“While many other countries are standing still and shrugging their shoulders in the face of the cold wind, Japan is positioned to play a unique role in the crypto industry.”
So reads a proposal by Japan’s ruling Liberal Democratic Party Web3 project team. In other words: Where other nations fear crisis, Japan sees opportunity.
After a recent trip to Tokyo, it’s hard to overstate how out of sync Japan is with much of the world. No one I spoke with seemed particularly fazed by the FTX meltdown or the string of crypto implosions that preceded it. The FTX crash has had “no impact on policy making,” said Masaaki Taira, a member of the House of Representatives and the ruling Liberal Democratic Party’s Web3 Project Team.
As lawmakers and regulators from the U.S. to Europe to Asia express increased wariness of crypto, Web3 promotion remains part of Japan’s national strategy. A small but active group of politicians is proposing guidelines for everything from decentralized autonomous organizations (DAO) to non-fungible tokens (NFT). It’s getting easier for Japanese exchanges to list tokens. One onerous tax requirement has been revised, marking a major win for crypto entrepreneurs. Coinbase and Kraken withdrew from Japan, but Binance, which irked Japanese regulators in the past, managed to acquire a Japanese exchange. And stablecoins, which are currently not allowed on Japanese exchanges, have a new path forward.
Which raises the question: Why is Japan embracing crypto now?
Ghosts of hackers past
The simplest explanation may be that when it comes to crypto, Japan has already been to Hell and back. It proved that it can weather a storm. So now, some of the old fear is gone.
Japan was an early mover in crypto, and the setbacks came soon after. In 2014, Japanese exchange Mt. Gox was hacked. Then, in early 2018, hackers struck again, stealing over $500 million from Japanese exchange Coincheck in what was the biggest hack in crypto history. Not long before the Coincheck hack, Japan was poised to be a crypto capital of Asia, if not the world. But the hack spooked regulators in a big way, and Japan seemed to vanish off the crypto map. For a time it seemed almost impossible to list new tokens on exchanges.
It turns out that Japan had not, in fact, disappeared, it was just taking time to get its house in order. Following these hacks, Japan required that customer assets and exchange assets be separated, and that most exchange assets be kept in cold wallets. When FTX imploded, Japan’s regulatory approach showed its strengths.
“It is likely that FTX Japan’s Japanese customer assets will be returned without a significant impact from the Chapter 11 global bankruptcy filing,” said Ryosuke Ushida, chief fintech officer at the Financial Services Agency, the government agency that regulates crypto.
“In most jurisdictions there is no segregation of crypto assets. In Japan they are legally separated. That makes it easier for FTX Japan to return the money.”
“The reason why we ask for this kind of segregation of assets is because we learned our lesson from past incidents like the Mt. Gox and Coincheck hacks. Fortunately or unfortunately, we got used to this kind of emergency situation in crypto. Compared to other jurisdictions, we are knowledgeable,” Ushida said.
FTX Japan may allow user withdrawals as early as February.
Stablecoins enter Japan
Before the FTX debacle was the demise of Terra’s terraUSD (UST), the algorithmic stablecoin that collapsed in May. All over the world, this led to increased concerns about the stability of the stablecoins that play such a key role in crypto trade. These stablecoins claim to be pegged 1:1 to fiat currencies such as the U.S. dollar, but there are questions about whether issuers have the fiat reserves to back these claims.
There have been various stablecoin proposals circulating in Washington, D.C. The European Union is in the final stages of approving stablecoin rules in its Markets in Crypto Assets (MiCA) Regulation. Singapore has also proposed stablecoin rules. But for the most part, regulation has yet to take hold.
This means that Japan might end up in the lead.
“Japan may be the first country to regulate permissionless stablecoins. America is still debating how to regulate stablecoins. Japan’s stablecoin law will take effect in June of 2023,” said Tatsuya Saito, product manager at the digital planning office of the Japanese bank MUFG. MUFG is leading a consortium of banks and trust banks that will launch stablecoins on both private as well as public blockchains such as Ethereum.The software platform, known as Progmat, is supposed to launch later this year.
So while other jurisdictions are trying to rein in stablecoins, Japan is cautiously moving in the opposition direction. That’s because at present stablecoins are essentially not allowed in Japan at all.
“Tether, USDC are not listed on Japanese exchanges,” the FSA’s Ushida said. “In general because we ensure that a stablecoin is really stable, reserve assets are secure and redemption can be done on request.”
Now, thanks to the new rules, overseas stablecoins have a path forward. Starting in June, Japanese exchanges will be able to apply for a special license to trade stablecoins. This could make it possible for overseas stablecoins like tether (USDT) or USD coin (USDC) to enter the Japanese market. But that does not mean it will be easy. Saito says the dollars that would back the stablecoins circulating on Japanese exchanges will likely require a scheme in which the underlying assets are held in trust at a Japanese trust bank — an unusually strict requirement.
It may seem strange to welcome stablecoins at a time when much of the world is questioning their stability. It’s not hard to imagine why Japanese investors or exchanges would want access to stablecoins – either as a store of value or an on-ramp to other crypto products – but what is the government’s motivation?
One theory is that “the Japanese government wants to bring yen-based stablecoins into the global crypto trading system, and to increase the global usage of the JPY,” Saito said.
NFTs and DAOs
Some LDP politicians are not only embracing the potential of DAOs and NFTs, they have gone to great lengths to provide policy guidelines for them. Last year the project team published a rather detailed NFT white paper.
