One country, two crypto systems: Hong Kong harbors crypto hub ambitions despite China's crackdown

The crypto industry has had a rough year with digital currency markets crashing and companies collapsing across the board.

In spite of the volatility, Hong Kong is pushing to become a virtual asset hub.

The city's digital asset push is in stark contrast to the Chinese mainland, where Beijing has effectively banned trading and stamped out crypto-related activities.

Hong Kong is planning to introduce new rules in June that will require crypto trading platforms to be licensed by the Securities and Futures Commission. The regulator has already launched a consultation on its proposal to regulate virtual asset trading platforms.

Companies that spoke to CNBC say they are hopeful the central government may be watching Hong Kong's crypto moves.

"If anything, China might be looking at the effect on Hong Kong following those rules, the issuance of new crypto-linked products or blockchain-based solutions, and the pick-up of trading and business activity that might ensue," said Justin d'Anethan, institutional sales director at Amber Group.

Hashkey Capital's CEO Deng Chao had similar sentiments, and said Hong Kong's potential crypto legalizations could serve as a compass for China. 

"In the future, it may serve as a model for policy formulation in other regions [in China] if it proves successful," he told CNBC in an e-mail, and added that Web3 and crypto businesses might eventually adopt a more compliant approach to their daily operations.

Web3 refers to the next-generation of the internet. Proponents say it will be more decentralized and reduce the power of large technology companies. Some proponents say cryptocurrencies will likely be a key part of Web3.

In December, a former Monetary Policy Committee member of China's central bank, Huang Yiping, called on Beijing to review its widespread crypto ban.

Huang said there may be missed opportunities for digital technology development if crypto transactions are banned for a long time.

Still, caution remains on whether Hong Kong could eventually be China's crypto north star.

"While there is some chatter about China potentially loosening its stance on crypto, so far there's really nothing we can see to indicate anything like that," said d'Anethan. 

Besides, it's not going to be easy for retail investors wanting to hop onto Hong Kong's crypto bandwagon.

"Hong Kong is going to impose a set of strict regulations on crypto trading platforms," said Yuya Hasegawa, a market analyst from Japanese crypto exchange Bitbank.

"That means it will not be easy for newcomers to casually join in and start business," he said, adding that he's not sure if the government's plans to allow retail businesses access to virtual asset trading will necessarily generate much growth for the industry and as a hub.

While Hong Kong harbors high crypto ambitions and boasts relatively lower tax policy on businesses, the city could still potentially find competition with other crypto hubs.

"Regulation is, of course, necessary for healthy growth, but in order to compete with other crypto hubs, there also has to be appealing tax policy for crypto projects," said Hasegawa.

He pointed out that Hong Kong has a relatively low tax policy on businesses: corporate tax rate for the first 2 million Hong Kong dollars ($254,930) of assessable profit is at 8.25%, while any profit above that amount is taxed at 16.5%.

But compared to other crypto hubs like Dubai, which charges a flat rate of 9%, and Switzerland — with a 8.5% corporate rate, "it's still not that competitive," he said.

Other players which have previously strived to become digital asset centers recently implemented legislation to regulate the industry. Observers say regulation is required to create certainty for the crypto industry and increase adoption from consumers.

Last month, the UK government set out a roadmap to regulate the cryptocurrency industry in line with that of traditional financial firms.

The European Union last year rolled out the Markets in Crypto-Assets law, which required stablecoins to maintain ample reserves to meet redemption requests in the event of mass withdrawals.

Other jurisdictions like Dubai in the United Arab Emirates are looking to set themselves up as crypto-friendly places to do business.

However, some countries, in particular the U.S., have taken a tougher stance on the cryptocurrency industry — especially following the collapse of major cryptocurrency exchange FTX and the arrest of its founder Sam Bankman-Fried.

However, bitcoin's recent price drop has not dented hope from companies that crypto adoption will grow.

"For the longer-term investors, the green light by regulators should highlight the fact that crypto is gaining adoption regardless of temporary price moves or the volatility of this still young asset class," said d'Anethan from Amber Group.

Crypto markets have rallied recently in spite of bitcoin dropping below $20,000 toward the end of 2022. Bitcoin was trading at $27,834 at 9:30 p.m. ET Sunday, according to Coinbase. That's still nearly 60% lower than its November 2021 record high of $68,990.

"Although virtual assets are relatively new, retail investors already have some knowledge and experience in the market after these years of education. When the climate improves, maybe interest will also rise," said Deng from HashKey.

— CNBC's Arjun Kharpal contributed to this report.