Investor Attention：How the Hong Kong Government Regulates Exchange Compliance in Light of JPEX’s Debacle

Greenstone Exchange (JPEX) is a cryptocurrency asset trading platform headquartered in Dubai, established in 2020, primarily targeting the Hong Kong market. JPEX claims to be a licensed and recognized cryptocurrency asset trading platform in various parts of the world, offering leverage trading of up to 300x and over 30% stablecoin staking rewards. Since 2021, JPEX has invested heavily in marketing, employing celebrities like Zhang Zhi Lin and Chen Ling Jiu as brand ambassadors, gaining significant attention in the Hong Kong cryptocurrency scene.

Upon entering the Hong Kong market, JPEX engaged in extensive advertising through social media, over-the-counter exchange shops, and endorsements by celebrities and internet influencers. They touted “low risk, high returns” and used exaggerated, unrealistic marketing tactics, such as claiming “earn every day, never lose,” to attract investors and make them believe in substantial returns. JPEX also enticed users through the issuance of their platform coin, JPC, and promotions like “invite and earn commissions.”

However, "everything given by fate has already marked the price in the dark"; Under Hong Kong's new cryptocurrency regulations that came into effect in June of this year, any centralized platform providing virtual asset trading services in Hong Kong or to HK investors must be licensed by the Securities and Futures Commission (SFC), but platforms are permitted to trade without a license within a one-year grace period. While JPEX claimed to have licenses from various places around the world, they did not apply for or receive the Virtual Asset Service Provider (VASP) license from the Hong Kong government after the new regulations were introduced. In August 2023, the Hong Kong Securities and Futures Commission issued an unnamed warning to the public regarding improper practices of some virtual asset trading platforms, acting as a “pre-warning” before JPEX’s collapse.

1. JPEX’s Collapse Timeline

The JPEX collapse happened rapidly. On September 13th, the Hong Kong Securities and Futures Commission issued a warning statement, indicating that JPEX did not have an SFC license, nor had they applied for one. Their promotion methods were deemed suspicious. This meant that SFC’s investigation into JPEX’s illegal operations and fraudulent behavior had reached its conclusion, serving as a final warning to investors.

Two days later, on September 15th, JPEX abruptly announced the suspension of all trading services and set a withdrawal limit for cryptocurrency assets at 1000 USDT with a withdrawal fee of 999 USDT. This shift signified that JPEX could no longer maintain normal operations and was making off with the funds.

On September 18th, the Hong Kong police, with SFC’s referral, raided JPEX at the Token 2049 conference in Singapore and arrested 11 individuals involved, including well-known cryptocurrency influencer Joseph Lam. On the same day, JPEX delisted all trading on their platform.

On September 20th, JPEX announced that it would start repurchasing 400 million USDT from user deposits by the end of 2025. It can be seen that JPEX tries to alleviate investors' dissatisfaction and recovery by delaying redemption. However, it remains doubtful whether JPEX has the ability to convert these USDT into fiat currency for reimbursement. By that day, over 2000 people had reported losses, with an estimated total loss of approximately 1.66 billion USD.

Undoubtedly, through false advertising and promises of high returns, JPEX inflicted substantial financial losses and psychological trauma on investors, while also damaging trust in the crypto asset industry. It revealed the risks and regulatory gaps in the cryptocurrency market and triggered social and government attention and discussion about virtual asset industry regulation. Furthermore, JPEX’s collapse highlights the necessity and challenges of cross-border efforts against crypto asset crimes, demanding international cooperation and coordination to establish effective regulatory and enforcement mechanisms to protect investors and market integrity.

2. From Voluntary to Mandatory: Hong Kong Government’s Exchange Licensing System

Looking back at Hong Kong’s regulation of JPEX, it’s clear that despite its claims of licenses from various countries and regions worldwide, JPEX never obtained any licenses in Hong Kong.

Before June 1, 2023, Hong Kong regulated cryptocurrency exchanges based on a voluntary principle. According to the Position Paper: Regulating Virtual Asset Trading Platforms (hereinafter referred to as the Position Paper) issued in November 2019, only centralized exchanges engaged in security token trading could apply for license 1 and license 7 under the Securities and Futures Ordinance. Exchanges with these licenses could only provide services to professional investors. However, the downsides of this regulatory approach were evident: it was challenging to regulate non-security tokens, decentralized exchanges, or security token trading targeting individuals. Furthermore, the Position Paper was voluntary in nature, serving as a guideline for investors but offering limited market standardization.

In response to the limitations of the Position Paper and the needs of the growing cryptocurrency industry, on December 7, 2022, the SFC promulgated an amendment to the Anti-Money Laundering and Terrorist Financing Ordinance (AMLO) requiring VASP to obtain a compulsory license. These amendments took effect on June 1, 2023, and required any centralized exchange operating virtual asset services (VAS) in Hong Kong to apply for a license as a licensed virtual asset service provider (VASP). VASP license applicants had to meet specific qualification requirements and provide a Phase 1 report, assessing their business and associated risks, prepared by an evaluation expert designated or approved by the SFC. Subsequently, applicants had to submit a Phase 2 report for final approval.

