Japan is struggling with self-regulation during crypto-smelting

Visions of an ever-deepening cryptocurrency and the ruin of global investors were set aside at a luxury hotel in Okinawa recently where one of the industry’s most important annual conferences celebrated the potential of blockchain technology with influencers such as Mr Block and Miss Bitcoin.

At the only invited jamboree, more than 1,600 leaders and industry gurus gathered to celebrate all that is virtual. “The future has come,” the conference slogan declared. The mood at the three-day event in Naha, said the leader of an online Japanese exchange, was “alcoholic and optimistic”.

But back in Tokyo, where the drier and quiet groundbreaking work involved in the country’s bold digital currency experiment is taking place, the tone was quite different.

In extensive interviews with the Financial Times, industry leaders, lawyers and current and former financial regulators sounded the alarm over a spiraling regulatory crisis in Japan’s multi-billion dollar virtual assets business.

“When Japan decided to experiment with self-regulation of the cryptocurrency industry, many people around the world said it would not work. Right now, unfortunately, it looks like they may be right, said a person close to both the industry and the authorities.

In recent months, major disagreements have arisen in the Japan Virtual Currency Exchange Association – the body established in 2018 to create a global precedent for self-regulation of the crypto industry.

The organization itself, said members taken from the country’s 32 licensed crypto exchanges and including former government officials, is in the grip of a crisis that threatens the entire purpose.

The Japanese financial agency has repeatedly criticized its poor governance, and in striking defiance of Japan, staff at the JVCEA Secretariat have even formed a union to try to protect themselves.

The origins of the current crisis, which involves a stand-off with regulators, corrosive conflicts and a chronic lack of resources, lie in Japan’s approach to cryptocurrencies and the country’s status as a pioneering global activity center for trading virtual assets.

Shortly before it imploded spectacularly in 2014, the Japanese-based cryptocurrency exchange MTGox was the most active in the world with traded volumes of Bitcoin and other early cryptocurrencies.

As part of its ongoing efforts to protect individual investors while securing the country’s status as a global hub for a rapidly growing business, the government became the first in the world to recognize cryptocurrencies as financial assets in 2017.

Shortly afterwards, in the midst of an explosion of new exchanges and a massive investment boom from younger Japanese customers, the FSA established the first system for licensing crypto exchanges.

At the same time, it began its experiment with self-regulation in the industry, hoping that, given its own limited resources, it could rely on the JVCEA to monitor its own members and develop new dynamic industry guidelines.

Four years later, the regulator does not seem satisfied with the results.

The minutes of the board meeting from December obtained by FT describe that the JVCEA received an “extremely strict warning” from the FSA over two meetings at the end of last year.

People familiar with the situation said that the regulator has been concerned about delays in important regulations against money laundering, and that the minutes were not “clear what kind of considerations the body had, what the decision-making process was, why the situation was as it was, and what responsibilities the board members had”.

The FSA also pointed to a lack of communication between JVCEA directors, its secretariat and member operators, which resulted in poor management of the organization.

The recent market turmoil has led to both new and well-established cryptocurrencies having to go through a complete review process before new operators could trade with them. In some cases, it has taken six months to one year for a single currency to be assessed by the JVCEA.

“Regulators have been pushing for anti-money laundering regulations… But the industry has taken the time to work on it. There is a very strong request from the FSA to go ahead with this,” said Meiji University professor and JVCEA board member Masao Yanaga.

Yanaga said the JVCEA lacked the resources to move quickly. He also noted the concern that crypto exchanges were small operators “so if asked to implement high-level measures, it will be very difficult for them to respond” due to lack of resources.

He added that anti-money laundering rules were difficult to implement in the absence of international agreements on the sharing of customer data between exchanges.

“The operators of the exchanges are concerned that even if we make these rules, they will not be able to implement them,” he said.

A person close to the JVCEA said that office workers mostly consisted of retired people from banks, brokerages and public departments instead of seconded from member companies.

“Therefore, no one there really understands blockchain and cryptocurrencies. The whole mess shows that there is not a single problem with management. The FSA is very angry at the whole management,” the person said.

In response to a request for comment, the JVCEA said it made improvements in response to the FSA’s concerns.

The JVCEA is chaired by Satoshi Hasuo, President of the industrial giant Coincheck, with appointed representatives from various operators and external experts on the board.

Although it has worked to speed up the approval process, people who oppose Hasuo in the JVCEA said that delays in approving coins create an unfair disadvantage for newer entrants as they try to compete with more established players, such as Hasuo’s Coincheck.

The JVCEA admitted that the process has taken a long time due to a lack of skilled staff and that this “created inconvenience” for new members. However, it added that it did not intend to favor more established exchanges.

Those with knowledge of the union said it was created by employees who were dissatisfied with staff decisions made by management. The requirements, which it has published on social media, include the removal of key people at the JVCEA.

Board member Yanaga admitted that it was “very unusual for a union to be established in such a small organization”, adding that he “suspects that people from the understaffed administration office have been under a lot of pressure to process many coin applications quickly.”

The FSA and Coincheck declined to comment.