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J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.

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Join the most important conversation in crypto and Web3 taking place in Austin, Texas, April 26-28.

FTX was a massive hydra with subsidiaries across the globe. Amid FTX’s failure and entrance into bankruptcy court, one of these subsidiaries appears to be relatively unscathed: FTX Japan. Assuming FTX Japan makes it through, here are some things that other nations can learn from Japan’s experience.

J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog. This opinion piece is part of CoinDesk’s Crypto 2023 outlook.

FTX Japan is a Japanese-based crypto exchange, formerly known as Liquid, that Bahamas-based FTX purchased in early 2022. Whereas the customers of most FTX entities are in limbo, FTX Japan says that it is close to paying out its customers in full:

"We have put together a plan for the resumption of withdrawal service, which has been shared with and approved by the new FTX Trading management team. Development work for this plan has already started and our engineering teams are working to allow FTX Japan users to withdraw their funds."

Japanese customers' cash and crypto will not be bogged down in U.S. bankruptcy proceedings given "how these assets are held and property interests under Japanese law," the exchange says. Meanwhile, the funds of customers of the flagship Bahamas-based exchange, FTX International; Chicago-based FTX US; and FTX Australia remain stuck in bankruptcy limbo.

What is it about Japan that may end up allowing Japanese customers of FTX to get their money before anyone else?

In brief, careful regulation of crypto exchanges.

Spurred by the failure of Mt. Gox in 2014 and the 2017 hacking of Coincheck, both Tokyo-based exchanges, Japan's Financial Services Agency (FSA) established a broad set of standards for crypto exchanges, or what it defines as Crypto Asset Exchange Service Providers (CAESP). The FSA is also responsible for overseeing banking, securities and exchanges, and insurance sectors.

Here are six key elements of the FSA's framework for overseeing crypto exchanges:

1. Japanese crypto exchanges must segregate customer fiat and crypto from the exchange's own crypto. That is, they can't deposit the exchange's own operating funds into the same account, or wallet, as their customers' funds.

A separation of funds reduces the scope for fraud. For example, it would have been easier for FTX executives based in the Bahamas to raid customer funds held at their Japanese subsidiary if those funds were mingled together with FTX's corporate money.

2. Going beyond segregation, Japanese exchanges must entrust customers' fiat money balances to a third-party Japanese institution – a trust company or bank trust – where they are managed by a trustee with customers designated as the beneficiaries.

By interposing a third-party trustee between FTX Japan and its customers, regulators would have reduced the latitude for FTX insiders to tamper with Japanese customers' cash.

Another advantage of a trust requirement is that it adds a layer of protection in the event of bankruptcy. Storing customers' funds with a third-party trustee prevents them from being diverted into a general pot where they can be claimed by an exchange's other competing creditors.

Other countries are less stringent. Take the U.S., for instance. U.S. exchanges, including FTX US, operate under state money transmitter law. While some states do require money transmitters to keep customer funds in a trust but many don't, including Florida, Pennsylvania and Georgia. This lack of a trust company layer may be one reason why FTX US customers haven’t heard a peep about getting their money back.

FTX Japan claims to be holding 6.03 billion yen worth of customer fiat in trust, or US$44 million.

3. A more explicit bankruptcy protection stipulates that customers of Japanese exchanges are entitled to receive payment in priority to general creditors in the case of bankruptcy.

Customers are creditors of an exchange. They own an exchange-issued IOU. But a crypto exchange may have other creditors including bond holders, bank lenders, suppliers or other subsidiaries holding inter-company debts. When an exchange goes under, all of these IOU owners are desperate to get some of the remaining crumbs. Putting customers at the very front of the line of creditors is a way to protect them.

Compare the luxury of being a Japanese customer of FTX to the plight of Australian customers of FTX. To their horror, they recently found themselves competing with the parent company, FTX Trading, for part of the Australian bankruptcy estate.

4. The FSA requires Japanese exchanges to keep at least 95% of customers' crypto in cold wallets. Because cold wallets are not connected to the internet, they are more secure against hacking and internal fraudsters.

FTX Japan claims it currently holds 3,194 bitcoin (BTC) in cold wallets, as well as 16,418 in ether (ETH), 64.1 million XRP and a handful of other assets.

Many exchanges in unregulated jurisdictions already use cold wallets (although probably not for 95% of their customers' funds). However, smaller exchanges may use other exchanges such as FTX to store customer funds rather than their own cold wallets.

Australian exchange Digital Surge, with around 30,000 customers, recently entered into voluntary administration because it kept a significant amount of money on FTX. Huobi lost $13.2 million worth of customer funds that it had stored on FTX, while Crypto.com had $10 million in exposure.

Japan’s 95% cold wallet rule helps protect against such losses, as does the following 5% rule:

5. For the 5% of customer's crypto that can be kept in a less-secure hot [internet connected] wallet, Japanese exchanges must "back" each unit of hot-walleted crypto with exchange-owned crypto held in a segregated cold wallet. So, for example, if an exchange holds 5 BTC of customer funds in a hot wallet, it must hold another 5 BTC of its own personal coins in reserve, for a total of 10 BTC.

The FSA refers to these reserves as an exchange's performance-guarantee assets. If there are any inappropriate leakages from hot wallets, the exchange's reserve must be used to make customers whole.

6. Lastly, all of these rigid requirements must be verified by an external watchdog.

Each Japanese exchange must undergo a yearly "audit of separate management" whereby a public accountant examines that each of the above requirements for holding assets are abided by. That is, the auditor verifies that all customer fiat money is being held in trust, that customer funds are segregated from exchange funds, that at least 95% of all crypto is held in a cold wallet and that the exchange is holding an appropriate amount of performance guarantee assets.

FTX Japan customers haven't received their funds back yet. So we don't know for sure if they’ll be made whole. But initial indications suggest they will be. If so, credit goes to the six preceding protections afforded to customers of Japanese exchanges.

In response to FTX's failure, many jurisdictions are already scrambling to fashion their own regulations for crypto exchanges. They should be watching Japan closely.


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J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.

J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.