of one set of facts to the court and an entirely different set of facts to the public via the statements of Chair Gary Gensler. So the context for this discussion is, of course, the Coinbase lawsuit that was filed in April. This was a lawsuit alleging that the SEC had not done their duty in responding to a Coinbase question about how they defined securities that had come about 10 months earlier. The Coinbase lawsuit asked for court intervention to require the

SEC to formally respond to that petition for rulemaking that was filed last July. Coinbase asserted that a simple yes or no indication of whether the regulator was considering crypto rulemaking around certain issues would suffice. The SEC's reply to the lawsuit, again, court mandated, was to use Coinbase's characterization a resounding maybe. The regulator filed a reply, which asserted that it is still considering Coinbase's petition, and that a 10-month delay is entirely within reason. In fact, they cited prior situations in which government agencies had taken as long as 10 years to consider petitions before acting on them.

The reply rejected the premise that Coinbase is entitled to push for a response on any timeline outside of the regulator's sole discretion. Now, as part of the court mandate for the SEC to respond, Coinbase also had to respond to the SEC's response within a certain period of time. That response from Coinbase was filed on Monday, and in it, the exchange said, quote, the SEC is talking out of both sides of its mouth and is wrong at each end, which whether right or wrong is a great piece of writing. The brief agreed that the SEC is entirely correct that it is well within its rights to take time to consider petitions. However, argued that this is true if and only if,

the regulator's mind has not yet been made up. At its core, Coinbase is arguing that the SEC has formed a decision, not to embark on crypto rulemaking about the securities classification of certain digital assets and registration requirements of crypto firms, but has declined to commit to that stance formally. Because they have declined to commit to that stance formally, they deny the opportunity for Coinbase and other industry participants to challenge that view before a court. In other words, without a formal decision on the books, Coinbase is left without a due process Avenue to challenge the actions of the SEC. Coinbase argues that this position of regulatory ambiguity allows the SEC to continue its crackdown strategy without judicial oversight, at least

in the short term, while individual cases work their way through the legal system. Coinbase cites public comments by Gensler made the very same day as the prime example of this hypocritical stance. While the SEC was explaining to the court that it had not yet made up its mind on crypto rulemaking, Coinbase claims that Gensler, quote, stated unequivocally that there will be no rulemaking because the rules have already been published. Coinbase argues that even if the SEC were still undecided, the exchanges push for a firm position from the regulator is justified, stating that, quote, the SEC's delay in deciding whether to conduct a rulemaking is indefensible given its decision to pursue an aggressive, accelerating enforcement campaign regarding the very

topics identified in Coinbase's petition. The brief notes that the recent slate of enforcement actions represent a major change from prior SEC policy, a policy change, which they argue should be made explicit. The reply argues that while the SEC, quote, claims authority to bring enforcement actions against the industry indefinitely, for violations of new standards never disclosed, new standards of this magnitude must be made through rulemaking, not ad hoc enforcement campaigns. Overall, Coinbase are arguing that, quote, the chair's repeated unequivocal statements about the commission's rulemaking plans, uncontradicted by any other commissioner, conclusively demonstrate that the commission has no intention of engaging in the rulemaking,

Coinbase request it. Coinbase simply asks the court to direct the commission to say so formally. At Logical BTC writes, the SEC's disingenuity is laid bare once again. This is a pretty thorough dismantling of the agency's very weak previous brief. The SEC's attempt to use existing case law in a misleading way tells you a lot about their position. Speaking with Laura Shin on the Unchained podcast on Tuesday, Colin Lloyd, a partner at Sullivan and Cromwell, who have been engaged to represent Coinbase in their lawsuit, said,

enforcement is not a very good tool if it's not paired with a viable path to registration. If you sue someone for failing to register, the court can't make them come in and register in the still not yet created registration regime that would be appropriate for the activity. It's not a situation where there are multiple crypto asset securities trading platforms that are registered, and the SEC is going after the recalcitrant folks. We have a situation where there are none, at least for retail investors, and I don't think that's for lack of trying. Now, one of the things that people have been wondering is exactly what Coinbase's strategy here is,

and it seems not to be about a quote-unquote win. Instead, the strategy seems to be to pin down the SEC to having to take public positions on certain things. And in that, they seem to be being somewhat successful. Justin Slaughter, the policy director at Paradigm, wrote after the SEC's response, I'm mystified by the SEC's choices here. It's like Coinbase painted a tunnel on the side of a cliff with this petition, and the SEC actually ran headlong into it.

