On September 20th, the two-day 9th Global Blockchain Summit successfully concluded. Xiao Feng, Chairman of Wanxiang Blockchain, delivered the closing speech titled “Web3.0 and the Hong Kong Special Administrative Region’s Virtual Asset Policy Declaration” at the event. The following text is based on on-site notes of the event with slight modifications that do not affect the original meaning.
Recently, many people have been interested in the virtual asset declaration of the Hong Kong Special Administrative Region government. From the perspective of the market and practitioners, I would like to share my views on the virtual asset declaration announced by the Hong Kong SAR government and discuss why this declaration was made and what its intended goals are.
Why does the SAR government have a series of policy declarations on virtual assets? To explain its background, we need to start with the digital economy. The basis of this series of declarations is that Hong Kong wants to build a complete set of services to support the deep cultivation, landing, and development of the digital economy in Hong Kong. What are the characteristics of the digital economy?
First, the digital economy is not constrained by geographical space.
Because it is not constrained by geographical space, Hong Kong has the opportunity to leverage its unique advantages of “one country, two systems,” common law, and free port in the digital economy. Some people say, “Hong Kong missed the Internet, but don’t miss blockchain.” In fact, Hong Kong did not miss the stage of the Internet because the Internet is related to geographical space, jurisdictional regions, and the location of users. However, Web3.0 or blockchain is not closely related to geography. Therefore, Hong Kong did not have an Internet period, but it can have a Web3.0 period or a blockchain period. Moreover, during this period, Hong Kong has unique advantages, that is, the advantages of a free port.
What are the advantages of a free port? It means that funds can flow freely. The inflow and outflow of fiat currency are both obstacles and necessary prerequisites for large-scale applications.
On the other hand, there is common law. In Hong Kong, whether it is Web3.0, blockchain, or virtual assets, they can make good use of the advantages of the system, mechanisms, and the rule of law while avoiding geographical constraints.
Second, the digital economy is not constrained by physical rules.
For example, building a building or a city in the metaverse is not constrained by mechanical rules. Do you need to calculate its structural weight? No need.
Third, the digital economy is not constrained by business organizations.
Digital technology gives individuals tremendous capabilities, allowing individuals to do many things without relying on a business organization. For example, you can work for yourself without depending on an organization.
In addition to these characteristics, the value law of the digital economy is completely different. The value law of the digital economy is high fixed costs, low marginal costs, and even zero marginal costs. Developing software requires high fixed costs and huge investments. For example, developing GPT4, Open AI spent billions or even tens of billions of dollars. To upgrade to GPT5 or GPT6 in the future, it would require tens of billions or even hundreds of billions of dollars. This is a high fixed cost. However, after GPT4 is developed, the marginal cost for 100 million users and 1 billion users is almost negligible. This is a value law that industrial products and the industrial economy do not possess.
Under this value rule, the maximization path for the value of a digital product and service is open source, open, free, and permissionless, because only in this way can it be maximally promoted and used by others. In a cost and service with zero marginal cost, the cost of serving 100 million people and serving 1 billion people will not increase. In this case, ownership seems less important, while usage rights, which allow more people to use, become more important. Therefore, the digital economy can be said to be an economy of usage rights to some extent.
In an economy of usage rights, how can we capture the value of an open source, open, permissionless, and even free product or service? The value capturing tool for usage rights is Token. Token is the usage license in computer language, it is a token. The usage license for logging into a system has evolved into standardized usage rights in the era of blockchain. Taking the fax machine effect as an example, let’s assume that a fax machine network consists of 1 million fax machines. Does any user need permission to join the fax machine network? Not really, but you need to buy a fax machine first. If you don’t buy a fax machine, you cannot join the fax machine network. By purchasing a fax machine, you are purchasing the usage license to join the fax machine network. Just like you need to first buy a bitcoin to join the bitcoin network, and you need to have an Ethereum to use the Ethereum network. The fax machine, bitcoin, and Ethereum are all the same here, they are all usage licenses. When using this network and enjoying its value, you must have the token and permission. The difference between the fax machine and bitcoin or Ethereum is that one is digital and the other has a physical structure.
