Japan was among the first countries to establish a regulatory framework for crypto-assets, and is considered one of the most progressive. Blockchain technology is now being increasingly adopted in the Japanese financial industry. For example, there are 23 licensed crypto-asset exchange service providers (CAESP) in Japan as of April 2020.
However, the upsurge of the Japanese crypto-asset market in Japan was disrupted in January 2018 when one of the largest CAESP in Japan, announced losses of approximately USD530 million from a cyber-attack on its network. Adding to the negative publicity, crypto-assets are increasingly being used for speculative purposes, rather than as a means of settlement.
This situation eventually led to the revision of certain legislations governing crypto-assets, including the Payment Services Act (PSA), and the Financial Instruments and Exchange Act (FIEA), etc. These revisions, the primary of which is the strengthening of the regulatory framework surrounding crypto-assets, came into force as of 1 May 2020.
The following is a summary of the key aspects of the revisions.
Revisions to FIEA
Revisions to PSA
These legislative revisions are expected to bring about significant changes to the crypto-asset regulatory framework in Japan.
As Japan was a leader in establishing a regulatory framework for crypto-assets, blockchain technology is now being increasingly adopted in the Japanese financial industry.
For instance, in March 2020, Nomura Holdings, Inc, Nomura Securities Co, Ltd and BOOSTRY Co, Ltd announced that they have issued and underwritten "digital asset bonds" and "digital bonds" that utilise blockchain technology.
Under the PSA, a person who engages in the purchase and sale of crypto-assets as a business is required to be registered as a CAESP (Article 63-2 of the PSA). Only CAESPs are permitted to engage in CAES. The PSA requires a person who provides CAES to be registered with the Financial Services Agency of Japan (JFSA). A person who engages in CAES without registration is punishable by imprisonment for a term not exceeding three years or a fine not exceeding three million yen, or both (Article 107, Item 5 of the PSA).
Definition of Crypto-asset
The term "crypto-asset" is defined in the PSA as:
"Currency Denominated Assets" means assets denominated in Japanese or other foreign currency. Such assets do not fall within the definition of crypto-asset. For example, prepaid e-money cards are usually considered Currency Denominated Assets.
If a coin issued by a bank is guaranteed to have a certain value vis-à-vis fiat currency, such a coin is unlikely to be deemed a crypto-asset but would rather be considered a Currency Denominated Asset.
Definition of "Crypto Asset Exchange Service"
The term “Crypto Asset Exchange Services” means any of the following acts carried out as a business:
In 2017, based on the recommendations of the Financial Action Task Force (FATF) that virtual currencies could be used for money laundering, the Act on Prevention of Transfer of Criminal Proceeds (APTCP) was amended to include CAESPs as "Specified Business Operators" and to impose an obligation on CAESPs to verify the identity of their customers.
Under the APTCP, Specified Business Operators must verify the identity of their customers and comply with the APTCP and rules issued thereunder.
The JFSA has supervisory powers over CAESP based on the delegation of such powers from the Prime Minister.
As a result, the JFSA has the power, if it finds it necessary for the proper and secure provision/performance of CAES by a CAESP, to:
The JFSA can also sub-delegate its supervisory powers over CAESPs to the relevant Local Finance Bureau.
For the purpose of ensuring proper provision of CAES and to protect users of CAES, the Japan Virtual and Crypto Assets Exchange Association (JVCEA) was appointed as an approved self-regulatory organisation to regulate CAESPs. The primary objectives of the JVCEA are
There is an important judicial precedent of the Tokyo District Court dated 5 August 2015, which states that legal ownership or title does not apply to crypto-assets, as they are intangible assets. As a consequence, the transfer of a crypto-asset does not equate to the transfer of legal ownership or title in such crypto-asset under the Civil Code of Japan (the “Civil Code”).
In 2018, as a result of the leakage of users’ crypto-assets with a value of approximately USD530 million from a cyber-attack on one of the biggest CAESPs, the JFSA conducted sweeping on-site inspections of registered and provisional CAESPs. This was followed by the JFSA's announcement, on 8 March 2018, of the imposition of business suspension orders on two provisional CAESPs, and business improvement orders on two registered CAESPs and three provisional CAESPs. After further review, the JFSA on 22 June 2018, also imposed business improvement orders on six additional major registered CAESPs.
