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Regulation

Japan Might be Over-Regulating its Thriving Crypto Market

Quick Take

  • Japan is showing signs of over-regulation, possibly swayed by a series of high profile scandals and security breaches
  • It released a proposal to simplify the process of taxing crypto returns while considering whether cryptocurrency exchanges could forfeit customer information if suspected of evading taxes
  • It granted the crypto sector with a self-regulatory status but also came out with a new regulatory framework targeted at cryptocurrency wallets

Japan was once the darling of entrepreneurs in the cryptocurrency sector, adored by crypto startups, exchange operators, and investors alike. In recent months, however, the country has begun to demonstrate signs of over-regulation, possibly swayed by a series of high profile scandals and security breaches since the 2014 Mt. Gox bankruptcy.

Since the appointment of Nobuchika Mori, the longest-serving finance minister of Japan and the former commissioner of the Financial Services Agency (FSA), Japan has seen its cryptocurrency and blockchain sector grow rapidly. But, following his leave, the government has started to reassess the growth rate of the local cryptocurrency sector to push certain regulatory frameworks that could create a difficult environment for both companies and investors.

Conflicting Regulations

In October, as reported by Reuters, the FSA granted local cryptocurrency players a self-regulatory status, acknowledging the necessity of a quick response to potential unforeseen issues and situations.

A senior FSA official said in a press conference that experts in the industry need to be able to set appropriate regulatory frameworks to ensure that digital assets are not used in money laundering or are at risk of being vulnerable to hacking attacks.

“It’s a very fast moving industry. It’s better for experts to make rules in a timely manner than bureaucrats do. We will make further efforts to build an industry that is trusted by customers,” an FSA official said, requesting anonymity due to the sensitivity of the subject.

The abrupt decision of the FSA to allow the local cryptocurrency market to govern itself demonstrated a certain level of trust from the government in the dominant companies in the sector.

However, less than a month since they laid out a positive policy toward self-regulation by the FSA, the organization came out with a new regulatory framework targeted at cryptocurrency wallets, not exchanges, describing wallets as “bank accounts that store virtual currencies.”

The agency firmly said that wallet service providers, custodial or non-custodial, facilitate the transfer of payments for customers and thus, they also have to be regulated by the FSA in a similar way as exchanges.

Currently, wallet service providers are not required by law to register with the FSA. The agency said that if its proposed rule change is adopted then wallet service providers will have to register with the agency and the failure to do so could lead to the abolishment of businesses.

The published FSA meeting materials obtained by Bitcoin.com on November 15 emphasized that wallet platforms could be required to cooperate with the government in providing audits of financial statements and maintaining internal management and control systems. If the proposal of the FSA gets passed, it may not be possible for non-custodial wallet platforms to operate in Japan, as non-custodial wallets allow customers to have complete control over their funds through the independent ownership of their private keys.

Since the wallet holders maintain the private keys to their accounts, it is not possible for the wallet service provider to manage the payments of the users on the platform and as such, difficult to provide relevant financial statements to the government unless a full Know Your Customer (KYC) verification process is complete and the wallet operator has all of the personal information of its users.

The Aftermath of Nobuchika Mori’s Leave

In September, Nobuchika Mori completed his term as the commissioner of the FSA. Following the end of his term, Mori joined Columbia SIPA as a senior research scholar in the areas of financial regulatory policy.

Mori, known for his reforms in the areas of finance and technology, is said to be the main government official that led Japan to adopt an open-minded stance toward cryptocurrencies and blockchain technology after recognizing that the country has fallen behind the global trend in the past decade.

Subsequent to Mori’s leave, Japan and the FSA in specific have started to call for the implementation of policies that could limit the growth of companies and projects in the local cryptocurrency sector.

In October, the FSA decided to grant the cryptocurrency sector with a self-regulatory status. In the following month, the FSA stated that the inability of wallet providers to register with the FSA could result in abolishment. This month, in a strange switch of stance, Japanese regulators have proposed to simplify tax policies around the cryptocurrency sector to “revitalize” the market.

Firms Understand Where Japan is Coming From, But it’s Confusing

Based on the three policies the FSA have proposed in the past three months, it is evident that the government wants to sustain the momentum of the local cryptocurrency sector while severely cracking down on money laundering.

