In a landmark move for digital assets management, the Hong Kong Securities and Futures Commission recently approved the issuance of spot exchange-traded funds (ETFs) for bitcoin and ethereum. This decision not only reaffirms the Hong Kong Special Administrative Region’s position as a global financial hub but also sets a new standard in the financial markets and digital assets management globally. This initiative is expected to enhance market acceptance and stimulate innovation in investments, propelling the growth of digital finance. As digital assets gain acceptance worldwide, Hong Kong’s initiative could mark a new chapter in financial innovation and investment strategies.

The fast-paced evolution of financial technology has brought increased global focus on the regulatory frameworks surrounding cryptocurrencies. As a leading international financial center, Hong Kong has proactively adapted and strengthened its regulations to protect investors and ensure market stability. The introduction of cryptocurrency ETFs provides a standardized and transparent investment avenue, significantly reducing the risks of fraud associated with less familiar technical aspects like crypto wallets.

Last month, a cryptocurrency investment fraud case in Hong Kong, involving a woman who lost HK$7.1 million ($907,000) to a fraudulent platform that she had found via social media, underscored the risks present in the crypto market. This incident highlights the necessity for robust regulation and investor education. Cryptocurrency ETFs allow investors to interact with digital currencies through established financial institutions, mitigating the risks associated with direct transactions.

Additionally, global institutional investors are increasingly incorporating crypto assets into their portfolios. For example, the Japanese Government Pension Investment Fund — one of the world’s largest, with assets worth $1.53 trillion — is now considering cryptocurrencies for diversification and risk management. This indicates a significant shift, even among traditionally conservative investors, towards recognizing the value of virtual currencies in global financial asset allocation.

By endorsing cryptocurrency ETFs, Hong Kong’s regulatory authorities are not only maintaining the region’s leadership in the global financial market but also aligning with evolving investment trends and the growing acceptance of digital assets. This strategic decision enhances Hong Kong’s status as a financial innovator and provides a safer, more regulated framework for investing in digital currencies.

The rollout of virtual currency ETFs necessitates an urgent enhancement of regulatory frameworks and governance structures to promote the healthy development of this emerging market and protect all stakeholders

The introduction of virtual currency ETFs represents a significant step forward in financial innovation, offering multiple opportunities for the market and its participants. These are:

1. Enhanced liquidity and market pricing transparency: Virtual currency ETFs enhance liquidity and transparency in pricing. Traded on regulated exchanges like traditional stocks, these ETFs allow for easy buying and selling, enabling investors to react quickly to market dynamics with real-time pricing. This functionality improves market efficiency and capital utilization.

2. Improved risk diversification in portfolios: Virtual currency ETFs lower the entry barrier for individual investors, allowing them to engage in the broader cryptocurrency market or specific sectors with minimal initial investments. This structure aids in risk diversification, mitigating the volatility associated with individual cryptocurrencies. ETFs facilitate diversified portfolio management, helping even small investors to stabilize asset growth through professional asset management, thus democratizing access to the cryptocurrency markets.

3. Promoting innovation and development in Hong Kong’s financial market: The launch of virtual currency ETFs enriches Hong Kong’s financial product offerings and fosters integration between financial and blockchain technologies. This move is likely to attract global investors and tech companies, reinforcing Hong Kong’s position as a premier international financial hub. In line with Chief Executive John Lee Ka-chiu’s 2023 Policy Address, the introduction of these ETFs supports the strategy to attract high-end talent in finance, law, and technology, enhancing the city’s appeal as a fintech leader.

Additionally, this development reflects the proactive stance of Hong Kong’s financial regulators towards embracing and regulating technological innovations in the finance sector. By setting clear norms and guidelines, Hong Kong creates a stable environment conducive to the growth of fintech companies. This regulatory clarity, combined with strategic innovations, is poised to strengthen Hong Kong’s role as a top fintech hub in Asia and globally, boosting demand for skilled professionals in the financial and technological fields.

Virtual currency ETFs, while innovative, carry inherent risks linked to the characteristics of their underlying crypto assets. These are:

1. High volatility: Cryptocurrencies are notably volatile, with prices susceptible to sharp fluctuations influenced by market sentiment, global economic shifts, and regulatory changes. This volatility can pose significant risks for investors looking for stable returns.

2. Lack of information and valuation challenges: Even well-known cryptocurrencies like bitcoin lack reliable valuation models. Since most crypto assets do not generate cash flows or profits, traditional cash flow discount models are not applicable to many cryptocurrencies. Although scholars continue to explore different valuation methods, including basing calculations on factors like the asset base, asset turnover rate, and the value and quantity of digital resources, the field of virtual currency valuation remains nascent, and its methodologies are not yet mature.

3. Governance and regulatory challenges: The governance and regulatory landscape for cryptocurrencies is complex due to their unique characteristics like transparency and liquidity, which differ markedly from traditional investments. Moreover, the decentralized and anonymous nature of these assets complicates the implementation of effective governance structures. Additionally, the absence of consistent regulatory standards across jurisdictions can lead to regulatory arbitrage, further complicating global financial governance.

The introduction of virtual currency ETFs marks a significant advance in financial innovation, opening new investment avenues and underscoring the need for stronger regulation and governance. As cryptocurrencies evolve, it’s clear that governance frameworks and regulatory measures need refinement to protect investors. Enhancements should focus on increasing fund managers’ legal responsibilities, boosting transparency, and ensuring investors are well-informed about their rights and protections.

Initial coin offerings, while insightful through their whitepapers, often lack clarity regarding the identity of the issuing entities. Virtual currency ETFs offer a critical opportunity to improve information disclosure practices, aiding in the detection of fraud and outlining available legal protections. Additionally, developing technical audit mechanisms may play a crucial role in ensuring accountability and enhancing investor confidence in the cryptocurrency market.

In conclusion, the rollout of virtual currency ETFs necessitates an urgent enhancement of regulatory frameworks and governance structures to promote the healthy development of this emerging market and protect all stakeholders.

The author is an executive master in public administration candidate, Tsinghua University, a Sha Tin district councilor and a member of China Retold.

The views do not necessarily reflect those of China Daily.