Table of Contents
- Key Takeaways
- 1. Introduction
- 1.1 Crisis in the Japanese Crypto Industry
- 1.2 As the ground hardens after rain
- 2. Crypto Assets
- 2.1 Definition
- 2.2 Key figures
- 2.3 CAESP: To start a crypto business in Japan
- 2.4 JVCEA: Bringing crypto to the table
- 3. Stablecoin
- 3.1 Definition
- 3.2 Key figures
- 3.3 Types of EPI Businesses
- 3.4 Current status
- 4. Security Token
- 4.1 Definition
- 4.2 Key figures
- 4.3 Status
- 5. Tax Policy
- 5.1 Corporations
- 5.2 Individuals
- 6. Conclusion
- 6.1 Summary
- 6.2 Clear Pros and Cons
- 6.3 References
Researcher
Related Projects
Key Takeaways
The Japanese crypto industry has evolved based on trial and error through several crises.
Japanese regulations categorize crypto into crypto assets, stablecoins, and security tokens, each of which is subject to different regulations.
Compared to other countries, Japan's crypto taxation policy for companies and individuals is harsh.
Japan's crypto regulation is a good reference for other countries.
1. Introduction
1.1 Crisis in the Japanese Crypto Industry
Japan was one of the leading players in the market, recording a huge share of Bitcoin transactions in the 2010s, when blockchain first came to prominence. However, the pace of development of the market and the increasing volume of transactions were beyond the scope of management, and the exchanges were unable to establish a solid business structure. Eventually, the systemic flaws led to the execution of hacks, and Japan's position began to shrink as the following events occurred.
Hack of Mt. Gox
When: June 2011 & February 2014
The Mt. Gox hack of 2014, one of the worst hacks in the crypto industry, was a major trigger for the need for investor protection regulations around the world. Mt. Gox suffered one hack in 2011 that resulted in the loss of approximately 2,600 BTC, but another in 2014 that resulted in the theft of $4.7 million worth of BTC and bankruptcy. This incident was a direct cause of the major legislative changes in 2016.
Hack of Coincheck
When: January 2018
In January 2018, just as crypto regulations were being tightened, another massive hack occurred at Tokyo-based Coincheck. The damage amounted to approximately $530 million, and was a strong impetus for Japanese regulators to further tighten regulations on exchanges' fund management, leading to the establishment of a self-regulatory organization called the Japan Virtual and Crypto assets Exchange Association (JVCEA), which consisted of 16 exchanges at the time.
Hack of Zaif & Bitpoint
When: September 2018 & July 2019
Despite the establishment of various regulatory frameworks, two hacking incidents occurred in Japan one after another. Zaif, one of the oldest cryptocurrency exchanges in Japan, operating since 2014, had approximately $60 million in BTC, BTH, and MonaCoin stolen by hackers with unauthorized access to the exchange's hot wallet. Bitpoint was a relatively new cryptocurrency exchange at the time, and it too had approximately $32 million in cryptocurrency stolen after an exchange-owned hot wallet was hacked. These events were the direct cause of secondary legislation in 2019.
1.2 As the ground hardens after rain
However, Japan is about to be recognized as a new mecca for the crypto industry.
While there are great expectations in areas such as NFTs, metaverses, and blockchain-based games due to the strong influence of Japanese content and IP-based businesses, the fundamental reason is that through the above events, a regulatory environment that protects crypto investors and fosters the industry has been gradually created. This is in stark contrast to the situation in other countries, where the ambiguity of the crypto industry has become increasingly publicized and there seems to be no room for compromise.
The purpose of this article is to examine the regulatory aspects of the crypto industry in Japan. In Japan, crypto is categorized into crypto assets, stablecoins, and security tokens, and this article will examine the regulations that apply to each of these categories. In addition, we will also cover the tax policies that apply to companies and individuals.
