CoinDesk: Why is Japan going against the trend as global crypto regulation tightens?

Author: Emily Parker, CoinDesk

Compiled by: Ehan, Wu Says Blockchain

With strict regulations already in place, FTX Japan and its investors were spared significant losses during the FTX collapse, and Japan is formulating policies and guidelines related to stablecoins, NFTs, and DAOs to welcome the future of cryptocurrency.

While many countries remain stagnant during the crypto winter, Japan is ready to play a unique role in the crypto industry. This is stated in a proposal by the ruling Liberal Democratic Party's Web3 project team. In other words, where other countries fear crises, Japan sees opportunities.

After a recent trip to Tokyo, it is hard to overstate how out of sync Japan is with much of the world. Those I spoke with seemed particularly unfazed by the FTX collapse or the series of cryptocurrency implosions that preceded it. "The FTX collapse had no impact on policymaking," said Masaaki Taira, a member of the House of Representatives and the LDP's Web3 project team.

From the U.S. to Europe to Asia, lawmakers and regulators are becoming increasingly cautious about cryptocurrency, but promoting Web3 remains part of Japan's national strategy. From DAOs to NFTs, a small group of active politicians is proposing guidelines for everything related to crypto. It is becoming easier for tokens to be listed on Japanese exchanges; a burdensome tax requirement has been revised, marking a significant victory for cryptocurrency entrepreneurs. While Coinbase and Kraken have exited Japan, Binance, which previously angered Japanese regulators, has successfully acquired a Japanese exchange. There are also new pathways for stablecoins that are currently not allowed on Japanese exchanges.

This raises the question: why is Japan embracing cryptocurrency at this time?

The Ghosts of Past Hacks

The simplest explanation may be that Japan has already fallen into the depths of hell when it comes to cryptocurrency but has proven it can weather the storm. So now, some old fears have dissipated.

Japan was a pioneer in cryptocurrency, but setbacks soon followed. In 2014, the Japanese exchange Mt. Gox was hacked. Then, in early 2018, hackers struck again, stealing over $500 million from the Japanese exchange Coincheck, marking the largest hack in crypto history. Just before the Coincheck hack, Japan was poised to become the cryptocurrency capital of Asia and even the world. But this hack largely scared regulators, and Japan seemed to disappear from the crypto map. For a time, it seemed almost impossible to list new tokens on exchanges.

It turns out Japan did not actually disappear; it just needed time to clean up. After these hacks, Japan mandated the separation of customer assets and exchange assets, requiring most exchange assets to be held in cold wallets. When FTX collapsed, Japan's regulatory approach showed its advantages.

"FTX Japan's Japanese customer assets are likely to be returned without significant impact from the Chapter 11 global bankruptcy filing," said Ryosuke Ushida, Chief Fintech Officer of the Financial Services Agency, the government agency regulating cryptocurrency.

"In most jurisdictions, crypto assets are not isolated. In Japan, there is a legal requirement for crypto assets to be isolated. This makes it easier for FTX Japan to return the funds."

"The reason we require this asset isolation is that we learned from the past Mt. Gox and Coincheck hacks. A blessing in disguise, we have become accustomed to such emergencies in cryptocurrency. Compared to other jurisdictions, we have more experience," Ushida said.

FTX Japan may allow users to withdraw funds as early as February.

Stablecoins Enter Japan

Before the FTX collapse, there was the May collapse of the Terra algorithmic stablecoin UST. This led to growing concerns worldwide about the stability of stablecoins, which play such a critical role in cryptocurrency trading. These stablecoins claim to be pegged 1:1 to fiat currencies like the U.S. dollar, but there are doubts about whether issuers have the fiat reserves to back that claim.

Various stablecoin proposals are circulating in Washington, D.C. The European Union is in the final stages of approving stablecoin rules under its Markets in Crypto-Assets Regulation (MiCA). Singapore has also proposed stablecoin rules. However, most regulations have yet to take effect.

This means Japan may ultimately take the lead.

"Japan could be the first country to regulate unlicensed stablecoins. The U.S. is still debating how to regulate stablecoins. Japan's stablecoin law will take effect in June 2023," said Tatsuya Saito, product manager at MUFG's Digital Planning Office. MUFG is leading a consortium of banks and trust banks that will launch stablecoins on private and public blockchains like Ethereum. The software platform, named Progmat, is expected to launch later this year.

Thus, while other jurisdictions are trying to control stablecoins, Japan is cautiously moving in the opposite direction. This is because Japan currently essentially does not allow the use of stablecoins.

"Tether and USDC are not listed on Japanese exchanges," said Ushida from the FSA, "Overall, we want to ensure that stablecoins are genuinely stable, that reserve assets are safe, and that they can be redeemed upon request."

Now, thanks to new regulations, there is a pathway for overseas stablecoins. Starting in June, Japanese exchanges will be able to apply for special licenses to trade stablecoins, making it possible for overseas stablecoins like USDT or USDC to enter the Japanese market. But this does not mean it will be easy. Saito indicated that the dollars backing stablecoins circulating on Japanese exchanges may require a plan where the underlying assets are held in Japanese trust banks—an exceptionally stringent requirement.

At a time when many around the world are questioning the stability of stablecoins, welcoming them seems strange. It is not hard to imagine why Japanese investors or exchanges would want to introduce stablecoins—whether as a store of value or as an entry point for other crypto products—but what is the government's motivation?

