On Friday, Japan’s Financial Services Agency (FSA) issued business improvement orders to six licensed cryptocurrency exchanges. The orders followed on-site inspections and are the latest in a long line of regulatory actions the FSA has taken with regard to exchanges. The orders have impacted big players, like BitFlyer, which has suspended the creation of new accounts while it works on improvements. Some have noted a correlation with an 8% tumble in Bitcoin’s value. Yet while the market may read the actions as negative in the short-run, there is good reason to believe that Japan’s complicated relationship with cryptocurrency is a good thing for the industry long-term. In this article we will explain the story so far and what it means for the industry.
In April last year, Japan made the pioneering move of officially recognizing Bitcoin as an asset and a method of payment. It also required that cryptocurrency exchanges must register with the government and meet stringent technical and KYC demands to continue operating. In September, the government recognised eleven companies as registered exchanges (after receiving more than fifty applications). It recognised another six in May this year.
Japan was a pioneer, becoming the first country to oversee cryptocurrency regulation at a national level. Why? Did it want to prevent the embarrassment of another MtGox-style hacking scandal? Was it to seize upon the rare competitive gap opened up by China and America’s ambiguous stances towards cryptocurrencies? Perhaps Japan simply wanted to protect its citizens, keep money laundering at bay and drive innovation in a burgeoning space? Or could it have been, as some say, due to pressure placed on the government by Japan’s huge forex industry, whose companies rightly saw cryptocurrency exchanges as a threat to their existing businesses and wanted to slow them down so they could play catch up?
Perhaps it is all of the above. Whatever the case, life has not always been smooth sailing for cryptocurrency exchanges in Japan, who in April this year were reported to have more than 3.5 million traders (and who allegedly accounted for 40% of daily trading globally last year). Existing exchanges had to invest both heavily in order to gain acceptance. One exchange was rejected. In April, US-based Kraken withdrew from Japan.
In June, Hong Kong-based HitBTC suspended its services to customers based in Japan. Both companies cited the difficulties of conforming to Japanese regulation. Meanwhile, in March, Japan’s FSA issued a warning to Hong Kong-based Binance for operating in Japan without a license. Kraken, HitBTC and Binance are among the top fifteen exchanges in the world by trading volume. They do not lack resource. Are Japan’s regulations too demanding, or is the rest of the world not being demanding enough?
Meanwhile, Japan’s big forex and tech players have been entering the market, bringing big resources and customer bases, and ratcheting up the competition, including GMO Internet’s GMO Coin, SBI Group’s SBI Virtual Currencies; DMM’s DMM Bitcoin. Money Partners Group has invested in Kraken and Tech Bureau, which operates Zaif, and Yahoo! Japan bought a 40% stake in bitARG. Japan’s largest bank, MUFG, is also getting stuck in. Finally, following a major hack in January on Tokyo-based exchange Coincheck, the Japanese online brokerage Monex Group has confirmed that a deal in place is acquire the embattled exchange.
The Coincheck hack itself, in which more than $533 million worth (at the time of the hack) of NEM was stolen from digital wallets (making it bigger than MtGox), has brought more difficulty to the landscape. Following the hack, the FSA tightened regulation, requiring, among other things, that exchanges do not store tokens on internet-connected computers, must verify customer identity for major transfers, monitor account balances several times a day and establish rules to prevent officers from using client funds. Since the hack, the FSA has punished seven exchanges, ordering two of them to suspend business.
At first glance, the story of cryptocurrency exchanges in Japan looks like a train wreck in slow motion. Start-ups are being forced to prioritise expensive compliance over innovation. Incumbents are capitalizing on stringent regulations in order to muscle in on a dynamic marketplace. Japan is finding itself home to a huge hack in spite of all the regulation. Earlier this year, Japan’s sixteen licensed exchanges formed a self-regulatory body, but given the high level of competition and lack of transparency between exchanges. Coherent action may be easier talked about than delivered.
Another perspective might be that such chaos is inevitable in such a disruptive space and that Japan is merely ahead of the curve. Last week, Jay Clayton, the chairman of the US’s Securities and Exchange Commission, alluded to his frustration regarding exchanges operating in America, who have had a very limited dialogue with the regulatory body. Yet while the SEC has emphasised that cryptocurrency activity can be assessed within the framework of existing regulations (securities regulations, in particular), opinions differ as to how those regulations apply to the unique nuances of cryptocurrencies. Meanwhile, rumours emerged last week that China is in the process of establishing state-backed cryptocurrency exchanges that will enable the trading of Chinese tokens. How will the landscape change as the regulation in these countries cements itself?
It is likely that in these countries and others, clearer regulatory frameworks will emerge, whether via statements, documentation or direct legal action. Those exchanges who have not been able to arrive or survive in Japan will begin to face similar challenges on a global scale. The exchanges already operating in Japan, on the other hand, have already made headway to meet the high standards that may eventually be expected on a global stage, meanwhile making Japan one of the safest places to trade in the world.
A similar position has been taken by Yuzo Kano, CEO of BitFlyer, one of Japan’s largest cryptocurrency exchanges, who sees the work done in Japan as an ideal platform for further international expansion.
Japan has learned some hard lessons. While its journey has led to considerable difficulties, and there is still some way to go, it has also created opportunities for the Japanese government and entrepreneurs to capitalise on the steps it has taken so far. The Japanese government itself would be wise to use the stringency of its regulation to attract foreign investors to the market, offering more incentives for foreigners to use Japanese exchanges and perhaps offering high value visas for full-time traders who wish to move to Japan (and take advantage of its trading infrastructure). Japanese entrepreneurs would be wise to use their hard won developments within Japan to bring secure, reputable cryptocurrency trading opportunities to foreign shores.
The ecosystem is moving forward. Japan is home to some of the smartest and most active cryptocurrency entrepreneurs I know. OmiseGo has launched a blockchain co-working space in Tokyo. Hotaru has been supporting small start-ups and big companies alike, all of which are unified in using blockchain for high-impact, world-changing projects. Coinbase is coming to Japan.
Unlike MtGox, Coincheck is still in business. It has paid out nearly $435 million to investors, less than the full value of the initial loss, but higher than the market price of the token at the time of the refund. With so much competition, especially from big budget incumbents, there are sure to be more bloodbaths ahead, but the Japanese cryptocurrency trading market is proving itself to be more robust than it first appeared.