2. Crypto Assets
2.1 Definition
Crypto assets are assets such as BTC, ETH, UNI, BERA, etc. that we usually think of when we think of crypto, and this includes most of them except for security tokens and stablecoins.
The regulatory definition of crypto assets under the Payment Service Act (PSA) is as follows:
proprietary value that may be used to pay an unspecified person the price of any goods purchased or borrowed or any services provided and that may be sold to or purchased from an unspecified person (limited to that recorded on electronic devices or other objects by electronic means and excluding Japanese and other foreign currencies and Currency Denominated Assets; the same applies in the following item) and that may be transferred using an electronic data processing system; or
proprietary value that may be exchanged reciprocally for proprietary value specified in the preceding item with an unspecified person and that may be transferred using an electronic data processing system.
In short, crypto assets are assets that can be used as a form of payment between unspecified parties and cannot be denominated in a fiat currency. As you can see from the definition above, crypto was initially recognized as a form of payment rather than an asset, and its legal name was originally virtual currency. This name was modified to the current crypto asset in the 2019 amendment to the PSA.
2.2 Key figures
The following names often appear in the context of cryptocurrency regulation.
Financial Services Agency of Japan (JFSA): The JFSA is an organization responsible for the regulation and supervision of Japan's financial markets in general, not just crypto assets, but the entire crypto industry, including stablecoins and security tokens, which we will discuss later.
Japanese Virtual Currency Exchange Association (JVCEA): The JVCEA is a self-regulatory organization established in 2018 by crypto exchanges in Japan that works closely with the JFSA to provide guidelines for companies conducting business related to crypto assets.
Payment Service Act (PSA): The PSA is a law that aims to improve the safety, efficiency, and convenience of payment systems, which includes most regulations related to crypto assets.
In other words, the PSA contains the laws related to crypto assets, while the JFSA, a government agency, and the JVCEA, a self-regulatory organization, are the institutions responsible for crypto asset regulation.
2.3 CAESP: To start a crypto business in Japan
What does it take to conduct a crypto business in Japan? There are a number of qualifications and requirements, but the first is to register with the JFSA as a Crypto Asset Exchange Servcies Provider (CAESP).
According to the PSA, registration as a CAESP is required for companies that perform the following functions:
sale or purchase of Crypto Assets, or the exchange of a Crypto Asset for another Crypto Asset;
intermediating, brokering or acting as an agent in respect of the activities listed in item (a);
management of customers’ money in connection with the activities listed in items (a) and (b); or
management of customers’ Crypto Assets for the benefit of another person.
As you can see from the above conditions, any company that manages crypto assets on behalf of users, including exchanges and custodial services, or has the authority to transfer users' assets on their behalf, will fall under CAESP. Non-custodial wallet solutions that do not meet these conditions are not CAESPs.
2.3.1 Requirements and rules to follow
Due to the previous incidents, the requirements and rules for CAESPs are quite strict.
First, in order to register as a CAESP, a company must be a stock corporation, or if it is an overseas company, it must 1) have an office and representative in Japan, and 2) have an official license from overseas. You must also have sufficient capital of at least ￥10 million, a reasonable organizational structure, and internal protocols to satisfy the necessary regulations and laws. As of May 31, 2023, there are currently 30 registered CAESPs.
The regulations that CAESPs must follow are mostly focused on consumer protection. First, they must keep their customers' and their own crypto assets separate, and at least 95% of their users' crypto assets must be stored in cold wallets. For crypto assets held in hot wallets, the same types and amounts must be held in cold wallets to cover the risk of a breach. In addition, there are many other regulations that must be followed, such as prohibiting false and misleading statements and providing users with sufficient information about each crypto asset.
2.3.2 Case Study: Oasys
Oasys, a leading Japanese gaming blockchain, has a multi-layered structure consisting of a Hub layer that serves as the L1 and a Verse layer that is a rollup of the Hub layer. There are many reasons why Oasys chose a rollup-based model, but regulation played a big role.
