The Limits of DeFi for Financial Inclusion

4. Policy considerations

The development of digital finance activity has followed a pattern of constant growth both globally and regionally in Asia. The COVID-19 pandemic has accelerated and intensified the digitalisation trend in financial markets with an increase in both offer and demand for digital financial solutions (OECD, 2021[27]) (OECD, 2022[49]). Digitally-enabled financial services and products, in the payments sector in particular, helped economies avoid a complete standstill during the COVID-19 pandemic, and they have the potential to support a digitally-enabled recovery.

Policymakers in the ASEAN region have embraced digital innovation as an important lever to accelerate economic development and to gain a competitive edge. At the same time, policy efforts are underway in ASEAN and globally to address challenges stemming from particularly challenging and risky areas of digital finance, such as crypto-assets and DeFi, and to mitigate ensuing risks to investors, consumers and the markets.

4.1. A rapidly evolving regulatory framework for DeFi and crypto-asset activity to mitigate risks and protect investors and markets

DeFi and crypto-asset activity can involve the non-compliant operation of certain crypto-asset market players, offering regulated financial activities and products, and/or the operation of other players outside the regulatory perimeter, depending on the jurisdiction (OECD, 2022[3]). This exposes markets and their participants to significant risks that are usually addressed by consumer and investor protection rules in traditional financial services. A possible proliferation in crypto-asset activity could have implications for macroeconomic (IMF, 2023[50]) and financial stability (FSB, 2022[51]), in addition to risks for market integrity, prudential risks and risks to financial consumer/investors derived from crypto-assets (OECD, 2022[4]; OECD, 2022[3]; OECD, 2022[2]). Policymakers in ASEAN, and across OECD economies, have been seeking to ensure that safeguards are put in place to protect investors, consumers and markets from risks related to this activity.

ASEAN regulators and supervisors have been mindful of the significant risks involved in DeFi and crypto-asset activity and a number of policy actions have been implemented, are ongoing, or are planned in the region (Sonksen, 2021[52]) (Table ‎4.1). Malaysia, Thailand and Singapore, for example, have undertaken additional efforts to communicate their approach to investors and digital assets service providers, for instance, through guidelines.

At the regional level, Japan has already introduced its framework for stablecoins and crypto-assets (FSA Japan, 2023[53]), and Korea is in the process of introducing a comprehensive policy framework for these markets (FSC, 2023[54]).1 In Europe, regulation on Markets in Crypto-Assets (MiCA) came into force in June 2023 and will take effect in June 2024 (EU, 2023[55]). At the national level, some policymakers are considering complementary regulation and supervision of decentralised finance (e.g. (Banque de France ACPR, 2023[56])). At the global level, efforts are underway at the G20 level by the Financial Stability Board (FSB) to promote a comprehensive regulatory and supervisory framework for crypto-assets, including ‘global stablecoin’ arrangements, which are necessary to maintain macroeconomic and financial stability (FSB, 2022[57]; FSB, 2023[58]). IOSCO has also published Policy Recommendations for Crypto and Digital Assets (CDA) Markets and DeFi Policy Recommendations aiming to address market integrity and investor protection concerns arising from these markets by supporting greater consistency of regulatory frameworks and oversight in member jurisdictions (IOSCO, 2023[59]).

