Latest Legal Update on Blockchain, Tokenization, and Web3 | Paving the Way for Blockchain-Enabled Economies

By Joshua Chu, Solicitor, Group Chief Risk Officer at Coinllectibles, Marvion & XBE, Senior Consultant at Prosynergy Consulting Limited; and Julian So, Solicitor, Group Chief Executive Officer at XBE, Consultant at Prosynergy Consulting Limited

In 1878, Sir William Preece, Chief Engineer of the British Post Office once boldly proclaimed that:

“This 'telephone' has too many shortcomings to be seriously considered as a means of communication…  The Americans have need of the telephone, but we do not. We have plenty of messenger boys.”

Then in 2023 as if déjà vu, Gery Gensler, chairman of the United States Securities and Exchange Commission, boldly proclaimed:

“We Don’t Need More Digital Currency… We already have… currency. It’s called the U.S. dollar… It’s called the euro or it’s called the yen…”

Introduction

Love it or hate it, Blockchain technology continues to revolutionize various industries, and its potential is being recognized by governments worldwide. In particular, the People's Republic of China (“PRC”) and the Hong Kong Special Administrative Region have both expressed their strong support for blockchain-enabled economies as part of their long-term development strategies.

With the PRC's 14th Five-Year Plan emphasizing the promotion of smart cities and the integration of blockchain technology, the legal landscape surrounding blockchain, tokenization, and Web3 is experiencing significant developments. To this end, Hong Kong remains the flagship city within China pushing the envelope when it comes to Blockchain, Tokenization and Web3 (“BT3”) adoption.

This article will therefore endeavour to examine the PRC and Hong Kong’s perspectives on blockchain-enabled economies, explore the latest developments in this field, and delve into Hong Kong's groundbreaking achievement within the BT3 space including the first Digital Ownership Token (“DOT”) standard Security Token Offering (STO) in 2023 after the Government of Hong Kong SAR’s announcement of its pivot into the BT3 economy.

PRC’s and Hong Kong’s Pivot to Blockchain-Enabled Economies

Recognizing the transformative and economical potential of blockchain, smart contracts and tokenization technologies and their respective role in realizing the national goal at rolling out Asia’s first smart city concepts, both the PRC and Hong Kong governments have outlined their visions for blockchain-enabled economies.

The PRC's 14th Five-Year Plan lays emphasis on the development of smart cities and the integration of blockchain technology to drive innovation, enhance efficiency, and foster economic growth. This strategic focus highlights the government's commitment to leveraging blockchain's potential in various sectors, including finance, governance, supply chain, and much more. The emphasis also highlights the Central Government’s goal in transforming China’s manufacturing economy to one that is of tech and service.

To this end, the Central Government have envisioned Hong Kong as an international innovation and technology hub. It has implemented measures to foster the growth of Web3, blockchain assets, and smart city initiatives. These initiatives aim to harness Hong Kong’s unique ability as a premier financial centre to attract investments, promote technological advancements, and position Hong Kong as a leading global player in the blockchain space.

The emphasis is therefore an emphasis on pivoting of utilizing technology to monetize previously unmonetized aspects of Hong Kong’s financial economy through the promotion of use of BT3 in its economy.

“Crypto here to stay, must be regulated…”

- Christopher ***, Secretary for Financial Services and the Treasury

Dawn of Virtual Asset Trading Platform Regulations in Hong Kong

2023 has been a year of crypto infrastructure in Hong Kong. To unlock blockchain-enabled economies, it is important to understand the regulatory perimeter of virtual asset services in Hong Kong. Since 1 June 2023, the Securities and Futures Commission of Hong Kong (“SFC”) has brought the virtual asset space under its regulatory oversight with the passage of amendments to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”). The goal of the amendments was to:

“…capture all the dimensions of the public’s interface with virtual assets so that investors are protected, and also to address the prudential risks to financial institutions…”

In this connection, the SFC in Hong Kong has the authority to grant licenses for engaging in activities related to virtual assets. However, not all virtual asset services require a license from the SFC.

The provision of virtual asset services will only triggers the licensing requirement when it involves activities such as the exchange between virtual assets and fiat currencies, exchange between different virtual assets, transfer of virtual assets on behalf of another person, custodian wallet provider services, and participation in financial services related to the offer or sale of virtual assets.