Under the new AMLO regulations, exchanges already operating in Hong Kong before June 1 had a one-year grace period to continue their operations legally but were required to apply for the SFC license to operate legitimately after the grace period expired. For exchanges commencing operations after June 1, they had to obtain the SFC license before commencing operations. Moreover, the Hong Kong government emphasized that anyone convicted of fraud involving virtual asset investments could face a maximum sentence of seven years and a fine of HKD 1 million.

In the current regulatory framework, the AMLO amendments run in parallel with the Position Paper. If an exchange applies for the VASP license according to the AMLO regulations, it can only conduct centralized non-security token trading and not security token trading. Due to the blurred boundary between security and non-security tokens, the SFC also made it clear that virtual asset trading platforms should apply for both license 1, license 7, and the VASP license to avoid violating any licensing provisions and ensure their operations remain compliant.

Following the implementation of the new AMLO regulations, JPEX’s collapse was only a matter of time as their promoted 30% monthly returns and “invite and earn commissions” were unsustainable financial models and not eligible for an SFC license. Even if the SFC does not take action against JPEX at present, it is likely that JPEX will exit the Hong Kong market within a year, causing losses to investors.

3. The Alarm Bell from JPEX: Where Should Governments and Investors Head?

3.1 Investors: Financial Investment or Ponzi Scheme?

Based on the Efficient Market Hypothesis and the Rational Investor Hypothesis, the market should fully reflect the value and risk of assets, and investors should make rational choices based on their risk preferences and return expectations. JPEX's promise of a monthly return rate of up to 19% and its referral commission mechanism contradict the fundamental market assumptions and exhibit characteristics typical of a Ponzi scheme, which involves using new investors' money to pay short-term returns to old investors, continually expanding the fund chain. However, once new funds are insufficient or regulatory authorities intervene, the scheme collapses, leaving investors with nothing. This article believes that investors can assess whether an exchange is a Ponzi scheme from several aspects:

Does the exchange have a clear business model and a legitimate source of revenue? Investors should be cautious of exchanges that rely on attracting new users to sustain their operations and promise high commissions.

Does the exchange promise unrealistically high or unsustainable returns? If the exchange commits to providing investors with returns significantly higher than the market average or beyond reasonable expectations, without explaining the associated risks and costs, it is likely a Ponzi scheme.

Regulations in the cryptocurrency market are often lagging behind. At such times, investors might have the opportunity to capture more gains but should also be aware of the corresponding risks due to inadequate regulation. This article suggests that, compared to investors in mature markets, cryptocurrency investors should pay more attention to the compliance of the exchange itself.

3.2 Government: Need to Consider Controlling Exchange Risks

The JPEX incident has also triggered discussions and reflections on the regulation of cryptocurrency asset exchanges. Although the Hong Kong Securities and Futures Commission has already introduced new AMLO regulations, requiring exchanges to obtain licenses to operate legally, there are still some shortcomings in this regulation that need further improvement. This article suggests that the government should control the risks associated with cryptocurrency exchanges to limit the continued presence of bad actors in the industry. For example, some bad actors may move on to perpetrate fraudulent activities in other regions or platforms after one exchange closes or faces regulatory actions. Therefore, it is necessary to implement certain regulatory measures for cryptocurrency exchanges, such as establishing an international “blacklist” system to publicly disclose information about bad actors, limiting their participation in the crypt asset industry. Additionally, the government should strengthen background checks and qualification reviews for exchanges and promptly alert the public about exchanges that pose risks.

Secondly, market regulators should consider how to enhance the transparency and credibility of exchanges. Ordinary investors find it challenging to understand the real risks and returns of centralized exchanges. To protect investors’ interests, relevant policies should require exchanges to regularly disclose their financial reports (including tax information), audit reports, risk assessment reports, and mandate third-party oversight and review. Moreover, to address issues related to “unfair marketing” by exchanges, using false or misleading financial information to attract investors should be prohibited. Furthermore, concerning long-term credibility, regulators can contemplate establishing a public credit rating system to comprehensively assess exchanges and publicly display their historical credit ratings to help investors choose more reliable and secure trading platforms.

Lastly, there should be an emphasis on international cooperation and coordination. Cryptocurrency asset exchanges often operate across borders, offering services in different countries or regions, which poses challenges for regulation and law enforcement. In the JPEX incident, the Hong Kong Securities and Futures Commission could only investigate and penalize JPEX activities in Hong Kong, unable to hold them accountable in their “registered location,” such as Dubai or other regions. As a result, establishing an effective cross-border regulatory and law enforcement mechanism is essential to combat cryptocurrency asset-related criminal activities and safeguard investor rights. Specifically, governments can refer to the Financial Action Task Force (FATF) guidance on VASP regulation and establish a global VASP registration system while implementing the “travel rule,” requiring VASP to collect and transmit information about the sender and recipient when transferring virtual assets. The “travel rule” not only applies to regulatory requirements for investors but also demands that exchanges provide accurate transaction information and comply with compliance requirements during the information transmission and review process, thus curtailing the registration and activities of bad exchanges.

In conclusion, during this critical period of development in the cryptocurrency asset industry, investors should enhance their risk awareness and judgment, avoiding blindly chasing high returns and falling into scams. Governments should refine regulatory frameworks and rules, increase exchange compliance and transparency, protect market order, investor rights, and promote the healthy development of the industry.