In addition, on 21 June 2019, the JFSA imposed a business improvement order a CAESPs for the inadequacy of their business management, anti-money laundering and counter terrorist financing, and risk management systems, among other things.
To encourage fintech innovation, including the development and usage of blockchain technology, in June 2018, the Japan Economic Revitalization Bureau established a cross-governmental one-stop desk for a regulatory sandbox scheme in Japan. This scheme, available to Japanese as well as foreign companies, enables applicants (once approved) to carry out, under certain conditions, a demonstration of their projects even if such activities are not yet covered under current laws and regulations. Blockchain technology, together with AI, IoT and big data, are explicitly mentioned in the basic policy of the regulatory sandbox scheme as prospective and suitable areas for exploration and development.
One of the most important issues in Japanese taxation of crypto-assets has been the treatment of consumption tax. Under Japanese tax law, sale of crypto-assets was subject to consumption tax in cases where the office of the transferor is located in Japan. However, this was overturned in 2017.
The National Tax Agency of Japan also announced that gains realised from the sale or use of crypto-assets will be treated as “miscellaneous income” (zatsu-shotoku) and that taxpayers will not be permitted to utilise losses elsewhere to offset gains realised from the sale or use of crypto-assets. Furthermore, inheritance tax will be imposed upon the crypto assets in the estate of a deceased person.
The Japanese government has a generally positive view of the use of blockchain technology in various kinds of businesses.
For instance, in June 2019, the Japanese government published a “Growth Strategy Action Plan” discussing the importance of the use of blockchain technology, and stating that “AI, IoT, robots, big data, blockchain… are general purpose technologies (GPT) that broadly affect all industries, similar to the adoption of electric power from the 19th to 20th century and the inroads made by IT through the end of the 20th century”.
The legal characteristic of crypto-assets under Japanese civil law statutes is still unclear. According to a judicial precedent of the Tokyo District Court dated 5 August 2015, legal ownership or title does not apply to crypto-assets, as they are intangible assets. As a consequence, the transfer of a crypto-asset does not equate to the transfer of legal ownership or title in such crypto-asset under the Civil Code.
Furthermore, it is not clear under the Civil Code when transfers of crypto-assets via a blockchain network will be considered final, as the legal characteristics of crypto-assets have not yet been firmed up.
Digital assets generated and traded on a blockchain are often classified as crypto-assets, but their legal statuses vary depending on the function of the individual digital assets and other factors. For example, if a digital asset is prepaid and can only be used by a merchant to the extent of the amount prepaid and is prohibited in principle from being replenished, the digital assets may be classified as a prepaid payment instrument (PPI), while those that can be replenished in value may be classified as instruments for “funds remittance transactions (Kawase Torihiki)".
With the development of blockchain technology, so-called security tokens, or digital assets that represent shares, corporate bonds, fund interests, etc, have also emerged, and these are treated as securities, based on their nature and functions.
More specifically, if profit is distributed to the digital asset holder from the business income of the digital asset issuer, such digital asset would be classified as a security under the FIEA. By contrast, if no profit is distributed, the next factor to consider is whether the digital asset is issued for consideration. Digital assets that are issued for no consideration will likely be deemed unregulated service points. Where a digital asset is issued for consideration, its legal status will depend on whether the digital asset constitutes a "Currency-Denominated Asset”.
A digital asset that does not constitute a "Currency-Denominated Asset", and can be used vis-à-vis unspecified persons, and be bought, sold, or exchanged vis-à-vis unspecified persons, will in principle likely be deemed a crypto-asset or (if it can only be used for settlement with specified persons, such as merchants) a PPI. A digital asset that constitutes a "Currency-Denominated Asset" but cannot be exchanged for a cash refund, will likely be deemed a PPI. If, however, such digital asset can be exchanged for a cash refund, it will likely be deemed an instrument for “funds remittance transactions (Kawase Torihiki)".
In other words, depending on their functions, digital assets are classified as:
A Stablecoin is generally understood in Japan to mean a digital asset issued on a blockchain whose value is designed to be linked to legal tender, assets denominated in legal tender, or a basket of them, although there is no legal definition of the term.