The fax machine network does not belong to the person who buys the fax machine and connects to the fax machine network, just like Ethereum. Holding ETH does not mean you own the equity of the Ethereum network. You only have the usage rights or usage license. Therefore, the fax machine effect of usage rights has given birth to a new capital system – the stakeholder capital system. Everyone is a user, and no one owns the network.
At the same time, the fax machine network has a third characteristic. Any new user added to the network will bring value and benefits to the existing users who are already using the fax machine network. Because the more people join the fax machine network, the more possibilities there are for other fax machine users to send faxes, and obviously, the value is growing. This is the beauty of the fax machine effect or the usage rights effect. The more people use it, the better for everyone. If it were an ownership structure, owning a share of this company’s stock would be yours, and others could not claim ownership of it. Usage rights can be infinitely granted, and the more they are granted, the greater the value, but ownership is not like this.
Based on these three characteristics, we can consider the past decade of blockchain practice as a stage of infrastructure construction. It can also be seen as spending ten years to build a financial infrastructure for the digital economy with the above characteristics. According to the three characteristics of the digital economy summarized above, traditional financial infrastructure cannot serve it well. The practice of the past decade is to build a new financial infrastructure that can serve the digital native and digital twin well.
This financial infrastructure is first based on a distributed network, which is Web3.0. At the same time, on this distributed network, a new accounting method is built, which is distributed ledger, that is, blockchain. On the basis of such a distributed ledger, we have built a set of distributed finance, which is DeFi. In the future, all large-scale applications based on blockchain or Web3.0 will need this set of financial infrastructure, because traditional financial infrastructure cannot serve this new economic model.
In the new financial infrastructure, there are several key building elements.
First, a new accounting method.
The most important feature of the new accounting method is that it is an open, transparent, and global public ledger. Before this, all accounting methods were private ledgers, where one would keep accounts for oneself. My accounts are impossible for others to know or access. But anything on the blockchain is open and transparent to the entire network. Things built on the basis of a public ledger form a global ledger system. Once logged into the global ledger system, anyone in the world can access, see, trade, and interact with it. This is a feature that traditional financial markets do not possess. Assets in traditional financial markets are registered on private ledgers. If they are not made available to you, you cannot access them, buy them, invest in them, or trade them.
Second, a new account system.
Traditional finance is built on the bank account system, where all funds must be deposited in the bank account system. After the emergence of internet platforms, a new generation of internet accounts emerged, such as Alipay Wallet and WeChat Pay Wallet. These two wallets are not accounts established by banks, nor accounts managed by banks, but accounts managed by internet platforms, although they also contain fiat currency. The revolutionary change comes from blockchain. Blockchain’s digital wallets come in various forms, but to align with the above, we call them blockchain accounts. Blockchain accounts are completely detached from the traditional financial system and even the internet account system. They no longer transact with fiat currency, but with USDT and USDC, and in the future, they can also transact with central bank digital currencies (CBDC) issued by central banks. However, no matter what, if a currency cannot be digitized and run on smart contracts, it cannot be compatible with blockchain accounts.
Third, a new settlement method.
Another change is that the settlement method of this new financial infrastructure has undergone significant changes. Transaction confirmation and settlement are completed synchronously. Transactions are conducted peer-to-peer, and payments are also made peer-to-peer. This new settlement method has been accepted by traditional banks, at least from the United States and Singapore to Hong Kong. Recently, traditional banks have issued RWAs, which are tokens of real-world assets. Why issue real-world assets in the form of tokens? It has a great advantage – significantly improving clearing and settlement efficiency and greatly reducing transaction costs and steps. In addition, the form of currency in this financial system has also undergone major changes, and it can now be digital currency.
