The impact of VSAP, the new chapter of Web3, on exchanges, financial markets and TradFi

Author: Max.S

introduction

With the rapid development of the virtual currency market, more and more people start to invest and trade virtual currency. However, due to the special nature and high risk of the virtual currency market, the regulatory authorities have more and more regulatory requirements for centralized virtual currency exchanges. more stringent. In this context, the new license system (VASP) of Hong Kong's centralized virtual currency exchange came into being.

Virtual Asset Service Provider License (VASP) refers to a new licensing system established by the Hong Kong Monetary Authority (SFC) on June 1, 2023 to supervise and manage institutions that provide virtual asset transactions and related services, namely Centralized virtual currency exchange. **The introduction of the VASP license aims to strengthen the supervision of virtual asset service providers, ensure their compliance and protect the rights and interests of investors. **

The VASP license requires virtual asset service providers to follow a series of compliance requirements, including KYC (know your customer) and AML (anti-money laundering) regulations, capital adequacy requirements, security measures, transparency and reporting systems, etc. By obtaining a VASP license, virtual asset service providers can demonstrate compliance with regulatory requirements, boost market confidence, attract more investors to trade, and promote the development of the virtual asset market.

(Image source: Beosin Blockchain Security Audit)

Main provisions of Hong Kong VASP license system

The application process includes:

1. Recruit two suitable ROs (Responsible Officers) to oversee the operation of VASP and ensure compliance with AML/CTF and other regulatory requirements.

2. Prepare relevant files (shareholder information/business plan/corporate structure)

3. Complete the WINGS application form

4. Confirm application details/submit application

5. Specific decoration of the rented venue,

6. Approval by the CSRC/reply to relevant questions from the CSRC

7. Arrangement to open bank account

8. Receipt The applicant will receive a written notification about the approval

9. Hiring follow-up compliance officers and auditors

In the article "Hong Kong Web3: 1 Year, 1 License, 1 New Industry", we can see that the role of RO plays a vital role in license application. **RO is the role of a supervisor, paid by the licensed company but responsible to the Hong Kong Securities Regulatory Commission. RO needs to pass the assessment and registration of the China Securities Regulatory Commission (examination results are valid for three years), and can engage in related work for life. RO qualifications are related to personal qualifications and have nothing to do with the licensed company where they work, so ROs can freely change jobs in licensed companies. **According to this system, if the RO violates the regulations of the Securities Regulatory Commission, he may lose his qualification to engage in related work for life. Therefore, in order to maintain this professional qualification, RO will supervise the daily operation of licensed companies from the perspective stipulated by the China Securities Regulatory Commission to ensure compliance with regulatory requirements. They are the front-line managers of the Hong Kong Securities Regulatory Commission in licensed companies.

Regulatory Requirements and Compliance Measures

• It is recommended that trading platforms use cold wallets to store 98% of customers' virtual assets, and private keys and mnemonics should be stored in Hong Kong to reduce the risk of platform hacking or attacks.
• Platform operators are not allowed to participate in proprietary transactions (except offline back-to-back transactions) or self-operated bookmaker activities.
• Referring to the FTX case, the platform shall not deposit, transfer, lend, pledge, re-pledge or otherwise buy or sell customer virtual assets
• Client assets can only be safely held through a wholly-owned subsidiary holding a Trust or Company Service Provider (TCSP) license
• The platform needs to purchase third-party insurance or set aside its or its affiliated company's funds in trust as a reserve to provide protection for users.

The relevant laws and regulations for reference are as follows:

• Anti-Money Laundering and Counter-Terrorist Financing Ordinance 2022 ("2022 Amendment Ordinance")
• Consultation Paper on Proposed Regulatory Requirements Applicable to Operators of Virtual Asset Trading Platforms Licensed by the Securities and Futures Commission (VASP Consultation Paper)
• "Guidelines Applicable to Operators of Virtual Asset Trading Platforms" (VASP Guidelines)
• Anti-Money Laundering Ordinance
• Securities and Futures Ordinance

Impact on Centralized Virtual Currency Exchange

How compliant exchanges will benefit, when the Hong Kong virtual currency exchange obtains the VASP license**, first of all, the compliance status and official recognition will enhance the legitimacy and trust of the exchange, attracting more investors to choose on the platform trade on. **As Kevin, the head of the exchange Gate Hong Kong said, Hong Kong has more than 7.4 million local users. Through Hong Kong's status as an international financial center, it is important to build a bridge of capital circulation between the world's huge compliance capital and cryptocurrency exchanges. The significance of Gate actively applying for a license.

Obtaining a license will enhance the exchange's market reputation and industry recognition, and further attract the attention of more users and institutional investors. In addition, compliant exchanges can establish partnerships with banks, payment institutions, and other financial institutions to provide more trading pairs and financial instruments and expand the range of choices for users.

In terms of security, compliant exchanges need to comply with certain security standards and measures. Under multiple protection measures, users' assets and data security will obtain a safer and more reliable trading environment. At the same time, compliance supervision can reduce the risks of illegal activities such as market manipulation, fraud and money laundering, and maintain market order and stability.