Stablecoins are classified into several categories based on whether their values are backed by any underlying collateral asset and the nature of the mechanism in place to ensure the stability of their values.
"Currency Denominated Assets" are excluded from the definition of crypto-assets. "Currency Denominated Assets" is defined under Article 2, Paragraph 6 of the PSA as assets denominated in Japanese yen or a foreign currency, or with respect to which the performance, repayment, or any other activity equivalent thereto will be carried out in Japanese yen or a foreign currency. Based on this definition, a digital coin whose value is pegged to the Japanese yen, US dollar or any other fiat currency (such as, for example, where the price of a digital coin is always fixed at one Japanese yen or one US dollar, or where a digital coin is redeemable at one Japanese yen or one US dollar) would fall outside the definition of "crypto-assets".
Issuance of Stablecoins
Issuance of Stablecoins that fall within the definition of "Currency Denominated Assets" would likely be considered the provision of “funds remittance transactions (Kawase Torihiki)". "Funds remittance transaction" is not defined in the Banking Act or PSA. However, the Supreme Court, in a judicial precedent, has interpreted "funds remittance transaction" to mean "undertaking, or undertaking and executing funds remittance pursuant to the request of customers through a funds remittance system, without physical delivery of cash between distantly located parties." An issuer of Stablecoins would likely be deemed to be engaged in funds remittance transactions by issuing Stablecoins in exchange for fiat money.
Under the Banking Act, no person other than a Bank is permitted to conduct funds remittance transactions in Japan unless certain exemptions apply. A person licensed as an FRBO would fall under such an exemption, although funds remittance transactions conducted by an FRBO are subject to a limit of JPY1 million per transaction. Banks, on the other hand, are not subject to such a limit. However, as applications for Banking licenses require the satisfaction of very onerous requirements and involve a timeframe of a year or more, registration as a Bank would not generally be a practical option.
Basket Currency Stablecoins
With regard to Basket Currency Stablecoins (ie, Stablecoins backed by multiple underlying legal currencies or other financial assets) that are exchangeable for refunds of Japanese or other foreign currencies, the amount of such refund would be determined in the currency of the refund based on the weighted average price of the market value of the basket currency. However, there is still no consensus on whether such a Stablecoins can be considered currency-denominated assets. Even if such Stablecoins are deemed currency-denominated assets, their value would fluctuate based on the legal currency to be refunded; accordingly, there are differing opinions as to whether they constitute "funds" in the context of foreign exchange transactions.
In general, there is no limitation on the use of crypto-assets for payments. Accordingly, payments are allowed to be made with crypto-assets in Japan. It should be noted, however, that under the Foreign Exchange and Foreign Trade Act, notification to the Minister of Finance is required when a payment is made or received between Japan and a foreign country, or between a resident and a non-resident, in an amount exceeding the equivalent of JPY30 million (including cases where a payment in crypto-assets is made or where a payment in crypto-assets is received).
Non-Fungible Tokens (NFT) are generally non-substitutable tokens that are issued on a blockchain, with values and attributes unique to the token itself. The issue is this context is whether NFTs constitute Type II crypto-assets under the PSA, because digital assets with the characteristics of an NFT are mutually exchangeable with Type I crypto-assets (eg, bitcoin or ether) among unspecified persons on the blockchain.
Based on the JFSA’s public comments of 3 September 2019 (the “Public Comments”), the JFSA is generally understood to take the view that whether an NFT constitutes a crypto-asset should be determined on a case-by-case basis. At the same time, however, the Public Comments also suggest that the JFSA has adopted the view that even if trading cards or gaming items issued as digital assets recorded on a blockchain are mutually exchangeable with Type I crypto-assets (eg, bitcoin or ether), they do not constitute Type II crypto-assets because they serve no payment functions, unlike Type I crypto-assets. In view of this, it is unlikely that gaming items based on blockchain technology that are not used as a means of payment will be considered crypto-assets.
In Japan, regardless of whether a business operator keeps the private keys of a crypto-asset held by a user, the business operator will be required to undergo registration as a CAESP if it engages in the sale or exchange of crypto-assets as a business. Therefore, all digital asset exchanges in Japan are operated by registered CAESPs.