“Japan has rich, high-quality intellectual property (IP) such as animation and games that are internationally competitive, and has great potential to lead the world in the NFT business and, by extension, the Web 3.0 economy,” the white paper says. The white paper includes policy recommendations on themes such as promoting NFT business development and protecting the rights of content IP holders.
A lot of Japanese content is seriously undervalued, explained Masaaki Taira from the LDP’s Web3 Project Team. Some of this has to do with deflation, but it is also because much of it is in the hands of the content holders and not available on the global market. NFTs provide a path to digitizing this content and bringing it to a wider audience, thus potentially increasing its value.
“Content holders and big companies are still very nervous about Web3 and blockchain. Because there is no clear regulation around it, they are afraid of breaking a law,” Taira said.
“These big companies have plenty of money and they have technology. But if the government does not give them a green light, they will be afraid to enter the NFT space.”
DAOs are another area where Japan is positioning itself to emerge as a leader. Japan’s digital ministry is creating its own DAO. The Web3 Project Team views DAOs as an innovation that has the potential to do everything from resolving social issues to revitalizing local communities and the Japanese economy.
"There is no nation-state that has formal DAO legislation,” said Akihisa Shiozaki, also a member of the House of Representatives and member of LDP's Web 3 Project Team.
“We are planning to introduce a DAO law to allow an option for those who want to do business in the form of a DAO, to be protected under LLC,' said Shiozaki.
The reason for this is basically to give people more peace of mind about entering this new world. "If you were running a DAO and the DAO made a mistake and caused people damage, you could be sued,” Shiozaki said. “You want a corporation-type shield that would limit your liability."
One of Japan’s competitive advantages is regulatory clarity, in sharp contrast to the United States. The U.S. has a variety of federal regulators including the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), plus a patchwork of state regulators. Japan has one crypto regulator: the FSA.
In the U.S. there is still much confusion over what makes a token a security. In Japan, the lines are more clearly drawn. “Crypto assets and securities are different categories and tokens currently listed on crypto exchanges are crypto assets, not securities,” the FSA’s Ushida explained. “We have a clear definition of securities. You will find what is defined as securities in Article 2 of the Financial Instruments and Exchange Act.”
“If the underlying asset of the tokenized assets is a security (e.g., bond) or real estate, it is subject to security regulation,” he added. “Utility tokens which do not fall into the definition of crypto assets and other financial instruments are out of the scope or financial regulation.”
Clarity, of course, does not necessarily mean ease of doing business. Taxes remain an obstacle. The LDP’s tax committee recently approved a proposal that said crypto startups that issue tokens no longer have to pay corporate taxes on unrealized gains. But other tax issues remain unresolved.
Furthermore, getting a token listed on a Japanese exchange can be challenging. Tokens must first be approved by Japan’s self-regulatory organization, the Japan Virtual Currency Exchange Association, or JVCEA. But the JVCEA doesn’t act alone.
“JVCEA makes a recommendation to the FSA. It’s case by case. We respect the judgment of JVCEA but it also should be checked by us,” the FSA’s Ushida said.
The token approval process has recently been streamlined. In October 2021 there were 86 coins waiting to be listed; now there are only nine. The wait for getting listings approved has gone down from nearly two years to three months, according to a JVCEA representative.
Still, I heard complaints that listings are not moving fast enough. Coinbase Japan, for example, lists under 20 tokens, compared to over 200 in the United States.
Coinbase, in fact, has just pulled out of Japan, following in the footsteps of Kraken. Coinbase Japan users have until mid-February to make their final withdrawals. Coinbase pointed to “market conditions” as a reason for its departure, but its decision was likely affected by the challenges of profitability in Japan due to strict regulations, as well as the additional challenge of an overseas company breaking into a market where it had no pre-existing user base.
It’s clearly not easy to operate an exchange in Japan. In addition to rules about segregation of assets and cold wallets, exchanges must entrust customers’ fiat to a Japanese trust company or bank trust. And there are regular audits to make sure that exchanges play by the rules.
“We have to hold 100% of client assets (same kind and same amount) in cold wallets every day,” said Takaaki Kato, head of sales and trading at Bitflyer, one of Japan’s largest crypto exchanges. “If this is not met, we have to move crypto assets to cold wallets within five days by regulations, but we basically do this within 24 hours. Client fiat assets are in a trust bank, etc., with periodic reporting to regulators as well as publicly disclosed quarterly – so could be easily checked.”
Japanese exchanges also must hold capital to hedge against risks. “You have to put aside three months’ worth of selling, general and administrative expense (SG&A) costs, and our regulatory capital needs to exceed the risk amount, which it does by roughly three to four times,” Kato said.
Some would argue that such strict rules take a toll on profitability. But there are benefits as well, especially in a turbulent market. “Bitcoin could continue dropping significantly and we’d still be well capitalized,” Kato said.
After the drama of 2022, one gets the feeling that some lawmakers around the globe see crypto as something to protect people from. In Japan, the mood is very different. I heard something that sounded almost like optimism.
Not everyone is a crypto enthusiast, of course. Many people probably have little idea of what this whole crypto thing is about. But they’re not necessarily going to get in its way.
"There’s a small group of politicians that are pro-Web3 and then there’s a lot of people that don’t know,” Shiozaki said. “The good part about the LDP is that the people who don’t know don’t oppose these ideas, but let some of the younger generation politicians take initiative and run around in this blue ocean."
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