The Breakdown - Narrative Watch: Hong Kong Nudges Towards Legalizing Crypto Trading for Retail

Starting point is 00:00:04 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. The breakdown is produced and distributed by CoinDest. What's going on, guys? It is Tuesday, February 21st, and today we're talking about the changing landscape for crypto in Hong Kong. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, happy Tuesday. I hope if you are in the U.S., you had a good three-day weekend. Today, we are looking at some of the changing global alignment around

Starting point is 00:00:51 crypto jurisdictions, and this connects to our show last week on what was happening behind the Bitcoin and Crypto Price Rally. One of the narratives that was emerging at that time and that I covered on that show was this sort of new optimism around Hong Kong opening to crypto trading. So today we're going to pick up on that story as we've gotten more details and a ton more discussion about it. On Monday, the Hong Kong Securities and Futures Commission, or SFC, published its proposed rules for virtual asset trading platforms. The proposal would establish a licensing regime, but there are still lots of undecided questions, including whether licensed platforms should be allowed to serve retail investors and exactly which investor protection measures should be in place.

Starting point is 00:01:33 All existing platforms would be required to register, with the regulator saying that they, quote, should begin to review and revise their systems and controls to prepare for the new regime. They also added those who do not plan to apply for a license should start preparing for an orderly closure of their business in Hong Kong. Consultation paper sets out proposed requirements, including assessing clients' risk profile, as well as setting limits to ensure that their exposure is, quote, reasonable. The regulator would leave trading platforms to perform their own due diligence on tokens, including assessing their regulatory status in each jurisdiction the platform serves, as well as performing smart contract audit. exchanges would be limited to providing retail customers with access to, quote, eligible large-cap virtual assets, which means assets which are included in at least two, quote-unquote, acceptable indices.

Starting point is 00:02:16 While the criteria lacks a little definition, the SFC gives the example of a top-10 largest virtual assets index as acceptable. The proposal also sets a number of obligations for exchanges, including a suitable buffer of assets held in cold storage, as well as a duty to inform clients of any hard forks, airdrops, or regulatory action. The SFC acknowledged the desire to offer derivatives trading on exchanges, but said that they'll deal with that issue in a separate policy review. The consultation will extend to the end of March, with a view to launching the licensing regime in June. Now, aside from fuzzy details, the major,

Starting point is 00:02:48 major story here is that the Hong Kong regulator appears willing to grant crypto access to retail investors. This is something of a change because in November, when the SFC was laying out its intentions for crypto regulations, it seemed like a ban on retail access was in the car. cards. Many are noting, and I think this is the key part of the story, that while mainland China maintains its total ban on crypto exchanges, the move to legalize and regulate in Hong Kong could signal a significant softening in the Chinese stance towards access to crypto assets. Indeed, according to a Bloomberg article, officials from China's liaison office have been frequent guests at crypto gatherings in Hong Kong. Sources state that their interactions have been friendly

Starting point is 00:03:27 in nature, again perhaps indicating a tacit approval of Hong Kong's ambitions to once again become a crypto hub. Bloomberg reporting stated that, quote, The low-key support shows that officials are keen on using the Lazifere City as a testing ground for digital assets as they keep a tight rain on any such activity on the mainland. Nick Chan, a National People's Congress member and crypto lawyers, said, quote, As long as one doesn't violate the bottom line to not threaten financial stability in China, Hong Kong is free to explore its own pursuit under one country, two systems. Now, there are already some that are declaring a huge sea change in all of this.

Starting point is 00:04:01 Justin Sun, for example, said in January, quote, The changing attitude of the Hong Kong SAR government towards crypto signals a nod from the Chinese central government granting pilot status to HK for some forward-looking experiments on how can crypto be best adopted and localized for the huge Chinese market at large. I'm very bullish on the outlook for crypto in the greater China region for the next decade. It is worth noting that among all this speculation, there is not yet any real indication of any sort of policy shift on the mainland. Yihian, the founder and CEO of state-backed blockchain firm Red Date Technology, said,

