According to various pundits, decentralised finance (DeFi), an emerging financial technology based on secure distributed ledgers akin to those employed in cryptocurrencies, poses the potential to disrupt traditional finance and democratise capitalism.
Citing Investopedia, ‘DeFi eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology. This is accomplished through peer-to-peer financial networks that use security protocols, connectivity, software, and hardware advancements’
In theory, democratization – making something available to everyone – could help small and medium enterprises (SMEs) and startups fuel digitalisation, an essential attribute in today’s digital arena.
In an extended Disruptive.Asia interview, a British national based in Malaysia for 37 years, Kyri Andreou, Executive Director and Co-Founder, Ata Plus Sdn Bhd, shared his insights into DeFi and related matters.
Kyri pointed out that despite the massive potential of digital technologies, such as artificial intelligence (AI) and Industry 4.0, under-capitalised SMEs are too challenged with making ends meet financially in the current fragile economy.
“The majority of Malaysia’s 900,000 SMEs are finding it difficult to pay salaries, let alone invest in the future,” he said. “Perhaps more short-term initiatives like salary assistance to keep people employed would spur more immediate economic activity at present.”
The three co-founders of Ata Plus – who are all entrepreneurs with personal experience of the challenges of raising funds – are passionate about the belief that democratising finance for all has significant economic, financial and social benefits, ultimately leading to greater value creation and more equitable distribution of that wealth generated.
One of Malaysia’s first six pioneering equity crowdfunding (ECF) operators to be registered and recognised by the Securities Commission Malaysia back on 15th June 2015, Ata Plus also actively seeks to leverage technology tools to facilitate and promote transparency and good governance in investing and fundraising.
“We commenced operations in March 2016, and we have seen gradual uptake and interest from both companies and investors in this new asset class year upon year, especially in 2020 and again in 2021,” he continued. “We have helped to fund over 41 companies to date and we are confident of breaching the 50 companies mark by the end of this calendar year and surpassing the RM100 million funds raised mark as well.”
The long revolution
While he agrees that COVID-19 has helped to fast track some Malaysian small and medium enterprises (SMEs) towards digitalisation, he points out that: “During the pandemic, we have all watched as so many of our favourite restaurants, venues and small businesses closed because they didn’t have the financial ability to stay afloat. Equity crowdfunding presented a chance for some agile businesses to scale and take advantage of new market conditions and now for some of the businesses affected to get back in the game.”
He welcomed the unveiling of the 12th Malaysia Plan (MP12), which calls for encouraging SMEs to adopt innovation.
“However, it doesn’t explain how. The recommendation that more entrepreneurs should take up research from public universities and research institutes opens up a pandoras box of issues that aren’t easy to resolve,” says Kyri.
“For example, university and research institute intellectual property (IP) policies are restrictive and bureaucracy currently not SME friendly. Secondly, the actual researchers are usually full-time lecturers who have little time to assist SMEs take any piece of research from the research and development stage to the prototype and commercialisation stage.”
“In addition, getting funding to do this type of scaling up is extremely limited through agencies like the Malaysian Technology and Development Corporation (MTDC), which is already working at capacity. Finally, although most universities now have an extensive range of registered patents with the Malaysian Intellectual Property Organisation (MIPO), not many patents solve real commercial problems,” he added.
Speaking to Malaysian media last year, the president of the SME Association of Malaysia, Datuk Michael Kang, confirmed that businesses would need short term funding to drive digitalisation.
Hurdles to digital transformation
In Kyri’s view, most of the current challenges, such as encouraging more SMEs to seek equity crowdfunding or to help investors put funds into promising companies, appear to be driven by two fundamentals: insufficient understanding, which largely accounts for the second one – misguided perceptions.
“Ideas such as you are losing control over your company, or that you will have to be dealing with hundreds of individual investors daily; or, investing is about dividends, or there are no clear exits, need to addressed constantly,” he explained.
“We have since day one invested considerably in educating both SMEs and investors on the risks and rewards of equity crowdfunding and those efforts together with more liberalisation of the sector, are gradually paying dividends as we see considerable growth in both participation and interest levels.”
“The COVID effect of ‘fast-tracking’ to digitisation by businesses is obviously a big plus for us as we have always been set-up as a 100% digital platform though pre-COVID we did our investors meet the fundraising companies events at our office,” he admitted. “The rapid acceptance of online meetings meant we could bring the efficiencies borne by digital to both widen the participation of these events and increase their frequency.”
“Looking further ahead, as companies move more of their data into digital formats it will aid our ability to not only improve their experiences during pre-campaign, campaign, post-campaign but also introduce more innovative services and products.”