Decentralised exchanges (DEX) are not specifically regulated in Japan. However, as some of the services provided by DEXs may be deemed CAES (eg, sale or exchange of crypto-assets, intermediation of such sale or exchange, etc), it is high likely, where the operator of DEX is identified, that he or she will need to undergo registration as a CAESP.
Under the PSA, CAES means any of the following acts carried out as a business:
In this regard, the exchange of crypto-assets for legal tender constitutes "sale and purchase of crypto-asset”. Therefore, if the exchange of such crypto-assets and legal currency is carried out as a business, such activity will constitute crypto-asset exchange business and will be subject to CAESP registration requirements.
In addition, the act of exchanging crypto-assets for other crypto-assets constitutes "exchange of crypto-asset or other crypto-asset". Therefore, such activity, if conducted as a business, will also be subject to CAESP registration requirements.
Under the APTCP, Specified Business Operators, including CAESPs, must verify their customers’ identities and comply with the following.
Obligation to Identify Customers
When conducting the above-mentioned specified transaction with a customer, Specified Business Operators must verify the following (Article 4 of the APTCP):
Obligation to Prepare and Maintain Verification Records
Specified Business Operators must, after conducting customer identification, immediately prepare customer identification records, and maintain such records for seven years from the day on which the contract for a specified transaction, etc, terminates (Article 6 of the APTCP).
Obligation to Prepare and Maintain Transaction Records
Specified Business Operators must, after conducting a transaction in connection with specified business affairs, immediately prepare transaction records, and maintain such records for seven years from the day on which the transaction is conducted (Article 7 of the APTCP).
Obligation to Report Suspicious Transactions to the Relevant Authority
If a property accepted through its Specified Business Affairs is suspected to be criminal proceeds or a customer is suspected to be engaged in money laundering in connection with Specified Business Affairs, a Specified Business Operator must promptly report the same to the relevant authority (Article 8 of the APTCP).
Measures to Appropriately Conduct Verification at the Time of Transaction
Specified Business Operators must take measures to keep matters verified at the time of transaction up-to-date, and endeavour to improve the education and training provided to its employees and maintain such other systems necessary (Article 10 of the APTCP).
Under the PSA, CAESPs are required to:
It should be noted that a CAESP is required under the PSA to both manage the money of users separately from its own money, and to entrust users’ money to a trust company or any other similar entity in accordance with the provisions of the relevant Cabinet Office Ordinance. In other words, a CAESP is required not only to manage the money of users in bank accounts separately from its own, but also to entrust such money to a trust company or trust bank, acting as trustee.
In addition, the revised FIEA prohibits, with penalties, unfair acts in crypto-asset trading (without limitation as to victims of such acts) for purposes of protecting users and preventing unjust gains.
However, insider trading regulations have not been included within the scope of the revised FIEA because of the difficulties in identifying issuers and undisclosed material facts pertaining to crypto-assets.
CAESPs are obliged to segregate the crypto-assets deposited by their customers from their own assets, and to manage customers’ assets separately from their own assets. CAESPs are also required to manage their wallets separately from the crypto-assets held by the CAESPs themselves.
Therefore, CAESPs cannot create any security interest over the fiduciary crypto-assets it manages on behalf of its customers in favour of a third party without the consent of its customers.
The PSA designates “management of crypto-assets for the benefit of another person” as a type of CAES. Consequently, management of crypto-assets without the sale and purchase thereof (“Crypto Asset Custody Services”) is now included within the scope of CAES. Therefore, a person engaging in Crypto Asset Custody Services needs to undergo registration as a CAESP.
In this context, the "Draft Guidelines on Crypto Assets" issued by the JFSA on April 2020 provided the following clarification in respect of “management crypto-assets for the benefit of another person”: “although each case should be determined on its actual circumstances whether it constitutes management of crypto-assets, a case would constitute management of crypto-assets if the operator is in a position in which it is able to voluntarily transfer its users’ crypto-assets (for example, when the operator owns a private key with which it may transfer its users’ crypto-assets on its own or jointly with related parties, without the involvement of its users)”. Accordingly, it is understood that if an operator merely provides its users with a crypto-asset wallet application, so as to enable the users to manage private keys on their own, such an arrangement would not constitute a Crypto Asset Custody Service.
