Dr Xiao Feng: Web3.0 and the policy statement on the development of Virtual Assets in Hong Kong

Below is the full text of Dr. Xiao Feng’s closing speech at the Ninth Global Blockchain Summit.

Dear friends, good afternoon! Policy Statement on development of Virtual Assets in Hong Kong has recently aroused a great public attention. We had three speakers from Hong Kong during the event, namely Duncan Chiu, Legislative Council Member (Technology and Innovation Constituency), HKSAR; Peter Yan, Chief Executive Officer, Hong Kong Cyberport Management Company Limited and King Leung, Head of Financial Services and Fintech, InvestHK to interpret the policy from the perspectives of the Legislative Council and the government of HKSAR. I will also share my ideas on this policy and the opportunities from the perspective of marketing and practitioners.

First of all, let’s make it clear why the government of HKSAR has issued a series of policy statements on virtual assets. To understand the background of this, we need to start with the digital economy. Our fundamental goal is to support the sustainable development of the digital economy in Hong Kong. What are the characteristics of the digital economy? From my perspective, the digital economy features the following three characteristics.

To begin with, the digital economy has no geographical boundaries. That’s why the Hong Kong has the opportunity to make the best of its uniqueness in the digital economy, including the policy of One Country, Two Systems, a common law jurisdiction and a free port. Someone may say that Hong Kong missed the opportunities in the era of internet, so it must not miss the opportunities in the era of blockchain. In fact, Hong Kong did not miss those opportunities in the internet era because the internet is related to geographical space, jurisdiction, and user location. However, Hong Kong can leverages its advantages as a free port in the Web3.0 era as it does not have much to do with geographic factors.

As a free port, the capital can flow in and out of Hon Kong freely. As mentioned by previous speakers, the entry and exit of fiat currency is an obstacle and prerequisite to the massive adoption of Web3.0. Additionally, the common law in Hong Kong allows Web3.0, blockchain, and virtual assets to leverage its institutional, mechanical and legal regulation advantages while circumventing geographical limitations.

Secondly, the digital economy is not bound by physical rules. For example, you do not need to follow mechanical rules when you try to build architectures or cities in Metaverse.

Thirdly, the digital economy is not constrained by commercial organizations.

Digital technology has always empowered individuals, giving them enormous abilities so that they no longer need to rely on a specific commercial organization. They can work for themselves. Besides, the value of the digital economy follows different rules. The digital economy features a high fixed cost, a low marginal cost, and even zero marginal cost. Software development causes a high fixed cost and a significant investment. For example, Open AI spent billions of dollars on GPT4 and will spend billions or even tens of billions of dollars to upgrade it to GPT5 and GPT6. It’s a very high fixed cost. Once developed, the marginal cost for GPT to engage 1 billion or 1 hundred million users is nearly zero. The manufacturing economics that has been rampant in the past two centuries didn’t follow such value rules. Therefore, under this rule of value, the services of the digital economy is all about being open source and permissionless.

In an economy of access, how can a product or service that is open-source, open-ended, non-licensed, or even free capture its value? The answer is Token. Token is the use permission in computer language, that is, pass. The use license of logging into a system has evolved into the right to use in the blockchain era, becoming a standardized right to use. The case I particularly like to cite is the fax machine effect. Let’s assume that a fax machine network consists of 1 million fax machines. Do I need any permission from others to join the fax machine network? Not necessarily, but you do need to buy a fax machine. When you purchase a fax machine, you somewhat got a license to join the fax machine network. We can only join the Bitcoin network and use it by purchasing a Bitcoin. We need to have an Ethereum on hand to use the Ethereum network. Fax machines, Bitcoin and Ethereum, all use permissions. To use this network and enjoy its value, there must be a token and a license.

The fax machine network does not belong to the person who buys it and accesses the network. It’s a bit like Ethereum. You hold ETH, but it doesn’t mean you have the rights of the Ethereum network. You only have the right to use it. Therefore, the fax machine effect of the right to use has given birth to a new capital system called the stakeholder capital system. Everyone is a user, no one owns the network, and the fax machine network has a third characteristic: any new user adds value and benefits to other users already using the network. Because the more people join the fax machine network, the more possibilities for other fax machine users to send faxes, and the value is obviously increasing. This is the greatest advantage of the fax machine effect or the right to use effect. The more people use it, the better it is for everyone. If you are the owner of the company, and own one share of the company, then the share belongs to you, and no one else can claim ownership of it. The right to use can be granted indefinitely, and the more it is granted, the greater its value, but this is not the case with ownership.

