1. MIA to restrict its views to cryptocurrencies as investments only.
  2. MIA must not be seen favouring any cryptocurrency, and must not be seen favouring any cryptocurrency company.
  3. MIA will not to push for regulation of cryptocurrencies, however will push for regulators to be more active in educating themselves and the public on what they need to know before investing in cryptocurrencies.
  4. MIA will communicate with regulators on how real world regulations interact with the cryptocurrency scene, and how they can increase or reduce cryptocurrency investment risk.
  5. MIA maintains that cryptocurrencies remain an experimental asset class, and investments should be treated as caveat emptor.

Sunday, 29 January 2017

MIA Statement on Cryptocurrencies as an Investment

Since BNMs 2014 Statement on Bitcoins was released, the cryptocurrency scene has exploded in popularity both locally and around the world. Thousands of Malaysians, especially the younger generation are participating in the scene; motivated by a mixture of technical curiosity and financial returns. Despite repeated predictions of demise, the resilience of cryptocurrencies suggests less a passing fad and more a staple alternative investment in the future.

MIA has been keeping tabs on the cryptocurrency scene in Malaysia, spurred by the active discussions around it we observed in social media.  We have consulted with technical developers, community leaders, investment professionals and members of the public on their views of this emerging technology; and we believe the size of the scene have grown big enough to warrant increased official attention.

In essence, a cryptocurrency is a native token that exist inside a cryptocurrency protocol. A cryptocurrency protocol, in turn, is a system of rules governing affairs between parties that don’t fully trust each other – opening up the ability to perform commerce without intermediaries.

Facilitating trustless interactions is the big innovation of cryptocurrency protocols, and they could not have worked without native tokens. As that protocol is utilized in real world use cases, real actors (individuals, companies, machines) would be interested to acquire native tokens in order to perform actions on the protocol.

Hence, the intrinsic value of any cryptocurrency is solely derived from the adoption of its underlying protocol – the more use cases, the more geographical markets – the more real actor demand, the more valuable the cryptocurrency.

On the other hand, the market value of a cryptocurrency is what buyers and sellers believe its value should be right now, based on the traction its protocol has had so far, and the potential traction of that protocol in the future.

This dichotomy between intrinsic and market values of a cryptocurrency is what contributes to the infamous volatility the asset class is known for. As the capabilities of different protocols are being tested in various use cases, and as advocacy groups switch allegiance from one protocol to another, the market value of cryptocurrencies tend to rise and fall in tandem. That being the case, savvy investors betting on the right cryptocurrency may be rewarded with outsized returns should their protocol ends up being widely adopted.

The above summary is as simple as we managed it, and MIA feels it evident that investors should possess a minimum technological literacy before dabbling their hands in cryptocurrencies. However for better or worse; barriers of entry into cryptocurrencies are extremely low. Anyone, anywhere can acquire almost any amount at any time pseudonymously without restriction – all you need is a bank account and internet access.

With the growth of any new financial market, so too will come malicious actors looking to prey on vulnerable participants – including some Malaysians which the MIA has been alerted to. While most of the scams are simply old tricks cladded in new flavour (high-yield investment products, pyramid schemes etc.) some scams are new and unique to the cryptocurrency scene (cloud mining scams, fake wallets etc.).

It is pertinent that investors understand the true nature of a cryptocurrency ecosystem in order not to get bamboozled by these scammers. It is also pertinent that regulators engage with the cryptocurrency community to identify and apprehend scammers before they get out of control.

Fortunately over the last few years, best practices have emerged that can assist investors in identifying, assessing and protecting bona-fide cryptocurrency investment opportunities. These guidelines are proven for most cryptocurrencies that exists today, and will likely remain true for the foreseeable future:-

  1. Protocol

At the heart of every cryptocurrency is its underlying protocol – this is what gives a cryptocurrency its inherent utility in solving real world use cases. The protocol also governs critical functions of its native token – how they are produced and initially distributed, how they are secured, and how they are transferred. A cryptocurrency protocol that is open-sourced and backed by reputable developers ensures that it has mechanisms in place to improve utility, spot technical bugs and prevent spread of malevolent code.

  1. Community

The community around a cryptocurrency consists of developers, entrepreneurs and advocates that are attempting real world use cases for their chosen protocol. Most of them are financially vested in the cryptocurrencies themselves, and are aligned to ensure the protocol remains sustainable. The community is the one that facilitates entry of any cryptocurrency into new markets; via engagement with regulators, businesses, local developers and advocates. A cryptocurrency with a vibrant and widespread community ensures resilience in the face of competition with other protocols.

