Cryptocurrency in East Asia - Hong Kong and China: Chainalysis Report

Summary

• Eastern Asia saw a drop in crypto activity in 2022 due to China's restrictions.
• Hong Kong is emerging as a crypto hub, accounting for a significant portion of global crypto activity.
• Despite its small population, Hong Kong's crypto transactions rival those of mainland China.
• Retail investors dominate South Korea's crypto market due to strict regulations.
• Japan balances retail and institutional crypto activity.
• Hong Kong's crypto resurgence may influence China's stance, but it's unclear how.
• Cross-border wealth preservation and international payments drive crypto adoption in the region.

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The Rise of Crypto in Eastern Asia

Cryptocurrency has undergone a remarkable transformation over the past decade. What began as a remote concept has become a global phenomenon, with millions of users spanning numerous countries. Despite facing challenges, including a bear market in 2022, the crypto industry's adoption has surged, particularly in developing nations. 

Asian countries like the UAE and Singapore have been at the forefront of this growth. However, exploring the crypto landscape in Eastern Asia is crucial, where promising opportunities and challenges await.

Eastern Asia has witnessed a noteworthy shift in crypto dynamics. In 2022, the region experienced only a 4% year-over-year growth in transaction volume, marking it as the region with the lowest crypto activity. This was a stark contrast to 2020, when Eastern Asia ranked as the second-largest region in terms of crypto transaction volume. 

The decline can be attributed to the Chinese government's prohibitions, encompassing virtually all aspects of the crypto industry.

However, a glimmer of hope is on the horizon, as indicated by a recent Chainalysis report shared with BSC News. Hong Kong, in particular, is emerging as a global crypto and blockchain innovation hub. 

According to the study, Eastern Asia now ranks as the fifth most active crypto market, accounting for 8.8% of global crypto activity from July 2022 to June 2023.

A key point to remember is that Hong Kong is not a standalone entity but maintains close ties with mainland China. According to some experts, Hong Kong's emergence as a crypto hub may indicate a shift in China's attitude towards digital assets, possibly signaling more openness to crypto initiatives.

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Hong Kong's Crypto Prowess

Hong Kong's crypto dominance is evident when examining raw transaction volume. Between July 2022 and June 2023, the city received an estimated $64.0 billion in cryptocurrencies. Despite Hong Kong's small population, this figure is not far behind mainland China's $86.4 billion received during the same period.

One of the driving forces behind Hong Kong's crypto surge is its highly active OTC (over-the-counter) market. OTC trade desks cater to high-net-worth individuals and institutional investors and move large amounts discreetly to avoid impacting asset prices. Its OTC-focused approach stands out among its regional neighbors and global averages regarding transaction volume breakdown by transaction size.

While Hong Kong takes center stage in the Eastern Asian crypto narrative, it's essential to consider the crypto landscapes in neighboring countries, each marked by unique characteristics and trends.

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Crypto in South Korea and Japan: A Diverse Landscape

South Korea: Regulatory Challenges and Retail Dominance

South Korea stands out as a distinctive player in the Eastern Asian crypto arena. Its crypto market is characterized by a notable absence of large institutional transactions, with a majority of activity stemming from retail investors. 

As per CoinTelegraph, this disparity can be attributed to local regulations that impose significant barriers for financial institutions seeking to participate in crypto. 

For crypto exchange account creation, South Korea requires a specific type of bank account linked to an individual, discouraging institutional involvement.

Further, South Korea exhibits a pronounced preference for centralized exchanges, where approximately 68.9% of transaction volume occurs. This preference for centralized platforms may be influenced by negative sentiment following the TerraLuna incident, which garnered extensive local media, according to CoinDesk. As a result of the incident, South Korea implemented new regulations for centralized exchanges, including the requirement to hold reserve funds, potentially bolstering confidence in centralized platforms. 

Japan: Balancing Retail and Institutional Activity

In contrast, Japan's crypto landscape closely matches global averages regarding retail versus institutional holdings. The Japanese market strikes a balance, with activity split nearly evenly between centralized exchanges and various DeFi protocols. This equilibrium suggests a broader acceptance of retail and institutional participation in the crypto market.

“Whether or not traditional finance is ready to accept digital assets as a new asset class, the reality is that many institutional investors are now keen to explore and develop their own digital asset strategies,” said Dave Chapman, Head of Sales at OSL Digital Securities.

The Japanese crypto market shows a near-even distribution of activity between centralized exchanges and diverse DeFi protocols. 

In the following sections, we will examine the dynamics of crypto activity within China and Hong Kong, showing how traditional exchanges, DeFi markets, and OTC markets interact with one another.

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Hong Kong's Crypto Growth: How it can affect China

Hong Kong, a Special Administrative Region of China, has been at the forefront of crypto growth in Eastern Asia, making it an intriguing case study for the broader Chinese crypto landscape. One key factor in Hong Kong's crypto resurgence is its regulatory autonomy. 

Unlike mainland China, Hong Kong has the authority to establish its cryptocurrency regulations. Recent changes have allowed for regulated retail crypto trading, reflecting the region's openness to cryptocurrency within a structured framework. 

This newfound regulatory flexibility has also seen Chinese state-owned businesses engage in crypto-focused investment initiatives and collaborations with local crypto firms.

Diverse Use Cases Fueling Adoption

Hong Kong's crypto adoption is driven by a diverse range of use cases, which may offer insights into potential shifts in China's attitude toward digital assets. Institutional investors in both Hong Kong and China have recognized the value of cryptocurrencies as an integral part of their investment portfolios. Bitcoin and Ether remain the primary focus, although interest in smaller altcoins has grown.

“We work with many investment banks, private equity firms, and high-net-worth individuals. For them, cryptocurrency is part of their investment portfolio,” said Chapman. “They mostly want Bitcoin and Ether, though some have shown interest in smaller altcoins recently, which is interesting.”

Retail Adoption and Cross-Border Wealth Preservation

On the retail front, high-return potential motivates crypto adoption in the region. This mirrors the sentiments of institutional investors who acknowledge the permanence of digital assets. Retail users, too, seek opportunities for wealth growth through cryptocurrencies.

In addition, foreign users flock to Hong Kong to protect their wealth from economic instability or capital controls at home. Ordinary individuals are also turning to crypto for this purpose, underscoring its accessibility and appeal.

Users, including some from mainland China, leverage crypto to facilitate international transactions and move funds to countries with more favorable financial climates. The cumbersome nature of traditional banking systems and the prolonged settlement times for international bank transfers drive businesses and individuals towards crypto solutions.

This use case echoes China's broader ambitions to reduce reliance on the U.S. dollar in international trade, a goal shared by projects like China's digital yuan (CBDC). 

“The international payments use case also brings to mind another element worth noting: China has sought to undermine the dominance of the U.S. dollar in international trade, particularly given the power it gives the U.S. to sanction entities around the world, and that goal is one reason for projects such as China’s CBDC, the digital yuan,” said Merton Lam, founder of Crypto HK. 

The Enigma of China's Crypto Stance

As Hong Kong embraces cryptocurrency within a regulated environment, questions naturally arise about China's evolving stance on the technology. Despite Hong Kong's crypto initiatives indicating a growing interest in blockchain technology, Chapman said it's too soon to gauge their impact on China.

Hong Kong's unique crypto market caters to diverse use cases for its local populace and foreigners seeking financial stability and international trade advantages. Although the trajectory of China's crypto policy remains uncertain, Hong Kong's subtle endorsement of crypto innovation sets the stage for potentially significant developments in a nation that was once a pivotal player in the global crypto landscape.