Based on these three characteristics, we can say blockchain practice in the past decade was in a stage of infrastructure construction. At the same time, it can also be seen as a set of financial infrastructure for the digital economy with the above characteristics that we have spent ten years to build. It is clear that traditional financial infrastructure cannot serve it well. The practice in the past decade is to build a new financial infrastructure that can serve digital natives and digital twins well.

Fhis financial infrastructure is based on a distributed network, which is Web3.0. And on this network, we have constructed a new method of bookkeeping, which is distributed ledger, or blockchain. Based on such a distributed ledger, we have built a distributed finance, which is Defi.

In the future, all large-scale applications based on blockchain or Web 3.0 will have to use this financial infrastructure, because traditional financial infrastructure cannot serve this new economic model. There are several major building blocks in the new financial infrastructure.

First, the new method of bookkeeping.

I won’t go into much detail about this new method since it is already familiar to most of us. The main characteristic of this new method is that it is an open, transparent, and global public ledger. Previously, all bookkeeping methods were based on private ledgers, where individuals kept track of their own records. There was no way you could know about my accounts, or access to them. However, anything recorded on the blockchain is openly and transparently available to the entire network. It is built upon a public ledger system, which is essentially a global ledger. Once you log into this global ledger system, anyone around the world can access, view, interact with, and trade the recorded assets. This is a characteristic that traditional financial markets lack, as their assets are registered on private ledgers. If they are not made accessible to you, you won’t find out. And if you don’t know about them, you cannot buy, invest, or trade them. This is the first characteristic.

Second, a new account system.

Traditional finance is built upon the banking account system, where all funds are stored in bank accounts. However, with the emergence of internet platforms, a new generation of internet accounts has appeared that are different from the traditional banking account system. Examples include Alipay Wallet and WeChat Pay Wallet. These two wallets are not accounts set up by banks or managed by banks, but accounts managed by internet platforms, with fiat currency in them as well. The revolutionary change comes from blockchain technology. Blockchain-based digital wallets, which come in various forms, are referred to as “blockchain accounts” to align with the aforementioned concept. Blockchain accounts are completely detached from the traditional financial system, particularly the banking account system. There is no longer fiat currency running inside. However, in the latest developments, certain blockchain accounts can hold fiat currency such as USDT and USDC, and in the future, they may also support central bank digital currencies (CBDCs). Nevertheless, if a currency cannot be digitized and operated on smart contracts, it cannot be compatible with blockchain accounts.

Third, new settlement methods.

Another change is that the settlement method of this new financial infrastructure has changed dramatically. Transaction confirmation and clearing settlements occur simultaneously. Transactions are made peer-to-peer, and payments are made peer-to-peer. This new settlement method has already been adopted by traditional banks, at least from the United States, Singapore, and Hong Kong. Recently, traditional banks have started issuing RWAs, which are tokenizations of real-world assets. Why tokenize real-world assets? One major advantage is the significant improvement in clearing and settlement efficiency, along with a reduction in transaction costs and processes. Additionally, there has been a significant change in the form of currency within this financial system. The currency in use is now digital currency.

I classify digital currencies into three categories. Firstly, there are fiat digital currencies, which are central bank digital currencies (CBDCs) issued by central banks. Central bank-issued currencies are considered base currencies, and their creation requires the involvement of market institutions to establish currency leverage or money multiplier to better serve the real economy. Therefore, stablecoins have emerged as digital currencies issued by institutions. In traditional financial markets, banks are the main creators of currency, currency leverage, and money multiplier. So when it comes to stablecoins issued between institutions, we refer to it as M2, which is comparable to the M2 in the real financial market. It is currency “created” through leverage by market institutions like banks, rather than currency “issued” by central banks.

In Hong Kong, if you take a banknote, you will see a statement that says “Payable to the bearer on demand,” which is a promissory note and belongs to M2. In the new financial infrastructure, there is also a native digital currency, which is Bitcoin. Bitcoin has not yet fully evolved into a complete form; its form is still evolving, and its functionality is continuously being enhanced.

