The ASEAN region is grappling with two seemingly contradictory forces: on one hand, a large part of the population (more than half) being underbanked or unbanked, and on the other hand, a young and digitally savvy population with high mobile internet connectivity. The digitally savvy part of the population is also the most comfortable with using crypto-assets, including stablecoins, and Decentralised Finance protocols (DeFi) (together referred to as decentralised finance).

These characteristics are consistent with the sizeable activity of ASEAN member states (AMS) in decentralised finance markets. Thailand, the Philippines and Viet Nam were among the top 10 crypto-asset adopters globally in 2022, while Malaysia is one of the nine countries with the largest Bitcoin mining activity on its territory. “Play-to-earn” blockchain-based gaming applications involving crypto-assets lured in many young individuals in the Philippines and other AMS, although these activities proved short-lived.

Important crypto-asset flows per capita have been recorded in almost all AMS, with peaks in activity coinciding with high crypto-asset valuations, indicating speculative forces driving these markets to a large extent. The Bitcoin and stablecoins dominate decentralised finance activity in the region, following global trends in the preference for such ‘mainstream’ crypto-assets. Although it is difficult to obtain accurate statistics on the geographic breakdown of DeFi activity, industry estimates of aggregate flows indicate important DeFi protocol activity in Asia for the period 2022 - H1 2023.

Part of this activity could be attributed to ASEAN users seeking to participate in these markets for their purported benefits regarding financial inclusion. Indeed, crypto-asset and DeFi protocols have been marketed as a tool to promote the democratisation of finance by replacing legacy centralised and intermediated finance with peer-to-peer disintermediated markets. These markets, however, involve the unregulated or non-compliant provision of financial services, depending on the jurisdiction, and thus expose investors to important risks in the absence of traditional safeguards for investor protection, market integrity and financial stability.

In practice, at the current stage of development of these markets, decentralised finance has failed to deliver on the promise of democratisation of finance, instead exposing retail participants to disproportionately high risks and loss of investment without recourse. The Asian region was at the epicenter of the 2022-23 crypto-asset market downturn (the ‘crypto winter’), as the first major collapse of the domino failures was the Terra Luna implosion. The impact of crypto-asset firm failures on many retail holders was disproportionally high compared to large investors who have managed to cover some of their losses. In fact, small wallet-holders appear to be net buyers in the aftermath of the failures, against larger wallet-holders that offloaded their holdings early on.

Quantitative evidence from ASEAN suggests that professional and institutional investors (including centralised crypto-asset service providers) have been the most active participants of DeFi, and the share of professional activity as part of total volume is the highest in East Asia. Despite the prominence of professional investors, there are still sizeable amounts of retail users participating in these markets, and the number of small crypto-asset wallet holders has been increasing over the period 2020-H1 2023.

Speculative forces and a fear of missing out, rather than practical use-cases – such as to facilitate payments – have driven participation in these markets. The huge volatility of crypto-assets and the difficulty in valuing them make them unsuitable for payments purposes. When it comes to currently unregulated stablecoins, it is difficult to assess whether these have been used for real use cases, such as remittances, however, there are indications that these are heavily used either as a way to hedge against weak/volatile currencies or as a means of exchange within decentralised finance. Given that crypto-asset exchanges do not offer trading across all crypto-asset pairs, trading of small “altcoins” need to go through stablecoins, and this is also showcased by the high correlation between stablecoin and altcoin trading in ASEAN. The important risks associated with unregulated stablecoins (including unreliable reserves, unclear redemption rights and a lack of stability) make them outright unsuited for remittance use cases.

Retail participation in decentralised finance (particularly DeFi protocol activity) may also be more difficult due to its complexity, unregulated nature or the provision of uncompliant financial service provision and non-custodial nature. Despite the emergence of more user-friendly interfaces for access to these markets, they remain opaque and complex for the average retail user and involve complex leveraged trading strategies that are unfit for the uninitiated and non-tech-savvy retail user.

Despite its limitations in regard to the democratisation of finance, innovation associated with decentralised finance provided in a regulated and compliant form could offer possible benefits that may merit further exploration. Traditional financial market participants may adopt decentralised finance technologies and practices (e.g. atomic settlement of securities or post-trade/clearing disintermediation) to capture potential efficiencies and productivity gains in financial market infrastructure, and several experiments and pilots are underway globally – including in ASEAN – to explore such benefits. In the future, regulated or compliant crypto-assets and stablecoins may coexist with tokenised assets and tokenised forms of money (tokenised deposits and possibly central bank digital currencies (CBDCs)).

Other digital finance tools can act as important catalysts for financial inclusion in ASEAN, particularly when it comes to MSME financing. Thin file clients can be serviced through better calibration of lending risks, including through the deployment of AI-based models and big data for creditworthiness assessment. DLT-based finance and tokenisation can offer efficiencies by lowering the cost of servicing small size transactions. It can also allow for fractionalisation and offer new pathways for capital formation. Nevertheless, such innovative applications come with challenges and risks that need to be accounted for and mitigated.

ASEAN policymakers will need to consider ways to balance the opportunities of digital innovation in finance with the risks that these entails. ASEAN policymakers have been embracing the digital transformation of finance as an enabler for more efficient, inclusive and competitive markets. By fostering responsible and safe digital innovation in finance, policymakers can help unlock the potential for financial inclusion and productivity gains, while anticipating and addressing emerging risks for participants and the markets.

Digital finance-related policy frameworks need to be carefully calibrated and there is merit in harmonising policy approaches at the regional level, while ensuring consistency of domestic rules with global frameworks, such as the recent FSB framework for crypto-assets and stablecoin arrangements. Upskilling and capacity building among policymakers will be a prerequisite for the effective monitoring and oversight of these markets, while digital financial education could also be considered to strengthen user understanding and capacity. Nevertheless, FinTech on its own is no panacea, and the promotion of efforts and policies in traditional finance (e.g. digital IDs for banking KYC, credit bureaus) will need to continue to be pursued.