In this TechNode Global Q&A, Donald Day, the Chief Operating Officer of VDX, a Hong Kong-based digital asset platform, shares his perspectives on the evolution of the crypto market in Hong Kong and the exchange’s role in it. The Hong Kong Securities and Futures Commission’s (SFC) proactive and comprehensive approach to regulating digital assets, focusing on investor protection, initially faced resistance from the crypto market due to its complexity. However, the necessity of such a regulatory regime became apparent following instances of fraud and bankruptcy in jurisdictions with less stringent regulations. This landscape has driven interest from businesses toward Hong Kong, a global leader providing stability and predictability in the crypto space.

Day emphasizes the importance of comprehensive regulation for establishing and operating businesses in the digital asset domain. A robust regulatory environment allows for a broad spectrum of entities and individuals within the financial services sector to coalesce and create a strong capital market. Day’s involvement in the non-profit CFAAR, which focuses on mitigating crypto fraud, underlines the importance of these organizations in enhancing the market’s integrity and resilience.

Regarding securing operational licenses in Hong Kong, Day’s advice reflects his expertise from his time at the SFC. Understanding the requirements and expectations of regulators, working with experienced advisors, and fostering a compliance-oriented organizational culture are critical for success. The unique position of VDX as a consultant and an active market participant allows it to offer valuable assistance in navigating the application process for operational licenses in Hong Kong.

Donald Day, Chief Operating Officer, VDX

Can you elaborate on the steps that Hong Kong regulators have taken this year to facilitate the growth of Web3? How does this align with VDX’s mission of bridging traditional and digital finance?

In late 2018 the SFC introduced a comprehensive framework to license Virtual Asset Trading Platform Operators, which focused on investor protection and only allowed the onboarding of professional investors. Contrary to the regulatory approach in other jurisdictions, which chose a light-touch approach to appear more crypto-friendly, the SFC decided on a holistic approach, and included a wide variety of factors, including safe custody of assets, strong AML/KYC processes, robust cybersecurity protection, deep market surveillance function and institutional governance rules, to name just a few. Since its inception, this framework has proven itself to be stable, reliable, and resilient, especially in the face of the events of the past 18 months. In contrast to other jurisdictions, Hong Kong has succeeded in attracting high-quality and professional individuals and entities, who are passionate about building the digital asset class in a responsible and institutional manner.

With the recent updates, clarifications, and especially the updated guidance from June 1st of this year, the SFC seems to now be taking steps to expand the reach of the regulatory framework, and one step is the inclusion of retail investors. It was always clear that being able to offer the protection of SFC-licensed trading platforms licensed to retail investors would be a great step to safeguard investors’ assets. This comes with the obvious caveat that any retail investor would need to possess the experience and knowledge to make an informed decision of whether to invest in a digital asset or not, in a very similar way as investing in other asset classes. This will help Hong Kong extend its global lead in becoming the institutional digital asset center of choice. Future developments might include more standard risk management tools used by institutional investors to hedge market and idiosyncratic risk.

The SFC and HKMA have from April to June together issued circulars, and hosted roundtables, to address concerns around the opening of bank accounts of licensed firms in the virtual asset space in Hong Kong. It is certainly very encouraging to see regulators in Hong Kong listening to the market and working together to address and remove some of the hurdles participants face in operating their businesses. This supportive and proactive approach, flanked by positive and encouraging announcements by government officials, indicates that there is an amazing opportunity for Hong Kong to not only remain ahead in regulatory quality in the virtual asset space but also to become the leading international center for institutional digital assets. This is why VDX has chosen to establish its business and headquarters here in Hong Kong.

The SFC approach to regulation, subsequent specifications, and further developments, very much helped pave the way for institutional adoption. The vision of VDX is to be the preferred and trusted partner in the digital asset space, which is completely aligned with the SFC approach. Our goal is to build a bridge between traditional finance and digital assets and thus to facilitate the seamless offering of products and services for market participants in any of the areas of finance, whether traditional or new/digital.

To deliver on this promise requires a very deep understanding of how traditional finance operates (and why it does so), and a strong grasp on what blockchain technology can really offer. VDX focuses on a B2B model, onboarding and partnering with leading institutional intermediaries and counterparties. The institutional licensing framework helps establish trust and accountability – indeed many local and international counterparties from traditional finance have signaled that they are very appreciative of the licensing framework, which provides them with a level of trust comparable to what they are used to in other asset classes.

