Risks and Legal Protection in Hong Kong Cryptocurrency OTC Trading
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Risks and Legal Protection in Hong Kong Cryptocurrency OTC Trading
What are the risks of OTC trading in Hong Kong? How can retail investors protect themselves legally?
Navigating Web3 tides with focused insightsBy ManQin Blockchain Legal Services
According to the South China Morning Post, Hong Kong has seen the largest increase in cryptocurrency activity across East Asia this year. In Chainalysis' 2024 Global Cryptocurrency Adoption Index, Hong Kong jumped from 47th place last year to 30th this year—indicating a clear upward trend in crypto trading within the region. Beyond centralized exchanges, many individuals have also expressed growing interest in over-the-counter (OTC) virtual asset trading in Hong Kong. So what are the risks associated with OTC trading in Hong Kong? How can retail investors protect themselves legally? Today, ManQin lawyers will help you uncover the truth.
Retail Investors and Virtual Asset OTC Trading
1.1 Definition of Retail Investors and Over-the-Counter (OTC) Trading
A retail investor typically refers to an individual who trades virtual assets using relatively small amounts of personal funds.
An over-the-counter (OTC) market, also known as an off-exchange trading market, refers to transactions conducted directly between parties without going through a central exchange.
Exchange-based trading (also called on-exchange trading) relies on trust in the exchange platform, whereas OTC trading is based on mutual trust between counterparties. Due to its inherent advantages—such as reduced price slippage and greater privacy—even institutional investors or high-net-worth individuals may choose OTC for large-volume trades.
On February 8, 2024, the Hong Kong government released a public consultation paper titled *Legislative Proposals on the Regulation of Virtual Asset Over-the-Counter Trading*, which proposed defining "virtual asset OTC trading" as:
The provision of spot virtual asset trading services as a business, whether via physical outlets (including ATMs) or other means (e.g., online platforms), explicitly excluding licensed VASP (Virtual Asset Service Provider) platforms.
Since the term "virtual asset OTC business" only covers services offered as a business activity, peer-to-peer or entity-to-entity virtual asset transactions that are not conducted for commercial purposes are not subject to licensing requirements. However, this does not mean that retail investors engaging in OTC trading are free from other risks.
1.2 Main Forms of Virtual Asset OTC Trading in Hong Kong
OTC trading of virtual assets in Hong Kong can generally be divided into two categories: online and offline.
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Online: Direct buying and selling of cryptocurrencies between users without intermediary involvement. Typically, a platform acts solely as a matching medium, while actual fund and cryptocurrency transfers occur through external payment channels. A typical example is OTC DEX, widely used on major platforms such as OKX.
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Offline: Face-to-face transactions facilitated through personal networks or physical locations. For instance, Hong Kong once had numerous brick-and-mortar cryptocurrency exchange shops and ATM kiosks providing convenient physical access points for converting digital assets.
Based on preliminary field observations by Hong Kong law enforcement agencies, there are approximately 200 physical OTC stores (including those operating via ATMs) currently active across the city, along with around 250 online service providers actively offering virtual asset trading services.
Virtual asset OTC trading offers benefits such as transaction flexibility, reduced price slippage, and low entry barriers, making it relatively accessible and user-friendly for new retail investors entering the crypto space.
Major Risks for Retail Investors in Virtual Asset OTC Trading
2.1 Overview of OTC Trading Risks
While OTC trading provides advantages like reduced slippage and enhanced privacy, it also carries significant risks, including:
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Legal and criminal risks: Retail investors, especially in cross-border transactions, may inadvertently violate civil, administrative, criminal, or tax regulations across different jurisdictions, potentially leading to legal liability.
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Data leakage risks: Personal data may be exposed due to inadequate protection by OTC providers or cyberattacks on their systems.
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Transaction loss risks: Financial losses may arise from non-compliant OTC operators, market volatility, price manipulation, or counterparty default.
Given mainland China's strict cryptocurrency regulations, Hong Kong’s OTC market serves as a crucial channel for mainland investors, making it particularly significant. This article will highlight key risks by analyzing the regulatory frameworks of both regions.