One theory is, as Saito said, "The Japanese government wants to introduce yen-based stablecoins into the global cryptocurrency trading system and increase the global usage of the yen."

NFTs and DAOs

Some LDP politicians not only see the potential of DAOs and NFTs but are also going all out to provide policy guidance for them. Last year, the project team released a fairly detailed NFT white paper.

The white paper states, "Japan has rich and high-quality intellectual property (IP), such as internationally competitive animation and games, and has enormous potential to lead the world in the NFT business and even the Web 3.0 economy," and proposes policy recommendations on topics such as promoting the development of the NFT business and protecting the rights of content IP holders.

Many Japanese-language contents are severely undervalued, explained Masaaki Taira from the LDP's Web3 project team. This is partly related to deflation, but also because most of the content is held by content owners and cannot be accessed in the global market. NFTs provide a way to digitize this content and bring it to a wider audience, potentially increasing its value.

"Content owners and large companies remain very cautious about Web3 and blockchain. Because there are no clear regulations, they fear breaking the law," Taira said. "These large companies have a lot of money and technology. But if the government does not give them the green light, they will hesitate to enter the NFT space."

DAOs are another area where Japan is positioning itself as a leader. Japan's digital agency is creating its own DAO. The Web3 project team sees DAOs as an innovation with the potential to address all issues, from solving social problems to revitalizing local communities and the Japanese economy.

"No nation-state has formal DAO legislation," said Akihisa Shiozaki, a member of the House of Representatives and the LDP's Web 3 project team, "We plan to introduce DAO laws so that those who want to conduct business in the form of a DAO can choose to be protected as limited liability companies."

The reason for doing this is fundamentally to make people feel more secure about entering this new world. "If you are running a DAO and that DAO makes a mistake and causes personal injury, you could be sued, and you need a company-type shield that can limit your liability."

Regulatory Clarity

One of Japan's competitive advantages is regulatory clarity, in stark contrast to the U.S. The U.S. has various federal regulatory agencies, including the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), as well as state regulators. Japan has one cryptocurrency regulatory agency: the FSA.

In the U.S., there is still much confusion about what makes a token a security. In Japan, the lines are drawn more clearly. Ushida from the FSA explains, "Crypto assets and securities are different categories, and the tokens currently listed on crypto exchanges are crypto assets, not securities." "We have a clear definition of securities. You will find the definition of securities in Article 2 of the Financial Instruments and Exchange Act."

He added, "If the underlying asset of a tokenized asset is a security (such as a bond) or real estate, it will be subject to securities regulation." "Utility tokens that do not fall under the definitions of crypto assets and other financial instruments are not within the scope of financial regulation."

Of course, regulatory clarity does not necessarily mean ease of doing business. Taxation remains a significant barrier. The LDP's tax committee recently approved a proposal stating that crypto startups issuing tokens will no longer need to pay corporate tax on unrealized gains. However, other tax issues remain unresolved.

Additionally, listing tokens on Japanese exchanges is challenging. Tokens must first be approved by Japan's self-regulatory organization, the Japan Virtual Currency Exchange Association (JVCEA). The JVCEA does not act alone.

"JVCEA makes recommendations to the FSA. Depending on the situation. We respect JVCEA's judgment, but we should also scrutinize it," Ushida from the FSA said.

The token approval process has recently been streamlined. In October 2021, there were 86 tokens waiting to be listed; now there are only 9. According to JVCEA representatives, the waiting time for listing approval has been reduced from nearly two years to three months. Nevertheless, I still hear complaints that the listing speed is not fast enough. For example, Coinbase Japan has listed fewer than 20 tokens, while the U.S. has over 200.

Exchange Rules

In fact, Coinbase has just followed Kraken's lead and exited Japan. Coinbase Japan users must make their final withdrawals by mid-February. Coinbase cited "market conditions" as the reason for its exit, but its decision may have been influenced by profitability challenges due to Japan's strict regulations, as well as additional challenges from overseas companies entering a market without a pre-existing user base.

Running an exchange in Japan is clearly not easy. In addition to rules regarding asset segregation and cold wallets, exchanges must entrust customers' fiat currency to Japanese trust companies or banks. There are also regular audits to ensure exchanges comply with the rules.

"We must keep 100% of customer assets (of the same type and amount) in cold wallets every day," said Takaaki Kato, head of sales and trading at Bitflyer, one of Japan's largest cryptocurrency exchanges. "If we do not meet this requirement, we must transfer crypto assets to cold wallets within five days as per regulations, but we basically complete this within 24 hours. Customers' fiat assets are held in trust banks, reported regularly to regulators, and disclosed quarterly, making them easy to check."

Japanese exchanges must also hold capital to hedge risks. "You must set aside three months of sales, general, and administrative expenses (SG&A) costs, and our regulatory capital needs to exceed the risk amount, about three to four times the risk amount," Kato said. Some may argue that such strict rules affect profitability. But there are benefits, especially in turbulent markets, "Bitcoin may continue to plummet, but we will still have ample capital."

Unwavering Commitment

After a series of blows in 2022, some global lawmakers seem to view cryptocurrency as something to protect people from. In Japan, the mood is very different. I hear some more optimistic sentiments.

Of course, not everyone is a crypto enthusiast. Many may be completely unaware of the entire crypto situation. But they do not necessarily hinder it. Shiozaki said, "There is a small group of politicians supporting Web3, and many people are unaware; the advantage of the LDP is that those who do not know are not opposed to these ideas, but rather allow some younger politicians to take the initiative and run in this blue ocean."