As Hong Kong’s crypto exchanges race to submit licence purposes by the tip of February, town’s regulators are turning their consideration to different precincts of the crypto business.

Officers are weighing guidelines round stablecoins and over-the-counter buying and selling, in addition to investor safety.

But one essential space stays in limbo: crypto custodians.

Purchasers’ cash

In distinction to most of the gamers in Hong Kong’s freewheeling crypto scene, custodians really need regulatory consideration. Because it stands now, exchanges are liable for dealing with their very own custody, which isn’t an excellent scenario.

“They’re an change platform, proper? They’re not supposed to carry purchasers’ cash,” Alessio Quaglini, co-founder and CEO of Hex Belief, informed DL Information.

“Many of the platforms that truly failed, they failed precisely as a result of they have been holding purchasers’ cash they usually have been utilising purchasers cash for functions aside from the unique goal of offering an change,” he stated in an interview.

Amongst them is FTX, which was based mostly in Hong Kong at one time.

A level of readability could also be on the way in which. On Tuesday, the Hong Kong Financial Authority revealed guidelines on how establishments that settle for deposits ought to safeguard consumer belongings when utilizing custodial companies for crypto.

However these aren’t the laws crypto custodians want.

To make sure, separating custodian companies from exchanges can be a boon for outfits like Hex Belief.

But allowing exchanges to handle the digital belongings of consumers has confirmed to be one of many largest causes of crypto failures and the vaporisation of billions of {dollars} price of market worth.

Hong Kong particularly has been stricken by an outbreak of crypto fraud tied to suspicious exchanges.

Letting exchanges preserve custody of digital belongings is at odds with traits in different international locations, Quaglini says.

“Paradoxically, the entire world is transferring in a unique course whereby exchanges shouldn’t do custody,” he stated.

A spokesperson for the Securities and Futures Fee, or SFC, informed DL Information that it maintains common dialogue with the business however couldn’t touch upon particular measures.

A house in Hong Kong

The Hex Belief workplace occupies two flooring in a luxurious constructing on Pottinger Road, proper within the coronary heart of Hong Kong.

The crypto custodian launched in 2018 with a watch towards cultivating institutional buyers as prospects, and it has since opened places of work elsewhere in Asia, the Center East, and Europe. It has $5 billion in belongings beneath custody.

Hex Belief has been capable of get hold of licences in a number of of the locations the place it operates, equivalent to Dubai. However on its dwelling turf issues have been extra difficult.

‘Custody is admittedly essential within the blockchain world. Far more than conventional finance.’

— Alessio Quaglini

Quaglini says Hong Kong’s digital asset guidelines launched two years in the past have been a logical first step on defending retail buyers. However it’s created a headache for firms targeted on custody like Hex Belief.

They’ll’t service exchanges beneath present regulation. And there’s an absence of certainty as to the place they stand within the crypto regulatory panorama.

“I perceive the explanation why the SFC has targeted on regulating these exchanges, however the regulation has not lined different forms of service suppliers within the business, particularly custodians,” Quaglini informed DL Information.

Initially, Quaglini thought-about having Hex Belief apply for an change licence in order that its custodian companies can be lined.

“However we thought it might be just a little bit too difficult to elucidate ‘really we’re not an change, we simply utilized for an change licence in order that we could be as a custodian’,” he stated.

Getting regulated is pricey. Final 12 months, CoinDesk estimated that making use of for a digital asset licence in Hong Kong might value as a lot as $20 million.

A lot of that expense consists of auditing and different compliance necessities. However beneath Hong Kong guidelines, crypto exchanges are additionally required to custody their very own belongings via an related entity.

That unit “shouldn’t conduct any enterprise aside from that of receiving or holding consumer belongings on behalf of the Platform Operator,” in accordance with the SFC’s guidelines.

This requirement has led to duplication of in-house custodian companies throughout the business, considerably growing operational prices and complexities for exchanges.

“You probably have 30 exchanges for such a tiny market as Hong Kong, each change has to even be a custodian,” Quaglini stated. “It turns into extraordinarily costly.”

‘Actually essential’

Quaglini thinks the enjoying discipline have to be clarified, plus it must be opened for specialised custodial gamers to supply companies to market intermediaries.

He’s not alone. Different custodians have echoed this name. In October, Zodia Custody, a custody firm backed by the UK financial institution Customary Chartered, launched in Hong Kong.

In November, Zodia CEO Julian Sawyer told Finance Asia that regulation within the metropolis didn’t distinguish between crypto exchanges and custodians. Solely these arrange by exchanges have been lined.

The opportunity of regulating custodians seems to be at such an early stage it’s not even clear which company can be accountable.

Zodia Custody stated final 12 months it was in ongoing talks with regulators at each the SFC and the Hong Kong Financial Authority.

If the authorities are severe about cleansing up Hong Kong’s crypto scene custodians might help as a result of they have to run anti-money laundering and know-your-customer checks on prospects, Quaglini stated.

“Custodians are gatekeepers,” Quaglini stated. “I consider that custody deserves particular laws.”

Callan Quinn is DL Information’ Asia Correspondent. Get in contact at callan@dlnews.com.