As Ms. Julia Leung, the Deputy Chief Executive of the SFC (as she then was), pointed out in her speech on “Embracing Innovation, Regulation and the Future of Finance Keynote address at Hong Kong FinTech Week 2022” dated 22 October 2022:

“Our preliminary view is that tokenised securities, as digital representations of traditional securities on a blockchain, should be treated in a similar way as existing financial instruments. In substance, they have similar terms, features and risks as traditional securities, so it does not seem appropriate to classify them as “complex products” merely because they are issued or traded on a blockchain…

Under this approach, a tokenised plain-vanilla bond would be classified as a “non-complex product”, and therefore the firms distributing it would be subject only to the existing requirements for the distribution of conventional securities, consistent with our “same business, same risk, same rules” approach.”

As such, it is pertinent to note that analysis is to be taken into account as to how a technology is being deployed. Where a technology is being deployed to be nothing more than being a documentation tool, then it ought to reason that it will not automatically trigger virtual asset related regulation, but instead, existing rule relevant to the underlying transaction will apply.

It also stands to be noted that currently, the virtual asset regulation in Hong Kong primarily focuses on the operation of a centralized virtual asset trading platform (“VATP”). However, the regulatory landscape may evolve, and it is crucial for businesses involved in virtual asset services to stay updated on the regulatory requirements set by the SFC.

Introducing Digital Ownership Token, the Next Generation Documentation Tool

Digital ownership tokens (DOTs) are emerging as a groundbreaking solution to the challenges posed by non-fungible tokens (NFTs) in the realm of property law. With the potential to reshape the future of documentation, DOTs utilize blockchain and NFT technology to embed legally binding ownership documentation and ensure the secure transfer of assets.

For some time now, the PRC government have emphasized that it is keenly aware of the dangers posed by blank tokens (tokens which in reality have no legal documentation within it and are merely synthetic products – also known as air tokens). DOT solve this concern by imposing standards whereby tokens that wishes to be validly issued must represent objects of value and encapsulate relevant legal rights that it purports to represent.

Unlike traditional NFTs, which often lack legal rights conveyed by smart contracts, DOTs provide clarity and transparency to purchasers. By incorporating a unique identifier and accompanying legal documents, such as sale and purchase agreements, transfer deeds, and independent valuation reports, DOTs enable buyers to ascertain the true value and underlying assets they are acquiring. This addresses the previous limitations of NFTs, where value fluctuation and uncertainty were pervasive due to the absence of a reliable basis for assessing fair value.

Moreover, DOTs offer the benefits of seamless and paperless property transactions. By digitizing assets and facilitating secondary trades through DOTs, the legal profession can achieve both commercial goals of quick transactions and sustainability objectives. This transformative approach streamlines the process, eliminating the need for time-consuming paper transactions and enabling instantaneous transfers of ownership. This in turn achieve the Central Government’s overarching objective to promote market activity that paper based institutions are unable to deliver.

As the next generation documentation tool, DOTs have the potential to revolutionize property law by providing a secure and transparent framework for ownership rights. With their ability to embed legal contracts, clarify ownership terms, and facilitate efficient transactions, DOTs pave the way for a future where property rights are seamlessly transferred and protected in the digital realm.

Milestone: Hong Kong's First DOT Standard STO in 2023

Hong Kong achieved a significant milestone in its blockchain journey by successfully conducting its first Digital Ownership Token (DOT) standard Security Token Offering (STO) in 2023. The STO, marked a pivotal moment for the adoption of blockchain technology in the financial sector.

The DOT standard STO introduced greater efficiency, security, and transparency for bondholders by fully tokenizing the bonds, eliminating the need for third-party custodianship. This pioneering approach allowed investors to directly hold and control their securities, eliminating complex trust structures prevalent in earlier STO projects.

The successful completion of the DOT standard STO in Hong Kong exemplifies the region's commitment to embracing blockchain technology and its potential to revolutionize traditional financial systems. It sets a precedent for future STO projects and positions Hong Kong as a leading global hub for blockchain-based financial innovations.

Conclusion

The PRC and HKSAR governments' recognition of blockchain's potential has paved the way for the development of blockchain-enabled economies. The legal landscape surrounding blockchain, tokenization, and Web3 is evolving rapidly, with governments and industry stakeholders working together to establish robust frameworks and facilitate innovation.

Hong Kong's first DOT standard STO represents a significant milestone in this journey, showcasing the region's commitment to embracing blockchain technology and its potential to reshape the financial landscape.

Furthermore, understanding the regulatory perimeter of virtual asset services in Hong Kong, as outlined in the VATP regulation, is essential for businesses operating in the virtual asset space to ensure compliance with the licensing requirements set by the Securities and Futures Commission.