Anonymous account Robert writes, I would assume it isn't about forcing the SEC to issue rules. Traditional discovery isn't conducted in writs. Instead, the agency compiles an administrative record, which is everything the agency did relating to the Mamandus writ. If the SEC can't beat it with pre-answer motions, they will be forced to turn over a lot of internal communications and documents. I've received administration records of millions of pages from agencies way smaller than the SEC.

I would bet that's the real prize. Anyways, that fight is ongoing, but we learn more every time. a new shoe drops in it. Now, fund manager Kathy Wood has also recently hit out against the U.S. regulatory apparatus, claiming that America risks losing its position as the home of crypto innovation. Speaking at a conference last week, the Ark Invest founder argued that the crypto industry is looking abroad for a new home as major firms like Coinbase turn away from the U.S. in search of more reasonable regulations. Wood said, it would be nice if the U.S. were leading this movement, but we're losing it, and we're losing it because of our regulatory system.

Wood, whose funds are large holders of Coinbase and other crypto stocks, said that the collapse of FTX alongside recent bank failures had, quote, proved the concept of Bitcoin. She stated that both events had highlighted the dangers inherent with centralization in the financial system. The reason it's adopted, she said, is, first of all, many people like the idea of a decentralized, transparent, auditable monetary system. It was born out of the 2008-2009 crisis when people just lost all trust in financial services. end quote. So if Kathy Woods says that Coinbase and others are looking for an alternative externally,

where are they looking? Well, one option is somehow Hong Kong. After months of speculation, Hong Kong has detailed its plan to regulate crypto. They've announced that licensing applications are currently being accepted with the regulations coming into effect at the beginning of June. After conducting an extensive consultation process, the Hong Kong Securities and Futures Commission, or SFC, has determined a set of initial requirements that strike a balance between retail investor protection and permitting the crypto industry to operate in a regulated manner. The guidelines will detail rules around the safe custody of assets, segregation of client assets, avoidance of conflicts of interest and cybersecurity standards, among other things. Now, one of the big shifts is that

retail traders will be permitted to trade on regulated exchanges. This will be with a stricter set of guidelines for the tokens and services offered to retail, but at the end of last year, you know, it seemed like Hong Kong's rules would completely prohibit retail trading of crypto at all. This has been one of the most striking examples of the turnaround in perspective following the collapse of FTX and the subsequent crackdown of crypto in the U.S. Now, when it comes to those retail rules, the SFC will ensure suitability in the onboarding process and good governance, as well as defining an enhanced token due diligence and disclosure regime. Julia Lung, the SFC's chief executive officer, said in a press statement,

Providing clear regulatory expectations is key to fostering responsible development. Hong Kong's comprehensive virtual assets regulatory framework follows the principle of same business, same risks, same rules, and aims to provide robust investor protection and manage key risks. This will enable the industry to develop sustainably and support innovation. Now, current operators of virtual asset trading platforms were invited to apply for a license if they are prepared to comply with the SFC standards, and otherwise invited to, quote, proceed to an orderly closure of their business in Hong Kong. The SFC noted that despite the regulations coming into force next week,

they have yet to approve any exchanges to provide services to retail investors. Huobi, OKX, and gait.io all have pending applications. Now, some of the forthcoming rules do appear to cause a few problems with the current status quo for the industry. The SFC's current stance, for example, is that Stablecoin should not be offered to retail investors until the jurisdictions planned Stablecoin regulations can be implemented. Crypto Gifts designed to incentivize retail customers are also explicitly prohibited, which likely rules out some common forms of exchange promotions, but also most air drops. There are, however, some interesting regulatory innovations contained within the rules. Exchanges are entitled to perform their own due diligence

on token listings, a change from previous drafts of the guidelines. The SFC is clear in communicating that a token being present on two acceptable indices is the medium standard to be considered suitable for listing, which will likely limit retail trading to major well-established tokens. Exchanges are also required to maintain a minimum of 500,000 Hong Kong dollars in capital and report monthly on capital adequacy, outstanding credit, as well as profit and loss. Exchange listings are being used as a way to regulate minimum standards for tokens, which are expected to undertake independent smart contract audits and have a 12-month track record before being considered suitable for retail investors.