Starting point is 00:04:33 quote, As long as it's still under the party's control, there will be no U-turn on China's crypto policy. It does no good to the real economy. Now, still, it seems pretty hard to ignore this is a meaningful change in the greater China crypto landscape. Crypto Panda or At Noodle of Binance tweets, China and Hong Kong still two separate entities on crypto legislation. But you are naive to think swarms of mainland Chinese retail money won't find ways to sneak

Starting point is 00:04:57 into Hong Kong and speculate in the new paradigm. Also naive to think Hong Kong legalization isn't an experiment for the mainland. Revekin writes, HK is a controlled environment where China can interface with crypto without jeopardizing CNY capital controls. And I think broadly speaking, these analyses are pretty correct. So given that, it's worth pausing here and asking what's going on in China, economically speaking, and whether any of it might explain or help point to this softening stance. Right now, the big thing is that China is in full-on quantitative easing mode. Last week, Bloomberg published a piece called China ramps up economic support with biggest ever cash injection. Basically, the big shift in China over the last six months or so has been

Starting point is 00:05:35 the reopening of the economy. China had been in COVID-0, but made a rabbit about face at the end of last year. As everyone well knows, there are huge economic implications of ending lockdowns. Lockdowns depress demand inevitably, and so now that they're ending, China is seeing increased consumption and, importantly, increased demand for loans. Last month in January, Chinese banks made 4.9 trillion yuan worth of loans, which is the highest month on official records. That led to a situation where the cost of capital had gone up excessively due to liquidity issues. Last week, a gauge of Chinese interbank funding costs roared up to its highest point in two years and basically just stayed there. This led to the People's Bank of China feeling like it needed

Starting point is 00:06:15 to get cash into the banking system. Again from Bloomberg, the PBOC offered 835 billion yuan, $121 billion of cash via seven-day reserve repurchased contracts on Friday, resulting in an injection of $632 billion on a net basis. That's the largest one-day addition on record in data going back to 2004, end quote. So now you've got China in QE mode, and that's led to speculation about where that money is going to go. Specifically, is Hong Kong a release valve for CNY capital controls? And is there some intention to give the Chinese upper class better access to crypto markets without jeopardizing the Chinese currency by having mainland access for retail. Revekin again writes,

Starting point is 00:06:56 China knows it needs a seat at the crypto table, and they have decided to do so via Hong Kong. This way they can more effectively regulate and control access and mitigate impact CNY capital controls. Hong Kong is the approved gateway. To abstain from crypto is to forego the opportunity to take shots at the dollar. It is, however, a balancing act. Become too permissive and you undermine your own capital controls. Right or wrong, that's why you do it through Hong Kong.

Starting point is 00:07:18 And whether this analysis is right or wrong, boy, is this a new narrative driver. I'm seeing so many tweets like this one from 80-001-07.xbt, who writes, Chinese QE is what's going to fuel this next run, I think. Cameron Winklevoss, the co-CEO at Gemini, writes, my working thesis at the moment is that the next bull run is going to start in the east. It will be a humbling reminder that crypto is a global asset class and that the West, really the U.S., always only ever had two options. Embrace it or be left behind. It can't be stopped that we know. Any government that doesn't offer clear rules and sincere guidance will be left in the dust, quickly. This will mean missing out on the greatest period of growth since the

Starting point is 00:07:57 rise of the commercial internet, and it will mean missing out on shaping and being a foundational part of the future financial infrastructure of this world and beyond. Now, in terms of how strong the narrative is from an actual investment and price driving perspective, BN crypto did note this weekend that a few China-based cryptos were up double digits, but I would be a little wary of that. Byzantine General tweets this morning, so the Chinese are buying because we're buying because we think the Chinese are buying. I guess it works. Anyways, I think this is a pretty big narrative shift kind of moment.

Starting point is 00:08:28 It's not an accident, I think, that this is happening at the same time that the U.S. is starting to close off and close down around crypto. And I don't think you have to buy into some major sense of Chinese change in policy to see how this might be just a test to see what a realigned balance really looks like, especially as that global competition with the U.S. economically speaking continues. Anyways, I think it's fascinating. It is definitely a narrative watch to use a term that I've used frequently for those of you who've been following for years. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3,

Starting point is 00:09:04 happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Emmerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths. Visit consensus.coindex.com or check the link in the show notes. Now, let's stay on this theme of the global landscape for now. Another one of the big themes of this year is a pickup in the CBDC discourse.

