Author: TaxDAO
JPEX (JPEX) is a cryptocurrency exchange based in Dubai, established in 2020 and primarily targeting the Hong Kong market. JPEX claims to be a licensed and recognized cryptocurrency exchange in multiple locations worldwide, offering up to 300x leverage trading and over 30% stablecoin collateral yield. Since 2021, JPEX has spared no expense in marketing, inviting famous celebrities such as Zhang Zilin and Chen Lingjiu to endorse its platform, making a big splash in the Hong Kong cryptocurrency community.
Upon entering the Hong Kong market, JPEX extensively promoted itself through various advertisements, social media, over-the-counter exchanges, and endorsements from celebrities and internet influencers, touting “low risk, high returns”. At the same time, it utilized exaggerated and misleading marketing tactics, such as using slogans like “earn money every day, no losses” to attract investors, leading them to believe in its substantial returns. JPEX also recruited users through means like issuing its platform token JPC and promoting “invitation rewards”.
However, “everything that fate bestows has long been priced in the dark”. According to the cryptocurrency regulations that came into effect in Hong Kong in June this year, any centralized platform that provides virtual asset trading services in Hong Kong or to Hong Kong investors must obtain a license from the Securities and Futures Commission (SFC) of Hong Kong. However, platforms were allowed to operate without a license during a one-year grace period. Although JPEX claimed to hold trading licenses in multiple locations worldwide, it did not proactively apply for the virtual asset service provider (VASP) license issued by the Hong Kong government after the new regulations were announced. In August 2023, the Hong Kong Securities and Futures Commission issued a warning to the public regarding improper operations of virtual asset trading platforms without specifically naming JPEX, serving as a “pre-warning” before JPEX’s collapse.
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1. Timeline of JPEX’s Collapse
JPEX’s collapse unfolded rapidly. On September 13, the SFC issued a warning statement stating that JPEX did not obtain a license from the SFC and had not applied for one. The SFC found suspicious practices in JPEX’s promotion to the public. This indicated that the SFC’s investigation into JPEX’s illegal operations and fraudulent activities had reached its final stage, serving as a final warning to investors.
Two days later, on September 15, JPEX quickly announced the suspension of all trading services and set the withdrawal limit for cryptocurrency assets at 1000 USDT, with a transaction fee increased to 999 USDT. This shift marked JPEX’s declaration to the public that it could no longer sustain normal operations and made off with funds.
On September 18, Hong Kong police, with the referral from the SFC, raided JPEX at the Token 2049 conference held in Singapore and arrested 11 individuals involved in the case, including well-known cryptocurrency influencer Joseph Lam. On the same day, JPEX delisted all trading on its platform.
On September 20th, JPEX announced that it would start redeeming 400 million USDT from user deposits by the end of 2025. It can be seen that JPEX is attempting to alleviate investor dissatisfaction and demands by delaying the redemption. However, it is highly doubtful whether JPEX has the capability to exchange these USDT for fiat currency to repay consumers. As of that day, more than 2,000 people have reported being victims, with an involved amount of approximately 1.3 billion Hong Kong dollars (166 million US dollars).
Undoubtedly, through false advertising and promises of high returns, JPEX has caused significant economic losses and psychological trauma to investors, as well as negative impacts and a crisis of trust in the cryptocurrency industry. It has exposed the risks and regulatory deficiencies in the cryptocurrency market, and has triggered attention and discussions on the regulation of the virtual asset industry by society and the government. At the same time, JPEX’s collapse also demonstrates the necessity and difficulty of cross-border efforts to combat cryptocurrency crimes. International cooperation and coordination are necessary to establish effective regulatory and enforcement mechanisms to protect investor rights and market order.
2. From voluntary to mandatory: Hong Kong’s exchange licensing regime
Looking back at Hong Kong’s regulation of JPEX, it is not difficult to find that although it claims to have obtained exchange licenses in many countries and regions around the world, JPEX has never obtained any license in Hong Kong.
Before June 1, 2023, Hong Kong regulated cryptocurrency trading platforms based on a voluntary principle. According to the “Position Paper: Regulation of Virtual Asset Trading Platforms” issued in November 2019 (hereinafter referred to as the “Position Paper”), only centralized exchanges engaged in security token trading can apply for License Type 1 and License Type 7 from the Securities and Futures Commission (SFC) in accordance with the relevant provisions of the Securities and Futures Ordinance. Cryptocurrency exchanges holding such licenses can only provide services to professional investors. The shortcomings of this regulatory approach are also obvious: first, it is difficult to regulate non-security tokens, decentralized exchanges, or security token trading for individuals; second, the “Position Paper” is only a voluntary standard, which, although providing some investment guidance, has limited regulatory effectiveness in the market.
In view of the limited effectiveness of the “Position Paper” and the development needs of the cryptocurrency industry, on December 7, 2022, the SFC issued a revised Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) that requires VASP (Virtual Asset Service Provider) to obtain licenses by mandatory means, and the revision came into effect on June 1, 2023. The revised AMLO stipulates that any centralized exchange operating virtual asset services (VAS) in Hong Kong must apply to the SFC to become a licensed VASP. Applicants for VASP licenses not only need to meet certain qualification requirements, but also need to submit an external evaluation report (Phase 1 Report) at the time of application. This report is issued by an evaluation expert designated or recognized by the SFC to comprehensively assess the applicant’s business and corresponding risks. Subsequently, the applicant needs to submit a Phase 2 Report to obtain final approval.
