This article first appeared in Wealth, The Edge Malaysia Weekly on January 22, 2024 - January 28, 2024

It has been four years since the first licensed digital asset exchange (DAX) went live in Malaysia. The industry went on to amass more than a billion ringgit of assets under management (AUM) and nearly a million registered users within a short span of time.

On the global front, digital assets have entered the mainstream as Wall Street giants like Goldman Sachs and Bank of America affirm it as a new asset class. International supervisory bodies from the Financial Action Task Force to the Financial Stability Board are setting standards to regulate this sprawling industry. Even the International Monetary Fund has started to include crypto in its macroeconomic reporting.

To cap it off, central banks are issuing digital currencies (CBDC) on blockchain networks — the same technology that powers up digital assets. According to the Bank of International Settlements, 93% of central banks surveyed have engaged in some form of CBDC work.

But as digital asset investments gather apace here in Malaysia, there is a noticeable lack of participation from institutional investors. Why are many of them sitting out on the sidelines and what are the driving forces?

Unlike major markets where institutions account for most trading activity, Malaysian DAXs are largely dominated by individual retail users. For instance, in the US, 85% of bitcoin buying is done by institutions. Recently, a local spot bitcoin fund was launched targeting this segment. But the uptake has been sluggish, despite the sharp rally in the bitcoin price of nearly 50% during this period.

Digital assets have abnormally high residual risk. Research has shown that bitcoin has up to 91% unexplained risk, compared to less than 1% for broad-based equity indices such as the S&P 500. Unlike conventional stocks, there is no balance sheet, profit guidance, annual report or corporate disclosure of any kind for bitcoin. As a result, professional traders, and the institutions they represent, rely on hedging instruments to sufficiently diversify these risks away.

Malaysia is a spot-only market with retail-centric products. Even though there are corporate trading desks linked to the DAXs here, it is a “buy-and-hold” play for the most part. A spot market for commoditised products like bitcoin gets saturated quickly, with price-based differentiation, race-to-zero in fees (down to single basis point for corporate trades) and routine arbitraging among DAXs.

There is no venue for futures or derivatives, so portfolio managers would generally have to look for options elsewhere. Fortunately for them, these are offered by world-class platforms including Coinbase, Gemini, Paxos, Revolut and UPbit, which are licensed a hop, skip and a jump away in Singapore.

Those who are crypto-literate can plug directly into the global markets via decentralised finance (DeFi) platforms, where a limitless array of products to enhance trading performance await them.

In a local DAX, the price discovery is based on the prevailing supply and demand forces confined on the platform itself. Often, this, along with currency restriction effects, may cause a “ringgit premium” where bitcoin prices become costlier than the global average. Thus, many institutions would simply deign their local DAX accounts as ramps to enter and exit holdings, but not to trade.

While there seems to be inertia among the domestic banks and bulge brackets, the wider base of small and medium enterprise (SME) owners is surprisingly upbeat.

If you take a casual peek at the peer-to-peer (P2P) trading boards (platform that allows buyers and sellers to trade directly with each other) found on mobile apps, the MYR-USDT (Ringgit-

Tether) pair is typically among the most active. Their volumes dwarf those booked in the local DAXs by multiple fold. Many of the traders are from the SME community who use stablecoins for their cross-border sourcing and corporate treasury needs.

Stablecoins help them reduce foreign exchange costs by moving out of normal payment rails and providing rate certainty amid ringgit depreciation shocks. Remittance and e-commerce are rapidly growing use cases. Stablecoin issuers are making headway in this region, like Circle (licensed as a major payments institution in Singapore) integrating with Grab and Paypal (which surpassed Visa as the most popular digital payment option in Asia).

Malaysia also stands among the Top 10 crypto mining nations in the world, and is currently ranked fifth (after Russia and ahead of Canada), according to the latest United Nations report. Miners constantly need liquidity as they have cashed out their newly minted digital assets to pay for salaries and overheads.

Beyond that, many direct selling and multilevel marketing networks have warmed up to crypto and closed-loop token economies, especially those with footprints in multiple countries. And, of course, there’s our home-grown Web3 ecosystem, which is native to crypto.

As stablecoin trading is not approved in this country, the demand is often supported by a stealthy network of off-exchange trading services such as over-the-counter (OTC) desks, in addition to the P2P boards mentioned. Local DAXs are not involved as these are private unreported deals.

Research has shown that Asia contributes to nearly 40% of global crypto P2P web traffic, predominantly coming from this region. The crypto OTC market size is worth over RM5 billion with a compound annual growth rate of 4.2%. Actuals may be much higher as data is not always publicly available, especially when interdealer flow (intermediate trades between crypto brokers) is included.

Globally, the exchange industry is going through a shakedown. Compliance has increased the fixed cost of doing business, with the dreaded twins of high user acquisition cost and high dormancy rates. Empirically, most domestic DAXs won’t survive and would goose up themselves as mergers and acquisitions targets for global DAXs looking to accrete value by adding a geographic market to their portfolio.

Over the last few years in South Korea, one of the leading crypto markets in Asia, 97% of exchanges neared bankruptcy due to low trading volume and some 200 operators had to shut down due to compliance costs.

Institutional investors fully appreciate that crypto capital is borderless, markets never sleep and they are truly spoilt for choice of service providers. Domestic DAXs generally can’t compete on scale and speed, so they mustn’t lose out on scope (of services) to retain the institutional segment.

The Malaysian landscape is highly concentrated, where one DAX commands 90% share of trading volume and carries the incumbent advantage of liquidity and depth. This is not uncommon in Southeast Asian markets, where the leading DAX towers over its challengers (for instance, Indodax in Indonesia, Coins.ph in the Philippines and Bitkub in Thailand).

The newest DAX, which goes live next year, has its eyes trained on the corporate segment but operates within the same crowded spot. Without the right product drivers, the market won’t wean off its “dark pool” dependencies on P2P and OTC even with the introduction of digital brokerage.

The industry is maturing quickly with a dwindling profit pool for small DAXs. It shouldn’t lose sight of the fact that trading is not the endgame, but wealth management is. It could serve as strategic adjacencies, such as custody for consumer banks, prime services for investment banks and payment for digital banks.

To redress the above, the regulatory perimeter should be rewired to enable different value propositions and reduce market redundancies. One that’s not a vanilla “walled garden” but a truly diverse garden, where crypto innovators can cross-pollinate and complement each other, and with enough room for creative destruction.

Otherwise, the industry risks irrelevance as it gets bypassed in favour of our neighbours.

Edmund Yong is the managing partner of Celebrus Advisory, a digital asset consultancy

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