HONG Kong is set to follow in the footsteps of the US by listing a batch of cryptocurrency exchange-traded funds (ETFs), providing a window on whether the city is making progress on fashioning a hub for digital assets.

Some of China’s top asset managers are in the final leg of preparations for the spot Bitcoin and Ether ETFs to begin trading potentially by the end of April. The launches will likely invite comparison with a slew of three-month-old US Bitcoin funds that took Wall Street by storm, garnering US$56 billion in assets to date.

Hong Kong for more than a year has been vying with the likes of Singapore and Dubai to develop a tightly regulated home for the virtual-asset industry, part of a plan to restore the city’s reputation as a modern financial centre following a crackdown on dissent that dulled its allure.

The level of demand for the upcoming ETFs will provide clues on Hong Kong’s progress. Chinese wealth parked in the city is one potential source of demand, as are crypto exchanges and market makers active in the Asia-Pacific region. Bloomberg Intelligence ETF Analyst Rebecca Sin estimated the funds may amass US$1 billion in assets under management over two years.

US shadow

Yet the US-based Bitcoin funds from titans such as BlackRock and Fidelity Investments have already captured global interest and investment flows. The prospective Hong Kong issuers – Harvest Global Investments, the local unit of China Asset Management, and a partnership between HashKey Capital and Bosera Asset Management (International) – lack similar name recognition.

“Hong Kong doesn’t have the ‘BlackRock’ effect to call on,” said Roger Li, co-founder of One Satoshi, a chain of stores in Hong Kong offering over-the-counter conversions between cash and crypto. Expectations for ETF demand need to be calibrated in line with the city’s smaller financial sector, he added.

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The US Securities & Exchange Commission grudgingly allowed ETFs investing directly in Bitcoin, the largest digital asset, in January. The agency is sceptical of crypto after a market rout in 2022 alongside bankruptcies and high-profile frauds, so ETFs for second-ranked Ether face an uphill task for approval.

Hong Kong, in contrast, has given the initial nod for spot Bitcoin and Ether funds, according to issuers. Another difference is that HashKey Capital and Bosera have said that the Hong Kong spot ETFs would have an in-kind subscription and redemption mechanism. That allows for the underlying assets to be swapped for ETF units and vice versa, whereas the US funds operate on a cash redemption model.

Arbitrage opportunities

The in-kind approach “is particularly appealing to crypto natives, market makers and digital-asset exchanges” as it enables greater efficiency and arbitrage opportunities, said Evgeny Gaevoy, co-founder of crypto liquidity provider Wintermute Trading.

Hong Kong already permits crypto-futures based ETFs and three have listed so far: CSOP Bitcoin Futures, CSOP Ether Futures and Samsung Bitcoin Futures. They have total assets of about US$175 million, a fraction of US offerings such as the US$2.5 billion derivatives-based ProShares Bitcoin Strategy ETF.

“Setting realistic expectations for the Hong Kong ETF market is crucial, especially when considering the relatively modest size of the region’s existing futures ETFs,” Gaevoy said.

Aside from giving the green light for spot ETFs, officials are evaluating about two dozen applications to expand Hong Kong’s current roster of two licensed digital asset exchanges. The city is also working on a framework for stablecoins, a type of token that is pegged one-to-one to fiat currency and typically backed by reserves of cash and bonds.

Rally tailwind

Whether Hong Kong will succeed in fostering a crypto hub remains an open question. The ETF launches arguably have a tailwind courtesy of Bitcoin’s fourfold jump since the start of last year, including a record high of US$73,798 last month catalysed by inflows into the US Bitcoin products.

“I am getting a lot of inquiries from Bitcoin holders” about Hong Kong ETFs, said Marco Lim, who is based in the city and is managing director of crypto hedge fund MaiCapital. The speed of approvals for the products took some by surprise, he added.

Digital assets also continue to be in demand in China amid a mixed outlook for stocks and a weak real estate sector. But crypto trading is banned on the mainland, driving activity underground, and the upcoming fund launches will likely remain beyond the purview of a programme giving Chinese investors access to some Hong Kong ETFs.

“Virtual-asset ETF infrastructure will take time to develop,” said BI’s Sin. “Once the ETF ecosystem develops, more players will be able to participate, resulting in more flows, improved prices, tighter spreads, more liquidity and cheaper fees.” BLOOMBERG