As Hong Kong Prepares For The New Virtual Assets Era, It Must Embrace Innovative Dispute Resolution

Throughout the course of history, the world has seen a number of extinction events. The last of them, the Cretaceous-Paleogene extinction, or K-Pg event, wiped out the dinosaurs and led to the emergence of mammals and eventually the homo sapiens as the apex species. While life remains a cosmic oddity that for the time being is confined to the pale blue dot, it has adapted and continued to thrive through the eons. Extinction events, while disruptive, are drivers of evolution.

Such is the world of fintech, on a much shorter and accelerated time frame, but no less fierce. It has just been a bit over a decade since Satoshi Nakamoto first unveiled to the world his vision of a decentralized web of transactions to be powered by the then-little-known blockchain technology. That one small step has since inspired the global leap towards distributed ledger technology, DeFi and Web 3.0. The path to the promised land is however fraught with peril. In the space of just a few years, we witnessed the DAO crisis of 2016, the ICO bubble of 2017, and, more recently, the collapse of Sam Bankman-Fried’s FTX, echoing familiar tales of yesteryear.

It would, however, be rash to jump to a wholesale dismissal of the notion of fintech or the underlying technology as yet another South Sea Company. The South Sea Company was a punctured bubble that failed, not unlike FTX, but the New World was real.

While many people may, quite understandably, remain skeptical of cryptocurrencies and the exchanges given the incessant disruptions, the technology is nevertheless having an increasing impact on our society. It may be argued that explorers from both public and private sectors are still in the quest of finding practical applications of the technology, and the manners in which it is to be regulated. Some experimental regulatory frameworks have been introduced, and new age sheriffs are being recruited to regulate the Wild West of the 21st century.

Hong Kong, which has been bruised in its fight to defend its title as one of the world’s premier financial centers, has recently weighed in with an array of initiatives to advance in the fintech field. At the recent Hong Kong FinTech Week, Christopher Hui, the city’s Secretary for Financial Services and the Treasury, proclaimed three pilot projects: the first NFTs to be issued by the government, Green bond tokenization, and the eHKD. These moves appear to be signaling the territory’s embrace of the underlying technology and the gradual recognition of assets created, managed and transacted via such technology, ultimately steaming towards a more digitalized economy. The latest policy statement provides much needed regulatory certainty and a sense of general direction to the market.

It remains to be seen how the policies will turn into measurable outcomes. Just as momentum is being gathered, the calamitous collapse of FTX is a timely reminder of new systemic risks and associated legal issues brought by the technology that are not fully understood. And the impact of the recent collapse is barely being felt outside of the crypto ecosphere. At the time of writing, financial regulators of the Bahamas have appointed liquidators to run FTX’s unit in the country, and various allegations of mismanagement of the affairs of FTX and its associated company, Alameda Research, have emerged. The downfall of Tokyo-based Mt. Gox, a once-dominant bitcoin exchange, in 2014 may well shed some light on how the latest iteration of exchange collapses will unfold, but the current episode will no doubt gestate novel issues of its own, particularly from the restructuring perspective.

If Hong Kong is to propel itself into the direction of being a hub of virtual assets, and especially if retail investors are to be given some degree of access to virtual assets, it must quickly evolve to be prepared to deal with a raft of novel legal issues when ambitious ventures fail, which a lot of them unfortunately will. There is as yet a paucity of discussion on practical issues, such as the mode and regime for creation of secured interest in virtual or tokenised assets, and the interaction with and protection of such rights via a physical court of law. Our existing court-based dispute resolution regime has so far struggled in linking the online and the offline worlds. It was not long ago when service of documents by email was recognized as valid, and only in some limited situations.

While we tiptoe towards the brave new worlds of decentralized-land and metaverse, the law must recognize that boundaries between the real and the virtual will become increasingly and irreversibly blurred, and perhaps eventually fused. At present, arbitration appears to offer the best dispute resolution mechanism linking both worlds: it has the flexibility to tailor to the needs of the parties, it permits relatively speedy resolution, and allows the parties and the proceedings to stay confidential.

More importantly, in line with the spirit of decentralization, proceedings can be pursued from cradle to grave entirely online, and the parties are free to choose an arbitrator to their own liking, who could be an expert in the field, or simply be a trusted peer of their own, instead of a traditional judge bound by the confines of a particular jurisdiction, and who is perhaps more well-versed in the law than the technology. Awards can be enforced via traditional courts and Hong Kong, given its close ties to mainland China, offers a unique advantage. Some of the foresightful institutions here have already published rules and launched platforms tailor made for online dispute resolution (ODR).

As we continue to sail through these treacherous uncharted waters, let us not lose sight of the new continent—which will hopefully bring to humanity our next leap forward.

Co-authored with Plato Cheung, senior associate at Baker & McKenzie Hong Kong; and Beryl Wu, associate at Baker & McKenzie Hong Kong.