Traditional gaming companies prefer to build their own platforms for user retention and customization (IP protection, whitelisting of certain smart contracts, KYC). For this reason, some gaming blockchains offer private or consortium chains to individual operators. The problem with private chains is that they can be viewed as a custodial business because the operator has de facto control over the user's crypto assets, which would fall under CAESP.
To avoid this interpretation, Oasys uses rollups to provide a private chain-like experience for mainstream gaming companies, but unlike private chains, it is not a custodial business due to the following differences:
Layer 2 finality can be divided into several types depending on the trust assumptions, with the final hard finality occurring at layer 1, which does not require trusting the sequencer (operator in private chains) at layer 2. This is not a custodial business because the finality is not created by a single entity, but by multiple validators with different interests.
Unlike private chains, where the operator of the chain has the final authority over the user's crypto assets, it is possible to exit to layer 1 for malicious sequencers that perform censorship through forced inclusion at layer 2.
2.4 JVCEA: Bringing crypto to the table
Established in 2018, the JVCEA provides general guidelines for CAESPs, as discussed above, but its primary responsibility is to vet CAESPs as they deal with new cryptoassets. In fact, the law only requires CAESPs to notify the JFSA before dealing with new cryptoassets, but the JVCEA's own rules require them to be reviewed by the JVCEA (see Article 63-6, PSA).
While the JVCEA's review process may be necessary for consumer protection, it has been heavily criticized for its inefficiency. In 2021, there was a backlog of 80 crypto assets waiting to be reviewed, and it took 1.5 to 2 years for new crypto assets to appear in Japan, and at least a month for even relatively well-known assets like BTC and ETH to be listed on new exchanges. By the end of 2021, JVCEA received a firm warning from the JFSA about the progress of its work and the organization's operations.
To address this situation, in October 2021, the Crypto Asset Review TF was established and the following features were introduced.
2.4.1 Green List System
Introduced in March 2022, the Green List system allows crypto assets that meet all four of the following conditions to be introduced through the internal evaluation of each CAESP without the need for a JVCEA review process:
Already covered by three or more CAESP members.
have been handled by one or more CAESP members for at least six months.
The JVCEA has not set additional conditions for the handling of the asset.
No issues have arisen that would cause the JVCEA to determine that it would be inappropriate to include the crypto asset in the Green List system.
As of June 16, 2023, there are 24 crypto assets on the Green List. For new exchanges, crypto assets on the Green List may be introduced immediately without waiting for a JVCEA review.
2.4.2 Crypto Asset Self Check (CASC) System
Introduced in December 2022, the CASC system allows CAESPs that meet certain conditions to skip the JVCEA's pre-examination process and instead submit relevant materials every three months after handling new crypto assets.
With the introduction of these programs and the recruitment of additional staff, the time required for the crypto asset examination process has been significantly reduced, as shown below.
Although the review period has been significantly reduced compared to the past, it can still be said that the review process for crypto assets traded overseas that are new to Japan or for IEOs is still slow. In order for the JVSEA's examination process to improve, it is necessary to improve efficiency through customized examination according to the nature of each crypto asset instead of one-size-fits-all examination.
3. Stablecoin
3.1 Definition
The regulation of stablecoins began to be established in earnest through the PSA amendment proposed in March 2022 and enacted on June 3. The amendments came into effect on June 1 of this year, allowing the issuance of stablecoins in Japan. The amendment defines a stablecoin as an Electronic Payment Instrument (EPI) and specifies the definitions of EPI issuers and businesses that handle them.
Therefore, this article uses the terms EPI and stablecoin interchangeably.
The definition of an EPI under Article 2.5 of the PSA is almost identical to the definition of a crypto asset, with the main difference being that it is denominated in a fiat currency such as the dollar or yen. Therefore, algorithmic stablecoins or DAI that do not fall under this definition are classified as crypto assets rather than stablecoins under the regulations.
3.2 Key figures
The regulatory agencies and laws related to EPIs are very similar to crypto assets.