Ever since Mainichi Shimbun, the oldest newspaper in Japan, reported in June that more than 30 billion yen ($264 million) had been laundered by the Yakuza using cryptocurrencies, the FSA and the government have focused on preventing the usage of cryptocurrencies to finance criminal operations. At the time, an FSA official told Mainichi Shimbun that the agency would work with the G20, a global forum participated by government officials of the world’s 20 largest economies, to prevent the utilization of anonymous cryptocurrencies in the likes of Monero, Zcash, and Dash.

For the Japanese government, the involvement of Yakuza, once the biggest crime syndicate in the world, may have been a critical problem due to its complex history with the organization dating back to the 17th century.

Throughout the past several centuries, the Yakuza has co-existed with the Japanese government, and for a long period, the national police were reluctant toward engaging a direct conflict with the crime syndicate because of the complexity of the relationship.

However, in recent years, the Japanese government has been proactive in preventing the youth from being involved in any Yakuza-driven activity and passing laws that disallow the organization from expanding its operations ranging from drug trafficking to human trafficking.

At its peak in the 1960s, the Yakuza had more than 180,000 members. As of 2016, after the implementation of several policies, the number of members reportedly dropped to 39,100.

The release of Mainichi Shimbun article, which explicitly described a frequently used process of the Yakuza to launder large sums of money using Monero, Zcash, and Dash, led the Japanese government and the FSA to more aggressively crackdown on money laundering.

Effect of Over-Regulation

In a period in which several countries including Malta, Switzerland, and South Korea are competing against one another to create the next crypto valley and a friendly environment for startups, Japan’s over-regulation of the local cryptocurrency market could restrict its growth rate. Already, according to CryptoCompare, the euro (EUR) has overtaken the Japanese yen and South Korean won to become the second most liquid trading pair with Bitcoin and Ethereum behind the U.S. dollar.

At its peak, the Japanese yen accounted for more than 40 percent of global Bitcoin trades based on the data provided by CryptoCompare.

The high profile security breach of Coincheck in January which led to the loss of more than $500 million worth of XEM, the native cryptocurrency of the NEM blockchain, may have also led investors to lose confidence in local exchanges. As of December, no Japanese cryptocurrency exchange remains within the top 10 Bitcoin trading platform rankings by volume. Bitfinex, Coinbase, and Bitstamp, all of which primarily support the U.S. dollar, remain as the top three Bitcoin exchanges.

Will the Tax Policy Change Appeal to Investors?

This week, a Japanese lawmaker and congressman Takeshi Fujimaki released a proposal to simplify the process of taxing crypto returns to encourage investors to declare their taxes and to “revitalize” the market. Fujimaki suggested the government to reduce the taxation on crypto gains from 55 percent to 20 percent, completely eliminate crypto-to-crypto taxes and small payments, and allow investors to carry forward losses from previous years to ensure that they are not taxed after recording losses.

The taxation policy proposed by Fujimaki seems positive but it is still a proposal from one regulator in one country, and the probability of approval by the government remains uncertain.

More to that, the government has already started to explore the possibility of giving the National Tax Agency (NTA) the authority to demand cryptocurrency exchanges to forfeit customer information of those suspected of evading taxes from crypto gains.

Mainichi Shimbun reported that the NTA received about 300 tax gain declarations from investors following the bull market of 2017, in a period wherein many investors generated substantial profits. The NTA emphasized that investors only declared $100 million in profit.

In the short-term, the government aims to allow the NTA to demand exchanges to hand over the personal data of traders including individual identification numbers.

“In response to the situation, the government will reform the system to allow the taxation authority to demand that such businesses hand over personal information on their customers, such as names, addresses, and 12-digit individual identification numbers,” Mainichi Shimbun reported.

Forced Policies

Every policy the Japanese government has proposed in the past three months is contradicted by its recent actions. It proposed a crypto tax reform to convince investors to voluntarily declare their taxes while exploring the possibility of the NTA to crack down on individual crypto investors. It granted the crypto sector with a self-regulatory status but is actively trying to implement impractical policies that could restrict the operations of exchanges.

The selling point of Japan’s crypto market, as established by Nobuchika Mori, is its open-minded approach toward regulation and a practical environment for startups. However, recent initiatives and policies led by the FSA and local lawmakers have put the local market at risk of stagnation. That, as they say, isn’t good.

Joseph Young is a finance and cryptocurrency analyst based in Hong Kong. He writes about finance, fintech, cryptocurrency, and blockchain, and has written for many publications within the crypto ecosystem and mainstream media outlets.