This article first appeared in The Edge Malaysia Weekly on January 17, 2022 - January 23, 2022

AN increasing number of digital assets have entered the mainstream following the Covid-19 pandemic, which has yet to run its course. Young investors, seeing the spike in cryptocurrency prices, are ditching traditional asset classes and turning to crypto-related investments.

Notwithstanding the chorus of naysayers who claim that cryptocurrencies lack intrinsic value, the new form of currency has certainly become part of the financial ecosystem.

Investors hedging against inflation even propelled Bitcoin to a record high of almost US$69,000 (RM288,087) last November, outperforming traditional hedging instruments such as gold by a mile. Ethereum, the second-largest cryptocurrency by market value, also skyrocketed to a high of US$4,800 from US$500 a year ago.

Even after the recent sell-off, the total market capitalisation of cryptocurrencies was an impressive US$2.15 trillion as at last Thursday, although it was lower than the US$3 trillion recorded last November, according to crypto price and data aggregator CoinGecko.

News that the US Federal Reserve’s tapering of its bond purchases could happen sooner than expected has put riskier assets under selling pressure, with Bitcoin falling to about US$40,000 — the lowest since last September. It was a 40% decline from its November high and about a tenth lower than the beginning of the year

Tightening monetary policy has threatened to reduce the market liquidity that had lifted financial assets. Is the market in danger of a bubble that’s about to burst?

“In the past week, we have witnessed a less than favourable momentum as broader macroeconomic uncertainty impacted the cryptocurrency market. As a traditionally high-risk asset, Bitcoin tends to not perform well in periods of contractionary monetary policy, such as signs of the Fed initiating more hawkish economic policies,” Luno Malaysia’s country manager Aaron Tang tells The Edge.

However, he believes that as widespread adoption continues, it will eventually create a less volatile market, which is a positive sign for those looking to invest for the long term. “In addition, as more investors enter the market, more liquidity will be created, hence we expect less volatility,” he says.

Because of the economic impact caused by Covid-19, certain cryptocurrencies have been adopted as a hedge against pervasive currency devaluation, says Tang. For example, Bitcoin’s fixed supply of 21 million coins makes it a good inflation hedge as its price could potentially appreciate over time as demand goes up.

“Bitcoin price is determined by supply and demand, especially in the short term. This demand is driven by people who understand how the cryptocurrency could benefit the world and believe it will be more widely adopted in the future. What should be remembered is that Bitcoin is still a young technology with a lot of potential for the future,” he adds.

Tang notes that institutional investors have generally become more receptive to the idea of incorporating digital assets such as Bitcoin into their investment portfolios. Moreover, the interest and support of well-established companies such as MicroStrategy, Tesla and Square have increased Bitcoin’s status as a store of value.

“In addition, the belief shown by these institutions suggests that the industry as a whole is maturing. CEOs have concluded that the regulatory framework they need is now strong enough for their companies to get involved,” he says.

Bitcoin is no longer a fringe case, says Tang, and CEOs and companies that have put their money in Bitcoin will pave the way for other institutions and high-net-worth individuals to invest their liquid assets in cryptocurrencies.

Meanwhile, the crypto market has seen positive demand from retail investors, says Tang, as seen by the more than RM16 billion worth of cryptocurrencies traded in Malaysia between August 2020 and September 2021, according to the Securities Commission Malaysia (SC).

“In 2022, we believe these numbers will continue to grow as cryptocurrencies become an established asset class. Furthermore, our survey on understanding the financial management habits of Malaysians involving more than 1,000 adults in the country shows that 62% of investors would consider investing in alternative assets like cryptocurrencies as a way to diversify their portfolios,” he says.

“Meanwhile, 37% noted that utilising cryptocurrencies for long-term investment purposes was an exciting feature of the digital asset. And 40% would use cryptocurrencies as an alternative store of value.”

Yusho Liu, co-founder and CEO of Singapore-based Coinhako, points out that with the recent developments in the cryptocurrency space, people are starting to realise that cryptocurrency is here to stay, as evidenced by the surge in institutional interest.

“Traditional finance institutions are putting funds in crypto while venture capital investments in the crypto space have surged after Facebook’s push to the metaverse. Even Tesla has deployed balance sheet money into crypto,” he says.

“Retailers have begun to embrace cryptocurrency as a form of payment, with online retailers, dining establishments and even ride-hailing services now offering customers the option of paying with cryptocurrency.”

The rise of Bitcoin and Ethereum has set the stage for a lot of other exciting projects to take flight, says Liu. This includes decentralised finance (DeFi) and, more recently, non-fungible tokens (NFTs), virtual realities, landscapes and avatars within the wider blockchain community.

Compared with established cryptocurrencies such as Bitcoin and Ethereum, stablecoins — whose value is pegged to assets such as the US dollar and gold — are seen as less volatile.

“They combine the instant processing capabilities, functionality, adaptability and security of cryptocurrencies with the relative stability of fiat currencies. Unlike traditional cryptocurrencies, their price is not set by supply and demand. Instead, they employ a range of mechanisms to ensure the price remains pegged to that asset,” Tang explains.

“Temporary hedging is a big motivator for individuals to use stablecoins. For example, a cryptocurrency investor may split his portfolio between stablecoins and regular cryptocurrencies, so there is a hedge against volatility and he won’t lose as much during market dips.