Financial Services Agency of Japan (JFSA): See previous section.
Payment Service Act (PSA): See previous section.
Banking Act, Trust Business Act: These laws govern banks and trust companies as entities that can issue EPI.
3.3 Types of EPI Businesses
Businesses that handle EPI can be broadly categorized into those that issue EPI and those that do not.
3.3.1 Issuers of EPIs
Issuing and redeeming EPI is considered a currency exchange transaction under Japanese law and can only be done by 1) Banks, 2) Fund Transfer Service Providers, and 3) Trust companies. The following qualifications are required of these institutions to ensure that customers can recover their funds.
Banks: Can issue stablecoins as deposits, in which case stablecoin holders' funds are protected in the same way as bank deposits.
Funds transfer service providers: Can issue stablecoins as claims on outstanding debt, and the debt must be secured by safe assets such as bank deposits or government bonds.
Trust companies: Stablecoins can be issued as trust beneficial interests, and the trust assets must be held in the form of bank deposits.
3.3.2 Others
Companies that do not issue EPIs, but engage in the sale, exchange, brokerage, custody, etc. of EPIs must first register as an electronic payment instrument, etc. business operator in accordance with Article 62-3 of the PSA. Similar to CAESP, which handles crypto assets, it is necessary to implement measures to protect consumers and to manage the assets of customers and the company's own assets separately.
3.4 Current status
While still in the pilot phase, several financial institutions are experimenting with stablecoins.
Tokyo Kiraboshi Financial Group, Minna Bank, and Shikoku Bank.
The above banks have conducted a PoC project to issue stablecoins on a blockchain called Japan Open Chain. Japan Open Chain is an EVM-compatible chain created by G.U Technology that uses the PoA method and complies with Japanese regulations. Companies such as COREGEAR, Dentsu, Pixiv, and NTT Communications are currently participating as validators, and various other PoC projects are underway.
Mitsubishi UFJ Financial Group (MUFG)
MUFG is preparing a cross-chain infrastructure for stablecoins in collaboration with Datachain and a company called TOKI. MUFG is creating a stablecoin issuance management platform called Progmat Coin, and the infrastructure being prepared will allow stablecoins issued on the platform to easily spread to other ecosystems such as Ethereum and Cosmos. Datachain has been working on a project to extend IBC to the Ethereum ecosystem called IBC-Solidity, and the cross-chain infrastructure will also use IBC-Solidity. In addition, MUFG is also preparing to issue stablecoins pegged to other global currencies such as the dollar in Japan.
4. Security Token
4.1 Definition
After crypto assets and stablecoins, the last category is security tokens (STs). Prior to 2019, it was unclear which laws covered the act of raising funds through tokens such as ICOs and STOs in Japan, which led to the suppression of such activities and a significant number of frauds. To improve this situation, the Financial Instruments and Exchange Act (FIEA) was amended in 2019 to introduce the concept of electronically recorded transferable rights (ERTRs), and tokens issued through ICOs or STOs that meet the following conditions will be considered ERTRs.
The investor has invested cash or assets in the business.
The investor's cash or assets were utilized as an investment in the business.
The investor has the right to receive dividends on the profits or assets generated by the investment.
Previously, the FIEA categorized securities into 1) Paragraph 1 securities, which are traditional securities such as stocks and corporate bonds, and 2) Paragraph 2 securities, which are contractual rights such as fund or trust interests. While more liquid paragraph 1 securities have been subject to stricter disclosure and licensing requirements, ERTRs are classified as paragraph 1 securities (and STOs of paragraph 2 securities are treated as paragraph 1 securities in some cases) and are therefore subject to the same regulations as equities. Therefore, entities engaged in brokering, dealing or custody of ERTRs are required to register as a Type 1 Financial Instruments Business Operator (Type 1 FIBO).
4.2 Key figures
Financial Services Agency of Japan (JFSA): See previous section.
