This article first appeared in Wealth, The Edge Malaysia Weekly on December 25, 2023 - January 7, 2024

A slew of new digital asset (crypto) products and services were launched this year. Among them, the world’s first shariah-compliant crypto-currency unit trust fund and Malaysia’s first crypto hedge fund.

Halogen Shariah Bitcoin Fund is managed by Halogen Capital, the country’s first licensed digital asset manager, and was founded by Hann Liew and Lucas Ooi, who also co-founded financial comparison website RinggitPlus.

The Securities Commission Malaysia (SC) also approved boutique asset management firm Cross Light Capital, founded by hedge fund manager Jason Lee and head of quantitative strategist Heng Wui Leng, to offer its crypto hedge fund to investors. The Performa Digital Asset Fund (PDAF) invests in Bitcoin and Ether futures contracts and blockchain-related publicly listed companies globally.

CoKeeps, the first locally licensed digital asset custodian, which helps investors safeguard digital assets, also started operations this year. The firm is co-founded by its CEO Suhanna Hussein.

The fifth digital asset exchange (DAX), Hata Digital Sdn Bhd, recently obtained conditional approval from the SC to potentially kick-start its trading businesses next year. The firm, founded by Luno’s former Asia-Pacific general manager David Low, is the country’s first DAX that has also obtained a digital broker licence.

Meanwhile, Luno Malaysia, the largest local DAX, which is said to command over 90% of the retail crypto market, is expecting to launch the country’s first staking product early next year.

Staking means investors pledging their cryptocurrencies to a blockchain to help the network validate transactions. They are rewarded with cryptocurrencies in return, which they can later sell off for a profit.

The digital asset industry saw a downturn last year, caused by the collapse of TerraUSD (UST), the bankruptcy of crypto hedge fund Three Arrows Capital and the fall of FTX, but it continued to march ahead in 2023. The key difference between this year and the last is, perhaps, regulation.

Many new digital products and solutions are now regulated by the authorities in each country. The demonstration of licences by digital asset players is almost an unavoidable part in their sales and marketing pitches.

Industry players welcome this trend. Most of them expect institutional clients, such as financial institutions and private businesses, to start dipping their toes into the digital asset space.

Aaron Tang, Luno’s Asia-Pacific general manager, says regulators globally are speeding up the pace to regulate the digital asset industry. For instance, there has been a lot of talk in the US surrounding the launch of the first Bitcoin exchange-traded fund (ETF). Some of the world’s largest asset management firms, including BlackRock and Franklin Templeton, are looking to launch such a product.

In Singapore, the Monetary Authority of Singapore (MAS) recently gave approval, under the Payment Services Act, to three entities that will issue stablecoins. These entities will comply with the central bank’s upcoming stablecoin regulatory framework.

“We have seen rapid industry development, and regulation is a big part of it. I would say [regulatory approval at a faster speed] is not local but global as well. They are actively doing their part to encourage responsible growth in the digital asset space,” he says.

In fact, regulation is the key driver for the next phase of growth of the digital asset industry, most players agree.

Lee, co-founder, CEO and CIO of Cross Light Capital, welcomes regulation and is prepared to offer its new product to the market. PDAF is a wholesale fund that targets high-net-worth individuals and institutional investors with a minimum investment amount of US$25,000 (RM116,800).

The fund comes with a sales charge of up to 5%, an annual management fee of 2% and performance fee of 20% subject to a high-water market at the end of each quarter.

There is no hurdle rate as it is not a long-only fund that only profits from the prices of cryptocurrencies going up. The fund also aims to help investors smoothen volatility in their investment portfolio, as it is designed to have a low to negative correlation to some of the main equity markets.

A high correlation means that the fund’s price goes up when equity markets trend upwards, while a negative correlation means that the fund performs well when the equity markets are down or vice versa.

Based on its back-tested result, the fund has a low correlation to the European equity markets at -0.01. It also generated positive returns in 27 out of the 45 negative months in Euro Stoxx 50 (an index that tracks the performance of eurozone blue-chip companies), according to Lee.

The key difference between PDAF and Halogen Shariah Bitcoin Fund is that it invests one-third of its funds in Bitcoin, one-third in Ether and one-third in blockchain-related public-listed companies globally.

