On October 24, 2018, Japan’s Financial Services Agency (FSA) gave the country’s cryptocurrency industry self-regulatory status, allowing the Japan Virtual Currency Exchange Association (JVCEA) power to police and penalize Japanese cryptocurrency exchanges. It remains to be seen whether this development will be replicated by other crypto-friendly jurisdictions, and whether it will be effective in streamlining the current thicket of evolving digital currency regulation.
Although it is still early days for digital currency, Japan has gradually established an attractive climate for the industry.[i] Japanese entrepreneurs and citizens were early adopters and frequent users of cryptocurrencies, and a number of cryptocurrency-focused companies and product offerings have sprung up in the country. For example, the Japanese-based GMO Internet has a Bitcoin payroll service for employees,[ii] and the growth opportunities for cryptocurrency and related technology have led Japan to welcome crypto as a potentially lucrative future economic driver. But the embrace of cryptocurrency innovation has not come without incident. After several high-profile thefts from Japanese-based crypto exchanges – including more than $500 million in digital tokens from Japanese-based Coincheck Inc. in January 2018 – the country’s crypto industry was shaken.[iii] In response to these incidents, Japan’s sixteen recognized domestic exchanges formed the JVCEA.
Since its formation, the JVCEA has worked to release and tighten rules within the industry. Its formal recognition by the FSA deems it a “certified fund settlement business association,” with the power to establish standard operating procedures for digital currency exchanges, and levy sanctions on noncompliant participants. Despite this recent recognition, however, the JVCEA has seen some growing pains. For example, in June, two vice-presidents resigned after their exchanges received FSA regulatory warnings.[iv] There are also signs that other Japanese regulators will try and keep cryptocurrencies on a tight leash. In a lecture given on 21 October 2018, the vice-president of the Bank of Japan stressed that “careful consideration needs to be given to the potential effect [of cryptocurrencies] on financial stability and financial intermediation” and that there were “pretty high hurdles to clear before they would be widely used as a means of payment.”[v] But the latest authorization by the FSA is an indication of regulatory faith in the organization, and delegation of primary regulatory authority to industry experts.
Crypto Worldwide and the U.S. Landscape
As noted above, Japan has been an early adopter in the digital asset space, and its crypto marketplace has welcomed talent fleeing other, often less friendly jurisdictions. In certain countries, regulators have been overtly hostile to the growth of cryptocurrency, going so far as to prohibit operations. For example, in China, although development of blockchain technology is still generally encouraged, financial authorities banned sales of new cryptocurrencies through Initial Coin Offerings (ICOs) and effectively prohibited domestic bitcoin-yuan trading in September 2017. The country still accounts for the majority of bitcoin creation, but its dominance in trading was a casualty of regulatory intervention. In India, in September, the Reserve Bank of India barred banks under its regulation from dealing in digital currency—effectively a death knell for legitimate crypto operations in that country.[vi] Other jurisdictions, such as South Korea, Russia and the UK, have been uncertain at best as to how they want to handle cryptocurrency regulations: In South Korea, for example, regulators have prioritized spending on blockchain technology but have also actively discouraged cryptocurrency exchanges and banned local ICOs.[vii] Equally, in the UK, the distinct lack of formal regulation of cryptocurrency—and its potential role in money laundering—has led the House of Commons Treasury Committee to publish a recent report calling for more robust oversight of the sector. To expedite this process, the Treasury Committee has recommended that cryptocurrency regulation be folded into existing laws governing financial services (rather than adopting a new framework). Finally, jurisdictions such as Switzerland—self-described as “the crypto-nation”[viii]—are actively taking steps to ensure technology-neutral regulation that promotes the growth of the digital currency industry.
In comparison, the U.S. falls somewhere in the middle. By volume, the American crypto presence is significant; there are thousands of different digital currencies in circulation domestically, with a market cap in the billions.[ix] The appetite for cryptocurrencies has fueled a myriad of platforms built to facilitate exchanges that allow all types of consumers—retail investors, institutions, traders—to purchase, sell, and trade cryptocurrencies. Amid this proliferation, U.S. regulators have made it clear that they see cryptocurrency as posing a threat to investors,[x] especially retail investors, as many exchanges operate largely unfettered and unmonitored. While Japanese crypto-market participants saw this threat materialize in the Coincheck mishap, and formed the JVCEA to “protect the interests of users and  promote the sound development of the virtual exchange industry…”,[xi] the U.S. crypto industry has, so far, declined to implement a standardized compliance framework for exchanges. It remains unclear whether this is because the Japanese approach is untested, disfavored, or whether the U.S. market still needs time to assess the best approach to keep up with industry growth. As evidenced by a September letter from Congress asking SEC Chairman Jay Clayton for clarity on regulation,[xii] there is a strong desire for more regulatory guidance in the hopes of avoiding disruptive regulatory and/or enforcement intervention.
Will the U.S. or Other Countries Follow Japan’s Example?
