Regulation of Cryptocurrency: Japan

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Since April 2017, cryptocurrency exchange businesses operating in Japan have been regulated by the Payment Services Act.  Cryptocurrency exchange businesses must be registered, keep records, take security measures, and take measures to protect customers, among other things. Cryptocurrency exchanges are also subject to money laundering regulations.

I. Background

After Mt. Gox, then one of biggest bitcoin exchanges, alleged the theft of around 850,000 bitcoins that it was holding for itself and on behalf of its customers and claimed insolvency in 2014,[1] the Japanese government started to develop new regulations for cryptocurrencies.  A study group and a working group on “sophistication of payment and settlement operations” were established in the Financial Services Agency (FSA) in 2014 and 2015.[2]  The working group’s final report recommended

• the introduction of a registration system for cryptocurrency exchange businesses,
• making cryptocurrency transactions subject to money laundering regulations, and
• the introduction of a system to protect cryptocurrency users.[3]

The report was submitted to the Financial Council of the FSA.  Later, the government submitted a bill to amend the Payment Services Act, among other things, to the Diet (Japan’s parliament),[4] and the Act was amended in 2016.[5]  The amendments took effect on April 1, 2017.[6] 

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II. Registration of Cryptocurrency Exchange Business

The Payment Services Act defines “cryptocurrency”[7] as

• property value that can be used as payment for the purchase or rental of goods or provision of services by unspecified persons, that can be purchased from or sold to unspecified persons, and that is transferable via an electronic data processing system; or
• property value that can be mutually exchangeable for the above property value with unspecified persons and is transferable via an electronic data processing system.[8]

The Act also states that cryptocurrency is limited to property values that are stored electronically on electronic devices; currency and currency-denominated assets are excluded.[9]

Under the Payment Services Act, only business operators registered with a competent local Finance Bureau are allowed to operate cryptocurrency exchange business.[10]  The operator must be a stock company or a “foreign cryptocurrency exchange business” that is a company, has a representative who is resident in Japan, and an office in Japan.[11]  A “foreign cryptocurrency exchange business” means a cryptocurrency exchange service provider that is registered with a foreign government in the foreign country under a law that provides equivalent registration system to the system under the Japanese Payment Services Act.[12]  Documents that show its system for properly conducting a cryptocurrency exchange business must be attached to the registration application.[13]  The competent Finance Bureau examines the application; if it reject the registration it must notify the applicant of the reasons.[14]

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III.  Regulation of Cryptocurrency Exchange Businesses

The Act requires cryptocurrency exchanges businesses to establish security systems to protect the business information they hold.[15]  When such a business entrusts part of its operations to a contractor, it must take measures to ensure that business is appropriately conducted.[16]  The Act also requires cryptocurrency exchange businesses to provide information regarding fees and other contract terms to their customers.[17]  Cryptocurrency exchange businesses must separately manage customers’ money or cryptocurrency apart from their own. The state of such management must be reviewed by certified public accountants or accounting firms.[18]  The exchange business must have a contract with a designated dispute resolution center with expertise in cryptocurrency exchanges if such a designated center exists.  If not, it must establish its own system to deal with complaints from customers.[19]  It appears that there is no designated cryptocurrency dispute resolution center at present.

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IV. Supervision

Cryptocurrency exchange businesses must keep accounting records of cryptocurrency transactions[20] and submit annual reports on business to the Financial Services Agency (FSA).[21]

The FSA is authorized to order exchange businesses to submit reports and reference materials and to dispatch its officials to inspect the offices of an exchange business where necessary to secure the exchange business’s proper conduct.[22]  The FSA may issue orders to such businesses to improve their practices.[23]  The FSA may rescind registration of a cryptocurrency exchange business or suspend its business for up to six months in cases where

• the exchange business no longer meets one or more of the requirements for registration,
• the FSA discovers that the exchange business applied for registration illegally, or
• the exchange business violates the Payment Services Act or orders based on the Act.[24]

On January 26, 2018, Coincheck, one of Japan’s biggest cryptocurrency exchange businesses, lost about $400 million in NEM (cryptocurrency) tokens.  The local Finance Bureau ordered Coincheck to submit a report on the same day, examined it and issued an order of business improvement on January 29, 2018.[25] The following day the FSA requested all cryptocurrency exchange businesses to review their system-risk management plans and report the results to the FSA.[26]  On March 2, 2018, the FSA conducted an on-site inspection of Coincheck.  On March 8, 2018, local Finance Bureaus issued business-improvement orders to seven exchange businesses,[27] again including Coincheck.[28]  Two of the seven were ordered to suspend business for a specified period.[29]

A group of cryptocurrency exchange businesses publicized their decision to form new self-regulating body on March 2, 2018.  All registered exchange businesses will join it.[30]  They aim to obtain authorization from the FSA under the Payment Services Act.[31]

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V.  Money Laundering Regulation

When the Payment Services Act was amended in 2016, the Act on Prevention of Transfer of Criminal Proceeds[32] was amended by the same bill.[33]  The amended Act added cryptocurrency exchange businesses to the list of entities subject to money laundering regulations.[34] The cryptocurrency exchange businesses are obligated to check the identities of customers who open accounts, keep transaction records, and notify authorities when a suspicious transaction is identified.[35]

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VI.  Possible ICO Regulation

The regulations under the current Payment Services Act do not cover initial coin offerings (ICOs).  The FSA established a new study group on cryptocurrency exchange businesses in March 2018.  The study group will discuss the regulation of ICOs, among other things.[36]  The first meeting was held on April 10, 2018.[37]  Meanwhile, a private study group comprised of Japan’s three mega-banks and big security companies released their recommendations, consisting of seven basic rules and two guidelines, on April 5, 2018.  One of the group members commented that he hopes the recommendations will facilitate discussion of new regulations for ICOs.[38]

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VII.  Taxation

According to the National Tax Agency (NTA), the profit earned by sales of cryptocurrency is, in principle, considered miscellaneous income,[39] rather than capital gains,[40] under the Income Tax Act.  The NTA compiled questions and answers regarding the tax treatment of cryptocurrency and posted it online on December 1, 2017.[41]  Miscellaneous income is added to the amount of other income, excluding specified capital gains,[42] when a person’s taxable income is calculated and taxed.[43]

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Prepared by Sayuri Umeda
Foreign Law Specialist
June 2018

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