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How Singapore’s crypto regulations are shaping its DeFi space

  • Malcolm Tan
    • Singapore, How Singapore’s crypto regulations are shaping its DeFi space

    Image: Envato Elements

    What is DeFi

    Decentralized finance (DeFi) is a new way to execute financial transactions through applications called dApps. It is built on a blockchain network called Ethereum and it does not rely on mainstream financial intermediaries (centralized finance, or CeFi) such as banks, brokerages and conventional central exchanges. 

    DeFi allows people to lend or borrow money and earn interest. But instead of effecting transactions through a third party playing the role of middleman, people can transact directly between themselves (with no intermediary) through smart-contract programmes. 

    Smart contracts are digital contracts; they are essentially computer programs, or coded business protocols, stored on a blockchain that execute automatically when pre-decided conditions are fulfilled. They allow, verify, and enforce the performance of transactions without the need for any middleman.

    How does DeFi trigger traditional finances in Singapore?

    Notable examples of DeFi services that will have an impact on traditional finance include: 

    DeFi insurance is designed to protect cryptocurrency assets and covers investors for associated risks, such as protecting deposits against crypto-market volatility and safeguarding against theft of crypto wallets or hacks on exchange platforms.

    Stablecoins, on the other hand, serve as a medium for monetary exchange to store value over a longer period of time. Traders and investors will be interested in stablecoins that store value and involve lesser risk against adverse circumstances.

    Another financial product that has been having an impact on traditional finance is decentralized lending. Cryptocurrency holders can lend on decentralized platforms to earn passive income through interest fees paid by borrowers. This has become an attractive option to lenders as they can earn lower-risk interest and benefit from collateralized lending mechanisms that help ensure lenders get repaid even if borrowers default on their loan obligations.

    As we see significant growth and a rise in transaction volumes in DeFi, central banks now see DeFi as a potential threat. Transaction banking in traditional banks addresses the operational needs and day-to-day transactions of businesses (companies) and financial institutions. Usually only companies that are top-tier customers of banks are able to enjoy ready access to these services, which focus on managing company liquidity, cash flow, trade and supply chain finance, all of which are needed for local and international transactions. Crypto exchanges are, by contrast, interoperable in that they allow easy conversion from, say, one USD-backed stablecoin to another. This means that businesses have more options to conduct commerce independently without central banks playing the role of intermediary.

    Transactions in centralized banking are usually a relationship-driven business. Businesses rely on banks for services and also on the trust they have in bank relationship managers, particularly when the latter recommend services to businesses. DeFi, however, supports the migration away from client relationships. DeFi-based transaction banking promotes trust and is predicated on technology. In addition to being permissionless, DeFi offers greater interoperability, which in turn accords ease of user-onboarding when compared to the strict regulations of traditional banking. 

    DeFi is more attractive and provides an alternative system for businesses. Its decentralized nature means that it is easier for companies to scale their business owing to DeFi’s inherently less onerous checks. Before the advent of  DeFi, businesses would have to undergo a multitude of checks, including for anti-money laundering (AML) and know-your-customer (KYC) purposes, where sources of capital get queried. With DeFi, businesses do not need to present evidence of their corporate performance outside of financial statements.  

    While larger enterprises seek efficiency in transactions, small and medium enterprises (SMEs) face issues with access to funding. Banks typically have not deemed SMEs to be as profitable as their bigger counterparts and have not focused much on expanding their offerings to this segment. Owing to a relative lack of banking infrastructure for the SME space, SMEs often have to go for moneylender services as a case in point that are more costly. 

    By the nature of their business, SMEs are usually loss-making in the first two to three years of their existence. Some SMEs are family-run businesses or informally set up; often they are not properly structured and less secure in terms of their finances. In cases where SMEs are profitable they can still be found lacking when it comes to proper management/governance or corporate documentation. This makes it challenging for banks to underwrite loans for businesses in the SME space. 

    DeFi lending is another way for SMEs to digitize debts, and it has impacted traditional finance. With DeFi lending, SMEs can lock up digital/crypto assets as collateral and borrow/lend funds against those virtual assets with interest.  

    Are tokens and exchanges regulated in Singapore?

    In Singapore, both operational exchanges of buying and selling of tokens are regulated by the Singapore government. DeFi tokens are regulated by the Securities and Futures Act (SFA) and the Payment Services Act (PSA), both of which came into force in January 2020 to regulate payment services such as e-wallets and cryptocurrency. E-money-based payment services and digital payment token (DPT) services are regulated under the Payment Service Act (PSA). A DPT is a digital representation of value (not denominated or pegged to any currency) that functions as a medium of exchange accepted by the public. DPTs can be stored, transferred or traded electronically.

    Tokens are known as a capital market product and the token issuer is required to hold one or more licenses pertaining to the issuance of e-money unless the project falls under SFA exemptions. In Singapore, decentralized exchanges are considered an “organized market” (a formal market where buyers and sellers meet to trade according to rules and procedures) under the SFA, and companies are required to apply for approval or recognition from the Monetary Authority of Singapore (MAS).

    Is cryptocurrency legal in Singapore?

    Singapore is known for being a strict country regarding its laws and regulations. But Singapore is also referred to by many as a “crypto haven.” Crypto regulations and laws cover initial coin offerings (ICOs), tax, AML/CFT (combating the finance of terrorism) and the methods of buying and trading in virtual assets.

    Singapore’s cryptocurrency regulations may be summarised as follows:

    Singapore has always been one of the leading cryptocurrency jurisdictions globally. It was in the top five and was number one for a few months over the last four years, in terms of ICOs raising funds. Before 2020, Singapore regarded cryptocurrencies as digital assets and treated them as commodities (save for those few tokens that represented securities, which still fell within the Securities and Futures Act), and so a lot of projects and cryptocurrency exchanges came to call Singapore their jurisdiction. With the Payment Services Act coming into effect in January 2020 in Singapore, most startup projects left the shores of Singapore as regulatory compliance became too costly.

    Today, only the well-funded projects and those that value regulatory compliance or wish to reach out to institutional and other high-net-worth investors come to Singapore. Thus a very different crowd now favors Singapore as a jurisdiction for their cryptocurrency projects, and there has been a significant shift toward the higher income investors and institutional players, with the increasing regulation.

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