Disruption in Fintech and the Thai Regulatory Response

By Vinay Ahuja, DFDL Thailand

QR codes. Digital wallets. e-Commerce. Cryptocurrencies and tokens. ICOs. Like so many other industries, banking is in the midst of a continuing transformation into a new, digital incarnation. It is unclear exactly where this road will end up, or how many bumps will be felt along the way, but financial institutions as well as governments have by now come to the realization that careful but decisive action will be needed to steer the course.

To a certain extent, established institutions would prefer to see a continuation of the old banking models. Change brings risk – not only from potentially unstable products, but also from new and nimble competitors whose innovations may disrupt the market in unpredictable ways. Regulatory institutions, for their part, often hesitate to authorize new types of activity as well, particularly when the disruptive technology fundamentally alters the way a market had originally been conceived.

But the defining quality of disruption is its ability to force change even upon the unwilling, and exact a heavy price for late adopters. So how are Thai banking institutions and their regulatory overseers responding to the promise – and threat – of Blockchain-based technology? Can we expect cryptocurrencies to integrate successfully with other investment products, while establishing themselves as practical currencies for the real world? And will the future of banking belong to the banks, or the tech companies?

Shifting Boundaries

When Peter Thiel and Elon Musk launched PayPal in 1999, they didn’t wait for approval from regulators; they just got the ball rolling and presented the government with a fait accompli. PayPal wasn’t a bank, but it would perform many of the same functions as a bank, and the company’s in-between form would enable it to slip through legal hoops. Similarly, Facebook’s decision to occupy a niche somewhere between a platform and a publisher lets the company sidestep many potential editorial obligations related to its online content.

Cryptocurrencies are currently caught in another such limbo, acting as both data and currency. The world’s governments and regulatory bodies have been slowly but surely opening the door for Blockchain-based currencies to be traded – at least up to a point. The United States has so far denied applications for the establishment of a Bitcoin-based exchange traded fund (ETF), on the grounds that investor protection conditions have not been met and that Bitcoin cannot be shown to be free from price manipulation.

Moreover, for investment products to be traded on the market lawfully, they must be accurately described in plain terms – but plenty of misinformation surrounds Blockchain-based currencies. An even more fundamental structural hurdle also exists, due to the nature of Blockchain: The American SEC rather understandably finds it hard to put its stamp of regulatory approval on something whose structure ensures that it can’t be regulated.

Finding the Way Forward

Many governments and regulatory institutions are looking to the US for leadership on this and similar cryptocurrency-based questions. The high volatility of Bitcoin and its rivals makes the need for caution apparent, but increased regulatory approval could help shine a brighter light on this new ecosystem, differentiate between reliable versus unreliable investment vehicles and actors, and calm down a jittery market.

In mid-2018, Thailand approved seven cryptocurrencies for use in ICO transactions: Bitcoin (BTC), Ethereum (ETH), Bitcoin cash (BCH), Ethereum classic (ETC), Litecoin (LTC), Ripple (XRP), and Stellar (XLM). Shortly afterwards, the country began allowing cryptocurrency exchanges and brokers to apply for operating licenses. Its SEC then created three official categories under which initial coin offerings (ICOs) would be divided: investment tokens, utility tokens, and cryptocurrencies.

There are exceptions, but tokens are generally distinct from currencies. An investment token bestows the right to invest in a business or a project. A utility token allows access to a product or service – rather like a specialized type of money that can only be used in one type of store.

Cryptocurrencies, led by Bitcoin, are becoming increasingly accepted in all types of stores. Bitcoin’s popularity and ease of use have put pressure on institutions to accept the currency as a medium of exchange, but many still have misgivings – and the unstable market value of the currency is only one drawback among many.

2019 opened on an optimistic note for Digital Asset Businesses, as the Thai Ministry of Finance authorized 3 companies to operate as Digital Asset Exchanges, with another being permitted to operate as a Cryptocurrency Dealer and Broker. However, Know Your Customer (KYC), IT security and asset management safeguards remain – and concerns over inferior systems are still grounds for disqualification, as was the case with two applicant companies that failed to meet the stipulated benchmark laid down by the Thai Securities Exchange Commission in the relevant Digital Asset Business regulations. Notably, not one ICO Portal service provider has been approved yet.

Overall, on the Fintech front, 2018 was very busy year. 235 Designated Payment Systems and Designated Payment Services were granted licenses or duly registered (as required in context of the regulatory requirements of their specific business operations) with the Thai Ministry of Finance, under advisement of the Bank of Thailand.

These developments bode very well for fledgling Thai Digital Asset Businesses and the Fintech industry in 2019, as the incumbent regulators have demonstrated an uncommon savviness and a certain alacrity in licensing and registration procedures, given that relevant legislation was passed in mid-2018.

Is Bitcoin a Force for Good?