2.2 Legal and Criminal Risks
Although retail traders usually engage in infrequent and low-volume transactions, they still face potential legal and criminal exposure. Specific risks include:
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Money laundering or illegal gambling charges: Retail investors may receive illicit funds unknowingly, resulting in frozen accounts. Unlike centralized exchanges where trust is placed in the platform, OTC trading depends heavily on counterparty trust. Some malicious actors exploit information asymmetry to target inexperienced retail traders with seemingly favorable rates, effectively turning them into money mules for laundering stolen funds. Additionally, some unscrupulous OTC dealers themselves may be involved in criminal activities, or criminal groups may use legitimate-looking OTC services to launder money. Furthermore, Hong Kong’s anti-money laundering (AML) and counter-terrorism financing (CTF) regulations require all participants in OTC trading to remain vigilant to avoid violating these rules and facing legal consequences.
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Violations of foreign exchange controls: Converting fiat currencies into cryptocurrencies via OTC is common in Hong Kong. Under the *Regulations on Administration of Foreign Exchange of the People's Republic of China*, unauthorized forex trading, disguised forex trading, speculative currency dealing, or acting as an illegal broker for large-scale forex transactions may result in warnings, confiscation of illegal gains, and fines from foreign exchange authorities. If such conduct constitutes a crime, criminal responsibility may be pursued. Specifically, if retail investors use cryptocurrencies as intermediaries to provide cross-border payment and exchange services for profit—facilitating value transfer via “foreign currency → cryptocurrency → RMB”—this constitutes disguised forex trading and could lead to prosecution under the crime of illegal business operations.
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Tax violations under Hong Kong law: Is taxation required for OTC crypto trading in Hong Kong? According to Paragraph 47 of the Inland Revenue Department’s *Interpretation and Practice Note No. 39 (DIPN39)*, the term “cryptocurrency business” includes common commercial activities such as:
(a) Trading of cryptocurrency
(b) Exchange of cryptocurrency
(c) Mining of cryptocurrency
DIPN39 states that profits sourced in Hong Kong from cryptocurrency business activities are subject to profits tax. Hong Kong follows a territorial taxation system, meaning only profits arising in or derived from Hong Kong are taxable. Non-residents conducting business in Hong Kong must pay tax on Hong Kong-sourced profits, while profits sourced outside Hong Kong—even if managed locally—are exempt.
What is the profits tax rate in Hong Kong? According to Deloitte’s *2024 Hong Kong Tax and Investment Guide*, Hong Kong applies a two-tier profits tax regime:
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For unincorporated businesses (e.g., sole proprietorships or partnerships), the first HK$2 million of assessable profits are taxed at 7.5%,
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Profits exceeding HK$2 million are taxed at 15%.
What penalties apply for late tax payments?
Failure to pay taxes on time may result in the following consequences:
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A fixed penalty of HK$10,000,
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Fines up to three times the amount of unpaid taxes,
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In serious cases, imprisonment for up to three years (per the Inland Revenue Department’s Penalty Policy).
That said, occasional and small-scale crypto trading by retail investors is unlikely to be deemed a “business” under Hong Kong law, and thus would not trigger tax obligations. However, frequent or high-value traders must carefully consider their tax compliance responsibilities. Moreover, future changes in the regulatory framework warrant close attention.
2.3 Data Leakage Risks
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The technical complexity of fund settlement and asset transfer in OTC trading increases challenges in securing data. Large-scale OTC operations involve moving substantial funds and digital assets, creating risks of technical failures and management issues. These include blockchain network congestion, wallet security flaws, delayed transaction confirmations, and reliability concerns regarding infrastructure used for asset transfers. Administrative challenges may involve identity verification processes, terms negotiation, execution of legal documents, and record-keeping procedures.
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Some OTC providers fail to implement adequate personal data protection measures, leaving platforms vulnerable to security breaches. Third-party platforms facilitating OTC trading may suffer from vulnerabilities that expose sensitive data—including user identities, transaction details, and proprietary information—to unauthorized access. Cyber threats such as phishing attacks and malware can exploit these weaknesses, compromising platform integrity and endangering user assets.
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Even reputable exchanges like Huobi have faced data breach risks—in 2021, white-hat hackers disclosed vulnerabilities exposing extensive OTC transaction data, whale account information, customer records, and internal technical architecture. While Huobi claimed no actual data was leaked and only partial data downloaded, the incident should serve as a wake-up call for every retail trader using OTC services. Moreover, some criminal groups steal user data via OTC platforms, and unethical OTC platforms may even sell user data externally—raising serious red flags for all investors.