Table ‎4.1. Existing regulation of crypto-assets in ASEAN

Country	Associated Authorities	Regulatory treatment of crypto-assets
Brunei Darussalam	The Brunei Monetary Authority (AMBD)	Legal for trading/holding, not usable as tender
Malaysia	Malaysian Securities Commission, the Central Bank of Malaysia	Legal as a security, with a ban on ICOs but allowance of Initial Exchange Offering (IEOs)
Singapore	The Monetary Authority of Singapore (MAS)	Legal, explicit clear-cut regulation of crypto-assets
Thailand	Bank of Thailand	Legal, but with restrictions on the banking sector from their use, the most well developed and clear-cut regulation of crypto-assets
Philippines	The Central Bank of Philippines	Legal
Cambodia	The National Bank of Cambodia, Cambodian Securities and Exchange Commission, the National Police	Ambiguous, but effectively legal with restrictions placed only on banks
Indonesia	Indonesian Central Bank, An agency within the Indonesian Ministry of Trade	Legal for trading/holding, not allowed for payments
Lao People’s Democratic Republic	The Bank of Laos	Not illegal for individuals per se but prohibitions have been placed on financial institution
Myanmar	Central Bank of Myanmar (CBM)	Ambiguous for individuals, with explicit restrictions on financial institution
Viet Nam	The State Bank, Ministries of Finance and Public Security	Legal to hold/trade, but explicitly banned as a payment tool

Note: As of June 2023.

Source: Adapted from (Sonksen, 2021[52]).

The FSB framework calls for effective and proportionate regulation, supervision and oversight of crypto-asset activity and recommends that authorities require crypto-asset firms to have in place and disclose: governance frameworks; risk management framework; and reporting and disclosure frameworks (FSB, 2023[58]). Authorities should have the appropriate powers and tools, and adequate resources, to regulate, supervise, and oversee crypto-asset activities and markets, including those firms combining multiple functions and activities that may be conflicting.

Figure ‎4.1. FSB High-level Recommendations for the Regulation, Supervision and Oversight of Crypto-asset Activities and Markets and “Global Stablecoin” Arrangements

Source: FSB (2023[58]), FSB Global Regulatory Framework for Crypto-asset Activities, https://www.fsb.org/2023/07/fsb-global-regulatory-framework-for-crypto-asset-activities/

Institutional preparedness and co-ordination are two areas that may require particular attention by ASEAN policymakers for the implementation of the global policy frameworks for crypto-assets. In terms of preparedness, building institutional capacity for policymakers in AMS will be crucial for effective oversight of decentralised finance markets. In terms of co-ordination, ASEAN authorities will need to co-ordinate with each other at the domestic level to avoid fragmentation of oversight. AMS authorities will also need to co-ordinate at the international level both for information sharing and for supervision of crypto-asset and DeFi activity, which is inherently global by nature and is likely to require co-operation at the oversight level.

Co-ordination at the international level is one of the most critical areas going forward for decentralised finance markets. This is warranted given the speed at which these markets evolve and the rapid speed of development of new activities in these markets. International co-operation and co-ordination will protect against regulatory arbitrage and allow for consistency in regulatory and supervisory outcomes. Any lack of consistency in the application of the global frameworks and recommendations could result in a race to the bottom by regulators in countries with less strict frameworks, while opening the door for regulatory arbitrage by the industry. This will need to include both timely policy reaction in cross-border situations, as well as efficient information sharing between relevant authorities.

4.2. Policies to support a safe digital transformation and the development of FinTech that can contribute to financial inclusion

Although currently crypto-assets and DeFi are associated with significant risks for markets and their participants, appropriately regulated and supervised crypto-asset providers could in the future be beneficial contributors to the financial market ecosystem. Regulated and compliant stablecoins, for example, could provide an alternative for lower-cost international remittances, an important part of certain AMS financial systems (e.g. the Philippines). 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. Robust comprehensive policy frameworks for these activities and markets are necessary to achieve such policy objectives, while they also provide the legal certainty necessary for the industry to reap the benefits of decentralised finance.

Over the past five years, ASEAN policymakers have indeed implemented a wave of reforms to address the digital transformation in financial markets. These reforms typically seek to simplify regulatory regimes to encourage new entrants – entrants that could reach new customers, offer new products, and provide cheaper and faster services – while simultaneously attempting to mitigate risks to the financial system. Since 2020, six AMS (Indonesia, Lao PDR, Malaysia the Philippines, Singapore, and Viet Nam) have introduced new or adjusted rules to govern e-money and e-payment service providers. Thailand has also established rules to govern e-payment service providers, with the introduction of its Payment Systems Act (PSA) in 2017. The use of e-wallets and QR codes for payments in ASEAN is also growing rapidly. Four AMS (Malaysia, the Philippines, Singapore, and Thailand) have recently established a licensing framework for digital banks and have begun pilots in this area. AMS and in particular Cambodia, Indonesia, Thailand, and Singapore are very active in experimentation and pilots of CBDCs.

