The future of crypto markets will be driven by developments in Hong Kong and China

While political pundits focus on the diplomatic dance amid building tensions between the US and China (interrupted by some balloon-shaped comic relief that might not be so funny after all), there’s a more benign battle going on in the halls of financial regulators. Although local for now, nothing stays local for long in global markets. The potential ramifications go far beyond crypto markets, potentially shaping economic leverage that, in this changing landscape, is more geostrategically important than ever.

Earlier this week, Hong Kong’s Securities and Futures Commission (SFC) published the proposed text of its upcoming crypto regulation, set to take effect on June 1, and opened it up for public comment. The scope includes the licensing of service platforms for cryptoassets, which were originally only supposed to be allowed to serve accredited investors. The SFC is now seeking input on whether retail investors should also be allowed to participate, and what types of protection should be in place. Also open to discussion is the selection of “approved” assets, which in principle will only include a limited selection of the most liquid tokens.

So far, this seems like another example of a jurisdiction way ahead of the US in terms of regulatory clarity and willingness to engage with the public on the subject. Yet, lifting the lid a bit, there is so much more. It is also an example of the east-west strategy divide, the power of retail and the importance of looking at the trends.

Noelle Acheson is the former head of research at CoinDesk and Genesis Trading. This article is an excerpt from her Crypto is macro now newsletter, which focuses on the overlap between the changing crypto and macro landscape. These opinions are hers and nothing she writes should be taken as investment advice.

Not too long ago, Hong Kong wasn’t exactly welcoming to crypto businesses, but it wasn’t overtly antagonistic either. It seemed to regard them as largely insignificant, in contrast to China’s building opposition. In 2020, Hong Kong announced plans to introduce a new licensing regime to directly regulate all crypto platforms and limit their reach to accredited investors. This recent move looks not only to clarify those promises, but also to broaden their scope and take into account what regulators see as growing retail interest.

However, it is about more than licensing. Hong Kong has also budgeted HK$50 million (~$6.4 million) for crypto asset development, including education efforts for individuals and businesses. And Hong Kong’s Finance Secretary, Paul Chan, announced the launch of a working group composed of policy and industry representatives to explore the integration of cryptoassets. This feels much broader and more long-term than just oversight of crypto service providers.

In part, it is about laying some grounds for the economic growth in the region. Hong Kong’s economy is heavily dependent on financial services and tourism from the mainland, both of which were hit hard by the severe COVID-19 pandemic lockdowns. It recently reported its fourth consecutive quarterly GDP decline, and the region’s chief executive John Lee has pledged to prioritize attracting foreign talent. Most crypto firms based in Hong Kong exited as China’s ban on crypto trading and mining in 2021 cast a cloud of operational uncertainty. Several have now announced that they will apply to return.

It is also about more than just Hong Kong and its 7 million inhabitants. Hong Kong is obviously closely linked to China. The two jurisdictions operate under the constitutional principle of “one country, two systems”, which separates Hong Kong’s economic administration from its much larger parent. But events leading up to and during the recent protests made it clear to the world that China holds the reins and that nothing happens in Hong Kong without China’s approval.

This is where it gets particularly interesting: China appears to approve of Hong Kong’s crypto moves.

Earlier last week, Bloomberg reported that Chinese officials had been seen at crypto events in Hong Kong. They weren’t undercover. In January, Huang Yiping, a former member of the Monetary Policy Committee of China’s central bank, said in a public speech that the country should reconsider its crypto ban. He was not speaking on behalf of the central bank, but it is extremely unlikely that his speech would have become public without official approval.

None of this necessarily means that mainland China will open up to crypto markets anytime soon – but it could be that China is watching Hong Kong’s move with a view to relaxing its stance and eventually supporting the integration of global crypto assets into the economy.

This is partly due to its size. That’s not a small number in China, and the scale of the potential entrant pool can cripple virtually any market. The country reportedly has 212 million retail investors – by comparison, the entire population of the United States is about 330 million. Many of these investors have pulled out of the stock market due to the economic uncertainty of the dark lockdown period, but with the better outlook, some of the build-up of pandemic savings may be looking for high returns.

Also, Chinese retail investors tend to be less risk averse than their US counterparts. In general, they prefer momentum chasing to steady returns, which partly explains their enthusiasm for crypto markets a few years ago and why the potential risk of a wipeout grew to the stage where the government felt the need to close access. However, it failed to completely eliminate crypto activity – 8% of FTX’s creditors are mainland-based, according to its filings, and China-based miners may account for about 20% of global hashrate, according to the latest study of bitcoin mining published by Cambridge.

China is also one of the few regions in the world that actively eases the money supply. Earlier this month, the central bank increased liquidity support while keeping the policy rate steady, but analysts expect the committee to continue cutting interest rates in the second quarter. The number of new loans granted by Chinese banks more than tripled between December and January. Most of us don’t have to cast our minds too far back to remember what monetary easing can do for risky assets.

It is also important, partly because of geopolitics. It is no secret that China wants to see a weakening of the dollar’s international role without actually harming the dollar, and it appears to understand that the role of US capital markets is a key factor in global trade. For a few years now, financial regulators have been working to encourage more activity in Chinese markets, such as opening them more to foreign investors, enabling more hedging, streamlining onshore listing requirements and increasing yuan trading.

Of course, allowing the opening of crypto markets could encourage more outflows of the yuan, something Chinese authorities would understandably prefer to avoid. But if cryptoassets and the innovation they bring are going to be key to the development of tomorrow’s financial markets, then China will obviously have some influence. In addition, China is likely watching with interest the building antagonism towards crypto from Washington, DC. If the US sees crypto markets as a threat, it may be a threat worth exploring.

This is representative of the typical strategic approaches of the two economic superpowers. I once heard someone compare the relative philosophies to board games popular in each region. In the US they play chess, where you win by killing the opponent’s leader. In China they prefer Go, where you win by conquering and holding territory. It could be that Chinese leaders see cryptoassets as a territorial game, with global financial markets as the playing field. Rather than an enemy to be weakened, crypto markets can be a strategic pillar of a new world order, or at least an opportunity to attract global capital, talent and prestige.

So far this year, analysts have focused on macro factors as the main driver of crypto market performance, with evolving use cases and technical speculation also a feature of the recovery. It may be that a more significant driver is slowly building on the global strategic stage – specifically in the geopolitical rivers of the East.