Chainalysis has just released a new report- this time on the East Asia region. Since this region includes some of the most important economies in the world, this report is of particular interest.

The region itself receives 8.8 per cent of all crypto transactions worldwide- a figure made all the more impressive by the Chinese government’s ban on crypto transactions and crypto activity. Japan, South Korea, and Hong Kong are also included in the region, which means that this region is home to several jurisdictions that have expressed significant interest in becoming cryptocurrency hubs in the future.

Hong Kong, in particular, has probably been the most vocal in its ambitions, though how long that lasts is questionable as well, given recent events like the JPEX scandal. Additionally, we should also consider the slow encroachment of Communist Party influence into Hong Kong, and whether or not Beijing will seek to bring Hong Kong’s crypto more in line with its own.

Hong Kong: Burgeoning crypto hub

Hong Kong’s policies have attracted a wide array of crypto users, and is known for having a highly active OTC market, where large institutional transfers account for almost half of all transaction volumes within the city.

Chainalysis spoke to the founders of two different Hong Kong-based OTC firms to get their opinions on the situation.

Merton Lam of Crypto HK stated that his company has a diverse portfolio of clients, including investment banks, private equity firms, and high net worth individuals.

“For them, cryptocurrency is part of their investment portfolio. They mostly want Bitcoin and Ether, though some of them have shown interest in smaller altcoins recently, which is interesting.”

Dave Chapman of OSL Digital Securities also noted the marked optimism of his client base in Hong Kong, revealing that many of his clients were bullish on crypto.

“The future of digital assets is no longer questionable; it's widely acknowledged that digital assets are not going away. 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.”

Aside from a vehicle for investment, however, Merton also points out that one of the use cases for crypto is as a means to avoid the high capital controls that several countries in the region are known for.

In particular, crypto users are using crypto to move portions of wealth out of their local currency and banking systems, especially in countries with unstable economies or strict capital controls.

And these users are not necessarily part of the wealthy 1 per cent- Merton notes that ordinary people are also taking part, and that this ability to move capital across borders easily may be driving interest from Mainland Chinese users, who are often subject to strict capital controls by China’s central bank.

Yet, Hong Kong’s friendly policies have also drawn some criticism, not least because of the recent JPEX scandal. Thus far, 18 arrests have been made, including of JPEX staff and several local influencers who promoted the exchange. The exchange is currently being investigated for fraud.

In the aftermath, it was found that the exchange had falsely claimed to have been licensed by Hong Kong’s Securities and Futures Commission. In response, the SFC has promised to provide more transparency on crypto licence applicants and licensed institutions moving forward.

Several experts have also expressed concern that Hong Kong must now also prove that it can protect retail investors during crises like these, in addition to still welcoming new crypto companies to the city.

China: Signals for a possible policy reversal?

Whether the world recognises it or not, Hong Kong’s government still has to answer to the central government in Beijing- and it is almost certain that they know about Hong Kong’s crypto activity.

Yet, they have also been strangely quiet about everything that has been going on in Hong Kong.

The two jurisdictions could not be more different.

Since 2021, the Chinese government has effectively banned crypto mining, trading, and many other forms of crypto activity, even going as far as to press charges against individuals who conduct crypto transactions in Mainland China.

Two months ago, a former official received a life sentence for his role in concealing and harbouring a crypto mining operation in Fuzhou.

Yet, Hong Kong has welcomed crypto with open arms, with the central bank even questioning why traditional financial institutions like banks were not providing services to crypto companies.

When Coinbase was hit by a lawsuit and other regulatory obstacles elsewhere, a member of Hong Kong’s Legislative Council posted a viral tweet inviting Coinbase and other exchanges to set up shop in Hong Kong.

Chapman, however, cautioned that it was still too early to say that these developments indicate an upcoming policy reversal.

“The promotion of Hong Kong as a potential crypto hub is not necessarily indicative of the Chinese government’s stance on crypto. However, we are seeing a number of Chinese state-backed entities indirectly supporting Hong Kong’s Web3 ventures, and this could be viewed as an exploratory approach to understanding digital assets without loosening mainland policies.”

Indeed, this would not necessarily be the first time that China has done something in this vein.

During the 1980s, China did not fully open up its economy despite Deng’s commitment to an open economy. Instead, the Chinese government dedicated certain areas as open to foreign trade and capitalism, known as Special Economic Zones. From there, it observed the effects of these policies, before tailoring other aspects of policy to better suit its needs.

Now, with the central government seemingly leaving Hong Kong be with its crypto policies, it might signal a willingness to adopt a less hostile stance to cryptocurrency, if nothing else. Hong Kong’s success in regulating crypto, therefore, might be used to inform further policy on crypto in China, whether that means a reversal of certain bans or greater enforcement.

South Korea: the road to centralisation

While Hong Kong seems to be heavily focused on institutional investment, South Korea sits at the other end of the spectrum, with its crypto adoption driven primarily by retail investors.

Chainalysis attributes this to the local regulations that make it difficult for financial institutions to trade, including requirements for specific types of bank accounts being linked to crypto wallets in order for individuals to open a crypto exchange account.

At the same time, South Korea sees a large majority of its crypto flowing through centralised rather than decentralised exchanges. The only country in East Asia with a higher proportion of funds going through centralised exchanges in Mainland China, with 73.5 per cent as compared to South Korea’s 68.9 per cent.

Hong Kong, Japan, and Taiwan see only 29.2, 47.0, and 34.1 per cent respectively. Hong Kong and Taiwan in particular see much more activity in the DeFi sector, which accounts for 58.3 per cent and 56.4 per cent of crypto transaction volumes.

One possible reason for South Korea’s aversion to DeFi could be the collapse of the Terra-Luna ecosystem in May last year, which was heavily covered in South Korea since it affected a large number of South Korean crypto users.

Additionally, South Korea has since passed new regulations to govern how centralised exchanges can operate, including requirements to hold reserve funds. As such, CeFi might be benefitting not only from the reduced interest in DeFi, but also from newfound faith in CeFi because of the new regulations.

That being said, the collapse of FTX remains a hot topic within the crypto community, and media coverage of SBF’s misdeeds, including everything from witness tampering to lax security measures at FTX and his abuses of power, are a mainstay in crypto media. The FTX crash was also more recent than the Luna collapse.

Therefore, it remains an open question as to why South Korea so heavily prefers centralised exchanges as opposed to decentralised exchanges, and if the impact of the Luna collapse is really as significant as it seems.

East Asia is one of the most important regions for crypto- not least because it includes China and several other economies that have been mainstays of the international financial system. What happens here will have a significant impact on many other countries, including economies where large numbers of crypto users reside, to countries that are also aspiring to become crypto hubs.

If you want to find out more about what’s going on in East Asia’s crypto scene, check out the full report from Chainalysis here.