Cryptocurrencies (often called “coins” or “tokens”, and collectively referred to in colloquial manner as “crypto”) and blockchain technology (certain blockchain technologies may also be referred to as “Distributed Ledger Technology” or “DLT” for short) have, in their short life span of the past decade, created a new economy which to date stands at close to US$ 300bn.
The first cryptocurrency to enter the market was Bitcoin, and it has introduced an effective way to transfer value over the internet by relying on peer-to-peer and distributed verification. Ever since Bitcoin there have been other blockchain-based projects that have introduced new innovations to blockchain technology (these cryptocurrencies are often referred to as “Altcoins”), one of the most noteworthy being Ethereum, which allows for the deployment and execution of software on the blockchain called smart contracts. As a result of this growth, many private and public enterprises have formed in Hong Kong to take advantage of the opportunities this new technology can offer, and to leverage Hong Kong’s unique position in business, technology and law.
Hong Kong is a unique jurisdiction, as it leverages the “one country, two systems principle” which gives it a high degree of autonomy. The Basic Law of Hong Kong enshrines various free market principles and its position as an international financial centre. Thus, given its free market foundations, the Hong Kong government has not taken any specific measures to restrict cryptocurrencies or cryptocurrency businesses (save to the extent for enforcing the existing legislation), nor has the government so far passed any new bespoke regulations to control the cryptocurrency economy.
As there are no new statutory instruments to directly regulate cryptocurrencies in Hong Kong, there is a certain degree of uncertainty on the legal definition within the statutory law. There are secondary sources of law, namely the designation set by the Secretary for the Financial Services and Treasury Bureau (“FSTB”), Professor K C Chan, who designated Bitcoin (specifically) as a “virtual commodity”. In a press release, Hong Kong Monetary Authority (“HKMA”) stated in 2015 that Bitcoin and other similar currencies were not legal tender but “virtual commodities”, as Bitcoin has no backing – either in physical form or by the issuers – it cannot qualify as a means of payment or electronic money. The HKMA, which acts as Hong Kong’s de facto central bank, has also stated that it has no plans to issue any central bank-backed cryptocurrency. For the purpose of this publication, references to “cryptocurrencies” shall mean “virtual commodities” as meant by the HKMA.
The most observable attitude made by government and the various regulatory authorities is to warn the public against the uncertainties in the cryptocurrency marketplace. The earliest observable public warning was made by the Hong Kong Police in 2014 which highlighted that Bitcoins are not money and are not regulated by the HKMA; the volatility of the prices of Bitcoin; the cybersecurity risks associated with dealing with Bitcoin; and potential fraud especially with “Bitcoin Mining Contracts”. Any suspected proceeds of crime should be reported to the Joint Financial Intelligence Unit (“JFIU”), a joint unit composed of the Hong Kong Police Force and the Hong Kong Customs and Excise Department (“CED”). The press release issued by the HKMA contained a similar warning about the volatile nature of Bitcoins.
With the advent of Ethereum and other smart contract blockchain platforms, new applications of cryptocurrency such as initial coin offerings, or token sale (collectively “ICO(s)”) became more widely popular in Hong Kong and globally. As many ICO issuers have established their base of operations in Hong Kong and have opened their campaigns to Hong Kong residents, the local securities regulator, the Securities and Futures Commission (“SFC”) has issued various statements warning the public about: (i) the risk of participating in ICO campaigns; (ii) that ICO tokens that possess features of “securities” as defined under the Securities and Futures Ordinance (Cap. 571) would require to be authorised by the SFC; and (iii) that dealing and advising on “securities”-based ICOs would require the person dealing to obtain the appropriate licences.
In subsequent public communications, the SFC has stated that it is monitoring the cryptocurrency space and will enforce any relevant provision under the SFO if necessary. Aside from the statement given by the SFC, in early 2018 the Investor Education Centre and the FSTB launched an education campaign on ICOs and cryptocurrencies. The campaign’s key message is to not buy something you do not understand. In conclusion, the Hong Kong government’s view towards cryptocurrencies can be described as relatively passive.