Another development is the emergence of a new asset category, which is tokens. We can classify the purpose of tokens into two main categories: utility tokens and security tokens. In the past two days, there have been numerous discussions on STO (Security Token Offerings) and RWA (Real-World Assets). In my opinion, in the future, 70% to 80% of digital assets will be utility tokens rather than security tokens under the STO concept.

Let’s look at the United States Congress, there are around seven or eight legislations related to blockchain, Web3.0, and digital assets. Different proposals and viewpoints have led to significant debates. There are bills from the Senate, bills from the House of Representatives, bills supported by the Democratic Party, and bills supported by the Republican Party. However, they all agree one specific point: they intend to delegate the primary regulatory authority to the Commodity Futures Trading Commission (CFTC) instead of the Securities and Exchange Commission (SEC). This also implies that they have reached consensus on at least one point, which is that these virtual assets are commodities. Therefore, the CFTC will be responsible for regulating 70% to 80% of tokens classified as virtual commodities. This perspective highlights that utility tokens constitute a significant portion of digital assets. Therefore, it is crucial to design the compliance boundaries for utility tokens and possess the necessary capabilities in this regard.

In this new financial infrastructure, there is a new token called NFT, which stands for Non-Fungible Token. NFTs are digital tokens used to prove ownership of intangible, virtual, and non-identical assets. They serve as a means of self-identification, representing identity, qualifications, work records, and more. This aspect is widely understood, so I won’t delve into it further.

Next, I have a few more issues to clarify.

Firstly, let’s talk about STO. There has been a lot of discussion about it.

In the eyes of regulatory authorities in Hong Kong, STO can be divided into two categories.

The first category is security tokens or equity tokens, which involve tokenizing the equity of a company. Instead of going through an initial public offering (IPO), the company’s equity is tokenized through an STO.

The second category is RWA (Real World Asset), where you might issue a collective investment scheme. Since RWA involves interest payments, it falls under the securities category.

Both of these categories fall within the scope of STO in Hong Kong.

In the context of STO, it must be issued on the blockchain, and it is a public ledger, preferably on a global public ledger, because then, no matter whether it is a securities token or RWA, it becomes an asset that is issued, registered, and circulated on a global public ledger, and therefore it gets the support of global liquidity, not the liquidity support of a certain region. Then, when we consider the liquidity of these Tokens, it is no longer just restrained by the depth and breadth of the financial market in one particular location.

The second topic is stablecoins.

From my understanding, stablecoins are crucial in any market. They serve not only as trading vehicles on exchanges but also as bridges between the real world and the virtual world. They connect the traditional economy with the digital economy and act as a link between private ledgers and public ledgers. Private ledgers refer to the individual financial institution’s own records, while public ledgers refer to blockchain. Therefore, stablecoins also serve as bridges between bank accounts and blockchain accounts, which facilitate the conversion of fiat currency in bank accounts into digital currency. They also bridge the gap between CeFi (Centralized Finance) and DeFi (Decentralized Finance), fiat currency and digital currency, as well as non-programmable currency and programmable currency. The importance of stablecoins cannot be overstated. It is unimaginable for any region to not have its own stablecoin. For example, in Hong Kong, there would be a stablecoin based on the Hong Kong dollar.

Another topic is RWA (Real World Asset). RWA has gained significant attention and support from regulatory authorities worldwide. It involves tokenizing real assets, bank assets, and cash-flow generating assets to obtain support from global liquidity markets. Once it receives global liquidity support, the issuance is likely to be based on a global public ledger and is unlikely to be conducted on private chains or private ledgers.

More than 80% of the RWA market share is not targeted toward centralized exchanges but is rather an institutional and interbank market. It is a tokenized market where traditional financial institutions issue and trade assets among themselves. This is similar to how almost all stock exchanges worldwide have attempted to establish a centralized, standardized bond market, but no stock exchange has succeeded in doing so. This is because RWAs or similar fixed-income products are not suitable for standard centralized trading; instead, they should be traded peer-to-peer. Even when buying and selling the same bond, the counterparty’s creditworthiness, payment terms, and the size of the purchase quantity can vary, leading to different quoted prices. It is not feasible to match these trades using automated systems, making exchange-based trading less suitable for such assets.