Through its delegation of authority to the JVCEA, Japan continues to build and promote a framework to lure crypto industry participants and investment. Now, the question is whether the U.S. or other countries will follow suit.
Likely not in the near term. First, a clear counterpart to the JVCEA has yet to emerge in the U.S. or other countries. This is not for lack of effort; there have been many attempts to streamline regulatory oversight and coordinate efforts. For example, cryptocurrency exchange Gemini announced its partnership with Nasdaq in the spring of 2018, and in August, four major crypto exchanges formed an U.S.-based self-regulatory organization (or SRO) – the Virtual Commodity Association (VCA) working group.[xiii] Other consortiums are seeking to do the same, and the U.S. is also home to multiple non-profit organizations and burgeoning groups designed to grow technology and development in the field.[xiv] The VCA may be the closest comparable organization to the JVCEA, but in contrast to the JVCEA, which is made up of all of the recognized virtual currency exchanges in the country, the VCA is at best a representative sample. Further, the VCA is in its early stages and is just beginning to discuss best practices.
In the UK, participants have sought to introduce a level of self-regulation into the cryptocurrency market. CryptoUK was established in February 2018 as the UK’s first crypto-relevant SRO, introducing a code of conduct and set of best practices for the sector. However, the codes and practices are voluntary, which has led some to criticize CryptoUK for lacking the necessary authority to hold the UK cryptocurrency industry accountable. And even in Switzerland, a haven for cryptocurrency development, the dominant Crypto Valley Association is a non-profit, not a SRO.
Second, Japan’s willingness to delegate powers to the JVCEA was rooted in a level of trust in industry participants, with one unnamed FSA official widely quoted as saying that industry experts were better suited to make these rules than bureaucrats.[xv] But as of now, U.S. regulators have repeatedly demonstrated their intent to regulate the industry. In fact, a host of domestic regulators—the Securities and Exchange Commission, the Commodities Futures Trading Commission, the National Futures Association, the Financial Crimes Enforcement Network, the Treasury Department, the Internal Revenue Service, and state regulators such as the New York Department of Financial Services—have weighed in on digital currency, by either offering guidance or filing enforcement actions.
As cryptocurrency continues to find its way into the everyday vernacular, more and more participants in various jurisdictions are driving the expansion of the industry. But as 2017 brought an explosion of interest and investment, 2018 and 2019 promise to bring vigorous regulatory scrutiny. This reckoning has taken many forms; caution, confusion, prohibition, advancement, and, in Japan’s case, delegation of regulation to industry experts.
[i]Quite apart from the move towards self-regulation, established technology majors in the Japanese market—such as LINE and Yahoo! Japan—are looking to establish themselves in the cryptocurrency field and leverage their market standing to plug a potential credibility gap caused by several instances of digital currency theft in Japan.
[iii]In addition to the high-profile Coincheck heist, Japan has had two other major digital currency thefts. In early 2014, the Japanese-based Mt. Gox, once the largest bitcoin exchange in the world, lost about 850,000 bitcoins (6% of all bitcoin in existence at the time). Although 200,000 bitcoins were later “found,” the rest were never recovered and the exchange shut down shortly after the incident. In September 2018, hackers stole about $60 million worth of bitcoin, bitcoin cash, and MonaCoin from Japanese-based crypto exchange Zaif.
[iv] See https://cointelegraph.com/news/japan-vps-of-crypto-self-regulatory-body-quit-after-receiving-exchange-compliance-orders
[v] https://www.asahi.com/articles/ASLBN6X6BLBNULFA00P.html (text is in Japanese)
[vi] On October 24, India’s first Bitcoin ATM was seized.
[vii] The South Korean government has earmarked billions for the tech sector, and has indicated that the budget will be partially invested in developments in blockchain. See https://www.forbes.com/sites/yoavvilner/2018/08/23/south-korea-is-cementing-its-place-as-a-global-blockchain-leader/#3abcd7d89bc7.
[viii] https://www.ft.com/content/737b9634-1303-11e8-8cb6-b9ccc4c4dbbb. See also https://www.reuters.com/article/us-cryptocurrencies-banking-switzerland/switzerland-seeks-to-regain-cryptocurrency-crown-idUSKBN1K91AY
[ix] For a list of coins by market capitalization, see https://coinmarketcap.com/coins/
[x]See, e.g. SEC: “A number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.” https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11. See also CFTC: Customer Advisory: Understand the Risks of Virtual Currency Trading. https://www.cftc.gov/sites/default/files/idc/groups/public/@customerprotection/documents/file/customeradvisory_urvct121517.pdf. See also New York Attorney General: Virtual Markets Integrity Initiative Report. https://ag.ny.gov/sites/default/files/vmii_report.pdf?mod=article_inline
[xiv]E.g. U.S. Blockchain Association, Nevada Blockchain Association, United States Blockchain & Cryptocurrency Association, Digital Chamber of Commerce.