Risks and challenges of non-compliant exchanges, exchanges operating without regulatory approval may violate local financial laws and regulations, and face the risk of being fined, suspended or other laws. In the absence of supervision, user assets can only rely on the exchange's own risk control system. Therefore, lack of compliance may lead to a decline in investors' trust in the exchange and affect trading volume. Under the pressure of market competition, it may cause the loss of users.

IMPACT ON THE MARKET

Market makers are a group of professionals who are most sensitive to transactions. After interviewing several local market makers in Hong Kong, I choose to look at this impact from the perspective of market makers. Hong Kong’s cryptocurrency market makers are currently holding a wait-and-see attitude towards the new VASP license system, because compliance operations will help improve the trust and transparency of the entire cryptocurrency market. Licensed exchanges comply with stricter regulatory requirements, which helps reduce trading risks and protect the interests of retail and institutional investors.

However, this is not absolute, and market makers will also consider other factors when choosing an exchange, such as trading volume, transaction fees, technical and operational capabilities of the exchange, etc. Higher liquidity is the guarantee to provide faster and more stable trading opportunities. The transaction fee determines the relevant transaction cost, and a reasonable fee structure will help the profit margin of the market maker. Market makers are more likely to choose to trade on licensed exchanges if they can provide competitive services in these areas.

Impact on Traditional Finance

After the cryptocurrency exchange obtains a license for compliant operation, it will have various impacts on the traditional financial industry. **Compliant cryptocurrency exchanges will introduce a large number of new financial products and services, which will enhance the competitiveness of the entire Hong Kong financial market and pose a challenge to traditional financial institutions. At the same time, this may also push traditional financial institutions to innovate to meet new market demands. **

The emergence of compliant cryptocurrency exchanges will change investors' investment behavior and strategies. The high volatility of cryptocurrency investment is more attractive and will attract some "hot money" from the traditional financial market. This will have an impact on the flow of funds in traditional financial markets.

In addition, the services provided by cryptocurrency exchanges are usually more convenient, user-friendly, and available 24/7. This may push traditional financial institutions to improve their services to meet customers' needs and promote the integration of fintech and traditional finance.

It is worth noting that compliant cryptocurrency exchanges may also bring new risks, such as cryptocurrency price volatility and security issues. This may affect the strategies and policies of financial regulators.

In general, the compliant operation of cryptocurrency exchanges can not only have a profound impact on the traditional financial industry, but may also promote the further integration and development of financial technology and traditional finance. **The financial market in the future may become more diversified, open and flexible as a result. **

International Regulatory Comparison and Enlightenment

Regulatory models for virtual asset service providers (VASPs) vary significantly across regions. The regulatory model of each locality usually depends on its attitude towards virtual assets, its legal system and the characteristics of its financial market. In many jurisdictions, such as the United States, the regulation of virtual asset service providers is the responsibility of multiple agencies. For example, exchanges may need to obtain a license from the Financial Crimes Enforcement Network (FinCEN), while also meeting requirements from the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). This decentralized regulatory model can provide more comprehensive oversight, but may increase compliance costs.

The European Union (EU) has adopted a more centralized regulatory model. Europe has incorporated the regulation of virtual asset service providers into its Anti-Money Laundering and Countering Financing of Terrorism (AML/CFT) regulations, which all member states are required to comply with. The advantage of this model is that it can provide a unified regulatory framework and simplify the compliance process.

** Hong Kong's regulatory model is unique. ** In 2020, the Hong Kong Financial Services and Treasury Bureau (FSTB) proposed new virtual asset trading regulatory rules, requiring all virtual asset trading platforms to obtain a license from the Hong Kong Securities and Futures Commission (SFC) to operate. **Unlike many jurisdictions that only regulate services provided to retail customers, Hong Kong’s regulatory scope includes all cryptocurrency transactions, whether they are retail or institutional customers. **

In addition, Hong Kong has also achieved regulatory docking with traditional financial markets. For example, the SFC's regulatory requirements for virtual asset trading platforms are similar to those for traditional securities trading platforms. This model helps to ensure the stability of the virtual asset market and provides a compliant path for the further development of virtual assets.

** Hong Kong's regulatory model has certain reference significance. **First, it provides a comprehensive regulatory framework that includes all types of virtual asset transactions. This helps prevent regulatory loopholes and eliminates potential investment risks. **Secondly, by linking the supervision of virtual asset trading platforms with the supervision of traditional financial markets, it will ensure the fairness and transparency of the market, and at the same time provide a compliant path for the further development of virtual assets. This provides valuable insights into how other regions can balance innovation and regulation.

Finally, Hong Kong, as an international financial center and innovation and technology hub, will usher in a broader development prospect after the virtual assets are regulated. With the rapid development of the global digital economy, virtual assets will become an important part of the financial transaction and investment field. The Hong Kong government is actively promoting the compliance of virtual assets, and has established corresponding regulatory frameworks and regulatory solutions, which will surely lead the pace of global financial innovation.