Once this matter is explained clearly, we will understand the legitimacy or rationality behind the policy made by the Hong Kong Special Administrative Region (HKSAR) government regarding virtual assets. The policy objectives of making Hong Kong an international virtual asset center go beyond merely establishing a trading market for speculative buying and selling of virtual assets.Their goals are much broader. They aim to utilize tokenization as a means to integrate blockchain, Web3.0, and virtual asset services into the real economy, supporting technological innovation, and further upgrading the financial center. This cannot be achieved by merely having a secondary market, meaning it cannot solely have virtual asset exchanges.

Hong Kong, as an international virtual asset center, is constructed with a four-tier structure, forming a complete financial system.

The first tier requires an active secondary market with vibrant trading. On top of active trading, there is a need for a primary market that can issue new digital assets or virtual assets to support the real economy and technological innovation, thereby constructing a new and more advanced version of the financial market. Without such a market, the value of the policy statement on the development of virtual assets in Hong Kong would be significantly diminished.

With an effective trading market and issuance market, the third layer of the international virtual asset center is centralized industry services. As issuing and trading services require the participation of numerous institutions and professionals, therefore, a new virtual asset industry will be formed. What does this industry entail? Firstly, it addresses employment problems, and secondly, it provides tax revenue. However, this industry goes far beyond that because with the preceding three layers in place, the industrial ecosystem of Web3.0 will also land in such a city. We have observed many Web3.0 entrepreneurial projects seeking to establish themselves in Hong Kong Cyberport or Hong Kong Science Park because they possess the core foundation of the ecosystem: the primary market and the secondary market. Blockchain or Web3.0 entrepreneurs may be experts in gaming, but not necessarily in blockchain technology. Therefore, on-chain, there is a need for third-party technical support and the design of a robust economic model to sustain business logic and support Web3.0 logic. It also requires specialized knowledge and professionals to support it, thus forming a modern industry. This is its four-layer structure.

Building upon these foundations, we have already seen the imminent emergence of Hong Kong International Financial Center 2.0. In the past, Hong Kong, as an international financial center relied on two central pillars. The core pillar was its stock market. The other one is financing for international trade and international shipping. However, this pillar has been impacted in recent years due to factors such as the pandemic. When trade declines, shipping also decreases. The decline in trade and shipping gradually weakens Hong Kong’s role as an international financial center. This means that the quantity of services provided by banks for trade and shipping financing will decrease, and their importance will also diminish.

Let’s set aside that discussion and focus on the stock market in the 1.0 version of Hong Kong International Financial Center. The institutional foundation in Hong Kong is known as shareholder capitalism, and the stock market is based on this shareholder capitalism. Based on the institutional foundation of shareholder capitalism, we use the corporate system to fix the rights of all shareholders. Therefore, shareholder capitalism or the stock market is a market of ownership. We convert ownership shares into standardized stocks and list them for trading on the 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 are based on a different institutional foundation. As mentioned earlier, the foundation of the system has changed. It has transitioned from “shareholder” to “stakeholder” capitalism. For stakeholder capitalism, it is not necessary to use the corporate system to fix and determine the rights of all stakeholders. Since it involves stakeholders, we can utilize organizational structures such as non-profit organizations and open-source organizations. In non-profit organizations and open-source organizations, system architecture revolves around the concept of usage rights, where these rights are tokenized and standardized, known as utility tokens. Therefore, the establishment of the Hong Kong International Financial Center 2.0 version revolves around the virtual asset market through tokenization.

Therefore, the policy statement on the development of Virtual Assets in Hong Kong is crucial for the status of the Hong Kong International Financial Center, it is also essential for upgrading and revitalizing Hong Kong’s role in serving the mainland China market, and even more importantly, Hong Kong’s economic restructuring and urban upgrading. It is not only a matter about the financial market or the establishment of a exchange and obtaining a license to facilitate Bitcoin trading. That is just one aspect of its value. Looking ahead five years, it is not even the most important value.

That’s all I have to share! As the organizer, I would like to take the opportunity of this last speech to thank you all for coming to the summit over the past two days. Whether you were a guest speaker or an attendee, thank you all! I look forward to seeing you here next year, thank you!

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