After the implementation of the AMLO regulations, there is a one-year transition period for the existing VASPs that were already operating in Hong Kong before June 1st. They can continue to operate during the “non-violation period” in the first year of the regulation, but they must apply for a license from the Securities and Futures Commission (SFC) to operate legally after the end of the “non-violation period”. For VASPs that start operating after June 1st, they must obtain a license from the SFC before operating. The Hong Kong government also emphasizes that anyone convicted of fraud involving virtual asset investment can be sentenced to a maximum of seven years in prison and fined HK$1 million.
In the existing regulatory system, the AMLO regulations and the “Position Paper” are “dual-track”. If VASP licenses are only applied for based on the AMLO regulations, centralized non-securities token transactions can be conducted, but securities token transactions cannot be conducted. Due to the ambiguity between securities tokens and non-securities tokens, the SFC also explicitly stated that “to avoid violating any licensing regime provisions and ensure the continued operation of the business”, virtual asset trading platforms should simultaneously apply for License Type 1, License Type 7, and VASP licenses.
After the implementation of the AMLO regulations, it is only a matter of time before JPEX collapses, as its advertised 30% annual return rate and “invitation rebate” are unsustainable financial models, and it is impossible to obtain a license from the SFC. We believe that even if the SFC does not take action against JPEX at present, JPEX will still withdraw from the Hong Kong market within a year and cause losses to investors.
3. JPEX’s alarm: Where should the government and investors go?
3.1 Investors: Financial investment or Ponzi scheme?
Based on the efficient market hypothesis and the rational investor hypothesis, the market can fully reflect the value and risk of assets, and investors can make reasonable choices based on their risk preferences and expected returns. The high monthly return rate of up to 19% and the invitation rebate mechanism promised by JPEX violate the basic market hypothesis and are typical characteristics of a Ponzi scheme, which uses money from new investors to pay short-term returns to old investors, continuously expanding the fund chain. However, once there is not enough new money or if it is investigated by regulatory authorities, the scheme will collapse, leaving investors with nothing. This article believes that investors can judge whether an exchange is a Ponzi scheme based on the following aspects:
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Does the exchange have a clear business model and source of income? Be cautious of exchanges that rely on attracting new users to sustain operations and promise high rebates.
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Does the exchange promise excessively high or unrealistic returns? If an exchange promises investors returns far above the market level or within the realm of reason, without explaining the risks and costs involved, it is likely a Ponzi scheme.
The regulation of exchanges in the cryptocurrency market is often lagging behind in terms of legal and policy frameworks. During this time, investors may be able to capture more opportunities, but they also need to bear the corresponding risks of insufficient regulation. This article believes that compared to investors in mature markets, cryptocurrency investors should pay more attention to the compliance of the exchanges themselves.
3.2 Government: Need to consider how to control exchange risks
The JPEX incident has also sparked discussions and reflections on the regulation of cryptocurrency exchanges. Although the Securities and Futures Commission of Hong Kong has issued the AMLO new regulations, which require exchanges to obtain licenses to operate legally, there are still some shortcomings in this regulation that need to be further improved. This article believes that the government needs to control the risks of exchanges in cryptocurrency trading and limit the continued involvement of bad actors in the industry. For example, some bad actors may start anew and continue to engage in fraudulent activities in other regions or platforms after a closure or investigation of one exchange. Therefore, it is necessary to implement certain regulatory measures for cryptocurrency exchanges, such as establishing a “blacklist” system internationally to publicly disclose information about bad actors, in order to restrict their continued participation in the cryptocurrency industry. At the same time, the government should also strengthen background checks and qualification audits for exchanges and promptly alert the public to exchanges that pose risks.
Secondly, market regulators should consider how to improve the transparency and credibility of exchanges. Ordinary investors find it difficult to understand the true risks and returns of centralized exchanges. In order to protect the interests of investors, relevant policies should be introduced to require exchanges to regularly disclose their financial reports (including tax situations), audit reports, risk assessment reports, and other information. They should also be required to accept supervision and review by third-party institutions or departments. In addition, to address the issue of “unregulated advertising” by exchanges, the use of false or misleading financial information to attract investors should be prohibited. Furthermore, in terms of long-term credit, regulators can consider establishing a public credit rating system to comprehensively evaluate exchanges and publicly announce their historical credit ratings to investors, so that they can choose more reliable and secure trading platforms.
Lastly, international cooperation and coordination should be strengthened. Cryptocurrency exchanges are often cross-border and can provide services in different countries or regions, which hinders regulation and law enforcement. In the JPEX incident, the Securities and Futures Commission of Hong Kong could only investigate and punish JPEX’s activities in Hong Kong, without being able to hold it accountable for its actions in its “registered” location of Dubai or other regions. Therefore, it is necessary to establish an effective cross-border regulatory and law enforcement mechanism to combat cryptocurrency-related criminal activities and safeguard the rights and interests of investors. Specifically, governments can refer to the guidance provided by the Financial Action Task Force (FATF) on the regulation of virtual asset service providers (VASPs) to establish a global VASP registration system and implement the “travel rule,” which requires VASPs to collect and transmit information about the originator and beneficiary of virtual asset transfers. The “travel rule” not only serves as a regulatory requirement for investors, but also requires exchanges to provide genuine transaction information and comply with compliance requirements during the process of information transmission and review, thus curbing the registration and activities of bad exchanges.
In short, during this critical period of development in the cryptocurrency industry, investors should enhance their risk awareness and judgment, avoiding blindly chasing high returns and falling into scams. Governments should improve regulatory frameworks and rules, increase compliance and transparency of exchanges, protect market order and investor rights, and promote the healthy development of the industry.
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