The dramatic rise of decentralised finance (DeFi) — the umbrella term used to refer to financial services that work on a public blockchain platform — was one of the most defining traits of Southeast Asia’s tech landscape in 2021.
The year saw play-to-earn monster pet game Axie Infinity become a global hit, allowing its producer, Vietnam-based Sky Mavis, to achieve the rare feat of surpassing $1 billion in valuation in the Series B funding round.
Two cryptocurrency exchanges, Singapore-based Matrixport and Thailand-based Bitkub, also reached the coveted unicorn status last year as Bitcoin, the bellwether of all things crypto, went mainstream as a speculative financial asset.
A review of historical data by DealStreetAsia’s DATA VANTAGE that was published in late December underscored the speed at which DeFi progressed in 2021. Last year, equity funding into Southeast Asian DeFi startups multiplied by more than six times, compared with 2020, to touch nearly $1 billion, or equal to 80% of the total funding collected since 2014.
Equity investment into DeFi-focused startups in Southeast Asia
Without a doubt, 2021 was a momentous period in the development of DeFi in the region. But the growth has been driven mainly by speculative activities on the price of cryptocurrencies and non-fungible tokens (NFTs).
While DeFi, in general, has yet to disrupt real-world finance or create sustainable value in the virtual world, stakeholders argue that it’s only a matter of time.
Though greed may have driven investments into the space, it is not counterproductive to the development of blockchain as the underlying technology for finance. On the contrary, it has incentivised innovations that address major challenges such as blockchain scalability, speed of transactions, and interoperability between different protocols.
Looking ahead, the DeFi space is bracing for big regulatory disruptions as financial authorities prepare interventions to address issues such as taxation, compliance, consumer protection, and risk to financial stability.
A grassroots phenomenon
Characterised by growing retail investment in cryptocurrency and NFT, the adoption of DeFi has largely been a grassroots phenomenon.
Chainalysis, a blockchain data platform that tracks AML & KYC compliance for governments and private institutions, ranked Vietnam first globally in its annual Cryptocurrency Adoption Index and second globally in its DeFi Adoption Index in 2021.
Separately, Australia-based Coinformant ranked Indonesia the first among 50 global markets in its 2021 Cryptocurrency Interest Index, based on market penetration levels, web search metrics, and online engagement of news articles on crypto-related topics.
Coinformant noted that 7.3 million Indonesians, 6 million Vietnamese, and 4.4 million Filipinos owned cryptocurrencies last year, while Chainalysis concludes that emerging markets in Asia were largely responsible for the 880% increase in worldwide cryptocurrency adoption last year.
The high propensity for gambling is perceived to play a part in driving the adoption of cryptocurrency and NFTs. The trend is also driven by the lack of access to highly-regulated capital markets to trade stocks, ETFs, and other securitised assets. This is emblematic of the situation in most markets in Southeast Asia, where financial inclusion and literacy still require a lot of interventions.
Riding on the wave of adoption, cryptocurrency exchanges that are based in Southeast Asia clocked at least $327 million in equity funding in 2021, up by more than 13 times year-on-year, according to DATA VANTAGE.
On the NFT front, no other platform reflects the rapid rise of adoption like Axie. Driven largely by Filipinos, the game saw its daily active users rising from just 20,000 in March to more than 2.5 million as of Dec. 17, according to crypto analytics platform DappRadar. This represents a 12,400% increase in its user base in just 9 months.
Axie’s monster pets became the most traded NFT collection ever with almost $4 billion in historical trading volume. In the third quarter of 2021, the game accounted for 19.5% of the total $10.6 billion NFT trading volume globally.
NFT in-game trading volume in billion USD
“In the year ahead, these blockchain-based digital collectible games will be one of the subsets of DeFi that I think will be worth following and hold the most promise away from mainstream financial services,” said Yi Ming Ng, the CEO of Tribe Accelerator, a blockchain-focused startup accelerator that is backed by the Singapore government.
Led by Sky Mavis’s $152 million funding round, startups in the GameFi category recorded 17 funding deals with $241 million in total proceeds. This compares to only one deal, with undisclosed value, in 2020, according to DATA VANTAGE.
Zennon Kapron, the founder of fintech research and consulting firm KapronAsia said GameFi platforms like Axie will continue to bring more individuals to the DeFi ecosystem, a trend that is unlikely to slow anytime soon.
“Institutions still seem to be trying to come to grips with the potential impact. Many have certainly looked to integrate digital assets into their product offerings, but they seem to have a blindspot to the more wholesale disruption that may be in the cards,” Kapron concluded.
Long way for institutional adoption
While feeling generally positive about the recent developments in DeFi, Genping Liu, a partner at Vertex Ventures Southeast Asia, which recently invested in crypto exchange startup Coinomo and smart contract platform Dedoco, argues that the sector is still in an infant stage of innovation and continues to present significant hurdles for institutional adoption.
Regulation and more sustainable value creation would pose as major bottlenecks for now, he said, while adding that meaningful institutional adoption would only happen once these challenges are overcome.
Patrick Tan, the CEO of Novum Alpha, a Singapore-based digital asset management firm, said DeFi would continue to blossom at the grassroots level.