Policymakers in ASEAN could also consider supporting the safe development of other FinTech applications that could be beneficial for the promotion of financial inclusion, fostering the safe and responsible digital transformation of their markets. This is particularly important when it comes to underserved MSMEs in the region, struggling to access finance. The promotion of the safe use of digital tools as enablers of MSMEs financing in a safe and compliant manner could assist in unlocking capital for productive uses. Such digital tools include inter alia the use of artificial intelligence-based models for credit scoring of thin file clients, such as MSMEs without tangible assets or prior credit history; the use of machine learning applications by development banks granting credit guaranteed loans for fraud detection in the application and screening process; or the deployment of DLT-based finance, such as tokenisation, for capital formation, fractionalisation and for the promotion of efficiencies in capital markets that can benefit all market participants.

Digital finance-related policy frameworks need to carefully balance risks and opportunities. The promotion of digital finance tools as enablers of SME financing needs to be done in a safe and compliant manner, addressing any emerging risks, with a view to allow for the benefits of digitalisation while safeguarding consumers and markets. Innovation facilitators and regulatory sandboxes or other types of participation in public-private co-operation for pilots and experimentation are possible ways for supervisors to stimulate innovation in finance in a controlled manner, while benefitting themselves from interaction with applications of novel mechanisms and technologies (OECD, 2023[60]).

Harmonisation of policy approaches to FinTech in the ASEAN region could be considered as a means to encourage cross-border activity and support innovation at the regional level. Particularly given the diverse level of institutional capacity in the region, more regional and international dialogue could help AMS tap into broader and deeper expertise and to develop policies and instruments that can best support domestic priorities. Where resources allow, AMS could consider establishing units that monitor innovations in financial markets in the relevant authorities.

Investment in skills, training and capacity building is a prerequisite for the successful implementation of any policy in digital finance, both for users (MSMEs in particular) and for policymakers. Users, such as MSMEs, may be willing but not capable to move towards digitalisation, including for their financing needs. Support for the promotion of digital financial literacy is increasingly important to equip users for their digitalisation journey in finance (OECD, 2018[61]).

When it comes to policymakers, resources need to be deployed to keep pace with advances in technology. The upskilling of policymakers is increasingly important given the increasing technical complexity of digital innovation. Enforcement authorities in particular will need to be technically capable of supervising such innovative forms of finance and empowered to intervene when required, but also to enjoy the benefits of digital innovation in RegTech/SupTech applications. Possible capacity constraints may undermine the policy effort and reduce the effectiveness of any global co-ordination not only in terms of addressing current risks (e.g. FSB recommendations in the case of crypto-assets) but also in terms of taking advantage of the benefits of digitalisation in finance.

Nevertheless, FinTech on its own is no panacea, particularly for financial inclusion objectives, and policymakers should also aim at the promotion of efforts in traditional finance. These include, inter alia, infrastructure development where necessary to reach remote areas, work on digital identification by the government for the simplification of KYC checks and onboarding by both traditional and innovative financial institutions, but also the strengthening of traditional credit bureaus to support creditworthiness assessments. FinTech and conventional financial services need to co-exist and interoperate in the wider financial market ecosystem, and the various policy initiatives need to be co-ordinated in that sense.

Note

← 1.  The Financial Services Commission announced that the Act on the Protection of Virtual Asset Users was passed at the National Assembly’s plenary session on June 30. The Act focuses on enhancing the protection of virtual asset investors by introducing the following key points: (i) the definition of “Virtual Asset,” (ii) the definition of “Virtual Asset Service Provider” (“VASP”), (iii) the obligations and prohibitions of VASPs to protect investors, and (iv) the Financial Services Commission’s (“FSC”) authority to supervise and inspect VASPs. (FSC, 2023[54])