ASK Law

Introduction to Blockchain-based Digital Assets and its Regulatory Framework in Malaysia

The emergence of blockchain technology has moved us from the internet of information to the new world of internet of value. Today, blockchain technology has evolved far beyond the mere decentralization of the financial sector. Its ability to enable trust in a trustless environment opens the door to redefining and revolutionizing Malaysia’s political, social, and economic landscape.

  1. Introduction: Blockchain as a Distributed Ledger Technology

Distributed ledger technology (‘DLT’) refers to the broad umbrella of technologies that seek to store, synchronize and distribute data, publicly or privately, across a network of nodes[1]. Blockchain is a specific or a subset of DLT in which its data is bundled into a block with a hash – a unique identifier for the block that came before – and these blocks are then appended to the end of a chain of blocks in chronological order, creating an immutable database as one change in any block in history would change all subsequent hash, therefore invalidating all the following blocks[2]. This is illustrated below:

  1. The Blockchain Generations
  • Blockchain 1.0 – Digital Currency

The early utilization of blockchain technology was intended to improve the current financial systems that we have in place by offering a decentralized payments network that is peer-to-peer, anonymous, transparent, and immutable. However, the first generation blockchains, such as Bitcoin, has limited functionality as it only allowed parties to send each other digital currencies. If A sends money to B for a service or product, there is no guarantee that B would perform its obligation to provide that service or product.

  • Blockchain 2.0 – Digital Economy

Second generation blockchains, like Ethereum, followed once it has been recognized that blockchain applications could exist beyond simple payments, transfers, and transactions. Perhaps the most significant technical difference to first generation blockchains is the deployment of smart contracts, which are programs stored on the blockchain to digitally facilitate, execute and enforce the terms of an agreement once specified conditions are met, without an intermediary. Looking back at our analogy above, when B successfully provides the service or product to A, the smart contract will automatically move an amount of cryptocurrency from A’s wallet to B’s wallet.

Smart contracts also allow the creation of new digital assets (both fungible and non-fungible tokens (NFTs)) for the purpose of Initial Coin Offerings (‘ICOs’). ICOs allow firms and businesses to raise capital for their projects, by issuing digital tokens in exchange for fiat or crypto currencies.

  • Blockchain 3.0 – Digital Society

Third generation blockchains refer to the vast array of applications that do not involve economic and financial activity. The sectors and industries that can benefit from blockchain technology include real estate, health, governance, data management, and Internet of Things. We will discuss in-depth in future articles as to how Malaysia can adopt blockchain technology in its political, social, and economic landscape.

  1. Blockchain-Based Digital Assets and its Regulatory Framework in Malaysia

With the advent of smart contracts, came the rise of ICOs which led to the cryptocurrency boom in 2017 and crash in 2018[3](there is nothing inherently wrong with the technology itself; many failed ICOs were in their substance, or the lack thereof). This has prompted international and domestic policymakers and regulators to increase regulatory scrutiny on digital assets.

In Malaysia, the Securities Commission Malaysia (‘SC’) has fostered a balanced regulatory regime that seeks to enable innovation while ensuring investors’ protection. By January 2019, the SC had put in place the Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 (‘Prescription Order 2019’) to bring blockchain-based digital assets within the remit of securities law to ensure the risks associated with it are safeguarded.

The Prescription Order 2019 distinguishes between the types of digital assets by defining ‘digital currencies’ as digital representations of value that act as a mediums of exchange and are interchangeable with money and ‘digital tokens’ as digital representations which are recorded on a distributed digital ledger.

Digital currencies and digital tokens are prescribed as securities for the purposes of securities law if they satisfy the criteria laid out in Section 3 of the Prescription Order 2019:

 

 

Digital Currency

A digital currency which –

a)    is traded on a exchange;

b)    there is gainful expectation from trading the digital currency; and

c)   the digital currency is not issued or guaranteed by any government body or central banks.

 

Digital Token

A digital token which represents a right or interest of a person in an arrangement, where –

a) the person receives the digital token in exchange for a consideration and such consideration are pooled;

b) the returns from the arrangement are generated from acquiring or holding of any property or management of business activites;

c)     there is gainful expectation from trading the digital token;

d)  the person does not have day-to-day control over the management of the arrangement; and

e)  the digital token is not issued or guaranteed by any government body or central banks.

Pursuant to the coming into force of the Prescription Order 2019, the SC had issued the Guidelines of Digital Assets (‘DA Guidelines’) which outlines the framework for Initial Exchange Offerings (‘IEOs’), setting out the requirements for issuers seeking to raise funds through digital token offering and platform operators intending to operate an IEO platform. The DA guidelines require all offerings of digital tokens to be carried out through an IEO operator that is registered with the SC.

Furthermore, SC’s Guidelines on Recognized Market (“RM Guidelines”) was amended to introduce a new Chapter 15: Digital Asset Exchange (“DAX”) which prescribes the regulatory requirements for the operation of DAX in Malaysia. Under the RM Guidelines, no DAX operators are permitted to facilitate the trading of any digital assets unless prior approval from SC has been obtained for the trading of such digital assets. Furthermore, any digital token sought to be traded on any DAX platform shall also require SC’s approval.

  1. Conclusion

Blockchain technology has emerged as a true disruptor particularly to the traditional financial industry through the distinct concept of decentralization and smart contracts. Although blockchain has changed the way crowdfunding works, it was seen that quality ICO projects were quickly overrun by scammers saturating the market with fake projects[4].

Therefore, the approach adopted by SC is welcomed as it provides stronger protection to investors and traders in the nascent market, given that, despite the high level of awareness around blockchain-based digital assets displayed by Malaysian investors, the actual understanding of the investment product was still very low[5]. It is foreseeable that further developments on the regulatory framework of blockchain-based digital assets will be put in place, and the challenge for policymakers and regulators will be to strike the right balance between fostering innovation while maintaining financial stability and putting investor’s interests at the forefront.

 

[1] A node is a physical electronic device attached to a network and is capable of creating, receiving, or transmitting data.

[2] “Blocks” – Etheruem.org

[3] “Crypto’s 80% Plunge Is Now Worse Than the Dot-Com Crash” – Bloomberg

[4] “Marketing Was A Driving Force In The ICO Hype And Crypto Crash, And May Lead Its Rebirth” – Forbes

[5] The survey reported that at least 84% of Malaysian respondents were aware of cryptocurrency, while only 14% had high levels of understanding – “Cryptoassets in Asia: Consumer Attitudes, Behaviours and Experiences” – OEC