An example of a blockchain-related company is Coinbase Global Inc, a regulated cryptocurrency exchange listed on the Nasdaq. Others include companies like NVIDIA Corp, which produces equipment to mine cryptocurrencies; IBM, which is involved in blockchain infrastructure; and Ubisoft Entertainment SA, which is developing blockchain-powered games, says Heng.

However, the fund’s exposure to these companies is through exchange-traded funds (ETFs), such as the Next Generation Internet-related Global Equities ETF, managed by Cathie Wood’s Ark Invest. It could also be the Metaverse-related Equities ETF managed by Roundhill Investments, a registered investment adviser in the US that focuses on innovative ETFs.

Those ETFs would give PDAF exposure to about 50 blockchain-related publicly listed companies, says Lee.

Why public-listed equities? He says it is for diversification and risk management. Again, through back-tested results, the fund’s exposure to public-listed equities can reduce its volatility significantly as compared with those of Bitcoin and Ether price.

Lee shows that Bitcoin’s spot price has a volatility of 71.62%, measured by standard deviation, and a maximum drawdown of 62.46%, which means its price can fall over 60% from the top.

By including publicly listed equities and its risk management strategy, the fund’s volatility can be reduced to 34.89% and maximum drawdown to 29.45%, says Lee.

The Sharpe ratio of the fund, which measures the risk-adjusted returns, also increases to 0.98 from 0.57, he adds.

Another differentiator of the fund and the existing product in the market is that PDAF seeks exposure to Bitcoin and Ether through futures contracts offered by the Chicago Mercantile Exchange (CME).

“Our underlying [security] is CME futures [contracts]. In our view, it has an established settlement mechanism and lower risk, as compared with us trading directly with a crypto exchange,” says Lee.

He stresses that the firm is not an expert in the crypto space and technology but specialises in trading alternative assets and managing risk through hedging.

“We are risk managers who invest in highly volatile investment instruments and manage the risks. That’s our expertise. We don’t necessarily want to pick the next big crypto in the market. How we compete with our peers is that we have a lot of experience and the model to manage our exposure and risk prudently,” he says.

Some investors are wondering if they can have exposure to cryptocurrency futures contracts offered locally moving forward. Luno’s Tang says industry players are still in the preliminary stage of discussions.

Similarly, the introduction of cryptocurrency ETFs is still in its early stage. “There are discussions about these instruments. Futures, ETFs and so on. But I would say they are still in the beginning phase,” he says.

However, Tang is optimistic on the launch of staking products early next year, where investors can pledge their cryptos to specific blockchains and be paid in digital assets/coins. They can sell these assets later on to realise capital gains.

Many Malaysian investors are looking for income-generating products, adds Tang. “In terms of staking, we see huge demand from the retail side. In fact, investors like any sort of yield-generating products where they can get stable returns.”

Tang says relevant parties are in “serious discussion” on staking products and industry players are looking forward to them being launched. “We are optimistic that they can be launched early next year. But it is subject to the SC’s approval.”

According to his personal knowledge, staking products fall under the ambit of the SC and do not involve Bank Negara Malaysia. Some quarters argue that staking products are a deposit-taking activity, as investors pledge their cryptocurrencies to a blockchain and are “locked in” for a specific period in exchange for returns.

However, Tang says these cryptocurrencies are considered as securities and not currencies. It is deemed deposit-taking only if investors pledge stablecoins for returns instead of cryptocurrencies like Bitcoin or Ether, which are deemed securities locally.

Luno is looking to list more cryptocurrencies next year and is looking at offering digital assets to institutional clients.

Tang says investors are getting more sophisticated and are more receptive to cryptocurrencies other than Bitcoin and Ether. It makes sense that Luno wants to expand its crypto offerings to them.

“A hundred per cent. We are looking to list more coins on our exchange. We offer a very selective number of tokens so far. But as the space has grown, and the knowledge of the Malaysian investing public improves, more and more offerings are going to be acceptable,” says Tang.

Like other industry players, Luno is banking on the increase in demand from institutional investors to grow its business. This is reflected through more institutional investors, including financial institutions, corporates and smaller businesses, approaching Luno recently with cryptocurrency-related questions.

While Luno’s focus is on the retail space, it has started to offer more to institutional clients, says Tang.