Many other Fintech companies might look at the competition or industry trends or even how to serve the existing financial system to drive their platform roadmaps, and perhaps this might work well in the short term, but we feel it is not the best way to build a truly differentiated service for the long-term. We base everything we do on our core purpose, which is to create as much as possible equality of opportunities when it comes to accessing and participating in and deriving more of the benefits of capital markets.
What is the next step?
Kyri’s response was: “I’m not sure if there is ‘A’ next step – as there are so many things happening at all levels, especially in the DeFi space and all at the same time. DeFi proponents say it can address challenges within the traditional financial system. The use of open-source technology, economic rewards, programmable smart contracts and decentralised governance offer greater efficiencies, opportunities for inclusion, rapid innovation and entirely new financial service arrangements.”
“It is always useful to reflect back on the evolution of the economy and financial system we have today as nothing happens completely by chance,” he adds.
Since the 1980s, he explained that IT systems and cost-cutting led to the collapse of community social structures and the centralisation of banking, the economy, and more.
He said that communities came under attack from the first wave of digital technology, making it cheaper and easier to manage diverse communities from a central database using centralised administration.
The resulting concentration of information and financial capital led to the disappearance of community financial institutions and local businesses.
“Greater centralisation produces greater uniformity, where small businesses and marginalised communities suffer because they aren’t big enough to matter in the central planners’ calculations. Big banks don’t generally lend to companies making less than $1 million per year, despite the fact that these smaller companies still employ a huge fraction of all workers.”
Indeed, this shift to centralisation was later reflected in stock market valuations, where the biggest companies grew the fastest.
Centralisation also impacted innovation, as small, young businesses are generally nimbler and more innovative than big companies.
For instance, in the US, where data is readily available, in 1980,12.5% of companies were less than a year old, but by 2014 this number had shrunk to 8% – and this shift likely contributed to the overall slowing of economic growth and the rise of inequality.
“While centralised systems have helped power capitalist economies for generations, they nevertheless have shortcomings that have resulted in systemic failures,” commented Kyri, citing the example of the global financial crisis of 2007, which highlighted how single failures within DeFi can lead to systemic ripple effects across an entire economy.
“Traditional financial systems are also characterised by unequal access and have a poor track record of meeting the needs of everyone — particularly in less-developed regions of the world,” he says.
This impacted even first world countries. According to the US Federal Reserve, in 1991, the Richest 1% owned $5.2 trillion whilst the Poorest 50% had $0.8 trillion. By 2021 that had changed to the Richest 1% holding $41.5 trillion whilst the Poorest 50% owned just $2.6 trillion. Today, the wealthiest 10% of Americans own 89% of all US stocks.
“It would be extremely interesting to know that figure for Malaysia,” he said.
DeFi’s core principle is that disintermediation of legacy financial infrastructure is the key to democratising financial access: reducing the fees and costs of financial products, as well as to increase the speed and settlement times of payments and transactions; improving the stability of financial systems and increasing transparency via open blockchains.
DeFi also offers the potential for innovation and the creation of new services not possible with traditional financial systems.
Kyri revealed, “My grouse with many Fintech startups is that they have only sought ways to disrupt the financial industry with the aim of taking market share from incumbents primarily by using technology to provide a better customer experience and by introducing new products, often at lower prices. These companies are not as ‘disruptive’ as they may appear because they still rely heavily on traditional bank-owned financial infrastructures to power underlying systems.”
DeFI: Community Capitalism
Admittedly, DeFi also poses a more systemic threat by providing an entirely new and distinct technology platform for the creation and delivery of existing financial services and yet-to-be imagined new services, built on a completely new decentralised system modular economy with communities at the core.
“The opportunity presented by distributed digital networks is that they can be as cost-effective as centralised databases and management,” Kyri said.
He also surmises that distributed networks will empower local communities by allowing them to set their regulations and control investment in their neighbourhoods. A modern version of community capitalism could deliver efficiency and empowerment, and citizen engagement.
“The economy and the financial system can then begin to work for everyone rather than just the fortunate few by providing equitable access to financial capital, data, and social capital. This focus on community can help to address some of the root problems with capitalism, by giving communities more control over their fate and recognizing, as economist Thomas Piketty says, that there is nothing wrong with large returns to capital, but rather that the capital is in too few hands.”
“For us at Ata Plus, the financial future needs to be about more accessibility and the continued building on a foundation for underserved people to gain access to the financial system whether in terms of meaningful investments or gaining access to funds to help their business grow.”
DeFi allows for greater inclusion for both of these constituents. Any entrepreneur, from any industry, at any stage of his business growth, will be able to access capital quickly and cost-effectively from a multitude of options from equity to debt, to revenue or royalty-based, to new instruments such as NFTs or utility tokens.