One of the fears surrounding cryptocurrencies is that they would facilitate all types of unregulated transactions, including criminal activity. Counter-arguments highlight the fact that paper money also allows for anonymous transactions, but this fact obscures the revolutionary nature of untraceable online currency.

Even with paper money, the participants in a transaction need to meet in physical locations in order to make the exchange, and the movements of the participants can be followed by investigators. The alternative is to send money online, but the digital trail of these exchanges mean that significant international payments can generally be tracked without difficulty.

All of these observable trails disappear when transactions are made in a cryptocurrency such as Bitcoin. As a consequence, laws like KYC, Consumer Due Diligence (CDD) and Anti Money Laundering (AML) are also inapplicable to the concept of cryptocurrencies. The high-level security and anonymity offered by Blockchain technology has the effect of bypassing government control, for better and for worse.

The potential – and indeed history – of bad actors in the cryptocurrency world can cause well-founded concern about how the medium will be used in the coming years. Regulatory institutions, politicians, and the public all have a natural aversion to things like ‘dark money’ and ‘the dark web’; the names alone are hard to support publicly and easy to build opposition to.

It is worth remembering, however, that Blockchain’s promise of secure distributed ledger technology represented some much-needed good news in a digital environment where hacking and data manipulation were (and continue to be) significant problems in need of a cure. New ideas often receive disproportionate attention on their faults, to the point that their advantages are sometimes overlooked.

Nevertheless, those faults must be acknowledged. Specific dangers for cryptocurrencies include money laundering, as anonymity allows bad actors to move cash without identification. For digital tokens, investors are in danger of being kept in the dark, left with information that is inadequate to make meaningful determinations about the health of individual token and ICO issuers. Utility tokens are vulnerable to exploitation as well, if issuers tie their tokens to empty promises that are unlikely to ever materialize in the real world.

These separate but very real sets of dangers are indeed the main reason why distinct regulatory categories exist for cryptocurrencies, digital tokens and utility tokens. In Thailand, some control and oversight can be applied to the market due to the regulatory approval of these categories, as digital exchanges now have the obligation to report certain types of transactions.

At the time of writing, no ICO portal has yet been approved by Thailand’s SEC. Some ICO investments are nevertheless being promoted by their backers, prompting the SEC to warn investors of the dangers of unregulated investment in this sector.

Many questions remain, in terms of the level of regulatory enforcement and supervision, as well as where legal liability rests in cases of alleged fraud and other issues. Much will depend on whether, for example, purchasers of unredeemable ICO tokens can successfully sue the issuers of those tokens, for selling a faulty product.

Next Steps

In January 2017, the total worldwide market capitalization for cryptocurrencies was $7 billion. A year later, it rose to over $800 billion. As of December 2018, the number fell to $100 billion before rebounding again slightly.

>Regulation can help cryptocurrencies achieve real stability and growth, but these types of seismic fluctuations do little to inspire confidence. They are, however, an inevitable characteristic of a brand new technology which works well in theory, but has no close analogues in the real world – and therefore inspires widely diverging estimations about its ultimate potential.

Meanwhile, innovators across sectors continue to try to get in on the ground floor, fundraising to get a head start in what may be the next big tech disruptor. Back in 2016, the combined total of all ICOs was modest, raising just under $100 million. The following year’s ICOs totaled nearly $6.6 billion in funds. Over $20 billion was raised in 2018.

Blockchain-based transactions may open the door to new types of risks, but the investment world has clearly already determined that lucrative business opportunities are entering through the very same door.

A real test will come when the tech companies behind these ICOs deliver the first generation of products they have promised. If they function as advertised, a secondary investment boom may flood the Blockchain-based sector with a level of funding that is virtually unheard-of for an industry that is still in its infancy. If not, then an equally dramatic correction could force the market back in the opposite direction.

With so many competitors vying for position, regulators and financial institutions seeking the benefits of new economic activity may not have the luxury of waiting until the results are in. Encouraging initial product performance will result in an immediate acceleration within the Blockchain sector, and the funding will go to the entities whose systems are already built up and set into motion.

For its part, the Bank of Thailand has announced that local banks will be allowed to open subsidiaries that deal with cryptocurrency transactions. If and when mainstream regulatory bodies determine that digital assets can be considered investment grade, larger institutional investors will receive the green light to add cryptocurrencies to their portfolios, adding long-term stability to the market.

Blockchain-based currencies and tokens are providing a novel challenge for institutions that are tasked with stimulating growth without adding significant systemic risk. Time will tell whether the right balance can be struck; or whether the best solution involves institutional acceptance even under less than ideal conditions, on the grounds that some of the hazards can best be mitigated through regulation.

One way or the other, many are betting that Blockchain technology will play a large role in the future of finance – and each institution will need to decide for itself how to balance the risk of exposure against the risk of falling behind in one of the most promising areas of investment in a generation.

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