Starting point is 00:09:43 The latest news there is that the Bank of Russia is set to commence a pilot program of its CBDC, the digital rubble in April. One of the bank's deputy governors said on Friday that the project will be launched for peer-to-peer transfers as well as retail purchases. Quote, the pilot will work on real operations for real people, but only for a limited number of them, with the 13 banks that have signaled they're ready. The central bank first proposed its CBDC project in October 2020, with later comments adding the explicit goal to reduce the Russian economy's reliance on the U.S. dollar,

Starting point is 00:10:11 as well as mitigating the effective sanctions following the invasion of Ukraine. The pilot was initially scheduled to go ahead in 2021, but concerns were raised by the Russian banking community that the infrastructure would become burdensome for banks, as well as making the banking system more centralized and less diverse. The Bank of Russia later pledged to modify their proposal to ensure no harm was done to the traditional banking system. Deep Blue Crypto, a vocally anti-CBDC Bitcoiner writes, India is in CBDC pilot stage, UAE is going to pilot CBDC soon, Japan to pilot CBDC in April 2023, Russia to pilot CBDCs in April 2023. The world is moving towards CBDCs blindly without realizing the deadly consequences. Your central banks will have absolutely

Starting point is 00:10:48 financial control over your money. It really does feel like the last few years of building and narrative construction around CBDCs are finally coming to the front. I think many of us thought that we'd see more of these types of experiments faster, but governments just don't work fast. However, it's pretty undeniable that at least from a test standpoint, the CBDC era has begun. Now, on the flip side of CBDCs are stable coins, and there is one interesting little thing on that front. The Financial Stability Board released a note on Monday to G20 finance ministers and central bank governors discussing a number of upcoming guidance statements from the international financial standards institution, including how to deal with financial stability risks that could be posed

Starting point is 00:11:25 by crypto markets. The letter reads, this year the FSB will finalize its recommendations for the regulation, supervision, and oversight of crypto assets and markets, and its recommendations targeted at global stablecoin arrangements, which have characteristics that may make threats to financial stability more acute. upcoming FSB standards will address stablecoin governance, redemption rights, and the need to maintain effective stabilization mechanisms. Now, the reason that this matters is that FSB recommendations often become the model for regulations in national jurisdictions. Initial high-level guidance from the FSB will be followed by a joint paper with the IMF

Starting point is 00:11:57 that synthesizes work done on the macroeconomic and monetary policy implications of digital assets. The FSB will then follow up with more granular policy recommendations to G20 nations. Now, separate report on Defi will also be delivered exploring the need for, quote, proactive monitoring, filling data gaps, and exploring to what extent the crypto asset recommendations may need to be enhanced to cover defy risks. The FSB recommendations will take the outlook of, quote, same activity, same risk, same regulation, so we'll presumably take some steps in attempting to categorize crypto firms into traditional finance regulatory buckets. We've talked before a lot on this show about how there are really two sides to governmental

Starting point is 00:12:33 concerns about crypto assets, with one being investor protections and the other much more significant one being risks to financial stability. The fact that those are the more acute concerns, is why FSB recommendations actually matter. Now, speaking of stability risks, an interesting piece out of Reuters this weekend with the title kind of saying it all. Quote, IMF says El Salvador's Bitcoin risks have not materialized, but quote, should be addressed. Basically, the IMF visited El Salvador as part of a planned annual visit and released a statement following which basically takes pains to not admit it was wrong while sort of admitting it was wrong. Last month, El Salvador made a $600 million bond payment in a pretty defiant contradiction to the narrative around.

