What Japan can teach the US – and the world – about regulating crypto

After the MtGox hack, Tokyo introduced tough rules that later protected FTX customers. Now, from that secure base, it is moving to allow blockchain technologies to flourish.

Mover a million investors worldwide were left stranded when FTX suddenly collapsed in November with a staggering hole, estimated at $8.7 billion, in its balance sheet. The cryptocurrency exchange and its 130-plus affiliates have been bankrupt for five months, and a new management team claims to have recovered $7.3 billion of the missing cash and tokens. Yet only one component of the company has returned money to customers.

FTX’s Japanese unit allowed all verified accounts to resume withdrawals on February 21. As of April 25, nearly 10,000 individual and corporate customers had withdrawn crypto and cash worth about 23.4 billion yen ($175.4 million), according to the company.

Consider this a victory for Japan’s financial regulators and the strict rules they have put in place to protect consumers in the wild and woolly world of crypto.

Japan cracked down on safety and soundness rules from a unified regulator after two major stock market hacks. But now, from that stable (and some in the industry would say overly restrictive) base, it is seeking to come up with a strategy to become a leader in the collection of largely decentralized, blockchain-based technologies known as web 3. The US, on the other hand, has arguably has been open to more innovation, but its dueling regulatory agencies and lack of rules have created gaps in oversight and a regulatory culture of enforcement that makes strategic planning dangerous.

Japan, an early adopter of digital assets, learned the value of regulation early and the hard way through what is arguably the most infamous crypto hack ever – the 2014 looting of 800,000 bitcoins from MtGox, which had been the world’s largest bitcoin exchange . Four years later, Coincheck, another cryptocurrency exchange based in Tokyo, was robbed of $500 million of the NEM blockchain’s xem coins.

“The drama and turmoil that the US is experiencing around the Sam Bankman-Fried, FTX, Bahamas situation is not relevant in Japan,” said Sheila Warren, executive director of the Crypto Council for Innovation, a Washington, DC-based industry advocacy group Worldwide. That’s because Japan has already been there and done that.

After the MtGox and Coincheck shocks, Japan’s primary financial regulator, the Financial Services Agency (FSA), tightened the rules on crypto exchanges, notes Ananya Kumar, associate director of digital currencies at the Atlantic Council’s GeoEconomics Center, the think tank’s unit that addresses foreign policy, finance and economics.

The FSA’s rules include:

• Customer and company funds must be kept separate, with inventory verified in annual audits.
• Investors cannot borrow more than twice the investment for leveraged trades on exchanges. (Many cryptocurrency exchanges, including Binance, allow trading with 100x leverage.)
• Exchanges must have at least 95% of customer funds in cold wallets, which are not connected to the internet.

The measures proved instrumental in enabling customers of the Japanese subsidiary of FTX to withdraw their assets after the parent company filed for bankruptcy in November. It is still unclear when other FTX clients will be able to get their money back, and how much of it they will get.

Japan has thus become a customer-friendly crypto paradise, but at the cost of strict oversight of the free-wheeling digital asset industry.

Now Japan is building on that secure base, with a national economic strategy and an effort to lead its allies in creating rules that will effectively govern the industry.

“The FSA contributes to international policy discussion, including that of the Financial Stability Board – an international organization that monitors and makes recommendations on the global financial system – on crypto-assets by leveraging its experience as a global forerunner in the regulation and monitoring of crypto-asset activities and markets,” told the agency Forbes in written comments.

OOn April 6, the ruling Liberal Democratic Party’s web3 project team, tasked with drafting crypto-focused policy proposals, issued a white paper outlining several recommendations, including a call for Tokyo to take the lead.

“After crypto winter, Japan could be the first to welcome spring,” the 35-page document predicts. “As a country that has overcome many difficulties in the cryptocurrency industry, we are in a position to persuade the world about the immeasurable potential of web3.”

Proposals in the paper cover tax reform, improved accounting standards and regulation of blockchain-based finance. There is even a recommendation for the government to drive the conversation on digital assets at the next Group of Seven (G7) summit, scheduled to be held in Hiroshima later this month.

“While Western financial regulators seem single-mindedly focused on tightening regulations in the midst of what is being called a crypto winter, I believe that Japanese financial regulators correctly understand the potential of blockchain and other technologies and are working to shape regulations in a forward-looking manner,” said Masaaki Taira, the team’s leader and member of the House of Representatives, in written comments to Forbes.

In February, Prime Minister Fumio Kishida told the Budget Committee of Japan’s House of Representatives that there are “various opportunities to use web3” in Japan. He said the Japanese government could use blockchain-based mechanisms such as non-fungible tokens and decentralized autonomous organizations to revitalize regions and promote “Cool Japan” – a national strategy aimed at promoting the country’s innovations and culture to the rest of the world that dates back to the beginning of the 2000s and reflects Britain’s ‘Cool Britannia’ policy of the 1990s.

