The Election Commission said the decision to drop the plan was made after police investigations revealed that some "irresponsible people" had smuggled in their own ink to deceive voters in Saturday's election.
"Following legal advice and looking at the issue of public order and security, the commission decided not to proceed with its proposal to introduce the use of indelible ink," it said in a statement on Tuesday.
The cancellation just days before the March 8 vote has raised fears of electoral fraud and fuelled opposition anger.
The commission had widely advertised the planned use of the special ink – to be applied to a voter's fingernail after casting his ballot – as its response to long-standing allegations of vote-rigging.
Bersih, a loose coalition of 70 civil society organisations and political parties campaigning for electoral reform, criticised the commission's reversal saying it would affect the outcome of marginal seats.
"The cancellation of the use of the indelible ink makes the deployment of phantom voters operationally easier and cheaper," the group said in a statement.
"The decision shows very clearly that the commission has neither the intention nor the commitment to carry out electoral reform."
Impersonators of fraudulently-registered and genuine voters are commonly known as phantom voters.
"The democratic rights of Malaysians may have already been stolen from them before they can be exercised!" it added.
Bersih urged the public to support its proposal to set up an electoral reform panel and to collect evidence of "all instances of fraud, irregularities and misconduct".
The group staged a protest of tens of thousands of people early last November to press for clean, free and fair elections, including the cleaning up of the electoral rolls and the use of the ink.
On Wednesday Abdul Rashid Abdul Rahman, the commission chairman, was quoted in local media as saying that police received reports of a plan to sabotage the election process in several northern states.
"These voters may be regarded as having voted when they come to cast their votes on the polling day," he said.
"This may cause chaos at polling stations which, if widespread, may be difficult to control."
The decision comes as police reinforcements were deployed nationwide to prepare for the parliamentary and state level elections.
Some 222 parliamentary and 505 state seats are up for grabs on Saturday.
Analysts are predicting a win for the ruling Barisan Nasional (BN) coalition but with a reduced majority in parliament.
The BN won only 60 per cent of the popular vote in 2004 but secured 91 per cent of the seats in parliament.
"The Election Commission is working hand in hand with the Barisan Nasional to cheat in the elections"
Lim Guan Eng, opposition leader
The opposition has accused the Election Commission of working with the ruling coalition.
Lim Guan Eng, chief of the opposition Democratic Action party, told Reuters he was shocked at the development.
"It shows that the Election Commission is working hand in hand with the Barisan Nasional to cheat in the elections."