Starting point is 00:13:14 it. And in the statement they wrote that risks, quote, have not materialized due to the limited Bitcoin use so far, it also said that Bitcoin's, quote, use could grow given its legal tender status and new legislative reforms to encourage the use of crypto assets, including tokenized bonds. The report goes on. Given the legal risks, fiscal fragility, and largely speculative nature of crypto markets, the authorities should reconsider their plans to expand government exposure to Bitcoin. Quote, greater transparency over the government's transactions in Bitcoin and the financial situation of the state-owned Bitcoin wallet remain essential. Anyways, there's not a huge amount of significance there. Just interesting to note that the

Starting point is 00:13:47 IMF has had to eat their words at least a little bit. Now, finally, bringing things back to the U.S., a story I share not because of it being some urgent concern, but just because it shows how crypto critics are pretty emboldened right now. A bill has been introduced in the Illinois State Senate, which lawyer drew Hinkies has described as, quote, the most unworkable state law relating to crypto and blockchain that he has ever seen. The bill was introduced by State Senator Robert Peters and would require that crypto miners, validators, and node operators facilitate block chain transactions without the use of private keys in response to court orders. Titled the Digital Property Protection and Law Enforcement Act, the bill would allow the courts to

Starting point is 00:14:22 order any blockchain transaction that is deemed to have originated in the state be rescinded. Network operators would be forced to figure out a way to do the impossible and reverse blockchain transactions or face fines of $5,000 to $10,000 per day. The bill also appeared to mandate that any person using a smart contract to deliver goods and services would have to include code in their smart contracts to allow compliance with the law. Perhaps the most insane thing about this is that there would be no defense based around the impossibility of this feat. In other words, if crypto protocols had not enabled miners to invalidate transactions via a backdoor, then they would still be subject to fines.

Starting point is 00:14:53 Under the proposed legislation, a court would be able to order a transaction be reversed as a remedy for a lost private key, fraud, a mistake, or to enforce the transfer of collateral. Now, obviously, the law is ostensibly about consumer protection, but it also is just completely counter to the way that blockchain's work. Carlo Reyes, an assistant professor of law at SMU Law School, writes, please, lawmakers, stop grandstanding about crypto and only pass laws if you understand what you're saying. This may be the worst proposed blockchain-related bill I've ever seen, and clearly evidences a lack of understanding in how the tech works.

Starting point is 00:15:24 Peter Van Valkenberg from Coin Center writes the proposed Illinois legislation is absurd and utterly misunderstands the way these technologies work. Essentially asks persons in the state to violate the laws of physics, making transactions without private keys, in order to obey the laws of Illinois. like asking vehicles to levitate when they use state highways. Now, I think all of these skepticism are correct, but for the sake of trying to actually derive understanding and value out of this, I think there are two things worth noting. As I said at the top, the first is the emboldening of crypto opponents right now in the U.S.

Starting point is 00:15:52 The second, which is perhaps even more worthy of consideration, is how immutability is just a really different phenomenon, and one that runs up uncomfortably against the traditional financial system. Even people who aren't crypto opponents might feel like the U.S. does need to do something about fraud. And to the extent that reversing transactions isn't viable, our time is probably better spent on helping legislators understand what workable solutions there are, even if it's just in the form of consumer education and better warnings around tools. Anyway, it is poised to be another interesting week. There is more FTX file out with another of SBF's inner circle, apparently on the verge of pleading

Starting point is 00:16:24 guilty. And I think there's also some really interesting stuff happening around Caitlin Long's custodia. Long came out last week and said that she had handed over evidence of probable crypto fraud, yet that wasn't listened to and still she had her custodia bank targeted by the feds. Crackens' Jesse Powell actually went a little further on this line and shared a theory on Twitter. He writes, I have a theory. Regulators let the bad guys get big and blow up because it serves their agenda. One destroy capital and resources in crypto ecosystem. Two, burn people and deter adoption.

Starting point is 00:16:53 Three, give air cover to attack good actors. The bad guys are actually on side. Good guys are the enemy. If the bad guys can run long enough without blowing up, they just might kill the good guys for you. Bad guys operate with huge competitive advantages. They suck up users, revenue, and venture capital that would otherwise have gone to good guys. Bad guys can always be jailed later. Now, this is something I think we're going to explore much more this week. But listen, with the Hong Kong and Asia narrative, it certainly sort of feels like we're coming to a

Starting point is 00:17:19 culmination of the question of what the U.S. wants its role to be in all of this. That's definitely the biggest theme I'm seeing for this year and I am excited to dig more into it with you guys in the days, weeks, and months to come. For now, I appreciate you listening, and until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Narrative Watch: Hong Kong Nudges Towards Legalizing Crypto Trading for Retail

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