The regulatory authorities have not called for new legislation to regulate cryptocurrencies, as current laws are still applicable. For now, it is observable that the government and the regulatory authorities aim to educate the public about the risk involved in the cryptocurrency economy. The Hong Kong government and several agencies have put in place initiatives to promote fintech development in Hong Kong, for example through regulatory “sandboxes” (as discussed below).
As mentioned above, HKMA and the SFC have recognised Bitcoins and other currencies like it as a “virtual commodity” (it is not clear if and how this extends to other Altcoins) and Hong Kong has not created new legislation or regulations to regulate this “virtual commodity”. Certain businesses which are common in the cryptocurrency economy are ordinarily regulated in Hong Kong, and thus a cryptocurrency company that wishes to participate in such market must abide by such specific legislation.
Hong Kong does not regulate private possession or transfer of cryptocurrencies between private individuals, on the assumption that the cryptocurrency in question was obtained and is transferred in good faith (cryptocurrencies are subject to anti-money laundering laws which are discussed below).
The most noteworthy regulated industry that is quite pervasive in the cryptocurrency economy is the ICO space. ICOs are campaigns where issuers sell blockchain-based tokens to potential participants in exchange for other cryptocurrency such as Ether or Bitcoin. The purpose of conducting an ICO is to crowdsource funds for a specific project that the issuer aims to develop, and the tokens have certain “utility” within such project. One example is the OAX project (https://www.oax.org/en) which was considered as the first ICO in Hong Kong. The conventional ICO follows the ERC-20 Ethereum standard and the sale is conducted through a web portal. Aside from the technical elements, the issuers also circulate several documents to the public during the ICO period such as the white paper (or even technical white paper) and the token sale agreement, if any.
Nevertheless, if the tokens that are sold in ICO campaigns possess the features of “securities” under the SFO, e.g. the characteristics of equity, debt or collective investment scheme, such ICO tokens may be regarded as “securities” and the related advertisements, invitations or documents which involve securities, structured products and collective investment schemes would be subject to the provisions of the SFO.
In general, Hong Kong does not prohibit the possession or trading of cryptocurrencies, as Bitcoins and currencies similar to it are considered to be virtual commodities and not electronic money, provided the cryptocurrencies are possessed and traded in good faith. There are other regulatory considerations depending on the use of cryptocurrencies, such as the running of ICO campaigns or trading Bitcoin futures contracts.
As remarked in the paragraph above, the government has a duty to safeguard the free flow of capital as enshrined under Article 112 of the Hong Kong Basic Law. Trade controls and consumer protection are predominantly controlled by the CED, and the basic trading of cryptocurrencies is subject to oversight by CED. The applicable legislation and regulations on the trading of cryptocurrencies will depend on the features of each particular cryptocurrency, as certain cryptocurrencies such as ICO tokens may take the form of or possess features that are common in other financial products such as shares, interests in a fund or securitisation of another asset or asset class, and they will be regulated by the applicable legislation such as the SFO.
Trading of Bitcoin in Hong Kong is commonly done on cryptocurrency exchanges, on over-the-counter (“OTC”) desks and peer-to-peer (“P2P”) platforms with both consumer and institutional participants; depending on the nature of the transaction, different legislation will apply. In most business-to-consumer transactions conducted on exchanges and OTC desks, general consumer protection laws such as the Sales of Goods Ordinance (Cap. 26) and the Trade Descriptions Ordinance (Cap. 362) apply, with the former specifying the procedures and rights of parties in the transaction, and the latter setting out rules on the prevention of unfair trade practices. Business-to-business transactions are not covered per se by the above statutes which are mostly aimed at protecting individual consumers.