I divide digital currencies into three categories. The first category is legal digital currency, which refers to the CBDC issued by the central bank. The central bank issues base currency, and base currency needs to go through the currency creation process of market institutions to create currency leverage or currency multiplier in order to better serve the real economy. Therefore, stablecoins were created, which are digital currencies issued by institutions. In traditional financial markets, banks are the main creators of currency, currency leverage, and currency multiplier. Stablecoins issued by institutions are called M2, which is the same as M2 in the real financial market. It is currency created by leveraging by market institutions such as banks, not currency issued by the central bank.
In Hong Kong, when you hold a banknote, there is a payable note on it, which is a promissory note and belongs to M2. In the new financial infrastructure, there is also a native digital currency, which is Bitcoin. The form of Bitcoin is still evolving and has not yet evolved into a complete form, and its functions are constantly being improved.
In addition, a new asset category has emerged, which is Token. We divide homogeneous Tokens into two categories: functional Tokens and security Tokens. In the past two days, there have been many discussions about STO and RWA. In my personal opinion, in the future, 70% to 80% of digital assets will be functional Tokens, not security Tokens under the concept of STO. There are seven or eight legislations related to blockchain, Web3.0, and digital assets in the US Congress, and everyone has different opinions and views, and there is a lot of debate. There are laws from the Senate, laws from the House of Representatives, laws primarily led by the Democratic Party, and laws primarily led by the Republican Party, and the viewpoints are different. But everyone agrees to transfer the main regulatory authority to the Commodity Futures Trading Commission (CFTC) through legislation, rather than the Securities and Exchange Commission (SEC). On this point, there is no dispute among the Senate, the House of Representatives, the Democratic Party, and the Republican Party. This means that they have reached a consensus at least on one point, that is, 70% to 80% of Tokens are virtual commodities to be regulated by the Commodity Futures Trading Commission (CFTC). This also indicates that most things in digital assets are still functional Tokens, so it is very important to design their compliance boundaries.
In this new financial infrastructure, there is a new token tool called NFT, which stands for Non-Fungible Token. NFT is a digital token used to prove the identity, qualifications, and work of all digital, virtual, invisible, and intangible things. Next, there are several issues that need to be clarified:
First is STO.
In the view of regulatory authorities in Hong Kong, STO can be divided into two categories. The first category is security Tokens or equity Tokens, which tokenize the equity of a company, replacing IPO with STO. The second category is RWA, which may be an issued collective investment plan, because RWA involves interest payments, and interest payments are considered securities. Both of these categories fall under the scope of STO in Hong Kong.
STO must be issued on the blockchain, preferably on a global public ledger. This way, whether it’s security tokens or RWAs, they become assets that are issued, registered, and circulated on a global public ledger, thus gaining support from global liquidity, rather than just regional liquidity. Looking back at the depth and breadth of the financial market, it can be seen that the liquidity of these tokens is no longer supported by the depth and breadth of a specific financial market.
The second is stablecoins.
I believe that stablecoins are crucial in any market. Because stablecoins are not only trading tools for exchanges, but also bridges that connect the “real world and virtual world,” “physical economy and digital economy,” and “private ledgers and public ledgers.” The so-called private ledgers refer to the ledgers of various financial institutions, while the public ledger refers to the blockchain. Therefore, stablecoins also serve as bridges connecting bank accounts and blockchain accounts, transforming fiat currency in bank accounts into digital currency. They also serve as bridges connecting “CeFi and DeFi,” “fiat currency and digital currency,” and “non-programmable currency and programmable currency.” Thus, their importance cannot be emphasized enough. In any region, there are stablecoins anchored to their own currency, such as stablecoins based on the Hong Kong dollar. It is unimaginable without them.
RWA is a direction that regulatory authorities in various countries have been promoting. By tokenizing real assets, bank assets, and cash-flow-generating assets, they can obtain support from the global liquidity market. To gain global liquidity support, it is essential to issue them on a global public ledger, which is unlikely to be done on private chains or private ledgers.