Colin Wu tweets, The Hong Kong SFC issued a conclusions consultation on regulation of virtual asset trading platforms, non-security tokens are required to have 12 months of no bad records, stable coins are currently not allowed to be purchased by retail investors and need to wait for the new policy. According to the requirements of the Hong Kong government, the tokens purchased by retail investors need to be included in two major indices, which is the minimum requirement, so the following tokens are the tokens that may be listed in the first batch of Hong Kong compliance exchanges. Wu points then to Bitcoin, Ethereum, Lightcoin, Bitcoin, Cash,

polka dot, Solana, Cardano, Avalanche, Polygon, and Chainlink. Now, when it comes to Crypto derivatives, regulation will be considered at a later date, but the SFC acknowledged the importance of derivatives instruments to institutional investors. The Financial Action Task Force's travel rule will be enforced, requiring exchanges to share identification information alongside transactions, with real-time data exchange being required from the beginning of next year. Now, when it comes to crypto-twitter, the narrative is firmly, Hong Kong legalizes crypto, so they're going to pump our bags. Still, the more sophisticated commentary is about what this means relative to the global power bag. balance of crypto in general. Emmy Crypto writes, the jurisdiction competition has a new challenger. Dubai,

it's your turn now. Crypto God John says less than a month away until Hong Kong opens up crypto. The East is advancing far in the adoption and growth of blockchain technology, while the West continues to do everything in its power to fall behind in the race of the fourth industrial revolution. Lost profit writes, Hong Kong banning crypto at the top and legalizing it at the bottom is goaded A.F. H.K. teaching their entire population how to be a Chad trader. So of course, there are really two entirely separate things here. The first is whether Hong Kong is going to pump our bags, and the second is whether it shows a power balance shift in the larger conversation. On the first, I'm much more skeptical. Gainesi wrote, ah, lads, we had a she-candal last echo bubble,

where if I recall correctly, China had legalized crypto. And now we have a Hong Kong legalizing crypto leg up. If it's anything like last time, don't short this, we're going to get an epic squeeze. And then, turbo nuke. Obviously, I think that crypto-Twitter is hungry right now for narrative rotation and is going to find things even if there are less than solid facts behind that narrative. It's understandable on some levels, right? Hong Kong is one of the wealthiest cities in the world, and so people are expecting there to be big pent-up demand. Obviously, from the standpoint of the breakdown and our interest in big picture power shifts,

that is far, far from what's most interesting about this. Over the last six months as Operation Chokepoint 2.0, or even just a less pernicious version of that crackdown has taken hold in the U.S., there has been a freezing effect on the infrastructure for crypto in America. Whether you think it's a big intentional campaign or not, there is no denying the practical effect. It is very clear, given what Hong Kong was saying about this just as recently as last November, that Hong Kong authorities and Chinese authorities are recognizing that there is now an opportunity. You're seeing it not just in these new Hong Kong rules, although they are representative of that shift, but also around the policy of banking in Hong Kong as well.

Chinese state-run banks have been explicitly inviting crypto companies in Hong Kong to come in and try to get accounts with them. That is a sea change and represents a larger geopolitical realignment when it comes to crypto. So if anyone is wondering whether crypto has a seat at the geopolitical table, I think that's your answer. Now, what it does for the industry, I'm not sure. Obviously, in general, I am more supportive of more jurisdictions being more open to crypto than not. I agree also, though, that we tend to get overheated and over-excited about these narrative shifts, especially when we are still in a pretty cold crypto winter. But this one is worth watching and worth paying close attention to.

And by the way, the person who invoked Dubai, I don't think is wrong either. It feels to me like every week when I schedule someone to be on this show or Bitcoin Builders, I have to wait a little while because of a planned trip to Dubai. So let's keep an eye on the Middle East as well. Anyways, guys, that is it. Hong Kong is open for business, and it's bigger than it seemed that it would be last year when they announced this new regime in the first place. I appreciate you guys listening as always, and until tomorrow, be safe and take care of each other. Peace.