  1. Infrastructure

Infrastructure is what links cryptocurrencies with the real world. For most investors, they are critical for entering into, and engaging with a cryptocurrency scene. Typical cryptocurrency infrastructure include wallets, exchanges and commercial services run by private companies or non-profits.

  1. Wallets

Wallets are applications where cryptocurrencies are kept and spent. While standalone wallets can be maintained by investors themselves (on their own computers), the more popular option is use wallets provided by 3rd parties.

Investors should be aware that since there are no federal insurance program protecting wallet deposits from failure, a compromised wallet will mean total loss of the balances within.

Investors are advised to keep to a discipline of maintaining cold (self-maintained; for storage) and hot (3rd parties; for convenience) wallets to ensure security of their investments.

  1. Exchanges

Exchanges are online platforms where cryptocurrencies are traded between market participants. A cryptocurrency exchange is functionally similar to a commodity exchange; participants make deposits in fiat, and buy and sell cryptocurrencies or their derivatives in real time.  A liquid local exchange is prerequisite for the development of a local cryptocurrency community, as they are the most convenient touchpoints for new entrants into the scene.

However, the large amount of valuables stored in exchanges make them attractive targets for sophisticated cyber-attacks. Recent high profile thefts in cryptocurrencies such as the MtGox case in 2014 and the BitFinex case in 2016 involved hacking of wallets used by exchanges.

Exchanges are also vulnerable to shifts in regulatory landscape; – should a local regulator freeze the operating bank accounts of an exchange, then the fiat balances of their entire customer base will be at risk.

As with wallets, Investors are advised to keep the bulk of their cryptocurrency holdings in a self-maintained cold wallet to ensure security.

  1. Commercial services

Commercial services greatly increase the utility of cryptocurrencies by allowing merchants to accept them in exchange for goods and services. A cryptocurrency with wide merchant acceptance will be more intrinsically valuable compared to a cryptocurrency solely used for its native platform.

Already, many digital products (games, tickets, professional services, debit cards etc.) can be bought online using cryptocurrencies. For more traditional merchants, localized commercial services help them navigate intricacies of accepting cryptocurrencies as payments (dynamic pricing, taxes, accounting etc.).

Commercial services are also important for Malaysians working in the online gig economy. Tech companies sourcing developer talent from around the world are increasingly looking into cryptocurrencies to streamline payment for services rendered.

Investors are advised to keep abreast of the commercial services available for the cryptocurrency of their choice, should they intend to spend their cryptocurrencies for day-to-day activities.

Due to the supranational nature of cryptocurrencies, various components of the above ecosystem are already routinely used by Malaysians, albeit with minimal recourse should things go wrong. While investing in cryptocurrencies carry legitimate risks, lack of a local ecosystem amplifies those risks disproportionately.

Without reputable local wallet, exchange and commercial services, investors will have to rely on individual brokers or foreign entities to acquire cryptocurrencies; taking on counterparty risks that should be preventable. While the local community has been vigilant towards bad actors, there currently exist no alternatives that operate within oversight by the Malaysian government.

On the other hand, restricting access to cryptocurrencies will prove to be both difficult to implement, and counterproductive in the long term, as these technologies are evolving organically in many regions at once. Viable use cases may well emerge in Malaysia, and we already have an enthusiastic local community to bring these into fruition, creating wealth and jobs along the way.

There are several regions around the world where a robust cryptocurrency ecosystem has developed. This includes the US, China & Europe. Coincidentally each of these markets have a vibrant fintech scene looking for new ways to offer financial services. While they may or may not have anything to do with cryptocurrencies, openness to cryptocurrencies signals openness for disruption, attracting capital and talent to develop the sector further.

If Malaysia choose to ignore cryptocurrencies, in the long term we are at risk of losing a chunk of our capital market activities to these online, laissez-faire alternatives. It is already possible for companies to raise capital (either in equity or debt) from global investors completely in cryptocurrencies. The amounts involved are significant; for example The DAO project raised a total of USD 117m in less than 3 weeks.

While The DAO itself ended in failure, it has not stopped several companies from following suit – it is now routine for high-profile projects to obtain upwards of USD 10m when fundraising using cryptocurrencies. Eventually it will become practical for bricks and mortar businesses to do the same – provided they have access to a local exchange to convert the amounts raised into fiat.

In light of how different the landscape is now compared to how it was in 2014, the MIA proposes that BNM update its official statement to reflect the scene’s growing popularity. The MIA also hopes that BNM facilitates the development of a viable local cryptocurrency ecosystem (with oversight), so that local investors entering the scene may do so without exposing themselves to preventable risks.