RWA’s market share of over 80% is not targeted at centralized exchanges, but rather at inter-institutional and inter-bank markets. It is a tokenized market issued by traditional financial institutions and traded between institutions. This is similar to how almost all stock exchanges around the world have attempted to establish a centralized and standardized bond market, but no stock exchange has succeeded. This is because RWA or similar bond markets, which are fixed-income products, are not suitable for standard centralized trading. They should be traded peer-to-peer, even if trading the same bond, the counterparty’s credit, payment terms, and the size of the purchase quantity will result in different quotes. It is impossible to match these trades using machines in a system, so it is not suitable for trading on exchanges.
After explaining this, we understand the significance or scientific nature of the virtual asset policy declaration made by the Hong Kong SAR Government. The policy objective of the Hong Kong International Virtual Asset Center is not only to establish a trading market for speculative trading of virtual assets. Its goals are much broader. They hope to find a path that combines blockchain, Web3.0, virtual asset servicing the real economy, and supporting technological innovation through tokenization, as well as further upgrading the financial center. This cannot be achieved with just a secondary market, meaning there cannot be only virtual asset exchanges.
The International Virtual Asset Center in Hong Kong is built on a four-layer structure, and only with these four layers is it a complete financial system.
The first layer requires an active secondary market with active trading. Above the active trading, there needs to be a primary market that can issue new digital assets or virtual assets, supporting the real economy and technological innovation, thus building a new and more advanced version of the financial market. Without such a market, the value of virtual assets in Hong Kong will be greatly discounted. With an efficient trading market and issuance market, the third layer of the International Virtual Asset Center is centralized industry services. Because the issuance and trading services require the participation of many institutions and professionals, a new virtual asset industry will be formed. Where does this industry fall? First, it solves employment issues, and second, it provides tax revenue. However, this industry is much more than that, because with the previous three layers of structure, the industrial ecology of Web3.0 will also be implemented in such a city. We have observed that many Web3.0 entrepreneurial projects are seeking to land in Hong Kong Cyberport or Hong Kong Science Park because they have the core foundation of the ecosystem – the primary market and the secondary market. Blockchain or Web3.0 entrepreneurs may be gaming experts, but not necessarily blockchain experts, so they need third-party technical support on the chain, need to design a good economic model to support business logic, support Web3.0 logic, and also need professional knowledge and professional talent to support it, thus forming a modern industry. This is its four-layer structure.
On this basis, we have already seen the emergence of Hong Kong International Financial Center 2.0. One of the core pillars of Hong Kong International Financial Center 1.0 is the Hong Kong stock market. The Hong Kong International Financial Center relied on two centers, one for international trade and international shipping financing, but this pillar has clearly been impacted in recent years due to factors such as the epidemic. After the decline in trade, shipping will also decline. The decline in trade and shipping has gradually weakened Hong Kong as an international financial center, that is, the number of banks providing trade financing and shipping financing services will decline, and their importance will also decline.
The foundation of the Hong Kong stock market is shareholder capitalism, but on the basis of shareholder capitalism, we use the corporate system to fix the rights and interests of all shareholders. Therefore, shareholder capitalism or the stock market is an ownership market, transforming ownership shares into stocks, and listing and trading them on a stock exchange. This is the 1.0 version of the Hong Kong International Financial Center, which will always exist, and the corporate system will also always exist.
However, the changes brought about by the emerging digital economy have changed the foundation of the system. It has changed from shareholder to stakeholder, from shareholder capitalism to stakeholder capitalism. On the basis of stakeholder capitalism, it is not necessary to use the corporate system to fix and determine the rights and interests of all owners. Since it is a stakeholder, the organizational structure of non-profit organizations and open-source organizations can be used. In non-profit organizations and open-source organizations, it is actually a system structure of use rights, transforming usage rights into functional tokens. Therefore, the Hong Kong International Financial Center 2.0 version establishes a virtual asset market based on tokenization.
Therefore, the policy declaration on virtual assets by the Hong Kong SAR government is not only about Hong Kong’s status as an international financial center, but also about the upgrade and update of Hong Kong’s function in serving the mainland. It is even more about the major events of Hong Kong’s economic transformation and urban upgrading. It is not just a matter of the financial market, nor is it just about establishing an exchange and obtaining an exchange license. This is just one of its values. Five years later, we may even find that this is not the most important value.
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