Certain commodity exchanges are prohibited from establishing in Hong Kong, under the Commodity Exchanges (Prohibition) Ordinance (Cap. 82) with the list of prohibited commodities being specified in the Schedule of the above Ordinance, e.g. barley, cocoa, coffee, copper, cotton, gold, lead, maize, oats, platinum, rice, rubber, silver, oil seeds and vegetable oils, sugar, timber, tin, wheat, zinc, jute, frozen meat, poultry and fish and soybeans. To date, cryptocurrency (or “virtual commodity”) has not been added to the Schedule, and therefore there are no statutory prohibitions on operating exchange in Hong Kong for trading of cryptocurrencies, which are classified as virtual commodities.
Cryptocurrency exchanges and OTC desks do also observe other legal requirements such as anti-money laundering and counter-terrorist financing and customer due diligence checks (further discussed below).
There are certain cryptocurrencies that will be restricted in trading on the abovementioned platforms. The first type of restricted cryptocurrency is the “security” token, which replicates features of securities and under Hong Kong law is the broadest category of restricted cryptocurrency given the broad definition of security under the SFO. This definition is contained under Schedule 1 of the SFO and can be broadly split into the following categories:
- Shares – shares are defined under the Companies Ordinance (Cap. 622) and in the common law relate to an equitable ownership interest of a company; such interest gives the holders certain rights, as stipulated in the company’s articles of association. A cryptocurrency token can form a blockchain-based share certificate, if each token unit represents inter alia legal or beneficial ownership in the company, a right to vote in shareholders’ meetings, and a right to receive a dividend or some kind of distribution. Public offerings of such cryptocurrencies via ICO would be restricted on the basis that in Hong Kong, under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), a person may not offer the sale of shares of a company to the public without registering a prospectus, unless the issuer elects to issue the tokenised shares in accordance with the “safe harbour” provisions under the SFO.
- Debentures – encompasses various debt-based instruments issued by a company. This category is quite broad as it is not necessary for a debenture to be expressly described as one; all that is required is that the instrument evidences a debt obligation by the company, whether or not the debt is charged against the company. Cryptocurrencies that could be considered as a debenture would be distributed in a similar manner as share tokens and would be subject to similar restrictions.
- Collective Investment Schemes (“CIS”) – the provisions concerning CIS products aim to regulate investment products that are collective in nature; examples of such products include unit trusts and mutual funds. Unlike the definition of “share” above, a CIS may form if the definition under Schedule 1 of the SFO, which includes four components, is satisfied:
- There must be an “arrangement of property”.
- The participating persons do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management.
- The property is managed in whole or on behalf of the person operating the arrangements; and/or contributions and profits or income are pooled.
- The purpose or effect, or the pretended purpose or effect, is to enable the participating persons to receive: (a) profits, income or other returns represented to arise; or (b) payments from the acquisition or disposal of the property.
Given the broad nature of the CIS definition, it could be argued that many ICO campaigns could fall within the parameters of the CIS definition. If this is the case, the issuer may not make the ICO open to the public without prior authorisation from the SFC. In March 2018, the SFC halted the ICO operated by a company called Black Cell Technology Limited (“Black Cell”), which allowed token-holders to redeem their tokens into equity shares in Black Cell. The SFC has considered this arrangement to be a CIS under the circumstances. In the above case, Black Cell has undertaken not to proceed with the ICO. It is important to note that in light of SFC numerous statements to date, the regulators are closely observing the ICO and broader cryptocurrency economy to ensure that the relevant securities legislation is complied with. As with “shares” tokens, the trading of “CIS” tokens will be subject to similar restrictions, thus cryptocurrency exchange must conduct sufficient legal due diligence to ensure the cryptocurrencies they allow on their marketplace are not considered “securities”.
Aside from securities, other types of financial instrument markets have also developed in the cryptocurrency economy. Bitcoin-based derivatives products have enjoyed considerable popularity, trading on exchanges such as Bitmex. Bitcoin futures gained even more popularity in late 2017 when CBOE and CME started offering Bitcoin futures contracts. The SFC stated in its announcement on 11 December 2017 that any intermediary in Hong Kong that offers brokerage services for the above Bitcoin futures will be required to obtain the appropriate licences from the SFC (namely “Type 2” when dealing with such futures contracts, and “Type 5” when advising on such futures contracts).
