Is there a future for cryptocurrencies in GCC states?

Digital assets can generate value to investors, traders and the stakeholders

Until a few years ago, trading of like Bitcoin in the Arabian Gulf was little more than hype. Indeed, because of the global uncertainty associated with cryptocurrencies, few traders were interested in talking openly about them.

Over the last couple of years, however, the acceptance of cryptocurrency has increased in a few countries in the region, with the UAE, Saudi Arabia and Bahrain taking the lead. This is driven primarily by two factors: first, a strong regulatory framework backing crypto assets, and second, a push to blockchain technology, which lies at the heart of cryptocurrency. This is also facilitating the emergence of newer types of digital assets like securitized tokens, stable coins, and initial exchange offerings (IEOs), collectively advancing the digitalizing of financial markets across the whole ecosystem.

In June 2018, the Abu Dhabi Global Market (ADGM), the international financial centre in Abu Dhabi, launched the Crypto Regulatory Framework and guidelines to regulate crypto asset activities, a clear sign of growing acceptance of cryptocurrency in the region.

Another was the UAE’s launch of the Blockchain Strategy 2021 in 2018, which aims to which aims to conduct 50 percent of government transactions at the federal level using blockchain technology by 2021.

The next trigger was the launch in January last year of a joint pilot cryptocurrency by the UAE and Saudi Arabia for banks to use in cross-border payments between the two countries.

PROXY FOR VALUE
So the big question is, why are the UAE and the Arabian Gulf region at large pushing ahead with cryptocurrency and digital assets despite the wild price swings this asset class has gone through in recent years? The answer lies in a growing recognition that digital assets can generate value to investors, traders and the stakeholders.

“The region has a long history of facilitating alternative investments, such as property or commodities, and many see Bitcoin as digital gold. Secondly, there is a more accommodating regulatory regimen which has been in place for a couple of years,” said Adam Grimsley, Investment Director, Aberdeen Standard Investments.

He also attributed the growing popularity of crypto assets to the shifting trends among investors in the region. “Many are willing to accept the large volatility and risks involved for a combination of diversification and potentially outsized returns,” he added.

A related factor is the high concentration of HNI investors, according to Arshad Khan, co-founder and CEO of Arabian Bourse, Abu Dhabi, a crypto asset exchange being set up under the ADGM: “The higher risk tolerance of HNI investors in the Middle-East, who are already actively trading in other volatile assets such as equities and currencies, has resulted in increasing acceptance of cryptocurrencies as an efficient and effective asset class for diversification of portfolio risk.”

BLOCK PUSH
Putting aside price volatility and other risks, one of the positives of crypto and digital assets is that their value can be transferred efficiently from one party to another through the shared real-time ledger called blockchain technology, thus effectively eliminating human error and duplications in transactional data.

A blockchain is a digitized, decentralized public ledger of all cryptocurrency transactions. By spreading transactions across a network of computers instead of one central hub, blockchain allows crypto trading to operate on a decentralised platform.

It goes without saying that UAE’s Blockchain Strategy 2021 is going to give a massive push to blockchain technology and virtual currency in the country and the region.

THE FUTURE OF MONEY?
Experts believe that cryptocurrency and the broader digital assets have the potential to be an important tool in the economic diversification the region is going through. A well-regulated digital assets platform could also make it possible for genuine startups to raise capital through securitized tokens offerings (STOs), for which ADGM has put in place sophisticated regulatory frameworks.

Digital assets could be the harbinger of a digital-money revolution in the region, but challenges abound. For one, trading of crypto and digital assets in the Arabian Gulf is still in its infancy and is therefore facing a number of issues related to regulations, cyber security, protection of investor interest and stringent legal frameworks set up to safeguard cryptocurrency transactions from financial malpractices.

Another key challenge is the high cost of blockchain networks. One of the basic ingredients for the success of crypto trading is a robust platform of crypto miners who can crack the complex mathematical codes in each block of transactions, verify it and add it to the blockchain digital ledger, a process called mining. Cryptocurrency mining requires a great deal of computing power and consequently more energy, which makes it a costly affair.

“Currently, the algorithm protocol in most of the blockchain technology networks is based on a proof of work (POW) concept that requires large amounts of computing power,” said Khan. However, he added that “with the emergence of other protocols like the proof of stake (POS) or proof of reputation (POR) and with more powerful processors, miners can mine and validate block transactions with less consumption of energy. This could make the process faster and more energy efficient”.

Additionally, except the UAE, Saudi Arabia and Bahrain, the Gulf and Middle East have largely taken a wait-and-see approach to cryptocurrencies and digital assets and have yet to launch enabling frameworks to facilitate development of crypto assets.

“We may need to wait a little longer before we see the wider adoption of crypto assets across the GCC,” said Samir Safar-Aly, Senior Associate at Baker McKenzie Habib Al Mulla. “Although countries across the GCC have in recent years made great strides to develop their anti-money laundering legislations, I believe more guidance should be in place to better prepare the market to address concerns specific to cryptocurrencies.”

If crypto assets become a mainstream asset in financial markets, they need to emerge as a forefront alternative. The next phase of their growth will largely depend on whether there is an effective and widespread regulatory framework in place governing the entire trading and settlement process, which would increase confidence among institutional and retail investors. The future of crypto assets will also depend on investor education and awareness, higher risk monitoring, adoption of the latest technology and stringent cyber security.