Core Asset Custody for Compliance of Virtual Asset Trading in Hong Kong

Recently, two virtual digital asset exchanges in Hong Kong obtained the virtual asset service provider license approved by the Securities and Futures Commission, starting to offer virtual asset trading services to retail investors in Hong Kong. This marks a further enhancement of the importance of Compliance exchanges in the virtual asset field.

The Hong Kong Securities and Futures Commission and the Monetary Authority have successively issued a series of measures for virtual asset trading since October last year. Starting from June 1 this year, more exchanges can apply to the Securities and Futures Commission for a compliance virtual asset trading license. In such a policy environment, many exchanges are planning to apply for a Hong Kong license.

The regulatory framework for compliant trading in Hong Kong sets high technical requirements for exchanges in terms of software and hardware compliance. Among them, customer asset custody is one of the core areas of concern for the Hong Kong Securities and Futures Commission.

The Difference Between Virtual Asset Exchanges and Traditional Financial Custody

In traditional finance, brokers cannot directly hold customer funds; instead, banks and other institutions are responsible for fund custody. Under the compliance framework for virtual asset trading in Hong Kong, exchanges need to take on a role similar to that of banks by directly holding customers' virtual assets. This requires compliant exchanges to possess hardware and software capabilities close to that of banks, while also needing to incorporate cryptographic dimensions.

Security Issues in Virtual Asset Trading

From a security perspective, blockchain can be divided into on-chain and off-chain. On-chain carries risks such as smart contract vulnerabilities, while off-chain requires a comprehensive security system engineering, including user authentication, network and terminal security, and emergency response mechanisms.

From a Compliance perspective, regulatory policies have gradually become clearer in recent years. The virtual asset licensing regulatory policy released by Hong Kong this year is very specific, starting to regulate the entire industry from trading platforms.

Requirements of Hong Kong Regulation on Asset Custody

The regulatory policy in Hong Kong is both logical and comprehensive:

1. The digital asset private keys must be stored locally in Hong Kong.

2. Applicants are required to independently build a virtual asset security custody system and list detailed requirements.

3. Emphasize the maturity of the technology route, requiring the use of technologies certified by internationally recognized authorities.

4. An authoritative third-party evaluation agency is required for assessment and certification.

Measures to Protect User Asset Security

1. IT requirements include network security, infrastructure, endpoint security, disaster recovery emergency response, etc. 98% of assets must be stored in cold wallets.

2. Compliance requirements include the appointment of a professional Chief Compliance Officer, responsible for KYC and Travel Rule, etc.

3. Risk control needs to manage market manipulation, fraud, counterparty, credit, and other risks.

4. Governance requires the establishment of a sound system, including the separation of entities, clarity of funds, and the separation of roles and responsibilities.

Possible Solutions for the Future

1. New technologies such as MPC may be adopted after maturing.

2. A complementary model between personal wallets and centralized exchanges may emerge.

3. In the future, asset custody may be concentrated in the hands of a few leading institutions.

4. With the improvement of regulations, the role of custody may become independent from exchanges.

5. After the new technology route matures, the technology choices of the custody service providers will become more diversified.