In the broad sense, trading of cryptocurrencies is not restricted in Hong Kong so long as they are classified as “virtual commodities” (and not “securities” for the purpose of SFO) and do not infringe on any applicable securities and futures legislation. Cryptocurrency exchanges are not subject to legislation that prohibits the operation of commodity exchanges.
In general, there is no capital gains tax payable from the sale of financial instruments in Hong Kong. That being said, any Hong Kong-sourced income from frequent cryptocurrency trading in the ordinary course of business may be treated as income in case of individual clients, and profits in case of a corporation, and subject to income tax and profits tax respectively, regardless of whether the trading is made in exclusive cryptocurrency or fiat-to-cryptocurrency exchanges. To date, the Inland Revenue Department has not issued specific guidelines on how it would treat cryptocurrencies for the purposes of tax assessment.
Many jurisdictions have implemented stringent anti-money laundering and counter-terrorist financing (“AML/CTF”) laws and regulations, with the majority implementing recommendations set out by the Financial Action Task Force (“FAFT”), an international intergovernmental organisation that aims to standardise AML/CTF systems around the world.
In Hong Kong, the principal AML/CTF legislation is the Anti Money Laundering and Counter Terrorist Financing Ordinance (Cap. 615) (“AMLO”) which applies to financial institutions (including HKMA-authorised institutions, i.e. banks, SFC-licensed corporations, licensed insurance companies, stored value facility issuers and money service operators) and “designated non-financial business and professions” (“DNFBP”) (such professions being lawyers, public accountants, estate agents, and trust and company services agents), and also creates a licensing regime for money service operators, and trust and company services providers. Businesses that principally deal with cryptocurrencies such as exchanges and OTC desks are not directly subject to the provisions of AMLO, as such businesses do not fall within the definition of a financial institution or DNFBP unless the cryptocurrency business partially operates in a regulated business, for example, providing money services such as money changing and remittance services. Further to the rules set out in AMLO, each regulatory authority has formulated its own guidelines on dealing with AML/CTF issues.
As mentioned in the paragraph on the “Government Attitude” above, the Hong Kong regulatory authorities have maintained a cautious approach to cryptocurrencies. In 2014, both the HKMA and the SFC issued circulars to their respective supervised institutions warning of the anonymous nature of cryptocurrency transactions and their inherent money-laundering and terrorist-financing risks. These statements come around the same time as the most noteworthy cryptocurrency money-laundering case stemming from the apprehension and conviction of Ross Ulbricht, the operator of the deep-web marketplace, “Silk Road”. Both regulators have clearly indicated the requirement for increased vigilance when dealing with cryptocurrency business, including inquiring into the internal controls on AML/CTF policies and procedures of the cryptocurrency businesses. In light of these requirements, many cryptocurrency businesses voluntarily apply the customer due diligence measures set out in Schedule 2 of AMLO as part of their AML/CFT policies.
While AMLO sets out specific guidelines applicable to financial institutions and DNFBPs, other business and individuals have a statutory duty to report any suspicious transactions under various criminal statutes, namely the Drug Tracking (Recovery of Proceeds) Ordinance (Cap. 405) (“DTRPO”), Organised and Serious Crimes Ordinance (Cap. 455) (“OSCO”), and the United Nations (Anti-Terrorism Measures) Ordinance (Cap. 575) (“UNATMO”). Any suspected transactions involving money laundering, terrorist financing or receipts of crime must be reported to the JFIU by submitting a suspicious transaction report (“STR”); failure to file an STR is a criminal offence which is liable to HK$ 50,000 fine and three-month imprisonment. As highlighted above, many cryptocurrency businesses implement AML/CTF measures to comply with the relevant suspicious transaction reporting provisions under the DTRPO, OSCO and UNATMO, and also the likely requests from their banks in Hong Kong.
Various regulatory bodies in Hong Kong have embraced the Hong Kong government’s plan to promote fintech and financial innovation in the city. Currently the HKMA, SFC and the Insurance Authority are operating “sandbox” programs that allow innovative financial products to be tested in a limited regulatory environment.