In addition, CAESPs are required to manage their users’ crypto-assets (“Entrusted Crypto Assets”) separately from their own crypto-assets. CAESPs are also separately required, except in exceptional circumstances, to manage Entrusted Crypto Assets (other than crypto-assets that are subject to the “requirements specified by the relevant Cabinet Office Ordinance) to ensure users’ convenience and to ensure smooth performance of crypto-asset exchange services”, using the “methods specified in the relevant Cabinet Office Ordinance, being methods that are unlikely to result in insufficient protection of users”.
Furthermore, CAESPs are required to hold crypto-assets of the same kind and quantity as crypto-assets that are subject to the aforementioned requirements (ie, the requirements that seek to ensure both users’ convenience and the smooth performance of crypto-asset exchange services).
Based on the prevailing view and current practices, where a token issued via an Initial Coin Offering (ICO) is already in circulation on a Japanese or foreign crypto-asset exchange, such token would be deemed a crypto-asset under the PSA, since a market of exchange for that token is already in existence.
On September 27, 2019, the JVCEA published its self-regulatory rules and guidelines regarding ICOs for crypto-assets entitled “Rules for Selling New Virtual Currency” (the “ICO Rules”). Under the ICO Rules, an ICO can be legally launched in Japan as long as such launch is conducted in compliance with the ICO Rules.
According to the ICO Rules, there are two types of ICOs. The first is where a CAESP issues new tokens and sells such tokens by itself. The second is where a token issuer delegates the sale of newly issued tokens to CAESPs (an IEO (Initial Exchange Offering”). As a general matter, the ICO Rules stipulate the following requirements for both types of ICO:
Additionally, the ICO Rules require an ICO to be implemented in compliance with the following steps:
As noted in 5.1 Initial Coin Offerings, along with details of ICO rules, IEOs are subject to essentially the same rules as ICOs.
As a result of amendments to the Regulations for Enforcement of the Act on Investment Trusts and Investment Corporations and Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc, investment trusts and investment corporations are prohibited from investing in crypto-assets.
Accordingly, an investment fund that invest in crypto-assets has to be established in the form of a partnership-type investment fund based on a silent partnership agreement under the Commercial Code.
Digital assets that constitute "crypto-assets" are subject to regulation applicable to CAES, ie, regulations that relate to the exchange, intermediation, agency, and brokerage of crypto-assets (Article 2, Paragraph 7, Item 2 of the PSA).
In other words, broker-dealers or other financial intermediaries that deal in crypto-assets will also be subject to CAES regulation.
There is not clear definition of “smart contracts” under Japanese law, nor is there any specific regulation of smart contracts in Japan.
Assuming that smart contracts generally mean “self-executing contracts containing terms that are pre-determined pursuant to specific programming codes”, the use of smart contracts may raise issues of enforceability, although the costs of resolving such issues may be offset by the use of smart contracts.
For instance, a smart contract based on blockchain technology would be automatically enforced and irrevocable even if such contract is unenforceable for violating applicable law. It should be noted, however, that there are no judicial precedents addressing the legal enforceability of such smart contracts.
There are no specific regulations regarding the responsibility of developers of blockchain-based networks or the codes that run on these networks under the laws of Japan.
In general, if there is any breach of a contract in terms of the work performed by a contractor, the contractor will be responsible for losses arising from such breach under the Civil Code.
In respect of software bugs, where a contractor resolves the issue without delay after it has been pointed out by a user or if the contractor consults with the user and takes reasonable alternative measures for the resolution of the issues, then the contractor would not be deemed to have breached the software development contract.
However, if a software bug leads to significant interference with the function of the software and cannot be resolved quickly, results in significant issues, arises regularly, or causes interference with the operation of a system, then such bugs would constitute breach of a software development contract, and the software developer would be responsible for such breach.
The issue here is whether decentralised financial (DeFi) platforms, being platforms for the lending and borrowing of digital assets that constitute crypto-assets, are considered CAES under the PSA or money lending business under the Money Lending Business Act.
Applicability of CAES Regulations
CAES refers to the sale and purchase of crypto-assets (Article 2, Paragraph 7, Item 1 of the PSA) and the “management of crypto-asset for the benefit of another person” (Article 2, Paragraph 7, Item 4 of the PSA).