VDX is aspiring to create a leading regulated digital asset exchange. Could you share your vision for VDX in this context and how you anticipate this aspiration to materialize over the next year?

VDX is committed to bringing safe, compliant, reliable, and fair digital asset services to professional investors and institutions worldwide. Client assets custodied by VDX are fully segregated and insured, and regularly audited by a Big Four Accounting Firm. This, we believe, makes VDX the most trusted gateway for traditional financial firms to enter the digital assets space.

The digital asset markets both in Hong Kong as well as globally remain fragmented and heavily retail-dominated. The opening up of the SFC regulatory framework to retail investors is a very welcome development that provides the same level of protection to retail investors as to professional investors.

Having said that, institutional investors have yet to allocate assets to this asset class in a significant way – despite many media articles and announcements from so-called experts, stating the opposite over the past years, this has not yet happened. The reasons are varied, the main factors including a lack of clear regulatory guidance, lack of trustworthy counterparties, lack of reliable custody, lack of proper AML/KYC procedures, and lack of infrastructure.

In the past few years, the regulatory landscape has cleared up and there is a reliable and consistent framework available in Hong Kong, which has proven itself to be robust and resilient. The need now is for trustworthy counterparties, who really understand the institutional business, to enter this field. At VDX we have assembled a very strong team with deep experience in investment banking, management and technology consulting, hedge funds, law firms, and regulators. We understand on a fundamental level how to address the needs and requirements of our client, and how to work together with them to identify new opportunities. We believe the experience of our team, our unique company culture and our laser focus on client satisfaction on all levels really sets us apart.

Of course, the digital asset market offers many more opportunities than merely trading in cryptocurrencies. We are confident that we will be successful in leveraging our, and our clients’, experience to capitalize on these opportunities.

We will always retain a high degree of flexibility in our organization and resist any restrictive bureaucracy common to large organizations, especially if they have been operating for many years. This flexibility, together with a highly experienced and motivated team, and active dialogue with our clients, will allow us to quickly pivot and make use of opportunities when they present themselves. Or, even better, we would strive to create these opportunities in the first place.

Leveraging your regulatory background, how are you addressing the unique challenges and complexities of ensuring compliance in the digital assets space?

Working at the SFC has given me a unique insight into how a regulatory organization operates, forms opinions, and makes decisions. People who work at the regulator, especially in Hong Kong, are very smart and hard-working. For entities and people applying for a license, there are no shortcuts, no ways to fast-track, and nobody can “pick up the phone and put pressure on them” (despite what some people in the market opine). But of course, there are ways to make the application process smoother. This includes being fully aware of the expectations of the regulator, delivering consistent and high-quality submissions, answering questions fully and directly, understanding the background of regulatory comments, and addressing them.

Compliance in digital assets is not dissimilar to compliance in other asset classes. Of course, there are differences resulting from the specific characteristics of blockchain technology, but in general, compliance is a mindset. Introducing compliance ex-post, almost as an afterthought, like some companies in the crypto space attempt, is not something that is straightforward, and most often is not going to be successful. Our team on the contrary has extensive experience being licensed and regulated. We use this compliance mindset to drive all our design decisions. For us, compliance is not an afterthought, but a key part of our fabric.

Our focus on governance does not stop at using the gold standard of vendor systems. It includes, for example, setting up robust processes which at all times mandate 4-eye principles, and the most important transactions require 5 or more individuals. There will always be multiple employees involved, and all actions are audit trailed. These are just a few of the many different ways we address potential collusion risks and conflicts of interest. This is all very much common sense, and very established in traditional finance, but so far has not been largely adopted in the digital asset space. We will help bring compliance discipline into the digital asset markets.

How do you perceive Hong Kong’s role and competitive edge in becoming Asia’s main crypto hub? What shifts have you observed since last year?

