Hong Kong’s newest licensing laws for cryptocurrency exchange platforms are seeing the gradual weeding out of the smaller exchange platforms due to a lack of capital to invest in the registration process. It is also seeing the unmasking of fraudulent players as they default on their obligations to their clientele. JPEX is one such platform that stands accused of defrauding its investors. Company representatives were forced to abandon their booth at the Token2049, a cryptocurrency conference in Singapore in a bid to flee from law enforcement. Six employees were arrested on sight on charges of fraud. By the 21st of this month, Hong Kong police reported the arrest of 11 employees and brand influencers on charges of fraud and the operation of an unlicensed virtual asset exchange.
These charges come in the wake of JPEX failing to obtain the licence necessary to operate the exchange platform. More than 2,000 are said to be affected, with a sum of $1.4 billion ($166 USD) involved. According to the police, these funds have been embezzled by company employers for their own ends. The police raid on the cryptocurrency conference resulted in the arrest of key JPEX executives. This was followed by the company voluntarily deregistering its Australian entity from the Australian Securities and Investment Commission – with the deregistration came the disclosure that the Australian entity did not have many assets left. Other company responses to the crisis included the swift halt of their operations related to return-generating products and imposing high withdrawal fees on their clients.
JPEX defends their operations – accuses new laws of being unfair
JPEX however insists that they are not defrauding their clients as they have every intention of releasing their funds in a timely manner. On the 20th, JPEX announced that 400 million Tether’s worth of investor deposits will be redeemed – starting in 2025. According to JPEX, this is because the police have instructed their telecom service providers and asset custodians to freeze JPEX’s assets, thereby hindering the firm from accessing them until investigations are concluded. The two telecommunications companies working with JPEX have also confirmed to news media that they have complied with a police request to block local access to the exchange platform’s website.
As mentioned, JPEX’s collapse directly follows new licensing laws for cryptocurrency exchanges operating within the city, and only three months have elapsed since the new laws were introduced. These regulations required that crypto exchange platforms obtain a licence and investor protection standards. A week prior to raiding the crypto event, the Securities and Futures Commission (SFC) had issued a warning against JPEX promoting their services to the Hong Kong public despite not being officially registered as an exchange platform. Another suspicious element flagged by the SFC included the improbably high returns the platform offered. The annual yield offered by some of the products platformed on the exchange for example promised a return of over 20%, which failed to materialise when investors tried to withdraw their assets.
For their part, JPEX criticises the new laws for being unfair and biased. According to the statements made by the company, JPEX had made several attempts to register with the SFC in line with the legal requirements. The new licensing laws also allowed existing players on the market a time window of a one-year grace period before applying for a trading licence, which JPEX have arguably been denied. The sudden freezing of their assets necessitated the much-criticised sudden increase in withdrawal fees on the platform in order to mitigate the liquidity crisis that it created. According to the company, the sudden halt in their return-generating products also contributed to this crisis. Existing earners from these assets will only be able to benefit from these until the product end date, or until the assets mature.
New laws that weed out the smaller players in the market
The allegations of bias levelled at the SFC by JPEX are in part explained by the strict requirements and high costs of obtaining licenses that make obtaining them difficult for smaller firms and brokerages. Commercial exchange platforms such as OSL and HashKey have already obtained the necessary paperwork that allows them to operate on Hong Kong territory, due to the wealth capital available to the companies backing them. These companies are now allowed to serve retail investors. It is said that obtaining this licensing can set a firm back by anywhere from $12 to $20 million Hong Kong dollars. Licensing consultants can charge nearly one million Hong Kong dollars for their services, and companies looking to register are expected to maintain a paid-up share capital of five million Hong Kong dollars. They are also required to maintain sufficient assets (not virtual) to fund one year of operations.
Other requirements include the hire of compliance officers (Responsible Officers) to ensure that all regulatory demands are being met, the maintenance of a local presence in Hong Kong, and investments that ensure segregation of client funds, safe custody of client assets, and payments related to smart contract audits and overall corporate governance. Exchange companies will also have to assess their own knowledge of virtual assets before allowing investors on board. All this ensures that there is a rigorous and expensive benchmark that needs to be met to cater to Hong Kong residents. Exchanges that only deal with a small trading volume or are inexperienced in meeting regulatory standards will soon find themselves excluded from the market.
Why are stricter laws necessary?
Cryptocurrency trading is completely outlawed in the mainland of China. However, Hong Kong has so far received Beijing’s support to explore its proposal to become a digital asset hub for the region. Hong Kong also has its own financial laws that it uses to regulate the market for financial instruments. Hong Kong’s aspiration to become a leader in the market, however, means that it faces the delicate challenge of incentivising potential market players to enter the market while stepping up regulations to protect investors. The new laws are a first step in ensuring that this balance is achieved for the sake of both investors and the companies that platform them.
The new laws target both exchange platforms such as JPEX as well as over-the-counter cryptocurrency brokerages. These OTC brokerages have also utilised social marketing methods such as the use of social media influencers to inflict high-pressure sales tactics on unguarded potential victims in the context of ‘crypto classes’ to drive profits. The aggressive marketing methods employed by these brokerages have been key in driving efforts to increase the regulatory regime on crypto exchange platforms. Experts even say that more regulations may well be necessary on OTC brokerages to ensure that they don’t platform money laundering as well as to ensure that they carry out their due diligence on the backgrounds of their clientele.
Police seize assets in high-profile raids
Ongoing investigations have led police to conduct about twenty raids on private homes and businesses in search of the accused as well as the assets that they embezzled. Cash, computers, and luxury handbags have been seized in the process. The police enquiries are also allegedly looking into whether JPEX had worked hand in glove with influencers and crypto retailers to masquerade as a licensed entity as well as to exaggerate the value of the assets they held. These over-the-counter (OTC) brokerages had hitherto enjoyed a legal loophole that exempted them from financial regulation – which the licensing system seeks to address.
Hong Kong police are yet to arrest the key players in the incident, for which Interpol’s help has been enlisted. Among the 11 individuals arrested, the police have arrested two social media influencers with a combined following of 200,000 on YouTube. Among the arrested are also the company’s only director, a restaurant director and three celebrities who had promoted the platform.
JPEX trading remains active despite an active criminal investigation
Despite the scandal taking place, it appears as if the Dubai-based exchange still remains functional. Spot trading is still taking place on the platform, despite the website being blocked in Hong Kong. The firm also promises to adjust withdrawal fees back to normal levels after finishing their negotiations with the third-party partners who have withdrawn their services from them. JPEX has also announced that it will be engaging the help of a decentralised autonomous organisation (DAO) for professional advice on how the company would go about restructuring its user base.
(Theruni Liyanage)