2.4 Transaction Loss Risks
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Transaction loss risk is particularly critical in OTC trading. Compared to centralized exchanges, OTC trading demands higher levels of mutual trust between counterparties. Either party may default, delay performance, or partially fulfill obligations. Information asymmetry and communication barriers can exacerbate trust issues, leading to broken deals or complete erosion of trust. Once the foundation of trust collapses, it can negatively impact future cooperation and even the broader market environment.
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Fraud is one of the primary risks in OTC markets, especially in large-value or cross-border transactions. Counterparties may falsify identities, falsely claim or exaggerate their ability to deliver digital assets, or deceive others into signing fictitious trade agreements. A common scam is fraudulent refund schemes, where one party receives the digital asset but reverses the payment afterward.
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Fraud or insolvency of a transaction facilitator can lead to financial losses. In OTC trading, if the party responsible for brokering the deal engages in fraud or goes bankrupt, other participants may suffer significant losses. Since trust is central to OTC trading, any failure by the intermediary can trigger a chain reaction, damaging the assets of all involved parties.
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Cross-border transactions—particularly between mainland China and Hong Kong—pose heightened risks due to differences in legal systems, regulatory frameworks, and enforcement capabilities. Jurisdictional conflicts may make it difficult to seek legal remedies when a counterparty defaults or commits fraud. Language barriers, divergent documentation standards, and conflicting legal interpretations further increase the likelihood of misunderstandings or disputes.
How Can Retail Investors Protect Themselves and Ensure Compliance?
3.1 Mitigating Legal and Criminal Risks
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Enhance compliance awareness: OTC traders should stay updated on the latest regulatory developments, particularly concerning AML, CTF, and tax compliance requirements.
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Avoid suspicious transactions: Do not purchase virtual assets with unclear origins; avoid becoming part of an illegal money flow chain. Keep detailed records of all transactions to demonstrate the legitimacy of fund sources if required by regulators.
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Seek professional support: Consult legal professionals experienced in virtual asset trading and related laws to obtain comprehensive guidance on license applications, drafting compliance agreements, and dispute resolution.
3.2 Mitigating Data Leakage Risks
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Conduct due diligence: Thorough due diligence is essential. This includes verifying counterparties’ identities, assessing their financial stability, and reviewing transaction histories. Tools such as Know-Your-Customer (KYC) procedures and background checks can provide valuable insights.
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Limit submission of personal information: Provide personal identification information (e.g., KYC data) to trading platforms only when absolutely necessary, and avoid sharing sensitive data with third parties.
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Maintain cybersecurity hygiene: Access trading accounts only through trusted devices (e.g., personal computers or smartphones), avoid public Wi-Fi networks, and use strong, regularly updated passwords for all accounts.
3.3 Mitigating Transaction Loss Risks
To reduce transaction loss risks, traders should strengthen technical safeguards. For example:
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Secure fund storage: Multisignature wallets (Multisig) and cold storage (offline wallets not connected to the internet) are essential for protecting large holdings. These technologies significantly reduce the risk of unauthorized access and hacking.
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Use third-party escrow services: Reliable escrow services act as neutral intermediaries, holding funds or assets until both parties fulfill their obligations. Escrow arrangements minimize default risks, especially in large transactions.
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Clearly define contractual terms: Well-drafted contracts should specify delivery timelines, payment methods, and dispute resolution mechanisms to reduce ambiguity. For example, jurisdiction clauses allow both parties to resolve disputes according to agreed-upon governing law and venue in case of conflict.
By adopting these measures, virtual asset traders can effectively mitigate the three major risks—legal/criminal exposure, data leaks, and transaction losses—and better protect their interests. While these strategies are effective, no approach can completely eliminate risks inherent in the decentralized and global nature of OTC trading. Retail investors must remain vigilant, take proactive steps, and be prepared to respond to potential disputes to safeguard their assets and rights.
Conclusion
The virtual asset market in Hong Kong presents abundant opportunities for retail investors, but it also comes with complex risks and challenges. From criminal liability and data breaches to financial losses, each type of risk poses a threat to investors’ personal safety, property, and privacy. Therefore, before entering this market, retail investors must prepare thoroughly—not only understanding relevant laws and regulations but also acquiring foundational knowledge of cryptocurrency trading.
Compliance, strengthened security awareness, and rational investment are key to managing risks. Additionally, understanding regional legal frameworks and seeking advice from professional advisors can effectively protect one’s rights in a complex market environment. Only by maintaining caution can retail investors achieve sustainable growth and navigate the cryptocurrency market with confidence.
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