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Trading of virtual assets

Q1 : What factors should Platform Operators consider when conducting due diligence on virtual assets?

A:

Platform Operators are generally expected to consider the following factors (where applicable) when conducting due diligence on virtual assets:

(a)       the background of the management or development team of a virtual asset or its known key members (if any), for example, the team maintaining the software and releasing updates to address vulnerabilities;

(b)       the regulatory status of a virtual asset in Hong Kong, for example, whether it constitutes a security token, and whether its regulatory status would also affect the regulatory obligations of the Platform Operators; 

(c)       the supply, demand, maturity and liquidity of a virtual asset, for example, its market capitalisation, fully diluted market capitalisation, average daily trading volume, track record (where the virtual asset (except for a security token) should be issued for at least 12 months), whether other Platform Operators also provide trading for the virtual asset, whether there are market-makers or liquidity providers for the virtual asset, whether major holders of the virtual asset are subject to a lock-up period, the availability of trading pairs (eg, fiat currency to virtual asset), and the jurisdictions where the virtual assets have been made available for trading; 

(d)       the technical aspects of a virtual asset, for example, the security infrastructure of its blockchain protocol, the size of the blockchain and network, and especially how resistant it is to common attacks (eg, a 51% attack1 or similar attacks with an impact on transaction finality), the type of consensus algorithm, and the risks relating to code defects, breaches, exploits and other threats relating to the virtual asset and its supporting blockchain, or the practices and protocols that apply to them;

(e)       the development of a virtual asset, for example, the outcomes of any projects associated with it as set out in its Whitepaper and any previous major incidents associated with its history and development; 

(f)        the market and governance risks of a virtual asset, for example, concentrations of virtual asset holdings or control by a small number of wallets, individuals or entities, price manipulation, fraud, and the impact of the virtual asset’s wider or narrower adoption on market risks;

(g)       the legal risks associated with the virtual asset and its issuer (where applicable), for example, any pending or potential civil, regulatory, criminal, or enforcement action relating to its issuance, distribution, or use;

(h)       whether the utility offered, the novel use cases facilitated, technical, structural or cryptoeconomic innovation, or the administrative control exhibited by the virtual asset clearly appears to be fraudulent or illegal, or whether the continued viability of the virtual asset depends on attracting continuous inflow into the virtual asset;

(i)         the enforceability of any rights extrinsic to the virtual asset, for example, rights to any underlying assets, and the potential impact of the virtual asset's trading activity on the underlying markets; and

(j)        the money laundering and terrorist financing risks associated with the virtual asset, for example, risks of a virtual asset with anonymity or privacy enhancing features.

(Key references: Paragraph 7.6 of the VATP Guidelines)

Q2 : Are stablecoins eligible for trading by retail clients?

A: In light of the risks posed by stablecoins, regulatory authorities worldwide are working to develop more comprehensive regulations for stablecoins. Amongst other things, the Hong Kong Monetary Authority published the conclusion of its discussion paper on crypto-assets and stablecoins in January 20232 and the regulatory arrangements for stablecoins are expected to be implemented in 2023/24. Prior to stablecoins being subject to regulation in Hong Kong, it is the SFC's view that stablecoins should not be admitted by Platform Operators for retail trading.

(Key references: Paragraphs 7.7 and 7.8 of the VATP Guidelines)

Q3 : For virtual asset trading platforms that only target non-retail investors, can Platform Operators rely solely on the client’s self-declaration confirming that the client is not a Hong Kong retail investor to fulfil the requirement to restrict offers of investments under Part IV of the SFO?

A: Platform Operators should ensure that their trading platforms are properly designed and have appropriate access rights and controls to ensure compliance with Part IV of the SFO. Platform Operators should use methods which are appropriate to satisfy themselves that a client meets the relevant assets or portfolio threshold to qualify as a professional investor, or to obtain certain prescribed evidential documents showing that the client qualifies as a professional investor. Platform Operators should keep proper records of their assessment process or the prescribed evidential documents obtained so as to demonstrate that they have exercised professional judgment and have reached a reasonable conclusion that their clients meet the relevant thresholds.

(Key references: Paragraph 7.7 of the VATP Guidelines)

Q4 : What steps should Platform Operators take if a specific virtual asset available for trading by its retail clients no longer fulfils the admission criteria, for example, an admitted virtual asset falls outside the constituent virtual assets of an acceptable index?

A:

Platform Operators should evaluate whether to continue to allow the trading of the virtual asset that no longer fulfils the admission criteria by retail clients. For instance, the Platform Operators should consider why the virtual asset has been removed from the acceptable index, whether there are any material adverse news (including those relating to underlying liquidity issues) and any other issues which are unlikely to be resolved in the near future.

If there are other considerations which make the virtual asset no longer suitable for trading by retail clients, Platform Operators should, amongst other things, suspend the trading of the virtual asset by retail clients (except for allowing these clients to sell their existing positions) and promptly notify clients of this decision (and the underlying rationale). Platform Operators should also inform the clients holding that virtual asset of the options available and ensure that all clients are fairly treated.

(Key references: Paragraph 7.11 of the VATP Guidelines)

1   This refers to an attack on a blockchain by a group of miners controlling more than 50% of the network's mining hash rate or computing power.
2   Conclusion of discussion paper on crypto-assets and stablecoins (https://www.hkma.gov.hk/eng/news-and-media/press-releases/2023/01/20230131-9/)

Last update: 31 May 2023

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