“We’re still, in some ways, away from institutional adoption of DeFi whether in Southeast Asia or anywhere else in the world. Because DeFi has no barriers to entry, anyone can interact with a smart contract. Issues of AML [Anti money laundering] and KYC will keep institutions away from the space.” said Tan.
Sequoia India managing director Abheek Anand said many financial institutions had expressed interest in DeFi but they don’t, for the most part, know what to do.
“There are some hurdles like infrastructural challenges that fintechs and traditional institutions are facing. A lot of the infrastructure like custody, key management, authentication, and integration still needs to be built,” Anand said, while adding that these are some of the challenges that Sequoia had been working on with its partners.
The other challenge is the lack of regulatory clarity today, he adds.
“We have seen some movement here with certain jurisdictions progressing further than others, but broadly, more government regulation is needed to protect retail investors, and we look forward to more developments on this front,” Anand said.
While it will be sometime before governments can catch up with the development of DeFi technologies and respond with appropriate regulations to address compliance issues and consumer protection, they are likely to move rapidly ahead in an effort to secure taxes from the trade of crypto assets.
Responding to the popularity of Axie in the Philippines, the country’s Undersecretary of Finance Antonette Tionko told reporters in August that players must pay income tax, but the government has yet to decide whether the transactions are classified as securities or currency trade.
In Indonesia, where cryptocurrency and NFTs are formally recognised as securities, the government is considering levying a 0.03% income tax for these assets, according to media reports in December.
“Indeed, the cryptocurrency market is a focus of regulators in almost every country as existing policy frameworks are relooked at for how well they can absorb this new age of digital currencies and to what extent new laws need to be passed specifically targeting them,” said Yi Ming.
Beyond domestic taxation, a policy move in the US looms large as potential risk for digital asset investors. After adopting a non-interventionist approach to the development of cryptocurrency, the US government is mulling regulations to address potential fraud and systemic risk from US dollar-pegged stablecoins.
Regulators are concerned whether stablecoin firms have enough reserves to back their issuance, as well as the potential loss of confidence that may lead to a run on stablecoins through mass redemptions, which in turn could impact the broader financial system.
In November, President Biden’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) jointly released a report calling for urgent legislative action to limit the issuance of stablecoins to insured depository institutions and to enable prudential regulation of stablecoins to address the risks to the broader financial system.
Some experts argue that some of these risks may be resolved if the US Federal Reserve issues a digital currency, or a central bank digital currency (CBDC).
“US dollars are widely used throughout Southeast Asia alongside national currencies, and I do believe that in the absence of a US Federal Reserve digital currency, it is almost inevitable that countries will one day accept dollar-backed stablecoins like Tether, whether or not they are regulated,” said Tan of Novum Alpha.
Damien Loh, the CEO of Matrix Asset Management, argues that CBDC would be able to significantly reduce the layers of intermediaries involved in domestic and international remittance. This cost savings could consequently be passed on to businesses and individuals, he adds.
“I think we will see a diminishing of stablecoins overall, as their use case would be reduced, especially if the CDBCs can be used across both regulated and unregulated spaces,” Loh said.
Other short-term predictions
Assuming no dramatic change in regulations, the adoption of cryptocurrency and NFTs will continue to see strong expansion in Southeast Asia.
“A few tailwinds that we see suggest that [DeFi adoption] will only increase in the coming year. One of these is that these statistics don’t take into account other [emerging blockchain networks]. And, as the DeFi ecosystem for on-chains like Solana, Avalanche, and Terra grows, the user base will increase,” said Anand.
He argues that the blurring line between DeFi and other categories such as play-to-earn gaming, or GameFi, which is just one example of a mainstream consumer use case, will only further the user base of DeFi.
The review of startup fundraising activities by DATA VANTAGE suggests that yield farming may become the next growth category this year as cryptocurrency holders learn to diversify their investment. Yield farming is the act of lending and staking tokens on blockchain networks. Staking is a term for committing crypto assets in blockchain projects for a set period and earning rewards in the form of tokens.
30-day average lending rates offered on selected global platforms
Homegrown startups are already busy focusing on building yield farming infrastructure. They raised $91.6 million in equity funding across 15 deals in 2021, up from $23 million and five deals in 2020. The earliest funding data on record is from 2019, which saw four venture rounds with a total value of $1.2 million, suggesting that the space is still in a very early stage of development.
“We will see more innovation in derivatives, meaning going beyond the current fairly limited futures market for cryptocurrencies to a whole new subset of things that can be traded against the underlying value of digital currencies and assets,” said Yi Ming of Tribe Accelerator.
Yi Ming also expects to see other major trends happening in 2022. He believes non-dollar stablecoins will become more popular as traders become more comfortable with the whole stablecoin concept and demand exposure to a wide range of international fiat currencies.
Last, but not the least, given China’s recent crackdown on cryptocurrency, all sources interviewed by DealStreetAsia for this story were unanimous that Southeast Asia, in particular Singapore, may emerge as a global innovation hub for DeFi as entrepreneurs, innovators and institutional investors favour jurisdictions where downside risk is lower, especially at a time when India is considering following China in banning cryptocurrencies.