For the investor, there is the levelling up of access to the promising stars of the future so that they can share in the wealth creation of future unicorns or high growth companies.
“It will also be attractive for them to invest in social enterprises where they could earn social dividend tokens based on the impact created by the enterprise they have invested in which can then be redeemed via supporting partners or invested into other social enterprises or projects. Communities will thus be able to build considerable social capital,” said Kyri.
The core elements of a decentralised financial system are the smart contract, the token and the exchange. “The smart contract, which is the backbone of DeFi, can be programmed in an open and transparent manner allowing for creating and issuing assets on this network and for counterparties to enter into transactions that settle in accordance with the code without others having to even know who the counterparty is.”
Capital markets, and in particular private markets, currently operate on an infrastructure that consists of many networks that are private, resulting in many companies that are disconnected and siloed, he said.
DeFi would essentially offer three key advantages over this legacy system by firstly replacing many of the middlemen and having trust-by-design via smart contracts; greater efficiency by utilising a single and trusted network, so many functions can be drastically improved, leading to higher performing assets; and, global reach, allowing issuers to onboard investors globally in a seamless and inexpensive manner.
Role of regulators in a DeFi architecture
Regulators face significant challenges in balancing risks and opportunities in the DeFi architecture, and premature regulation could dampen innovation and create unexpected outcomes.
However, since this is a brand new area, many jurisdictions still lack regulatory clarity, Kyri explained. “Probably the best pathway is to not rush into regulation: Regulation can add value when it is carefully considered, evaluated, and weighed.”
He said that some DeFi applications could be radically modified to introduce know-your-customer and anti-money laundering laws and meet other regulatory requests.
“A light touch at this stage, however, would be preferable as the space is evolving rapidly and global developments could affect the local context for determining regulation. Dialogue between the public and private sectors can be extremely useful and can help regulators frame the right questions around the benefits and risks in order to develop a toolbox for future regulation.”
Securing global opportunities
Returning to the 12th Malaysia Plan (MP12), Kyri notes that chapter three of the plan is dedicated to industry, micro, small and medium industry (MSMEs), and entrepreneurship.
“Once again, the government has selected specific industries it considers will be the growth drivers of the economy. These are the electrical and electronics industry, global services, the aerospace industry, creative industries, tourism, the halal industry, smart farming and biomass products.”
“However, MP12 has little to assist the hundreds of thousands of existing SMEs, financially stressed from the pandemic,” he believes. “Most of what MP12 lays out for the sector has already been done over a number of years, by multiple agencies. There are numerous mentions of the triple helix, collaboration between institutions of higher education, government and business, without explaining how this concept will be used to assist existing and new businesses. Incubator programs already exist around the country at universities, technical colleges, ministries, and other government agencies. Expanding them will require not just the physical infrastructure, more building, but experienced entrepreneurship teachers and mentors, who are already in drastic short supply. Nothing has been mentioned about how the trainers can be trained.”
He pointed to opportunities not being fully maximised. “The halal industry is rapidly growing internationally, and Malaysia isn’t getting a big enough share of this growth. The growth of the halal industry in Malaysia will be directly related to market development, which has been ignored by MP12. Smart farming and biomass industries are very specialised, and those companies that are already involved or are likely to enter are technology-based and highly capitalised companies that don’t need government assistance. The effort could be put into existing farmers who urgently need assistance to survive. They need assistance in production and market development, where more extension is needed, and the role of FAMA expanded.”
Looking towards optimistic elements, Kyri said: “Collectively, the crowdfunding industry will play an even bigger part as policymakers are increasingly acknowledging the ability of platforms to deliver in an efficient, fast, low cost and transparent manner, funds for SMEs due to their digital and regulatory infrastructure. The European Union, for instance, has begun to look at how Managing Authorities (MAs) managing the Union’s huge Structural and Investment Funds can take advantage of crowdfunding platforms to channel resources towards segments of the market that may be underserved yet important to the European economy. Also under consideration are financial instruments, including equity investments and loans, which is a huge step up from grants only.”
The introduction of financial instruments in public support means that the private investors can be paired with public money, and the public authorities can support the private investor directly through credit risk guarantees or indirectly through co-investing.
“To give credit to our regulator the Securities Commission, they have to an extent pioneered a form of private-public partnership through the introduction of Malaysia Co-Investment Fund Scheme(MyCIF) back in September 2019, which is a co-investment matching fund,” he said.
Kyri concludes: “As we forge ahead into 2022, the impact of equity crowdfunding for COVID-19-affected small businesses will play out with positive ramifications in the economy by creating not only capital for businesses, but creating jobs as well.”