The first regulatory sandbox was introduced by the HKMA on 6 September 2016. The sandbox provides HKMA-authorised institutions (“AIs”), e.g. banks, to allow for live testing of financial technologies before their formal launch. AIs must set applicable boundaries to conduct the trials on the client base and must offer appropriate customer-protection measures to resolve customer losses. On 28 November 2017, the HKMA introduced the Fintech Supervisory Sandbox 2.0 Chatroom that allows AIs to receive supervisory feedback through emails, video conferences and face-to-face meetings from the HKMA’s Fintech Facilitation Office and Banking Department during the early stages when the new technological application is being contemplated by the AIs. As of July 2018, the HKMA has reported that it has supervised four distributed technology projects; this means that banks in Hong Kong are actively looking at rolling our blockchain technologies as part of their services. The one visible disadvantage of the HKMA sandbox is that it is only available to AIs or technology companies that are associated with an AI. Technology start-up companies that do not meet the above criteria are limited from accessing the HKMA sandbox.
The SFC sandbox was announced on 29 September 2017. The objective of the SFC sandbox is to allow firms to utilise innovative technologies and demonstrate a genuine commitment to carry out SFC authorised activities through the use of financial technology that may increase the quality of products and services for investors in Hong Kong. The SFC sandbox will be open to qualified firms who are ‘fit and proper’ and hold the applicable SFC licences and comply with the licensing requirements such as Financial Resources Rules. The SFC will impose licensing conditions on firms in the sandbox, which can be removed upon the firms’ exit from the sandbox when the firm satisfies the requirements to operate outside of the sandbox. The guidelines from the SFC do not specify what technologies are permitted in the sandbox as they only require a genuine commitment to use financial technology in carrying out regulated activity, i.e. a cryptocurrency-based service that falls within the preview of regulated activity. Similar to the HKMA sandbox, access to the scheme is also limited to firms that hold SFC licences or who qualify for SFC licences, which may also limit access to the sandbox for start-up companies.
Aside from the sandbox initiatives by the various regulatory authorities in Hong Kong, the HKMA has, along with the Monetary Authority of Singapore, announced on 15 November 2017 its intent to launch the Global Trade Connectivity Network using DLT, and connecting the Hong Kong Trade Finance Platform and the National Trade Platform in Singapore. The Trade Finance Platform is scheduled to commence operation by the end of 2018.
Ownership of cryptocurrencies is currently not subject to any restrictions and regulations in Hong Kong, provided they are obtained in good faith. Possession of cryptocurrencies may be illegal when their sources originate, amongst others, from computer crime, which under Hong Kong laws are proscribed in section 161 of the Crimes Ordinance (Cap. 200), and section 27A of the Telecommunications Ordinance (Cap. 171) and other applicable Hong Kong legislation including the DTRPO and the OSCO which establish offences for handling the proceeds of crime.
There are no requirements to date to obtain any licence to own or trade cryptocurrencies which are classified as “virtual commodities”. On the other hand, this statement is subject to exceptions when dealing with securities and futures involving cryptocurrencies, such as Bitcoin futures: a broker who wishes to offer such contract to their client will require the appropriate SFC licences.
Mining is the process of creating of new blocks on the blockchain; this process includes verifying transactions and collecting “block rewards” of cryptocurrencies. This type of activity is common to blockchain platforms that use the “proof-of-work” consensus algorithm, where the transaction is proved by the computing power used to process it. There are other consensus models such as “proof of stake”, where the block producers stake their cryptocurrencies to gain the rights to process the transaction.
Assuming that ‘mining’ is considered as mining of “proof of work”-based cryptocurrencies (such as Bitcoin) to date, there are no specific regulations governing mining of cryptocurrencies in Hong Kong. Moreover, to date no Hong Kong governmental body has issued any guidance that discourages, restricts or prohibits Bitcoin mining activities. Whether cryptocurrency mining is legally permitted in Hong Kong is subject to other regulations in Hong Kong under certain circumstances, as discussed below.