The lending and borrowing of crypto-assets is not caught by the PSA. More specifically, crypto-assets that are lent to or borrowed from users are considered to belong to the crypto-asset lending company. As the lending and borrowing of crypto-assets do not constitute management of crypto-asset "for the benefit of another person", such lending and borrowing do not constitute CAES.
As a result, a DeFi platform does not constitute a crypto-asset exchange business (although a DeFi platform operator that manages crypto-assets held by users may be deemed to be providing Crypto Asset Custody Services).
Applicability of Money Lending Regulations
Money lending business refers to "the business of loaning money or acting as an intermediary for the lending or borrowing of money on a regular basis" (Article 2, Paragraph 1 of the Money Lending Business Act). Generally, crypto-assets are not deemed to constitute legal tender or "money" as such term is referred to in the Money Lending Business Act.
Accordingly, operation of a DeFi platform does not constitute conduct of the money lending business unless the platform is used to lend or borrow crypto-assets in such a manner as to effectively constitute the lending or borrowing of legal tender.
As noted in 3.1 Ownership, legal ownership of crypto-assets is currently not recognised in Japan as crypto-assets are intangible. Therefore, it is believed that it would be difficult to create security interest directly in the crypto-assets that are managed by a borrower at its own address when the crypto-assets are delivered to the lender as security.
By contrast, if the borrower has deposited its own crypto-assets with a CAESP, the lender would conceivably be able to create a pledge or transfer security interest in the borrower's claim for the return of the deposited crypto-assets against the CAESP.
Transfer by professional investors of digital assets in which they have invested to a custodian are not specifically regulated in Japan.
Persons wishing to act as custodians of digital assets are required to undergo registration as CAESPs because they will be offering the service of “management of crypto-assets for the benefit of another person” (ie, Crypto Asset Custody Service) to professional investors in this case.
It should be noted, however, that a trust company may be entrusted with crypto-assets pursuant to the Trust Business Act without being registered as a CAESP (Article 2, Paragraph 7, Item 4 of the PSA). With that said, a trust company that is a subsidiary of a bank, a bank holding company or a trust bank is not permitted to hold crypto-assets on entrustment.
Business operators using blockchain technology may be subject to the Act on the Protection of Personal Information (APPI) if they handle the personal information.
Considering that a public blockchain involves the sharing of a database among unspecified participants, where information on the blockchain will not in principle be deleted or retracted once uploaded on the blockchain, the use of blockchain technology may trigger the application of the APPI. For example, Article 19 of the APPI requires business operators who handle personal information to delete unnecessary personal information once the purpose for which such personal information is required has been achieved. However, a business operator that records the personal information of its users on a blockchain may have difficulty deleting such information, and this could result in a violation of the APPI.
Data that creatively express thoughts or sentiments, such as images and music, fall within the definition of “work” under the Copyright Act. What this means is that usage of such data may be subject to the Copyrights Act. Where the Copyrights Act applies, it would be necessary to ensure non-infringement of the rights of the data’s author.
Additionally, usage of data that constitute trade secrets may subject to the Unfair Competition Prevention Act. Where the Unfair Competition Prevention Act applies, it would be necessary to ensure non-infringement of the interests of the owners of such trade secrets.
Under Japanese regulations, including the PSA, the mining of crypto assets itself does not fall within the definition of CAES. Accordingly, mining activities are not regulated under existing Japanese regulations.
It bears noting, however, that interests in mining schemes formulated as collective investment schemes or in cloud mining schemes may be deemed securities under the FIEA, and could therefore be subject to provisions under the FIEA.
The staking of tokens itself is not regulated in Japan. Depending on the content of the staking service involved, however, it may trigger CAES regulations under the PSA or regulations in respect of collective investment schemes under the FIEA.
More specifically, if the private key of the crypto-assets held by customers in the staking service is transferred to the provider of the staking service, and such service provider is able to transfer and dispose of the crypto-assets without the involvement of the customers, then the staking service will likely constitute either:
In contrast, if there is no transfer of the private keys of crypto-assets held by customers to the staking service provider, such that the service provider cannot transfer or dispose of such crypto-assets without the involvement of the customers, then such staking service is unlikely to be deemed to involve either "management of crypto-assets for the benefit of another person" or solicitation in respect of a collective investment scheme.
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