Japan Security Token Offering Association (JSTOA): The JSTOA is an organization of securities firms in Japan and was recognized by the JFSA as a self-regulatory organization with the implementation of the 2019 amendments. It is similar to the JVCEA and performs a number of tasks related to the security token industry.
Financial Instruments and Exchange Act (FIEA): The FIEA is the law for securities and companies that deal in securities, and unlike the PSA for crypto, the ERTR is governed by the FIEA.
4.3 Status
These examples are taken from Capital Market Research Institute's ''Status and Implications of Security Token Offerings (STOs) in Japan'' and Despread's ''STO Series Part 1: History and Current Status of Japan’s Security Token Market”.
2020
Securitize Japan & LIFULL launch real estate STOs, to be operational from January 2021
[SBI Holdings to tokenize and issue shares of subsidiary SBI e-Sports]](https://www.securities.io/sbi-e-sports-to-host-sto-through-issuance-platform-boostry/)
Sumitomo Mitsui Trust Bank converts revenue securities to ST via Securitize platform
2021
2022
2023
5. Tax Policy
Currently, the biggest obstacle to the crypto industry in Japan is the excessive taxation of companies and individuals.
5.1 Corporations
Prior to 2023, companies holding crypto assets were subject to f year-end fair value assessment taxation even if they held them for long-term purposes, making it very burdensome for companies to invest in other companies through tokens. Fortunately, the 2023 tax reform exempted self-issued crypto assets from taxation, but there are still issues with taxation of crypto assets issued by third parties that are held for long-term purposes.
The accounting standards for crypto assets for companies were created when crypto assets were used as payment methods and speculative instruments, and are not suitable for the current state of the crypto assets. Therefore, it is necessary to modify the current standards for crypto assets or make exceptions for certain types of crypto assets, such as governance tokens, as proposed in the recent Web3.0 White Paper by the Headquarters for the Promotion of Digital Society of the Liberal Democratic Party. The sooner these changes are made, the more likely it is that investment in blockchain companies in Japan will be encouraged.
5.2 Individuals
For individuals, Japan considers income from the transfer of crypto assets as other income, and therefore imposes a comprehensive income tax at a rate of 5% to 45% in addition to other income (10% residence tax and 2.1% reconstruction special income tax). This differs significantly from other financial assets, where gains on stocks and bonds are considered capital gains and are taxed separately at a rate of 15%.
The reason for this difference is that, similar to corporations, crypto is viewed as a financial instrument, but also as a payment method. Except for Japan, South Korea and Germany are some of the other countries that classify crypto assets as other income, and in South Korea, the tax rate is similar to that of other financial investment income (20%), and in Germany, crypto assets are not taxed if they are held for more than one year, or if they are held for less than one year and generate less than 600 euros in income, so the tax system for crypto assets in Japan is particularly harsh.
6. Conclusion
6.1 Summary
6.2 Clear Pros and Cons
Japan's regulation of the crypto industry is clearly ahead of other countries. First, as the FTX case shows, Japanese regulation is better than other countries in terms of consumer protection. It is also positive that the discussion on security tokens started earlier than other countries, and there are clear regulations on stablecoin issuance due to a law that came into effect in June this year.
However, there are downsides as well, first of all, the taxation of crypto assets for individual investors is much harsher than other financial assets, and it is burdensome for companies to hold crypto assets. Tighter regulation is a positive for consumers, but the fast-moving nature of the crypto industry means that other countries may be slow to adopt changes.
What is clear is that Japan can serve as a good case study for other countries that are currently establishing regulations for the crypto industry, and in this regard, Japan's regulatory policy for the crypto industry is worth a look.
6.3 References
Crypto Travel Rule in Japan by the Financial Services Agency (FSA)
Blockchain & Cryptocurrency Laws and Regulations 2023 | Japan
STO Series Part 1: History and Current Status of Japan’s Security Token Market
Thanks to Kate for designing the graphics for this article.