In 2018/2019 when contemplating its approach to virtual asset regulation in Hong Kong, the SFC decided to focus on investor asset protection. This led to the comprehensive framework that was issued in 2019 and has been in place ever since (recently updated and expanded). In the first years, there was a lot of push-back from the crypto market, claiming that the framework was too “complex” or “onerous”, and that other jurisdictions were more “crypto-friendly.” Notably, this push-back did not come from participants with a background in traditional finance or experience in professionally managing client assets.

The unfortunate incidents over the past 12-18 months have signified the importance of being licensed and regulated in a comprehensive manner. Most of the cases of bankruptcy and fraud occurred in jurisdictions with a light-touch approach to regulating digital assets, often prompting those regulators to significantly tighten up their licensing regimes, and thus in effect playing catch-up with the superior regulatory regime in Hong Kong. This in turn has resulted in businesses having to relocate, as their strategy was no longer feasible.

In contrast, the approach taken in Hong Kong has proven to be successful, stable, and robust. As the requirements have not fundamentally changed, businesses operating under this framework are offered stability and predictability in setting up and running their operations. This puts Hong Kong in the enviable position of leading global efforts to provide the necessary building blocks to enable institutional adoption.

This pivot to an increased focus on regulation in the global digital assets space has now led to renewed interest in establishing businesses in digital assets in Hong Kong. We have had many conversations with potential future partners and clients over the past 6 months, and it is immensely encouraging to see seasoned professionals entering Hong Kong and setting up enterprises across the whole value chain of digital financial services. Clearly, it is not enough to only have fund managers and trading platforms operate in Hong Kong. There are a lot more entities and people across the entire spectrum of financial services who in conjunction make up a strong, and deep, capital market.

For example, I am a co-founding member of the Hong Kong chapter of CFAAR, a not-for-profit focusing on how to handle cases of crypto fraud and asset recovery. Consisting of mainly legal professionals, our aim is to help with educating the market as to best practices to prevent fraud, especially crypto-specific fraud, and what to do in case it already has occurred. Initiatives such as this really help build the ecosystem in Hong Kong and move Hong Kong forward as it becomes the dominant global digital asset center.

What advice would you offer to other crypto companies seeking to secure operational licenses in Hong Kong, based on your experience in both regulatory and digital asset domains?

It really depends on which kind of business model they want to obtain a license for. Examples include being a broker/dealer of virtual assets, a fund manager investing in virtual assets, or a virtual asset trading platform/service provider. The application processes for the first two are quite different from the latter.

In general, I would recommend fully understanding the licensing requirements and expectations of the regulator. Additionally, it would make sense to work with an advisor or consultant who has gone through such an application process themselves to guide the creation and review of documents, help with the different stages of the process, avoid costly mistakes and delays, and ensure a smooth process.

Above all, the proper mindset is the deciding factor. All employees, processes, systems, documents, as well as organizational setup and decision-making processes, must be aligned with the requirements of being licensed and regulated.

We actually do partner with selected applicants and help them with their applications. Our unique selling point is that not only are we competent advisors, but we are also active market practitioners. Contrary to consultants available in the market, or legal advisors, we have been in the trenches and gone through this process ourselves and thus can add real value and help make the application process smooth.

As VDX delivers customized solutions in areas including compliance, trading, regulatory, financial, and risk reporting, could you delve into a specific use case that highlights VDX’s approach and capabilities?

As a trading platform, it is of course of vital importance to provide deep liquidity and best-in-class products, apart from outstanding security and safety.

One way we differentiate ourselves from our competitors is the strong focus on client services. We truly understand their industry, their business, and their operations. This enables us to develop tailor-made solutions that address their requirements and needs and help them not only onboard seamlessly, but also operate with ease. This enables our mostly institutional clients to provide access to digital assets to their clients in a very similar way as to other asset classes – ideally, our clients (and their clients) can trade digital assets as they trade stocks or bonds, for example.

Another differentiating factor is the way we help our clients on their regulatory journey. Some clients are already licensed and need to “upgrade” their existing license to include digital assets. Others are only at the start of the journey to get licensed and might have never before interacted with a regulator. We have created a unique approach to help our clients, based on my previous consulting experience together with our own deep experiences of going through this journey. We had to get our “hands dirty” and still do, and are able to share our real experience with our clients. In this way, we help them avoid costly rework and delays, smooth independent assessment and reviews, and efficient interaction with the regulator.

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