Mining operations (especially for cryptocurrencies such as Bitcoin) can be highly industrialised operations, usually involving the use of hundreds of ASIC (application-specific integrated circuits) computers to mine cryptocurrencies. Such operations closely resemble large-scale data centre operations. Any regulations that apply to other similar applications such as data centres may also be applicable to cryptocurrency mining sites. In Hong Kong, data centre facilitation is overseen by the Office of the Government Chief Information Officer.
Businesses that intend to operate large-scale data centres should be aware of the relevant land-use rights stipulated under the laws of Hong Kong. Under the statutory Outline Zoning Plans prepared by the Town Planning Board under the Town Planning Ordinance (“TPO”), such data centres belong to “Information Technology and Telecommunications Industries for cryptocurrency mining purposes and would therefore require application for amendment to the OZP under Section 12A of TPO. Apart from zoning permission, it should be noted that development of a site is subject to inter alia the terms and conditions of the land lease governing the site; the usage set out in the occupation permit; and the deed of mutual covenants, if any.
The operation of a data centre involves mechanical and electrical installations which may be subject to statutory requirements in Hong Kong. The key statute in question is the Buildings Energy Efficiency Ordinance (Cap. 610) and, in order to comply with the ordinance, the owner or operator of a data centre in a prescribed building should engage a Registered Energy Assessor to certify that its building services installations have complied with the requirements under the above ordinance. The above rules would only be applicable to large-scale cryptocurrency mining operations and would not likely apply to domestic or small-scale mining operations.
Prior to recent legislative changes there were no statutory declaration requirements on the import and export of large quantities of money in Hong Kong as advised by FATF Recommendation 32. As of 16 July 2018, with the commencement of the Cross-boundary Movement of Physical Currency and Bearer Negotiable Instruments Ordinance (Cap. 629) (“CMPCBNIO”), a person who physically imports or exports large amounts of currency or bearer-negotiable instruments (“CBNIs”) through the designated checkpoints stated in the CMPCBNIO must now disclose and declare such movement to CED. The disclosure threshold is set at HK$120,000 (Schedule 4 of the CMPCBNIO).
The new CMPCBNIO is only applicable to CBNIs, which are defined as cash or negotiable instruments such as bearer cheques, promissory notes, bearer bonds, traveller’s cheques, money orders or postal orders. As Bitcoin has so far been classified by the HKMA as a “virtual commodity”, it should not fall within the definition of CBNI, but it is unclear how this would apply to other Altcoins. There also would be considerable difficulties in enforcing this provision, as CMPCBNIO requires the physical movement of CBNIs; thus to enforce the declaration requirements, the CED would have to prove that Bitcoins were physically moved across the border.
In Hong Kong, there is no requirement to report cryptocurrency transactions of any amount. Profits generated through cryptocurrency trading may be subject to declaration in a tax return under the applicable tax legislation, as discussed above. As cryptocurrencies are not defined as CBNIs, there is no obligation to declare them to CED when importing them to Hong Kong.
In essence, any cryptocurrencies or cryptocurrency accounts would be treated as personal property and would fall into the estate of the deceased, which can be administered by the Executor named in the Will of the deceased or an Administrator appointed by the Probate Court. The Executor or the Administrator could apply for a “Grant of Probate” or a “Letter of Administration” before he is allowed to handle the cryptocurrencies or exchange accounts.
Ordinary access to cryptocurrencies requires the user to have access to the private key to make transactions on the blockchain, and if the private key is lost then the cryptocurrencies are irrecoverable. Thus when conducting estate planning, arrangements should be made to preserve the private key beyond the death of its owner, such as recording the recovery seed and storing in a safe environment (i.e. a bank safe deposit box). Cryptocurrency exchange accounts may be accessed by the Executor or the Administrator in accordance with the procedures of each exchange; like with many internet-based services, this may require the Executor or the Administrator to submit the certificate of death, the Grant of Probate and/or the Letter of Administration to the exchange.