A GUIDE TO DIGITAL ASSETS AND TOKENS IN HONG KONG

1. The rising significance of digital assets and tokens in Hong Kong

Digital assets, cryptocurrencies and tokens have captured increasing attention in Hong Kong.  For instance, PwC Hong Kong has partnered up with the Sandbox in purchasing a virtual land in the Sandbox metaverse.  NFTs dominate the recent discussions in the blockchain ecosystem.  We also see massive development in the Hong Kong regulatory landscape – the Financial Services and the Treasury Bureau of Hong Kong (“FSTB”) published its consultation conclusion paper proposing a licence regime for virtual assets exchange (the “FSTB Conclusion Paper”) (see our news update here), the recent conclusion paper from the Hong Kong Monetary Authority (the “HKMA“)  focusing on payment-related stablecoins (see our news update here), and a couple of initiatives from the Hong Kong Securities and Futures Commission (“SFC”) on Virtual Assets Service Providers (“VASPs”) and Securities Token Offering (“STO”).  It is therefore important to discuss the different forms of digital assets and their regulatory implications in Hong Kong.

2. What are the different types of digital assets and tokens?

We outline below the various classifications of digital assets.  While by no means exhaustive, they serve as a useful starting point for our discussion.

Digital assets

Broadly speaking, a digital asset is an intangible asset that may be created, traded, and stored in a digital format.  It is a generic term which covers all forms/ classifications of assets to be illustrated below, such as virtual assets, cryptocurrencies, digital tokens, including non-fungible tokens (“NFTs”), and Central Bank Digital Currency (“CBDC”).

Virtual assets

According to the FSTB Conclusion Paper, virtual asset (“VA”) is a digital representation of value that: [1]

(i) is expressed as a unit of account or a store of economic value;

(ii) functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes;

(iii) can be transferred, stored or traded electronically; and

(iv) is irrespective of the purported form of underlying assets and whether it is stable or not.

Based on the above definition and as will be further discussed below, the scope of VAs does not cover NFT.  For regulatory purposes, it does not include CBDC. 

VA is sometimes referred to as crypto-asset. There is no universal consensus among the community and the regulators as to which terminology prevails. For example, the term “VA” is deployed by the FSTB whereas “crypto-assets” is used by the HKMA.

Crypto-assets

According to the Financial Stability Board, crypto-asset refers to “a type of private digital asset that depends primarily on cryptography and distributed ledger or similar technology”.[2]

While it is used interchangeably with VAs, crypto-asset includes NFTs, which are a form of cryptographic tokens and not covered under the scope of VA.

Cryptocurrencies

A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it almost impracticable to counterfeit or double-spend. It is a sub-set of each of (i) virtual assets and (ii) crypto-assets. The most well-known examples are Bitcoin and Ethereum.

Our other observations are:-

• Cryptocurrencies are based on decentralised blockchain networks and distributed ledger technology.

• It usually refers to the coins or tokens which are fungible in nature (i.e. it is impossible to distinguish one from another of the same kind just by looking at the matter itself).  Due to this nature, they are in general treated as virtual commodities.

• Crypto-assets and cryptocurrencies are often used interchangeably.

• A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation. This distinguishes itself from CBDC.

However, in practice, cryptocurrencies are not fully insusceptible to regulatory actions. In September 2021, the People’s Bank of China announced a blanket ban on all cryptocurrency transactions and mining.  Overseas exchanges are barred from providing services to PRC-based investors.  It also prohibited financial institutions, payment companies and internet firms from facilitating cryptocurrency trading in the PRC.

Stablecoins

Stablecoins are a sub-set of crypto-assets. According to the FSB and the Bank for International Settlements, stablecoins are defined as “a crypto-asset that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets” and “cryptocurrencies with values tied to fiat currencies or other assets” respectively.[3]

Stablecoins can be designed for different purposes with a corresponding backing mechanism. It could be broadly categorised as (i) asset-linked stablecoins; or (ii) algorithm-based stablecoins.  Asset-linked stablecoins are usually pegged to or backed by fiat currencies, commodities (e.g. gold), or other financial assets (e.g. securities). If they are linked to financial assets, arguably they can be considered as securities tokens as well.

CBDC

Unlike stablecoins, CBDC is “a digital form of central bank money that is different from balances in traditional reserve or settlement accounts”.[4] It is a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank.  It has a legal status, which distinguishes itself from cryptocurrencies (which are generally decentralised in nature).

The HKMA has explored a technology architecture of CBDC designed to enable households and businesses to hold and make payments with CBDC more safely.

Tokens

Tokens (or cryptographic/ digital tokens) are a digital representation of a physical asset or a utility that blockchain-based organisations or projects develop on top of existing blockchain networks.  A token can have different natures and purposes at the same time.

Other features/ observations include:-

• They can be smart contract embedded.

• The most popular blockchain network for token issuance is the Ethereum (which may be referred to as the blockchain network or the native currency used in such network).

• They are often created on a blockchain protocol (i.e. a set of rules governing the creation and use of such tokens).

• ERC-20 has become the most popular protocol used for the smart contracts on the Ethereum blockchain for token implementation.

• They come in different flavours – utility tokens, security tokens as well as the recently popular non-fungible tokens (“NFTs”), to name a few.

• Notably, NFTs are non-fungible – meaning that each NFT can be made “unique” via the applicable blockchain smart contracted embedded protocol.  Also, since we do not have a standardised form of NFTs at this stage, we would need to have a close look at a particular NFT in order to ascertain its nature.

3. Why is it important to understand the different nature of digital assets?

Such categorisation is useful in understanding the nature of tokens for discussion purpose.  Indeed, depending on the circumstances, the issue of digital assets may or may not attract jurisdiction from the SFC.

Taking NFTs as an example, given the non-standardised nature, some NFTs may be granted with “security”-like features and thus the issue of which would normally be regulated in Hong Kong.  Whether it attracts regulatory scrutiny would require us to take a close look at not only the form but also the substance of such tokens.

Of course, regulation is not necessarily a bad thing – if the token constitutes a “security”, the token holder should deserve additional protection as an investor.  On the other hand, it is important to strike a delicate balance between investor protection and over-regulation.  Given the technicality involved, we encourage issuers especially start-ups to seek advice from professionals in order to understand their relevant legal positions and structure their token issuances accordingly.

If you have any specific plans to conduct a token offering, or would just like to have a general discussion on the above, please feel free to contact our Partner Mr. Rodney Teoh.

This newsletter is for information purposes only. Its content does not constitute legal advice and should not be treated as such.  Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.