“Additionally, fiat onramp and offramp fees make stablecoins a viable solution for exchanges and institutional traders looking to reduce their crypto exposure without fully cashing out and having to pay withdrawal fees.”

Liu thinks stablecoins are suitable for people who want to get involved in cryptocurrencies, but may not want to ride the ups and downs of the volatile cryptocurrency market. “Because their prices don’t fluctuate much, one shouldn’t expect massive gains if they choose to put their money in stablecoins,” he says.

In line with the cryptocurrency trend, DeFi is also on investors’ radar screens. For one, MyEG Services Bhd announced last August that it would introduce DeFi products in Malaysia to provide cryptocurrency services to users of digital asset exchanges. The move would enable cryptocurrency holders to enter into smart contracts for the purpose of borrowing cryptocurrency or lending against their cryptocurrency assets.

Bank Negara Malaysia and the SC declined to comment on whether such an offering should be regulated.

Tang stresses that any products or services related to digital assets need to abide by local regulations to ensure greater transparency and fund protection to generate consumer confidence. “While we can’t specifically say what regulations should be put in place, DeFi products and services highlight precisely why the digital asset industry needs to work closely with local regulators to establish appropriate regulatory frameworks that benefit industry players and customers.

“We believe that regulation will raise the bar in the industry and in our experience, this is also what customers want. It will continue to strengthen cryptocurrencies and encourage mass public adoption. We are building the bridge between what we have today and a future financial system that ensures faster, more secure and more accessible transactions.”

Liu, however, thinks that DeFi may be almost impossible to regulate as by nature, it is designed to be open and borderless, and will not be tied down to a jurisdiction.

Having declared all cryptocurrency-related transactions illegal, China intensified its ban on digital assets last September, clamping down on so-called speculative investments and potential money laundering activity.

“The situation in China highlights the importance of fair and progressive regulations for the healthy growth of an industry. Furthermore, a practical regulatory framework promotes the protection of customer funds and strikes a balance between the need for rules and the space needed for innovation to happen,” observes Tang.

Nonetheless, he believes the crackdown on bitcoin miners in China will help strengthen the cryptocurrency’s long-term growth, as increased mining decentralisation will ensure that the Bitcoin network is less vulnerable to the regulation of one country in the long run.

“Furthermore, the mining regulation in China presents an opportunity for miners to move to locations with abundant renewable energy sources such as El Salvador for its geothermal energy and Texas, in the US, for its solar and wind power … We believe legitimate crypto mining should be encouraged in Malaysia as well as this can help drive its digital economy, creating jobs and prosperity, as well as encouraging foreign investment.”

Even though Bitcoin’s total hash rate — a measure of how much computing power is available to mine bitcoins — dropped in May 2021 when China’s ban was announced, it has recovered and is steadily approaching an all-time high. In other words, although bitcoin mining has left China, it has recovered in other places around the world.

Liu agrees that long-term improved decentralisation is positive for the industry and the countries where new operations are deployed, despite some negative impact in the short term due to the dip in hashing power.

According to the SC, there are four licensed recognised market operators in Malaysia: Luno Malaysia Sdn Bhd, MX Global Sdn Bhd, Sinegy Technologies (M) Sdn Bhd and Tokenize Technology (M) Sdn Bhd.

This is pursuant to the Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 released on Jan 15, 2019, and the subsequent revised guidelines on Jan 31, 2019.

Tokenize Technology became a target of Kenanga Investment Bank Bhd a year ago, after the investment bank acquired a 19% stake in the digital asset exchange for exposure to the cryptocurrency space.

In Malaysia, digital assets are not a payment instrument regulated by Bank Negara and do not constitute money that is legally accepted for the exchange of goods and services, meaning they are not legal tender in the country. That is because privately issued digital assets are not suitable as a general payment instrument since they do not exhibit the universal characteristics of money and face some limitations, including price volatility and vulnerability to cyberthreats.

However, to facilitate responsible innovation and manage any emerging risks from the digital asset space, Bank Negara and the SC regulate a specific set of business activities, including the issuance of digital assets via initial coin offerings and the trading of digital assets on digital asset exchanges in the country. The SC prescribes digital assets as securities under its laws, whereby digital assets can be issued by a company for the purpose of raising funds, subject to the issuer fulfilling the conditions set by the regulator.

Last Wednesday, Bloomberg reported that Hong Kong’s central bank plans to come out with a regulatory regime for crypto assets by July. The regulations will cover three aspects: stablecoins that can be used for payments, investor protection and how authorised institutions deal with digital assets. This comes as regulators in the territory shift towards increased oversight amid extreme volatility and frequent scams.

While aiming to become a hub for cryptocurrency and financial technology, Singapore’s government has warned its people to be mindful of digital investments, saying it is “closely studying” the characteristics and risks of technologies such as blockchain, DeFi, NFTs and the metaverse.

Financial crimes, in particular money laundering, are the key risk for any cryptocurrency-related transactions. The world’s largest cryptocurrency exchange Binance, for example, has come under scrutiny in several countries due to concerns that it failed to meet anti-money laundering requirements.

Last month, Binance withdrew its application for a cryptocurrency exchange licence in Singapore and is set to close its operation by Feb 13.

There has always been a debate on how to shape balanced regulation and compliance so as not to hamper cryptocurrency and blockchain development as a whole. Bank Negara’s Financial Sector Blueprint 2022-2026, to be unveiled next week, could offer a glimpse of its latest stance on this space, as more offerings are expected to come on the market.

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