“We haven’t been super loud about it, as we are still investing more in solutions for institutional investors. But definitely, it’s something that we see as inevitable as more of them are coming into this space as it is a lot more regulated today.”

Moving forward, Tang hopes to see institutional investors engaging more with the licensed digital asset industry players and further development in the digital asset payment space.

Unlike Singapore, which has started to regulate stablecoins, Bank Negara has not announced any regulatory framework to govern stablecoins locally. However, Hata Digital does offer USD stablecoin (USDC) and USD Tether (USDT) to investors, according to its official website.

However, investors will need to have US dollars in their bank account to trade USDT with the exchange, which means that they need to have a dual currency account or master foreign currency account with the banks. These investors are mainly high-net-worth individuals, according to industry players.

Industry players note that a sizeable number of Malaysians keep US dollars in their bank accounts these days due to the depreciating ringgit, which could provide a boost to Hata’s USDT-related businesses.

When contacted, Low explains that the USDT is offered through its Labuan entity, which can accept money from investors globally, including Singapore and other countries. And its official website lists about 30 cryptocurrencies that can be traded by investors.

As MAS has granted approval-in-principle to three entities to issue stablecoin, is Hata Digital looking to introduce more stablecoins that are pegged to other currencies? Low says he will definitely explore the potential of doing so, but the matter might not be that straightforward.

The US dollar stablecoin is in favour as it is the most widely used and safest currency in the world. Existing US dollar stablecoins such as USDT also have a relatively long history in the market with ample liquidity.

It remains to be seen whether the newly issued stablecoins by Singapore regulated entities have the same liquidity to entice investors, says Low.

“People have been using USDT or USDC for the longest time. What is your incentive to suddenly use a new coin? It is probably a lot more illiquid and less accessible.

“For instance, if you want to buy US dollar stablecoins out of Singapore, it is like buying digital assets issued only in Singapore. And you can only reach out to that Singaporean entity to access it. The cost of doing so is a consideration. There’s liquidity consideration, too. Maybe you can buy US$1,000 worth of stablecoins. But can you buy US$5 million or US$10 million? We don’t know yet.”

Low adds that it is also yet to be seen if the market has demand for ringgit stablecoin as the ringgit has been depreciating against the US dollar for some time. And it could be deemed less attractive as a store of value for investors who want to convert their crypto gains into fiat money.

Low says it is more interesting to look at whether institutional investors will start putting money into digital assets if more interesting private companies start raising funds through the initial exchange offering (IEO) platforms.

“I think NFT (non-fungible tokens) will be back again, where people are going to speculate and hedge on the price of digital art to make a profit. It was quite big in Malaysia during the last crypto bull cycle. So, if you bet [that] what happened in the last cycle will amplify in the next cycle, then NFT is coming up soon,” he says.

Another new development in the digital asset space is the launch of the first locally licensed digital asset custodian (DAC), CoKeeps Sdn Bhd. Its founder Suhanna says the firm aims to keep investors’ digital assets safe from cryptocurrency theft and attacks.

Just like a gold vault that stores and secures physical gold, an independent DAC ensures investors’ digital assets are kept safely beyond the reach of hackers or unethical behaviours.

The fall of FTX, one of the world’s largest cryptocurrency exchanges before its demise last year, taught investors the importance of safeguarding their digital assets.

“The FTX saga last year strengthened the case of needing an independent third party like ours, to have proper governance in place and have proper segregation of assets and managing investors’ funds,” she says.

An advantage of having a locally licensed DAC is that it ensures any court proceedings and legal disputes follow the Malaysia legal framework, instead of that of a foreign jurisdiction.

“Engaging a locally licensed DAC helps to provide clear accountability and transparency. We can help simplify the processes of retrieving documents and information for our clients,” she adds.

The adoption of digital assets among individuals and institutions is increasingly prevalent, with the global digital asset market valued at US$447.9 billion in 2022. Naturally, participants in the private wealth sector are in search of reliable digital asset custody solutions.

Suhanna believes there is a huge market for digital asset custodians, but challenges remain, especially on how existing securities and financial rules should be applied to safeguard digital assets.

“The lack of clarity [in how existing rules should be applied] might slow down the progress of global digital asset custodian services,” she says.

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