Hong Kong OTC Cryptocurrency Trading Guide: Risks and Legal Red Lines Every Retail Investor Must Know

According to the latest ranking by Chainalysis, Hong Kong has jumped from 47th place last year to 30th this year, becoming the fastest-growing region for cryptocurrency activity in East Asia. This reflects the booming OTC trading market in Hong Kong—besides centralized exchanges, an increasing number of retail investors are turning to over-the-counter trading for more flexible trading experiences. However, this wave of growth also hides many pitfalls.

Hong Kong OTC Trading: Opportunities and Risks Coexist

What is Over-the-Counter (OTC) Trading?

Over-the-counter (OTC) trading refers to virtual currency buying and selling conducted directly between two parties, bypassing centralized exchanges. Unlike on-exchange trading that relies on platform trust, OTC trading is based on mutual trust between the trading parties.

In February 2024, the Hong Kong government issued the “Legislative Proposal on Virtual Asset OTC Trading,” which clearly defines: OTC business refers to activities that provide virtual asset spot trading services in a commercial manner, including physical stores and online platforms. However, personal-to-personal transactions for non-commercial purposes are not subject to licensing restrictions—this is the legal basis for retail investors to participate.

The Two Main Forms of OTC Trading in Hong Kong

According to preliminary statistics from Hong Kong law enforcement agencies, there are approximately 200 physical virtual asset OTC shops and about 250 active online merchants across the city.

Online Form: Users facilitate direct trades through platforms, with funds and virtual currencies flowing outside the platform via other payment channels. OTC DEXs are typical representatives and are widely used on major trading platforms.

Offline Form: Face-to-face transactions based on personal networks, with virtual currency exchange shops and ATMs on the streets of Hong Kong providing convenient physical trading channels.

OTC trading is friendly to beginners due to its high flexibility, low price slippage, and low participation barriers. However, this decentralized nature also brings significant risks that cannot be ignored.

The Three Major Risks Retail Investors Face in Hong Kong OTC Trading

Risk One: Illegal Crime Traps

This is the most easily overlooked yet most deadly risk for retail investors.

Money Laundering and Fund Freezing: Unlike platform trust mechanisms of centralized exchanges, OTC trading relies on mutual trust. Many unscrupulous merchants exploit information asymmetry to trap inexperienced retail investors—tempting them to accept suspicious funds at favorable prices, turning them into tools for money laundering. Once funds are deemed illegal proceeds, retail accounts may be directly frozen, resulting in loss of assets. Hong Kong’s anti-money laundering (AML) and counter-terrorist financing (CTF) regulations have clear requirements on this, and retail investors must stay vigilant.

Foreign Exchange Control Risks: In Hong Kong OTC, it is common to exchange fiat currency and virtual currencies. According to the “Regulations of the People’s Republic of China on Foreign Exchange Administration,” unauthorized foreign exchange trading is illegal and can result in fines or criminal charges. If retail investors use virtual currencies to conduct “foreign exchange → virtual currency → RMB” disguised transactions to evade national regulation, they may be prosecuted for illegal operation if caught.

Tax Compliance Risks: The Hong Kong Inland Revenue Department’s “Interpretation and Practice Note No. 39” (DIPN39) clearly states that profits derived from virtual currency activities (trading, exchange, mining) conducted in Hong Kong are subject to profits tax. Hong Kong applies a two-tier tax rate: the first HKD 2 million of uncombined business profits are taxed at 7.5%, and amounts exceeding that are taxed at 15%. Failure to pay taxes on time can have serious consequences—fines start at HKD 10,000, and penalties can be up to three times the unpaid tax, with severe cases facing up to three years in prison. Retail investors engaging in frequent, large transactions must consider themselves as conducting “business” and file accordingly.

Risk Two: Personal Information Leakage

OTC trading involves large fund transfers, increasing the complexity of data security.

Platform Security Vulnerabilities: Many OTC merchants do not implement effective personal information protection measures. Third-party platforms are vulnerable to security breaches and data leaks, leading to unauthorized access to user identities, transaction details, and sensitive information.

Lessons from Past Incidents: Even well-known exchanges like Huobi have been exposed in 2021 to risks of information leaks involving OTC transaction data, large account details, customer information, and internal technical architecture. Although Huobi denied actual leaks, it serves as a reminder for OTC retail traders to stay alert.

Malicious Theft and Data Selling: Some criminal groups steal user information via OTC platforms, and unscrupulous platforms may sell user data externally, posing long-term privacy threats to retail investors.

Risk Three: Counterparty Default and Fraud

Trust Crisis: OTC trading requires a high level of trust between trading parties. Either side may default, delay, or fail to fulfill the agreement, and information asymmetry and communication barriers can exacerbate trust issues, leading to transaction failures.

Common Fraud Tactics: Counterparties may fabricate identities, exaggerate delivery capabilities, or sign false transaction terms. The most common scam is “fraudulent refunds”—the other party retracts payment after receiving virtual assets.

Intermediary Risks: If the third-party facilitating the trade commits fraud or goes bankrupt, both parties could suffer significant losses. Such failures can trigger chain reactions affecting all participants.

Cross-Border Transaction Risks: OTC transactions between Hong Kong and Mainland China involve legal system differences, jurisdiction issues, language barriers, and law enforcement disparities, greatly increasing risks. If retail investors encounter defaults or fraud, legal recourse is difficult.

Self-Protection Strategies for Retail Investors

How to Address Illegal Crime Risks

Build Compliance Awareness: Continuously monitor the latest regulations, especially changes related to AML, CTF, and tax requirements.

Avoid Suspicious Transactions: Do not purchase virtual currencies from unknown sources to prevent becoming part of illegal fund transfer chains. Keep detailed records of all transactions and, if necessary, provide proof of legitimate source to regulators.

Seek Professional Assistance: Hire lawyers experienced in virtual currency trading and relevant laws to obtain comprehensive guidance on licensing, compliance agreements, and dispute resolution.

How to Address Data Leakage Risks

Due Diligence: Verify the identity of trading counterparts, assess their financial stability, and review transaction history. Use KYC procedures and background checks to gather reliable information.

Share Personal Data Cautiously: Only provide personal identification information on a need-to-know basis to trading platforms; avoid disclosing sensitive data to third parties.

Online Security Measures: Access trading accounts only through trusted devices, avoid public Wi-Fi, and set complex passwords that are regularly updated.

How to Address Trading Loss Risks

Technical Safeguards: Use multi-signature wallets (Multisig) and cold storage (offline wallets) to protect large holdings, reducing risks of unauthorized access and hacking.

Custody Services: Utilize reputable third-party custody services as escrow agents, holding funds or assets before both parties fulfill their obligations, especially for large transactions.

Clear Contract Terms: Draft detailed trading agreements specifying delivery schedules, payment methods, and dispute resolution mechanisms. Jurisdiction clauses should clearly specify applicable law and dispute resolution locations to facilitate legal remedies if needed.

Conclusion

Hong Kong’s OTC virtual currency market offers abundant opportunities for retail investors, but risks are equally complex. From illegal activities to data leaks and trading losses, each can threaten retail assets and safety.

Key to safely participating in Hong Kong OTC trading is: gaining in-depth understanding of laws and regulations, mastering basic knowledge, operating compliantly, strengthening security awareness, and making rational investment decisions. Additionally, seeking professional advice can help retail investors effectively protect their interests in a complex market environment.

While no strategy can completely eliminate OTC trading risks, cautious attitudes and proactive actions enable retail investors to achieve long-term, steady growth in Hong Kong’s virtual currency market.