Regulation of Cryptocurrency and Initial Coin Offerings (ICOs) in Japan
Japan was the world’s largest Bitcoin market accounting for over 61% of global trades as of December 2017, twice the trading volume of the United States . Japan recognised cryptocurrencies as a legal payment method in April 2017 when the Payment Services Act (the PSA) was amended. Virtual currencies are treated as assets which can constitute means of payment rather than as legal currencies.
The PSA also gave the Japan Financial Services Authority (the FSA) the ability to license and regulate cryptocurrency exchanges in Japan. Cryptocurrency exchanges are subject to money laundering regulations and are required to check customer identity when accounts are opened, maintain transaction records and notify authorities of suspicious transactions.
In May 2018, it was reported  that the FSA is considering imposing more stringent review standards for registered exchange operators. This comes in response to the hack of Tokyo cryptocurrency exchange, Coincheck, in late January 2018 which saw almost $500 million in digital tokens stolen . The proposals involve regulating cryptocurrency exchanges under the Financial Instruments and Exchange Act (FIEA) rather than the Payment Services Act which would oblige exchanges to manage customer funds separately from corporate assets and generally provides more robust investor protection including rules on insider trading. If implemented, the proposals would classify cryptocurrencies as a “financial product”. New restrictions would also be imposed on the kinds of cryptocurrencies that will be allowed on government-registered exchange operators. For example, highly anonymous cryptocurrencies will most likely not be allowed.
If introduced, the new framework will apply to existing operators as well as new applicants.
The FSA issued a statement on ICOs  on 27 October 2017 warning of the risks of fraud and price volatility and outlining the possible regulatory treatment of ICOs. In summary, depending on how an ICO is structured, it may fall within the scope of the Payment Services Act and/or the Financial Instruments and Exchange Act. Thus:
- Where a coin issued in an ICO is a virtual currency under the PSA, any business which provides exchange services for virtual currencies on a regular basis must be registered with the Local Finance Bureau; and
- An ICO which has the characteristics of an investment and “the purchase of a token by a virtual currency is practically deemed equivalent to that of legal tender”, the ICO will be subject to the Financial Instruments and Exchange Act.
On 4 April 2018, Tama University’s ICO Business Research Group, which is backed by the Japanese government, published a report proposing to regulate ICOs in Japan  (the “Tama Report”) as a means to establish ICOs as a sustainable financing method. The report proposes regulation covering all stages of ICO issuance and financing, including both preliminary activities – that is private sales of tokens as well as the public sale. The report identifies three principal types of ICOs:
- Venture Company type – i.e. tokens are issued by small venture companies that find it difficult to access the main capital market or obtain venture capital. Buyers tend to be investors seeking a higher return than is available on conventional equities and are willing to take a higher degree of risk.
- Ecosystem type – i.e. tokens issued by multiple collaborating companies and/or local governments to form a new market through an ecosystem, which will give rights of participation in the ecosystem on advantageous terms.
- Large company type – i.e. tokens issued by companies to raise funds for higher-risk in-house projects (e.g. development of new products). Token purchasers tend to be those who seek special offers from the issuers or want to express support for their projects.
The trading of ICO tokens in the secondary market is already regulated under Japan’s Payment Services Act (discussed above). The Tama Report thus focusses on regulation of ICO issuance and is proposing the adoption of two key principles and guidelines for ICO issue and five trading principles aimed at protecting purchasers of tokens.
I. Proposed Principles for ICO Issuance
- Issuance principle 1 – Issuers should define and disclose:
- conditions for the provision of conveniences such as services and
- rules on the distribution of procured funds, profits, and residual assets to token purchasers, shareholders, and debt holders;
- Issuance principle 2 – Issuers should define and disclose a means for tracking the progress of white papers. The rationale for the principle is that token purchasers need to be able to ascertain the progress of the plans described in the white paper. The Tama Report notes that the information disclosed need not necessarily be financial statements. The report further emphasizes the need for transparency around white papers including provision for their revision and making a revision history available to token holders.
II. Proposed Guidelines for ICO Issuance
- Guideline 1 – ICOs should be designed to be acceptable to existing shareholders and debt holders. The intention behind the proposed guidelines it that ICOs should not be used as a means to bring advantage or disadvantage to specific stakeholders.
- Guideline 2 – ICOs should not provide a loophole in existing financing methods. The report notes that ICO use should not be allowed to avoid financial laws.
III. Proposed Principles for Investor Protection around Token Purchase and Sale
5 principles are proposed to protect purchasers of ICO tokens.
- Trading Principle 1 – Token sellers would need to confirm the identity (KYC) and suitability of customers.
- Trading Principle 2 – Administrative companies supporting token issuance should confirm issuers’ KYC.
- Trading Principle 3 – Cryptocurrency exchanges should establish and adopt an industry-wide minimum standard for token listing.
- Trading Principle 4 – After listing, insider trading and other unfair trade practices should be restricted.
- Trading Principle 5 – All parties involved in the trading of tokens including issuers, trading exchanges and administrative companies should take measures to ensure cyber security.
Bloomberg reports that the Financial Services Agency of Japan will consider the guidelines outlined in the report in late April 2018, but that implementation could take a few years.
Note: The above represents Charltons’ current understanding of the regulation of ICOs in different jurisdictions. Charltons advises only on Hong Kong law and while the above represents our understanding of the legal position in certain other jurisdictions, legal advice from qualified lawyers in the relevant jurisdictions should be sought in relation to any particular transaction or situation. Further, this note is intended for educational purposes and it does not constitute Hong Kong legal advice. Specific advice must be sought in relation to any particular situation.
- Japan Times. “Cryptocurrency’s worrying boom”. 26 December 2017. <https://www.japantimes.co.jp/opinion/2017/12/26/editorials/cryptocurrencys-worrying- boom/#.WmVd8ryWZhE>
- <https://asia.nikkei.com/Spotlight/Bitcoin-evolution/Japan-fleshes-out-crypto-market-rules-to-prevent- Coincheck-2.0>
- Japan FSA. “Initial Coin Offerings (ICOs) – User and business operator warning about the risks of ICOs”. 27 October 2017. <http://www.fsa.go.jp/policy/virtual_currency/07.pdf>.
- Bloomberg. “Japan Unveils Guidelines for Allowing Initial Coin Offerings”. 5 April 2018 <https://www.bloomberg.com/news/articles/2018-04-05/japan-plans-first-step-toward-legalizing-initial-coin-offerings>