According to Taira, his team—including about 10 members of the Diet (Japan’s national legislature), six private-sector lawyers with web3 expertise, and 10 leading Japanese digital influencers acting as advisors—is working directly with Kishida and several government agencies. “The policy proposals prepared by the project group are adopted almost directly by the LDP, and a significant part is adopted in government policy. It is an extremely strong team,” he says.

“The way they talk about crypto is very crypto-native in terms of what the technology enables and what aspects of current regulation just can’t work,” says Crypto Council’s Warren. “They say analog regulation doesn’t work in digital environments.”

Japan does not have a long history of being hospitable to blockchain entrepreneurs. In addition to heavy regulation, Japan’s tax laws are particularly hostile to industry. It is also difficult to get new cryptocurrencies approved. After founding the gaming company Murasaki on their home coast last year, Shinnosuke Murata and Shunsuke Sasaki recently decided to move the business to the Netherlands. “Why would two Japanese entrepreneurs with considerable experience starting companies in their own country travel halfway around the world to set up a new business? Murata wrote in a Nikkei issue in October. “Simply because it was not possible to do it in Japan.”

With a corporate tax rate set at around 30% on unrealized gains from cryptocurrency holdings, getting a new blockchain-based business off the ground is a real struggle, says Murata Forbes. “Suppose you issue 100 tokens each worth $1 million. Even if you don’t realize any gains, you’ll have to pay $30 million next year. Practically no startup founders can issue a token,” explains Murata.

Major US crypto exchanges such as Kraken and Coinbase have recently closed their subsidiaries in Japan, citing “market conditions”. In total, there are 37 crypto exchanges registered in the country, according to the FSA.

In addition, the agency can take months to review proposals to list new tokens, resulting in Japan’s trading market growing much more slowly at lower liquidity levels than other countries, Murata says.

“Japan is losing entrepreneurs who can build $100 million businesses because of these barriers,” he laments.

The existing framework makes it difficult for local entrepreneurs, agrees Roi Hirata, head of a new Japanese subsidiary of the Avalanche blockchain’s main developer company, New York-based Ava Labs. Avalanche’s brand recognition in Japan is exploding, says Hirata, who has prompted Ava Labs to begin building a presence in the island nation. As a first step, his team has partnered with Japanese media giant GREE on a new blockchain game.

“I see a great opportunity for both intellectual property providers and traditional businesses in Japan to adopt a blockchain like Avalanche, which provides both decentralization and matching services,” Hirata said in an email to Forbes.

For now, its deep pockets of tech giants leading the blockchain push in Japan. This year Forbes The Blockchain 50, an annual list highlighting the best enterprise applications of distributed database technology, features three Japanese companies, Fujitsu, LINE and NTT.

Social media giant LINE is helping create NFTs for 26 major clients, including SoftBank, South Korea’s Naver search engine and Visa. According to the company, more than two million wallets have registered on the DOSI NFT platform since September. NTT Docomo, the country’s dominant mobile phone service, has pledged to invest up to $4 billion in web3 infrastructure.

Electronics powerhouse Fujitsui teamed up with financial services giants including Mitsubishi UFJ Mizuho and Sumitomo Mitsui to build the “Ryugukoku” or “Japanese Metaverse Economic Zone.” The initiative, announced in February, seeks to build a shared metaverse infrastructure for large enterprises.

Meanwhile, the FSA plans to lift the ban on domestic distribution of stablecoins later this year. The exact date and coins that will be allowed have not been determined, but decisions are planned for June.

“This does not mean that all foreign-issued stablecoins will be allowed without any restrictions,” the agency said Forbes via written comments. “We will allow the handling of stablecoins after individual investigation, if there are no issues regarding user protection, etc. Examples include: foreign issuers in their countries are subject to similar regulations as in Japan, and underlying assets are properly preserved.”

Late last year, the ruling party’s tax committee approved a proposal to exempt crypto startups that issue their own tokens from paying corporation tax on unrealized gains. New proposals introduced in the white paper include tax exemptions for companies that hold tokens issued by other companies that are not to be traded in the short term, and limiting taxable events only to cases where the assets are exchanged for traditional currencies.

“I think it’s not only very exciting, but it actually paves the way for demonstrating to the rest of the world here is how you create forward-looking flexible regulation that can re-navigate this difficult balance between preserving a great deal of room for innovation while protecting consumers,” says Warren.

The overall message is “Japan is back, again.”

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