Growing the Market Through Cryptocurrency Regulation?..."Look at Japan Now" [Bitcoin Twist]

2016 Attempt to Institutionalize Japan's Cryptocurrency Market
Shift to Strong Regulation After Numerous Victims
Japan's Cryptocurrency Market 'Declared Dead'... Margin Trading Still Active

The cryptocurrency craze is sweeping across the globe. It is even compared to a so-called ‘mania.’ However, the more intense the mania, the more necessary it is to pause and observe carefully. If problematic aspects are swept away along with the hype, they are bound to resurface as bigger issues someday. This is a time to calmly review the cryptocurrency market, a moment to ‘Twist Bitcoin.’

[Image source=Yonhap News]

[Asia Economy Reporter Gong Byung-sun] Recently, the government has been struggling with the cryptocurrency market. Criticism has arisen that despite numerous victims following the 2017 cryptocurrency mania, no measures were taken. In fact, it appears the government deliberately neglected the cryptocurrency market. On the 22nd, Eun Sung-soo, Chairman of the Financial Services Commission, stated at the National Assembly’s Political Affairs Committee plenary session, “The government has consistently said that cryptocurrencies are unacceptable as currency,” and added, “We do not think we should protect people just because many invest.”

In response, many experts argued that the cryptocurrency market should be institutionalized to protect investors and grow the market. The most frequently cited example in this process was Japan. The cryptocurrency industry claims that Japan amended the Payment Services Act and the Financial Instruments and Exchange Act to establish mechanisms to protect investors and encourage innovation. The example of Japan soon led to discussions about a specialized industry law. On the 7th, Lee Yong-woo, a member of the Democratic Party of Korea, introduced the Virtual Asset Business Act, marking the first step toward such legislation.

However, a closer look at the process of creating Japan’s cryptocurrency-related laws tells a different story. Until the current laws were enacted, Japan’s cryptocurrency market produced numerous victims. Did Japan truly succeed in promoting the cryptocurrency market through institutionalization while leaving victims behind?

2016: Institutionalizing the Cryptocurrency Market with Ambitious Aspirations

To understand why Japan first institutionalized the market, we must go back to 2014. Japan’s cryptocurrency market was more active than any other country at the time. The Japanese cryptocurrency exchange Mt. Gox accounted for about 70% of global Bitcoin transactions.

However, in 2014, Mt. Gox suffered a theft of 850,000 Bitcoins. The damage amounted to approximately $473 million (about 530 billion KRW). Bitcoin investors were unable to recover their investments, and Mt. Gox filed for bankruptcy.

Japan chose not to shut down the cryptocurrency market but to institutionalize it. The government believed that by intervening in part of the market and making it transparent, it could protect investors while promoting the market. Professor Hong Ki-hoon of Hongik University’s Business Administration Department explained, “At a time when no country recognized cryptocurrencies, Japan took the initiative. They partially benchmarked Estonia, which was already embracing blockchain technology.”

In 2016, Japan amended the Payment Services Act, referring to cryptocurrencies as ‘virtual currencies’ and recognizing their function as currency that can be used to pay for goods. They also defined them as assets with property value that can be bought or sold. Virtual currency exchange operators were required to register with financial authorities, provide explanations to users, and segregate users’ assets.

Conditions for registering cryptocurrency exchanges were also established. Exchanges had to hold capital of at least 10 million yen (about 100.64 million KRW) and obtain approval from the Financial Services Agency (FSA). The ‘whitelist’ system, allowing trading only of cryptocurrencies recognized by the FSA, was introduced at this time. Currently, only five cryptocurrencies are traded on BitFlyer, a Japanese exchange, compared to 178 cryptocurrencies traded on Upbit in Korea.

Institutionalization Done, But Damages Worsen?

Despite establishing investor protection measures through institutionalization, damages continued to occur. In fact, the scale of damage grew larger.

In January 2018, 58 billion yen worth of cryptocurrencies disappeared from Coincheck, Japan’s largest cryptocurrency exchange. Coincheck could not explain the leakage route at the time. It was also suggested that about 8.98 billion yen of the stolen cryptocurrencies might have been laundered through illicit channels. Coincheck’s management held a dawn press conference to publicly apologize.

