The Impact Of Japan’s Revised Regulations On The Crypto Industry

News, Opinion, Regulation | May 8, 2020 By:

Japanese regulators have tightened restrictions on the crypto industry with recent updates to two legislations in Japan — the Japanese Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA) which were both implemented on May 1, 2020. While many may think that small updates to existing regulations will not make much difference, Japan’s updated policies have the impact to move the entire crypto industry towards the path of mainstream adoption. 

Japan PSA — Casting a Wider Crypto Safety Net

As there are also no official laws to regulate cryptocurrencies in Japan, casting a wider regulatory net is the only option for digital assets to have a legal status and potentially go mainstream. The first update in the PSA changes basic crypto terminology from “virtual currency” to “crypto asset”. While a two-word change does not seem like a big deal, specifying and agreeing on terminology is crucial as there are still differences in how regulators define certain activities. In this instance, not every virtual asset is defined as a currency—meaning that the updated terminology will greatly impact all crypto exchanges as all crypto assets, regardless of type (cryptocurrencies, stablecoins, utility tokens, etc.)  will now fall under this regulation. 

The PSA revisions also addressed the custodianship of digital assets and states that all crypto exchanges operating in Japan will have to manage users’ money separately from their own cash flows—meaning all exchanges will have to explore using third-party operating systems, like traditional cold wallets, when storing their client’s assets. 

Cryptocurrency custodians have been specially targeted by regulators not just in Japan, but also in other countries such as Germany or various offshore jurisdictions. Just like the heavily regulated custodians in traditional finance, clear regulations and policies around safekeeping of digital assets need to be implemented in order for it to receive mainstream adoption and buy in from traditional financial institutions. 

If users still insist on hot wallets, the revised PSA states that exchanges will be responsible for the reimbursement of theft to the users. While each exchange will have a different procedure when it comes to reimbursement, it will eventually be a common practice across the industry — and we may even see the development of new insurance products that will help cater to this issue.

Financial Instruments and Exchange Act (FIEA) — Taming the Lion’s Share of the Crypto Market

Crypto derivatives will soon fall under the regulation of the Financial Instruments and Exchange Act (FIEA) as crypto derivatives are currently largely unregulated and consist of approximately 80% of existing trades in Japan. This will prohibit anyone in Japan from engaging in disseminating rumors, or using fraudulent means to engage in a derivatives transaction.

While this announcement seems like a surprise to the industry, almost all Japan-based crypto exchanges that offer derivatives have been aware that this will happen for over a year and have been well-prepared through guidelines received by Japan’s Virtual Currency Exchange Association (JVCEA), a self-regulatory body that has been recognised by the Japan Financial Services Agency (JFSA). With a full year to consider how to comply with the FIEA regulations, exchanges have had ample time to decide if they should remain in Japan — and if so, how to proceed — or take their operations elsewhere.

Even within traditional finance, derivatives markets are considered a higher-risk market and it was only a matter of time before more stringent regulations were put in place. For crypto derivatives to receive mainstream adoption, the FIEA updates are necessary to enhance customer protection and fair trading practices. 

In conclusion

Although Japan’s stringent rules may naturally limit new entrants into the market, the revised regulations should be seen as another step towards the mainstream acceptance of the crypto industry. Clear cut regulations will protect retail investors, encourage fair market practices and attract traditional financial institutions to move investments to the crypto market. Major financial institutions such as Nomura, SBI, and Rakuten have already made significant investments into the Japanese crypto market, and with crypto regulations moving in tandem with traditional financial markets, this trend is set to grow.