In response, the Japanese government began inspecting the security status of exchanges. Virtual asset exchange operators were required to review and report on their system risk management frameworks. In March 2018, seven cryptocurrency exchanges received administrative orders such as business improvement directives.

Nevertheless, victims continued to emerge. In September 2018, 6.7 billion yen worth of cryptocurrencies disappeared from Zaif, a Japanese cryptocurrency exchange. Zaif had previously been subject to business improvement orders, so despite government inspections, hackers were able to breach security. The Japanese National Police Agency reported that hackers launched 158 attacks between January and June 2018, stealing a total of 60.5 billion yen worth of cryptocurrencies.

2019: Declaration of Active Intervention... Cryptocurrency Industry Begins to Tread Carefully

Photo by Getty Images Bank

In March 2019, the Japanese Financial Services Agency submitted amendments to the Payment Services Act and the Financial Instruments and Exchange Act to the parliament with renewed determination. Professor Lee Byung-wook of Seoul Graduate School of Science and Technology explained, “Unlike before, the Japanese government declared it would actively regulate the cryptocurrency market.”

First, the Payment Services Act was amended. The term ‘virtual currency’ was changed to ‘crypto asset,’ and its function as currency was denied. This aligns with the current Korean government’s view of cryptocurrencies as assets. Additionally, cryptocurrency exchanges were required to entrust users’ funds to trust companies to strengthen investor protection. This measure prevents the outflow of investors’ funds invested through exchanges and removes the anonymity characteristic of cryptocurrencies. Changes related to crypto assets also require prior notification.

The amendment to the Financial Instruments and Exchange Act classifies cryptocurrencies as financial products. This is to impose regulations equivalent to those on financial products. It prohibits fraudulent acts such as using unfair means or false or omitted disclosures of important facts during cryptocurrency trading or related derivatives transactions. It also bans spreading false rumors, coercion, threats, or violence intended to manipulate prices. This can be seen as a regulation to prevent cryptocurrency price manipulation, which investors in Korea also criticize.

Most importantly, the FSA shifted from a policy of leaving the market free to one of active intervention. In April last year, the FSA implemented a rule limiting margin trading leverage to 2x. Margin trading allows investors to invest amounts several times their margin, enabling large profits or losses. Unlike Korea, Japan permits cryptocurrency margin trading.

Initially, Japan set the maximum leverage for cryptocurrency margin trading at 4x, but the FSA decided to regulate more strictly. Before the law’s enforcement, the FSA solicited opinions from the cryptocurrency industry on the 2x margin trading limit through a ‘public comment’ system but received no responses. This was due to fears that opposing the FSA’s strong regulations could make it difficult to operate within Japan.

Japan’s Cryptocurrency Market Receives Death Sentence... Demonstrating That Investor Protection and Market Promotion Cannot Come Simultaneously

Currently, Japan’s cryptocurrency market has effectively received a death sentence. Despite the current boom, cryptocurrency trading volume in Japan remains subdued.

According to cryptocurrency data site Coinhills, as of the 8th, Japan ranks 4th in Bitcoin trading volume by national currency, accounting for 4.51%. Korea, which mainly invests in altcoins, accounts for about 8.44%, ranking 2nd globally. Professor Lee explained, “Because the types of cryptocurrencies tradable in Japan are limited, Bitcoin trading is concentrated, but its share of global trading volume is low.”

Margin trading still occupies a large portion of Japan’s cryptocurrency market. According to the Japan Virtual and Crypto Assets Exchange Association (JVCEA), margin trading volume in Japan was about 6.7 trillion yen in March this year. Spot cryptocurrency trading volume was about 3.4 trillion yen, nearly half. Professor Lee pointed out, “Derivatives do not contribute to the development of the cryptocurrency market. This is a clear example showing that cryptocurrency investors are chasing volatility.”

Ultimately, experts agree that Japan should not be cited as an example when discussing cryptocurrency institutionalization and promotion, even if investor protection is considered. Professor Hong said, “Japan’s attempt to institutionalize the cryptocurrency market showed that investor protection and market promotion cannot come simultaneously. Japan likely learned through experience that promoting the cryptocurrency market is difficult.” Professor Lee advised, “In Japan, the FSA’s whitelist system is approached from the perspective of investor protection rather than as government-certified investment products. From the standpoint of investor protection rather than promotion, Korea also has lessons to learn.”